On Tuesday Oct 25, 2010 a 5-year US Treasury TIPS (Treasury Inflation-Protected Security) bond was sold to the public at a yield below 0%. In other words, the investor is paying the difference between the negative yield and 0% (this happens via the purchase price) for the privilege of getting his or her money back. How could this be, and what are they thinking?
First, there is no way such a yield could occur in normal markets. In this case the manipulation is being carried out as one part of a 2-prong tactic by the US Treasury. The reason we care, is that Treasury these actions get translated throughout world markets. These translations, or effects, involve (a) interest rates charged within various countries and (b) impact the relative value of currencies in relation to the USD.
Let's take as an example the pump price of gasoline at the present time in Ontario. With minor location variations it has already risen above $1/L. There is no scarcity of physical supply. North American and European economies are weak. The summer driving season is at an end. New vehicles get better mileage. So the current demand outlook is not a source of pressure.
Since the US Treasury began suppressing interest rates and at the same time introduced "quantitative easing" (QE1, flooding the banks with cash but ensuring by regulatory changes that bank lending to most individual and business customers cannot be easily expanded) the US dollar has lost about 20% of its relative value when compared to proxies for the US dollar, such things as oil (energy), gold or copper. The basic prices for these things are denominated in US dollars.
A foreign exchange effect occurs when countries with strong positive trade balances with the US see their currencies rise in terms of the US dollar. China's own intervention in currency markets has put a braking effect on its rate of increase. If the RMB were to rise as quickly as the dollar has fallen is seen as a threat to social stability within China.
Canada should be in a pretty good place. Its strength but also its Achilles heel, is its geography, its location on the planet. Our trade patterns have lead to deep integration with American business and consumers. But unfortunately, our export firms get paid primarily in US dollars rather than for example, RMB. It is very difficult to create massive substitute demand, at competitive prices, from elsewhere in the world - especially in the complete absence of any strategic Canadian plan to do so. The National Oil Policy was attacked and tanked years ago.
The public often feels pleased when the Loonie moves toward par. Great to visit Buffalo. But since the US dollar has been sinking at a high rate, the reality is that the Loonie's purchasing power of products or commodities whose values are in process of de-linking from the US, is higher prices here. Welcome to $1.04 gas.
The second phase of quantitative easing, QE2, is about to begin as quietly as possible. What is the end-game of this strategy? Certainly not the same thing as any government public policy statements. The US is far beyond its ability to pay back money it has borrowed from the rest of the world (retire its debt as it matures). This especially true when it needs to restructure its internal and individual state financial problems.
An interest rate increase on debt sold abroad would seriously worsen the problem. Super-low domestic rates forces those dependent on investment income to look elsewhere - invest in stocks or (hopefully) in real estate sufficient to arrest its slide. The proof of this is that many stocks now have yields higher than the bonds of the same companies. Without market manipulation this could never happen.
At this point it becomes clear that the chosen method of reducing US external debt is to export inflation worldwide. The object is to pay external debt obligations (which are not inflation-protected) in electronic dollars of greatly reduced value. If the US dollar were not the principal world reserve currency, the US would be forced to default as in the case of Argentina. Canada cannot simply let its own currency appreciate to the point that the US sources elsewhere.
The Treasury maintains that when the world, and especially the US recovers from its balance sheet and related domestic employment crisis, it will quickly switch gears and rein in the ensuing inflation. Failure to do so would risk hyperinflation.
Easy to say, but no modern major industrial country has ever done it, regardless of the effort.
Tuesday, October 26, 2010
Tuesday, September 21, 2010
The Final "Tell"
Today the FOMC's (Federal Open Market Committee) comments following its notice not to change US interest rates, marked the point at which it would not step onto the path of a harder currency in the way they so strongly urged the EU countries to do. It is also politically opposite to the effect implicit in Tea Party people talk - I say 'effect' instead of 'policy' because I do not believe the TP actually has a policy or understands the implications of what it says.
Regardless, the FOMC comments opened the way for an imminent return to QE2, or the second coming of the Quantitative Easing experiment. When this happens, it will be a point of no return. The Bernanke-Geitner duo will speak and it will happen. As I said in an earlier blog, this was first tried years ago by Japan and is given prominence for that country's economic "lost decade".
As a backdrop, the predominent recent US guru wisdom has been that there would be no "double dip" in GDP, just slow but steady growth. By Sept 20 a wrench seemed to be thrown into that scenario when the Fed announced that the decline had ended a year ago! As Obama was politely asked that same day on TV by some of his most supportive public, to be told now that this was a year of recovery after bailouts, QE1, etc was scarcely credible.
Whispers had been saying the amounts deployed were not big enough. Now the result was clear. Even the slightest future downtick would put "double dip" in play. And as we have said before, the only tool left to the Fed and Treasury would be QE2.
