Wednesday, 2 March 2011

Spiking oil, gold and a rather uncomfortable looking Fed chairman

Yesterday was decidedly not a good day for the animal spirits as most risk assets spent the day spiraling downwards.

Seen below is the 240 minute chart for the e-Mini S&P 500 futures (March 2011 contract) which provides a very clear illustration of yesterday’s (and other recent) plunges, and also the chart indicates a clear barrier which will need to be overcome in coming sessions at the 1310 level.

I spent part of yesterday watching the testimony of Ben Bernanke before the Senate Banking committee. The overall impression was of someone who found the questioning at times tedious, and at other times awkward. His demeanor, at least from this writer's perspective, could best be described as uncomfortable.

He made some rather remarkable comments in response to what, from time to time, were some very good questions put to him by members of the committee. One of my favorites was when he stated that he did not think it would be a good idea for the US to default on its debts when he was asked about the consequences of not raising the debt ceiling...that was rather reassuring!

The central theme of his remarks, and he came back to the point several times, was that the efficacy of QE2 should be judged primarily on its demonstrated ability to lift equity prices and thus avoid asset deflation. Given that the S&P 500 has doubled in the last two years he would seem to have been vindicated. However, as a side effect (not an entirely unintended consequence) of QE and ZIRP, it has to be clearly acknowledged that the US dollar is particularly weak at present in a global economy where rising commodity prices are ensuring that many nations are suffering from rising inflation. And that could get much worse if the events in North Africa and the Middle East continue to push Brent Crude and WTI further into triple digit territory.

In the fullness of time it could well become manifest that Chairman Bernanke has been following an imprudent course. His belief, and the received wisdom of many mainstream economists, that the US will somehow stay immune from higher input prices, including food and energy, could well turn out to have been a momentously significant misjudgment.

Also noteworthy was his firm reassurance, when interrogated on the matter, that the Fed has not actually been monetizing the debt of the US when it keeps taking hundreds of billions of US Treasuries onto its balance sheet. Just how he was able to say that quite so blithely remains a bit worrying. His rejoinder to this allegation, expressed somewhat diffidently, was to articulate his long term plan to sterilize the present QE related accommodations by eventually selling all of this Treasury paper back to the private sector.

Even for an optimist the best that could be said of this exit strategy is to express the hope that this procedure will work out as smoothly as he seemed to be suggesting. For a realist, the preferred approach would be, if not already doing so, to begin investing in a variety of inflation hedges including ETF's which provide exposure to commodities (e.g. DBB, GLD, DBC, REMX etc.) and also, in the longer term to be considering instruments which move in the opposite direction to the prices of long term US Treasuries such as TBT, which moves up as yields move up.

As Dr. Bernanke repeatedly pointed out in his testimony, higher yields on the mountain of US debt would be very troublesome for the US public balance sheet. It will be just as troublesome for those holders of longer term UST's that either want, or have, to sell those notes and bonds in the secondary market.

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