The price of gold fell last week to the $1,200 level. The lemming sentiment in capital markets is uniformly bearish, yet every price-drop brings forth hungry buyers for physical gold from all over the world. Even hard-bitten gold bugs in the West are shaken and frightened to call a bottom, yet it is these conditions that accompany a selling climax. This article concludes there is a high possibility that gold will go sharply higher from here. There are three loose ends to consider: valuation, economic and market fundamentals.
It should come as no surprise to most ZeroHedge readers but sometimes the facts and data need to be reiterated to ensure the message is not getting lost. As Michael Snyder rhetorically asks, did you know that U.S. banks have more than 1.8 trillion dollars parked at the Federal Reserve and that the Fed is actually paying them not to lend that money to us? We were always told that the goal of quantitative easing was to "help the economy", but the truth is that the vast majority of the money that the Fed has created through quantitative easing has not even gotten into the system. Instead, most of it is sitting at the Fed slowly earning interest for the bankers. Our financial system is a house of cards built on a foundation of risk, leverage and debt. When it all comes tumbling down, it should not be a surprise to any of us.
Tuesday humor struck early, courtesy of Goldman's head of the New York Fed, Bill dudley:
- DUDLEY SAYS FED AT TIMES WAS `TOO OPTIMISTIC' ON FORECASTS
That in itself is not the humor. The humor is, as always the context. Such as this:
- DUDLEY SEES STRONG CASE GROWTH TO PICK UP 'NOTABLY' IN 2014
Now that is funny when one considers the following past headlines...
Following the Friday plunge in the ISM-advance reading Chicago PMI, it was a night of more global manufacturing data, which started off modestly better than expected with Japanese Tankan data, offset by a continuing decline in Chinese PMIs (which in a good old tradition expanded and contracted at the same time depending on whom one asked). Then off to Europe where we got the final print of the June PMI which continued the trend recent from both the flash and recent historical readings of improvement in the periphery, and deterioration in the core. At the individual level, Italy PMI rose to 49.1, on expectations of 47.8, up from 47.3; while Spain hit 50 for the first time in years, up from 48.1, with both highest since July and April 2011 respectively. In the core French PMI rose to a 16-month high of 48.4 from 48.3, however German PMI continued to disappoint slowing from 48.7, where it was expected to print, to 48.6. To the market all of the above spelled one thing: Risk On... at least until some Fed governor opens their mouth, or some US data comes in better than expected, thus making the taper probability higher.
Near-term outlook for the major currencies discussed and a brief analysis of the short-coming of fair-value "discounting" models in understanding recent price action.
At the end of the day, Friedman jettisoned the gold standard for a remarkable statist reason. Just as Keynes had been, he was afflicted with the economist’s ambition to prescribe the route to higher national income and prosperity and the intervention tools and recipes that would deliver it. The only difference was that Keynes was originally and primarily a fiscalist, whereas Friedman had seized upon open market operations by the central bank as the route to optimum aggregate demand and national income. The greatest untoward consequence of the closet statism implicit in Friedman’s monetary theories, however, is that it put him squarely in opposition to the vision of the Fed’s founders. As has been seen, Carter Glass and Professor Willis assigned to the Federal Reserve System the humble mission of passively liquefying the good collateral of commercial banks when they presented it. Consequently, the difference between a “banker’s bank” running a discount window service and a central bank engaged in continuous open market operations was fundamental and monumental. In short, the committee of twelve wise men and women unshackled by Friedman’s plan for floating paper dollars would always find reasons to buy government debt, thereby laying the foundation for fiscal deficits without tears.
As excess reserves in Europe continue to fall, prompting some to claim this is positive since banks are "no longer hoarding cash," the reality of a dramatically deleveraging European financial system is far worse. As Goldman notes, lending to Non-Financial Corporations (NFCs) fell by a significant EUR17.2bn month-on-month (seasonally adjusted) in May (with a stunning 19.9% drop in Spain). Perhaps more worrisome, while NFCs have been seeing lower lending, households have been 'steady' for much of the last year - until now. Bank lending to households fell by EUR7.5bn in May. This marks the first material decline since July 2012. Simply put, the European economy (ad hoc economic data items aside) is mired in a grand deleveraging and since credit equals growth - and the ECB somewhat scuppered by a German election looming likely to hold down any free money handouts (and the fact that they cling to the OMT promise reality that is clearly not doing anything for the real economy) - with lending collapsing, growth is set to plunge further. As we noted previously, there is a simple mnemonic for the Keynesian world: credit creation = growth. More importantly, no credit creation = no growth. And that, in a nutshell is the entire problem with Europe.
