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Which commodities are the best hedge for inflation?

Investors are alert to US inflation risks as corporate earnings exceed expectations, the US persistently runs large budget deficits, and because of the opportunity for inflationary policies following the presidential election in November. Commodities have demonstrated strong resilience in the face of inflation and have been a critical hedge for bonds and equities when prices and wages are climbing, according to Goldman Sachs Research.

A 1 percentage point surprise increase in US inflation has, on average, led to a real (inflation adjusted) return gain of 7 percentage points for commodities, while that same trigger caused stocks and bonds to decline 3 and 4 percentage points, respectively, write Daan Struyven, head of oil research in Goldman Sachs Research, and analyst Lina Thomas in the team’s report.

The team finds that commodities provide a direct hedge against negative commodity supply shocks, which tend to depress bond and stock returns as interest rates rise, as well as providing a hedge against lower stock returns as rising prices cause GDP growth to slow.  Commodities also tend to rally when inflation is boosted by economic growth, and they can provide wealth preservation when central bank credibility declines.

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