The Economy and Bond Market (May 21, 2012)

Saturday, May 19th, 2012

The Econ­omy and Bond Mar­ket (May 21, 2012)

Trea­suries ral­lied this week, send­ing long-term yields sharply lower. With head­lines tout­ing bank runs in Greece and Spain, the risk-off trade was in full swing this week as both gold and the U.S. dol­lar ral­lied along with Trea­suries. Ten-year Trea­sury yields hit the low­est level in 60 years this week and Ger­man 10-year bonds hit new record lows as part of the risk-off/fear trade.

Strengths

• The con­sumer price index for April was unchanged and the trend in infla­tion data is lower.
• Hous­ing starts rose 2.6 per­cent in April as the hous­ing mar­ket remains a bright spot.
• Cen­tral banks remain sup­port­ive as the Fed min­utes released from the April Fed­eral Open Mar­ket Com­mit­tee (FOMC) meet­ing hinted at more mon­e­tary eas­ing if the econ­omy slows. The Bank of Eng­land echoed sim­i­lar thoughts and the mar­ket sees higher chances of addi­tional quan­ti­ta­tive easing.

Weak­nesses

• The Con­fer­ence Board Lead­ing Eco­nomic Index fell 0.1 per­cent in April.
• Chi­nese power pro­duc­tion rose a mod­est 0.7 per­cent, the small­est gain since May 2009.
• Euro­zone indus­trial pro­duc­tion fell 0.3 per­cent in April; expec­ta­tions were for a gain of 0.4 percent.

Oppor­tu­nity

• Bonds con­tinue to grind higher and appear to be fore­cast­ing benign infla­tion and slow growth.
• The Fed­eral Reserve appears will­ing to increase mon­e­tary accom­mo­da­tion if nec­es­sary, which would be a boost to the bond market.

Threat

• China’s econ­omy is slow­ing faster than expected and gov­ern­ment pol­icy mak­ers appear com­fort­able with this dynamic.
• Europe remains a wild­card with aus­ter­ity pro­grams under pres­sure, cre­at­ing sig­nif­i­cant uncertainty.

Tags: 10 Year Bonds, Austerity Programs, Bank Of England, Bond Market, Central Banks, Chinese Power, Consumer Price Index, Economic Index, Eurozone, Federal Open Market Committee, Full Swing, Government Policy Makers, Housing Market, Housing Starts, Inflation Data, Open Market Committee, Record Lows, Term Yields, Treasuries, Treasury Yields
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Gold: Fundamentals Strong, Price Action Ugly

Thursday, May 17th, 2012

by Guy Lerner, The Tech­ni­cal Take

Until proven oth­er­wise, cen­tral banks will con­tinue to devalue their cur­ren­cies and inter­vene in mar­kets because if they didn’t “life as we know it would not exist”.  This is the sole basis for under­stand­ing the pos­i­tive fun­da­men­tals behind gold.  Period.  Eco­nomic weak­ness lead­ing to lower inter­est rates is very gold pos­i­tive.  But some­times the price action gets divorced from the fun­da­men­tals, and this appears to be the case with gold.  Price is break­ing down despite the pos­i­tive fundamentals.

Fig­ure 1 is a monthly chart of the SPDR Gold Trust (sym­bol: GLD).  The pink labeled bars are neg­a­tive diver­gence price bars.  (The diver­gence is between price, which is head­ing higher,  an oscil­la­tor that mea­sures price, which is head­ing lower.)  What we know about neg­a­tive diver­gence bars is that their pres­ence sig­ni­fies slow­ing upside momen­tum such that price usu­ally con­sol­i­dates within the highs and lows of the neg­a­tive diver­gence bar itself.   The low of the most recent neg­a­tive diver­gence bar is 154.19, and a monthly close below this level would imply lower prices.  Based upon this analy­sis, the next level of sup­port is at 145.20.

Fig­ure 1. GLD/ monthly

Fig­ure 2 is a weekly chart of the GLD.  Price has gapped below the 153.12 sup­port level.  Old sup­port is new resis­tance.  Such breaks in the price struc­ture are never good and imply fur­ther selling.

Fig­ure 2. GLD/weekly

Fig­ure 3 is a daily chart of the GLD.  The red and black dots are key pivot points, which are the best areas of buy­ing (sup­port) and sell­ing (resis­tance).  Note the gaps in price as the 158.20 and 151.96 price lev­els were bro­ken.  The next area of sup­port is at 144 to 145.

Fig­ure 3. GLD/daily

In sum­mary, the price action in GLD is ugly and incon­gru­ous with the fun­da­men­tals.  As I see it, there are two ways to play this.  You can buy into fur­ther weak­ness, and this would be the sup­port level at 144.145.  Or you buy into strength and that would be when price closes above the 151.96 resis­tance level.

Copy­right © The Tech­ni­cal Take

Tags: Central Banks, Dots, Economic Weakness, Figure 1, Figure 3, Gaps, Gld Price, Gold Price, Guy Lerner, Highs And Lows, interest rates, Momentum, Nbsp, Negative Divergence, Next Level, Oscillator, Pivot Points, Price Structure, Sole Basis, Two Ways
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The Flaws of Finance (James Montier)

Tuesday, May 15th, 2012

by James Mon­tier, GMO

This paper is based on a speech deliv­ered at the 65th Annual CFA Insti­tute Con­fer­ence in Chicago on May 6, 2012.

As a child, watch­ing my par­ents write post­cards whilst we were all on hol­i­day was an instruc­tive expe­ri­ence. My mother would metic­u­lously write out the card, scat­ter­ing a few inter­est­ing hol­i­day tid­bits within the text. My father, whose sum total of post­cards sent was invari­ably just one (to his office), opted for a con­sid­er­ably more effi­cient approach. His method is shown at the left in Exhibit 1.

I think we can con­struct a sim­i­lar dia­gram to explain the Global Finan­cial Cri­sis (GFC), rep­re­sented at the right in Exhibit 1. In essence, the GFC seems to have sprung from the inter­ac­tion of the fol­low­ing four “bads”: bad mod­els, bad behav­iour, bad poli­cies (which is really just bad behav­iour on the part of cen­tral banks and reg­u­la­tors), and bad incentives.

In an effort to rethink finance, I want to exam­ine each of these fac­tors in turn, begin­ning with bad mod­els. Bad Mod­els, or, Why We Need a Hip­po­cratic Oath in Finance

The National Rifle Asso­ci­a­tion is well-known for its slo­gan “Guns don’t kill peo­ple; peo­ple kill peo­ple.” This sen­ti­ment has a long his­tory and echoes the words of Seneca the Younger that “A sword never kills any­body; it is a tool in the killer’s hand.” I have often heard fans of finan­cial mod­el­ling use a sim­i­lar line of defence.

How­ever, one of my favourite come­di­ans, Eddie Izzard, has a rebut­tal that I find most com­pelling. He points out that “Guns don’t kill peo­ple; peo­ple kill peo­ple, but so do mon­keys if you give them guns.” This is akin to my view of finan­cial mod­els. Give a mon­key a value at risk (VaR) model or the cap­i­tal asset pric­ing model (CAPM) and you’ve got a poten­tial finan­cial dis­as­ter on your hands.

The intel­li­gent sup­port­ers of mod­els are always quick to point out that finan­cial mod­els are, of course, an abstrac­tion from real­ity. Just as physi­cists can study worlds with­out fric­tions, finan­cial mod­el­ers should not be attacked for try­ing to reduce the com­plex­ity of the “real world” into tractable forms.

Finance is often said to suf­fer from Physics Envy. This is gen­er­ally held to mean that we in finance would love to write out com­plex equa­tions and mod­els as do those work­ing in the field of Physics. There are cer­tainly a large num­ber of mar­ket par­tic­i­pants who would love this outcome.

I believe, though, that there is much we could learn from Physics. For instance, you don’t find physi­cists bet­ting that a feather and a brick will hit the ground at the same time in the real world. In other words, they are acutely aware of the lim­i­ta­tions imposed by their assump­tions. In con­trast, all too often peo­ple seem ready to bet the ranch on the flim­si­est of finan­cial models.

Read the whole let­ter in the slid­edeck below (Fullscreen for the eas­ier read, or download)

JM_FlawsofFinance_512

Tags: Asset Pricing, Bad Behaviour, Bads, Capital Asset Pricing Model, Capital Asset Pricing Model Capm, Central Banks, Cfa Institute, Eddie Izzard, Financial Disaster, Financial Modelling, Financial Models, Global Financial Crisis, Hippocratic Oath, James Montier, Line Of Defence, National Rifle Association, Rebuttal, Sum Total, Value At Risk, Value At Risk Var
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Gold ‘Will Go To $3,000/oz’ – David Rosenberg

Friday, May 11th, 2012

Gold ‘Will Go To $3,000/oz’ – David Rosenberg

Highly respected econ­o­mist and strate­gist David Rosen­berg has told that Finan­cial Times in a video inter­view (see below) that gold “will go to $3,000 per ounce before this cycle is over.”

Mar­kets are repeat­ing the down­turns of 2010 and 2011 and it is time to search for safety, David Rosen­berg of Gluskin Sheff tells James Mack­in­tosh, the FT Invest­ment Editor.

Rosen­berg sees a “very good oppor­tu­nity in gold” as it has cor­rected and seems to be “off the radar screen right now”.

He sees gold as a cur­rency and says the best way to value gold is in terms of money sup­ply and “cur­rency in circulation.”

As the “vol­ume of dol­lars is going up as we get more quan­ti­ta­tive eas­ing” he sees gold at $3,000 per ounce.

Mack­in­tosh says that Rosenberg’s view is a “pretty bear­ish view”.

To which Rosen­berg responds that it is “bull­ish view on gold and gold min­ing stocks.” Mack­in­tosh says that it is “bear­ish on every­thing else”.

Rosen­berg  says that it is not about being “bull­ish or bear­ish,” it is about “stat­ing how you view the world” and he warns that the major cen­tral banks are all going to print more money and keep real inter­est rates neg­a­tive “as far as the eye can see.”

This is “crit­i­cal” as one of the key deter­mi­nants of the gold price are real short term inter­est rates.

The longer they stay neg­a­tive “the longer the bull mar­ket in gold is going to be.”

Rosen­berg sums up that “this is not about being bull­ish or bear­ish, it is about how do we make money for our clients.”

The inter­est­ing inter­view can be watched here.

Tags: Central Banks, David Rosenberg, Determinants, Economist, Editor Rosenberg, Financial Times, Gold Mining Stocks, Gold Price, gold stocks, Mackintosh, Money Supply, Nbsp, Ounce, Quantitative Easing, Radar Screen, Sheff, Strategist, Sums, Term Interest, Video Interview
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BoJ Buys Record Amount Of ETFs And REITs To Prevent Crash

Monday, May 7th, 2012

One can call the BOJ inef­fi­cient, slow and for the most part utterly worth­less, but one can cer­tainly not accuse them of lying, and beat­ing around the bush. Because unlike all other cen­tral banks, with the BOJ at least it has been fully pub­lic knowl­edge that this par­tic­u­lar cen­tral bank unlike all oth­ers (wink wink), is actively engaged in buy­ing equity prod­ucts, among them REITs and broad equity ETFs (which pro­vide much explicit tail-wags-dog lever­age and explains why the FRBNY's red phone hot­line goes directly to Citadel's ETF trad­ing desk).

And buy stocks on full tilt and in record quan­ti­ties is pre­cisely what the BOJ just did, only as one can expect, with absolutely no impact on the broader stock mar­ket. Because once even the cen­tral bank is exposed as par­tic­i­pat­ing in the mar­ket, the ele­ment of sur­prise is gone, and the cen­tral bank becomes just one mark (if one with a lar­gish bal­ance sheet).

As Mar­ket­Watch reports, "The Bank of Japan stepped back into the stock mar­ket Mon­day, mak­ing its largest single-day pur­chase of exchange-traded funds to date... The Japan­ese cen­tral bank said it spent 39.7 bil­lion yen (about $500 mil­lion) buy­ing up stock ETFs as part of its ongo­ing asset-purchase pro­gram, break­ing a pre­vi­ous record of ¥28.5 bil­lion, set on April 16. In addi­tion to the ETF buys, the Bank of Japan also acquired ¥2.3 bil­lion in real-estate invest­ment trusts Monday."

Too bad that this lat­est out­right bull in a Japan store (sic) inter­ven­tion had zero impact: "the move failed to pre­vent a sharp fall for the Tokyo equity mar­ket." But at least they are hon­est. Imag­ine the shock and hor­ror (and com­plete lack of apolo­gies to all those who have pre­dicted just that) when the world finally gets a trade confirm-based proof that Brian Sack was indeed buy­ing (never sell­ing) SPYs and ES. Why every­one would be truly shocked, SHOCKED, that the Fed is noth­ing but another two-bit gam­bler in a rigged and bro­ken casino.

For those who are unaware of Japan's explicit but at least forth­right approach to asset price manip­u­la­tion, read on:

Japan’s mon­e­tary author­ity is almost unique among its peers in the major devel­oped economies, in its high-profile pur­chases of ETFs, which it began in Decem­ber 2010 as part of aggres­sive eas­ing measures.

Since then, the Bank of Japan has bought almost ¥1 tril­lion worth of ETFs — along with another ¥78.9 bil­lion in REITs — and has an addi­tional ¥642 bil­lion to spend on the stock funds after rais­ing the program’s size at it last pol­icy meet­ing in April.

The cen­tral bank empha­sizes that the pro­gram has only broad goals such as sup­port­ing inter­est rates and reduc­ing risk pre­mi­ums, rather than sup­port­ing finan­cial markets.

Jef­feries Japan’s head of Japan­ese strat­egy Naomi Fink says that while the ETF pur­chases are really part of the broad push to reflate asset prices in the deflation-plagued coun­try, they do “pro­vide a bit of a back­stop, when they think they can curb the down­side” for the market.

“Still, it’s a very small amount,” Fink said of the ETF pur­chases. “It’s more designed to bol­ster sen­ti­ment ... [and] it works best when sen­ti­ment is frag­ile.”

As a tan­gent here, do these "strate­gists" even lis­ten to what they sound like? "Very small amount"... "designed to bol­ster sen­ti­ment." Oh ok. That makes every­thing so much bet­ter. It is just too bad that a Mar­tin­gale strat­egy where one has an infi­nite bal­ance sheet is not all that avail­able to every­one in the world, except to 5 or 6 mar­ket par­tic­i­pants of course, all of whom are incen­tivized to destroy their cur­ren­cies and ramp their "inflation-sensitive" assets ever higher. Surely that accord­ing to Jef­feries is per­fectly acceptable.

Sen­ti­ment was cer­tainly frag­ile Mon­day, as investors returned from a four-day hol­i­day week­end to find the yen con­sid­er­ably stronger — a neg­a­tive fac­tor for Japan’s export-focused cor­po­ra­tions — U.S. employ­ment growth weaker than expected, and Euro­pean elec­tion results rais­ing more uncer­tainty for the euro zone.

And while investors don’t find out about the Bank of Japan’s mar­ket oper­a­tions until after the close of trad­ing, “there’s a mar­ket assump­tion that when the Topix falls more than 1%, that trig­gers ETFs,” accord­ing to Fink.

