With fears of a global recession growing, analysts are starting to speculate that central bankers will cut interest rates further in the near future. They usually cut interest rates when growth is slowing in a bid to stimulate demand and then increase rates when the economy is growing in an attempt to control inflation.
The theory is that higher interest rates will incentivise consumers to save more money, which means demand for goods and services slows. Price growth should moderate as a result. Cutting rates should have the opposite effect.
Uncharted territory
The problem is, since the financial crisis, central banks have been cutting rates aggressively. But these actions have not stimulated demand as expected. The situation has got so bad that some central banks around the world are imposing negative interest rates, which means consumers are having to pay to keep their money in the bank.
At the same time investors, fearing further interest rate reductions, have rushed to buy bonds which offer some kind of yield. This has had the effect of pushing bond prices up and yields down to negative levels. Investors are now actually paying to lend money to countries such as Germany and Switzerland.
The financial world has never before seen such a strange setup, and this is why many analysts are recommending investors buy gold.
Store of value
Gold is the world’s global currency, and has proven to be an excellent hedge against inflation over the long term. This is important because negative interest rates mean savers’ money isn’t protected from rising prices.
If inflation spikes thanks to negative rates, the purchasing power of your money could quickly evaporate if you’re not receiving any interest on cash deposits. Owning gold should provide some protection against this, although I highly recommend combining it with dividend-paying stocks as well.
Dividend stocks
Gold has proven itself to be a great hedge against inflation over the long term, and so have dividend stocks. High-quality ones such as Diageo have an impressive track record of increasing their dividends in line with earnings growth. As earnings tend to grow with inflation over the long term, this should provide a measure of protection against rising prices.
If you don’t know which is the best dividend stock to invest in the current environment, it might be just as easy to buy a low-cost FTSE 100 tracker fund.
Over the past 10 years, the FTSE 100 has produced an average annual return for investors in the region of 8%, more than enough to offset the scourge of inflation. The index’s dividend yield of 4.5% is also significantly above the interest rate available on most current accounts today.
When combined with the gold price, I believe the FTSE 100 could be a great way to protect your portfolio from rising prices and negative interest rates, as well as any fallout from Brexit.
