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QE3 Isn't Coming This Summer -- Buy These 4 Stocks Instead - views
BALTIMORE (Stockpickr) -- QE3 isn’t coming for investors -- at least not yet. Here’s why you shouldn’t care.
There’s been a lot of talk about QE3, the nickname for the Fed’s next projected round of monetary easing. Put simply, it’s a program where the Fed starts buying financial assets in an attempt to stimulate the economy. While the idea of QE3 was unthinkable in the first few months of 2012, it became a big buzzword again as soon as Mr. Market crapped out in April.
So what’s wrong with the Fed swooping in to save stocks? For starters, that’s not what the Fed cares about.
Lots of people think that QE3 is going to come about as a reaction to poor performance in stocks, or real estate prices, or jobs numbers. But the third round of quantitative easing isn’t some shot in the arm that gets administered when stock prices are struggling. Sure, Ben Bernanke does plenty of hand wringing on TV about tough stock markets when he speaks to congress or to the media, but there’s only one metric that the Fed is trying to control directly with QE3: inflation.
The Fed has publicly said that it's trying to target a 2% inflation rate. But again, that’s not really what’s going on. Instead, they’re just trying to keep inflation above that 2% low water mark. And when the inflation meter goes too low, Bernanke and company just dump a bunch of cash into the marketplace.
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For the last couple of months, since the QE3 talk reemerged, I’ve been watching the Fed’s 5-Year Forward Inflation Rate. It’s a number that basically works out the inflation rate that’s being priced into the Treasury’s TIPS securities, and for the last few years, it’s predicted QE like clockwork.
Here’s the key: Every time forward inflation dips below 2.2%, we get another round of quantitative easing.
First, it happened back in late 2008, when inflation slid below 2%. In mid-2010, the Fed caught it earlier, not letting the number dip below that 2.2% level before announcing QE2. And it happened again in September 2011, when the Fed announced Operation Twist in what was effectively a QE3-lite. Each time that number has tested 2.2%, the Fed announces a new monetary easing program.
With the Fed’s 5-Year Forward Inflation Rate sitting at 2.6% as I write (and trending higher), I’m betting that QE3 isn’t going to happen this summer. Does that mean it won’t happen? Of course not -- but inflation has been slow-moving enough recently that if we start to move toward that 2.2% level, we’ll get at least a little bit of advance notice.
Why You Shouldn’t Care About QE3
Obviously, inflation isn’t a number that exists in a vacuum -- so when inflation drops, it’s often accompanied by drops in market values. But don’t think that QE3 is strictly a good thing.
After all, when the Fed’s buying Treasuries, there can be some nasty consequences.
That’s because dumping money into Treasuries hikes Treasury prices, dropping risk-free interest rates at the same time that money printing is inflating the dollar. So interest rates are lower and inflation is higher, which means that investors have to suffer through a toxic environment where it’s impossible to get a real return on their money. We’ve already seen extreme examples of this in places like Switzerland, where two-year bond yields went negative.
Yes, investors are paying Switzerland to hold onto their money for them.
Buy Gold This Summer
But there are alternatives right now that can make money, especially if QE3 isn’t coming. The first is gold. Gold prices got shellacked back in September, when Operation Twist sucked all of the demand from the yellow metal and shoved it over to Treasuries (a lower-risk option thanks to the Fed’s public buying). But gold is a hard asset that’s not dollar-denominated, so it stands to do well as a flight-to-quality play in low-rate environments like this one.
Gold miners are one of the best bets right now. As a group, mining stocks have been trading at a discount to the value of the metal they own, so if gold could rally from a lack of QE3, gold mining stocks could stage an even higher run. Newmont Mining (NEM) is a perfect example -- the $25 billion mining firm has 99 million ounces of proven reserves, a hoard that’s worth more than six times as much as its market capitalization.
