Warning! Gold Could Drop Below $500

By Alex Dumortier | More Articles 

November 2, 2010 | Comments (71)

Gold has performed very strongly over the past decade, trouncing equities and bonds in the process and handing investors who own the SPDR Gold Shares (NYSE: GLD) or the iShares Gold Trust (NYSE: IAU) handsome gains. Amid a heated debate about whether gold is in a bubble, it's worth taking a historical view to examine the risk investors are taking by paying more than $1,300 for an ounce of gold.

Gold's real return: zeroIn fact, gold appears to have eked out a small positive real return over time. Using data from the World Gold Council and precious metal dealer Kitco, I was able to construct a series of inflation-adjusted gold prices going back to 1851, according to which gold generated a historical average return of 0.7% per annum. However, even that small positive real return is a bit of a mirage resulting from the powerful gold rally we've witnessed. Indeed, as recently as 2005, gold's average real return over 154 years was zero, period.

That shouldn't be surprising: There is no reason to expect that an inert asset that produces no cash flows and has few industrial applications to accrete value. By stating that gold has returned nothing, I'm not disparaging the yellow metal; rather, it shows that the precious metalhas acted as a store of value -- over the very long term (for practical purposes, however, gold's price volatility makes it unsuitable as a store of value). That's consistent with the notion that it is an alternative currency that no government can debase.

Still, this alternative currency could be in for a big devaluation. To see why, look at the following graph of 10-year trailing real returns for gold since 1861 (based on average annual gold prices):

Sources: World Gold Council, Kitco.

Recent gains could reverseThere are two important observations to make:

1. Gold returns are mean-reverting: The alternating peaks and valleys in the graph illustrate the fact that periods of higher-than-average returns tend to usher in periods of lower-than-average returns, and vice-versa. That's not surprising since this property shows up across different asset classes, including stocks.
2. Investors who have owned gold over the past 10 years have earned a real return that is far in excess of the historical average. In fact, there is only prior period that witnessed higher returns: the bull market in gold that culminated in January 1980. Judging by gold's performance over the next two decades, that top capped off an enormous bubble.

Putting one and two together suggests gold returns going forward will be lower than the ones we have become accustomed to during the past decade. Just how severe could a reversal be? Let's take a look at the current price of gold in context. The following chart shows the average annual price of gold expressed in constant 2010 dollars (i.e., inflation-adjusted):

Sources: World Gold Council, Kitco.

Gold could fall by two-thirds!Gold is galloping ahead of its historical average (the red line)! In fact, the price of gold would need to fall by almost two-thirds to get back to its long-term average of $456/ ounce, not to mention that markets typically overshoot. That's a sobering thought if you have a significant position in gold.

Don't let the gold hucksters fool youGold is inherently a speculative asset. Despite what I wrote above, I do believe that it represents an attractive, but high-risk, speculation, as the current supply demand dynamicslook compelling. However, I can't rule out that things will turn out differently than I expect them to. If the economic recovery stabilizes and high inflation doesn't materialize, gold could decline significantly from its current level.

Let me emphasize that point: At these prices gold is no safe haven; it's an active bet on a specific scenario for the U.S. economy. Super-investor John Paulson owns gold because he believes the U.S. will experience double-digit inflation, but if that doesn't pan out, the bet could prove costly. Major gold miners that have closed out their hedges, including AngloGold Ashanti (NYSE: AU), Barrick Gold (NYSE: ABX) and Gold Fields (NYSE: GFI) would share in the pain.

Gold is now a bubbleI have been bullish on gold ever since I began looking at this market in February 2009, and I have argued against the idea that this is a bubble. As I review my thesis, I now believe it's likely that we are in bubble territory; nevertheless, I remain bullish because the conditions are in place for this bubble to continue expanding. Investors who wish to speculate on this can do so via the two ETFs I mentioned in the opening paragraph or through the following vehicles:Sprott Physical Gold Trust (NYSE: PHYS), the Central Gold Trust or the Central Fund of Canada (AMEX: CEF).

http://www.fool.com/investing/etf/2010/11/02/warning-gold-could-drop-below-500.aspx

Why You Shouldn't Invest in American Stocks

By Tim Hanson and Brian Richards
November 5, 2010

Before you get any ideas, let it be known that we love the NCAA tournament, Oreo cookies, and Saving Private Ryan. But when flipping through an issue of Fortune, an astoundingly hammy ad made me (Brian) stop cold.

