How to invest successfully to beat inflation

Back in the 1970s the global economy suffered from a condition of 'stagflation', or stagnation of GDP plus inflation. At the present time only the US has a combination of low GDP growth and higher levels of inflation but there is a tendency for the rest of the world to follow the US in economic trends.

Inflation has a corrosive effect on corporate profits if input costs rise ahead of selling prices, and is therefore not usually good news for equities, although over time stock prices also tend to drift upwards if inflation really begins to rage.

Bonds loathe inflation because central banks have to raise interest rates in order to combat inflation and so fixed-yield bonds fall in value. Hence, inflation and a bear bond market are bed fellows.

Debt destruction

On the other hand, rising inflation can amortize debt most effectively as a debt will remain unchanged while salaries might well be increased to keep up with inflation. Thus inflation is a cure for an over indebted economy. Russia in the 1990s was an extreme example of debt destruction. Perhaps the US needs a dose now.

On the other hand, if high inflation also brings high interest rates then the attractiveness of debt is reduced. But inflation does tend to carry the prices of all assets higher, including real estate and commodities; or at least to disguise a real fall in real estate prices by sustaining nominal prices.

The most recent example of surging commodity prices is the so-called 'agrinflation' of agricultural commodities, reflected in higher prices on the supermarket shelves. But it is true that bear markets for bonds and equities are usually counterparts to bull markets in commodities, as in the 1970s.

Buying opportunity

So while a stock and bond market correction over the next few months might temporarily also depress the price of commodities then this is probably just a buying opportunity. For commodity prices are far more likely to perform well under conditions of stagflation than bonds and equities.

Gold and silver hit their highest values ever back in 1980, and could surge much higher if similar economic conditions are repeated today. Indeed, it is surely a peculiar anomaly that precious metal prices are lower now than they were 27 years ago, while monetary inflation has picked up sharply worldwide.

And once investors get the scent of an opportunity they are likely to jump on the relatively fixed supply of gold and especially silver and drive prices up again. Investment history does tend to repeat itself, and it is probably safe to assume that it will be no different this time!