Today many investors, particularly those in or nearing retirement feel compelled to own traditional fixed income investments. Such investments usually take the form of bonds. On the surface bonds seem like a marvelous, low-risk idea. You loan someone your money and they agree to pay you back with interest for your loan. The risk of a borrower not paying the principal and interest it owed seemed remote just a few short years ago, but no longer can such a risk be ruled out. Today we have political leaders, proudly proclaiming they will not pay the interest due bondholders. The politicians justify this in their own minds as being prudent, all too happy to toss bondholders under the bus in their search for popularity. Hopefully those headline grabbing defaults will remain the rare exception rather than the rule for fixed income investors.

But even if your borrower repays you the interest and principal he promised he would … does that mean your bonds are still the same value proposition as when you loaned an entity the money?

The answer in 2011 is a resounding no.

The reason is that the most critical element to valuing a bond has deteriorated. Specifically when you loaned your money as a bondholder to a borrower a number of years ago inflation was much lower and your bonds likely yielded a positive real return. That simply means that when you locked into your bond agreement inflation may have been 2% and your coupon or income may have been 5%. So in that environment you increased your purchasing power by 3% while making the loan. Today however virtually every measure of inflation other than CPI (the government of course has a strong incentive to report inflation as being low to minimize the cost increases government must pay out) is running north of 5%. If inflation is really 7%, then your 5% bond is actually a contract to lose money as your coupon payments are not keeping pace with increases in living expenses.

Most importantly, when your bond finally matures, even if the bond issuer pays your loan back, the amount the borrower pays you will be worth much less during periods of inflation than it was when you leant the borrower money. This is the crux as to why bonds were poor performers in the 70's. If your view is that inflation is increasing again, that is why bonds may prove poor investments in the coming decade as well.

Precious metals however thrive during periods of inflation. Their beautiful lack of correlation to bonds makes them an attractive addition to a fixed income portfolio. Furthermore with our fixed cash flow service you can look towards complementing the coupons from your bond portfolio with cash flow from your metals portfolio. This combination of assets moves investors notably further on the efficient frontier of investing improving their risk/reward.

If you have been holding onto your bonds because of an "addiction" to the coupon payments even though you are worried about the deteriorating landscape for bonds call us or email us. We would welcome the chance to show you alternatives to bonds that may thrive in periods of inflation rather than withering. We look forward to taking a deep dive with you on this topic.

Drew Mason