In big, bold letters, it read: "When you invest in America, you're really just investing in yourself."

The ad is for the SPDR Dow Jones Industrial Average ETF (NYSE: DIA), and we have nothing against that exchange-traded fund per se -- it has low expenses and does what it says it will, tracking the 30 stocks in the Dow.

The ad, though, sells an investment in a way that undermines the investor -- by pandering to patriotic emotions. Here's more of the text:

There's an unspoken agreement in America that each generation should leave this country in better shape than they found it. Maybe that's why the U.S. economy has been growing since the Industrial Revolution. Everyone tries to do their part. If you believe this covenant still exists today, consider the SPDR Dow Jones Industrial Average ETF. [emphasis ours]
A touch melodramatic, eh?

We'll cut straight to why you shouldn't invest in American stocks: Because you are patriotic and sentimental about America. Kudos if you are those things -- just don't invest for those reasons.

Losing money is not patriotic
Consider, for example, Ford (NYSE: F) and Toyota (NYSE: TM). Are you more patriotic if you owned Ford over the past decade? No, you're just poorer (though both have lost money for investors, given how difficult it is to compete in the cyclical auto industry).

And while you might have thought it would help Ford out to purchase its stock when it was imploding in 2009, the fact is, when you buy a stock in the stock market, that money does not go to the company. Instead, it goes to a person who bought the stock from some other person.

So rather than bail out Ford, you were actually bailing out the person who bought Ford before you. That said, Ford has turned out to be a great investment since 2009, thanks to its return to profitability under Alan Mulally -- for reasons that have nothing to with patriotism.

The point is, companies only raise money during offerings. If you're buying or selling stock on the open market during a regular trading day, it generally will have no effect on the operations of the underlying company.

And even when it comes to offerings, you shouldn't buy shares of a company because you think it needs help, or because it might be patriotic to do so -- as the marketing surrounding the inevitable GM IPO will almost certainly imply. Most companies, when push comes to shove, won't return that thoughtfulness to their shareholders.

There's a larger lesson here
Patriotism, however, is only one of the ways that you might get suckered into making a poor investment decision. Others include buying into a rising stock for fear of missing out on gains (as so many did during the tech bubble), or selling a stock that's dropping solely because you're afraid it might go lower. Or as The Wall Street Journal explained recently:

Everyone develops attachments that can be irrational sometimes, whether to a house, a car, even a person. People can also get overly attached to a particular investment, believing it will reach -- or return to -- a certain price. Or they may place too much importance on one piece of information when making an investment decision. These are examples of anchoring bias, which causes the investor to hold on to the asset for longer than they should.

So there's a large lesson here, and it's this: An emotional investment is bad investment.

Don't believe us? Thankfully, there's now an entire field -- behavioral finance -- devoted to studying the ways in which our investing hearts get the best of our investing minds (actually most emotion happens in the brain as well, but stay with us).

Rather than rehash it all, we'll quote a Stanford study sums it up unequivocally: "Emotions can get in the way of making prudent financial decisions." We also recommend you read the fabulous Jason Zweig book, Your Money & Your Brain.

But back to America
Frankly, we think it's irresponsible for an ad agency to pull your patriotic heartstrings to make you want to buy an investment product that tracks the Dow 30. Not only is it intellectually strange -- assuming your dollars do go to support the business you buy, wouldn't it be more patriotic to buy shares of a collection of American small business, rather than 30 massive multinationals? -- it's just flat-out inane. A sense of civic duty is no reason to buy a stock or ETF, period.

Yet none other than investing icon Warren Buffett went to the exact same well when, during the peak of the financial crisis, he published his now-famous New York Times op/ed titled "Buy American. I Am."

To be fair, editorial page editors often pick the titles of editorial page editorials, so Buffett may not have been responsible for that slightly over-the-top headline (though who are we to criticize for an over-the-top headline?). Furthermore, the headline isn't even consistent with what Buffett's actually been buying at his investment vehicle, Berkshire Hathaway.

The holding company now owns stakes in China's BYD, the U.K.'s GlaxoSmithKline (NYSE: GSK), Switzerland's Nestle, and France's -- yes, France's -- Sanofi-Aventis (NYSE: SNY). What's more, Berkshire owns sizable stakes in ostensibly American companies such as Coca-Cola (NYSE: KO) and Wal-Mart (NYSE: WMT) that have investment and growth abroad -- key parts of their business strategies going forward.

