QE Watch

As we watch the meltdown in Europe, events appear to be developing very much as we anticipated.

Gold is up. European stocks and banks are down, and so, too, are world stocks.

The fear of a global recession is growing, a fear we expect to persist until the next massive money printing effort —the third round of quantitative easing (QE) — is launched in Europe later this year. The U.S. and Japan will follow suit, and probably China and other countries as well. While different in form and name than previous bond-buying QE endeavors, the effect will be very similar. Large amounts of liquidity will be infused into the global economy to raise stock markets and encourage the optimism of consumers.

Until governments roll out the next versions of QE in a few weeks or months, look for continued weakness in global stocks and a rise in bonds as investors retreat to short-term debt instruments. These are consequences of the fear phase, which, we hasten to add, is bullish for gold and currencies of the types we have been recommending in our newsletter.

Many pundits in the U.S. think a new manifestation of QE by the Federal Reserve will not happen. They are wrong. The U.S. will do a big kind of QE or a combination job creation program/QE with lots of fanfare as we get closer to the elections of November 2012. You can count on it. Unfortunately, politicians dictate fiscal policies, and they all want to get re-elected.  This situation inspired us to paraphrase that great musical hit of yesteryear, the “Beer Barrel Polka.”

Roll out the money, we’ll have a barrel of dough.

Roll out the money, don’t matter how much we owe!

Zing boom tararrel, ring out a song of good cheer,

Now’s the time to roll out the money…the election’s near.

New Rounds of QE Are Taking Shape In Europe, Brazil, And In Other Countries.

At the present, a variety of QE-type activity is already underway in a number of countries. Their goal is to decrease the value of their currencies out of concern for the rising price of exports. A prime example is Switzerland, which has pumped 80 billion Swiss francs (over 100 billion dollars) of liquidity into the market to purchase Swiss bonds and swaps. That’s a lot of money. It totals about 13 percent of the total U.S. QE from September 2010 until June 2011. Moreover, it was done in a short period. The Swiss did manage to get their francs to fall a little but they paid a high price.  According to the following excerpt from Citibank economist Michael Saunders last week, the Swiss Central Bank has indicated more moves may be on the way.  He cites a Swiss National Bank report that says:

“The measures taken thus far by the Swiss National Bank (SNB) against the strength of the Swiss franc are having an impact. Nevertheless, the Swiss franc remains massively overvalued. The SNB has therefore decided to expand again significantly the supply of liquidity to the Swiss franc money market. In so doing, it is increasing the downward pressure on money market interest rates with a view to further weakening the Swiss franc exchange rate. With immediate effect, it aims to expand banks’ sight deposits at the SNB further, from CHF 120 billion to CHF 200 billion. In order to achieve this new target level as quickly as possible, it will continue to repurchase outstanding SNB Bills and to employ foreign exchange swaps. Furthermore, the SNB reiterates that it will, if necessary, take further measures against the strength of the Swiss franc."

One way to diminish the attraction of a strong currency is to print more money and buy bonds with the money. Fiscal manipulations of this sort have been commonly applied in the past and sooner or later will also be pursued by Australia, Canada, Brazil, and other countries as their currencies rise in value against the falling U.S. dollar and Euro. These activities will increase world liquidity and cause asset prices to rise.

Another type of liquidity being engineered by the European Central Bank involves buying bonds of the profligate and irresponsible Greek, Portuguese and Irish. Later, it will also buy bonds of Italy, Belgium, Spain and even France. To no one’s surprise, German taxpayers will pay the bill.

So, get ready for a big stock market and industrial commodities rally later in the year after QE maneuvers in Europe and the U.S. 

World Watch: Oil and Turmoil

Events in Libya and Syria aside, we believe there’s considerable volatility and discontent yet to unfold in the Arab world. Revolts are far from over. 

It’s summer now across the Arab world and temperatures routinely top 130 degrees fahrenheit. The heat may have a temporary cooling effect, so to speak, on bottled-up emotions and angers. Wait until the weather cools off for yet another new upsurge of protests and uprisings, and perhaps even sooner on the Israel-Palestinian front.

We expect regional turmoil to last for quite a while, and this opinion is one reason why we still believe that oil can move to $150 per barrel. Whatever the level when the disturbances begin, you can bet that oil will move higher.

Anti-Corruption Movements on the Rise

Recently we have been watching and applauding as a major anti-corruption movement gains momentum in India, one of the world’s fastest growing countries. 

Those of you who live in so-called developed nations like Europe, Japan, the U.S., Canada, Australia or New Zealand, and have never lived in India, have no idea about the depth of corruption in that country.  Doing business typically requires permission from discouraging layers of government agencies and bureaucrats who delay any progress unless they receive some inspiration to move your project along.  Such inspiration almost always takes the form of a cash payment or favor. The people of India are getting fed up.  We include a link to a New York Times article that describes the extent of the problem. Please click the following link for the New York Times article ^[1].

India is not alone. In China and Brazil, corruption is often encountered at the ministerial and bureaucratic level. In these countries, too, fed-up citizens and media are becoming louder and bolder in their criticism of corrupt officials. They are especially vociferous about shoddy public works projects that have led to serious safety problems. It is accurate to say that public dissatisfaction with corrupt officials has reached a new high in all three countries.

Corruption is a drain on a nation’s GDP and diminishes the national growth rate. First, bribe-paying taxes every level of society. Secondly, income from corruption is hidden from tax authorities so it cuts government revenues. 

We view the public hue and cry as a very positive development. To be sure, we don’t expect an entrenched tradition of corruption and influence-peddling to vanish or change overnight. But the fact that a significant backlash has emerged makes us feel optimistic. Less corruption will help India, China, and Brazil become stronger, improve their GDP, and increase their economic growth and influence.

A Bit of Caution is in Order on the Gold Front

Gold is experiencing a pullback. It ran up more than $400/oz in a seven-week period. It is normal to see a strong correction after a dynamic price rise of this magnitude. Long term we continue to favor gold but we are cognizant of the fact that gold has had a record-breaking rise over the last 10 years, and a decisive spike in recent weeks. 

We have repeatedly emphasized in this letter the wisdom in taking some profits on rallies and waiting for a pullback before recommitting.  As gold spiked early this week, we took partial profits for clients on Monday 8/22/11 and very early on Tuesday 8/23. We will buy some of the gold back at lower prices. Remember steep price increases give rise to sharp price corrections. Be sure to take profits on spikes.

Gold has good long term prospects, but short term it is definitely vulnerable to continuing volatility. We have been dismayed by the degree of overconfidence among some gold investors.  For example, we heard from several gold buyers between August 15 and 22nd; when we suggested to them that gold could have a violent correction at any time they scoffed. They were deluding themselves.

As any experienced investor knows, gold (and every other investment) is vulnerable to corrections, and as gold rises to new highs, corrections will become more frequent and more violent.

Over the long term, gold can maintain strength as long as there is demand from central banks and as long as Europe continues to screw up its debt problems.  Because of Europe’s debt issues, gold will be perceived as a store of value among Europeans for the foreseeable future.

The ultimate upside for gold could be achieved if gold is accepted as part of a world monetary system.  It’s a great idea, but not likely to happen until much more suffering is visited upon the world’s central banks.

Gold shares are grossly undervalued when compared to the gold price, especially if gold stays above $1,400 an ounce for a prolonged period of time. With mining shares, just be careful to only buy well managed companies with good growth prospects.

To request information about Guild Investment Management services and offerings please call (310) 826-8600 ^[2] or email guild@guildinvestment.com ^[3]

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