International Inflation Protection

By Aaron Levitt | March 29, 2010 AAA

During the global credit crisis, the Federal Reserve pulled out all the stops in order to jumpstart the economy. While efforts seem to be working, they are not without unintended consequences. With interest rates still hovering around zero and soaring federal and state budget deficits, investors are beginning to really worry about the effects of inflation on their portfolios.

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Investors put more than $7 billion to work in ETFs that follow Treasury inflation protected securities (TIPS), such as the iShares Barclays TIPS Bond (NYSE:TIP) or the SPDR Barclays Capital TIPS (NYSE:IPE). These bonds that are designed to increase dividend payments as the consumer price index rise.

Gold, considered the "ultimate wealth preserver" has seen its price skyrocket and the SPDR Gold Shares (NYSE:GLD) has become the second largest ETF, with assets approaching $40 billion.

However, TIPS haven't had to deal with a real bout of high inflation since they were first issued in the nineties, and gold has retreated quite sharply from its record highs. Many investors may want to consider other options for inflation protection in addition to TIPS and gold.

Commodity-Driven Economies
With the world's exploding population and faster growing emerging market nations, scarcity of resources is one the driving forces behind inflation. An investment strategy that benefits from exposure to the leaders in the global pursuit of commodities can do wonders in stemming the cold hand of inflation. The general worldwide market recovery will drive the prices for natural resources as per capita usage increases. Companies domiciled in commodity-based nations provide investors an opportunity for growth and higher income.

In addition, commodity-based economies are typically driven by exports. These export-based financial systems can make great inflation hedges due to their strong trade balances and higher interest rates that support their currencies. (For a related reading on commodities, take a look at Big Dividends in Oil and Gas.)

As Easy as ABC
Adding a dose of commodity-rich economies to a portfolio is actually quite easy due to the plethora of exchange-traded funds on the market. Using these mature export driven nations we can develop a quick and simple portfolio that offers exposure to commodities without many of the related challenges associated with direct investment.

Australia was the only major economy to avoid recession in 2009 and was the first G-20 nation to begin tightening interest rates. Providing developed commodity rich market exposure to the high growth emerging areas in Asia, its economy is expected to grow at 3.75% in 2010. China will continue to grow at its rapid pace and will look to Australia for its resources, as will India, South Korea and Japan.

A healthy banking sector combined with prudent fiscal responsibility make the nation an ideal place for future inflation fighting. Investors can buy the nation using the iShares MSCI Australia Index (NYSE:EWA) which currently has more than a third of its holdings in commodities. Investors wanting to play the weakness of the greenback versus the Aussie can do so using the CurrencyShares Australian Dollar Trust (NYSE:FXA).

With its growing trade surplus and large balance of foreign reserves, Brazil's economy is at the top in South America and quickly approaching major economic superstar status. The nation, which is rich in oil and minerals, is experiencing a mining boom. Brazil is getting richer, which translates to an improvement of living standards for Brazilians. The iShares MSCI Brazil Index (NYSE:EWZ) offers a 53% weighting towards commodities and energy including mega-miner Vale S.A. (NYSE:VALE).

As a top producer of precious and industrial metals and the largest source of foreign energy for the United States, Canada has certainly earned its place in any portfolio. Deals such as Petro China's (NYSE:PTR) $1.7 billion offer for 60% control over two oil-sands projects owned by Athabasca Oil Sands, highlights the increasing demand for its natural resources. One of the soundest banking systems in the world and high renewable water resources add to its investment thesis. The iShares MSCI Canada Index (NYSE:EWC) and the loonie play, the Canadian Dollar Trust (NYSE:FXC) are the easiest ways to add Canada to a portfolio.

The Bottom Line
With interest rates continuing to be at near zero and massive budget deficits plaguing our future, investors are worrying about inflation. While TIPS and gold are a great place to start, other strategies may be necessary. Investing in commodity rich export-based nations are a great way to help keep inflation at bay, and Australia, Brazil and Canada are three of the best for an inflation protection portfolio.

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