The Mint: FED QE Aftermath, are there any Bonds left to buy? Canada Keeps Potash Local

11/5/2010 Portland, Oregon – Pop in your mints…

Today it appears that word is spreading throughout the stock, bond, and commodity markets that indeed the FED will support them (and sacrifice the dollar) at all costs. Have any extra bonds laying around? The FED will buy them. In fact, according to one estimate, the FED may now be buying too many of them and "forcing" cash into the stock and commodity markets. From the Wall Street Journal:

"At RBS, Mr. Briggs noted that the Fed's $600 billion in expected purchases, on top of an expected $250 billion to $300 billion reinvested from maturing existing bond holdings, will absorb a large percentage of expected net new bond issuance in 2011. RBS estimates that in 2011, the net new issuance of "high quality" bonds issued by the U.S. Treasury, government agencies and corporations, will total $1.352 trillion.

With the Fed potentially buying $900 billion of that, "it leaves very little for the rest of us," Mr. Briggs said. That scenario would result in downward pressure on yields across nearly the entire bond market, he added."

Mr. Briggs, by recognizing that the FED buying "leaves very little for the rest of us" is simply stating the obvious strategy of the FED. You see, the recent flood of capital into Bonds is the equivalent of the lifeguard screaming "Everybody! Get out of the pool!" Yesterday, the FED announced that it will now begin to run around the pool and push all of the market participants back in, whether they want in or not! Does this seem insane? That is because it is insane!

You see, the FED, through its actions over the past 3 years, is moving in on cornering US Bond Market. Now the Bond Market, at first glance, is a complex beast. Upon further examination, however, you can see that it operates just like any other market, with prices set based on supply and demand. For a peek at what the likely fate of the current Bond market is, we can study any other instance of what happens when a single party or small group working together become the dominant purchasers and holders of an asset. One of the most famous examples of a global market that someone tried to "corner" was the Silver market in the early 80's. The Hunt brothers began accumulating a Silver in large quantities and drove the price to over $50 per ounce (see chart below). For an account of the details surrounding the Hunt brothers' attempt to corner the Silver market, please click here. For an in depth history of the Hunt family which is interesting in its own right click here.

How high can bonds go? How far will they drop? A study of the Silver chart above may guide us to the answer!

The only difference in the case of the FED purchasing bonds today and the Hunt brothers' shenanigans is that while the Hunt brothers were risking their own accumulated capital, the FED is creating the money out of thin air. Since the FED's action is physically and economically impossible, it is better stated that the FED is stealing money in the form of purchasing power from every current dollar or dollar denominated bond holder.

The conclusion of this brief analysis is the following. The FED's artificial demand for bonds will drive up the price of existing bonds for a time. As higher prices spur the "production" of new bonds, the newer bonds will be of ever lower credit quality and more numerous. The FED will then face the same choice it had on Tuesday, print more money to prop up the price of the lower quality bonds and destroy the currency or to let the chips fall where they may and trigger a precipitous drop in bond prices (i.e. let the bond market crash, which it has been trying to do for some time now). In every case for the past 30 years, the FED has opted to go down the road leading to the destruction of the currency, a road that is getting steeper and more slippery every day as it careens toward a cliff.

We will soon attempt a more thorough explanation of Bond Markets soon as it will quickly become important.

Another important development today that may have flown under the radar is that BHP Billiton, the world's largest mining company, had its attempt to purchase Potash, the world's largest fertilizer company, blocked by the Canadian government. While the motivation appeared to be political, Canada defended its actions by citing that the transaction would not result in a "Net Benefit to Canada." You can read more about this here.

There are two things about this story that are important to note. One, the reason that BHP has the cash to make this offer is that a relatively large portion of the cash that the FED and every other central bank on the planet have been creating has ended up in their pockets via rising raw materials prices. The second is that Canada considers itself a shareholder in Potash. It receives its "dividends" in the form of tax revenue from Saskatchewan, where Potash is headquartered. If the transaction were to take place, most of these "dividends" would then go to the Australian government. You see, in each and every case, what appear to be attempts by governments and central banks to control the markets are simply another data point that the markets take into account when setting final prices. More on this to come…

Have a great weekend and Stay Fresh!

David Mint