I can’t help but think that with all the money the Government is dumping into the economy, particularly money we don’t have and must borrow or print, that our country is due for some serious inflation in the somewhat near future.  You can’t dump trillions of extra dollars into an economy and expect the value of the dollar compared to the cost of goods to stay the same.

So, in my macro-economic scope, if this is what’s coming, how can I capitalize on it?

If you believe that inflation in our country is around the corner, where can you put money to either hedge against the negative trend, or perhaps increase your return?  To answer that question, you have to understand what inflation really is in order to know where to funnel your money.

What Does Inflation Mean?

Inflation is the rate at which the general cost of goods and services compares to purchasing power for those goods and services.  For instance, if the value of the dollar goes down and the intrinsic value of, say, toilet paper stays the same, it will take more dollars to buy toilet paper with rising inflation.

There are lots of things that could devalue the almighty dollar, and directly diluting the value by printing more money is one of them.  If you put it in investment terms, it’s a bit like diluting stock by printing more shares to raise capital.

To be certain, sometimes diluting stock or currency can be a good thing so long as the return on that money is greater than the cost of borrowing the money in the first place.

So how do I hedge against inflation?

Gold.

Gold has been the time-tested and preferred hedge against inflation when markets panic and governments try to “help”.  The reason?  Gold is the universal currency that holds its own value.  Sure, it’s valued in US Dollars on the open market, but since its accepted as a form of payment around the globe, the real value of the precious metal precedes the US currency.

There are ways to buy gold without actually taking delivery of the metal itself, which is good since it’s not an attractive option to have to ship, and even more costly, store the tangible asset.  However, gold coins are always an easy way to insulate yourself and they’re small enough to store in a safety deposit box.

Another way is to buy a gold ETF like SPDR Gold Shares (GLD: chart, web, Y!).

What are other options?

You can also look at Treasury Inflation Protected Securities (TIPS).  These are typically treasury bonds that protect against inflation.  Essentially TIPS pay a fixed coupon plus a rate that rises with inflation and falls during deflation.  The portion that adjusts for inflation gives investors protection against erosion in the purchasing power of the dollar.

TIPS are indexed to the Consumer Price Index (CPI), which is released monthly and tracks prices paid by consumers for a representative basket of goods and services.
Investments like the iShares Lehman TIPS Bond Fund (TIP: chart, web, Y!) or the SPDR Barclays Capital TIPS ETF (IPE: chart, web, Y!) will fit the bill if this is the direction you want to go.  The iShares Lehman TIPS Bond Fund is by far the largest of the ETF’s, valued at over $10 billion.  It maintains a portfolio of 28 TIPS with a weighted average maturity of about nine years out.  The fund will typically pay out a monthly distribution during times of inflation, but may actually reduce or cut the distribution in times of deflation.

In either case, keep an eye on the monthly CPI data to determine where your TIPS investment is headed.

Commodities?

Another avenue to hedge inflation is to invest in commodities.  Much like gold, commodities represent the tangible asset that the devalued dollar is used to purchase.  If the value of the dollar goes down in times of inflation, chances are the intrinsic value of the tangible assets goes up.

Commodities like crude oil ($wtic: chart) and natural gas ($natgas: chart)  are good bet, as demand is still steadily increasing globally.  Funds like the U.S. Oil Fund (USO:  chart, web, Y!) seems to track the price of crude oil fairly well, although there are some fees taken out of the price structure, so it’s not a one-to-one direct comparison to crude.

Corner Office Comments

There are many other ways to hedge against inflation, like real estate or other natural resources or precious metals.  However, I still fundamentally like gold as it’s fairly simple to track, and there’s no index weighted against any government numbers that you need to be concerned about.

As I’ve mentioned before, I picked up some shares of GLD at $90/share and will continue to invest on dips in the near future.

Economics, Investing crude oil, GLD, hedge, Inflation, investment, TIPS, treasury