Inflation

All posts tagged Inflation

Unless you’ve just woken up from a week-long coma, you already know that Ben Bernanke, Chairman of the Federal Reserve, announced the Fed is going to maintain its Zero-Interest Rate Policy for the next 2-3 years. It is also going to buy $500 billion worth of mortgages every year until the economy improves.

One opponent of this measure was president and CEO of the Dallas Federal Reserve, Richard Fisher. Fisher maintains that buying bonds probably won’t help stimulate the economy. Instead, it will however increase inflation, and expectations of inflation.

As one of the richest members of the Fed, we should probably listen to him. Worth an estimated $21 million, Fisher has worked as a Banker and a Hedge Fund Manager. And he’s been voicing inflation concerns since 2005.

While opposing the Fed’s stance on bond purchases, his personal portfolio is well positioned to benefit from any inflation that might occur due to it.

Fisher owns about $1 million worth of gold in the form of the gold ETF (GLD), $250,000 in uranium, and over 7,000 acres of land in the Mid-West.

In a prior post, I mentioned that everyone’s portfolio deserves an allocation to gold. As a percentage of his portfolio, Fisher’s allocation to gold is sitting at about 5%. In addition to gold, real estate is also inflation hedges. (While I wouldn’t necessarily recommend uranium as an inflation hedge, it is a commodity and thus being somewhat uncorrelated to either stocks or bonds, would provide some value in a portfolio).

So he’s definitely set up his investments to benefit from inflation.

What else does he own? Several million in Texas Municipal Bonds – earning him tax-free interest on his money. And a lot of blue-chip stocks like Eli Lily and Du Pont along with MLPs like Magellan Midstream Partners. You can check out the entire list here.

Nothing like a well-balanced portfolio to live out your retirement years in case your cushy government pension runs out!

Let’s face it, European countries are bankrupt. First it was Greece and Ireland. Now it’s Portugal. Pretty soon it’ll be Spain and Italy.

Politicians will never admit there’s a problem. Portugal’s prime minister just said that they don’t need any financial assistance. Just like Greece’s prime minister said last March, he claims they want to help themselves out of this mess. And like Ireland’s minister of foreign affairs said last November, there’s no need to panic. Of course a couple of weeks later both prime ministers came begging for aid. Portugal will probably do the same.

Everyone wants someone else to bail them out, and pay for their transgressions.  And other nations are rushing in to buy the sovereign debt – using freshly minted money of course. Maybe these saviors know that their own balance sheets are somewhat murky and hopefully someone else will return the favor in the future?

After all, printing more money to buy another country’s debt is a splendid idea. Keeps the world economy chugging along without having to deal with any of the difficult issues. Like reducing debt. (I’ve never quite understood the notion of solving a country’s excessive debt problem by rolling it over in to more expensive debt. But financiers make money selling debt, so that’s what economists (who secretly harbor dreams of working on Wall Street) will advise the governments to do). But there is a crisis of sorts and whenever there is a crisis anywhere, people flock to the US and to the relative safety of US treasuries.

Everyone and their mother seem to be making financial and investment predictions for the rest of 2011. So I’ll do the same.

1. For the first half of the year the US dollar and government bonds will appreciate – especially against the Euro.

2. Also during the first half of 2011, Gold and Silver prices will drop from their spectacular highs as the US dollar appreciates. But I think Gold prices will stay above $1000/ounce.

3. But eventually, probably during late-summer, people will realize that all the major countries are printing money and using it to prop up failing countries and companies by buying debt, the US dollar and treasuries will slide. And Gold and Silver prices will start to rise again.

