GLD And SPY Are Buys During QE

Includes: DIA, GLD, SPY, TLT
by: Logan Corbin

Many marked the end of the gold trade when Credit Suisse called an end to a bull rally this spring, spurring selling in the gold ETF (NYSEARCA:GLD), which suffered a 52-week low as a result. Many are reeling in their positions on precious metals including silver (NYSEARCA:SLV) due to low inflation rates and especially the fear that the end of QE will challenge the investment. Equity investors fear the same for the S&P 500 (NYSEARCA:SPY) but there will be no tightening yet, therefore the recent slowdown in the S&P 500 and the pullback in gold have created opportunities for investors. Many investors are at odds with Credit Suisse but their points are valid, albeit preemptive.

The market pulled back yesterday on many concerns about global growth despite affirmation from Japanese and European Central banks for economic support in those areas. Many are still concerned over the Federal Reserve potentially ebbing or ending their stimulus program. The Federal Reserve met last in April and it seems that dissension is building on the board of directors, with some pointing out mixed data on economic activity and a growing balance sheet as reasons to taper bond buying or raise the interest rate. Investors peeled off profits after the minutes from the Federal Open Market Committee (FOMC) hit the public because of the concern that the Federal Reserve would end their economic stimulus. Make no mistake, the end of QE will be painful for U.S. Treasuries and equities, but that challenge is not entirely framed yet and there is ample time left in the QE program for new highs to be reached making a bearish sentiment premature. Moreover, the gold trade will remain intact during QE; expect the trend to continue despite what may be happening in equities.

Accommodative Fed

Chairman Ben Bernanke and Vice Chairman Janet Yellen are widely considered to be dovish central bankers who are very accommodative in their policy views, they are not likely to pull the rug out on stimulus before the economy is balanced and prepared for growth. That said, there is no precedent for this stimulus package coupled with such low interest rates. There is little chance Bernanke or his likely successor, Yellen, will approve any contractionary rate hike soon, but eventually economic and political pressure will cause rates to be pushed higher.

The Federal Reserve will act within its mandate to ensure price stability and low unemployment (high productivity). Investors selling at the thought of interest rate hikes simply because stocks have headed to record-breaking levels are misled. Interest rates will only be used to reign in unsustainable growth. Before interest rates increase, tapering of bond-buying would be of more imminent concern. But there again, in favor of price stability, Quantitative Easing will likely continue since short term inflation is well below the target of 2%.

A low inflation environment in a context of uncertainty about long term inflation is an excellent environment for gold appreciation and justifies its historically high price. Since there is concern about growth and productivity but not of prices, then to expect more QE is only natural. With more QE, expect S&P 500 and Dow (NYSEARCA:DIA) increases as well as a reversal in treasuries (NYSEARCA:TLT) with rates decreasing as the government will remain a buyer of bonds until they see apparent and consistent domestic growth. All of this liquidity manufacturing is also good for gold and silver

Time Left for QE

The effect of rising interest rates will negatively affect the bond market as well as the stock market. The best way to analyze an issue is usually the simplest. As rates increase, productivity will slow because it costs more to borrow/expand, spending will decrease because there is more incentive to save and the result is lower earnings and slower growth. Ultimately, the stock market is driven on earnings, if that driving force slows then the wind will be knocked right out of this rally. Bernanke and the Fed are well aware of investors' concerns and are not going to risk all of their economic development over the past several years by tightening too soon.

The accommodative Federal Reserve is still in easing mode while European and Japanese Central banks are also very stimulus oriented, there is an implication for precious metals as well. Stimulus is rampant around many of the largest global economies and as that occurs while markets are still uncertain, the strongest demand for gold and silver from an economic standpoint should occur while stimulus continues. With prices slumping in metals, this could represent a lucrative buying opportunity in metals as well as the market.

Chart forSPDR Gold Shares

The reaction investors took when considering the end of QE was a knee-jerk pullback and while based in valid concerns, they are very premature. Assuming the bull rally stays intact, a technical view would put the top-end of the S&P price channel at a stunning $1800 by the end of the year. More surprisingly perhaps is that gold could recover quite nicely as the fundamental (global economic asset growth) and technical support remains despite calls for lower prices. The upper end of the price channel could easily top $210 before the end of the year should the themes of global stimulus and uncertainty remain.

Most investors are not going to stand on the sidelines while the market presses higher though they should prepare themselves for a macro-economic event. One way to buy broad market protection is through the S&P 500, or Dow index puts, another is through buying calls on the volatility index (NYSEARCA:VXX), if allocated correctly, these strategies will enable investors to continue be long in this market and in gold while insuring against a significant pullback resulting from the end of QE. The single-most important factor in the bull-rally today is the Federal Reserve; dips will continually be bought as the opportunity remains in equities and gold until the Fed exit from QE in 2014.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. I am not a professional advisor; my interpretations of the market are independent and should not be construed as investment advice