|QE1 and QE2 have been very good for stocks, confirmed by Figure 1. Many, including analyst Tom McClellan, have shown through detailed graphs that without quantitative easing and Fed Treasury purchases (Permanent Open Market Operations [POMO]), there would have been no stock rally (see http://www.mcoscillator.com/learning_center/weekly_chart/pomo_the_hot_new_timing_tool/ ).|
|Since the US Dollar Index last put in its major peak in January 2002, the DX has fallen 37%. Meanwhile, commodities have been a huge beneficiary of a weakening dollar, rallying more than 246% since then. A weak dollar has been a real shot in the arm for many tangible goods.|
|FIGURE 1: S&P 500 AND QUANTITATIVE EASING|
|Graphic provided by: www.GenesisFT.com.|
|But what impact has quantitative rasing had on commodities? In Figure 2, we can see it in this new age of central bank intervention. |
As Figure 2 shows, the inverse correlation between the dollar and commodities is strong. Whenever the dollar strengthens, commodity prices tend to fall. As of May 17, this correlation stood at -0.84. The lower horizontal blue dashed line represents a perfect negative correlation of minus 1.
|For investors, this is a good-news, bad-news story. If stock markets (and the economy) react negatively to the end of QE2, there is a strong probability that QE3 will be announced given that an election is approaching when governments have shown a propensity to stimulate their way to voter popularity. |
QE3 should likely have a positive impact on stock prices and the economy, at least short term. But this would also further pump up commodity prices and hurt the dollar. The Federal Reserve and Treasury have demonstrated that while they may talk a strong dollar policy, they are clearly not walking the talk. If QE3 is implemented, chances are considered high that it will further stimulate real inflation.
|FIGURE 2: CORRELATION, WEEKLY. Weekly chart showing the correlation between the US Dollar Index (DX) and the CRB index (CRBX), complete with notes about when QE1 and QE2 were announced and initiated.|
|Graphic provided by: Chart courtesy of www.GenesisFT.com.|
|Fed chairman Ben Bernanke has proven that he is all too willing to print his way to prosperity, even if he has to throw money out of helicopters to do so. But he, along with the rest of us, is learning that this road creates a whole new set of problems that to paraphrase Albert Einstein will require a much more complicated solution to overcome.|
By comparison, the dilemma facing traders is simpler. Without QE3, we will probably see stock and commodity prices continue to correct until there are more convincing signs that the economy is truly on the mend. If QE3 does occur, expect the dollar to weaken further and both stocks and commodities to renew their rallies as inflation gathers more steam.
Over to you, Ben.
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