Inflation - Public Enemy #1

[Gosso]

Gosso, to me the irony is that you are a Canadian and so quite possibly will be entirely untroubled by a slow gradual sliding of the USD from its global reserve currency perch. Canada will always have enough food and minerals for its own people won't it? It doesn't matter to Canada whether it sells commodities to China and India rather than to USA, Europe and Japan.

I do agree that Canada is sitting on a gold mine (literally), but we would still be hurt by a slowdown/collapse in China, or even a more global slowdown.  We are also tied at the hip to the US and if their currency started declining then Canada would have to follow suit, or else we lose our trade surplus and whatever remains of our manufacturing sector.  When the US dropped their interest rates in 2008, Canada had to follow suit even though our economy was not quite as bad.  This has resulted in a housing bubble which IMO is on the verge of collapsing (although I'm a renter so I'm biased).

On the plus side our political system is very stable (not perfect), and friendly to the natural resource sector.  But this could change if we elected a very socialist/green party.  Also don't forget that we do have neighbours that like to "free" countries containing large amounts of natural resources 

So really I have no idea what the future will bring, which is why I like the PP.

[pershing83]

Changing the subject, I'm always curious as to our members' holdings. How much is held in pp or PRPFX or even PERM. Leave out farm land, the lake house, you know what I mean. Post you percentages.

I've got 33% in PRPFX, most bought in '07. Luck, luck, but at 75 I was nervous.

And last, by no means least, I have 38% in VWIAX (V-Wellesley) up 10% in '11 when PRPFX gained 2-3%. PRPFX bonds were not all LTT in best H Browne mode- probably PRPFX would have been up 10%.

[Gosso]

Changing the subject, I'm always curious as to our members' holdings. How much is held in pp or PRPFX or even PERM. Leave out farm land, the lake house, you know what I mean. Post you percentages.

I've got 33% in PRPFX, most bought in '07. Luck, luck, but at 75 I was nervous.

And last, by no means least, I have 38% in VWIAX (V-Wellesley) up 10% in '11 when PRPFX gained 2-3%. PRPFX bonds were not all LTT in best H Browne mode- probably PRPFX would have been up 10%.

I'm 75% Canadian PP.  I also own some junior gold mining stocks (just in case Eric Sprott is right), and I couldn't resist RIMM when it fell to $14.  I know RIMM is run by a bunch of f-ing morons, but $14 was pretty much its book value.

[LonerMatt]

I ran the numbers on a FTM/PP mix in Australian assets  (domestic currency and stocks only) and found a few interesting things:

- The risk/reward is remarkably similar to the PPs
- The off years, on the whole, tended to be the same (negative results)
- Different rates were achieved at different times, of course, but generally the PPs best years were linked with gold, the FTMs with stocks, as far as I could tell.
- The overall results of a 100% PP, 100% FTM or 50/50 blend were almost exactly the same (with 1% difference over a 38 year period when averaged).
- Standard Deviation dropped noticeably for the 50/50 blend (as was to be expected)

3 caveats:
- There was no international diversification (which may have turned those few negative years into  break even years for all I know)
- There was no Small Caps (as advocated by Swedroe - I don't have data on this for Australia)

- The Bonds I used were the same for both the PP and FTM - which may not be accurate for the inflation + 1 Swedroe discusses.

So, is it worth the extra effort?
I think so - the FTM method is easier to set up than the PP here, and provides a bit more of a chance to get easy access to international exposure. For a similar risk/reward profile, and a drop in Standard Deviation - it seems a pretty simple method. The really bad years were cushioned.

However, the circumstance Clive wrote about needing the blend for (stagnation were the PP lagged) was not part of the years I tested.

[stone]

Clive, the very long dated TIPs look to be a whole other world of complexity. The UK index linked 40 year gilt TR8F has a lot of volatility comparible to LTT or gold but somewhat different from either. I noticed that Australian TIPs are actually available with longer times to maturity than conventional Australian bonds are. I wasn't sure where long dated TIPs fitted in amongst the "four economic conditions" PP philosophy. Are they currently trading at such a high price that either rising rates or low inflation would both make them suffer? Unlike gold they perhaps don't tap into what Indian and Chinese people are up to. Perhaps the current high long term TIP prices reflect fleeing money from the euro crisis.

I hold NS&I ILSC but those seem to me to be very different from long term TIPS. ILSC are the ultimate zero risk store. Long dated TIPs seem more of a volatility capture tool

[stone]

Clive, am I correct in thinking that the last time long term index linked gilts looked very attractive was spring 2009. So basically when stocks were also at a "buying oppertunity" price. That is really my problem with them. I really wonder whether they might actually mess up a PP by zig zagging to where ever you don't want them. I suppose the test would be what correlation they show to  the overall PP price movement. If they dip when the PP as a whole dips, then adding them might simply worsen things

[Gosso]

12.5% TSM
12.5% Total International Stocks
25% LTT
25% Gold
25% TIPS

By removing short term bonds are you not exposing yourself to rising interest rates?  That could be a couple of very ugly years if the Fed grew a pair and started raising rates.  This scenario does appear impossible at the moment, but stranger things have happened.

Edit: Never mind, I just read your post above where you say you would blend short-term and long-term in the LTT and TIPS.  Interesting...

