Hard Assets Make Gains in The Face of Economic Uncertainty

There is an old saying, “You have to see it to believe it.” This is the strongest argument for an investment in hard assets. The appeal for many investors is that hard assets can be seen and touched, making them tangible and somehow safer to invest in.

The four hard asset investments below have demonstrated the ability to preserve investors’ capital. As well they have shown that they can make gains in the face of economic uncertainty and the rising costs of living.

Precious Metals

Gold has seen has seen a meteoric rise in value. Prices of this hard asset have appreciated over 500% since the year 2000 alone. Buying gold bars, coins, and jewelry ensures that the value of the assets in your hand will move in partnership with spot gold pricing.

The appeal of investing in silver and platinum is two-fold. On one hand, the precious metals are considered to be a worthy hedge against inflation. On the other hand, widespread industrial use is what separates platinum and silver from gold, and really adds to its value.

Farmland

An expanding agribusinesses has caused the price of farmland to greatly appreciated in recent years. Historical data shows us that this hard asset – between 1987 and 2004 – averaged annual increases of 4.8%. Farmland prices averaged annual gains of 15% between 2004 and 2008, demonstrating to investors that this hard asset can deliver returns uncorrelated to broad equity markets.

Shipping Containers

Much like other hard assets, shipping container investments have the potential to generate impressive, uncorrelated returns. This is especially true when stock markets are performing poorly. Directly tied to the global economy, shipping containers are used to transport approximately 95% of the world’s cargo. This consistent demand over the last half century has treated investors to returns as high as 35%, even during the global financial crisis in 2008-2009.

Collectibles

Most collectibles, like classic cars and fine wine, are luxury goods that can also be used for personal enjoyment. These hard assets are a viable alternative investment for one simple reason; they can preserve an investor’s capital because they posses intrinsic value given their limited supply.

The Challenge To Owning Hard Assets

The challenge with owning hard assets is that they often require proper storage. Like investing in fine wine for example, careful maintenance is needed to retain and increase the investment’s value. Gold bars must be securely stored, farmland must be mowed, and classic cars and shipping containers must be maintained. If this is something you cannot do yourself, it may become an additional, unexpected expense.

Economists Use Inflation to Describe a Rise in Price Level

Inflation occurs when the general price of the goods and services you are buying are rising and, as a result of the increase in cost, the purchasing power of your money is falling. The term may also be used to describe a rising price level within a narrower set of assets, goods or services within the economy. These include commodities (such as food, fuel, metals), tangible assets (such as real estate), financial assets (such as stocks, bonds), services (such as entertainment and health care), and labor.

Economic Terms Related to Inflation

Most economists today use the term inflation to refer to a rise in the price level. An increase in prices is called price inflation, which distinguishes it from monetary inflation, which occurs when there is a rise in money supply. Other economic terms related to inflation include:

  • Asset Price Inflation – a general rise in the prices of financial assets without a corresponding increase in the prices of goods or services.
  • Deflation – a fall in the general price level.
  • Disinflation – a decrease in the rate of inflation.
  • Hyperinflation – an out-of-control inflationary spiral.
  • Reflation – an attempt to raise the general level of prices to counteract deflationary pressures.
  • Stagflation – a combination of inflation, slow economic growth, and high unemployment.

Purchasing Power

The rising costs/loss of purchasing power affects economies in various ways; both positive and negative. As a consequence, there are hidden costs to some and benefits to others. From a negative perspective, the uncertainty about the future purchasing power of money discourages investing and saving. For example, inflationary expectations and interest rates will determine the risks associated with bond investments. Inflation is a bond’s worst enemy; it erodes the purchasing power of a bond’s future cash flows.

Generally speaking, economists favor a low and steady rate of inflation. This is because a low figure, as opposed to zero or negative, reduces the chance that an economic recession will occur. Moreover a lower figure reduces the risk that inflation will undermine the performance of your investment portfolio.

The Five Greatest Risks Facing Investors Investing in Bonds

Although bonds are a great tool to generate income, and are widely considered to be a safe investment especially when compared to the risks of investing in stocks, investors need to be aware of some of the potential challenges to holding corporate and/or government bonds.

The greatest risks posed to bond investors are:

  1. Interest Rate Risk
  2. Reinvestment Risk
  3. Inflation Risk
  4. Default Risk
  5. Liquidity Risk

Interest Rate Risk

Interest rates and bond prices enjoy an inverse relationship. As interest rates fall, the price of bonds trading in the marketplace generally rises. Conversely, when interest rates rise, the price of bonds is likely to fall.

Reinvestment Risk

Another challenge facing bond investors is something called reinvestment risk. This is the risk of having to reinvest investment proceeds at a rate that is lower than the funds were previously earning. Over time, this reinvestment risk can have an adverse effect on an investor’s investment returns.

Inflation Risk

If the cost of living and inflation increase dramatically, and at a faster rate than income investment, investors will see their purchasing power erode and may actually achieve a negative rate of return.

Default Risk

When investors purchase bonds, they are actually purchasing a certificate of debt. This is money that is borrowed and must be repaid by the company over time, with interest. The risk with this is that corporate bonds are not guaranteed. Instead, these bonds depend greatly on whether the company is able to repay that debt.

Liquidity Risk

Although there is almost always a market ready to purchase government bonds, corporate bonds are sometimes entirely different. There is a risk that an investor might not be able to sell his or her corporate bonds, or may be forced to take a much lower price than expected to sell the bond.

Accounting For Bond Risks

Aside from interest rate risk, which is the most well-known of risks in the bond market, reinvestment, default, and liquidity risk should also be closely considered when choosing to pursue a bond investment.

In an effort to protect themselves, investors can can learn more about the risk of different bonds from a credit rating agency like DBRS, Fitch, Moody’s or Standard & Poor’s. These agencies rate the issuer’s ability, in the opinion of the agency, to make regular interest payments and to pay investors back when the bond matures.

Additionally, investors should read investment reviews and adopt a strategy that chooses a mix of bonds with different features. This increases the odds that some of your bonds will perform well at times when others do not. Investors should consider buying a mix of government and corporate bonds that contribute to a well-built portfolio, and account for financial goals and tolerance for risk.