Imagine that in 1975, an investor had $10,000 in cash. Rather than doing anything with it, he sticks it in the bank, finally putting the money to work in 1983. This was a bad move. The investor crunches the numbers, and discovers that thanks to inflation, it only buys about half the amount of goods that it would have just eight years earlier. The investor thinks he’s protected his capital by putting that money in the bank, but in reality he hasn’t. Inflation in those years was so high that any investment during that period that doubled only kept up…
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Imagine that in 1975, an investor had $10,000 in cash. Rather than doing anything with it, he sticks it in the bank, finally putting the money to work in 1983.
This was a bad move. The investor crunches the numbers, and discovers that thanks to inflation, it only buys about half the amount of goods that it would have just eight years earlier.
The investor thinks he’s protected his capital by putting that money in the bank, but in reality he hasn’t. Inflation in those years was so high that any investment during that period that doubled only kept up with inflation. Many investors experienced some serious pain during that market cycle.
These days, inflation is much lower. The Bank of Canada officially aims to keep core inflation at 2% annually, right in the middle of the sweet spot between making sure the economy is growing and making sure people aren’t being hit too hard by rising prices.
As investors, we have to constantly worry about inflation. There are certain businesses that are naturally protected against inflation and others that aren’t. Fortunately, there are a lot of stocks that naturally protect investors against inflationary pressures. If they were around in 1975, they would have been the place to be. Here are three.
Canadian Oil Sands
Traditionally, investors have flocked to gold as a traditional inflation hedge. Since gold is viewed as a store of value that isn’t easily manipulated, this makes sense. But, it turns out that oil has actually been a better hedge against inflation.
Which is why investors worried about inflation should look at Canadian Oil Sands (TSX: COS), one of Canada’s largest oil sands producers. Through its share of the Syncrude project, the company currently has 1.7 billion barrels of oil reserves, along with an additional 2.5 billion barrels of likely reserves. That’s enough to keep the pumps going for another 43 years at current production.
The world needs oil, especially as the developing world begins to really modernize. Even if the United States eventually gets to the point where its domestic production lessens the need for Canadian imports, there are still plenty of other regions hungry for Canadian crude. Canadian Oil Sands is well positioned to fill this need.
Investors are also treated to a 5.9% yield, which should rise as the price of oil rises. That’s another inflation hedge right there.
During times of high inflation, investors often flock back to the basics, since real assets tend to rise with prices. Therefore, farmland is always popular during inflationary periods.
It’s difficult for investors to invest directly in farmland without physically purchasing a quarter section or two, so they’d be better off investing in PotashCorp (TSX: POT)(NYSE: POT), Canada’s largest supplier of fertilizer.
Farmers tend to hold their own during inflationary times, since land and crop values tend to move hand in hand with prices. This makes selling fertilizer to farmers a far more attractive option than selling goods to consumers who aren’t seeing salaries rise as fast as the cost of goods.
Potash also pays patient investors a 3.9% dividend to wait, and has finally gotten serious about growing its quarterly payout, growing it more than ten-fold over the past five years.
The easiest way for most investors to hedge against inflation is to buy real estate, since it has traditionally tracked inflation pretty nicely.
But many investors don’t want the hassle of dealing with tenants. Cap rates for Canadian real estate are really low, which leads to disappointing returns. Since prices have ran up so much, the potential for capital gains is muted. So what should investors do?
It’s simple. Buy Boardwalk REIT (TSX: BEI.UN).
Canada’s largest owner of apartment buildings protects against inflation in a couple of ways. First, the value of its buildings should continue to creep up, at least matching inflation. And secondly, since its tenants have only signed leases a year at a time, the company has the power to renew at a higher rate.
Boardwalk also gives investors a 3.2% dividend, and is poised to nicely grow the number of units it has under management.
Will inflation matter?
Luckily for investors, many of Canada’s top companies are also natural hedges against inflation. Simply by building a diversified portfolio of these companies, they can easily take a big bite out of inflation risk. It’s a win-win for Canadian investors.
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Fool contributor Nelson Smith has no position in any stock mentioned in this article. The Motley Fool owns shares of PotashCorp.