Gearing up for QE3

By Justin Carley - August 29, 2012 | Tickers: ANR, ACI, FCX, SLV, SLW | 0 Comments

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Are you ready for QE3?  The question to ask is when, not if, following continued remarks by The Chairman that he stands ready to intervene if the conditions warrant.  We won’t debate the economic landscape here, but instead focus on how investors can best take advantage of the eventuality of QE3.  During the first two episodes of quantitative easing, certain stocks/industries performed exceptionally well.  While two observations is a very limited sample size, it still provides some color on what investors can expect.  Other than gold, there have been two overwhelmingly successful industries during the previous quantitative easing episodes- silver and coal.  These are two places that aggressive investors may want to start building positions.  Conversely, it doesn’t hurt to forego the risk that the economy weakens materially before any QE3 announcement and wait for the official declaration.  In doing so, investors will only miss the 2-3% pop, but ensure they are on the right side of the trend.  But be prepared to act by doing your homework ahead of time.

Silver Soars

The case for silver during QE3 hinges on its performance during previous episodes as well some other favorable characteristics that provide an additional tailwind.  The table below shows the total return of the silver ETF and a leading silver company relative to the S&P 500.  (QE2 is measured from The Chairman’s speech at the Jackson Hole Symposium in 2010 where he highlighted upcoming plans to embark on additional easing) 

The iShares Silver Trust ETF (NYSEMKT: SLV) is the preferred tactical way to invest in silver.  It tracks the underlying spot price of the metal and has robust daily volume.  The first thing to note is the fact that SLV actually performed better during QE2 than QE1.  This fact has strong appeal as nearly all asset classes performed better during the first bout of quantitative easing.  This suggests that silver could again take a leadership role when QE3 commences.  Silver may also have some fundamental appeal.  First, the gold/silver ratio stands at 54:1 versus a historical average of 36:1.  This indicates the metal is cheap relative to gold and may outperform should both benefit during renewed quantitative easing.  Second, September is historically the best month for silver.  And lastly, silver prices are down more than 35% from their 2011 peak.

Another option investors may want to consider is Silver Wheaton (NYSE: SLW).  This unique company has a market capitalization in excess of $11 billion.  The pure-play silver company doesn’t actually own any mines, but instead contracts with leading mining companies to purchase a fixed percentage of production at a fixed price.  It serves to give the company mine diversification, lower capex, and tax benefits.  Still, the company is a bet on higher silver prices.  As the table shows, the stock exploded during QE1, but this can be attributed to the massive sell-off that engulfed the shares during the Global Financial Crisis.  This stock can be extremely volatile.  Investors should reasonably expect performance to be 1.5x to 2x that of the S&P 500- in either direction.

Coal- A Tactical Play

Coal stocks have been absolutely crushed from their 2008 peak and have been in a steady free-fall ever since, except for two key time intervals.  That’s right, QE1 and QE2.  The table below highlights the performance of two leading coal companies, Arch Coal (NYSE: ACI) and Alpha Natural Resources (NYSE: ANR).

The table shows big gains during QE1 and less stellar results during QE2.  Combined, the coal sector has been a big outperformer during QE episodes.  Some of the allure is lost due to the notably more sanguine results during QE2, negative political rhetoric against the industry, still depressed natural gas prices, and weak global demand.  These stocks seem to have been left for dead and may just need a little QE3 pop to get value investors awakened.  Given massively oversold levels, these stocks could jump significantly in a short period of time.

Bottom Line

QE3 is becoming more and more of a reality.  Stocks, as represented by the S&P 500, may have baked in that eventuality to some extent.  Still, the real bellwethers of QE3- commodities- are reflecting a big slowdown in global growth and offer opportunity.  Gold, silver, and coal stocks have been the standouts in previous QE periods and it stands to reason that they could assume that role again.  Also, Freeport-McMoRan & Copper (NYSE: FCX) more than doubled the S&P 500’s total return during both QE1 and QE2.   It is important to remember that investors don’t have to jump in too early, but with Jackson Hole upon us and the September FED meeting shortly thereafter, aggressive investors should be ready to act.

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