Daily Gains Letter

Worried About Inflation? Profit from It Instead

By for Daily Gains Letter | Apr 9, 2013

















Dictionary Series - Economics: inflation

Central banks around the world are printing in overdrive mode. Their goal is to bring economic prosperity to their countries. For example, the Federal Reserve is printing $85.0 billon a month—buying mortgage-backed securities and government bonds. The Federal Reserve wants to improve the U.S. economy by lowering the unemployment rate.

The Japanese central bank is taking similar actions—its goal is to boost economic growth by lowering the value of its currency, the yen. Japan is an export-based country, and with higher currency value, it’s hard to sell to other currencies. Japan is in recession and the slump in its exports has been taking a heavy toll.

Regardless, what holds true is that a number of central banks printing their currency to spur growth in their respective countries is increasing. As a result of all this, many are worried these actions will trigger inflation to rise in the future—some are even calling for hyperinflation and the prices will skyrocket.

Keeping all this in mind, one question comes to mind: how does an investor actually make money with high inflation?

 

Gold and Inflation

Gold is known as one of the best hedges against inflation. The idea behind this is very simple; as central banks print money, the value of the currency declines. This phenomenon causes the value of gold to increase.

If inflation rises quickly, then gold prices will see a similar effect. Investors concerned about inflation in the future can buy gold to protect their wealth from deteriorating from rising prices.

Consider this: what $1.00 could buy in 1975, costs $4.35 now. (Source: Bureau of Labor Statistics, last accessed April 5, 2013.) A Simple calculation would show that prices have increased 335%.

In the same period, gold has risen from just above $160.00 an ounce to about $1,550 now—an increase of more than 868%. (Source: National Mining Association web site, last accessed April 5, 2013.) Look at the chart of gold prices from the last 30 years—they have appreciated substantially.

dl_0409_graph1

Chart courtesy of www.StockCharts.com

Note: the inflation number is only from the U.S. When you look at the price change from around the world and bring in the amount of fiat currency that has been printed, the rise in gold prices is justified.

On top of all this, gold is also considered to be a safe haven during times of economic uncertainty. The belief behind this is that gold has kept its value for thousands of years—before paper currencies were made. So if anything happens to the currency, gold can help investors preserve their capital.

Those who are investing for the long term must know that inflation can take a heavy toll on one’s portfolio. Investors must make sure to protect their portfolio from rising prices, which reduces their return. If inflation is running at three percent per year and an investor is only earning five percent on their investments, then their actual or real return would be only two percent, accounting for price changes. This, in turn, can cause a delay in an investor achieving his or her portfolio goal(s). Investors should focus on investing in securities that at least beat inflation over time, or their actual returns will be negative.

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