Real Interest Rates
With France's AAA credit rating looking shakier by the day and Spain being downgraded by two notches, gold should be supported by safe haven demand. Every day that goes by without resolving the issue of too much debt in the global financial system is a day closer to financial contagion. Gold looks very well supported between the 100 and 144 day moving average (simple) with the 144 day moving average providing strong support for nearly three years - since January 2009. Bullion dealers in Hong Kong say physical demand is robust at these levels with one dealer reporting “a wave of physical buying” once prices went below $1,630/oz. Newsletter writer, Dennis Gartman again made negative sounds about gold’s prospects. This is bullish in the short term as many of his short term calls in recent months have been inaccurate. Indeed, some traders use him as a good short term contrarian indicator. The Chart of the Day (‘Real Interest Rates and Gold – 1970-2011’) shows that gold prices rise during periods of negative real interest rates in the U.S. as was clearly seen in the 1970s and again since the early 2000s.
While there may be a time when gold becomes protection against hyperinflation -- indeed, the nature of hyperinflation is ultimately behavioral, triggers quickly, and is hard to forecast, in my opinion -- I think Krugman is quite correct in pegging the outperformance of gold to the dearth of other investment opportunities. The present dearth of other investment options is illustrated by very low interest rates in nominal terms, negative interest rates in real terms, and a highly volatile environment, not only for equities but for most global currencies, thus rendering gold a least-worst investment option. Krugman's view matches my own that gold is a winning investment in a period of economic -- nay, systemic -- decline. Contrary to the misguided view that gold is in a bubble, gold actually becomes, and is continuing to become, the more stable asset in an investment universe that has entered secular contraction. It is the deflating of the credit bubble and the instability this presents on a chronic basis to the financial system that have attracted capital to gold.
Retails Sales Beat Expectations On Levered Car And Gas Sales, As Inflation Picks Up Again In Import PricesSubmitted by Tyler Durden on 10/14/2011 07:49 -0500
There is good and bad news in today's economic data release: on one hand retail sales in September beat expectations at 1.1%, on expectations of 0.7%, and up from an upward revised 0.3% in August. Retail sales less autos was a modest beat at 0.6% on expectations of 0.3%, although the previous number was revised substantially higher from 0.1% to 0.5%. Yet confirming that the bulk of the "beat" was in auto and associated gas sales, was that Retail Sales ex Autos and Gas (duh) came at 0.5% on expectations of 0.4%. Basically, surging subprime loans to autopurchasers and the resulting increase in gasoline sales was the reason for this "surprise" beat. And as for the bad news, import prices jumped to 0.3% in September, on expectations of -0.4%, a surge from August's revised -0.2%. And while fuel imports had dropped in August -1.4%, in September these jumped to a positive 0.1%, showing just how big the monthly sensitivity to any moves in the energy complex are. In other words, should inflation persist, don't expect for retail sales, which we expect to decline to recent deleveraging at the consumer level, to persist.
The continuation of ultra loose monetary policies and new rounds of QE is supportive of gold in all currencies. Negative real interest rates mean that there continues to be no ‘opportunity cost’ to own gold which is a key driver of gold’s bull market. In time, quantitative easing will be seen for what it is - bailing out banks and financial institutions and a form of currency debasement. Developments in gold and wider markets this week are bullish. There are continuing signs of very significant demand in the Middle East, India, Vietnam and China. There are reputable reports of shortages of gold bars in Hong Kong, Singapore and Vietnam, of shortages of silver bars in India and delays in delivery and rationing of silver coins internationally. The CME decision to increase the amount of gold accepted as collateral and the LCH. Clearnet decision to allow gold bullion to be used as collateral shows the financial system is increasingly seeing gold as an asset on a par with cash and bonds.
What happened in Sweden in early 90's? How they they sort out the mess, and become the Tiger Economy of Europe? Some lessons for the PIIGS Politicians....
