How to profit from inflation and the best investments to make

Inflation was the dominant theme of 2022 as governments and central banks grappled with measures to slow the pace at which consumer prices were rising. These fears over the damage high inflation is causing the economy has continued into 2023 with interest rates set to continue rising for a while yet, increasing the likelihood of a global recession.

But what is inflation? Why is it so closely tracked by central banks and investors? And what are the best investments to make at times of high inflation?

Why does inflation happen?

Inflation happens when the cost of goods and services rises. Typically this is the result of demand outstripping supply, be that for the commodities needed for our food, or a shortage of labour pushing up the wages needed to hire a suitably skilled workforce.

There are different gauges for inflation, which include different elements of a typical household spend to derive their index. The most widely used indices are Consumer Price Index (CPI), Retail Price Index (RPI), the Producer Price Index (PPI) as well as those tracking house prices.

Each country will adjust the basket of products that comprise these indices to best reflect a typical household’s spend. For example, the UK added 19 items to its CPI in 2022. These additions included meat-free sausages, canned pulses, sports bras, pet collars and antibacterial surface wipes, while 15 items were removed, including doughnuts, men’s suits and coal.

These indices are often used by companies to determine how much the price a consumer pays on their phone contract or train season ticket for example rises while pensions are also linked to them.

While high inflation is seen as detrimental to a country’s economic prospects, as it erodes the buying power of the citizens who are on largely fixed incomes, low inflation is regarded as the optimal way for governments to drive growth and productivity in an economy.

The likelihood of the price of an item being more expensive in the future encourages consumers to buy now rather than hold off. If consumers believed goods could be purchased for less in the coming months, they would delay buying them which could then in turn lead to companies cutting back as they are not generating the sales they hoped for. Wages would fall, jobs might be lost and the economy would enter a downward spiral.

It is for that reason that central banks typically have a target rate for inflation at about 2%. This is regarded as the sweet spot between encouraging investment and growth without harming consumer buying power too much.

What are the main causes of inflation?

Sharp spikes in inflation are typically caused by supply shocks. This could be the outbreak of war in a key producing country or region as witnessed in the ongoing conflict between Russia and Ukraine. Ukraine is regarded as the breadbasket of Europe with its vast plains making it one of the world’s largest grain exporters, while Russia was the world’s largest exporter of oil.  

Following Russia’s invasion of Ukraine, the supply chains of agriculture and energy were thrown into disarray with prices surging as a result. While prices are now cooling again, this sustained shock to global markets caused inflation to surge to levels not seen for multiple decades.

A country going through an accelerated growth phase is also likely to drive up inflation. For example, China’s thirst for commodities at the turn of the century drove a huge demand for commodities, metals in particular. This pushed up prices for consumers around the world as a result.

How can you profit from high inflation?

High inflation can erode the value of assets so it is important to consider the types of asset classes likely to suffer during periods of fast-rising consumer prices and those with the potential to keep pace with inflationary pressures.

While it is perhaps asking too much to be able to “profit” from high inflation, it is certainly possible to position your portfolio so that it holds its value.

Best investments to make during inflation

The first protection against high inflation is to have a sufficiently balanced portfolio that is able to withstand not just rising consumer prices but other factors that may hit it, such as recession, housing market crashes and stock market jitters.

As such it is unwise to make an investment solely on the basis of it performing well during periods of high inflation. That said, the asset classes likeliest to perform best are those with the scope to pass on these extra costs to their consumers or those with a finite supply, such as gold and commodities, which a central bank can’t simply print more of.

Quality companies and brands that consumers have built up an assurance with, such as German sportswear manufacturer Adidas, food behemoth Nestle or drinks giant Diageo, are among those worth considering as customers are likely to stay loyal even if the goods go up in price.

Similarly, sectors such as commercial property, with a prevalence of inflation-linked contracts are more resilient to the inflationary storm. However, in the current environment where working from home has reduced the attraction of office space, this sector should be treated with caution, with a focus instead on warehouse and non-office commercial options.

Finally, Kinesis offers two inflation-resilient products in the form of its digital currencies, KAU and KAG. These two digital currencies are backed by physical gold and silver, respectively, and enable holders to benefit from precious metals that can hold their value over time, while also delivering a yield.

Holders of KAU and KAG can spend them with their Kinesis Virtual card, converting their gold and silver-backed assets to local currency whenever they purchase everyday items. Each month, users receive a Velocity yield proportional to their spending activity – paid out in gold or silver. So not only do the two currencies benefit from any gains in the gold and silver price, but the monthly return also helps to ensure holders’ have extra cash to cover the rising cost of goods, making KAU and KAG doubly inflation-proof.

Rupert is a Market Analyst for Kinesis Money, responsible for updating the community with insights and analysis on the gold and silver markets. He brings with him a breadth of experience in writing about energy and commodities having worked as an oil markets reporter and then precious metals reporter during the seven years he worked at Bloomberg News. 

As well as market analysis, Rupert writes longer-form thought leadership pieces on topics ranging from carbon markets, the growth of renewable energy and the challenges of avoiding greenwash while investing sustainably.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.