QE takes the gilt of the investment gingerbread

The Investment Club had a little bit of bad luck in September. We were sitting on a little stock pile of cash, which, when not invested, suppresses the club's unit price.

Therefore, at the beginning of the month, a buy limit of 78.42 was placed with our broker to invest in War Loan, and come 20 September its price was down at our purchase level. Unfortunately, while the bid price fell below our limit the offer price did not, and the moment slipped away. Consequently, the club's unit price slipped down to 2.73 last month. Are we going to get a second bite at the cherry in October?

Very difficult to say but the omens are not good. This is because Adam Posen, a member of the Bank of England's interest rate setting committee, and the US Fed chairman, Ben Bernanke, are advocating more quantitative easing (QE), a process by which governments print money to buy back their own debt. The intention of this device is to drive down interest rates across the bond maturity spectrum, thereby stimulating investment demand and increasing the prosperity of the nation. How successful was the last experiment with QE in bringing down interest rates?

QE was first mooted the last time in 2008, and stretched one year to February 2010. In anticipation of QE commencing, yields fell to 3.8 per cent by Christmas Eve 2008. Within one month, just before QE started, yields had risen to 4.8 per cent. One month into QE, yields had fallen a bit to 4 per cent, but by June, half way through the QE period, yields were up at 4.7 per cent.

At close of QE play in February 2010, yields had reached 5 per cent. So 200 billion pounds of debt to buy gilts had been created for the UK tax payer and interest rates had gone in the opposite direction from that intended. Yields had risen from 3.8 to 5 per cent during QE, a rise of 30 per cent.

QE achieves nothing but higher interest rates, a blip in GDP and then an asset bulge. Witness commodity price rises in a supposed recession. It is basically state speculation with a moral mask to improve the economy. However, the practice makes it very difficult to know the true cost of borrowing and, just like any speculation, causes huge volatility in prices of debt.

How does the Investment Club intend to cope with this environment? Following the club's paper and pencil analysis (papa), if War Loan reaches 87.5 in the short term, then the club will sell all its stock. It will then monitor the economy and FTSE. Papa has the FTSE topping out at 5,582.5 best case, or 5,721.9 as an upper ceiling.

If the FTSE100 then falls through its 200-day moving average this should push bond yields down. However, if the economic numbers start to be particularly bad in tandem then QE might be initiated and this would start to negate any beneficial effects of the FTSE's fall.

But, if the FTSE surges through the ceiling then we have another debt-induced rally forcing us out of bonds and into the relative safety of utilities. It is, therefore, on a knife edge whether the Investment Club is divested of its government debt by month end or buying into bonds for another all-time unit price high.