Three Ways to Beat 6.2% Inflation: Puts, Gold Mines, and Pipelines
TIPS will not do this. If you want to come out on top, you have to take risks.
The surge in prices that the authorities qualified as âtransitoryâ seems to be continuing: 6.2% over 12 months until October. What are you going to do about it?
The obvious and safe choice is an inflation-protected Treasury securities portfolio. But everyone buys these bonds, raises their price, and gives them a negative real return. Hold one until the deadline and you are guaranteed to be poorer by the end.
If you want to hope to beat the Consumer Price Index, you have to take risks. Here are three ways to add inflation hedging to a portfolio. They are all much more volatile than TIPS. But they give you a chance to beat inflation.
1. Put options on bonds
Inflation, if it persists, will push up interest rates. It would kill the bonds you have in your retirement account. Consider purchasing an insurance policy. The Simplify Interest Rate Hedge ETF provides this assurance.
This new fund traded on the stock exchange, released for public consumption six months ago, has, in addition to a cash position, only two assets. One, representing $ 25 of the net asset value per $ 40 share, is a very secure five-year treasury bill. The other, representing $ 15 in value, is a put option. The option is an indirect bet against $ 800 in long-term bonds.
The option is a long shot. When it matures in May 2028, it is only valuable if 20-year Treasury bills (the usual variety, without inflation protection) then return more than 4.25%. Since those T bonds are now earning 2%, the bond market would need to undergo a pretty sharp correction, pushing rates up 2.25 percentage points, for your put to have a value in 2028.
You can’t call your broker and buy a put like this on an options exchange. Simplify buys over-the-counter options from banks. (The puts are tied to the 20-year swap rate, which closely tracks Treasury yields.) With $ 125 million of investor money on hand, the fund has puts on $ 2.5 billion. dollars of bonds. The fund (symbol: PFIX) has an annual fee charge of 0.5%.
Harley Bassman, an executive at Simplify Asset Management who helped concoct the option strategy, notes that the put is a bet on nominal interest rates, not inflation. Inflation and nominal rates are closely linked, as one economist noted a century ago, but they do not go hand in hand.
In theory, we could have high inflation for a few years while bond investors sit still for that shabby 2% yield on long-term Treasuries. Such a result would mean that real rates would drop even further below zero than they currently are. In this case, the put options are not profitable, even if your grocery bills go up.
But the rate equation could just as easily go the other way. In this scenario, savers tire of lending money to the US government at 2% while that government inflates their dollars to 4% or 6%. They stop buying so eagerly, and the inflation-adjusted 20-year T bond rate climbs from its current value of -0.7% into positive territory. If the real rate reaches 1% at the same time that the expected inflation is 4%, the rate on long treasury bills without inflation adjustments increases to 5%. Your put options would generate a sizable gain, enough to cover grocery bills or some of the damage caused by rising rates on the bonds in your retirement portfolio.
Bassman estimates that if nominal rates increase by 2 percentage points over the next two years, the value of PFIX’s share should more than double. Even if the puts would still be out of the money at that point, they would be very valuable as they would have five years of life left in a highly volatile bond market. At seven years, however, future volatility no longer matters, and puts are only worth money to the extent that long-term rates rise above 4.25%.
You could cover $ 1 million in long-term bonds by purchasing 1,250 shares of PFIX for $ 50,000. You would have fire insurance, but with a large deductible. (Remember bond yields have to move far enough before the puts start.) If we get another 1970s-style bond crash, insurance will pay you back a lot of your losses.
If the puts expire worthless, a separate possibility, you will lose $ 20,000.
2. Gold mines
Traditional inflation hedge: gold. It’s a flawed hedge, with long periods of disappointing returns, but it seems to work in the long run. Over the past century, the price of gold has greatly exceeded the CPI.
You can simply buy an investment fund. But there is an easy way to profit from the bet. Instead of buying gold, buy stocks of gold producers.
For arithmetic, we will turn to Joseph Foster, a geological engineer turned portfolio manager at Van Eck Associates. For half a century, this firm has offered tools to fight inflation, initially precious metals funds. The diverse lineup now includes cryptocurrency games.
Barrick Gold Corp. The Foster projects will produce 4.5 million troy ounces of gold this year at an average cost of $ 700. It is the marginal cost of moving the metal from the earth to an ingot; it excludes the sunk costs of mine development. When gold is at $ 1,860, Barrick’s gross profit is $ 1,160 per ounce. If the price of gold increases 10% to $ 2,050, the profit increases by 17%.
Gold producer stock prices track earnings, but not precisely. âThe long history of gold mining stocks is almost 2 times the leverage on the price of gold,â Foster said.
For even more leverage, avoid blue chips like Barrick and Newmont Corp. in favor of small producers with higher costs. Argonaut Gold, traded on the Toronto Stock Exchange, produces 222,000 ounces per year at a cash cost of $ 1,000, Foster says. A 10% move in bullion would likely do more for Argonaut than it does for Barrick.
The Van Eck Junior Gold Miners ETF has $ 5 billion invested in 100 companies like Argonaut. The annual expense rate is 0.52%.
A classic way to track the cost of living is to own a rental property whose rent is adjusted frequently. This is the argument for buying shares of real estate investment trusts. Reits, however, are quite expensive relative to the income they distribute. Another problem, made visible by the pandemic: it is not easy to occupy office buildings and shopping centers.
For another stream of rental income, consider companies that charge fees for handling fossil fuels, in effect levying rent on pipes, barges, and compressors. Some are organized in partnerships, others in companies. They fall into the âintermediate energyâ category. They pay great dividends. Examples: Oneok, Targa Resources, Cheniere Energy.
Simon Lack, a portfolio manager from Westfield, NJ, specializing in energy equity portfolios and other inflation-resistant assets, says mid-market earnings are “reasonably well shielded from inflation” thanks to contracts involving cost of living adjustments. or are linked to the price of fuel.
My favorite mid-level ETF is Tortoise North American Pipeline (TPYP), with assets of $ 450 million. It has two virtues that are infrequent in energy funds: a low expenditure rate (0.4% per year) and a portfolio allocated less than 25% to partnerships. Exceeding this percentage makes a fund potentially subject to corporation tax.
Morningstar rates TPYP’s return at 4.5% and gives the fund five stars and a gold rating.