With oil at more than $130 a barrel, rising inflation and sluggish economic growth, you could be forgiven for thinking you were back in the 1970s — the decade when Britain last suffered stagflation, which occurs when high inflation coincides with a period of economic stagnation and job losses.

UK shares rose only 0.4% in the 1970s, while in America stocks managed to gain 1.4%, according to the Barclays Capital Equity Gilt Study. These returns were better than bonds, which fell 3.2% and 3.6%, respectively, over the same period. Mick Gilligan of Killik, a stockbroker, said: “In periods of true stagflation, investors do not have many places to hide. In the mid-1970s, the only places that people really made money were gold and oil.”

The economic situation today is yet to reach the gravity of the 1970s and today’s investors do have some advantages, including the ability to short asset classes that they feel are likely to dip in value. They can also access hedge funds that specialise in making money out of falling markets.

Damian West, a 36-year-old sales agent, has benefited from high inflation because the steel agricultural equipment he sells has gone up in price and the farming sector is booming on the back of rising food prices.

West, who lives in Lanark near Glasgow with wife Susan, 39, and children Luke, six, and Lucy, four, said: “My commission goes up in line with the prices of the equipment I sell, so high inflation is not all bad for me.

“My biggest fund holding is in the JP Morgan Strategic Equity Income fund, which will hopefully weather the storm. I have also chosen the Merrill Lynch Gold & General fund for my wife’s pension as I know gold tends to do well in times of economic uncertainty.”

We asked specialists to offer five tips for investors in this difficult environment.

Protect your cash

For those wanting to safeguard their capital, index-linked savings certificates from National Savings & Investments offer a way to benefit from high inflation. Mark Dampier of Hargreaves Lansdown, an adviser, said: “These are a good choice in a high-inflation environment. However, you can only put up to £15,000 in the current issue.”

With NS&I certificates, the value of your investment increases in line with the retail prices index (RPI), with interest on top. Returns are also tax-free, making accounts of this kind especially attractive to higher-rate taxpayers. However, you won’t know exactly how much you are going to receive until the certificate matures due to the fluctuating nature of inflation. The current three and five-year issues offer interest of up to 1.17% on top of RPI, or 5.37%. This is equivalent to 8.95% for a higher rate taxpayer.

Another option is the Leeds building society Inflation Buster bond. This is open to anyone with between £1,000 and £1m to invest and pays RPI plus 2.5% — a very attractive 6.7%. Interest is paid on maturity on July 31, 2010, but the returns are taxable.

Buy a pig

The soaring oil price has proved hugely profitable for investors who bought into energy funds or oil companies a year or so ago. It has come off a bit recently — to $134.89 a barrel — while wholesale gas is also at a high. However, there is a growing feeling that the better opportunities lie in soft commodities such as wheat, or secondary products such as livestock. Fredrik Nerbrand at HSBC Private Bank said: “Oil and gas tend to underperform six months after the start of an inflationary period, suggesting a decline or flattening of prices, while foodstuffs, livestock and fats tend to significantly outperform.”

One of the best ways to invest in soft commodities is to pick a fund with exposure to this area. Gilligan said: “We like the Eclectica Agriculture fund, which invests in equities that are linked to food prices, so it should be well placed in the current environment.”

If you would rather invest in livestock — one of the hot tips for the next year because meat prices generally lag grain prices by about six months — the best route is through exchange-traded commodities (ETCs). You can choose to invest in livestock generally or solely in cattle or pigs through ETF Securities.

If quirkier investments are of interest, timber may prove a good bet as demand is on the rise across the world.

To take a punt, invest in a fund such as the Phaunos Timber fund, which recently upgraded to the main London exchange.

Have a bit of gold

Gold was one of the few success stories of the 1970s. It is currently trading at $861 an ounce, after hitting record highs of well above $900 an ounce earlier this year, largely due to the recent strengthening of the dollar and weakening of the oil price.

However, Gilligan believes the price will rise again if stagflation takes hold. He said: “I would advise having at least 2% — or much more if you feel we are heading into stagflation — of your portfolio in gold.”

One option is to buy gold bullion via a broker such as Goldmoney, which will store it for you. Perhaps a better choice for the average investor, though, is to follow West’s lead and invest in a gold fund.

Try a hedge fund

There are a number of funds that aim to use hedge-fund tactics to achieve positive returns — even in falling markets. Blackrock's UK Absolute Alpha fund is Gilligan’s favourite.

He said: “Market volatility tends to be higher in periods of stagflation, which gives managers more opportunity to make money using hedge-fund strategies. The Blackrock fund should continue to eke out returns of about 1% to 2% a month.”

Odey European is another fund that can take a short position if the manager feels a sector or asset class is likely to underperform. “This fund was up 70% last year and should do well if stagflation begins to bite as it is short on financials, consumer stocks and businesses carrying a lot of debt,” Gilligan said. The fees are higher than average due to the more complex investment tactics. Blackrock charges 5% initially and a further 1.5% a year. Odey’s scheme carries a 5% initial fee plus 1% a year and a performance fee of 2% of any appreciation.

Select your equities carefully

While equities in general performed poorly in the 1970s, some sectors did make money — industrial goods companies were up 3% a year while oil and gas companies were up 2%. These sectors are tipped to brave the current climate better than others this time too, while retailers and other companies that depend on consumer spending are unsurprisingly expected to suffer more.

Some investors may therefore prefer to invest in a lower-risk equity income fund with a defensive remit. Gilligan and Dampier are fans of Neil Woodford’s Invesco Perpetual Income and High Income funds.

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