Still, Fink advised against try­ing to front-run the cen­tral bank by jump­ing into the mar­ket when­ever the Topix — Japan’s key broad-market index — drops 1%.

And what­ever you do kids, remem­ber: fron­trun­ning cen­tral banks is not to be tried at home...

“I wouldn’t exactly call that my favorite strat­egy,” she said, adding that since the ETF-buying pro­gram isn’t meant to be a “price-keeping oper­a­tion,” it offers lit­tle in the way of trad­ing opportunities.

... After all that's what Pri­mary Deal­ers are for: and since they make sure that no bond auc­tions can ever fail (cour­tesy of the $30 tril­lion cus­to­dial asset cloud, which des­per­ate econ­o­mists have pegged fancy post-modernist the­o­ries to explain how infi­nite sup­ply can gen­er­ate infinite+1 demand with­out hav­ing the faintest clue of how the shadow bank­ing sys­tem works) there nat­u­rally has to be some kick­back in it for them. Because oth­er­wise one of them might even speak up and tell the rest of the world just how much of a fraud the sys­tem truly is.

And yes, the BOJ IS com­pletely open about what they buy and how much:

Tags: Asset Purchase, Bank Of Japan, Beating Around The Bush, Buy Stocks, Central Banks, Element Of Surprise, Equity Products, ETFs, Exchange Traded Funds, Frbny, Full Tilt, Japan Store, Japanese Central Bank, Phone Hotline, Public Knowledge, Real Estate Investment, Real Estate Investment Trusts, Spys, Tail Wags, Wink Wink
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The Big Easing

Friday, May 4th, 2012

by Daniel Gros, Cen­ter for Euro­pean Pol­icy Stud­ies, via Project Syn­di­cate

BRUSSELS – More than three years after the finan­cial cri­sis that erupted in 2008, who is doing more to bring about eco­nomic recov­ery, Europe or the United States? The US Fed­eral Reserve has com­pleted two rounds of so-called “quan­ti­ta­tive eas­ing,” whereas the Euro­pean Cen­tral Bank has fired two shots from its big gun, the so-called long-term refi­nanc­ing oper­a­tion (LTRO), pro­vid­ing more than €1 tril­lion ($1.3 tril­lion) in low-cost financ­ing to euro­zone banks for three years. For some time, it was argued that the Fed had done more to stim­u­late the econ­omy, because, using 2007 as the bench­mark, it had expanded its bal­ance sheet pro­por­tion­ally more than the ECB had done. But the ECB has now caught up. Its bal­ance sheet amounts to roughly €2.8 tril­lion, or close to 30% of euro­zone GDP, com­pared to the Fed’s bal­ance sheet of roughly 20% of US GDP.

But there is a qual­i­ta­tive dif­fer­ence between the two that is more impor­tant than balance-sheet size: the Fed buys almost exclu­sively risk-free assets (like US gov­ern­ment bonds), whereas the ECB has bought (much smaller quan­ti­ties of) risky assets, for which the mar­ket was dry­ing up. More­over, the Fed lends very lit­tle to banks, whereas the ECB has lent mas­sive amounts to weak banks (which could not obtain fund­ing from the mar­ket). In short, quan­ti­ta­tive eas­ing is not the same thing as credit eas­ing. The the­ory behind quan­ti­ta­tive eas­ing is that the cen­tral bank can lower long-term inter­est rates if it buys large amounts of longer-term gov­ern­ment bonds with the deposits that it receives from banks. By con­trast, the ECB’s credit eas­ing is moti­vated by a prac­ti­cal con­cern: banks from some parts of the euro­zone – namely, from the dis­tressed coun­tries on its periph­ery – have been effec­tively cut off from the inter-bank market.

A sim­ple way to eval­u­ate the dif­fer­ence between the approaches of the world’s two biggest cen­tral banks is to eval­u­ate the risks that they are tak­ing on. When the Fed buys US gov­ern­ment bonds, it does not incur any credit risk, but it is assum­ing interest-rate risk. The Fed acts like a typ­i­cal bank engag­ing in what is called “matu­rity trans­for­ma­tion”: it uses short-term deposits to finance the acqui­si­tion of long-term secu­ri­ties. With short-term deposit rates close to zero and long-term rates at around 2% the Fed is earn­ing a nice “carry,” equal to about 2% per year on bond pur­chases total­ing roughly $1.5 tril­lion over the course of its quan­ti­ta­tive eas­ing, or about $30 billion.

Read on ...

Copy­right © Project Syn­di­cate

Tags: Balance Sheet, Big Gun, Central Banks, Daniel Gros, ECB, Economic Recovery, Federal Reserve, Financial Crisis, Government Bonds, Massive Amounts, Periphery, Project Syndicate, Qualitative Difference, Ris, Risky Assets, Term Interest, Trillion, Two Shots, Us Federal Reserve, Us Gdp
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ECB Warns Easy Money No Solution (Merk)

Friday, May 4th, 2012

by Axel Merk, Merk Funds

May 3, 2012

Axel Merk May 3, 2012

Cen­tral Banks around the world have been under pres­sure to cover short­falls in fis­cal pol­icy. At his monthly press con­fer­ence, Euro­pean Cen­tral Bank (ECB) Pres­i­dent Mario Draghi stuck to his guns, telling politi­cians to focus on struc­tural reforms to stim­u­late growth, rather than rais­ing hopes for more easy money from the ECB. Inter­est rates remain at 1%; the euro reacted pos­i­tively to Draghi's comments.

Point­ing to the expe­ri­ence of how stagfla­tion in the 1970s was over­come, Draghi points out struc­tural reform, not increased spend­ing, is the the proper course of action. Specif­i­cally, Draghi calls for: fis­cal bal­ances, fis­cal sta­bil­ity and com­pet­i­tive­ness. Hav­ing said that, the pre­pared intro­duc­tory state­ment of the press con­fer­ence men­tions "growth" 13 times, stress­ing that "growth and growth poten­tial in the euro area need to be enhanced by deci­sive struc­tural reforms. In this con­text, facil­i­tat­ing entre­pre­neur­ial activ­i­ties, the start-up of new firms and job cre­ation is cru­cial. Poli­cies aimed at enhanc­ing com­pe­ti­tion in prod­uct mar­kets and increas­ing the wage and employ­ment adjust­ment capac­ity of firms will fos­ter inno­va­tion, pro­mote job cre­ation and boost longer-term growth prospects. Reforms in these areas are par­tic­u­larly impor­tant for coun­tries which have suf­fered sig­nif­i­cant losses in cost com­pet­i­tive­ness and need to stim­u­late pro­duc­tiv­ity and improve trade per­for­mance."

Draghi also calls for a vision of how the Euro­zone ought to look in a decade, so that such vision can be imple­mented. A fis­cal com­pact, not a "trans­fer union" is the appro­pri­ate start­ing point of how fis­cal sov­er­eignty can be del­e­gated over time to a cen­tral Euro­zone author­ity. The press con­fer­ence was ahead of this weekend's national elec­tions in France and Greece, as well as regional elec­tions in Germany.

In our assess­ment, aus­ter­ity is the easy part, struc­tural reform is the tough part. With regard to mon­e­tary pol­icy, Draghi was notably light. He shed cold water on the notion of re-activating the periph­eral bond pur­chase pro­gram (Secu­ri­ties Mar­kets Pro­gram, SMP). He also damp­ened expec­ta­tions of a rate cut by empha­siz­ing bal­anced infla­tion risks, as well as a grad­ual eco­nomic recov­ery, albeit with down­side risks. He sug­gested the Euro­pean bank­ing sec­tor is improv­ing, not only vis­i­ble in reduced intra-bank refi­nanc­ing (repo) rates, but also appar­ent in an increase of the deposit base in periph­eral Euro­zone countries.

Curi­ously, just about all actions sug­gested by Draghi are really out­side of the purview of the ECB. We may want to add a com­ment recently made by Bun­des­bank Pres­i­dent Jens Wei­d­mann: the higher cost of bor­row­ing can also been seen as an encour­age­ment to engage in reform. It appears that the ECB is in line with our view that the one lan­guage pol­icy mak­ers lis­ten to is that of the bond market.

Please sign up for our newslet­ter to be informed as we dis­cuss global dynam­ics and their impact on currencies.

Axel Merk
Pres­i­dent and Chief Invest­ment Offi­cer, Merk Invest­ments
Merk Invest­ments, Man­ager of the Merk Funds

Tags: Austerity, Central Banks, Easy Money, Ecb Interest Rates, Ecb President, Elections In France, Elections In Germany, Employment Adjustment, Entrepreneurial Activities, Eurozone, Fiscal Policy, Fiscal Stability, Growth Prospects, Introductory Statement, Job Creation, National Elections, Product Markets, Regional Elections, stagflation, Trade Performance
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Bill Gross: Investment Outlook (May 2012)

Wednesday, May 2nd, 2012

Tues­day Never Comes

May 2012

by William H. Gross, Co-Chief, PIMCO

- The cur­rent accel­er­a­tion of credit via cen­tral bank poli­cies will likely pro­duce a pos­i­tive rate of real eco­nomic growth this year for most devel­oped coun­tries, but the struc­tural dis­tor­tions brought about by zero bound inter­est rates will limit that growth and induce seri­ous risks in future years.

- Not sud­denly, but over time, grad­u­ally higher rates of infla­tion should be the result of QE poli­cies and zero bound yields that will likely con­tinue for years to come.

- Focus on secu­ri­ties with shorter dura­tions – bonds with matu­ri­ties in the five-year range and stocks pay­ing div­i­dends that offer 3%–4% yields. In addi­tion, real assets/commodities should occupy an increas­ing per­cent­age of portfolios.

The global econ­omy is float­ing on an ocean of credit, and a good thing too as our car­toon friend Wimpy reminds us. With­out it, he would be a hun­gry puppy by next Tues­day and nearly seven bil­lion world cit­i­zens would be worse off if barter, and not credit, was the oil that lubri­cated trade. Unlike Wimpy, early soci­eties func­tioned with­out an exchange of (money) or the promise to pay it back in the future (credit). Growth was lim­ited, how­ever, because sav­ings or invest­ment could not be incented prop­erly. Those that wanted to save for a rainy day had no means to express that cau­tion; bet­ter to con­sume a banana or a ham­burger today than to watch it rot and become worth­less on Tues­day. But money changed all of that and the abil­ity to bor­row and exchange it for repay­ment at some future date was the eco­nomic elixir of the ages. Shake­speare, with his admo­ni­tion to “nei­ther a bor­rower nor a lender be,” might have won a 17th cen­tury Pulitzer, but def­i­nitely not a Nobel Prize for economics.

Still, the use of credit never really kicked into high gear until the dis­cov­ery of frac­tional reserve bank­ing and the ulti­mate for­ma­tion of cen­tral banks to facil­i­tate and pro­tect its dis­burse­ment. Pic­ture a Wild, Wild West Bank in Yuma, Ari­zona back in 1901. It had a big safe where min­ers left their gold nuggets for safe keep­ing, but in order to become more than a depos­i­tory, the bank needed to issue notes and let­ters of credit in an amount greater than the gold in its vault. The­o­ret­i­cally there was some of the owner’s gold dust in there too, but who was count­ing as long as gold came in and gold went out and Yuma’s cit­i­zens thought that the bank’s notes were backed by tan­gi­ble evi­dence of wealth. Frac­tional reserve bank­ing was aborn­ing in the 20th cen­tury, sharp­shoot­ers and all.

Prob­lem was that many of those local banks with their indi­vid­ual cur­ren­cies and drafts went out of busi­ness, lead­ing to pan­ics and mild depres­sions through­out the grow­ing states, and so in 1913 the dol­lar became our sin­gle cur­rency, and the Fed­eral Reserve our offi­cial cen­tral bank. The Fed, with a cer­tain amount of gold cer­tifi­cates, would then extend credit to its mem­ber banks, which would then extend credit to busi­nesses, which would mag­i­cally pro­mote sav­ings, invest­ment and eco­nomic growth. No left­over ham­burg­ers on Tues­day for Wimpy – his tummy was grum­bling and by god, or by Fed, he was gonna get it NOW.

This process of credit and its cre­ation pow­ered global economies for the next cen­tury. It ben­e­fited not only con­sumers who wanted their burg­ers now, but lenders and investors who were will­ing to go hun­gry on Fri­day for the ben­e­fit of get­ting their money back with inter­est on Tues­day. Both sides expe­ri­enced a win/win exchange as the real econ­omy charged ahead, cre­at­ing jobs, tech­no­log­i­cal advances and the erad­i­ca­tion of dis­ease. What was not to like about credit? Noth­ing really, except much as the absence of it hin­dered ancient soci­eties, the excess of it now hob­bles mod­ern economies. Credit is the foun­da­tion of the wealth cre­ation process, but it can also be the cause of finan­cial insta­bil­ity and poten­tial wealth destruc­tion. Like nuclear energy, “atomic” credit or debt must be con­trolled if it is to ben­e­fit, as opposed to destroy.

And so the job of modern-day cen­tral bankers – Bernanke, King, Draghi and their global coun­ter­parts – is to decide how to con­trol a ben­e­fi­cial chain reac­tion with­out it get­ting out of hand. In many ways they are like their Wild, Wild West coun­ter­parts, try­ing to con­vince skep­ti­cal depos­i­tors that the gold will always be there. Yet, since 1971, when Nixon cratered Bret­ton Woods, there has been no explicit or even implicit gold back­ing. The U.S. and there­fore the world’s finance-based economies have been backed by an increas­ing amount of IOUs, which are sim­ply paper promises to cre­ate more paper when there is an old-fashioned 20th cen­tury run on the banks, or incred­i­bly enough – even when there is not. Lack­ing a dis­ci­plined parental exam­ple, the banks, invest­ment banks, money man­agers and hedge funds piled paper on top of paper as well, cre­at­ing deriv­a­tives and seem­ingly end­less chains of repos and rehy­poth­e­ca­tion of repos to amass a total amount of credit that lit­er­ally can­not be counted. Esti­mates sug­gest global credit in the finan­cial sec­tor exceeds $200 tril­lion, with devel­oped economies’ cen­tral banks hold­ing only $15 tril­lion in reserves or fig­u­ra­tive “gold dust.” If so, then the global bank­ing sys­tem is lev­ered at least thir­teen times. These num­bers don’t even count the amount of side bets or credit default swaps, which can’t be used as burger pay­ments, but which total $700–$800 tril­lion alone. Wimpy has financed so many Whop­pers that Tues­day can never come. Judg­ment day must always be around the cor­ner or after the next week­end. Wimpy can­not pay the tab, except with more and more credit cre­ation, as Euroland coun­tries are dis­cov­er­ing first hand.

Yet how much credit is too much credit and how is a ded­i­cated cen­tral banker to know? Part of the prob­lem is in clearly defin­ing what does or doesn’t fit the def­i­n­i­tion. There are the fam­i­lies of M’s – M1, M2 and the dis­banded M3 in the U.S. – the for­mer two of which the Fed now loosely uses to mon­i­tor a growth rate so as not to bring credit cre­ation to a boil. 21st cen­tury pri­va­teers, how­ever, proved there can be no accu­rate gauge of credit growth as long as banks and the shadow banks can cre­ate their own money at will. CDOs, CLOs and secu­ri­tized lend­ing that man­aged to skirt reg­u­la­tory stan­dards for bank loans by apply­ing 1%, 2% and 5% “hair­cuts” to secu­ri­tized assets made a mock­ery of sound bank­ing and ulti­mately cre­ated great risk for cen­tral bankers and their abil­ity to tem­per the excess of credit cre­ation. In 2008, cen­tral bankers never really knew how much debt was out there, and to be hon­est, they don’t know now.

