How to Protect Yourself From Inflation... and Get Rich in the Process

By Porter Stansberry.

It's almost become a joke to the American people by now...

In the spring of 2008, the U.S. government reported inflation rose at just 4.2% in the month of May.

The real life effects of inflation are unique to each individual. Some people almost never drive. Some people commute 50 miles to work each day... and spend hundreds of dollars a week on gasoline. But to the majority of people who live and work in the U.S., the government's claim of just 4% annual inflation is ridiculous.

Consider the price of corn. In just three years, this major input in beef, chicken, cereal, and soda production has tripled in price. Or take crude oil. Oil doesn't just affect the bill you see when you fill up your gas tank. Oil is a major factor in the price of plastics, airline tickets, and all types of chemicals. Dow Chemical, America's largest chemical producer, announced its largest price hikes ever in June.

In addition to the developing world's increased consumption of raw materials like copper, oil, iron ore, corn, and soybeans, our current inflation problem comes down to the giant increase in the world's money supply.

Since the summer of last year, the world's central banks have been flooding the world with money and credit, trying to stave off a global credit default caused by highly leveraged investments in real estate.

You can measure the supply of money in half a dozen ways. The broad measures show increases to the money supply are growing around 30% year over year. But the best way to measure inflation is by looking at commodity prices – like gold, which is up 40% year over year, and oil, which has doubled.

The efforts to "paper over" the mortgage crisis are nowhere near finished. Moody's estimates one in 12 American families with mortgages – 4 million in all – already owe more than the current value of their homes. They are said to be "underwater." The firm predicts that by early 2009, nearly one in four homeowners (a total of 12 million) will be underwater.

More and more people will simply walk away from these mortgages. When this "second wave" of mortgage defaults hits, entire neighborhoods will go "no bid." In other words, there will be hundreds of thousands of homes that can't be sold at any reasonable price.

While no one can know with any certainty how this experiment with vast amounts of additional paper money will turn out, it seems obvious to me sooner or later America's creditors are going to say "enough." The U.S. dollar will continue to deteriorate in value. Many signs indicate that has already begun to happen.

The dollar is the world's reserve currency. Therefore, a dollar "default" is theoretically impossible. Instead, our trading partners will simply refuse to accept it. So far, Egypt and India have placed a ban on exporting rice. Argentina has banned beef exports and effectively banned soybean exports with a 40% tariff. Kazakhstan has stopped exporting wheat. China, Cambodia, Malaysia, the Philippines, Sri Lanka, and Vietnam have all begun rationing food exports since the beginning of 2008.

You'll see the same things happen next with oil and other key commodities, like copper. How far will it go? Is this the beginning of the end of the global dollar standard? While it might sound crazy, I think so.

An unreliable future value of the world's reserve currency is causing a basic breakdown in the world's economy because no one knows what anything will be worth in six months, two years, or 10 years. How do you invest safely in a world gone mad?

In this report, I'm going to show you three ways to protect – and grow – your money in an inflationary environment. One I'm sure you're familiar with... but you've likely never considered the strategy behind the other two "inflation beaters."

If inflation continues to increase and the dollar continues to slide, the three investments in this report will more than protect your money. One could easily increase in value 1,900% in the next 20 years.

Warren Buffett's Secret to Beating Inflation

The world's richest and most successful investor, Warren Buffett, discovered in the 1970s that the best way to hedge against the falling value of the dollar (inflation) is to buy companies with cherished brand names, whose operations don't require much spending to upgrade and maintain their equipment and physical plants.

These companies possess what Buffett calls "economic goodwill" – an asset not found on the balance sheet that allows them to make outsized returns on invested capital.

This strategy flies in the face of the more traditional approach, which is to buy companies with lots of fixed assets – for example, large mining companies. It's true, companies with lots of fixed assets will appreciate and protect shareholders from inflation. But Buffett discovered these companies spend so much capital maintaining their assets, they don't have much capital left over for investors. As a result, they tend to do poorly over time.

Meanwhile, thanks to their brand names and premium market positions, some companies – Coca-Cola, for example – can raise prices to keep pace with inflation. These companies' earnings grow tremendously during inflationary periods. And because their earnings aren't needed to maintain their assets, they're able to increase the amount of capital returned to shareholders. As a result, these "asset-light" brand-name stocks typically outperform all other businesses during periods of rapid inflation.

This is a real financial secret, but 99 out of 100 investors will never understand it. Instead, faced with rising inflation, your typical investment manager is likely to invest directly in commodities and foreign currencies.

While I believe it's smart to own around 10% of your net worth in gold coins, as insurance against hyper-inflation and the collapse of the dollar, I wouldn't recommend speculating in the commodities markets. It's just too risky. If you stick with the more conservative strategy of buying capital-efficient, brand-name companies, you'll make even more money.

Here are two of my favorites...

