Despite being born in the same decade as the rest of our analytical team, I’m known around the office as something of a cantankerous old bastard.
Harsh, I’d say. But if thinking that people should accept some responsibility for their own actions means you’re cantankerous, then I’m guilty. The solution to our financial predicament seems to be to rescue everyone who’s been spending more than they earn and living in houses they can’t afford, by printing as much money as we can and deflating the wealth of those who actually had the temerity to save (yes, that includes me). Apologies, but it riles me.
And it’s also causing me troubles from an investing perspective. As they attempt to save the world, central bank printing presses are running red hot. As well as degrading their currencies and balance sheets, I expect the logical outcome of all the hyperactivity will be inflation. It will return, and perhaps quite shockingly.
And I’m not on my own. Quite a few renowned contrarian investors (many of whom foresaw the financial meltdown of 2008) are now concerned about inflation.
Warren Buffett, in an op-ed piece in The New York Times last October, said that the ‘policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts’.
Seth Klarman, a value investor with a very impressive long-term track record, is similarly concerned. In his quarterly letter to investors in October last year, Klarman wrote: ‘The extraordinary and unpaid-for financial market bailout should add to inflationary pressures over time, especially when the economy begins to recover from the current economic downturn. Against this possibility, Baupost has built a sizable position in low-cost inflation protection for the next three to five years.’ Elsewhere, he said: ‘We think inflation could become out of control in 3 to 5 years. Yet, we might not wait for that position. Hence, perhaps early, we have a large inflation hedge.’
The original Dr Doom, Marc Faber, has been calling for the collapse of western capitalism for some years. Finally, the world is listening. More recently, in this Barron’s article, he called the US treasury market the ‘short of the century’ as a result of his inflationary views. Similarly prescient newsletter writer Jim Grant, of Grant’s Interest Rate Observer, sees the US working towards disastrous inflation and has referred to US government bonds as ‘toxic treasuries’. He’s also expecting a significant rebound in commodity prices down the track.
Of course, not everyone thinks inflation will be a problem soon. Jeremy Grantham, who warned us all about the bubble years before it burst, suggests inflation could be an issue down the track: ‘Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!’ Of course, just because inflation might not show up for a while doesn’t mean one should wait before taking out insurance.
The good news is that with most investors panicking about deflation and recession, today’s market is offering cheap long-term inflation bets precisely because the majority of investors are looking the other way. Now’s the time to start thinking about how to protect yourself against inflation, and even set up to profit from it.
Finding good hedges can be tricky, though. You can short US treasuries via short exchange traded funds as recommended by Marc Faber, such as the Pro Shares UltraShort 20+ Year Treasury, which make money when US bond yields go up. But this isn’t necessarily a low downside bet, and it introduces currency risk for an Australian investor.
Then there are traditional inflation hedges like gold, oil or timber, or a broad commodity exchange traded fund. Property is also known as an inflation hedge, although I’m convinced that Australian residential property has some more deflating to do before it starts inflating again. Perhaps farmland is the way to play it, although farms can also be tremendous capital sinkholes. At the riskier end of the spectrum, options on commodities or shares of commodity producers could be interesting.
Another possible solution is to buy shares in non-capital intensive businesses with significant pricing power. At the least, steer clear of the opposite – capital intensive businesses with limited pricing power are usually hazardous to one’s wealth, but particularly so in an inflationary environment.
Likely, the problem needs to be attacked from numerous angles. I’m still mulling over the issue. Whatever the solution, though, I’m convinced the problem demands attention now, before the rest of the world starts taking inflation seriously. I’m searching for low downside, true inflation hedges. If you know of any, be sure to let me know.
By The Intelligent Investor senior analyst Gareth Brown.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.