Real yields are back, and the inflation hedge has to change

The S&P/ASX 200 Materials index returned 47.4 per cent in FY26. The broader ASX 200 managed 2.77 per cent. Advisers who reached for resources as their inflation hedge have been paid handsomely for the call, and Mishan Dahia, investment analyst at Atchison, thinks that run is precisely why the position deserves a second look.

His argument starts from agreement. The resources hedge worked, and it worked for a reason any adviser can explain to a client in a sentence.

The arithmetic that made resources work

“When a miner’s costs are largely fixed, most of a price rise drops straight to the bottom line,” Dahia says.

That structure explains the FY26 numbers. Commodity prices rose, cost bases held, and earnings expanded faster than revenue. Materials outperformed every other positive sector on the ASX combined, and it carried the index into positive territory almost single-handedly.

The question is what has to keep happening for the trade to hold.

One buyer carries the whole position

“The whole trade needs Chinese demand to hold up, and right now the market plainly doesn’t believe it will,” Dahia says.

The evidence he points to comes from bonds rather than commodities. China’s 10-year government bond yield eased to 1.67 per cent on 18 August, holding at more than a one-year low. It has traded below 2 per cent since early 2025, and it drifted lower again this month after Premier Li Qiang called for stronger policy support, with growth slipping under Beijing’s 4.5 to 5.0 per cent target.

“Bond markets don’t price yields down there when they’re expecting a recovery.”

The same maths runs in reverse

The magnification that powered the gains works just as powerfully in the other direction. Liontown Resources lost more than 40 per cent through July as lithium prices turned, according to figures cited by Atchison.

“The same sums that look wonderful on the way up hurt just as badly on the way down,” Dahia says.

Fixed costs magnify a fall as cleanly as they magnify a rise.

An adviser holding resources for inflation protection therefore carries three exposures in one position: the commodity price, Chinese policy, and whatever concentration risk the underlying holdings bring.

Investors are paid to wait again

The defensive side of the portfolio has changed underneath advisers, and many have yet to reprice it in their thinking. For most of the past decade, the traditional inflation hedge was costly to hold and exposed to a single variable, leaving advisers choosing between bonds that lost ground to inflation and commodities that only rewarded them if prices kept climbing.

Australia’s 10-year government bond yield pushed above 5 per cent this month and reached 5.04 per cent on 19 August, roughly 0.74 percentage points higher than a year earlier. Headline inflation ran at 3.8 per cent in the year to June.

Government paper now pays a real return. The trade-off has softened. Atchison argues short-dated government bonds now supply income while the portfolio waits, with the added benefit of gaining if rates fall.

Gold’s buyer has changed

The gold allocation in the barbell has been the quietest and most consistent performer. Gold traded near US$4,334 an ounce in mid-August, about 30 per cent above where it stood a year ago, and Atchison attributes much of the move to persistent central bank buying, naming Poland, Turkey and the Gulf states among the steady accumulators as reserves move away from the US dollar.

Official-sector demand behaves differently from momentum money. Central banks buy against a reserve policy rather than a price target, and they rarely sell into weakness. That makes the bid more durable than a speculative one, though it also means the price is being set by buyers who answer to politics as much as to markets.

Where the barbell could break

Gold’s reputation as crisis protection comes with an asterisk. In the sharpest liquidity events, investors sell what they can rather than what they want to, and gold falls with everything else. It dropped hard through the second half of 2008 and again in March 2020, at the exact moments a hedge is meant to earn its keep.

Bonds carry their own scar tissue: in 2022 an inflation shock took fixed income and equities down together, and the defensive leg gave clients no shelter at all.

The structure also asks something of the person running it. Dahia describes a hedge that gets adjusted as conditions move.

“If oil rolls over because the Middle East calms down, you trim the energy exposure. If China’s numbers keep sliding, you lean harder on real yield and gold.”

Those are timing calls, and timing calls are the discipline most portfolios apply worst. A barbell held passively through a five-to-seven-year horizon behaves very differently from one that gets trimmed and rebalanced with conviction.

What advisers do with it

“We’re not trying to pick the one winner,” Dahia says. “We’re trying to build something that doesn’t fall apart if we turn out to be wrong on any single piece.”

Much of the current inflation impulse runs through oil, which spiked on Middle East tension and could reverse just as quickly. A single-asset inflation hedge leaves a client portfolio fully exposed to that reversal.

When one of the three legs breaks, the question is what the other two are still doing.