4. This collapse in treasuries will be precipitated by multiple bankruptcies in the municipal bond markets.
In the past 2 years, 15 municipalities have filed bankruptcy. According to a recent article in WSJ:

Mr. Bernanke downplayed the notion that many state and local governments run the risk of defaulting and that the municipal bond market could be headed for turmoil. The muni market, he says, has been functioning “reasonably well,” with lots of bond issuance and liquidity in trading. “We’re not seeing extraordinary stress,” he says. Some analysts have been warning that a crisis is looming in the muni market. Mr. Bernanke described these warnings as overly pessimistic. He also said the Fed, which has some limited authority to buy short-term municipal debt, has “no expectation or intention to get involved in state and local finance.” If states are to be bailed out, he said, “it would have to be Congress.”

Isn’t that exactly what he said right before Fannie Mae and Freddie Mac went bankrupt? Let’s face it. There will be a muni-bond meltdown, and Bernanke will scare congress into bailing them out. Bernanke is just a bare-faced liar. Actually, he got tired of being called a bare-faced liar which is why he sports a beard. But regardless, the only reason he brought it up is because it is an issue that will become pertinent within the next 18 months.

Incidentally, previous Fed Chairman, Alan Greenspan, said exactly the same about the housing bubble back in 2005. That it wasn’t an issue and there was nothing to be worried about. As an economist, he should have seen it was a bubble, of his own creation.

This collapse of muni-bonds will scare the pants of regular Americans and foreign investors. As the last bastion of fixed income for the retired, the wealthy and global pension-funds, muni-bond defaults will trigger a major panic. Citizens and investors will realize that they’ve been hoodwinked by the government and Wall Street, and they can’t trust either of them.

5. This will cause a flight to gold and silver, possibly the last and most intense run in this bull market.
I predicted back in December 2005 that “the US is going to enter a period of inflation and recession brought on by the trade & budget deficit and precipitated by the devaluing dollar” and that at $508, it was a great time to buy gold. I still believe it is. If you haven’t already established a position, make sure you buy both gold and silver on dips. If you don’t know how to buy, read through the previous posts on gold and silver. Hopefully, this major rush in gold will not trigger the complete collapse of global currencies. And if it does, it’s still a few years away, so it’s not an 2011 prediction.

Disclaimer: I’m short a Euro ETF, long gold and silver (bullion and mining stocks). None of this should be construed as investment advice.

Today the US debt broke the $13 trillion level. Considering that the US GDP or the US economy is $14.2 trillion (according to the World Bank), that makes our debt level just over 91% of the GDP. Greece’s debt-to-GDP ratio is currently at 115%  (or 133% depending on who you ask – I don’t think even the Greeks know for sure!) and look at the trouble it’s facing!

Professor Morici, of the University of Maryland, is critical of excessive government spending. He claims that whenever the debt-to-GDP ratio exceeds 150%, you run the risk of hyperinflation or “the Chinese buying up Wall Street”, a reference to China being the largest foreign lender to the US government. Either way, he claims that we will run the risk of losing our financial standing.

On a brighter note, the UK is trailing right behind us with a debt-to-GDP ratio of 78%.  But the real leader of pack is Japan, with a whopping 227%! Not to worry, we’re nowhere close to Japanese levels yet!

After WWII, our debt stood at 125% of our GDP and we were able to bring it under control. Let’s hope we can do the same thing once again. Meanwhile, we can all watch our share of the federal debt over on http://www.usdebtclock.org, and how the national debt seems to be growing $50,000 every second!

With the passing of the Health Care Bill, there is a slew of tax increases that will go towards paying for it. I don’t think any of them are going towards paying down our ballooning debt. Congress probably feels that inflating it away is the easiest solution! And it is, provided the inflation comes in an orderly fashion. But what if it doesn’t?

The Wall Street Journal had an article advising homeowners who were upside down on their mortgage to just throw in the towel and walk away from their mortgage. Here’s the abridged version:

Millions of Americans are now deeply underwater on their mortgage. If you’re among them, you need to stop living in a dream world and give serious thought to walking away from the debt.

No, you shouldn’t feel bad about it, and you shouldn’t feel guilty. The lenders would do the same to you—in a heartbeat. You need to put yourself and your family’s finances first.

