On Thursday, the Federal Reserve initiated QE3 and this prompted a big rally in risky assets. As you know, we were expecting Mr. Bernanke to unleash 'stimulus' but even we were taken aback by the extent of the easing.
During his press conference, Mr. Bernanke stated that the Federal Reserve will buy US$40 billion worth of agency mortgage-backed securities every month until the US job market improves. Furthermore, he confirmed that the Federal Reserve will continue with its Operation Twist 2 program,keep interest rates at near zero until mid-2015 and maintain an accommodative monetary policy well into the economic recovery! When a reporter asked Mr. Bernanke whether he could elaborate until when the Federal Reserve will continue to create US$40 billion every month 'out of thin air', he evaded the question.
There can be no doubt that the Federal Reserve's move is unprecedented and it is astonishing that the American central bank is openly debasing its currency! More importantly, if the US job market does not improve soon, it is probable that QE3 will continue for several months or even years! In terms of morality, the Federal Reserve's latest policy initiative is questionable at best because an open ended QE will diminish the purchasing power of money and penalise savers. Nonetheless, from an investment perspective, QE3 will probably trigger a massive rally in global stocks and commodities.
For our part, we have allocated capital to some of the strongest companies and sectors which are in an ideal position to benefit from QE3. Furthermore, we have also re-invested capital in precious metals and it is our belief that both gold and silver will appreciate significantly over the following months.
Turning to the stock market, it is notable that major US indices have climbed to multi-year highs and it is conceivable that the S&P500 Index will break out to an all-time high over the following months. As we have been stating for several months, Wall Street seems to be in the final innings of its secular bear market and a new high in the S&P500 Index will confirm the next primary uptrend. In terms of sectors, as long as QE3 is in force, consumer discretionary, technology, biotechnology, financials and precious metals miners are likely to outperform and the defensive industries will probably underperform the broad market.
Looking at commodities, the CCI Index has climbed to a multi-month high and hard assets are likely to inflate over the following months. It is notable that both copper and crude oil have reclaimed the 200-day moving average and this is a bullish development. From our perspective, we continue to believe that industrial commodities will continue to underperform precious metals. Accordingly, we are not initiating any positions in the industrial hard assets.
Over in the precious metals arena, both gold and silver are soaring and at the very least, this rally is likely to continue until next spring. On Thursday, silver was the big beneficiary and we believe that over the following months, silver will outperform gold by a wide margin. Interestingly, the junior gold miners are also coming back to life and today, we are allocating some capital to this sector. If our assessment is correct, the following months will be very bullish for the junior miners and this is the time to join the party. After today's allocation, approximately 15% of our equity portfolio will be invested in precious metals.
In the currencies patch, the US Dollar has embarked on a new downtrend and further weakness is on the cards. Given the fact that the Federal Reserve is debasing its currency, the greenback should depreciate significantly against other forms of paper money. In terms of the technicals, the US Dollar Index has slipped below the 200-day moving average and that line should now act as a source of major overhead resistance.
Finally, QE3 is already having an impact on bond yields and it is probable that long-term US interest rates will rise and the yield curve will steepen. Conversely, bearing in mind the ongoing rally in risk, we believe that peripheral European bond yields will decline and high yield corporate bonds will also appreciate over the following months. Thus, this is the time to liquidate US Treasuries and allocate capital to high yield bonds.
The above 'Weekly Update' was sent out to subscribers of Money Matters on 14 September 2012