Fed’s Big Move, Gold Goes Wild, Buy or Sell China? And More!

by Addison Wiggin & Ian Mathias

  • Fed changes the game… how the FOMC statement “sealed the next big move up” for tangible assets
  • So is inflation a sure thing? One chart that should give you pause
  • Dan Denning on the real purpose of the Fed’s big move… and how you could benefit
  • Dollar in the dumps… even famous perma-bull burns his greenbacks on live TV
  • Plus, the debate begins: Will China be the global economic savior or “the next Detroit?”

 

  “I have a strong feeling,” short sider Dan Amoss wrote us yesterday afternoon, “that this decision has sealed the next big up move in gold, oil and other valuable tangibles. And by a big move, I mean multiples of current prices over the next few years.”

  In a single breath, the Fed committed another $1.15 trillion to the credit quagmire. The dirty details:

* $750 billion for purchasing mortgage-backed securities from Fannie Mae and Freddie Mac (on top of the $500 billion the Fed has already promised)

* Another $100 billion directly toward Fannie and Freddie’s debt. That’s also atop a pre-existing $100 billion program

* The knockout blow… the Fed will officially begin buying “longer-term” U.S. Treasury notes. The FOMC said they’d spend at least $300 billion over the next 6 months.

  Yesterday’s announcement could easily balloon the Fed balance sheet to over $3 trillion. We expect that to go even higher by the end of 2009. These are "up to" numbers, mind you. So it may never happen. But the Fed did choose them for dramatic effect. Likewise, we thought we’d show you a chart of the Fed’s balance sheet, if it ballooned as dramatically as last fall:

Lest you become as concerned as our Mr. Amoss, “The Committee expects that inflation will remain subdued,” reads the Fed’s statement. Phew.

  “With the Fed now explicitly supporting the Treasury note and Treasury bond market,” Amoss continues, undeterred, “how will ‘bond vigilantes’ express their displeasure with the inflationary policies emanating from Fed/Treasury/Congress?

“Econ 101 tells us that government-imposed price floors (in this case, for Treasuries) lead to persistent gluts/surpluses… think of farm price supports during the Depression and dumped milk. So today’s action will, unfortunately, only encourage the crooks in Congress to float even more Treasury bills for their pork projects.

“We’re just that much closer to a banana republic after today. The only relief valve for today’s decision that comes to mind is accelerated decline in the dollar’s value against anything tangible. Then again, that might have been Bernanke’s intent, given his ‘fight deflation at all costs’ mentality.”

  Naturally, Treasuries had a historically big day yesterday. The yield on a 10-year note fell nearly half a percent, to 2.5% — its biggest one-day move since 1987.

  “The real goal of the Fed policy change,” suggests Dan Denning from his post in Australia, “is to bring mortgage rates lower and engineer a refinancing boom.”

When the Fed announced its first mortgage-backed security buyback program, back in December, the average 30-year fixed fell to 4.9%. That move was entirely speculation. To date, the Fed has bought only $100 billion of the original $500 billion promised.

Given the size of their latest move, and the huge remaining portion of the previous, the same rate could get closer to 4.5%… what would be the lowest of its kind since the 40s. We wouldn’t be surprised to see 4% 30-year fixeds… a level the FDIC and Obama administration have both publicly sought.

“It’s hard to see how refinancing activity leads to a clearing of the huge and growing inventory of new and existing homes. But maybe the Fed thinks lower mortgage rates will kick off new home buying — or at least stabilize the fall in house prices nationwide. Maybe they’re trying to head of the implosion of option ARM resets. We’ll have to see which mortgage-backed securities they buy.”

Meanwhile, some 8.3 million American homeowners are “underwater” in their mortgages. That should make for a quite a queue for refis.

Yesterday’s Fed announcement junk-punched the dollar in its man business. While we were writing this morning, Larry Kudlow, a perennial bull for all things America, burned a dollar on his show and told viewers of CNBC: “This is the value of our money.”

Traders had already been growing weary of the greenback and getting behind the recent rally in the stock market. But this chart says it all. Can you guess when the Fed released their statement?

That was a 2.7% drop for the dollar index during yesterday’s session — its worst one-day performance since 1971 when the index began. (The index was created in lieu of any solid backing for the dollar under the Bretton Woods exchange rate system. Then-President Nixon, the imperial president, dismantled Bretton Woods on Aug. 15 of that year, blaming a run on the dollar on “international speculators.”)

 The euro grabbed a big sip of wine and celebrated its best daily gain versus the dollar in nine years. The euro goes for $1.36 as we write, up about 6 cents from Wednesday’s low.

  And what a coincidence: The same days the dollar suffers its worst fall in 38 years, a United Nations panel suggested, similar to Kremlin mumblings yesterday, the dollar be stripped of its status as the world’s reserve currency.

