How the Fed Playing with Matches Can Affect Your Investments

By Dan Amoss
November 2, 2010

We could see some fireworks in the market this week. We have the midterm elections in the U.S., of course. But we also have what some are billing one of the most important policy meetings of the Federal Reserve is its history.

The Fed is boxing itself in, allowing the markets to dictate its decisions. Over the next few years, as a huge portion of the national debt needs to be rolled over, political pressure on the Fed to keep rates low will grow dramatically. With repeated doses of quantitative easing (QE), the Fed risks surrendering its remaining shreds of credibility and independence.

If bond investors lose confidence in the Fed, then financial markets will be in serious trouble. It may happen soon, depending on how aggressively QE2 is implemented. In his latest Investment Outlook, Bill Gross of PIMCO hits the nail on the head: “Check writing in the trillions is not a bondholder’s friend,” Gross writes; “it is, in fact, inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic.”

PIMCO’s opinion matters, as it’s the largest bond manager in the world.

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Gross concludes with his view that the 30-year bull market in bonds is over, or nearly so. This is huge news. He’s essentially saying that PIMCO will look to hit the Fed’s bid for the Treasuries currently sitting in PIMCO’s inventory. Then PIMCO is likely to sit on its hands in the Treasury market until yields are much higher.

This may represent a prudent course of action for the PIMCOs of the world, but what of other Treasury bond holders — banks, insurance companies, and foreign central banks? What if they look for the exits? If so, the Fed would have to print much more money than it expects in order to “cap” or “target” long-term Treasury yields.

This is why the Fed is playing with fire starting next week. It was one thing to open the “liquidity” floodgates in 2008 when everyone wanted to dash to cash, no matter how cheap the assets they had been holding. It’s another thing entirely to try to use monetary policy to lower unemployment. This notion is so ridiculous that only an academic in an ivory tower could dream it up. It’s very likely to fail, and when it does, the financial markets won’t like it. The bond market could start looking more like it did in the late 1970s than in did in the 1930s.

Gross lays blame for reaching this unpleasant state on the spendthrifts we elect to Congress. That’s only partly true. Past Congresses could not have spent nearly as much if it weren’t for the Federal Reserve.

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Since the end of the gold standard, we’ve been left with a Ponzi paper currency system — one without any guarantee that its value will be safeguarded by constraints on its supply. The concept of funding investments with savings went out the window a long time ago. Now, new credit largely funds investments. The mantra of propping “demand” up — by any means necessary — is the mainstream economist view. This begs the question: How can you have demand without supply? The answer is you cannot — not for very long, anyway.

A country that consumes far more than it produces can live off its accumulated capital for a while, until it self-cannibalizes. Claims on production and capital can be handed out with gusto. Today, they take the form of new Treasury notes and new U.S. dollars. But sooner or later, producers begin to question the value of those paper claims. At that point, they require a few more currency units to part with a unit of their production. Saudi Arabia lifting its target range for crude oil prices would be just one example.

Control over the world’s reserve currency is a privilege that shouldn’t be abused. Yet the Fed has abused it, and doesn’t look to be letting up.

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Savers and investors could choose to implement their own monetary policy. It’s pretty certain that more and more people with capital will shift a percentage of their assets to gold, as insurance against a bonfire of fiat currencies.

Savers and investors must cooperate if central banks are to achieve their absurd “goals” of tweaking the economy here and there. If Ben Bernanke is giving savers no reason to treat the U.S. dollar as a store of value, then it should be no surprise that they will not.

If QE2 backfires, resulting in continued price strength in “undesirable” items (i.e., food and energy), then the Fed will be compelled to tap on the monetary brakes.

Meanwhile, in the wake of the market’s “QE2 anticipation rally,” technical trading conditions are signaling danger for bulls in the near future.

Dan Amoss

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Details On How To Profit From Promoted Penny Stocks

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Timothy Sykes – How To Avoid Losing $25k Like I Did

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How Not to Get Spooked By Penny Stock Charts

By Greg Guenthner
November 1, 2010

For traders, stock charts can give a wealth of knowledge about how a stock is trading. They can tell you if a rally could ensue – or if it’s time to unload your shares. Follow this advice to avoid finding false positives in your buy and sell signals…

Charting isn’t some bizarre cult that works off magic and hope. It’s actually the opposite. It works because human nature is predictable. People investing in stocks will follow predictable trading patterns more often than not. If you learn to find these areas in charts that will coax investors to buy or sell, you can make money by trading stocks. It’s that simple.

However, many traders get the basic principles of support and resistance totally wrong. It’s critical to view support and resistance levels as flexible zones, rather than unbreakable points that always trigger a big move. In fact, if you see a stock break below short-term resistance intraday, you could be getting clues as to how strong the buyers really are.

Here we have a stock that had traded in a narrow range for many weeks. If you owned shares while the stock was trading in this channel, you might have been tempted to sell when it broke support during the trading day. But notice how every time it dropped below support, strong buying pushed it back before the end of the day. This is a great indication that investors aren’t willing to part with their shares at lower levels and that buyers are willing to pay the higher prices to add to their positions. Also take note that the volume was strong as the stock rallied back to its channel.

In these situations, it’s best to wait for the market to close before deciding that it might be time to part with your shares. Fake outs like these happen all the time, both at support and resistance. Without volume confirmation and some follow-through, the move might not be the real deal…

If you had been spooked out of your shares on one of the days when the stock briefly dropped below support, you would have missed the powerful rally just a couple of weeks later when the stock convincingly broke resistance on heavy relative volume.

Greg Guenthner

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