Up until Friday, October 15th, the market has largely ignored those two words. Instead, all we’ve been hearing is, “I’ve gotta have more cowbell…I’ve gotta have more quantitative easing”. Now, investors are tired of hearing speeches for the need for QE 2.0; rather, they want specifics. In Bernanke’s speech last Friday titled, “Monetary Policy Objectives and Tools in a Low-Inflation Environment”, no new information was given about any real specifics or timing for the new policy and we were again reminded, “if necessary”. It has been nearly three months since James Bullard’s article (Seven Faces of “The Peril”) spun the markets in a tizzy over QE 2.0 on July 28. Ever hear about what happened to the boy who cried wolf? Investors are “Fed up” and the market isn’t listening any more. The “if necessary” component of QE 2.0 has finally hit home and the U.S. dollar made an intraday reversal on Friday to close up at 77.04.
At this point, you’d expect the Treasury to come out saying, “we maintain a strong dollar”, as they have in the past. This time, however, Geithner triple-double-dog stamped by saying the U.S. dollar would remain the reserve currency of the world, the Treasury supports a strong dollar, and the U.S. would not resort to policy that would devalue the currency. Those are some strong words Mr. Geithner!
Now our readers at FSO know the Treasury is speaking out of both holes. We’ve seen the U.S. dollar lose 33% of its value since we started investing in precious metals in 2002; however, reality doesn’t move the markets, perception does. If you think reality moves the markets, how do you explain Potash is worth $112/share on one day and $143 the next? I digress…perception moves the markets in the short and intermediate-term. That perception is beginning to question exactly what is going to come of QE 2.0 and how much of that is already priced into the markets after a 140 point rise in the S&P 500 and $226 in gold.
Bottom line: precious metal stocks and commodities were technically overbought and due for a correction. Vice Versa, a rally was due in the U.S. dollar. Traders today merely said, “Ok I’ll sell on that news because my stock price is breaking down.” China raised interest rates? That’s not bullish for the U.S. dollar. That would not make me want to move money away from China’s cheap stock valuations and into the U.S. dollar. The recent selloff is purely nervous traders locking in profits.
I warned in a 7-page paper last Friday of an imminent short-term to intermediate-term top in precious metals for technical reasons. This doesn’t help our FSO readers today after the Chinese announced a rate hike and gold has sold off. Now we have the fundamental reasons for a U.S. dollar rally based on the Fed and the Treasury Secretary. Key word, “rally”, implicating this is only a short to intermediate move in the dollar to answer the oversold conditions and overly bearish sentiment (only 3% bull in the dollar recently). Mean reversion is as strong as gravity my friends.
Ryan, didn’t you say buy stocks, it’s simple, due to Q.E. on October 5th? Monetary policy has shouted from the rooftops what its intentions are. They want growth and they’re willing to inflate if they don’t get it. If the economy gets back on its feet and consumers start shopping, then the Fed won’t need to do QE 2.0. Either way, it’s supportive for stocks, but it’s possible that gold bugs might have read too much into “more cowbell” and not as much into “if necessary”. It’s also possible that investors have become “too bullish” since August in relying on QE 2.0 for growth. No, it’s growth OR QE 2.0. Not both. Investors have jumped the gun on more monetization. All the Fed has been doing since August is buy U.S. Treasuries with interest from mortgage-backed bonds. Essentially, this is “baby steps” towards Q.E. 2.0, and not full-fledged quantitative easing the likes of which we did see in 2009. If you follow Bernanke’s policies, this isn’t out of the ordinary. He’s a consensus builder. Slow to act.
Ryan, that’s all well and good as everything you’re saying is being priced into the market today. What else can we talk about? Remember first, this is a Market Observation slot on FSO so I’m reporting on what I see; however, there are quite a few things I’ve been thinking about lately – the most important being, how far down for gold miners?
I’m thinking of two scenarios right now, both are bearish for the short-term to intermediate term. Most of that weighs on whether the broad stock market can hold onto its gains and tread water for a couple weeks until November 3rd (FOMC meeting). On November 3rd, all bets are off. How the market responds to the news of no QE or too little QE will be what determines the intermediate move in commodities. I’ll let you know when I find a crystal ball. The short-term support on the S&P 500 is around 1166. We passed through that intraday today and finished at 1165.90. If we experience a running (flat) correction in the stock market or head higher, I think we get a shallow correction in precious metal miners (scenario A). If the S&P 500 breaks down here, then I’m guessing deleveraging and the miners are in for a sore ride, down another 10% on the GDX over the next week and a half (scenario B).
The long-term fundamentals for owning gold haven’t changed. Interest rates are still at generational lows and the monetary base of our country is expanding. The only thing I’m worried about – as a portfolio manager concerned about outperforming the S&P 500 – is if U.S. economics improve substantially in the fourth quarter, as they did in 2009. That triggered a rally in the U.S. dollar and stock market while it triggered a correction in commodities across the board. It’s only because of a sovereign debt crisis that gold bullion was buoyed during that time. Don’t forget that gold fell from $1225 to $1050 on a dollar rally last winter. Leading economic indicators have turned up briefly recently and retail sales weren’t too shabby last week. Precious metal investors that are concerned about performance in Q4 2010 would do well to watch for a rising dollar and better economic news. Both are a prescription for underperformance versus the S&P 500.