The anointed god of bonds, Bill Gross of PIMCO, was already standing by on CNBC. Within a minute after release of the FOMC statement, Gross said it could only mean a decline in the dollar*. Almost simultaneously, charts of spot gold spiked to a new current high approaching $1,290/oz, while the US dollar abruptly commenced a renewed stage of its fall. Stock markets rose in unison. However, before the day's close at 4pm, the market began to reassess the consequences. By 5pm, Larry Summers, Director of the Obama Council of Economic Advisors had announced his resignation.
If QE2 does happen, new consequences being unleashed by the "solution" will eventually have to be fixed. An important part of those problems will occur in non-indexed public and private pensions as yields disappear and fixed incomes progressively fall. The fix is unlikely to be pretty. When rates rise - which will happen again at some point - bond values and pension assets will be crushed.
Whatever policyspeak may sound like, investors should instead take what it says on the cop cars as the greater reality -"Deeds Speak".
* His unspoken message (known as "talking your book"): Get out of your weak cash and into the safety of US Treasuries. He may not tell those same potential investors when to get out, until PIMCO has already vacated stage left at a profit. PIMCO is the world's largest bond investor.
James Carville, Bill Clinton's famed campaign manager is reputed to have joked "Once when I was asked what I would want to be if could have all the power in the world I would have said "God" - now I would say a bond fund".
Regardless, the FOMC comments opened the way for an imminent return to QE2, or the second coming of the Quantitative Easing experiment. When this happens, it will be a point of no return. The Bernanke-Geitner duo will speak and it will happen. As I said in an earlier blog, this was first tried years ago by Japan and is given prominence for that country's economic "lost decade".
As a backdrop, the predominent recent US guru wisdom has been that there would be no "double dip" in GDP, just slow but steady growth. By Sept 20 a wrench seemed to be thrown into that scenario when the Fed announced that the decline had ended a year ago! As Obama was politely asked that same day on TV by some of his most supportive public, to be told now that this was a year of recovery after bailouts, QE1, etc was scarcely credible.
Whispers had been saying the amounts deployed were not big enough. Now the result was clear. Even the slightest future downtick would put "double dip" in play. And as we have said before, the only tool left to the Fed and Treasury would be QE2.
The anointed god of bonds, Bill Gross of PIMCO, was already standing by on CNBC. Within a minute after release of the FOMC statement, Gross said it could only mean a decline in the dollar*. Almost simultaneously, charts of spot gold spiked to a new current high approaching $1,290/oz, while the US dollar abruptly commenced a renewed stage of its fall. Stock markets rose in unison. However, before the day's close at 4pm, the market began to reassess the consequences. By 5pm, Larry Summers, Director of the Obama Council of Economic Advisors had announced his resignation.
If QE2 does happen, new consequences being unleashed by the "solution" will eventually have to be fixed. An important part of those problems will occur in non-indexed public and private pensions as yields disappear and fixed incomes progressively fall. The fix is unlikely to be pretty. When rates rise - which will happen again at some point - bond values and pension assets will be crushed.
Whatever policyspeak may sound like, investors should instead take what it says on the cop cars as the greater reality -"Deeds Speak".
* His unspoken message (known as "talking your book"): Get out of your weak cash and into the safety of US Treasuries. He may not tell those same potential investors when to get out, until PIMCO has already vacated stage left at a profit. PIMCO is the world's largest bond investor.
James Carville, Bill Clinton's famed campaign manager is reputed to have joked "Once when I was asked what I would want to be if could have all the power in the world I would have said "God" - now I would say a bond fund".
Tuesday, September 14, 2010
The Gold Conundrum
The combination of unusually contradictory economic signals plus political and social crosswinds have meant extraordinary volatility and confusion in debt and equity markets. Expectations and explanations for the action in gold are no exception. As the spot market rose to new highs today, September 14, disbelief appears extremely high. What is going on?
"Gold bugs" have always been derided. This has made it pretty hard for investors that are already involved or considering that section of the market to believe in their rationale, lest they have been unwittingly infected by "the bug" or considered part of the tinfoil hat crowd.
For the moment, let's set aside thoughts about Indian jewellery demand, absence of industrial use and the repeated view that it is a relic of an earlier order of international settlements that eventually outlived its reason for existence until the Nixon era. The first is too small to have anything other than seasonal effect; it's true, there really is no industrial demand on the horizon and the prospect of the IMF or other bodies adopting some widespread form of gold-related standard among nations appears unlikely any time soon. Then there is is the debate that we are more likely entering a deflationary period (declining aggregate prices) than an inflationary - even hyper-inflationary - one.
In this writer's view, at present the monetary issue is the key. Observations that the current environment has deflationary characteristics have supportable evidence, but a lot of it - not all - involves the rear-view mirror. The public perception of well-being typified by the seemingly permanent decline in Walmart pricing is ending as originating and transportation costs rise. US consumers are struggling with personal balance sheets by curbing consumption and paying down debts. For now, Canadians are busily going in the opposite direction, increasing their debt. The divergence will not be permanent.