No, Buffett is not a hypocrite
This is all very smart -- both for the companies and for Buffett. Emerging markets are growing faster than the U.S. and have less ominous debt profiles. The dollar is weakening relative to those currencies. It makes sense to have a healthy dose of foreign exposure today! In fact, we'll go so far as to predict that if you buy foreign stocks, you'll earn better investment returns and end up paying more in capital gains taxes -- money that will actually go to prop up America (if that's the sort of thing you're looking to do).

All told, the takeaway from Buffett's editorial was not "Buy American," but rather found farther down in the copy: "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors." Sometimes, that means Buy American, and other times it means Buy Abroad. But all the time, it means that you should make smart, unemotional decisions with your investment capital.



http://www.fool.com/investing/general/2010/11/05/why-you-shouldnt-invest-in-american-stocks.aspx

Higher LTV ratio to have drastic impact on mortgage loans demand

Posted on 

November 5, 2010, Friday

KUCHING: The banking industry is expected to face a drastic impact on mortgages loans demand following the announcement of the higher loan-to-value (LTV) ratio for financing third properties and onwards.

According to OSK Research Sdn Bhd (OSK Research), the higher LTV ratio on financing the third property and onwards was aimed at curbing the degree of speculation currently being experienced by industries.

However, banks, via the Central Credit Reference Information System (CCRIS), would be able to detect if a borrower was driven by speculative intention, especially if he/she had purchased multiple properties within a short time span.

In such cases, OSK Research said that banks with proper risk management would have already pre-empted such risks by lowering the LTV for those financing facilities.

The research house stated that property purchasers might also be able to circumvent the new ruling by purchasing property under their children or spouses’ names while acting as guarantors to the loan.

It further added that property developers could raise prices while providing rebates to partially blunt the impact of the higher LTV ratios.

The research house observed the strong loans growth in the property segment coupled with a surge in working capital loans over the past five months had elevated year-to-date (YTD) annualised loans growth to a much stronger 11.8 per cent compared with the research house’s market estimates of nine per cent to 11 per cent.

As such, even with the assumption that residential property loans growth moderated by 50 per cent due to Bank Negara Malaysia’s (BNM) more stringent credit lending restrictions, the research house could still see total industry loans growth coming in at 10 per cent to 10.5 per cent, which was at the upper end of market estimates.

The research house highlighted that loans for residential properties contributed to 25 per cent to 30 per cent of total industry loans growth over the past six months, but the strong recovery in working capital and non-residential property loans grew significantly over the past three months, contributing to 16 per cent to 23 per cent of total industry loans growth, compared with six per cent at the beginning of 2010.

http://www.theborneopost.com/?p=73019

KNM settles termination of oil sands project with Fort Hills

November 5, 2010, Friday

KUCHING: KNM Group Bhd’s (KNM) subsidiary, KNM Process Equipment Inc (KNMPE) executed a settlement and release agreement and a right of consideration agreement with Fort Hills Energy LP (Fort Hills) and Suncor Energy Inc (Suncor) to terminate an oil sands project for the Fort Hills Froth Treatment (FHFT) project in Canada.

CONTRACT SETTLEMENT: KNMPE has executed a settlement and release agreement and a right of consideration agreement with Fort Hills and Suncor to terminate an oil sands project for the FHFT in Canada.

According to OSK Research Sdn Bhd (OSK Research), Fort Hills would pay RM9.3 million to KNMPE in addition to the progress payment previously paid as full and final compensation for the termination of the contract.

KNM had excluded all of the oil sand orders from its overall order book. Its existing order book of more than RM1.5 billion should be able to keep the company busy for the next nine to 12 months which did not include any more oil sand projects.

In consideration of the mutual agreement, Suncor (as partner of Fort Hills) would also pay KNMPE the first consideration for performance of identified products for five years from the date of the agreement.

Despite this contract termination, OSK Research noted that KNM’s tenderbook was now worth more than RM10 billion which was reflective of the recovery in the global economy.

In a separate report, AmResearch Sdn Bhd (AmResearch) remained cautious of KNM’s target of securing new orders of RM2 billion for the financial year 2010 forecast (FY10F) as the group’s quarterly replenishment had struggled to reach RM500 million since its completion of its Borsig acquisition back in 2008.

In particular, the group had only secured RM1 billion in new orders for FY10F to date with a target to secure another RM1 billion by year-end.

