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Vedran Vuk
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Vedran Vuk graduated with a BBA in Economics from Loyola University of New Orleans. Currently, he is pursuing a M.S. in Finance at Johns Hopkins University. He also spent time on a PhD. economics program. His publications include academic journal articles, book chapter contributions, newspaper... More
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Casey Research
  • The Recent Fed FOMC Minutes Should Anger Every Investor

    With gold dropping nearly 3% on February 20, we at Casey Research had to look closely at the FOMC minutes, which were partially responsible for that movement. Since there are quite a few highlights, I have split this analysis into three sections: the confusion over the minutes in the market; the ambiguous language hinting at deep problems; and a few quotes to make your blood boil.

    The Confusion

    A Bloomberg headline from Wednesday, February 20's news reads Fed Signals Possible Slowing of QE Amid Debate over Risks. This headline is characteristic of most of the reporting on the FOMC minutes. Supposedly the Fed signaled a desire to end the quantitative easing earlier. There was actually no such signal.

    The committee did, however, discuss possible reasons why they might want to end QE4 earlier. Here are some excerpts from the meeting:

    "However, a few participants expressed concerns that the current highly accommodative stance of monetary policy posed upside risks to inflation in the medium or longer term."

    "In this regard, several participants stressed the economic and social costs of high unemployment, as well as the potential for negative effects on the economy's longer-term path of a prolonged period of underutilization of resources. However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability."

    Wow, that sounds pretty serious. It's like the Fed has turned a new leaf. Isn't this a clear signal to the market that the easing will end earlier? In a word, no. Here's the most important excerpt, which came toward the end and which many people may have breezed over or missed:

    "One member dissented from the Committee's policy decision, expressing concern that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations."

    This quote puts the rest of the comments into perspective. There was a discussion of possible risks, but at the end of day, that's all it was, a simple discussion. Although several members expressed concerns in the discussion, when it came down to voting on the actual policy, only a single member dissented.

    This reminds me of our internal meetings at Casey Research. Every two weeks, the whole team - including some guest participants - gets on a conference call to discuss the economy and especially gold prices. During the meeting, some participants will voice concerns about the possibility of weaker gold prices. However, at the end of the meeting, all of us are still long gold. A discussion about a change of direction is not the same thing as an actual planned change of direction. It's healthy to have a devil's advocate in any discussion, regardless of the final decision.

    Now, the fact that the Fed is discussing these problems is certainly significant; after all, they could just ignore the issues. The sheer fact that there was a discussion means there's a possibility that at some point the concerns could become more serious and then turn into action. But that action hasn't taken place yet, nor is the FOMC planning it. So while what happened in the meeting may warrant a temporary weakening in gold prices, it certainly shouldn't have resulted in Wednesday's major drop.

    The Mystery

    A few parts of the meeting were quite intriguing, but the purposely murky wording makes it difficult to completely nail down their meaning. It seems that the FOMC has deeper concerns than those discussed above. Here's the first of these mysterious paragraphs from the minutes:

    "In general, after having been depressed for some time, investor appetite for risk had increased. A few participants commented that the Committee's accommodative policies were intended in part to promote a more balanced approach to risk-taking, but several others expressed concern about the potential for excessive risk-taking and adverse consequences for financial stability. Some participants mentioned the potential for a sharp increase in longer-term interest rates to adversely affect financial stability and indicated their interest in further work on this topic."

    So what does "excessive risk-taking and adverse consequences for financial stability" mean? The next sentence on long-term interest rates offers a clue. Participants warn of a "potential for a sharp increase in longer-term rates." Sure, a sharp upward turn in rates would hurt just about everything, including the stock market, but the sectors that will get hurt the most are real estate and bonds.

    Let's see if we can find out which one they're talking about. I wouldn't exactly describe the current real estate market as an area of excessive risk-taking. Most people still won't touch real estate with a ten-foot pole, and though real estate has heated up a bit, I wouldn't call the recent moves in the market excessive. Bonds, however, are in a bubble - and the yields of risky junk bonds have been pushed down a great deal by investors piling into them in search for higher yield, regardless of the underlying risk. Now this is just my interpretation, but it seems to me the Fed is saying that the bond bubble is a serious problem.

