Business

Investing for QE3

with Emile Wallace-Waddell

Wednesday, October 10, 2012    

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I will be examining the US Federal Bank's Quantitative Easing policy. You may have heard about QE1, QE2 or QE3 and wondered what these abbreviations stand for. Well the "QE" refers to Quantitative Easing and the numbers refer to the particular round of easing. But more importantly, what is quantitative easing? Simply put, it is a government monetary policy tool used by central banks to stimulate growth within the economy by buying up debt which results in lower yields and borrowing costs. Essentially, the central bank injects capital into the economy in the hope that businesses and consumers will take advantage of the more affordable funds for use in expansion and spending.

QE3 was announced on September 13th and started shortly after on September 14th. It entails the purchase of US$40 billion in mortgage-backed securities by the Federal Reserve each month. By doing this, the Fed intends to spur banks to lend more, hopefully resulting in increased expenditure and employment. Of note, the end date of QE3 has not yet been disclosed.

Before QE3, this monetary policy had been put to work by the Fed on two occasions. The first round of quantitative easing commenced in November 2008 and concluded in March 2010. During this period, the Fed purchased US$175 billion worth of agency debt and securities and US$1.25 trillion of mortgage-backed securities. The second round of quantitative easing came in November 2010 and concluded in June of the following year. Between both of these procedures, over

US$2 trillion was injected into the US economy.

QE funds are not printed but are instead electronically created and used to credit the accounts of the banks from which the Fed is buying assets. This money is then introduced to the public in the form of loans. With the announcement of QE3, the savvy investor may wonder: "How can this policy be beneficial to me?" Firstly, the effects of quantitative easing must be considered. One of the main risks associated with quantitative easing is inflation; an increase in the money supply chasing the same amount of goods.

Despite inflation being a risk associated with quantitative easing, it presents opportunity. Commodities are known to be a hedge against inflation due to the fact that their prices usually increase as inflation accelerates. With this in mind an investor can explore the commodities market, commodity-backed stocks or an Exchange Traded Fund (ETF).

During the period when the Fed was conducting QE1, the price of gold skyrocketed by approximately 50.7 per cent to US$1,115 per ounce in June 2010 from US$740 per ounce in November 2008. During the lifespan of QE2, gold gained as much as 15 per cent as gold went as high as US$1550 per ounce in June 2011 from US$1340 per ounce in mid-November 2010. While not entirely due to QE1, the increase in gold prices was partially attributed to

this policy.

Silver is another metal that fared well in the Fed's QE1 and QE2 period. During QE1, silver appreciated significantly rising to a price of US$17.50 per ounce in late March 2010 from US$9.25 per ounce in mid-November 2008. In the QE2 period, silver continued to appreciate and rallied as much as 44 per cent. Nevertheless, there were more issues at play during these times than just quantitative easing, something that has to be taken into account by investors.

For the investor who is interested in an Exchange Traded Fund, SPDR Gold Trust (GLD) is an ETF with the investment objective of reflecting the performance of the price of gold bullion, less the expenses of the Trust's operations. This Trust is more affordable than purchasing gold itself as the cost of one unit in the ETF is US$170.97 (as of October 9, 2012). During QE1, prices rose from US$73.30 to US$108.59 representing a 48.14 per cent gain. During QE2, the price of the Trust's stock appreciated approximately 7.61 per cent. Since the announcement of QE3, the price of this ETF has already started to pick up, presenting opportunity for investors.

In closing, commodities, commodity backed stocks or ETFs are not the only asset classes that stand to benefit from quantitative easing. As mentioned earlier, banks will be more likely to disburse more loans, hence their earnings may rise. These loans can then be used by the public to purchase homes leading to increased income for companies affiliated with the construction sector.

Additionally, since commodity prices advance when inflation accelerates oil and gas companies stand to possibly benefit from increased earnings, giving rise to their stock prices. QE3 therefore potentially provides direct as well as spinoff benefits to investors who are willing to brave the volatile financial currents.

Emile Wallace-Waddell is a Research Administrator at Stocks and Securities Ltd and can be contacted via ewallace-waddell@sslinvest.com

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