The People's Bank of China (PBOC) released an official statement addressing directly the latest liquidity conditions in the banking system and indicating that the central bank intends to maintain sufficient liquidity conditions in the interbank market. As Goldman notes, this clear communication of policy intentions is highly important to guide market expectations, avoid liquidity hoarding, and contain excessive volatility of market. While they hope this calms markets in coming days, Goldman notes that the interbank rates are likely to settle back to a level higher than before to rein in leverage growth. However, in a helpful prompt for more jawboning, the squid notes, continued communications on policy intentions and actions will be helpful to further ease market uncertainties, given the extreme volatility in recent weeks; though we note the tightening bias will remain as the new leadership appears to prefer to take their pain early (and blame previous parties) than wait.
Overview of the great unwind, which I suggest has three components--tapering talk in the US, Japanese selling foreign assets and the liquidity squeeze in China (squeezing another carry carry trade).
The recent one month spike in interest rates, along with the mind numbing chatter about the end of the "bond bull market," has sent investors scurrying from from the bond market right into the waiting arms of a stock market correction. Will the "bond bull" market eventually come to an end? Yes, it will, eventually. However, the catalysts needed to create the type of economic growth required to drive interest rates substantially higher, as we saw previous to the 1980's, are simply not available currently. This will likely be the case for many years to come as the Fed, and the administration, come to the inevitable conclusion that we are now in a "liquidity trap" along with the bulk of developed countries. While there is certainly not a tremendous amount of downside left for interest rates to fall in the current environment - there is also not a tremendous amount of room for them to rise until they begin to negatively impact consumption, housing and investment. It is likely that we will remain trapped within the current trading range for quite a while longer as the economy continues to "muddle" along.
EB heads to TV...and reflects on predictions from 2009's "A Grand Unified Theory of Market Manipulation"
With China’s credit-to-GDP ratio over 200%, it appears, as Barclays notes, that the PBoC is acting in line with the government’s efforts to deleverage, rebalance and position the economy towards a path for sustainable growth. Though they expect that the PBoC is likely to stabilize the interbank market in the near term (perhaps by more of the same 'isolated' cash injections), short-term rates are likely to remain elevated, at least for a while, possibly leading to the failing of some smaller financial institutions. With the small- and medium-sized banks having grown considerably quicker than the larger banks, having been more aggressive on interbank business (i.e. alternative channels to get around lending constraints), the following banks are at most risk of major disturbance of the funding markets remain stressed leaving the potential for retail bank runs or greater fragmentation in the commercial bank market.
The days of reasonable economic forecasting are over. Today, an economic forecast is more like the analysis of a criminal mind than the evaluation of economic data. The dominating role of government overpowers markets intentionally. In the short-term that will continue. Reactions to Federal Reserve minutes referencing continuation, alteration or cessation of quantitative easing cause stock markets to move by over 100 points. Other markets are affected by government interventions, just not so noticeably. Long term, markets will overpower government. Welfare states can no longer maintain their level of spending, services and welfare. However, they dare not stop lest civil unrest and violence break out. The bind they are in has no solution. Governments around the world are doing whatever is necessary to survive. Lying, stealing and outright confiscation will begin in order to support their bankruptcies. Cyprus was a minor precursor of what is coming.
As we noted just two weeks ago - before the hope-and-change-driven exuberance in Japanese equities came crashing down - "those who believe in Abenomics are suffering from amnesia," and Nomura's Richard Koo clarifies just who is responsible for the exuberance and why things are about to shift dramatically. Reasons cited for the equity selloff include Fed Chairman Ben Bernanke’s remarks about ending QE and a weaker than expected (preliminary) Chinese PMI reading, but, simply put, Koo notes, more fundamental factor was also involved: stocks had risen far above the level justified by improvements in the real economy. It was overseas investors (particularly US hedge funds) that responded to Abe's comments late last year by closing out their positions in the euro (having been unable to profit from the Euro's collapse) and redeploying those funds in Japan, where they drove the yen lower and pushed stocks higher. Koo suspects that only a handful of the overseas investors who led this shift from the euro into the yen understood there was no reason why quantitative easing should work when private demand for funds was negligible... The recent upheaval in the JGB market signals an end to the virtuous cycle that pushed stock prices steadily higher.
This was one helluva week. Nevertheless current markets are still hooked on QE.