Do you have any suggestions for a oil only ETF?

hey felix, we've posted a breakdown of the various proxies to invest in oil through ETFs (exchange traded funds) and ETNs (exchange traded notes). This should help give you some ideas for whatever you're looking for: http://www.marketfolly.com/2009/01/how-to-play-...


also, for everyone else, since gold was mentioned in the post. GLD has been a top holding picked up by numerous prominent hedge funds who have proven track records of outperforming over the long term. here's an example: http://www.marketfolly.com/2009/03/art-sambergs...

Typically, there are few ways to preserve your wealth during periods of high inflation or deflation. When prices run rampant, it's very hard to find areas that will help you stay ahead.
The best place during inflationary periods is USUALLY commodities, since these are the area that have the most price growth during periods of inflation. Looking back to the 1970's, one can see the growth of gold prices as an indication of how that operates.
However, gold is already well up WITHOUT inflation. People have been hedging there for quite a while, either in expectation of inflation, or because of the worldwide growth of currency. So there is some upside - but how much more is there? Hard to say, of course.

If you're willing to have a long time line, then stocks are always a good answer. Stocks won't move much during high inflation, but once it's been wrung out of the system, they have to make the adjustment upward. Similarly, real estate will move once most of the inflation is out of the system.

Inflation moves from place to place, depending on where the cash is. One of the problems with the current methodologies used to track inflation is a lack of understanding what is being tracked. CPI is CONSUMER price inflation. It's a market basket of goods which the average person supposedly purchases, and the prices are weighted based on how much of the average income is being spent on these items. This market basket changes from time to time to keep up with spending changes.

The Fed uses a different group of indicators to derive the GDP Price Deflator, which is a better measure of overall inflation of final, finished goods.

However, there are no real measures of TOTAL inflation. For example, the inflation of asset prices and home values as part of overall price increases. This is true inflation. We have seen massive price inflation in assets over the last 16 years, and this has masked the growth of money supply over that period. This price inflation was partially driven by debt, and partially driven by money creation (or money substitutes). It is the debt portion which created many of the problems we are currently facing because there has not be enough growth in the overall economy and final prices to keep pace with the need for more value to back up the debt.

Two ways to fix the problem:
1. unwind the debt via business closures and some deflation/unemployment. This is the best method, as it "clears the table" of unneeded and unwanted debt and sets realistic price valuation.
2. Inflate the economy, which will create unreal values, depress the dollar, and create unemployment. This method is preferred by politicians as it masks real gains and losses. If you see your property rise 5%, you feel wealthier, even though CPI (where you're really spending your money) is up 10%. You've lost ground, but you don't even realize it. Nice trick.

Either way, unemployment has to be part of the picture due to uncertainty. Both inflation and deflation create massive amounts of uncertainty, so companies scale back to try and maximize output. It's hard to plan if you're unsure of what prices will be 6 months from now.

Considering how hard it is for companies to do it...imagine the average person, who is barely capable of understanding the economy or barely capable of balancing their checkbook, trying to figure all this out.

By creating winners and losers (and usually with inflation the winners are those that already have alot, whereas with deflation they tend to lose quite a bit), the government can maintain a political balance and appear to be "doing something" when doing nothing is the better solution.

This implies that there is nowhere to put your money during inflation. That's essentially true, anymore than there is someplace to put your money when there is deflation (besides the mattress). But if you look ahead, and see where the bright spots are on the horizon, those are the places you'll want your money to be.

Fossil fuels are NOT going away. Fossil fuels, despite the government's plans, will still be 92% of the energy resources of this country in 4 years. Fossil fuel prices will keep track of CPI, because we ALL use them, and we cannot live without them.
Buy oil, buy natural gas, buy companies that invest in these areas. They will outperform when inflation hits. Until the government passes a windfall profits tax to take it all back.

Are I bonds a decent way to go if worried about future inflation? I know the fixed rate is very low right now, but it's certainly not that much worse than a savings account at ING Direct for example. And besides, i bonds at least are pegged to government inflation numbers through the variable rate part.

