The crude contagion could cause chaos, crash

On the heels of another massive sell off in crude oil, the US stock market woke up from its slumber.  Instead of the discount in crude oil being priced in as a stimulus, it was seen (perhaps more accurately) as a risk. Crude touched prices that had not been seen since April, 2009.

US equities sold off on higher than average volume, with bonds, gold and silver catching a bid.  The VIX showed fear entering the market and spiked higher, but the rally faded as the day went on.  The US dollar strengthened modestly on the back of a weaker Euro and Yen.

Interest rates on the 10 year bond tested 2.00%, while gold has climbed above $1,200 and stabilized.  Tonight the Nikkei is selling off significantly in Tokyo.

crude oil

Greed may pause to give room for fear to take the reigns.

Markets are decidedly in a risk off mindset.  I suspect that this fear of risk will prevail over the leveraged and crowded long side bullishness that has pushed the US stock market up to record highs with few downdrafts over the last few years.

The fundamental improvements in the US economy have been sluggish, with many corporations buying back their own shares to boost EPS.  There is a dislocation between current perceived valuations and the global economy’s condition.

The crash in crude oil has brought about a serious challenge to many economies of energy producing nations, including the US.  Since 2008 many of the high paying new jobs have been in the energy sector.  Now that oil is down over 50% from its highs, many of these projects are no longer viable and drill rig operations are now at 10 month lows.

us oil and gas rigs jan 5 2015

Energy markets are an indication of economic health.

There is a certain amount of feedback from energy market prices that can be indicative of manufacturing activity, shipping and transportation.  To the extent that supply exceeds demand, prices should diminish until demand returns.  But even with a 50% cut in prices, there still seems to be room for more of a decline.  That is because while demand is diminishing, some oil producers are keeping or increasing supply rather than removing production.  This includes OPEC, Russia and Iraq, who stubbornly churn out more oil as prices lose support.

The perception becomes that a flood of oil is oversupplying the markets, but the reality is that demand has declined to such an extent that softening Chinese manufacturing demand has caused a ripple effect.  Most of the softening demand comes from Europe, China’s largest customer, coming to grips with a wave of economic headwinds.

This new normal, if we are to give it a name, is likely an indication of future global macroecnomic trends.

Global GDP 2015

Deflation strikes Japan and the EU.  Is the US next?

Persistent deflation is becoming a persistent theme.  Bond yields in Germany on 5 year notes hit negative yields.  Japanese bonds have fractional yields.  The US bonds seem to be ebbing lower and lower in interest rates in sympathy of the global deflationary pressures coming home to roost.

Are we going to experience a lost quarter century like Japan?  It seems ever more likely as the similarities are increasingly problematic.  A prescription of debt to solve debt-related problems.  Liquidity injections for structural economic problems show a lack of understanding from central authorities about what is wrong with our economy.

Nikkei stock index

Too much leverage, too many derivatives, too little transparency.

What the world needs now is more clarity about how far stretched the current system has become.  With over 700 trillion dollars of global derivatives, there is such an enormous amount of risk in opaque markets that a significant dislocation could cause another financial collapse.

None of the problems of 2008-2009’s Great Recession have been resolved at home or globally.  Instead the financial players that created the problem have now been given the reigns of the global economy and are leading us down a destructive path towards crisis.

The problems of the world will most likely come home to the US in 2015 and cause a profound impact on our economy and financial markets.  While it may not be apparent yet, I believe that the risks now are much greater than back in 2008-2009 and the ability of monetary authorities to mitigate those risks is impaired by the current and recent aggressive measures.

DerivMkt-BIS-Dec'87-Dec'10

Stay tuned in to the flow of news.  Interesting things may happen sooner than we expect.

Risk off trade resumes after bounce

High frequency traders, institutions and retail investors pushed markets lower today, and in recent days, after a brief reprieve from the selling abated in to a liquidation frenzy. Gold made new record highs, silver stayed strong as the commodity complex crumbled. Most investors are very nervous about the prospects of another recession looming, but the reality is we’ve been in a depression for four years and a recession within a depression is looming.

We’ve been enjoying the eye of the storm since April of 2009, when the banking system no longer was obligated to mark its assets to their real values and trillions of dollars were injected in to the banking system. Unfortunately the sugar high has worn off, and now the situation is worse than before.

As the oversold correction was neutralized by short covering, opportunistic buying and technical traders the stream of bad news resumed, with more worrisome headlines about the Greek debt situation, widespread investigations in to high frequency trading firms, a spread of the European bank contagion because of their leveraged bad debt holdings, and American banks facing the prospect of the credit default swaps they sold to the EU banks being called in.

In addition, economic data has been deteriorating, with poor jobs, inflation and housing data rattling the fundamental picture from a recovery to the brink of an economic contraction. Inflation and unemployment are higher, while new home sales are flopping.

