For Real - How Much is Inflation? (from icma-rc.org)

Food and Energy Prices Driving Overall Inflation
Chart of the Week for March 25 - March 31, 2011

Inflation is a general increase in prices and is carefully monitored to gauge economic health. Too much, too little, or unexpected changes in inflation is generally thought by economists to be detrimental to the economy. Inflation is typically measured by the Consumer Price Index ("CPI"). This index is calculated by measuring the average change in price of a given basket of goods.

Core CPI is the same index, with volatile food and energy prices excluded. The chart above illustrates the trend in these two versions of the CPI over the past two years.

Core CPI remained around 2% in 2009, but falling food and/or energy prices drove the overall CPI into negative territory for much of the year.

In 2010, Core CPI dropped to under 1% with food and/or energy prices remaining fairly stable until the fourth quarter.Thus far in 2011, supply constraints, primarily stemming from the improving global economy and political unrest in the Middle East, have propelled a rise in food and energy prices. This change has been a key factor in the overall CPI increase from 1.5% in December 2010 to 2.1% in February 2011.

The Federal Reserve Open Market Committee ("FOMC") met on March 15, 2011, and issued a press release stating its expectation that the upward pressure of energy and other commodity prices on inflation will be transitory. Therefore, the FOMC will continue purchasing longer-term Treasury securities and maintaining a target range for the federal funds rate at 0 to 1/4 percent. However, the FOMC will act to stem inflation, should it threaten the economic recovery.

While Overall and Core CPI remain low, they have been trending upwards. This change has been felt by consumers in higher prices of food and energy and is being monitored by Federal Reserve.

© Copyright 2011 ICMA Retirement Corporation, All Rights Reserved.

Master Limited Partnerships for Income (Barrons)

Master Limited Partnerships



: A Good Place to Get 6% Payouts
By DIMITRA DEFOTIS
Five energy plays that could stoke your portfolio.
Every day, a veritable ocean of oil cascades through thousands of miles of pipelines crisscrossing America, making its way from shipping ports and exploration fields to refineries and end users. A similarly vast tangle of pipes does the same kind of job for natural gas. And then there's the pipeline for investors.

Master limited partnerships, which typically process oil and gas, store it and move it through pipelines, are producing some of the best yields anywhere -- typically 6% and sometimes more. And the outlook for these ventures is excellent.

MLPs pay out most of their cash flow as dividends, or "distributions." MLPs are exempt from corporate taxes. But investors are taxed on some of their distributions annually. Taxes on the rest are deferred until units are sold. In the meantime, the structure can provide hefty payouts year after year, and the deferred tax burden disappears at the unit holder's death -- making the MLP an attractive wealth-transfer tool.

The industry, which has assets of about $250 billion, should have plenty of growth ahead. Traditional energy companies are likely to sell more assets to MLPs for the tax savings and yield. In addition, partnerships have ample borrowing capacity to fund expansions. The profits from all that will flow to investors through payouts.

Yes, there are risks. MLP unit prices are on the high side right now, and payouts could suffer as interest rates and borrowing costs rise. Still, some of the sharpest investors in the field are expecting double-digit total returns for some time to come.

"If you look at where MLPs are trading relative to similarly risked assets, we think the yield is attractive," says Terry Matlack, co-founder of Tortoise Capital Advisors, which manages MLP closed-end funds. "The sector continued to grow distributions through the teeth of the economic downturn."

ANY FURTHER IMPROVEMENT in the economy would help MLPs by lifting demand for energy. Plus, a recent federal tariff increase has brought about clarity on pipelines' pricing in the coming years, says Kyri Loupis, who directs MLP strategy within Goldman Sachs' investment-management division. He holds several pipeline players, including Plains All American Pipeline (ticker: PAA), Magellan Midstream Partners (MMP) and El Paso Pipeline Partners (EPB).

Houston-based Plains transports, stores and markets crude oil, liquefied petroleum gas and related products. The current rise in oil prices could give the stock a nice nudge. Because futures prices of oil right now are higher than the current price, companies like Plains that can store crude and sell it later have greater power in negotiating storage fees.

Plains is the largest operator of storage in the energy hub of Cushing, Okla., and also has storage in Illinois that can hold Canadian crude. Plains pays a 5.9% yield, and brokerage house Stifel Nicolaus thinks distributions per unit could increase 4% in 2011, boding well for the yield.

Magellan, based in Tulsa, Okla., stores and transports refined petroleum products. It expects 7% growth in its annual distribution in each of the next two years, a growth rate that should exceed the sector average, Loupis says.

Magellan is attractively priced: Its enterprise value (market value plus net debt) is 13.3 times its adjusted Ebitda (estimated earnings before interest, taxes, depreciation and amortization, all adjusted for earnings paid to a general partnership), below the industry average of 14.3. Its yield is 5.1%, according to Wells Fargo. Plains is trading at an adjusted Ebitda multiple of 20.5, but pays a higher yield.

