The world has entered an unprecedented era in economic history. For years we’ve seen an increasing amount of coordinated Central Bank actions to bolster the economy and head off any sharp financial slowdowns. We’ve become accustomed to these policies, despite being unsure of their long-term consequences. On top of that, governments are now spending increasing funds on Covid-19 pandemic relief programs.
This new fiscal stimulus has a magnified effect. Now, we have both monetary stimulus from easy Central Bank policy and huge budget deficits in many governments around the world. That’s uncharted waters as far as monetary acceleration goes. We’ve seen huge government deficits before, and we’ve had near-zero interest rates since 2008. However, the combination of the two is novel and could lead to unexpected consequences.
One of these would be inflation. Prices have surged so far in 2021. Some of this is due to Covid-19 induced shortages, to be sure. When you freeze supply chains for a time, it leads to various shocks and inefficiencies. However, a broader inflationary trend could be just beginning.
Perhaps all this new monetary supply and government deficit spending will lead to a spiral of sharply higher prices, like we saw in the 1970s. That would lead mean chaos for many investment portfolios.
However, these seven exchange-traded funds (ETFs) are well-positioned to profit from current monetary and fiscal conditions and cash in if the inflationary wave continues to rise:
- Energy Select Sector SPDR ETF (NYSEARCA:XLE)
- iShares North American Natural Resources ETF (BATS:IGE)
- VanEck Vectors Russia ETF (BATS:RSX)
- iShares MSCI Chile Capped ETF (BATS:ECH)
- Horizon Kinetics Inflation Beneficiaries ETF (NYSEARCA:INFL)
- iShares TIPS Bond ETF (NYSEARCA:TIP)
- VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (NYSEARCA:EMLC)
Best funds to Buy during Inflation: Energy Select Sector SPDR ETF (XLE)
The Energy Select Sector SPDR ETF invests in the largest oil and gas companies in the United States. That gives you exposure to the traditional giants such as Chevron (NYSE:CVX) along with newer leaders that have come up in fracking, shale and other specialized technology. There’s also some exposure to pipelines and oil refineries as well.
The appeal of this fund should be obvious in an inflationary environment. For all the green revolution we’ve seen so far, renewable energy makes up just 14% of the world’s total consumption, as per International Energy Agency data. Nuclear chips in a decent amount too, but the vast majority of the world still runs on oil, gas and coal. Needless to say, oil and gas aren’t going anywhere for at least the next 10 or 15 years, as priority number one is reducing coal usage.
And now, particularly with many governments seeking to limit or outright ban new oil exploration and drilling, a supply shortage could be setting up. Energy has been in the dumps since 2014 anyway, so oil producers have cut back investment in the industry. Combine a shrinking oil supply with sharply higher demand post-Covid and an inflationary wave, and oil could be set for a moonshot. With so many other commodities such as lumber and copper blasting off already this year, it wouldn’t be at all surprising if oil goes next. And when it does, XLE will soar.
Best funds to Buy during Inflation: iShares North American Natural Resources ETF (IGE)
The iShares North American Natural Resources ETF gives investors another way to play energy with a broader platform. The emphasis on North America allows the IGE fund to include a significant number of Canadian companies in its holdings. Many of the highest-quality energy firms, historically, have hailed from Canada. These include IGE holdings Enbridge (NYSE:ENB) and Suncor (NYSE:SU). An investor that only owns U.S.-focused funds might miss out on these firms.
The broader emphasis of this fund on natural resources allows it to catch some other angles such as precious metals as well. Both the U.S. and Canada have an abundance of minerals and are set to profit if commodity prices keep moving north. IGE looks poised for solid gains in any sort of prolonged inflationary scenario.
Best funds to Buy during Inflation: VanEck Vectors Russia ETF (RSX)
The VanEck Vectors Russia ETF is one of the easiest ways to invest in Russia. The fund is a broad, widely-diversified portfolio focused on Russian equities. As of this writing, 33% of this Russia fund is invested in energy stocks, and another 28% is in basic materials. This gives investors tons of exposure to Russia’s enormous reserves of oil, natural gas, iron and other key minerals.
