Friday, March 11, 2011

If QE3 were not to immediately follow QE2 ...

There has been a possible scenario stewing in my head over the last few months after seeing some charts which showed the relationship between the US Fed QE programs/balance sheet and the rallying stock markets, commodities and other assets.

 The above from Free Gold Money Report - Link

  The above from Zero Hedge - Link

Many commentators in the precious metals sector write about the Fed printing to infinity, endless QE programs, Bernanke throwing money out of helicopters and so forth, but very few talk about the risks associated with a halt of the QE program (even if it were only temporary).

I recently read an article by Christ Martenson which discusses the possibility (worth following the link to read in it's entirety).
There's a scenario that could play out between May and September in which commodities (including my beloved silver) and the stock and bond markets could all sell off between 20% and 40%.  The trigger will be the cessation of QE II and a multi-month pause before QE III. 
This is a reversal in my thinking from the outright inflationary 'buy with both hands' bent that I have held for the past two years.  Even though it's quite a speculative analysis at this early stage, it is a possibility that we must consider. 
Important note: This is a short-term scenario that stems from my trading days, so if you are a long-term holder of a core position in gold and silver, as am I, nothing has changed in my extended outlook for these metals.  The fiscal and monetary path we are on has a very high likelihood of failure over the coming decade, and I see nothing that shakes that view.
But over the next 3-6 months, I have a few specific concerns. Read the rest of the article here.
I haven’t got a paid subscription to see more detail around where Chris sees markets, etc heading if this were to occur, but I thought I would draw up my own timetable to give an idea of how I think things could play out if QE3 weren’t to immediately follow QE2 at the end of June. Keep in mind these targets are simply guesstimates and the actual figures could vary wildly as could the outcomes.

March to April

Middle East/Northern Africa unrest continues to push oil price higher
(Oil Target $140-160)

Gold/Silver will rally with oil as a safe haven/speculative trade based on expected inflation
(Gold Target $1600, Silver Target $45, GSR of 35.5)

Rising inflation seen as a key risk, so US Dollar index (USDX) will fall
(USDX Target lower than 74)

Rising oil price puts dampener on further market rallies (e.g. DOW/S&P) - sideways action, maybe correction (but nothing of significance)
(Dow Jones Target 11,000, S&P 500 Target 1150)

May to June

Announcement: Halt in QE program or reduction in size 
De-leveraging/deflation takes hold
Pressure from high oil price has pierced hopes of US recovery

Markets roll over and start a sharp correction

Gold/Silver could also sell off (risk higher for Silver as more volatile metal)
Oil may not sell off too badly initially if Middle East/Africa troubles continue

July to December

Market continues to drop on it's way within next year or two to new lows (e.g. below March 2009 bottom) both here, US and elsewhere (including emerging markets)

Oil price will likely take a hit like it did in 2008 following reduced demand as recession/depression take hold (doubt we'll see it back at $40 again)

Commodities sell-off will cause Australian economy to tank (house price correction will accelerate, AUD could once again fall of a cliff)

Gold/Silver see continued falls and weakness (through seasonal middle of year)
(Gold Target $1250, Silver Target $25, GSR of 50)


If the scenario were to play out above with most assets being sold off in a deflationary spiral then Gold and Silver equities could potentially be smashed even if the price of the metals hold up. In a situation were margin calls are being made regularly investors may need to liquidate any assets they can get their hands on. Junior stocks who rely on a stable and liquid market for regular capital injections could be particularly badly affected. In the 2008 collapse there were some Gold/Silver equities that dropped 90% from their recent peaks.

If the AUD dropped sharply against the USD the AUD price of Gold may still rise even if the USD deominated price is falling, e.g. US$1250 Gold with AUD at 60c against USD would give us AUD$2100 Gold. This may make physical Gold in Australia a good buy/hedge regardless of the outcome. If we see the deflationary conditions then the falling AUD will hold up the local Gold price and if QE were to continue, fueling inflationary pressures, then Gold priced both in USD and AUD should continue to rise.

