How to Hedge Inflation
Have you ever noticed that, as time goes by, your money doesn’t seem to go as far? You are not imagining it, ten pounds today does not buy you the same amount as it would have 20 years ago. This is due to inflation, which measures the rate at which prices increase over a period a time.
As prices increase, money loses its purchasing power, which is why many investors attempt to hedge against inflation. But what is inflation hedging? And what is the best inflation hedge? In this article, we will look at these questions as well as demonstrate how to hedge inflation.
Table of Contents
What Is Inflation Hedging?
Hedging is a method used in the financial markets in order to mitigate risk. This is typically done by opening an opposing position in the market in order to offset any loss incurred in the main position.
A simple way to think of hedging is as an insurance policy, which some investors choose to take out in order to protect themselves against an adverse market movement.
Inflation hedging involves protecting your capital against inflation’s devaluing effect. Therefore, in order to successfully hedge against inflation, investors need to find assets the value which will rise in tandem with, or at a faster rate than, inflation.
Why Hedging Inflation Is Important
When inflation is lower than, or the same value as, interest rates, inflation does not pose a significant danger to savers. When this is the case, the rate at which your savings are losing value due to inflation is being offset by the interest you are earning for storing your money in the bank.
However, problems arise when inflation begins to outstrip interest rates. When this happens, money which is sitting in the bank is losing purchasing power with every day that passes. Unfortunately, this is a situation that many countries around the world find themselves in.
Therefore, now, more than ever, it is important for investors to understand how to hedge against inflation. So, how can you protect your savings against inflation?
4 of the Best Inflation Hedges
In the following sections, we will introduce what are typically considered some of the best inflation hedges.
Commodities
Commodities are one such asset class which can potentially be used as an inflation hedge. Commodities are the building blocks for other goods and services, so it follows that when these goods and services rise in price, the price of the commodities used to produce them will also rise.
Naturally, for logistical reasons such as storage, it is impractical for investors to hedge inflation by purchasing physical commodities. This is why financial derivative products, such as Contracts For Difference (CFDs), can be a useful tool for investors looking to hedge against inflation with commodities.
However, investors considering using commodities as an inflation hedge will need to consider the fact that commodity prices can be very volatile. Due to the fact that commodities can generally only be produced in certain parts of the world, their prices are very sensitive to factors such as geopolitical events and weather.
Gold
There is one particular commodity which is considered by some to be the best hedge against inflation. Gold.
Gold is considered to be a safe-haven asset – which means that during periods of economic turmoil or periods of high inflation, many flock to this precious metal, increasing demand and pushing up price.
Whilst gold is considered by many to offer protection against inflation, and there may be some statistics out there which support this view, it is far from the most reliable inflation hedge. We don’t have to travel too far back in time to observe evidence of this unreliability.
Despite inflation reaching its highest levels in decades during 2022, gold prices actually spent much of the year in decline, falling around 20% between March and November.
Subsequently, gold prices went on a rally, which saw the precious metal recoup the vast majority of its losses. However, this rally actually coincided with cooling inflation in many economies.
Together with gold, other precious metals such as silver and platinum are also considered by some as good inflation hedge assets.
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Property
The property market has historically proven to be a reliable way to hedge inflation. In periods of increased inflation, not only do property prices tend to rise, but so too does the rent which landlords charge their tenants.
Investing in physical property does require a substantial minimum investment, however, there are alternatives available for investors such as Real Estate Investment Trusts (REITs) and property ETFs (Exchange-Traded Funds).
REITs are publicly traded companies which pool investor money in order to purchase income generating properties, such as apartment or office buildings. Furthermore, REITs are obliged to pay out 90% of their taxable income as dividends, which makes them an attractive option for income investing as well.
Stocks
A well-diversified portfolio of stocks is often viewed as one of the best hedges against inflation over the long-term. However, not all stocks perform well during periods of high inflation. In order to effectively hedge against inflation, you need to identify stocks which provide a higher rate of return than the rate of inflation.
Certain stocks in certain industries can achieve this. One option would be to buy shares in companies which are engaged in the industries we have looked at already in this article. For example, with respect to gold and other commodities, you could look at the possibility of buying shares in mining companies.
Other stocks to look for in order to hedge against inflation are those which are able to weather economic turmoil without losing demand for their goods or services. For example, companies which provide consumer staples – everyday goods which people need – fit this bill. Consumer staple products tend to have inelastic demand – meaning that consumers will keep purchasing them regardless of their financial situation.
Some examples of companies which produce staple goods are Unilever, British American Tobacco, Diageo and Coca-Cola.
How to Hedge Against Inflation
You will be pleased to know that, with Admirals, you can hedge against inflation using all the methods which we have examined in this article!
A Trade.MT5 account allows traders to trade CFDs on a range of commodities, including gold, whilst an Invest.MT5 account allows investors to purchase shares in over 4,500 companies and more than 200 ETFs around the world! Click the banner below to register for an Invest.MT5 account today:
Hedging Against Inflation FAQ
What Is a Common Hedge Against Inflation?
Assets commonly used to hedge against inflation include gold, other commodities, property and stocks.
Why Is Gold a Hedge Against Inflation?
Gold is considered by many to be a hedge against inflation due to the fact it has proven to be a store of value for thousands of years. Furthermore, during periods of inflationary pressure, many investors buy gold in an attempt to preserve their purchasing power, which can cause prices to increase. However, the reality is that gold has mixed results when it comes inflation hedging.
Why Is Real Estate an Inflation Hedge?
Real estate is considered by many to be an effective hedge against inflation because property prices tend to rise in times of inflationary pressure.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