If you are reluctant to give up on “your” home, realize that it isn’t “yours.” If you are in negative equity, it’s the bank’s home. You’re just renting it. And right now you may be paying way above market rates. You need to be ruthless about your cash flow.

Still, when it comes to the idea of walking away from debts, many people are held back by a sense of morality. They feel it’s wrong to abandon their obligations. They don’t want to be a deadbeat.

Your instincts, while honorable, are leading you astray.

The economy is fundamentally amoral.

Whether we like it or not, walking away from debts is as American as apple pie. Companies file for bankruptcy all the time, and their lenders eat the losses. Executives and investors pocketed millions from the likes of Washington Mutual, Lehman Brothers and Bear Stearns when the going was good. They didn’t have to give back one cent of that money when the companies went into bankruptcy.

Wow, I’m speechless. It seems the greed of Wall Street has permeated down to the lower rungs of society and it’s perfectly okay to socialize your debts and losses. (By socializing, I mean the bank or taxpayer or a large group of people who are not affiliated to you end up paying for your debts/losses/mistakes/greed). Apparently its as American as apple pie. Is this the change I didn’t vote for? If everyone in all sections of society thinks its perfectly okay to default on your obligations, logically, the next question is

How much longer until the US Government starts defaulting on its debts?

Of course, the US Government cannot default, since it can keep printing US Dollars to pay for its debt. Which it is already doing. The only problem is that this increases the number of dollars in circulation and causes the currency to devalue. Sooner or later, we’re going to see a large of amount of inflation. No we may not see hyperinflation like Brazil or Zimbabwe, but we sure might see 10-12% inflation for a few years.

But 12% inflation for only 6 years would cause the price of everything to double. If you don’t think that’s possible, just look at a country which isn’t currently in deep recession, like India. Inflation in India is currently running at 9%. And over the past decade it has been running at a similar rate.

So what’s the effect on the average Indian? Highly skilled workers saw their salaries jump 10 times, while salaries for unskilled labor is up about 5 times. So everyone is better off, right? Not exactly, people living on fixed incomes basically got screwed as prices for everything else went up 5-10 times as well. It was great if you owned real assets like real estate, gold and to some extent stocks, but terrible if you owned bonds or cash. Just make sure your investments are tailored towards those investments that happen to do well during inflationary times.

Here’s an interesting article by Dominic Frisby about Venezuela’s devaluation, the effect on a country’s currency and the relation with gold prices.

Gold bugs are forever telling you to buy gold because it is ‘nobody else’s liability’. It’s become one of those hackneyed phrases that has almost lost its meaning.

But recent events in Venezuela give us a nice illustration of what that phrase really means. And there’s a stark, but important message for savers everywhere.

Inflation is currently running at 27% in Venezuela. That’s just the official figure. You can expect the real number to be considerably higher.

Earlier this month, the Venezuelan president Hugo Chavez, devalued the bolivar by half, from 2.15 per US dollar to 4.30 per dollar. There will be a second peg, subsidised by the government, of 2.60 bolivars per dollar for essential imports such as food, medicine and machinery.

This devaluation has effectively doubled the cost of imported goods and halved the Venezuelan people’s purchasing power in a single stroke. Savers – though I doubt there are that many given the country’s precarious situation – will have had half of their wealth effectively wiped out overnight.

Chavez is doing it, he said on state TV, ‘to boost the productive economy, to reduce imports that aren’t strictly necessary and to stimulate exports.’ But that won’t be the effect. All his actions will do is discourage people from working at all. Leaving aside the moral issue of whether government should have the power to do that (and, largely speaking, with our modern system of money and credit, they do), many Venezuelans will now ask themselves: ‘What is the point of my working at all, if the proceeds are going to be devalued so suddenly?’

