"A Vision of Financial Security"

 SageInvest,Inc.

Brave New World of Inflation    By A. Raj Kumar          July 16, 2008

                 We have a serious INFLATION PROBLEM in the United States and the rest of the world.  The causes of inflation are the same the world over: rising prices for crude oil, gasoline, natural gas, coal, heating oil, jet fuel, grains like corn, wheat, rice and soybeans, and metals like iron ore, copper, aluminum, and steel.  We know there is inflation every time we go to the gas pump or shop at the grocery store.

 

                 The world of low inflation and low interest rates that we lived in during the last 25 years is gone.  We are now living in an inflationary and resource short world and it has huge implications for our living standards and the way we conduct our daily lives.  We will need to adapt to this new inflationary environment.

 

                 Let me give you a simple example.  Do you know which agency in the U.S. has the largest fleet of trucks (215,000 vehicles)?  It is the U.S. Postal Service and their fuel costs went up by $500 million in 2007 alone.  They need to recover their higher fuel costs.  How will they do that?  They will, of course, raise the price of stamps.  It has already happened and will continue to happen every May.

 

So what are the possible solutions for us consumers to address this problem of escalating stamp prices?  We will need to minimize mailings 1) by paying bills online, 2) by text messaging our birthday wishes, 3) by sending electronic greeting cards, 4) by not mailing Christmas cards and/or 5) by buying hundreds of Forever Stamps so that we have locked in the current price.  Do you see what I mean about adapting and changing the way we live?

 

                 Here is an another example: the high price of gasoline has many people thinking about alternate ways to get to work and to save on gasoline costs.  People are switching to mass transit.  Some people are riding their bicycles to work.  Others are starting to think about car-pooling.  Many more people are telecommuting.  A few employers are switching to four-day workweeks so people don’t have to drive on the fifth day.  Dramatic changes at the workplace are on the way!

 

                 These consumer behavior changes because of high inflation have huge implications.  For example, the U.S. auto industry is undergoing gut-wrenching structural changes.  As you know, sales of SUVs and trucks have fallen off the cliff.  The Big Three have laid off thousands of people and closed dozens of factories.  These companies are shrinking dramatically because they don’t offer small fuel-efficient cars (unlike the Japanese auto companies) that consumers are now demanding.  Their sales and profits are suffering tremendously which is taking a great toll on their stock prices.  Shares of GM, for example, are now trading at prices not seen since the 1950s (around $9)!  More than 50 years worth of wealth for GM shareholders has disappeared.

 

                 Just as the auto executives will need to re-think about competing in the new inflationary world, we will also need to reflect on how our families and we will adapt to this new environment.  We will need to change our mind set.

 

                 Of course the next big question for us as investors is how shall we adapt our investments to this new environment?  What sectors do well in an inflationary economy?  The answer is precious metals (like gold), mining companies, and oil related companies.  In past inflationary times these three sectors were the only ones that actually increased in value; the rest fell in price. 

 

Recently, an interesting class of Exchange Traded Funds (ETFs) came into existence.  They are inverse funds; these funds move in the opposite direction of the stock market so that when the stock market falls, inverse ETFs actually go up in price.  Basically, an inverse fund is short the stock market.  Here are several examples of inverse funds: ProShares Trust Ultra Short Dow 30 (symbol DXD), ProShares Trust Ultra Short QQQ (symbol QID), Rydex ETF Trust Inverse S&P 500 2x (symbol RSW), and ProShares Trust Ultra Short 1000 Growth (symbol SFK).

 

                 These inverse funds are not meant as long-term investments.  They should be used for short time periods only (during downturns) because if we hold them for the long term, we will lose money.  Remember when the market goes up (which is most of the time), inverse funds go down.

 

                 The investment climate during the next few years is going to be extremely challenging.  Be careful.¨

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                 ETFs mentioned in this article are for illustrative purposes only and are not recommendations for individuals to buy.  Past performance is no guarantee of future performance.