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The Daily Reckoning

Gold good, TIPS dumb, if you're worried about inflation (which you shouldn't be)

TIPS, inflation-protected Treasury bonds, are now selling at $105 for $100 worth of bonds. People are paying Uncle Sam to for the privilege of loaning him money. Huh?

By Guest blogger / October 29, 2010

Gold. Gold is gold. Buy gold, and then you'll have gold. Unlike TIPS, where, at their current inflated prices, you are guaranteed to lose money. In this 2009 file photo, a bullion house employee in Mumbai shows off gold bars. He knows the value of gold. Why don't TIPS investors?

Photo illustration / Arko Datta / Reuters / File

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What a whacky, whacky world…

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“Debt sales highlight abnormal conditions,” says the headline in yesterday’s Financial Times.

Abnormal? Freaky. Bizarre. Strange.

The latest auction of TIPS – US Treasury debt with inflation protection – produced a curiosity. Investors were willing to pay $105 for every $100 worth of inflation-protected notes.

Go figure.

What does it mean? What are investors worried about? On the surface of it, they are setting themselves up for a built-in loss. TIPS always offer less interest than regular bonds. You give up some yield to pay for the inflation protection. But TIPS buyers are now buying them with negative yields. Which is to say, they pay for the privilege of owning the bonds. Inflation has to beat expectations…and then some…before they are even at breakeven.

All very weird. If they are so afraid of inflation, why not buy gold? No negative yield. You pay $100…you get $100 worth of gold.

And you won’t have to worry about the people who are making the calculations. In the case of TIPS, the people who sell the notes are the same people who determine how much they’re worth – because they’re the people who figure out the CPI. Besides, we haven’t studied the matter, but when we last looked into it, we found that there was a delay in making the adjustments. So, in a period of hyperinflation the adjustment process would be overrun by events. When Hungary had its hyperinflation of 1947, for example, the pengo lost half its value every 13 hours. No adjustment in the world can keep up with that rate of loss… A TIPS holder would be wiped out. A gold buyer, on the other hand, would be, well, golden….

The other strange thing about protecting oneself from inflation via TIPS is that there isn’t any inflation to speak of. According to the people who keep the statistics, the rate of consumer price inflation is barely 1%. And according to the people who buy regular non-adjusted Treasury debt, there is no inflation on the horizon either.

All of which makes the TIPS auction curiouser and curiouser…

Stock market investors didn’t seem to know what to make of it either. The Dow ended yesterday essentially unchanged.

Gold didn’t know what to think. It didn’t move yesterday.

And that’s not all…how’s this for weird?

From Bloomberg:

“Dollar Gains Against Euro on Speculation Fed Easing Will Spark Inflation”

Huh? Investors worried about inflation in the dollar. They buy dollars? Yep.

The dollar strengthened against the euro for the first time in three days on speculation an increase in debt purchases by the Federal Reserve will cause inflation to accelerate.