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Silver has been selling off relentlessly
since the Federal Reserve expanded its third quantitative-easing campaign
last week. As that decision was highly inflationary, silver’s
subsequent weakness has really vexed traders. But its counter-intuitive
selloff had nothing to do with fundamentals. As the Fed’s past QE
campaigns demonstrated abundantly, QE3 will eventually prove to be very
bullish for silver’s fortunes.
Quantitative easing is a pleasant-sounding
euphemism for debt monetization. Historically this dangerous practice
has been scorned because it ultimately unleashes serious inflation.
Monetizing debt is exactly what it sounds like. A central bank chooses to buy
bonds, and then conjures up the money to do so out of thin air.
This new money is injected into the economy as the bond sellers spend it,
igniting inflation.
The rapidly-expanding money supply grows
much faster than the underlying economy. So relatively more money chases
after relatively less goods and services, which bids up their prices. As more
money is poured into the system, each unit has less purchasing power.
Inflation is ultimately an oversupply of money, which quantitative easing
greatly accelerates. Investors flock to precious metals in such times.
The supply-and-demand dynamics of gold and
silver protect and multiply capital when central banks are inflating
their money supplies. Since fiat money can be wished into existence instantly
in unlimited quantities, its growth vastly outpaces the naturally-constrained
growth in global precious-metals supplies from mining. A lot more currency
competing for relatively less silver inevitably drives up its price.
So make no mistake, the Fed’s
decision to more than double QE3 last week is wildly bullish for
silver going forward. The Fed just announced an unprecedented tidal wave of
money-supply growth from debt monetization that is going to start hitting our
economy’s shores in January. The recent silver selling is the result of
unrelated
bearish psychology, and such extreme sentiment anomalies never last for long.
Why is QE3 so bullish for the white metal?
Because its probable scope
dwarfs
that of QE1 and QE2, and both of those earlier inflationary campaigns
eventually worked wonders for the silver price. This first chart shows silver
over the Fed’s QE era of the past four years, along with QE’s
growth. The direct injection of new money into our economy from the
Fed’s debt monetizations is a great boon for
silver.
This chart is updated from a more comprehensive study of
the Fed’s QE campaigns I wrote a couple months ago. When the Fed
creates new money to buy bonds, these purchases grow its balance sheet which
is shown in orange. The yellow and red lines, which are stacked like an area
chart, show the types of bonds the Fed buys through QE, mortgage-backed
securities and Treasuries respectively.
And it is the red Treasury buying we want
to focus on today. Of all the debt a central bank can choose to monetize, its
government’s bonds lead to the most direct inflation. Central banks
only print money to buy their government’s debt when it is living far beyond
its means. Thus all the money created to buy these bonds is spent
nearly as rapidly as the issuing government receives it. It flows directly
into the economy.
So it shouldn’t be surprising that
the Fed’s unprecedented quantitative easing over the past four years
corresponds exactly with Obama’s extreme record deficits. As
unchecked federal-government spending soared to a quarter of the
total US economy, the Fed monetized increasing amounts of the resulting
deluge of new Treasuries. And as the government immediately spent all this
newly-created money, silver surged.
All three of the Fed’s QE campaigns
were introduced in two stages, to blunt their psychological impact on
inflation expectations. QE1 was born in November 2008 and expanded in March
2009. Through it the Fed created an epic $1750b out of thin air to buy bonds,
but only $300b was allocated for Treasuries. They were gradually monetized
over roughly 15 months, working out to buying of about $20b per month.
And how did silver do over this entire QE1
span? Awesome, it rocketed about 80% higher! Of course this gain wasn’t
just from QE1 and its relatively-small Treasury monetizations.
As a hyper-speculative metal extremely sensitive to sentiment, silver was
ripped to shreds in the epic fear of the stock panic. So as QE1 was launched,
silver started from a very depressed base. Still, the QE1
inflation was very bullish.
Today traders are freaking out because
silver hasn’t been skyrocketing since QE3 was born a few months ago.
But look at its behavior during QE1. Though silver rose mightily on balance,
it still experienced periodic sharp selloffs like in the second quarter of
2009 and first of 2010. Other times it just ground sideways and consolidated.
Silver is and always has been volatile, traders have to accept
that.
Though the inflation unleashed by
quantitative easing is a strong tailwind, many other factors
affect short-term silver psychology from time to time. Greed can erupt to
catapult silver higher far faster than QE alone warrants, and fear can crush
silver much lower than fundamentals merit. But normal sentiment-driven
selloffs within a timeframe where the Fed is monetizing certainly don’t
make inflation less bullish.
