Tuesday, October 16, 2012

Paper: "'Real' Assets"

Fascinating new paper, 'Real' Assets by Andrew Ang,

Commodities offer some inflation protection, but they certainly are not a perfect hedge. The overall GSCI correlation with inflation is 29%. This reflects the relatively good inflation hedging performance of energy futures. The correlations of crude oil and energy overall (which lumps crude oil, brent crude oil, unleaded gas, heating oil, gasoil, and natural gas together) with inflation are 23% and 26%, respectively. Non-energy futures are poor inflation hedgers. Agriculture, for example, has only a -4% correlation with inflation.
Here is the fascinating claim,
Traditionally, "real" assets such as inflation-indexed bonds, commodities and real estate were thought to have correlate well with inflation and thus provide protection against rising price levels. But many of these assets turn out not to be that "real." Cash (T-bills), in contrast, is one of the best inflation hedges.
Here's why,
"[I]nflation hedging is all about the comovement of asset returns with inflation, not the average return. T-bills are highly correlated with inflation because monetary authorities respond to inflation in setting the short-term interest rate..."
It's worth reading the whole paper.

10 comments:

Stagflationary Mark said...

Traditionally, "real" assets such as inflation-indexed bonds, commodities and real estate were thought to have correlate well with inflation and thus provide protection against rising price levels. But many of these assets turn out not to be that "real." Cash (T-bills), in contrast, is one of the best inflation hedges.

It is indeed a fascinating claim and one I would certainly attempt to debunk.

If I buy a 5-year TIPS bond with a 0.0% real yield and hold it to maturity then it is a PERFECT CPI inflation hedge (not counting taxes). It doesn't take a chart wizard to figure that out.

The problem of course is that there are no 5-year TIPS bonds that pay a 0.0% real yield now. Too many investors have flooded in.

In February of 2011, Jeremy Siegel proclaimed that TIPS were an actual bubble. I'd be slaughtered when real yields rose. They paid a real yield of 2% and I backed up the truck. I continue to hold to maturity. The real yield is now just 0.5%.

Go figure.

Stagflationary Mark said...

I should point out that all I have been trying to do since 2004 was protect what I have.

I turned to gold and silver as an inflation hedge from 2004 to 2006. When they went parabolic, I sold.

I continue to add I-Bonds to my portfolio. I continue to hold TIPS.

The market says my TIPS have appreciated nearly 50% since Siegel warned me not to buy them in 2011. I could care less what the market thinks. I was planning to hold them to maturity when I bought them and I still am.

As Greenspan said in 1966, there is no safe store of value in a welfare state. I don't claim that my solution is safe. I just think it is safer than many alternatives. Sigh.

CP said...

I think it's time to sell the TIPS.

Stagflationary Mark said...

CP,

TIPS are no bargain at these levels. That said, there is a strong correlation between long-term TIPS yields and long-term real GDP growth. I'm not exactly bullish on the latter. Sigh.

Real GDP: Japan vs. USA

Industrial Production

CP said...

Why don't you invest you money in something underpriced then?

You know that wealth requires energy inputs (effort and intelligence) to maintain? There are no ways around this.

Stagflationary Mark said...

CP,

Why don't you invest you money in something underpriced then?

1. I'm not a trader. Every trade I make feeds the brokerage firms at my expense. I therefore prefer to buy and hold to maturity unless I have near proof that I can do better elsewhere. In this case, I cannot.

2. Have you looked at real yields in the 1970s and World War 2? They can go a LOT lower.

3. Mundell-Tobin Effect Epiphany!

My central theme since turning bearish in 2004 was that I was concerned about falling real yields. That's how I positioned myself. My theory has not changed just because yields have fallen.

I truly believe that it will continue to be harder and harder to make money off of money.

Consider EE bonds. I can't say they are a bargain, but they are extremely mispriced compared to 20-year treasuries. That's my next investment in January if the government doesn't correct their mistake.

I have no need to hit the ball out of the park any longer. I'm just trying to protect some of what I have. That's it. So far, that has been an extremely good strategy for me.

CP said...

I like the paper towels and garbage bags strategy better than TIPS.

Stagflationary Mark said...

CP,

Believe me when I say this. I do too!

At the very least, I won't have to pay tax on any inflationary gains nor will I ever require a greater fool to buy my toilet paper or garbage bag hoard from me.

Greenspan said in 1966 that there is no safe store of value in a welfare state. I'd say toilet paper and garbage bags for future personal consumption comes pretty darned close though.

CP said...

What else would be good to hoard?
Shouldn't you hoard everything that isn't perishable?

CP said...

Mark,

I have to say I called this pretty well.

Bearish on TIPs at -1.5% yields. Now I'd be bullish again at 0%.

CP