The largest energy partnership around, with a market capitalization of $36.5 billion, is Houston-based Enterprise Products Partners (EPD). It operates thousands of miles of pipelines, and processes and stores natural gas, oil and related products. Enterprise has been making some promising moves and, in the process, streamlining a convoluted operating structure, says portfolio manager Tom Cameron, who allocates about 20% of the Rising Dividend Growth Fund (ICRDX), to MLPs.

Enterprise has absorbed its general partner; merged with Teppco Partners, a pipeline company spinout; and recently announced its intention to merge with Duncan Energy Partners, a pipeline MLP. Enterprise Products isn't particularly expensive, with an enterprise value to Ebitda multiple of 13.8. Its yield is 5.4%.

The beauty of pipelines is that they collect steady fees based on volume, rather than volatile commodity prices. Natural-gas pipelines are all the more attractive as the country increasingly turns to this clean-burning form of energy. Natural-gas pipeline operators like El Paso Pipeline stand to benefit handsomely. This MLP was carved out of the exploration and production company El Paso in 2007. The parent still has pipeline assets that it's likely to "drop" into the tax-efficient MLP structure, a practice that has increased distributions 50% since 2007. El Paso's yield is 4.7%, and it looks reasonably priced with an enterprise value to Ebitda of 13.4.

Beyond pipelines, there's a coal play worth a look: Natural Resource Partners (NRP), a Houston-based MLP. Formed in 2002 with properties sold by U.S. railroads and coal companies, NRP leases land to America's biggest coal companies. Its land produces 5% of all U.S. coal and its contracts wisely hedge against drops in coal prices.

NRP is now acquiring 200 million tons of coal reserves in the Illinois basin, with production beginning in 2012. That should contribute to 5% to 6% annual distribution growth starting in 2012, according to Dallas-based Swank Capital. NRP trades with a multiple of enterprise value to Ebitda of 16.2, and its yield is 6.1%.

Investments like these could be just the thing to fire up your income.

.E-mail: editors@barrons.com

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Investing in Energy using ETFs (from Investopedia.com)

ETFs Provide Easy Access To Energy Commodities
by Rich White

If you fill up a car with gasoline or heat a home with oil or natural gas, you know that rising energy costs have put a dent in your budget. But do you also know how easy it is to buy shares in a brokerage account or IRA that can help you hedge energy commodity price increases?
This article will help investors understand the benefits of investing in energy commodity ETFs and detail choices available to interested investors. It specifically covers investments that seek to track commodities prices - not ETFs that invest in energy sector stocks, in which investment returns are influenced by the overall direction of the stock market and do not always mirror energy commodities prices.

Welcome to the World of ETFs
In recent years, thanks to the growth of exchange-traded funds (ETFs), ownership of energy-sector commodities has become more accessible for individuals. For example, buying one share of the U.S. Oil Fund ETF (AMEX:USO) gives you exposure roughly equal to one barrel of oil. If oil prices rise by 10% in a given period, your investment should theoretically appreciate by about the same percentage. You can own oil through this ETF without incurring the cost normally associated with storage or transport. The only costs that you will pay include brokerage fees to buy and sell shares plus a modest ongoing management fee.
USO is not mentioned as a specific investment recommendation. It is significant because it was the first energy commodity ETF introduced, in February of 2006, and remains one of the most popular by asset size and trading volume. Since USO's introduction, ETF energy commodity choices have greatly expanded.
Why invest in energy commodity ETFs?
ETFs are traded on exchanges (like stocks), and shares may be bought or sold throughout the trading day in large or small amounts.
At the heart of the "energy complex" is crude oil and products refined from it, such as gasoline and home heating oil. Natural gas is a by-product of oil exploration and a valuable product in its own right, used throughout the world for heat and power generation. Lesser products in the energy complex include coal, kerosene, diesel fuel, propane and emission credits.

Energy commodity ETFs can be useful tools for constructing diversified investment portfolios for the following reasons:

1. Inflation hedge and currency hedge potential - Energy has recognized value all over the world, and this value does not depend on any nation's economy or currency. Over time, most energy commodities have held their values against inflation very well. For example, the spot price of a barrel of crude oil increased at an average annual rate of 6.5% per year from 1950 through 2007. Over the same span, the annualized increase in the U.S. Consumer Price Index was 3.9%. Energy prices tend to move in the opposite direction of the U.S. dollar - prices increase when the dollar is weak. This makes energy ETFs a sound strategy for hedging against any dollar declines. (To read more on currency ETFs, check out Currency ETFs Simplify Forex Trades.)

2. Participation in global growth - Demand for energy commodities keeps growing in industrializing emerging markets such as China and India. In 2007, as in most years, the U.S. consumed about 25% of the world's 85 million barrels of total daily oil production, and U.S. consumption has been increasing by about 3% per year, according to the International Energy Agency. Some experts believe that it will be difficult for global oil production to grow in the future due to dwindling reserves, especially in Saudi Arabia. In addition, several of the world's leading oil export nations (ex. Russia, Iran, Iraq, Venezuela and Nigeria) are politically volatile and could be unreliable as future sources of supply.
3. Portfolio diversification - According to modern portfolio theory, investors can increase portfolio risk-adjusted returns by combining low-correlating assets in which returns do not tend to move in the same direction at the same time. However, few asset classes accessible to individual investors have consistently produced low correlations with U.S. stocks. Correlations are measured on a scale of 1 (perfect correlation) to -1 (perfectly negative correlation). Oil is among the few asset classes that have consistently produced very low (or negative) correlations with U.S. stocks. According to FactSet, the correlation between oil futures and the S&P 500 Index was -0.31 for the five-year period 2002-2007. For this reason, investors can expect oil commodity holdings to help diversify and balance stock-heavy portfolios.


