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Hedge Against Inflation

2010/03/24

Hedge Against Inflation
Many commodities, particularly metals and energy
related commodities, have relatively strong
positive correlation with inflation and thus may
provide a potential hedge against inflation.

During periods of high and/or increasing inflation, many commodities tend to maintain their purchasing power and value. As prices of goods and services increase, the prices of the commodities used to produce those goods and services tend to also rise. Weakening growth and accelerating inflation often cause currency depreciation. In this environment, investors often turn to real assets such as gold and other precious metals whose purchasing power is not directly dependent on the value of the currencies. In contrast, financial assets such as stocks and bonds tend to depreciate, as inflation diminishes the value of their cash flows.

Hedge Against Event Risk

Commodities may also offer investors a potential hedge against “event risk”, or the risk that a financial crisis, war or another geopolitical event could cause other assets to depreciate. Commodity returns have historically outperformed equities during the most depressed equity return observations.

Commodity resources are usually located in areas of political instability. Thus, deteriorating geopolitical conditions can threaten commodity supply and cause price appreciation. During financial crises, commodities are likely to outperform financial assets due to their intrinsic value as raw materials. As a result, commodities tend to positively correlate with inflation.

 

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