Steve's note: Today's essay comes from Alex Green. Alex is a good friend of mine, and one of the best investors I've ever met. For his unusual idea on how to beat inflation, read on...

The Ultimate Inflation Hedge Is Revealed...
By Alex Green, The Oxford Club
August 16, 2008

Investors looking for the ultimate inflation hedge have few attractive choices right now...

Real estate is fine under ordinary circumstances. But the housing market is in a death spiral. And we're still a good ways from the bottom, in my view.

The barbarous relic – gold – is another good choice, usually. But gold has already appreciated from just over $300 an ounce six years ago to almost $900 today. It could be a little late.

And inflation-adjusted Treasuries have moved up so much over the past year that they're currently yielding less than 1%. That's an awfully steep price to pay for inflation protection.

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In stocks.

This may seem counterintuitive at first. After all, inflation devalues corporate earnings, the major driver of stock prices. But the mere presence of inflation also indicates that many companies are successfully passing along price increases to customers. This allows stocks to rise even when inflation is climbing.

In 1980, for example, the Consumer Price Index rose by more than 12%. Yet the stock market rose 32%. And while the average rate of inflation throughout the 1980s was an uncomfortable 5.6%, it still turned out to be a great decade for stocks: The S&P 500 rose by an average of 12.6% a year.

A recent analysis by Ibbotson & Associates found that in inflationary periods – as measured from troughs to peaks – going back to August 1972, some six of 10 market sectors in the S&P 500 actually gained ground.

So don't let anyone persuade you that you should bail out of stocks and into precious metals, commodities, and real estate investments. Sure, these asset classes should make up a portion of your portfolio, but certainly not the bulk of it.

Dr. Jeremy Siegel, a professor of finance at The Wharton School of the University of Pennsylvania and author of Stocks for the Long Run, has done a thorough historical study of the returns of different types of assets over the past couple hundred years.

What he discovered is dramatic:

• $1 invested in gold in 1802 would have been worth $32.84 at the end of 2006.

• The same dollar invested in T-Bills, with interest reinvested, would have grown to $5,061.

• $1 invested in bonds would be worth $18,235.

• And $1 invested in common stocks with dividends reinvested – drum roll, please – is now worth more than $12.7 million.

The odds are good, of course, that you weren't around a couple hundred years ago. And, unless something truly exciting happens soon in the field of cryogenics, you won't be around 200 years from now, either.

It's not necessary to think that long term, however...

Start whenever you want and you'll find that when measured in decades the investment opportunities and returns for different asset classes are remarkably consistent.

Why Tiffany Beats Gold as an Inflation Hedge Two Strategies for Prospering During Inflationary Times

Stocks are the big winner. Since 1926, the stock market has generated a positive return in 59 out of 82 calendar years – or nearly three out of every four years.

President Harry Truman once observed that, "The only thing new in the world is the history you don't know."

For the past 200 years, nothing has come close to matching the long-term compounded returns of common stocks. It's hard to imagine that anything ever will.

That's why you don't hear about the world's great investors – men like Warren Buffett – selling their stocks. They're too busy doing the smart thing: Putting their money to work in great companies at fire sale prices.

Regards,

Alex Green