Bonds, commodities have mixed year

Prices in the bond and commodity markets centered around this question: "Will there be inflation in 2012?" And the answer in most markets was, "No, probably not."

Inflation is the enemy of bond investors, because it erodes the value of a bond's fixed interest payment. When inflation is the air, traders push bond yields up and prices down. And commodity prices are a real-time indicator of inflation in everything from copper to gold to grain.

Despite worries that the Federal Reserve's easy-money policies would drive up inflation - and that the nation's rising debt would intensify that - inflation was remarkably restrained in 2012. The government's consumer price index rose just 1.8% the 12 months ended November, according to the Bureau of Labor Statistics.

Most commodity prices confirmed that. For example, the Commodity Research Bureau index, which reflects a broad basket of commodities, fell 7.7% in 2012. The average price of unleaded gasoline at the pump fell 0.5%, to $3.276 a gallon, according to AAA.

But precious metals investors are still true believers in inflation, and have been pushing prices up all year. But even gold bugs lost conviction in inflation: A late-year sell-off in the yellow metal trimmed those gains, however, and gold closed the year at $1664.00 an ounce, up 5.4% from a year earlier.

The bond markets also showed little fear of inflation.

The bellwether 10-year Treasury note's yield ended 2012 at 1.76%, just a bit lower than where it was at the start of the year. Investors collected meager interest and got a tiny bit of price appreciation - bond prices rise when yields fall, and vice versa.

The iShares Barclays 7-10 Year Treasury ETF, which invests in Treasury notes that mature in seven to 10 years, gained 4.1% with dividends reinvested, according to Morningstar, which tracks the funds.

Treasuries typically have the lowest yields in the bond universe, because investors figure there's no chance that the government will default on its debt. And the Federal Reserve helped keep Treasury yields low throughout the year, in a bid to stimulate the economy.

The bond market favored the bold in 2012, but taking more risk for higher yields is always a risky strategy.

Those who invested in high-risk junk bonds - IOUs issued by corporations with dubious credit rankings - gained an average 14.6%. These bonds are economically sensitive, just as stocks are. Should the economy dive, more shaky corporations will default on their debt, and junk investors could get hurt.

Bond yields typically rise when traders think inflation is in the air: Rising inflation erodes the fixed interest payments that bonds make. So far, at least, the bond market sees little inflation ahead.

USA Today