Will the Absence of QE Continue to Melt Gold?

The Fed just announced that sterilized QE is over, done, toast. Gold prices have crashed, slicing through a 15-month support shelf like a knife through butter. But, are QE and gold really connected? This chart shows the surprising truth.

Here are two facts (most investors will say they are not random):

  1. QE is over.
  2. Gold is crashing.

Here is a key question:

Is gold crashing because QE is over?

To get the answer, we’ll do two things: 1) Rewind and 2) Reason.

Rewind Time to 2008

Gold’s last big bull market leg started in October 2008, right after the Federal Reserve unleashed QE1.

Investors feared inflation due to the massive liquidity influx. Gold was considered as the default inflation hedge and prices soared from $680/oz to $1,900/oz.

At first glance it seems like QE1 buoyed gold. The inverse conclusion is that the end of QE may well sink gold.

Reason & Facts

During QE1, gold prices, and gold ETFs like the SPDR Gold Shares (NYSEArca: GLD), gained 34%.

QE2 lifted GLD by 10%.

But, and that’s a big but, throughout QE3/QE4 GLD lost 32%.

The chart below plots GLD against a visual description of QE1 – QE4. QE3 and QE4 are lumped into one graph (light green) to illustrate the combined effect of both programs.

QE3 started when gold was still trading near $1,800/oz ($175 for GLD). It’s been down hill ever since.

Gold rallied during QE1 and QE2 and declined during QE3 and QE4. Statistically, the evidence shows a 50% chance that QE may or may not have affected gold prices.

I realize that there are other factors in play, but one takeaway from this chart is that the absence of QE in itself is not necessarily terrible for gold and GLD.

More Facts

The December 29, 2013 Profit Radar Report featured the following gold forecast for the year ahead:

Gold prices have steadily declined since November, but we haven’t seen a capitulation sell off yet. Capitulation is generally the last phase of a bear market. It flushes out weak hands. Prices can’t stage a lasting rally as long as weak hands continue to sell every bounce.

Gold sentiment is very bearish (bullish for gold) and prices may bounce from here. However, without prior capitulation, any rally is built on a shaky foundation and unlikely to spark a new bull market.

We would like to see a new low (below the June low at 1,178). There’s support at 1,162 – 1,155 and 1,028 – 992. Depending on the structure of any decline, we would evaluate if it makes sense to buy around 1,160 or if a drop to 1,000 +/- is more likely.”

Obviously much has happened since December 29, and the levels mentioned back then may need some tweaking. Nevertheless, gold has fallen below 1,178 and is trading near the 1,155 support level.

In addition, gold sentiment has soured quite a bit. Two recent CNBC articles expected gold prices to drop below $1,000 and trade at $800 next year.

The Commitment of Traders report shows increased pessimism, but not historically extreme pessimism.

The chewed out adage that fishing for a bottom is like catching a falling knife obviously applies to anyone looking to buy gold.

But based on a composite analysis of fundamentals, sentiment and price action, the falling golden knife is closer to the kitchen floor than the hand that dropped it.

The latest Profit Radar Report includes a detailed strategy on how to buy gold with minimum risk and maximum rewards.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Dare to Compare – Could the End of QE Crash Stocks Like in 2010 and 2011?

The S&P 500 dropped 17% right after QE1 ended and 20% right after QE2 ran out? Will stocks crash again now that QE3 and QE4 have been completed? Here is the only visual QE history chart along with an unexpected conclusion.

QE1 ended on March 31, 2010. Shortly thereafter the S&P 500 dropped as much as 17.12%.

QE2 ended on June 20, 2011. Shortly thereafter the S&P 500 dropped as much as 20.76%.

Fed officials are expected to end asset purchases (QE3 and QE4) at the next FOMC meeting on October 28-29. Will stocks crater like they did in 2010 and 2011?

QE History & Comparison

QE1 started in December 2008 with $660 billion, was expanded by $1,050 billion in March 2009, and ended in March 2010.

