Inflation's ETA

Maybe you’ve noticed: The U.S. government is running up quite a tab. From the economic stimulus bill (which I wrote about last month) to TARP (the Troubled Asset Relief Program) to TALF (the Term Asset-Backed Securities Loan Facility) to Cash for Clunkers and various other multibillion dollar programs, printing money has been the weapon of choice in combating the financial crisis and the recession.

How much is the government in hock? Well, earlier this fall, the Congressional Budget Office reported that the U.S. deficit was $1.4 trillion in fiscal year 2009, which ended September 30. That’s more than triple last year’s deficit. Such a dramatic increase in deficit spending could cause massive inflation down the road—and that’s without passage of a deficit-building health care bill.

We don’t need to worry about inflation quite yet. Even if a tidal wave of inflation is headed for the U.S., it’s a ways out to sea. With nearly 10 percent unemployment and a persistent housing crisis severely dampening consumer demand, many economists are more concerned about deflation, or falling prices, in the short term. The slow emergence from the recession that’s been forecast should put off inflation for a couple years.

However, some investors are preparing right now for an inflation tsunami. Since the October 2008 passage of the TARP funding, investment in the U.S. government’s Treasury Inflation-Protected Securities (TIPS) is up more than 10 percent. Hedge funds have been offering “hyperinflation” funds, betting on inflation reaching levels not seen since the late 1970s. And earlier this fall, the price of gold bullion hit record highs, still another signal of higher inflation expectations.

The problem with these investments, though, is that your portfolio won’t profit until inflation rears its ugly head a couple years from now. Instead, why not position your portfolio to profit in the near term and be responsive to inflation when the time comes? One way to do it is with energy stocks.

Energy stocks are the best investments to shield against the threat of inflation, while also providing a boost to portfolio values as the economy slowly regains its health. Today, energy market fundamentals are getting stronger. The number of rigs drilling for oil in North America is down 30 percent from last year. Natural gas rigs are down nearly 50 percent.

Less drilling will create a production shortage if the pace of economic recovery occurs more quickly than expected. Gasoline demand was up 4 percent in late October compared with the same period last year. The International Monetary Fund recently revised its 2010 global growth estimates upward, with China leading the way with a forecast 9 percent growth rate and India following at 6.4 percent. As a result, the International Energy Agency has bumped up its estimates for crude oil demand for 2009 and 2010. As this trend continues, energy stocks will go up.