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- QE3 could be $1.2 to $2.0 Trillion
- Will Ben Bernanke Awaken the Inflation Monster?
- How to Invest When Fire Hoses of Money Are on Full Blast
- Use Gold Futures & Options to Send Your Profits Soaring!
The latest round of quantitative easing by Fed Chairman Ben Bernanke was anticipated by Wall Street-but it's also a game changer.
the sheer size and scope of QE3, as it is called, will have tremendous and long-lasting effects from Wall Street to Washington and across America.
We saw a game-changer in the Federal Reserve's decision to proceed with a new round of quantitative easing (this one is focused on mortgage backed securities), an extension of Operation Twist through the end of the year, and keep interest rates low "at least through mid-2015."
amounts to a flood of money, and that rising tide should lift asset prices, including both commodities and stocks.
For many investors, the biggest question is "what should I do with my money now?" In this special report, we'll show you what history tells us about quantitative easing … why this QE is so different … how this could send ripples through the market for years to come…and what your best bets are to protect your money and invest for potentially big, fat profits.
What Actually Happened
There's a lot of hysteria surrounding the Fed's latest round of quantitative easing. Here's what happened:
The Fed will buy mortgage backed securities at a pace of about $40 billion per month. Unlike previous QEs, the new program does not focus on Treasuries. However, the Fed is keeping the current Operation Twist in place through end of year, under which the Fed will buy longer-term Treasuriesand simultaneously selling some of the shorter-dated issues it already held.
These will result in combined $85 billion or so per month (new program plus twist) through the end of the year, and $40 billion per month in 2013.
The Fed also said it will keep the commitment open-ended, and possibly ramp up the program ("undertake additional asset purchases"). The important quote from the Fed statement is here: "If the outlook for the labor market does not improve substantially, the Committee will continue its
purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability."
So Uncle Sam is has committed to writing open-ended checks until the cows come home – or the employment picture improves. That's why I consider it a game changer.
The Fed has a dual mandate – to combat inflation and ensure full employment (or as full employment as possible). With this new QE3, it seems to be taking its eye off inflation and focusing on employment like a laser beam.
You can see why the Fed is worried. There are now 3.5 unemployed workers for every job opening. This is actually an improvement from a year ago, when there were 4.1 job seekers for every opening. But it's still way too high.
The US economy has now been producing at a level which is clearly below its potential for the last four years. The unemployment rate is at levels that are higher than any sensible estimate of the natural unemployment rate.
Congress is sitting on its hands, refusing to put people to work, so the Fed is doing what it can. And what it can do is provide as much free money as possible to grease the wheels of the economy.
What Does History Show Us?
The Fed learned some hard lessons from the first two rounds of quantitative easing.
The first round of QE began in March 2009. The Fed started purchasing $1.25 trillion of mortgage-backed securities, $175 billion of agency debt and $300 billion of Treasuries to provide further stimulus after the benchmark rate was cut to zero in December 2008.
In the second round, announced in November 2010 and lasting through the following June, the Fed bought $600 billion of Treasuries.
Finally, last September, the Fed announced its Operation Twist program to replace $400 billion of debt in its portfolio with longer-term securities through June 2012. That was later extended to the end of this year.
Importantly, the Fed announced the end of all these programs in advance. So, the market starts pricing that in, undoing the stimulus that
the Fed was trying to accomplish.
QE Infinity – to the Moon, Alice!
So this time around, the Fed isn't capping its money pumping. It won't stop until it gets results.
How much could that be? Goldman Sachs chief economist Jan Hatzius wrote that:
… Under the [Federal Open Market] Committee's economic forecasts, we estimate that the funds rate would stay near zero until mid-2015, while QE3 would run through mid-2014 and total $1.2 trillion.
Under our own economic forecasts, we estimate that the funds rate would stay near zero until mid-2016, while QE3 would run through mid-2015 and total just under $2 trillion. $1.2 trillion is a lot of money – it's twice the size of QE 2, and as big as QE1. $2 trillion is basically unprecedented. It's not just a flood of money.
It's a potential tidal wave!