“The Americans complain,” Avinash Persaud, a panel member, told Reuters, “that when the world wants to save, it means a deficit. A shared [reserve] would reduce the possibility of global imbalances."

 

According to Reuters, Persaud, a one-time currency strategist at JPMorgan, argues a similar point as we did in The Demise of the Dollar: The next natural choice for a global reserve currency would be the Chinese yuan.

A common reserve currency might negate this situation, he said, but he expects the yuan will assume that role within “decades.” To which, we add, maybe sooner.

“As we used to say when I worked in Texas,” said Byron King, after checking gold prices today, “Sumbitch!”

Indeed, gold snapped right out of its recent funk after the FOMC announcement. The spot price is up over $50 over the last 24 hours, to $950 an ounce as we write. That’s the beauty of the stuff during times like these… just as its advantage as a crisis hedge started to fade, gold’s inflation-proof status jumped back into the spotlight.

(BTW, the gold move put yet another of Steve Sarnoff’s picks in the money. He’d recommended calls on GLD, the gold ETF. Yesterday’s 6% bump in the spot price corresponded to a 45% spike for those plays, which are currently up 81% in just 3 days.. If you’re interested getting Steve’s recommendations yourself, tonight is your last chance to take advantage of our 600% guarantee on Options Hotline).

  Oil is off to the races today, too. The FOMC move bumped the front-month contract up $3, and today you can add another $3 a barrel, to $51. Same trade here as gold… inflation, it’s a-comin’.

  Another week, another record number of Americans on unemployment. Continuing claims for jobless benefits exceeded 5.4 million last week, the Labor Dept. said today.

  “China will be the new Detroit… as in the new post-auto industry apocalypse Detroit,” writes a reader, responding to Wayne Burritt’s bullish defense of Chinese stocks yesterday. “And the rest of Asia should follow suit.

“China’s GDP numbers alone are reason to doubt Wayne’s case. China compares its growth year to year, not month to month or even quarter to quarter, the way we do in the States and elsewhere. So you don’t get a picture of a growth trend that’s gone south toward the end of a year. For instance, China’s 9.4% GDP growth in 2008… doesn’t say anything about how, according to Merrill Lynch, its growth was zero in the final quarter.

“And zero growth in China is a very, very big deal. More so than in the U.S. How come? Because the country’s greatest asset — a massive, work-hungry population — is also its greatest liability. China absolutely must add 15 million new jobs every year to keep up with population growth. That means it’s in deep doo-doo if it sinks below 5% growth, a number that anywhere else would make it ‘Millah time’… even during a worldwide boom.

“And car sales surged in China? Maybe so. I thought I read a stat that said otherwise. But either way, China has some 80 car companies… not three. Meanwhile, in nearby Japan, car sales are half what they were in the boom years… nearly two decades ago. That doesn’t bode well for China.

“Maybe China can continue to fool the world when American consumers are slapping down credit cards, but when that dries up… an enormous number of ground gears in the Chinese miracle machine start to squeal.”

 “I couldn’t agree more with Wayne,” says our small-cap man, Greg Guenthner, referring to the same comments, “when it comes to the potential that still lies ahead for Asian nations like China. You can deny the validity of GDP and other indicators all you want to, but you can’t deny the power of a new middle class.

 

“Between 1990-2005, China’s middle class population grew from a measly 15% of the population to 62%, according to The Economist. That’s millions of people who suddenly have money in their pockets. This is what Homi Kharas of the Brookings Institution calls the ‘sweet spot of growth.’

“A middle class is the vehicle that launches an economic powerhouse — just look at post-World War II America. Right now, Asia is busting at the seams with a huge majority of the world’s middle-class population.”

The 5 responds: We haven’t made up our mind yet. We see the argument for a strong and growing middle class. And have been arguing for years that the Chinese have been playing in this century the role the U.S. played in the 19th century, as the low-cost producer of the world. There were booms and busts in the U.S. all throughout the 1800s, but ultimately, the productive capacity of the economy led it to be the dominant economy on the planet.

Still, that productive capacity has been heavily dependent on the Western consumer culture and loads of free and easy credit. If those days are gone, we’re not sure domestic demand in China or across Asia has developed enough to keep the miracle glowing. And we have an even healthier disrespect for Chinese government stats than we do for the American variety.

Frankly, we’re leaning toward the China bust scenario. Having said that… now you know what our editorial meetings are like. They can get quite passionate and, umn, loud. You want to join the debate? We’d be curious to hear whether you’re a China bull, like Burritt and Gunner… or leaning the other way.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S. Just one more reminder: The 600% guarantee for Options Hotline expires this evening at midnight. Inquire within, here. This is an interesting environment for options trading. There are many surprises to the upside… Steve can help you enjoy them.

 

 

rspertzel

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