Lending money to issuers of fixed debt securities when inflation is high is a prescription for certain losses at the prevailing inflation rate. So why would I lend my money to the United States Treasury when I expect inflation to pop sometime in the next several years?
The answer is TIPS, Treasury Inflation-Protected Securities. TIPS are US Treasury Bonds with contracts that call for increases in the bond principle based on the movements on the Consumer Price Index (CPI). The interest rate is fixed but when the principle is adjusted the actual semiannual interest payout moves up and down with the principle.
The face value at the time the bond is issued is an absolute floor on the principle of the TIPS Bond. If inflation has increased the principle since the bond was issued the bond principle can fall if the CPI falls but it can fall no further than the original face value.
I have heard that the Treasury cooled on new issues of TIPS. If true, it is itself a signal that the United States Treasury expects higher inflation and wants to sell conventional bonds for as long as they can get away with it.
TIPS can be purchased directly from the Treasury or in the open market. In addition, they are packaged into specialty TIPS mutual funds and ETF’s.
I chose to buy TIPS through the Vanguard TIPS mutual fund for my traditional IRA account. If you buy TIPS in an IRA the principle appreciation is under the IRA account’s tax protection. However, if you buy TIPS in a taxable account the IRS requires payment of capital gains tax on the inflation induced increase in principle.
TIPS bonds offer low risk inflation protection for your principle and the interest income derived from it.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
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Friday, June 26, 2009
Friday, June 19, 2009
Inflation Protection – Part 3 – Oil
In 2008 the price of a barrel of oil topped out at $147. So far in 2009 oil bottomed at $34 per barrel and then rose to $71.
Before the financial crisis changed everything, many people talked about the “peak oil” thesis. This is a prediction that world-wide oil production has reached its all time past and future peak. And, since world-wide demand for oil continues to rise the price of oil must go up to balance demand with supply.
We have since discovered that demand and the price of oil can go down – drastically. Nevertheless, the underlying equation remains intact even though short term fluctuations in demand can and do result in price fluctuations.
Several arguments speak in favor of using oil and natural gas as protection against inflation. In the long term the “peak oil” thesis is valid. Global demand is expected to continue increasing especially in China, India, and Brazil.
Even though more oil is discovered everyday it is discovered in increasingly more difficult and expensive to recover places. Because the costs of new oil & gas production are increasing; temporary decreases in demand that cause a fall in the oil price make marginal production projects uneconomic. They are then cancelled or abandoned. This automatic reduction of supply puts a floor under the price of oil.
Oil markets world-wide are priced in US dollars. When the dollar inflates relative to world currencies the price of oil in dollars goes up, even if the price remains stable in other non-inflating currencies.
Some will argue that alternative energy sources will reduce oil demand, but alternative energy sources are not yet commercially viable. They will likely first become commercially viable for generating electricity. It may be many years before they significantly replace oil.
If you choose to use the oil and gas markets to protect yourself from inflation there are several ways to do it. (1) You can buy oil futures contracts, contracts to take delivery of a quantity of oil at a set price sometime in the future. I strongly advise against this approach. (2) You can buy the common stocks of companies in the oil and gas business such as exploration companies, production limited partnerships, refiners, vertically integrated oil companies, and oil service companies. Or (3) you can buy energy sector ETF’s or mutual funds.
I’ve chosen to own shares of exploration companies, production limited partnerships, refiners, and integrated oil companies; all companies that pay significant dividends in addition to giving me the opportunity for share price appreciation as the price of oil rises.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
Before the financial crisis changed everything, many people talked about the “peak oil” thesis. This is a prediction that world-wide oil production has reached its all time past and future peak. And, since world-wide demand for oil continues to rise the price of oil must go up to balance demand with supply.
We have since discovered that demand and the price of oil can go down – drastically. Nevertheless, the underlying equation remains intact even though short term fluctuations in demand can and do result in price fluctuations.
Several arguments speak in favor of using oil and natural gas as protection against inflation. In the long term the “peak oil” thesis is valid. Global demand is expected to continue increasing especially in China, India, and Brazil.