But any Venezuelan who happened to have converted some of their wealth into gold would be protected from these government foibles – at least, as much as is possible under the circumstances. [LOD”s note: Not only gold and silver, but even real estate would hold its price in an event like this. Over the long term, real estate matches inflation, and to some degree population growth]. Chavez cannot suddenly devalue gold by half to ‘boost the productive economy’. So the proceeds of that individual’s labour would have been preserved. The purchasing power of gold against essential goods such as food, energy and shelter remains unchanged – in fact it’s probably risen.

I remember backpacking across South America in the early ’90s. Venezuela was one of the wealthiest, most advanced nations on the continent. It’s such a shame to now see the country on Hayek’s The Road to Serfdom, or, worse still, to Zimbabwe.

“Chavez”, writes Daniel Cancel on Bloomberg, “is trying to maintain spending for his 21st century socialist revolution as South America’s largest oil exporter fails to emerge from its first recession in six years. The government is seeking to stem its falling popularity and the highest inflation rate among 78 economies tracked by Bloomberg, ahead of parliamentary elections scheduled for September.”

Well, isn’t our own government doing the same thing? Haven’t they boosted spending over the last three years in an attempt to stem falling popularity ahead of an election? Isn’t quantitative easing an elaborate form of currency devaluation? The effect of their actions has been that sterling has been losing its purchasing power. It buys us considerably less food, energy, medicine, industrial goods and anything else you care to mention (except mass manufactured goods from Asia) than it did five years ago.

It even buys us less foreign currency, as the chart below – which shows sterling against a basket of foreign currencies – shows. (I’ve drawn on that white line highlight the market direction) The only reason sterling has not fallen further is that other foreign central banks have been doing the same things to their own money. It is a race to the bottom.

british-pound-against-basket-of-currencies.ashx

Our currency has devalued many times before. Anyone who remembers 1976 can tell you about the sterling crisis then. Financial markets were losing confidence in the pound. (I believe that loss of confidence is coming again. If sterling drops below $1.57 against the dollar, look out below).

The UK Treasury could not balance its books, while Labour’s strategy emphasized high public spending. The newly-elected prime minister, Jim Callaghan, was told there were three possible outcomes: a disastrous free fall in sterling, an internationally unacceptable siege economy, or a deal with key allies to prop up the pound while painful economic reforms were put in place. What will David Cameron be told should he win in the summer? The parallels to today are uncanny.

In more recent memory, we have had the sterling lows of March 1985 (when we almost hit parity with the dollar), then another crisis with ‘Black Wednesday’ in October 1990, when we were forced to drop out of the European Exchange Rate Mechanism.

What is worrying is that our current deficits, debts and spending are all at far greater levels than during any of the previous crises. So many toxic assets have been transferred from the balance sheets of banks to governments, that sovereign debt default – not just here, but throughout the Anglo-Saxon economies – is now a major risk.

You can read the entire article on moneyweek.

So Why should you care?
If you invest in US companies that do business with Venezuela, then your portfolio returns will definitely be adversely impacted. US companies that do business with Venezuela like Haliburton are likely to feel the impact of this currency devaluation. Haliburton CEO just announced that they may face a $30 million loss in the 1st quarter because of this.

While I liquidated almost my entire stock portfolio at the market open this morning (including Harvest Natural Resources which does business in Venezuela), I’m still keeping my gold and silver coins!  Talking the about market, its risen 50% since the March lows of last year. I might even go short some weaker stocks on any market bounces too.

According to a quote in the Telegraph, HSBC has issued a new report stating that the Federal Reserve’s ultra-loose monetary policy is forcing China and other emerging countries to create a new global currency “order”. According to David Bloom, HSBC’s currency chief, the dollar looks like the sterling did after World War I.

