On 4th January 2010 (ie. yesterday) , the S&P 500 rose 1.6%. Gold rose 2.23% to US$1120.90 and Silver rose 4.21% to US$17.61. Platinum and Paladium also rose 3.75% and 3.20% respectively. Oil rose 2.70% to US$81.51.

Inflation makes our money worth less and it makes sense for us to hedge against it. But what’s the best way to hedge against inflation?

To address this question, it’s useful to understand what causes inflation.

Simply put, inflation is caused by an expansion in money supply.

Under the fiat monetary system, governments can increase the supply of money and credit at will (aka. printing money), which is what they have done since the onslaught of the “subprime” crisis. Once the economy recovers and banks start to lend again with the expanded monetary base, the velocity of money increases, chasing after other asset classes. In addition, the prohibitively low interest rate (close to zero percent for US dollar at this moment) forces investors and speculators to get out of their short-term cash to invest in higher yielding assets (see my previous post here).

Therefore, the best way to hedge against inflation is to invest in high-yield stocks.

Another way is to buy hard assets like commodities, including agriculture commodities and industrial metals, as well as precious and semi-precious metals (eg. Gold and Silver).

The idea is to get out of cash, which the government can create out of thin air, and exchange it for some other assets.

I believe that inflationary pressure will continue to gather pace from here resulting in another asset bubble.

Related posts:

1. Super Boom In Asset Prices

– Bill Gross

I believe we’re in the early stage of a super boom in asset prices, thanks to a stabilizing economy and an expansion in money supply around the world.

China had gone shopping all over the world for resources it knows it will need as the economy recovers, as well as to diversify away from the US dollar.

I’m expecting commodity and asset prices in general to go much higher over the next decade.

The credit contraction due to the “subprime” crisis has temporarily suppressed commodity prices and caused commodity producers to delay their projects which had suddenly become unprofitable. This will lead to a supply bottleneck as the economy recovers and demand starts picking up.

The unprecedented monetary expansion around the world will inevitably lead to much higher inflation rate which will be reflected in higher asset prices.

There’s a lot of money on the sideline waiting to get out of cash and into higher-yielding assets.

As Bill Gross has highlighted in his recent commentary, there are over $4 trillion dollars in the money market funds with a yield of “close to nothing”. That’s in the US alone. Bill noted that such prohibitively low interest rate will “force or entice investors to term out their short-term cash into higher-risk bonds or stocks”.

There’s also a huge amount of private funds and sovereign wealth funds on the sideline which will be chasing after higher-yielding assets as the economy recovers.

I’m therefore fully invested, particularly in commodity-related companies including oil, mining and agriculture. My portfolio is concentrated in companies that have businesses in China, Australia and emerging markets. I am particularly excited about the growth prospects of emerging markets as well as resource-rich countries like Australia, Canada and Brazil.

Related posts:

1. The best way to hedge against inflation