PIMCO

While this week's two previous auctions were uneventful and very much unimpressive, today's 7 Year $29 billion issue continues to show that the bulk of the curve action continues to be at the belly. Unlike January's spotty 7 Year auction which saw a massive 56.64% in Primary Dealer take down, today's was the opposite, with the auction pricing a whopping 3 bps inside of the When Issued at 1.418%, with Dealers taking down just 38.89%, well below the TTM average 47.46%. This was the lowest Dealer take down since December 2010.  The Indirect Bid was well higher than in January when as we already noted previously foreign investors were dumping US paper, yet at 41.85% was just in line with the TTM average of 41.54%. The big outlier however was the Direct Bid take down which soared from 11.59% to a massive 19.27% take down - a low 44% hit rate on the Direct Bid. Why the huge shift in sentiment toward US paper? It hardly has anything to do with the yield rising from a meager 1.36% to a just barely higher 1.42%. And yet, there was a tangible change in Direct interest - is it merely PIMCO buying up more paper? Most likely - this is perfectly aligned with the fund's recent average effective duration so we would not be surprised if Bill Gross is now loading up on the belly. The result of the super strong auction is the entire treasury curve sliding in yield, as it indicates that the wholesale expectation of a shift away from Treasurys and pushing into stocks, is nowhere to be seen. And stepping back from the tree, the forest now stands at just under 101.5% debt/to US GDP. Many more auctions coming.

A lesson to be learnt from the individuals who continue to buy European Debt

Much has been said in the past about the world's largest university endowment fund - that of Harvard University, whose most famous overseer is the current Pimco CIO and part-time blogger Mohamed El-Erian. Yet relatively little light has been shed on the endowment fund of that "other" school - the one with the original business school, and whose alums have been largely credit with shaping the modern financial world as it stands: the University of Pennsylvania. Also, the one which for many years has oddly underperformed its peers, yet which during the financial crisis suffered the least of its peer Ivy League peers. Until now. In his latest letter, Oaktree's Howard Marks shares the lessons he learned as the Chairman of the Penn endowment in the period from 2001 to 2010. He also analyzes the various angles from which one should approach in evaluating investment performance and track records, in his traditionally meticulous and informative style - a lesson very much needed in today's market climate of bipolar euphoria.

For a while now we have said that the very weakest link in Europe is not the banks, not the ECB, not triggered CDS, and not even the shadow banking system (well, infinitely rehypothecated Greek bonds within a daisychain of broker-dealers, which ultimately ends up at the ECB at a negligible repo discount, that could well be the weakest link - we will have more to say about this over the weekend) but two very specific insurers: Italy's mega insurer Assecurazioni Generali, which at last check had more Greek bonds as a % of TSF than anyone else, and Europe's biggest insurer and Pimco parent, Allianz, which is filled to the gills with pretty much everything (for more on Generali, or as we like to call it by its CDS ticker ASSGEN read here, here, here, and here). Well, Moody's just gave them, and the entire European space, the evil eye, and soon the layering of margin calls upon margin calls, especially if and when Greece defaults and a third of ASSGEN's balance sheet is found to be insolvent, will make anyone who still is long CDS those two names rich. Assuming of course the Fed steps in and bails out the counterparty the CDS was purchased from.