Areas of future influence where governments have the least control, such as worldwide food prices, are much more inflationary than those such as interest rates that are under vigorous, ongoing government suppression. US rates and the value of the US dollar relative to other currencies are the most significant influencing factors in the gold price.
Since US rates are the lowest in the world (the Japanese yen is not a currency for international settlement), the US treasury bonds that must be sold to fund the US trade deficit, increasingly cannot be sold in sufficient quantity to foreigners. The shortfall in purchases therfore has to come from the US government itself. This puts it in the position of being both the seller and a buyer. The result affects the US government's own balance sheet. The combination of these policies, when extended over an unusually long period of time such as is the case today, comes with an unavoidable delayed cost. Due to the nature of its markets, gold is an erratic but inexorable measure of these effects, when measured in US dollars.
Historically the international mechanism compensating for these effects occurs through differences in interest rates between nations. Debtor nations, of which the US is by far the world's largest, will usually have the highest rates. The problem is that simultaneously, as issuer of a currency that in better times was accorded the status of reserve currency, meaning the one that all other settlements can be paid with, there is a huge conflict.
As a current core aspect of US government policy, the American interest rate shock absorber has been disabled. Throughout the exercise, official salesmanship says US policy is one of "maintaining a strong dollar." In the short term it is a situation with no political prospect of change. As a result, gold gradually and unofficially resumes the role of adjustment mechanism.
Notice that official US talk dismissing a rising gold price as meaningless, is completely consistent with its misleading "strong dollar" sales pitch. The key to the gold price conundrum is that for the remainder of this policy period - for whatever time it continues - the effect of these policies is the true driver of the gold price and the market is the enabler.
Of course in the world of global politics and international hegemony, it cannot be ignored that the US's single biggest creditor, China, has now become the world's largest gold producer. China is now putting in place its own policy of allowing gold to become a more important component of its currency policy. Part of this is being done by changing internal Chinese regulations to ecourage wider domestic investment in the metal but especially wider opportunity for Chinese citizens to invest in gold-related stocks.
Among these planned market vehicles, certain of them are identifiable as "dragon's head" national champions in which elements of the Chinese government itself has a stake. It will be interesting to see if this policy will induce some level of switch by investors to Chinese gold stocks from Chinese real estate. Not only are real estate prices viewed as unsustainable, but there have been calls for real estate prices to be moderated in the Chinese market for social reasons.
On the other hand, as well as providing a new investment alternative, such a directed capital reallocation should avoid pushing funds into and thereby exerting pressure on other domestic prices to feed inflation. For China, gold investment opportunities may achieve that goal.
At the same time, success for investors would increase the "wealth effect" for a growing middle class. This is needed to pick up slack in export demand and shifting it internally. In turn it also mitigates the otherwise negative effect from a trade standpoint from the resulting higher value that will take place in the Chinese yuan.
Such an increase in the relative value of the Chinese currency has been loudly demanded in US political circles for several years. China appears now in the process of putting this demand into effect as a change in its economic policy. I expect it could be evident by Q2 2011.
There is a saying, "watch what you wish for", because unintended consequences abound.
Disclosure: long CGG-T
"Gold bugs" have always been derided. This has made it pretty hard for investors that are already involved or considering that section of the market to believe in their rationale, lest they have been unwittingly infected by "the bug" or considered part of the tinfoil hat crowd.
For the moment, let's set aside thoughts about Indian jewellery demand, absence of industrial use and the repeated view that it is a relic of an earlier order of international settlements that eventually outlived its reason for existence until the Nixon era. The first is too small to have anything other than seasonal effect; it's true, there really is no industrial demand on the horizon and the prospect of the IMF or other bodies adopting some widespread form of gold-related standard among nations appears unlikely any time soon. Then there is is the debate that we are more likely entering a deflationary period (declining aggregate prices) than an inflationary - even hyper-inflationary - one.
In this writer's view, at present the monetary issue is the key. Observations that the current environment has deflationary characteristics have supportable evidence, but a lot of it - not all - involves the rear-view mirror. The public perception of well-being typified by the seemingly permanent decline in Walmart pricing is ending as originating and transportation costs rise. US consumers are struggling with personal balance sheets by curbing consumption and paying down debts. For now, Canadians are busily going in the opposite direction, increasing their debt. The divergence will not be permanent.
Areas of future influence where governments have the least control, such as worldwide food prices, are much more inflationary than those such as interest rates that are under vigorous, ongoing government suppression. US rates and the value of the US dollar relative to other currencies are the most significant influencing factors in the gold price.
