Quantitative Easing

Confused why every asset class is up again today (yes, even gold), despite the pundit interpretation by the media of the FOMC statement that the Fed has halted more easing? Simple - as we said yesterday, there is $3.6 trillion more in QE coming. But while we are too humble to take credit for moving something as idiotic as the market, the fact that just today, none other than Goldman Sachs' Jan Hatzius came out, roughly at the same time as its call to buy Russell 2000, and said that the Fed would announce THE NEW QE^TM, as soon as next month, and as late as June. Furthermore, as Goldman has previously explained, sterilization of QE makes absolutely no difference on risk asset behavior, and it is a certainty that the $500-$750 billion in new money (well on its way to fulfilling our expectation of a total $3.6 trillion in more easing to come), in the form of UST and MBS purchases, will blow out all assets across all classes, while impaling the dollar. Which in turn explains all of today's action - dollar down, everything else (including bonds, which Goldman said yesterday to sell which we correctly, at least for now, said was the bottom in rates) up. Finally, as we said, yesterday, "In conclusion we wish to say - thank you Chairman for the firesale in physical precious metals." Because when the market finally understands what is happening, despite all the relentless smoke and mirrors whose only goal is to avoid a surge in crude like a few weeks ago ahead of the presidential election, gold will be far, far higher. Yet for some truly high humor, here is the justification for why the Fed will need to do more QE, even though Goldman itself has been expounding on the improving economy: "The improvement might not last." In other words, unless the "economic improvement" is guaranteed in perpetuity, the Fed will always ease. Thank you central planning - because of you we no longer have to worry about either mean reversion or a business cycle.

I have suggested for weeks, I suggested in my piece yesterday, that you take some money off the table, sell some of your bullets, and re-deploy. Quantitative Easing is coming to an end and there will be ramifications for the bond markets and, eventually, for the equity markets. The days of free money, newly printed money, are coming to a close as America begins to right itself and as our banking system is mostly out of the woods. The longer end of the curve, hit hard yesterday, is heading to higher yields in my opinion. We will also begin to see inflation creep in for a variety of reasons and I point specifically to the price of gas at the pump which, while no one was looking, has hit its all-time highs this week as each penny of increase adds $1 billion to household spending and gasoline has risen thirty cents in the last month.

As we have repeatedly said in the past, the quarterly Flow of Funds (or Z.1) statement is most interesting not for the already public household net worth and leverage data which serves to make pretty charts and largely irrelevant articles, but due to its insight into the stock and flow of both the traditional financial system but far more importantly - into shadow banking. And this is where things get hairy. Because while equities may have returned to 2008 valuations, the credit shortfall across combined US liabilities - traditional and shadow - still has a $3.6 trillion hole to plug to get to the level from March 2008 (see first chart). It is this hole that is giving equities, which have already surpassed 2008 levels, nightmares. Because while the Fed is pumping traditional commercial banks balance sheets via reserve expansion (read: fungible money that manifests itself most directly in $5 gas at the pump) resulting in a $2.3 trillion rise in traditional liabilities from Q3 2008 through Q4 2011, what it is not accounting for is the now 15 consecutive quarters of shadow banking system contraction, which peaked at $21 trillion in Q1 2008, and in Q4 2011 declined to $15.1 trillion... and dropping. It is this differential that will be the source of the needed "Outside" money, discussed yesterday, and that is only to get equity valuations to a fair level! But considering the Fed's propensity to print at any downtick, this is very much a given, much to the horror of Dick Fisher. Any additional increase in stock prices will require not only the already priced in $3.6 trillion, but far more direct Outside money injections.

In the Spring of 2011, when Libyan oil production -- over 1 million barrels a day (mpd) -- was suddenly taken offline, the world received its first real-time test of the global pricing system for oil since the crash lows of 2009. Oil prices, already at the $85 level for WTIC, bolted above $100, and eventually hit a high near $115 over the following two months. More importantly, however, is that -- save for a brief eight week period in the autumn -- oil prices have stubbornly remained over the $85 pre-Libya level ever since. Even as the debt crisis in Europe has flared. As usual, the mainstream view on the world’s ability to make up for the loss has been wrong. How could the removal of “only” 1.3% of total global production affect the oil price in any prolonged way?, was the universal view of “experts.” Answering that question requires that we modernize, effectively, our understanding of how oil's numerous price discovery mechanisms now operate. The past decade has seen a number of enormous shifts, not only in supply and demand, but in market perceptions about spare capacity. All these were very much at play last year. And, they are at play right now as oil prices rise once again as the global economy tries to strengthen.

For all this talk and hype, QE 3 is nowhere to be found. And it won’t be showing up anytime soon unless a full-scale Crisis hits. The reason for this is that the political landscape in the US has changed dramatically with the Fed becoming more and more politically toxic. As a result of this, the Fed (with few exceptions)  has begun to shift into damage control mode.

The Fed can get more market gains from Charles Evans than $600 billion in QE. Hey Bernanke, here’s an idea: just stop bothering with monetary policy at all give Charles Evans his own TV show. Heck, we'd get the same effect with less Dollar devaluation. 

All you need to read.

All you need to read.

