TIPS tip: nix the TIPs, they're worth zip.

[pedorrero]

This topic comes up sometimes: whether TIPS are a good inflation hedging bet in your portfolio. (I always say "No," but mainly because I'm a pessimist.)

Here is a view on that topic by Mogambo Guru, which if you can get behind the lunatic schtick, is actually written by a real-world money manager:

Here's the link:

http://www.dailyreckoning.com/Writer.../MG050907.html

[. . . Yrs to Go]

Wow, that was some painful rant.

So his argument is two-fold 1) TIPS are bad because gold is a better hedge of inflation and 2) TIPS are bad because CPI understates inflation.

1) Flawed logic. The quality of gold as a hedge against inflation says nothing of the quality of TIPS. Besides, how good of a hedge against inflation was gold purchased in 1980? Pretty miserable. How good will gold be as a hedge when bought in 2007? Nobody knows. But it's worth considering that after a ~300% increase, it may already price in the next 20 years of inflation. But all of this, of course, is besides the point of whether TIPS are a good or bad inflation hedge.

2) More to the point, he rants that CPI understates inflation (and even argues that 5.4% nominal TIPS yields are below inflation). But nowhere does he provide any data whatsoever to back up his assertion. He claims that M3 growth is a better proxy for inflation, but wheres the price data to show that?

In this old post I compared prices found in the NJ Record from 1935 with those from 2005 and found that over a 70 year period, CPI explained a surprisingly large amount of the change in price.

we can also simply look back on the last 20 years of nominal Treasury yields, where we see an average yield of 6.21% before taxes. That yield is especially diminutive when compared to the average increase in M3 of 7.8% (which is closer to the actual rate of inflation) over the last 35 years."

Going back to the trusty prices in the NJ Record for 1965, and using a 7.8% inflation rate over 40 years we'd find that:

A VW Bug would cost $32,174 (new VW's start at $16,500)
A sofa would cost $6,435
Gallon of paint (interior) $60
Sears Socket Set $2,532
Refrigerator $5,810
Newspaper $1.41
Bacon ($/lb) $13.92
Butter (1 lb) $13.92
3.5 room apartment rent $2,824 (per month, Morristown NJ)
Men's slacks $443
Air Conditioner (5,300 BTU) $2,803
Bleach (1 gallon) $10.09

As you can see, Mogabo is soooo far off the mark as to be nowhere near credible.





Other quibbles:

As it turns out, it looks to me like all this borrowed money went into the stock market, and this new monetary fuel sent stocks to new records of various kinds.

That is one possible explanation. Another, and more reasonable one IMO, is that earnings growth expectations for the first quarter were somewhere around 5% and actual earnings growth came in at ~11-12%. That's a huge surprise to the upside. As it stands now, large cap equities are only trading at a mid-teens 2007 Earnings multiple. That doesn't sound like a bubble to me just because the market is hitting new highs. As Buffet said, if the S&P 500 grows only 5% a year we'll be marking a record high of 1,200,000 at the end of the century . . . between here and there are tons of new record highs, most of which will not be bubbles.

Doug Noland of the Credit Bubble Bulletin at PrudentBear.com writes . . .

And

David Tice, founder of the PrudentBear.com site, figures . . .

I'm supposed to take investing advice from these guys??

[mathjak107]

tips are used for income and are predictable as far as amount vs cpi . gold may or may not respond to anything but hyper inflation and actually costs you money to store it. it pays no interest and is highly volatile.

while gold may be considered an inflation hedge its no replacement for tips.

gold and tips may be an acceptable hedge in the right allocations.

[calmloki]

Gold's more fun to hold. Storage costs? A wee safety deposit box at the bank holds all the papers and has enough room left over for an easy 10 -20# of gold - $100-$200k. I guess one could worry about an Ocean's Eleven bunch breaking in and drilling all the locks....

[chinaco]

Gold is an inflation hedge... but its price pretty much moves on speculation relevant to a specific currency and inflation (in a country).


Gold was about $800/oz us in the late 70's early 80's. Went down to approx $300+/oz in the late 80's and 90's.

If you are going to play with gold... it is best to be contrarian and buy when it is way down. Eventually people will worry about inflation and the speculation will kick in again. Then it is time to sell.

If you buy now... Expect to be buying at the top and getting scr3wed. The only way it makes sense to buy now is if world wide financial markets were expected to collapse or hyper-inflation.

[mathjak107]

even with a storage box at the bank when i was following harry brownes permanent portfolio decades ago and was holding gold i had to get a rider on my insurance policy to cover it. the best was he always advocated keeping at least some of it accessable locally so i had fidelity send me some of my gold coins. i got hit with freakin sales tax too

[calmloki]

Buying gold coins and NOT holding them tight in my clutching talons (my Precious! my Precious!) seems counter to the whole idea of holding gold - thought one held it so you could sew it into the hem of your coat when fleeing across the new apocalyptic landscape?! Wasn't it fun getting gold shipped to you? Almost as fun as having cases of ammo or a firearm delivered. I figure there's more fun in fondling gold coins than going to the casino, and costs me less too! Re: expenses - even Vanguard charges fees to hold paper & money, no?

[unclemick]

A little gold(St Gaudin's), platinium(Aussie Koala) and some Morgan silver dollars rattling around in the old safe deposit box.

10% interest in a non working Colorado gold mine anyone.

Ah - the 1970's in Colorado. Passed on the Morman idea of seven years supply of freeze dryed food - the small meals that came out for backpackers weren't bad.

I do vaguely remember a discussion with a lead engineer at Boeing in the late 60's as to the proper method of crossing borders with the family fortune(his parents beat Mao out of China). Metal/metal detectors can make things iffy at times - Jade carvings and precious/semi precious stones definitely have a place in times of turmoil.

heh heh heh - let's hope inflation stays calm and some of the more 'estoric' investment discussion's of my past have no reason to return. I'm getting too old to be looking for 'the last train leaving Berlin.'