[stone]

Clive, I am intriuged as to how CPI decides when to be in what asset. It is I suppose a bit like a fund with 80% cash, 20% the top two Decision Moose style flavour of the month assets. Last time I looked they had US small caps instead of Yen. I wonder how good they actually are at the market timing efforts they make. Might they do just as well with a PP but with the cash bloated up to 80% .

On a separate (inflation) note, have you seen the CPI ETF choice of asset allocation/holdings? (I mentioned this for no particular reason other than out of interest).

Fund description : The IQ CPI Inflation Hedged ETF seeks to track, before fees and expenses, the performance of the IQ CPI Inflation Hedged Index. The Index seeks to provide investors with a hedge against the U.S. inflation rate by providing a “real return,”?or a return above the rate of inflation, as represented by the Consumer Price Index (the “CPI”?). The CPI is a measure of the average change in prices over time of goods and services purchased by households and a widely-recognized barometer of inflation in the US

Top fund holdings (12/31/2009)

Asset class exposures (through ETF holdings) vary based on monthly rebalance. Available asset classes include: U.S. Large Cap Equity; U.S. Small Cap Equity; International Equity; British Pounds; Euro; Japanese Yen; Real Estate; Oil; Gold; Short Term U.S. Treasury Bills; and Long Term U.S. Treasury Bonds.

SHV iShares Barclays Short Treasury Bond Fund 54.89%
BIL SPDR Barclays Capital 1-3 Month T-Bill ETF 26.15%
TLT iShares Barclays 20+ Year Treasury Bond Fund 8.95%
GLD SPDR Gold Shares 4.71%
FXY CurrencyShares Japanese Yen Trust 3.36%

[Gosso]

Just a quick comment on TIPS from a Canadian prospective.  Real Return Bonds in Canada (the equivalent to US TIPS) do not guarantee the bonds face value during deflation.  Here's an excerpt from the Canadian Boglehead's Wiki:

In the event of deflation, the nominal dollar amount received for an RRB at maturity would decrease with a decrease in the index ratio. However, the CPI adjustment would mean that the real value would remain constant.

RRBs do not offer a $100 guarantee on the principal, so in the event of extended deflation, the final value of the bond could drop below $100, although its inflation-adjusted value would still remain constant. Since that eventuality would require the Reference CPI of the bond to drop below its Base CPI, it is considered extremely unlikely. For the oldest RRB, the 2021 issue, the Index Ratio as of Feb. 19 2009 is about 1.37; a drop in the CPI of over 27% over the next 13 years would be necessary to move the Index Ratio below 1.00 and the terminal value below $100. For the more recent issues, less deflation would be required; the 2041 bond would require only 2% deflation over the next 33 years to have an index ratio below 1.00.

[stone]

Clive, do you think that the CPI etf managers are misguided in using a 10% LTT, 50% STT barbell rather than just having all of the treasuries being intermediate? I know you have pointed out that LTT don't generally trigger rebalances but I presumed that despite that, the LTT price gyrations meant that in practice in the PP they ended up being bought when cheap. So let's imagine over the last decade LTT averaged a 4% yield, those bought by a PP holder might average 4.5% of the buying price

[Ad Orientem]

This thread has moved me to reread parts of Reinhart & Rogoff's "This Time is Different: Eight Centuries of Financial Folly" which as one might expect, discusses inflation, currency debasement and crisis at some length.  One interesting observation that I missed in my first reading (it may be the most thoroughly data packed and annotated book I've ever read) is that from AD 1500-1799 the mean inflation rate among viable states for which data is available was .5%.  From AD 1800-1913 the mean inflation rate was .7%.  From AD 1914 -2006 the mean inflation rate jumps to a full 5%, essentially increasing by a factor.  I am more and more coming around to Clive's point that in a global economy founded on fiat paper money, inflation and currency crisis is the principal (though certainly not only) major threat to one's wealth and savings.

[AgAuMoney]

This thread has moved me to reread parts of Reinhart & Rogoff's "This Time is Different: Eight Centuries of Financial Folly" which as one might expect, discusses inflation, currency debasement and crisis at some length.  One interesting observation that I missed in my first reading (it may be the most thoroughly data packed and annotated book I've ever read) is that from AD 1500-1799 the mean inflation rate among viable states for which data is available was .5%.  From AD 1800-1913 the mean inflation rate was .7%.  From AD 1914 -2006 the mean inflation rate jumps to a full 5%, essentially increasing by a factor.  I am more and more coming around to Clive's point that in a global economy founded on fiat paper money, inflation and currency crisis is the principal (though certainly not only) major threat to one's wealth and savings.

Great book.

It is striking to me that in the U.S. during the revolutionary war and during the civil war inflation was HUGE as paper money (of one form or another) was issued and devalued.  Yet soon after both conflicts the paper money was either redeemed or allowed to fail and prices shortly returned to essentially the same level.  Net inflation?  Almost nothing.

Compare that to the 20th century where we experienced HUGE currency inflation and devaluation during two declared world wars and the innumerable smaller wars and/or war-like conflicts since then.  At the end of each conflict, rather than prices returning to their former levels, the depreciation in money was mostly permanent and only the rate of depreciation (aka inflation) was reduced.

Then after looking at that history, look at the immediate past where we have inflated the money supply far more than in any previous decade since the Fed, and compare with what happened to paper money during similar inflations prior to the Fed in the U.S. and in other nations.

If you think, "this time it is different", you need to read the book.