Since US rates are the lowest in the world (the Japanese yen is not a currency for international settlement), the US treasury bonds that must be sold to fund the US trade deficit, increasingly cannot be sold in sufficient quantity to foreigners. The shortfall in purchases therfore has to come from the US government itself. This puts it in the position of being both the seller and a buyer. The result affects the US government's own balance sheet. The combination of these policies, when extended over an unusually long period of time such as is the case today, comes with an unavoidable delayed cost. Due to the nature of its markets, gold is an erratic but inexorable measure of these effects, when measured in US dollars.
Historically the international mechanism compensating for these effects occurs through differences in interest rates between nations. Debtor nations, of which the US is by far the world's largest, will usually have the highest rates. The problem is that simultaneously, as issuer of a currency that in better times was accorded the status of reserve currency, meaning the one that all other settlements can be paid with, there is a huge conflict.
As a current core aspect of US government policy, the American interest rate shock absorber has been disabled. Throughout the exercise, official salesmanship says US policy is one of "maintaining a strong dollar." In the short term it is a situation with no political prospect of change. As a result, gold gradually and unofficially resumes the role of adjustment mechanism.
Notice that official US talk dismissing a rising gold price as meaningless, is completely consistent with its misleading "strong dollar" sales pitch. The key to the gold price conundrum is that for the remainder of this policy period - for whatever time it continues - the effect of these policies is the true driver of the gold price and the market is the enabler.
Of course in the world of global politics and international hegemony, it cannot be ignored that the US's single biggest creditor, China, has now become the world's largest gold producer. China is now putting in place its own policy of allowing gold to become a more important component of its currency policy. Part of this is being done by changing internal Chinese regulations to ecourage wider domestic investment in the metal but especially wider opportunity for Chinese citizens to invest in gold-related stocks.
Among these planned market vehicles, certain of them are identifiable as "dragon's head" national champions in which elements of the Chinese government itself has a stake. It will be interesting to see if this policy will induce some level of switch by investors to Chinese gold stocks from Chinese real estate. Not only are real estate prices viewed as unsustainable, but there have been calls for real estate prices to be moderated in the Chinese market for social reasons.
On the other hand, as well as providing a new investment alternative, such a directed capital reallocation should avoid pushing funds into and thereby exerting pressure on other domestic prices to feed inflation. For China, gold investment opportunities may achieve that goal.
At the same time, success for investors would increase the "wealth effect" for a growing middle class. This is needed to pick up slack in export demand and shifting it internally. In turn it also mitigates the otherwise negative effect from a trade standpoint from the resulting higher value that will take place in the Chinese yuan.
Such an increase in the relative value of the Chinese currency has been loudly demanded in US political circles for several years. China appears now in the process of putting this demand into effect as a change in its economic policy. I expect it could be evident by Q2 2011.
There is a saying, "watch what you wish for", because unintended consequences abound.
Disclosure: long CGG-T
Wednesday, August 25, 2010
Bummed Out by the Confusion
It's all been said endlessly, in newspapers, CNN, CNBC and the financial blogosphere - there has never been a time of such conflicting data and opinion. People are genuinely being turned off North American equity markets. The tone of US political bickering is discouraging and uninformative. Canadian politics seem designed to put the electorate to sleep and if they wake up, they shut the shop. Out of all this, people are advocating "throw them all out", which is understandable but seem at the same instant to embrace radical positions that if actually enacted, would worsen their own situations, which is not.
On top of this, we have cries of 'treasury bubble', 'gold bubble', scary Hindenburg Omens, what-if "W" scenarios, deflation-inducing de-leverage, closed-door credit, persistent unemployment, flatlined incomes, debt and pension crises, 'I'm OK so far' housing here, debacles elsewhere. No wonder equity investment is declining and people are easily stampeded into bonds at non-existent interest rates, just in the hope of preserving original capital. Theories abound for an imminent further drop in US markets. None, except for general contrarians, call for an advance.
The actions being talked up in America and Europe, if actually pursued to their conclusions will mean at least 2 or 3 years of considerable difficulty for most citizens. In Europe they are already in place. In the US they are not. I believe they will not be enacted there before the Nov. 11 elections and even less so afterwards, despite current claims to the contrary.
Many large corporations have quite decent balance sheets. But the US government, whose actions in conjunction with the US Federal Reserve affect us all, does not. Add to this state revenue shortfalls and the competition to sell bonds by governments to somebody that is NOT the government (unless its foreign), will be intense.
Most recent government financing has been into the short-term market. That means - as a certainty - that in order to raise new money, simultaneously all of the short-term debt has to be rolled over (re-sold) also.
We see that in the short term the economy will be weak and unemployment persistent, so tax revenues will be poor. The new debt numbers will therefore be monumental. If the debt is not sold - and the need will be such as to guarantee fierce competition - it is exceedingly unlikely that rates can be held down. The repeated periods before each major issue will seem like mini-crises.
This not irrational scenario will put huge pressures on North American and European currencies. Commodity sales will help Canada but our currency cannot get so far separated from the USD as to collapse our industrial sector.
