How To Play The Inflation Trade Using ETFs

I've been asked frequently how to play the inflation trade using ETFs.

Let me show you how to do it, with the warning that you are likely early in this trade.

The simplest way to play the inflation trade is to buy gold-and that's easy with ETFs. The SPDR Gold Trust (GLD) tracks the price of gold. While in theory it reflects global demand for gold, in reality it moves when one of two events occur: 1) high levels of uncertainty, or 2) high levels of inflation.

The GLD spike up at the end of 2007 and into 2008, moved down as the markets moved sideways in 2008, then spiked up again toward the end of 2008 and into 2009 on the combination of uncertainty and some chest-pounding over the inflationary implications of the stimulus package and the Fed's low interest rate campaign.

But since then there has been little movement in gold, indicating that there is no immediate concern about inflation from the gold bugs.

Another way to play the inflation trade is to bet that Treasuries will be dropping and yields increasing, since investors will demand higher yields whenever inflation rears its head.

The ProShares UltraShort 20+ Year Treasury(TBT) , which owns long-dated Treasuries and goes up twice as much if Treasury bonds go down, did see a small spike at the end of March and into April but since then has fallen back.

Again, no real signs of dramatic concerns about inflation.

None of this means that inflation won't happen, indeed one of the arguments of the inflation hawks is that the huge supply of debt that the U.S. government is issuing wil be inherently inflationary--eventually.

Tim Middleton, who writes an ETF newsletter, wrote about this in his recent issue: "When government floods the market with paper that is, after all, backed by nothing except its own good name, inflation is likely to result."

With the government target inflation in the 1 to 2 percent range, Middleton notes that even small moves up in inflation--into the 3 percent range--would benefit anyone holding the ETFs above.



Questions? Comments?