What do you guys think?

I Bonds maintain their value based on inflation. So there is a benefit in that. Plus you get interest, but it's painfully small right now.

Also, remember that you lose 3 months' interest if you cash in before 5 years. So there's some lost value on this. Plus, whatever your interest is when you purchase is what you continue to get for the life of the bond. It doesn't adjust. Right now it is .7%, with an upcoming adjustment (likely back down to zero).

One simple answer on how to prepare for inflation is to buy items you will need in the coming future. For example, instead of putting aside $400 in gold or something I don't need, I am looking at putting it into a replacement tub. Another example is to purchase enough food staples to last 6-12 months.

Hey at least inflated dollars will help me pay off my inflated mortgage cause I bought a house during the bubble. I'm trying to find a bright side.

Except that it's really not worth the same.
Sure, you've met your payments, but the house isn't really worth the same amount. You're actually worse off you just have rationalized that you're not.

Think of it this way:
Housing prices fall 20% in year 1, when inflation is 1% Your $900,000 house is now worth $720,000. It should be worth $909,000.
Year 2, 3, 4 and 5 inflation runs 7%. Your house keeps pace. Your house is now worth $943,700. Wow! In 5 years you have a 5% gain! Woo-hoo, right?

Wrong. Your "real" house value should be $1,191,500. This means you've "lost" 21% of the value of your home. That's pretty significant...but you're just not thinking about it that way, because you've made the payments.

Hopefully. The problem is that in having 7% inflation, you've had more pressure to meet your monthly payments for food, clothes and gas. By year 3, you'd started struggling to meet those payments, even though your mortgage has taken a smaller share of your paycheck, which has been rising about 5% a year (during times of high inflation, wages rarely keep pace). There's a chance that the inflation helped you earlier in the process, but it's hurting you as time goes on.

Inflation is fool's gold. It's a perception thing that if prices are rising, everyone is benefiting.

The ONLY way for the economy to improve is and for everyone to benefit is through productivity gains. Productivity gains keep inflation down, but provide more of everything for everyone.

Not to quibble about details, but the Fed is not buying money, it is spending it, and when the Treasury issues bonds the money supply decreases, not increases. I do agree that it looks like inflation on the horizon.

A big inflation hedge not mentioned here is to borrow money and buy something of real value that will appreciate in dollar terms. The big obvious example of this is to buy a house using a mortgage. Consumers who own a house with a mortgage (particularly a fixed-rate one) are often more than hedged against inflation, and in fact should be cheering it on.

Yes, I should have said "buying debt" not " buying money," which I've fixed in the article.

The Fed is buying Treasury notes, which means it is expanding the money supply, not shrinking it. Treasury notes are not M1, but they are M2. Which means they are inflationary because they act to INCREASE the money supply. Treasury notes act as assets on a balance sheet which can be borrowed against, meaning that if I pay $100,000 in notes, I can then borrow a portion of this against my holdings. Assuming I were to then lend this money (or pay it in purchase) to someone else, a portion of that can then be borrowed against. And so on.

Furthermore, the Fed is currently pumping close to $1 Trillion into the economy by purchasing these notes. Where does the Fed get this money? It is printed by the Treasury. But the Treasury does not print money to repurchase existing bonds (that would be monetization of debt), it simply "reinvests" in itself.

The debt which you refer to that the Fed is purchasing must be the TALF, or the repurchase of the toxic assets and creation of "bad banks". This, in itself, is not inflationary at all, and merely a repurposing of currency from one portion of the economy to another in order to create a Ponzi scheme to inflate the unknown value of otherwise degraded assets so that banks can clean up their balance sheets. In reality, this is a massive credit default swap using Taxpayer money to protect private investors against potential downside risk (which is still substantial) in order to promote purchase of the assets (the concept of no loss with only the potential for gain would get ANY investor interested - wouldn't it? Too bad you and I can't get to play in this game.).

