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Record low interest rates, unprecedented government stimulus and a healing global economy could be a recipe for the return of inflation.

“While inflation remains very low, conditions for an eventual uptick may well be building,” says Scott Clayton, a Toronto-based senior researcher with TSI Network, a Canadian equities research firm that publishes newsletters for retail investors.

The U.S. Federal Reserve has indicated it will likely let inflation run above its traditional 2 per cent target before hiking rates, while the Bank of Canada has hinted it’s unlikely to raise rates for a couple of years.

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Significant inflationary pressures aren’t expected anytime soon, but “these factors may result in a temporary burst of inflation” as the economy gains momentum, adds portfolio manager Alan Fustey with Adaptive ETF, a division of Bellwether Investment Management Inc., based in Winnipeg.

A variety of exchange-traded funds (ETFs) can help concerned investors grapple with a general rise in the level of prices that’s coming:

Stick with equities

Inflation typically negatively impacts all markets, as interest rates rise to tame it, making borrowing more costly, says Mark Yamada, president of PUR Investing Inc. in Toronto. Fixed-income investments are often more negatively affected, he notes.

“The best thing going to deal with inflation is often equities,” Mr. Yamada says, citing his firm’s research showing stocks historically outperform bonds during periods of rising rates.

“In a rising interest rate environment, (bonds) have negative real yields.”

Mr. Yamada suggests investors consider the Invesco QQQ Trust ETF (QQC-T), which tracks the Nasdaq-100 Index and provides exposure to the largest U.S. technology companies.

Mr. Yamada says innovative technology often dampens inflation. “And the key to the future of the economy is technology,” he says.

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The golden touch

Gold is considered a hedge against inflation, rising in value when the U.S. dollar – the world’s reserve currency – declines.

“For many investors, gold represents a safe harbour in turbulent times,” says Mr. Clayton of TSI Network says.

A gold ETF can increase in value with inflation, but so too can gold mining stocks – which tend to do even better with rising gold prices, he says.

One ETF of interest is the iShares S&P/TSX Global Gold Index (XGD-T). With an MER of 0.61 per cent, XGD holds “top-quality” gold miners with large reserves of the metal, Mr. Clayton says.

The risk is if “gold enthusiasts lose interest, gold stocks could drop significantly,” he adds. “That could happen if … stock markets move up gradually, which could lead to stable interest rates and moderate inflation.”

Mining for money

Mr. Clayton notes demand for resources, such as copper and steel-making coal, is often a cause of inflation as the economy expands.

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“As a highly general rule, resource stocks… will provide the most effective hedge against inflation, because they gain directly from rising prices for the commodities they produce,” he says.

Mr. Clayton suggests investors consider the iShares MSCI Global Metals & Mining Producers ETF (PICK-A), with an MER of 0.39 per cent, which provides exposure to 195 stocks involved in mining.

Mining stocks also act as an “early warning” for inflation,” he says. “They may well shoot up before it becomes clear that inflation has revived.”

Still, he notes investors should be wary of the high volatility, since the mining sector often suffers disproportionately during downturns.

Emerging price growth

As noted, inflation often rises as an economic recovery gains steam. In this environment, emerging markets often outperform developed markets, says Mr. Fustey of Adaptive ETF.

The BMO MSCI Emerging Markets Index ETF (ZEM-T), with an MER of 0.27 per cent, is a consideration for investors:

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“Many emerging markets equity prices are very inexpensive compared to historical valuations and relative to developed markets,” Mr. Fustey says.

“Additionally, some of these countries have economies that are large commodity producers that would benefit from an increase in the rate of global inflation.”

The risk, however, is emerging markets are generally more volatile, reacting more negatively to troubling economic news.

Food securities

One cause, and result, of inflation is higher food prices, says Mr. Yamada. That can manifest in higher prices for raw commodities.

Investors can look to ETFs covering single commodities like corn, soy, wheat and sugar.

Or, he says they might consider a “diversified one holding all of the above” like the Teucrium Agricultural Fund (TAGS-A).

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Although it provides exposure to these commodities, TAGS has a relative high MER of 1 per cent, and it only has US$1.6 million in assets under management, a low sum putting it at risk for closure by the provider.

Dividends to ease the blow

An alternative to fixed income is dividend-paying stocks, which are less negatively affected by inflation and rising rates, Mr. Clayton says.

One reason is solid dividend-paying companies generate a lot of cash. And in an inflationary environment, “that cash lets them absorb higher input prices,” he says.

One option is the iShares Canadian Select Dividend Index ETF (XDV-T), with an MER of 0.55 per cent, which holds Canada’s highest dividend-yielding stocks.

The downside is inflation hurts consumer buying power, which can reduce revenue.

Mr. Clayton notes that inflation generally negatively affects all equities, but less so firms with “sustainable dividends.”

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For the fixed-income crowd

Finally, fixed income investors fearing inflation might look to the iShares TIPS Bond ETF (TIP-A), with an MER of 0.19 per cent, which tracks an index of inflation-protected U.S. Treasury bonds.

“TIPS are government bonds whose face value rises with inflation,” Mr. Fustey explains.

These securities attempt to nullify inflation’s impact as their principal value is adjusted to match increases in the consumer price index (CPI).

“So, there is no guesswork required on how these investments will perform in a period of rising inflation,” Mr. Fustey says, adding that its underlying assets come with “very little” risk as the bonds are backed by the U.S. government.

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