US economic and precious metals outlook

I remain reluctantly bullish on gold, silver and platinum (and bearish of palladium). I fear we are entering a time of turbulence via geopolitical events, monetary policy tightening (during the greatest policy experiment perhaps in human history); a national, state and city debtastrophe, retail implosion (in a sector that employs millions) and an increasingly gig-oriented job market — that provides quite poorly for its paycheck-to-paycheck participants. The housing bubble 2.0 is beginning to sputter with almost as much leverage as 2007 in the speculative areas (flippers especially).

Further, I fear that the economic recovery did not manifest as hoped, and instead we’re seeing fudged metrics across the board (whether it is labor statistics that are double and triple counting the aforementioned gig jobs as separate people each getting a new job — when it is a single person with 2-3 jobs). We see funny data coming from Facebook where they are saying they have more users than the US census says we have population. We see enormous misallocations of capital as a result of these and other fuzzy numbers. At the end of the day we have a weak economy that is limping along, despite the record setting stock market saying otherwise as its returns grace the headlines on a near daily basis.

GDP growth has largely been predicated upon expansions in cost, not true increases in activity. Medical costs being one of the primary drivers, which are now rising at about 200% the rate of inflation by conservative measures. Compounding that problem is the fact that the FIRE (finance, insurance, real estate) component of the economy continues to occupy an outsized portion of GDP, creating a situation that has changed the lubricant for the engine of economic growth in to a drag.

So much wealth has been transferred vis-a-vis QE and this ongoing monetary policy experiment, from the working and middle glass to the very wealthy. This further creates an enormous strain on the largest input of US economic growth — consumption. Combining that with the overhang of student debt which is now approaching or exceeding $1T depending on the measure. We have a growing swath of consumers that can’t afford to engage in their namesake activity. And we just broke through record credit card debt in the US. So it’s safe to say we’ve pushed a lot of consumption forward without the means to keep that pace going.

Shifting gears to the central bank conundrum, a Warsh appointment at the Fed doesn’t do much to resolve the largest quandary in the institution’s history: how to unwind a 4.5 trillion dollar balance sheet before the next crisis — without causing the next crisis? Warsh’s own WSJ op-ed opined about his remorse and skepticism regarding QE. Will he be capable of unwinding what he admits he (and others at the Fed) barely even understand? It will be fascinating to watch. Makes buying VIX long dated calls look tempting if he is appointed and such an endeavor is undertaken. The current unwinding of the balance sheet is unrealistically slow unless they never intend to normalize.

What are the odds that this equity bull market, the second longest in US history by my calculation, continues unabated? I would imagine further strength in equities is required to keep the Fed determined to raise interest rates — and significant weakness could pause the tightening or even reverse it. Even if Warsh is at the helm, he would be under massive pressure from the administration to keep the economy looking better the closer we get to re-election.

That all said, I think we are navigating one of the most fascinating markets in my lifetime. It has evaded almost all logic and reason. So many much more gifted investors than me have missed a lot of this rally having been extremely skeptical of its durability and potential.

At this time I don’t see a lot of value in the US markets. Valuations feel stretched and equities priced to perfection. I’ve been allocating more capital in to emerging markets where the yields are higher, the valuations are more fair and there is some potential for hedging against US dollar weakness — which still concerns me over the intermediate to long run.

I plan to increase my own exposure to high quality silver miners based on my thesis that silver industrial usage will increase with larger demand for solar power, communications, computers, mobile devices and weapons systems (such as drones and missiles). Unlike gold, silver is used and quite hard to reclaim. Silver investing may also grow in time, but that isn’t the center of my thesis with silver. I suspect, instead, that investment will remain flat and the outsized portion of increased utilization will be non-reusable applications. That, and the fact that silver is generally mined as a secondary metal (incidentally rather than purposefully) at most mines, makes the opportunity a bit more bullish for me than gold.

