No Exchange Benefits More from QE 3 than the TSX Venture

By Aaron Hoddinott

Managing Director

Pinnacle Digest

"The Fed confirmed Thursday what many had expected - that it would buy US $40 billion worth of mortgage backed securities every month, launching its third round of quantitative easing on Friday. And it acknowledged it will continue to print money to make those purchases even after there are signs of stronger growth in the economy and employment"

The Financial Post

(financialpost.com)

Bernanke has made it clear that his only solution for the US economy is to throw more money at it- and quite frankly, what else can he do?

In Bernanke's defense, the Fed's dual mandate, which is overbearing in my view, is to ensure full employment and combat inflation. He can certainly combat inflation, just look at what Volcker did in the 80's. However, for the Fed to ensure full-employment, it would require a conducive government which provides an economic and fiscal environment which promotes growth. The US government has done very little to support that type of environment. Both the Obama administration and congress need to come together and eliminate the uncertainty surrounding the so called 'fiscal cliff' or risk another credit rating downgrade for the US. The government tactics of deficit spending to promote jobs while simultaneously stepping up regulation has failed miserably.


Both Republicans and Democrats need to align themselves for the better of the country and start compromising on fiscal policy. They need to put together a budget for the country, figure out a long-term tax plan and improve the regulatory environment. Without clear and concise plans, the private sector will remain in a state of nervousness and uncertainty. That is not a pro-growth environment; and it leaves Bernanke without any options other than to throw money at all problems and hope that Washington begins functioning again. So unless Washington starts to operate in the best interest of the American economy, the only winners of these quantitative easing programs will be those who hold hard assets and equities.

Prior to the QE 3 announcement, Bernanke had already injected nearly $2 trillion through QE 1 and QE 2. These programs did very little to help the employment rate in the US, but they greatly benefited most members of Pinnacle Digest - as almost all of us hold significant positions in commodity based equities (particularly the junior resource opportunities).

We are set to once again benefit greatly from Bernanke's latest round of quantitative easing. I wanted to take this week to explain exactly how previous quantitative easing programs have influenced the TSX Venture, as well as what I see for the index over the next six months.

The TSX Venture - The Greatest Beneficiary of Quantitative Easing

There is no better gauge for risk tolerance in the market than the TSX Venture. When loose monetary policy is implemented, this exchange thrives as risk aversion dissipates.

In the midst of the 2008 financial crisis, slow growth and high unemployment took a lot of the 'risk money' out of the stock market. At that time no exchange was harder hit than the TSX Venture. It fell to its lowest level of all-time and was largely forgotten as risk-tolerance was gone. As things got progressively worse, the Fed was forced to stimulate the economy through its policy of quantitative easing. Bernanke announced on November 25, 2008 that QE (now known as QE 1) would be starting immediately, with the injection of $600 billion (later on that amount was increased to $1.2 trillion). He also included in his speech that the program would run until June 2010.

On November 25, 2008 the TSX Venture closed at 719.96 - down over 2000 points from the start of the year. Within two months of the first QE announcement from Bernanke (Nov. 25 2008) the Venture was up to 859.69 (up 20%). Four months later, the TSX Venture was at 961.02 (up roughly 34%). Six months after the first QE announcement, the Venture was at 1,124.80 - up 57% in that time period. Twelve months after, the Venture was at 1,436; almost a 100% increase in exactly one year. The Venture was the best performing index in North America for that time period.

It's important to remember that Bernanke let the public know, when he first implemented QE, that it would conclude in June 2010. By April 9, 2010, 2 months before QE 1's scheduled conclusion, the TSX Venture was beginning to stall, and it closed at a post-2008 crash high of 1,680 (16.5 months after QE was announced). The market was well-aware that Bernanke's QE program was concluding in June and the 'risk money' was running to the exits (as it was believed to be the end of loose monetary policy). By the start of July 2010, the TSX Venture had officially re-entered a technical bear market - it had lost over 20% of its value in just three months.

