Inflation Rising? Asset Classes To Consider Are Precious Metals, Real Estate & Private Market Infrastructure

Last Updated on July 23, 2021

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Inflation numbers have been very low for a long time now. For most people, except the elderly, 1970s-style inflation seems only a dry textbook sort of fact, not a real danger. 

Yet, to recall: in 1972 the inflation rate was a reasonable-seeming 3.27%. The following year it more than doubled, to 6.66. Between 1973 and’ 74 it nearly doubled again, reaching 11.3%.

It did not keep going consistently up from there, thank heavens, but there was another spike late in the decade. It got to 13.58% in 1980.  That was when new Federal Reserve chair Paul Volcker was slamming on the money-creation brakes in order to cure it. The cure worked, though at extraordinary costs in people’s lives.   

Are we headed in the same direction: a spiking of inflation that will eat away at asset values and savings, confuse people’s efforts to understand their own financial position, add asterisks to every plan or projection, and in time force very difficult policy decisions? 

What are the proper asset-portfolio adjustments? 

The inflation rate in the United States in 2020 was just 1.23%. But for the 12-month period July 2020 to June 2021, the rate was 5.39%. We’re closing in on the 1973 level. Further, yes, there is a general expectation that this will continue. But UBS takes a relatively benign view of its course. The spike is a consequence of pandemic relief and, on the assumption that the pandemic itself is receding, the bank suggests that inflation should moderate over the course of the second half of 2022.

The Assets to Look For

If you don’t take their word for it, if you want a portfolio that will protect you should this be the start of something that will continue: a common  suggestion is that investors should look to tangible assets: precious metals, real estate, and private market infrastructure.

The precious metals space has a fraught relationship with inflation. A market strategist for Sprott has said: If a high inflation scenario takes hold, gold has more positive convexity or right-tail upside than any single liquid asset.”

In a bell-style graphing of possible outcomes for an investment, the “right side” of the curve represents the best outcomes, the left side the worst. 

The price of gold began July at $1,775.70. It rose steadily through the first two weeks of the month, reaching $1,829. It has since given back some of that gain, but $1,800 has been acting as a floor for days.

Among somewhat less tangible assets, investors might consider inflation-linked bonds, and the equity of companies with pricing power. 

Bonds, Stocks, and Pricing Power

So what are safe assets? Inflation-linked bonds, as you might expect, were invented precisely for this contingency. They exist as assets because bonds with fixed nominal interest rates are a lousy buy in an inflationary environment. Accordingly, sovereign issues must be in a position to offer potential advisors something better, and this link is the solution.

Equities can suffer during inflationary periods. Indeed, the U.S. stock market was in the doldrums throughout the 1970s. The Dow Jones Industrial Average opened on January 2, 1970 at 809 points. It closed on the last trading day of December, 1979, at 839 points. That was almost no nominal gain then, and adjusting for the inflation of the period, a value loss of nearly half.   

Nonetheless, if you want to stay in stocks through the (still hypothetical) inflationary spiral to come, you ought to consider the pricing power of the issuer. Can it unilaterally increase the price of its products from $10 To $11 when that is necessary to compensate for the inflation of the costs of its raw materials and overhead? Or could it be stuck at $10 for a prolonged period, absorbing those higher input prices, given fierce competitive pressures? 

You’ll clearly prefer buying from the latter merchants, not the former. But you’ll prefer investing in the former.