What We Learned From Ben Bernanke's Speech

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Fed Chairman Ben Bernanke held his first press conference after a Federal Reserve meeting… ever. Traditionally, the Fed releases minutes to the meeting about three weeks later. That’s not what other central banks do around the world.

Most give a press conference.

And now the Federal Reserve will be giving these conferences after every meeting. It’s an effort to offer a clear view into their decisions. But is it really?

Here’s what we learned from Ben Bernanke’s speech:

The Certainties

The Federal Reserve will complete its $600 billion buy-up of government debt. This program will end in June, so we have two full months of bond-buying to go. We could see U.S. Treasury yields drop again.

The Fed will also keep interest rate at near zero. That means the cost of borrowing and the value of the dollar will remain cheap.

Ben Bernanke and the rest of the Reserve have lowered expectations for GDP growth from 3.9% to 3.3%.

That’s what we know…

The Uncertainties

What we don’t know is what investors should be worried about.

We don’t know if there will be a third round of bond-buying from the Fed. The second round, worth $600 billion, has led the Fed to raise its inflation forecast, but hasn’t led to a strong recovery.

Though the Federal Reserve says unemployment will fall to 8.4% this year, GDP growth has also been trimmed. I think that means the Fed doesn’t have a lot of faith in the strength of our economy right now. This might mean buying more government debt later this year.

The Fed’s balance sheet stands at $2.67 trillion, and Bernanke told reporters that it will keep this amount steady “for a time.”

That doesn’t sound very clear to me.

Six months from now we’ll be in the fourth quarter of 2011 with the holiday season right around the corner. If the economic recovery does not strengthen, will the Fed pull the trigger on another round of quantitative easing?

The Interpretation

What should investors take from Bernanke’s first-ever press conference after a Fed policy meeting?

Let’s talk about what’s likely to happen.

It’s likely that the Fed will keep interest rates near zero for the rest of the year, no matter what inflation turns out to be.

The markets climbed after Bernanke’s news conference… The Dow gained almost 100 points. In fact, the Dow hasn’t been this high since May 2008. This should make you nervous. It makes me nervous. On Monday, I gave you some examples of how the stock market and the economy are similar to this time last year, just before we saw a major pullback.

Want to know what else was up? Gold, oil, silver, wheat, corn and a number of other commodities… and foreign currencies.

Now guess what was down… The U.S. dollar. Take a look at this image from a listing of currency futures from Barchart.com:

Currencies Chart
View larger chart

The U.S. dollar is acting like a lever for higher commodity prices and higher foreign currency values.

The policies the Federal Reserve revealed yesterday will keep digging a hole for the dollar. And if the Fed buys even more government debt, the U.S. dollar might as well be six feet under. Commodity prices will go through the roof!

Gold at $1,500 will look like gold at $800 in January 2009. Corn could trade for $12 a bushel, and oil could aim for a new all-time high.

Be Proactive

It is crucial that investors protect their portfolio from inflation. The Federal Reserve has finally “come out of the closet” on inflation. That means that inflation is a much bigger problem than the markets realize.

The U.S. Dollar Index is at a 52-week low, and we’re not seeing a bottom yet.

Anybody holding long-term bonds could get burned. If you’re just holding cash, inflation will eat away at your savings. It’s time to be proactive. Precious metals and agricultural commodities could be a great hedge against inflation.

There are a number of exchange-traded funds that track commodities, and silver ETFs had a banner day yesterday.

Many commodity-based ETFs hold commodity futures. These are an easy way for stock investors to get involved in commodity futures without having a futures account. But beware…

Always check the fees — sometimes fees can be just as bad as inflation. In comparison to mutual funds, ETFs are less expensive. The opposite is true when you compare ETF fees to stocks. Another thing — be careful of ETFs that are highly leveraged.

The ProShares Ultra Silver ETF (AGQ:NYSE) is one example. Yesterday this ETF gained more than 13%. Its gains equal twice the gains silver actually makes. Sounds great, right?

And it is, so long as silver prices rise. But if silver prices fall, this highly-leveraged ETF will get slammed.

Concerns like these are valid. But there are wonderful ETFs out there that offer investors some great advantages, particularly when they are used to hedge against inflation. Using commodity-based ETFs can lower management costs and reduce fees (compared to investing in futures), and give you access to markets that a small investor cannot — or will not — get into.

We particularly like precious metal ETFs and agricultural ETFs headed into rising inflation. Those that track the prices of their commodities on a one-to-one basis are more straightforward than those that leverage the value of their commodities.

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