Up until now, the third quarter of 2022, the U.S. inflation surge remains unsettled. From our previous U.S. Inflation Surge series, we covered how the U.S. saw its biggest interest rate hike in 22 years along with its effects. And on 28th July 2022, the U.S. Federal Reserve is still raising its interest rate by another 75 basis points to curb this ongoing inflation.
In general, inflationary changes often lead to a vast or possibly devastating influence on the value of a currency, consumers’ purchasing power, and the banks’ monetary policies.
That said, investors and traders have been speculating on the inflation’s movement and planning their investment decisions accordingly. Thereby, we call this inflation trade or trading on inflation.
What Is Inflation Trade
An inflation trade is an investment strategy or trading method where a trader aims to get returns from a heightening price level affected by inflation or expectations of forthcoming inflation.
So, with increasing price inflation and the market expecting the U.S. Federal Reserve to revise their interest rates decidedly over the coming months, investors definitely have been opting for inflation trade whether consciously or subconsciously.
During this inflationary period, investors reckon that there is either a risk or a profit opportunity. Hence, they will trade the inflation and shift their investment portfolios into assets that are principally more approbatory in an inflationary environment.
Through inflation trade, investors also speculate on markets that are particularly sensitive to price inflation, such as the U.S. dollar, gold, or silver.
How To Trade During Inflation
Here, we explore the major markets that are ideal to trade during inflation and have historically been seen as inflation hedges.
Commodities – Crude Oil
This year, commodities rallied, surpassing equities and highlighting their eligibility as a hedge against rising inflation.
Commodities are deemed a hedge against inflation by their fundamental value. Plus, when prices for consumer goods are appreciating, commodities are likely to excel.
Meanwhile, equities’ performance on the other hand is likely to deteriorate, as inflation causes increases in interest rates. As a result, the value of cash flows for companies are reduced due to the effects of inflation.
Since the beginning of this year, crude oil has led the price rally in commodities, rising 48% despite a strengthening U.S. dollar with the U.S. dollar being the preferred currency in the global commodity trade.
Through this, traders could take advantage of the commodities’ value and at the same time trade on other weaker financial products to gain more during inflation.
Precious Metals – Gold
For years, gold has been the leading haven – be it during economic downturn or stock market crash. In this case, inflation is indefinitely pushing all prices to rise, including gold.
Trading gold to hedge against inflation works similarly to trading commodities. Their values are both measured and traded with the U.S. dollar. On top of that, oil and gold’s value rise along with inflation as well.
By the nature of gold’s value, investors who hold gold are able to establish a diversified trading portfolio and at the same time protect their capital against value erosion.
While gold and inflation are connected: this precious metal also safeguards investors against economic events like currency devaluation as well as an acting cushion during periods of political instability.
Apart from investing or trading in gold itself, investors can also consider trading precious metals stocks.
Let’s take Newmont (NYSE:NEM) as a case study.
According to a writeup from yahoo!finance, Newmont stock has rose higher by 29% in the past six months as gold surges. Hence, this recent correction from highs seems like a good accumulation opportunity for long-term investors.
Overall, this stock looks attractive at a forward price-to-earnings-ratio of 25.4. With positive industry tailwinds and a dividend yield of 2.86%, the stock is worth holding in the portfolio.
Stocks
The dynamic between inflation and stock prices is intricate and every different type of stock should be assessed on its own specific values.
However, value stocks are likely to overshadow growth and income stocks during periods of higher inflation.
In the long run, stocks can act as a hedge against inflation. With rising inflation, the value of stocks will appreciate over time, as businesses will eventually adapt to the inflationary pressures and adjust their own prices. Hence, revenues will increase, and normal profit rates may resume, leading to investors getting their dividends returns.
Nonetheless, the results in the short run have been negative as the stock market has lost most of its gains achieved in July and near early August. This is due to the fact that traders are still worried that the U.S. Federal Reserve will not end its interest rate hike streaks anytime soon, just to bring down the decade high inflation.
What’s Next:
At this point, the rapid inflation spike can spark many possibilities. We might see a recession or even stagflation if things continue to go sideways.
Regardless, investors should keep speculating on the market conditions and any inflation-sensitive affairs to evaluate what these mean for their portfolio.
Ultimately, the U.S. Bureau of Labor Statistics latest jobs report suggests the U.S. Federal Reserve’s plan to fight inflation might just be working. Job growth eased throughout last month, which hints that the economy is settling into a phase of weaker growth amid rising interest rates.
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