The golden canary in the coalmine


Author Cam Hui

Posted: 14 May 2013

Shortly after the market closed, the WSJ published Jon Hilsenrath’s article Fed Maps Exit From Stimulus in which the Fed discusses a gradual withdrawal of QE:

Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy—an effort to preserve flexibility and manage highly unpredictable market expectations.

No doubt the markets will get spooked by this “leak” and as I write these words, ES futures are moderately in the red. The question is, “How much and how far?”

Watch gold for clues to market direction
For me, the canary in the coalmine is the gold price, which is highly sensitive to expectations of monetary stimulus. Gold has staged a tactical V-shaped bottom and the silver/gold ratio has stabilized, which is constructive (see Watching silver for the bottom in gold). Gold rallied to fill in the gap left by its free fall in April – so now what?

With the news that the Fed is starting to think about an exit from QE, the near term downside risk is evident. There are many opinions about the fallout of this “leak”. Josh Brown has two sides of the story. On one hand, he believes that with sentiment excessively bullish, we aretactically headed for a hard correction. On the other hand, he seems more relaxed longer term.

As for myself, I am watching for a re-test of the April lows in gold to see if that low can hold as a sign for the risk-on trade. Longer term, the April decline caused considerable short-term technical damage, but the long-term uptrend remains intact. The other key issue is whether the uptrend can hold here.

A Lost Decade or a “beautiful deleveraging”?
Will this Fed action be a repeat of the Japanese experience where the authorities go through ease-tighten cycles that caused ups and downs in stock prices? This will be a test of Ray Dalio’s beautiful deleveraging thesis where the United States has undertaken just the right mix of austerity, money printing and debt restructuring.

David Merkel wrote a timely post recently entitled Easy In, Hard Out (updated):

My view is that there is no such thing as a free lunch, not even for governments or central banks.  Any action taken may have benefits, but also imposes costs, even if those costs are imposed upon others.  So it is for the Fed.  At the beginning of 2008, they had a small, clean, low duration (less than three years) balance sheet on assets.  Today the asset side of their balance sheet is much larger, long duration (over 6 years), negatively convex, and modestly dirty as a result.

He went on to outline the risks [emphasis added]:

Fed tightening cycles often start with a small explosion where short-dated financing for thinly capitalized speculators evaporates, because of the anticipation of higher financing rates. Fed tightening cycles often end with a large explosion, where a large levered asset class that was better financed, was not financed well-enough. Think of commercial property in 1989, the stock market in 2000 (particularly the NASDAQ), or housing/banks in 2008. And yet, that is part of what Fed policy is supposed to do: reveal parts of the economy that are running too hot, so that capital can flow from misallocated areas to areas that are more sound. At present, my suspicion is that we still have more trouble to come in banking sector. Here’s why:

We’ve just been through 4.5 years of Fed funds / Interest on reserves being below 0.5% — this is a far greater period of loose policy than that of 1992-1993 and 2002 to mid-2004 together, and there is no apparent end in sight. This is why I believe that any removal of policy accommodation will prove very difficult. The greater the amount of policy accommodation, the greater the difficulties of removal. Watch the fireworks, if/when they try to remove it. And while you have the opportunity now, take some risk off the table.

Zero Hedge put it more forcefully:

It is possible a steep decline in financial assets would ensue with the lowest part of the capital structure being hurt the most. TheFed has chased investors all in the same direction; into risk-seeking securities. Few care about “right-tail” events, but should investors decide to pare risk in reaction to a hint of ‘tapering’, the overshoot to the downside may surprise many. The combination of too many sellers, too few buyers, and dreadful (and declining) liquidity means a down-side overshoot is highly likely. It would provide the Fed with their answer as to whether they have been creating market bubbles.

It appears that the Federal Reserve is well aware of these risks. In a speech last week, Ben Bernanke said that the Fed was closely monitoring the market for signs of excessive risk appetite, such as reaching for yield [emphasis added]:

We use a variety of models and methods; for example, we use empirical models of default risk and risk premiums to analyze credit spreads in corporate bond markets. These assessments are complemented by other information, including measures of volumes, liquidity, and market functioning, as well as intelligence gleaned from market participants and outside analysts. In light of the current low interest rate environment, we are watching particularly closely for instances of “reaching for yield” and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals. It is worth emphasizing that looking for historically unusual patterns or relationships in asset prices can be useful even if you believe that asset markets are generally efficient in setting prices. For the purpose of safeguarding financial stability, we are less concerned about whether a given asset price is justified in some average sense than in the possibility of a sharp move.

The Fed being aware of a problem is the first step. Whether they can either react, either preemptively or after the fact, in the correct manner is another problem.

I prefer to watch the golden canary in the coalmine to see how the markets react, or over-react to the news that the Fed is mapping out a plan to gradually withdraw from quantitative easing.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Gold Equities Likely Disappointed Today


Author Larry Berman

Posted: 1 Aug 2012 re-posted from etfcm

If historical patterns repeat, and we know they do, gold equities are likely to be disappointed for a few days following the FOMC not adding more QE today. Although most economists surveyed think they will add more QE at some point, the Bernanke has clearly stated that they want to see things get a bit worse before they act.

World oil process weakened again yesterday as WTI struggles to hold above $90 while the XEG put in a notable bearish reversal pattern, perhaps capping the near-term upside for the TSX. If gold and energy look weaker, it is hard for the TSX overall to do much on the upside.

 

Risk-On, Risk-Off Markets to Dominate Trading


Author Larry Berman

Posted: 10 July 2012 re-posted from etfcm

We continue to expect the risk-on, risk-off markets to dominate trading until further notice—global economies are slowing and stimulus is expected. Last week’s response to the trifecta of an ECB rate cut, a Chinese rate cut, and a material increase in QE from the BoE was poorly received. We expect the trading ranges of the past year to generally contain the market for the next few quarters.

