Parallel Universe in Gold: More US States Push for Gold as Money

Even amidst aggressive inflationism from central bankers and from predatory confiscation of people’s savings, prices of gold has staggered.

Priced in major currencies (USD, EUR, GBP) except Japan’s yen, gold has substantially softened since mid 2011 (Gold.org)

Technically speaking, languid gold prices has been mostly due to a selloff in paper gold and through short sales. (chart from Danske Research)

In an interview with the South China Post, George Soros attributes falling gold prices to deleveraging in the Eurozone:

But when the euro was close to collapsing in the last year, actually gold went down, because if people needed to sell something, they could sell gold. Therefore they sold gold. So gold went down together with everything else

This implies that gold has not been deflationary hedge.

Nonetheless Mr. Soros partly acknowledges of the parallel universe that exists in the pricing of gold:

Gold was destroyed as a safe haven, proved to be unsafe. Because of the disappointment, most people are reducing their holdings of gold. But the central banks will continue to buy them, so I don’t expect gold to go down. If you have the prospect of a crisis, you will have occasional flurries or jumps. So gold is very volatile on a day-to-day basis, no trend on a longer-term basis.

Gold really has not lost its safe haven status, the role of currency safe haven may have partly been assumed by bitcoin.

But the bear raid on paper gold could have been orchestrated to influence “inflation expectations”. Gold plays a vital role in the commodity sphere, signifying a key benchmark on commodity ETFs, from the Mineweb last March:

The exodus from gold pulled down the entire commodities ETP complex, global data from BlackRock showed, as the gold segment accounts for some 70 percent of total commodity ETP investments.

Some $5.1 billion left commodities ETPs as inflows to industrial metals and broad basket commodity ETPs failed to offset the gold meltdown.

In other words, by suppressing gold prices, the general commodity sphere will likewise follow.

 

Also my personal view that gold’s has been undergoing a normal reprieve (profit taking-shake out phase) considering TWELVE consecutive years of advances.Markets hardly ever move in a straight line.

Yet aside from record central bank buying buying of physical gold as noted by Mr. Soros, gold coin sales has just been slightly off the record highs, while silver coins remains on record breaking path,

The more significant part of the growing parallel universe in gold dynamics is that about a dozen US states appear to be in the process of legislating gold as money.

From Bloomberg

Distrust of the Federal Reserve and concern that U.S. dollars may become worthless are fueling a push in more than a dozen states to recognize gold and silver coins as legal tender.

Arizona is poised to follow Utah, which authorized bullion for currency in 2011. Similar bills are advancing in Kansas, South Carolina and other states.

The measures backed by the limited-government Tea Party movement are mostly symbolic -- you still can’t pay for groceries with gold in Utah. They reflect lingering dollar concerns, amplified by the Fed’s unconventional moves in recent years to stabilize the economy, said Loren Gatch, who teaches politics at the University of Central Oklahoma.

If gold’s role as money will continue to get political recognition, then eventually this will reflect on prices, in spite of Central bank-Wall Street’s stealth suppression schemes.

Syria’s Gold Market Thrives Amidst Civil War

Syria’s gold markets remains buoyant despite the ongoing civil war. 

Importantly events in Syria has been providing some insights on resident Syrians perceived value of gold.

For these economically marginalized by the war, gold has been sold in order to raise cash

From Al Arabiya News

In a Damascus jewelry shop, the customer’s jaw drops when he hears what he is being offered for his gold ring. Barely $100. “Can’t you do any better?” he asks timidly before accepting the deal.

After nearly 20 long months of conflict, many Syrians are now digging deep into their pockets, with many having to sell their jewelry -- including family heirlooms -- just to survive.

The conflict between government troops and the rebels may have brought the economy to a stalemate, but the gold market is experiencing an unprecedented frenzy.

For those who have lost their livelihood with the closing down or destruction of their workplace, selling off jewelry is an unwelcome but necessary option so they can feed their families.

Because gold has not yet been recognized as money on the street levels, and because gold is yet considered an asset, economically marginalized people prefer cash over gold.

The point here is that gold hardly signifies hedge against “economic hardships” or what others would (mis) classify as “deflation”.

But it has been a different story for those who have savings

From the same article:

For the rich, the precious metal represents a bulwark against the collapse of the Syrian pound.

According to Sonia Khanji, a member of the Damascus Chamber of Commerce, 30 percent of small and medium enterprises in the country have now closed, throwing roughly a quarter of the workforce out of a job.

