Three strategies to beat inflation

published 9 April 2009

While most 'gurus' continue to throw up poor recommendations, one group of investors has performed exceptionally well and has the results to prove it.

It might strike you as perverse, but the Bank of England, or rather the pension fund for the Bank, has been one of the best investors throughout 2008.

They won the game by not playing at all.

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You see, last year the fund underwent a major shift as it "made a fundamental change in investment strategy, as a result of which the Fund's assets are now predominantly invested in gilt-edged securities." They sold all their stocks and bought government bonds at the top of the bull market in stocks and the beginning of the bull market in government bonds. And now they've made another big call

A recent report from the Bank shows that the fund called the top in government bonds. They've sold out and moved into index linked gilts. That's a bet on inflation and they've gone all in. The asset allocation of the Bank's fund has gone from having a quarter of the pot in index-linked gilts in 2007 to more than 70% in 2008.

You should consider following this trend as inflation starts to creep back into the picture

What will cause the inflation explosion?

While recent figures show that the UK is on a deflationary path, we expect this to be short lived. The rapid increases to the supply of money will bring about the return of inflation.

The label "quantitative easing" (or QE) describes the purchase by the Bank of England and HM Treasury, of gilts and other assets such as corporate bonds. Through a chain of events following these purchases, bank deposits and commercial bank reserves rise. And this raises the supply of money in circulation. The process may be more complex than it once was, but in effect it is no different to turning on the printing presses and handing out wheelbarrows full of brand new ten pound notes to people in the street.

QE could bring about an abrupt increase in inflation as soon as the "velocity" of money recovers, just as it did in the 1970s. In plain English, that means that inflation will not creep back up on us, but go from nought to 100 in the blink of an eye.

And this is exactly what the policy makers are hoping for. As legendary economist Irving Fisher famously said: "Depressions are curable through reflation and stabilisation." The Bank of England certainly hopes so, both for the economy's sake and for their pensions.

But what you need to know is how to protect yourself from inflation

How to buy inflation protection

There are three time-tested solutions to inflation: stocks, gold and index-linked bonds.

Stocks are a good counterweight to inflation as they have the potential to appreciate in value greater than the rate of inflation.

Gold is a true store of wealth that is not devalued by inflation.

Index-linked bonds are a class of debt security that directly track the current level of inflation.

They're all good options - and, for the time being, we recommend investing in stocks. As we've said before here in The Right Side, stocks are the best way to beat inflation and to grow your wealth over the long term. The fact that you have inflation at all is evidence that many companies are successfully passing on price increases to customers. This will allow shares to rise even when inflation is climbing.

I would recommend targeting the blue chip companies that have a dominant position and lead their sectors. A company with price-making power is what you are aiming for. Think companies like GlaxoSmithKline (LON: GSK) and Tesco (LON: TSCO) that have dominant market positions and raise prices without losing market share. And think quick as it's time to act

There's a lot of new money, billions of pounds, sat on pieces of paper and electronic accounts. When the QE starts to filter through and banks start lending that will bring about the return of inflation.

We know it and the pension funds know it too. They've already taken action and we advise you to do the same. Inflation insurance comes in all shapes and sizes, but for the time being we recommend stocks for the long run.

Theo Casey is Investment Director of The Fleet Street Letter. Theo is currently putting together a comprehensive anti-inflation strategy. Find out more about The Fleet Street Letter here .