In the first quarter of 2010, Canada’s economy posted an annualized growth rate of 6.1%. That’s the fastest pace in more than a decade, and much stronger than the 5.8% that the Bank of Canada and consensus forecasts called for.
The sharply higher growth has added to investor concerns about inflation, and was part of the reason why the Bank of Canada raised its key interest rate by 25 basis points, to 0.50%, on June 1. That’s the first time the bank has raised the rate since 2007.
However, despite the sharp rise in economic growth, Canada’s current inflation rate of 1.8% (as measured by the consumer price index) is still well within the Bank of Canada’s target range of between 1% and 3%.
Keep higher inflation in mind — but don’t go overboard
We think inflation could well move higher over the next few years, and you should keep this inflationary potential in mind, but making investment decisions based solely on inflation concerns can expose you to other, more harmful risks.
For example, inflation typically pushes up the prices of commodities. That makes resources one of the sectors that can be a useful inflation hedge in a portfolio. But commodity stocks operate in one of the most volatile and erratic sectors. It’s better to be late and/or under-represented in this volatile sector, rather than to get in early and sit through a slump with too much committed to commodity stocks.
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Over the next year or even two, resource prices are likely to continue to be highly erratic as the global economy continues to recover. Meanwhile, commodity consumers are likely to find innovative ways of making do with less, including redesigning products, substituting materials and so on. This will whittle away at demand growth. At the same time, commodity stocks will continue to bring new production on stream.
Even many of the most pessimistic observers now feel that resource prices are bound to rise over the next few years, as millions of Indian and Chinese workers pole-vault into the middle class. But many pessimists felt the same way following the last great resource-and-commodity boom, which occurred in the 1970s and 1980s. After that boom ended, commodity stocks went into a slump that lasted more than 15 years.
We strongly doubt that we’ll see anything so extreme this time around. But we plan to err on the side of too little rather than too much exposure to commodity stocks over the next few years.
So, rather than looking for specific companies or sectors that will gain the most from inflation, we’d stress that you should follow our long-standing advice: invest mainly in well-established companies, and spread your money out across the five main economic sectors (Manufacturing & Industry; Resources; Consumer; Finance; Utilities).
If you follow this advice, you’ll improve your chances of making money over long periods, regardless of inflation.