Aus­trian school econ­o­mists might say “no mat­ter, for­get the count­ing – all a cen­tral banker has to do is observe the inter­est rate, the price of credit, to know whether things have got­ten out of hand.” And they may have had a point – even after 1971 and up to the mid-1990s, but then economies and the credit that was dri­ving them mor­phed into a uni­verse that the con­ser­v­a­tive Aus­tri­ans would not have rec­og­nized. With the dot­coms, the sub­primes and now the reflex­ive delev­er­ing of our finan­cial sys­tem, it is prac­ti­cally impos­si­ble to know what inter­est rate is applic­a­ble. With the QEs and LTROs reduc­ing real yields far below absolute zero, a cen­tral banker must wan­der aim­lessly in pol­icy space, won­der­ing how much credit to cre­ate, how many Trea­suries to buy, and how firm a twist to give the yield curve in order to allow Wimpy the chance for another burger and a side order of fries.

What they should know – and what the fol­low­ing chart, pro­vided by the always obser­vant Jim Bianco, shows – is that when QEI and QEII lapsed in recent years, stock prices declined by 10%–15% until mag­i­cally they came back to live another day. The same stunt­ing effect can be observed in the bond mar­ket when mea­sured by real as opposed to nom­i­nal inter­est rates. They go down with QEs and up in their absence.

Admit­tedly, Chart 1 shows only two real data points, which are dif­fi­cult for a Fed Chair­man or his staff to rely on, but com­mon sense under­lies the his­tor­i­cal obser­va­tion as well. With the Fed buy­ing nearly 70% of all five– to 30-year Trea­suries dur­ing Oper­a­tion Twist, and sim­i­larly large per­cent­age amounts of Trea­sury and Agency mortgage-backed issuance since the begin­ning of QEI in Decem­ber 2008, who will buy them now, if the Fed doesn’t?

The Fed appears to have a the­ory that is some­what incom­pre­hen­si­ble to me, stress­ing the “stock” of Trea­suries as opposed to the “flow.” Future flows and annual sup­plies of $1 tril­lion and more, the the­ory argues, will be gob­bled up by the mar­ket even with­out the Fed’s help, at cur­rent arti­fi­cially sup­pressed yields because the pri­vate market’s “stock” of Trea­suries has been depleted. Much like a wine cel­lar, I sup­pose, that is now nearly empty because pol­i­cy­mak­ers have been drink­ing the rare vin­tages, wine lovers will now be forced to restock their cel­lars to get a his­tor­i­cally com­fort­able inven­tory. Hmmm, being a beer drinker myself, I might oth­er­wise assume that appetites might switch due to higher prices (and lower yields). And if wine or bonds were man­dated to fill the cel­lar, then why not a for­eign wine or a for­eign bond? And too, I’m sure the Chi­nese in addi­tion to PIMCO clients would be will­ing at the mar­gin to change their pref­er­ences to real as opposed to finan­cial assets. More con­ser­v­a­tive investors might migrate to cash as the pre­ferred alter­na­tive, because the price of bonds or burg­ers was too high. Wimpy, in other words, might just go vegan if burg­ers aren’t cooked to taste.Because of QEs, the asso­ci­ated Twist, and sim­i­lar check writ­ing by the BOE, BOJ and ECB, sev­eral tril­lion dol­lars of what is aca­d­e­m­i­cally referred to as “base money,” and what Main Street cit­i­zens would rec­og­nize as “gold dust,” has been added to global cen­tral bank vaults. Rather than dug out of the ground, this credit has been cre­ated at the stroke of a pen or a touch of the key­board in today’s elec­tronic mon­e­tary sys­tem. How that is done is a topic for another day, but since the early 1900s, and espe­cially since 1971, it has been done so often that prices of goods and ser­vices are 400% of what they were when Pres­i­dent Nixon decided to pro­pel cen­tral bank­ing to another orbit. “We are all Key­ne­sians now,” he said back then, but he should have replaced Mr. Keynes with Mr. Burns, Miller, Vol­cker, Greenspan and Bernanke. We are all cen­tral bankers now, at least from the stand­point of endors­ing stim­u­la­tive poli­cies that per­mit Wimpy and his seven bil­lion coun­ter­parts to keep on eat­ing burg­ers, and their lenders, by the way, to keep on coin­ing profits.

Part pro­duc­tive, but increas­ingly destruc­tive, the cur­rent accel­er­a­tion of credit via cen­tral bank poli­cies will likely pro­duce a pos­i­tive rate of real eco­nomic growth this year for most devel­oped coun­tries, but the struc­tural dis­tor­tions brought about by zero bound inter­est rates will limit that growth as argued in pre­vi­ous Out­looks, and induce seri­ous risks in future years. In addi­tion, infla­tion should creep higher. Do not be mel­lowed by the affir­ma­tion of a 2% tar­get rate of infla­tion here in the U.S. or as tar­geted in six of the G-7 nations. Not sud­denly, but over time, grad­u­ally higher rates of infla­tion should be the result of QE poli­cies and zero bound yields that were ini­ti­ated in late 2008 and which will likely con­tinue for years to come. We are hooked on cheap credit just as Wimpy was hooked on Friday’s burg­ers. As I high­lighted last month in “The Great Escape,” bond and equity investors should focus on secu­ri­ties with shorter dura­tions – bonds with matu­ri­ties in the five-year range and stocks pay­ing div­i­dends that offer 3%–4% yields. In addi­tion, real assets/commodities should occupy an increas­ing per­cent­age of port­fo­lios. Wimpy would not be pleased by this change of diet nor by the cost and risk of burg­ers for deliv­ery next Tues­day. But for him, and for cen­tral bankers, the hope is that Tues­day never comes.

William H. Gross
Man­ag­ing Director

Tags: Admonition, Bank Policies, Bill Gross, Central Banks, Disbursement, Distortions, Fractional Reserve Banking, Future Years, Global Economy, Gross Co, Gross Investment, Hungry Puppy, Investment Outlook, Maturities, Nobel Prize For Economics, Qe, Real Assets, William H Gross, Wimpy, World Citizens
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Gold Market Radar (April 30, 2012)

Sunday, April 29th, 2012

Gold Mar­ket Radar (April 30, 2012)

For the week, spot gold closed at $1,662.75 down $19.82 per ounce, or 1.2 per­cent. Gold stocks, as mea­sured by the NYSE Arca Gold Min­ers Index, rose 1.5 per­cent. The U.S. Trade-Weighted Dol­lar Index slid 0.61 per­cent for the week.

Strengths

• So when you thought the invest­ment case for gold was all over in March with no immi­nent QE3 com­ing from the Fed, guess who was buy­ing gold? – Cen­tral banks who fully under­stand you can’t park your reserves in the cur­ren­cies of coun­tries that are mired in an end­less wall of debt. Over­all, cen­tral banks appar­ently pur­chased no less than 58 tonnes in March. The three largest buy­ers were Mex­ico, which increased its hold­ings by 16.81 tonnes to a total of 122.58 tons, Rus­sia with pur­chases of 16.55 tons giv­ing it total reserves of 895.75 tons, and Turkey with 11.48 tons tak­ing it to 209.6 tonnes in reserves. Some sug­gest an accel­er­a­tion in cen­tral bank pur­chases could con­tinue through­out the year as first quar­ter eco­nomic growth num­bers are look­ing a bit flac­cid. Last year, cen­tral banks bought 439.7 tonnes of gold, the biggest annual increase in almost five decades.
• Agnico-Eagle Mines reported first quar­ter results that hand­ily beat mar­ket expec­ta­tions. CEO Sean Boyd noted that Agnico-Eagle pro­duced more gold in the first quar­ter of 2012 than in the first quar­ter of 2011, which included pro­duc­tion of the now sus­pended Goldex mine. Com­pared to its peers, Agnico-Eagle has one of the high­est qual­ity resource state­ments and has a great cor­po­rate cul­ture, so we expect the com­pany to con­tinue to gain mar­ket respect for the rest of the year.
• Gold Stan­dard Ven­tures reported two drill holes from its Rail­road project in Nevada. Drill hole 12–1 hit 164 meters at 3.38 g/t gold while the sec­ond one about 100 meters south of drill hole 12–1 net­ted 56 meters of 4.29 g/t Au. Gold Standard’s share price fin­ished the week up 59 percent.

Weak­nesses

• Pes­simism in gold stocks may have reached a peak. In a recent mar­ket­ing trip, Stephen Walker, a top gold min­ing ana­lyst at RBC, noted investor sen­ti­ment still seemed a bit depressed as investors appeared to be wait­ing for a cat­a­lyst to bring gold off the bot­tom, such as emerg­ing mar­ket infla­tion, QE3, or cen­tral bank buy­ing, before step­ping back into gold stocks. As a point of con­trast, IAMGOLD came to the table on Fri­day to buy Trelawney Min­ing, send­ing the share price up 41 per­cent. It is inter­est­ing to note that Bar­rick Gold just sold its 20 per­cent stake in High­land Gold the day before. Bar­rick Gold has been crit­i­cized in the past for doing deals when price points hit painful lev­els, such as buy­ing both a cop­per com­pany and an oil com­pany at peak cop­per and oil prices. Inter­est­ingly, IAMGOLD was one of the few com­pa­nies to make an acqui­si­tion when gold stocks plum­meted in late 2008 through early 2009.
• Feed­back from the Zurich gold show is that com­pany atten­dance out­num­bered investor atten­dance by a good mar­gin, again reflect­ing some of the dis­con­tent with buy­ing gold com­pa­nies. One par­tic­i­pant we spoke with noted there was even some talk about indus­try par­tic­i­pants com­ing to terms, when it comes to mar­ket­ing the prof­itabil­ity of the com­pany, with using cash cost ver­sus all-in costs or total pro­duc­tion costs.
• Cash cost is a con­cept that is a legacy mea­sure which com­pa­nies used to fig­ure out if they were going to go bank­rupt the next week. It says noth­ing about whether the com­pany is prof­itable and that is what investors are con­cerned with today. For the senior gold min­ers, investors want to know if the com­pany is mak­ing a profit and can grow its div­i­dend. When com­pa­nies espouse low cash cost num­bers that don’t reflect the full cost to pro­duce an ounce of gold, it just becomes a light­ning rod for gov­ern­ments to increase taxes.

Oppor­tu­ni­ties

• Bob Hoye of Insti­tu­tional Advi­sor pub­lished a report on Fri­day titled “Gold Con­sol­i­da­tion Approach­ing an End.” The report shows that the rel­a­tive strength of min­ing shares to the price of gold bul­lion is at extremes only seen five times in the past one hun­dred years. The report also notes that, his­tor­i­cally, investors should look to the junior tier names to exhibit the greater price action rel­a­tive to their senior peers.
• Gold­man Sachs noted it expects to see higher gold prices up to its pre­vi­ous tar­get of $1,840 an ounce this year. With real GDP adjusted for the build in inven­to­ries com­ing in at only 1.6 per­cent in the first quar­ter, some form of quan­ti­ta­tive eas­ing may be in the cards.
• Quatar Invest­ment Author­ity (QIA), the Gulf state’s aggres­sive sov­er­eign wealth fund, noted it has more than $30 bil­lion to spend on invest­ments this year and sees com­modi­ties as a key target.

Threats

• Has any­thing been learned by the gov­ern­ment? We had a tech boom par­tially dri­ven by Y2K spend­ing. We had lend­ing stan­dards relaxed so that any­body who wanted to buy a home could get one at an inflated price. We have health care reform which will increase the patient load on the med­ical sys­tem, but does noth­ing to incen­tivize an increase in the sup­ply of doc­tors and nurses which we will surely need. And now the gov­ern­ment wants to con­tinue to give loans to col­lege stu­dents at below mar­ket rates? Stu­dent debt has now reached $1 tril­lion dol­lars and jobs are scarce, but is this the solution?

Tags: Bank Purchases, Central Banks, Currencies Of Countries, Dollar Index, Drill Hole, Drill Holes, Eagle Mines, Endless Wall, Gold Market, Gold Miners, gold stocks, Growth Numbers, Market Expectations, Market Radar, Nyse Arca, Nyse Index, Qe3, Quality Resource, Railroad Project, Spot Gold
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Energy and Natural Resources Market Radar (April 30, 2012)

Sunday, April 29th, 2012

Energy and Nat­ural Resources Mar­ket Radar (April 30, 2012)

The S&P 500 Energy Index has decreased about 8 per­cent over the past 12 months. This decline rep­re­sents a one-sigma event in stan­dard devi­a­tion terms. His­tor­i­cally, this has occurred only 18.5 per­cent of the time in the past 10 years. As shown in the chart below, there were only two episodes when per­for­mance was worse on a one-year rolling basis: Dur­ing the 2002–2003 period and dur­ing the global finan­cial cri­sis in 2008–2009 when the U.S. was in a reces­sion. To us, the S&P 500 Energy stocks rep­re­sent a buy­ing oppor­tu­nity, as adding to core posi­tions after a cor­rec­tion is a pru­dent way to invest.

Strengths

• Accord­ing to the World Steel Asso­ci­a­tion, global steel pro­duc­tion rose 1.8 per­cent year-over-year to 132 mil­lion tonnes in March and China pro­duced 46.6 per­cent of the world’s crude steel.
• Emerg­ing mar­ket oil fun­da­men­tals con­tinue to improve with Indian oil demand in March higher year-over-year by 5.4 per­cent (175 thou­sand b/d) to a record high of 3.403 mb/d. Diesel demand was higher year-over-year by a strong 10.8 per­cent (143 thou­sand b/d) to 1.464 mb/d, buoyed by higher diesel pen­e­tra­tion in auto­mo­biles and strong growth in the power sec­tor too.
• Cen­tral bank gold buy­ing in March was con­firmed by a data release from the Inter­na­tional Mon­e­tary Fund on Tues­day. Mexico's cen­tral bank pur­chased 541,000 ounces dur­ing the month, Rus­sia added 532,000 ounces, Turkey bought 369,000 ounces and Kazakhstan's reserves rose by 138,000 ounces. Although the buy­ing is not large rel­a­tive to cen­tral bank pur­chases over the same period in 2011 (for Mex­ico in par­tic­u­lar), con­fir­ma­tion that cen­tral banks are still net buy­ers should be over­all pos­i­tive for the market.
• Accord­ing to the China Elec­tric­ity Coun­cil (CEC), elec­tric­ity con­sump­tion in the coun­try grew by 6.8 per­cent year-over-year in first quar­ter 2012 to 1,166 bil­lion kWh. Mean­while, March’s growth rate was 7 per­cent year-over-year, with a decent pickup from man­u­fac­tur­ing indus­try con­sump­tion at 7.6 per­cent year-over-year com­pared with 2.1 per­cent year-over-year for the quar­ter as a whole. Cop­per hit a three-week high on Fri­day as tight sup­plies of the metal out­side China kept prices sup­ported, although there are wor­ries about the esca­lat­ing debt cri­sis in Europe fol­low­ing a Span­ish credit downgrade.
• In a sign of tight­en­ing sup­plies, cop­per inven­to­ries in LME-registered ware­houses fell to their low­est lev­els since Novem­ber 2008 at 251,825 tonnes, with can­celled war­rants — the metal ear­marked for deliv­ery — at 39.5 per­cent of total stock. In Shang­hai, cop­per stock­piles fell to the low­est since Feb­ru­ary to 204,762 tonnes.

