TOP INFLATION FIGHTERS ARE TANGIBLE

May 12, 2004

Inflation is back. No big surprise. Two of the top five inflation hedges are 1) Gold, silver and other commodities ... and 2) Collectible U.S. gold and silver coins! Here's why and what you should do ...

Is inflation lurking around the corner? Or is it already here?
By Barbara Hagenbaugh, USA TODAY
May 5, 2004

WASHINGTON — Franklin Adams sees the headlines and hears the economists' statements that there is very little inflation in the economy.

But that's hard for him to believe.

"Every time I buy a plane ticket, I'm shocked," says Adams, 34, of Washington. "Every time I go to the gas station, I'm shocked. Housing prices are insane. That's inflation, right?"

After being on the back burner for several years, inflation has once again become a topic of conversation around office water coolers, gas pumps and boardrooms. It likely was near the top of the agenda when Federal Reserve policymakers met Tuesday to discuss interest rate policy. In a post-meeting statement, the Fed said long-term expectations for inflation were "well contained."

While consumers might be seeing higher prices when buying milk, purchasing a house or paying the electricity bill, a widespread, worrisome gain in inflation is not showing up in the official statistics. That's shining a light on a nagging issue in the economics community: How do you define inflation?

It's harder than it seems, and it's important not just for Fed officials as they consider when to raise interest rates to keep inflation under wraps. It's also key in determining adjustments to federal benefits, such as Social Security payments. Wages, child support and other items that are indexed to inflation depend on gauges of price pressures.

Getting it right is key for the health of the economy. But knowing what is right might never be possible.

The fast-paced nature of the economy makes measurement difficult. Products come and go at rapid speed, notes Michael Boskin, economics professor at Stanford University and head of the "Boskin Commission," which looked at problems with government inflation measurement in the mid-'90s. "Measuring prices and their rate of change in a complex, dynamic market economy, where in a typical large store you may have 40,000 or 50,000 items ... is very, very difficult," he says. "Let alone very difficult to do in real time."

To people such as Adams, a fundraiser at National Public Radio, it seems a little more obvious. Take clothes shopping: In the past, he found sales. "I haven't had as much luck lately," he says.

INFLATION 101

Conditions for inflation:
-Too much money in circulation. Not enough in-demand products and services available

How inflation hurts:
Purchasing power falls, consumers pay more, and it becomes more difficult for business and consumers to make plans about future purchases.

Attempts to control:
The Federal Reserve tries to keep the inflation rate stable by buying and s elling Treasury bonds.
It can: Lower interest rates. If the Fed wants to lower interest rates to stimulate the economy, it adds money into circulation by buying bonds, thus giving the bondholder money to spend in the marketplace.
Raise interest rates. If the Fed wants to raise rates in response to inflation concerns, it will reduce the money supply by selling bonds, thus taking money out of circulation.

Sources: Pimco Advisors; USA TODAY research
http://www.usatoday.com


[Image: I N F L A T I O N GAME R U L E S (COPYRIGHTED 1936) "The object of the game is not only to afford amusement to the players but also to illustrate to them how proposed Share-the-Wealth Plans, Excessive Old Age Pension Plans, etc., will increase taxes and place a heavy burden on all citizens and, at the same time, make it possible for the shrewd manipulators to gain a dominating position in economical affairs of the country. At the outset, let it be understood that before the Government can bring about a share- the-wealth program it must own all properties and all monies. Under a share-the-wealth scheme it is proposed that the Government shall make every man a king and give each person an equal share of the money, after which time each must take care of himself. If a man has good luck and is a shrewd manager, he may beat the game of "inflation." If he isn't, he will be no better off than theretofore and distribution of the wealth of the country will not have availed him anything."]

Top 5 inflation fighters -Linda Stern, Reuters
May 12, 2004

WASHINGTON, May 12 (Reuters) - The Fed is getting ready to take away the punchbowl, before the recovery party gets too hot. But a cynic might say we're due for an inflation hangover anyway, because of rising federal deficits and the impending retirement of many baby boomers.

This argument holds that the only way to make good on those long-term Social-Security promises and reduce the deficit is to pay it all off with cheaper money -- and that means inflation.

Inflation can kill the best-laid savings plans. Bonds and stocks both can get walloped during periods of rapidly rising prices. Maybe that's not happening this week or next -- some economists argue that the economy is still too weak to get inflationary and that heightened global competition will keep prices under control.

But, remember the 1970s? Low growth. Newly opened international markets. Drifting and falling stock prices. ... And, inflation through the roof.

The moral: It's a good idea to keep an inflation kicker in a well-balanced portfolio. You may have missed the best bottom-priced buying opportunities, but the point of inflation protection is that you put it in your portfolio and then forget about it. Sooner or later, the time will come when you're happy you did.

Here are some investments that should do the trick, though each has its disadvantages and advantages.

-- TIPs. Treasury Inflation Protected Securities is the first place people go when they think about beating inflation. These bonds are government-issue safe, and have a component that is guaranteed to keep pace with the Consumer Price Index. That's dandy. But, most recently, a disadvantage of TIPs has come to light: They also have a component that's market-priced, and right now it is priced to reflect the fact that everyone loves TIPs.

Regular 10-year Treasuries are yielding 4.78 percent, but TIPs are yielding around 2 percent. Inflation over that period would have to be at least 2.78 percent a year to justify buying TIPs instead of regular Treasuries.

Of course, that is why you buy TIPs. You can do that cheaply and easily through the Vanguard Inflation-Protected Securities Fund (http://www.vanguard.com) or directly from the Treasury at http://www.treasurydirect.gov. Just remember that a worst-case scenario for TIPs holders -- rising interest rates and moderate inflation -- is a distinct possibility this year.

-- Commodities. Gold, silver, copper, paper and pork bellies do really, really well when inflation rules. But it's not so easy to buy them. Where would you store your gold bricks and sides of meat? Mutual funds aren't allowed to own commodities.

The day will soon arrive when exchange traded funds are made up of baskets of commodities, but it isn't here yet. The closest you can come right now is to invest in a fund that specializes in mining or natural resources companies, or industrial products, or individual stocks that specialize in those products.

You could also buy shares in one of these two funds that specialize in matching commodity index moves: The Pimco Commodity RealReturn Strategy Fund (http://www.pimco.com), and the Oppenheimer Real Asset Fund, which tends to be energy-heavy, says Morningstar, the Chicago research firm.

-- Energy. It's a commodity, of course, but energy is a world unto itself this year, and most years. The Commodity Research Bureau reports that energy futures prices have gone up about 27 percent in the last year, but there's no top in sight. Shares of oil and gas companies tend to do well when the rest of the market is victimized by rising prices.

-- Real estate. This is everybody's favorite inflation hedge, because owning real estate can be so much fun. But your home isn't just an investment; it's your home. To invest in real estate, buy real estate investment trusts or the funds that hold them. (The problem with this approach is that REITs have gone up about 21 percent a year for the last five years and -- like most real estate properties -- are pretty pricey now. You can find a thorough listing at the Web site of the National Association of Real Estate Investment Trusts, http://www.nareit.org.

-- Jewelry, art and collectibles. Take your cue from that Van Gogh auction -- art can be an investment. But you really have to know how to buy, store and sell these items, and the profits you make get none of the tax breaks that similar profits in stocks or bonds would reap. In other words, use diamonds, art or designer lunchboxes as your inflation hedge only if you can afford to become an expert in the field.

http://www.reuters.com


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DISCLAIMER: All of the information in this story is believed to be true, however errors are possible. Past performance is no guarantee of future performance. All investments have risk. -SATC

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