Currency changes exist in relation to other things. The best of energy and gold stocks would survive. If as an alternative you want the most secure and liquid direct gold participation, I have previously suggested looking at the Sprott PHYS ETF of Canadian-held physical gold. It trades in USD. Don't switch currencies until you are ready.
Position: Long ARNA-Q, CGG-T, VET.UN-T
On top of this, we have cries of 'treasury bubble', 'gold bubble', scary Hindenburg Omens, what-if "W" scenarios, deflation-inducing de-leverage, closed-door credit, persistent unemployment, flatlined incomes, debt and pension crises, 'I'm OK so far' housing here, debacles elsewhere. No wonder equity investment is declining and people are easily stampeded into bonds at non-existent interest rates, just in the hope of preserving original capital. Theories abound for an imminent further drop in US markets. None, except for general contrarians, call for an advance.
The actions being talked up in America and Europe, if actually pursued to their conclusions will mean at least 2 or 3 years of considerable difficulty for most citizens. In Europe they are already in place. In the US they are not. I believe they will not be enacted there before the Nov. 11 elections and even less so afterwards, despite current claims to the contrary.
Many large corporations have quite decent balance sheets. But the US government, whose actions in conjunction with the US Federal Reserve affect us all, does not. Add to this state revenue shortfalls and the competition to sell bonds by governments to somebody that is NOT the government (unless its foreign), will be intense.
Most recent government financing has been into the short-term market. That means - as a certainty - that in order to raise new money, simultaneously all of the short-term debt has to be rolled over (re-sold) also.
We see that in the short term the economy will be weak and unemployment persistent, so tax revenues will be poor. The new debt numbers will therefore be monumental. If the debt is not sold - and the need will be such as to guarantee fierce competition - it is exceedingly unlikely that rates can be held down. The repeated periods before each major issue will seem like mini-crises.
This not irrational scenario will put huge pressures on North American and European currencies. Commodity sales will help Canada but our currency cannot get so far separated from the USD as to collapse our industrial sector.
Currency changes exist in relation to other things. The best of energy and gold stocks would survive. If as an alternative you want the most secure and liquid direct gold participation, I have previously suggested looking at the Sprott PHYS ETF of Canadian-held physical gold. It trades in USD. Don't switch currencies until you are ready.
Position: Long ARNA-Q, CGG-T, VET.UN-T
Thursday, August 12, 2010
Confirmation of a View
With a stay in the hospital happening within a market period with plenty of weekly volatility but very little new substance behind it, I have been keeping up but not writing. Events make it time for another post.
A few weeks ago, everything focussed on the demise of Euro sovereign debt and a corresponding media barrage supporting future strength in the USD. While large US corporations and banks were (and are) doing fine and many manufacturers were finding an improved export edge due the previously lower dollar, nothing that the US government or the Fed had done suggested that they had changed their position of allowing the dollar follow its own course. That this course is downward has no connection with the permanent official line of support for "king dollar".
On Tues Aug 10, the message from the Fed Open Market Committee (FOMC) was that it was leaving rates alone. It did not mention deflation but stressed the economy was weak and indicators unusually mixed. This caused an immediate general selloff that swept across Asia overnight. Strangely to some of us, gold dropped in lockstep with the market. Since "everyone knew" that the Obama administration had been forced to stop anything resembling a further bailout or economic support - very dirty populist words - prior to the November 8 elections, it could make sense.
However, the real reason was because commentators had not looked closely enough at the Fed's additional statement that capital recoveries on their previous purchase of "toxic" mortgage debt (to save the real estate industry, mortgage holders and those in Congress up for re-election), the proceeds would be reinvested in US long Treasury bonds. Since all those mortgages could not be a total writeoff, the plan was that any capital recovery would drop off and reduce the debit side of the Treasury's balance sheet. A day later, markets grasped that this previous potential reduction would now be used to monetize new US Treasury debt. The semantics if not the theory being, no new money would be involved! The USD sank and gold recovered.
In a nutshell, this validates our position that there is insufficient political will in any currently visible US Administration to do what Europe at least officially stated it would do; that is, put hard decisions into actual effect to improve their sovereign debt positions. Of course by its very actions, the Fed has made it much more difficult for those that are trying to put their houses in order, to do so. The Canadian economy, which had been remarkably strong, started to look weaker as the BC and Ontario HST kicked in and manufacturers felt their prices rising in the US market as the US dollar fell. Recent hikes in Canadian interest rates only added to the discrepancy and make the timing look inappropriately hasty.
Our investment outlook is unchanged for the time being. We have re-expanded our long position in China Gold International Resources (CGG), formerly Jinshan Mines (JIN). We have also expanded our position in the well-managed and geographically diversified Vermilion Energy Trust (VET.UN), which will soon be converted to a normal corporation. There is a possibility that in due course Vermilion may seek to expand its listing (and therefore its market capital potential) to include the NY NASDAQ. We initiated a modest speculative position in Arena Pharmaceuticals (ARNA). The US FDA will review its unusually promising diet and weight control product, Locaserin, in mid-September.
