Iron ore prices, which have fallen by 24% in the past month, have been front and center in our views on the China debacle recently. Following the RBA's decision not to cut rates last night we thought Macquarie's recent insight into just how bad an impact a sustained weakness in demand could have on the Australian economy was worthwhile, as hope seems to remain that the destocking among Chinese steel mills will end at some point and demand will re-emerge phoenix-like (though we strongly suspect not). The relative resilience of the AUD suggests that most investors believe that iron ore prices will recover over the next few months. But if they don’t then this could be the 'Wile E. Coyote moment' for the AUD, as GDP drops 3ppt, unemployment rises 4ppt, and busienss investment is slashed 20% below consensus.
If the leaks from the European Parliament are to be believed then the lines are being drawn in the sand for quite a fight. The rumor is that Mr. Draghi is going to propose a plan to buy short sovereign debt (0-3 years) without limit if a nation fills out the requisite form and officially asks for aid with conditionality. This once again proves that the rules and regulations in Europe, the very stipulations that we rely upon, can be changed, modified or distorted with the blink of an eye and the wave of a hand. It seems that nothing is set in concrete, nothing is firm and that everything is moveable upon a moment’s notice. the amount of upfront debt, which would constantly have to be rolled, would present a series of dangers including the inability to finance it as it comes due along with a balance sheet at the ECB that could swell well past the $4 trillion mark where it is now or 45% larger than the current balance sheet at the Fed. The world does not receive funding from alien worlds and there are consequences that append from having a ledger that expands without boundaries.
Gold’s seasonality is seen in the above charts which show how March, June and October are gold’s weakest months with actual losses being incurred on average in these months. Buying gold during the so-called summer doldrums has been a winning trade for most of the last 34 years. This is especially the case in the last eight years as gold averaged a gain of nearly 14% in just six months after the summer low. We tend to advise a buy and hold strategy for the majority of clients. For those who have a bit more of a risk appetite, an interesting strategy would be to buy at the start of September, sell at end of September and then buy back in on October 31st.
It is now one week until the Krimson Kardinals of Karlsruhe make their decision which can make or break Europe's peripheral bonds, if only for a few months. They are pictured below doing what they do best.
- The ESM Violates the Law And EU Treaties (Welt)
- Fears Rising, Spaniards Pull Out Their Cash and Get Out of Spain (NYT)
- RBA stays put for third straight month (SMH)
- Why PBOC will not cut rates: China’s Repo Rate Drops Most in Six Months as PBOC Injects Cash (Bloomberg)
- Manufacturing Downturn Spreads Gloom Across Asia, Europe (WSJ)
- "Sources" tell Dutch Dagblad that Weidmann is isolated in his objection to ECB monetization (Reuters, FD)
- Europe Bank Chief Hints at Bond Purchases (WSJ)
- Australia's Fortescue slashes capex as iron ore mkt drops (Reuters)
- Loan rates point to eurozone fractures (FT)
- U.S. nears deal for $1 billion in Egypt debt relief (Reuters)
- Majority of New Jobs Pay Low Wages, Study Finds (NYT)
Yesterday we dedicated significant space to the most recent piece of perfectly ludicrous propaganda out of the ECB, namely that monetizing debt with a maturity up to three years is not really monetization but is instead within the arena of "money market management" (images of Todd Akin defining when something is 'legitimate' and when it isn't swimming our heads). The implication of course is that debt under 3 years is not really debt, but some mystical piece of paper that nobody should be held accountable for. Hopefully all those consumers who have short-maturity credit card debt which nonetheless yields 29.95% APR are made aware of this distinction and decide to follow through with Mario Draghi's logic, which is about to take the war of words between Germany and the ECB to the next level. Sure enough, this is precisely the news item that is dominating bond risk markets this morning, if not so much futures, and sending Spanish and Italian 2s10s spreads to record wides on hopes Draghi will definitely announce some sub 3 year monetization program for the PIIGS. Bloomberg summarized this best last night when it commented on the move in the EURUSD, since retraced, that we now have speculation Draghi's move will bolster confidence. In other words: the market is now hoping there is hope. Sure enough, even if Draghi follows through, for the ECB to monetize Spanish bonds, Spain still has to demand a bailout, which however is now absolutely out of the question as mere jawboning has moved the entire highly illiquid curve so steep Rajoy (and Monti) have absolutely no reason to hand over their resignations (i.e., request a bailout). And so we go back to square one. But logic no longer matters in these markets.
