Sunday, September 25, 2011

Markets tumble on Greece default fears and Operation Twist

US markets rose on Friday after tumbling for four days in a row. On Friday, the S&P 500 rose 6.83 points or 0.60% to 1,136.39. The Dow added 37.19 points or 0.35% to 10,771.02. For the week, markets tumbled on fear of an imminent default by Greece, and the Fed's unimpressive Operation Twist.  For the week, the S&P 500 dropped 6.6%, while the Dow tumbled 6.4%.

Operation Twist disappoints markets

On Wednesday, Ben Bernanke announced Operation Twist. With the Fed's assets at $2.65 trillion and its Treasury holdings at $1.65 trillion, the Fed will sell $400 billion of its Treasuries that mature in 3 years or less. The proceeds will be used to purchase an equivalent amount of Treasuries that mature in 6 to 30 years.

As a result of the move, yields on 2-year Treasuries rose 20% to 19 basis points, while yields on 30-year Treasuries fell 6.85% to below the 3% level, the lowest level since January 2009.

Gold and other commodities tumble

Because Operation Twist does not involve any new money, gold and other commodities sold off as investors realized that this Fed operation would affect commodities differently than QE2. December gold futures dropped 9.6% this week for its biggest fall since 1983. On Friday, December gold futures fell 5.9% or $101.9 to close at US$1,639.80. 

Meanwhile, silver December futures fell 17.7% on Friday to US$30.101, its biggest one-day fall in history. In addition, copper fell 16.6% this week to US$3.28/pound, while WTI crude fell 0.8% on Friday to US$79.85. 

I see the pullback in gold as the perfect buying opportunity. Nothing has changed for my thesis for investing in gold. Greece has yet to default. Even if Greece were to receive the next tranche in its bailout, the inevitable solution is either a haircut or a default. While markets were disappointed that Operation Twist may not benefit gold as much as QE2 did, an additional round of QE is likely needed, which would boost the price of gold. 

Euro zone officials soothe markets

On Thursday, euro zone officials calmed markets by stating that the EFSF will be expanded to prevent the crisis from spreading. 

China data disappoints

Helping to push markets lower on Wednesday was HSBC's reading of China's September PMI, which fell to 49.4, the 3rd consecutive month below 50. The number raised concern that China might not be able to prop up world economic growth as European and US economies falter. 

Italy downgraded 

On Monday, S&P downgraded Italy from A+ to A, citing slow economic growth and political instability.

Looking ahead to next week

If Greece defaults next week, US markets will likely take a 3%-4%. Banks, in particular, could face a large sell-off. A small haircut, on the other hand, would be better received by markets.

If Greece receives the $8 billion tranche of its bailout from the IMF, EU and ECB, then markets will likely receive a short-term lift. The expansion of the EFSF would also boost markets. However, expanding the EFSF requires each member country to approve the measure, which would take weeks. At current levels, good news could provide markets a temporary lift.

I see current gold and silver prices as a good buying opportunity. Kinross closed at C$15.67 on Friday. It is trading at about 0.7 times NAV, and is below the $16 level which I usually buy, as discussed in detailed in Gold Investing Mastery Guide. Meanwhile, Silver Wheaton closed at C$33.14, which is close to the $30-$31 level that I consider as a very attractive buy.

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