The comical thing is ECB repeatedly said it cannot directly buy bonds from the peripheral countries. Instead it lent unlimited amounts to Europe's banks. This effectively pumps liquidity into the banking system. Any bank in Europe with any form of collateral with government guarantee can pledge it and borrow at 1%. So a European bank can buy a Spanish bond that pays 1.75% for 1 year and pledge it with ECB, borrow at a rate of 1%. Effectively the bank earns 0.75%.
I was surprised that the US stock markets fell tonight. But I believe it will soon rally at least until January 2012. Under such a scenario, I will do the following asset allocation:
30% Amundi Volatility World USD
20% DB Systematic Alpha SGD Hedged
20% Schroder Gold SGD Hedged
30% First State Global Resources SGD Hedged
My focus will be a lot on alternatives. I am still not very convinced that the stock markets will rally because the EU is in a recession and it is hard to fathom that QE, however big can push stocks up. Back in Sep 2010, stocks rallied after QE2 by the US Fed because economic data turned upwards sharply. I am still watching that space.
Below is a picture of Amundi Volatility World. It is one of the few funds that went up by 5 - 10% after May 2 2011.
CTAs like DB Systematic Alpha didn't do very well, but still it's ability to long and short prevented it to drop sharply in Aug 2011. It's still up 1 - 3% since May 2 2011.
I've been heavily buying Schroder Gold this year. It is uncorrelated with the stock market. I've drawn a comparison between Schroder Gold pink, top line, vs MSCI Asia x Japan (orange line) vs MSCI World (green line). It has outperformed equities. I am quite sure that when the new year comes and institutional investors return from their holidays, gold will resume its uptrend and hit 2000 in 2012.
http://seekingalpha.com/article/315252-the-ecb-may-have-brought-some-glitter-to-gold-for-christmas
"Two of the ECB’s new programs have been drawing investor attention. First the ECB has been saying it will only buy a limit of 20B Euros of sovereign debt per week. However, the committee deciding this limit meets every two weeks to decide the limit going forward, and there has been significant talk of making the limit 20B to 30B Euros per week. With approximately 4.35 weeks in a month, this means the ECB can spend approximately 87B to 130B Euros on sovereign debt a month. Even if you take the 87B Euro figure as the high limit, this is the equivalent of a maximum of approximately $114.5B per month that the ECB can spend on sovereign debt. By comparison, the US Fed’s QE2 program amounted to only approximately $70B/month. The ECB already has the okay to far exceed what the US Fed did. The idea that the ECB is not doing the same kind of QE the US Fed did with its QE2 program is a fallacy. The ECB’s program is potentially several times the size of the US Fed’s program.
The second program drawing investor attention is the ECB’s new LTRO (Long Term Refinancing Operations) program. This is an attempt by the ECB to help banks overcome the 720B Euros' worth of funding due to mature next year (and other large amounts in the ensuing years). It provides for virtually unlimited 3 year loans by the ECB to EU banks who have the collateral to offer up. The ECB is encouraging virtually all banks to take advantage of this program in order to reassure the markets of the stability and the liquidity of the EU banks. The ECB does not reveal the individual names of the participants. The ECB said today, Wed. Dec. 21, 2011, that 523 banks requested a total of 489B Euros ($641B) in funding from the ECB. The US market's reaction to this so far has been negative as it is far more than the median estimate of about 300B Euros. Still I think once the market figures out that the EU bankers would have to be morons not to be availing themselves of this program, the markets should rebound.
We have already seen some positive results from this program. The recent Spanish 3 month T-bill auction on Tuesday paid an average yield of 1.735%. This was down dramatically from the 5.11% in a similar auction a month earlier. Why was the effect so dramatic? Short term T-bills are not in much danger of default. Therefore they are acceptable as collateral. This means banks can buy Spanish T-bills for a yield of 1.735% (currently). Then they can assign the T-bills as collateral for the ECB LTRO 3 year loans. The banks will profit by 0.735% per year on the deal if the ECB’s lending rate is 1% (the current rate). What a cushy deal! Any bank not availing itself of the ECB’s largess is falling far behind the pack.
The Euro/Euro carry trade these banks are effectively entering into is pumping money into the sovereigns' economies. It may be only dramatically lowering the 3-month T-bills right now, but it is having a trickle down effect on the longer dated sovereign bonds. For instance, the Spanish 10 year note yield is at 5.1% today (Wed. Dec. 21, 2011). This is down significantly from its November high of approximately 6.7%, and it is down from its recent secondary peak of approximately 5.8%. 5.1% may still be too expensive for Spain’s economy, but it is a significant improvement. Plus this yield may go further down as the ECB’s strategy may eventually make longer dated T-bills acceptable as collateral. This would have an even larger trickle down effect to longer term notes and bonds. Eventually even notes might be acceptable as collateral. This strategy follows the “patience” theme of the ECB.
Further the banks now have all the extra interest to use to try to shore up their finances. When you are talking about 489B Euros, this is not insignificant. It can provide needed liquidity by itself. If the banks treble borrow, the interest on two parts can pay the interest on the part borrowed for liquidity’s sake (and then some). Of course, the banks are already likely getting interest on whatever non-carry trade securities of their own they are using for collateral. If the ECB lowers its interest rate even further, this program will work more heavily in the banks' favor. This may mean it will result in even lower sovereign T-bill yields (and so bond rates). Since this is desirable, one might expect the ECB to lower interest rates further in upcoming meetings -- more QE.
The recently passed, nearly $1T US Spending Bill is still more liquidity for the markets. Plus it ensures that the US government will be funded for the near future. This is a weight off the markets‘ shoulders. With all of the above events, even with the still present credit crisis, it makes sense that we will see a rally in commodities, especially in commodities such as gold used as a hedge against inflation (liquidity). In fact, gold has already started to rally. It has rallied from its recent low of $1562.50/oz. to its current price of $1628/oz. The gold mining stocks have just started following it upward. If the money managers do indeed want a Christmas rally, the above data and other recent positive data such as the US new home data and recent Initial Claims data should help the money managers engineer a Christmas rally. If you believe this is not only a possible, but a probable outcome, you may want to invest in gold stocks for the near term (and perhaps for the longer term).
All of the major currencies have shown signs of weakness. The universal currency -- gold -- is going to become more important (more valuable) instead of less over the next several years. Many will look at it as an important way to preserve value. We may see it fall further in an EU recession, but it will with strong likelihood pop back up to even higher prices with any recovery.