In order for there to be true inflation, wages must increase. How many employers are giving out or will be giving out 7% or higher pay raises for the next few years. The problem is that we are moving out of a high inflationary period: house price and stock market prices growth of more than 5% a year is inflation. The problem with the current inflationary period that we are leaving is that real incomes for the entire economy did not keep.

Define "true inflation".
There are several types of inflation, most are all related in some way. You defined "wage push" inflation as "true inflation", which means that the cost of labor is increasing to such a point that it's impossible to add one more worker at the same low wage, and thus higher marginal costs of labor drive inflation. I assume you mean to say that it's only "true" inflation if shortage of labor is driving wages and prices up. But clearly that isn't always the case, as we have been at full employment several times (Non-Acclerating Inflation Rate of Unemployment is assumed to be 5.5% or so), and inflation has not risen dramatically.

There's also "demand pull" inflation, which we should have had over the last 24 years or so. However, this "demand pull" was offset by higher productivity by workers, a result of higher levels of investment and capital. More capital per worker - higher productivity. This capital, in particular, has been computer technology and its effect on driving lean production and helping to manage prices and risk more effectively.

Then there is monetary inflation. Assume there is $100,000 in circulation. If a new technology is introduced, monetary velocity could double, which means that the $100,000 circulates twice as fast through the system. This means "two times as much" money is available for spending. Thus, prices would increase (not necessarily double, as the new technology may be increasing the overall supply of goods and services). Or, alternatively, the Fed could release an additional $100,000 by lowering the Fed Funds rate and buying Treasury notes. This would mean monetary velocity wouldn't have to increase as more cash is in circulation. Either way, prices rise.

The simple way of viewing this is in a static economy. If you have $100,000 in circulation, and a fixed number of goods for purchase, and you double the amount of cash in circulation, then the "cost" of those fixed goods doubles because there is more money available to purchase them. Real cost is the same, nominal cost doubles.
Since this static view never happens, it's really just a way of explaining why increasing the money supply doesn't ever "fix" anything, but does erode values by creating a mismanaged mindset for the uninformed.

If you perceive the value of your home doubling because the Fed doubled the amount of cash in the system, you may be inclined to take certain risks that you wouldn't ordinarily take. Which is precisely part of what has been going on for the last 6 years (in addition to many other enforcement and political idiosyncracies which have sidetracked the market and driven money to non-productive activities).

Wage Push inflation, which you described as "true inflation" can easily be stopped using monetary policy. Simply raise interest rates and stabilize or shrink money supply. This reduces demand for labor, and the inflation is wrung out of the system (aptly employed by Paul Volcker in the 70's and 80's).

My whole point is that what has happened over the last decade is that prices for housing, food, fuel, and clothes has exceeded peoples income. According to the IRS, the median house hold income is 52K. That is not individual income, but household income. Along with more people per household working and access to easy credit, the price of everything shot up. In order to sustain this inflation rate, “individual” incomes must start increasing rapidly. If incomes do not start increasing rapidly, prices have and will continue to fall.

Another point here: The government is piling up huge amounts of debt which must be paid back by increase tax revenues. There is only two ways that tax revenue (which is largely based on the percentage of income) can be increased. One is increasing wage inflation (huge pay raises for everyone). Second in times of wage stagnation is increasing the tax rate. If there is wage stagnation (pay raises that are less than 3.5%), increasing the tax rate will means less spending on the part of the consumer. This will cause deflation. Since I do not see employers across the country starting to increase their payrolls or giving out huge pay raises, I see deflation.

What we have experienced in the last 10 years is a wage pull. Well the wages did not cooperate and decided not to be pulled. Deflation is occurring.

Actually, core inflation (excludes the volatile energy and food) is up 27% over the last 10 years, while median income is up 33%. Overall inflation is up 29%, so even if you include food and energy, incomes have kept pace.

Average incomes are only up 10%, but this is misleading and really not a good gauge of comparison, because if there are 3 people in the economy and their incomes are $30,000/$52,000/$1,000,000 whereas 10 years ago they were $18,600/$45,000/$920,000, then it's clear there is no real message being sent. Median income ($52,000) grew 15.5% over that period and low income grew 61%, while high income grew only 8%.

