June 2011 - Posts
Read this article in pdf format: june-27-2011
Thursday, June 23rd, 2011 was a day of infamy: The International Energy Agency surprised the world by announcing that 60MM barrels of oil would be released over 30 days, as an answer to the disruption of oil supplies from Libya.
Personally, we were slow to react to the announcement. Naturally, we first viewed it as unnecessary: If a market suffers from a supply shortage, the best way to encourage supply is to allow prices to increase, to boost production of the good in question. As the day progressed, we read, watched and listened to commentators throw the idea that because the price of oil was going to come down, as it did, the markets in general were going to welcome the decrease: Long stocks was the way to go!
But what totally caught our attention was the performance of gold. A day earlier, on Wednesday June 22nd, gold had moved from the $1,540-5/oz range to $1,550, with the expectation that at the press conference held by Ben Bernanke (after the release of the FOMC notes) a hint of further monetary policy easing would be given. That was not the case. Mr. Bernanke was as neutral as he could in his conference and that brought gold back to the $1,540/oz range, at the close of the session. That was the range gold should have held on Thursday, but events on Thursday changed the game dramatically. As a consequence, since then, gold backed all the way down to $1,499 on Friday, only to close barely above $1,500/oz. What triggered the sell-off? Was it “technically” dragged by the correlation with oil? We are not so sure, and here’s why:
We first note that the decision to release oil reserves on Thursday was of a global nature. Some analysts have made the point that the decision was tailor-made for those affected by the widening in the spread between Brent and West Texas Intermediate crude, and we tend to sympathize with that view. The next conclusion obviously was: “If politicians were able to pull this one of a global nature, ruining in the process a lot of market participants, what would deter them from selling the gold reserves of the US Treasury if, say tomorrow the debt ceiling for the US is not expanded? “
Selling reserves of any good that is in short supply is only a very short-sighted solution, for by temporarily lowering the price of that good, its production is further discouraged, causing higher prices longer term, which will have to be paid, to restore the same reserves. In the process, as the reserve bid is unleashed in the future, final prices end higher than previously expected.
Now, if the collapse of the current fiat currency system finally arrives, the easiest way out will be a system that still allows fractional reserves (i.e. reserve ratio below 100%), but without a lender of last resort, with the central bank of the world’s reserve currency (presumably still the US) backing its notes with gold. It’s an imperfect solution that would only delay the final deleveraging this crisis demands, but it would work. Would it not make sense to see, before this occurs, that gold reserves are sold by necessity at fire sale prices, ending in the hands of friends, who later sell them back to the government, at higher prices? It would. After the intervention on Thursday, it does. Anything goes.
Those who last week recommended taking advantage of the low prices in shares of oil producers, speculating with future higher prices of oil, do not capture the essence of the problem we are facing. We have entered the stage where the world will need goods, but government intervention will discourage their provision: The world will need more oil, but nobody will find it profitable to supply it, given the risks involved. The world will need a safe reserve currency to park savings, but governments will deny it even in the form of gold. The world will need a stable financial system, but banks will be prohibited from providing it. This will bring misery to the point where basic needs, such as food, will be precious, but given price controls, will not be profitable to produce. Furthermore, these interventions of global reach generate the resentment of those nations affected, with one event leading to the other, including military interventions that eventually get out of hands.
In summary, we see the relationship between cause and effect differently: We don’t see future higher oil prices driving energy stocks higher in the long term. On the contrary, because interventionism is destroying wealth, lowering asset valuations (i.e. stocks), production will be affected and the lower supply will push prices higher. If central banks validate the higher prices by printing money, the process will spiral. Until Thursday, we wanted to own physical gold. Thursday was the game changer and cash is now supreme. Financial repression has arrived sooner than most expected and is now the order of the day.
Martin Sibileau
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Hi everyone,
I've been kind of busy lately, to write my letter. However, I did not want to miss the chance to explicitly note that what happened yesterday, with the GLOBAL nature of the intervention in the oil market (to help someone really affected by the Brent/WTI spread) the game has totally changed. TOTALLY!
