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Hedging Inflation: Comparing Commodity Futures and TIPs

by Daniel Edinger

I have generally recommended the use of Treasury Inflation Protected Securities (TIPs) as a hedge against inflation.  Are Commodity Futures an attractive inflation hedge similar to TIPs?

In a March 2011 article, author Geetesh Bhardwaj, addresses the use of various investments as a hedge against unexpected inflation.  (Let me know if you would like a copy of the paper).  The author differentiates between expected inflation, that is already incorporated into stock and bond prices, and unexpected inflation, that is not reflected in prices of most assets.  Both TIPs and Commodity Futures have a positive correlation to unexpected inflation and are unrelated to expected inflation.   Interestingly, REITs show little or no relationship to unexpected inflation.

One negative of commodity futures is that they can be volatile in price, unlike TIPs, whose value should be more stable.

As an investor wanting to hedge against inflation, a portfolio consisting of stocks, bonds, TIPS certainly makes sense.  Commodity Futures, while intriguing,  probably carry more risk than reward.

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