Skip to main content

While there are still issues to fix from the recent financial crisis, the next one is already approaching. The IMF's latest Global Financial Stability report does not paint a picture of a bright future.

While the massive flood of money created by central banks has stimulated growth in developed economies, it has inflated asset bubbles in emerging markets. Additionally, low interest rates have incentivized banks and governments to load up on debt.

As the U.S. dollar is soaring, huge amounts of USD denominated debt is crushing some of these economies. The global debt crisis that started in Europe is spreading into emerging markets. Due to the crisis in emerging markets, especially in China and Russia, it's not only the IMF that fears a coming financial crisis. The Bank of England, the UN, the Bank for International Settlements also see dark clouds ahead.

Investors Fear Inflation, Look for Opportunities to Hedge

Investors are divided into two groups. Some expect a scenario similar to Japan, where deflation cuts into the economy, weighing heavily on economic growth. However, the majority of investors expect the exact opposite: Global inflation that will cause their savings to fade away.

Considering low interest rates worldwide and the massive asset-purchase program in Europe, this fear is not far-fetched. Economist David Rosenberg expects a mild stagflation, a combination of high unemployment and inflation.

Meanwhile, investors are fleeing into private assets because they have lost trust in the world's central banks. They are seeking other opportunities. The online platform Bitgold, for instance, offers not only an opportunity to invest in gold, but also a prepaid card to redeem vaulted gold in real time and use currency to buy goods and services. It's a way for investors to return to the gold standard.

Financial Markets Offer Various Opportunities to Hedge Against a Cycle Shift

Investors who want to hedge against inflation have several options. None of them is risk free, but neither is holding cash.

1. Real Estate

If you have enough cash, buying a real estate property is a good option. Even if you don't have enough cash, you can benefit from the low interest rates and take out a mortgage. Land ownership not only gives you access to a real asset, but by renting out your property, you can also generate additional cash flow.

Instead of going through the hassle of becoming a landlord, you could also join a real estate investment group. This way, you can invest in real estate, but the investment group will manage the property.

2. Equities

Historically, equities soar during periods of high inflation. Revenues and earnings of a company should increase during times of inflation. However, if Rosenberg is right and we are facing stagflation, buying stocks may not be the best way to hedge.

Moreover, a cost-push inflation is ahead. That means higher costs for companies will decrease production output. Combined with steady demand, prices will increase even more. In this case, buying stocks won't protect you from anything.

3. Commodities

Prices of commodities usually go up with rising inflation. This time, prices will increase big time. Investors are losing their confidence in governments and the public sector in general, because the most significant factor that has been driving bond prices during the last years were central banks buying assets and flooding the markets with money.

As investors are starting to realize that, we will face a shift in public confidence. The result will be an accelerated outflow of money from the bond market -- the biggest market in the world -- into private and tangible assets. With commodities being currently undervalued, especially gold, they are attractive for investors and will gain significantly in value.

As most people usually don't want to purchase commodities and store them in a warehouse, trading futures is a good alternative. You can either open an account by yourself with a broker or a futures commission merchant or you can pay someone else to trade your futures through a managed account.

Another option would be the various commodities ETFs. Some of them track a specific commodity; others invest in a broad range of different commodities. Especially the latter are interesting for those who want to hedge against inflation and improve their portfolio diversification. Examples are the UBS Etracs Bloomberg CMDTY TOT RET ETN and the iShares Diversified Commodity Swap UCITS ETF.

4. Forex

Inflation is not only the depreciation of a currency against real assets but it may also be the depreciation against other currencies. Obviously, the trick is to select the right currency pair.

"You want a central bank that's going to be ahead of the curve and hawkish," says Rebecca Patterson from JP Morgan. There are risks such hedges -- and they won't be perfect hedges. Nevertheless, the Forex market provides an opportunity to offset your loss of spending power by holding another currency.

5. Alternative Investments

Have you ever thought about buying a cow and selling its milk? Or stamps? Or ancient weapons? If that sounds crazy to you, you're not alone, but these assets can be good investments. 

And in case of a total apocalypse, you will still be able to drink milk or eat your cow. 

As of this writing, the author did not hold a position in any of the aforementioned securities.