    Here's our next mystery paragraph:

    "A few also raised concerns about the potential effects of further asset purchases on the functioning of particular financial markets, although a couple of other participants noted that there had been little evidence to date of such effects. In light of this discussion, the staff was asked for additional analysis ahead of future meetings to support the Committee's ongoing assessment of the asset purchase program."

    You see what I mean by murky wording. "Particular financial markets" and "little evidence to date of such effects" don't say much. What evidence and what effects, and in which financial market? Apparently, the Fed members find this issue worrisome enough to warrant further analysis; unfortunately, they're not being very forthcoming about it. What it does show, though, is that there are two conversations taking place about risk: one for the public and another one behind closed doors.

    The Anger

    As promised, here are a few quotes that might make your blood boil. If you read through the minutes quickly, they seem benign, but if you stop to think about them, they're infuriating. Here's the first:

    "In 2014 and 2015, real GDP was projected to accelerate gradually, supported by an eventual lessening of fiscal policy restraint, increases in consumer and business sentiment, further improvements in credit availability and financial conditions, and accommodative monetary policy."

    Umm… wait; what "eventual lessening of fiscal policy restraint"? Essentially, the Fed is saying that as economic conditions improve, the American voter will stop complaining, and the government can finally get back to spending wheelbarrows of money. It's scary to think that these additional government spending plans are already reflected in the Fed's GDP projections, but apparently this isn't the only forward-looking policy prediction from the Fed:

    "For example, a couple of participants noted evidence suggesting that a shift in the relationship between the unemployment rate and the level of job vacancies in recent years was unlikely to persist as the economy recovered and unemployment benefits returned to customary levels."

    It seems that the Democrats have been very touchy about reducing those unemployment benefits, and the Fed seems to have a lot of faith in the government doing the right thing. But it's going to be tough for any party to curb those benefits when unemployment rates are even as low as 6%. Let's see what else the Fed's crystal ball forecasts for us:

    "The staff continued to project that inflation would be subdued through 2015. That forecast is based on the expectation that crude oil prices will trend down slowly from their current levels, the boost to retail food prices from last summer's drought will be temporary and relatively small, longer-run inflation expectations will remain stable, and significant resource slack will persist over the forecast period."

    OK, I buy the argument about the temporary effect from the summer drought, but the assumption of downward-trending oil prices seems a bit unrealistic. And if we're seeing growth in the economy as the Fed expects, then shouldn't the Fed forecast rising oil prices to match growing demand? Why even tinker with the numbers in this way? The Federal Reserve doesn't have a comparative advantage at projecting oil prices.

    Here's the last bit worth noting:

    "In addition, the Committee's highly accommodative policy was seen as helping keep inflation over the medium term closer to its longer-run goal of 2 percent than would otherwise have been the case."

    If you read that quickly, you might think to yourself, "Well, that sounds good. I guess they managed to keep inflation closer to the 2% target." But think about what they're actually saying. Their accommodative policy is also known as "printing money." That's a process of pushing inflation up, not down. So, what they're saying is, "Man, we did a good job of pushing inflation up to 2%! Otherwise, it would have been lower." Ain't that just great?

    It's imperative to protect yourself from the Fed's rampant money-printing, as sooner or later it can't help but cause serious inflation. One of the best ways to do that is internationalize.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Feb 28 6:26 PM | Link | Comment!
  • Will Bernanke Save The Equity Markets?

    How far is the Fed from reaching the bottom of its ammunition box?

    Well, both Mario Draghi and Ben Bernanke said no to yet more monetary stimulus last week.

    Wall Street unsurprisingly was disappointed.

    Wall Street expected more stimulus, as institutional investors are analyzing monetary policy from their own perspective rather than the central bank's viewpoint - understandable, but a big mistake.

    Wall Street's Conundrum: with the S&P 500 up less than 7% in 2012, the year is almost over, and the investment firms have little to show for it.

    This 7% return might be OK in calmer markets, but instead investors have been taken on a rollercoaster ride - all for a measly 7% return.

    So what could send stocks higher?

    Well, if the European crisis just disappeared, things would turn for the better… but that's not likely to happen.

    Or perhaps if US unemployment finally moved downward… but that's not going to happen either.

    The only short-term savior for equity markets is another round of extreme monetary stimulus, which will keep things propped up a bit longer.