Weak­nesses

• World Steel (WSA) pub­lished its updated Short Range Out­look for appar­ent steel use. The 2012 fore­cast was revised down by 3.5 per­cent to 1,422 mil­lion tonnes. Ton­nage wise, this is mainly dri­ven by China where the 2012 fore­cast was revised down by 33 mil­lion tonnes, or 4.8 per­cent. The global revi­sion was 51 mil­lion tonnes. The fore­cast for the EU-27 was revised down by 5 per­cent and the NAFTA esti­mate is up slightly by 0.6 per­cent. 2012 growth is expected to be 3.6 per­cent, down from 5.6 per­cent in 2011. Steel use in 2013 is expected to grow 4.5 per­cent. Growth in China is expected to be 4 per­cent both in 2012 and 2013. These fore­casts from WSA regard­ing Chi­nese steel use growth are the low­est ones yet. Chi­nese steel usage is expected to be 45.6 per­cent of global usage in 2012. The EU-27 is the only region where steel use is expected to fall in 2012, by 1.2 percent.
• Accord­ing to the National Devel­op­ment and Reform Com­mis­sion, China’s crude oil out­put fell 1.4 per­cent year-over-year to 50.03 mil­lion tonnes in the first three months of 2012.

Oppor­tu­ni­ties

• Credit Suisse esti­mates that Chi­nese total oil demand will rise to 12.2 mil­lion bar­rels per day by 2015, up from approx­i­mately 10 mil­lion bar­rels per day cur­rently and will reach 15 mil­lion bar­rels per day by 2020 as China’s car fleet grows to record levels.
• Japan will con­tinue using U.S. cok­ing coal as an alter­na­tive to major sup­pli­ers such as Aus­tralia, but for the longer term, coun­tries such as Mozam­bique and Rus­sia will play a larger role in the Asia-Pacific cok­ing coal mar­ket, the head of Japan's steel asso­ci­a­tion said this week. Cok­ing coal imports by Japan from its top sup­plier in Aus­tralia will fall sharply in April and May due to force majeure declared on April 2 by BHP Bil­li­ton Ltd. and Mit­subishi Corp. at mines they jointly own, Hayashida said. This was due to strikes and heavy rain. Japan's imports of U.S. cok­ing coal surged in March, ris­ing 57 per­cent on the year, while its imports from Aus­tralia dropped 17 per­cent, gov­ern­ment data showed.

Threat

• Peru’s min­ers plan to start a national strike on May 14 to protest worker lay­offs at mines and refiner­ies, said Luis Castillo, Gen­eral Sec­re­tary of Peru’s Min­ing Fed­er­a­tion. Min­ers are protest­ing the dis­missal of work­ers at Ger­dau unit Empresa Siderur­gica del Peru SAA and Shougang Corp.’s Hierro Peru iron mine, as well as a deci­sion by cred­i­tors to liq­ui­date Renco Group Inc.’s zinc smelter, Castillo said. Union offi­cials will meet for talks with Pres­i­dent Ollanta Humala, he said.

Tags: Bank Gold, Bank Purchases, Central Banks, Core Positions, Crude Steel, Diesel Penetration, Electricity Consumption, Energy Index, energy stocks, Global Financial Crisis, Global Steel, Indian Oil, International Monetary Fund, Market Radar, Oil Demand, Power Sector, S Central, Steel Association, Steel Production, World Steel
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Is it 2010 and 2011 All Over Again?

Thursday, April 26th, 2012

Fol­low­ing a string of weaker than expected eco­nomic reports over the last few weeks and today's much larger than expected drop in Durable Goods Orders, investors are increas­ingly ask­ing if the mar­ket is set­ting itself up for a repeat of 2010 and 2011.  In the chart below, we high­light the annual per­for­mance of the S&P 500 so far this year, as well as in 2010 and 2011.  As shown in the chart, in both 2010 and 2011 the S&P 500 ral­lied in the first four months of the year.

In 2010, the S&P 500 was up 9.2% when it reached its first half peak on 4/23.  From there, the index dropped sharply and was down as much as 10% YTD before ral­ly­ing when the Fed stepped in with QE2.  In 2011, we saw a sim­i­lar pat­tern.  When the S&P 500 reached its first half peak on April 29th, the index was up 8.4% on the year.  From there, it was a down­ward slide as the index fell roughly 20% through Octo­ber.  Then late in the year, the mar­ket once again ral­lied when the Sum­mer ended and the Fed stepped in with 'Oper­a­tion Twist.'

This year, the mar­ket finds itself in a sim­i­lar posi­tion as the month of April comes to a close.  At its peak on 4/2, the S&P 500 was up 12.8% on the year, but it has since seen a minor pull­back.  This pull­back cou­pled with recent weak­ness in eco­nomic data and the on-going Euro­pean debt cri­sis has investors wor­ried that this could be a long hard Summer.

Will 2012 turn out a lot like last year?  Only time will tell, but while there are some sim­i­lar­i­ties between now and then, there are also some key dif­fer­ences.  For starters, the econ­omy is at a higher level now than it was then.   Addi­tion­ally, while most global Cen­tral Banks had a bias towards tight­en­ing early last year, this year the bias is towards eas­ing.  Finally, last year's peak in the mar­ket and eco­nomic activ­ity came just weeks after the earth­quake in Japan.  As we noted back then, when the world's third largest econ­omy essen­tially grinds to a halt, the global econ­omy will feel an impact.

Tags: Amp, Bias, Central Banks, Debt Crisis, Downward Slide, Durable Goods Orders, Earthquake In Japan, Economic Activity, Economic Data, Economic Reports, Four Months, Global Economy, Half Peak, Investors, Month Of April, Months Of The Year, Pullback, Qe2, Starters, Ytd
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Volatile or Not? (Tchir)

Sunday, April 22nd, 2012

From Peter Tchir of TF Mar­ket Advisors

Volatile or Not?

It is strange to start a weekly update and not be sure whether the week was volatile or not.  North Amer­i­can stock indices ranged from –0.4% for Nas­daq to 0.6% for the S&P.  Not much to look at there.

U.S. fixed income fin­ished with small weekly gains.  The 10 year trea­sury was 2 bps bet­ter.  Fixed income ETF’s like TIP, TLT, LQD, HYG, JNK, and MUB all had small gains.  Even the CDS indices, IG18, and the under­per­form­ing HY18 saw some small spread tight­en­ing over the course of the week.

Look­ing at Europe and we start to see some more volatil­ity and diver­gence.  The DAX was up 2.5% will the IBEX was down 2.9%.  Span­ish bond yields were mixed to bet­ter on the week, but Ital­ian yields were worse.  In a week of obvi­ous attempts by gov­ern­ments and cen­tral banks and the IMF to calm mar­kets, they had lim­ited suc­cess with the smaller and more eas­ily manip­u­lated Span­ish bond mar­ket, and failed in Italy.  One scary under­tone devel­op­ing in the mar­ket is the con­cern about France and the poten­tial impact of the French elec­tion.  French 10 year yields moved 14 bps, and it wasn’t because the sit­u­a­tion was improv­ing, because Ger­man 10 year yields moved 3 tighter on the week.  Ger­many con­tin­ues to have a flight to qual­ity bid, but France, not so much.

Maybe it is the activ­ity in Europe that made the mar­kets feel more volatile than the weekly changes show.  Or maybe it was that the futures traded in an almost 3% range – from 1,359 to 1,390 with sev­eral 0.5% swings dur­ing the course of most days.  Mar­ket dar­ling Apple isn’t help­ing calm the mar­ket either.  That can reverse on a moment’s notice, or a great earn­ings release, but the momen­tum that was drag­ging more and more hedge funds into the trade, is now work­ing in reverse as stop losses are being triggered.

So often lately, the bulls are able to point to a decent tape in face of weak data and no stim­u­lus, and this week ended with the oppo­site.  Bulls will be ner­vous that decent earn­ings and a mega-plan from the IMF failed to pro­vide strength to the market.

So, it was a strange week that was more volatile than the weekly changes show, and where some real cracks are being exposed.

Politi­cians and the Markets

In a week where the Birkin wield­ing head of the IMF went from G-20 del­e­ga­tion to del­e­ga­tion ask­ing for them to com­mit their taxpayer’s money to another illu­sory fire­wall, it is impor­tant to focus on what was accom­plished and what wasn’t.

By all accounts, the IMF has received com­mit­ments to increase the “fire­wall” by some amount, pos­si­bly as much as $500 bil­lion.  The politi­cians expect the mar­kets to be excited about this “heroic” effort and the guar­an­tee that no debt prob­lem is too big that it can’t be solved with more debt.  In spite of the head­lines, I’m being asked

How will the coun­tries honor their com­mit­ments?
Where will the money come from?  Espe­cially the Euro­pean por­tion?
How would the money be used?  For coun­tries?  For banks?
If com­mit­ments made in 2010 haven’t been approved, what good are these com­mit­ments?
What does this do to help the coun­tries that are in trou­ble?  Why does the IMF think it is safe to lend when real investors won’t lend?
The list is long, but is also accurate.

The entire IMF Fire­wall is being run as though it was an elec­tion.  The lead­ers use the same slo­gans over and over.  They say the money is needed to avoid calamity.  They say the money will help.  No evi­dence of either is pro­vided, but who needs evi­dence when you are just run­ning a cam­paign.  So they cam­paigned, and in their view, they “won” the elec­tion, by get­ting these commitments.

That is the big dis­con­nect.  Politi­cians are sit­ting around Wash­ing­ton con­vinced that they have won.  They fought a hard cam­paign to con­vince peo­ple that the Fire­wall was needed and would be good, and they got the job done.  What they haven’t done, is seen how the mar­ket will react.

Unlike a real elec­tion, the mar­ket doesn’t give the win­ner a free pass for a cer­tain amount of time.  You haven’t won until the next elec­tion, you have merely won until the mar­ket tests your resolve.

That test will come quickly, quite likely this week.  Mar­kets will likely put pres­sure on Span­ish and Ital­ian yields, and pos­si­bly French yields depend­ing on the elec­tion results.  Noth­ing about the fire­wall changes a thing about the cur­rent sit­u­a­tion these coun­tries find them­selves in.  That is the key.  If the fire­wall actu­ally did some­thing for these coun­tries, we might be able to stage a strong rally, but the fire­wall doesn’t have an imme­di­ate impact.  The fire­wall just ensures that these coun­tries can bor­row more money.  That when the mar­kets shut down on their abil­ity to bor­row, the IMF will lend to them.  Your best hope as a cur­rent lender, is to hope you own short enough dated bonds that the IMF is still being gen­er­ous and lend­ing to the coun­try to pay you back, rather than hav­ing gone into PSI mode.

Spain and Italy need to reduce the cur­rent inter­est bur­den, the total debt, make long term adjust­ments that while tech­ni­cally aus­ter­ity, can have min­i­mal near term impact, and they need to embark on some growth poli­cies.  A debt restruc­tur­ing can accom­plish the first two items.  Pol­icy and some IMF money can help on the all impor­tant growth issue.  With­out some form of PSI, the fire­wall at best will shift who coun­tries owe money to, and at worst will dis­cour­age banks from lend­ing to any­one other than sovereigns.

The mar­kets will test the resolve of the EU, ECB, and IMF this week.  They will see how read­ily “com­mit­ments” turn into “actions”.  Once again, the smug vic­tory speeches being made by the politi­cians are likely to look very wrong, and pos­si­bly before they have even fin­ished their vic­tory tour.

Last chance to QE?

I think we have one group within the Fed that is des­per­ate to do QE and wants to do it now.  There is another group that believes the econ­omy should be left alone, unless the data dete­ri­o­rates sig­nif­i­cantly.  As we head towards the elec­tion in Novem­ber, the hur­dle of what con­sti­tutes “weak” eco­nomic data will increase.  Right now, Benyellen might be able to argue “only” 120,000 NFP jobs is enough to launch QE.  I don’t think they would have a chance of launch­ing in August with NFP num­bers like that.

So, Benyellen will push hard at this meet­ing.  I think they will still face too much resis­tance.  It is only one bad NFP num­ber and 2 bad “ini­tial claims” num­bers.  Not enough for the last defend­ers of any­thing resem­bling a free mar­ket at the Fed.  Hous­ing has been weak too, but again, per­mits were up, and although not bounc­ing, there does seem to be some sta­bil­ity return­ing to the hous­ing market.

I don’t expect QE this week.  I think the state­ment will be slightly more dovish than the last one, but that is priced in as the mar­ket does often seem to take the “bad news” as good news path.  Real­is­ti­cally, the next meet­ing is the most likely one to see QE announced since it would only take a few more data items con­firm­ing recent ones to let Benyellen rail­road the rest into one more round.

Earn­ings, just how good?

I was frus­trated and dis­ap­pointed with BAC and MS.  They aren’t the only ones (GS and C did accounted for things sim­i­larly), but for what­ever rea­son, they caught my eye, and con­vince me that this is what is wrong with the market.

Last year, when DVA and FVO were big pos­i­tives, those num­bers were not only included in the head­line, but in the case of Gor­man at MS, were trum­peted as he pounded his chest that MS beat GS in Q3 2011.  The qual­ity and wis­dom of DVA account­ing has been ques­tion­able at best and the FVO adjust­ments are stag­ger­ing in the ratio of the mag­ni­tude of the amounts ver­sus the amount of disclosure.

I would much rather have seen head­line num­bers con­sis­tent with 2011.  Then we could focus on how they did that quar­ter. What the busi­ness out­look is.  Instead, it looks like they are try­ing to trick the media and investors and make the story bet­ter than it is.  Investors aren’t stu­pid.  They will do the work.  They will fig­ure out the dif­fer­ences in how Q3 2011 and Q1 2012 were reported.  Then, not only will they be dis­ap­pointed with what the firms tried to trick them on, they will ques­tion what else is being done.  If you are will­ing to “mas­sage” (sounds bet­ter than manip­u­late) the way you report each quarter’s earn­ings to make it seem the best, what else are you will­ing to “mas­sage”?  Banks are opaque.  On 100’s of bil­lions of assets, what’s a bp or two here or there?

All com­pa­nies should lay it on the line.  Report what hap­pened in the way they always do, then rely on them­selves and their con­fer­ence calls and good ana­lysts to fig­ure out the longer term pic­ture.  Com­pa­nies have to trust in the intel­li­gence of investors and investors will have trust in the companies.

