Even Federal Reserve Chair Jerome Powell is no longer calling inflation transitory. In fact, he has made a sort of mea culpa on that statement, noting its inappropriate use in Federal Reserve statements.
"Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation," Powell said in prepared remarks on Wednesday. "These problems have been larger and longer lasting than anticipated, exacerbated by waves of the virus. As a result, overall inflation is running well above our 2 percent longer-run goal and will likely continue to do so well into next year."
As such, investors will need to contend with an inflation environment that is likely to last longer than initially anticipated. This, in turn, necessitates an allocation in one's portfolio that can hedge against both inflation and the anticipation of a more hawkish turn from the Fed should the phenomenon persist.
Yet, the debate on what is the best asset class or investment available to do so is far from settled. With experts advocating everything from gold to real estate to cryptocurrencies, an examination of the evidence is certainly in order.
Causation, Crypto and Correlation
Before a debate can even be opened about the response to inflationary pressures, there must be some agreement on a root cause.
For monetarists following the lead of famed University of Chicago economist Milton Friedman, the current inflationary environment is one of the Federal Reserve's own creation. As he famously declared, "inflation is always and everywhere a monetary phenomenon."
Indeed, a popular conjecture at the moment is that the Fed's years of easy money policies are helping to drive inflation. Perhaps chief among those calling Federal Reserve policy reckless are the proponents of cryptocurrencies.
"The widely held belief in the crypto community is that given bitcoin's deflationary nature, it will serve as a hedge against inflation," Josh Goodbody, COO of digital asset infrastructure provider Qredo, told Real Money. "It isn't a magical bullet, but over a longer time frame it has, and will perform consistently, year on year."
While the abundant optimism on future prospects are characteristic of investors in cryptocurrencies, it is not reflected in recent price movements of major cryptos like bitcoin. Instead, as inflationary fears have ramped up in the past month, bitcoin has tumbled into a bear market, trading about $20,000 below its early-fall peak.
One must wonder, then, about the correlation with inflation and if its purported use as a hedge has much to do with highly volatile swings in price.
Whether cryptocurrencies are a good investment or not is ultimately up to an individual investor, given the highly speculative nature of these investments. Still, the inflation angle seems a tenuous one to prompt a bet on bitcoin, ethereum, or other major currencies given the lack of data supporting correlation.
Going for the Gold?
On the opposite end of more future-focused cryptocurrency investors are those advocating gold as the tried and true method to protect one's portfolio from being eroded by inflation. In fact, it is just this historical track record that Juan Carlos Artigas, Executive Director and Head of Research at World Gold Council, honed in on as a key impetus for investment.
"Many currencies are under pressure, which means that both consumers and investors are losing purchasing power," he told Real Money. "These investors and consumers are likely to prefer an asset that is well tested as a hedge against inflation."
Artigas also pointed to the institutional support for gold, citing research from his organization that suggests greater demand as well as a lack of overlap in the crypto investors. As such, he suggested the large institutions, not to mention numerous central banks, are likely to provide far more support for gold than digital assets.
He added that gold's traditional role as a long-tested inflationary hedge is only aided by its use cases in not only jewelry, but in technology and even as a viable ESG investment for investors concerned on both inflation and environmental impact.
However, investment in gold comes with just as many question marks as cryptocurrencies in the most important department: effectiveness. In fact, commodities in general have raised eyebrows in recent decades as their perception as effective inflation hedges have not measured up to reality for quite some time. Especially in recent history, gold and other commodities like oil and gas have lagged broader equity returns significantly, even in inflationary periods.
"Using commodities to hedge inflation and diversify equities exposure is akin to investing in a high-premium insurance policy: While you may eventually file a claim, the long-term premiums will likely dwarf the payout," Bryan Armour, Director of Passive Strategies Research at Morningstar recently wrote. "Commodities may be useful as a tactical asset class in the face of inflationary pressure, but this strategy invokes the harsh reality of market-timing, where it's often too late to capture the gains once you recognize the opportunity...Investors can find better options for managing inflation risk."
Berkshire Hathaway (BRK.A) (BRK.B) Executive Vice Chairman Charlie Munger had a more coarse way of putting it at a Berkshire shareholder meeting about a decade ago.
"Gold is a great thing to sew into your garments if you're a Jewish family in Vienna in 1939," he quipped in his typical acerbic fashion. "But I think civilized people don't buy gold, they invest in productive businesses."
Pivoting on the Pandemic
So if not crypto, gold, or commodities, where can investors find shelter amidst a potential storm of inflation?
"The most obvious hedge against inflation is in the bond market in the form of inflation-linked bonds (TIPS in the U.S.)," Christopher Iggo, Chief Investment Officer at AXA Investment Managers, advised. "If inflation averages three percent for a five-year period, the bond holder would see the price of the bond go up by three percent per year and would receive a coupon payment as a percentage of that inflated price."
He added that short-maturity inflation linked bonds have actually delivered total returns in excess of inflation so far this year.
Another area of interest for investors might be in real estate investment trusts (REITs).
"From 1972 through 2018, we found that equity REITs outpaced stocks when interest rates were rising," Robert Johnson, a professor of finance at Creighton University, told Real Money citing his recent research. "From 1972 through 2018, equity REITs returned 9.5 percent in rising rate environments and 16.3 percent in falling rate environments."
As such, he considered REITs a truly opportune investment for investors cautious about interest rates rising in the near future. REITs like American Tower (AMT) , Crown Castle (CCI) , and Prologis (PLD) have certainly reflected this anticipated strong performance as concerns on inflation bubbled to the surface.
In the end, however, the question appears to pivot fundamentally on the question of causation. For both Fed Chief Jay Powell and AXA's Iggo, the dynamics of the current supply chain and Covid-19 crises are the crucial questions on the table.
"Today's inflation results from strong economic growth and supply-side issues that have created a global supply-demand imbalance in goods markets," Iggo explained. "That is an environment that also supports equity markets as companies are seeing strong revenue growth and that generally results in growing earnings-per-share."