Polls force Spain to stall bailout; gold rally on QE: UBS

Stephane Deo, global head- asset allocation, UBS Investment Bank explains to CNBC-TV18 that regional polls in Spain in October has caused the government to stall accepting the bailout package as that would imply a failure of policy.

Deo adds there would enough liquidity to trickle down even after the Fed's purchase of mortgage-backed securities and gold will continue to rally as the markets have already priced in the QE and Draghi's announcements. Below is an edited transcript of the analysis on CNBC-TV18.  Q: The last we spoke was before the ECB decision to buy bonds and you had forecasted that a big bazooka was in the offing. Now that all the action including initiatives from the Fed has played out, how do you deploy assets? Are the markets in for some kind of consolidation at the moment?
A: I think there has been a lot of news in the recent past led by the ECB and the Fed. The Bank of Japan has also announced more measures. And the markets have rallied quite a lot in response to all this. The market has priced a lot of good news already and I don't think there is much to come. So, I would expect consolidation.
Commodity prices, equity and volatility which have improved massively two weeks ago are now starting to level off. Though I am reasonably positive until the end of the year, the pace of improvement will be much slower. Q: How are you reading the events in Spain? Do you think it's just a matter of time before Spain seeks a bailout or do you think politicians are going to have a much tougher time convincing their constituencies?
A: I think there's a very high probability that Spain will ask for help. The schedule of issuance is quite frightening and I don’t think Spain can do it alone. And it does not mean that it will go smoothly; it looks like the Spanish administration is trying to postpone the request for help which means that the ECB might need a tough market to force the Spanish administration to ask for help.
And I think that's one of the key risks in the immediate future. So, the markets could be entering a phase where it would have to actually wear a volatility cap again to force Spain to ask for help. Q: What is the reason for Spain not asking for aid? What is keeping them from asking for aid?
A: I think the argument is very political. On October 21, there will be regional elections in Spain and a request for help by the Prime Minister implies acknowledgment of the failure of the policy. So, I think they will want to postpone until then. And that is why you might need a crisis to force Spain to do it.
_PAGEBREAK_ Q: What about the US? The S&P has reached very attractive highs. Do you see resistance at these levels and some sell-off until Bernanke once again makes an announcement or do you think that the markets are good to go for more and this is just an inevitable consolidation?
A: No. We think that there will be some consolidation. In the US, the fiscal cliff and the debt-ceiling issues could become detrimental for equities. If you remember in the summer of 2011 when the debt ceiling was negotiated, the S&P was down and there was a lot of uncertainty.
So the valuations are not very compelling in the US. There could further rally but it will be very slow, with some risk on the downside and a political risk from the fiscal cliff. Q: If the upside in equity is capped in the near term, what else do you see moving? Do you expect some of the commodities to continue with the rebound or will gold sort of give the extra alpha?
A: We have played a lot of the rebound. We were overweight on equities essentially in emerging markets. We were also overweight on commodities. Though all of that has worked very well during the first half of this month, there is a consolidation coming. So, if you want further rally, you need additional good news.
This could come in the form of Spain requesting some help, it could come from some resolution of the fiscal cliff or it could also come from better economic data. But I am not really expecting that. The point is that there is not much room for a big rally in the immediate future.  We still like gold because of QE, but that is an exception. Q: Most of the risk asset rally has been on news that Bernanke will purchase mortgage-backed securities in forthcoming months. After the purchases, will there still be enough liquidity to trickle down?
A: Yes, I think there will be enough and the market has priced a lot. One asset class we did not mention is inflation-linked bonds which have reacted preemptively to the announcement of QE. But we do believe that when the money flows into the economy, gold will continue to rally.
The argument is that the market has done a lot in terms of the adjustment already and most of the rally on the back of QE and Draghi’s announcement is probably behind it.