An intriguing research note from Goldman's Global Economics team tonight brought up the subject of 'unconventional' unconventional policies and how they ended the 'first' Great Depression. This gentle push towards softening the inflation leg of the Fed's mandate 'stool', while interesting in its own right given Goldman's policy-leading record, reminded us, by contrast, of a paper discussing how deflation is perhaps the more likely outcome when one shifts perspective from Keynesianism to a more Austrian view of the Fed's options. We are not choosing sides but for a quiet evening following a hope-shattering sell-off in risk assets, we thought it worth reflection.
If there has been one consistent theme since day one at CI, it has been our perhaps near myopic focus and focal point highlight of importance that is the macro credit cycle. Does this play into long wave and perhaps Kondratieff cycle or Austrian economics type of thinking? Call it what you will, but elements of all of these schools of thought very much overlap. Right to the point, we believe THE key thematic construct to keep in mind as a macro cycle decision making overlay and character point dead ahead is the now more than apparent collision of the generational long wave credit cycle with the current short term business cycle of the moment. Without trying to reach for melodrama, this is the first time a multi-decade long wave credit cycle has collided with the short-term business cycle since the late 1920’s/early 1930’s. Most decision makers and Street seers of the moment have absolutely no experience with this type of a generational collision. Moreover, our illustrious academician Fed Chairman has never even considered long wave or credit cycle based Austrian economics thinking in his and the broader Fed’s policy making – absolutely key and crucial mistake. Although it’s just our perception, this will be Bernanke’s legacy Waterloo. It also tells us directly that his only policy tool ahead will be more money printing.
Uncertainty. That has become the key word of the day, the month, and of 2011 in general. And while broad uncertainty has manifested itself most notably in the capital markets, it has a far more practical representation in labor markets, where the main reason why employers are not hiring more people, arguably the primary scourge of the Obama administration's record low approval rating, is due to corporate uncertainty about the future: about taxes, about government demanding its pound of flesh when the time comes, and about the economy in general. Ironically, as PIMCO speculates in its daily note authored by Tony Crescenzi, probably the primary driver of global uncertainty is the increasingly uncoordinated response by monetary policy authorities (read Central Banks) in which where before all had cooperated in the global game theory, now increasingly it is every printer for himself, as the default response turns to one of defection. And as everyone who has studied Game Theory knows, it is only the first defection that provides the biggest return, with each subsequent act generating far less benefits to the uncooperative actor, forcing even more uncooperative irrationality, and so on in a toxic spiral until outright belligerent action develops. For now said belligerence has begun to manifest itself in plain vanilla trade wars, such as that pointed out last night with the Chinese response to Europe's lack of response to its "bailout" overtures, and following up with the just announced complaint filed by the US against China on chicken prices. Naturally this is just the beginning. The real concern is that where trade wars end (which in turn begin when FX wars end), real ones start. When a year ago we first branded the Chairsatan as "genocidal" we were mostly joking. Perhaps it is time to reevaluate our definition, as it is far less comical under the current environment. Here is what Pimco has to say on the issue.
With the expanded two-day FOMC meeting (which until 45 days ago was supposed to be just one day) set to start shortly, here is chief policy maker Goldman Sachs reiterating again how much futile loosening to expect from the Fed. Nothing new here: Goldman repeats its call that Twist will hit tomorrow (and in a following report MS reiterates its call for Torque), sees IOER being cut from 0.25% to 0.1%, (sending the money and repo markets into a tailspin), but stops short of demanding another major round of LSAP. Basically, anything short of this will crash the market; anything long of this (as Rosenberg predicts) including several hundred billion in outright bond purchases, sends risk and gold soaring, and the dollar plunging.
So we all know that gold prices and UST 10Y yields are as high, and low, respectively, as they have ever been. This is nothing more or less than human adrenaline overriding reason and logic, driving return expectations to the distribution of max entropy. It’ll pass. Sometimes it makes sense to fight the crazy impulses of greed and fear. But often this gets you creamed in the center. Sometimes it doesn’t. For those times, the prices of straightforward hedges like 10Y Ts and gold make them very unhedge-worthy. There is no sense in jumping on trades that already have the risk premium baked in. The alternative is to ride the apocalypse with an eye on the relative mispricing of extremal points. I’m creating what I call a braided basket to do this. I’ll take two pair trades and go short the rapier points of the apocalypse and long something correlated, but underperforming it. In this way I’ll catch some hedge on tail risks on my core book due to the darkening outlook. At the same time, I’ll catch some cover when people come back to their senses. Why braided? Check out the charts, and see how the pairs interweave.