It’s a very difficult metal to analyze, though. Thinly traded, often beaten up by large banks in concert (silver price rigging investigations have proven that several of the largest banks in the EU and US were working together covertly to suppress prices — and they saw minimal consequences for this activity).

Trading silver is not for the faint of heart, either. I spent a few months trading small lots of silver mini contracts and found the volatility very difficult to execute against because the bid would just dry up during times of high selling pressure. Most of the silver miners are much more liquid than the futures, which is a bonus. But there are very few of them to choose from and even fewer worth investing in.

As always I hope my commentaries are constructive to those who make their way through them!

Full disclose: Long positions in emerging markets bonds, stocks, precious metals mining companies; short position against NASDAQ 100.

Gold may be closing in on a bear market bottom

As we approach extremes in bearish sentiment, the number of gold ounces promised per contract (on the Comex at least), relative strength and the dollar rallies on the promise of a tightening cycle — I think it’s important to take a moment and reflect.

Interest rates make a bad situation worse for debtors

The US government currently spends over 6% (about $250 billion per year) of its budget on interest alone.  If interest rates were to normalize this figure would swell significantly.  So the idea of a tightening cycle being a possibility without a significant (and deflationary) reduction in government spending is unlikely.  Even if spending were to be decreased, it would not be in time to reduce the deficit or debt burden.

Further, liabilities in the private sector are explodingStudent loans, car loans, credit card debt, mortgages and debt-driven share buybacks are all at unprecedented levels.  This is further evidence that the system at large is far too debt-dependent to move to a higher rate structure without a significant rise in insolvencies.

Leverage and volatility don’t mix well

Lest we forget the interest rate complex at large.  The biggest swath of derivatives in the world, hundreds of trillions of dollars of leveraged OTC instruments, are tied directly to it.  To give you an idea of its scale, the amount of interest derivative products alone dwarf the global GDP by nearly 7 fold.

Large moves in short periods of time render leveraged trades insolvent due to the trade turning against them.  If one is borrowing $9 for every $1 they put in to a trade, then if the trade goes against them by 10% they are wiped out.  More than 10% and they owe more than the $1 they put down.

This is precisely the risk present in the world of derivatives.  The only difference is the leverage is much, much higher than 10 to 1.

Another problem is that in a tightening environment that’s unilaterally led by the US central bank (when other central banks do not follow), deflationary shock waves may proliferate throughout the global financial system and wreak havoc on interest rate derivatives markets, emerging equity and bond markets, US corporate debt and ultimately global financial markets as a whole.

Sensitive markets showing stress

Corporate bonds are beginning to sell off. Emerging markets have been in a funk for some time as they were once the beneficiaries of QE.

Given the level of medicine applied, one would expect the patient (the global economy) to have either rebounded or died of an overdose. Neither has happened, but markets are essentially in the eye of the storm.  The troubles past are gathering speed again at a remarkable pace behind the scenes.

Consequences are continuing to climb

This time around it is not just the financial system at risk, it is many governments of the world and many of their respective central banks that risk insolvency.  We are witnessing the biggest bubble that has ever been blown in history.

No wonder there is so much effort in preserving such a bubble.  The result of its end is a mind blowing problem.  And that’s precisely why the rate normalization cannot happen.  We may see a push higher by 25-50 basis points.

Policy road fork ahead

Such a hike, however, will in all likelihood pale in comparison to how the Fed manages its maturing balance sheet of bonds.  A new round of QE-like activity will likely emerge as those funds that mature are put to use to purchase longer dated bonds to re-stimulate debt markets in a variant of operation twist.

As equity markets finalize what appears to be their ultimate topping formation, I assume that we will witness another sharp move downward.  The Federal Reserve appears to be more sensitive to the gyrations of financial markets than the economy at large.  As a result it will likely pause and possibly even reverse in to this new variant of operation twist.

