Don't Get Burned if Prices Ignite

From TIPs to ETFs, hedges come in more flavors than they did when inflation last broke out

Are we seeing shades of the 1970s when it comes to inflation, the scourge of savers? While economic forecasters disagree about the outlook, the similarities between now and that inflationary decade are striking. Now as then, oil prices are at nosebleed levels, food prices are spiraling higher, the dollar is weak, and the price of gold is soaring. It's easy to imagine a scenario where consumer price inflation picks up sharply from its current 4.3% pace.

If that's the case, how can you protect a portfolio from a depreciating currency or, better yet, profit from it? In the '70s the answer was hard assets: residential real estate, farmland, art, commodities, and gold. Problem is, many of these assets have enjoyed significant price hikes in recent years even in the absence of much inflation. For instance, home prices jumped by a real 44% from 1995 to 2005—and now they're swooning. In other markets, such as collectibles, well-heeled private equity financiers and flush overseas merchants have pushed prices into eye-popping territory. The boom in emerging markets has driven strong gains in commodities.

The degree of appreciation, if it's sustained, will depend on whether inflation moves to, say, 5%, or heads even higher, perhaps into the 6%-to-9% range. Nevertheless, "if you're going to have an inflation problem, gold, commodities, and other assets like that will go up in price even more," says James W. Paulson, chief investment officer at Wells Capital Management (WFC).

Take gold, a traditional hedge against inflation and political upheaval. The metal traded as low as $276.50 an ounce in 2001. On Nov. 8, however, it nearly hit its 1980 all-time high of $850, although it has backed off to about $793. David Darst, chief investment strategist at Morgan Stanley' (MS)s Global Wealth Management Group, doesn't think gold's run is over. "If you get a step up to 5% to 7% in inflation, it isn't hard to believe gold could reach $2,250, its 1980s peak price adjusted for inflation."

What's different from the '70s is that you have more ways to protect against inflation. Even a vehicle as mundane as a money-market mutual fund was relatively new back then. Today's money funds won't get you ahead of inflation, but they will keep pace. The streetTracks Gold Shares Trust (GLD) is an exchange-traded fund good for betting on the future of metals prices. A number of ETFs will appreciate if the dollar continues its downward slide, such as Rydex Investments' (RYNVX) currency funds in the euro, the British pound, and the Mexican peso.

Perhaps the best hedge dates back only to 1997: Treasury Inflation-Indexed Securities. Better known as TIPS, these creditworthy securities guarantee investors a real return by adjusting the principal and coupon payments for inflation. Right now investors will do better owning 10-year TIPS vs. a traditional 10-year Treasury bond if inflation exceeds an annual rate of 2.3% over the next 10 years. "We have more TIPS than traditional bonds in our portfolios," says Jonathan T. Guyton, a certified financial planner at Cornerstone Wealth Advisors in Edina, Minn.

The fear of inflation has never gone away. It just waxes and wanes depending on the economic and political environment. Investors, however, have more—and better—ways to safeguard their money than during the last great spike in inflation over 30 years ago. At least that's progress.

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