Archive - Jan 2011 - Story

You read that right. After such establishment "luminaries" as World Bank president Robert Zoellick, Warren Buffett's father Howard, Jim Grant, and, most recently, Kansas Fed president Thomas Hoenig, all voiced their support for a return to a gold standard, the most recent addition to the motley group of contrite voodoo shamans is none othe than the man who is singlehandedly responsible for America's addiction to cheap toxic credit, who spawned such destroyers of the middle class as the current Chaircreature, and who currently is the chief advisor in John Paulson's crusade to gobble up every ounce of deliverable physical in the world: former Fed Chairman - Alan Greenspan! In an interview with Fox Business, the man who refuses to go away into that good night: "We have at this particular stage a fiat money which is essentially money printed by a government and it's usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that all of history suggest that inflation will take hold with very deleterious effects on economic activity... There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard." And a further stunner: Greenspan himself wonders if we really need a central bank. Now our only question: why couldn't the maestro speak as clearly and coherently during his tenure which resulted in our current near-terminal financial state. And as a reminder, courtesy of Dylan Grice, if and when we do get a return to a gold standard there would be a need to reindex the monetary base to a real time equivalent price of gold, putting the price of the precious metal at about $6,300: "The US owns nearly 263m troy ounces of gold (the world's biggest holder) while the Fed's monetary base is $1.7 trillion. So the price of gold at which the US dollars would be fully gold-backed is currently around $6,300." And here you have people worried about day trading volatility...

China's economy appears to have reached a critical threshold of complexity and obscurity that renders it uncontrollable. Recent reports of surging bank loans, real estate speculation, industrial growth and inflation triggered a sharp decline in the Shanghai stock index yesterday. A recent comparison of food prices in Boston and Beijing found that China is now more expensive than the US. Though the first link states that the average urban wage in China is about $3,000 a year, my sources in China report that a college-educated worker makes about $6,000 a year--about one-eighth the average U.S. income of $49,777. A mid-level manager might make $12,000 a year--an excellent salary in China. Food eats up (sorry) about 40% of the average household budget in China, roughly in line with the percentage U.S. households devote to housing/mortgages. As I have noted here before, it's not the absolute percentage rise in essentials such as food and energy that matters, it's the relative impact on lower-income households that matters. A 10% rise in food prices in a household that spends 10% on food (a typical upper-middle class U.S. household) results in a "statistical noise" 1% increase in the family budget. In a family budget with 40% devoted to food, a 10% increase in food meaningfully crimps household spending. A doubling of food prices would be catastrophic.

For technical reasons already discussed, I am generally bearish on US Fixed Income for the near/medium term. What bothers me with the way we have traded is that since December we are essentially stuck in a range which is much more reminiscent of a bear flag than a bottom in the long end. Also, while implied volatility has come in a lot since the local lows of 12/15, realized volatility is actually very high in Fixed Income. As a matter of fact the spread between Fixed Income realized volatility and Equities realized volatility is at historical levels. Lastly, while in this ZIRP environment sell-offs have been associated with steepening of the curve, given the reflation arguments in vogue and all the hype about inflation, it would make sense to see this sell-of capped by some proper pressure in the short-end or at least the belly of the curve. We caught the bounce from 103 in 10s30s up to 120 but here I suspect pressure on the curve in the long end is about to return. To better illustrate these last 2 arguments, we were able to buy for our clients some 99.00 puts expiry February on EDH2 for only 5bps on Wednesday. Knowing that hardly 2 weeks ago the contract was trading at 98.85, it seems that implied volatility was quite shy of reflecting what is realized in the market. This is indicative of a quite high level of complacency despite high realized volatility. I have added charts for the 10Y US Treasury future. Targets indicate targets of 117-14 to the downside at the minimum. The support of the recent range is 119-20, this will be the acceleration level confirming the next leg lower is on its way. For the Bund I had already specified I was looking for a move towards 121.45 at least.

We believe Ben Ali tried the same quote. We are not sure if he used the precisely same wording: maybe that's why he was almost decapitated in the town square by a mob of angry and very hungry vigilantes. And if the quote above is FTW, then this one is FTMFW: "CPI, excluding currency, commodities and VAT impact, is low" also, let's not forget food prices, energy and petroleum byproducts. We totally agree with Adam: aside from everything, inflation is negative.

Recently, the most trendy (not to mention profitable) socio-political class is not that of capitalists, socialists, communists or even fascists (despite what some would claim), but that of the "bailoutists": those enlightened individuals who have bet everything on black, when black is the certainty that global governments will stop at nothing to, well, bail out the worst of the worst (to an extent explaining the continued outperformance of the worst stocks compared to quality names, a fact which as we predicted a year ago will make traditional long-short investing obsolete). For the full agenda of what a bailoutist believes in, we present today's follow up David Tepper interview with CNBC. In it, in addition to explaining what the creme of the crop of today's hedge fund world sees as the upside in a bailout driven world, the Appaloosa manager touches on such things as his market target for 2011 (S&P earnings of over 100 and a P/E multiple of 15, you do the math), corporate efficiency (the realization that companies can get away with much more, by firing many, and paying the remaining far less), the reasons for his caution (not many, though certainly the balls and the wall made legendary from his prior interview have no certainly diverged), but mostly why the same investment strategy that worked in the past (the central bank cartel rescuing everyone and everything) should continue to work indefinitely. And why shouldn't it: with taxpayers around the world apparently ok with transferring their wealth to the oligarchy in the form of a record steep yield curve, an unrepayable debt load, and increasing inflation, governments and bankers have a carte blanche to do as they see fit. And last, say what you will about the tenets of bailoutism... at least it's an ethos.

