Reality

In a slight digression from the usual pure market-based discussions of Jeremy Grantham's perspectives, the fund manager addresses what is potentially and even more critical factor for the markets. As he writes, we are in a race for our lives, as our global economy, reckless in its use of all resources and natural systems, shows many of the indicators of potential failure that brought down so many civilizations before ours. By sheer luck, though, ours has two features that might just save our bacon: declining fertility rates and progress in alternative energy. Our survival might well depend on doing everything we can to encourage their progress. Vested interests, though, defend the status quo effectively and the majority much prefers optimistic propaganda to uncomfortable truth and wishful thinking rather than tough action. It is likely to be a close race.

Two days ago we first posted a Youtube clip in which a Greek reporter asked Argentina's Economy Minister Hernan Lorenzino a simple question: "what is inflation in Argentina" - a sensitive topic to a country with price and capital controls, and where inflation ranges between 0 and 20% depending on whether one uses official, or unofficial but based on reality, data. The result was a why we dubbed the clip "Thursday humor" as after several minutes of meandering gibberish, Lorenzino concluded by telling his aided that "he wants to leave", which in turn promptly became a twitter hashtag meme #mequieroir, in which the minister's response to a simple request for the truth was promptly lampooned around the world. However, that may have been just the beginning of Hernan's problems. As Bloomberg reports, citing Clarin, Argentina's president CFK, was also quite taken aback by the bumbling economist that she met with him subsequent to the interview going viral, and told him he has lost credibility and the most likely next step is his resignation.

A bank in some European country such as Spain lends money but the collateral, Real Estate or commercial loans, are going bad. The bank then securitizes a large pool of this collateral and pledges it at the ECB to receive cash. In many cases to take the pool the country has to guarantee the debt. So Spain, in my example, guarantees the loan package which is then pledged at the ECB and is a contingent liability and which is not reported in the debt to GDP ratio of the country but nowhere else that you will find either. “Hidden” would be the appropriate word.  Then as time passes the loans get even worse so that the ECB demands cash or more collateral because they will not be taking the hit; thank you very much. The bank cannot afford to post more collateral so that the country, Spain, must post the collateral and add an additional guarantee for the new loan or they must post cash which is oftentimes the case.  Consequently as time passes and more cash has been spent the country, Spain, begins to run out of capital and the 10.6% deficit figure, that Spain announced recently, is not anywhere close to the actual reality so that they will get forced to officially borrow more money from the ESM as the sovereign guarantee of bank debt becomes unsustainable.

How much is the 'promise' of a European Central Banker worth? As European macro data in the last month has plunged at its fastest rate in 6 years, equity markets have, of course soared back to near multi-year highs (EuroStoxx 600 up 5% in the last week alone). We only hope that the equity markets really do know something different this time - as opposed to the last two times we saw this kind of disconnect. The answer - Draghi's 'whatever it takes' promise is maintaining a 30% illusion of wealth in European equities over their macro reality.

A lot of Americans know that the US government is out of control. Anyone who has cared enough to study the US Constitution even a little knows this. Still, very few of these people are taking any significant action, and largely because of one error: They are waiting for “the good guys” to show up and fix things. Some think that certain groups of politicians will pull it together and fix things, or that one magnificent politician will ride in to fix things. Others think that certain members of the military will step in and slap the politicians back into line. And, we're sure there are other variations. There are several problems with this. The sad truth: No one is going to ride in and save you. If you want things to get better, then YOU will have to make them better. YOU will have to stand up and take the arrows, yourself. Liberty, at this stage of human development, requires risk and pain.

Succinctly summarizing the positive and negative news, data, and market events of the week...

For the fifth week in a row, US Macro data deteriorated markedly (not helped at all by today's GDP miss). The Q1 earnings picture is dismal, with beats far less than average and revenues hugely disappointing. But, in light of all that reality, where-ever you look, screens are green. Despite some softness today (oil, S&P, and Nasdaq down) the week showed impressive gains for equities amid the lowest volume week in three months (mostly driven by the epic short squeeze on Tuesday), modest gains for Treasuries (yields lower by 2-4bps), significant outperformance by precious metals (up over 3-4% on the week - having given some back in a post-Europe smackdown today), and WTI crude up over 5% on the week.  Perhaps the most notable fact about the week (apart from equity's inexorable bid in the face of nothing positive at all) was the surge in JPY. In an Abenomics-shattering print, last night's deflation data helped USDJPY rally its most in 11 months for the week. While all asunder will be celebrating another green week, it is perhaps worth noting that while the Russell gained 1.3% from Monday's close, the 'most-shorted' names of that index more than tripled that performance - gaining 4.4% on the week... squeeeeze.

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Gold has surged 4.9% in dollar terms so far this week and is headed for its biggest weekly gain in one-and-a-half years. Gold has recovered in all currencies and is up by 4.8% in euro terms and 3.7% in sterling terms. 

Therefore, gold has recovered nearly half of its recent sharp decline and is now just 7% below its price ($1,560/oz) prior to the futures induced sell off on April 12th and 15th.

