TIPs on TIPs

 

We got a couple of nice comments on our coverage of TIPs yesterday. I had one specific question that might be on other people's minds as well. Here we go:

 

"I like the tip on TIPS. Very informative.

 

Knowing how unpredictable the economy is and understanding our debt situation and direction we can anticipate, regardless of what the market does, I would be curious what trends happened in the past during similar times that we can learn from to invest in...for example, should we anticipate inflation to go up which will likely increase interest rates and therefore make the bond market more attractive so we hold on bonds for now...you know what I mean. I wonder if the Carter years can provide any lessons and therefore opportunities?"

 

What a great question. (And I mean that. In our industry, scuba instructors are conditioned to reply to every question with, "What a great question." or "Thank you for asking that question." Regardless of how lame the question might be. I can see Scott and Skip and Douglas and Ted and Dana and Bob and James laughing their snorkels off right now.) Really a good question, and it is both easy and hard to answer.

 

As we know, inflation is the rise in cost of goods in a given economy. (Sorry about last night. In explaining TIPs, I inadvertently left some of the reference material in the body of the message so it may have seemed redundant. I think that is what you are supposed to say when you get busted plagiarizing? I don't know because I don't usually get caught.) It may also be the devaluation of the currency used to buy those good and is often a combination of both.

 

The last few days is a good example. The dollar has gotten stronger in the last 5-6 sessions against a host of other ugly currencies. (Yes we are winning the ugly dog competition.) We have seen gold come down and oil come down and grains come down, but it has little to do with the supply and demand pressures on those commodities as much as the improved or strengthening value of the US dollar. If that were sustained over say a 90 day period we would see a drop in inflation as the value of our dollar would lower the cost structure of producing many more goods.

 

Not all inflation is bad. As prices inflate, the government usually reacts by tightening liquidity in the market place by raising interest rates. That increase in the cost of capital makes other investments look interesting. Right now we have a great example of that. The 10 year yield is below 2%. There are trillions of dollars on the balance sheets of companies all over the world looking for reasonably safe ways to get a return because of the instability of the markets. As the market stabilize and interest rates increase you see more diversified investments.

 

The causes of inflation could fill a book if you go way back in history. Since the time England and then the US abandoned the gold standard, the prevailing cause of inflation is what is called the quantity value of money theory which states the value of a fiat currency (paper money) is based upon the supply of money in that economy along with the inertia or liquidity of the money in that economy and it value as exchanged for goods and services. Look at what happened to the Deutschemark before World War II. The excessive printing of money and its abundance made the paper money worthless. Some fear that is what is happening here as we continue to provide Quantitative Easing (a fancy word for printing more money) to solve our problems.

 

Are there lessons to be learned from the past. Probably. The Carter reference is accurate, but a little misleading as Carter did inherit an energy crisis a recession and the 8% inflation from the Ford administration. In an effort to ward off massive layoffs in a very Democratic city (Detroit) he bailed out Chrysler (He was way ahead of his time) and he solved the energy crisis by wearing sweaters in the White House. I believe Mr. Rogers was his wardrobe guy.

 

As an astute investor, you must watch certain economic data points which is why we spend 1-3 hours a weekend trying to figure out what might be reported and how it might impact our portfolios. CPI is just one element. If you had to pick one thing that might impact the cost of goods sold in the world, what would it be? (I will give you a hint. Nixon asked then fed Chairman Burns to come up with a Core inflation measurement. It removed food and energy because the Administration said it was too volatile to measure every month. That is why they called him Tricky Dick. Here is a photo of him explaing the sneaky move to VP Ford)

Yeah, keep a close eye on Brent crude and West Texas crude. That is a leading indicator of core and overall all inflation.

 

 

As you see energy costs escalate or you hear about more Quantative Easing you might want to hedge your portfolios by buying more bonds or gold or TIPs. A good financial advisor can make those recommendations and are more likely to pick good inflation protecting devices than good growth investments.

 

Hope that helps. I am going to sleep now as the wine dinner was huge success and we have a long day tomorrow.

 

Salve Lucrum