Long accustomed to stable prices and currency, Syrians have seen rampant inflation reduce their purchasing power by one third since the revolt against the regime of President Bashar al-Assad broke out in March 2011.

Damascus blames the country’s economic woes on sanctions imposed by Europe and the United States, whose administrations accuse the regime of conducting a bloody crackdown on its own people.

Blaming external factors has been a mechanical response by almost every politicians.  In reality, wars are mainly funded by inflationism. 

The Syrian government recently announced a significant spending hike to cover salary increases (+13%) and subsidies on food, fuel, power and agriculture (+25%), apparently to buy popular support even when the economy has been hit hard by the rebellion.

Yet without sufficient tax revenues to cover the added expenses including the existing ones, then the Syrian government may have already become dependent on her central bank for financing, thus the recent spike in price inflation (chart from tradingeconomics.com)

And many Syrians see gold as safe haven of their savings against monetary inflation

Again from the same Al Arabiya News article

Today, those who still have a steady income put their faith in gold.

“People prefer to buy gold or sterling ounces rather than trinkets,” Mdari says, adding that people are hunkering down for a protracted period of unrest.

“People have lost faith in the national currency. Whenever new economic sanctions are announced, I notice that the rich flock to buy gold. They believe that acquiring the yellow metal offers security,” says Michel, a jeweler.

Damascus industry professionals agree that the precious metal provides a form of savings that appreciates in times of political and economic uncertainty.

“To save money, people prefer gold. They fear a rising dollar and the fall of the Syrian pound, and gold is easier to transport if we need to leave quickly,” said Hisham, a goldsmith on Abed Street in downtown Damascus.

In the real world, gold represents a hedge against currency inflation.

Soros, Paulson and Emerging Market Central Banks Ramp Up Gold Purchases: Calm Before the Storm?

Speaking of demonstrated preference or actual choice revealed through actions taken, billionaire fund managers-investors George Soros and John Paulson have reportedly been escalating on their gold positions.

From the Bloomberg,

Billionaire investors George Soros and John Paulson increased their stakes in the biggest exchange- traded fund backed by gold as prices posted the largest quarterly drop since 2008.

Soros Fund Management more than doubled its investment in the SPDR Gold Trust to 884,400 shares as of June 30, compared with three months earlier, a U.S. Securities and Exchange Commission filing for second-quarter holdings showed yesterday. Paulson & Co. increased its holdings by 26 percent to 21.8 million shares…

Paulson, 56, who became a billionaire in 2007 by betting against the U.S. subprime mortgage market, lost 23 percent in his Gold Fund through July as lower bullion prices and slumping mining stocks contributed to declines.

Holdings in the SPDR Gold Trust are Paulson’s largest position. He also bought shares of NovaGold Resources Inc. (NG) last quarter and sold other stocks, leaving his $21 billion hedge fund with more than 44 percent of its U.S. traded equities tied to bullion.

Paulson’s U.S.-listed holdings peaked at $34.3 billion at the end of March 2011, with about $7.7 billion of that amount, or 23 percent, invested in gold related stocks. He had 33 percent of his U.S. stock holdings in gold-related securities at the end of the first quarter and 25 percent a year ago.

What has piqued my interests me has not just been Mr. Paulson or Mr. Soros’ gold buying spree, but of the apparent shifting made by Mr. Soros, who seem to be emptying his stock market exposure, particularly on the financials, and repositioning them all into gold ETFs.

Analyst Mac Slavo at the Shtfplan.com notes,

Soros, who manages funds through various accounts in the US and the Cayman Islands, has reportedly unloaded over one million shares of stock in financial companies and banks that include Citigroup (420,000 shares), JP Morgan (701,400 shares) and Goldman Sachs (120,000 shares). The total value of the stock sales amounts to nearly $50 million.

What’s equally as interesting as his sale of major financials is where Soros has shifted his money. At the same time he was selling bank stocks, he was acquiring some 884,000 shares (approx. $130 million) of Gold via the SPDR Gold Trust.

When a major global player with direct ties to the White House, Wall Street, and the banking system starts off-loading stocks and starts stacking gold, it suggests a very serious market move is set to happen.

And this hasn’t been just about Messrs. Soros and Paulson; emerging market central banks, including the Philippines, the ultimate insiders, seem to be joining the ranks of gold hoarders.