I always wanted to debate those smart guys at the Fed, ECB and Irish Central Bank. After all, blowing up country after country is a notable accomplishment, right???!!!

It is a convoluted world. The money rolls in from the Fed, the ECB and various European funds where money is pledged by each country and put up by none. Pledges, contingent liabilities, guarantees of bank debt are not counted but have not vanished and show up when the bills are due decreasing the assets of everyone.  The newly printed money must find a home and so supports the sovereign debt yields while costing each European government more in the process. Austerity fails, unemployment rises, economies decline, more taxes are applied and the use of newly printed money is the only thing that separates us from some sort of financial chaos. The differential between the European economies and the European markets increases and the actual losses increase. Print forever. Lies without end. Reality redefined.

We are a long way from really resolving the argument between the Keynesian and Austrian economic theories, despite some so-called experts proclaiming Krugman's victory this week. The discovery of the calculation error in the Reinhart/Rogoff study does little to change the overall premise that excessive debt levels impede economic growth and have, historically, led to the fall of economic empires.  All one really has to do is pick up a history book and read of the Greeks, Romans, British, French, Russians and many others. Does fiscal responsibility lead to short term economic pain?  Absolutely.  Why would anyone ever imagine that cutting spending and reducing budgets would be pain free?  However, what we do know is that the path of fiscal irresponsibility has long term negative consequences for the economy. In the meantime we can continue to ignore the long term conseqences in exchange for short term bliss.

The S&P cash got within a point or two of its closing high but between FSOC concerns about US financial stability, German court concerns over Draghi's OMT and ESM, and a large (likely CBOE-shutdown-inspired) imbalance into the close, stocks tumbled off those highs with the Dow almost back to unchanged before a small ramp into the close. While equities were on most media headlines, today was 'epic' for commodities. The biggest jumps in gold, silver, and oil prices in between five and nine months despite significant USD strength in the US day session. JPY carry was in charge early (and late as we sold off) with EUR ran the show in the middle of the day. With CBOE down for much of the morning, once it reopened it traded down with stocks up but gradually leaked higher all afternoon to end the day very slightly green. Treasuries rallied into the close to end unchanged. Another low volume day that saw the Dow unable to close above pre-Boston levels. So stocks mixed (Russell +0.6%, TRAN unch), VIX unch, Treasuries unch, EURUSD and JPYUSD unch, Oil/Copper/Gold/Silver up 2.5 to 5%!

The uncomfortable effects of government actions are being felt everywhere. Obamacare concerns are, anecdotally, delaying hiring, causing firms to change benefits for the people, and increasing taxes on the great majority. On the other hand, in the context of the "sequester", which is merely a slowdown in the breakneck rate of government spending, anyone who has traveled by plane in the last month knows the full court press efforts under way to ensure the American public knows just how 'devastating' the sequester cuts are - with delays rising exponentially with every dollar removed from the FAA budget. But there is a group on 'Americans' who are not feeling the pain of Obamacare or Airport delays. This group of people remains comfortably unaware of the reality that is being passed on the rest of the US citizenry. As Politico reports, Congressional leaders in both parties are engaged in high-level, confidential talks about exempting lawmakers and Capitol Hill aides from the insurance exchanges they are mandated to join as part of Obamacare; and as the Washington Times reports, the chief of the FAA told Congress today that Washington-area airports will largely escape the effects of the air traffic controller furloughs.

There are growing supply issues and a range of gold and silver coins and bars are in short supply internationally and premiums are rising globally. Many smaller dealers have been cleared out of their bullion inventories.

Gold prices are expected to recover in the coming weeks and months according to the Reuters Precious Metals Poll of analysts.

Most of the 29 banking and brokerage analysts and consultants polled expected prices to find support and stay above the $1,400 mark. The majority of analysts, 20 out of 29, expect gold to end 2013 above $1,450 per ounce and 6 analysts, including GoldCore, saw gold above $1,650/oz by the end of 2013.

Interestingly, the majority are bullish at these price levels with average price forecasts for the year of 2013 much higher than today's prices - at a mean of $1596/oz and a median of $1627/oz.  

With an increasing number of market participants expecting a rate cut from the ECB at next week's May meeting, Goldman Sachs is piling on in a considerably less exuberant manner than the crash lower in peripheral bond yields would suggest. EURUSD reversed its gains very rapidly as Goldman slashed its growth forecast from -0.5% to -0.7%, expects a 25bps cut next week, but notes that this is "largely cosmetic" with few real implications for the economy. Critically, they also remind us that Draghi and his fellow ECB'ers have been increasingly stressing the limits of what the ECB can do - making it clear that it is local governments that must create conditions for the recapitalization of their banks. The point is, Goldman, like us, recognizes this is an insolvency (capital) issue not a liquidity issue, and it seems the ECB also knows that now. European stocks faded modestly on this as EUR sold off and peripheral bond spreads have ben leaking wider since yesterday as perhaps the reality is far less risk-supportive (via bond purchases?) than many had hoped.