Inflation rates are record high around the world, and Canada is no exception, with an 18-year high of 4.7 percent in November. Prices rose across sectors, ranging from bakery, dairy, and meat to furniture, household products, energy, and transportation. A combination of factors is driving inflation, the main being money printing, high oil prices, product shortages, supply chain disruptions, and pent-up consumer demand.
Reasons for Record High Inflation
Whether high inflation rates are driven by global supply chain issues or money printing is a hotly debated issue at the moment. In the view of some academics and finance experts at the Bank of Canada, it is supply chain disruptions that cause inflationary pressures and drive food and energy prices up. According to a second group of academics, monetary printing creates an overabundance of demand while supply would not always catch up. The result is inflation whereby prices rise and purchasing power declines.
If we take the monetarists’ argument, inflation is not a temporary phenomenon and requires a tight fiscal policy and interest rate hikes. Such policies would involve tax increases, spending cuts, unemployment, and recession. Recession is generally a period of economic decline marked by substantially lower levels of industrial and economic activity. Businesses see less demand and are forced to lay off workers to cut costs, generating unemployment and insecurity.
As prices rise, inflation also eats away at our money and savings. Inflationary pressures not only result in an overall decline of purchasing power but affect the performance of companies and interest rates on savings accounts. When inflation is high, central banks would typically raise interest rates to discourage consumers from borrowing and buying and keep the cost of goods and services stable. The Bank of Canada recently signaled that interest rate hikes cannot be ruled out as a way to keep inflation under control. The current situation, however, is high inflation and low interest rates on savings whereby the value of your money declines. Fortunately, there are plenty of things to do to protect your savings, like investing in real estate, precious metals, commodities, crypto, and defensive stocks.
Investing in Real Estate
As the value of real estate rises with inflation, rental income can be a potential hedge, especially when it comes to short-term leases such as multi-family properties. Investors who are able to keep their mortgage terms the same and adjust their rent up benefit from inflation. Investing in real estate also provides recurring income that either exceeds or keeps pace with inflation.
Precious metals such as platinum, silver, and gold are known to be a hedge against inflation as well as a portfolio diversifier. Each precious metal, whether palladium or gold, has its own unique specifics, benefits, and risks. Gold, for example, is less affected by demand and supply, making it easy to sell and buy. An added advantage is the fact that there are different investment options to choose from, including numismatic coins, bars, and proof and bullion gold coins. The downside is that it doesn’t produce passive income the way real estate does.
When inflation is high, commodity prices also rise and offer a good return potential. Unlike financial assets such as bonds and stocks, commodities are one of the few investment classes that actually benefit from inflationary pressures. The rationale is that rising demand for services and products results in price increases and hence, the value of the commodities that go into producing goods and services also increases.
Bonds and stocks, on the other hand, tend to perform better when the inflation rate is either slowing or stable. When inflation picks up, it reduces the interest rate that bonds pay while high-dividend and income-oriented stock prices fall. This is why returns from commodity indexes like the S&P Goldman Sachs Commodity Index, Credit Suisse Commodities Benchmark, and Bloomberg Commodity Index are independent of bond and stock returns.
Defensive stocks offer stable earnings and dividends regardless of market conditions and typically outperform other investments in periods of economic decline such as recession or stock market crash. The reason is that they belong to sectors of the economy where there are only minor changes in demand. Such sectors are, for example, healthcare, utilities, and food and beverages. The consumer defensive sector includes businesses engaged in the production of packaging, personal and household products, food and beverages, and tobacco. The sector also includes companies offering services such as training and education. Organizations providing healthcare services fall in this category, including medical supplies and equipment, long-term care facilities, hospitals, home health care, research services, and pharmaceuticals. Examples are also life science development and biotech, vaccine developers, and medical device manufacturers. A third sector is utilities, comprising independent power producers and water, gas, and electric utilities and a fourth – communication services such as media and advertising, 5G network, and telephone and broadband.
Investing in crypto currencies can be a viable alternative to stocks and bonds, with a return of over 6 percent. Proponents point to the fact that bitcoin is not tied to a particular economy, fiscal policy or currency and cannot be devalued by a central bank or government printing money. Not only is bitcoin a digital currency but it has a limited supply and is secure, interchangeable, and durable. Finance experts, however, warn that crypto is a highly volatile asset and one tied to speculative trading. Also, cryptocurrencies have been around for a relatively short period to establish whether they can really act as a hedge against inflation.
Gold, on the other hand, has held its value for centuries. Academics at Duke University also note that bitcoin is vulnerable to crashes and manias over relatively short periods, which makes it a risky asset. Its value is tied to two factors – speculative trading and supply. All in all, bitcoin may have a limited value in developed postindustrial countries with stable fiat currencies. Crypto currencies may have a more practical use in countries prone to political instability and turmoil and hyperinflation.
Inflation is currently higher than normal in Canada, primary drivers being money printing, pent-up demand, and supply chain bottlenecks. Droughts affecting agricultural produce across the country are only making things worse.
Global supply chain disruptions are likely to continue in 2022, mainly due to China’s Covid-19 zero policy, resulting in delayed ships and overwhelmed ports. Inflation rates of 4 – 5 percent could also be with us until 2024. While these changes are temporary, a shift in Canada’s monetary policy may not have the desired effect. Hiking interest rates would result in economic slowdown at a time when governments around the world are withdrawing emergency support and fiscal stimulus.
What Canadians can do to protect their savings is invest in precious metals, real estate, defensive stocks, or commodities, all of which acting as a hedge against inflation. Other assets that offer protection against inflation are leveraged loans, real estate investment trusts, and mortgage-backed securities and corporate bonds.