Based on this, AmResearch pointed out that KNM’s plant utilisation rate was likely to remain just above its operating breakeven level of 60 per cent.

To conclude, OSK Research pegged the group’s target price at RM0.56 per share while AmResearch pegged the group’s target price at RM0.42 per share.

http://www.theborneopost.com/?p=73029

Buffettology

Everything you need to know about Warren Buffett

http://monsterhash.com/beta/2009/exclusives/money/everything-you-need-to-know-about-warren-buffett/

Buffetology Workbook by Mary Buffet and David Clark

http://share.sweska.net/2007/08/23/buffetology-workbook-by-mary-buffet-and-david-clark/

Philip Fisher: Warren Buffett’s lesser-known mentor

http://monsterhash.com/beta/2009/exclusives/money/philip-fisher-warren-buffets-lesser-known-mentor/

Steady investments can beat the market by a mile

4 NOV, 2010, 01.31AM IST,
AMAR PANDIT,

Steady investments can beat the market by a mile

Guessing the index seems to be like an exciting pastime for most investors. They look at the index as some sacrosanct indicator to decide whether they should buy a stock.

“Sensex is back to 20000 and I feel something wrong is going to happen again,” said one learned acquaintance. “The markets are overvalued and I will invest when it corrects,” said another gentleman who did not even invest when the market was at 8000, thinking it will go down to 6000.

I asked many people who have been investing since 2005, “Do you remember the index levels in the year 2005?” Almost everyone replied in the negative. In 2005, the Sensex was between 6103 and 9397. I remember in 2005 a lot of people called even 6600 as a high level. One client had even said, “Let’s wait till 5000.” But guess what: he does not even recall the 2005 level remotely. This is because people have made fantastic returns over five years and it’s no longer important whether you invested at 6500 or 7000 or at 7500.

Here is why index levels should not be a real determinant of your investing decision: A difference between the lowest level every year and a fixed level every year over a long time frame does not matter at all.

Consider three different scenarios of index: 8000 in 2009, 13500+ in June 2009 and 18000 levels in August 2010.

1. Let’s say you started investing in 1991, when liberalisation in India started. If you managed the feat of investing at the lowest level every year since 1991, your annual returns would have been 15.88% CAGR as of June 1, 2009 at 13500+ levels. 
2. On the other hand, if you invested at the highest level every year, your returns would have been 11.78% CAGR. 
3. Now, if you had invested on a fixed date every year, let’s say, January 1, then your returns would have been a surprisingly 15.77%. 
4. The difference between a fixed date and the lowest date is just 0.11% pa.

Since 1991, the CAGR as on March 9, 2009,

• for annual investments made at the highest Sensex levels was 8.21%, 
• while it was 12.18% when the investments were made at the lowest levels. 
• For investments made on January 1 every year, it was 12.08%.

Similarly, since 1980, the CAGR as in August, 2010,

• for annual investments made at the highest Sensex levels was 16.19%, 
• while it was 17.60% when the investments were made at the lowest levels. 
• For investments made on January 1 every year, it was 16.91%.

Think for a moment. Does the paltry difference in returns between the lowest levels and regular investments really matter to you? For most equity investors, the answer will be a resounding no.

http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/Steady-investments-can-beat-the-market-by-a-mile/articleshow/6868486.cms

India: Banks will now lend only 80% of home price

Banks will now lend only 80% of home price
TNN, Nov 3, 2010, 01.10am IST

Tags:Reverse Repo Rate|Repo Rate|RBI|Home Loan

MUMBAI: While most banks are in a wait-and-watch mode on their lending and deposit rates after the Reserve Bank of India's decision on Tuesday to hike key policy rates--repo and reverse repo--by a modest 25 basis points (100 basis points=1%), it is certain that from now on, anyone applying for a housing loan from a bank will have to pay a margin money of at least 20% of the value of the property. This in effect means that you will have to shell out more from your own savings to buy that house you have been eyeing for a while. Earlier, this margin money varied between 10% and 15 %.

That's not all. The RBI also increased the risk weightage of loans above Rs 75 lakh taken for buying property, which could increase the interest rates on loans for high-cost properties. This is being seen as a pre-emptive measure to rein in the possibility of the creation of an asset bubble and a sign that there could be overheating in the property market.