The Fed saw liquidity leaving the overall market by mid-summer and started to worry. After the Jackson Hole meeting in August 2010, Bernanke indicated another round of QE (dubbed QE 2) was coming. The announcement was made on August 27, 2010. Essentially, the Fed was printing $600 billion to purchase U.S. Treasury bonds.


Once again, the TSX Venture would be saved. That speech from Bernanke in Jackson Hole indicated to investors that the risk trade was back on and boy did it ignite the TSX Venture. Within a month of that announcement from Bernanke, the Venture was up 250 points (hit 1,707 on September 27, 2010) - an increase of 17%. Within four months of announcing QE 2, the TSX Venture was up roughly 62%. Given the loose monetary policy, the Venture was unaffected by the usual tax selling and hit 2,188 by Christmas. Within six months of announcing QE 2, the Venture was white hot and hit 2,437 - an increase of roughly 67%. Again, during that time period, the TSX Venture was the best performing index in North America.

By the spring of 2011, the market was a year wiser and more privy to the influence of the Fed's QE programs. When announcing the launch of QE 2, Bernanke made the same mistake he did with the initial round of QE. He informed investors it would conclude in June 2011. Naturally, by March of 2011, we saw the TSX Venture (the best risk gauge on the planet) begin to sell-off sharply - a few months in advance of QE 2's conclusion. It was nearly identical to the sell-off we saw a couple months prior to the conclusion of QE 1 - except this time the selling started even earlier.

More than a year after QE 2's conclusion, Bernanke finally announced QE 3. Subsequently, the TSX Venture suffered its longest correction ever. Take a look at the chart since March 2011's high:

When loose monetary policy is in place, the TSX Venture thrives better than any exchange in North America. Bernanke has learnt his lesson from previous QEs and wants to keep the market in the dark as to when QE 3 will conclude. He led us to believe that QE 3 will remain open-ended and in place for as long as it takes, even after the economy starts to recover. Given the indefinite time commitment of $40 billion a month in liquidity for mortgage-backed securities, combined with the extension of 'Operation Twist' until year-end, this is going to be the most aggressive round of QE ever. And the market has no idea when it will end! It is Bernanke's objective to keep the end-date a mystery so investors won't begin to sell assets prior to QE 3's conclusion.

Expect the next six months for the TSX Venture to be extremely robust. There will be frequent project financings, which will lead to large drill programs, which in turn will lead to new discoveries. And discoveries are why we play the TSX Venture. As Rick Rule stated "Nothing pays like discovery".

I think a conservative six month target for the TSX Venture is 1,810 - roughly 40% higher than where it was prior to the announcement of QE 3. It currently sits at 1318.10. Most of the gains in the next six months will be front-loaded. I believe there are a ton of opportunities on the Venture which are primed to make investors massive profits. I also believe that over the next six months the TSX Venture will be the best performing exchange in North America.

Where do I get my prediction of 40% from?

* Within six months of QE 1 being announced, the Venture was up 57%

* Within six months of QE 2 being announced, the Venture was up 67%

In anticipation of more headwinds now than in recent years (US fiscal cliff, potential rating downgrade for the US, European economic troubles etc.) and an overall more doubtful and pessimistic investor sentiment these days, I think 40% in six months is still CONSERVATIVE as it would be much less of an increase than the previous QE rallies. And I make this prediction despite the fact that this round of QE is more aggressive than those previous.

I have little doubt that the actions taken by the Fed will eventually lead to an economic collapse, dangerous inflation (potentially hyperinflation) and a loss of world reserve status for the USD. However, before that all happens, there will be fortunes made in both the equity and commodity markets - two sectors we are focused on. We are now in a situation where, as opportunistic investors, we can't fight the Fed. We must quickly reap profits through sectors that benefit from loose monetary policy. By stating that the Fed will be purchasing $40 billion per month in mortgage-backed securities, for an indefinite amount of time, Bernanke has shown us how little value the US dollar really has left. To be so reckless and loose with its authority to print the world's reserve currency, the Fed has shown just how bad the US economy is and how over-valued the USD is.

~ Aaron

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