Archive - Dec 10, 2011 - Story

It's the end of deficit spending in Europe as we know it. That's how Charles Biderman, of TrimTabs, rightly describes the unwilling-to-compromise German's (perhaps heroic) attitude to their fellow European sovereigns. From his perspective, this forced austerity will mean slower growth and with that all chance that the European nations can 'grow/tax' their way out of this charade. He notes there is simply no way they can grow fast enough to be able to kick the can far enough down the road for it to matter. Pointing to his 'better early than late' calls on markets over the last 40 years, the man from Sausalito sees it as inevitable that the practical insistence on the elimination of deficit spending will force banks into bankruptcy, leading, as asset values are marked down, to a spiral collapse in equities. He then dismisses the simple-minded decoupling perspective as if no new Keynesian-inspired 'technology shift' occurs, US growth will be in the doldrums as European deleveraging drags global growth down with it. It's not all doom-and-gloom though as he ends on the upbeat notion that this collapse won't happen tomorrow, given balance sheet strength, although selling into rallies is the clear picture he is painting.

Even as Eurozone leaders attempted to instill some meager sense of accomplishment following the latest (but certainly not last) Euro summit culminating with yet another 7-page term sheet which achieved absolutely nothing, and in fact succeeded in alienating the UK even more, the real game continues behind the scenes. And it is a game which the euro looks set to lose. As Bloomberg reports, in the aftermath of the Telegraph's latest report confirming what has been said here all about the collateral crunch in Europe, Europe's CEO are now actively preparing for the worst case outcome: the end of the Euro (despite UBS' and other banks' repeated calls that such an event would result in an end of the world). To wit: "Grupo Gowex (GOW), a Spanish provider of Wi-Fi wireless services, is moving funds to Germany because it expects Spain to exit the euro. German machinery maker GEA Group AG is setting maximum amounts held at any one bank. “I don’t trust Spain will remain in the euro zone,” said Jenaro Garcia, founder and chief executive officer of Madrid- based Grupo Gowex, which provides Wi-Fi access in 15 countries. “We moved our cash and deposits to Germany because Spain will come back to the peseta"... Contingency planning for an unraveling of the currency involves cutting investment, moving money to Germany, transferring headquarters to northern Europe from southern, and even going out of business." And to all the chatterboxes on CNBC repeating ad inf that a Eurozone collapse would be "manageable" here is a person who actually knows what he is talking about: "“How do you control an explosion in a controlled way?” Fiat SpA (F) Chief Executive Officer Sergio Marchionne told reporters in Brussels on Dec. 2. “That’s a contradiction in terms.  This will be an implosion of some size with potentially disastrous consequences." He is right, and while the outcome is certain, it will not stop Europe's financial leader Germany from intervening in an attempt to prevent a surge in Deutsche Marks once the currency returns, and will likely set up capital control measures - that last bastion to every failing monetary system - to halt what is sure to be a record inflow of post-collapse DEM appreciating capital.

To better comprehend the chaos that is currently viciously circling in European funding markets, its critical to understand the difference between 'linear' collateral needs and the highly non-linear self-destroying re-pledging collateral crunch that is about to occur. Perry Mehrling, of INETeconomics, does a good job of explaining, in his chalkboard-style video, the three lending-based demands for collateral among the European banks and their central banks (Interbank, National Central Bank, and TARGET-2). He notes the IMF's proposed interjection might help to relieve the collateral crunch that we have been so actively discussing. However, these are all lending channels that rely simply on haircuts and specific collateral needs, what is being missed here is the much bigger problem of re-hypothecation (or re-pledging) of the collateral which leaves the considerably larger shadow-banking system facing a run on ever-decreasing piles of assets. So simply put we have a crunch in credit as increasing needs for collateral for 'pure' lending will be greatly exaggerated by the shrinking 'net' availability of collateral (as risk manager after risk manager tightens up their systemic risk criteria and reduce availability of funds for re-pledging). Put another way, while policy-makers focus on the big bazooka top-down, it is the smallest fund manager 'cog' in the chain of re-pledged collateral that will inevitably bring the system down.

What is there to be so optimistic about (in resource investing)?

1. We are going to face an awful lot of volatility. And I should start by saying that volatility can be good news for you if you are prepared for it. It gives you frequent sales. Why the volatility? In the first instance, there are seven or eight trillion dollars sitting on the sidelines just in the United States looking to be invested. That has some upward bias.

2. We are in a secular bull market in 'stuff'. The bottom of the [global] demographic pyramid as it gets richer, and it is getting a bit richer, uses a lot more stuff than the top of the pyramid. So per capita consumption of stuff is growing, spread over lots and lots and lots of capitas.

3. Resource stocks have not kept pace with commodity prices. So resource stocks for the first time in several years are attractively priced.

4. The senior resource companies, including the mining companies that have been real under-performers for the last decade, are starting to make an awful lot of money. And one of the themes I think that you are going to see in the resource space is mergers and acquisitions.

