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Central banks around the world have been printing money like it is going out of style. It appears that Europe, England, Japan and the United States all believe that there is no limit on how much liquidity can be poured into the financial system. In fact, the European Central Bank and the Federal Reserve have both taken an “unlimited” approach when it comes to their respective bond-buying programs. However, much like an American Express card, just because there is no clearly stated spending limit, does not mean a ceiling can not be reached.
Hedge fund manager David Einhorn, who is well-known for shorting Lehman Brothers and Green Mountain Coffee Roasters, recently released his Greenlight Capital quarterly investment letter. The founder and president of the firm regularly provides an entertaining and colorful outlook on the economy, as well as investments. His latest letter takes issue with the massive amount of spending by central banks.
“This buying binge brings to mind American Express cards, which are famous for their promise of no pre-set spending limits. But as some AmEx customers have learned, there is a spending limit – they just don’t tell you what it is. AmEx anticipates how much you can repay based on your annual income and your payment history. When your charges exceed their estimates, they cut you off until you pay off your balance,” Einhorn writes. “Central bankers should keep this dynamic in mind, as they continue to run their printing presses. While the ink may be endless, the market’s tolerance is not (though there is no sign that it is nearly exhausted). Like American Express, the market won’t let the central bankers know what their spending limits are until they have exceeded them and get cut off.”
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While the market has not yet cut off central banks, there are certainly worrisome signs. On September 13, the Federal Reserve launched its latest spending spree, QE3, also known as QE unlimited. The quantitative easing program fills the Fed’s shopping bag of agency mortgage-backed securities at a pace of $40 billion per month, for as long as it feels is necessary. Even if financial conditions improve, the central bank plans on keeping its finger on the print button until well after an economic recovery takes place. The past QE programs have served as a launching pad for equity prices, but Mr. Market appears to be getting tired of the Fed’s shop till you drop strategy. All three major equity indices now trade below the levels seen at the time of the QE3 announcement. Discussions are even heating up that the Fed will be forced to replace Operation Twist with a non-sterilized program by early next year, in order to keep asset prices propped up.
Precious metals are also trading below their QE3 announcement day levels, but as this earnings season is proving, gold and silver have much better fundamentals than equities, and tend to outperform during central bank shopping sprees. Between such a strong surge in the third quarter and October being a historically weak month, it is not too surprising for gold and silver to be consolidating. Looking at the bigger picture, the price of gold has doubled since the Fed’s first QE program, while the price of silver has tripled. In comparison, the S&P 500 and Dow Jones Industrial Average have gained 65 percent and 55 percent, respectively.
As history shows, when governments or central banks engage in reckless spending and currency devaluation methods, people often turn to hard assets to protect and preserve wealth. In addition to successful equity positions such as Apple and Sprint, Einhorn credits gold for his 9.4 percent overall return in the third quarter. The latest Federal Open Market Committee statement shows that the central bank has no plans of slowing down their shopping spree, but if gold and silver prices are any indication, the Fed’s spending limit and ability to artificially boost the economy may be reached sooner than some realize.
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Disclosure: Long EXK, AG, HL, PHYS