While much of the focus has been on Paulson & Co., the hedge fund founded by billionaire John Paulson, cutting its stake in the SPDR Gold Trust by 15% in the fourth quarter, possibly of more importance is the fact that PIMCO, the Texas Teacher Retirement System and George Soros all increased their holdings of the biggest exchange-traded product backed by gold. Paulson cut his gold ETF bullion holdings by about 600 million dollars in Q4, a reduction that was likely driven by client redemption needs as he and his fund remain upbeat on gold – primarily due to inflation concerns.  Paulson’s reduction in SPDR was offset by other important buyers such as PIMCO, which oversees $1.36 trillion and is home to the world's biggest bond fund and significant institutional buying from the likes of the Texas Teacher Retirement System and billionaire investor George Soros. ‘Bond King’, Bill Gross recently wrote about gold as a “store of value” and PIMCO’s allocation to GLD may be ongoing as they seek to diversify their portfolios and hedge against inflation. Soros, who once suggested gold was or would be "the ultimate asset bubble," raised his stake in the SPDR Gold Trust (GLD), a gold-backed exchanged-traded fund, to 85,450 shares, up from 48,350 shares in the period. Soros, who had disclosed call and put options on the gold fund in the prior period, reported no such investments in the fourth quarter. Soros’ GLD position is worth a mere $13 million, however it suggests that he is not as bearish on gold as portrayed and that he sees further upside for gold.

Is a bonus culture beneficial to the economy?

Regular readers of Zero Hedge know that in recent months tracking the portfolio and thoughts of one Bill Gross via the holdings of his flagship Total Return Fund (which just jumped by $6 billion in the past month and is just shy of its all time record north of $250 billion) has meant one thing and one thing only: betting on the Fed monetizing Mortgage Backed Securities or bust. Well, in January he just took it to a whole new level. The fund has now borrowed a record $88 billion, or -35% of its AUM, in cash (shows how much he thinks of the dollar) and used the proceeds (together with dumping European sovereign bonds from 18% to 11% of AUM) to bet on MBS which now stood at a whopping 50% of the entire portfolio - the highest since July 2009 when QE1 was in full force. However, in absolute dollar terms, due to the growth of the fund's AUM, the actual bet on MBS has never been bigger, and at $125 billion, represents the biggest notional bet ever made by PIMCO. Treasury holdings of just over $100 billion with an effective duration of 6.33 complete the epic bet that the fund has now put on QE3.

Mohamed El-Erian, CEO and co-chief investment officer of bond fund giant PIMCO, said investors should be underweight equities while favoring "selected commodities" such as gold and oil, given the fragile global economy and geopolitical risks. Over the long term gold will reward investors who own gold as part of a diversified portfolio. Trying to time purchases and market movements is not recommended – especially for inexperienced investors.  New research from Credit Suisse and London Business School entitled ‘The Credit Suisse Global Investment Returns Yearbook 2012’ continues to be analysed by market participants. The 2012 Yearbook investigates data from 1900 to 2011 and looks at how best to protect against inflation and deflation, and how currency exposure should be steered. The chief findings are that bonds do well in deflation and benefit from currency hedging, and equities are not a perfect inflation hedge, but benefit from international diversification.  The report shows that gold offers a timely inflation hedge and long term holders of gold should expect a positive correlation to inflation – gold is one of only two assets since 1900 to have positive sensitivity to inflation (of 0.26). Only inflation-linked bonds had more - 1.00, as expected. By contrast, when inflation rises 10%, bond returns have fallen an average 7.4%; Treasuries fell 6.2%, and equities lost 5.2%. Property fell by between 3.3% and 2%. Importantly, gold managed to increase its value across both extreme inflationary and deflationary scenarios. The academics from LBS analysed 2,128 individual years in 19 major countries (1900-2011), finding gold rose 12.2% in the most deflationary years - when average deflation was 26%.

