Monday, June 24, 2013

Rick Rule: Can the Fed Ever Afford to End QE?

Rick Rule founded Global Resource Investments Ltd. in 1994, and is the Chairman of Sprott USA – which includes money management through Sprott Asset Management USA and retail broker-dealer services through Sprott Global Resource Investment Ltd. On a conference call June 24, Rick laid out his views on the current markets.

“What we’re seeing now is chaos in the markets – that’s the only way to describe it. Interestingly, we’re seeing chaos, but not volatility, as indicated by the options markets. This type of market environment is unusual, since market declines are typically accompanied by high volatility.”

The Fed’s policies have forced investors to enter stocks instead of safer bond investments, says Rick.

“The markets have been buoyed for several years by a flood of liquidity from Central Banks around the world. Short-term credit markets are awash with cash. This short-term liquidity has led to excessively low interest rates, which were in fact negative on an inflation-adjusted basis. In reaction to low interest rates, investors went looking for yield elsewhere.”

According to Rick, the current turbulence in the markets, following Fed Chairman Ben Bernanke’s comments last Wednesday, shows that the markets are still very uncertain about the merits of the current stock market, despite rising stock prices. “Although the markets are extremely liquid, many of the debtors – in particular government entities – are insolvent. I believe that the wreckage we’re seeing right now is being caused by the realization that liquidity is not a substitute for solvency.”

“Last week, Ben Bernanke whispered the notion that the Fed’s $85 billion a month of money printing might come to an end. The sense that the ‘liquidity faucet’ might be turned off was enough to send bonds, stocks, emerging markets, and commodities – including gold, silver, platinum, and palladium – all down the drain.”

The repercussions of Ben Bernanke’s comments are worldwide, Rick continues:

“While the Fed whispered, China whimpered. Liquidity went wild in China overnight. Unlike the Fed, the Chinese Central bank actually did respond by constraining liquidity. The ‘shadow banking’ market, however, allows banks and other financial institutions to sell ‘wealth management’ products, known to you as ‘term deposits,’ circumventing the credit controls put in place by the Chinese government. The Shanghai index collapsed as a consequence of the poor global forecast for commodities.”

Rick doubts whetherQEwill actually come to an end, despite what the Fed says:

“Could the Central Banks in fact end Quantitative Easing? I have long believed that the government deficits in the U.S. are so large that the government cannot sell all of its debts, which is the main reason forQE’s existence. The government buys about half of the debt from itself and I doubt there is room in the debt markets to fund the government’s liabilities without support from the Fed.”

Given the near uniform descent across stocks and bonds alike that we have seen in the past week, Rick says: “Can they ever afford to endQE? If they do begin to ‘taper,’ what impacts will that have on a liquidity-driven market?”

Rick Rule founded Global Resource Investments in 1994. He has an exemplary track record of performance in the natural resources and has originated and participated in hundreds of private placement opportunities. In 2011, Global merged with Sprott Inc. Rick continues as Chairman of Sprott USA.