Since QE1 miraculously failed to
significantly raise mainstream traders’ inflation expectations,
the Fed was greatly emboldened for QE2. It was exclusively Treasury
purchases, the purest form of inflation from debt monetization. And it
weighed in at a whopping $900b over about 10 months, although the first third
of this was from rolling over already-monetized mortgage-backed
securities into Treasuries.
So we are talking about a $90b-per-month
rate of Treasury monetizations. And as you can see
above, during this QE2 span silver skyrocketed. It ultimately blasted a
staggering 177% higher in 9 months, its biggest upleg
of its secular bull by far! QE, especially the direct inflation that comes
from monetizing Treasuries, is very bullish for silver. But like QE1, QE2
didn’t mean silver never experienced weakness.
In August 2010 when the Fed announced the
rollover of maturing MBSs into Treasuries, it wasn’t called QE2 at the
time. And silver surged dramatically after this, largely for other reasons. It
wasn’t until QE2 was tripled in November 2010, to intense
global political criticism, that it actually became known as QE2. But right
after that QE2 expansion that would ultimately prove wildly bullish, silver
consolidated.
This metal had just rocketed 39% higher in
less than 3 months, thus it was short-term overbought. So silver climbed a
bit higher into late 2010 before selling off sharply in early 2011. Silver
lost an eighth of its value in several weeks despite the Fed’s QE2
Treasury monetizations being very bullish. Sound
familiar? Later in May 2011 silver plummeted after getting wildly overbought, QE isn’t its only driver.
Nevertheless, over the entire span of QE2
silver still powered 89% higher! This is despite the near-crash after silver
euphoria grew far too extreme in that mammoth QE2 upleg.
When the Fed is aggressively growing its balance sheet by buying bonds with
freshly-conjured money, especially through Treasuries, silver investment
demand surges. Silver has always been one of the best assets in inflationary
times.
Interestingly after QE2 ended in the middle
of 2011, silver continued correcting sharply. Though the Fed was shifting its
Treasury allocation from shorter term to longer term through what became
known as Operation Twist, it wasn’t growing its balance sheet. The
tailwind of new QE inflation was gone, so silver investment demand and prices
naturally deflated. But correction
sentiment was the dominant factor.
Silver didn’t really start showing
some sustained signs of life until QE3 expectations really began to flare
late this past summer. Between early July and the day in September the Fed
birthed QE3, silver surged 29% in a couple months. So as the next chart
illustrates a little later, this metal was definitely short-term overbought.
And then the initial stage of QE3 avoided Treasury monetizations
for political reasons.
After it expanded QE2 in November 2010, the
Fed was shocked by the resulting firestorm of global criticism. World leaders
condemned this brazen monetization. And more importantly, here in the States
Republican lawmakers accused the Fed of being in cahoots with Obama to
“finance” his record deficits. And Congress can kill the Fed with
a single vote. So the Fed remained wary of monetizing Treasuries.
But QE3’s first stage was still unprecedented.
Instead of a static target like QE1’s $1250b of
mortgage-backed-securities monetizations, the Fed
announced its first-ever open-ended QE of $40b per month
this past September. But the banks and large investors selling MBSs to the
Fed don’t spend this new money right away like the federal government
does after Treasury sales, so the inflationary impact was muted.
Then after Obama won re-election a couple
months later, the Republican political threat to the Fed greatly diminished.
It could continue brazenly monetizing Obama’s record deficits without
an immediate risk to its survival. So just last week, following the pattern
established in QE1, QE2, and even Twist, the Fed expanded QE3. For silver,
this new QE3X is the most bullish inflationary campaign of the entire QE era!
The Fed just announced adding $45b per month
of Treasury monetizations to QE3’s existing
$40b per month of MBS buying, more than doubling the campaign. Now $45b per
month might not sound like a lot compared to QE1’s $300b of Treasury
buying and QE2’s $900b. But QE3 is open-ended. There is no end date. And
based on the Fed’s own targets, QE3 is likely to run for a long time.
We are talking years!
Last week the Fed said it plans to continue
manipulating interest rates to levels near zero “at least as long as
the unemployment rate remains above 6-1/2 percent”. The last time we
saw a 6.5% unemployment rate was over four years ago in late 2008 as the
stock panic started to unfold. Even the economic optimists figure it will take
several
more years before unemployment heads decisively below 6.5% again!
$45b per month of Treasury monetizations for one year works out to $540b, already
dwarfing QE1’s and nearly as large as the new component of QE2. After
two years it grows to $1080b, and three years would take QE3 to a staggering
$1620b of new Treasury monetizations! Not including
the rollovers of MBSs and other already-monetized Treasuries, QE1 and QE2
only saw $900b in total Treasury monetizations.
