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Inflation Is Coming, Sooner or Later

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If there's any worry lurking larger in the minds of investors than the risk of a double-dip recession and another market crash, it'd have to be our old friend, inflation. The I-word has been making its rounds in the media and throughout investors' psyches, stoking fear that a repeat of the runaway stagflation of the 1970s is right around the corner.

But are inflation concerns overblown? And just how effective is the arsenal of inflation-fighting tools investors have at their disposal?

Tomorrow's threat
So where are the signs of rampant inflation in our economy? Well, they're nowhere to be found right now. Right now, deflation is actually more of a risk to our economy than inflation. The Consumer Price Index's year-over-year measure of inflation turned negative several months ago, the first time that has happened in more than 50 years.

Also, the spread between intermediate-term Treasuries and inflation-protected securities of the same maturity has been hovering around the same 1.5%-to-2% range for several months now, which is actually slightly lower than the long-term average. All of these signs point to inflation being a rather dormant threat right now. There's just too much excess capacity and economic weakness in our system for meaningful inflation to take hold.

But the true alarm is being sounded about the inflation that might be hiding around the corner. It's true that a massive amount of money has been pumped into our financial system in an effort to beat back the current recession. The Fed has lowered interest rates to historically low levels. While these are the correct recession-fighting policies, they will almost inevitably trigger inflation down the road. Prices may be under control right now, but tomorrow is another story.

Not so golden
So what can investors do to proactively stave off inflation? Well, many of the traditional measures we turn to may not work quite as neatly as we would believe.

For instance, gold has traditionally been thought of as an inflation hedge. And, as might be expected, gold has been rallying as of late. Gammon Gold (NYSE: GRS  ) has more than doubled in the past year, while Freeport-McMoRan Copper & Gold (NYSE: FCX  ) has nearly tripled.

But while gold has done well in past inflationary periods, there is a good chance that much of the current gold rally is being driven by worries over a weakening U.S. dollar. If the dollar should strengthen, odds are good that gold would get knocked down, even if inflation starts to gain momentum. And even if gold does turn out to be a good inflation hedge this time around, gold has not done well as a wealth-builder over the long run. Although it has done very well in the so-called lost decade for stocks, gold has significantly trailed stock returns over longer periods of time.

TIPS are another commonly sought inflation-stopper. These bonds are indexed to inflation, so the face value of the bond rises in lockstep with the CPI. However, although the CPI is a useful inflation measure, it doesn't reflect all costs a consumer pays, and your expenses may vary considerably from what the CPI indicates. Even though TIPS won't provide a perfect inflation hedge, they're a decent option if you are a fixed-income investor and wish to preserve your purchasing power.

Fortunately, you probably already own one of the best inflation fighters around -- stocks. Over the long haul, stocks have provided inflation-beating returns. To bolster your portfolio's inflation-busting powers, consider picking up a few consumer stocks with strong market share that will have some wiggle room to raise prices. Names like Philip Morris (NYSE: PM  ) , Coca-Cola (NYSE: KO  ) , and Altria Group (NYSE: MO  ) should successfully deal with increased prices down the road.

Preparing for the worst
One veteran fund manager who is concerned about inflation is David Winters, manager of the Wintergreen Fund (WGRNX). Before leaving to start his own firm, Winters ran the Mutual Global Discovery (TEDIX) fund from 2000 to 2005, racking up 10% annual returns, compared with a 1% annualized loss for the average world stock fund.

In a recent interview, Winters noted that while pricing pressures were minimal right now, he is very concerned about future inflation, given the amount of money being printed across the globe. As a result, Winters is favoring companies that he feels will be able to retain pricing power, such as U.K.-based British American Tobacco. Closer to home, Winters is also a fan of Warren Buffett's Berkshire Hathaway (NYSE: BRK-B  ) and McDonald's (NYSE: MCD  ) .

Take a hint from David Winters and make sure you take advantage of the best tool for managing inflation now -- stocks. The inflation front may look secure now, but once prices start to pick up their pace, the optimal time for preparing your defenses will have already passed. Snap up some bargains across the globe that can thrive in an inflationary environment and you'll be on your way to snuffing out inflation before it gets a hold of your portfolio.