Update: yup. It's Jon "Mouthpiece" Hilsenrath all right. This is nothing but a test to gauge if the market will ramp on the clarification that future QE may be sterilized. If market ramps regardless, the sterilized clause will be ultimately eliminated. Full story link.

While we have yet to see the actual report, almost certainly emanating from Jon Hilsenrath, it appears that the QE3 rumormill has started, initially with speculation that the Fed's activity will be merely "sterilized" or more Twist-type purchases, unclear however if in TSYs or also in MBS. Via the WSJ:

• Fed Officials consider "sterilized" option for Future bond buying
• Operation Twist Reprise, QE Other Options For Fed Bond
• Still Unclear Whether Fed Will Launch Another Bond-Buy

As a reminder, yesterday we said that according to the EURUSD, the implied market expectation is for a $750 billion QE out of the Fed. However, that is for unsterilized balance sheet expansion. If the Fed goes ahead and does not grow its balance sheet (hence "sterilized"), it may well be EURUSD, and thus risk, and gold, negative, as no new money will enter the market for actual speculation. Which perhaps is precisely what the Fed is planning, as every incremental dollar now goes into Crude first, and everything else later. In other words: this is a very big risk off indicator as no new money will be available to pump up stocks!

All you need to read.

And now for some pure irony, we have a member of the Fed, granted a gold bug, but a Fed member nonetheless, one of the same people who not only enacted ZIRP, but encourage easy money every time there is a downtick in the market, complaining about, get this, Wall Street's "continued preoccupation, bordering upon fetish" with QE3. The irony continues: "Trillions of dollars are lying fallow, not being employed in the real economy. Yet financial market operators keep looking and hoping for more. Why? I think it may be because they have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery, rescuing the economy from the Financial Panic of 2008–09, and then kept the medication in the financial bloodstream to ensure recovery....I believe adding to the accommodative doses we have applied rather than beginning to wean the patient might be the equivalent of medical malpractice." So let's get this straight: these academic titans, who for one reason or another, are given free rein to determine the fate of the once free world with their secret decisions every two or three months, are completely unaware of classical conditioning, discovered by Pavlov nearly 90 years ago, also known as a salivation response. The same Fed is shocked, shocked, that every time the market dips, the red light goes off, and the "balls to the wall" crowd scream for more, more, more free money. Really Fisher? Really? Oh, and let us guess what happens the next time the S&P slides into the tripple digits: will the Fed a) do nothing, thereby letting the market slide to its fair value in the 400 point range, or b) print. Our money, in the form of hard yellow metal, is on the latter, just like we predicted, correctly, back in March 2009 in " Bailoutspotting (Or The Search For The Great Financial Methadone Clinic" that nothing will ever change vis-a-vis the great market junkie until it all comes crashing down.

Central banks are printing money all over the world. New names have been given to what is really an age old phenomenon. Desperate governments have traditionally debased their currencies when they have no other way of financing their deficits. So far the world’s central banks have been “lucky”. Thanks to the prior global bubble ending in 2008 and the realization that the so-called advanced countries are reaching the end of their borrowing capacity, the world is in a massive deleveraging mode which tends to be deflationary. For the moment the central banks can get away with printing all the money they want without massive increases in consumer price indexes. The public doesn’t connect increases in prices of commodities like gold or oil with the current bout of money printing. But if history is any guide, this money printing will matter and the age of deflation and deleveraging will be followed by an age of inflation.The coming battles over solving the problems of the bankrupt American government will not be pretty. It will be a bit more difficult for an American president to preach patriotism to the affluent in these circumstances. Although, if there is a war with Iran, he might try.

Citigroup have said that they believe that gold will rise to $2,400/oz in 2012 and by $3,400/oz in “the coming years”. However, Citi’s Tom Fitzpatrick warned of price weakness in the short term and said there is a “real danger” that there may be a correction to $1,600/oz which would provide an even better buying opportunity. Citi are also cautious near term on oil and silver. Production of gold in Australia slid again last year, despite gold fetching higher nominal prices than ever before. According to gold experts, Surbiton Associates, 264 tonnes of gold were produced last year, two tonnes less than in 2010. The 264 tonnes equated to about 8.5 million ounces and ensures that Australia remains a major player in gold, with only China producing more last year. The United States was the world's third-biggest producer with 240 tonnes. Australia's gold production was well below the nation's production peak in the late 1990s.  This further suggests the possibility of peak gold production. Of the world’s four biggest gold producers (China, Australia, the U.S. and South Africa), only China has managed to increase gold production in recent years and this Chinese gold is used in China to meet the rapidly growing demand for gold jewellery and coins and bars as stores of value in China.

All you need to read.

We are in “The Lull” which has been caused by the injection of capital by the Fed and by the ECB. This is exactly, exactly, what took place I remind you during the weeks after the subprime mess exploded. Massive injections of capital, run-ups in equities, compression in bonds, higher prices for commodities and then the reversal of course took place. When easing ends then the course back tracks and I predict a re-do of this in the coming months. It will not take some trigger event, though there may well be one, to cause this; just the easy money being placed and no more manufactured money to follow.

“As the well runs dry the throat parches and dehydration begins.”

-The Wizard