How to Protect Against Inflation?

Posted on May 26th, 2009 by admin in How to Invest

We  just got a note from our friend, Dr. Ruth, the economist. She was responding to a note we had sent about the virtues of Treasury Inflation Protected Securities (TIP) as an inflation hedge. She pointed out gold is better, because TIP uses the Consumer Price Index (CPI) for its measure of inflation, and CPI is well known to understate true inflation. So we fired up the Web and got some interesting comparisons. She’s probably right, but it’s hard to “prove” based on recent history.

Look at the three graphs below in Figure 1. Each one compares relative returns for TIPS (TIP), S&P 500 (^GSPC) and gold (GLD ) the gold ETF that buys and sells physical gold. The time periods are year to date, the last 2 years, and last 5 years.

Figure 1: Relative Performance of TIP, ^GSPC and GLD

Comparison: Year to Date

Comparison: Year to Date


Comparison: Last 2 years

Last 5 years

Comparison: Last 5 years

These historical data are clear: gold has been the best investment of the three compared, with S&P500 and TIP changing places, depending on timing of entry, as the worst performer.

Of course, in the past 5 years none of these securities has actually operated during inflationary times, so this comparison is somewhat weak regarding inflation per se. The last five years have been essentially inflation-free, and possibly slightly deflationary in last six months. However, even during deflation, TIPS should perform well since their principal is guaranteed by US Treasury.

These results are probably more intriguing than decisive, since the world has had major paradigm shocks and gold is emotionally the winner for any type of systemic uncertainty or fear.

Oh–the answer to the question in the title of this post is: buy some gold and buy some TIPS!

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