Dodgy and Dodgier

— Hmmm. Curiouser and curiouser? Not really. Try dodgy and dodgier.

— Things are indeed getting weird. The day after Bernanke holds a press conference on monetary policy saying he’s a tad confused as to why the economy hasn’t really responded to an historic amount of monetary stimulus, the price of oil (and gold) tanks.

— Why is this weird? Well, following Bernanke’s speech yesterday, oil prices actually increased while earlier gold nearly breached US$1,560 an ounce. Gold then drifted lower throughout Asian and European trade but when the US futures market opened (last night Australian time) it got hit for six, falling nearly $20 in less than 30 mins.

— Futures volume was huge – meaning a whole bunch of manufactured paper gold hit the market out of nowhere. If you’re new to this game it might sound preposterous. But if you’ve been watching loosely for a few years, these tricks are pretty standard.

— More importantly, if you’re looking to protect your wealth with physical metal ownership, the price correction is just another opportunity to accumulate – courtesy of a bumbling ruling class that is inadvertently biting the hand that feeds it.

— But there was even more bumbling in oil, where a panicked G7 announced the biggest release of strategic reserves since 1991. The FT reports

Oil prices dropped more than 7 per cent after western nations released the biggest amount of oil from their emergency strategic stocks since 1991, in a warning shot aimed at Opec, the oil producers’ cartel.

The International Energy Agency agreed to release 60m barrels of oil in the coming month to offset the daily production loss of 1.5m barrels of high quality oil from Libya, the north African country engulfed in a civil war.

The US led the release with its special petroleum reserve providing 50 per cent of the crude oil. Japan, Germany, France, Spain and Italy are providing most of the rest.

— This is a blatant attempt to lower oil prices and take some heat off Western politicians dealing with a myriad of problems of their own making.

— Let me explain:

— QEI and II boosted asset prices and put a rocket under commodities. But they both failed to improve employment, which is one of the Fed’s mandates. With QEII ending and the US economy again slowing down, the Fed has been criticised for doing nothing but creating inflation through higher commodity prices, which have flowed through to higher food and petrol prices.

— Bernanke wants to conduct another monetary experiment, but that can’t happen with commodity prices still elevated. So if they won’t go down of their own accord, give them a helping hand.

— Oil is the most politically and economically sensitive commodity in the world. Politicians prefer low or at least stable prices, provided the economy is not imploding.

— But releasing strategic oil reserves to do so? That is a new and dangerous development. The loss of output due to the war in Libya is the purported reason but don’t believe it. This is all about lowering oil prices across a bunch of mismanaged economies. The only mystery is why Britain didn’t join in.

— If you put nearly free money in the hands of speculators through irresponsible monetary policy, they will always outsmart you. Cheap money is the real reason behind US$100 plus oil prices. Releasing strategic stockpiles to flood the market and spook the speculators is only a short-term fix. Especially if the intent is to print more money.

— As we mentioned above though, the Fed will find it hard to do another round of stimulus with commodity prices remaining elevated. Check out the CRB Commodities Index below. Last night’s fall saw the index just breach the 200-day moving average.

— While commodities across the board have been correcting since April, prices are still way above the levels that triggered the initiation of QEII. Back in late August 2010, when Bernanke first hinted at QEII, the index was below 270. Despite recent falls, it’s still sitting at 330.

— The problem with QEII is that is has been a failure. There are many who think QEIII or some incarnation of it is a forgone conclusion and that is probably correct. But not yet. Politically, pushing the money printing button from here will be difficult. If it’s not assisting employment and only pushing up the cost of living, Prez Obama will not be so keen on it.

— There will likely be some lengthy discussions about the consequences (that is, whose job is under threat) from more ill-directed stimulus. Expect at least a few more months before you hear anything official. Until then, expect more manipulation and shenanigans in the important markets of gold and oil.

— Thankfully, we have a blueprint for what Bernanke has up his sleeve. While this speech was delivered as a Governor, rather than a Fed Chief, it is one of his most famous and a big reason why he got the top job when Greenspan scurried off.

— The Speech, Deflation: Making Sure “It” Doesn’t Happen Here, is from November 2002 and remains highly relevant. Bernanke has already put many of the ideas contained in the speech into practice. Here are the next ones to ponder as the Fed continues to slowly destroy your wealth and indeed, its own existence:

Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade.

If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities.

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.

— Bernanke did make the point that trashing the international value of the dollar (which such a move would clearly do) was not on the horizon. But what was over the horizon in 2002 is now fast approaching. So whatever the Fed does next, don’t be surprised.

— Discussing the motives of central bankers is not a good way to finish the week, so we thought we’d try and leave a far better taste in your mouth. Plus, we’re still hanging on grimly to our holiday memories.

— Get a load of this dinner for one we had on our last night in Istanbul. As well as all those grilled lamb skewers, there’s a (clockwise) plate of fresh mint, spring onion with yellow chillies straight from Prometheus’ garden, fresh parsley, char-grilled tomatoes, onions and (thankfully) milder chillies, mashed tomato in pomegranate sauce, fresh wild rocket, onion with sumac and, of course. a basket of too much bread.

— Needless to say we couldn’t eat it all, although we did give it a nudge.

— Oh and it only cost about $12…

Greg Canavan
Markets and Money Australia

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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3 Comments on "Dodgy and Dodgier"

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Oh for a free market!Wait, this is a free market and all can play!
Anyway, the potential future trade is an oil shock event together with QE3 in some form. But this will never happen as the oil producing counties are very stable and Big Ben and the Fedheads are in contol.
What do you think, six months for all to go wrong?


I agree with you David. Oil shock on the distant horizon.

QE3 will destroy the notion of investment and make speculation the only form of profit.


Yep oil will bottom soon and rise to shock levels with qe3

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