The Federal Reserve, Janet Yellen, QE and Gold

The Federal Reserve

The formulation of any investment strategy requires the investor to be well aware of the big picture which includes an understanding of the wider economic and political environment. One of the major elements to be considered is the various actions being implemented by our politicians and the central banks. One such central bank is The Federal Reserve who controls the money supply in the United States. 

The Federal Reserve was formed after its supporters paid for the presidential campaign of US President, Woodrow Wilson. President Wilson went on to sign the bill that transferred the control of US currency to twelve regional private banks.

The very same President Wilson later regretted his decision saying the following: 

“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world. No longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”  

So here we are decades later and the Fed has more power than ever before. They can turn the liquidity tap on and off as they see fit; as evidenced by Ben Bernanke’s introduction of Quantitative Easing, which involved the buying of mortgage-backed securities, and Treasury notes. This form of stimulus has been increased to tune of 4 trillion dollars being added the Feds balance sheet over the last few years.

Chart the Federal Reserve Balance sheet 22 Feb 2014

As Ben Bernanke approached the end of his tenure he introduced ‘tapering’ which is a slow, but steady reduction in the amount of buying the Fed will do on a monthly basis. This decision is largely based on then perception that the US economy is improving, unemployment is falling and inflation is heading towards its ‘Fed set’ target area. Ben Bernanke has now departed and handed the Chair to Janet Yellen.

Janet Yellen 

If we take a quick look at Janet Yellen’s resume we can see that there isn’t a mention of real job anywhere on it. This is a person whose career consists of school, university and more university, a pure academic who has spent a lifetime acquiring many academic accolades from within the academic institutions

This lady has no experience whatsoever in working or running a real business as she has never ventured into the world of private enterprise. Her theories are just that; theories, backed by not one once of experience. I must admit that it scares the life out of me to think that we can place such an inexperienced person into such a powerful position where her actions, or lack of them, will affect every single one of us.

Quantitative Easing (QE) 

The introduction of QE has provided the market with boat loads of liquidity in an attempt to ensure that there was enough money in the system to oil the wheels of industry, recapitalize the banks and provide financial stimulus to both Wall Street and Main Street. The effect of this stimulus has been to boost the stock markets to all-time highs. Unemployment is coming down, according to government figures, although others would dispute this. Inflation has moved higher, although without much conviction. At this point we ought to be aware that money knows no boundaries so some of these newly manufactured dollars have flowed out of the US and into foreign markets. The additional liquidity has provided easy money to their banking systems and their financial markets, for better and for worse.

However, the Fed is now of the opinion that this infusion of cash has served its purpose and so a programme of reducing this stimulus is now in place and is commonly referred to as tapering. The Fed will continue to monitor inflation and the employment figures; should both be considered to be making satisfactory progress then tapering will continue. However the last two monthly reports on employment showed that the creation of new jobs had fallen short of expectations and should this become a trend then the Fed could well suspend tapering and if considered necessary they could reintroduce QE. The ramifications of such an action are too numerous to mention today, but as a gold and silver bug I will take a quick look at what could be in store for this tiny precious metals sector.

Gold

The introduction of money printing and especially the implementation of QE greatly inflated the money supply and to a large extent provided the oxygen that gold needed to rally to its all-time high of $1900/oz, or so. Gold peaked and then started to fall until QE3 was announced in 2012 which saw gold rally once more to around $1800/oz. Since then it would appear that ‘The Law of Diminishing Returns’ comes into play as gold drifted lower, all the way down to $1180/oz in June of 2013. At this point gold prices rallied to around $1400/oz before falling back to retest the June lows of $1180/oz in December 2013. Gold stayed above the June lows and rallied to where it stands today at $1329/oz. It is interesting to note that gold appears to have ignored the introduction of tapering and the planned reduction of its oxygen supply. This is knife edge stuff as gold may have disconnected itself from the actions of the Fed, QE and tapering and may well be behaving in accordance with traditional drivers such as supply and demand.

It is a tad too early for us to say that this is in fact the case as tapering is in its embryotic phase and should it continue through 2014 then gold’s ability to rally could be capped. At the moment we cannot over stress the importance of the Fed and its implementation of monetary policy.

If we now take a quick look at the miners we can see that they have had a torrid time over the last few years. The Gold Bugs Index, the HUI, has fallen from a high of 625 in 2011 to today’s level of 240 registering a very painful loss of 61%. If we look at 2013, the HUI fell from a January figure of 430 to 200 in December 2013 registering a loss of 53% as the chart below shows:

Chart courtesy of StockCharts

Note that the technical indicators are a bit on the high side suggesting that a pullback might be on the cards.

Now, if we had purchased a gold mining stock for $100.00 in January 2013 by the end of the year it would be worth just $47.00. The average rise in gold stocks in 2014 is 20%, so our acquisition would now be worth $56.40, hardly a cause to break out the champagne.

We have witnessed a number of false dawns over the last few years and this could well be another one. For this rally in gold to be the real deal we would like to see gold form a higher high, which requires gold prices to trade above $1360/oz.

We would also like to silver prices to move up in support of gold however, silver’s rally has hit resistance at $22.00/oz, failing to form a higher high which requires silver to trade above $22.50/oz.

In conclusion we need to see more in the way of all round strength in this sector before we can implement an aggressive acquisitions strategy and so we have the lion’s share of our portfolio in cash.

However, allocating a small amount of your investment funds to the acquisition of a few good quality gold and silver stocks in order to have a one foot in the precious metals camp might not be a bad idea, but go very gently as these are dangerous times for gold bugs.

Got a comment, fire it in, especially if you disagree, the more opinions that we have, the more we share, the more enlightened we become and hopefully the more profitable our trades will be.

Take care.

In September 2011 the Gold Bugs index, the HUI stood at 630 as gold prices peaked, since then both have trended lower with the HUI losing about 65% of its value. The bottom has been called a number of times and after such a dramatic decline its difficult not to think that we are there now. However, as we all know the timing of any investment is crucial to its success and that is exactly what we are trying to do here, trying to pick advantageous entry and exit points. If you would like to know which stocks we are buying and selling please join us at ‘Stock Trader’ our premium investment service.