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Protect Yourself From Future Inflation Shocks

Posted: Nov 27, 2008 14:13 PM by Gregory S. Davis

Tickers in this Article: TIP, FXE, UDN

Here's an inflation story for you. A loaf of bread in Zimbabwe will cost you about 1.6 trillion Zimbabwe dollars. The runaway inflation gripping Zimbabwe is not at the forefront on the fear list for investors in U.S., however, and even inflation fears at home have disappeared, replaced with discussions about job creation and repairing the credit markets. But inflation should not be forgotten. It is a silent danger of the additional $800 billion bailout recently added onto the existing $700 billion Troubled Asset Relief Program (TARP).

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A combination of currency and inflation-protected ETFs currently in negative territory may be able to protect an investor portfolios if the inflation expectations become real. (To learn more on this concept, be sure to visit our Inflation Tutorial.)

Bearish on the U.S. Dollar
The PowerShares DB US Dollar Index Bearish (AMEX:UDN) is down 7.9% since the beginning of the year through November 25. UDN's value increases when the US dollar index is falling. Since the U.S. dollar has consistently maintain a position of safety and strength backed by the full faith and credit of the U.S. government the dislocation in the markets has kept the U.S. Dollar Index around 85. In March of this year when the US Dollar index was down in the 72-value range, the UDN was trading between $28 and $29. UDN closed on November 25 at $25.28.

In Defense of Rising Consumer Prices
The iShares Lehman TIPS Bond (AMEX:TIP) is also down 7.39% since the beginning of the year. The TIP fund is linked to a measure of inflation known as the Consumer Price Index (CPI or CPI-U). The CPI measures the prices wage earners, clerical workers or basically 87% of the entire U.S. population (est. 266 million) pay for a variety of expenses including food, transportation, energy and medical care. In October, the CPI-U decreased 1% led by falling prices in the energy indexes tied to the falling prices of motor fuel and gasoline. With oil prices down to $53 per barrel, the break in fuel prices helps keep inflation in check and could represent the early stages of a buying opportunity for investors. (To learn more about this important statistic, read Economic Indicators Tutorial: Consumer Price Index.)

Currency Exchange Consideration
Earlier in the year people traveling to the U.S. from Europe enjoyed the benefits of less expensive shopping, dining and lodging due to the strength of the euro against a weak U.S. dollar. As the dollar has regained its poise the CurrencyShares Euro Trust (NYSE:FXE) has fallen 7.55% for the year through November 25. A weaken U.S. dollar could have the reverse effect on the FXE fund.

Final Thoughts
The land reform programs and the volatile government structure in Zimbabwe are major factors contributing to the country's hyperinflation numbers. The U.S. government's stability is not in question, but the growing amount of debt being used to finance the economic recovery is cause for concern. Future inflation in not a certainty, but the ETFs mentioned do offer protection should investors notice that prices are beginning to rise once again.

To learn more about these specialized ETFs, read Currency ETFs Simplify Forex Trades and Profit From Forex With Currency ETFs.

By Gregory S. Davis

Gregory S. Davis is an investment writer and consultant for his company G.Davis Capital Inc. His core methodology for choosing investments include patience, diversification and asset due diligence. Gregory is a graduate of the Wharton School of Business. He is also a board member of StoriesWork, a non-profit organization based in Durham, NC that uses storytelling to empower youth and individuals to utilize alternative dispute resolution tactics.

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