The Letter - Bordier & Cie

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6.3 Period 1987-1990 125 120 115 110 105 100 95 FOCUS ON 1987-1990 1987 1988 1989 1990 INFLATION OUNCE OF GOLD (R.H.SCALE) METALS INDEX (R.H.SCALE) FARM PRICE INDEX (R.H.SCALE) HOUSE PRICES (R.H.SCALE) 180 170 160 150 140 130 120 110 100 S&P 500(R.H.SCALE) Source: Thomson Datastream Infl ation advanced by 19% over the four-year period. Growth was in the range of 2.5% to 4.25% between 1987 and early 1990, before turning negative in early 1991. The economic trend during this period may be described as moderate stagfl ation. In this environment, equities held up well, while infl ation was 30% higher than the price of gold. 16 90 80 6.4 Period 1997-1999 106 105 104 103 102 101 100 99 INFLATION OUNCE OF GOLD (R.H.SCALE) METALS INDEX (R.H.SCALE) FOCUS ON 1997-1999 1997 1998 1999 FARM PRICE INDEX (R.H.SCALE) HOUSE PRICES (R.H.SCALE) 200 180 160 140 120 100 S&P 500(R.H.SCALE) Source: Thomson Datastream This was a dream period with infl ation running at less than 6% over the two years and average growth in the order of 4%. Commodities were beaten heavily by infl ation, while property gained in relation to infl ation and the equity market took off by an impressive 90%. 17 80 60
6.5 Period 2004-2006 112 110 108 106 104 102 100 98 INFLATION OUNCE OF GOLD (R.H.SCALE) METALS INDEX (R.H.SCALE) FOCUS ON 2004-2006 2004 2005 2006 FARM PRICE INDEX (R.H.SCALE) HOUSE PRICE(R.H.SCALE) 260 240 220 200 180 160 140 120 100 S&P 500(R.H.SCALE) Source: Thomson Datastream Infl ation rose by 9% over a two-year period. Growth slipped gradually from 4.1% to 2.4%. The recession to come was not yet perceptible. A new factor now came onto the scene: the ferocious appetite of the emerging countries, especially China, for commodities. All the forms of hedging easily beat infl ation, including equities, with a special mention for industrial metals and gold. 7. Infl ation-linked Government bonds The number of States which offer at least one infl ation-linked bond traded on the bond market is limited and currently stands at twelve. The fi rst market for infl ation-linked state bonds was opened by Great Britain in 1981, in particular to strengthen the government’s credibility in its fi ght against infl ation at a time when this was particularly high. The basic principle of an index-linked bond is to vary the value of 18 80 60 the coupons and redemption of the principal in the light of the trend of a reference infl ation index. There are three important variables which differ from one issuing country to another: • The frequency of the coupon which may be quarterly, halfyearly or annual. • The monthly or quarterly reference infl ation rate which will infl uence the price of the bond on the secondary market. • The existence or otherwise of a redemption guarantee at par for the principal in the event of defl ation. Because of the hedge against the infl ation risk, the indexed bond has a signifi cantly lower nominal coupon than that of a conventional bond with an equivalent time to maturity (see the example below of cash fl ow simulation). In the United States, the Treasury Department issued the fi rst loan indexed on the Consumer Price Index (CPI) on 29 January 1997; this type of loan has been called Treasury Infl ation-Protection Securities (TIPS). The index-linked coupons are paid every six months and a guarantee on redemption of the principal in the event of defl ation is provided. In France, the Government issued for the fi rst time on 15 September 1998 a bond Obligation Assimilable du Trésor (OAT) indexed on the national rate of infl ation (OATi), this being calculated excluding the tobacco price. In October 2001, the State issued an OAT€i, with the harmonized price index for the euro zone as its reference index. To illustrate the difference between the cash fl ow generated by a conventional bond and an infl ation-linked bond we have designed a simplifi ed example: during the ten year lifetime, linear infl ation of 2% per year, with an annual coupon, no reinvestment of the coupons paid, nominal rate of 4% for a conventional OAT, an initial nominal 19
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The Letter - Bordier & Cie

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