Posted on 05/09/2011 12:09:49 PM PDT by Shout Bits
Last week, the Wall Street Journal’s Brett Arends published an article questioning why TIPS had a negative real yield. TIPS, US Government bonds that adjust their yield with changes in inflation, are currently so popular that Mr. Arends notes that some of them have a negative real yield(real yields are total yields less factors like inflation). Arends wonders why anyone would want a guaranteed loss of the real value of his investment. The answer is obvious to anyone besides Fed Chairman Ben Bernake –people are willing to pay to protect themselves from the coming storm of inflation. This concern for the value of the US Dollar has turned TIPS into insurance rather than an investment.
TIPS are one of several vehicles commonly accepted as inflation hedges, along with real estate and commodities like gold. Each of these investments is expected to increase in value at about the rate of inflation (although TIPS are tied to the CPI, which may currently be understating true inflation). Unlike real estate and gold, TIPS are not particularly prone to speculation. Real estate has proven to be highly volatile, and gold has recently collapsed. TIPS are more stable, and the cost to buy and sell them is negligible compared to the competition. Further, raw gold does not pay interest like TIPS, and TIPS do not depreciate like real estate.
Advanced financial tools like futures options can isolate the inflation hedge element of gold from its speculative value, but such techniques are beyond most investors. Further, after considering the cost to buy and store gold and the cost to protect it from declines, TIPS are very competitive.
TIPS investors are fully rational. They know that the real yield on these bonds is close to zero, but they also know that they will be protected from surprise inflation. TIPS are not an investment whereby wealth grows; rather TIPS are inflation insurance, and their negative yield is the premium investors pay. The US Government uses its market power to charge for insurance against the very inflation it recklessly invites through expansive policies like stimulus and QE2.
Investments with negative yield are nothing new. Middle Age goldsmiths (early bankers) charged to store their clients’ wealth safe from thieves. The Knights Templar charged to transport wealth across dangerous trade routes. During times of crisis, such as 2008, investors have accepted negative yields on regular US T-Bills, paying the US Government to protect their money. All these are instances where investments became insurance and protection.
Arends misses the point of TIPS. The fact that people will accept negative real yields on TIPS proves that the market thinks inflation is a real threat, and they are willing to pay to protect their savings. This market consensus, along with the collapsing US Dollar and soaring commodities should be enough to get the Fed’s attention. Recession or no, the US must avoid another Nixon / Carter 1970′s stagflation disaster.
What has prevented you from posting links and formatting here?
Are the comments at your blog superior to the comments on Free Republic?
Why do you wish to drive traffic away from Free Republic?
Have you perhaps a monetary stake in doing so?
Is that Maui Wowie or Sinsimilla you're smoking? Gold corrected a couple of percentage points but is still above $1500.
said thing is tips depend on fed calculation of the cpi, which will almost certainly be badly understated (it is now) in a major inflationary event.
The CPI reflects a middle to upper middle class basket of goods. For these people, food and energy are a small part of their budget. For poor to working poor people, the CPI is especially misleading.
At the end of April, Gold fell from 1560 to 1480. It just today topped $1500. That is a serious decline for something that is used as a hedge or a safe haven for assets.
Gold has a long history of spiking during times of fear and unrest, but later losing most of its value. As a primary investment, it has proven to be unattractive most of the time.
I still wish I had bought gold at $800 instead of my TIPS at the same time. While the TIPS are up 30% - gold is up 100%.
During the financial crisis TIPS were trading at the same price as comparable Treasuries. That is when I loaded my portfolio up with them. I still wrestle with whether it was a good move, and why I did not exit after the 30% run up. I would have done much better in stocks at that point.
I have a hedge using TBT which is the Ultrashort 20 year Treasury. I am hoping to preserve my TIPS inflation protection feature with a hedge against interest rate spikes.
Gold’s price today reflects anticipated changes in the value of the Dollar. So, if inflation is less than about 6% over the next decade, gold will likely underperform other investments like stocks (my gross estimate of the inflation rate that gold’s run-up implies)
As I said, TIPS are more of an inflation hedge than gold because gold is more prone to speculation, hence gold’s run-up. Unlike TIPS, gold has no guarantee of a minimum return. TIPS provided you their intended inflation protection and a modest real return - that is what was promised.
Anyway, the main point of my article was that the TIPS run-up is a signal that inflation is building. Thanks for sharing your experiences.
My guess is he's just too lazy to work up the proper formatting for the article. Maybe he doesn't know how, and uses blog software to do all the real work for him.
The bigger problem with TIPS is that they are tied to the price of the dollar. So, if the dollar itself collapses, but we don’t have inflation because our food and other major components are dollar-denominated, the TIPs won’t really cover the drop like gold.
That said, I used I-savings bonds for this purpose, although I’m not buying any at the moment. Some of them have a good real rate of return now, and will keep up with inflation when it arrives. It’s a small part of my porfolio, just a hedge to cover me for a few months if things get dicey.
Of course, that assumes the government will be around.
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