Copy­right © TF Mar­ket Advisors

Tags: 10 Year Treasury, American Stock, Bond Market, Bond Yields, Bps, Central Banks, Divergence, Earnings Release, Fixed Income, French Election, Hedge Funds, Hyg, Jnk, Lqd, Mub, Stimulus, Stock Indices, Tlt, Undertone, Volatility
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Art Cashin: The Clandestine War Among Central Banks

Wednesday, April 18th, 2012

Noth­ing dra­matic here, but the Chair­man of the fer­men­ta­tion com­mit­tee [Cashin] just has that unique flair for explain­ing things so sim­ply, even an eco­nom­ics Ph.D., a cave­man, or the other kind of 'Chair­man', would understand...

The Not So Clan­des­tine War Among The Cen­tral Banks - Back in Phi­los­o­phy class in the 5th grade, the instruc­tor in Epis­te­mol­ogy used to have an inter­est­ing para­ble on prob­lems of perception.

The the­sis went some­thing like this: Sup­pose you are an alien and have been told about the game of chess. Due to a tech­ni­cal­ity, how­ever, your equip­ment would only allow you to see one square on the board. Over the course of the game any, or all, the pieces might arrive on your square.

You might see a Knight or a Bishop; a Rook or a Queen or a Pawn, but you would never know where it had come from nor where it had gone when it dis­ap­peared. You never got quite enough infor­ma­tion to envi­sion the entire board or the con­cept of the game.

I was reminded of the para­ble as I have watched the actions of some key cen­tral banks over the last few years.

Accord­ing to the finan­cial media, each cen­tral bank is eas­ing aggres­sively to serve a need of the area it serves.

The Fed is eas­ing to help employ­ment and the hous­ing mar­ket in the U.S. The ECB is eas­ing to help it banks, sink­ing under sov­er­eign debt prob­lems. The People’s Bank of China is eas­ing to avoid a hard land­ing. The Bank of Japan is eas­ing to restart an econ­omy that has been dor­mant for two decades.

Those may be the offi­cial lines but cyn­ics think there may be more to the game than is seen through this tele­scope. Cyn­ics think it’s all about the currencies.

The think­ing is that each bank would like to see its cur­rency weaken to make its exports more attrac­tive. It doesn’t stop there. With Europe being China’s biggest trade part­ner, some believe the PBOC is the bid under the Euro at 1:30, keep­ing the Euro strong enough to make Chi­nese goods attractive.

The cur­rency influ­ences of the other cen­tral banks may be a bit more sub­tle but no less effec­tive or intense. No trade war yet but lots of drilling and marching.

Actu­ally that is not true. from Mer­co­press: "US and EU con­sid­er­ing WTO actions against Argen­tine ‘pro­tec­tion­ist practices"

The US and forty coun­tries which for­mal­ized a joint state­ment before the World Trade Orga­ni­za­tion com­plain­ing about Argentina’s trade restric­tions are con­sid­er­ing mov­ing a step fur­ther and begin a “dis­putes set­tle­ment” process which could lead to an open con­dem­na­tion if the admin­is­tra­tion of Pres­i­dent Cristina Kirch­ner does not lift the pro­tec­tion­ist network.

Accord­ing to Buenos Aires daily Clarin quot­ing WTO sources in Geneva, “expec­ta­tions are that it will be the US that presents the “dis­putes set­tle­ment” process since the White House was the main spon­sor of the joint state­ment. The process could end with a for­mal con­dem­na­tion of Argentina open­ing the way for com­mer­cial reprisals”.

In the March joint state­ment pre­sented by the US and forty other lead­ing coun­tries the main com­plaints against Argentina included the non auto­matic licences sys­tem; the pre­vi­ous sworn state­ment reg­istry to obtain the approval of an imports oper­a­tion and the pol­icy forc­ing com­pa­nies to apply the ‘dollar-to-dollar’ mech­a­nism which means they have to export a dol­lar for each dol­lar import.

Once the dis­putes set­tle­ment begins there is a period of con­sul­ta­tions in which in this case Argentina must prove it has not infringed WTO rules, and if no agree­ment is reached a three mem­ber panel is named, cho­sen by the lit­i­gants or WTO Direc­tor Gen­eral Pas­cal Lamy.

Time for some blogger-cum-budding author (which is about 99% of all) to write a cur­rency wars sequel: Trade Wars: The Final Frontier.

Tags: Art Cashin, Bank Of China, Bank Of Japan, Caveman, Central Banks, Chinese Goods, Clandestine War, Cynics, Debt Problems, ECB, Epistemology, Game Of Chess, Parable, Pboc, Philosophy Class, Problems Of Perception, Rook, Sovereign Debt, Technicality, Trade Partner
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Recovery: Who Are We Kidding?

Friday, April 13th, 2012

by Axel Merk, Merk Funds

April 10, 2012

The global econ­omy is heal­ing, so we are told. Yet, the moment the Fed­eral Reserve (Fed) indi­cates just that – and thus imply­ing no addi­tional stim­u­lus may be war­ranted – the mar­kets appear to throw a tantrum. In the process, the U.S. dol­lar has enjoyed what may be a tem­po­rary lift. To make sense of the recent tur­moil, let’s look at the dri­vers of this “recov­ery” and poten­tial impli­ca­tions for the U.S. dol­lar, gold, bonds and the stock mar­ket.

In our assess­ment, what we see unfold­ing is the lat­est chap­ter in the tug of war between infla­tion­ary and defla­tion­ary forces. Dur­ing the “goldilocks” econ­omy of the last decade, investors lev­ered them­selves up. Home­own­ers treated their homes as if they were ATMs; banks set up off-balance sheet Spe­cial Invest­ment Vehi­cles (SIVs); gov­ern­ments engag­ing in arrange­ments to get cheap loans that may cost future gen­er­a­tions dearly. Cumu­la­tively, it was an amaz­ing money gen­er­a­tion process; yet, cen­tral banks remained on the side­lines, as infla­tion – accord­ing to the met­rics focused on — appeared con­tained. Indeed, we have argued in the past that cen­tral banks lost con­trol of the money cre­ation process, as they could not keep up with the plethora of “finan­cial inno­va­tion” that jus­ti­fied greater lever­age. It was only a mat­ter of time before the world no longer appeared quite so risk-free. Ratio­nal investors thus reduced their expo­sure: de-levered. When de-leveraging spreads, how­ever, mas­sive defla­tion­ary forces may be put in motion. The finan­cial sys­tem itself was at risk, as insti­tu­tions did not hold suf­fi­ciently liq­uid assets to de-lever in an orderly way. With­out inter­ven­tion, defla­tion­ary forces might have thrown the global econ­omy into a depression.

The trou­ble occurs when the money cre­ation process takes on a life of its own, because the money destruc­tion process is rather dif­fi­cult to stop. How­ever, it hasn’t stopped pol­icy mak­ers from try­ing: in an effort to fight what may have been a dis­or­derly col­lapse of the finan­cial sys­tem, unprece­dented mon­e­tary and fis­cal ini­tia­tives were under­taken to stem against mar­ket forces. Tril­lion dol­lar deficits, tril­lions in secu­ri­ties pur­chased by the Fed with money cre­ated out of thin air (when the Fed buys secu­ri­ties, it merely cred­its the account of the bank with an account­ing entry – while no phys­i­cal dol­lar bills are printed, many – includ­ing us – refer to this process as the print­ing of money).

Will it work? The Fed thinks it might. But nobody really knows. We do know that a depres­sion works in remov­ing the excesses of a bub­ble. How­ever, the cost of a depres­sion may be severe, both in social and mon­e­tary terms. Crit­ics of the “let ‘em fail” argu­ment say that busi­nesses and jobs beyond those that have engaged in bad deci­sions will be caught by con­ta­gion effects and may ulti­mately be bound to fail too. Fed Chair Bernanke, a stu­dent of the Great Depres­sion, fre­quently warns against repeat­ing the pol­icy mis­takes of that era. So does the refla­tion­ary argu­ment work, i.e. does print­ing and spend­ing money help bring an econ­omy back from the brink of dis­as­ter? We can­not find an exam­ple in his­tory where it has. As Bernanke points out, pol­icy mak­ers have learned a great deal by study­ing crises of the past. Our reser­va­tion comes from the fol­low­ing obser­va­tion: cen­tral bankers at any time have always been con­sid­ered amongst the smartest of their era, yet – with hind­sight – they may have engaged in ter­ri­ble mis­takes. While we cer­tainly wish that Bernanke is right, we nonethe­less main­tain a degree of skep­ti­cism and believe it is any investor’s duty to take the risk that the world does not evolve the way he envi­sions into account. Our pol­icy mak­ers also might be well served to be more hum­ble, as they are putting the world’s sav­ings at risk.

Yet, the rea­son cen­tral bankers are bold, not hum­ble, is because they fear hes­i­ta­tion will lead to defla­tion­ary forces tak­ing the upper hand yet again. Bernanke’s con­tention, that one of the biggest mis­takes dur­ing the Great Depres­sion was to tighten mon­e­tary pol­icy too early, stems from that fear. In its recently released min­utes, the Fed­eral Reserve Open Mar­ket Com­mit­tee (FOMC) placed that fear in today’s con­text: “While recent employ­ment data had been encour­ag­ing, a num­ber of mem­bers per­ceived a non neg­li­gi­ble risk that improve­ments in employ­ment could dimin­ish as the year pro­gressed, as had occurred in 2010 and 2011, and saw this risk as rein­forc­ing the case for leav­ing the for­ward guid­ance unchanged at this meet­ing."

In our view, the rea­son why the Fed is com­mit­ted to keep­ing rates low until the end of 2014 is pre­cisely because the Fed does not want to be per­ceived as tight­en­ing too early. Why the end of 2014? Well, because it’s not today or tomor­row. We believe nobody – not even at the Fed – knows whether the end of 2014 is the right date. The prob­lem with that pol­icy will be when the mar­ket no longer buys it. The mar­ket just needs to see one mem­ber of the FOMC turn more hawk­ish, as a result of improv­ing eco­nomic data, to inter­pret that we may be start­ing down the road of mon­e­tary tight­en­ing. Yet, if the mar­ket thinks the Fed may tighten, defla­tion­ary forces take over, pos­si­bly unrav­el­ing all the “hard work” the Fed has done.

Will tight­en­ing ever be bear­able for the econ­omy again? U.S. finan­cial insti­tu­tions are in a stronger posi­tion than they were in 2008. Con­versely, gov­ern­ments around the world – not just the U.S. gov­ern­ment – are in far weaker posi­tions, given the large amounts of debt they have incurred, in an effort to man­age the finan­cial cri­sis. Many con­sumers have down­sized (read: lost their homes / filed for bank­ruptcy), but there con­tin­ues to be down­ward pres­sure on the hous­ing mar­ket, as mil­lions of homes remain in the fore­clo­sure process and are only slowly mak­ing it to the mar­ket. Bernanke may have cho­sen the end of 2014 as the ear­li­est time to raise rates because it rep­re­sents a date when the hous­ing mar­ket may have freed itself from much of the fore­clo­sure pipeline. Indeed, Fed research sug­gests that res­i­den­tial con­struc­tion won’t fully recover until 2014. We don’t think that is a coin­ci­dence. To Bernanke, a thriv­ing home mar­ket appears to be key to a healthy con­sumer and thus a healthy and sus­tain­able recov­ery in con­sumer spending.

Tying mon­e­tary pol­icy to the cal­en­dar has cre­ated alarm with eco­nomic “hawks” – not just the Fed itself, with the lone hawk­ish vot­ing FOMC mem­ber, Rich­mond Fed Pres­i­dent Jeff Lacker, openly dis­sent­ing. But if one fol­lows Bernanke’s line of think­ing, what’s the alter­na­tive? The alter­na­tive would be to firmly err on the side of infla­tion, as the Fed thinks infla­tion is the one prob­lem it knows how to fight. Except that a cen­tral bank must never com­mu­ni­cate that it wants to induce infla­tion, as it may derail the mar­kets. So the 2nd best option, from Bernanke’s point of view, may be to com­mit to keep­ing rates low until the end of 2014; the “risk” that the econ­omy might per­form bet­ter than expected (and thus ear­lier tight­en­ing war­ranted) appears to be shoved aside. Just to make sure the mar­kets behave, the Fed also intro­duced an infla­tion tar­get, assur­ing the mar­kets not to worry, all will be fine on the infla­tion front.

Unfor­tu­nately, we don’t think Bernanke’s plan will work. The rea­son is that infla­tion may not be as eas­ily fought as Bernanke thinks. The extra­or­di­nary poli­cies that have been pur­sued have not only planted the seeds of infla­tion, but have re-introduced lever­age into the sys­tem. While Bernanke claims he can raise rates in 15 min­utes, we believe there is sim­ply too much lever­age in the econ­omy to raise rates as much as for­mer Fed Chair Paul Vol­cker did in the early 1980s to con­vince the mar­kets the Fed is seri­ous about infla­tion. Given the increased inter­est rate sen­si­tiv­ity of the econ­omy, much less tight­en­ing would likely be nec­es­sary. We are not as opti­mistic as many cur­rent and for­mer Fed offi­cials that it will be pos­si­ble to engi­neer a sus­tain­able eco­nomic growth while adher­ing to the Fed’s infla­tion tar­get. The Fed is ulti­mately respon­si­ble for infla­tion; how­ever, we have also learned that the mod­ern Fed is unlikely to risk severe eco­nomic hard­ship to achieve its price sta­bil­ity mandate.

What does it all mean for the mar­kets? Defla­tion­ary forces have favored the U.S. dol­lar and been a neg­a­tive for gold. As indi­cated, how­ever, we don't think the Fed will sit by idly as the mar­kets price in tight­en­ing before the econ­omy is “ready”. As such, a flight into the dol­lar out of gold might be an oppor­tu­nity to diver­sify out of the dol­lar into a bas­ket of hard cur­ren­cies, includ­ing gold. With regard to the bond mar­ket, we are rather con­cerned that the long end of the yield curve has been extra­or­di­nar­ily well behaved until just a few weeks ago. The rea­son for our con­cern is that peri­ods of low volatil­ity in any asset class usu­ally means that money has entered the space that might leave on short notice: we call it fast money chas­ing yields. We don’t need a cri­sis for investors to run for the hills in the bond mar­ket; we may just need a return to more nor­mal lev­els of volatil­ity. As such, investors may want to con­sider keep­ing inter­est risk low, i.e. stay­ing on the short-end of the yield curve, both in U.S. dol­lars and other cur­ren­cies. With regard to the stock mar­ket, it may do well should the Fed think of another round of eas­ing, but let’s keep in mind that the stock mar­ket has had a tremen­dous rally in recent months.

If investors con­sider invest­ing in the stock mar­ket because of the Fed’s mon­e­tary pol­icy, why not express that same view in the cur­rency mar­ket? After all, cur­ren­cies – when no lever­age is employed – are his­tor­i­cally less volatile than domes­tic (or inter­na­tional) equi­ties. Cur­ren­cies may give investors the oppor­tu­nity to take advan­tage of the risks and oppor­tu­ni­ties pro­vided by our pol­icy mak­ers with­out tak­ing on the equity risk.

