Previously, I wrote about the implications for the stock market once the latest round of Federal Reserve intervention, known as QE II, ends. That is a real concern, but I also have questions about the impact of QE II on commodities. My two questions are:
- Have commodity prices been driven by QE II?
- What is likely to happen to commodity prices when QE II ends?
Under Chairman Ben Bernanke, the Federal Reserve has popularized a form of economic stimulus known as quantitative easing (QE). The first round of QE expired a while back and now we are in the last phase of QE II. QE II is scheduled to finish up by the end of June.
This report spells out the details [emphasis added]:
Top Fed officials believe the securities purchase program has been effective and has helped improve the economy’s performance in recent months. Some want to see how the economy performs later in the year without it. The recovery, in this view, might be likened to a child riding a bicycle with training wheels. How will it perform when the added support comes off?
What is left unsaid here is that the Fed is deathly afraid of the deleveraging process that is underway in the private sector. Real estate prices are falling. Families and individuals and businesses are cutting debt, either by paying it off or going through foreclosure. The only entity actively taking on more debt is the government.
Stocks & QE II
I’ll get to commodities in a moment, but first take a quick look at the impact of QE I and QE II on stocks (See Stocks, the Fed & QE II). I believe there is a correlation between the impact on stocks and on commodities.
Check out this chart that shows the recent history of the stock market coupled with significant QE events (click to enlarge):
Source: Calculated Risk
The blue line shows the ups and downs of the S&P 500 from January 2008 to the present time. The red annotations show the timing of significant QE events (if you want to see a bigger version of the chart, just click on the link above).
The stock market peaked in May of ’08 and headed south. The bottoming process coincided with the initial announcements (November & December 2008) and later expansion of QE l (March 2009). March 2009 was also the bottom for the S&P 500. When QE l ended on March 31, 2010, the stock market continued its rally, but began falling over the summer. Then, in August 2010, Fed Chairman Bernanke made remarks suggesting that another round of QE would be forthcoming. Stocks rallied and continued rallying after QE ll was announced in November.
Will the end of QE ll hurt commodities?
With QE ll almost certainly ending on June 30th, what does this mean for commodities? First, have commodity prices been driven by QE II? Second, what is likely to happen to commodity prices when QE II ends? Take a look at this chart and then we’ll talk (click to enlarge):
The gold line is the CRB Commodity Index which shows an amazing correlation to Federal Reserve Treasury purchases which is the black line.
As you can see, when QE I ended in March 2010, commodity prices plunged. Later that summer, when discussion of QE II kicked in, commodity prices went up dramatically, closely correlated to Fed purchases which also soared. Assuming this correlation holds true when QE II ends, look for commodity prices to soften.
Precious metals prices are likely to be impacted by this as well. And, gold and silver prices tend to soften in the summer anyway, so the end of QE II could exacerbate that normal cyclical softening.
Hat tip: Barry Ritholtz