For those a little dusty on their history, the British pound sterling (so called because it’s value was backed by sterling silver) was the world reserve currency until the 1930’s. After that, the sun set on the British Empire and the sterling was replaced by the US dollar. Now it seems the dollars time in the sun has come to end as well. The Telegraph article states:

Crucially, China and rising Asia have reached the point where they can no longer keep holding down their currencies to boost exports because this is causing mayhem to their own economies, stoking asset bubbles. Asia’s “mercantilist mindset” of recent decades is about to be broken by the spectre of an inflation spiral.

A monetary policy of near zero rates – further juiced by quantitative easing – is completely incompatible with circumstances in most of Asia, the Middle East, Latin America, and Africa. Divorce is inevitable. The US is expected to hold rates near zero through 2010 to tackle its own crisis.

Mr Bloom said regional currencies would emerge as the anchor for their smaller trading partners, with China, Brazil, or South Africa substituting the role of the US. Australia is already linking its fortunes to China through commodity ties.

This is nothing new, but it is the first time a major bank has openly stated this. But the important question hasn’t been answered.

What does it mean to the average American?

In order to obtain the necessary financing to fund the multi-trillion dollar stimulus/bailout package the government needs to sell bonds. Traditionally, the Chinese and other foreign governments have used their excess reserves of US dollars to purchase these bonds. If we switch to some other currency (or mixture of different currencies), the amount of US dollars held by foreign governments will decrease and the demand for US treasuries that yield next to nothing will decrease substantially. In order to entice the buying of these treasuries, the interest rates will have to jump substantially higher. And when this happens, the cost of the US government’s debt will start to rise. As will the cost of borrowing for US citizens and businesses. The government already pays nearly a billion dollars a day in interest payments (hat tip: Silver Bars Direct: Why $1,000 gold is now significant). If this cost were to double, and we add in the additional $9 trillion in debt the white house has admitted it is likely to borrow, we’re looking at over a trillion dollars a year in debt payments.

In order to repay this interest (and maybe the original principle too), do you think the government is likely to raise taxes or just print more money? If it prints more more, its just fueling the debt spiral which will lead to Zimbabwe-type hyper-inflation.

So what should you do?

Invest in hard assets that have been proven to keep their buying power during inflationary times.  Along with gold and silver bullion, buy some cheap land to either farm, hunt or bury your precious metals! And if you’re one of those people who think buying gold and silver is useless then hold on to your dollars and watch them become even more worthless. Since 1900, when the dollar coin actually contained silver, the dollar’s purchasing power has dropped to only4 cents. This trend is only like to get worse.

Purchasing-Power-of-the-US-Dollar-1900-2005

Disclosure: I own gold & silver bullion, numismatic coins and mining stocks.

Almost a year after the historic collapse of Lehman Brother, Fed Chairman Dr. Ben Bernanke announced that the worst recession since 1930 is finally over!

recession next exitHowever, this is only from a “technical perspective”, and unemployment for 15 million Americans (officially 9.7%) will continue, if not get worse. In fact, it may stay this way for nearly 4 more years according to other economists.

So what does this mean? The operation was a success but the patient still died!

Apparently pumping a trillion dollars in to the economy will create a technical expansion even if the net benefit to society is negative. What happens when the government pulls the plug on throwing money at the ecnomy? Won’t the GDP decline again, pushing us back in to a double dip recession?

And what happens if our lenders make this decision for us? Supposing China and Japan no longer want to buy our 30 years bonds at a measley 3 or 4%. What if the interest rates go up to 8%? Will we be able to afford $1 trillion dollars a year in interest payments? Will we start issuing notes for the interest payments? Nah, we’ll just devalue the currency and let inflation help us out of this mess. Either that or the government stimulus will continue indefinitely, aka monetary policy Zimbabwe-style! Oh wait, isn’t that the same thing?

Here are some must-read articles I’ve read this week. None of them talk about gold breaking a $1000, dividend stocks or things you’ve probably read in the news.

Finally Warren Buffett said what I’ve been harping on about for two years. In his NYT op-ed piece titled “The Greenback Effect” he admited that the government is setting us up for massive inflation and destruction of the US Dollar.