The rally in WTI was stopped dead in its tracks last week and our call to take some money off the table in the sector was right on the money. For now, we do not see WTI dropping back below recent lows around $78, but we do not see it getting back above $90 unless there is an escalation of tensions in the Strait of Hormuz and a real supply squeeze, we do not see a demand pull for a while—these things are hard to forecast with any certainty.

The gold sector has had the biggest volatility of all as investors await QE or not QE, that is the question. Seasonality for gold stocks begins to look really good over the next few months, so buying dips in the sector is back on the front burner.

Goldman Doesn’t Know What’s Next Either


Author Larry Berman

Posted: 3 July 2012 re-posted from etfcm

It should be no surprise that the market jumped like a rocket and stopped the month and the quarter end rally right at the key retracement resistance of 1363, as well as the previous June high. This should only serve to prove the point we raised last week which is Goldman (or the person that made the now stopped out market call) does not know what is going to happen next either.

I think we can all agree that the infrastructure of the global capital markets is weak at best. They can patch it up and maybe even fix it with massive money printing [said with an Austrian accent a la Dr. Marc Faber] over very long periods of time. But as Japan has aptly demonstrated, the longer-term QE does not work to fix the problem.

So the markets are about assessing the trading risks looking out for several weeks to months, and it appears that for now, the EU has come up with another band-aid. But also trust that Europe is not fixed and there is much more to go in the saga. Our trading bias is to lighten up positions into earnings season and if the market breaks out, stops should be trailed up to protect the gains.

 

This Market is About Fast Money, Not Fundamentals


Author Larry Berman

Posted: 12 June 2012 re-posted from etfcm

There is no fundamental reason for WTI to have a $5 range yesterday from peak to trough. It reminds us that this market is not about fundamentals, it’s about fast money guys punting billions of dollars around front running event risk. We do know that the US is pumping out more oil today than it did in 1998 thanks entirely to Bakkan. This is causing quite a problem for the Canadian exporters, and unlikely to clear up anytime soon.

The TSX energy sector could have notable earnings impairment for an extended period with nat gas prices cratering once again, which might explain why XEG has been behaving so badly for the past year. Do not expect that to clear up anytime soon, so look for bounces to be limited to about $16.50 in the coming months, barring a big QE bazooka that gets world commodity prices juiced up again (but not until things get much worse first).

The TSX is still constrained in our prime economic scenario for the next few quarters though short-term sentiment is an issue.

 

Is the QE glass half-full or empty?


Author Cam Hui

Posted: 12 June 2012

How the market reacts to news can be an important clue of future direction. In my last post, I wrote that you shouldn’t expect too much from the ECB or Fed this week. The European Central Bank certainly disappointed the bulls with their inaction, not only on interest rates, but on the prospects for “extraordinary measures”.

Now it’s Ben Bernanke’s turn.

We already have a clue on what Bernanke will say from Jon Hilsenrath’s WSJ article entitled Fed Considers More Action Amid New Recovery Doubts. Here is what I am watching for. Will the markets key on the comment that action is not likely in the June FOMC meeting?

The Fed’s next meeting, June 19 and 20, could be too soon for conclusive decisions. Fed policy makers have many unanswered questions and have had trouble forming a consensus in the past. Top Fed officials have said that they would support new measures if they became convinced the U.S. wasn’t making progress on bringing down unemployment. Recent disappointing employment reports have raised this possibility, but the data might be a temporary blip. Moreover, the Fed’s options for more easing are sure to stir internal resistance at the central bank if they are considered.

Or will the market key on the fact that the Fed is considering further quantitative easing [emphasis added]?

Their options include doing nothing and continuing to assess the economic outlook—or more strongly signaling a willingness to act later if the outlook more clearly worsens. Fed policy makers could take a small precautionary measure, like extending for a short period its “Operation Twist” program—in which the Fed is selling short-term securities and using the proceeds to buy long-term securities. Or, policy makers could take bolder action such as launching another large round of bond purchases if they become convinced of a significant slowdown.

What Hilsenrath wrote is not that different from what New York Fed President Dudley said in late May in the WSJ, that the Fed will act should it see signs of economic weakness:

Expectations for U.S. economic growth, while “pretty disappointing” at around 2.4%, is sufficient to keep the central bank from easing monetary policy, Federal Reserve Bank of New York President William Dudley said.

“My view is that, if we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front,” Dudley said in an interview with CNBC, aired Thursday.

Now that we know what Chairman Bernanke is likely to say, watch the market reaction. Is the QE glass half-full or half-empty?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The Last Bastion of a Broken Republic is Printing Money


Author Larry Berman

Posted: 28 Feb 2012 reposted from etfcm

Silver broke out while crude is showing some signs of cooling, though nothing that would suggest a breakdown. Gold is lagging a little on the breakout as are gold stocks, but there is clearly some breakout potential on the new tranche of cash the ECB is going to inject into the European banks. It was larger than expected, but so far has not excited the metal (could see a ‘sell the news’ type of reaction today).

We are simply amazed that some very smart portfolio managers in Europe feel that this QE will somehow fix the banks—it’s almost laughable if it were not so sad. To be fair, they are almost all taking the cash, why wouldn’t they, but like we saw with TARP, they do not have to lend it out.

The last bastion of a broken republic is printing money to dig their way out—it would seem that is the MO of all central banks. The good news is that austerity seems to be taken seriously, but the deleveraging process has years to run. The push and pull on commodity prices in the coming years due to the printing presses running overtime will be challenging to navigate.

 

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