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Gold is Down… This is What Comes Next...

Commodities / Gold and Silver 2013 Apr 29, 2013 - 04:11 PM GMT

By: Investment_U

Commodities

Alexander Green writes: Gold recently hit a 19-month low, surprising gold bugs and inflation hawks. A particular government bond may be next.

Bonds and gold often move in opposite directions. It’s not hard to see why. Gold is viewed as an inflation hedge, and bonds sell off at even a whiff of higher consumer prices.


Yet bonds and gold have spent most of the last 14 years moving up hand in hand. And, given that the Fed stimulus program is holding bond rates artificially low and there is much talk of a bond bubble, it’s a shock to many gold investors that it is gold that took a recent hit and not bonds.

I think bonds will sell off when the economic recovery kicks into gear. But one kind of bond could easily see a more immediate adjustment: Treasury Inflation-Protected Securities or TIPS.

Ready to Tip?
First created by Uncle Sam in 1997, TIPS pay interest every six months, just like a regular Treasury bond. But, unlike traditional bonds, the holder’s principal increases each year by the amount of inflation, as measured by the consumer price index (CPI). Semi-annual interest payments also increase by the amount of inflation.

The interest you receive is exempt from state and local (but not federal) income taxes. TIPS are less volatile than traditional bonds. They are also excellent diversifiers.

Given the growth in the federal budget deficit, it is no great surprise that TIPS have had a tremendous run.

Even the Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIPX) has compounded at more than 7.25% annually over the last three years. According to The Wall Street Journal, investors have poured $883 billion into the bonds over the past year alone.

But these returns are almost certain to moderate over the next few years and could turn negative.

Here’s why…

First off, while the long-term outlook for our federal deficit is atrocious, over the next five years the national debt as a percentage of GDP is projected to actually decline thanks to Congressional gridlock, higher marginal tax rates and an improving economy.

That’s one reason gold has backed off recently. But it hasn’t caused TIPS to decline.

That’s a bit of a surprise, especially since TIPS now sport a negative yield. Investors are banking on inflation of approximately 2% and figure that even with a negative yield these bonds should earn roughly what 10-year Treasuries yield.

But if inflation remains subdued (or MIA – March saw the consumer price index fall 0.2%), just how long are investors going to hold on to an income investment that promises a negative yield?

Not long.

Does that mean you should sell the TIPS in your portfolio? That depends.

A Good Risk
I suggest that investors who are short-term oriented should, at the very least, lighten up their position. But those who are longer-term oriented should hang on.

So if you own my recommended Gone Fishin’ Portfolio, a long-term asset allocation strategy, stay put.

Why stay put? Because higher CPI figures may indeed materialize down the road. And by the time inflation shows up in the official numbers, insurance like this will be awfully expensive.

And, make no mistake, it is insurance.

This is inflation protection that is 100% guaranteed by the best risk on the planet: the full faith and credit of the U.S. government.

Gold, on the other hand, pretends to be an inflation hedge but is often anything but. The 65% drop in gold between January 1980 and August 1999 – before factoring inflation – was hardly the kind of hedge most investors had in mind when they bought the metal.

Given the strengthening dollar, the likelihood of an improved debt-to-GDP in the U.S. and falling commodity prices, TIPS are likely to soften in the near term.

And gold has further to fall, as well.

Good investing,

Alex

Editor’s Note: Alex and Steve McDonald have been banging the table over the past two years about the bubble forming in U.S. Treasuries. (Read more here and here.)

The only question has been “When?”

After almost two years of extensive research, Marc Lichtenfeld believes this burst is coming sooner, and will happen faster, than anyone imagines.

“If you’re serious about investing, you deserve to know what’s coming,” says Marc.

To see Marc’s work on how to protect yourself (and profit), click here.

Source: http://www.investmentu.com/2013/April/gold-is-down-this-is-next.html

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Comments

hannahgodfrey
01 May 13, 09:17
US Bond Market Bubble

It's strange that the bubble forming in U.S. Treasury bonds isn’t talked about much in the mainstream media.


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