    Hopefully in that time, unemployment and the general economy would improve, which would lead to a reduction in the fiscal strain on troubled governments.

    So Bernanke has control of the only immediate game-changer left on the table, and he's not playing Wall Street's tune.

    Without that money, Wall Street faces the reality of a stagnant market.

    Frankly, fund managers don't need a meltdown to be badly hurt here; failing to produce adequate returns is a bad enough outcome.

    After all, how many people would place their money in a high-risk market after a few years of low single-digit returns?

    Probably much fewer than today.

    As a result of this conundrum, Wall Street sees monetary stimulus as the only way forward - hence the strong belief that Bernanke and Draghi will produce stimulus at any moment.

    To Wall Street, this makes sense, but unfortunately for them, the Federal Reserve has different incentives.

    Bernanke realizes that he is low on bullets. The last few landed way off target, and his final bullet might miss the mark even more so.

    Bernanke is stuck with two options here: he can fire off his last bullet now (as Wall Street desires) and can send the market up maybe 1,000 points on the DJIA.

    Or he can wait to save this last bullet in case the market crashes.

    But if Bernanke shoots his bullet now and the market crashes anyway, he's going to go down in history as the worst Federal Reserve chairman ever.

    And if he tries to shoot the gun again in an emergency after he has overheated it, Bernanke might very well send the economy into a hyperinflation.

    In such a scenario, he would become a cautionary tale for econ graduate students for the next hundred years (and I'm not kidding about that… economists are still discussing the monetary policy of the Great Depression).

    Would you take such a risk for a couple of hundred extra points on the DJIA? I don't think so.

    Wall Street's incentive and Bernanke's couldn't be further apart on delivering another monetary stimulus before it's desperately needed.

    You may ask yourself:

    "Didn't Bernanke boost the stock market only a few years ago? Why wouldn't he do it again now?"

    Times change. A few years ago, Bernanke had a lifetime wealth problem on his hands regarding the average US consumer. When someone loses 25% of their home's equity and their 401(k) crashes by 35%, they become shell-shocked as a result of their total lifetime wealth taking a sudden large dip.

    Economists understand that the spending behavior of someone with a $500,000 nest egg saved for retirement isn't the same as for a person with half as much.

    It's really a simple concept: when we feel more comfortable about our future, we can spend more today.

    Even if one had no risk of losing his or her job in the crash, personal spending habits would often change in reflection of reduced lifetime wealth.

    Beforehand, by boosting equity markets, Bernanke could stimulate the economy by increasing everyone's sense of their lifetime wealth, inducing them to spend more in the present.

    Unfortunately, as we've reported on many occasions, this strategy didn't work so well.

    Now Bernanke again holds the option of boosting equities with yet more stimulus. Will another thousand points on the DJIA really send the economy back into a recovery?

    Most likely not.

    That said, another round of monetary stimulus isn't completely out of the question.

    A High-Risk Gamble: However, with the possibility of a European-led market crash around the corner, an early stimulus would be a very high-risk gamble in Bernanke's eyes - a gamble that may seal his fate forever.

    While Wall Street fund managers are worried about delivering returns to their clients, Bernanke has a million problems on his mind, and equity prices are not one of them.

    Though the market will continue to get overexcited at the possibility of more monetary stimulus, we probably won't see another round of a truly massive program until things really hit the fan and the Fed is forced to reach toward the bottom of the ammunition box.

    While Ben scrambles around on the floor for more bullets, investors need to rethink their strategy to get them through to the other side of this crisis, because it's far from over.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Aug 16 9:55 PM | Link | Comment!
  • ETFs: Do You Really Know What You're Buying?

    Exchange-traded funds have been all the rage in recent years - they are easy to buy, easy to sell, and often have lower expense ratios than index mutual funds. But the Casey Research team dug deep into the complex world of ETFs and found that in many cases, their names can be utterly deceptive.

    Here are a few excerpts of our revealing special report, The Top Ten Misleading ETFs.

    Market Vectors Junior Gold Miners (NYSEARCA:GDXJ) - This ETF sure has a funny definition of a junior mining company. In my opinion, a junior miner is a small, speculative company just getting off the ground. Our publication, Casey International Speculator, specializes in this particular kind of company. If I had to put a number on the market cap, I'd say that junior miners fall under the $500 million mark. If you really want to push the definition to its limits, maybe a market-cap ceiling of $1 billion could still qualify for junior status.

