Hedge your wealth against stagflation

Back in 1962, a writer in one of the UK's political magazines lamented the fate of US oil companies. In the face of US oil stocks that were priced way too high and oil prices that looked far too low (oil was $2.80 a barrel), they were nothing more than a group of "Kings Canute" hopelessly trying to turn back "the flood tide of oil" tipping into their refineries.

Refinery output was at an all-time high, and so extreme was the oversupply that the major oil companies were accused of "petrol dumping". They were giving up on their more expensive high octane "exquisite fuels" and instead creating economy grades that they were selling at cheaper and cheaper prices. It was, said the 1961 report of California's Richmond Oil, "the most prolonged price war in the history of the Pacific Coast oil industry".

The misery of the oil companies was summed up by the management of Plymouth Oil a few months later. Thanks to "oversupply, with attendant low selling prices and intensified competition", they were constantly operating at a loss a problem they, and everyone else, expected to be of a "continuing nature".

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So they chucked it in, selling their refinery assets on the cheap to Ohio Oil in 1962. The management at Plymouth Oil turned out, of course, to be completely, totally and absolutely wrong.

A decade later, the oil price was spiking, the muscle cars of the easy-riding 1960s were being parked up and it was clear that cheap oil was not something of a "continuing nature".

Today, the idea of being able to buy oil for $2.80 is absurd. But, increasingly, so is the idea of being able to buy oil for under $80.

Global stockpiles are low and, while they might handle a short production halt from Libya, if things get worse, all bets are clearly off.

However, even if peace returns to the Middle East and North Africa region fast, we still have to factor a higher than usual political risk premium into the oil price.

A change of government here and there is hardly going to promise peace in economically dysfunctional states that have young and angry populations (note that half of Egypt's population is aged under 24). It makes more sense to expect constant unrest than any sudden shift to stability. All those governments will want to keep the oil flowing but how successful will they be?

Finally, we have to factor in the possible reactions of Western governments to a rising oil price. They are unlikely to raise interest rates as the high oil price filters through into inflation. Given the fragility of their banks and economies, they can't afford to.

So, just as they are now, they will continue with their astonishingly loose monetary policies, albeit perhaps with the odd token rate rise. They might even print a little more money to compensate for the way high oil prices hurt economies.

The result? Anyone looking for a return will keep moving out of cash and into everything and anything else. And they will also keep working to hedge their inflation risks. That should keep the oil price moving too.

So how do you hedge yourself against another spike in the oil price and the stagflation that almost inevitably comes with it?

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Clearly, you look at the energy sector. But it is also worth noting that gold has a nice record of protecting investors. Back in 1973, the price doubled from $85 an ounce to $180. It then eased. But as GMP Securities point out, the end result was that it stabilised in a much higher range $130-$150 than before.

The same happened the next time around. As the Iranian Revolution developed, the gold price spiked to $850. Then, when it fell back, it didn't revert to $200. Instead, driven by geopolitical risk perceptions and the inflation fears triggered by the rising price of oil, it moved into a higher range around the $600 level.

If the crisis in the Middle East spreads and oil spikes again, it seems reasonable to expect the same thing to happen. Expect, say GMP, "a very significant impact" on short-term and, as in the 1970s, on medium-term gold prices too.

Finally, a point on my column few weeks ago on how fund management fees are finally falling. Since then, I've been inundated with information on this. Various firms are dropping upfront fees completely, others are upping the percentage of annual fees that they rebate to investors. Elsewhere, fund supermarkets that rebate all commission and charge only fees are popping up.

I'm also pleased to see that Schroders is launching a low-cost but actively-managed fund: the total expense ratio is capped at 0.4%, less than a third of that of traditional funds.

The fund management industry moves slowly and, when it comes to price cutting, also rather reluctantly. But add all this up and it really does seem that good things are happening. Finally.

This article was first published in the Financial Times