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How to Save Your Wealth From Stagflation

Stock-Markets / Stagflation Aug 18, 2011 - 08:00 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleSean Hyman writes: The year was 1973.

I was just a toddler, so I couldn't fully appreciate the next-generation Camaro that had just come out or the release of the new Pontiac Firebird Formula.


But of course, very few remember 1973 as the year of the Firebird or Camaro. That's because something else was brewing that would push the U.S. economy off a cliff.

An organization that most Americans had not yet heard of called the Organization of Petroleum Exporting Countries (OPEC) was about to flex some muscle, and punish the U.S. economy.

OPEC Tries to Get Revenge on America
In 1973, the U.S. government re-supplied the Israeli military during the Yom Kippur war. The decision-makers at OPEC didn't like that one bit. So they decided to get even.

As payback, they significantly cut back the flow of oil to the United States.

This cutback in oil production from OPEC lasted until March of 1974. This, along with other factors, helped to slow down our economic growth while inflation soared. Up until that point, economists had said "high prices" and "sluggish growth" were nearly impossible.

But there it was: a new phenomenon known as stagflation.

With oil prices rising, corporations had to pay more to transport their goods. They had to raise prices to cover transportation costs. Suddenly everything Americans bought cost more − practically overnight.

The economy went south. Corporate profits slowed, and stocks went into a two-year bear market. Companies also had massive layoffs, and unemployment rose to 8.8%.

Meanwhile, the new fiat dollar slumped in value.

All this happened just because some oil bigwigs decided to decrease our oil supply. After all, prices only rise either because demand increases or the supply decreases (or both). In this case, it was the decreased oil supply.

These problems persisted for quite some time, too. You see, even though the oil embargo was over in March of 1974, gas prices continued to soar until March of 1981. In today's dollars, the peak price was equivalent to $3.41.

Back in the 1970s there wasn't much the average person could do to fend off the effects of stagflation on their personal finances. Americans either had to sit in cash or watch their stock portfolios bleed money.

Same Stagflation, Different Market

Today's markets are shockingly similar to the 1970's stagflation. We have the same sluggish growth, and the same rising prices.

One difference: The last time we saw stagflation it was a supply-side issue. This time it's mainly a demand-side issue.

We simply have too many people chasing the same amount of oil.

The world's population has grown from 6.1 billion people in 2000 to 6.9 billion this year. It's said we'll hit the 7 billion mark as soon as October. As a result, there's been a huge increase in demand for oil/gasoline.

At the same time, we are seeing more affluent people in places like China and India. This rising middle class has not only grown in numbers - but in influence.

Many have traded walking or bike riding for cars. This has led to a huge surge in the growth of the automobile market in these nations. So much so that the largest car shows are now in China instead of Detroit.

In short, this higher demand has forced oil and gas prices higher once again.

This problem has been growing since 1999. However, most people didn't realize it until oil prices surged significantly in 2008. People were screaming bloody-murder when oil reached $147 a barrel.

As I said earlier, gas prices peaked at the equivalent of $3.41 cents in 1981, but in 2008 they rose to an average price of $4.12. In fact, earlier this summer, prices were still over $4.00 a gallon. (Right now, they are about $3.58 a gallon according to AAA.)

All of this is the inflation side of stagflation, but what about the stagnation?

A Picture of Stagnation
U.S. gross domestic product (GDP) increased at a paltry 1.3% annual rate in the second quarter. And first-quarter quarter growth was revised down to 0.4% from 1.9%. Generally speaking, a growth rate of 3% or higher is needed to create jobs.

The combination of a slowing growth rate and rising inflation has kept corporations from hiring as they normally would. When your costs are rising, you have to "cut the fat" somewhere − and one of the easiest things to cut back on is employees. That has kept unemployment numbers bobbing around 9% to 10% since 2009.

It's a wicked combo: high costs, slow growth and high unemployment.

Stagflation-Fighters for Your Portfolio
Fortunately, one thing has changed for the better since the 1970s. We now have a couple of tools to help fend off the worst effects of stagflation.

The 1970s were the prehistoric days for the currency market. Only the big institutions traded, and the little guys like you and me were left out in the cold as the dollar sunk and prices rose.

Commodities weren't that easy to buy and sell, either.

But this time around there is a way to fend off the higher prices, and even compensate for some of the slow growth, by using both currencies and commodities.

Principally, there are two ways to protect your wallet − both related to soaring energy costs:

•Use oil and gas exchange-traded funds (ETFs) to mirror price moves in commodities.
•Invest in the currency of an oil-exporting country - preferably one with a stronger economy than the U.S.
Back in the "70s there was no such thing as an ETF. So there was really no easy way to hedge against - or profit from - rising oil prices.

Today, you can buy an oil ETF - such as the iPath GSCI Crude Oil Total Return Fund (NYSE: OIL) - through your regular stock brokerage account when you feel oil prices are going to rise. Even better, you can check out the Untied States Gasoline Fund LP (NYSE:UGA), so you're the one smiling at the pump as gas prices rise.

Oil-exporting countries also love it when energy prices rise. So another way to join the party is to buy the currency of an oil-exporting nation, like the Canadian dollar.

Of course, an even better way to trade the Canadian dollar is by shorting the U.S. dollar vs. the Canadian dollar - the USD/CAD pair - in the spot forex market.

The USD/CAD pair has a HUGE inverse correlation to oil. So as oil rises, USD/CAD heads lower overall.

My neighbors always ask me how I can still smile as gas hits $4 a gallon. That's because I've protected myself trading the Canadian dollar the entire time gas prices have climbed.

However, not everyone is as fortunate as you and me. Most mainstream investors still don't know the first thing about the commodity markets (let alone the currency markets). So I humbly suggest you use this knowledge to your advantage.

Bottom line: 1970s-style stagflation is already here. Make sure you use the tools at your disposal to protect yourself and your family.

[Bio Note: With the outlook for the dollar and the euro growing increasingly bleak, many readers have asked us about currency trading. So we decided to respond by bringing on a new currency expert - Sean Hyman. Hyman is a veteran currency trader with more than 20 years of experience. He also currently serves as Investment Director for World Currency Watch. Watch for his columns on currency trading in Money Morning.]

Source :http://moneymorning.com/2011/08/18/two-easy-ways-to-save-your-wealth-from-1970s-style-stagflation/

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