Forget Gold -- Potash Corp. Is Your Inflation Hedge

NEW YORK (TheStreet) -- Are you looking for a conservative inflation hedge that's not gold? Then you may want to take a closer look at Potash Corp. of Saskatchewan (POT).

It's got liquidity, a nice dividend and good technicals. Despite being a portfolio staple, Potash Corp. has acted as a leveraged inflation hedge in the past and could do so again in the near future.

I'll explain why, but first let's backtrack a bit. "Inflation" is generally recognized as an increase in consumer prices, but prices anywhere can rise and fall either because demand rises, supply falls, the total money supply changes or there's combination of all three.

To call an increase in demand or decrease in supply "inflation" is simply wrong. Inflation is an increase in the money supply rather than an increase in prices. Inflation is the cause. Price increases are the effect.

Let us call the effect "price inflation" and an increase in the money supply itself "inflation proper".

In order for price inflation to be unleashed, you need is a catalyst. If a match is lit and there's already lots of inflation proper in the system, that's when prices can really take off.

For example, the ongoing drought in Brazil has the effect of constricting coffee supply, but not so much that prices would double in four months. One can assume that demand has stayed more or less the same over the past four months, so the answer must be that the inflation proper already in the system found a place to go once a coffee supply crunch started. The new money was just looking for an excuse to land somewhere and it found coffee, amplifying the price rise. Following is a chart of the iPath Dow Jones-AIG Coffee Total Return Sub-Index (JO), and exchange-traded note designed to track coffee futures.

Exactly how much more money is now circulating since coffee bottomed in early December? In other words, how much inflation proper is in the system since coffee bottomed? About $291 billion, according to Federal Reserve statistics. 

The most important lesson from the coffee spike, however, is not that you should take a guess at what will be the next hot commodity. Instead, it's that commodities of all stripes will start being pushed higher because inflation is already here.

Indeed, this is exactly what we saw in the 2008 commodity boom. Although there was no quantitative easing program back then, the M2 numbers were growing at an incredible 11% annual clip by May due to heavy bank lending at the time.

The commodities bubble topped one month later in June. By Sept. 8, 2008, inflation proper had completely reversed itself and the money supply, M2, was actually shrinking. The bottom fell out of commodities a few weeks later.

Yes, the broader market crashed as well, but not nearly as badly as commodities did, which are usually the most effected by inflation proper.

It is very difficult to tell which commodity will be catalyzed next after coffee, but patient investors can safely assume that eventually, pretty much all major commodities will be catalyzed. With M2 still growing fast and excess reserves at a record $2.54 trillion and growing, there is simply too much liquidity in the system for any major commodity to miss out.

This gives patient investors the opportunity to use large-cap, highly-liquid dividend stocks, usually labeled as defensive or conservative, as potential aggressive growth stocks.

Back to Potash Corp. It's one of the largest commodity stocks, with a market cap of $30 billion, and pays a growing dividend. Its shares went ballistic in 2008 as commodities followed the M2 growth explosion of 2007-2008. They crashed weeks after M2 growth (inflation proper) stopped and reversed on Sept. 8, 2008. You could have followed the money supply numbers in advance of the big fall and gotten out of the stock near the top.

Potash Corp.'s earnings and share price basically follow the price of potash, phosphates and other fertilizers. Like most other commodities, potash went parabolic in 2008 and crashed in September of that year when inflation proper stopped. Will potash be the next coffee? Maybe, maybe not. That's not the point. The point is that eventually, all will be catalyzed, just as happened before.

With Potash Corp it could take some time, but with a staple like POT, one can afford to wait. Eventually we will see a repeat of the commodity boom. Stay close to the M2 numbers to monitor inflation proper. Price inflation will be right behind.

While the rest of the investment community continues to debate whether price inflation has arrived or not, rest assured, inflation proper is already here, waiting for its next cup of coffee.

At the time of publication, Farber was long shares of POT.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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