All that Glitters can be better than Gold

Radhika Dirks Uncategorized

People have been talking about investing in gold as an inflation hedge for a while now. As Peter Schiff likes to point out, in the Roman Empire an ounce of gold purchased a Roman citizen a toga (suit), a leather belt, and a pair of sandals. Today, one ounce of gold will still buy a man a suit, a leather belt, and a pair of shoes. So gold is definitely a long term inflation hedge. But here’s the run down on the cons of investing in gold and a quick look at other inflation-hedges.

 

Cons of Gold:

1) Gold has large volatility and long periods of time (like 20 years around the 80s) when the prices won’t go anywhere.

2) From a contrarian standpoint, we hear way too much about gold nowadays. Everyone knows about Cash4Gold and similar websites. Other useful commodities that have not yet increased in price as much as gold might be better. Oil, iron, copper, etc. are all great inflation hedges for the same reason as gold – they can’t be devalued by printing more. They take hard work to find and unearth and thus carry intrinsic value. And they are not on late night infomercials… yet.

Option 1 : Better -than- gold Tier I stocks
Asset-backed / Necessary-Goods Stocks: Gold is only an inflation hedge. In the long run you are much better off with a company that is producing something useful, since, over time that company can be worth more, not just the same. So for example any asset backed/commodity stock (oil, energy, food) is a better inflation hedge. The value of any asset backed/commodity company will get automatically adjusted for inflation, which will be reflected in the stock price. A better hedge against inflation is a company that sells something that people will always need, even when they are broke and thus, has a competitive advantage. So they can quickly pass along price-increases and potentially grow your money profitably. Examples of companies like this might be Johnson and Johnson, Walmart, and 3M. On top of inflation-adjustment, you will also see the usual returns/losses of investing in businesses. It might get hard to decouple the two, but you won’t be “wasting” your dollar because of inflation.

Option 2 : Even- better inflation hedge – Tier II Stocks
Necessary-Goods Companies with High Leverage
: The dream inflation hedge would be in a company that apart from selling ever-needed products with a steady stream of earnings and having some competitive advantage (what we call the Tier-I stocks) is also heavily leveraged. Then if inflation does happen, they would able to easily pay back their debt in much cheaper dollars. Now you’ve got a hat-trick – a company with real value, that makes something people need, has pricing power, and is actually taking advantage of inflation to pay off their debts. Warren Buffett’s purchase of Burlington Northern is a brilliant inflation hedge as it satisfies all these criteria to the T. Large moat, steady earnings, asset based, highly leveraged, and good potential for growth.

Aside: Alternatively, you can take on personal leverage as well, you might be able to find a company that satisfies the dream criteria above AND pays a dividend that will cover the cost of margin for example. Also, just taking large loans can make a good inflation bet since you would be able to pay them back for a fraction of their original “value”. This assumes two things though: 1) You can continue to make the payments. 2) You invest the money in something of value. For example, you could buy a house on a highly leveraged basis, subsidized by Uncle Sam.

Option 3: Best bang for your dollar-buck? – Tier III stocks
Highly-Leveraged Necessary-Goods Companies outside the US: The third option is to invest in tier-II stocks outside the US (the Euro or the Yen for instance) if on top of inflation you are worried about the dollar losing value because of a demotion from its current place as a global currency standard. A global currency standard means that if a French bank and an Indian bank need to conduct a transfer, they would both have to transfer their currency into dollars, transfer the money, and then back again. The same is true for buying oil. This means that there is an additional “artificial”, if you will, demand for the dollar effectively raising its intrinsic value. There are now talks about replacing the global standard with the Euro, or Yen, or a “bag of currencies” – if this happens, there will a related devaluation of the dollar, which has nothing to do with inflation. For this you could check out countries that Peter Schiff recommends in his book “Crash Proof”. Australia and New Zealand come to mind.
These are fun times we live in. Smart moves can give über -smart returns.

Acknowledgments: This article was coauthored with Travis Dirks.