Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
QEs Eventual Revival and Its Effects
Owing to what the Fed called a moderately improving labor market, the FOMC found reason enough to exit its QE program altogether this week. However, fearing a stock market reprisal, it reaffirmed its position on interest rates (the Fed Target rate), keeping them low for a “considerable time.” That in conjunction with better-than-expected third-quarter US GDP growth of 3.5%, weak confidence data from the eurozone, and the Bank of Japan’s $100.0 billion QE increase overnight Thursday had the dollar spiking higher, gold and the miners lower, and stocks in a moonshot back to interim highs – a move that was also inspired by quarter-end fiscal gaming.
Even though the BoJ’s announcement moved markets this week, we still have no reason yet for the Fed to reinstate its QE efforts. That means that following fiscal quarter-end gaming and/or the mid-term elections, stocks will likely be under pressure again soon. That fact, combined with the high level of leverage in the market, suggests that the price action in equities stands a good chance of becoming fairly ugly. As for the metals and the miners during that time, I anticipate some mild improvement up until the Fed takes one last stab at printing to save the day. But let’s face it, gold and the miners are extraordinarily cheap in both absolute and relative terms. If there is anything to be said about the selling in the last two years or more, it’s that the metals have moved from weak hands to strong. In that light, it’s safe to say that, regardless of the news, downside risk underscores the potential for upside movement.
That brings up the subject of deflation that many so-called specialists in the gold sector have hashed and rehashed ad nauseam. In a deflationary scenario, the theory holds that just about everything – with the possible exception of bonds and the dollar – would fall in price. That notably includes the metals. What these experts fail to realize is that gold has been negatively correlated with stocks for some time now (since 2011), as anyone willing to step out of the land of theory and into the realm of daily price action can readily see. Today’s trading was no exception: As stocks rose, gold fell – in unison. So sharp was the correlation that it seemed a pair’s trade was an essential part of the plan. This simply buys more mileage for QE packages by artificially suppressing articles of inflation while simultaneously juicing stocks for growth. All this is to say that when stocks reverse, gold is set to rise – perhaps rapidly – as these complex trades unwind.
Determining the point at which stocks will reverse course is another matter. I’ve alluded to some dynamics above that would lead to some short-term volatility, but in the long run everything will depend on the Fed’s ability to manipulate long-term interest rates. As anyone paying attention may have noticed, that game hasn’t been going so well for the Fed lately. As I have said here many times, absent foreign creditor support for dollars and/or debt, which went away at the same time rates began to rise in May of last year, the Fed’s job of manipulating long-term rates became much more difficult, if not impossible – whether they want to admit it or not. Stocks are therefore faced with the small dilemma of a non-printing Fed in the short run, and the larger issue of QE as an ineffective driver of interest rates and corporate earnings in the long run. In other words, the bulls have much to be wary of.
For those wanting a second opinion on Fed policy and its questionable future, former Fed Chairman Alan Greenspan posted some remarks on Bloomberg and the Financial Times this week. His comments about Fed QE and gold are enlightening as well as prophetic – links are provided below. If you’re short on time, the takeaway is Greenspan’s final sentence: “Buy gold.” At the New Orleans Investment Conference in late September, he was asked how much higher the price of gold could go. His answer: “substantially higher.”
Financial Times: Fed Eyes First Rate Rise After End to QE
VP Investment Management
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