How to Hedge Against Inflation
Have you ever noticed that, as time goes by, goods seem to become increasingly expensive? You are not imagining it, it is an undeniable fact that ten pounds today does not buy you the same amount as it would have 20 years ago.
This is due to inflation, which, although may sound bad, is a perfectly normal phenomenon. In fact, a certain amount of inflation is actually desirable in a healthy, well-functioning economy. But when inflation gets out of control, it can start to put your hard-earned money at risk. This is why it is important for investors to hedge against inflation.
Table of Contents
What Is Inflation?
Inflation is the rate at which goods and services rise in price over a period of time and, consequently, the rate at which a currency loses value, or purchasing power.
Naturally a currency losing its purchasing power sounds like a terrible thing, particularly for consumers. However, most large, developed economies actually target a low, stable rate of inflation of around 2%, as it encourages a certain amount of spending over saving which, in turn, helps boost economic activity.
It is also seen as far preferable to the alternative of deflation, where prices decrease and a currency’s purchasing power increases. This, despite sounding good on the surface, can lead to an unproductive economy, as consumers are less willing to part with their money.
What Is Hedging?
Hedging is a method used in the financial markets by traders and investors in order to mitigate risk. This is typically done by opening an opposing position in the market in order to offset any loss incurred on their main position.
A simple way to think of hedging is as an insurance policy, which you might choose to take out in order to protect yourself against any adverse movements in your investments.
But what does this have to do with inflation?
When we talk about hedging against inflation, we are talking about protecting your capital against the devaluing effect which inflation has upon it. Therefore, in order to hedge against inflation, investors need assets which will not be adversely affected by rising inflation.
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Why Do I Need to Hedge Against Inflation?
When the inflation rate 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.
The problem arises when inflation begins to outstrip the interest rate, a scenario which is currently a reality in many countries around the world. When this happens, money which is sitting in the bank loses value with every day that passes.
Global interest rates have been at historic lows for more than a decade, ever since the ‘Great Recession’ of 2008, whilst inflation is beginning to creep up above the desired levels.
The causes of this recent increase in inflation are two-fold. Firstly, many central banks have been steadily increasing the supply of money in circulation throughout the coronavirus pandemic – a process known as quantitative easing – in an attempt to kick-start their economies. This has an unavoidable consequence of devaluing currency. Furthermore, as economies around the world begin to get back on track after the economic shock of the pandemic, demand is increasing at a rate faster than supply, which is pushing up prices.
In the US, for example, inflation recently exceeded 5% for the first time since 1990, whilst the interest rate remains sitting at a paltry 0.25%. Based on these figures, money currently saved in US banks is essentially losing value at a rate of around 4.75% a year.
Therefore, now, more than ever, it is important for investors to hedge against inflation. But what are the best ways to protect yourself against inflation?
How to Hedge Against Inflation
So how can an investor effectively hedge against inflation? We will now introduce some of the best inflation hedge investments.
In order to hedge against inflation, investors need to place their money in an asset whose price is rising in tandem with or, preferably, at a faster rate than inflation. Commodities are one such asset class which can be used as an inflation hedge.
During times of inflation, investing in commodities can help preserve your money's buying power. Commodities are the building blocks for other goods and services, so it follows that when these goods and services rise in price, their respective commodities will also rise in price.
Naturally, for logistical reasons such as storage, it is impractical for investors to hedge against inflation by purchasing physical commodities. This is why financial derivative products, such as Contracts For Difference (CFDs) are a useful tool for investors hoping to hedge inflation by investing in commodities.
In order to gain greater exposure to the commodity market, investors may prefer to choose a commodity Exchange-Traded Fund (ETF) such as the iShares S&P GSCI Commodity Indexed Trust ETF.
Depicted: Admirals MetaTrader 5 - iShares S&P GSCI Commodity Indexed Trust ETF (GSG) Weekly Chart. Date Range: 14 October 2018 – 25 August 2021. Date Captured: 25 August 2021. Past performance is not a reliable indicator of future results.
However, investors considering investing in commodities to hedge against inflation will want to consider the fact that commodity prices tend to 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.
There is one particular commodity, however, which is considered above all to be the best for hedging inflation.
Gold as Inflation Hedge
Forgive the pun, but when it comes to hedging against inflation, gold is viewed by many as the gold standard.
Gold is considered to be a safe-haven asset – which means that during periods of high inflation and economic uncertainty, investors traditionally flock to this precious metal, increasing demand and pushing up price.
This safe-haven quality was evident most recently during the coronavirus pandemic. Whilst many other assets plummeted in value, gold prices soared to record all-time highs. If, as anticipated, inflation continues to rise over the coming months you can expect the price of gold to also increase.
Depicted: Admirals MetaTrader 5 – Gold Weekly Chart. Date Range: 27 December 2015 – 25 August 2021. Date Captured: 25 August 2021. Past performance is not a reliable indicator of future results.
Together with gold, other precious metals such as silver and platinum are also viewed as safe-haven assets and, therefore, good investments to hedge against inflation.
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Property Inflation Hedge
The property market is historically proven to be a reliable way to hedge against 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 good alternatives available for investors such as Real Estate Investment Trusts (REITs) and property ETFs.
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.
An example of a REIT which has been performing well this year, has an attractive current dividend yield of around 2.8% and which might prove a good option for hedging against inflation in 2021 is the Tritax Big Box REIT - which focuses on investments in large logistics facilities.
Depicted: Admirals MetaTrader 5 – Tritax Big Box REIT Weekly Chart. Date Range: 6 December 2015 – 25 August 2021. Date Captured: 25 August 2021. Past performance is not a reliable indicator of future results.
Stocks as Inflation Hedge
A well-constructed portfolio of stocks is seen as a good inflation hedge over the long-term. However, not all stocks perform well during periods of high inflation. Naturally, in order to effectively hedge against inflation, you need to find stocks in companies which are experiencing 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 evaluate 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 consumer 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 provide staple goods are Unilever, British American Tobacco, Diageo and Coca-Cola.
Depicted: Admirals MetaTrader 5 – The Coca-Cola Co. Weekly Chart. Date Range: 29 November 2015 – 26 August 2021. Date Captured: 26 August 2021. Past performance is not a reliable indicator of future results.
Hedge Against Inflation With Admirals
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 and ETFs from 15 of the largest stock exchanges in the world!
In order to start hedging against inflation with Admirals, follow these steps:
- Register with Admirals
- Log in to your ‘Trader’s Room’ account
- Once inside your account, scroll down to the Live Accounts section and select ‘Open Live Account’
- You will need to provide your contact details, tax information and passport number, before confirming which type of account you wish to register for
Your application will then be reviewed by Admirals who will contact you by email in order to advise of the outcome. If your application is successful, you will also receive your account details by email.
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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.