Hedging Against Inflation

Check out gold, commodities, and more

Think that whiff of inflation in the air may get stronger in the new year? With the effects of the fall's hurricanes receding and energy oil prices dropping, along with continued vigilance by the Fed, most prognosticators don't see a big uptick through 2006. That doesn't mean you should let down your guard on the traditional inflation hedges, such as gold and commodities. After all, a year ago, forecasters underestimated how bad inflation would be in 2005.

Commodities

FORMAT: Futures, limited partnerships, mutual funds

WHAT HAPPENED IN 2005

Rapid growth in the developing world, especially China and India, has sharply driven up the prices for copper, platinum, and other metals. The Goldman Sachs Commodities Spot Index was up nearly 42% for the year to date, as of Dec. 9.

OUTLOOK FOR 2006

Double-digit rises are expected to continue. "Investors should have hard assets in their portfolio," says New York planner Kathleen Piaggesi. Natural-resources funds offer the broadest plays, whether they buy commodities contracts or stocks in producers, and allow for a quick exit if prices overshoot demand.

Currencies

FORMAT: Cash, futures, mutual funds

WHAT HAPPENED IN 2005

The surprise of the year. Despite higher inflation in the U.S. and record budget and trade deficits, the greenback rose against the euro and the yen. That means the euro is down about 13% against the dollar and the yen 15%. The Chinese government finally relented and revalued the yuan against the dollar, but only by a little bit -- about 5%.

OUTLOOK FOR 2006

The dollar is expected to resume its long-term slide, making other currencies, particularly the euro, appealing. The Swiss franc is a good bet if you believe gold prices will climb, since the Swiss hold lots of the metal.

Energy

FORMAT: Energy company stocks, limited partnerships, futures

WHAT HAPPENED IN 2005

Oil soared to new heights and then retreated a bit, with commonly watched West Texas Intermediate crude oil climbing from an average of about $47 a barrel in January to an average of $65.59 in September. It has since slipped to about $60 a barrel now, according to the U.S. Government's Energy Information Administration.

OUTLOOK FOR 2006

Similarly sharp short-term climbs seem unlikely, barring supply disruptions. Still, pressure on oil won't abate soon, as demand continues to rise. Global growth will keep driving oil prices, so selected stocks might be worth bets.

Gold

FORMAT: Physical gold, exchange-traded funds, commodity futures

WHAT HAPPENED IN 2005

The precious yellow metal shot up from $428 in January, to $536 an ounce in December amid worries over soaring trade deficits, inflation, energy price hikes, and fears that Social Security would crumble.

OUTLOOK FOR 2006

Skepticism abounds over the sustainability of current prices, the highest in two decades. Given the runup, a pullback is a strong possibility -- and some advisers say it may be smart to make purchases if gold falls below $450. Still, don't bank on the $800-an-ounce record set 25 years ago, and keep in mind that prices fell below $300 during the 1990s.

Inflation-Indexed Securities

FORMAT: U.S. Treasury Inflation-Indexed Securities, Series I Savings Bonds, mutual funds

WHAT HAPPENED IN 2005

The rise in inflation led to higher returns. Those bonds that reset their rates in the fall got a boost from the Hurricane Katrina-induced spurt of inflation. Ten-year TIPS returned 4.5%, and the I Bonds, 6.73%.

OUTLOOK FOR 2006

With inflation expected to moderate, yields should be lower. The real yield -- what you earn over the inflation adjustment -- is less than 2%, and that's not expected to change. As inflation moderates, adjustments to I bonds will likely lower the yield. Still, the point of these securities is not to make a killing but to earn a real return on your capital.

Real Estate

FORMAT: Residential and commercial properties, real estate investment trusts

WHAT HAPPENED IN 2005

The housing bubble didn't burst, but it's definitely losing air. With prices far outrunning income growth in many markets, what else could you expect? Rising mortgage rates are cutting away at affordability, too, something even creative financing can't paper over.

OUTLOOK FOR 2006

Commercial real estate looks to be a better bet than residential, since businesses will continue to grow and their office needs must be met. One smart way to diversify risk is through real estate operating companies, or REOCs.

By Joseph Weber

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