Ultimately this is bullish for gold

I believe we will have already formed the bottom in precious metals and begin to see a resurgence in prices once the stock market has topped and the Federal Reserve is no longer willing to tighten.  Whether the gold price tests the $1,000 level is still on the table, but I don’t see much further downside from here based on these assumptions.

Gold continues tumble without outside catalyst

Producer prices were flat as was the US dollar index, but that didn’t stop a determined seller from pushing gold prices down this morning.

What is driving the selling pressure?

Most traders are paid to execute orders to maximize value.  That is to say, if you are selling a commodity you want to sell it for the highest price (or short it at the highest price) to maximize your profits.

What we’ve seen within the last several years is the opposite of that.  Regular dumping of gold (and silver) futures contracts with heavy volume at the lowest prices.  Huge lots executed at once — rather than distributed over the course of a day to achieve a volume average weighted price.

Are prices being fixed?

This leads the gold investing community to believe that there is malicious manipulation underway in these markets.  And with just about every other market in the world having been proven to be manipulated, such as LIBOR, foreign exchange, bonds, equities and other commodities — perhaps, just perhaps it’s not too paranoid of a theory after all.

A reason to sell so many contracts in to the market at once would be to push price down through sell stop orders.  

This action forces prices even lower and pushes many out of long positions.

Only the people pushing the sell button truly know their own intentions (or that of the institution they are employed by).  An outside observer of these markets is forced to draw their own conclusions.

How can so many claim to own the same gold?

The ratio of futures contracts to ounces of physical gold at the COMEX has risen to the highest levels on record.  Last checked, it was closing in on 250 gold futures claims per ounce of physical gold actually available.  This means that should there be a large demand for COMEX gold delivery, there may not be the gold available to fulfill the order — necessitating a cash settlement.

If one was seeking delivery to obtain physical metal for storage, this would force that party to seek gold elsewhere as soon as possible with that settled cash.  And given that so many parties seem to have claims on the same ounces of gold, that could prove to be an interesting setup for a phenomenal short squeeze that drives prices much, much higher.

Potential scenarios for the continued decline.

How this particular situation resolves remains a mystery, but I am inclined to speculate that we have two possible scenarios that could play out:

1: We are witnessing the beginning of the one of the greatest deflationary collapses the world has ever seen, as evidenced by commodity prices imploding, China’s economy in serious decline and recent volatility in equity markets.  If this is the case then it will be difficult to find a safe home for one’s money almost anywhere.

2: The precious metals markets’ prices are being guided lower in order to reduce the bid for what were once considered safe haven assets by many.  Eventually, if such a scheme is underway, it will unravel with prices going much higher.

Which of these scenarios is playing out remains to be realized.  

The former means the global markets are coming unglued at the seams and the global economy is crushed.  The latter would indicate that certain parties are concerned that a higher gold price could reduce confidence in other markets such as stocks and bonds.

Silver’s scary sell-off

Silver and silver-related assets were smashed across the board on Friday as the World Bank and IMF met in Washington, DC to discuss the worsening global crisis.  Other commodities saw sharp declines as well.  More silver was traded that day in any given hour than silver is available on the market for an entire year.  It was an electronic sell-off.  Physical prices now command a 10-20% premium to spot paper prices, the highest in years.  Gold to silver ratio is now over 1:50, the highest in a very long time.

Predictably news comes out after the trading day (but we must assume the large insiders knew the whole time) that COMEX was raising margins by 15.6% on silver. 

http://www.gold-prices.biz/comex-raises-gold-margins-by-215-silver-margins-by-156/

The problem is the COMEX does not have the silver to deliver, so forced liquidation is the strongest tool they have to bring prices down and take parties who would seek delivery out of the equation.

Silver is still up 46.31% on the year and has strong support in the $30.00 area.  I think we need to see what the price action is when buyers step in and shorts cover.  It could very well move up as fast as it did down (and higher) if we see ECB rate cuts, a Greek bail out, good earnings in the US, emergency Fed easing or other central bank policy movements as well as any geopolitical or event risk scenarios playing out.

