Market update June 2012

IS THE FED GETTING READY TO JUICE ONCE AGAIN?

As fiduciaries our job is to forecast which asset classes have the highest probability of increasing in value with the least amount of risk. Since late 2008, irrational market behavior has increased due to the monetary interventions by central banks. Herein lies the problem. The rules of the game have changed and we must change the way we look at the markets as well. Governments around the world have been using their central banks to extend the life of the current economic system. Confirmation of this behavior is evident in the diminishing number of foreign buyers of US debt, yet we are at record low yields. Foreign Holdings of US Treasury Securities

Source: http://www.treasury.gov/resource-center/data-chart-center/tic/documents/mfh.txt

Market update June 2012 Without the largest buyers in the treasury market to soak up the ever-increasing supply, we know the Fed must inevitably intervene and fill that gap again. This brings us to the Feds bond buying programs, each more cleverly named than the last. Lets step back and see how the markets have reacted or anticipated this type of easy monetary policy. The following chart of the S&P 500 was generated in 2008 during the announcement of QE1. The market anticipated the announcement and reversed on big volume the day before. The result was a 21.6% move in five trading days.

When this proposed stimulus wasnt sufficient to pump the markets higher and interest rates lower, the Fed expanded its program to $1.25 trillion on March 18th 2009. Again this was anticipated six trading days earlier with a reversal of 13% before the announcement was made.

Market update June 2012

During the summer of 2010, market volatility picked up at an intense pace. The stimulus engine was running out of steam and it looked like the market was about to roll over. The Fed announced at Jackson Hole, Wyoming on August 27th 2010 its intentions for a QE2 program. The market responded with a rally of over 20% during the next 4 months.

Market update June 2012

Towards the end of the summer of 2011, stimulus again began to run dry causing volatility to sharply increase. This time around, the term QE had so much negative press attached to it that the Fed announced a bond buying program under the name Operation Twist on September 21st 2011. The market reaction was strong again; in a little over a month the market moved almost another 20% from low to high.

So here we are mid-June 2012, and once again the previous program is coming to an end. We see the resurgence of market volatility as the Fed has managed to push interest rates to previously unimaginable levels. On June 6th 2012 we noted that the Dow was up almost 300 points on no significant news. At this stage in the monetary easing cycle, we think the market is anticipating another program to be announced in the near future, maybe even in the next two weeks. The chart below confirms current market behavior similar to what is previously described in this article. The probability of a new bond buying program increased after the big move in the DOW and S&P on June 7, 2012. Ben Bernanke took a seat on Capitol Hill and downplayed any more stimulus programs. Normally this would send markets violently lower, but they finished higher and up again the following day into the weekend.

Market update June 2012

Market behavior today is truly irrational. Navigating these treacherous waters requires years of training your mind to see the world through an objective lens. Today we see that the market has only two asset classes: risk on and risk off. The problem is that the central banks have placed the wrong label on the underlying assets through monetary intervention. The WEE (Washington Economic Establishment) has convinced the general market opinion that the US government Treasury Bond is one of the safest assets, even though we see this as one of the riskiest. To put this in perspective, take a look at this long-term chart on the 30 year US Treasury Bond.

Market update June 2012 Financial Times reported on June 8th: So far this year, fixed income ETFs have attracted inflows of $36.5bn, up 148 per cent on the same period last year. This type of behavior is reminiscent of the top of the real estate market in 2006.

As the money flows into these return free risk assets at record levels, we at KSIR Capital see the real opportunity for our clients in the junior gold and silver producers trading at record low multiples relative to the metals they produce.

As always, if you would like to further discuss what we view as the highest reward, lowest risk segment of the market today please email: brett@ksircapital.com Brett Heath