Thus, median income is the preferable standard, as it is a pure middle point on the income scale.

Either way, incomes have continued to keep pace or exceed inflation, due to productivity gains we've seen over the last 10 years. There is a false assumption that people's incomes have NOT kept pace with inflation. In fact, what has not kept pace is expectations of income level. As we see more good available on the market (IPods, Hybrid cars, European vacations, etc.), we come to believe everything is within our grasp even if it isn't.

Americans, if you toss in public and private debt, have leveraged the economy to the tune of 3.4X. That is, we have 340% more debt than value in the economy. This debt has allowed us to go on vacations, get Ipods, and buy expensive homes we can't afford. It hasn't been an issue of incomes not keeping up with prices, it's entirely an issue of expectations exceeding capabilities.

Thus, the monetary inflation we are about to see is completely driven by Fed/Treasury action to grow the money supply to offset debt values. Rather than letting people get back to zero the "hard" way - allowing some deflation and killing of debt - they'd prefer to do it the "easy" way. Inflate the economy, devalue the dollar, and fool people into believing they haven't lost ground when they've lost tremendous ground.

Deflation is considered "bad" because the people most hurt by it are those who hold assets - the wealthy. This, in fact, does trickle down into the economy and leads to unemployment which hurts many more people. But the lower cost of goods mitigates this somewhat. The problem is avoiding EXCESSIVE deflation.
Higher inflation (not necessarily excessive), on the other hand, most hurts the poor because it too leads to unemployment AND makes them incapable of purchasing more expensive goods and services. In addition, it angers our partners who hold US debt because it devalues their holdings, and they get paid back in dollars that are worth far less than they paid for their debt.

While this administration is gearing up for redistribution of income, what they haven't clearly delineated is where it's being redistributed TO. Clearly, they are taking from the middle class and giving to the wealthy AND poor alike. The TALF plan is a guarantee of 14X leverage gains for the super rich (you and I can't take part in this), while the stimulus and budget are tossing money at the lower end of the income scale.

Above you say:

If you're willing to have a long time line, then stocks are always a good answer. Stocks won't move much during high inflation, but once it's been wrung out of the system, they have to make the adjustment upward. Similarly, real estate will move once most of the inflation is out of the system.

If we experience inflation in 2011-2012 and beyond, when do you think residential real estate values will rise ? What happens when inflation moves out of the system, and how long does it take ? Does inflation have to "normalize" first ? And if the goverment is looking to pay down debt with depreciating dollars, is not that a very long term strategy ? Seems this could take a decade or longer, much longer. If this is the case, then it's a double hit for boomers - depressed home values, higher cost of living expenses for many years. In this scenario, it seems quite risky to either lever up or stay highly leveraged.

But if home prices start to rise in 2011 and picks up steam in 2014 and beyond, then alot of owners, and investors in particular, can bail out of the debt that is now weighing them down, through downsizing and just the plain unloading of debt. In this scenarion, it seems that it may make sense to either lever up a bit now that prices are deppressed, or hang on to properties to avoid the "sell-low" mistake.

Your thoughts would be greatly appreciated.

Timelines are hard to predict.
Theoretically, we should have had fairly high inflation over the last 15 years, due to the massive increases in currency. However, new outlets and vehicles for this currency shifted their flow away from areas that typically are counted in the inflation numbers. That is why we have a fiat currency - to help new areas and ease the path to growth. But fiat currencies are fickle. They cannot create growth, they can only enable growth.

The past 15 years HAVE seen inflation in many asset categories, which is precisely the wealth that is currently being destroyed right now, because much of that wealth was created via debt - easy money, too much currency. It wasn't REAL growth.
Now we are faced with asset categories that are going to stubbornly resist increased prices due to easy money and this extra currency in circulation will filter through the economy raising prices of everyday goods. You typically have a 6-9 month timeline before the first effects of this are seen. So give it until October before we start seeing anything.

