Beware of Negative TIPS
Research for Online Investors

by John Dalt

10/28/10

We wrote about Treasury Inflation Protected Securities (TIPS) in July as a good place to park money if you were concerned about inflation.  TIPS can protect your fixed term investments from the ravages of our Federal Reserve’s loose monetary policy.

Our original article TIP Return of your Money is available under Investor Resources at galtstock.com  Earlier this week TIPS were sold at auction for a minus 0.55% yield.  It seems investors are taking the threat of inflation seriously.

We hope our subscribers didn’t run to TIPS at this late date.  We don’t believe in locking in a losing position.  Why would investors buy TIPS at a minus 0.55% interest rate?  Five year bonds are paying 1.2%  Investors must believe that inflation will run at 1.75%, or more.

TIPS at -0.55% from five year treasuries that pay 1.2% equals 1.75%  If inflation is over 1.75% the investor is better off with TIPS. TIPS are the only government debt that can be auctioned at a negative yield according to McKayla Barden, a spokeswoman at the Bureau of Public Debt.

Investors are betting on inflation greater than 1.75%  Remember the face amount is adjusted every six months, and then the interest payable (or due) is calculated.  With 2% inflation a $1000 TIPS would adjust to $1010 at six months and the owner would pay $5.56 back to the Treasury (or have it deducted from face value).  The owners of these instruments have a tiger by the tail.  They better hope the Fed is successful at stoking the fires of inflation.

What happens if we have deflation?  If the economy recorded 2% deflation the $1000 TIPS would have its face value reduced to $990, and the owner would owe the Treasury $5.45  Whoa Nellie!

Hopefully this explains why you should not buy TIPS now.  We pointed out in our Investor Resources article that the etf TIP owns TIPS and pays interest monthly.  Net Asset Value (NAV) of TIP is 111.00 per share.  TIP closed today at $111.25 and yields 3.59%  Just be careful of buying this ETF (or any other) for more than NAV.  As with any stock, the stock price changes daily.  If you buy at more than NAV, you can easily lose money on the stock when you sell.

Now might be a good time to sell any TIPS you own, as they are commanding a high price.  Dry powder is always a good commodity to have.  Subscribe to our Long-Term Portfolio, we will help you put it to work.

New claims for unemployment were less than expected last week. Exxon turned in great numbers before the market opened.  The dollar looked to reverse the bounce we have felt for the last few days.  What happened…the market dropped!

This is the confusing state we are in.  Everything looks good.  The Fed is ready to start the helicopter and drop money on the streets of the economy.  Conservatives look to gain control in the House of Representatives.  What more could investors want?

It seems we just can’t believe everything is roses.

Editor’s note:  The mailbag is empty, I get lonely if I don’t hear from you.  Go ahead and unload some anger.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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