When will the music stop?

Under QE3, it will take 44 months to create the same liquidity as QE1 did and 15 months as QE2...

What about the impact on asset prices? Pick the number you like....

Source: The Federal Reserve, click to enlarge 

2012 is going to repeat 2010

After the ECB and the Fed both rolled out their own bazooka, all bears, myself included, should have surrendered.

Without digging into details too much, the rest of 2012 is going to be a repeat of 2010 - a policy-induced bull market. Here are quite a few self - explanatory charts:

Source: Reuters, click to enlarge 

Source: Reuters, click to enlarge 

Source: Reuters, click to enlarge 

Let's enjoy the rally while it lasts. If 2012 turns out to repeat 2010, then 2013 is going to be a repeat of 2011, if not 2008...

I will illustrate further here the headwinds facing the market next year both in the US and Europe as we head toward the end of this rally.

The ECB’s bazooka/ Gold rising on misunderstood fundamentals

Basically all assets were buoyed by the ECB’s bazooka, a plan to load up unlimited amount of troubled country’s debt, since last Thursday. I have to admit that my assessment regarding “no open-ended commitment from the ECB” (See rationale here) was wrong and hence I missed the rally in the past few days.

With the one-sided rising asset prices in the past few days, I spot some upward movements in certain assets were unjustified, and gold (silver as well) is one of the assets that rose on a misunderstood fundamental.

The ECB’s bazooka, a.k.a. Outright Monetary Transactions (OMT), is a plan to remove certain “tail risks of  Euro breakup” with the details listed below:

1.          Purchases of sovereign bonds maturing in 1 – 3 years in the secondary market

2.          No quantitative limits are set on OMT

3.          No subordination of private investors

4.          Full Sterilization

5.          Conditionality of OMT is attached to EFSF/ESM program

Indeed, OMT is enough to build a firewall to safeguard the too-big-to-fails (Spain and Italy) as long as those countries comply with austerity measures (Of course, austerity will mean a recession for them). OMT, in my opinion, has several implications to the market:

l   Removing a Lehman-like re-denomination risks in Europe in the intermediate term (until a blowup of the ECB)

l   Increasing recessionary risks for countries under OMT, just like the Greece and Portugal which carried out austerity measures under the current Trioka plans

l   The total liquidity in the euro system will stay unchanged given the full sterilization structure

I think the Operation Twist (OT) by the Fed which was firstly launched in Sep 2011 and then extended in Jun 2012 was a good example in explaining the term “sterilization” and its impact on asset prices.

As I covered here few months ago, sterilization is hardly supportive to commodity prices (incl. precious metals).  This is also the reason why gold peaked at US$ 1,900 last September and trended down to recent low at US$ 1520 in Q2 2012 despite the crisis in Europe kept worsening.

If OMT really means less crisis, no money printing and higher chance of recession in Europe, I don’t see the reason why the “safe-haven”, “money-printing-sensitive” gold could rise as much as, if not more than,  equities, Euro or others assets that benefit from the removal of tail risks in Europe.

While some investors are arguing gold will rise as the Fed will carry out QE 3 on 13^th Sep FOMC meeting to match what the ECB did last Thursday, I am holding my breath to see what will happen otherwise.

I am particularly interested in the movement of gold in Euro (XAUEUR) if QE 3 doesn’t become reality this week. A dramatic fall for this pair is likely to happen: 

Source: Reuters, click to enlarge 

If central banks only get a BB gun while the market expects a bazooka…

The article was firstly published on September4, 2012 on the Marketwise column of China Daily.

Since mid-June, risk assets across the board have been buoyant for various reasons. One of the most dominant reasons is that central banks globally started hinting for another round of accommodative momentary policies in the face of poor economic readings and worsening debt woes in Europe.

Mario Draghi, the president of the European Central Bank (ECB) has made a strong statement in an investment conference in London on 26^th July, 2012 pledging to do whatever it takes to save the Euro. Mr. Draghi further announced that the ECB is considering some non-standard monetary policies after the Governing Council Meeting on 2^nd August, 2012.

After Mr. Draghi’s speeches in the past two months, it is widely believed that the ECB would set a target yield range for short-dated Spanish and Italian government bonds and enforce this target yield range by purchasing enormous amount of these bonds in the secondary market. However, given the plan’s structure and timing, I remain skeptical as to whether or not this grand plan will come into being on time while the market is expecting it in a matter of weeks.

Firstly, if a target yield range is set, it literally means that the ECB will enter into an open-ended commitment to buy unlimited amounts of Spanish and Italian government bonds whenever the interest rate rises above the target range. Nonetheless, an open-ended commitment has been a taboo for the ECB since such a commitment would give rise to debt monetization and mutualization among member states in the currency bloc according to their stakes in the ECB.

Source: Reuters, click to enlarge

Unlike the Federal Reserve in the US which only serves one single federal government. The ECB is held accountable to the 17 fiscally independent member states which are not supposed to share liability with each other. While the Eurozone is still at an early stage toward fiscal union, it is hard to believe that Eurozone leaders would agree on re-distributing liability from debtor states like Spain and Italy to creditor states like Finland and Germany in an unfair manner at this point in time.

Secondly, I would argue that if the ECB and other policy makers have the sense of urgency to take this bold step when the capital market in Europe seems like it is returning to normality after Draghi’s speeches in the past two months. The Euro has rebounded from a multi-year low of $1.20 to the recent high close to $1.26 while the two-year Spanish yield dropped to below 4% from nearly 7% just a month ago (See chart). These market movements demonstrate not only improving signs of the debt crisis in Europe but also a high expectation of investors regarding upcoming policy responses.

Draghi’s speeches have indeed succeeded in kicking the can down the road and calming the jittery market. If buying more time is ultimately what policy makers in Europe want to achieve, this goal is considered done. I expect the ECB meeting on 6^th September, 2012 is more likely to surprise to the downside, especially when investors have such a high expectation on it.

If the market is expecting a bazooka while the ECB can only provide a BB gun, disappointment among investors will be a sufficient reason to sink risk assets.