Update: Buy this issue? I say, no.

The U.S. Treasury will auction a reissue of a 5-year Treasury Inflation-Protected Security on Aug. 18, 2011. It will be interesting to see how much buyer interest this auction can raise. My point of view: It looks like a dreadful offering. Things can change, but I will almost certainly pass this one up.

Announcement: Thursday, Aug. 11
Auction: Thursday, Aug. 18
Settlement: Wednesday, Aug. 31

I was a buyer of the last 5-year TIPS, CUSIP 912828QD5, which auctioned April 21 with base yield of negative 0.18%. Before that decision, I remember wondering, quite sensibly: ‘Why would anyone buy a TIPS with a negative real interest rate?’

Here’s why. Well, first of all, the principal gets adjusted for inflation, and at the time, that made a 5-year TIPS preferable to other super-safe investments, like a 5-year CD. And at the time inflation appeared to be looming just around the corner.

And … It’s only five years.

This time it’s different. The market rate for a 5-year TIPS is currently running about -0.862% (updated for Monday’s rate), before the inflation adjustment. That means buyers are willing to accept a return .862% below the inflation rate for the next five years.

At the same time, the economy is wilting and inflation in the near term is looking less and less like a risk. (Unless you see QE3 coming in the next year.)

And what about 5-year bank CDs? You can get a 5-year CD at a rate around 2.32%.  So, to make this 5-year TIPS attractive, inflation would have to average around 3.1% over the next five years. That certainly could happen. Or maybe inflation would average around 2.3%, which could also happen. In that case:

• With a bank CD you’d get 2.32%
• With this 5-year TIPS would would get about 1.5%

TIPS have been in a mini-bubble the last few weeks, and are still rising sharply. The TIP ETF hit another all-time high today, at $113.50, and at one point was at $114.26. It was at $107.82 on April 21, the day the last 5-year TIPS was auctioned.

That’s a capital gain of 5.2% in 100 days. How much gain is left in this TIPS tank?

OK, let’s recap. In April, you could have bought a new issue 5-year TIPS in a somewhat shaky environment (and as I noted, I did buy it):

April 2011
– 5-year TIPS auctions with a real yield of negative 0.18%
– 5-year bank CD with a fixed interest rate of 2.43%
– 5-year TIPS vs. bank CD, breakeven inflation rate: 2.61%

And how things have changed in August 2011:

August 2011
– 5-year TIPS could auction with a real yield of negative 0.862%
– 5-year bank CD pays a fixed interest rate of 2.32%
– 5-year TIPS vs. bank CD, breakeven inflation rate: 3.182%

Alternatives. There are 10-year and 30-year reissues still coming up this year, so I am taking the month of August off. I am not buying this 5-year reissue.

And remember … The first $5,000 or $10,000 you invest this year in inflation-protected bonds should be in US Savings I Bonds. They fully protect you against inflation and cannot carry an interest rate below 0.0%, so you are protected against deflation, too.

You can own them one year and sell them, and you won’t earn less than 2.3%.