As for the investment timeline, you did describe a long term strategy. But it is not a maximal or optimizing strategy. It's a strategy that is willing to accept short term losses for long term gains.
If you draw a linear straight line chart of 6% growth per year for 10 years, the line that would chart your strategy would be a curve, starting and ending on the same linear trajectory, but with much of the curve BELOW the 6% straight line. That's 10 years of lost opportunity.

Nobody can expect to optimize perfectly, so some loss of opportunity has to be accepted. The question is how much are you willing to accept?

Real estate is an area that, right now, I won't even pretend to know when it will turn around. Obama said yesterday that the "first signs of a bottom" are forming. As opposed to the first signs we saw 4 months ago? Much of the "growth" that we experienced in real estate the past month was based on foreclosures being bought and flipped. This certainly begins to form a floor, but it in no way represents a bottom. There is still another wave of Jumbo Mortgages sitting out there, ready to move into foreclosure in the next 3-6 months, which has been cautiously NOT mentioned by Geithner or this administration. Because they have yet to determine how they will deal with having to bail out homeowners who appear to be high wealth (but most certainly are not).
It is likely that we may see a short term upward blip in the coming months due to the optimism Obama is suddenly painting. But there is no doubt a double dip is coming, so keep raising cash.

Thank you.

If people pay down debt instead of spending, does that offset the stimulus money being injected into the system? It does seem logical that there will be inflation in the longer term (starting in say 1 to 2 years), since money has to be incorporated somehow, but the following is what I'm thinking...

I figure this timeline would depend on how many people are trying to reduce debt and how long this takes. If people are paying off debt before spending, then that money effectively vaporizes because it pays for something that has already been produced. Given the level of household debt and the level it needs to go down to before people start spending as before it seems like it might be a while before things get back to "normal".

Would investment properties be a good investment at this time (buy and rent out)? These could be leveraged with low cost fixed mortgage.

Excellent question! If people pay off debt instead of creating new debt, the money supply does not shrink. Think about it this way. Who creates most of the actually money in existence. That’s right it is not the Government. It is the banks. Every time someone borrows $100 from a bank, the bank turns $5 dollars (sometimes less) into a $100. The magic works so well that the US Government printing presses cannot keep up with the banks. That is where money mostly exists electronically. Once money has been created it usually does not disappear—unless someone starts a big bonfire or the US runs out of electricity to run the computers that manages everyone’s accounts.

The problem that we are facing now that we faced during the great depression is that the banks have tightened the credit system. Our whole economy and the worlds are modeled to work with a certain amount of inflation caused by increase money supply. If inflation is not occurring fast enough, the models and systems falls apart. Think about it this way:

What if someone told you that all investments (house, stock, bonds, and everything) would only average a return of 1% for the next ten years and you had debt that had an interest rate of 5%? What would be the smart thing to do for the next 7 years? That’s right; a smart person would pay off the 5% debt before making a 1% investment. Now, if people are not investing, businesses grow slower which causes even less inflation.

Now, let us throw the government into this whole affair. The government bases its models on certain amount of inflation; the government is always growing it’s budget. But with low inflation and the government needs more money, it will have to raise taxes. That is right, you will get a 1% raise and the government will raise taxes on your income by 2% more. You get negative income growth. Now your salary has decreased and everything around you is still going up by 1%. Sounds like a good case of deflation to me.

