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Inflation to Take Big Bite Out of Your Wallet

By Tom Hutchinson   |   Monday, 25 Jul 2011 08:47 AM

The time to prepare for inflation has come.

Skyrocketing debt and deficits, as well as the Fed's easy money policies and penchant to print paper money, have stoked fears of inflation for some time. Lately, however, inflation has transformed from likely to tangible.

Prices of commodities such as oil, gold, silver and food have dramatically increased over the past year. While most commodity prices pulled back in May amidst news of tepid economic growth, prices are on the rise again even in a slow economy.

Last year, the Fed worried that deflation in a sluggish economy was more of a risk than inflation in a strong economy. But recent strength in commodity prices indicates that inflation is likely to increase regardless of the strength of the economy. It looks like we are either in for plain old inflation or stagflation.

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Take a look at the numbers.

In just the past year gold has gone to $1,600 an ounce from $1,200 last July, silver prices have more than double in the same period as have corn prices and oil has jumped from $76 to about $100 today.

While store prices haven't taken off yet, it's only a matter of time until higher input costs come out the other end in the form of higher consumer prices. In fact it's already happening in other countries.

China's inflation rate is about 5.1 percent, Brazil's is 5.91 percent, and India has a 7.5 percent rate of inflation.

These higher inflation rates are coming our way, and given the level of monetary irresponsibility over the past several years, inflation could be severe.

Where to invest

Typically, hard assets or commodities (grains, metals, sugar, cotton, livestock and oil) maintain their value during times of inflation. For example, when the consumer price index (CPI) increased from 3 percent in May of 1972 to 11 percent in December of 1974, the S&P Goldman Sachs Commodity Index rose 222 percent.

Investors can put money directly in commodities through several ETFs.

There are also commodity oriented stock investments that not only provide investors with commodity exposure but pay an income as well.
ExxonMobil (NYSE: XOM) is the world's largest publically traded oil company. Oil prices, and XOM profits, should keep pace with inflation and then some as supply and demand factors also buoy prices. XOM has returned investors an average of 11 percent per year for the past 15 years and pays a solid dividend that has doubled over the past decade.

Monsanto (NYSE: MON) is a St. Louis-based agricultural products maker and the world's leading producer of seeds for corn, soybean, cotton, fruits, vegetables and other crops. Worldwide food demand is souring and should continue to soar as growing populations and increased industrialization necessitate a larger food supply.

MON has returned investors 17 percent per year over the past ten years compared to less than 4 percent for the S&P 500 over the same period. And, the future looks bright.

Rising interest rates generally accompany inflation as the Fed tries to contract the money supply by raising interest rates. There are a few fixed income investments that protect against rising rates.

Adjustable rate bond funds are a good way to keep pace with rising interest rates. There are two major types of adjustable rate bond funds, bank loan funds and adjustable rate mortgages. Bank loan funds invest in senior secured debt of lower credit-rated companies and adjustable rate mortgage funds invest in mortgage bonds, typically guaranteed by the federal government or its agencies. Because distributions on these funds can rise, the principle typically remains stable.

Then there are Treasury Inflation-Protected Securities (TIPS). The principal of TIPS is indexed to the consumer price index (CPI), providing investors with rising principal and interest payments during periods of inflation.

One of the easiest ways to gain exposure to TIPS is with the iShares Barclays Capital U.S. Treasury Inflation Protected Securities (NYSE: TIP).

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