Given that even though silver fell to $30.00, but physical silver commands a price of $33-35.00, there is evidence of a growing paper vs. physical price discovery bifurcation. 

http://www.apmex.com/Category/160/Silver_Eagles___Uncirculated_2011__Prior.aspx

As far as my strategy goes, I don’t see any change in the situation for the dollar long term.  The recent strength has been more of a liquidation panic in Europe and foreigners buying dollars because it’s the least bad currency for the moment.  There’s even some rumor of weaker central banks liquidating gold and silver holdings to raise liquidity.

I saw the same pattern of behavior in 2008 and 2009, yet gold and silver are much, much higher now despite the occasional (and sometimes violent) correction.

Over the last 11 years silver and gold have outperformed all sectors of the S&P 500 by many multiples.  There is no paper asset class quite as trusted during times of crisis, either. 

http://finance.yahoo.com/q/ta?t=my&s=SLV&l=on&z=l&q=l&c=SPY (three year chart)

Now, given the potential for further easing by the Fed, ECB, BOJ, BOE, SNB and others, the need to monetize debt in the US to keep the government open (i.e. the necessity for QE3) — without debt monetization the government will go in to a crisis mode where their ability to spend will be limited as interest rates rise because treasuries are sold more than bought.  But we’re not the only country that has to monetize debt.  Keep in mind the US government has over $75 trillion in unfunded liabilities and there’s no ‘economic growth’ scenario that allows these debts to be funded from revenues.

QE3 from the Fed at this point seems like a foregone conclusion once we see a sovereign debt or large bank collapse.  The ECB is also monetizing debt in the Euro zone for a few of the larger PIIGS, the BOE has QE’d in England and there’s a good chance the BOJ and SNB will continue to print money to artificially devalue their currency.

http://www.reuters.com/article/2011/09/24/us-imf-ecb-stark-idUSTRE78N1Y220110924

These actions will create a short to intermediate term burst in global money supply — and hot money seeking a high return.  These types of inflationary pressures lead to booms for precious metals.  

http://www.businessweek.com/ap/financialnews/D9PU96280.htm

Greece’s default is all but inevitable, and that is going to rock the world and create the need for much, much more liquidity.  This situation will spread throughout Europe and spread here and to Asia.  Lower rates and more stimulus will follow.

http://www.zerohedge.com/news/lehman-weekend-redux

Many shops sold out of their silver bars and coins on Friday because the appetite for physical silver was so strong at $30.00 (even though customers gladly paid the $5.00+ premium making purchases $35.00+ per ounce).  In fact I still saw online stores selling silver for $45.00 to $50.00 per ounce.

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2011/9/23_Sprott_Money_Temporarily_Runs_Out_of_Physical_Silver.html

I believe that the bifurcation in physical and paper prices is important to note because it indicates that there are two markets.  A real market and a phony market.  The phony market is being manipulated downward to an artificially depressed price.

This happened in 2008, too.  But from that low price of $8.00 silver quickly rose to $48.00 in the course of three years, a 600% increase or averaged to 200% per year.

http://www.kitco.com/charts/popup/ag3650nyb.html

Gerald Celente, one of the best trend forecasters of our era is now buying physical silver.  He made the announcement on Friday, so I believe that will mean something to the many that follow his advice and watch his investments closely.

http://kingworldnews.com/kingworldnews/Broadcast/Entries/2011/9/24_Gerald_Celente.html

One year silver chart

Tonight silver is testing the 350 day moving average.  Some continuation selling was to be expected after Friday’s drop, but we’re looking for some consolidation or even a short term reversal due to the very, very oversold condition, combined with the support of the 350 day moving average at 29.57 as well as the appetite that should be present in Asia during this season.

We’re also dealing with price move that is over a four standard deviation event — i.e. something that is extraordinarily rare and it’s punctured the bottom bollinger band, leaving a reversion to the moving average around $37.00-40.00 quite possible if technical buyers come in.