Please sub­scribe to Merk Insights by click­ing here to be informed as we ana­lyze the global dynam­ics play­ing out. Also, please click here to reg­is­ter for the Merk Webi­nar: Quar­ter 1 Update on the Econ­omy and Cur­ren­cies which will take place on Thurs­day, April 19th at 4:15pm ET / 1:15pm PT. We man­age the Merk Funds, includ­ing the Merk Hard Cur­rency Fund. To learn more about the Funds, please visit www.merkfunds.com.

Axel Merk

Man­ager of the Merk Hard Cur­rency Fund, Asian Cur­rency Fund, Absolute Return Cur­rency Fund, and Cur­rency Enhanced U.S. Equity Fund, www.merkfunds.com

Axel Merk, Pres­i­dent & CIO of Merk Invest­ments, LLC, is an expert on hard money, macro trends and inter­na­tional invest­ing. He is con­sid­ered an author­ity on currencies.

The Merk Hard Cur­rency Fund (MERKX) seeks to profit from a rise in hard cur­ren­cies ver­sus the U.S. dol­lar. Hard cur­ren­cies are cur­ren­cies backed by sound mon­e­tary pol­icy; sound mon­e­tary pol­icy focuses on price stability.

The Merk Asian Cur­rency Fund (MEAFX) seeks to profit from a rise in Asian cur­ren­cies ver­sus the U.S. dol­lar. The Fund typ­i­cally invests in a bas­ket of Asian cur­ren­cies that may include, but are not lim­ited to, the cur­ren­cies of China, Hong Kong, Japan, India, Indone­sia, Malaysia, the Philip­pines, Sin­ga­pore, South Korea, Tai­wan and Thailand.

The Merk Absolute Return Cur­rency Fund (MABFX) seeks to gen­er­ate pos­i­tive absolute returns by invest­ing in cur­ren­cies. The Fund is a pure-play on cur­ren­cies, aim­ing to profit regard­less of the direc­tion of the U.S. dol­lar or tra­di­tional asset classes.

The Merk Cur­rency Enhanced U.S. Equity Fund (MUSFX) seeks to gen­er­ate total returns that exceed that of the S&P 500 Index. By employ­ing a cur­rency over­lay, the Merk Cur­rency Enhanced U.S. Equity Fund actively man­ages U.S. dol­lar and other cur­rency risk while con­cur­rently pro­vid­ing invest­ment expo­sure to the S&P 500.

The Funds may be appro­pri­ate for you if you are pur­su­ing a long-term goal with a cur­rency com­po­nent to your port­fo­lio; are will­ing to tol­er­ate the risks asso­ci­ated with invest­ments in for­eign cur­ren­cies; or are look­ing for a way to poten­tially mit­i­gate down­side risk in or profit from a sec­u­lar bear mar­ket. For more infor­ma­tion on the Funds and to down­load a prospec­tus, please visit www.merkfunds.com.

Investors should con­sider the invest­ment objec­tives, risks and charges and expenses of the Merk Funds care­fully before invest­ing. This and other infor­ma­tion is in the prospec­tus, a copy of which may be obtained by vis­it­ing the Funds' web­site at www.merkfunds.com or call­ing 866-MERK FUND. Please read the prospec­tus care­fully before you invest.

Since the Funds pri­mar­ily invest in for­eign cur­ren­cies, changes in cur­rency exchange rates affect the value of what the Funds own and the price of the Funds' shares. Invest­ing in for­eign instru­ments bears a greater risk than invest­ing in domes­tic instru­ments for rea­sons such as volatil­ity of cur­rency exchange rates and, in some cases, lim­ited geo­graphic focus, polit­i­cal and eco­nomic insta­bil­ity, emerg­ing mar­ket risk, and rel­a­tively illiq­uid mar­kets. The Funds are sub­ject to inter­est rate risk, which is the risk that debt secu­ri­ties in the Funds' port­fo­lio will decline in value because of increases in mar­ket inter­est rates. The Funds may also invest in deriv­a­tive secu­ri­ties, such as for– ward con­tracts, which can be volatile and involve var­i­ous types and degrees of risk. If the U.S. dol­lar fluc­tu­ates in value against cur­ren­cies the Funds are exposed to, your invest­ment may also fluc­tu­ate in value. The Merk Cur­rency Enhanced U.S. Equity Fund may invest in exchange traded funds ("ETFs"). Like stocks, ETFs are sub­ject to fluc­tu­a­tions in mar­ket value, may trade at prices above or below net asset value and are sub­ject to direct, as well as indi­rect fees and expenses. As a non-diversified fund, the Merk Hard Cur­rency Fund will be sub­ject to more invest­ment risk and poten­tial for volatil­ity than a diver­si­fied fund because its port­fo­lio may, at times, focus on a lim­ited num­ber of issuers. For a more com­plete dis­cus­sion of these and other Fund risks please refer to the Funds' prospectuses.

This report was pre­pared by Merk Invest­ments LLC, and reflects the cur­rent opin­ion of the authors. It is based upon sources and data believed to be accu­rate and reli­able. Opin­ions and forward-looking state­ments expressed are sub­ject to change with­out notice. This infor­ma­tion does not con­sti­tute invest­ment advice. Fore­side Fund Ser­vices, LLC, distributor.

Tags: Central Banks, Cheap Loans, Deflationary Forces, Dollar Gold, Financial Innovation, Future Generations, Global Economy, Gold Bonds, Goldilocks Economy, Investment Vehicles, Last Decade, Liquid Assets, Matter Of Time, Money Creation, Plethora, Rational Investors, Sidelines, Stimulus, Tantrum, Tug Of War
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PIMCO's Gross: Market Has Bernanke in a Box, QE3 Still on the Way

Thursday, April 5th, 2012

Bond king Bill Gross is right along the same line of think­ing as I am on this sub­ject.  Unfor­tu­nately, moral haz­ard is now the name of the game, and rather than being dis­si­pated, it has been enhanced.  To that end the top head­line on CNBC is "Why Fed is likely to Inter­vene if Mar­ket Falls too far" – as if "stock mar­ket man­age­ment" is part of their Con­gres­sional man­dated duty.

Bernanke wants a wealth effect from equi­ties since he is unable to reblow a bub­ble into hous­ing, and the mar­ket knows it.  Hence the tem­per tantrums each time the mar­ket does not get what it wants.  Ben also sees how badly the mar­ket acted dur­ing peri­ods the Fed was not sup­port­ing it the past few years.  You can imag­ine they are watch­ing what has hap­pened since 2 PM yes­ter­day in hor­ror.   Gross pro­vides more color, and why the mar­ket over­re­acted to a few words yes­ter­day.  Again, what that means for the mar­ket in the next hour or days or weeks, who knows.

• The stock mar­ket is over­re­act­ing Wednes­day to what the Fed­eral Reserve didn't say about quan­ti­ta­tive eas­ing in the min­utes from its March meet­ing, bond king Bill Gross told CNBC. It's much ado about noth­ing or much ado about a lit­tle," the founder of Pimco said.
• "We should think of the Fed as like a chess game where some of the pieces are more impor­tant than oth­ers," liken­ing Fed Chair­man Ben Bernanke to the king, San Fran­cisco Fed gov­er­nor Janet Yellen to the queen and New York Fed chief William Dud­ley to the cas­tle, with the rest of the gov­er­nors the knights.  "You have a story when some of these major pieces, one of the three, basi­cally con­cedes and says, 'Check mate.' But we haven't seen that," Gross said. "Until that hap­pens this wordsmithing…is rel­a­tively unimportant."
• But Gross thinks the Fed is very cog­nizant of the state of the stock mar­ket, and if it falls too much it may have to act with some form of eas­ing. The Fed and other cen­tral banks have "got to keep going [with some form of stim­u­lus] if they expect equity mar­kets to continue…at this level," he said.
• "When QE1 has ended, when QE2 has ended, basi­cally the stock mar­ket has gone down by 1,500 points the next month or two," Bill Gross, co-CEO of bond giant Pimco, said in a CNBC inter­view. "Is the Fed trapped in this conun­drum of pro­vid­ing cheaper liq­uid­ity in order to pump up the stock mar­ket and risk mar­kets? I think they are. I won't argue…whether it's good pol­icy, but it's nec­es­sar­ily pol­icy based on where cen­tral banks have led us."

8 minute video

Tags: Bill Gross, Central Banks, Check Mate, Chess Game, Chief William, Cnbc, Fed Chairman, Fed Chief, Fed Governor, Gross Market, Market Management, Moral Hazard, Name Of The Game, New York Fed, PIMCO, S Gross, Temper Tantrums, Wealth Effect, William Dudley, Wordsmithing
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Bernanke's Problem with the Gold Standard

Wednesday, March 28th, 2012

by Axel Merk, Merk Funds

In his new lec­ture series, Fed­eral Reserve (Fed) Chair­man Ben Bernanke is going out of his way to dis­cuss the "prob­lems with the gold stan­dard." To a cen­tral banker, the gold stan­dard may be con­sid­ered "com­pe­ti­tion," as their power would likely be greatly dimin­ished if the U.S. were on a gold stan­dard. The Fed, Bernanke argues, is the answer to the prob­lems of the gold stan­dard. We respect­fully dis­agree. We dis­agree because the Fed ought to look at a dif­fer­ent problem.

Bernanke lists price sta­bil­ity and finan­cial sta­bil­ity as key objec­tives of the Fed. Focus­ing on the lat­ter one first, the Fed was estab­lished to reduce the risk of finan­cial pan­ics. Bernanke points out:

"A finan­cial panic is pos­si­ble in any sit­u­a­tion where longer-term, illiq­uid assets are financed by short-term, liq­uid lia­bil­i­ties; and in which short-term lenders or depos­i­tors may lose con­fi­dence in the institution(s) they are financ­ing or become wor­ried that oth­ers may lose confidence."

Bernanke goes on to blame the gold stan­dard for the pan­ics. While he is cer­tainly not alone in his view – indeed, his very lec­ture to stu­dents at George Wash­ing­ton Uni­ver­sity is pro­mot­ing that view to a new gen­er­a­tion of econ­o­mists -, we beg to differ.

Banks — by def­i­n­i­tion — have a matu­rity mis­match, mak­ing long-term loans, tak­ing short-term deposits. As such, banks are prone to finan­cial pan­ics as described by Bernanke. To mit­i­gate the risk of finan­cial pan­ics, cen­tral banks can do what the Fed is doing, namely to be a lender of last resort. Alter­na­tively, cen­tral banks can focus on the core issue, the struc­tural "prob­lem of bank­ing." Fol­low­ing the Fed's approach, there are inher­ent moral haz­ard issues – incen­tives for finan­cial insti­tu­tions to increase lever­age, to become too-big-to-fail. To address a panic that might hap­pen any­way, the Fed would dou­ble down (pro­vide more liq­uid­ity), poten­tially exac­er­bat­ing future bank­ing pan­ics. After yet another cri­sis, new rules are intro­duced to reg­u­late banks. The result­ing finan­cial sys­tem may not be safer, but it will increase bar­ri­ers to entry, fur­ther bol­ster­ing the lead­er­ship posi­tion of exist­ing, too-big-to-fail banks. With all the gov­ern­ment guar­an­tees and too-big-to-fail con­cerns, banks might then be reg­u­lated in an attempt to have them act more like util­i­ties. Ulti­mately, that might make the finan­cial sys­tem more sta­ble, but will sti­fle eco­nomic growth. Finan­cial insti­tu­tions, as much as we have mixed feel­ings about their con­duct, are vital to finance eco­nomic growth, as they facil­i­tate risk tak­ing and investment.

The prob­lem of all finan­cial pan­ics is not the gold stan­dard — oth­er­wise, the panic of 2008 would not have hap­pened. The prob­lem of finan­cial pan­ics is — again — that "longer-term, illiq­uid assets are financed by short-term, liq­uid lia­bil­i­ties." Miss­ing from Bernanke's def­i­n­i­tion is a key addi­tional attribute, lever­age. A matu­rity mis­match with­out lever­age might cause a lender to go bust, but — in our inter­pre­ta­tion — does not qual­ify as a panic when a lim­ited num­ber of depos­i­tors are affected. The "panic" and the "con­ta­gion" may occur when lever­age is employed, as it cre­ates a dis­pro­por­tion­ate num­ber of cred­i­tors (includ­ing con­sumers with cash deposits).

There's a bet­ter way. To avoid hav­ing finan­cial insti­tu­tions serve as “panic” incu­ba­tors, reg­u­la­tion should address the core of the issue. Bernanke shouldn’t use gold, as a scape­goat for all that was wrong with the U.S. econ­omy pre­vi­ously, to jus­tify a license to print money. First, fail­ure must be an option; indi­vid­u­als and busi­nesses must be allowed to make mis­takes and suf­fer the con­se­quences. The role of the reg­u­la­tor, in our opin­ion, is to avoid an event where someone's mis­take wrecks the entire system.

The eas­i­est way to achieve a more sta­ble finan­cial sys­tem is to reduce incen­tives for lever­age. A straight­for­ward method is through mark-to-market account­ing and a require­ment to post col­lat­eral for lever­aged trans­ac­tions. The finan­cial indus­try lob­bies against this, argu­ing that hold­ing a posi­tion to matu­rity ren­ders mark-to-market account­ing redun­dant. Con­sider the fol­low­ing exam­ple, which high­lights the impli­ca­tion: assume a spec­u­la­tor before the finan­cial cri­sis took a lever­aged bet that oil prices — at the time trad­ing at $80 a bar­rel — would go down to $40 a bar­rel. In the “ideal world” accord­ing to the banks, this spec­u­la­tor would not have been required to post col­lat­eral and would have been proven right when oil (briefly) dropped to $40 a bar­rel after the finan­cial cri­sis. In real­ity how­ever, as oil prices soared to $140 a bar­rel before declin­ing, the typ­i­cal spec­u­la­tor would have been forced to post an ever larger amount of col­lat­eral; likely, the speculator's bro­ker­age firm would have closed out the posi­tion, as the spec­u­la­tor ran out of money. The spec­u­la­tor lost money because he was unable to meet a mar­gin call; impor­tantly, though, the sys­tem remained intact. The spec­u­la­tor might com­plain: the price ulti­mately fell to $40! But such whin­ing is futile because the rules of engage­ment were known ahead of time. As such, the spec­u­la­tor had an incen­tive to use less (or no) lever­age. The bank's atti­tude, in con­trast, incu­bates pan­ics. In this exam­ple, reg­u­lated exchanges exist. But even with­out reg­u­lated exchanges or eas­ily priced secu­ri­ties, sim­i­lar con­cepts can be developed.

Another way to make finan­cial firms more panic prone is to require them to issue stag­gered sub­or­di­nated debt. Rather than rely­ing heav­ily on short-term fund­ing (retail deposits or inter-bank fund­ing mar­kets), banks should be required to stag­ger the matu­ri­ties of their own fund­ing over years. If, say, each year 10% of their loan port­fo­lio needs to be refi­nanced, then — in times of finan­cial tur­moil — it might become exor­bi­tantly expen­sive for a bank to finance that 10% of their loan port­fo­lio. A bank should be able to shrink its loan port­fo­lio by 10% in a year in an orderly fash­ion, with­out jeop­ar­diz­ing the sur­vival of the firm or spread­ing exces­sive risks through­out the finan­cial sys­tem. Note that this is a market-based mech­a­nism to police the finan­cial system.