David Rosenberg submits a list of the ten things that would make him bullish on the US economy. As precisely zero of these have a snowball's chance in hades of happening, we are not too concerned about Rosie leaving the "realist" fold any time soon.

Gold is flat and silver marginally lower despite dollar weakness this morning. Some market participants are blaming the precious metal sell off on speculation that China may take more monetary action to curb surging inflation. This is unlikely to be the reason for the sharp selloff, rather it looks like another paper driven sell off in the futures market by leveraged players on Wall Street with various motives. The fact that silver is again in backwardation at the front end of the curve suggests that tightness in the physical bullion market continues and may even be deepening. Indeed, the massive increase in silver bullion demand from China (confirmed overnight - see below) suggests that silver’s bull market remains very much intact despite becoming overvalued in the short term towards the end of 2010.

While rising prices alone are traditionally never seen by conventional economists as sufficient to push inflation into the stratosphere, due to the claim that flat wages prevent a comparable rise in spending, the same can not be said about the combination of rising prices and wages. In fact, when that happens, there is little that a deflationist can assert will offset the price pressure. And it just happened in the epicenter of the Chinese frothy excess liquidity driven inflationary bubble, after Shanghai just announced it will hike minimum wages by 10%. This also means that labor costs are about to surge, corporate margins for Chinese corporations will plummet, and CEOs will be forced to sell their trinkets to the US at higher prices to offset the margin plunge. Which in turn means prices for "commodity" made in Wal Mart prices will be forced to also go much higher, setting off screams about wage hikes in the US, which in turn will force either US companies to see margins drop even more, or the Fed to assume that it has to offset the resulting equity weakness with more money printing. In other words, bad news all around.

Commodity prices are flying higher, interest rates are near zero, base money growth is staggeringly high and inflation expectations are going to the moon. It looks like inflation is back, but it isn't the kind of inflation the Germans worry about or the kind that leads to high interest rates followed by a deep recession. If this is not the inflation of post-WWI or the 1970's, then what is it? Although the current bout of food shortages and price increases have helped topple the government in Tunisia and led to food riots in Algeria, these commodity price increases and the excess money being spread around should not have any impact in the G-10 countries, unless some central bank makes a big mistake and hikes interest rates. Why is it so different this time around? - John Taylor

• Peter Orszag: America must brace itself for turbulence (FT)
• ECB Flags Risks of Higher Prices (WSJ)
• Spain Plans Partial Nationalization of Savings Banks (Reuters)
• BofA Reports Loss on Costs Tied to Bad Loans, Mortgage Unit (Bloomberg)
• European Governments Weigh Bond Buybacks (WSJ)
• Portugal Vote Imperils Accord (WSJ)
• Obama Taps GE's Immelt to Head Economic Advisor Panel (Bloomberg)
• Hu defends Beijing’s Currency Policy (FT)
• GE Net Rises 31%, Tops Estimates Amid Finance, Health Gains (Bloomberg)
• Nigeria oil fund fears hit bond issue (FT)
• Ivory Coast's Gbagbo Faces Financial `Asphyxia' by EU (Bloomberg), bad news for bondholders

Three months ago, in light of the then released news that various parties among which the New York Fed and PIMCO are seeking to putback $47 billion worth of mortgages to Bank of America, we looked at the bank's reserve for reps and warranties and came to the conclusion that it was woefully underreserved (see: Can You Spell U-N-D-E-R-R-E-S-E-R-V-E-D? If Not, Here Is A Visualization Aid). Today, to our complete lack of surprise, we find that the Bank's reserve for such demands has exploded nearly five fold to a number that is probably the highest in history, at $4,140 million compared to a tiny $872 million in Q3, primarily driven by the settlement by Fannie and its sell out General Counsel Tim Maoypoulos. This is also the main reason for the bank's huge "charge" today which caused Earnings to be well below expectations. That said, that particular settlement is just the beginning of the firm's putback woes. Of course, what the bank is doing here is pretending this is a one time charge and hoping investors will give it credit for the Q3 number being the trendline, as opposed to the Q4, when it is precisely the reverse. Furthermore, we predict that soon enough declining reserves in all other categories will soon be reversed much higher as the sad reality of the US consumer, who has already extracted all benefits from not paying a mortgage, will become very evident and bank charge off ratios will be the first to suffer.

Futures in positive territory bolstered by earnings and European growth signals. Yesterday's data was mixed with leading indicators and claims reporting better than expected results while Philly Fed came up short of expectations. Today is a blank on the US economic front with next week scheduled for the FOMC and home price data. The FOMC will be closely watched to see if the statement is used to correct the previously mentioned communication problem and if there is any reference to commodity price inflation versus wage/labor inflation. NYT report that municipal bankruptcy legislation is on the table, such actions would provide the states a negotiating table with pension obligations.

Germany (i.e., Europe) sure is milking the one-time destruction of its currency this past year for as long as it can. To wit: the just released IFO Business Survey in January continues to reach to all time highs, on the back of a one-time export renaissance. Of course, now that the euro is so tremendously volatile, and little in terms of trade effect can be projected based on daily 200+ bps gyrations in the currency, expect confidence to continue to surge until, just like a high beta stock, it plunges upon the realization that it is time to kill the euro once again, and resume the "Greece is getting expelled any day now" rumors.

Going through Bank of America's apples to monkeys numbers, and awaiting the Q4 presentation eagerly, but for now BAC missed both the top and the bottom line by a mile: the company reported sales of $22.67B, vs. consensus $24.87B with EPS of $0.04 on expectations of $0.21.

RANsquawk European Morning Briefing - Stocks, Bonds, FX etc. – 21/01/11