QE2’s $600 billion asset purchase injection started in November 2010 and lasted until June 2011.

QE3 started in September 2012 at a rate of $40 billion per month.

QE4 started in December 2012 at a rate of $45 billion per month.

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Starting in January 2014, QE3 and QE4 have been reduced gradually by $5 billion per month.

QE3 and QE4 have already been wound down to combined monthly purchases of $15 billion, and Fed officials said they expect to end asset purchases after the October 28-29 meeting.

Will the QE3 and QE4 withdrawal shock the system (aka stock market) as QE1 and QE2 did?

QE After Shock?

I’m a visual person and find that a picture (or chart) really says more than a thousand words.

Here is a simple, visual explanation of the various QE programs. This is the only QE history chart on the web, and was originally published in the October 5 Profit Radar Report. QE1, QE2, QE3 and QE4 are illustrated by various shades of green, because green is the color of money (chart courtesy of the Profit Radar Report).

Illustrated are the monthly dollar purchases. Exact monthly asset purchase data for QE1 and QE2 is not readily available, so the amounts shown are based on total committed funds divided by the number of months the program was in effect.

QE3 and QE4 differ from QE1 and QE2 and two important ways:

1) The asset purchases under QE1 and QE2 were more significant than the asset purchases under QE3 and QE4.

2) QE1 and QE2 stopped cold turkey. The Federal Reserve obviously learned from the almost instant S&P 500 (NYSEArca: SPY) selloffs and equipped QE3 and QE4 with the ‘taper’.

Purely theoretical, the actual end of QE3 and QE4 could be a non-event, and should be much less noticeable than the end of QE1 and QE2.

Why Did the S&P 500 Just Lose 200 Points?

But, if that’s the case, why did the S&P 500 just lose as much as 200 points?

Investors may have simply sold stocks in anticipation of QE ending. Sometimes it’s all about mind of matter. If investors mind (that QE is ending) it matters, at least temporarily. In addition, the Dow Jones reached an important technical resistance level on September 17. The Profit Radar Report predicted that this resistance level would increase the risk of a correction.

It is undeniable that the various QE programs have driven asset prices higher. It would be intuitive to conclude that the absence of QE (at least sterilized QE) will send stocks lower.

But the stock market is not always intuitive and doesn’t conform to investors’ expectations.

Furthermore, despite the end of QE, the stock market has not yet displayed the classic pattern of a major market top, the kind of pattern that foreshadowed the 1987, 2000 and 2007 highs. Here’s what I mean: The Missing Ingredient for a Major Bull Market Top

In summary, I wouldn’t sell stocks just because QE is ending.

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Federal Reserve – How to Tame the Monster it Created

Thanks to quantitative easing (QE) stocks are up 130% and more. The Fed created a monster of a rally, but how do you tame the monster without killing it? As the most recent Fed minutes indicated, it may be ‘easier’ than some think.

Never under estimate the psychological power of a dangling carrot. For years the Federal Reserve used the promise of more QE as an incentive (carrot) to drive stocks higher.

This has worked well. Too well. The Dow Jones, Russell 2000 and other major indexes are trading at all time highs and the Fed’s next challenge is to tame the monster (rally) it created without killing it.

How can this be done? Perhaps with the ‘reverse dangling carrot approach.’ Before we talk about the reverse carrot approach, let’s review how the ‘dangling carrot approach’ works.

The ‘Dangling Carrot Approach’

At how many post FOMC meeting conferences did we hear Ben Bernanke assure Wall Street that the Federal Reserve is ready and willing to assist?

From July – November 2010 Bernanke’s steady assurance was nearly as potent as QE2. Do you remember the August 2010 Jackson Hole summit? Bernanke then said: “I believe that additional purchases of longer-term securities … would be effective in further easing financial conditions.”

The placebo QE effect was strong enough to lift the S&P 18% before QE2 became official on November 2, 2011. Thereafter the S&P 500 rallied another 16% to the April 2011 high. QE2 ended in June 2011.