I am considering reducing my exposure to junior Gold and Silver mining stocks and will be looking at AUD Gold proxies such as PMGOLD and GOLD on the ASX to cover the above scenario.

I will be offline for the weekend, however will likely come back to this topic sometime next week to discuss it further.


Disclosure: Positions held in Gold & Silver. Not investment advice. Do your own research.


  1. If all the Bullion banks are actually as short as the COT/Bank participation report suggest, this may give them a good opportunity to reduce their position during a "QE3 Interuptus" scenario.

  2. Hi BB
    Thanks for your posts. Very informative.

    You might like to listen to the Jim Rickards interview on King World News about QE going on. Good insight into the operation of the Fed.

  3. Great blog, very informative. I'd be interested to know what you think the impact of the recent Japan Earthquakes will have in your projections.

  4. Babstar, I can only speculate, but my thinking is the large traders are using their COMEX short positions as a hedge to their long positions in the precious metals market (e.g. JPM/HSBC, etc have large positions in precious metal miners and assume exposure elsewhere). If that's the case, if they start heavily reducing their short position (rather than the undulating positions they have now) it might actually be a negative as they would be reducing their long positions at the same time (e.g. they no longer believe large $ should be allocated to precious metals)... only speculation on my part however...

    Thanks Rad, I agree with Rickards that QE will be with us for sometime, however that doesn't mean there won't be gaps in the program. Of course the scenario I painted above is only 1 possibility, if the Fed were to extend QE2/announce QE3 without any gaps then the melt-up could continue without significant disruption.

    Thanks WQL, I can't see the Japan disaster having a large effect on the short term predictions above. The Japanese Yen only makes up 13% of the USDX so shouldn't have too much bearing on the trajectory of the USDX continuing it's fall. Looks like we are going to see Japanese government involvement in stabilising their market, but if things were to play out as the scenario I posted suggests then I suspect the Japanese markets would also be hit hard.



  5. What Rickards said in the interview makes a lot of sense, the fact the fed can buy an (estimated) $750 billion of treasuries a year without expanding their balance sheet by reinvesting funds speaks volumes. In the Feds definition QE might be stopping in June, but in reality it sounds very different.

  6. Whats the difference between GOLD and PMGOLD? I have a stash in GOLD but there is a bit of talk at the moment regarding whether ETFs are "safe".

  7. Anon, probably the main difference is the custodian. The physical Gold backing GOLD is stored by HSBC (custodian) who have been implicated in metals manipulation, whereas the PMGOLD product is Perth Mint, a much more reputable organisation in my opinion.

    I'm sure there would be other differences, you would be best to compare the prospectus for each product.


  8. @ BB

    Personally, I believe that the Big Babies that have unsuccessfully manipulating the Bullion Markets have see the light along with those feral we call "leadership" whereby they have now finally decided to design a Global Gold Standard - but one which suits them. If correct, then they must get their hands on as much hard Gold and Silver as possible at a price to be paid in Fiat, and then let the fiat and Gold relationship rise to what they think it should be - my guess is between usd50 to 60k pto and try to start the gaming again. Yes, they need to at least make some effort at reducing their shorts but it doesn't rally matter now as they are all on the same side and Law is being applicable to them.

    This means much more volatility and no place for the weak - but I am holding on and buying at really any price for the long term and forget the fluctuations. Remember SPOT price is now mostly insignificant - price for hard is now seen as market demand. Three new markets now - Shanghai have reduced margins - Hong Kong coming soon and Singapore coming soon - Comex represents 5% of World and is totally corrupted and manipulated.

    Why? Because the Gold and Silver values haven't moved - it is the Fiat that are collapsing PLUS the confidence in government by the human base.

    This lot of "leaders" are done - and their Fiat ain't worth dickie doo.

    Guess at full collapse in 2012 and Gold eventually set at (today's pricing) USD56,000 for at least unto 2017. Silver will ratio back to ~20:1

    But the only certainty is the collapse of the current economic system at a Global scale.