Capital Markets

The day many have predicted would come, has finally arrived: 100% initial margin on gold. For now it is just one Futures Commission Merchant, in this case ex-CBOT traders Crossland LLC (motto: "Where Speed And Service Matter"), but tomorrow it will be another, and another.

Over a year ago, we first explained what one of the key terminal problems affecting the modern financial system is: namely the increasing scarcity and disappearance of money-good assets ("safe" or otherwise) which due to the way "modern" finance is structured, where a set universe of assets forms what is known as "high-quality collateral" backstopping trillions of rehypothecated shadow liabilities all of which have negligible margin requirements (and thus provide virtually unlimited leverage) until times turn rough and there is a scramble for collateral, has become perhaps the most critical, and missing, lynchpin of financial stability. Not surprisingly, recent attempts to replenish assets (read collateral) backing shadow money, most recently via attempted Basel III regulations, failed miserably as it became clear it would be impossible to procure the just $1-$2.5 trillion in collateral needed according to regulatory requirements. The reason why this is a big problem is that as the Matt Zames-headed Treasury Borrowing Advisory Committee (TBAC) showed today as part of the appendix to the quarterly refunding presentation, total demand for "High Qualty Collateral" (HQC) would and could be as high as $11.2 trillion under stressed market conditions.

Capitalism may have bested communism a few decades ago, but exactly how our economic system allocates society’s scarce resources is now undergoing its first serious transformation since the NYSE’s founding fathers met under the buttonwood tree in 1792.  Technology, complexity and speed have already transformed how stocks trade; but As ConvergEx's Nick Colas notes, the real question now is what role these forces will play in long-term capital formation and allocation.  Rookie mistakes like the Twitter hack flash crash might be easy to deride, but make no mistake, Colas reminds us: the changes that started with high frequency and algorithmic trading are just the first step to an entirely different process of determining stock prices.  The only serious challenge this metamorphosis will likely face is a notable crash of the still-developing system and resultant regulation back to more strictly human-based processes.

Over the years, Jim O'Neill, former Chairman of GSAM, rose to fame for pegging the BRIC acronym (no such luck for the guy who came up with the far more applicable and accurate PIIGS, or STUPIDS, monikers, but that's neither here nor there). O'Neill was correct in suggesting, about a decade ago, that the rise of the middle class in these countries and their purchasing power would prove to be a major driving force in the world economy. O'Neill was wrong in his conclusion as to what the ultimate driver of said purchasing power would be: as it has become all too clear with the entire world drowning in debt (and recently China), it was pure and simply debt. O'Neill was horribly wrong after the Great Financial Crisis when he suggested that it would be the BRIC nation that would push the world out of depression. To the contrary, not only is the world not out of depression as the fourth consecutive year of deteriorating economic data confirms (long since disconnected with the actual capital markets), but it is the wanton money (and bad debt) creation by the central banks of the developed world (as every instance of easing by China has led to an immediate surge of inflation in the domestic market) that has so far allowed the day of reckoning, and waterfall debt liquidations, to take place (and certainly don't look at the stock index performance of China, Brazil, India or Russia). Despite his errors, he has been a good chap having taken much of the abuse piled upon him here at Zero Hedge somewhat stoically, as well as a fervent ManU supporter, certainly at least somewhat of a redeeming quality. Attached please find his final, farewell letter as Chairman of the Goldman Asset Management division, as he moves on to less tentacular pastures.

The recent slide in the gold price has generated substantial demand for bullion that will likely bring forward a financial and systemic disaster for both central and bullion banks that has been brewing for a long time. To understand why, we must examine their role and motivations in precious metals markets and assess current ownership of physical gold, while putting investor emotion into its proper context. The time when central banks will be unable to continue to manage bullion markets by intervention has probably been brought closer. They will face having to rescue the bullion banks from the crisis of rising gold and silver prices by other means, if only to maintain confidence in paper currencies. This will likely develop into another financial crisis at the worst possible moment, when central banks are already being forced to flood markets with paper currency to keep interest rates down, banks solvent, and to finance governments’ day-to-day spending. History might judge April 2013 as the month when through precipitate action in bullion markets Western central banks and the banking community finally began to lose control over all financial markets.

Update: we decided it may be an opportune time to remind readers of this particular fact, not opinion, not propaganda, not insinuation.

One of the main, unintended consequences of this development to prop up markets at all costs, even if it means removing all logic and reliance on fundamental data, has been the complete evaporation of interest in any finance-related media, forcing the bulk of financial outlets to rely on such cheap gimmicks as slideshows, pictures of kittens, trolling and generally hiring liberal arts majors straight out of school to copy and paste articles while paying them minimum wage, and providing absolutely no insight (and then wondering why the Series ZZ preferred investors will never get their money back, let alone the A round). However, nowhere is this more obvious than in the relentless imploding viewership of once financial media titan, CNBC, which lately has become a sad, one-sided caricature of its once informative self, whose only agenda is to get the most marginal Joe Sixpack to dump his hard-earned cash into 100x P/E stocks, and where according to data from Nielsen Media Research, the total and demographic (25-54) viewership during the prime time segment (9:30am - 5:00 pm) just tumbled to 216K and 40K - the lowest recorded viewership since mid 2005 and sliding.

