TIPS: Great or Terrible?

Min Zeng, on page C2 of yesterday's WSJ:

With oil prices above $100 a barrel and countries from China to the U.S. reporting sharp gains in consumer prices, now may be the time to buy inflation-protected securities.
Big bond investors, including Pacific Investment Management Co. and American Century Investments, favor buying Treasury inflation-protected securities, or TIPS, which will outperform their euro-zone counterparts, as the Federal Reserve's hefty rate cuts fuel inflation pressures.

Brett Arends, on page D4 of yesterday's WSJ:

Inflation's a big risk to your savings. But inflation-protected bonds are an even bigger risk these days...
As fresh data showed yesterday, consumer prices are rising faster than expected, even while the economy sags. Many investors, and their financial planners, are reacting to the danger by rushing into what they think is a safe haven: Treasury inflation-protected securities or TIPS.
It's a bad move.
The bidding frenzy has sent TIPS prices soaring. The bonds have become wildly overvalued and now offer a terrible long-term bet.

Comments

[Planetdrum6]

I noticed that yesterday too, and laughed -- seemingly conflicting information from our friends over at News Corp.

To be fair the first article actually advocates going short treasuries and long TIPS, but the fact that both appeared on the same day is just one more data point to support the decline of overall editorial quality at WSJ. It would be easy to pin it on Murdoch, but in reality the editorial slide started long ago -- I've noticed many more copyediting errors over the last few years, even right on Page 1. And I don't know when, but at some point they amended their style sheet so that now at the first mention of either bond prices or yields in a given story, they are obligated to point out that when bond prices go up, yields go down and vice versa, which I find a little insulting of my intelligence.

I haven't dumped my WSJ subscription yet, but it won't take a lot more to push me over the edge.

[JohnnyBitchdog]

If you want to frame the argument correctly, you must understand the following simple facts:

1. TIPS returns are positively correlated with inflation and therefore are considered to be an inflation hedge.

2. However, TIPS prices are set based on supply and demand, and when there is heavy demand for an inflation hedge their price can surge. Of course this surge in price can actually reduce your overall returns to the point that standard treasuries would have performed better even if expected inflation occurs.

Obviously the issue centers around expectations. Generally speaking you will only get compensated for inflation in excess of expectations at the time of purchase. So you really only win with TIPs when you are a better forecaster of future inflation than the entire market which sets TIPs prices.

jbd.

[cheesecake]

excellent johnny, an even better explanation than the original article. now it makes sense.

[Amitps]

Can you please explain what exactly does this mean:

However, TIPS prices are set based on supply and demand, and when there is heavy demand for an inflation hedge their price can surge. Of course this surge in price can actually reduce your overall returns to the point that standard treasuries would have performed better even if expected inflation occurs.

Are you saying that with the increase in prices for TIPS, one could loose money? I am in VIPSX and it has been going up, do you recommend I pull out of it?