Forget The Inflation/Deflation Debate: The Real Threat Is Biflation

by on April 13, 2010 | ETFs Mentioned:

Currently, there is fierce debate raging over the future of the economy. Some economists and investors are projecting a period of deflation spurred by falling asset prices for debt-based goods (such as houses) and the lack of credit available to most small consumers. In addition, the core CPI level recently fell for the first time since the early 1980′s, sparking fresh fears over a return to a deflationary environment. Deflation isn’t here yet, “but it’s the closest we’ve come since the Great Depression,” says Sherry Cooper, chief economist for BMO Capital Markets. “Housing prices are falling, commodity prices are falling, so are lots of goods and services — that sounds scary to me.” David Rosenberg, a North American economist at Bank of America Securities-Merrill Lynch, sees deflation as the “primary risk” to investments in the near future, noting that “it is truly difficult to believe inflation is going to be revived in the intermediate term.” (see Five ETFs To Own During The “Great Deflation“)

Meanwhile, “inflationists” such as the legendary investor Jim Rogers, believe that the many quantitative easing programs put in place by central banks around the world will ultimately result in massive levels of inflation. “The Federal Reserve has laid the groundwork for some serious inflation down the road by printing all this money,” Rogers says. “So have many other central banks. We’re going to be paying more for just about everything down the road.” Asked if he foresees a 1970s-style stagflation period ahead, Rogers chuckled and gave an ominous reply: “I hope it’s that good. It might be much, much worse” according to the Business Insider (see Beyond TIP: 10 ETFs To Protect Against Inflation).

While virtually every investor is concerned with the prospects of deflation or inflation ravaging their portfolios, many have failed to examine a little known theory on the subject that combines both inflation and deflation; biflation. Biflation is a relatively new idea that was initially proposed by Dr. F. Osborne Brown in 2003. It states that in a biflationary environment, inflation and deflation occur simultaneously. Inflation occurs because more dollars are chasing goods such as oil and gold as well as earnings based assets which drives up their price. Meanwhile, deflation occurs for debt based assets such as cars and houses since credit dries up or becomes hard to come by for most consumers which helps to decrease demand (and prices) for these types of assets.

How To Prepare

Some could argue that our economy has already reached a point of biflation as unprecedented central bank intervention around the world has helped to drive commodity prices higher; oil has nearly doubled from a $45/bbl. level in June of 2009. Meanwhile, home prices continue to sink across the country, sliding more than 6% in March. In addition many small businesses and individuals are still citing a lack of credit, suggesting that many non-essential purchases will have to be put on hold for the time being. According to the Market Oracle,

“The economy is fueled by an over-abundance of money injected into the economy by central banks. Since most essential commodity-based assets (food, energy, clothing, precious metals) remain in high demand, the price for them rises due to the increased volume of money chasing them. The increasing costs to purchase these essential assets is the price-inflationary arm of biflation.”

This suggests that commodity-based securities may make an interesting investment during a biflationary scenario. Particularly, commodity producing equity ETFs may make for an intriguing choice in this type of environment since these funds own stocks that produce goods that are in high demand and are able to pass on costs to consumers or those further down the value chain. In light of this, we have highlighted three ETFs which could become an investor’s best friend if biflation begins to strangle the American economy (also see What Every Investor Should Know About Commodity ETF Investing).

Market Vectors Gold Miners ETF (GDX)

GDX tracks the NYSE Arc Gold Miners Index which follows companies that are primarily involved with mining gold. GDX contains 32 firms and is heavily concentrated into Barrick Gold, Goldcorp, and Newmont Mining which combine to make up roughly 37% of the fund’s total assets. The fund charges an expense ratio of 0.55% and it is up about 4% this year. This ETF could benefit in a biflationary environment because the increased money supply would entice investors to invest in assets that can hold their value better than dollars, such as gold. Furthermore, a lack of credit would prevent many new mines from opening up which would further cap the supply of gold which could send prices of the metal even higher.

PowerShares Water Resource Portfolio (PHO)

Regardless of what happens with the prices of many assets, water will remain in high demand. As the ultimate essential commodity, some investors foresee a big upswing in the business of procuring and delivering  water as more dollars begin chasing a finite supply of resources. One way to play this trend is with PHO, which invests in companies that focus on the provision of potable water as well as the treatment of water and the technology and services that are directly related to water consumption. PHO focuses on industrial companies which make up three-fourths of the total assets of the fund but it also has a sizable allocation to utilities. The fund also has a significant small-cap tilt with an average market capitalization of just $4 billion. PHO charges an expense ratio of 0.6% and is up about 5% this year.

MarketVectors Agribusiness ETF (MOO)

If biflation hits, it could likely drive up the price of many essential food items, which would greatly help the agribusiness industry and funds like MOO that thrive off of investment in agriculture. MOO does this by tracking the DAXglobal Agribusiness Index which contains 47 firms. It currently is heavily invested in Wilmar International (8%), Potash of Saskatchewan (7.8%), and Monsanto (7.7%). MOO has a heavy slant towards agricultural chemical and agriproduct operations which combine to make up roughly 75% of the fund. MOO charges an expense ratio of 0.59% and it is up 2.5% in 2010.

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Disclosure: No positions at time of writing.