Still worried about your investments? Alex Dumortier is, too -- and he can show you how to protect your assets from the mother of all bubbles.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. The Fool owns shares of Berkshire Hathaway, which is a Motley Fool Stock Advisor selection. Berkshire Hathaway and Coca-Cola are Inside Value picks. Coca-Cola is an Income Investor selection and Philip Morris International is a Global Gains recommendation. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 06, 2009, at 3:14 PM, Anadultmale wrote:

    Inflation is already on us. When China was hit for unfair trade in the tire biz. The prices for your car or light truck shot up. Wait until China moves on REE (Rare Earth Element) which are used on about ever new technology. For Gold moving so high this month and some of last month, can only be short lived. Even NEWMONT Mining has open a new mine in Australia and little unknown mines are pushing as hard as possible the output to keep making money. The question is more of why is China buying 51% of an American Gold mine in Nevada called Firstgold for $15m? It must because it's so cheap and it's making gold bars as you read this. Output and production of Gold will increase for all of the mines in the world. When I'm making money and you're (employee) working hard, I'm going to push you as hard as possible.

  • Report this Comment On November 06, 2009, at 8:10 PM, xetn wrote:

    Aside from the fact that we currently are experiencing deflating in a lot of assets is because of supply and demand. But, I just have to ask, what is wrong with being able to purchase things cheaper? If you go purchase a new car, do you tell the dealer that the price is too low and you intend to pay more for it?

    What the real problem with deflating prices of many assets is that the banks are holding pieces of paper that are not worth their face value, so all banks are over-valued. And, to make matters worse, the Fed has been buying a lot of these "toxic" assets a face value, with government notes. In a sane economy, the banks would instead be writing off those bad assets or at least writing them down. Just like all companies are suppose to show a reserve for noncollectable receivables and inventory at the lesser of cost or market.

    And now we have the FDIC telling banks that what ever assets they purchase as a result of an FDIC takeover can be listed on their balance sheets at 100% value. What a concept.

    I am just curious why any one would want to invest in a bank at this time. All of their balance sheets are "overinflated".

    Anadultmale: how do you explain the increase in the price of gold after the RBI purchased of 200 tons of gold from the IMF? Do you think it might be because it took 200 tones of gold out of the market and added it to RBI's reserve? What about the amount of gold the Chinese have been purchasing in the open market for the last 5 years? Or how about the fact the the Chinese government is telling its citizens to purchase gold and silver to protect their wealth?

    Does any one think it might just be because the massive amount of fiat money the Fed has been creating since its creation in 1913 and especially in the last year? The currency that is supposed to be the world's official settlement currency.

  • Report this Comment On November 07, 2009, at 9:06 PM, jennifergmd wrote:

    The argument of deflation vs inflation was decided long ago. The Feds have decided that deflation is worse than deflation. Deflation would lead to more crushing effect of our debt. Inflation is the only way out of this mess- which will lead to a worse mess. The trillions of dollars the Fed is spending is not to "beat back" the recession. It is to cause inflation, thus preventing deflation. How is the stimulus money helping the economy? The banks are not lending the money to people who need it. They are using it to speculate and this money is driving up the stock market. Unemployment is getting worse not better. Where is the money going? Not in our hands.

  • Report this Comment On November 07, 2009, at 9:07 PM, jennifergmd wrote:

    sorry- should have read- deflation is worse than inflation

  • Report this Comment On November 07, 2009, at 9:11 PM, jennifergmd wrote:

    By the way- deflation is a bad thing for the economy. When deflation hits- no one wants to spend money because they think it will lose value or will be cheaper later. So the economy contracts because no one is buying anything. It is bad for debt- the real cost of debt increases during deflationary times. And that is our problem- most people are in debt up to their eye balls, including our government. That is why deflation would destroy us a lot sooner than inflation and why the Feds are so aggressive about fighting it. Why do you think they are going to continue the stimulus money?? More inflation...... Wake up folks, I expect better out of TMF.

  • Report this Comment On November 07, 2009, at 9:16 PM, jennifergmd wrote:

    The argument of deflation vs inflation was decided long ago. The Feds have decided that deflation is worse than deflation. Deflation would lead to more crushing effect of our debt. Inflation is the only way out of this mess- which will lead to a worse mess. The trillions of dollars the Fed is spending is not to "beat back" the recession. It is to cause inflation, thus preventing deflation. How is the stimulus money helping the economy? The banks are not lending the money to people who need it. They are using it to speculate and this money is driving up the stock market. Unemployment is getting worse not better. Where is the money going? Not in our hands.

  • Report this Comment On November 07, 2009, at 9:18 PM, jennifergmd wrote:

    You are right in that some stocks will weather the storm well. But I strongly suggest you examine the valuation levels of stocks seen during inflationary times vs. other times. They are much lower....

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Amanda Kish
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Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter.

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