Sunday, October 31, 2010

The US Fed takes centre stage

North American markets were little changed this week ahead of a very important week. The Dow slipped 0.1% lower, while the S&P 500 moved up 0.02% for the week. Overall, October continued with September's impressive gains, with the Dow gaining 3.1% and the S&P 500 rising 3.7% for the month.

Early in the week, the end of the G20 summit and a lack of significant news from the summit gave traders the signal to continue selling the US dollar. As a result, the yen was at a 15-year high at 80.4 yen versus the US at one point in the week. The euro hit US$1.405, while the Australian dollar hit US$0.9954.

During the week, U.S. September pre-owned homes sales rose 10% to 4.53 million houses, the second consecutive monthly increase. US 3rd quarter GDP rose 2% over the same quarter in 2009, which was 0.3% higher than 2nd quarter's 1.7% growth. However, it was lower than economists' expectations of 2.1%. In addition, the Reuters/University of Michigan consumer index fell in October from 68.2 to 67.7.

Gold shines on Diwali

Gold rose 2.3% this week, breaking above the US$1350 level and ending the week at US$1357.59/ounce. Gold has fallen since hitting a record high of US$1387/ounce two weeks ago. Investors had become concerned about the size of QE2, and gold's rapid rise in recent weeks. However, it received support in recent days from the Indian Diwali Festival. 

One very important week

Investors have arguably been looking forward to next week since Federal Reserve Chairman Ben Bernanke's statement on August 27th. Markets have climbed substantially higher because of expectations for QE2. In fact, the S&P 500 has gone up 8.8% in September and 3.7% in October, two traditionally poor months for stock markets. 

In the early part of October, investors had priced in a QE2 of US$1 trillion to be announced November 2nd and 3rd. However, analysts and strategists have since stated that QE2 is more likely to be about $500 billion. In fact, recent reports have suggested that QE2 will be carried out over several months, and not in one big lump sum. 

I wrote an article on this blog on October 17th stating that “an announcement for QE2 of less than US$1 trillion could leave investors disappointed and stocks heading lower”. That is exactly the same analysis that analyst Mark Faber reportedly stated this Tuesday, as well as many others. However, while most investors will likely be disappointed by a QE2 that amounts to no more than $600 billion in the first few months, the prospect of cheap money could see North American equities heading as much as 10% higher. In fact, that is partly the reasoning behind the US Federal Reserve's QE2, which is to increase Americans' wealth by driving stock markets higher with cheap money.

Gold will shine regardless of QE2's size

Regardless of the direction of North American equities post-QE2, it appears nearly certain that the price of gold will be heading higher. A large QE2 would certainly send gold skyrocketing because of a weaker US dollar, while a smaller QE2 could get investors worried about economic growth, thus sending their money into the safety of gold. I see the recent pullback in gold as a temporary breather, as investors wait and see what the US Fed does. QE2 is a certainty at this point. Thus, regardless of its size, gold will be continuing its uptrend for the rest of 2010 and into 2011.

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