What the Looming Inflation Tsunami Means for the U.S. Housing Market and Commodities

[Editor's Note: In his Feb. 9 story "How to Beat the Looming Inflation Tsunami," Money Morning Contributing Editor Martin Hutchinson told readers how to prepare for looming U.S. inflation. Many of you immediately responded with excellent questions, and Hutchinson addresses some of your biggest concerns in this follow up.]

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A few weeks ago, Money Morning Contributing Editor Martin Hutchinson warned readers about the looming inflation tsunami threatening the United States.

Easy money policies like those of the U.S. Federal Reserve and other central banks have helped raise prices in emerging markets, as well as the United States, and sent the commodities sector surging.

"[W]e can expect inflation to be with us for several years, too," said Hutchinson. "In fact, expect it to get worse for the next three to four years, while Ben S. Bernanke remains at the helm of the nation's central bank."

As inflation threatens to eat away at the value of stocks and bonds and cut into investors' returns, Hutchinson said one of the best investments to make ahead of rising prices actually is a house.

The housing market is at or near its bottom and rates on 30-year mortgages are desirable for buyers. Investors who find the right neighborhood, strike a good deal and don't financially overextend themselves could find a sound housing investment as the best store for their money.

While Hutchinson thinks owning a house offers a good balance to inflation – and is in the process of buying a home right now – he is not ignoring the real estate's pitfalls. He warns investors to not commit all of their wealth to the "treacherous and illiquid sector" that has left many investors badly burned in the past. But since everyone has to live somewhere, and renting is essentially a short position, a one-house investment with a mortgage fitting the buyer's finances is a smart way to play real estate.

Hutchinson's analysis prompted many reader comments like this one from reader Robin: "Awesome article! 1982 to 2000 also coincided with the secular bull market for stocks at that time. In essence, your article basically explains the basis for the secular bulls and bears – great!"

Other readers wrote in with questions regarding inflation and its effects on homes, gold and silver. Hutchinson took the time to answer those questions and more.

Will Prices Go Even Lower?

Question: I understand that housing prices have come down and interest rates are historically low, but houses still are not selling well. It would seem that if interest rates go up, the price of the house would have to go down, or else the monthly payment would be too high to be affordable. I bought my first house in 1982 and was 'lucky" to get a 30-year 12% fixed-rate mortgage at the time. Home prices did not increase until the interest rates fell. What is your opinion?

– Mark L.

Martin Hutchinson: I think house prices have further to fall, and mortgage interest rates have further to rise. Whether you buy now, or wait for both to happen, depends on how much prices fall and how much rates rise. I suspect that in many areas, the future fall in prices is less than the future rise in rates (because if we get inflation, both prices and rates will rise!).

All I suggest is that if you think the future fall in prices is modest in your area, and you agree with me that the future rise in rates may be substantial, it may be a good time to lock in the current deal.

Do I Sell Now?

Q: I own a house in Washington, D.C. that I am currently renting for 33% above the monthly mortgage payment. I bought the house in 2004 with a 7-year adjustable rate mortgage (ARM) and refinanced in 2009 with a 30-year fixed 4.75% loan. I currently have about 35% to 40% equity in the house at today's prices.

After reading your article, I'm not sure if I should sell the house when the current lease expires in June or continue to rent? I agree with your projections that the Washington area will see "downsizing" as the budget crisis is resolved and this could mean falling house prices for the area. However, Washington being Washington, a new group of players usually replaces the previous group, thereby maintaining the status quo in some respects. Your thoughts?

- Jeff J.

M.H.: Nationally, I think rents are about to start rising fast, because over the last 10 years they haven't risen much. Rents rising will be one of the factors limiting the future fall in house prices. Washington, D.C. is tricky though, because it depends on whether government is expanding rather than the overall economy – the local housing market had a lousy 1980s! Your guess is as good as mine as to where you think politics is going over the next 5 – 10 years, but if you think President Obama will be re-elected, you should probably hang on to your Washington, D.C. house. However, if this is your only retirement savings, sell it and put the proceeds into stocks, preferably though a 401(k).

Keep Buying Silver?

Q: I see your point on gold, but I don't understand you coupling it with silver. It would seem to me that silver is an excellent investment going into a potential inflationary cycle. Am I missing something?

- Steve L.

M.H.: Silver and gold are very closely linked; the speculative demand exceeds the industrial demand for both. Your precious metals investments should be spread between the two, and should not exceed 20% – 25% of your net worth (including mining shares).

What About Real Return Bonds?

Q: During the late 1970s inflation, metals and oils also increased in tandem with inflation until interest rates really jumped up. Can you look into buying real return bonds now? If inflation goes up, the bond will pay more and move up in value. Double action possibility?

- Charles C.

M.H.: Commodities generally have had a hell of a run, pulled both by inflation and by emerging-market demand. I think they have further to go, but more at the industrial end than at the precious metals end. If by "real return bonds" you mean Treasury Inflation Protected Securities (TIPS) and the like, they will protect you against inflation, but their yield won't necessarily drop as inflation rises. Since I expect current sloppy money policies to end, pushing real interest up as well as nominal interest rates, I would expect the real return on TIPS to rise somewhat – and prices to decline.

[Editor's Note: Analyzing the housing market and the global effects of inflation are just a couple areas in which Money Morning Contributing Editor Martin Hutchinson excels.

You see, he's a numbers man. And he successfully applied his mathematical knowledge - as well as his financial expertise - to his 37 years as an international banker.

Now Hutchinson is using those same skills to help investors multiply their wealth by uncovering outstanding quality stocks with consistent high cash payouts. Just click here to read a report on how you too can pull enormous amounts of money out of the markets, or subscribe to his advisory service Permanent Wealth Investor.]

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  1. Rick | February 25, 2011

    I like the idea of writers responding to reader's questions within the article. Good piece.

  2. donald cornell | February 28, 2011

    I agree with you, that when inflation happens (it will),rate will rise,prices will increase, it will cost much more to build new,the current overstock will be taken up (pop increases),and to top it all, purchasers will run to real estate to PROTECT THEMSELVES, just like they have in the past. Further, if you buy one house, you are NEVER ahead, because if you move, you replace it with a similar home, costing as much as the one you sold!
    Right now rates are at all time lows, rents are increasing,buy now with other peoples money, then rent to tenants that have jobs, this is a LONG process, be patient. This is the ONLY way to make money for your retirement. I speak from experience. It is also HANDS ON, you make the decisions. To all you youngsters, buy ten if you can, think of the leverage! Put say 25% into a property (if you can), and your returns are based upon the TOTAL PRICE of the property, not your 25%! Good luck.

  3. Cindy Gibb | July 12, 2011

    Yes, everyone (in theory) has to live somewhere; but, with unemployment figures rising, money for a residence, purchased or rented, is not going to be available. So, unless a home buyer has the staying power to support the property for a long time, this strategy probably doesn't hold water. If one can't move the property quickly or find someone who can afford the rent, the costs of an empty structure skyrocket. Homeowner's insurance alone (if you can get it) will cost plenty, as will the utilities, property taxes, repairs from vandalism, etc. Does not seem a wise investment to me in this economic climate!

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