With these economic headwinds, and several market powderkegs ready to blow, the average investor is looking for a safe haven. Many are buying US Treasury bonds, pushing the yields to record lows below 2% on the 10 year and collapsing the 2s to 10s spread, making lending less lucrative for banks. Others are turning to precious metals, as we see gold, silver and even platinum have good price action and solid technicals.

At this point the likelihood that a significant further leg down in the economic picture and within the equities markets will occur has heightened significantly. The macroeconomic risks in most developed and emerging countries, ranging from inflation, social unrest, high unemployment, losses in investments and property, continue to gain momentum and appear to be converging as a catalyst towards a global risk asset sell-off, the likes of which we haven’t experienced since 2008-2009.

The likelihood of bank holidays and further government and Federal Reserve intervention in to bond markets, money markets and potentially equity markets has also heightened. Further fiscal and monetary policy that accommodates a deflationary environment will more than likely occur within the next quarter.

Gold and silver prices should head much higher because of the aforementioned situation and response. Gold is due for a correction, but when that may occur is questionable given the mood of the markets and the desire to hold tangible assets over equities or paper currencies. Silver on the other hand is poised to test the $42.50 resistance level, and if it can breach higher, potentially test the $48-50.00 area where the last high was made. Within the next 3-5 years, it is very likely that both gold and silver will be multiples higher than they are today in terms of pricing in US dollars.

Either a deflationary depression or a hyperinflationary monetary collapse would be beneficial for precious metals in the short, intermediate and long term. Whether or not such severe events occur is uncertain at this point, but currently deflationary forces are at battle with inflationary central bank policies — and it is extremely rare that either economic catalyst is balanced out perfectly with the other. Instead, massive bouts of volatility and overshooting towards deflation or inflation are a more likely scenario, as tools of fiscal and monetary policy are more like howitzers than scalpels.

Risk off panic selling, Euro collapse and more

The world markets were roiled today by panic selling. The sell off was catalyzed by negative news on Italy’s solvency, accelerated further by margin calls on major institutions, forcing a major deleveraging across the board. Many are fearing a reemergence of recessionary declines across the globe.

Europe’s outlook has significantly weakened as of late after its been revealed that the fiscal problems of the sagging debtor states are growing more severe at a rapid rate. Headlines today included major exchanges shuttering temporarily, bond issuances being suspended and civil unrest growing. The Euro lost about 1.35% of its value in a single day, a significant sell-off — and one that is likely to continue.

The downside risks for speculative paper assets are intensifying. Growth stocks lost 5-8% or more of their value in a matter of minutes. Some posted double digit losses. The selling in the US continued in to the close without much sign of short covering, indicating that many are still bracing for a negative jobs report tomorrow.

Gold, silver and other precious metals were no exception, as margin calls forced traders and investors who were employing margin to deleverage their portfolio, selling their profitable positions to cover losses, presumably in equities.

The only green on the board was primarily in the US dollar and bonds, once again finding themselves as a safe haven asset during times of panic. One has to wonder, given the underlying uncertainty regarding the US debt, and the condition of global and local financial markets, how long such a phenomenon can last — especially given the tendency for investors to migrate in to hard assets when there’s a whisper of inflation.

The most likely scenario from this point forward is more quantitative easing, probably coordinated by the G7 countries, instead of a unilateral US effort, to prop up sagging markets. Such a liquidity infusion would likely spark a significant rally in commodities and equities, at the cost of the purchasing power of various fiat currencies. Such a powerful inflationary force could cause precious metals to stage vicious upward price discovery as more paper currency is created out of thin air.

In the short term and intermediate term we are looking at a very oversold market. By just about every measure possible we are in a very dangerous zone to be selling stocks. A violent bounce is highly likely, but how sustainable that bounce is depends entirely on what the ECB and Fed say in the coming weeks.

Technically on the S&P 500 there’s a good chance that we’ll see a retest of November, 2010’s lows around 1171 if economic data and news continue to build on the negative sentiment. The 1225 area has now become resistance. This could be the formation of a new trading range or the beginning of a significant downtrend.

Gold made new highs today, but margin calls forced liquidation and brought the price down over $40 from its highs. Silver tested the $42 level, but the same liquidation brought silver down by over 7% at the lows. There’s a good chance that the correction in precious metals could continue if the liquidity vacuum effect of souring debt markets in Europe continues. If instead central banks announce additional easing and credit expansion then we may see a significant rally.

Unfortunately today’s markets are no longer primarily powered by economic growth, but instead moreso from central bank money printing and artificially low interest rates. This is the main reason that more and more investors are turning to hard assets to hedge against, if not profit from, future inflation. If the sell-off continues, with gold, silver and other hard assets seeing discounts, I would consider it an opportunity to buy such assets as the longer term outlook is higher inflation and a resulting attraction towards precious metals.