Stagflation Threat Requires Strategy
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February 20th, 2008
Feb. 20, 2008 - Stagflation is a threat that is best defended against with commodities and Treasury Inflation Protected Securities or TIPS as they are commonly referred to.
A recent article by John Wasik, Bloomberg describes a few ways that investors protect against stagflation:
Several investments come to mind: commodities and Treasury inflation-protected securities, or TIPS.
…One refuge in inflationary times has been gold. Held in huge quantities by large banks and the favorite commodity of inflation speculators, it has been in demand over the past year.
You are better off buffering the ravages of inflation on your portfolio.
That means finding investments that combine income and price appreciation, and rise with inflation expectations.
Two investments come to mind: commodities and Treasury inflation-protected securities, or TIPS. A deft combination of TIPS and commodities can be found in the PIMCO Commodity Real Return Strategy Fund. It returned 23 percent last year. This is my portfolio’s key inflation buffer.
Whatever stagflation strategy you adopt, remember that overconcentrating in any of the inflation-fighting vehicles will add unnecessary risk to your portfolio.
Inflation is an often-unpredictable ogre that creeps up slowly. You will need a number of weapons to do the job.
Canadian investors seeking to invest in inflation protected securities and commodities may look at any of a number of Real Return Bond and diversified commodity products. Some of these include:
ETFs
iShares Real Return Bond ETF (XRB)
Claymore Global Agriculture (COW)
Canadian Mutual Funds
TD Real Return Bond Fund A (TDB755)
Investors Real Return Bond Fund (IGI491)
Don Coxe’s January 2008 recommendations include this particular paragraph:
Bond investors face two risks: inflation and credit. Nominal Treasury bond yields are far too low, and quality corporates are too rare – with 71% of corporate debt junk-rated. Buy inflation-hedged sovereign bonds – preferably in major foreign currencies. Simplicity is good: avoid complex products that are subject to drastic rating writedowns.
George Soros discusses the circumstances under which the Fed might be rendered impotent at macroeconomic control:
Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
Caution: One thing to remember is that TIPS or Real Return Bonds in a mutual fund do not provide investors with the same degree of risk management where date-driven spending plans are concerned. The maturity date of any bond is a guarantee the face value will be paid at an exact time in the future. Bond mutual funds, unlike the underlying security, do not provide any fixed maturity date or guranteed sum. Ideally, if you can get your hands on the bonds, then do so.
…leaves you wondering just how far the Fed may or will have to go with rate cutting in order to get the economy going again, and in the process, provide enormous [inflationary] stimulus to the rest of the world. This is truly a mixed blessing.
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Tags: Agriculture, Commodities, Credit Market, Investment Strategy, Markets
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