    Regardless of the exact line of demarcation, most of us can agree that "junior" means "small." Furthermore, most investors can agree that market caps over a billion dollars are anything but small. A billion isn't a major, but it's clearly in mid-tier territory. That said, the Junior Gold Miners ETF's top 10 holdings are all over a billion dollar or more. The top holding, with 5.23% of assets, even has a market cap of $2.4 billion - that's not exactly a junior, to say the least, and neither are the other companies on the list:

    GDXJ was a flawed idea from the very start. Junior miners are necessarily bad choices for bundling into large ETFs. A large market cap ETF funneling funds into tiny mining companies sounds like a bubble waiting to happen. This is one area where carefully selecting individual plays is the only way to go. And this ETF has come no closer to changing that approach.

    SPDR Gold Shares (NYSEARCA:GLD) - Since the last two funds had problems with rolling over futures contracts, you might be thinking to yourself, "Well, why not just buy funds that actually hold the underlying assets?" That's a genius idea… if it were only so simple. Even SPDR Gold Shares (GLD), a fund that holds physical gold, has much hidden in its fine print.

    At first blush, most investors think that GLD securely protects their gold and that they can retrieve it upon request. Yes, GLD has a giant vault where gold is actually kept. However, exchanging your paper shares for gold is much harder than the click of a mouse that gets you into GLD.

    First of all, to retrieve the gold one must have special permission - meaning one is either a broker or market maker. And there's another footnote worth mentioning: Gold can only be redeemed at a minimum of 100,000 shares of GLD, equivalent to 10,000 gold ounces (a little over $17 million at current prices). For the high rollers reading this article, that might mean something. For the average Joe out there, that means you will never be able to redeem your GLD shares for gold. Those shares are nothing more than pieces of paper - or worse yet, electronic bytes in your account.

    With a closer examination of GLD, even the high rollers are misled by GLD. Deep in the SPDR Gold Shares prospectus, the fund includes an option to redeem gold requests in cash rather than physical metal. So, even if you are holding $17 million in GLD, you still might not receive your gold upon request in the case of a crisis in the gold market.

    But wait - there's more. Though GLD seems like any other ETF, it isn't. GLD is structured as a grantor trust. Hence, the investor doesn't pay taxes similar to regular ETFs. Instead, the investor pays taxes on the underlying assets - in this case, gold. Unfortunately, gold is taxed for long-term holdings at a higher rate of 28% as a collectible instead of the 15% capital gains tax. What seems like a simple fund actually has a world of complicated specifics in the fine print.

    iShares MSCI Emerging Markets Eastern Europe Index Fund (NYSEARCA:ESR) - What do you think of when someone says "Eastern Europe?" The Iron Curtain, stuffed cabbage, kolaches, pierogies… No, besides that. For anyone who's been asleep for the past few decades, Eastern Europe now has more countries than most can count. In the Balkans alone, there's Slovenia, Croatia, Bosnia, Serbia, Montenegro, Macedonia, and even Kosovo… not to the mention all the other countries, such as Romania, Bulgaria, Lithuania, Estonia, the Ukraine… and the list goes on.

    With so many different countries and stock exchanges, an ETF would seem like a perfect way to cover them all. Unfortunately, the MSCI Emerging Market Eastern Europe Index Fund (ESR) will cover none of those countries just mentioned. In fact, the ESR does a better job of covering Russia, with a 76% allocation, than the rest of Eastern Europe - a whole 21% of the fund is invested in Russia's Gazprom alone.

    Besides Russia, the fund only holds a couple of other countries including Poland at 16%, the Czech Republic at 4.1%, and Hungary at 3.4%. Though some companies in the fund may serve Eastern Europe, this is hardly what most investors had in mind for an Eastern European ETF. If investors really want a Russian ETF, those are not hard to find.

    [To find out what the other 7 ETFs are - and whether you might own one yourself - click here for your FREE special report, The Top 10 Misleading ETFs.]

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: etfs, gold, silver, market
    Mar 28 4:00 PM | Link | Comment!
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