The recovery is real and investors should buy on setbacks in the market, but the risk is rising that the Federal Reserve could make a serious mistake going forward, warns Jim McCaughan, CEO of Principal Global investors.
Fundamentally, commodities were higher because of the Fed’s policy of quantitative easing (QE), basically printing dollars to buy up Treasury bonds in order to keep interest rates low.
Expectations of roaring U.S. inflation and a rapid decline in the value of the U.S. dollar has led investors to snap up commodities such as gold and silver, pushing prices to absolute, if not yet real, records and pressuring oil to well above levels one would expect in a slow U.S. economy.
“I think the Federal Reserve is now in a situation where it's on the verge of a policy error,” McCaughan told CNBC. “I think it has let QE go on too long already. QE was the right policy when the economy suffered from a lack of liquidity. That is not the problem now. We have plenty of liquidity in the economy.”
Fed Chair Ben Bernanke
(Getty Images photo)
Banking lending is available, McCaughan points out, to those who should be able to access it. Any new effort to make money available, or a blunder in removing the props to the economy, could create bigger problems, he warned.
“Liquidity is not an issue in the market. Quantitative easing going on so long is now in the situation where it has pushed the dollar below its fundamental valuation and has created a bubble in commodities,” he said.
Gold opened Monday back above $1,500 an ounce and silver recovered some ground lost after it collapsed 25 percent in a week. The dollar stabilized at around 75 on the U.S. Dollar Index, above its low point of 70 against a basket of global currencies.
The sharp decline in commodity values last week were warning signs investor should take seriously, McCaughan said. The drop was typical of an asset bubble, but the setbacks in commodity prices were not enough to unwind their inflated values, McCaughan said.
He’s says investors now should be underweight material stocks, miners, and commodities, calling the rush into commodities “dangerous.”
In fact, rising U.S. interest rates could trigger a “very bad time” for commodities in the next 12 months, since in it will suddenly become expensive to hold non-interest bearing assets.
“I'm hoping that we're towards the end of QE. I'm hoping there isn't a QE3. If that isn't the case, then it will prove transitory. If they carry on easing, we have a problem,” McCaughan said.
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