What will be an effective inflation hedge?

Inflation hedges

I was presenting in Sydney last week, and a few people asked about effective inflation hedges.

Traditionally, tangible assets such as land, commodities and precious metals including gold and silver, and commercial property have variously been popular. 

Stocks tend to be the strongest bet as a long-term inflation hedge, but in the U.S. valuations are still historically expensive and probably won't enjoy rising interest rates and quantitative tightening (when rates are falling people often recite 'don't fight the Fed'; on the way back up, it seems, not so much).  

It was widely argued that cryptocurrencies could be a hedge against irresponsible central bankers, but instead of being an inflation hedge the opposite has been true of late - as interest rates and risk-free returns increased, many of the coin valuations have dropped by 55 to 85 per cent (and Coinbase has seen its share price fall by more than 80 per cent).

I have no dog in this race, but Taleb posits that a negative-sum instrument such as Bitcoin with no explicit income stream or residual value must have a present value of zero, with future risks ranging from the extinction of miners, obsolete technology, and so on. 

Of course, cryptocurrency prices in dollar terms can still rise by a lot, and perhaps for a very long time. 

But since prices can't rise forever - they'd ultimately swallow the economy if they did - eventually prices have to fall, at which point there's no purpose in owning the underlying instrument - and as no further new entrants are lured in the pyramid implodes. 

Farmland hedge

My bet is that farmland prices could be one of the most effective hedges over the period ahead.

I'll write about UK farmland here, since that's where I invest, but similar dynamics may apply to Australia, especially for farmland which also has future development potential.

Farmland prices fell sharply in the UK after the Brexit vote in 2016, and even though consumer price inflation is expected to hit 10 per cent imminently, farmland prices are currently still below their 2016 highs of around £8,000 per acre. 

So although the 50-year returns remain solid at a 3,130 per cent price increase (compounding growth of 7¼ per cent per annum), the price change over the past six years has been negative.

However, supply has become very tight, partly due to interest from buyers such as hobby farmers, or those with an interest in planting trees, peat restoration, or starting organic farms.

And farmland prices are now rising, up by 14 per cent over the year to March 2022. 

Farmland as an inflation hedge

The massive push for ‘net zero’ is adding to the pressures as big corporates look to offset their carbon emissions or gain credits for planting forests or undertaking other biodiversity projects. 

Remarkably, in fact, almost 40 per cent of land sales last year were to non-farming buyers, which is one the many unintended consequences of so-termed 'net zero'. 

Knight Frank notes that during the inflationary 1970s farmland values spiked by 500 per cent, and questions whether something similar could happen now. 

I'm not so sure about that given where prices are today, but farmland does tend to attract the interest of the super-wealthy in England, not least because it doesn't attract inheritance tax, as well as being a source of environmental and carbon credits. 

So that's my bet: farmland could prove to be one of the most effective inflation hedges, on a risk-adjusted basis. 

There's not much supply, and demand is increasing for a whole range of economic and environment-related reasons. 

Food insecurity

A further related issue has become the tragic war in Ukraine. 

The wheat belts of Russia and Ukraine combined accounted for 30 per cent of the world's wheat supply, more than half of the world's sunflower oil, and 35 per cent of its barley, among other produce.

But the Ukraine has been invaded and the western world has imposed severe sanctions on Russia, which has cut off global markets from critical food and energy supply. 

Food prices are spiking nastily, not helped by the disastrous experiment in Sri Lanka with a switch to organic farming. 

The UN reports that 323 million globally face starvation, largely due to the pandemic response - which has severely limited fiscal space, massively depleted foreign currency reserves, and crippled global supply chains - as well as now due to the war in Ukraine. 

This doesn't mean life will be easy for farmers, mind you, even if the value of their land goes up.

Although food prices are likely to surge, so to rising are the prices of feed, fertiliser, oil, diesel, and other key input costs. 

Source: FT

The world faces a tough 12 months ahead, to avoid famine.