The Federal Reserve announced additional rounds of quantitative easing with a major departure from QE1, QE2, and operation twist—this one comes with unlimited duration. Federal Reserve Chairman Ben Bernanke essentially gave the Fed freedom to continue to purchase mortgage backed securities and increase the money supply for as long as necessary, while keeping interest rates low until at least 2015. We agree with Bernanke’s move, as one of the major lessons learned from the Great Depression was that raising rates too early (or engaging in any contractionary monetary policy) could immediately choke off growth and put an end to any fragile recovery (view lesson 3 here). Bernanke is well-schooled in Depression economics, so the move today is consistent with what we were expecting from the Fed chief.
The announcement of additional easing has already had a profound impact on financial markets. Easing, coupled with a $150 billion infrastructure plan announced in China, has sent coal stocks soaring. Alpha Natural Resources (click ticker for report: ), Cloud Peak (click ticker for report: ), James River Coal (click ticker for report: ), Peabody (click ticker for report: ), and Arch Coal (click ticker for report: ) have advanced considerably in recent trading sessions.
And while the coal industry remains relatively cheap, we’re not big fans of the structural characteristics of the space, given how prone it is to oversupply, regulation, and natural gas substitution. We think we’ll see a lot of coal miners benefit if pricing in the less heavily regulated Chinese market becomes stronger, but we’d rather bet on the success of a global mining giant like Rio Tinto (click ticker for report: ) in the portfolio of our Best Ideas Newsletter than a pure play in the coal sector. Liquidity remains a legitimate risk at James River, as well as at Alpha Natural. Both have substantial upside if coal prices soar, but that remains a large unknown, in our view. Growing natural gas reserves (and weak pricing) remain key impediments.
Gold miners like Goldcorp (click ticker for report: ), Eldorado (click ticker for report: ), and Barrick Gold (click ticker for report: ) have experienced nice moves on the back of the Fed’s announcement, too, but we don’t see much upside in this space. Gold doesn’t have healthy demand fundamentals and is almost entirely a play on speculative buying at current price levels. The gold market, in our view, fits almost perfectly with the framework of the greater fool theory – gold pays no dividends, engages in no productive activity, or manufacturers any goods or services. Holders of gold are simply hoping that there will be someone else (a greater fool) out there that will become more concerned about global inflation (or the global economy) than they are so they can sell their gold positions to them at a higher price. We’re not interested in holding the bag if/when the market tumbles.
US Steel (click ticker for report: ), Alcoa (click ticker for report: ), and ArcelorMittal (click ticker for report: ) have also rallied, but again, we don’t think the structural characteristics of this industry have become any more compelling. All three firms would need significant macroeconomic tailwinds to start generating more cash, but we simply haven’t seen those signs in their numbers—yet. For one, AK Steel (click ticker for report: ) recently warned about its third quarter earnings coming in lower than expected due to weak pricing resulting from poor demand. Though we hold Rio Tinto in our Best Ideas portfolio (based on its elevated Valuentum Buying Index rating and compelling valuation), we’re not rushing to add any more commodity-producing firms at this time.