24 hour silver chart Right now silver is trading at $29.83, having found some support at the $29.57 area.

Volume is light as to be expected, but once Sydney and Hong Kong open we’ll get a better idea of what the Asian appetites for metals are after last week’s discount.

Personally, I am tempted to buy silver and silver-related assets given these discounts.  Even if prices are weak short term, I know they will be much, much higher in the intermediate and longer term.

Central bank intervention for profit retention?

Today we read about Kweku Adoboli, the UBS equities trader that allegedly went rogue and lost the firm $2B in Q3 profits.  We also learned about the ECB effectively using extraordinary measures to prop up insolvent EU banks.  A rumor also floated through the blogosphere that Mr. Adoboli was shorting large amounts of precious metals, specifically silver, through ETFs.  What one has to wonder, given the timing of these events and the downdraft in metals prices today, is if the ECB and/or SNB is helping to support UBS by pushing down metals prices so they can exit the short position with less of a loss to report on their upcoming earnings announcement.

This sounds like a conspiracy theory, right?  I would have thought so, too, many years ago.  However, given the recent and direct Swiss central bank intervention in the Franc and precious metals markets, the dire situation in the EU threatening the monetary union and its currency was well as the threat of a global double dip recession, it seems more than possible that central banks are beginning to exercise their power in the precious metals markets more overtly.

Psychologically it’s a very effective technique.  Hit metals hard on days that they would ordinarily rally to push weak (see leveraged) hands out of the market.  Try to inflict as much technical damage as possible (although at this point no severe damage has been inflicted — but if this continues it will be).

The question is how long could such manipulation last, if that is in fact what’s going on here?  I would personally doubt that such interventions can have staying power — at least not yet.  The SNB hit on precious metals did not last very long, and when priced in Francs gold rallied to a record high.  The previous sell-offs we’ve seen have produced a large amount of buying appetite around $39.00.

Today that seemed to be the case.  I was buying some silver CEFs (closed end funds) when the price hit $39.49.  I felt that a lot of buyers would begin to bite with more conviction as that has been the bottom end of the technical trading ranging silver has been within for the past few weeks.

There is some chance it could break down to $36.00, of course, but with a stop around $38.75, I’ll take a small downside risk given that the upside potential seems to be  about 33% in the short to intermediate term.  Good luck investing and trading, everyone.  And be careful out there.  The sharks are circling.

 

The coming global debt-driven depression

Reality begins to set in, which inspires panic. Frantic selling across various speculative assets brings prices drastically lower. Retirements and pensions wiped out. Paper investments made effectively worthless. Sound like a repeat of 2008-2009?

The American Nightmare

This horrifying scenario is coming to fruition not because the economy is dipping back in to recession — the fact is without the bailouts, deficit spending and stick saves by the Fed, we’ve been in a depression since late 2008. All of the papering over fraud was about kicking the can down the road rather than fixing the underlying economic, fiscal and monetary imbalances.

Zero interest rate policy combined with reckless fiscal measures have sealed the fate of the US markets and the greater global economy. By implementing such a robust framework without fixing any of the underlying problems on bank balance sheets, in various governments forward debt loads or in household debt we are now looking at repeating the kind of volatility we saw in late 2008 to early 2009, but worse yet there are far greater consequences to a significant economic dislocation. Consequences that were entirely avoidable had the authorities, corporate leaders, banking executives and individual households of the world looked at deleveraging more aggressively and taking the bitter pill that is a brief, but sharp depression so that the excess could be cleared out in favor of rebuilding a more stable and sustainable economy.

Past the Point of No Returns

Now we’re nearing the cliff. The drop-off that is a near mathematical certainty given that many countries governments are reaching their upward debt limit (that is to say no party but their respective central banks are willing to buy their debt). This includes the US, Japan and much of Europe — countries that were once economic superpowers are being reduced to beggar thy neighbor debtors, hat in hand, begging for handouts.

