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October, 2007


For a number of reasons, the high and increasing prices of energy, food, medical care, some commodities, and many foreign goods, for instance, it may be appropriate to prepare one's nest egg for the possibility we are facing a few years of relatively higher inflation than we have been used to lately.

There is, of course, the prospect that instead a domestic slump in housing prices could lead the U.S. economy into recession, which might then result in some disinflation. But, unless we fall into a full depression, long-term moderately or greater rising prices seem the more likely and persistent eventuality to me. A small amount of inflation can be a boon, aiding the rise of both home and stock prices, but if it should go up above around 3% a year, stocks and bonds often react with falling market values. In the short run, it seems the Federal Reserve is inclined to lower interest rates in response to a credit squeeze and the current weakness in housing. But beyond a certain threshold, further fed action may itself tend to be inflationary, weakening the dollar plus encouraging additional speculative borrowing and lending.

I generally prefer to invest, year in and year out, in value stocks or mutual funds rather than trying to time the market. These have in the past weathered most economic and equity storms well. But supposing one were interested in a bit of safeguarding against the negative effects that inflation might have on one's portfolio, what means are available for the purpose?

Two type assets that can be useful in this regard are inflation protected bonds (or bond mutual funds) and precious metals stocks (or precious metals equity mutual funds).

Inflation protected bond assets automatically go up as there are rising prices for goods and services. Precious metals assets tend to go up with inflation, market uncertainty, industrial demand for the respective commodity (gold, silver, or platinum), or significant negative geopolitical surprises.

A small allocation, say 5% in each type holding, can provide more stability to one's portfolio in the event of further inflationary developments, for instance a Turkish invasion of Iraq or a U.S. attack on Iran, with consequent fears of a disruption in the global oil supply, sending crude prices to $100 or more a barrel.

Here are assets of each sector that personally appeal:

iShares S&P GSSI Natural ResourcesIGE$133.600.87%28.34%Precious metals exchange traded fund
ProFunds Precious Metals UltraSector Inv. FundPMPIX$54.234.35%21.29%Precious metals open end mutual fund
Tocqueville Gold FundTGLDX$60.930.34%28.03%Precious metals open end mutual fund
iShares Lehman TIPS Bond*TIP$101.803.74%3.83%Inflation protected bond exchange traded fund
Vanguard Inflation-Protected Securities Fund Investor Shares*VIPSX$12.004.49%3.88%Inflation protected bond open end mutual fund

As always, past performance is no guarantee of future returns.

The assets cited here are for illustration only. I am not an expert in such investment vehicles. I suggest each investor, before purchasing any asset, do her or his own due diligent research and/or consult a trusted financial advisor.

*Note: Inflation protected assets are adjusted upward with inflation based on the Consumer Price Index (CPI). However, they are also subject to tax each year based on this adjustment. They are accordingly more appropriate for tax-deferred accounts than regular, taxable ones. Some economists believe the CPI exaggerates the rising costs of our goods and services. Therefore it has been suggested that the "chain-weighted CPI," which tends to rise more modestly that the regular CPI, be substituted for the CPI in determining the inflation adjustment. If this switch occurs, it will make inflation adjusted bond securities less attractive.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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