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eToro Post – Different Types of Inflation and Assets That Hedge Against Each

This pot was originally shared on my eToro feed in November 2021. Make sure to follow me there as well, and did you know that you can copy my trading there for free? Create an account today, copy my portfolio by searching for user “Allseasonsport” to automatically duplicate my All Seasons Portfolio strategy effortlessly.

Surely you have not missed the talks about inflation the past year. Even from the Fed and Yellen, the sentiment about inflation has changed from “not a problem” to “transitory” to “longer than first expected” and now to “good for the economy”.

While the price of risk assets, such as stocks, may also inflate due to the rise in inflation, they are not rising as much in real terms.

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Trade stocks, crypto and ETFs listed on 14 exchanges on eToro. You can copy my portfolio by searching for user Allseasonsport

Rising inflation, and especially inflation that is higher than expected, is harmful to most common portfolios that comprise of stocks, or a combination of the two like the 60/40 Portfolio. Both stock and bonds are assets that perform well in times of low or decreasing inflation, and will lag in times when inflation rises.

It is thus vital to have a portfolio which also includes inflation hedges to mitigate the risk of unexpected inflation prints.

The portfolio that I run here on eToro is exactly one such portfolio.

In this post I discuss 5 asset classes that serve as hedges against different types of inflation. These are gold ($IAU, $GLD and $GOLD), commodities ($DJP and $DBA, and $OIL, $COPPER and $WHEAT), TIPS ($TIP), EM Stocks ($EEM) and cryptocurrencies ($BTC and $ETH).

To summarize, there are two regimes where inflation manifests in a matrix with 4 quadrants of rising/slowing economic growth and inflation: during inflationary stagnations and inflationary booms. But there is also three types of inflation.

This means that the inflation hedges will behave a bit differently depending on which inflation type we are experiencing. Thus it is important to own a diverse basket of inflation hedges, rather than just gold or commodities.

The three types of inflation are:

  1. Increases in monetary supply caused by central bank money printing
  2. Cost Push Inflation caused by rises in costs to produce commodities or goods
  3. Demand Pull Inflation when the demand for commodities and goods rises above the supply

All of these three types increase prices, and therefore cause inflation, but in different ways. That is why different inflation hedges need to be included in a portfolio. But how do you protect your wealth against inflation, regardless the type? Let’s take a look at the most common assets used for this purpose:

1. GOLD Gold is the best protection against inflation caused by increasing monetary supply. The value of gold remains quite constant over long periods of time (>100 years) measured in purchasing power. With a 1oz gold coin, you could 2,000 years ago buy a toga worn by wealthy Romans. Today, with the same 1oz, you can buy a $1,800 suit from Ermenegildo Zegna.

2. COMMODITIES Commodities benefit typically from Cost Push Inflation. If coms such as oil, metals or softs become more costly to produce, you will profit by having invested in futures contracts with these commodities as underlying assets.

3. INFLATION-LINKED BONDS TIPS give the most clear protection against Demand Pull Inflation together with commodities. When prices rise due to supply/demand imbalances, e.g. due to y supply chain disruptions when ships are waiting for offloading at port or when there are not enough semiconductors produced. This drives prices for consumer goods, despite unchanged production costs. As changes in consumer prices are measured with CPI, to which TIPS are linked, the value of IL bonds increase with CPI.

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Trade stocks, crypto and ETFs listed on 14 exchanges on eToro. You can copy my portfolio by searching for user Allseasonsport

4. EMERGING MARKET STOCKS EM stocks benefit from inflationary booms and when commodities appreciate as EM indices include a greater portion of commodity producers and refiners. EM or Global ETFs are hence good inflation hedges.

5. CRYPTOCURRENCIES The role of cryptocurrencies in inflationary environments is yet to be tested, it still being a young asset class. It could in theory be a similar hedge as gold, as the value of cryptos is detached from fiat. But it should not be a sole inflation hedge as the price is also linked to other factors than just inflation.

You can also see these assets summarized relative to other assets and market environments in the below chart from Resolve Asset Management:

MY ETORO ALL SEASONS PORTFOLIO To protect and grow my and any copiers’ wealth in any market regime, my All Seasons Portfolio includes all the discussed inflation hedges. Additionally, these are weighted in accordance with risk parity principals to further balance the risk-adjusted returns.

For example, I currently have 7.5% commodities, 7.5% gold, 11% inflation-linked bonds, 4% cryptocurrencies and approx. 3% EM stocks (part of 30% stock allocation).

It is vital to always be mindful of the probabilities of market regime surprises and to have the portfolio built accordingly. Especially now when rising inflation is becoming increasingly obvious, it is important to have the hedges already in place. It is too late to by in when the inflation has already happened. Follow me for more info about risk parity investing, or copy me to easily get access to a diversified and balanced dynamic risk parity portfolio which aims at returning equity-like return over time but with half the volatility.

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Trade stocks, crypto and ETFs listed on 14 exchanges on eToro. You can copy my portfolio by searching for user Allseasonsport

You are more than welcome to stick around for this journey that I have been on for several years already with this strategy, and I look forward to interacting with you along the way. And make sure you look up my profile on eToro, if you haven’t already.

All the best,
Nicholas


The opinions shared in this article are those of the author and do not constitute investment advice in any form. Any mentions of my trading strategy are for descriptive and information purposes only of what I do with my money. All investments carry the risk of capital loss.

This post includes affiliate links for eToro, and by clicking the links, I may get a compensation, at no extra cost or disadvantage for you. On eToro, the trading on my account is done with my own money, and if you chose to copy my trading, I have skin in the game and incentives to stick to my strategy and perform well.

This Post Has 2 Comments

  1. shu

    hi Nicholas,

    i have noticed that in your AWP, the TIPS % has increased to 24% and Bond has decreased to 25%, what is the reasoning behind this change? is it permanent? or only due to the recent inflation quadrant that we are in right now.

    i try to find it on your recent post, but couldnt find it.

    would be great to know the reason behind it.

    thank you.

    regards,
    shu

    1. Nicholas

      Hi Shu,
      That was very observant of you! I have jut posted a new monthly update for April, where I briefly explain this. It is mainly due to the inflation quadrant and for as long as nominal government bonds remain in their negative trend (until yields on longer maturities stop rising).
      -Nicholas

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