The RBI, with a focus on taming the currently rigid high inflation rate in the economy, raised repo rate (the rate at which banks borrow from the RBI) to 6.25% and reverse repo rates (the rate of interest that banks get when they park their surplus money with the central bank) to 5.25%. These steps were expected by most market players ahead of the policy. The central bank also said that unless anything drastic happens to the economy, it would probably pause in hiking rates for the time being. Simultaneously, IDBI Bank, announced raising deposit rates by 10-50 basis points and lending rates, including home loan rates for loans of Rs 75 lakh and above, by 25 basis points.

RBI said that loan-to-value (LTV) ratio for housing loans should not exceed 80% and increased the risk weight for residential housing loans of Rs 75 lakh and above, irrespective of the LTV, to 125%, from 100% now. It also increased the standard asset provisioning by commercial banks for all housing loans with `teaser rates to 2%.

The raising of LTV ratio to 80% means that any new home buyer going for a housing loan, will have to bring in at least 20% of the value of the property while the balance, 80% or less, could be financed from a bank or a HFC.

Top industry officials feel this is a pre-emptive measure and is a warning sign for all in the real estate sector--developers, financiers and also the buyers--that there could be danger ahead. `` The RBI has always taken pre-emptive measures to prevent asset bubbles, particularly in real estate. It is in this context that the RBI has restricted the maximum loan to value ratio to 80% and increased risk weights on housing loans above Rs 75 lakh, said Renu Sud Karnad, MD, HDFC, the mortgage finance major.

Going by tradition, even other housing finance companies (HFCs) not under RBI will perhaps adhere to the same rule of margin money of 20% of the property value. This is because in the past whenever the central bank imposed some new rules related to housing loans by banks, National Housing Bank (NHB), the regulatory body for HFCs, had imposed the same conditions on these companies.

Industry players pointed out that the RBI's steps were more directional since the average LTV in the housing finance industry is at about 67% while average loan size would be between Rs 20 lakh and Rs 25 lakh. On the teaser loan rate, industry players pointed out that such schemes which are still being offered is expected to end by March 2011.

The RBI measure could also work in favour of home buyers in the form of a either a slow or nil rise in real estate prices. ``The message from RBI is clear: There is a worry about real estate prices spiralling. This concern will ensure that there is a short-term cap on real estate prices and in the near future it may come down marginally,'' said Gagan Banga, CEO, Indiabulls Financial Services. ``A correction in prices should result in higher volumes given the strong macro economic conditions,'' Banga added.

As for lending rates, any decision to hike them going forward will depend upon the availability of funds in the banking system, also called liquidity, bankers and economists said. ``The market was expecting these hikes and have already discounted the same. For lending rates to go up, along with hikes in policy rates, we also need to consider the liquidity situation,'' Arun Kaul, chairman, UCO Bank said. ``The combined impact of these two would be reflected in the cost of funds. In case the cost of funds goes up, banks would hike rates. As of now, we are in a wait-and-watch mode,'' he added.

Although it was clear from the tone of the policy document that reining in inflation and managing people's expectations about the rate of inflation were the RBI's major concerns, it could not completely put the growth factor in the background. ``The low possibility of any further rate action in the immediate future and the decision to leave the cash reserve ratio unchanged indicate that RBI wants to keep the monetary environment conducive for growth in the economy,'' said Chanda Kochhar, MD & CEO, ICICI Bank, the largest private sector bank in the country. ``RBI has also assured that it will monitor the liquidity situation closely to avoid choking off fund flows required for growth,'' she added.

Seen from another side, the decision to hike key policy rates could also lead to some tough times for the RBI itself, market players pointed out. Lured by higher interest rates in the country compared to most developed markets, there could be a rush of foreign funds into the Indian debt market, just like the rush of FII money that the stock market is witnessing at present. The fact that the RBI is also keeping a strict vigil on capital flows through the debt market route was proved when the central bank's governor, D Subbarao, dwelt on this topic in substantial detail in his post-policy media conference.

``It has often been argued that the widening of interest rate differential between the domestic and international markets will result in increased debt-creating capital flows. While it is true that large interest rate differential makes investment in domestic debt instruments and external borrowings by domestic entities more attractive, we need to keep in view three aspects in the Indian context,'' the RBI governor said.

• ``First, the economy's capacity to absorb capital flows has expanded as reflected in the widening of the current account deficit. 
• Second, despite the already large differential between domestic and international interest rates, capital flows in the recent period have been predominantly in the form of portfolio flows into the equity market. This suggests that the interest rate differential is not the only factor that influences capital flows.
• Third, in line with our policy of preferring equity to debt-creating flows, we still maintain some controls in respect of debt flows.''