Much has been made of a current gold bubble. There are vested interests who wish to maximize this view. It can be argued that a much larger bubble is occurring in long-dated (10 year is the bellweather) US federal, state and municipal debt. An eventual decline there will affect debt markets everywhere. Whether the Euro zone recovers will depend upon the ability of the weaker countries to govern in the months immediately ahead as the effect of tough policies bite pocketbooks and retirement.
I came on this jewel recently, written by Ambrose Brice circa 1880. Brice was an American essayist and social critic.
"... politics is a strife of interests masquerading as a contest of principles...the conduct of public affairs for private advantage."
A few weeks ago, everything focussed on the demise of Euro sovereign debt and a corresponding media barrage supporting future strength in the USD. While large US corporations and banks were (and are) doing fine and many manufacturers were finding an improved export edge due the previously lower dollar, nothing that the US government or the Fed had done suggested that they had changed their position of allowing the dollar follow its own course. That this course is downward has no connection with the permanent official line of support for "king dollar".
On Tues Aug 10, the message from the Fed Open Market Committee (FOMC) was that it was leaving rates alone. It did not mention deflation but stressed the economy was weak and indicators unusually mixed. This caused an immediate general selloff that swept across Asia overnight. Strangely to some of us, gold dropped in lockstep with the market. Since "everyone knew" that the Obama administration had been forced to stop anything resembling a further bailout or economic support - very dirty populist words - prior to the November 8 elections, it could make sense.
However, the real reason was because commentators had not looked closely enough at the Fed's additional statement that capital recoveries on their previous purchase of "toxic" mortgage debt (to save the real estate industry, mortgage holders and those in Congress up for re-election), the proceeds would be reinvested in US long Treasury bonds. Since all those mortgages could not be a total writeoff, the plan was that any capital recovery would drop off and reduce the debit side of the Treasury's balance sheet. A day later, markets grasped that this previous potential reduction would now be used to monetize new US Treasury debt. The semantics if not the theory being, no new money would be involved! The USD sank and gold recovered.
In a nutshell, this validates our position that there is insufficient political will in any currently visible US Administration to do what Europe at least officially stated it would do; that is, put hard decisions into actual effect to improve their sovereign debt positions. Of course by its very actions, the Fed has made it much more difficult for those that are trying to put their houses in order, to do so. The Canadian economy, which had been remarkably strong, started to look weaker as the BC and Ontario HST kicked in and manufacturers felt their prices rising in the US market as the US dollar fell. Recent hikes in Canadian interest rates only added to the discrepancy and make the timing look inappropriately hasty.
Our investment outlook is unchanged for the time being. We have re-expanded our long position in China Gold International Resources (CGG), formerly Jinshan Mines (JIN). We have also expanded our position in the well-managed and geographically diversified Vermilion Energy Trust (VET.UN), which will soon be converted to a normal corporation. There is a possibility that in due course Vermilion may seek to expand its listing (and therefore its market capital potential) to include the NY NASDAQ. We initiated a modest speculative position in Arena Pharmaceuticals (ARNA). The US FDA will review its unusually promising diet and weight control product, Locaserin, in mid-September.
Much has been made of a current gold bubble. There are vested interests who wish to maximize this view. It can be argued that a much larger bubble is occurring in long-dated (10 year is the bellweather) US federal, state and municipal debt. An eventual decline there will affect debt markets everywhere. Whether the Euro zone recovers will depend upon the ability of the weaker countries to govern in the months immediately ahead as the effect of tough policies bite pocketbooks and retirement.
I came on this jewel recently, written by Ambrose Brice circa 1880. Brice was an American essayist and social critic.
"... politics is a strife of interests masquerading as a contest of principles...the conduct of public affairs for private advantage."
Monday, July 5, 2010
When Did the Game Change?
Did you see that? A few days ago, Europe, the Euro and European sovereign debt problems were pulling markets down. Thank goodness the US was coming to the rescue with its strong dollar. But in a blink after the TV channels were were changed from the FIFA World Cup, we find that Europe looks OK, but the US is falling apart! Are you kidding? What happened over the weekend?
Like we said in an earlier post, the Euro was looking bad only when it was playing catchup in the downward currency slide already led by the US dollar. Suddenly, northern European competitiveness is looking vastly enhanced. Europe was apparently not only talking tough fiscally but looked like it might actually do something about it.
Rather inconveniently, figures confirmed that the typical American consumer is absolutely mired in a negative personal balance sheet disaster, but also that employment - already officially overstated - was plunging no matter what rosy spin was put on the numbers. The combination is utterly toxic and short of faith-based economics, is beyond structural fixing in the near term.
