"The Committee currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal-funds rate, at least through mid-2013."
If you were ever looking for a way to make gold prices soar, the above quote from yesterday's Federal Reserve meeting is it. Citing a "considerably slower" recovery than expected, the Fed policymakers said they discussed different ways to goose the economy. To put the Fed's entire statement (which you can read here) in plainspeak...
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We're out of options... Interest rates are already at zero, and the only thing rising is gold. We'll keep them there for another two years, hoping to discourage investors from holding cash. We reserve the right to print trillions of dollars should these measures not spur the economy. Considering how bad things are right now, that printing could come very soon... |
We're not the only ones betting on an expedited third round of quantitative easing (QE3)... Goldman Sachs' Jan Hatzius said QE3 is Goldman's new "base case" scenario. Here's a snippet from Jan's release…
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If there is additional easing, it would likely take the form of QE. After all, "these tools" mentioned in the statement presumably need to be more powerful – or at least not much less powerful – than the action taken today in order to avoid a sense of anti-climax. This means that they are unlikely to consist of small incremental steps such as a commitment to keep the balance sheet large, a gradual shift of the securities portfolio into longer maturities, or a cut in the interest rate on excess reserves from 25 basis points (bp) to zero. |
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This leaves the stronger options, which include QE as well as even more aggressive forms of easing such as rate caps (a form of QE in which the Fed promises to buy as many securities as needed to hit a longer-term yield target), a price level or nominal GDP target, or interventions in non-government securities markets (for which funding from Congress would be needed). Of these, "conventional" QE is very likely the option with the lowest hurdle, and the first one to be deployed. |
Yesterday's indirect nod to more easing and the fact that the Fed telegraphed interest rates for two years brought the bulls out. The Dow and S&P rallied around 4% and 4.74%, respectively. But knowing the interest-rate environment through 2013 wasn't enough...
More bad news from Europe – and perhaps the realization that no amount of money-printing can save the U.S. – sent markets tumbling today. At the time of this writing, the Dow and S&P are both down around 3%. Financial stocks are leading the way...
Goldman Sachs fell more than 7%. Bank of America is down more than 6%. Wells Fargo is down around 5%. The fear stems from rumors that French Bank Societe Generale is near collapse. Stansberry's Investment Advisory readers are aware of the pending collapse of the European banking system. In his July issue of Stansberry's Investment Advisory, Porter recommended selling short shares of Deutsche Bank and Royal Bank of Scotland to hedge your portfolio. He wrote…
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Several years ago, when it established the capital requirements of European banks, the Bank for International Settlements (BIS) made an exception to the reserve requirements for sovereign debts. |
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As a result, European banks were greatly encouraged to buy government debt, which enabled them to raise their leverage ratios and report far bigger profits. The rub, of course, is these debts are not safe and will surely default. That will cost the equity investors in these banks all or most of their investments. These stocks, which are very liquid and trade in the U.S., should be easy for you to sell short and will provide a great hedge against the coming global volatility. |
For an example of how Greek debt destroys European banks, see the recent earnings from Germany's Commerzbank. Net income for the bank fell 93% after writing down its Greek holdings. Earnings fell to 24 million euros from 352 million euros in the last year. The bank booked 760 million euros of impairments on Greek sovereign bonds as part of a European Union (EU) deal to bail out the country. The stock fell more than 11% today.
Today, Deutsche and RBS are down 9.4% and 8.3%, respectively. Since the July 19 short sale recommendation, Deutsche is down 18%, and RBS has fallen 44%. We know most of you will never try selling a stock short. But as you can see, it's a great way to hedge your portfolio in times of turmoil. (Another of Porter's short sales – homebuilder PulteGroup – is down more than 8% today, bringing that return to nearly 50% since January.)
Jeremy Grantham, the head of investment firm GMO, recently released his second-quarter investment outlook. Grantham's advice is simple... Be careful. He admits to underestimating the Greek and U.S. debt problems. (We'd add those enveloping the rest of the EU.) Grantham says he's a "modest buyer for the first time since mid-2009." In particular, he likes farmland, high-quality stocks, and commodities.
On the commodities topic, Grantham described in his first-quarter investment outlook a "paradigm shift" in commodity prices. He declared "peak everything"… he believes the world is running out of natural resources. He wrote…
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The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value. We all need to adjust our behavior to this new environment. It would help if we did it quickly... |
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So, oil caused my formerly impregnable faith in mean reversion to be broken. I had always admitted paradigm shifts were theoretically possible, but I had finally met one nose to nose. It did two things. First, it set me to thinking about why this one felt so different than those false ones claimed in the past. Second, it opened my eyes to the probability that others would come along sooner or later. |
At the time, we said this was the ultimate sign of a top in commodities. Grantham preaches "mean reversion" – that everything must eventually return to its average. By heralding a "paradigm shift" in commodity prices, Grantham was betraying his core belief... Never a good sign.
We wrote…
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Whenever an investor strays so far from his circle of competence and/or dismisses a core belief, it's a bad sign. And let me say, we don't entirely disagree with Grantham on the topic of rising commodity costs. We think commodities will trend higher (not without corrections) – but it'll be due to inflation, not a global shortage. |
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We do agree with Grantham that commodities will have a major correction in the next few years. Grantham believes, as we do, that a Chinese slowdown and good weather (we're coming off one of the worst years for weather in decades) will push commodity prices down. And we'll buy then. In the meantime, we're holding onto our gold. – Sean Goldsmith, S&A Digest, April 26, 2011 |
So how has oil, which shook Grantham's faith in mean reversion, performed since his letter?
For a different perspective on the recent market turmoil, I'd encourage you to read an interview with one of Porter's mentors, Mark Ford. In it, Mark explains how he's handling the market upheaval... and more specifically, why he doesn't care. He offers some valuable tips that could help you through these times. Read the free essay here...
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New 52-week highs (as of 8/9/11): SPDR Gold Trust (GLD).
Someone tried selling stocks short, and someone made a lot of money. How have you done hedging your portfolio? Let us know... feedback@stansberryresearch.com.
"I am a four month old subscriber, after 30 days I am thinking like Buffett. You take 4 credit cards at 0% for 18 months, max them out with 1/2 silver and 1/2 gold bullion sent to your house, then make min. monthly payments and you have a 18 month metal backed savings account. You guys opened my mind and I am cutting my own path." – Paid-up subscriber DG
Goldsmith comment: I don't remember advocating credit card schemes to buy bullion...
"After Monday's massive drop in the market I nervously checked my online brokerage account balance after the carnage. Because I had followed your advice and shorted some stocks for the first time, I found some nice green numbers instead of the dreaded negative reds. Up 45% in PHM, over 22% in COF and a nice gain in GE (which I closed so as not to be too greedy). I know you repeatedly say most people will not follow your advice. Well this person did, and not only did I not take a major hit, but I escaped with a few more shekels in my pocket." – Paid-up subscriber L.L.
"I work in a state penitentiary. Today, one of the inmates told me that I should listen to him very carefully, that it was time to buy gold, because 'paper money is just promissary notes that aren't worth anything.' I was wondering if you would call this a sign of a top in gold? I am kidding of course, but that conversation really did occur, I thought you would find it amusing." – Paid-up subscriber Robert B.
Goldsmith comment: I'd ask that inmate if he owns any bullion before declaring a top.
Regards,
Sean Goldsmith
Baltimore, Maryland
August 10, 2011
How to make gold soar... Goldman says more quantitative easing is the 'base case'... Financials get hammered... Why you should sell stocks short... Checking in on Grantham's 'paradigm shift'... How Porter's mentor is navigating the turmoil... Inmates calling a gold top?...