The demographic issues in these areas may differ, but the fundamental economic, monetary and fiscal problems are all too similar. Persistent high unemployment, a highly leveraged financial sector, households that are swimming in debt (with the exception of perhaps Japan) and stock markets that are losing a decade+ in any form of gains.

Worse yet, the forecasts being foisted upon the public are overly optimistic, full of fluffy economic growth predictions that are impossible to achieve. That means that the growth which was necessary to service debt burdens and keep the overly extended economies of the world lurching forward will not occur and thus leaves a much more dire scenario. One of sovereign debt defaults, crashing stock markets, currency crises and an atmosphere of higher unemployment and more civil unrest.

Caution: Debt-Driven Depression Ahead

Let’s look towards the possible future by examining one country that’s already where many will be in the coming months and years ahead. Greece’s stock market is down 85% from its peak, their 1 year government bonds are trading at an absurd yield of about 97% and there is talk of a full scale default as early as this weekend. The Greek people have been protesting, rioting and the unemployment rate by modest measures is 16%. This is a depression, not a recession. While the media is largely ignoring the severity of the crisis, those within Greece are all too familiar with the situation. One that has the potential to become significantly worse before any improvements may happen.

All of the bailouts for Greece have only managed to make the situation worse, because they piled on debt Greece could not pay off while forcing Greece to sell off the few productive assets it has to foreign parties. The combination of these factors ensure a severe economic contraction.

Much of the rest of Europe, with perhaps the exception of Germany, Norway, Finland, Switzerland and Sweden, face the same dilemma: too much debt, too little economic growth. In the United States we face the same crisis, which has only been temporarily offset by the dollar’s reserve currency status — a privilege we may not enjoy for much longer here given the incompetent and dangerous monetary policies of the Federal Reserve. By Bill Gross’ measurement the United States has $75 trillion in unfunded liabilities. That is approximately a 500% debt-to-GDP ratio (over twice that of Japan). Some even say Gross’ measurement is too conservative and the number could be closer to $100 trillion in unfunded liabilities. The fact remains that there is no mathematical or economic scenario where this debt becomes serviceable or sustainable.

The problem is simple, though the solution has been muddled by short-sighted piecemeal bailout attempts. A debt crisis cannot be solved by piling on more debt. It is impossible to achieve economic equilibrium by bailing out corporations that do not know how to manage risk properly. Consumers, who account for 70% of US GDP, are being largely ignored and yet are experiencing significant harm from this crisis. Instead these insolvent banks need to be unwound, brought through bankruptcy and their speculative subsidiaries and divisions need to be completely separated and spun off from their depository and lending functions. We learned this lesson from the Great Depression, but somehow forgot it in the last decade as banks were once again allowed to recklessly speculate with money they did not have.

Modern Banking Is Anything But

Let us remember that banks should really only function as a basic utility for depositing funds and matching those that wish to lend money with those that are seeking interest on savings. That is the vary essential function of a bank. The speculative gambling that occurs on Wall Street has no place in conventional banking and it should never have been allowed to re-join the conventional banking industry.

Those who intentionally defrauded their clients, the government and employed criminal tactics to profit should be indicted, prosecuted and hopefully incarcerated for their crimes against society. Those reckless, greedy and immoral enough to bring down the entire world economy so that they can profit from its artificial rise and subsequent demise are the true threats to a prosperous future. So long as they remain in power we will not see any trust return to the markets nor shall we see any glimpse of true economic recovery. After all, if the rule of law breaks down, there is not much left to keep people from essentially avoiding the entire gulag casino that Wall Street has become.

We must unite around the world and demand that the crooks are prosecuted, the insolvent banks are unwound and that we, the people are not robbed blind to continue to fund these morally and financially bankrupt institutions. It is the only way that we can begin to move forward and start to rebuild our respective countries.