What Are the 3 Incredible Fed Reserve “Variables”?

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The Federal Reserve is being more transparent, trying to lead investors and the markets with better guidance on their potential actions.

They’ve now winded down their bond-buying program. Next in line is increasing the Fed interest rate. But what do they look at before they pull the trigger?

GDP, Unemployment and PCE Inflation

The brain trust looks at three different variables. Really its four but one is just two different, but very similar, inflation numbers. You can take a look at their latest projections in this PDF.

GDP is, of course, the biggie. If our economy is shrinking, slowing or growing that’s gonna make a huge difference to Fed behavior. Next year they predict a range of 2.1 to 3.2 percent growth. And we just got quarterly numbers saying GDP grew by 3.9 percent!

That’s good news and confirms the belief that they will raise rates in 2015. Fully fourteen, of seventeen, members think 2015 will be the right time to raise rates. Only two members think 2016 is the prime time. So its a good bet that next year we’ll see rates move up.

They also expect unemployment to drop to as low as 4.7% in 2017. Or as high as 5.8 percent, depending on which Fed member you believe. The lower number would be an even bigger improvement than we’ve already seen.

The inflation figure is based on Personal Consumption Expenditures, or PCE inflation. Here they project very moderate rates no higher than 2.4% and maybe as low as 1.5 percent. That’s very moderate and below the 3 percent historical average.

With inflation expectations low rates should move up pretty slowly. They don’t have to put on the brakes quickly to control runaway price increases.

What’s an investor to do? Make sure sure you have plenty of risk exposure, short-maturity bonds and alternative bonds that behave differently than traditional bonds. Also, make sure you’re long-term bond exposure is very light.

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HOW TO GUARANTEE A LOSS: Buy 5-Year CDs

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With interest rates being low for over a decade, it’s tempting to buy long-term products that pay better interest. A lot of investors will look at 30-year Treasury bonds, 5-year CDs or even long-lock-up fixed annuities.

Most of those actions are just about the worst thing you can do with Fed rates being near zero. You’ve probably heard of the seesaw relationship between interest rates and bond prices. One’s up, the other’s down. And vice versa. If you buy a 30-year T-bond, or other long-term bond, at low rates then the chances are very big that you’ll lose principal value when rates move up. Bad timing and low or negative returns.

With the CD or fixed annuity options you probably won’t get hurt. You’re not going to lose principal but you will be locked into rates that likely won’t meet or beat inflation. That means you have a real loss due to a consistently weakening dollar (inflation). A guaranteed loss.

Specifically, if you buy a 5-year certificate, with the current average yield of 1.56 percent, then you’ve lost ground to the average 3% inflation we’ve experienced. And that’s just the government figure for inflation. We all know, when you include food and fuels, real inflation is commonly believed to be even higher. So an investor needs to earn even more to really keep up and grow. But it’s possible.

Also, the fixed annuity could lock you into fees that last 4-7 years or longer. Beware of the exit details.

What’s one solution to low interest rates? Buy “alternative” bonds that have minor impact from rising rates. There’s a lot of different types out there. Also, invest overseas, add more risk categories (like real estate) and seek out sustainable, high-yield investments. Visit my site, RetireIQ.com, and request an appointment. We’ll talk about the details.

 

Gold Holding Its Own…Or is It?

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Gold has sunk quite a bit since I heard prognosticators expecting $5,000 per ounce prices a few years back. Remember the times? You couldn’t pick up a paper, read a magazine or website, watch a TV show, drive down the street or listen to the radio without hearing the virtues of this shiny metal. It reminded me of the fervor of the dot-com days of the late ’90s.

Recently, Bloomberg.com had an article about gold holding steady. It’s not that steady considering that this glimmering Siren was at over $1,800 an ounce a few years back. That’s a drop of about 33 percent.

I have a client whom I recommended selling his physical gold right about at this top. He chose to invest it in a diversified portfolio with me. His account was up a little over 50 percent. Adding the avoidance of gold’s drop (about 33%) with his gain (over 50%) gives him a relative out-performance of over 80 percent compared to a gold investment.

Is gold holding steady?

A lot of folks mistakenly think that gold tracks, or even hedges against, inflation. The first link I’m sharing with you is some personal research I did several years back. The research only goes to 2010 but the point remains the same: gold does not track inflation.

I was fed up of hearing this nonsense over and over so, on that arbitrary day, I decided to make a few charts. The first one shows the rate of inflation compared to the price performance of gold, on that random day I started my homework. I tried to get as near to that day as possible in each individual year but weekends and holidays threw me off a little. Still, it’s unbiased research. I was just seeking the answer to that question: Does gold track inflation?

I heard a good answer, too: “Gold tracks the expectation of inflation.” Good answer. Big difference.

Gold Tracks Inflation? Not really…

Gold reached a top near the middle of 2011. If you look at the second link you’ll see the downward price trend since this top. If you look at even longer gold charts you’ll see that the “miracle” metal has had flat price trends that last about two decades! That’s a long time for an investor who buys at the top and wants to hold on to their position. Besides losing opportunity to other growing sectors this investor receives zero income. This would result in a net loss when you consider the ravages of inflation.

Courtesy of BigCharts.com, take a look at the SPDR Gold Trust ETF. This is an exchange-traded fund that tracks, almost exactly, one-tenth the price of gold. To get the approximate spot price of gold you just multiply this investment times ten. The symbol of the fund is “GLD”.

Gold Mutual Fund Price Trend

Bonus link: I just can’t say it better than this…

Why Warren Buffet Hates Gold