Inflation Products

Are we heading towards or already suffering from inflation like we had in Huggy Bear's time?

There is no shortage of opinion in either direction but really the only thing most folks probably care about is how higher prices for every day items like gas, food and healthcare effect them versus how lower prices for their homes effect them. It stands to reason that people would each view this differently.

I don't think people should be so fixated on the current value of their home but they are and so my own take is that a lot of people would be more concerned about what was a $400,000 house a year ago now being at $360,000 than gas being $10 more per tank or spending $12 more at Walmart every week, however I would not argue with anyone saying the $10 and $12 are more important.

Regardless of what you think about inflation rates, we have had relatively low inflation over the last decade or so and having it be a little higher for a while seems reasonable so it makes sense to build in some inflation protection into a diversified portfolio. That might mean TIPS to some folks, gold to others, equities too can help offset inflation over the long term, maybe REITs are the answer.

This brings us to a related comment left by long time reader OG. He said he is not sure what the optimal mix of gold and TIPS would be.

This chart comparing GLD and TIP (both of which are client holdings) probably makes it clear as mud what the mix should be.

I don't see any sort of correlation but I do believe both of them serve important inflation related purposes but they will deliver different effects to a diversified portfolio. Since 1971 gold has had huge moves up, a huge move down and periods of seemingly not doing much. You obviously expect much less action, as shown in the chart, from TIP.

If you believe in both (and I do) but are not a fan of volatility then perhaps an equal mix of the two could help with managing the volatility. FWIW I tilt a little heavier to TIP versus GLD but I have some mining stock exposure which has done well but I think of it as more of a regular equity holding than a pure inflation hedge.

A close to even split may not seem too interesting but the most important thing is having any exposure at all. At different times, obviously different mixes would be the best. When GLD was going up to $100 you should have more GLD. When GLD was headed down to $84 you should have had more TIP. If you are not likely to win between the two then it is better to just focus on whether owning the asset class is appropriate for you and if it was is the best way for you to do it.

OG then followed up with an idea for an exchange traded product tied to "real" CPI that he would only trust Barry to devise. Barry'd be a good choice. I touched on this before too. I think the idea of indexing CPI rates from different countries, regions or other logical baskets of countries into an exchange traded product and perhaps levering them 1.5-1 (that's one point five to one) would make for a very compelling security. A CPI basket of the GCC countries looks pretty good to me right now as long as those countries continue to peg to the greenback.

David Swensen and others have talked about inflation protection as being an asset class. This makes intuitive sense after all these years of somewhat low inflation. There have been a few other TIP products that have come along since TIP (maybe some of the OEFs are older than TIP) but more importantly this seems like a space that is destined to evolve into more innovative choices like the SPDR Intl Inflation Fund (WIP) which I own for some clients.

Obviously I think the CPI fund idea is interesting but there must be others being studied in various labs throughout the industry. Picking up a few hundred basis points from increases in CPI plus a little interest seems like a good way to invest in what is happening on the ground in a region without taking stock market risk. It could offer a new type of emerging market exposure for folks not too comfortable with iShares Emerging Market (EEM) or other broad EM funds.

One last point about inflation protection as an asset class is that you don't want it to be the best performing thing you own. Ideally stocks would be going up and inflation would be tame. Is there anyone who does not want that? Stocks always going up with tame inflation may not be real world, except for the 1990s anyway, but I think that is what people would prefer--not that their hedges are doing great.

Congrats to John Lester on throwing a no-hitter for the Red Sox last night.