B Hold the Fed-Fueled Commodities Boom

Speculative buying in the commodities pits is hitting fever-pitch status, with investors pouring money into virtually every commodity out there. In fact, commodity prices have been booming ever since Federal Reserve Chairman Ben Bernanke gave his now-famous Jackson Hole speech back on Aug. 27. That's the speech in which Mr. Bernanke signaled the market that quantitative easing part II, or QE2, was just around the corner.

Well, the central bank chief made good on his QE2 signal last week, agreeing to buy some $600 billion in longer-term Treasuries at a clip of $75 billion a month for the next eight months. The immediate reaction of investors was to keep on doing what they had been doing since the Jackson Hole speech, and that's buying up both stocks and commodities.

To give you an idea of just how big the buying has been in stocks since late August, all you have to do is to calculate the percentage gain on the S&P 500 Index of that time period. The benchmark U.S. index is up nearly 14% since Jackson Hole. Most major commodities are up even more since late August, with the Deutsche Bank Liquid Commodity Index -- a broad measure of agricultural commodities like coffee, sugar, cocoa, etc. -- climbing more than 18% since then.

Precious metals also are up sharply, with gold up more than 12%. But the real precious metal taking off like a silver rocket ship is, well, silver. The precious metal has been the darling of precious metals investors since QE2 became evident. In fact, the iShares Silver Trust (SLV) is up 40% since Jackson Hole.

Now, there was record-high trading volume on SLV in Tuesday's trading, and we saw the price of silver gyrate wildly late that afternoon. While this price swing was due to new changes in cash requirements instituted by the Chicago Mercantile Exchange for trading silver futures, it still shows how much action is taking place right now in precious metals.

So, why is there such renewed interest in commodities and precious metals? That's simple; the Fed's QE2 is going to put pressure on the value of the U.S. dollar. And a weaker dollar is inflationary. The inevitable result is higher inflation, and that inflation will take place first in the price of commodities. Investors now simply are reacting to the economic truths that Mr. Bernanke and company are trying to orchestrate into reality.

Another consequence of the Fed's QE2 is going to be a rise in "long-term" Treasury bond yields. I say "long-term" in quotes because in the Fed's actual statement, the verbiage used was "longer-term" Treasury bonds.

You see, the Fed's definition of "longer-term" Treasuries is around five to seven years, and that's where the central bank plans to concentrate its $600 billion in QE2 purchases. Now, the usual meaning of "long-term" bonds is farther out maturities like 20+-year Treasury bonds. So, what the Fed is doing, essentially, is leaving this segment of the market out to dry. This also means that "long-term" bond yields will have to rise to make them attractive again to investors.

It is my contention that with all of the borrowing that is taking place by countries around the world, interest rates are bound to continue climbing. According to estimates from the International Monetary Fund (IMF), the amount of money that advanced-nation governments will need to borrow in 2011 is a staggering $10.2 trillion. These debt levels have not been seen since the aftermath of World War II.

Next year, the U.S. government will have to borrow $4.2 trillion, according to the IMF. That's 27.8% of its annual economic output, up from 26.5% this year. By comparison, Greece needs $69 billion, or 23.8% of its annual gross domestic product. The point here is that with so much borrowing needed, interest rates are bound to continue rising.

ETF Talk: Unveiling a Basket Full of Glitter

More and more, investors are trying to protect themselves from market volatility. With the Fed's recent commitment to buy $600 billion in Treasury bonds, inflationary expectations are rising along with commodity prices. The biggest gains right now seem to be taking place among precious metals.

The chart below shows that the price of gold has been soaring. The price of gold has risen 26.71% so far in 2010 and it keeps climbing. Another precious metal, platinum, is up 19.07%, while silver and palladium are up 66.28% and 73.40%, respectively, so far this year.

With all of the precious metals on the rise, you may be wondering which one offers the best investment going forward. Since gold, silver, platinum and palladium all are gaining in value, it certainly can be difficult to decide where to invest. However, a new way to bet on all four of the precious metals at once was launched on Oct. 20 through the introduction of ETFS Physical Precious Metals Basket Shares (GLTR).

The shares, issued by ETFS Precious Metals Basket Trust, are intended to reflect the performance of the prices of gold, silver, platinum and palladium bullion, less fees and expenses. GLTR eliminates the need for investors to choose between these four very attractive precious metals. Each share is backed by 0.03 troy ounce of gold, 1.1 ounces of silver, 0.004 ounce of platinum and 0.006 ounce of palladium. The shares represent beneficial interest in the trust.

In turn, the trust holds physical gold, silver, platinum and palladium bullion in the vaults of its custodian, JP Morgan Chase Bank. All physical bullion held with JP Morgan Chase conforms to the London Bullion Market Association's and the London Platinum and Palladium Market Association's rules for good delivery. Gold and silver will be held in London, while platinum and palladium will be held in either London or Zurich.

Get Your Precious Metals Watch List

The ETF universe now is teeming with more than 1,000 funds. Yet there is one asset class, particularly this year, that really has captured everyone's attention -- and that's precious metals.  Precious metals, like stocks and bonds, are an asset class which represents a great deal of risk, along with the potential for big rewards. One of the biggest challenges confronting precious metals investors is dealing with the tremendous volatility in the sector.

We've seen this volatility in the premier precious metal, gold, as the value of the yellow metal has gyrated wildly during the past 12 months. Because gold and other precious metals generally are non-stock, non-bond correlated investments, they've become very attractive to individual investors despite their propensity for volatility.

This low market correlation is a crucial component for investors who seek diversification within their portfolios.