Two Stocks You Can Beat Inflation With Forever

For more insight into Warren Buffett's thinking in this area, consider that he told a federal judge in 1977 that the sure way to make money from inflation is to own a monopoly toll bridge.

Buffett was being sued under antitrust laws for launching a Sunday edition of the Buffalo Evening News – a move that would probably put its local competition out of business. Buffett made no secret of his desire to have a monopoly in Buffalo, comparing the advantages of being the sole local newspaper owner to owning a toll bridge.

As Buffett told Judge Charles L. Brieant: "I have said in an inflationary world that a toll bridge would be a great thing to own... You have laid out the capital costs. You build the bridge in old dollars, and you don't have to keep replacing it."

Buffett was pointing out that inflation wipes out capital costs if they can be expensed and paid for over time. The money borrowed today to build a bridge will be much cheaper to repay in five years... or 30 years.

While there aren't many toll bridges for sale on the stock market, there are plenty of monopoly power companies.

It just so happens that this same business is also one of America's leading nuclear power operators. And this power company returns about $2 billion worth of capital each year to investors, mostly in the form of dividends.

Even if the company's revenues and profits don't grow (which they're sure to do, thanks to inflation), you'll still get all of your initial investment back within 10 years, via dividends and buybacks. It's difficult to find a cheaper, higher-yielding investment anywhere.

Duke Energy (NYSE: DUK), hit my radar after it spun off its Spectra Energy subsidiary in 2007. That spinoff has left the parent horribly mispriced: Earnings fell by less than 1% in the first quarter following the spinoff, but the company's market cap took a 40% hit.

Duke owns and operates a monopoly power utility based in North and South Carolina. Specifically, the company owns 28,000 megawatts of regulated power-generation capacity (nearly all of which is coal and nuclear), 8,100 megawatts of unregulated installed capacity (most of which serves industrial customers in Indiana and Ohio), and 4,000 megawatts of capacity in Latin America (nearly all of which is hydroelectric).

This is an extraordinarily low-risk business. All of its regulated capacity is distributed under a system that guarantees Duke a profit. Almost half of its commercial power is regulated in Ohio. And 90% of its Latin American capacity has been sold forward – so it carries zero "dispatch risk." If the power isn't bought, the turbines won't run, and the river will keep flowing.

Duke will continue to significantly benefit from inflation, leveraging its power to borrow cheap dollars while collecting ever-higher rates. The company's ability to borrow cheaply over the long term allows it to essentially sell the dollar short, in huge amounts.

Given the currency situation, that may come in handy. Currently, the company's blended borrowing cost is less than 5%. This, along with the company's regulated price and cost structure, makes it nearly impossible for Duke not to continually increase profits.

Duke yields around 5%, and I expect investors will see double-digit capital gains in the coming years. As long as Washington continues to spend more than it collects in taxes, this investment will average annual gains of about twice the rate of inflation.

Buy Duke Energy (NYSE: DUK). Use a 25% stop loss. Expect to hold this position forever. If you can, reinvest your dividends to compound your gains over time.

An Iconic Brand – Protected by the State

When you learn the name of this inflation-beating stock, I promise you'll smile.

It won't disappoint you. No peeking ahead, though. I don't want you to rely on the company's reputation. I want you to rely on the company's numbers, which are extraordinary...

First, you should know this is a slow-growth business. Sales have only increased 24% over 8 years. That, surely, will turn off most investors. Most people simply don't understand the impact of even, slow growth over time in businesses that are extremely capital efficient.

The other thing: this company's profit margins seem unsteady, going up one year and down the next. That doesn't bother me because this company has the ability to constantly raise prices.

In fact, it raised prices across the board last year with no negative impact on units sold. Margins will, therefore, periodically increase after a big price hike and will then fall again as a certain key commodity increases in price. No matter what happens to the dollar, this company can raise its prices at will.

Next, the dividend makes up a large percentage of profits – between 30% and 40% every year. This company has paid a dividend for 313 consecutive quarters – more than 78 years. It has raised its dividend every year since 1974. In almost every year, the company's dividends are larger than its capital expenditures – not including the share buybacks. This company rewards shareholders, not its managers.

In fact, since 2005, this inflation beater has repurchased at least $800 million worth of shares. Thus on a combined basis (dividends and buybacks) the company has paid out almost every single penny it has made for the last three years.

Over the last 10 years, the company's annual capital spending has remained essentially unchanged. In 1997, the firm invested $172 million in additions to property and equipment. By the end of 2006, the annual capital budget had only increased to $198 million – a paltry 15%. Meanwhile, cash profits and dividends nearly doubled.

This is the beauty of capital-efficient businesses: As sales and profits grow, capital investments don't. Thus, the amount of money that's available to return to shareholders not only grows in nominal dollars, it also grows as a percentage of sales. In 1999, dividends paid out equaled 3.4% of sales. But by 2006, the company spent $735 million on dividends and share buybacks, an amount equal to 14.8% of sales.