TJJ, the banks are NOT the largest impact on money supply growth - not by a long shot.
Money supply is only increased by a few key things.
1. actual money creation - which is occurring at a very rapid pace right now This is M0 and usually not worth talking about.
2. actual money + demand deposits (what you refer to - the lending of money, a portion of which always winds up back in the bank). This is M1. This is what most people refer to. If you take a look at the historical rate of increase from 1975, it's been picking up pace since 1975, but at a relatively steady rate. Then look at around October 2008 - BOOM! Hyperbolic growth. How is this happening JUST from banks lending money? Because the #1 LENDING BODY in the world is - the FEDERAL RESERVE. Regardless of your belief set, the lending by the Fed isn't small potatoes, and it isn't limited to the deposits borrowers have in the Fed. You can see this by comparing the hyperbolic growth of the currency portion versus the demand deposits - which had actually fallen, then SPIKED with the sudden influx of "free cash" and has since fallen from its highs, even as currency continues to be pumped into the economy.
Finally you get M2 and M3, which include small and large time deposits. These are meaningful because they point to future expansion of spending (potentially). From 2001 to 2006, these actually FELL, indicating the potential for deflationary pressures. But after 2006, there is an ENORMOUS spike, which fell after midsummer 2008...only to SPIKE in January again. So we see there is massive inflationary pressures building in time deposits. (funny how Krugman notes there is a worldwide glut of savings, which is why he says deflation is a bigger worry - forgetting that the savings will get spent at some point, leading to massive inflation - remember the Eastern European experience post Communism).

Of course, potential for inflation doesn't always MEAN inflation. It depends where the money goes. The post 1970's spike in time deposits went into the stock market....which should be included in inflation figures (per Fisher), but are not. As a result, inflation is constantly undermeasured because stock market asset inflation is not "inflation".

Thus, the "deflation" of the stock market is not being counted in our current inflation figures. If it were, Krugman would be right - because massive deflation in asset prices has already occurred.

Finally, if you're told that growth of an investment is 1% and your debt is paying 5%, you have the correct analogy - pay it off. But you've ignored one thing. The savings rate in the US has shot up in the last year. While still very low by long historical standards, it's still pretty high by recent standards. Currently at 6%, personal savings haven't been this high since 1993. Considering the rate had gone negative in 2004/2005, that's pretty heady stuff.
So, we've already had the savings occur. While more is likely to come, it will happen at a slower rate. More importantly, the payoffs you're referring to have also already occurred as personal debt has been dropping.
Your analysis of government savings and taxation, and its net effect is incorrect, but not worth going into - it still implied the lunacy of the current environment in which we are inflating everything. Government spending ALWAYS means inflation in the short term, and when you do it to the tune of the current level, coupled with massive Fed activity, and a savings overhang....you're basically saying "inflation, what inflation?". Because it takes time for the inflation to hit - and then you have to HOPE (something the electorate is hinging everything on, but is the last bastion for those the facts have abandoned) that the Fed can raise rates fast enough to kill it without killing the economy.

Good luck with all that.

Point is - we have massive inflation stalking us right now. Regardless of how deflationary you think paying off debt is (not very since the debt you're referring to represents such a small portion of the economy), the fact is we'd be better off dealing with some level of deflation - and we have (we just haven't been told about it yet).
Why haven't we been told? Because we only look at the CPI - and that's only the inflation the government wants you to think about. Meanwhile, REAL deflation has been about 50% over the last 2 years, if you factor in asset price deflation. Meanwhile, they've stuck a finger in the dike of further deflation by removing Mark to Market rules. So we're content to believe the assets that Citi is holding are worth $40bb (or whatever) when they're really worth $10bb. Fact is, the deflation is here now...but its only visible in things we can't see.


So, how will the government "fix" this? Inflation. Inflation will help those assets "return" to their original value. However, you and I mostly have our savings in cash - so that is going to have to be eroded as prices climb.
Meanwhile, the government's loans to cover its spending will actually be worth LESS due to inflation (the dollar paid tomorrow being worth less than it is today), which means they don't have to raise taxes to the extent you've suggested. They will have to raise taxes, but it won't be as meaningful and more importantly - it will be up to your kids to pay.

So what is the net result? You're cash savings will be worth less, but the asset values of the very wealthy will be worth something more than the pittance they'd have been left with. Inflation will be the tax on your savings to pay off the wealthy.
THEN the government will tax ALL of us (but they'll say only the wealthy) to pay off the remainder - making us all poorer.

IN THE MEANTIME, for all its largesse, the government will increase its role in your life...and you won't be allowed to complain about it. Because this has been done before...and we're always worse off in the end because of it.

Social upheaval is very likely.