Inflation – The Sleeping Giant
Why does the Fed think it ignore inflation? Well, inflation is very tame. In the 12-month period that ended in August, overall consumer prices increased 1.7%, staying below the Federal Reserve's target of 2%. However, inflation doesn't have to stay low. Recent measures of inflation expectations indicate bond holders have doubts the Fed will hold price increases within its 2% goal.
Rather than try to predict higher inflation, it's easier to wait and see A) when it happens and B) what kind of action the Fed takes when higher inflation takes place.
Who Loses? Savers Get the Cold Shoulder
Normally, when inflation starts heating up, the Fed raises interest rates to cool the economy. That gives at least some cushion to savers, because the interest on their deposits goes higher. But The Fed has extended the amount of time it will hold its benchmark interest rate near zero – to 2015 from the previous target of 2014.
So sitting on your money in a savings account is probably not the best thing to do. What should you do?
How to Invest When the Fire Hoses of Money Are on Full Blast
Let's take a historical look at what happened the last time that quantitative easing was announced – I'm talking about QE2 in 2010.
Looking at the chart, you can see that stocks sold off when QE2 was finally announced. But then they rallied back, pushed above the old high and rallied another 9.6%. And some stocks did much better than the S&P 500. I do not expect a carbon-copy repeat of what happened last time. But we could see something like it. As the old saying goes, "history doesn't repeat, but it sometimes rhymes."
And there is something in play that tells me the boost to stock prices and commodity prices could be even bigger than last time.
This Time, They're Actually Printing Money
In regular QE, "open market operations" are conducted simply by electronically changing the amount of base money that a bank has in its reserve account at the central bank. So, money isn't actually "printed," but it is created.
However, for the mortgage backed securities, the Fed buys them on the market. To pay for these assets, bank reserves in the form of new base money (for example newly printed cash) are transferred to the seller's bank and the seller's account is credited. At least, that's how it's been done in the past. I don't know for sure how they'll do it this time around.
So, money is actually going to be printed, unless they change how they buy MBS. All that paper money laying around … what could happen? I think that money could start flying out the door. And that will be inflationary.
Alternately, banks could turn around and just use that money to buy Treasuries. There is some risk of that. But for now, let's follow the premise that inflation will heat up.
Gold is perceived as a good hedge against inflation (historically, its performance can vary, but at this stage of the market, it's perception that counts). And gold does especially well when benchmark interest rates are low. And when the benchmark 10-year rate is below 2.25%, gold can do EXTREMELY well.
Guess where the benchmark rate is now?
We've seen that the Fed is going to keep a zero interest rate policy (ZIRP) into 2015.
Meanwhile, gold recently tested its highs for the year. And central banks around the world show signs of being more determined to take up further stimulus to aid a frail global economy.
Here's another chart for you – a chart showing how gold does in periods of an accommodative monetary policy from the Fed.
As you can see, gold is a very good bet when the Fed is opening the money spigots. And now that the Fed is doing "open-ended" quantitative easing?
I'd say the sky is the limit.
More Potential QE Winners
When QE3 was announced, I took note of the ETFs that were big movers that day …
- Nasdaq 100 (QQQ) +1.4%
- SPDR Gold Trust: (GLD) +2.02%
- SPDR Financial Sector (XLF) +2.6%
- MarketVectors Russia ETF (RSX) +3.9%
- iShares Silver Trust: (SLV) +4.36%
- S&P Metals and Mining (XME) +4.4%
- MarketVectors Gold Miners (GDX) +5.0%
It's easy to see why these might rally. Precious metals ETFs are likely to be hot during QE3, just like they were during previous rounds of easing. Ditto for commodity ETFs. And materials, metals and ETFs are leveraged to commodities.
Financial ETFs now have the full faith and credit of the Federal Reserve behind them. And emerging markets, which have been beaten into the dirt, could make a strong comeback as their own central banks join in the money printing.
If you're most concerned about PRESERVATION of capital, you can simply buy the S&P 500 index, using a fund like the SPDR S&P 500 (SPY). As long as it looks like the Fed is going to keep printing money, the likely big trend of the SPY will be up. There will be zigs and zags in that big trend, and you can use corrections as buying opportunities.
