Archive - Feb 22, 2012

Just because it is a nice, round, and very symbolic number...

Somehow out of the blue, the strangely morbid yet delightfully Hollywood-esque story of Greek modern day Robin Hood Vassilis Paleokostas re-emerged today. Which, considering the latest developments out of Greece is probably oddly appropriate: if there is anything the Greek population needs now to finally free itself of its usurping, unelected and banker-appointed technocratic oligarchy, which does nothing but keep selling the nation ever further down the river just so it can use Greece as a passthru funding vehicle to keep Europe's banks solvent, it is many more like Paleokostas. And incidentally, so does the US, when considering the farce the country's "democratic process" has become, where both parties are merely representative agents of the Wall Street banking class (recall who the main funders are of the last three presidential campaigns). It is thus our belief that in keeping with the endless global Onion-esque farce that has gripped the world, Kodos (of Simpsons fame) is a perfect running mate for Paleokostas' presidential campaign - a campaign that is suitable not just for the US, but for any country which is controlled not by democratic checks-and-balances, but by bank issued checks (backed by nothing but electronic "money"). Because the farce will truly be strong with those two. And that, unfortunately, is all that makes any sense in this centrally planned world.

Day after day, the long overdue correction of gold to fair value which as we have discussed previously, is now at about $2000 based on the recent multi-trillion Central Bank balance sheet expansion, keeps getting delayed, providing cheap entry points to all real money adherents. And then we get moments like the past 10 minutes, when gold goes on the same kinds of buying sprees that we remember best from the summer of 2011. With no news at all, in a span of minutes, both gold and silver have soared, with gold touching on $1772, and now about $150 away from its all time highs. The return of gold now is 13% YTD, compared to the far lower 8.4% return for the general market. Why the move? A big buyer obviously. But besides that, why the hell not - when one considers that the last time gold was over $1900, total central bank assets were $2 trillion less, it is a miracle gold is not far, far higher. The catalyst this time according to some is the "sudden realization" that in one week the ECB's balance sheet is about to increase by at least 20% courtesy of the latest and greatest LTRO. According to others, it is "more buyers than sellers." Both are right. As a reminder: we have warned repeatedly that the massive balance sheet expansion is spilling over out from equities and into everything else, including gas and now, gold. We pointed out that the biggest trade off of a soaring market could well be the one thing that derails Obama's presidential campaign. Now the only other thing that could stop central bankers from their CTRL+P frenzy - the surge in real money - is starting, and unlike 2011, it is starting quite early this time around. As we said over the weekend: inflation is a-coming back.

Little to note about today's unremarkable bond auction of $35 billion in 5 Year bonds. Hot on the heels of yesterday's just as unremarkable  2 year bond auction, which saw total US debt/GDP surpass 101% two weeks after total debt/GDP rose over 100% for the first time, the details surrounding today's issuance were more or less as expected: the closing yield of 0.90% was inside the When Issued of 0.905%. The Bid To Cover was 2.89, weaker than January's 3.17, but right inline with the TMM BTC of 2.89. The Indirects took down 41.8%, Directs 12.9%, and the Dealers held at 45.3%, all in line with TTM average, so nothing to write home about. Overall an auction that just added a few pips to the total US debt/GDP, with the proceeds, especially by the Dealers, promptly to be pledged back into the repo market with the blessings of BoNY and State Street, where it is never heard from again.

Since the system itself has disconnected risk from consequence with backstops, guarantees and illusory claims of financial security, then it is has lost the essential feedback required to adapt to changing circumstances. As the risk being transferred to the system rises geometrically, the system is incapable of recognizing, measuring or assessing the risk being transferred until it is so large it overwhelms the system in a massive collapse/default. The consortium has only two ways to create the illusion of solvency when the punter's $100 million bet goes bad: borrow $100 million from credulous possessors of capital or counterfeit it on a printing press. These are precisely the strategies being pursued by central banks and states around the globe. BUt since risk remains disconnected from gain/loss, then capital and risk both remain completely mispriced. Risk is being transferred to the entire global financial system at a fantastic rate, because counterfeiting money or borrowing it on this scale to cover losses creates new self-reinforcing feedbacks of risk....At some unpredictable stick/slip point, the accumulated risk will cause the system to implode like a supernova star.

Earlier today, we learned the first stunner of the Greek "bailout package", which courtesy of some convoluted transmission mechanisms would result in some, potentially quite many, Greek workers actually paying to retain their jobs: i.e., negative salaries. Now, having looked at the Eurogroup's statement on the Greek bailout, we find another very creative use of "negative" numbers. And by creative we mean absolutely shocking and scandalous. First, as a reminder, even before the current bailout mechanism was in place, Greece barely saw 20% of any actual funding, with the bulk of the money going to European and Greek banks (of which the former ultimately also ended up funding the ECB and thus European banks). Furthermore, we already know that as part of the latest set of conditions of the second Greek bailout, an 'Escrow Account" would be established: this is simply a means for Greek creditors to have a senior claims over any "bailout" cash that is actually disbursed for things such as, you know, a Greek bailout, where the money actually trickles down where it is most needed - the Greek citizens. Here is where it just got surreal. It turns out that not only will Greece not see a single penny from the Second Greek bailout, whose entire Use of Proceeds will be limited to funding debt interest and maturity payments, but the country will actually have to fund said escrow! You read that right: the Greek bailout #2 is nothing but a Greek-funded bailout of Europe's insolvent banks... and the Greek constitution is about to be changed to reflect this!