Even though more oil is discovered everyday it is discovered in increasingly more difficult and expensive to recover places. Because the costs of new oil & gas production are increasing; temporary decreases in demand that cause a fall in the oil price make marginal production projects uneconomic. They are then cancelled or abandoned. This automatic reduction of supply puts a floor under the price of oil.
Oil markets world-wide are priced in US dollars. When the dollar inflates relative to world currencies the price of oil in dollars goes up, even if the price remains stable in other non-inflating currencies.
Some will argue that alternative energy sources will reduce oil demand, but alternative energy sources are not yet commercially viable. They will likely first become commercially viable for generating electricity. It may be many years before they significantly replace oil.
If you choose to use the oil and gas markets to protect yourself from inflation there are several ways to do it. (1) You can buy oil futures contracts, contracts to take delivery of a quantity of oil at a set price sometime in the future. I strongly advise against this approach. (2) You can buy the common stocks of companies in the oil and gas business such as exploration companies, production limited partnerships, refiners, vertically integrated oil companies, and oil service companies. Or (3) you can buy energy sector ETF’s or mutual funds.
I’ve chosen to own shares of exploration companies, production limited partnerships, refiners, and integrated oil companies; all companies that pay significant dividends in addition to giving me the opportunity for share price appreciation as the price of oil rises.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
Friday, June 12, 2009
Inflation Protection – Part 2 – Gold
During every commercial break on television and radio you hear ads from companies offering to buy your gold jewelry or sell you gold coins. “Experts predict gold will double!” “Gold is the perfect way to diversify your portfolio.” “Now is the time to own gold.” Is it all hype or hope?
If there is an extended inflation, the price of commodities will inevitably rise. Gold and silver have thousands of years of history as a reliable store of value. When people are worried they feel better holding gold.
There are many ways to participate in the markets for gold and silver. You can buy and take physical possession of gold jewelry, gold coins, or gold bars (bullion). You can buy gold ETF’s (Exchange Traded Funds) that give you part ownership of a store of gold bullion in a bank vault somewhere. You can buy the common stock shares of gold mining companies. Or, you can buy shares in mutual funds or ETF’s that specialize in gold, silver, and platinum mining company shares.
Which method you choose to connect to the gold market depends on your comfort level with stocks and mutual funds and on just how bad you think things might get.
Personally, I don’t think the economy will collapse leaving the survivors reduced to subsistence farming and barter. I am convinced, however, that inflation is coming sometime in the next three years. As a result of my conviction I’ve invested a portion of my retirement fund in a precious metals mutual fund.
I find physical gold too awkward to buy and sell or to use as money. I thought about buying gold ETF’s but in the end I settled on a mutual fund that invests in gold and silver mining companies.
I’m content with my choice. It pays dividends and annual capital gains distributions and it is leveraged to the price of gold. The underlying mining company stocks go up faster than the price of gold goes up; they will also go down faster if the gold market turns down.
My way is not the only way nor is there a “best” way to own gold. This is a case where you must indeed “work out your own salvation with fear and trembling.”
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
If there is an extended inflation, the price of commodities will inevitably rise. Gold and silver have thousands of years of history as a reliable store of value. When people are worried they feel better holding gold.
There are many ways to participate in the markets for gold and silver. You can buy and take physical possession of gold jewelry, gold coins, or gold bars (bullion). You can buy gold ETF’s (Exchange Traded Funds) that give you part ownership of a store of gold bullion in a bank vault somewhere. You can buy the common stock shares of gold mining companies. Or, you can buy shares in mutual funds or ETF’s that specialize in gold, silver, and platinum mining company shares.
Which method you choose to connect to the gold market depends on your comfort level with stocks and mutual funds and on just how bad you think things might get.
Personally, I don’t think the economy will collapse leaving the survivors reduced to subsistence farming and barter. I am convinced, however, that inflation is coming sometime in the next three years. As a result of my conviction I’ve invested a portion of my retirement fund in a precious metals mutual fund.
I find physical gold too awkward to buy and sell or to use as money. I thought about buying gold ETF’s but in the end I settled on a mutual fund that invests in gold and silver mining companies.
I’m content with my choice. It pays dividends and annual capital gains distributions and it is leveraged to the price of gold. The underlying mining company stocks go up faster than the price of gold goes up; they will also go down faster if the gold market turns down.