The European central banks are only charged with keeping inflation under control. The US Fed has the extra official burden of maintaining employment. Congress wants both but jobs talk loudest. What they say is 'this time is special, so roll the presses'. Did I mention that the US wants to wind down its military presence overseas but at the moment the are no extra jobs waiting, as was promised, for returnees?
That's one side of the dilemma. The other is that China now owns one-half of the US external debt and makes the stuff that US consumers want to spend their not so available money on. If money is relatively unavailable, that would make rates go up, right? Interest rates must be held down at home or the time bomb of external American interest payments will blow everything else it tries to do out of the water. Never mind entitlement expenditures. Interest rates are the 800-pound gorilla that's too scary to talk about.
We are now entering an end-game period when the curtain will be lifted on just how much the US dollar, the world's reserve currency, is going to have to be inflated to keep Americans working at the same time as it attempts to diminish the external value of American debt repayment. The Japanese have a huge debt to GDP ratio. The thing about Japanese debt is that, by far, most of it is owned in Japan. So, other people's currencies getting stronger; official reserve currency getting weaker. Expect international rhetoric and protests to get very strident and hope for nothing worse.
For the Fed to fix that one painlessly, the trick will be to shift the pain elsewhere. Elsewhere may not be happy at the prospect.
Like we said in an earlier post, the Euro was looking bad only when it was playing catchup in the downward currency slide already led by the US dollar. Suddenly, northern European competitiveness is looking vastly enhanced. Europe was apparently not only talking tough fiscally but looked like it might actually do something about it.
Rather inconveniently, figures confirmed that the typical American consumer is absolutely mired in a negative personal balance sheet disaster, but also that employment - already officially overstated - was plunging no matter what rosy spin was put on the numbers. The combination is utterly toxic and short of faith-based economics, is beyond structural fixing in the near term.
The European central banks are only charged with keeping inflation under control. The US Fed has the extra official burden of maintaining employment. Congress wants both but jobs talk loudest. What they say is 'this time is special, so roll the presses'. Did I mention that the US wants to wind down its military presence overseas but at the moment the are no extra jobs waiting, as was promised, for returnees?
That's one side of the dilemma. The other is that China now owns one-half of the US external debt and makes the stuff that US consumers want to spend their not so available money on. If money is relatively unavailable, that would make rates go up, right? Interest rates must be held down at home or the time bomb of external American interest payments will blow everything else it tries to do out of the water. Never mind entitlement expenditures. Interest rates are the 800-pound gorilla that's too scary to talk about.
We are now entering an end-game period when the curtain will be lifted on just how much the US dollar, the world's reserve currency, is going to have to be inflated to keep Americans working at the same time as it attempts to diminish the external value of American debt repayment. The Japanese have a huge debt to GDP ratio. The thing about Japanese debt is that, by far, most of it is owned in Japan. So, other people's currencies getting stronger; official reserve currency getting weaker. Expect international rhetoric and protests to get very strident and hope for nothing worse.
For the Fed to fix that one painlessly, the trick will be to shift the pain elsewhere. Elsewhere may not be happy at the prospect.
Monday, June 21, 2010
An Intellectual and Tactical Challenge
Financial and investment markets at mid 2010 have rarely presented an equivalent challenge.
The growing concensus in early May of a V-shaped recovery abruptly shattered by June against the morphing of the international crisis of housing and banking into a sovereign debt crisis. This materialized with the exposure of the unsustainability of southern European national finance and social policy through their negative impact on the Euro. The outcome briefly made it appear that the US dollar was inherently strong. But it soon became apparent that the effect was only one of relationships, during which the Euro's decline simply accelerated to catch up with a decline that had already occurred in the US dollar.
Muddied over by the ongoing news coverage of the gulf of Mexico ecological disaster, the dawning understanding that the US housing debacle's effect had not yet played out occurred just as the inability of the federal government to continue its monetary stimulus made the dreaded W-recovery (or double-dip) loom as the more likely outcome. US consumers appeared to be spending on current needs by ceasing mortgage payments on houses in which they had no equity and from which they were unlikely to be evicted. State and municipal tax revenues continue to plunge.
New financial regulations (the so-called FINREG bill) may become within the US are expected imminently. However, the investment community feels that as presently constructed, they will serve banking interests far more than consumer interests as originally proposed.
While that works its way along, there is the realization that the post-2008 monetary easing is for the first time occurring within a fully engaged and therefore essentially closed global system, which now needs to be priced into international debt and equity markets. During the leadup to the Toronto G20 meeting, increasing angst and ink was spent on the relationship between the US dollar, the Chinese yuan (RMB) and gold. Gold morphed from an inflation play to a fiat currency issue and reached new current (non inflation-adjusted) highs. Saudi Arabia disclosed a major proportionate increase in gold among its reserve holdings. Already the largest producer, China continued to lock up more non-Chinese gold properties throughout the world by commercial deals, at the same time stating it saw no reason to buy more on the open market, such as from the IMF. Its latest currency adjustment makes gold cheaper within the domestic market.
