Gold And The Next Great Monetary Easing

Wow, a Morgan Stanley analyst is bullish on gold.  That's enough to get one fired on Wall Street.


http://www.zerohedge.com/news/2013-03-05/gold-and-next-great-monetary-easing

Diminishing returns on monetary easing

With everybody closely watching the FOMC on whether they re-institute another round of QE and/or Operation Twist, I think it's instructive to examine the frequency of easing.  QE 1 was launched in March 2009 to stem the collapse on Wall Street.  QE 2 was launched in November 2010 (the Fed announced it in August 2010).  Operation Twist was initiated in October 2011.

edit:  As I type this, Operation Twist has been extended from June 30 to December 31, 2012. Short-term interest rates will also continue to be pinned to 0% until 2014.

Based on the timeline of monetary easing (i.e. money printing), the law of diminishing returns is in full effect--and that includes its effect on propping up asset markets.  The period between QE 1 and QE 2 was 20 months, and the period between QE 2 and Operation Twist 1 was 11 months.  The period between Operation Twist 1 and Operation Twist is 8 months.  It appears markets need more sugar, more frequently to maintain its highs.

Previous announcements of easing caused markets to rally sharply.  With the latest announcement, it appears markets have already priced it in.  Printing money out of thin air seems to be dampening the wealth effect--or at least is becoming less and less effective.

Of course, the counter argument is that the economy is stronger now and doesn't need more sugar--it just needs an extension of current monetary policies.  I believe this view is Polyannish, as the world economy is still teetering on the verge of another financial collapse.

The Fed also downplays the desired outcome of elevating markets, but that easing is more intended to cap interest rates to stimulate the economy.  Given rates are already at historical lows, this justification seems flimsy.  The Fed is pushing on a string.

My views are debatable, but what is intractable is the balance sheet of the US continues to balloon.  This does not bode well for the financial condition of the US, especially if inflation ends its apparent dormancy.  At that point, a rising interest rate environment would be a death knell for the US economy.

Fed resumes currency swaps

Since the available bullets available to the Fed to further ease monetary policy, and the phrase "quantitative easing" has become anathematic to disgruntled fiscal disciplinarians, the Fed has decided to resume currency swaps to support the Euro zone. I'll keep it simple: currency swaps are just another means to print more currency. We've seen it before, and we'll see it again.

http://www.bloomberg.com/apps/news?pid=20601087&sid=adES6qP.P7AI&pos=4

Countries in default--a blueprint for the US?

Countries which have defaulted on their bond obligations: first Russia in 1998, then Argentina in 2001, Iceland last November, Ecuador last December, and Ukraine on the brink.

More emerging countries are at risk. What's important to note is that in each case, the local currency was debased due to exorbitant printing of said currency. This was done in response to governments looking to print their way out of a huge deficit problem. This monetary and fiscal easing caused hyperinflation, which then caused interest rates to soar. This further exacerbated the ballooning debt, and eventually, the countries could not meet their debt covenants. This caused the country to shut down, as the government IOU's were now worthless, and credit disappeared.

The US Treasury and Federal Reserve Bank are essentially implementing these same policies of easy money and quantitative easing--only on a much grander scale. Exactly how they expect a different outcome for the US is beyond me.

Treasury Bonds tanking

Today was a watershed event in my eyes. Despite the feel-good moment the media and powers-that-be are trying to portray with today's presidential lunch, the markets reacted very unfavorably to Paulson's semi-admission that we are not out of the woods yet. For those that follow fixed-income markets (which is much bigger than the equities market, and hence, much more foretelling), the Treasuries bubble has burst, and the Fed and Treasury will no longer be able to influence the long end (30-year bonds). They have dropped short-term interest rates as low as they could, but the long-end is mostly market-driven. Buyers of bonds believe inflation will be muted going forward (either 10, 20, or 30 years). Sellers of bonds believe inflation will erode their returns. Mistakenly, bond buyers also believe they are safe havens. The future will prove this assumption false, as bond prices are subject to the soundness of the currency, inflation expectations, and supply/demand of said Treasuries.

Once the market figures out (and it eventually will) that the USDollar is about to be a toilet paper currency, they will demand higher rates of return, driving up interest rates--and basically undoing what the Fed and Treasury have worked so hard to do--lower long rates to reduce mortgage rates, and stabilize the housing market (hopefully). In other words, the gov't can only do so much--and artifically keep long rates down for only so long. The dam will eventually break, rates will soar, as will inflation eventually. The bottom line is that the Chinese and Japanese will no longer support the US deficit (our funding needs are in the trillions) and stop buying our Treasury bonds, as they retrench and try to stimulate their own economies. In other words, buyers at our huge debt financing auctions will be scarce. This is the final bubble bursting, and this time, no one will be able to step in to prop it up.