It could be pointed out here that in recent times while several of the top RBI officials have spoken about controlling capital flows, both through the equity and the debt routes, the finance ministry has mostly been against any form of capital control.


Read more: Banks will now lend only 80% of home price - The Times of India http://timesofindia.indiatimes.com/business/india-business/Banks-will-now-lend-only-80-of-home-price/articleshow/6862052.cms#ixzz14NHSlCJi

Stocks Soar, Dollar Dives on QE2: Here's What You Need to Know

Posted Nov 04, 2010 04:35pm EDT by Joe Weisenthal

From The Business Insider

A mini taste of Zimbabwe today? It kind of felt like it:

But first, the scoreboard:

Dow: +222
NASDAQ: +35
S&P 500: +23

And now, the top stories:

* Well, obviously "today" started yesterday at 2:15 PM ET when the Fed announced its quantitative easing initiative. What's funny is that it didn't actually move the markets all that much Wednesday (after some initial chaotic trading).

* But stocks surged higher in Japan last night, and that set the tone for a monster global "risk-on" rally around the world. China had a monster night as well.

* Of course, "risk-on" is codeword for "dump the dollar and buy everything else in sight" so there were huge rallies in Treasuries, precious metals (new highs in gold and silver!) industrial commodities, agricultural commodities, and of course stocks.

* Notably weak: PIIGS debt. Spreads are blowing out wildly in Ireland and Greece, though the effect on the euro really is almost non-existent. After all, the euro isn't the dollar, so it is something to be held. Also, there were riots and bombs around Athens all day, but again, nobody cared. (See: Us vs. Them: U.S. Opts for More Bailouts, Europe Takes Road to Austerity)

* In the U.S., the big macro data of the morning was the weekly jobs report which jumped and was worse than expectations.

* Did we mention that gold surged? Yes, we did, but it's worth mentioning again. It's above $1390.

* As for stocks, well, they surged all day, ending right near their highs. And look, Bernanke literally said last night that higher stock prices were part of his goal, so if you're betting against stocks, you're betting against the guy with the biggest long-only fund in the world. (See: What's Bernanke Smoking? "A Complete Mystery" How QE2 Helps the Economy, Galbraith Says)

* The bottom line: Everyone is terrified by the severity of the 'everything-but-the-dollar' trade lately. Hopefully Ben Bernanke knows what he's doing. (See: Bernanke Christens QE2: Fed "On a Very Dangerous Path," Axel Merk Says)

Tulip Mania of 16th Century Holland: Deciphering the hype and the truth

http://econjournal.com/2008/11/26/a-series-on-depression-tulip-mania-of-16th-century-holland/

A History of Home Values

http://www.accumulatingmoney.com/real-estate-mania-a-history-of-home-values/

Doubts grow over wisdom of Ben Bernanke 'super-put': Soaring bourses may have stolen the headlines, but equities are rising for an unhealthy reason.

Doubts grow over wisdom of Ben Bernanke 'super-put'

The early verdict is in on the US Federal Reserve's $600bn of fresh money through quantitative easing. Yields on 30-year Treasury bonds jumped 20 basis points to 4.07pc

By Ambrose Evans-Pritchard, International Business Editor
Published: 7:58PM GMT 04 Nov 2010

60 Comments

Mr Bernanke is targeting maturities of 5 to 10 years with purchases of Treasuries. Photo: GETTY

It is the clearest warning shot to date that global investors will not tolerate Ben Bernanke's openly-declared policy of generating inflation for much longer.

Soaring bourses may have stolen the headlines, but equities are rising for an unhealthy reason: because they are a safer asset class than bonds at the start of an inflationary credit cycle.

Related Articles

• Fed stimulus triggers global stock market rally, dollar slide

• Buyback hopes buoy BHP as FTSE 100 stocks fly

• Share prices shoot up to pre-banking crisis levels

• Is the Dow right to be in such celebratory mood? Me thinks not

• Fed prints another $600bn to keep US recovery on track

• Fed's $600bn gamble risks throwing away America's biggest asset

Meanwhile, the price of US crude oil jumped $2.5 a barrel to $87. It is up 20pc since markets first concluded in early September that 'QE2' was a done deal.

