David Morris
LAST week was a difficult one for equity investors, thanks to a lack of clarity from policymakers and central bankers. On Tuesday, the minutes of the last Federal Open Market Committee meeting stated that it may “be appropriate to provide additional monetary policy accommodation” if economic growth remained too slow to reduce unemployment. This led to speculation that a third round of quantitative easing (QE3) loomed and investors piled back into risk assets.

But in front of the Senate Banking Committee, Fed Chairman Ben Bernanke downplayed the idea. He noted that there was too much uncertainty about the current state of the economy to risk another round of quantitative easing at this time. He also pointed out that inflation was higher than a year ago.

Europe’s banking stress tests haven’t calmed investors’ nerves. The European Banking Authority ignored the sovereign debt crisis, failing just eight banks out of 90 included in the test. The aggregate capital shortfall for these eight is calculated at just €2.5bn, a figure which most analysts believe grossly underestimates the fragility of Europe’s banking system.

Meanwhile, US policymakers squabble over measures to deal with the debt ceiling. The major ratings agencies have warned of dire consequences should Republicans and Democrats fail to agree. But S&P upped the ante by saying that the US faces a downgrade even if agreement is reached, as concrete measures must also be taken to reduce the budget deficit substantially.

Not surprisingly, investors are reducing their risk exposure. It has been instructive to see how strong gold and silver have been, particularly as prices typically weaken over the summer months. Their previous inverse correlation with the US dollar appears to have broken down completely. With the US and Europe hobbled by concerns over their debt, it makes sense for investors to diversify into the safe haven of precious metals. Following their recent rally, both are vulnerable to profit-taking. But if gold and silver can break and consolidate above $1,600 and $40 respectively, there is a good chance of further gains for the rest of the year.