As we have discussed numerous times over the past year, there is a quiet movement among the world's central banks to diversify their reserves away from the pejorative USD. Whether it is direct trade linkages, hording physical precious metals, or simply buying foreign sovereign debt, there is a trend emerging. The latest defection, as BusinessWeek reports, is Australia's plan to invest about 5% of foreign currency reserves in China. The decision "represents the first time that the RBA will have invested directly in a sovereign bond market of an Asian country other than Japan," the country's deputy governor noted, adding that this step was an "important milestone" to "stronger financial linkages" leaving Australia "better positioned to benefit from the shift in global economic growth towards Asia." Of course, palling up to its closest trade partner is a big driver, but in a somewhat barbed comment on the strength of the AUD, Lowe noted, "quantitative easing that has taken place in a number of countries is having a significant effect on exchange rates of freely floating currencies... which is clearly making for difficult conditions in certain parts of the Australian economy."

• The Inland Empire bubble is back: BMW to Amazon Space Demand Spurs Rush to Inland Empire (BBG)
• Tamerlan Tsarnaev was on classified government watch lists (Reuters)
• Brothers in Boston Bombing Case Said Drawn to Radicalism (BBG)
• Germany Spurns Calls to Loosen Austerity Stance (WSJ)
• Spain poised to ease austerity push (FT)
• What ever happened to France's voice in Europe? (Reuters)
• U.S., South Korea Reach Nuclear Deal (WSJ)
• U.S. Sees No Hard Evidence of Syrian Chemical Weapons Use (BBG)
• RBA Set to Invest Foreign Currency Reserves in China, Lowe Says (BBG)
• FedEx Wins $10.5 Billion Postal Contract as UPS Shut Out (BBG)

An attempt to look ahead at the drivers of the capital markets in the week ahead.

Those who have been following the US debt to GDP ratio now that the US officially does not have a debt ceiling indefinitely, may have had the occasional panic attack seeing how this country's leverage ratio is rapidly approaching that of a Troika case study of a PIIG in complete failure. And at 107% debt/GDP no explanations are necessary. Luckily, the official gatekeepers of America's economic growth (with decimal point precision), the Bureau of Economic Analysis have a plan on how to make the US economy, which is now growing at an abysmal 1.5% annualized pace, or about 5 times slower than US debt growing at 7.5% annually, catch up: magically make up a number out of thin air, and add it to the total. And it literally is out of thin air: according to the FT the addition will constitute of a one-time addition of intangibles, amounting to 3% of total US GDP, or more than the size of Belgium at $500 billion, to the US economy.

The main take away from events in Japan is that the BOJ shifted from a tactic of interventions (under former Governor Masaaki Shirakawa) to one of monetary policy (under current Governor Haruhiko Kuroda) . What strikes us is that the monetary policy is precisely to... well, destroy their money and in the process any chance of having a monetary policy. In our view, it was exactly because the Fed’s (undisclosed) intention was to engage in never ending Quantitative Easing, that Japan was forced to implement the policy undertaken by Kuroda. Coordination with the Fed was impossible. With Mr. Kuroda’s policy, we now have the BOJ with a balance sheet objective, the Fed with a labour market objective (or so they want us to believe), the European Central Bank with a financial system stability objective (or a Target 2 balance objective) and the People’s Bank of China (and the Bank of Canada) with soft-landing objective. It is clear that any global coordination in monetary policy is completely unfeasible. The only thing central banks are left to coordinate is the suppression of gold.

There have been several recent developments that have flown in the face of both neo-liberalism and ordo-liberalism and thrown investors off balance.  Discuss.  

The Treasury Department planted a "dirty bomb" at the Bank of Japan, and tossed a grenade at the Swiss National Bank.

Asset price correlations across a wide spectrum of industries and asset classes are meaningfully lower than the last few months. ConvergEx's Nick Colas note that this is something completely unexpected: we’ve approached a “Normal” capital market over the last 30 days. S&P 500 sector correlations are below 80% relative to the index, foreign stocks are 77-87% correlated to U.S. stocks, and even domestic high yield corporate bonds are 56% dancing to their own tune. However, before we run off celebrating the return to a stock-picker’s market, it is worth noting one statistical point worth your time: when industry sector correlations have dropped below 80% from 2010 to the present, the subsequent one month, one quarter and one year returns have been below average, especially the shorter time frames.

• Korean Nuclear Worries Raised (WSJ)
• Och-Ziff, With Strategy from a 30-Year-Old Debt Specialist, Racks Up Big Score (WSJ)
• Japan's big "Abenomics" gamble: how to tell if it's paying off (Reuters)
• Kuroda walks a two-year tightrope (FT)
• China Rebound at Risk as Xi Curbs Officials’ Spending (BBG)
• BOJ Said to Consider Boosting Outlook for Inflation (BBG) - for energy prices? Absolutely: by double digits
• Cyprus May Loosen Bank Restrictions in Days (WSJ)
• Cyprus mulls early EU structural funds (Reuters)
• Russia slashes 2013 growth forecast (FT)
• Japan, U.S. Agree on Trade-Talks Entry (WSJ)
• IMF Trims U.S. Growth Outlook in Draft Report Citing Fiscal Cuts (BBG)
• Mexico Is Picking Up the Peso (WSJ)