The other day, I got another subscriber question that’s worth diving into a little further here.
“Was there another time that financial assets were the inflation hedge but real assets like commodities were not?”
Commodities are generally considered a good inflation hedge for a few reasons. First and foremost is the fact that commodities go into just about every physical thing that would be used in the calculation for inflation. Commodity prices don’t directly show up in the calculation of the CPI index, but their influence is everywhere.
Here’s a snapshot of how inflation is calculated in the United States.
What goes into housing? Lumber, steel, copper and other materials. Transportation? Industrial metals, oil and rubber. Food & beverages? Corn, wheat, soybeans, etc.
If the prices of these items are rising, it makes sense that the components that go into their production are going up as well. If you add exposure to these commodities in your portfolio, either through futures contracts, an investment fund or by some other means, it should, in theory, protect you to some degree from inflation.
The other reason why commodities can work as an inflation hedge is because their prices can respond in real time. Geopolitical events are a good example of how commodity prices can change very quickly. If an oil field in Saudi Arabia is bombed or goes offline, it’s not uncommon to see crude oil prices rise by 5% or more that same day. The same could be said of a natural disaster, such as a hurricane in the Gulf of Mexico. It could take weeks or months for the impact of commodity prices changes to move through the production chain or into the economic data. Commodities ownership can protect your portfolio ahead of when the impact might be felt later.
Obviously, this hedge won’t work in every situation. There are any number of factors that can impact the effectiveness of commodities. Supply or demand shocks might cloud the picture. Events on the other side of the world might not quickly translate into what happens in the United States. Gold, historically, has nearly zero correlation with the S&P 500, so it may or may not work as a hedge even under normal conditions.
Commodities Have Correlated With Inflation Pretty Well
While the broad basket of commodities will have its hits and misses, it historically has done a good job of moving with inflation trends.
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