Anybody who lived thru the 70's knows how ravaging high interest rates are. To be honest, I've been shorting T bonds for a couple weeks, and with Barron's article over the weekend proclaiming the same, I actually have more conviction, as Barron's is one of the few prescient mediums. Gold is still in a secular bull market, but it is taking a necessary pause due to deflationary concerns. But even the Fed and Paulson are acknowledging the long-term risks of what they are doing--they just can't help themselves as they fear the mother of Depressions. Problem is, they are only delaying it, and exacerbating it with their monetary and quantitative easing (providing credit and injecting capital).

Despite periodic snapback rallies, we are in for a different era--and it's not going to be pretty. We are in for several years of deleveraging, with markets moving sideways with a downward bias. Gold and silver will continue their secular bull market.

I have incorporated a wave investment thesis, and firmly believe big asset moves occur approximately every 20 years. It's uncanny, and there is a reason for it: investing is generational. We have lost a whole generation of investors who will never touch stocks again, due to scandals, crises, TWO stock market bubbles, fraud, and most of all, LOST money and lost confidence that buy and hold works. They've seen their grandparents' retirement savings dissipate overnite, their parents lose their jobs, and their own job prospects bleaker than ever. THIS OCCURRED IN THE LATE60'S/EARLY 70'S, USHERING IN A DECADE OF DOLDRUMS! The former Nifty Fifty stocks collapsed, and I recall my dad's friends declaring they will never invest in stocks again. They were justified--until the 1982 bottom, when smart investors eased back into stocks, while the general public was shunning them. Previous false rallies were met with shunted resistance, causing the last bulls to throw in the towel.

A bottom was only formed because Volker said enough is enough, and raised interest rates into double digits (money market accounts were earning 12-13%!). Mortgage interest rates were 15%, because Volker shook out the excesses, and then ushered in lowered rates.

So given that this bear market began in 2000 with the tech bust, we've got another 8-10 years of crappy returns, with sawtooth volatility and sucker rallies. Warren Buffett himself warned of this 8 years ago, as he said investors needed to lower their expectations of equities going forward. Remember: between 1982-2000, stocks had their best run EVER! (Unfortunately, the average investor only earned 2.3% per annum during that span, as they are horrible market timers).

In fact, the only asset that gained in the 70's was our friend gold. I have no idea of the timing, but it is coming. Shorter-term, I'm already up 40% on my short T-bond trade (it's a double-short ETF) in a week. Despite further attempts to prop up bond prices, eventually the avalanche of sellers, and lack of buyers will usurp any attempts to prop up the US bond market.

The latest outsourcing business to hit the US...

The US Treasury is busy printing so many US Dollars that they have outsourced it to printers in Switzerland. That's right--our government is so intent on printing trillions of dollars that they are wearing out their printing presses, and have had to resort to offshoring the printing process. Hence, the ultimate conundrum: "Helicopter" Bern Bernanke and fellow cohort Hank "Machine Gun" Paulson have repeatedly preached about a strong US Dollar. Yet, their actions for months have been completely undermining the strength of our currency.

This indiscriminate and unconscionable monetary easing dwarfs any on record--it is essentially criminal.

Meanwhile, my long gold and long yen positions are playing out as predicted, so my portfolio is profiting handsomely. But it is bittersweet, as we will experience the second act of post-1990 Japan. Japan's Nikkei stock market index stood at 39,000 in 1990. In 2008, it stands at 9,000.

The next bubble to burst are Treasury Bonds. The 30-year maturities are yielding 2.6%. Investors by the droves are basically saying, "Mr. U.S. Government, I know your currency is tanking by the day, I know you are printing dollars like there is no tomorrow, I know your solvency is at risk, I know your balance sheet is deteriorating with trillions of debt, and I know you have to chase good money after bad money (the bailout mantra), and yeah, I know you've been beaten down. But can you please hold on to my money for 30 years, and pay me 2.6%, for the privilege?"

Once investors wake up to the reality that their allegedly "safe" investments aren't so credit-worthy anymore, they will demand higher rates of return in exchange for taking on the additional risk. And when that happens, the Treasury Bond bubble will burst, just like the residential sub-prime mortgage bubble burst. The Fed eased too much, creating a real estate bubble after the tech bubble burst. They then raised rates 17 times, bursting the real estate market. Now they are easing rates to 0%, creating another bubble--this time US Treasuries.

Is anybody seeing a pattern here?