It is necessary to rethink one?s investment strategy in inflationary times. With monetary policy remaining accommodative and real interest rates being eroded by inflation inflationary trends might not subside. Costs of significant raw materials (Example : iron ore and aluminium) and production energy costs (such as coal and natural gas) will continue to impact costs of production equipment and components. If the commodity prices keep rising, headline inflation could remain elevated for longer, lifting people?s inflation expectations and putting upward pressure on wages as households increase resistance to the erosion in purchasing power.?
The rising cost of oil and gas is also increasing interest in bio fuels and other alternative sources of energy. However, many of these are produced from grains, which are in turn escalating in cost. Food price inflation is likely to endure longer than many people expect, with agricultural commodity prices expected to stay high for the foreseeable future. Central banks may have little choice but to live with inflation levels above their targets (and governments with relatively sluggish consumption growth) for years to come.?
The starting point for an investor in any asset class, particularly equities, is critical. Returns from equities would have been substantially different if one had invested following the sharp global sell down in 1973-74. Global markets peaked on January 5, 1972, and fell 41.9% to bottom in October 1974. Since the highs of October 31, 2007, global markets have declined by 21.3%. Investors entering the market following previous large declines have reaped substantial rewards over the following years. We believe such an opportunity exists following the most recent equity market sell off.
History shows that returns from equities and bonds suffer when inflation surges. Upswings in commodity prices raise the cost of materials, curb corporate profits and push inflation and bond yields higher. However, high inflation can provide opportunities for some companies with few competitors, those with sales exposure to high ? growth sectors in emerging markets such as infrastructure and consumer goods, those in regulated sectors that let revenues increase in line with inflation, and those with links to real assets like hard and soft commodities, precious metals, oil and gas and real estate.?
Quality companies with moderately high levels of debt and strong cash flows and interest cover are likely to benefit from an inflationary environment. During periods of high inflation, the value of outstanding debt is eroded. If there are sufficient cash flows to support the debt structure, such companies can efficiently use capital for investment.?
With the powerful momentum in commodity price trends, further new price records over the short ? term and potentially the medium to ? long term are likely scenarios. From an investor?s perspective, inflation risks are sufficiently serious that investors should consider protecting themselves via defensive assets and focusing on an investments real rate of return. Real return assets such precious metals, hard and soft commodities and infrastructure are identified as among those likely to thrive in an inflationary environment.