Over the weekend, we commented on Dylan Grice's seminal analysis which excoriates the central planning "fools", who are perpetually caught in the "lost pilot" paradigm, whereby the world's central planners increasingly operate by the mantra of “I have no idea where we’re going, but we’re making good time!” and which confirms that in the absence of real resolutions to problems created by a century of flawed economic models, the only option is to continue doubling down until terminal failure. Basically, the take home message there is that once "economists" get lost in trying to correct the errata their own models output as a result of faulty assumptions (which they always are able to "explain away" as one time events), they drift ever further into unknown territory until finally we end up with such monetary aberrations as "liquidity traps", "zero bound yields" and, soon, NIRP (which comes after ZIRP), if indeed the Treasury proceeds with negative yields beginning in May under the tutelage of the Goldman-JPM chaired Treasury Borrowing Advisory Committee. Today, it is Bill Gross who takes the Grice perspective one step further, and looks at implications for liquidity, and the lack thereof, in a world where one of the three primary functions of modern financial intermediaries - maturity transformation (the other two being credit and liquidity transformation) is terminally broken. He then juxtaposes this in the context of Hyman Minsky's monetary theories, and concludes: "What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed? What incentive does Pimco or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is two per cent of par and the downside substantially more?" In other words, Pimco is finally grasping just how ZIRP is punking it and its clients. It also means that very soon all the maturity, and soon, credit risk of the world will be on the shoulders of the Fed, which in turn labor under a false economic paradigm. And one wonders why nobody has any faith left in these here "capital markets"...

• Merkel Seeks to Reassure China (FT)
• German-IMF Rift Stalls Greece Deal (WSJ)
• Survey of Banks Shows a Sharp Cut in Lending in Europe (NYT)
• Bernanke to testify on economy and deficit (AP)
• House votes to freeze congressional, federal pay (WaPo)

As a follow up to today's must read letter from Bill Gross, the PIMCO head explains what was the thinking behind the conclusion that is slowly leading him to become a gold bug, the potentially erroneous assumption that the Fed can not drop rates below zero (not if Goldman and JPM have their way), why Bernanke has no choice but to write checks when the Twist ends in June which will lead to bond buying for the next 12-24-36 months. Nothing new. What is new, and absolutely stunning, is Gross' endorsement for president: 'I'm a little Ron Paulish." (6'24" into the clip)... That's right. The bond king endorses Ron Paul for president, apparently on the realization that very soon he will have to pay Tim Geithner for the privilege of holding hundreds of billions in US paper. And now we've heard it all.

One of the laments of the uberdoves in the world over the past several years has naturally been the fact that interest rates are bound by Zero on the lower side, and that the lowest possible rate on new paper is, by definition, 0.000%. Which is what led to the advent of QE in the first place: in lieu of negative rates, the Fed was forced to actively purchase securities to catch up to a negative Taylor implied rate. This may be about to change, because as the just released letter from the Treasury Borrowing Advisory Committee, or as we affectionately called the JPMorgan/ Goldman Sachs Chaired committee, the "Supercommittee That Runs America", simply because it alone makes up Tim Geithner's mind on what America needs to do funding wise, demand, "It was broadly agreed that flooring interest rates at zero, or capping issuance proceeds at par, was prohibiting proper market function. The Committee unanimously recommended that the Treasury Department allow for negative yield auction results as soon as logistically practical." And what JP Morgan and Goldman Sachs want, JP Morgan and Goldman Sachs get. And once we get the green light on negative yields at auction, next up will be the push for the Fed to impose negative rates on all standing securities, which means that coming soon savers will be literally paying to hold cash. And that will be the final straw.

While sounding just a tad preachy in his February newsletter, Bill Gross' latest summary piece on the economy, on the Fed's forray into infinite ZIRP, into maturity transformation, and the lack thereof, on the Fed's massive blunder in treating the liquidity trap, but most importantly on what the transition from a levering to delevering global economy means, is a must read. First: on the fatal flaw in the Fed's plan: "when rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street." And secondly, here is why the party is over: "Where does credit go when it dies? It goes back to where it came from. It delevers, it slows and inhibits economic growth, and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this up as we go along for what may seem like an eternity. A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets – bonds, stocks, real estate and commodities alike – is now delevering because of excessive “risk” and the “price” of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time." Yet most troubling is that even Gross, a long-time member of the status quo, now sees what has been obvious only to fringe blogs for years: "Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside. Still, zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly. It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper." Let that sink in for a second, and let it further sink in what happens when $1.3 trillion Pimco decides to open a gold fund. Physical preferably...

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