No Twisting by the Pool for Canadian Insiders or Investors

In the wake of the prolonged 1980-82 UK recession, pop band Dire Straits released a tongue and cheek swing record Twisting by the Pool romanticizing the good life on Europe's Mediterranean coast. The song popped into my mind after reading the Federal Reserve's monetary policy statement today. For some reason, the US Federal Reserve has deemed it fit to try and flatten the yield curve by selling short-term bonds and buying bonds with maturities of over six years. While I know this was rumoured in the market for some time, based on today's late day action in the bond and equity markets I would suggest that there was some skepticism that the Fed would actually do this. They have and this is generally bad news for Canadian resource interests. As we wrote in our August 22nd Market INK update, negative real interest rates were supporting commodity prices and commodity stocks. Since the peak of real 5-year US Treasury yields in November 2008, the S&P/TSX Capped Materials Index is up 125%. However, the Fed today signalled that it is going to try and push up short-term yields. Unless consumer prices start to soar in the United States, short-term real rates will be on the rise. That will increase the carry-cost for commodities and decrease demand for what Canadian miners and energy companies produce. Higher short-term rates will also support the US dollar which is not great for gold, at least in the very short-term. Of course, there are other factors at work in gold's favour such as a Euro banking system on life-support. Canadian gold insiders may indeed be dancing the Eurobeat. We're going on a holiday nowGonna take a villa, a small chaletOn the Costa del MagnificoWhere the cost of living is so lowYeah, we're gonna be so neatDance to the EurobeatYeah, we're gonna be so coolTwisting by the pool - Mark Knopfler of Dire Straits, 1983 On a policy front, my view is that this will turn out to be a big policy blunder by the Fed. First, a flattening yield curve signals a slowing economy. So, why they are proactively doing this is puzzling. Secondly, this will not help the US banking sector which needs a steep yield curve so they can borrow cheap and lend at more expensive rates over longer term loans. There are some mitigating factors. Despite Mark Carney's chest-pounding yesterday about core-inflation being under control, he is failing to keep consumer prices within his mandate. Today's CPI release showed that Canadian consumer prices are at advancing at 3.1% annually which is apparently a surprise to some Bay Street economists. In any event, a rate cut in Canada is out of the question short of a global financial melt-down. That will provide some support to our Canadian dollar which otherwise would likely be on a steady downward dive based on the firming of US short rates under the new twist policy. A strong Loonie is important for Venture issuers with international assets under development as it helps companies reduce their capital raising needs at home. At the stock level, new projects with robust economics can still enjoy success particularly in the mineral area if energy prices fall. However, there will be no rising tide to support marginal projects until the Fed's twist routine is over. With any luck, the US central bank will throw in the towel before June of next year when their dance routine is scheduled to end.

The Fed has created a big mess with its twist routine. While it may not be able to wiggle out of the program, it can respond to the self-created debacle by doing more outright bond purchases. I expect we will see that before March 9, 2012.

I will be interested to see what Canadian insiders do in the face of any stock market weakness. If prices tumble enough, we could see a jump in our INK Indicator. This would likely represent contrarian buying of securities that are being unduly punished in light of their prospects. However, contrarian trades are only for those with strong long-term stomachs.

Disclosure: I am long the Horizons Betapro Comex Copper Bear+ ETF (HKD)

This post originally appeared on INKResearch.com on September 21st, 2011.