Why the energy sector is a good hedge against inflation

Q: What asset classes might investors consider if they’re worried about inflation?

A: Having inflation protection in a portfolio is incredibly important and there are cheaper ways to get that protection than TIPS. While there’s not one substitute for TIPS, there are other asset classes that do a good job of hedging against inflation that investors may want to consider. Within fixed income, floating-rate notes and bank loans that will reset as interest rates go higher are options. On the equity side, some of the natural resource companies, and particularly energy companies accessible through the iShares S&P Global Energy Sector Fund (IXC), can do a very good job of hedging against inflation. And right now, those companies offer a fairly generous yield. Finally, though I advocate it be a small part of a portfolio, gold can be an effective inflation hedge over the long term.

Why the energy sector is a good hedge against inflation

Market Realist –The graph above shows how inflation rates and the energy sector (XLE)(XOP) have moved in the last ten years. The latter seems to move similarly to the former. In fact, the energy sector is a better hedge against inflation compared to even the S&P 500 (SPY)(IVV). The fact that gas is part of the Consumer Price Index (or CPI) could partly explain that advantage.

So investors looking for an alternative to gold (GLD) can consider investing in the energy sector to shield themselves from the wealth-eroding effects of inflation.

Please read Market Realist’s series Why you should ready your equity portfolio for rising rates to learn more about positioning your portfolio.