The crisis in Libya and resulting spike in oil prices have investors reluctantly stepping into inflation protection, even though only a handful of market pros consider it an imminent threat. But that handful is growing.
CNBC.com
There are scant voices in the investment world raising red flags about inflation, even as oil flirts with $100 a barreland many of the Middle East protests are directly traceable to soaring food costs.
As such, the uncertainty is creating cross-currents—a boost in gold, the most traditional of inflation plays, but also a rise in Treasury yields, though fixed income normally suffers when inflation is on the rise.
But there's no mistaking that the inflation pressures are at least getting more attention.
"They're not only intensifying, I think they are going to go off the charts for some non-believing investors," said Marilyn Cohen, CEO of Envision Capital Management in Los Angeles. "What concerns me is the fact that so many baby boomers who capitulated out of stocks and haven't gone back have never lived through an inflationary environment [while] having skin in the bond game."
Cohen says investors ought to seek protection with Corporate Inflation Protected Securities, as a shorter-term fixed-income sister of Treasury Inflation Protected Securities, or TIPS. She also says fixed-income protection can be had in bank loan securities.
But inflation remains a veritable bogeyman in the market, seen only by believers.
Disbelief that soaring commodity prices, easy monetary policy and an overflow of global debt won't lead to actual inflation stem from the theory that rising prices alone don't cause long-term inflation. Instead, there traditionally also comes price pressure outside food and energy as well as wage increases that complete the picture.
They also point out that even with oil back in focus, its cost is still well below historical inflation-adjusted highs and well below its nominal high of $147 a barrel in 2008.
But bond king Pimco has begun warning that these assumptions are incorrect. They say the traditional inflation models don't work because they do not account adequately for unprecedented demand growth in emerging market nations, as well as historic levels of monetary easing from the Federal Reserve.
"More important and immediate, these closed economy models for domestic inflation do not pick up the inflationary impact, both direct and indirect, of higher commodity prices resulting from strong emerging market growth," Mihir P. Worah, portfolio manager at Pimco, said in a research note.
"There are three ways to solve our debt problem: Growth, inflation or default," he added. "The choice is clear to us; which one seems most likely to you?"
Worah advises using traditional "real return" inflation havens such as commodities, real estate, stocks, bonds from secure countries that provide high yields, and some TIPS.
Stocks have pulled back somewhat this week as the Libyan situation has intensified and oil prices have surged. The general feeling at this stage is that equities should hold up so long as inflation does not get out of control.
"The USA will never abandon the strong debt policy which encourages the constant selling of sovereign debt," Richard Hastings, macro and consumer strategist at Global Hunter Securities in Newport Beach, Calif. "This type of inflation modus operandi is not a recipe for a straight line up in equity prices, although in the longer-term scheme of things, equities will outperform sovereign debt especially in the second half of the year."
Other pros have been busy trying to pick winners and losers if oil prices continue trending higher.
David Rosenberg, economist and strategist at Gluskin Sheff in Toronto, thinks big importers like the US, China, Japan, Germany, India and Korea will get hurt, while Russia, Norway, Kazakhstan and Canada will benefit. Rosenberg, however, believes in a larger sense that inflation is only a near-term problem and higher energy prices eventually will reignite a global recession.
Among the other losers on the equity side will be consumer stocks, he says.
"The accelerated cutbacks in spending and higher taxes at the state and local government levels will only serve to aggravate the stress," Rosenberg said in a note. "This, as far as I can tell, is far from being priced into consumer discretionary stocks at the current time."
Other inflation warnings, though, are more urgent.
Pimco's Mohamed El-Erian, for one, warned during a CNBC interview Wednesdayof possible stagflation, with both rising prices and unemployment. Elsewhere, John Calamos, CEO of Calamos Investments, recently told Morningstarthat the inflation storm will be quick and painful, with yields rising 3 or 4 percentage points in two to three weeks.
He advises investors to look for high-yielding bonds below investment grade.
"It reminds me when I first started investing professionally in the 1970s and people look at that decade—the bond market just got cratered as inflation went up and interest rates went up," he said in the interview. "So, it's not the safe haven that people might think it's going to be."
Such concerns have sent many investors flocking into metals, particularly gold and silver, which are more traditional inflation hedges, and away from copper, which is generally considered a bet on growth.
Keith Springer, president of Springer Advisory Services in Sacramento, Calif., said he's using exchange traded funds—the Market Vectors ETF Trust and the iShare Silver Trust—to play the metals.
"Gold and silver would do poorly in deflation. However, they would hedge you for inflation," Springer says. "More importantly, they act as a third currency. As the world evaluates the developed world currencies, gold becomes more valuable. It's also a crisis hedge. There's no better place to hide."
