The best way to hedge against inflation

Posted by Lee Chee Keong on 05/01/2010 under Finance, Investment | Be the First to Comment

Inflationary pressure seems to be building up as evidenced by the persistent rise in prices of stocks and commodities.

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 bonds or 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