This amounts to a tax on US consumers, transferring US income to Mid-East petro-powers. Copper has behaved in much the same way. So have sugar, soya, and cotton.

The dollar plunged yet again. That may have been the Fed's the unstated purpose. If so, Washington has angered the world's rising powers and prompted a reaction with far-reaching strategic consequences.

Li Deshui from Beijing's Economic Commission said a string of Asian states share China's "deep bitterness" over dollar debasement, and are examining ways of teaming up to insulate themselves from the tsunami of US liquidity. Thailand said its central bank is already in talks with neighbours to devise a joint protection policy.

Brazil's central bank chief Henrique Mereilles said the US move had created "excessive dollar liquidity which we are absorbing," forcing his country to restrict inflows. Mexico's finance minister warned of "more bubbles."

These countries cannot easily shield themselves from the inflationary effect of QE2 by raising interest rates since this leads to further "carry trade" inflows in search of yield. They are being forced to eye capital controls, with ominous implications for the interwoven global system.

In London and Frankfurt the verdict was just as harsh. "In our view, this is one of the greatest policy mistakes in the Fed's history," said Toby Nangle from Baring Asset Management.

"The Fed is gambling that the so-called 'portfolio balance channel effect' – pushing money out of government bonds and into other assets – will lift risk asset prices. The gamble is that this boosts profits and wages, rather than simply prices. We remain unconvinced. How will a liquidity solution correct a solvency problem?" he said.

"A policy error," said Ulrich Leuchtmann from Commerzbank. The wording of the Fed statement is "potentially dangerous" because it leaves the door open to a further flood of Treasury purchases if unemployment stays high. "It is a bottomless pit," he said.

Of course, it is precisely this open door that has so juiced risk trades, from Australian dollar futures, to silver contracts, and junk bonds. Goldman Sachs thinks QE2 will ultimately reach $2 trillion, with no exit until 2015. Such moral hazard is irresistible. It is the Bernanke 'super-put'.

Yet the reluctance of investors to leap back into the US Treasury market as they did after QE1 is revealing. The 30-year segment of the Treasury market is too small to matter, but symbolism does matter. Vigilantes sniff stealth default. "If long bond investors continue to throw their collective toys out of the cot, it risks upending the Fed's policy," said Michael Derk from FXPro.

Mr Bernanke is targeting maturities of 5 to 10 years with purchases of Treasuries. These bonds have behaved better: 10-year yields fell 14 points on Thursday to 2.48pc. However, Mark Ostwald from Monument Securities said foreign funds may take advantage of QE2 to dump their holdings on the Fed, rotating the money emerging markets rather than US assets.

Bond funds are already restive. Pimco's Bill Gross says the great bull market in bonds is over, denigrating Fed policy as the greatest "ponzi scheme" in history. Warren Buffett has chimed in too, warning that anybody buying bonds at this stage is "making a big mistake",

Fed chair Ben Bernanke uses the term 'credit easing' to describe his strategy because the goal is to lower borrowing costs. If he fails to achieve this over coming months - because investors balk - the policy will backfire.

No clear rationale for fresh QE can be found in orthodox monetarism. Data from the St Louis Federal Reserve show that M2 money supply stopped contracting in the early summer and has since been expanding at an accelerating rate, topping 9pc over the last four-week bloc.

The Fed has used the 'Taylor Rule' on output gaps as a theoretical justification for QE, but Stanford Professor John Taylor has more or less said his theories have been hijacked. "I don't think (QE) will do much good, and I also worry about the harm down the road," he said.

It has not been lost on markets that the Fed's purchases of $900bn of Treasuries by June (with reinvested funds from mortgage debt) covers the Treasury's deficit over the same period. The slipperly slope towards 'monetization' of public debt beckons.

Global investors mostly accepted that the motive for QE1 was emergency liquidity, and that stimulus would later be withdrawn. But there are growing suspicions that QE2 is Treasury funding in disguise.

If they start to act on this suspicion, they could push rates higher instead of lower, and overwhelm the Bernanke stimulus. That would precipitate an ugly chain of events for the US.

http://www.telegraph.co.uk/finance/economics/8111153/Doubts-grow-over-wisdom-of-Ben-Bernanke-super-put.html


Note:


Pimco's Bill Gross says the great bull market in bonds is over, denigrating Fed policy as the greatest "ponzi scheme" in history. 


Warren Buffett has chimed in too, warning that anybody buying bonds at this stage is "making a big mistake",