In the aftermath of the "rehypothecation" analysis exposing the quantum differences between the US and the UK, where the former at least tries to put some breaks on "fractional reserve" synthetic liquidity creation by Prime Brokers (which these days would be virtually anyone) while the latter believes that virtually boundless risk is a welcome thing, there has been a barrage of inquiries seeking further clarification of the nuances of shadow banking. In order to bring some clarity to the matter we present two of the seminal pieces on the topic: first, fro the IMF: "The (sizable) Role of Rehypothecation in the Shadow Banking System" and then from one of the best scholars of shadow banking, Gary Gorton, "Haircuts." We will let readers digest the wealth of information contained in these two pieces on their own, however, we will point out the two key messages: on one hand we get a definitive explanation of why not NY but London is true hub of financial engineering and infinite leverage (recall that the UK is in fact the most levered nation on a GDP basis in the world when one takes into account all outstanding debt, not just sovereign - a fact well known to S&P and explaining why the UK will be the last to be downgraded as this would bring attention to the last domino in the chain) as follows: "Mathematically, the cumulative ‘collateral creation’ can be infinite in the United Kingdom" - that's from the IMF basically telling everyone that courtesy of no rehypothecation haircuts one can achieve infinite shadow leverage. And the other one comes from Gorton who explains why haircuts are the functional equivalent of information arbitrage: "Increases in repo haircuts are withdrawals from securitized banks—that is, a bank run. When all investors act in the run and the haircuts become high enough, the securitized banking system cannot finance itself and is forced to sell assets, driving down asset prices. The assets become information-sensitive; liquidity dries up. As with the panics of the nineteenth and early twentieth centuries, the system is insolvent." And the punchline: "Liquidity requires symmetric information, which is easiest to achieve when everyone is ignorant. This determines the design of many securities, including the design of debt and securitization." Reread the last statement as it explains perhaps better than anything, the true functioning of modern capital markets and why they are terminally broken: in order to preserve the system, the banking cartel need to make everything of virtually infinite complexity so that no one has a clear understanding of what is going on! Which is where sites like Zero Hedge step in - to expose "shadowy" places where things are best left unseen.

In his latest weekly chartology, Goldman's David Kostin takes a different route to recapping the week's events and instead of merely summarizing the market action, explains what the views of Goldman's clients are, especially the bulls among them ("Bullish investors hold more positive outlooks for margins and Europe, and argue that our target is too low. Some investors generally agree with our muted outlook for the economy and corporate earnings, but feel that an agreement to end Europe’s debt crisis will inevitably be reached next year. They argue that the stabilization of sovereign balance sheets, recapitalization of European banks, and clarity in the region’s future will cause a surge in investor confidence. Investors commonly quote 1400 as a target S&P 500 price level in this “risk-on” scenario of multiple-expansion.") and then juxtaposes to its why Goldman continues to be bearish: "We expect the situation to worsen before it gets better with market pressure necessary for progress. EU Summit demonstrates progress but lacked “regime change.” Overall, policymakers are making progress and signaled a commitment to address the twin sovereign and banking system crises. However, lack of clarity on the IMF’s role and no clear change in the ECB’s activities in sovereign debt markets will likely leave some investors disappointed." Which is precisely what we have been claiming for weeks - that unlike the other banks who are preaching rosy outlooks out of sheer terror for what a European crash would mean for them, Goldman is hoping it comes quickly, so that ostensibly several big banks can blow up, and the ECB steps in forceefully but not before Goldman's extended web of control in political Europe allows it to step into the void and become a major market presence on the continent.

In what is likely the most logical follow up to our post of the day, namely the news of the lawsuit between HSBC and MF Global over double-counted gold, or physical - not paper - that was "commingled" via rehypothecating or otherwise, we present readers with the monthly note by Eric Sprott titled "Silver Producers: A Call to Action" in which the Canadian commodities asset manager has had enough of what he perceives as subtle and/or not so subtle manipulation of the precious metal market, and in not so many words calls the silver miners of the world "to spring to action" and effectively establish supply controls to silver extraction to counteract paper market manipulation in the paper realm by treating their product as a currency and retaining it as "cash". To wit: "instead of selling all their silver for cash and depositing that cash in a levered bank, silver miners should seriously consider storing a portion of their reserves in physical silver OUTSIDE OF THE BANKING SYSTEM. Why take on all the risks of the bank when you can hold hard cash through the very metal that you mine? Given the current environment, we see much greater risk holding cash in a bank than we do in holding precious metals. And it serves to remember that thanks to 0% interest rates, banks don’t pay their customers to take on those risks today." And the math: "If silver miners were therefore to reinvest 25% of their 2011 earnings back into physical silver, they could potentially account for 21% of the approximate 300 million ounces (~$9 billion) available for investment in 2011. If they were to reinvest all their earnings back into silver, it would shrink available 2011 investment supply by 82%. This is a purely hypothetical exercise of course, but can you imagine the impact this practice would have on silver prices?" And there you go: Sprott 'reputable' entity to propose to fight manipulation with what is effectively collusion, which in the grand scheme of things is perfectly normal - after all, all is fair in love and war over a dying monetary model. Who could have thought that the jump from "proletariats" to "silver miners" would be so short.