So QE3 is going to utterly dwarf QE1 and
QE2 combined
in its inflationary impact! The Fed has effectively committed to monetize half
of Obama’s record deficits, which are expected to average $1100b
annually in his second term. And if silver surged 80% during QE1 and 89% in
QE2, which were much less inflationary than QE3 is looking to be, why would
silver not fare at least as well in this latest QE?
The Fed monetizing Treasuries, with the
government then immediately spending this new money and injecting it into the
economy, is highly inflationary. Despite
silver’s day-to-day volatility, investors eventually realized this and
drove massive silver uplegs during QE1 and QE2.
Mark my words, the same phenomenon is going to
happen again as the crazy inflationary implications of QE3 start to sink in.
So with QE3’s coming Treasury monetizations so massive, why hasn’t silver
responded favorably yet? The answer is temporarily bearish sentiment totally
unrelated to QE3. Remember that silver fell sharply at times
during both QE1’s and QE2’s durations, yet on balance it still
soared dramatically. Though QE is a strong tailwind, it is a background
driver. Meanwhile greed and fear batter silver around as always.
Last week in an essay on silver’s young upleg, I discussed the lingering correction
psychology that is a major reason for silver’s recent weakness. Early
in new uplegs few traders believe one is indeed
underway, so they figure any new selling means the correction is back.
Bullish contrarian sentiment remains rare. But a second reason silver has
been weak is because it got too overbought before QE3.
This last chart looks at the 10-trading
day, 20d, and 30d returns in silver over its entire secular bull. These
metrics measure how fast silver has moved. Naturally when it has surged too
far too fast, it is overbought and greed is excessive. So depending on where
silver is in its upleg cycles, either a pullback,
correction, or consolidation is necessary to rebalance sentiment. And that is
what silver has been suffering lately.
Partly due to the anticipation of QE3,
partly due to being very oversold, and partly due to strong autumn seasonals,
silver surged dramatically in late August and early September. After its
massive 14-month correction, this was a lot of fun. But silver got ahead of
itself. At best it was up 13.9% in just 10 trading days, 24.6% in 20, and
27.5% in 30. As you can see above, such extreme rallies are rare and
short-lived.
If silver happens to be in a mature upleg after such incredible short-term runs, it soon
rolls over into a new correction. But following its massive correction that
bottomed this past summer, that sure doesn’t
describe silver’s state in September 2012. It was early in a new upleg,
so the necessary reckoning to rebalance away the excess greed generated by
such a fast surge was merely a pullback or consolidation.
Interestingly, short-lived early-upleg surges are not uncommon. Each of
silver’s five major uplegs of its secular
bull has seen rapid advances early on that were followed by sharp pullbacks.
Yet this selling certainly didn’t short-circuit these uplegs. In fact just the opposite was true. These
pullbacks and consolidations after silver had advanced too far too fast bled
away greed, keeping the uplegs healthy.
Silver’s apparent lack of response to
the Fed’s highly-inflationary QE3 expansion has nothing to do with QE3.
The QE3 Treasury buying hasn’t even started yet,
the Fed isn’t spinning it up until January. Silver simply got
overbought early in a new upleg, and selling
emerged as always to rebalance sentiment. And it has worked. All
the greed that was mushrooming in mid-September has totally yielded to
serious fear.
Gold has been a major factor in
silver’s recent weakness as well. Silver traders have always looked to
gold as their major cue for buying and selling the white metal. Gold is
silver’s primary driver. And due to a combination of poor sentiment and
fund selling, gold has been much weaker than normal this time of year. This
has heavily weighed on silver, and is probably responsible for the great
majority of its selloff.
But don’t get too caught up in this
temporary weakness. Silver rises and silver falls, but there is no doubt
monetizing Treasuries is wildly bullish for this metal. Sooner or later all
the distractions keeping investors from buying silver since the QE3 expansion
will evaporate, and the urge to get deployed will hit hard. Silver nearly
doubled during both QE1 and QE2, and QE3 will almost certainly
prove much larger!
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The bottom line is the Fed’s new QE3
campaign is wildly bullish for silver. Monetizing Treasuries leads to direct
inflation, which drives investors into the precious metals. And QE3’s
Treasury buying is going to utterly dwarf that seen in QE1 and QE2. Yet
silver still nearly doubled during each of those earlier monetizations.
The longer QE3’s monthly Treasury buying lasts, the more capital will
flood into silver.
It’s true,
silver has plunged since this unprecedented QE3 expansion was announced. But
that selling had nothing to do with QE3’s Treasury buying, which hasn’t even started yet. While QE provides a
strong tailwind for silver prices over time, this metal’s trademark
volatility remains intact. The fearful sentiment that drove this recent
selloff will soon dissipate, and silver’s young QE3 upleg
will resume.
Adam Hamilton, CPA
December 22, 2012
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