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Inflation, Investing and Everything

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Sunday March 23, 2008

ABC Guide to Beating Inflation in Singapore and Elsewhere, Part 3

Burning dollars. While this may largely be a metaphorical image at the point of writing for most, people did burn money for real during the German Weimar republic hyperinflation. At the time, it was actually cheaper to burn the paper money itself than to use the money to buy wood or fuel for the stoves.

Inflation drives people to do things that they might not ordinarily do - such as barter trade (as mentioned earlier), hoarding things like food and fuel, and, yup, burning paper money. These usually take place towards the middle to the end of a hyperinflationary cycle. So where are we now in this particular cycle? We are near the end of the beginning, as people worldwide are starting to wake up to the threat of rising inflation, and savvy investors, including fund managers of small private investment funds and gigantic pension funds alike, have already started to position themselves accordingly. It is becoming a political issue in many places, as witnessed in China and even in otherwise "politically-quiet" Singapore, where an unprecedented public march was held by the SDP opposition party to protest against price inflation.

Well, you need not necessarily go out into the streets to protest against inflation. If you feel like it, nobody's going to stop you (except the police who, of course, are just doing their job). Here is Part 3 of a more practical guide on how to beat inflation in Singapore (and elsewhere) :

Housing.

Real estate, or property, used to be a pretty good inflation hedge. Which partly explains why so many people, particularly Asians, are fixated on acquiring a piece of property or two. After all, so goes the conventional wisdom, it's not so easy to make land, is it? That was then. Now, you have to consider the housing bubble bursting, the mortgage / credit / subprime / CDO / MBS / SIV crisis (or whatever this whole collapsing pyramid of financial weapons of mass destruction is called nowadays). There *are* some places where you could possibly get a good deal on housing, perhaps a rental property in a good location, but for the most part, seeing how the looming recession could affect the rental market, not only in Singapore, but also elsewhere, I would recommend going neutral (staying in your present home) or short the housing market (selling, taking profit, moving to a cheaper location, downgrading). Besides, you wouldn't really want to be involved with the previous bubble, do you? Where you really want to be is the next bubble, and that is most certainly not going to be the object of the previous bubble.

Hoarding.

Hoarding is a strategy to deal with two issues that occur during periods of extreme inflation : soaring price increases and outright shortages. But the word "hoarding" has such a negative stigma associated with it, that we could perhaps call it setting up a strategic stockpile. You don't necessarily have to adopt a survivalist attitude - that might be called for later on, who knows. But you can always start "lite" - basic things like food (rice, biscuits, canned food, cooking oil), water (have some bottles of mineral, or better, distilled water, which you rotate through), and fuel (if you have a car, top it up to full when it goes below the half-tank level, so you don't need to join the long queues when something does happen). If you adhere to this consistently, you will be better prepared for many emergency situations in addition to hyper-inflation.

Hybrid cars.

Over the past few years, hybrid-electric cars have been alternately championed and panned. They have been praised for having low emissions and improved fuel consumption but were then criticized for being more expensive and not having high enough mileage to offset the extra cost. Some calculations pegged the payback period as long as 10 years. I guess they forgot to take into account the exponential nature of rising oil prices and the subsequent impact at the pump. The next generation of lithium-ion powered hybrid cars will help to address the cost issue since lithium battery chemistry is cheaper, lighter and more powerful than the Ni-MH being used in most hybrids nowadays (nickel being very, very expensive). The Chevrolet Volt, powered by an advanced A123Systems nanotech lithium-ion battery, will be one of the first of the next-generation hybrids. If you have to get a car in the medium-term, get one of these next-gen hybrids if you can. If humankind has enough time for even a partial fleet change, these will make a difference in the twin fights against rising petrol prices and global climate change. As for hydrogen cars, I'm much less sure about these for the mid-term. If, and that is a very big if, we have enough time to switch to these, such as the Honda FCX Clarity, it would be great. But I suspect that we would have come to one of two conclusions long before widespread adoption of hydrogen fuel-cell technology : a. we have somehow managed to solve our problems of energy, climate change, overpopulation and financial crises, or b. we have managed to hyperinflate beyond belief, collapse our global economy and eventually let nature take its course on population and climate.