Some hours ago Spain finally bit the bullet, and after months of waffling had no choice but to hand over €4.5 billion (the first of many such cash rescues) in the form of a bridge loan to insolvent Bankia, which last week reported staggering losses (translation: huge deposit outflows which have made the fudging of its balance sheet impossible). As a reminder, in June Spain formally announced it would request up to €100 billion in bailout cash for its insolvent banking system, which subsequently was determined would come from the bank rescue fund, the Frob, which in turn would be funded with ESM debt which subordinates regular Spanish bonds, promises to the contrary by all politicians (whose job is to lie when it becomes serious) notwithstanding. And while Rajoy has promised that the whole €100 billion will not be used, the truth is that considering the soaring level of nonperforming loans in Spain - the biggest drain of both bank capital and liquidity - it is guaranteed that the final funding need for Spain's banks will be far greater. As a further reminder, Deutsche Bank calculated that when (not if) the recap amount hits €120 billion, Spanish total debt/GDP would soar to 97% in 2014 from an official number of 68.5% in 2011 (luckily the endspiel will come far sooner than that). But all of that is well-known, and what we wanted to focus on instead was the fact that bank bailout notwithstanding, Spain will have no choice but to demand a full blown rescue within a few short month for one simple reason: its cash will run out.
We recently discussed Guggenheim's 'awe-full' charts of the level of central bank intervention from which they noted that the Fed could lose 200 billion US$, when inflation comes back again. Interest rates would increase by 100 basis points and the US central bank would be bankrupt according to US-GAAP. We explain in this post the differences between money printing as for the Swiss National Bank (SNB), the ECB and the Fed. We show the risks the central banks run when they increase money supply, when they “print”. As opposed to the ECB, the SNB only buys high-quality assets, mostly German and French government bonds. However, for the SNB the assets are in foreign currencies, for the big part they are denominated in euros. Further Fed quantitative easing drives the demand for gold and the correlated Swiss francs upwards. Sooner or later this will pump more American money into the Swiss economy and will raise Swiss inflation. For the SNB these two are the Mephistos: Bernanke and Draghi, the ones who promise easy life based on printed money.
Ignore the news about what is surely the next airline to join every other legacy, and not so legacy, carrier into Chapter 11 and focus on the headline, where both the story author and its editor seem to have been preoccupied with Freudian ruminations if not on whether gold is money, then certainly how much paper money one can generate by selling gold...
Since the peak in the S&P 500 around two weeks ago, equities and their sectors have traded in a considerably more disperse manner than one would expect given all the talk of central-bank intervention, liquidity-gasms, and monetization. This is borne out empirically as the average pairwise realized correlation within the 100 stocks of the S&P 100 and the 125 credits of the CDX investment grade credit index has dropped dramatically. Extreme peaks or troughs in realized correlation have tended to coincide with notable (and tradable) trend changes in the market - though we note, as shown below, that the moves are not always so clearly bullish or bearish for stocks (though VIX shows a more consistent reaction). Critically, the outperformance of Healthcare and underperformance of Industrials and Materials in the last two weeks suggests more than a little apprehension at the Central Banks being able to 'bridge' yet another global slow-down with money-printing.
Until 1976, all student loans could be discharged in bankruptcy. Until 1998, student loans could be discharged after a waiting period of five years. In 1998, Congress made federal student loans nondischargeable in bankruptcy, and, in 2005, it similarly extended nodischargeability to private student loans. Since 2000, student loan debt has exploded, and private student loans have grown even faster. This presents a bigger problem than simply sending people to college who end up unemployed or underemployed. It means that capital is being misallocated. If debt for education cannot simply be discharged through bankruptcy, as other debt can be, private lenders will tend toward offering much more of the nondischargeable debt, and less of dischargeable debt. This means that there is less capital available for other uses — like starting or expanding a business. If the government’s regulatory framework leans toward sending more people to college, more people will go (the number of Americans under the age of 25 with at least a bachelor’s degree has grown 38 percent since 2000) — but the money and resources that they are loaned to do so is money and resources made unavailable for other purposes.
Not entirely surprising following the outlook changes for Germany, France, UK, and Holland but still an intriguing move right before Draghi's big unveiling: Moodys maintains AAA rating but shifts to outlook negative.
Moody's believes that it is reasonable to assume that the EU's creditworthiness should move in line with the creditworthiness of its strongest key member states considering the significant linkages between member states and the EU, and the likelihood that the large Aaa-rated member states would likely not prioritize their commitment to backstop the EU debt obligations over servicing their own debt obligations.
Interestingly they also note that a further cut could occur due to: changes to the EU's fiscal framework that led to less conservative budget management...