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Inflation Bonds Tip the Scale

Here's a tip: Don't expect TIPS funds to take flight just because inflation is finally showing up in the official data.

A pair of reports last week from the Institute for Supply Management may have shown contrasting results -- the services index plummeted in September, while manufacturing rose -- but they did share rapidly rising inflation gauges.

In the manufacturing survey, the prices paid index surged from 62.5 in August to 78 in September. In the service sector index, the prices paid index jumped from 67.1 to 81.4, which was the index's highest reading since it was created in 1997.

The idea that inflation is rearing its ugly head is hardly a shocker. Americans have spent the year steadily watching their purchasing power erode in every place except Wal-Mart (WMT), where most of the goods arrive on fast boats from China.

What they have not seen, however, is a marked step-up of inflation in the official data -- a conundrum that may rank second only to Fed chief Alan Greenspan's mystery of the flattening yield curve.

That riddle could very well be solved as early as Friday, when the September consumer price index is released. Economists are expecting a dramatic increase to 0.9%, up from 0.5% growth in August. Some are predicting even bigger jumps down the road as higher energy prices are finally pushed onto the consumer.

"We have seen the CPI creep up lately, but over the next few months it is poised to really take off," says John Silvia, chief economist at Wachovia, who adds that that the big gains in the CPI will be presaged by spikes in the producer price index.

Under these circumstances, it would seem like Treasury Inflation Protected Securities, or TIPS, funds would emerge as the perfect investment. They are designed to protect investors from the erosion of purchasing power that rising inflation can cause.

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