Insurance.

Avoid insurance policies that lock you into multi-year or even multi-decade periods, and then give you returns that hardly give you much of a fighting chance against the rate of inflation. The problem is that most of these insurance policies, whether whole-life (living) policies or endowment plans, tend to invest most of their money in local government bonds. In times of low inflation rates, these insurance plans make some sense with government bonds returning yields of say 3%, 4% or thereabouts. But times are different now. Actual inflation rates are far outstripping the yields of government bonds. Taking a look at Fundsupermart's SGS bond yield tables, we see that the effective yield of a Singapore government bond maturing in 14 years' time is about 2.85%. Now compare that to the latest Singapore CPI inflation rate of 6.6% per year. Most local insurance products will invest in local government bonds. In other words - you lose. Plain and simple. It is a similar story for our American friends : ten-year Treasury yields are below official CPI inflation rates.

So what should one do? Here's the acronym for what one should do : BTAITR. Buy Term And Invest The Rest. Buy term insurance which gives you high coverage for a low price, and invest the rest of your money in investments with higher yield and higher performance. It might be worthwhile to hold on to one whole-life policy with a modest premium amount for the critical illness coverage, and one or two plans that cover healthcare costs such as hospitalizations, but that's about it. Don't waste your money on lock-in products. Especially those that masquerade as "enhanced savings accounts". They have been selling more of these lately. Beware of them.

Jobs.

What kinds of jobs will help you beat inflation? This one's easy - that would be CEO's, top lawyers, bankers, and those government ministers whose salaries are pegged to them. The people holding these jobs can look forward to, say, 33% pay rises, which puts them in a very good position to cope with rising costs of living. Well, not that they were in any sort of shabby position in the first place.

Okay, but what about the rest of us? I could look at this roughly the way that the S&P 500 stock sectors are sub-divided. With a looming economic slowdown, you might probably want to avoid jobs in the consumer discretionary industry which would be most sensitive to pullbacks in consumer spending. For obvious reasons, such as the subprime / credit / CDO / etc. financial meltdown going on, you might want to avoid looking for a job in the financial industry (unless you are a top banker but maybe not even then - just ask the top people at $2 Bear Stearns, for example). You'd want to be in companies which are able to pass on increased costs to the consumer, or that are protected in one way or another from rising costs. You could try consumer staples, or healthcare, or materials (which includes commodities - I hear that good geologists and petroleum engineers practically get to write their own pay cheques nowadays). You could try the government (which is the cause of inflation in the first place and is quite good at matching their own pay to compensate) or the military (which doesn't cause inflation per se, but is also very good at the latter). Call me biased, but I do have a vested interest in the last three sectors above.

Join (or form) a club, group or organization.

Why fight the inflation monster all by yourself? It's time to go get help, backup, and fresh ideas. Join a club or group or organization that talks about these things, or even better, acts on them. Together with a friend, I am co-founder of Contravestors Asset Management, a private investment club and investment fund. It helps to have people at your side fighting the same battle. For more ideas, there are online forums such as goldclubasia.com for the Asian (particularly Singapore) gold investor, and there is peakoil.com to talk to other people who are very knowledgeable about peak oil, the energy industry, and energy-related investments. These are a couple of examples - there are many more sites out there : pick some that match your style. Fight the good fight, but you don't need to fight all alone.

King.

You know what people say : cash is king. Or is it? Try putting your money in a savings account or fixed deposit at 1% or less, and see what happens to your money 20 years later - you might be lucky to be able to buy a banana with it. Cash is not always king. Cash is prone to being inflated away to nothingness. The history of cash, or fiat money, is a tale of collapses, with values going down to zero. On the other hand, gold is a much better king, and it always has been. The price of gold might go up and down, but it never goes to zero. And the chances are good that, in dollar terms, the price of gold is going to have more zeroes added at the end. Buy gold and hold on to it.