With Fed Eyeing Inflation Overshoot, JPMorgan Likes Gold, TIPS

Many assets have been labeled inflation hedgers in market lore, but some of them might not work so well as the Federal Reserve considers trying to let inflation run above target.

Everything from broad stock indexes to agriculture and emerging-market assets has been categorized at times as a refuge from rising prices. Financial stocks could counter rising interest rates, while single commodities or base metals might work because resource scarcity can drive inflation, according to JPMorgan Chase & Co. But based on the firm’s analysis, there are two that stand out as the best choices at the moment.

“TIPS and gold seem like the most durable inflation hedges for a unique macro environment when the Fed’s reaction function isn’t the only regime change impacting real assets,” strategists led by John Normand wrote in a note dated Feb. 22. “Also critical are structurally weaker Chinese demand for some commodities (base metals) and structurally more elastic supply for others (oil).”

The Fed appears to be considering trying to let inflation run hotter than its 2 percent target to make up for years below that level, and JPMorgan’s recommendations respond to the “newish attempts” to generate an overshoot. Though of course, for years policy makers, economists and strategists have been overestimating price increases — so this is an insurance policy that investors may never need. Also, the weaker Chinese demand for base metals cited by JPMorgan could be disinflationary.

READ: Fed Officials Talk Up New Approach to Meeting Inflation Goal

Investors are best-off focusing on assets that could benefit from the things that are most likely to happen, JPMorgan said. The strategists recommend the overweight on TIPS, or Treasury inflation-protected securities, based on a forecast that labor markets will tighten further and push up core and headline inflation. They like gold on the idea that the Fed will erode real yields to spur the economy, undermining the dollar.

The source and result of price pressures are key in picking inflation hedges, the strategists wrote. They noted, among other examples, that commodities’ historical gains during inflationary periods are skewed by the oil shocks in 1973 and 1979. Base metals and mining stocks’ track record was boosted by a China credit binge in the early 2000s that no longer exists.

“While we may continue to hold various trades that benefit from the broader macro and policy context, the ones less likely to be unwound until much later in the inflation cycle are these two,” JPMorgan said, referring to gold and TIPS.

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