Thoughts On Fed Intervention (Are They Out Of Bullets?), Currencies And Gold
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August 3, 2012
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by: Jeremy Robson
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I have been thinking about long term investing. Below are some of my thoughts on Fed intervention, currencies and gold. They are long term thoughts covering the position over the next 1-2 years.
Central bank intervention
The investing world is presently as difficult as it gets. There are so many crosscurrents, that picking the right course is extremely difficult. Is bad economic data good for the market or bad? Is a stronger dollar, good or bad? Are interest rates at historic lows, good or bad? With all of these crosscurrents, I have been thinking about the basics of investing and concluded:
Bad data is bad data and is a negative for the market. Money printing will not hold up the market in the long term, unless there is a political will to print in excess. This brings me to the heart of this debate, which is - What tools have the Fed got left in the long term? All of the talk about good and bad data is dependent on the central bank response. Without the policy response all of this talk would disappear. Without the policy response, bad data would be bad data and the market would fall on its release. There is talk that the Fed is out of bullets. I think that they have several bullets left, it is just a question of whether there is the political will to fire them. I also think that the bullets have the ability to move the markets upwards, but not to aid the economy out of its morass. Does that mean they are out of bullets? They can:
1. Charge interest on reserves to make banks change how they use excess cash. This has been done in Europe and the results seem to be that the banks have bought U.S. treasuries, German Bunds and Finnish, Swiss and Dutch bonds, with their excess reserves. There has been little evidence that the removal of interest on reserves has increased the circulation of money through lending. However it is early in the process.
2. Increase the size of the next QE. If the next QE were $1.5 trillion over 9 months, the stock market would rise on the expectation that flows into the market would raise all boats.
3. With treasury yields at historic lows, the Fed could buy up shares directly to prop up the market. This would send the indexes up vertically. Imagine an announcement that the Fed were going to buy $1 trillion of U.S. stocks over 9 months.
4. Go to perpetual QE. No date for purchases or amounts would be specified. The Fed would buy up assets to support the market whenever they deemed fit.
At present I could see the Fed doing 1, but not 2 , 3 or 4. Things would have to deteriorate further for the Fed to be buying in greater size and directly into the stock market. I wouldn't rule out any of the options, in the longer term. The only lasting solution to the present malaise is to ratchet down people's expectations on entitlements and their standard of living. It is not a popular message and it is unlikely to be chosen by any political party. This crisis is unlikely to be a short one, which is why I do not rule out options 2, 3 or 4.
But, I ask myself, 'will this actually help the economy, reduce unemployment and increase growth?' I don't think so. I am back, in the long term to bad data is bad for markets. Congress may decide to go for further fiscal stimulus, if the economy goes into recession. This will produce growth on a temporary basis. Is this the route that we will travel - the Japanese fix. The Japanese stock market has fallen unremittingly for 20 years. I am back to bad data is bad for markets in the long term. The volatility may be extreme but the end results are a lower market.
Currencies
In this environment, the real safe haven currencies are:
1. Norwegian Krone
2. Swiss franc
I have chosen these 2 as the sovereign debt position of both is good. The Norwegian economy has 2 danger signals of high house prices and high levels of household debt. However the sovereign debt position is so strong that I still rate it as a safe currency. The Swiss economy also has high house prices, but no other problems.
In the second tier of safe currencies, I have:
1. Canadian dollar
2. Australian dollar
3. Swedish Krone
3. Chinese Renminbi
Some people would have the Canadian dollar in the first tier of currencies and it is a close call. However it does not get there as the overall economy and sovereign debt are not as good as the first 2 (in my opinion).
The Japanese Yen and U.S. dollar are not safe currencies. They may appreciate in the short term, but in the long term, neither is a store of value. The Euro is difficult to assess, as it is unclear what countries will form part of the block in the future. The currency trade of the next 5 years will be the Yen short. It is only for the brave, as multi decade bull markets, which the Yen is in, do not end without a lot of volatility at the turn.
Sterling is worse than either the U.S. dollar and Yen as total debt to GDP is over 500%. In our current low growth world, this is a very precarious position indeed!
Gold
It seems unlikely that the Gold bull market has ended. Poor seasonality ends at the end of July. Below is the monthly pattern for gold price movement:
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I am still cautious in the short term. The 38.2 Fibonacci retracement of the move from 2008 to 2011 comes in at $1462. I would suggest that we will see this level before the next up move.
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This would contradict the seasonal pattern in gold. If QE is announced at the Fed meeting on the 1st August, I will be wrong to have waited before re-entering the gold trade. The next phase of the bull market will likely take gold above $2,000, so there will still be a good buying opportunity at higher levels. Gold is still my first investment pick for the next 2-3 years.* I say this as the crisis in Europe will only be over when the periphery nations have regained competitiveness and reduced their debt/ GDP to below 60%. This is some way off. The U.S. has to scale back expectations of entitlements and standards of living. This is also a long way off. Gold seems to have room to run!
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*Just as a note, my second favorite pick is short US small caps through RWM.
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