Want to hedge against inflation? Buy farm land, says Maneesh Dangi

“The conditions are set to ensure that inflation will sustain at a high level and eventually policymakers will end up surprising markets somewhat nastily. Which is why purely as a risk investor, it makes sense to be somewhat cautious, says Maneesh Dangi, Macro Investor & Advisor.

You have been arguing for the last couple of months that crude will go higher, inflation will make a comeback and it is time to exercise caution. Crude is at $85, commodity prices are at record high and the government is in a denial mode saying inflation is transitory. What is happening?
I am not sure the government is in denial but to a certain extent at least, the world policy makers are somewhat over committed, largely because of the fact that over the last two decades, inflation has proven to be very fleeting and especially in last 10-12 years, it has been very difficult for most policymakers to bring inflation back.

So to that extent, I think they are playing with fire but they have been far too patient with this idea of inflation and I have said in the past that it is very likely that they will be proven wrong and we should discuss as to why? The conditions are set to ensure that inflation will sustain at high enough level and eventually policymakers will end up surprising markets somewhat nastily. Which is why purely as a risk investor, it makes sense to be somewhat cautious.

There is a level at which you would say inflation comeback is healthy because it gives back pricing power. Have we gone beyond that healthy mark of inflation?
Absolutely. At least in the developed world, it is a welcome thing that inflation is returning; but remember this inflation is not just the demand side. It is also supply driven and what we are experiencing is that in a post Covid world, two big forces are somewhat independently working on the world economy and creating inflationary impulse.

One is that the post Covid economy is different. It has more demand for goods than the world could produce and to that extent, the goods economy is overwhelmed. The stuff that we buy at home, we want much more of it than we wanted before Covid. So to that extent, there is a demand-supply mismatch more driven by higher demand which supply cannot meet.

On the service economy side, while the demand is still much below pre-Covid level, yet because of the Covis protocols, there have been supply constraints and to that extent even at lower level of demand in the service economy, we are seeing demand-supply mismatches resulting in shortages. What we are seeing at ports and airports is that while the PLF numbers are still low, airports are getting overwhelmed. Demand-supply mismatches or imbalances are creating inflationary impulse. It is not a very welcome thing because it means that at some point in time, we will have to tame demand just to ensure that the demand-supply mismatch does not result in high inflationary expectation and durable inflation. So that is one part of story.

I just want to sort of bring in another story which is energy shortages. That is independent of Covid and what is happening is that many years of under investment has resulted in this situation where we cannot get enough of old sources of energy and given that demand has recovered meaningfully, there are demand supply mismatches on the energy side. So both of these forces — demand-supply mismatch in goods and services and energy shortages — are resulting in a situation which actually is quite malevolent. It is not necessarily something that is good and welcome by anyone. Unfortunately, there is no solution to it. Very likely, we will have to tame demand at some point in time to ensure that this inflation does not become pervasive and a headache for common people and policy makers.

What should an investor do because FD returns are low, bonds are not going to give good returns and now equity returns will get capped?
I follow a cycle investing approach. The first phase of the cycle is from the end of March 2020 till August of 2021. It was the reflation trade and that is when investors made huge tonnes of money in equity on all sorts of risk assets. We have entered a mid cycle now in which policy makers are beginning to restrain the economy. Policymakers like the RBI, Fed will tell you that they will tighten rates and to that extent, it doesn’t really matter much to the asset market.

Now what is happening is that because inflation is misbehaving to a certain extent and shortages are all across, it is likely that we can quickly move from mid cycle to end of cycle period in 6 to 12 months’ time. Remember that at the end of cycle in equities and other risk assets, one actually ends up losing money. So while it is not my base case yet, it is now time to move away from small and midcaps. If you are a risk investor and a compulsive investor, hide yourself in the Nifty and largecap oriented mutual funds if at all and wait out the underweight equity because that is the only way you can be overweight in reflationary time.

But if inflationary impulses consistently surprise the market, eventually the markets will be surprised by policy actions also and that would also mean that they would not like it and will have a selloff coming in at certain intervals. As such, this is a period of not significant returns in any asset class. Bonds, of course, are absolutely a no-no. Fixed deposits, bonds are all no-no. Commodities look expensive. Equity is the only place where you can hide in mid cycles but do not have FOMO, do not have too many expectations from equities.

The expected returns from equity in real term will be lower. But we are quickly or fast approaching the end of cycle symptoms as far as the business cycle is concerned. Be aware that if that plays out, we will have to sort of reduce risk further and trim the Nifty oriented or S&P oriented exposures. That is the approach I will follow as far as investors are concerned.

I must say that you are the first of the lot to actually say that on record but point taken. I get where the fears are emerging from. If one goes underweight equities, where can one invest? Fixed income is not giving returns, gold has not had the best of the ride as it did in 2020. So where do you park your money? You cannot be sitting on cash?
Fixed income is not a place to go to, especially duration assets, if you are fearing inflation. But remember equity is the longest duration product. The long bonds of course are duration and so one ought to hide in short duration like three months, six months, one year assets but there the real returns are actually negative. Something cannot scale up in a significant manner but it could mean a lot if you buy farm land because that gives the best protection against inflation.

Gold and silver have independent cycles but there could be some steam there. One cannot have significant exposure to gold and silver as a percentage of a portfolio. So broadly speaking, one still has to be in at least equal weight risk assets but you one has to persify, it could be real estate, more specifically farm land. Some of it could go to gold and silver and then one has to sit on equity mutual funds or equity oriented exposures but just be aware that if it is an end of cycle. you ought to be careful and quickly trim the exposure even on the largecap Nifty at some point time.

Buy farm land? Are you sitting on your farm land?
Yes, yes, literally. I am literally on farm land. As a matter of fact, it is also an asset class and over the last couple of years, especially after 2014, equities have significantly outperformed farm land. As such, the whole real estate sector has had six, seven years of lull. Farmland in India, relative to any time in the last 15-20 years, especially after 2004, is actually quite cheap relative to financial assets and one can get a reasonable rental yield or farm yield.

I am also sort of very bullish on farm prices and as such the agri sector in India should do really well. So I would advise that people should buy farmland if they can, otherwise the first asset that you must buy now is your own house.