Speculation that the Federal Reserve will announce a new round
of quantitative easing has increased over the last two weeks and
investors are convinced enough that it will happen to put their
money on the line.
Big money has been flowing into Treasury inflation-protected
securities (TIPs) as investors anticipate the next round of
so-called QE will lead to higher inflation in the years ahead. The
inflation concern is based on the belief that to pay for the Fed's
purchases, the government must print more money.
To prove my point about inflation expectations you can turn to
the breakeven rates, which measure the spread between conventional
bond yields and the yields on the TIPs. Last week the spread rose
to 193 basis points based on the 10-year Treasury note, the largest
since June and well above 147 basis points in August. The number
suggests investors are pricing in an inflation rate of 1.93 percent
within a decade.
The 10-year breakeven rate is almost back to its five-year
average of 210 basis points, but well off the year high of 249
basis points in January. Because it's clear the Fed isn't concerned
about inflation, inflation-protection-related investments should
continue to outperform. My belief, which I share with a lot of
people, is based on a view that Bernanke wants inflation above the
1.5 percent to 2 percent target.
If you still need more evidence that inflation is a concern in
the future, I present you with the iShares Barclays TIPS Bond ETF
(NYSEArca:TIP). The ETF invests in a variety of TIPs with an
average maturity of 9.3 years and currently has an SEC 30-day yield
of 0.35 percent. Year-to-date the ETF is up 7.5 percent and is
close to breaking above the 2008 high. TIP has an expense ratio of
In September 2009 Pimco launched three ETFs that tackle the TIPs
market. The Pimco Broad US TIPS ETF (NYSEArca:TIPZ) is similar to
TIP with an average maturity of 9.1 years, an SEC 30-day yield of
1.6 percent, and 0.2 percent expense ratio. This Pimco ETF is up
8.3 percent in 2010.
PIMCO offers investors exposure to more concentrated TIP ETFs
through the Pimco 1-5 Year US TIPS ETF (NYSEArca:STPZ) and the
Pimco 15+ Year US TIPS ETF (NYSEArca:LTPZ). As the name implies,
STPZ invests in TIPs with maturities between one and five years.
The average maturity is 3.0 years and the SEC 30-day yield is 1.55
percent. The shorter the maturities, the lower the volatility and
therefore the gains/losses will be muted compared to a bond ETF
with longer maturities. Year-to-date the ETF is only up 3
On the other end of the spectrum is LTPZ, which has an average
maturity of 23.0 years and has risen 13.5 percent in 2010. The SEC
30-day yield is slightly higher at 2.0 percent. Both ETFs have
expense ratios of 0.2 percent.
Investors that believe the Fed will come in with more
quantitative easing and keep interest rates artificially low and at
the same time set the economy up for inflation should lean toward
LTPZ. However, keep in mind that if the Treasury bubble bursts it
would have a larger effect on LTPZ and the price of the ETF could
Commodities Are Telling
If you are still in the deflation camp and are hesitating
joining the "inflation is coming" party, here is more evidence.
Gold, which is seen by many as an inflation hedge, is hitting
all-time highs on a regular basis. Silver is trading at a 30-year
high. Copper is at the best level in over two years. And it does
not stop with the metals. Cotton, coffee, corn, and wheat have all
hit multi-year highs in the last couple of months. The inflation
concerns are real and must be addressed if you invest your
hard-earned money in the market.
Commodity ETFs to consider include the SPDR Gold Trust
(NYSEArca:GLD), which tracks the price of gold bullion. For silver
there's the iShares Silver ETF (NYSEArca:SLV). The grains can be
covered with the iPath Dow Jones Grains Sub-Index ETN
(NYSEArca:JJG) and the soft commodities are available through the
iPath Dow Jones Softs Sub-Index ETN (NYSEArca:JJS).
Now or Never
Once the headline reads, "Inflation is Here," it will be too
late to make money in inflationary investments. Gold and the TIPS
have already rallied, but I feel you can still buy on pullbacks to
prepare for what may turn into hyperinflation in the coming
Matthew D. McCall is editor of The ETF Bulletin and
president of Penn Financial Group LLC, a Ridgewood,
N.J.-based wealth management firm specializing in investment
strategies using ETFs.
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