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Broad markets have shown a positive response to the details of the European Central Bank’s (ECB) Outright Market Transactions (OMT) programme and the Federal Reserve’s decision to embark on a third round of quantitative easing (QE3). Investors should not underestimate the effect that these actions will have.
The ECB’s plan involves injecting money into the government bond market in order to push peripheral bond yields down and reduce the risk of investing in the eurozone. The Fed’s actions are aimed at tackling high levels of unemployment in the US and constitute an outright easing of monetary policy, which we believe will most likely stoke higher appetite for risk among investors during the fourth quarter of this year.
Open-ended QE will encourage risk taking and speculation and may force very risk-averse investors away from bonds and cash, which are offering yields significantly below inflation. We believe investors should take the cue from the Fed and begin to look for beneficiaries of QE in an attempt to generate returns higher than the inflation that this policy will eventually create.
It was notable that yields on US long-dated bonds rose, rather than fell, on the latest announcement from the Fed. The market is obviously more concerned about the future inflationary consequences of this loose monetary policy, rather than the impact of the $40bn (£25bn) of bond buying every month, which should push yields lower.
Many bond investors have benefited from the precipitous fall in interest rates, based on extreme aversion to risk. It is worth noting that the double-digit capital return from owning a 10-year gilt in the past year will go the other way in equal measure should interest rates return to where they were last year (2.6 per cent at the end of September 2011 compared with 1.5 per cent at the end of August 2012), and experience a significantly larger drawdown if bonds start to yield more than current levels of retail prices index inflation.
We have taken out short positions in bonds that are at all time low yields to benefit from this potential, rather than be hurt by rising yields, which will happen to most funds with a fixed strategic allocation to bonds.
Monetary policy tends to have a big effect on commodity prices in general. Investors should be making sure that they have some exposure here. We expect further appreciation in precious metals as investors pile into assets which they believe will protect them from the inflationary fires being stoked by loose monetary policies.
We expect the fundamental arguments for all precious metals will be buoyed by central banks until employment is strong enough to warrant a change in policy, which will likely be 2015 at the earliest. Our preferred exposure is to platinum, which has the store of value and precious metal characteristics of gold, but also may benefit from the reflationary forces pushing up industrial demand for catalytic converters and oil refining. Platinum prices also stand to benefit from the strikes and general unrest in South Africa, which is disrupting production. Approximately 70 per cent of the world’s production is based in South Africa, which leaves the potential for price spikes on any deterioration of the situation.