This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion.

During this fiscal year, [our net debt] will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out.

The US debt is currently financed by foreigners. Foreigners who have excess Dollars because we used to import everything from them. Three years ago during the height of the housing boom, consumers refinanced their homes every year and bought stuff they couldn’t afford, most of it imported from these same foreign countries. Indeed, consumer spending was 75% of our GDP. But with the collapse in housing, what has happend to consumer spending at the retail level?

Monthly US Retail Sales Total YoY

Retail spending has dropped off a cliff. Click on the image to go to retailsails.com which is has a lot of indepth information about the dismal level of retail sales.

And with the decline in spending, imports decline and in turn the ability of foreigners to finance our deficit spending. As they decide they no longer want to buy US treasuries at 3.5% but instead would like to buy stock in undervalued companies, real estate or maybe gold, the Federal Reserve is going to have to work overtime to print all the money it needs to fund the government spending. Buffett projects that the Treasury will need to finance at least $900 billion this way!

With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required.

Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

I forget who said it but inflation is essentially taxation without representation!

Rampant inflation will cause the Dollar to lose its purchasing power against foreign currencies and precious metals like gold and silver which have been stores of value for 5,000 years. Unlike paper money, gold and silver are not subject to the human greed of rulers and maintain their value since their supply cannot be increased exponentially.

Buffett knows that the reputation of the Almighty Dollar is at risk.

Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.

Will Congress do the right thing or just do what’s easy and keeps them in office? Buffett is betting on the later and has slowly been converting his hoard of of billions of dollars in to foreign currencies like the Brazilian real.

At least I’m sure I did the right now when I started buying gold at $495/ounce!

While the debate between inflation and deflation keeps on going, I’m firmly in the camp of inflation. And so is Warren Buffett, as are many other investment advisors. So how do you protect yourself and your investments from the effects of inflation?

Investment newsletter editor, Keith Fitz-Gerald, recently had a post on his blog regarding the 4 ways to protect your investments against inflation. Here’s an excerpt:

What’s interesting is that many investors holding large cash positions view their money as an asset, when, ironically, it’s really more of a liability at this stage of the game.
Some might take issue with that statement. After all, even we at Money Morning have counseled readers that cash – correctly deployed – can allow an investor to sidestep the worst stretches of a financial crisis, like the one from which we’re currently attempting to extricate ourselves.

But when the markets are as beat up as they as they have been, history suggests there’s probably more upside than downside – even if we haven’t bottomed out yet.
And there’s a broad body of research to support that contention – including our own newly created “LSV (LIBOR/Sentiment/Value) Index” (published as a part of The Money Map Report, the monthly investment newsletter that’s affiliated with Money Morning).

There’s also data sets widely published by others, such as Yale Economics Professor Robert J. Shiller. Shiller has found that when you look at 10-year periods of Price/Earnings (P/E) data dating all the way back to 1871, the markets tend to rise when the average P/E is low, as it is right now. Conversely, when the average Price/Earnings values are high – as they were in late 1999, and again in 2007 – a decline in stock prices is much more likely.

There are obviously no guarantees that history will repeat itself. But if it does, the same data implies we could see real returns of 10% a year or more “for years to come,” as Shiller noted in a recent interview with Kiplinger’s Personal Finance.

My own research seconds the general-market-increase theory, but I’m much more conservative in my expectations of returns and think that returns of 7% are more likely.

Perhaps what’s more important right now is that inflation typically accompanies growth – and with a vengeance. And that means that investors who are sitting on cash “until the time is right” may have their hearts in the right place but are relying on the wrong protection strategy.