Personally, I am now entirely out of gold in my own portfolio. I am inclined to add to the short-stocks trade, but I have a hunch that tactically today would not be the time to do so.
I am scared to see how easily a global intervention in the oil market was pulled out of nowhere and wonder what would deter governments to intervene the gold market. As the situation deteriorates and the run for liquidity spikes, I imagine the possibility of an arbitrary sale of gold.
In my mind, the macro level post FOMC press conference was $1,540. The sell off after that was totally unwarranted and the lack of information tells me somebody bigger than me knows something I obviously don't.
Any thoughts?
MS.
Please, click here to read this article in pdf format: june-13-2011
This past week may well have been the game changer. To be fair, the game change began the week before, with the lower than expected jobs growth print. Since then, we have seen the Fed reiterate their exceptionally accommodative policy, the ECB delay rate hikes (an expected event, we must add) stating that no restructured sovereign debt will be taken as collateral, and the advance towards a more regulated and less profitable banking sector in the US.
What to make of all this? Gold, in USD terms ended the week lower, a reflection of the ongoing deleveraging. It is noteworthy that gold and the Euro did not correct on the more dovish outlook presented by Trichet in the press conference of Thursday. In that conference, Trichet obviously did not pre-commit to a rates path, but made it clear that the European Central Bank would not participate in a restructuring of Greek debt (or support anything that would trigger a credit event in sovereign debt for that matter). The Euro (and gold) did not react here, just as it did not react earlier in the week, when Moody’s signaled the possibility for the US of losing its AAA rating.
Last Friday, the Euro and gold reacted to European Central Bank Executive Board member Juergen Stark’s comments with regards to the participation of private investors in sovereign debt. The comments simply reminded investors that there is no united front but friction between the ECB and Eurozone governments, vis-à-vis a viable solution, if any, for the periphery. Also relevant was the fact that these comments were made concurrently with a report from the Wall Street Journal of a Spanish bank which sold only about half its offering of covered bonds backed by loans to Spanish regional and local governments.
In the meantime, we paid close attention to Mr. Geithner’s remarks on Monday, who said that : “…Just as we have global minimum standards for bank capital , we need global minimum standards for margins on uncleared derivatives trades…”
Think of this for a moment…What does the US Treasury Secretary have to do with derivatives trades? Would it not make more sense to hear such remarks from the Fed? Don’t derivatives trades affect monetary policy, rather than fiscal policy? Indeed. The only reason the US Treasury is behind this crusade for regulation on derivatives is to coerce global banks to buy US Treasuries and hold them as collateral. If they succeed, they will have taken the risk contagion to a much higher level. Given the size of the derivatives market, they are playing with fire.
Back on January 28th , we suggested and explained how the Eurozone could still hope for an orderly solution of its institutional crisis, if funds from the European Financial Stability Facility were to be used to buy peripheral debt in the secondary market. That window of opportunity is now gone and we are absolutely convinced that Greece ends with a run against its banks, which will surely propagate to other Eurozone countries. It is only a matter of time. In the past however, we were comfortable with the notion of hedging this risk with gold ETFs. Now, with the harassment of the US government, the proven futility of the ECB’s existence (which we forecasted in detail on May 13th, 2010, when we explained the scenario where the ECB purchased peripheral debt and concluded that: “…There cannot be an exit strategy. The ECB has its hands tied and eventually depends on the PIGS sovereign to generate a consolidated fiscal surplus to buyback their debt. Therefore, a reputational issue threatens the European financial system…”) , the developments in Canada surrounding the Toronto Stock Exchange’s merger, the world’s indifference towards the massacres of dictatorships in the Middle East, we are left with the general feeling that savings are no longer safe anywhere else but in the form of physical, real, assets (ie. gold). All other asset classes will be highly correlated in a scenario where the present situation spirals. The global financial establishment is facing a slow death at the hands of a political establishment which desperately seeks to sustain their status quo.
We realize that to some readers, this long term view is catastrophic and that in the world of trading, long term views are irrelevant. Usually, we would agree with them. This time however, we fear they will be wrong and that our thesis will prove more tangible as the weeks pass by.