Newmont has mines all over the world, with North America making up just 33% of total gold production last year. One result of that is a low production cost – Newmont’s mines in places like Peru and Indonesia are extremely profitable, contributing in large part to the deep double-digit margins that the firm earned in the most recent quarter.
Better still, the firm’s 2.77% dividend yield is linked to the price of gold, which means that it’s a way to earn income for your portfolio that isn’t tied to cash right now. Like many other gold miners, Newmont also has significant copper production, giving it industrial metal exposure that takes some of the pressure off of a gold rally if the economic situation changes, and QE3 does come into play down the road.
Yamana Gold (AUY) is another miner that’s an attractive way to take advantage of gold’s upside. Yamana isn’t as cheap as Newmont on the basis of its gold reserves, but it has managed to turn out impressive growth since it was started back in 2003. Just as important, Yamana sports some of the lowest production costs in the industry, averaging just $450 per ounce last year. So even though gold has pulled back since September, the 1,600 and change it currently commands in the marketplace still looks like a profitable venture for AUY.
While Yamana’s growth has been financed by debt, the company’s massive gold production has moved the firm’s balance sheet into a positive net cash position since last year. Yamana is up close to 20% since spot gold prices bottomed last month (see 5 Stock Charts Every Investor Needs to See for more on that), putting it in a good position to benefit from further upside in its favorite metal.
Buy Value Stocks This Summer
Value stocks are another asset that could benefit from no QE3. I know that sounds fishy, but bear with me.
All markets are connected, and money flowing into Treasuries after a Fed quantitative easing announcement has to come from somewhere. In the past, it’s come from stocks. Back in September, Operation Twist knocked the wind out of a slow-forming equity rally as investors piled into Treasuries behind Bernanke, who’d already said that he was going to be bidding government bonds higher. Why would you own risky stocks if you knew that you could get capital gains out of Treasuries with effectively zero risk?
Without QE3, stocks stand to actually recover from the correction that’s gotten so many people anxious this summer. To take advantage of the trend, it makes sense to focus on value -- after all, the S&P is fundamentally 20% cheaper than it was this time last year, and there are bargains to be had again.
Corning (GLW) is a perfect example. The glassmaker is the biggest supplier of super-hard Gorilla Glass for the iPhone, and it’s a major manufacturer of the glass and ceramic substrates used in LCD screens. But the big thing to like about Corning is its bargain price right now.
Corning currently trades for just 87% of book value -- in other words, if you dismantled the firm and sold off its assets at book value, the money each shareholder got would be more than the $12 and change that GLW currently trades for. While the firm has a lot more cash sitting on the balance sheet than I’d like to see in a high inflation, low interest rate environment, Corning has been good about returning that cash to shareholders in the firm of a dividend payout.
An increase to its 2.3% yield in 2012, or better yet a bigger share buyback plan, makes sense as Corning tries to return some of that cash to shareholders.
Beer brewer Molson Coors (TAP) is another good example of a stock that should do well in this environment. The company is one of the largest beer brewers in the world, with brands that include the eponymous Molson and Coors as well as Blue Moon, Keystone, and Miller Lite.
Molson Coors has significant international exposure, a factor that’s been a drag on earnings in the past as currency translation costs ate into income statement performance. While that’s not likely to change immediately, a softening dollar could at least reduce the spread between dollar and euro price performance.
This “sin stock” has also been taking advantage of big trends in the beer industry to find growth opportunities here at home. The firm has poured resources into the craft beer segment, one of the fastest-growing areas of the alcoholic beverage space. While craft beer offerings aren’t going to supplant the firm’s mass-market offerings, they have the potential to provide top-line growth and deeper margins in 2012.
On its balance sheet, TAP is a net debtor, a position that’s not bad to be in when inflation is higher than interest rates. At the same time, a history of dividend payouts should help avoid the perils of holding onto too much static cash.
To see these anti-QE3 trades at work, have a look at the QE3 Isn’t Coming Portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.