An investment in Russia comes with plenty of political risk, to be sure. Russia’s government has major strategic differences with the United States and Europe, to put it mildly. There’s always the possibility that geopolitical tensions could flare, endangering an investment in the Russia ETF if Russia is hit by additional tariffs. That said, any volatility in, say, the Middle East would likely result in sharply higher oil prices, which would make Russian firms such as Gazprom far more profitable.
And speaking of profits, Russia has plenty of them. Russian stocks trade for a P/E ratio of around 10x. That’s incredibly cheap regardless, and even more so once you consider that profits are currently depressed due to the Covid-19 economic shutdown. If inflation really gets cooking, commodity prices will soar, sending RSX stock sharply higher.
Best funds to Buy during Inflation: iShares MSCI Chile Capped ETF (ECH)
Chile is another country set to benefit from sharply higher commodity prices and inflation. Chile is historically one of the world’s key copper exporters. Given the country’s small overall population, it earns a ton of income per capita from its exports of copper, gold, silver, and other such metals. The price of copper has doubled recently, as supply shortages mount. Copper is an integral component for building housing, cars, renewable energy equipment, and more, making it a hot asset to own in this economic expansion.
Chile has another angle to benefit from both growth and inflation as well: Lithium. Chile has huge lithium deposits in the Atacama Desert. Lithium is an integral component for batteries, and, by extension, electric cars. All the post-Covid investment in infrastructure is likely to lead to surging demand for batteries and thus lithium. This gives investors in Chile another way to win as the world economy charges back up post-Covid.
Horizon Kinetics Inflation Beneficiaries ETF (INFL)
It’s right there in the name. If you’re worried about inflation, you should give this ETF from fund manager Horizon Kinetics a look. It is designed to own equities that will prosper in a highly inflationary environment.
It owns many of the stocks that you’d expect it to own, such as oil, gold and agricultural production companies. However, there are some interesting diversifying picks in there. There are holdings such as land trusts and royalty trusts that should see higher residual revenue streams as prices go up, but which minimize the direct operating exposure you have with, say, mining.
The INFL fund also owns some less obvious plays on inflation. Think of areas such as stock exchange operators and health care providers. These are solid growth businesses that can easily raise prices and have favorable capital structures for an inflationary world. Consider health care, for example. It’s one of the most obvious pain points in terms of spiraling costs in recent years. Owning some health care stocks is a sensible, if slightly unorthodox, method of hedging yourself against runaway inflation.
iShares TIPS Bond ETF (TIP)
There are also ways to hedge against inflation in fixed income funds. For example, there’s the iShares TIPS Bond ETF. This owns a variety of U.S. government-issued bonds that are naturally constructed to remove inflation risk.
How’s it work? An inflation-protected bond pays a set fixed interest rate (generally around zero as of late) plus the change in the consumer price index (CPI) as its total yield. So, if the inflation rate is 2% in a given year, the bond would also yield around 2%. However, if inflation suddenly jumps to 7%, let’s say, then the inflation-linked bond would also start paying 7%.
If inflation remains subdued, then TIP would be a poor investment. However, if it takes off, then TIP will crush its fixed income counterparts. In a stagflation sort of scenario, fixed income investments tend to get crushed. TIP would be one of the few bonds funds that would prosper while its peers dropped sharply.
VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC)
There’s another way to hedge inflation in fixed income. This one assumes that you are also bearish on the U.S. Dollar in particular. If so, consider buying foreign currency government bonds. The EMLC fund buys a broad basket of emerging market government bonds.
These are denominated in their local currencies, and thus will rise in value as the dollar declines. Additionally, many of these emerging market rely on commodities to fund their budgets. Thus, as oil, gold, copper, etc. go higher, their governments will have more and more tax dollars with which to repay debts and invest in local infrastructure and social services.
Also, because these are emerging markets, they tend to pay far higher interest rates than in the U.S. Right now, the EMLC fund is offering a 4.8% dividend yield. That’s pretty solid from a bond fund in today’s world. As a perk, the dividend is paid out monthly as well. And, if the U.S. Dollar heads significantly lower, EMLC could throw in a substantial capital gain in there along with the dividend.
On the date of publication, Ian Bezek held a long position in ECH, SU, and ENB stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.