Mark Your Calendar11 min read

The markets once again had a volatile week. To be completely blunt, I am getting very tired of the news, the stock market, and the same old political blunders plaguing our future.

For those of you who have been long time readers of the Equedia Letter, you know exactly where I stand. I’ve been talking about accumulating the gold majors since early June. I continue to favour them and I am slowly moving towards the mid-tier precious metals producers now. I still hold my gold and silver ETF’s and maintain my long term bullishness within the sector.

The ETF’s, the majors, and mid-tiers are my hedge for my bets on the juniors – which have seen very little bid support recently. While I expect that to change, I am still cautious as anything can happen.

What do I mean?

According to Goldman Sachs, August was among the worst risk-return months in the past 83 years, down 5.7% with an annualized volatility of 47%. Over that period, this volatility was in the 98th percentile at more than triple its 15% average since 1928. Just 25 out of 1004 months over the past 83 years have experienced higher realized volatility than August 2011. Since 1928, there have been only nine times when the S&P 500 declined more than four months in a row and only four times declining more than five months in a row. We currently stand at four months in a row.

If both September and October end down, it won’t be pretty.

It doesn’t take a rocket scientist to figure out that our near term stock market future relies on a few very important factors: QE3, Europe, and economic growth. All of which end up as one overall factor: Fear.

Europe

Just minutes after the Greece’s finance minister angrily denied rumours that the country faces possible default this weekend, Bloomberg publishes an article stating that:

Chancellor Angela Merkel’s government is preparing plans to shore up German banks in the event that Greece fails to meet the terms of its aid package and defaults, three coalition officials said.

The emergency plan involves measures to help banks and insurers that face a possible 50 percent loss on their Greek bonds if the next tranche of Greece’s bailout is withheld, said the people, who spoke on condition of anonymity because the deliberations are being held in private. The successor to the German government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks, one of the people said.

Greece is “on a knife’s edge,” German Finance Minister Wolfgang Schaeuble told lawmakers at a closed-door meeting in Berlin on Sept. 7, a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament.

The problems in Europe led to a massive Friday selloff in N. America as investors ran for the hills on the possibility of a major Greek default.

Just this morning, German Economy Minister Philipp Roesler said that an “orderly insolvency” for Greece must not be ruled out for the sake of stabilizing the euro.

Canadian Finance Minister Jim Flaherty said that Greece may have to leave the euro if it fails to press ahead with its budget-cutting plans. Today, Greece has already stepped up their plans by imposing a new property tax over the next two years in an effort to meet budget targets that it must fulfill in order to receive new financial aid. Without the aid, Greece is expected to run out of money within weeks.

That’s what happens when a country runs out of money and can no longer print itself out of debt. Taxes are raised and people riot. Eventually, the country becomes bankrupt and all is lost.

With the debt and the spending the US has done and is going to do, these tax cuts announced by President Obama will only be temporary. All Americans will eventually have to pay higher taxes, higher parking rates, and fines across the board will go up. That’s the only way the US will unload just some of its astronomical debt. The US may be the land of the free, but for how long?

QE3 and Big Ben

In a past issue (see America Selling Out), I mentioned that Bernanke has decided to add another day to the September FOMC meeting scheduled for September 20-21. Given the rationale behind the added day, the market is expecting something big.

Previous two-day meetings have seen a higher probability of steps to cut borrowing costs and the added day would undoubtedly add more time to review easing options, even if rising inflation may prevent action in the near term.

One of the strong possible outcomes would be to replace short-term Treasury securities in the Fed’s $1.65 trillion portfolio with longer-term securities, which should lead to lower interest rates for those bonds and other long-term investments. This would make it cheaper for businesses to borrow money for investments and push more dollars into the stock market, in addition to reducing rates on mortgages and other consumer loans.

If the Fed does this, the question will be how much shifting of the composition of bonds will take place. In other words, how much short term bonds will they sell to buy the long ones?

While Fed officials expect the new approach of “twisting” short term bonds for long term bonds to have a similar benefit for economic growth as QE, will the market understand it enough to fuel a market rally? I am not too sure…

The other outcome (the one that I am looking for as an investor) is a strong signal for QE3.

Bernanke wants stimulus. While inflation worries are high on the radar as the prices of practically everything has gone up, Bernanke has maintained his stance that the current rise in inflation is transitory and should moderate in the coming quarters.

Keep in mind the Fed’s preferred inflation gauge, which excludes food and energy, rose 1.6 percent in July from a year earlier. That’s the fourth straight monthly acceleration and the fastest since May 2010.

The only way we’re going to see stimulus in the short term is if the economy gets weaker (which it has) and the inflation picture moderates (which Bernanke has claimed that it will). As I mentioned before:

“QE3 is not what we want for the long term, but we what we need for the short term.”

If a stronger hint of a near trillion-dollar QE3 program is not announced by the end of the two-day event, I fear the markets may not hold up. The Fed needs for us to feel the pain (see Time to Feel the Pain) – its just a matter of how much pain we’ll need to feel before a true QE is announced and implemented. However, by that time, the markets will have suffered irreparable damage and another shot at a QE program will have little to no affect on our market.

September 21, 2011 will be big. Mark it on your calendar.

Perception is reality. If people believe, then it will happen. Since the highs earlier in the year, we have been bombarded with negative news and a grim outlook forcing investors to run scared. As one of the leading indicators for growth and stability, the stock market has faltered and we’re on the brink of yet another selloff.

I am not trying to add more fuel to the fire by telling you things look grim. While fundamentals are there, the overall outlook and negative sentiment is not very promising. If people don’t believe, our markets simply won’t hold up.

On the other hand, if Bernanke makes a prominent hint of QE3 during the two-day FOMC and the European crisis gains some stability, our markets will soar – maybe even making new 2011 highs. If neither is achieved over the following months, it may be time to consider hoarding your cash or trading your stocks for hard assets.

Rare Earths

The price of rare earths have rebounded significantly since dropping more than 25% since mid-July and are currently back to May/June levels, which is still up 300% to 600% since the beginning of the year.

Earlier in the week, China, the top exporter of the valuable minerals, announced it will halt production of rare earths at three of the eight major mines in China.

China already produces about 95 percent of the world’s rare earth minerals and has now capped production at 93,800 tonnes and exports at 30,184 tonnes, saying it cannot sustain the sort of output levels demanded by foreign customers.

Demand for rare earths is expected to double in the next five years, and you can be sure that Chinese output growth is likely to be much slower. This situation has become so dire that officials from the United States, European Union and Japan will gather in Washington next month to find ways of cutting demand for raw materials.

The demand for rare earths and the limited supply could force prices much higher.

I would be looking at big names in the rare earths sector such as Neo Material Technologies, Molycorp, and Rare Element Resources. I’ll also be writing up a bigger piece within this sector shortly in a future letter. There’s also a bunch of juniors I will be looking to accumulate should the equities market gain some stability. If you know of any promising ones, feel free to drop me a line.

While prices are still high, there is still a great opportunity to profit with the recent fall in prices and I think we should take advantage of this while we still can. I expect speculation in this sector to grow even stronger in the coming months.

The rare earths just got rarer.

Until next week,

Ivan Lo

Equedia Weekly

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