My way is not the only way nor is there a “best” way to own gold. This is a case where you must indeed “work out your own salvation with fear and trembling.”
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
Wednesday, June 3, 2009
Inflation Protection – Part 1 – The Need
Inflation is coming. It might be next year or the following year but it is coming. The Federal Reserve is creating money out of thin air to the tune of billions of dollars each day. The money the Fed creates will eventually reach the general economy and cause prices to rise.
Government spending has risen dramatically while revenues have fallen 34% year over year. The Obama administration predicts a recovery starting in early 2010. However, they also set the “worst case” scenario for the bank “stress test” at 8.9% unemployment in a recovery starting in late 2009. The Federal Reserve is now forecasting 9.4% unemployment by the end of 2009 and continuing to rise to around 10.5% before declining.
The administration promises to reduce spending in 2010 and to raise taxes everywhere on everything.
They want to create a carbon use tax also known as “cap and trade” that will increase the cost of doing everything that uses energy – virtually every human activity. Some estimates peg the carbon tax cost at an average of $3,000 per family. Make no mistake families will pay this cost through increased prices of goods and services.
They want to create a “value added tax” (VAT) on all economic activity. VAT taxes are commonly used in Europe. They are sort of like sales taxes that are applied at every level of production and consumption – unlike American sales taxes that are applied only at the retail level. A 10% VAT would increase the cost of everything a family purchases by about 10%. So a family that spends $30,000 a year would experience about $3,000 in increased prices of goods and services as a direct result of the VAT. It would also increase the administrative costs of running a business by requiring all companies to collect these taxes.
The recently announced increased CAFÉ standards for automobiles are estimated to add $1,300 to the price of an average new car.
Plus, the administration says it will allow the Bush tax cuts expire in 2011. That will effectively increase income taxes on the average family by about $1,500 per year.
Why am I talking about tax increases in a piece on inflation? Because increasing taxes will, I say again, will slow economic growth; perhaps enough to delay the recovery for years. A delayed recovery means that new taxes will fail to produce the predicted revenue. This will result in continuing deficits that must be financed through borrowing and the creation of ever more money.
Inflation is coming – get ready.
So, how does one “get ready” for inflation? By moving money into assets that will increase in nominal value as the currency inflates - more to come.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
Government spending has risen dramatically while revenues have fallen 34% year over year. The Obama administration predicts a recovery starting in early 2010. However, they also set the “worst case” scenario for the bank “stress test” at 8.9% unemployment in a recovery starting in late 2009. The Federal Reserve is now forecasting 9.4% unemployment by the end of 2009 and continuing to rise to around 10.5% before declining.
The administration promises to reduce spending in 2010 and to raise taxes everywhere on everything.
They want to create a carbon use tax also known as “cap and trade” that will increase the cost of doing everything that uses energy – virtually every human activity. Some estimates peg the carbon tax cost at an average of $3,000 per family. Make no mistake families will pay this cost through increased prices of goods and services.
They want to create a “value added tax” (VAT) on all economic activity. VAT taxes are commonly used in Europe. They are sort of like sales taxes that are applied at every level of production and consumption – unlike American sales taxes that are applied only at the retail level. A 10% VAT would increase the cost of everything a family purchases by about 10%. So a family that spends $30,000 a year would experience about $3,000 in increased prices of goods and services as a direct result of the VAT. It would also increase the administrative costs of running a business by requiring all companies to collect these taxes.
The recently announced increased CAFÉ standards for automobiles are estimated to add $1,300 to the price of an average new car.
Plus, the administration says it will allow the Bush tax cuts expire in 2011. That will effectively increase income taxes on the average family by about $1,500 per year.
Why am I talking about tax increases in a piece on inflation? Because increasing taxes will, I say again, will slow economic growth; perhaps enough to delay the recovery for years. A delayed recovery means that new taxes will fail to produce the predicted revenue. This will result in continuing deficits that must be financed through borrowing and the creation of ever more money.
Inflation is coming – get ready.
So, how does one “get ready” for inflation? By moving money into assets that will increase in nominal value as the currency inflates - more to come.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary
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