From October 2011 – September 2012 the Fed did nothing more than dangle the QE3 hopium carrot and the S&P 500 rallied 36%. QE3 was finally announced in September 2012, followed by “QE4” (replacement of Operation Twist by outright Treasury purchases).

Containing The Fed Monster – The ‘Reverse Dangling Carrot Approach’

From 2009 – 2012 the Fed talked up QE and stocks. Today the S&P 500 trades 135% above its 2009 low and the Fed knows it created a monster (rally). The Fed also knows that everyone else knows this is a phony funny money rally.

How can the Fed contain the monster it created – take away the punchbowl without causing a severe hangover. The ‘reverse dangling carrot approach’ is born.

Dropping hints about more QE contained the bear market, so dropping hints about reducing QE should tame the QE bull market. This process may have already begun.

The release of the Fed minutes on February 20, showed dissention among committee members about the duration and scope of QE.

Whether this division over the issue is real or just a new PR strategy to contain the Fed monster, I do not know. But we do know that stocks sold off right after the Fed minutes were released.

Just like controlled fires can stimulate a forest, the Fed may try to light ‘controlled burns’ to manage the stock market. As in nature, the summer time (starting in May) is a good time for a ‘controlled burn’ on Wall Street. Shareholders should plan accordingly.

I personally view the Fed like an unwelcome guest. Some guests bring happiness wherever they go. Some (like the Fed), whenever they go. Unfortunately, the Fed’s comment about leaving (scaling back QE) appear to be only a tease.

Glaring but Misunderstood QE – How Much the Fed is Really Spending

QE1, QE2, QE3, expiring Operation Twist, and now QE4. Which of those programs are “sterilized” (non-inflationary) and which ones devalue the dollar? If you’ve lost track, here’s a quick visual summary.

Will Operation Twist be replaced by outright QE was a question addressed here early in December. As it turns out, the Fed decided to do just that.

We now have multiple layers of QE working simultaneously. What’s the total amount being spent and will inflation finally take off?

QE Tally

There are three official tranches of quantitative easing (QE):

1) QE3, announced on September 13, 2012. The Federal Reserve will buy $40 billion per month worth of mortgage-backed securities.

2) QE4, announced on December 12, 2012. The Federal Reserve will buy $45 billion per month worth of longer term Treasuries (corresponding ETF: iShares Barclays 20+ Treasury ETFTLT).

QE4 will be replacing Operation Twist in 2013. Operation Twist is considered “sterilized” or cash neutral QE. Operation Twist simply reshuffled the balanced sheet (sell shorter term in favor of longer term maturities). It did not expand the balance sheet.

Unlike Operation Twist, QE4 will be financed by “non-sterilized” or freshly printed money. This process increases the Federal Reserve’s balance sheet and the amount of money in circulation.

3) Reinvestment of maturing securities. In a December 12 press release, the Federal Reserve stated: “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings mortgage-backed securities and, in January, will resume rolling over maturing Treasury at auction.” This amounts to roughly $25 billion/month of sterilized QE.

In total, the Federal Reserve will buy $110 billion worth of Treasuries and mortgage-backed securities every month until the unemployment rate drops below 6.5% and inflation remains below 2.5%.

The first chart below illustrates QE3, QE4, and reinvestments separately and how the three layers combined compare with QE1 and QE2.

The second chart provides a more detailed glimpse of the Fed’s balance sheet (and a mere glimpse is all mere mortals are allowed).

The Fed’s balance sheet as of November 21, 2012 stood at $2.84 trillion and is expected to balloon another $1 trillion over the next 12 months.

Currently $966 billion or 34% are invested in agency debt, mainly mortgage-backed securities. In other words, one of every three dollars in circulation is backed by toxic assets, the same stuff that caused the “Great Recession.”

Inflation

Inflation, where art thou? The Fed’s balance sheet exploded from below $1 trillion to nearly $3 trillion, but inflation (let alone hyper inflation) has been a no show.

Will the current round of QE deliver on inflationist’s predictions? I doubt it.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.