These con­cepts reduce lever­age in the sys­tem. And that's the point, as lever­age is the mother of all pan­ics. The con­cepts pre­sented above will not solve all the chal­lenges of bank­ing, but blam­ing "the prob­lem of the gold stan­dard" for finan­cial pan­ics is — in our analy­sis — premature.

Mod­ern cen­tral bank­ing is not the answer to mit­i­gate the risk of finan­cial pan­ics because the cost for this per­ceived safety is enor­mous. As a result of respond­ing to each poten­tial panic with ever more "liq­uid­ity", entire gov­ern­ments are now put at risk when a cri­sis flares up.

Beyond that, cen­tral banks have done a hor­ri­ble job in con­tain­ing infla­tion. The wis­dom of cen­tral bank­ing is that 2% infla­tion is con­sid­ered an envi­ron­ment of sta­ble prices. At 2%, a level often touted as a “price sta­ble envi­ron­ment”, the pur­chas­ing power of $100 is reduced to $55 over a 30-year period. It's a cruel tax on the pub­lic. What’s more, in prac­tice, coun­tries with a fiat cur­rency sys­tem have gen­er­ally been unable to keep long-term infla­tion below 2%.

Bernanke warns of defla­tion. To the saver, defla­tion is a gift. Not to the debtor. In a debt dri­ven world, defla­tion stran­gles the econ­omy. Gov­ern­ments don't like defla­tion as income taxes and cap­i­tal gains taxes are eroded. In a defla­tion­ary world, gov­ern­ments would need to rely more on sales taxes (or value added taxes): grad­u­ally reduced rev­enue in a defla­tion­ary envi­ron­ment would be okay as the pur­chas­ing power of those tax rev­enues would increase. That assumes, of course, that the gov­ern­ment car­ries a low debt bur­den — defla­tion would be a good incen­tive to limit spend­ing. Get the pic­ture why gov­ern­ments don't like deflation?

Read John Butler's new book
The Golden Rev­o­lu­tion: How to Pre­pare for the Com­ing Global Gold Standard

With infla­tion, peo­ple have an "incen­tive" to work harder, to take on risks, just to retain their pur­chas­ing power, the sta­tus quo. What about the pur­suit of hap­pi­ness? The idea that if you earn money and save, you can retire and live off your sav­ings? We con­sider it quite an impo­si­tion that unelected offi­cials have such sway over our stan­dard of living.

Bernanke also attacks the gold stan­dard for caus­ing havoc in the cur­rency mar­kets. Please sub­scribe to our newslet­ter to be informed as we pro­vide food for thought about the rela­tion­ship between gold and cur­ren­cies. We will also dis­cuss what investors may want to do in a world that has moved fur­ther and fur­ther away from the gold stan­dard. Sub­scribe to Merk Insights by click­ing here. Also, please click here to reg­is­ter for the Merk Webi­nar: Quar­ter 1 Update on the Econ­omy and Cur­ren­cies which will take place on Thurs­day, April 19th at 4:15pm EF / 1:15pm PT. We man­age the Merk Funds, includ­ing the Merk Hard Cur­rency Fund. To learn more about the Funds, please visit www.merkfunds.com.

Axel Merk

Man­ager of the Merk Hard Cur­rency Fund, Asian Cur­rency Fund, Absolute Return Cur­rency Fund, and Cur­rency Enhanced U.S. Equity Fund, www.merkfunds.com

Axel Merk, Pres­i­dent & CIO of Merk Invest­ments, LLC, is an expert on hard money, macro trends and inter­na­tional invest­ing. He is con­sid­ered an author­ity on currencies.

The Merk Hard Cur­rency Fund (MERKX) seeks to profit from a rise in hard cur­ren­cies ver­sus the U.S. dol­lar. Hard cur­ren­cies are cur­ren­cies backed by sound mon­e­tary pol­icy; sound mon­e­tary pol­icy focuses on price stability.

The Merk Asian Cur­rency Fund (MEAFX) seeks to profit from a rise in Asian cur­ren­cies ver­sus the U.S. dol­lar. The Fund typ­i­cally invests in a bas­ket of Asian cur­ren­cies that may include, but are not lim­ited to, the cur­ren­cies of China, Hong Kong, Japan, India, Indone­sia, Malaysia, the Philip­pines, Sin­ga­pore, South Korea, Tai­wan and Thailand.

The Merk Absolute Return Cur­rency Fund (MABFX) seeks to gen­er­ate pos­i­tive absolute returns by invest­ing in cur­ren­cies. The Fund is a pure-play on cur­ren­cies, aim­ing to profit regard­less of the direc­tion of the U.S. dol­lar or tra­di­tional asset classes.

The Merk Cur­rency Enhanced U.S. Equity Fund (MUSFX) seeks to gen­er­ate total returns that exceed that of the S&P 500 Index. By employ­ing a cur­rency over­lay, the Merk Cur­rency Enhanced U.S. Equity Fund actively man­ages U.S. dol­lar and other cur­rency risk while con­cur­rently pro­vid­ing invest­ment expo­sure to the S&P 500.

The Funds may be appro­pri­ate for you if you are pur­su­ing a long-term goal with a cur­rency com­po­nent to your port­fo­lio; are will­ing to tol­er­ate the risks asso­ci­ated with invest­ments in for­eign cur­ren­cies; or are look­ing for a way to poten­tially mit­i­gate down­side risk in or profit from a sec­u­lar bear mar­ket. For more infor­ma­tion on the Funds and to down­load a prospec­tus, please visit www.merkfunds.com.

Investors should con­sider the invest­ment objec­tives, risks and charges and expenses of the Merk Funds care­fully before invest­ing. This and other infor­ma­tion is in the prospec­tus, a copy of which may be obtained by vis­it­ing the Funds' web­site at www.merkfunds.com or call­ing 866-MERK FUND. Please read the prospec­tus care­fully before you invest.

Since the Funds pri­mar­ily invest in for­eign cur­ren­cies, changes in cur­rency exchange rates affect the value of what the Funds own and the price of the Funds' shares. Invest­ing in for­eign instru­ments bears a greater risk than invest­ing in domes­tic instru­ments for rea­sons such as volatil­ity of cur­rency exchange rates and, in some cases, lim­ited geo­graphic focus, polit­i­cal and eco­nomic insta­bil­ity, emerg­ing mar­ket risk, and rel­a­tively illiq­uid mar­kets. The Funds are sub­ject to inter­est rate risk, which is the risk that debt secu­ri­ties in the Funds' port­fo­lio will decline in value because of increases in mar­ket inter­est rates. The Funds may also invest in deriv­a­tive secu­ri­ties, such as for– ward con­tracts, which can be volatile and involve var­i­ous types and degrees of risk. If the U.S. dol­lar fluc­tu­ates in value against cur­ren­cies the Funds are exposed to, your invest­ment may also fluc­tu­ate in value. The Merk Cur­rency Enhanced U.S. Equity Fund may invest in exchange traded funds ("ETFs"). Like stocks, ETFs are sub­ject to fluc­tu­a­tions in mar­ket value, may trade at prices above or below net asset value and are sub­ject to direct, as well as indi­rect fees and expenses. As a non-diversified fund, the Merk Hard Cur­rency Fund will be sub­ject to more invest­ment risk and poten­tial for volatil­ity than a diver­si­fied fund because its port­fo­lio may, at times, focus on a lim­ited num­ber of issuers. For a more com­plete dis­cus­sion of these and other Fund risks please refer to the Funds' prospectuses.

This report was pre­pared by Merk Invest­ments LLC, and reflects the cur­rent opin­ion of the authors. It is based upon sources and data believed to be accu­rate and reli­able. Opin­ions and forward-looking state­ments expressed are sub­ject to change with­out notice. This infor­ma­tion does not con­sti­tute invest­ment advice. Fore­side Fund Ser­vices, LLC, distributor.

Copy­right © Merk Funds

Tags: Ben Bernanke, Central Banks, Core Issue, Depositors, ETF, ETFs, Fed Chairman, Financial Institutions, Financial Panic, Financial Panics, Financial Stability, George Washington University, Gold Standard, Hazard Issues, Illiquid Assets, India, Key Objectives, Lecture Series, Lender Of Last Resort, Long Term Loans, Moral Hazard, Price Stability, Short Term Deposits, Term Lenders
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This Is The World's Balance Sheet

Wednesday, March 28th, 2012

It is rather sur­pris­ing that in a world in which any­thing and every­thing is only about money, it is next to impos­si­ble to find a con­sol­i­dated bal­ance sheet of the world's insol­vent economies (i.e., the devel­oped coun­tries: US, Japan and the Euro Area). So for all those seek­ing a visual pre­sen­ta­tion of all the lia­bil­i­ties that have to be inflated away by the cen­tral banks (because that's what this is all about), rejoice: the broke world is pre­sented below in its glory. The irony is that the prob­lem would be quite fix­able if it weren't for one minor issue: the bulk of the world's assets also hap­pen to be its lia­bil­i­ties! At the end of the day, this may prove to be the fatal flaw in the chairman's attempt to dilute the global lia­bil­i­ties, he will be doing the same with the assets.

We will fol­low up with an analy­sis of what this actu­ally means shortly (those who have been read­ing in the past year can come to their own con­clu­sions), but more impor­tantly we well next show how the global "house­hold" sec­tor is invested across these three dis­tinct economies by assorted asset class. Pre­pare to be rather sur­prised as var­i­ous con­ven­tion­ally accepted notions are thor­oughly debunked...

Tags: asset class, Assets, Attempt, Central Banks, Conclusions, Consolidated Balance Sheet, Developed Countries, Distinct Economies, Household Sector, Irony, Japan, Liabilities, Money, Notions, Visual Presentation
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Interest Rates: The Market Has It All Wrong (Jakobsen)

Tuesday, March 27th, 2012

by Steen Jakob­sen, Saxo Bank

"In gen­eral, the art of gov­ern­ment con­sists in tak­ing as much money as pos­si­ble from one party of the cit­i­zens to give to the other." — Voltaire

To say that the last four years since the finan­cial cri­sis broke out in 2008 has been slightly atyp­i­cal would be the under­state­ment of the cen­tury. The cen­tral banks across the globe have reached deep into their tool­box  - first by low­er­ing inter­est rates to zero or effec­tively to zero, and then grasp­ing at “uncon­ven­tional mea­sures” that are aimed at keep­ing rates low at the long end of the curve as well by buy­ing up most of the bonds issued by their own gov­ern­ments' trea­suries. Decades ago, the lat­ter would have been called a Ponzi scheme, but in today’s world the mea­sures are sold as the “only alter­na­tive”. Voltaire saw it coming.

Tra­di­tion­ally, the cen­tral banks have only con­trolled the part of the yield curve from overnight and out to per­haps one year. But the severe drop in equi­ties in 2008/2009 and the huge fis­cal imbal­ances cre­ated from the biggest fis­cal stim­u­lus in his­tory cre­ated a need for secur­ing “orderly busi­ness” through ample liq­uid­ity at low rates. That was fol­lowed up with a PR blitz from cen­tral bank and pol­icy mak­ers, who told us: Trust us – we've got every­thing under con­trol. Sure you do! Since then, we con­tinue to the migra­tion from one bub­ble to the next, and now we are in a debt trap in which gov­ern­ments and banks remains thinly cap­i­tal­ized and have no access to fur­ther credit unless the cen­tral bank is willing.

The world gov­ern­ments and com­mer­cial banks now take so much of the “credit cake” that the pri­vate sec­tor is only left with crumbs. The pri­vate sec­tor, which is tra­di­tion­ally the risk-taking and prof­itable side of the econ­omy, has been cut off from its oxy­gen, credit — the macro side of the econ­omy has over­whelmed the micro. This is a ter­ri­ble mis­take. All enter­pris­ing indi­vid­u­als and com­pa­nies should want max­i­mum flex­i­bil­ity and access to cap­i­tal and risk, instead they are cut off, over­taxed and overregulated.

In 2012 we have so far seen a grad­ual nor­mal­iza­tion of inter­est rates com­ing off extreme lows. The move this month has been dra­matic rel­a­tive to the recent past and has lead to the talk of chang­ing growth fun­da­men­tals and the pos­si­bil­ity that the econ­omy (mainly the US) has turned the cor­ner. We were con­struc­tive on the US back in Q4-2011 as we saw that the con­sen­sus pro­jec­tions of expected future growth were too low (Remem­ber the "dou­ble dip" talk?) Now fast for­ward to Q1-2012 and the mar­ket is, in our view, too quick in pro­ject­ing that the recent “sta­bi­liza­tion” will blos­som into long-term growth. It’s too early, if any­thing our for­ward look­ing indi­ca­tors are show­ing signs of a pos­si­ble slow down, so we believe that the US will still out­per­form in 2012, but only because every­where else will fare much worse.

This leaves us with the conun­drum of the lat­est sharp rise in inter­est rates: Has the inter­est cycled bot­tomed? Is this the new "new nor­mal" or is it sim­ply a dose of mean-reversion? The gov­ern­ments and weak banks and over-indebted com­pa­nies need very low inter­est rates to con­tinue to carry and roll their gigan­tic debt loads, so the this inter­est rate ques­tion is vital as the future path of rates will have a mas­sive impact on future growth and the invest­ment climate.

With that in mind, we offer three sce­nar­ios and our per­ceived odds of their probability:

- Even lower inter­est rates/more uncon­ven­tional mea­sures going for­ward (Con­sen­sus: 60%, but we think far less likely) – based on infi­nite mon­e­tary expan­sion. This is the refla­tion trade. This is option favored by politi­cians as it is off bal­ance sheet and "off account­abil­ity" for them as the cen­tral banks con­tinue to bail out the sov­er­eign and other large debt hold­ers with the print­ing press. Since they pull the levers, this is seen as the most likely sce­nario and if you look at charts, it's also very appeal­ing in terms of the con­ti­nu­ity: ever lower inter­est rates in down­ward chan­nel as seen above. But shouldn't the mar­ket rec­og­nize that cen­tral banks only go uncon­ven­tional when the there is sys­temic panic and crash­ing mar­kets? Par­tic­u­larly given the gross imbal­ances they have already intro­duced? Besides, now that they have force fed so much liq­uid­ity into the sys­tem, they have actu­ally helped to remove the tail risks that lead to such out­comes in the first place.

- Lower in a chan­nel but all-time low in place (Con­sen­sus: 30%, but our pre­ferred sce­nario) – rates have vis­ited a long-term low as “uncon­ven­tional mea­sures” will need to be slowly unwound. The biggest pol­icy mis­take his­tor­i­cally has always been for cen­tral banks to stay too easy for too long. The politi­cians are clearly get­ting “gun shy” in the face of the mon­e­tary bazooka of “uncon­ven­tional mea­sures”. Another show-stopper could the law of stock ver­sus flow. The pol­icy mak­ers have printed in excess of 3 tril­lion US dol­lars glob­ally to keep the finan­cial mar­ket and gov­ern­ments afloat. This means that to have an addi­tional impact the net new issuance of money needs to be much big­ger in nom­i­nal terms and as the debt load swells, every incre­men­tal unit of debt sparks an ever dimin­ish­ing return on growth. The print­ing presses slow­ing from here would have pro­found impli­ca­tions as we dis­cuss below.

