An inflation hedge is an asset that protects investors against unexpected inflation. A number of assets are traditionally considered good hedges against hyperinflation. With inflation steadily picking up around the world, a common question among investors in recent years has been “how do I hedge against inflation?
On this page we discuss why gold is a good hedge against inflation, why real estate is a hedge against inflation, and how TIPS are the best hedge hedge against unexpected inflation.
What is a good hedge against inflation?
First, we discuss the traditional ways to hedge against inflation. These include commodities, gold and silver and real estate. First, let’s consider commodities. The prices of commodities, especially those that are used as inputs for other goods, are quite flexible and will quickly adjust to increasing prices. This implies that commodity prices will quickly reflect increases in prices. Of course, physically holding commodities is quite difficult, because of storage costs and the fact that most commodities take a lot of room. That is where precious metals come into play. Gold is a rare commodity that is also a very durable material. As a consequence, gold can easily be stored and is quite precious because it is so rare. This explains why gold is considered a perfect store of value.
Is silver a good hedge against inflation? Yes and no. Yes, it will also keep it’s value. Unfortunately, silver is more common so you have to buy more and thus need to store a lot more. Another problem with silver is that it oxidises. This is different from gold, which does not oxidise.
Third, there is real estate. Real estate is a real good and thus should maintain its value. Also, people have to live somewhere, so real estate is a good for which there will always be demand. Third, real estate generates income. This is different from gold and silver, which do not generate income.
What is the best inflation hedge?
Above we discussed gold, silver, and property as as hedges against inflation. But what is the best hedge against inflation? In fact, neither gold nor real estate will guarantee that you wealth will not be impacted from inflation.
While both are good hedges in the long run, in the short run they may not protect your wealth perfectly. That is where TIPS come in, Treasury Inflation Protected Securities. TIPS guarantee an interest rate that fully compensates for inflation as measured by the consumer price index (CPI). As such, you are guaranteed that your money will maintain its value. This makes TIPS the best inflation hedge out there.
How to hedge against hyperinflation?
Hyperinflation is a situation where inflation is no longer under control. When hyperinflation occurs, people lose all trust in paper money. In that case, any real asset is better than paper money. Recent cases of hyperinflation include Zimbabwe in 2008 and Venezuela in 2018. Probably the best hyperinflation hedge will be any strong foreign currency (such as the EUR or USD) as well as gold. Real estate will also maintain its value. Rental income, however, is unattractive in a hyperinflation situation, because the paper money tenants pay will lose it value quickly. A solution could be is to require rent to be paid out in a foreign currency such as EUR or USD.
We discussed what is a good hedge against inflation. While most people think of gold, real estate and certain kinds of bonds (i.e. TIPS) are also very good inflation hedges. The best hedge against inflation as measured by CPI are TIPS, because they are guaranteed by the US government.