My recommendation is a four-part plan that can help lock in the expected returns you want, while also protecting your cash from the ravages of inflation. Let’s take a close look at each of the four elements of this strategy:

  • First, protect your cash with Treasury Inflation Protected Securities (TIPs). Even though the trillions of dollars the Fed has injected into the system seem to be having some effect on the critically ill patient the U.S. central bank is trying to fix, we’re likely to pay a terrible price in the future. Forget the hyperinflation scenario so many people are hyping at the moment. While that’s certainly possible, it’s not probable. However, what is likely is a dramatic realignment of the dollar and a general increase in worldwide living expenses.

If you’re based in the United States and have mostly U.S. assets, you may want to consider something as simple as the iShares Barclays TIPS Bond Fund (NYSE: TIP) to offset this risk. The TIP portfolio is chocked full of inflation-indexed securities, but it also offers a healthy 7.46% yield. If you’ve got international exposure, you may also want to consider the SPDR DB International Government Inflation Protected Bond ETF (NYSE: WIP). It’s a collection of internationally diversified government inflation indexed bonds that provides similar protection. Make sure you talk with your tax advisor about both, though. Depending on your tax situation, you may find that because of the tax liability on inflation-related accretion, these are generally best held in tax-exempt accounts.

  • Buy gold but don’t go crazy. Despite widespread belief to the contrary, gold has never been statistically proven as an inflation hedge. But the yellow metal has proven to be a great crisis hedge because of the 10:1 relationship between gold prices and bond coupon rates – which obviously are directly related to inflation. Over time, the two move in such a way that having $1 for every $9 in bond principal can help immunize the value of your bond portfolio.

So to the extent that you own gold, do so not because you expect it to rise sharply, but because it will offset the inflationary damage to your bonds. A good place to start is the SPDR Gold Trust (NYSE: GLD) because it’s tied directly to the underlying asset without the hassles or risks of direct personal storage associated with bullion.

  • Consider commodities. It’s too early to tell if the so-called “green shoots” that everybody is so excited about are little more than weeds. Therefore, it makes sense to concentrate on picking up resource-based investments. History shows that these things are less susceptible to downturns, but more importantly, rise at rates that far exceed inflation when a recovery begins in earnest.

I prefer companies like Kinder Morgan Energy Partners LP (NYSE: KMP) that are less dependent on the underlying cost of energy than they are on actual growth in demand. That way, if energy prices don’t take off immediately for reasons related to deflation or stagflation, those still will benefit from demand growth. It’s a fine point, but one that merits attention for serious investors. KMP, incidentally, yields an appealing 8.68% at the moment.

  • Short the dollar to hedge your bets still further. Not only is the government going to borrow nearly four times more than it did last year, but when you add the complete federal fiscal obligations into the picture, our government owes nearly $14 trillion. This makes the dollar, as legendary investor Jim Rogers put it, “a terribly flawed currency” that could fail at any time.

To ensure you’re at least partially protected, consider the PowerShares DB U.S. Dollar Index Bearish Fund (NYSE: UDN), which will rise as the dollar falls. It’s essentially one big dollar short against the European euro, the Japanese yen, the British pound sterling and the Norwegian kroner, among other currencies.
In closing, there is one additional point to consider. You rarely get a second chance to do anything, especially when it comes to investing. So act now before the markets make it cost-prohibitive to protect yourself. When the economic recovery gets here, you’ll be glad you did.

Pretty sound advice. I was just thinking about converting my 401k into TIPS today when I came across this article. The rest of the advice I’ve followed in some form or another. Instead of directly shorting the dollar, I’m long FXA, which is the CurrencyShares Australian Dollar ETF and EDD which is an ETF of short-term foreign government and corporate bonds.

Another way to SHORT the dollar is buy going LONG foreign currencies. Everbank has multiple CDs you can open in various currencies. They also have some neat products where the principle is guaranteed against loss – there is no free lunch – the interest is used to hedge against loss – but you do get any upside appreciation of the currency. Check out their Marketsafe BRIC CD. Also check out their free newsletter, the Daily Pfennig, which is a good source of unbiased global macroeconomic/monetary and currency information.