For traders and investors with a higher appetite for risk and reward, there are other ways to play QE Infinity.
3 Funds for QE Infinity
Here are three funds that should do well as QE Infinity plays out. They're plays on the broad S&P 500, gold and financials.
My recommendations are leveraged funds – funds that aim to track TWICE the daily performance of the underlying index or commodity. My picks are …
- ProShares Ultra S&P 500 (SSO)
- PowerShares DB Gold Double Long ETN (DGP)
- ProShares Ultra Financials (UYG)
You can see that each of these funds outperformed the S&P 500 in its big uptrend. But be aware that when the S&P 500 was going down in April and May, these leveraged funds fell even faster.
If you do decide to buy any of them, importantly, wait to buy pullbacks. Wait for each of these to pull back to their 20-day moving averages and then head higher before you add new positions. A 20-day moving average is an indicator you can put on just about any chart. Here's a chart of the SSO with its 20-day moving average …
Remember, if you do decide to use the 20-day MA as an entry point,you might want to wait for the SSO to bounce higher off that moving average before you buy.
How to Profit from Pullbacks
Nothing travels in a straight line, and so the S&P 500 can certainly go down as well as up. If the Fed is blasting fire hoses of money at the markets, those pullbacks will likely be shorter than the moves higher. But those moves down can be fast enough to make your head spin.
More conservative traders will likely want to sit out the moves down as long as the Fed continues its money pumping, and use the bottom of those pullbacks as opportunities to reload new positions at cheaper prices. Traders with a higher appetite for risk can use vehicles like the ProShares UltraShort S&P500 (SDS), which aims to track twice the inverse of the daily movement in the S&P 500.
Remember two things. First, corrections to the big trend higher can be quite large – there's nothing that says the market MUST go up just because the Fed is throwing money at it. Second, at some point, the Fed's money pumping will end. The market will probably see that coming long in advance and sell off accordingly.
Professional traders don't really care about the direction of the market – they have to be flexible in our investment mindset, because they can make money in either direction.
More Leverage – E-mini S&P 500 futures and options
Futures contracts are leveraged to the price of the underlying commodities they track. An E-mini S&P 500 futures contract is an agreement to trade the S&P 500 at terms decided now, but with a settlement day in the future. That means you don't have to pay up just yet. Instead, you put up what is called "margin", a down payment lodged with an independent central trade clearing house.
An E-mini contract trades at 50 times the S&P 500 Index. If the S&P 500 Index futures contract is trading at 1,400.00, the value of one contract is $70,000. Meanwhile, the initial margin on an E-mini S&P 500 contract was recently $3,500. That means you can leverage $1 to control $20. That's a heck of a lot of leverage.
So what's the downside? If you have bought the E-mini S&P 500 future and the S&P 500 goes down in price, your loss is leveraged as well. And if the S&P 500 falls far enough from your initial entry, you will be obliged to pay more margin.
As a buyer you cannot get out of paying margin calls in a falling market until you sell, which is why buying futures sometimes costs people very much more than they originally invested.
E-mini S&P 500 futures options are opportunities (but not obligations) to buy a futures contract. How much a future option costs depends on your balance of risk and reward over time – options depreciate quickly – but you can control that $70,000 worth of the index for $1,000 – or less. That's over 70 times leverage. And there are no margin calls on futures.
The risk is that the value of the option will depreciate, and options can and do go to zero. You really need to get the direction and timing of a move right to make money on options. But you can do it. And with the kind of professional recommendations you get in Resource Roundtable, it's likely that your odds of doing it successfully are higher. We lay out our trading ideas in a simple-to-follow format, with profit targets and protective stops when applicable.
Still, you need to be aware that no one has a crystal ball. Past performance is no guarantee of future returns, and when the market turns against you, you can lose money in a hurry. It really comes down to your own appetite for risk versus reward. At Resource Roundtable, we recognize risk – but we want those big rewards, too.
However you invest, do your own due diligence. If you're using recommendations from Resource Roundtable, we'll do our very best for you, and welcome aboard.