Thursday 21 February 2013

The Fed spooks gold, stock and bond bulls

About Nigam Arora

Nigam Arora is an engineer, nuclear physicist, author, and entrepreneur and the founder of two Inc. 500 fastest growing companies. He is also the developer of the ZYX Change Method to profit from change by investing. The premise is that most money is made by predicting change before the crowd. Arora is the chief investment officer at The Arora Report and the editor of four newsletters that track the ZYX Change Method. Nigam can be reached at Nigam@TheAroraReport.com.
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By Nigam Arora
The Federal Open Market Committee (FOMC) meeting minutes from January 29 -30 were released yesterday afternoon. Within the Federal Reserve System, the FOMC is responsible for making key decisions about money supply and interest rates.
One paragraph in the minutes spooked gold and silver bulls, as well as stock and bond bulls. Here is the paragraph that caused concern:
"However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy. A few also raised concerns about the potential effects of further asset purchases on the functioning of particular financial markets, although a couple of other participants noted that there had been little evidence to date of such effects. In light of this discussion, the staff was asked for additional analysis ahead of future meetings to support the Committee's continuing assessment of the asset purchase program."
Gold and silver fell out of bed
Gold and silver bulls have been assuming that QE will last forever. Further, the assumption by the momo crowd that QE3 is inflationary has been proven erroneous as fully explained here.
The momo crowd was disheartened in that there is a discussion in the Federal Reserve about ending QE.
As shown on the updated chart, gold fell through the major support. The major support zone on gold ETF GLD +0.93% was at $153 - $156. Next there is a minor support at $145 - $146.
Support in silver ETF SLV +0.76% $27.80 to $28.00 was broken. Also broken was the support in gold miner ETF GDX +2.67% at $38.00 - $38.20.
Our response was fourfold. We were correctly positioned as described in “gold is at a critical juncture ”. First, we took profits on our short position in silver miner Silver Wheaten SLW +1.96% by exiting the last tranche at $32.22; our highest short was from $41.00.
Second, we decided to maintain our short position in the silver miner Hecla Mining HL +4.85% as our analysis showed more gains are yet to come.
Third, we took advantage of price levitation in First Majestic Silver AG +2.81% with a short at $17.82. First Majestic had entered into an agreement to acquire Orko Silver. Orko received a better offer from Coeur d'Alene CDE +3.08% for about C$35 million. First Majestic decided not to exercise its option to match the price. First Majestic will receive a breakup fee of C$11.6 million. The analysis is that ultimately First Majestic stock will be pulled down with the group.
Finally, we upgraded gold and silver in the very, very short-term to neutral. We had downgraded gold and silver on February 11th just before the recent drop.
Stocks addicted to QE
The stock market is addicted to QE. For some market participants, the extent of the discussion in the FOMC about changing QE was a shock.
The stock market is very overbought and needed an excuse to sell off.
No new defensive action was needed for our portfolios because we are already short SPDR S&P 500 ETF Trust SPY -0.60% , have hedged positions, and have raised cash.
For those interested in short selling the market for hedging or speculative purposes, at this time we don't recommend PowerShares QQQ QQQ -0.97% . The reason is that Apple AAPL -0.81% is a large part of QQQ. Lately Apple stock direction hasn't shown a good correlation with the stock market direction.
The bond bubble
At the prospect of QE withdrawal by the Fed, bonds first sold off and so did the popular bond ETF iShares Barclays 20+ Year Treasury Bond TLT +0.71% . Later losses in TLT were reduced as the bond players saw that QE withdrawal was sometime in the future but not now.
Since a lot of our subscribers are financial advisers who are managing retirement accounts and short selling is prohibited in retirement accounts, we are long inverse bond ETF TBF -0.79% . This inverse bond ETF TBT -1.48% is very popular, but we don't recommend it for long-term investors because it exhibits tracking errors.
What to do now?
According to our models, any correction in the stock market will be a buying opportunity; bonds are likely to fall further; and gold at this time is suitable mostly for traders.
Disclosure: Subscribers to The Arora Report are long TBF, are short SPY, HL, and AG.
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