For those with investments, maintaining their real value, let alone increasing their value, in real terms, has been a very difficult objective to attain.

Will the old adage “history repeats itself” come to bare once more? Below I provide an overview of some of the assets that historically have done well during times of inflation, how they’ve actually been faring so far in 2022 and how to get exposure to them.

Keep it Real?

With the major currencies devaluing in real terms, one quickly looks at gold as an inflation hedge, although gold so far this year has a negative 4.6 percent nominal return. Gold has two major downsides: owning it doesn’t provide you with an income from dividends or interest. The consequence of that is that the value of gold is negatively correlated to the yield on USD-denominated debt instruments. The value of gold has also been quite volatile since the mid-1970s. Nevertheless, over the longer term, gold has provided a reasonable real return. Central banks tend to hold part of their reserves in gold, the metal has applications for jewelry and some medical and manufacturing products and supply is limited. Direct exposure can be gained through owning physical gold or through investment in publicly listed miners and ETFs.

A commodity like oil has done well over 2022. Brent, denominated in USD, increased in value by 28.5 percent so far this year. An oil major like Shell PLC returned a whopping 43.6 percent this year, with the energy sector overall listed within the S&P500 returning 51.2 percent. Going forward, however, oil demand may be softening, as retail prices are relatively high and recession is looming. Also, given the fact that oil is traded in USD and the recent strength of the currency, oil becomes more expensive for users in non-USD economies. OPEC already is considering reducing production in order to provide a bottom to the price. In the long term, of course there is a global effort to move away from fossil fuels which can mean that the global peak in demand for the commodity is near, although analysts disagree whether that moment will be reached before the 2030s or 2040s. Not considering derivate instruments, exposure to oil can be gained through equity shares in the major oil companies, oil servicing and exploration companies and ETFs.

There are many more commodities to consider of course. The electrification of transportation will ensure an increased demand for lithium, nickel, copper, graphite and cobalt. Several agricultural products have risen in price quite substantially y/o/y. Each commodity has its own supply and demand characteristics. Some commodities, like cobalt, are primarily mined in highly unstable countries, while others, like agricultural products, are dependent on uncontrollable factors such as the weather, adding risks to having an exposure to their price. Most commodities are again traded in USD, adding a layer of volatility due to exchange rate fluctuations and the looming recession will depress demand for some, such as copper.

Still looking at the real assets, let’s finally consider real estate, specifically real estate in Portugal. On the demand side, due to the low mortgage interest rates of the past decade, buyers were able to pay more for properties and hence this was reflected by appreciating average transaction values, especially in Portugal’s largest cities, while housing supply is at historically low levels. The price increase has continued during the first half of 2022, thereby suggesting real estate has been a good inflation-hedge so far this year. Nevertheless, we are currently not under ceteris paribus conditions, as a number of key factors are changing. Mortgage interest rates have been increasing, however, they are historically still relatively low and also relatively low in Portugal compared to other countries in the EU. However, and this is the worrying part, Portugal differentiates itself from other European countries by having 93 percent of the outstanding loans at variable rates, meaning that as these are generally indexed to Euribor (3, 6 or 12-months), an increase will be felt directly by most home-owners (Euribor has been increasing YTD and is expected to increase further over the remainder of 2022 and 2023). Potentially, homeowners are facing a double-hit from both rising mortgage costs as well as daily living expenses due to the high inflation. Nevertheless, these forces will play out differently in different segments of the market. The luxury segment on prime locations has seen little supply increases, while there is strong demand from foreigners, especially given the weakness of the Euro compared to the USD. Next to owning a property to live in or rent out, an investor can get exposure to real estate by investing in exchange-traded real-estate-investment-trusts (REITs) or listed companies managing a real-estate portfolio such as Vonovia.

In part II, I will consider the inflation-hedging potential of other asset classes such as currencies (as a Euro-based investor, simply holding USD would have returned 12.6 percent YTD!), cryptocurrencies and equity and bonds in general terms as asset classes. If you cannot wait and would like to have a review of your investment portfolio, please contact us in our Lisbon office.

Add disclaimer: This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice form a professional adviser before embarking on any financial planning activity.

For more information contact Blacktower Financial on +351 289 355 685 or email: info@blacktowerfm.com