The Settlement Delay Of MBS Purchases Under QE3 And The Price Of Risk Assets

Includes: GLD, SLV
by: David Vengerov

There has been a lot of speculation lately as to why the Fed's balance sheet has not been growing at the rate of $40B per month since the QE3 announcement on September 13 (the Fed had promised to buy $40B of MBS securities every month). The recent $20B drop in Fed's assets as announced on 11/29/2012 has only intensified the sentiment on this topic. Some people were also wondering why the risk assets such as the iShares Silver Trust (NYSEARCA:SLV) and the SPDR Gold Shares (NYSEARCA:GLD) had a noticeable pullback right after that announcement.

I decided to do a little research on this topic and found a web site for the NY branch of the Fed, which actually performs the purchases of the MBS securities for the Fed. This web site lists all MBS purchases made by the Fed and their corresponding settlement dates. That web site shows that the NY Fed has indeed been buying around $40B of MBS per month on top of their planned reinvestment purchases. It also shows that for all the outright MBS purchases made between 9/14/2012 and 10/11/2012, the earliest settlement day was 10/11/2012. Here is a quote from Wikipedia about the settlement date: "As part of performance on the delivery obligations entailed by the trade, settlement involves the delivery of securities and the corresponding payment." This suggests that NO money from QE3 purchases was transferred from the Fed to commercial banks until 10/11/2012, which explains the pullback in gold and silver that happened after the QE3 announcement (gold and silver had a large rally in *anticipation* of a QE3 announcement, and then a natural "sell the news" phenomenon took place, which was not counteracted by any real money flowing into the system due to QE3 purchases of MBS securities).

The NY Fed web site also shows that of the $78B of MBS purchases made between 9/14/2012 and 10/11/2012, around $15B of purchases have not been settled yet, and of the $75B of MBS purchases made between 10/12/2012 and 11/13/2012, around $60B of purchases have not been settled yet (as of 11/29/2012). However, by early November a large enough part of securities purchased under the QE3 program has settled to start a new leg up for gold and silver, which was likely purchased with the money newly injected into the system.

Most interestingly, the data shows that the earliest settlement date in December is 12/12/2012, and a whooping $46B of purchases made over the last two months will settle on that day!

To me, this implies that the QE3 money will start being injected into the system at the full rate of $40B only after 12/12/2012, and that will start with a HUGE jump in all risk assets on 12/12 or 12/13 (when $46B will be injected into the system in a single day), since the banks traditionally invest a large (if not all) part of the money the Fed gives them into risk assets (that's how Bernanke is trying to lift the asset prices and generate a "wealth effect").

As an interesting coincidence, 12/12/2012 is also going to be the day when the FOMC makes its next statement, and as the minutes of the previous meeting showed, they will likely announce an unsterilized continuation to Operation Twist (purchases of the long-term Treasuries without the corresponding sales of the short-term Treasuries). Quoting from those minutes:

"Looking ahead, a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program in order to achieve a substantial improvement in the labor market."

That announcement should increase the monthly amount of money injected into the system to $85B, and since the Treasuries settle the next business day, that money will start flowing into the system right away. I do not see any reason to expect that the outcome of that announcement will be any different from the outcome of the QE2 announcement in the fall of 2010, which was followed by a huge rally in silver and gold.

Returning to what should happen over the next 2 weeks, it is quite possible that all risk assets including gold and silver will have a mild pullback, since NO money from the Fed will flow into the system until December 12. It is possible, of course, that some hedge funds will want to front-run the large rally in risk assets that should start on December 12 and buy some risk assets ahead of time. So the best strategy to invest based on the information from the NY Fed web site, IMO, is to buy some risk assets (such as GLD or SLV or gold/silver miners) now (if you don't already have a good size position in this sector) and then add to your position if that sector pulls back in the first two weeks of December.

Disclosure: I am long AUMN, OTCPK:PNPFF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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