While prices did go higher in several cases, investors need to understand that we are nearer the end of the rally. Or at best, there might be a short term pullback in the works that lasts beyond 30 minutes.  

In the ongoing 'game of chicken' in Europe (playing out between the core and the periphery as the main two players) it appears we are once again at a point of inflection in the Nash Equilibrium that exists only in the minds of the Eurogroup leaders. As Credit Suisse notes, the continued existence of the Euro will hugely depend on the incentive structure of its members to defend it (and implicitly this means costs and retaliations - downsides - must be appreciated and allocated). These incentives evolve through time (and interventions can have unintended consequences) and brinksmanship and threats (Greece's referendum comments for instance) can improve outcomes in the short-term. Most importantly, it seems the market is among the best mediators to 'fix' each player's action and outcome but each intervention reduces that effect, 'time becomes money' as costs are increasing through procrastination. This leaves the asymmetric interests of the players (remember how exposed the core is to the periphery?) likely to increase break-up risks with Credit Suisse seeing the logical and intended consequence 'an increase in stress' - with either a 'catastrophic' break-up (or member exit) or a long, painful and volatile continuation of the crisis that can only be slowly improved by some type of inter-European enforceable contract. The more intervention, the lower the immediate impact of inaction and the higher the pent-up volatility in the system before threats are taken seriously (or consequences admitted).

There is a very clear relationship between economic growth and sufficient quantities of high quality energy. A crude measure of energy quality is its price. The lower the price for a unit of energy, the higher its quality (or net energy), but this is a very crude measure that can and often is heavily distorted by subsidies, market pressures, and other factors. As we squint at the world price for oil and note that Brent today is trading at $120 per barrel, it is clear that this high price is signaling that energy is now more expensive than it used to be. By adopting the belief that Peak Oil has been debunked, one runs the risk of missing the larger story that our current economic model is unsustainable. And that stocks and bonds and other traditional investments that derive a large portion of their current value from expectations of future growth simply may not perform anything like they have in the past. And worse, that recent and continuing efforts to revive the old economy by printing money risk the destruction of the money system itself. Given this all-too-human tendency to attempt to preserve the status quo, in this case by printing money, I must reiterate my advice to be sure that gold forms a significant portion of your core portfolio. 

Fire when ready...

The fine folks at Street of Walls have been kind enough to provide us with their latest 13F breakdown which looks at the position changes across America's 30 largest and most important hedge funds. While we have already focused on some of the more entertaining ones, and tracked the recent rush back into gold, those curious about what the latest hedge fund hotel stocks are (aside from Apple of course) are encouraged to peruse the following exhaustive report.

And here is yet another reason why we will permanently ignore the pathologically lying real estate syndicate known as the NAR (link): December data was just revised from +5% to -0.5% (from 4.61 million to 4.38 million). Since December market expectations were for a +5.2% print, imagine the sheer horror the algos would have been faced with had the real number been reported on time. Needless to say, if this number had been unrevised, the January +4.3% increase would have been a decline. This way the aglos focused only on the immediate moment get two months of beats in a row. Huzzah. Anyone who trades anything based on this borderline criminal self-reporting enterprise needs to have their head checked. In other news, when will the LIBOR investigation finally target the NAR?

We have discussed, at length, the symbiotic (or perhaps parasitic) relationship between the banking system in Europe and the governments (read Central Banks). The LTRO has done nothing but bring them into a closer and more mutually-reinforcing chaotic relationship as we suspect many of the Italian and Spanish banks have gone all-in on the ultimate event risk trade in their government's debt. It should come as no surprise to anyone that the bulk of the Greek bailout money will flow directly to the European banking system and Credit Suisse has recently updated the bank exposure (by country) to peripheral sovereign debt that shows just how massively dependent each peripheral nation's banking system is on its own government for capital and more importantly, how the core (France and Germany) remains massively exposed (in terms of Tier 1 Capital) to the PIIGS. Retroactive (negative) salary cuts may well not be the worst of what is to come as the bankers deleveraging returns to bite them in a phoenix-like resurrection of sovereign risk on now even-more sovereign-bloated (and levered) balance sheets.

Here is a good chart showing data from the weekly mutual fund flow of funds report.   This series is using the domestic equity only data.   In the first chart, we have plotted the flow of funds in it’s raw form.    Though there has been a small recent uptick in funds coming in, note the strong consistent negative flow over the last couple of years.