A French-owned rating agency (the same country that currently has a short-selling ban) just did all it can not to tip the boat. What can one say but "truly a gutsy call." Unlike S&P which looks at such obsolete things as fundamentals and realistic projections, Fitch instead relies on something far more intangible: "its pivotal role in the global financial system and the flexible, diversified and wealthy economy that provides its revenue base." In other words, it's rated AAA... because it is rated AAA. Somehow we doubt Fitch will take the initiative to be the first to downgrade France... That said even Fitch had some pseudo-harsh words: "Despite its exceptional creditworthiness, the fiscal profile of the US government has deteriorated sharply and is set to become an outlier relative to 'AAA' peers. The overall level of general government debt, which includes debt incurred by states and local governments, is estimated by Fitch to reach 94% of GDP this year, the highest amongst 'AAA' sovereigns. However, federal government indebtedness is lower than in other major 'AAA'-rated central governments. Fitch estimates that federal debt held by the public will be equivalent to approximately 70% of GDP this year compared to around 75% for the UK ('AAA') and France ('AAA')." So, record debt for a AAA-rated country, check, but... AAA-rated. So all is good.
Economic growth is faltering in all major economies with data this morning showing Eurozone and German GDP growth slowing. Eurozone GDP rose 0.2% from the first quarter, when it increased 0.8% while German GDP growth fell by more than expected in the second quarter, dropping to a derisory 0.1%. Double dip recessions involving inflation and therefore stagflation seem increasingly likely.The conditions today are far more bullish than in the 1970’s as in the 1970’s the U.S. was the largest creditor nation in the world whereas today the U.S. is the largest debtor nation the world has ever seen. Gold went parabolic in the 1970’s after a period of stagflation. Today, we appear to be on the verge of a period of stagflation. The 1970’s saw significant geopolitical risk with oil crisis, the overthrow of the Shah of Iran and the Russians invading Afghanistan. Today there is significant geopolitical risk in the world, arguably more, and there remains the real risk of a conflagration in the Middle East between Israel and its allies and Iran and its allies. Today we have a global debt crisis, massive systemic risk in the financial system threatening the solvency of many banks and sovereign governments. This was not the case in the 1970’s. This makes a parabolic move in gold very likely in the coming days, weeks and months. Increasingly, the question is not if we go parabolic rather it is when do we go parabolic – in the weeks and months or in the coming years.
"With all the mess going on at the moment, I thought it was worth while stepping back a little and trying to look at the bigger picture." So begins Andy Lees' latest must read letter to clients whch explains succinctly virtually the entire story of where we were, how we got to where are now, how the current trajectory is unsustainable, why due to decades of capital misallocation anything that the Fed does now is essentially irrelevant, why our untenable debt pile does nothing but perpetuate an unsustainable ponzi scheme which will result in an unseen explosion in the true cost of capital: gold, and why the bond market will eventually, and inevitably, force an epic repricing in the cost of non-gold capital absent the arrival of the deux ex machina of real, actionable innovation that the Fed, and all global central planners, keep hoping for. Because the longer we keep plugging away with that worthless substitute, financial innovation, which is anything but, the greater the final collapse. Andy's conclusion: "Until the debt is cleared and capital starts to be properly allocated, economic growth per unit of additional debt will continue to sour. Until we get some real breakthrough technology, requiring large amounts of capital to both innovate and then roll out, we have no chance of supporting the economy." Too bad than that this absolutely spot on observation reflects precisely the opposite of what the Fed is pursuing. Which is why, all else equal, and it will be unless the Fed is finally eliminated from existence, America, and the entire western way of life, is doomed... But don't take our word for it. Here is Andy.