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Inflation Fears Are Back Again

Dan Caplinger
September 20, 2012

For years, investors have expected that an increase in interest rates was imminent. With bond rates falling to record-low levels, it appeared that they had nowhere to go but up. Fast-forward nearly four years later, though, and the Federal Reserve's reduction of the Fed Funds rate as low as it could go hasn't succeeded in jump-starting the economy back to its pre-crisis turbocharged levels.

The silver lining of low rates and a weak economy has been that inflation has largely been in check. But with the Fed's latest round of quantitative easing, investors are now convinced that inflation is about to rear its ugly head. And more important, they're putting their money where their mouths are. Let's take a look at how investors are getting ready for inflation.

What the market's telling you
Last week's QE3 announcement played havoc with financial markets. For stock investors, the news was almost universally positive. But the bond market told a much different story.

In one part of the bond market, rates on regular long-term Treasury bonds soared and bond prices tumbled as traders grasped the magnitude of the announcement and the dedication of the Fed to bring about economic growth whatever the cost. Given that investors had used Treasuries as a safe haven to park money that they might otherwise have earmarked for stocks, greater optimism about the stock market brought about a corresponding exodus from bonds. Perhaps the best sign of this was movement in the bond-bearish ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT  ) , which climbed more than 5% in a single day last Friday in response to the big move.

Yet one oft-ignored niche of the bond market went the opposite direction. Treasury inflation-protected securities, also known as TIPS, whose face value is tied to inflation by means of the Consumer Price Index, soared in value, with inflation-adjusted interest rates actually falling substantially on the day. The iShares Barclays TIPS Bond ETF climbed more than 1% during the final two days of last week. Investors were so hungry for inflation protection that they bid the real yield on the 20-year TIPS down into negative territory, meaning that they were willing to accept a guaranteed loss of purchasing power just to get a measure of protection against rising prices.

Other warning signs
Bonds aren't the only investments out there pointing to at least the possibility of higher inflation down the road. Gold, which many use as a hedge against inflation, soared last Thursday, with SPDR Gold (NYSE: GLD  ) jumping about 2% as the bullion-owning ETF climbed in sympathy with spot gold prices. Central Fund of Canada (NYSE: