Readers of my blog may know that I anticipate rising price levels and higher interest rates in 2010 and beyond. Bear in mind that it takes time, sometimes years, for a strong inflation to embed itself in the economy. I want to talk about ways to protect your portfolio from rising prices and interest rates, but first a bit of history:

While President Nixon was in office, Fed Chairman Arthur Burns responded to pressure from the White House eager to have a strong economy when Presidential ballots were cast in 1972. Burns expanded the money supply to help ensure a growing economy in time for Nixon's reelection. Inflation soared to 12% by 1974. The oil shock in 1973 compounded the economic and inflation situation. The stock market lost almost half its value, and inflation hedge investments such as gold and silver plummeted from their highs when the economy dove into a deep recession in 1973-74. In this case, political expediency led to easy monetary policies and extremely high inflation.

In early 1978, Federal Reserve Chairman G. William Miller inherited an economy with inflation under 7%. Miller did not curtail his expansionary monetary policy as he believed that market forces could diminish a rising price level caused by easy monetary policy. He continued to prime the pump. The second oil shock hit in 1979-80. Oil hit $40 per barrel and gold soared to $850 per troy ounce in 1980. Inflation and interest rates rose to double digits. The economy was a mess and Jimmy Carter was voted out of office.
 
One can draw lessons from history about how to position one's portfolio to rise along with a potential future inflation and higher interest rate level. Fed Chairman Ben Bernanke may indeed be able to engineer a successful unwinding of his policy of monetary ease, but there is no guarantee. According to Mr. Bernanke in his July 20th Wall Street Journal article, there are various tools available to the Fed which could accomplish the unwinding, but Bernanke has also stated that Fed policy may be accommodative for some time .

I believe that a continuation of expansionary monetary policy may be beneficial to investments such as gold and silver in the coming few years , just as it has been in the past. We already have buoyant gold and silver prices, though their bull market is showing signs of age (gold is currented at $949 per troy ounce and silver is at $13.55 per ounce). I believe that the unprecedented nature of the Fed's "rescue" of the economy may augur for an extension of the bull market in gold and silver, though their short term direction appears less clear to me. The oil market may be buoyed by a favorable long term supply decline as well.
I am positioning my portfolio in the following ways:

1. I own physical gold and silver, looking to unload the metals in stages should a bubble appear in these markets in the next few years or sooner.
2. I own natural gas and agricultural stock ETF's to potentially benefit from commodity price inflation in these areas and a stock market favoring these sectors (the prices of these commodities are sharply down from their climax highs in 2008).
3. I own multinational integrated oil company and oil service stocks to benefit from potential oil price increases and a possible return to an inflation hedge friendly stock market such as we experienced in 1979-80 and during the commodity price bull market from 1999-2008 (the 1979-80 bull run in oil and oil service stocks was punctuated by sharp declines, one of which was called the "October massacre.")
4. I continue to own shares in the Franklin Templeton Hard Currency Fund which can invest in the currencies of countries with low inflation and which may benefit from a falling U.S. dollar.
5. I own various other diversified equities and mutual funds to "hedge" my portfolio should my outlook on inflation be wrong.
6. I own my own residence and have a fixed rate mortgage. My residence is not underwater.
7. If prices of the daily staples I buy rise at a faster clip, I plan to stock up on them to beat the next price increase.

Inflation, by definition, erodes the purchasing power of our dollars. In the past, an overly expansionist Fed policy has led to a higher price level and rising prices for inflation hedges. The Fed accommodation that we see today may lead to a future price level bubble and a bubble in inflation hedges.
 
If a bubble develops in these sorts of investments, then their elevated price levels may eventually pop, just as the stock market bubble popped in 2000 and the real estate bubble began to deflate in 2007. Tight monetary policy may then be needed to contain a potentially powerful inflation.
 
But until then...