Posted on 02/22/2004 4:24:15 PM PST by BenLurkin
Dear Analyst, With the dollar sliding against foreign currencies and historically low interest rates, should I be worried about inflation and buy gold or some commodity?
George M.
The pathway of macro-economic forecasting is littered with failed predictions. We need only look back to 2003 to see that absolutely no one saw the robust 8.2% GDP growth coming in the third quarter. If you are good at predicting economic trends, congratulations. For everyone else, thankfully there's a way to hedge your bets by selecting companies that have a better-than-average ability to adapt and respond to changing economic conditions.
There's no silver bullet to fight inflation. If you know for sure it's coming, then gold and other hard assets look like attractive places to invest. However, I think selling all of your stocks in favor of bullion is a bold move that could leave your portfolio in the dust should your inflation fears prove to be overdone. The problem is that gold doesn't create value over time like a business can. Consider an example of gold's purchasing power over the ages: An ounce of gold would be enough to buy a nice cloak in the Roman Empire, and at around $400 per ounce it's still enough to buy a decent department store suit today. A sounder investment approach, in my opinion, is to own a few carefully chosen companies that have the ability to raise prices in the face of increasing raw-materials costs, thereby protecting against inflation and retaining the potential to create real value over time.
Don't get me wrong; inflation is bad news for just about every company. It's very difficult for managers to construct long-range business plans when they aren't sure how much things will cost and at what price they'll be able to sell goods and services. Still, you can alleviate a lot of inflation risk if the companies you select can raise prices in line with expenses with relative ease. Net income would take a big hit if costs of goods sold increased much faster than the firm could pass on higher prices to consumers.
Here are some examples of companies that have a favorable pricing relationship with their customers. Screening for companies with wide economic moats is a good place to start when looking for firms with pricing power. These stocks don't get cheap very often, but for that very reason it's worth keeping them on your watch list: They're fundamentally more likely to bounce back if inflation fears ever infect the market.
eBay (NasdaqNM:EBAY - News) This industry leader in online auctions has developed a formidable business through the network effect: The more buyers and sellers the network has, the more attractive it becomes to prospective users, and the tougher it becomes for competitors to contend with. It earns revenue through various fixed listing fees and a percentage of the final sale, a neat way to pin revenue to higher selling prices.
Altria (NYSE:MO - News) Altria's cigarette divisions have famously passed along price hikes to pay for everything from lawyers' fees, legal settlements, and just plain earnings growth. Consumers are very loyal to its brands and will pay higher prices for the products.
Praxair (NYSE:PX - News) Unlike most chemical companies, Praxair's performance is not inexorably tied to volatile oil and natural gas costs. For customers with high volume requirements and consistent demand patterns, industrial-gas firms like Praxair build plants on the customers' sites, supplying the product directly. These facilities require sizable up-front investments, creating a significant barrier to entry. Praxair derives 23% of its revenue from this on-site distribution channel. Long-term "take-or-pay" contracts, which obligate customers to purchase a minimum volume (regardless of whether they need it), make for a stable revenue stream and allow Praxair to pass rising energy costs on to customers.
Northern Trust (NasdaqNM:NTRS - News) Northern Trust enjoys a well-diversified revenue stream that encompasses trust fees, asset-management fees, and traditional interest-related revenue. Steady fee-based income now tops 70% and, for the most part, increases along with the dollar value of assets under management.
Kellogg (NYSE:K - News) Does a box of cereal really cost $5 to produce? Though it learned the hard way in recent years, management realized that selling more boxes of Special K by adding strawberries to them, for example, is easier and more profitable than trying to sell more boxes of Corn Flakes by discounting them.
WD-40 (NasdaqNM:WDFC - News) This little company has gotten by forever with a no-frills marketing plan, which named its flagship product after the laboratory trial: "Water-Dispersion Test number 40." The firm serves a very small household light oil market niche that isn't large enough for other big name chemical players to justify the research & development and marketing expenses needed to launch a competing product. And, how much should a can of WD-40 cost? Three dollars? Four dollars? Five dollars? Consumers who might only be making a purchase once every two years don't really notice price changes at this low level.
Carl Sibilski owns shares in Altria.
Gold
Silver
Copper
Platinum
Diamonds
Oil
That's one of the reasons it's near the bottom of the list. But remember how well they worked for the Jews in Germany just before WWII. Small, easily concealed, world wide liquid market, easily exchanged for any local currency, and non metallic. Another reason for being near the bottom is that you really gotta know what you're doing if you buy diamonds, it's not a game for amatuers.
Yeah, but tumult usually comes after the (next?) round of major inflation.
That's one of the reasons it's near the bottom of the list. But remember how well they worked for the Jews in Germany just before WWII. Small, easily concealed, world wide liquid market, easily exchanged for any local currency, and non metallic. Another reason for being near the bottom is that you really gotta know what you're doing if you buy diamonds, it's not a game for amatuers.
Don't "invest" in gemstones of any kind, especially diamonds, if you're not an expert gemologist and gem dealer. They're not fungible, for one thing, and organized markets don't exist. In all probability you'll be buying at retail and trying to sell back into the market at wholesale. For laymen it's a sucker's game.
Gems can be good investments for knowledgeable people already in the business but only if the right qualities are purchased (preferably at the mine, in the rough) at the right time. Anyone who bought fine Paraiba tourmaline (ever heard of it?) or large Tanzanites at the right price/time would have been very well off. But gems are for adornment, not investment. Don't be fooled by the boiler-room boys and their lies. I know of too many people who've lost their land and life savings to criminal "gem investment" shysters.
Absolutely! Like I said, you really gotta know what you're doing.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.