What You Can Do in Case of Rising Inflation

I believe that inflationary pressures will remain low for a few more years. But as we all know, the market is also affected by crowd psychology and inflation can be triggered because of fear of rising prices in the future. Hopefully, there are some good hedges using ETFs that investors can use for inflation protection.

Exchange Traded Funds (ETFs) offer investors plenty of choices for protection from rising energy and commodity prices. DBC can be used as protection against both commodity prices and energy prices because it is heavily invested in the energy sector. The chart below illustrates this point:

The top pane is a chart of daily DBC prices and the middle pane is a chart of daily UCO prices. The lower pane shows their 120-day rolling correlation. In the last 12 months, the correlation has ranged from +0.83 to +0.89 and currently is near its high. As long as the correlation stays that high, DBC can offer protection from both rising energy and other commodity prices.

Another popular hedge against inflation that offers protection to US debt holders is through TBF, the short ETF of the 20+ year Treasury. Investors can buy TBF, instead of shorting TLT. For those who worry how well a rising TBF could track a falling TLT, here is a chart of the two and their 120-day rolling correlation:

It may be seen that the correlation between TBF and TLT is for all practical purposes -1.0, i.e. they are almost perfectly anti-correlated. Thus, unless someone is involved with sophisticated intraday arbitrage strategies, long TBF is equivalent to short TLT.

If bond prices continue to correct due to inflation expectations, a good level to go long TBT could be near $32, after resistance at $30.62 is broken to the upside and then converted to support, as shown on the weekly chart above. The medium-term price target is at $40. In case this scenario does not work out, a close just below $28.30, the low of August 4, 2012, could be used to trigger a stop-loss.

Disclosure: no relevant position at the time of this post and no plans to initiate any positions within the next 72 hours..

Charting program: Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software. http://www.amibroker.com/”)

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