- Cri­sis 2.0 (Con­sen­sus: 10%) - This is our old theme — which is that mar­ket par­tic­i­pants will lose faith in the gov­ern­ment and its abil­ity to repay its debts. To some extent we have had already had a Cri­sis 2.0 in Club Med Euro Zone periph­er­als, but it has yet to pass on to the core Euro Zone economies like Ger­many and France, much less the UK, US, and Japan. This is the least likely sce­nario, but if we break the upper bound of the chan­nel in the chart above, it could touch off a whole new par­a­digm in which fiat money is no longer seen as sustainable.

If we are right and the market's belief that "the next bailout always awaits in case" is wrong, then the move away from uncon­ven­tional mea­sures, i.e., infi­nite money print­ing, is a major game changer. The banks and gov­ern­ment are depen­dent on the false sense of secu­rity low inter­est rates cre­ates. The lat­est move in inter­est rates is actu­ally tiny in the his­tor­i­cal per­spec­tive. Were we to see an expan­sion in the volatil­ity to the high-end of the present long-term trad­ing range — from 3.00% to 4.75%, for exam­ple, it would have a dra­matic impact on debt crisis.

Across Europe and the US, home­own­ers remain under pres­sure. A move in rates of any rea­son­able size would put mil­lions more even fur­ther under water on their home equity. That is the neg­a­tive impact of a debt trap, the inabil­ity to cre­ate any eco­nomic envi­ron­ment that allows us to extract our­selves from the pain of the debt ser­vice – just look at Japan. The stock– and house mar­ket topped in 1989 – now 22+ years later the stock mar­ket is 75% below its peak. Too neg­a­tive to apply to the rest of the world? Prob­a­bly, but a long life in trad­ing has taught me a few long-term facts. One: every­thing mean-reverts – What goes up must come down. (Think stock mar­ket, house prices, state inter­ven­tion, excess of all kinds.) and more impor­tantly — Two: we never learn any from history

Safe trav­els,

Steen

Tags: Central Banks, Commercial Banks, Debt Trap, Enterprising Individuals, Financial Crisis, Fiscal Imbalances, Fiscal Stimulus, interest rates, liquidity, Oxygen, Ponzi Scheme, Pr Blitz, Private Sector, Saxo Bank, Steen, Treasuries, Understatement, Voltaire, World Governments, Yield Curve
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Scratching My Head Till it Bleeds & The 5 classes of Corporate Bonds

Tuesday, March 27th, 2012

by Peter Tchir, TF Mar­ket Advisors

The mar­ket has ral­lied more than 2% since the lows on Fri­day morn­ing.  The rally has been almost exclu­sively cen­tral bank and gov­ern­ment driven.

On Fri­day the rally started with rumors of ECB bond pur­chases, it con­tin­ued Mon­day morn­ing with Merkel soft­en­ing her stance on how much Ger­many is will­ing to risk, and momen­tum accel­er­ated to a crescendo once Bernanke made it clear that not only is QE not off the table, but he is dying to do more QE ASAP.

Equi­ties seem to have com­pletely accepted that cen­tral banks and gov­ern­ments can only be good for the mar­ket.  That is what has me scratch­ing my head so hard.  Does noth­ing other than cen­tral bank pol­icy make a dif­fer­ence?  Any­one who nailed the eco­nomic data last week has to feel like an idiot. The Chi­nese land­ing ques­tion has not been answered, but there is grow­ing evi­dence that it could be the hard sort.  The Euro­pean econ­omy dete­ri­o­rated and some of the weaker coun­tries did the worst – Spain as a not so shin­ing exam­ple.  Hous­ing data in the US missed across the board, and gen­er­ally the data was weak.  Yet here we are, back to new highs in equities.

So it is true that flood­ing the world with money has helped stocks, there have also been peri­ods where stocks did poorly in spite of all these pro­grams being in place.  Are we now sup­posed to believe that we can never go down again while cen­tral bankers are at work? That doesn’t match with his­tory, yet yes­ter­day seems to have con­vinced many that the only direc­tion for stocks is up with Ben­draghi in charge.  The S&P is trad­ing at 14.7x earn­ings.  Maybe not over­val­ued, but also hard to argue that they are extremely cheap – espe­cially with eco­nomic indi­ca­tors not only a lit­tle weaker than expected, but show­ing signs that a lot of the strong data early this year truly was a func­tion of weather, and rather than being able to jump­start the econ­omy, merely pulled activ­ity for­ward and we are now see­ing the impact of that.

While equi­ties and com­modi­ties (except for nat­ural gas) knew exactly what to do with the Ben’s state­ment, trea­suries had more dif­fi­culty fig­ur­ing it out. They seemed to be left scratch­ing their heads and were torn between the desire to rally on the back of more gov­ern­ment sup­port, or sell­ing off as part of a “risk on” rally.  Trea­suries seem to be caught in no man’s land.  Fed pur­chases keep them arti­fi­cially low, but with any poten­tial for sta­bil­ity in the world, any signs of infla­tion, and a stock mar­ket this high, it is hard to be an “investor” in trea­suries here.  There is real fear that you do not want to be the one left hold­ing trea­suries once the QE game is over.  It is a bit sur­pris­ing that Ben wasn’t able to do more for trea­suries yes­ter­day.  The long bond is actu­ally 2 bps higher than it was on Friday.

Cor­po­rate bonds were okay.  Not as enthu­si­as­tic as stocks and com­modi­ties, but more excited by the prospects of addi­tional QE than trea­suries.  On the credit ETF side, it looks like most of the appre­ci­a­tion went into increas­ing the pre­mium as the NAV didn’t move as quickly.

Mort­gages should do best on any QE as it seems that will be the pri­mary ben­e­fi­ciary.  In the mean­time, cor­po­rate bonds seem to be 5 dis­tinct assets classes:

Invest­ment Grade Cor­po­rate: These are already trad­ing tight, but should have lit­tle volatil­ity.  I would want to own them on a hedged basis, if at all.  Noth­ing wrong with the bonds, but lit­tle upside left.

Finan­cial Bonds: Bonds issued by banks still have the most spread and best chance of appre­ci­a­tion.  They also clearly have the most risk.  I pre­fer bonds of the biggest Euro­pean banks (DB and SG), but would want to avoid or be short the banks that have used LTRO the most aggressively.

“Short Dated” HY Bonds: There are a lot of high coupon hy bonds trad­ing to call dates within the next two years.  Nor­mally these offer lim­ited upside, but it might be worth buy­ing some.  Retail investors seem to have their eyes on these bonds, and there is now at least one ETF specif­i­cally tar­get­ing these bonds.  There isn’t much value here, but retail is likely to drive these bonds up a cou­ple points higher than insti­tu­tional investors ever would – espe­cially with the econ­omy being sta­ble.  Decent carry and real chance that retail chases these bonds higher than they should be.

“Story Credit” HY Bonds: These have ral­lied but still have some poten­tial.  It really is a “close your eyes” and hope for the best at this stage as the down­side is prob­a­bly greater than the upside, but if you truly believe in QE and its abil­ity to make things good, you are sup­posed to close your eyes and buy these.  Not a strat­egy I like right now as I believe that in spite of (or because of) all the gov­ern­ment and cen­tral bank inter­ven­tion we are a long way from hav­ing resolved anything.

“high qual­ity non-callable” HY Bonds: These are poten­tially the most dan­ger­ous.  These are typ­i­cally BB com­pa­nies with bonds that have good call pro­tec­tion for at least 5 years.  Spreads are rel­a­tively tight, though have room to move tighter, but in spite of many arti­cles say­ing that HY doesn’t move with rates, these will.  We are in a pretty unique sit­u­a­tion in the credit mar­kets.  Trea­sury yields are very low.  Spreads on these bonds are okay, and could tighten, but the yields are very low.  The abil­ity for this class of bonds to rally in a ris­ing rate envi­ron­ment is low.  On a spread basis, they could tighten as they should out­per­form trea­suries, but they can still go down on price.  They will be squeezed out by BBB bonds in a ris­ing rate envi­ron­ment.  The analy­sis of HY cor­re­la­tion to trea­suries that I have seen is too sim­plis­tic.  The first two cat­e­gories of hy bonds that I men­tion do not have much rate risk.  This cat­e­gory does.

Tags: 7x, Asap, Central Banks, Chinese Landing, Commodities, Commodity, Corporate Bonds, Crescendo, Economic Data, Economic Indicators, European Economy, Friday Morning, Lows, Match, Merkel, Momentum, Monday Morning, New Highs, Qe, Spite, Tf, Weather
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Gold and China: Where the Bulls and Bears Square Off

Sunday, March 25th, 2012

Gold and China: Where the Bulls and Bears Square Off

By Frank Holmes, CEO and Chief Invest­ment Offi­cer, U.S. Global Investors

To para­phrase the great Steve Mar­tin, today’s investors are very pas­sion­ate peo­ple and pas­sion­ate peo­ple tend to over­re­act at times. An over­re­ac­tion is exactly what’s hap­pened in gold and global mar­kets in recent weeks. While mar­ket bulls have been sniff­ing out data points to sup­port their case, mar­ket bears have con­tin­ued to take a glass-half-empty approach.

Gold and China are two areas that have been caught in the bear trap this week, but we believe the gold and China bulls still have room to run.

Short-Term Chal­lenges for Gold
Ris­ing bond yields, a stronger U.S. dol­lar and an improv­ing U.S. econ­omy have squelched expec­ta­tions for a third round of quan­ti­ta­tive eas­ing (QE3) and con­se­quently, spelled trou­ble for gold. Since late Feb­ru­ary, gold has declined more than 7 percent.

As con­fi­dence improves, UBS says the yel­low metal is los­ing the dual role of safe haven and risk asset: “Gold is mov­ing off cen­ter stage, while growth assets are mov­ing to the fore.” Ear­lier this month, we saw the largest weekly con­trac­tion in long gold posi­tions on the Comex since 2004.

As I wrote in my blog this week, the sell­off has pushed the price of bul­lion below its 200-day mov­ing aver­age for only the 30th time over the past 10 years. Over this time period, gold has declined on aver­age 2.1 per­cent over the 10 days fol­low­ing the cross-below date. This means we’re likely only one-third into the cor­rec­tion in terms of price and duration.

All is not lost for gold. In his lat­est Gold Mon­i­tor, Dundee Wealth Eco­nom­ics Chief Econ­o­mist Mar­tin Muren­beeld lists 10 pos­i­tive fac­tors for gold, one of which is mon­e­tary refla­tion. We are cur­rently expe­ri­enc­ing one of the great­est global liq­uid­ity booms the world has ever seen. Over the past seven months, there have been 122 stim­u­la­tive pol­icy ini­tia­tives from cen­tral banks around the world, accord­ing to ISI Group.

You can see from Canaccord’s chart below that inject­ing liq­uid­ity into the global mon­e­tary sys­tem has been a steroid for stronger gold prices over the past decade. The global mon­e­tary base has bal­looned three times larger, with gold increas­ing nearly six-fold.

While we are see­ing strong signs of improve­ment in the global econ­omy, it’s impor­tant to remem­ber that the recov­ery has been built upon a moun­tain of printed money that can­not be hastily unwound. Dr. Muren­beeld explains, “money doesn’t grow on trees; it will have to be bor­rowed by some gov­ern­ment and/or it will have to be printed by some cen­tral bank.”

This is why we believe the bull mar­ket for gold remains intact.

Over­re­ac­tion on China
Indi­ca­tion of a Chi­nese eco­nomic slow­down and neg­a­tive com­ments from BHP Bil­li­ton regard­ing its out­look for Chi­nese demand caused anx­i­ety for investors this week.

The March HSBC Flash Man­u­fac­tur­ing Pur­chas­ing Man­agers’ Index (PMI) fell 3 points from the pre­vi­ous month due to weak­en­ing domes­tic and exter­nal demand.

How­ever, Mac­quarie says, “it’s not that bad out there.” The firm’s research shows that rel­a­tively strong demand from China dur­ing the first two months of the year has had a pos­i­tive impact on global com­mod­ity prices. Mac­quarie says, “while there is undoubt­edly a slow­down tak­ing place in Chi­nese eco­nomic growth as a result of domes­tic pol­icy tight­en­ing and weaker export growth, the impact on com­modi­ties demand has been negligible.”

As for the BHP com­ments, Bar­clays says that they were mis­con­strued, stat­ing the “BHP exec­u­tive was by no means bear­ish on near-term Chi­nese demand prospects and com­ments refer­ring to a soft­en­ing in Chi­nese steel demand were largely focused on the sce­nario post 2025 … the notion that iron ore and steel demand growth is unlikely to grow at a double-digit pace for­ever is not a sur­prise to the market.”

Bright spots in China’s econ­omy aren’t hard to find. Bar­clays reports that the back­log of man­u­fac­tur­ing orders saw its largest month-over-month increase since 2005 from Jan­u­ary to Feb­ru­ary of this year. Sup­ported by an all-time high in gaso­line demand, Chi­nese oil demand reached a record high in Feb­ru­ary. Gaso­line demand was resilient despite Bei­jing hik­ing prices by 4 per­cent in Feb­ru­ary due to higher oil prices. The Chi­nese gov­ern­ment fol­lowed that up with an addi­tional 7 per­cent hike ear­lier this month. Auto sales increased nearly 24 per­cent year-over-year (13 per­cent sequen­tially) in Feb­ru­ary, the largest increase since Novem­ber 2010, accord­ing to UBS.

While ris­ing fuel costs are a hot-button issue here in the U.S., CLSA’s Andy Roth­man says that the higher fuel prices will only mod­estly impact Chi­nese con­sumers because few come in direct con­tact with unsub­si­dized gaso­line. CLSA esti­mates that fuel accounts for only 2 per­cent of China’s Con­sumer Price Index (CPI) bas­ket, com­pared to 5.4 per­cent in the U.S.

We’re also see­ing pos­i­tive devel­op­ments in an area where Chi­nese con­sumers are vulnerable—housing prices. Accord­ing to CLSA and China’s National Bureau of Sta­tis­tics, home prices fell in 27 cities on a year-over-year basis dur­ing Feb­ru­ary, three times the vol­ume in Decem­ber. In addi­tion, none of the 70 cities tracked reported more than a 5 per­cent increase in new home prices. A grad­ual reduc­tion in home prices is exactly what the coun­try needs to pre­vent a major hous­ing crash, but don’t expect the Chi­nese gov­ern­ment to let the bot­tom fall out.

Remem­ber, the min­i­mum cash down pay­ment for a Chi­nese home buyer with a mort­gage is 30 per­cent. Investors are required to put 60 per­cent down in cash. Cur­rently, about one-third of home buy­ers are pay­ing all cash, accord­ing to CLSA. Andy says the gov­ern­ment is poised to relax the country’s strict hous­ing pol­icy mea­sures as soon as this sum­mer if the decline accelerates.

Tags: Bear Trap, Bond Yields, Bulls And Bears, Case Market, Central Banks, Chief Economist, Chief Investment Officer, Commodities, Commodity, Dual Role, Dundee Wealth, Frank Holmes, Global Liquidity, Growth Assets, Martin Murenbeeld, Moving Average, Overreaction, Policy Initiatives, Qe3, Selloff, Term Challenges, U S Global Investors
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