September 30, 2009, 5:00 am

Real Return Bonds and Gold: How to Hedge Yourself against Inflation

by: The Financial Blogger    Category: Investment, Market and Risk
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canadian-flagInterest rates are pretty low, companies are cutting back staff, improving their productivity and the US government is printing money (just think about their stimulus checks and Cash for Clunkers programs) like there’s no tomorrow. It seems pretty clear that sooner or later, inflation will surge.

So, you would think many investors are trying to find a way to protect themselves against inflation. While the rise of inflation is not unanimous among financial analysts, there is a definite interest to hedge against the inflation: the Canadian Government just issued $500 million in inflation hedged bonds (real return bonds) and Asian governments are seriously considering similar products in the near future. This is the first time we have heard about real return bonds since the Lehman Brothers’ failure.

Best ways to protect yourself from inflation:

#1 Buying real return bonds (hedged against inflation)

Real return bonds are exactly like regular bonds except the fact that the interest (usually semi-annual coupons) is payable based on an inflation-adjusted principal. At Maturity, they repay the principal in inflation-adjusted dollars as well. Therefore, real return bonds gives a perfect hedge against inflation.

In this world of volatily in the stock markets, buying bonds has been one of the most comforting actions by investors. Therefore, buying real return bonds can be even more comforting as you get the hedge against inflation!

There are 2 ways to buy real return bonds:

– You can purchase real return bonds with a minimum investment of $1,000 (you can see the complete real return bonds prospectus from the Bank of Canada here (it’s a .PDF document).

– You can also look at a real return bonds ETF. For example, Pimpco recently launched 2 new TIPS (Treasury Inflation Protected Securities).

#2 Buy gold (a natural hedge against inflation)

If your stomach is strong enough to handle even more volatility, you can leave the real return bonds and look at buying gold. Recently, gold hit $1000/ounce even though gold purchased by jewellers dropped by 22% during the last quarter. The investors’ enthusiasm towards gold thinking they need more protection against inflation was good enough to push the value of the golden metal.

As is the case with real return bonds, there are several ways you can buy gold:

– Buy gold coins or gold bars: probably the most expensive (and unlikely for an investor) way to buy gold. You have to consider the cost of making the gold bars along with shipping and insurances fees. But you would look pretty cool having a gold bar sitting on your desk at the office 😉

– Buy gold coins or gold bars in a pool: several gold brokers offer the possibility of participating in a pool of buyers (as you would do with a mutual fund for example). You would not benefit from holding the bar in your hand, but you would avoid shipping and insurance costs.

– Buy gold certificates through a brokerage account (like Quest Trade). You can buy certificates of gold and hold them in your brokerage account.

– However, the cheapest and easiest way is definitely buying a gold ETF. Buy My Stock Picks has recently made a list of the best ETF gold stocks. The most popular are GLD (created by SPDR, in US dollars) and HGU (created by BetaPro, no leverage and in Canadian dollars).

Unfortunately, buying gold may hedge you against inflation but will also create other trading concerns on stock, demand from jewellers and capacity of mining companies to find new gold mines. I must say that the perspective for gold over the next 2 years looks pretty good. And if you are too scared of gold, real return bonds still provide a great way to gain maximum hedge against inflation.

Edit: here’s the Canadian Real Return Bond definition for dummies 😀 along with a few ETF / Mutual funds of real return bonds and gold:

Ticker                         Name                                         Ytd           Last price

TIP US EQUITY ISHARES BARCLAYS TIPS BOND
6.45
102.34
TIPZ US EQUITY PIMCO BROAD US TIPS INDX FN LESS THAN 1Y OLD
50.53
IPE US EQUITY SPDR BARCLAYS CAPITAL TIPS E
8.004
50.53
GLD US EQUITY SPDR GOLD TRUST
12.113
97
HGU CT EQUITY HORIZONS BETAPRO S&P/TSX GLO
-8.088
12.16
AGFPREIF CN EQUITY AGF CN CONSERV INF MNG IN-MF
5.406
8.83


Image source: Herman Cheung

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Comments

[…] to new levels. As well, with all of the money that was pumped into the systems, many still regard inflation as a significant threat and gold seemed like a good bet in 2009. It has not proved as profitable as hoped but that is […]

In HGU’s “Description” on Google Finance, it says that it
“endeavor[s] to correspond to two times (200%) the daily performance of the S&P/TSX Global Gold Index. In order to achieve its objective, the total underlying notional value of these instruments and/or securities will typically not exceed two times the total assets of the ETF” but you said that there is “no leverage”. Was this a mistake, or am I reading wrong?

Source: http://www.google.ca/finance?q=TSE:HGU

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[…] discusses alternatives to inflation investing. I’m still not set on the debate between those who believe inflation is the concern against […]

Imran,

you are right, it is leveraged. I should have included CGL-U instead.

thx!

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