4. Backwardation - Backwardation is the most complex (and least understood) benefit of some energy commodity ETFs. These ETFs place most of their assets in interest-bearing debt instruments (such as short-term U.S. Treasuries), which are used as collateral for buying futures contracts. In most cases, the ETFs hold futures contracts with the least time left to delivery - so-called "short-dated" contracts. As these contracts approach the delivery date, the ETFs "roll" into the next shortest-dated contracts.

Most futures contracts typically trade in contango, which means that prices on long-delivery contracts exceed short-term delivery or spot prices. However, oil and gasoline historically have often done the opposite, which is called backwardation. When an ETF systematically rolls backwardated contracts, it can add small increments of return called "roll yield", because it is rolling into less expensive contracts. Over time, these small increments add up significantly, especially if backwardation continues.
Although this explanation may sounds highly technical, roll yield historically has been the dominant source of investment return in oil, heating oil and gasoline futures contracts. According to an analysis by author and analyst Hilary Till, long-term annualized returns of these futures contracts exceeded spot prices significantly, as shown in Figure 1, below, and the major reason for this differential was backwardation roll yield.


Annualized Returns from 1983 to 2004
- Futures Contract Spot Price
Crude Oil 15.8% 1.1%
Heating Oil 11.1% 1.1%
Gasoline (since Jan. 1985) 18.6% 3.3%
Source: "Structural Sources of Return and Risk in Commodity Futures Investments" by Hilary Till(Commodities Now, June 2006)
Figure 1


It should be noted that these energy contracts occasionally move from backwardation to contango for intervals of time. During such times, roll yield may be lower than shown in the table; they may even be negative. Historically, natural gas has not shown the same tendency toward backwardation and roll yield benefit as the three contracts listed in the table.
Types of Energy ETFs
Energy ETFs can be divided into three main groups:

Single contract - These ETFs participate principally in single futures contracts. For example, the iPATH S&P GSCI Crude Oil Total Return Index (NYSE:OIL) exchange-traded note (ETN) participates in the West Texas intermediate (WTI) light sweet crude oil futures traded on the New York Mercantile Exchange. Note: An ETN is an exchange-traded note, a structure that works much the same way as an ETF. PowerShares DB Oil Fund (AMEX:DBO) participates in the same WTI contract.

USO, the pioneering energy commodity ETF, is a subject of some controversy because it nominally participates in a single contract (WTI), while also dabbling in several other energy complex contracts. Therefore, most investors do not consider it be a pure single-contract ETF.
Multi-Contract - These ETFs offer diversified exposure to the energy sector by participating in several futures contracts. The iShares S&P GSCI Commodity-Indexed Trust (NYSE:GSG) has about two-thirds of its total weight in the energy sector and the remaining one-third in other types of commodities. It tracks one of the oldest diversified commodities indexes, the S&P GSCI Total Return Index.

PowerShares DB Energy Fund (AMEX:DBE) is a pure energy sector fund diversified across commodity types. It participates in futures contracts for light sweet crude oil, heating oil, brent crude, gasoline and natural gas. The ETF seeks to track an index that optimizes roll yield by selecting futures contracts according to a proprietary formula.

Bearish - Energy sector commodities can be volatile, and some investors may want to bet against them at times. The first "bearish" energy commodity ETF is Claymore MACROshares Oil Down tradable Trust (AMEX:DCR). It is designed to produce the inverse of the performance of WTI oil. This ETF is one-half of a pair of MACRO shares, a concept through which two ETFs are issued together but traded separately to track, respectively, the up and down movements in a commodity. (The other half of this pair is Claymore MACROshares Up tradable Trust (AMEX: UCR).
Final Points
While ETFs have made energy sector commodities more accessible to investors, it's important for investors to understand the mechanics of how individual ETFs work. Specifically, investors should realize that virtually all of these ETFs participate in futures contracts, and the "roll yield" of these contracts can be a major source of positive or negative return, depending on patterns of backwardation or contango. Multi-contract ETFs such as GSG and DBE can be a good way to add broad energy exposure across multiple contracts. But at times, some of these contracts may be in backwardation (producing positive roll yield) while others are in contango (producing negative roll yield).
For investors who own stock-heavy portfolios denominated in U.S. dollars and wish to increase diversification and inflation-hedge potential, some energy sector exposure may be advisable. However, it's a good idea to have a long-term horizon for such investments because they can be volatile over brief periods. Crude oil can be an especially valuable commodity for adding diversification because it has consistently produced negative correlations with U.S. stocks.