Friday, April 29, 2011

No QE3, Risk Trade Back On Anyway...

Back in early March I posed the question, what would happen if we didn't have QE3 immediately follow QE2? Well it seems the Fed is about to let us find out with Bernanke announcing last night that the Fed would finish it's bond purchasing to June, but made no promises about further increases to the Fed balance sheet.
April 27 (Bloomberg) -- Federal Reserve policy makers said the economy is recovering at a “moderate pace” and a pickup in inflation is likely to be temporary, as they agreed to finish $600 billion of bond purchases on schedule in June.

“The economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually,” the Federal Open Market Committee said today in its statement after a two-day meeting in Washington. “Increases in the prices of energy and other commodities have pushed up inflation in recent months,” and the Fed expects “these effects to be transitory,” the statement said.
Some commentators have observed that even following the scheduled $600b bond purchases, the Fed will continue to be able to purchase US Treasury Securities (without increasing their asset base) due to other securities they hold maturing (see more on this from Jim Rickards). This has been referred to by some as QE "Lite".

Apparently the market has taken the FOMC meetings results as a positive with US Markets finishing strongly in the green, Silver retracing most of it's losses from earlier in the week and Gold putting in a new all time high (in USD). It seems for now Mr Market is happy to put risk back on... but for how long?

Here is a graph showing a comparison between the Fed Adjusted Monetary Base and a Commodity Price Index. Both have risen 73% from a January 2009 starting point (the Fed did pump the monetary base up quite substantially in the last half of 2008 as we saw Lehman Brothers collapse, etc). Coincidence or is liquidity finding it's way into commodities and other assets as the Fed expands it's balance sheet?

I am still somewhat concerned about what happens when the Fed stops increasing their balance sheet. During the last turn down in it's size we saw the May 2010 "Flash Crash".

The VIX (Volatility Indicator) is showing the market is extremely complacent at the moment* and that is a dangerous place to be considering:

- We are about to see the Fed pull back on the money printing
- We have US Congress yet to increase the US Debt Ceiling

Silver has had an extraordinary run and Gold has seen a modest rise over the last 6 months also. I will be looking to reduce my exposure to the metals (and related stocks) throughout this rally we are in. It will be the first time I significantly reduce exposure since I started heavy accumulation in 2008/2009.

With so many mixed signals it's hard to know what sort of outcome we might see post June when the Fed stops expanding their balance sheet. The old saying "Sell in May and go away" might just be a rule to adhere to this year and those familiar with the metals seasonal patterns will know that June through August can often be a slow period.

Short term (over the next 4-6 weeks) I still see room for Silver and Gold (and related stocks) to move higher. A week ago I suggested we would see weakness heading into options expiry (and we did), but suggested a rally above $50 was still likely following:
I do think that $50 will prove to be a short term psychological barrier, but my thinking is that there will probably be a lot of stops (by those shorting) just above the $50 level. So if Silver's momentum takes it above and these are triggered then we might just see the mother of all covering rallies/short squeezes with the metal heading to $55-$60 (maybe even higher) before this rally is over.Bullion Baron
I stick by this call, but take care, don't get caught up in the hype. Don't be afraid to take some profits off the table. If you're brand new to the metals, don't be afraid to dip your toes in the water, buy a little for protection, but I would suggest avoiding any "all in" type buying at these levels and be ready to ride out any volatility or corrections.

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

* Thanks goes out to hiho @ Silver Stackers for noticing the VIX


  1. Nice to see a level headed silver article for once. To be honest at this stage I'm stumped and dont know what to do or what will happen. If Silver keeps soaring I wont be surprised but if we see a big correction (which we are overdue for) then I wouldnt be surprised either. Don't think I could sell though. I'm prepared to hold on but prob wont be buying any unless we see a $10 correction at least. Anyway good article...we are approaching unfamiliar territory.

  2. Thanks Ernie, it can be tough to try and keep a level head with the 'hype' surrounding Silver at the moment. I've sold around 10% of my physical Silver over the past two weeks and may sell another 10-15% if it rallies as strongly as I suspect, but will be holding the rest. Mainly I will be lightening up on the equities which can be hit harder than the metals in a correction.

  3. I think this is a sound analysis. One additional point, however, is that, when we had the May 2010 flash crash, the AUD fell sharply (if I remember correctly, before slowly rising again over the following months).

    If the Fed doesn't pursue QE 3, then we should again see a fall in the AUD.

    As PM's are priced in U.S dollars, unless they fall further than the expected rate of decline of the AUD, then it probably isn't as much of a concern to AUD buyers.


  4. I agree HJ, if we see Fed reduce/stop QE and commodities fall then the AUD will probably follow. I posed this scenario in the March post I linked above:

    In this case we may see PMs hold up somewhat when priced in AUD, possibly even rise. Depends on whether the PMs or the AUD fall harder.

    I have noticed though that our PM related stocks often reflect the sentiment of US PM related stocks, so even if the physical price holds up we could still see the equities hit hard. Especially juniors who rely on a stable/confident market to raise funds.