Martin Sibileau
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: june-06-2011
Almost two months ago, we went on record stating that stagflation was here to stay. On April 11th, we wrote:
“…If we had to define in one sentence the action last week and that which is to develop in the future, we would say it in actually one word, not even a sentence. That word is “stagflation”. We truly believed stagflation would present itself to us later this year or even next year. However, we think it is here now. This leaves us on the contrarian side, because almost everyone we read, hear or watch is telling us that “growth” (a misnomer used by mainstream economists, including those at the helm of the Fed, to refer to a higher GDP) will be high in 2011 and that the Fed will be forced to raise rates in 2012…”
The latest activity data seem to be supporting our call but we now fear a worldwide desperate reaction by all governments in general. Possibly, you may have heard a recently popular definition of such reaction: “Financial repression”. What does it mean? We will offer our explanation…
Since 2009, with the start of quantitative easing by the Fed, the expansion in the money stock has produced excess reserves in the financial system in the US. In the Euro zone, something technically similar has occurred with the monetization of the sovereign debt of peripherals: The ECB has issued short-term debt to sterilize the purchases. This is a liability to the central bank, just like excess reserves. But we are now reaching a point where the stagflation we identified in April is becoming self evident, challenging the wisdom of monetizing fiscal deficits. What can governments do about it? The usual: Deny the problem and blame speculators. However, the monetization of fiscal deficits must go on, to keep the circus playing. The way to achieve this is by forcing financial institutions and pension funds to buy sovereign debt while at the same time, the credit multiplier of the fractional reserve system is pressed down.
This is not new at all (Prof. Huerta de Soto in his great work “Money, Bank Credit and Economic Cycles”, 2009, tells us there was financial repression as far back as under the Ptolemaic rule in Alexandria, citing Michael Rostovtzeff’s “The Social and Economic History of the Hellenistic World”, 1957). But for what matters to us today, the first country to start with financial repression since the start of this last recession was China. We called collective attention to it when it picked up, back on January 21st, 2010. Back then, we warned that the People’s Bank, by making it harder to bring US dollars to China, was going to segment the funding market into a mainland China and a Hong Kong funding platform. The restriction of capital inflows is a “classic” form of financial repression within those countries that don’t face trade deficits and which seek to delay or even prevent the appreciation of their currencies. Sadly, we fear that Canada will be the latest to join this club. During last week, it was reported that the Office of the Superintendent of Financial Institutions was researching into how big a factor foreign investment in Canada’s housing market is. To blame capital inflows is ridiculous. If foreign demand generates a bubble it is because the Bank of Canada is not allowing the Canadian dollar to appreciate enough to restrict foreigners’ purchasing power in a “natural” way. And we think this answer is obvious, for the Bank of Canada has postponed raising rates in the face of clearly bullish activity data. In summary, as this crisis reaches its next stage, in trade surplus nations, citizens will see credit restrictions either because capital inflows are taxed or regulated or because reserve requirement ratios increase.
In trade deficit nations, financial repression will be more perverse. The increase in money stock in these nations does not stem from capital inflows or trade surpluses, but from governments whose deficits are monetized. That monetization needs to find a place. When it was not so obvious, it could end in the hand of retail or institutional investors. But as it gets more obvious the propensity of these investors to buy fiscal deficits disappears. Therefore, governments will have to force institutional investors and banks to acquire the debt. In other words, the asset side of pension funds and banks’ balance sheets will deteriorate, making them more dependent of their respective central banks. At the same time, once the monetized debt reaches the system, governments will blame speculators for the resulting increase in asset prices, forcing also the increase in reserve ratios.
In conclusion, in trade deficit nations, financial repression consists of two acts: In the first one, governments force the deterioration in the quality of assets carried by pension funds and banks. In the second one, governments increase the reserve requirements of banks. This last act has a negative impact on the profitability of banks. Right now, defaults are at record lows, but as the proverbial wall of maturities is hit in say, two years, and interest rates can not be lowered further, the impact will be really felt. The realization of this scenario, down the road, will call for demanding physical gold, rather than gold ETFs.
Martin Sibileau
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.