The slow decline policy of the yuan from its former US peg as newly revealed this past weekend will allow elasticity for consumer demand in the US and elsewhere to remain more intact than it would have been with the major one-off revision the US had pushed for. Since wages are rising in China and domestic demand there will be stimulated, any success of the revised Chinese export policy will mean the rest of the world will pay for the rise in the Chinese standard of living without being able to correct their own trade deficit issues. The sovereign debt issue will persist.
The relative rise in the dollar over the last month helped the US Treasury successfully sell more debt to income-starved investors around the world at ultra-low rates of return. As economic historian and Harvard professor Niall Ferguson stated in a CNBC interview today (June 21), a realization among investors is bound to arise - within 2 to 4 years at best, sooner at worst - that rates must rise. The outcome, when translated into the billowing aggregate global debt, will be that debt maintenance - let alone reduction - will have already moved beyond reach. If and when that day arrives, bond values will plunge as demand for higher yields force them down. The impact on many ordinary and institutional investors - especially the more conservative ones - will be disastrous.
The challenge right now is serious. Many mature investors will be hard pressed to survive with their lifestyle intact and with a recovery doubtful for them in a meaningful time frame, while most younger ones appear to be carelessly texting and tweeting into their financial fate. Collectively, it is not clear if the various national publics affected, from Greece to Britain and the US, will be willing to accept the necessary fiscal medicine as politically palatable, in view of the high economic price that, with hyperinflation the other option, needs to be paid.
The growing concensus in early May of a V-shaped recovery abruptly shattered by June against the morphing of the international crisis of housing and banking into a sovereign debt crisis. This materialized with the exposure of the unsustainability of southern European national finance and social policy through their negative impact on the Euro. The outcome briefly made it appear that the US dollar was inherently strong. But it soon became apparent that the effect was only one of relationships, during which the Euro's decline simply accelerated to catch up with a decline that had already occurred in the US dollar.
Muddied over by the ongoing news coverage of the gulf of Mexico ecological disaster, the dawning understanding that the US housing debacle's effect had not yet played out occurred just as the inability of the federal government to continue its monetary stimulus made the dreaded W-recovery (or double-dip) loom as the more likely outcome. US consumers appeared to be spending on current needs by ceasing mortgage payments on houses in which they had no equity and from which they were unlikely to be evicted. State and municipal tax revenues continue to plunge.
New financial regulations (the so-called FINREG bill) may become within the US are expected imminently. However, the investment community feels that as presently constructed, they will serve banking interests far more than consumer interests as originally proposed.
While that works its way along, there is the realization that the post-2008 monetary easing is for the first time occurring within a fully engaged and therefore essentially closed global system, which now needs to be priced into international debt and equity markets. During the leadup to the Toronto G20 meeting, increasing angst and ink was spent on the relationship between the US dollar, the Chinese yuan (RMB) and gold. Gold morphed from an inflation play to a fiat currency issue and reached new current (non inflation-adjusted) highs. Saudi Arabia disclosed a major proportionate increase in gold among its reserve holdings. Already the largest producer, China continued to lock up more non-Chinese gold properties throughout the world by commercial deals, at the same time stating it saw no reason to buy more on the open market, such as from the IMF. Its latest currency adjustment makes gold cheaper within the domestic market.
The slow decline policy of the yuan from its former US peg as newly revealed this past weekend will allow elasticity for consumer demand in the US and elsewhere to remain more intact than it would have been with the major one-off revision the US had pushed for. Since wages are rising in China and domestic demand there will be stimulated, any success of the revised Chinese export policy will mean the rest of the world will pay for the rise in the Chinese standard of living without being able to correct their own trade deficit issues. The sovereign debt issue will persist.
The relative rise in the dollar over the last month helped the US Treasury successfully sell more debt to income-starved investors around the world at ultra-low rates of return. As economic historian and Harvard professor Niall Ferguson stated in a CNBC interview today (June 21), a realization among investors is bound to arise - within 2 to 4 years at best, sooner at worst - that rates must rise. The outcome, when translated into the billowing aggregate global debt, will be that debt maintenance - let alone reduction - will have already moved beyond reach. If and when that day arrives, bond values will plunge as demand for higher yields force them down. The impact on many ordinary and institutional investors - especially the more conservative ones - will be disastrous.
The challenge right now is serious. Many mature investors will be hard pressed to survive with their lifestyle intact and with a recovery doubtful for them in a meaningful time frame, while most younger ones appear to be carelessly texting and tweeting into their financial fate. Collectively, it is not clear if the various national publics affected, from Greece to Britain and the US, will be willing to accept the necessary fiscal medicine as politically palatable, in view of the high economic price that, with hyperinflation the other option, needs to be paid.
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