The company earns more than $1 billion before taxes, interest, and depreciation. Its earnings are very consistent, and its brand places it in the upper tier of all businesses around the world. It could easily finance a bond offering large enough to buy itself – or "go private." Thus, I think it is extremely unlikely investors will lose money buying the stock at today's price and holding it for any reasonable (three to five years) length of time.

The longer you hold this stock, the more rapidly your wealth will compound. You'll never have to sell – ever. And as this company's prices grow with inflation, so will your investment.

Since the early 1980s, this company's stock outpaced inflation by over 900% - and it's shown itself to be profitable even during periods of high inflation.

I probably couldn't tell you anything that would impress you more than these facts. But in this case, the name of the business alone will undoubtedly make you even more bullish... It's Hershey (NYSE: HSY).

There are few businesses that you can expect to hold safely for 20 years, while you protect your money from inflation. But in this case, you can. The business was founded in 1894 by Milton Hershey. Very little has changed over the last 114 years. True, the company now has more than 50 brands and operations in 50 countries around the world, but the business is still very much centered on chocolate. And its leading product is known throughout the world as a leading "luxury staple."

The Hershey Trust Company largely owns Hershey. The Pennsylvania government will not allow the trust to sell shares. In fact, it blocked such an attempt in recent years. We like the idea of a controlling shareholder that isn't allowed to sell. Talk about aligning our interests. This is the only stock the trust owns. We might want Hershey to grow, but it needs Hershey to grow.

Assuming a 15% annual return on capital, we expect investors to make 400% in capital gains in 10 years, far outpacing inflation. But here's the part that's hard to get your head around... Thanks to the miracle of compounding, if this rate of growth continues over 20 years, investors should expect to make 20 times their money – or capital gains in excess of 1,900%. And that's not including the impact of reinvesting the cash dividends, which would significantly increase returns.

Buy shares in Hershey Co. (NYSE: HSY). Use a 25% stop loss. The shares may be volatile, but you should expect to hold this stock for an exceptionally long period of time.

The Ultimate Security Blanket For Wealth

For our final recommendation, I'd like to make sure you own some gold.

Gold has a unique and timeless role in the world's markets. It is the ultimate store of value. It is the ultimate form of savings. In a world awash in paper money, where debt forms the basis of most commerce, an ounce of gold is no one else's liability. This makes it uniquely attractive during periods of financial turmoil.

When I buy gold, I buy "bullion coins." Unlike rare gold coins, a one-ounce bullion coin generally sells at about the same price of (or at a small premium to) an ounce of gold. Famous bullion coins include South African Krugerrands and Canadian Maple Leafs. If gold is $900, you might buy these for $945. I buy whatever "flavor" of bullion coins are currently being offered at the smallest premium to melt value. Lately, that's been coins originally minted in Austria – the Corona.

I buy bullion coins because I want to protect my savings against inflation, and I have no interest in becoming a coin collector. Also, it's awfully difficult to make an ETF security disappear. Gold bullion coins, on the other hand, are very easy to buy with cash and to hide.

I prefer to deal with a coin dealer who will accept cash (some won't) because I don't want there to be a digital record of the amount of gold I've purchased. I'm not paranoid... I am knowledgeable on what governments do when they go bankrupt. I don't try to time my purchases of gold coins, because I don't consider them an investment. I consider them to be insurance against a catastrophe that I know will arrive sooner or later.

I began buying coins several years ago, when the price had just begun to creep over $400 per ounce. Whenever I have a surplus of cash in my checking account, I buy a few more coins. I suggest you do the same. It makes it very easy to sleep at night.

You can buy these coins at pretty much any coin dealer, but I'd recommend using Bert Blumert's company, Camino Coin. He's a legendary gold bug and has an excellent reputation. I get no compensation for mentioning him. He's simply a gentleman with an outstanding history of treating clients fairly. His company's contact information is as follows:

Burt Blumert
Camino Coin
P.O. Box 4292
Burlingame, CA 94011
Phone: 800-348-8001 or 650-348-3000
Fax: 650-401-5530
E-mail: burtblumert@comcast.net

While owning precious metals is one of the safest ways to profit from the ongoing inflation, owning high-quality, capital-efficient businesses is an even better way to protect yourself.

As Warren Buffett figured out, during periods of inflation corporate goodwill increases in value along with tangible assets. By owning the investments discussed in this report, you'll have all of the bases covered – no matter what happens.

This article appears courtesy of Daily wealth. For a info, please visit http://www.dailywealth.com/


Click here to purchase Warren Buffett's bestseller books!

DISCLAIMER: The contents in this blog are solely for your reading purpose and must not in any way be taken as a buy or sell advice. By reading this blog, you agreed that i am not responsible for your trading.