Research from Vanguard suggests that investing in commodities is the most powerful way to hedge against unexpected inflation. Pointing to a concept known as inflation beta – an asset’s predicted reaction to a unit of inflation – Vanguard found over the last decade that commodities rose between 7% and 9% for every 1% of unexpected inflation the economy experienced.
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The Vanguard research, which examined the historical returns of the Bloomberg Commodity Index, comes as national inflation has reached levels not seen in more than a decade. The Consumer Price Index recently surged to its highest point since Summer 2008, rising 5.4% in the 12-month period that ended in July.
While markets factor a certain level of inflation into the price of assets, unexpected inflation can wreak havoc on portfolios by diminishing investors’ purchasing power, making effective inflation hedges all the more valuable.
What are commodities and how do they react to inflation?
Simply put, commodities are raw materials or agricultural products that can be traded. Common examples of commodities are gold, oil, grain, natural gas, beef and even coffee. Because they are crucial to everyday life, investors see the inherent value in owning and trading commodities.
As economic forces push the price of goods and services upward, commodities often become more expensive during times of hyperinflation. For example, energy commodities, which include oil and all types of gasoline, rose in price by nearly 42% for 12 months ending in July, according to CPI data.
Sue Wang, an associate portfolio manager for the Vanguard Quantitative Equity Group, led the research that determined the inflation beta of commodities was between 7 and 9 over the last decade. “This suggests that a 1% rise in unexpected inflation would produce a 7% to 9% rise in commodities,” Vanguard wrote in its recent insights.
Read the full article here by Patrick Villanova, Advisor Perspectives.
