By Aaron Katsman

We are always complaining that prices that we pay for goods and services are always going up. Listen to the news and you will hear that the price of bread is going up, as is the price of gasoline. In addition, in order to escape the economic slowdown that has gripped the world, the US and almost every other country, is printing money 24 hours a day, 7 days a week to meet the trillions in new government spending.

We hear the term “Inflation” thrown around but what is it and how does it impact our investments?

Definition

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar can’t buy the same goods it could beforehand.

Inflation and Investment

With little in the way of economic growth in sight, the threat of inflation seems mild. Many analysts say that it could take months before we need to worry about inflation. With all due respect to those analysts, we have actual data that shows the economy is inflating. Data just released in the US showed higher consumer prices, and in Israel, we have had 4 consecutive increases in the CPI (Madad).

If it appears that we are going to enter a period of high inflation, and what we said above is true that inflation erodes the purchasing power of your money, the question for investors is how to protect your portfolio against a spike in inflation?

There are 3 traditional inflation hedges that investors use to protect their portfolios. The general principal is to buy something now and sell it later, after inflation has increased the price of the product.

The most popular hedge against inflation is to buy gold. According to Blanchard Economic Research, “Gold is renowned as a hedge against inflation. The most consistent factor determining the price of gold has been inflation - as inflation goes up, the price of gold goes up along with it. Since the end of World War II, the 5 years in which U.S. inflation was at its highest were 1946, 1974, 1975, 1979, and 1980. During those 5 years, the average real return on stocks, as measured by the Dow, was -12.33%; the average real return on gold was 130.4%.”

In recent times the use of commodities aside from gold has gained in popularity. Corn and wheat are just some of other base commodities that increase in price during inflationary periods.

The problem with gold and other commodities is that they are not very liquid. For those investors who require a high level of liquidity, government bonds linked to the inflation rate may be the way to go. In the US these bonds are called TIPS (Treasury Inflation Protected Securities). TIPS come with the same guarantee as other US government bonds, and investors will see an increase in interest paid if inflation increases. While in the US, CPI-linked bonds are rather new, in Israel (where we have seen hyperinflation) inflation linked bonds are very popular.

Don’t wait for inflation to arrive to start thinking about protecting your portfolio, because by then it may be too late. Get a head start now and protect the value and purchasing power of your money.

Aaron Katsman is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. a registered broker dealer, Member FINRA, SIPC, MSRB, NFA, SIFMA. For more information, call (02) 624-0995 or email aaron@lighthousecapital.co.il.

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The US dollar is flying by almost 2% against the Shekel this evening after the Bank of Israel said that they were stepping up the purchase of foreign currency.

According to Globes: “The central bank says it will buy government bonds to the tune of NIS 200 million daily, and will continue its program of expanding the foreign currency reserves at an average rate of $100 million daily.”

Why the need to weaken the Shekel? It has already dropped buy almost 30% in the last 6-9 months against the greenback. Trying to ignite an economy via inflation is bad news. Come to think of it wasn’t current BOI head Stanley Fischer head of the IMF back during the Asian, Russian and Latin American financial crises at the end of the ’90’s? Isn’t this a similar policy to what he recommended then? If so, look out. I sure hope that speculators don’t drive down the Shekel, like they did to Asian currencies 11 years ago.

How about a strong currency and to attract foreign investment, and lower taxes to help ignite long term growth?

Fischer is playing with fire, and if his track record is any indication, look out!

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The Bank of Israel surprised analysts by cutting interest rates a full 50 basis points to 2.5% This is the lowest level rates have ever been in Israeli history. Clearly this is a signal that the BOI is expecting much slower economic growth moving forward. Coupled with non-existent inflation it appears that the BOI felt that a bigger rate cut than was expected was justified to hep jump-start the economy.

As a result the Shekel looks to be weakening slightly and look for a move up in Israeli bonds tomorrow.

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Aaron Katsman is Managing Editor of the Israel Opportunity Investor newsletter. He is lead portfolio manager for the Israel Growth Portfolio and Managing Director of America Israel Investment Associates, LLC. For more information, go to www.israelnewsletter.com or call 1-888-327-6179, or email aaron@profile-financial.com.

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As inflation rears its head around the world, Israel is no different from many other countries that have seen prices spike as of late.  Where Israel differs from the rest of the world is not in experiencing inflation, but how the economy is leveraged to it.

Let me explain: Israel suffered from bouts of hyperinflation during its 60 years of existence.  Most salient was the 1970s which saw double digit inflation throught the decade, culminating in 100+% inflation in 1979.  The beginning of the 1980s introduced stagflation and saw even higher inflation rates.

Here’s where the history impacts today’s Israel: in an effort to combat hyperinflation, Israel created an economy-wide phenomenon of CPI-linked debt.  This debt is not specific to a specific sector and according to a report produced last week by UBS’s Israel analysts, may compose over 50% of corporate debt, over 60% of the government’s shekel debt, and 60% of mortgages.

After the last couple of boom years 2005-2006, most of the corporate debt raised by Israeli firms is also linked to the CPI.  Merrill Lynch is out this morning as well with a study on the effects of higher CPI on Israeli firms.

The money line from the UBS report: However the spike in CPI in Q2 could affect the bottom lines of many Israeli corporates and we are concerned that a continued high inflation could continue to weigh on the profitability of many Israeli companies.

So, what’s an investor in Israeli firms traded in the U.S. to do?  UBS suggests underweighting those institutions with high CPI exposure.  The storm feared by analysts would play out with consumers being hit with rising prices in the market also being compounded with resets in adjustable rate mortgages that are linked to the CPI.  In turn, this could curb consumer spending which is playing a bigger and bigger role in GDP growth.

While Olmert clings to a feeble position in a government beset by scandal, UBS suggests that “the rise in CPI will also have fiscal implications as the Government could be squeezed by paying more on its CPI linked debts as well as collecting less corporate taxes.”

Zack Miller
IsraelNewsletter.com

(Another Globes article out this morning entitled ‘Ticking Bomb‘)

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