The Mineweb reports,

perhaps one of the most interesting findings of this latest analysis is that gold buying by the world's Central Banks hit a new record of 157.5 tonnes , more than double the level of Q2 2011 and accounting for 16% of overall global demand. This, by our reckoning is also around 22.5% of total gold supply over the period extrapolating from the WGC's own annual figures for 2011. Central banks that significantly bolstered their holdings during the quarter included the National Bank of Kazakhstan, and the central banks of the Philippines, Russia and Ukraine.

The irony of this is that all these insider buying comes amidst dampened demand for gold in terms of investment and jewelry.

Chart from Forexpros.com

Yet part of the current slowdown in the conventional demand for gold can be traced to the ongoing weakness in the global economy.

A sign of this can be seen in Lisbon Portugal where residents may have already depleted their jewelries for cash.

From Bloomberg,

In Portugal, the historical home of some of Europe’s biggest gold reserves, the number of jewelry stores, which include cash-for-gold shops, increased 29 percent in 2011 from a year earlier, a study commissioned by parliament found. In the first quarter, an average of two new stores opened every day, the report said. Now some of them are closing.

“Business has gone from great to terrible in a matter of months,” Luis Almeida, whose family has owned a gold store near Lisbon’s Rossio Square for more than 40 years, said in an interview. “The sad truth is that most of my clients have already sold all of their gold rings.”

Selling gold for cash exhibits that gold barely functions as hedges against deflation.

Technically speaking, gold prices has been in a two year consolidation phase.

A seeming trend-continuing pennant or wedge-neutral formation could suggest that a breakout of the 1,650 resistance level could incite a test on the previous highs at the 1900 level.

Nonetheless, could (White house insider) Mr. Soros, Mr. Paulson and emerging market central bankers (ultimate insiders), such as Bangko Sentral ng Pilipinas’ Amando Tetangco, Jr. be anticipating something big soon?

Does the current environment represent proverbial calm before the storm?

On Gold’s Fantastic One Day $60 move

Speaking of the “illusion of understanding the world” of giving emphasis to “noises” especially on ticker tape activities, gold’s magnificent one day surge amidst collapsing stock markets have breathed life to the quack theory that gold stands as refuge to deflation in a world of paper money.

Stock markets collapsed alright, but Spanish and Italian sovereign bonds RALLIED.

The euro posted a huge .56% bounce on Friday too, which coincided with both the rally of Spanish-Italian bonds and gold.

The guys at Zero hedge offers this explanation[1]. (bold emphasis mine)

But Italian and Spanish bonds rallied. It seems EUR96 was the line in the sand that the ECB (or their proxy banks) decided was enough for Spanish 10Y bonds and that was where they were defended to (though we are suspicious why ECB would step in now after 4 months absence). There was eventually some notable divergence between underperforming Spain and outperforming Italy by the close (+40bps on the week vs +27bps). We suspect that much of the sovereign outperformance was a combination of Sovereign CDS-Bond basis traders (buying bonds and buying protection in Spain to lock in that wide spread) and a replay of the short financial credit, long domestic sovereign credit trade (as in banks will underperform the sovereign if things hit the fan/wall). That is the flow that was evident when looked at across markets.

My guess: the stealth contingent Emergency Liquidity Assistance[2].

This may yet be a precursor to the $620 billion EMS + the potential ECB cut of rates (most likely this week) and massive monetization of bonds possibly in support of the EMS.

Sorry for the chill: Gold’s rally was hardly about deflation.

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[1] Zero Hedge Euro VIX Jumps As ECB Pumps, June 1, 2012

[2] See ECB’s Stealth Mechanism to Bailout Banks: Emergency Liquidity Assistance (ELA), May 25, 2012

Risk OFF Environment: Surging US Dollar

The Bloomberg reports

The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.

From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.

International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.

“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”

In a world where debt has been the elephant in the room, especially for major economies then it would be obvious that once there will be pressure on the claims to debts then this would mean an increased demand for the US dollar. This is because debts have been denominated in fiat currencies mostly on the US dollar. Some people may have forgotten that the world still operates on a US dollar standard.

For instance, intra-region bank run in the Eurozone will likely extrapolate to higher demand for the ex-euro currencies, mainly the US dollar

From Kyle Bass/Business Insider

This means that anxieties over a shrinking pool of “high-rated assets” has also been misguided, because much of these so-called high-rated assets revolve around the problems which we are seeing today: DEBT!!!

In short, what has been discerned by the mainstream as risk-free or safe assets epitomizes nothing short of a grand myth, founded on the belief that government edicts can defeat or are superior to the laws of economics.

Yet the US dollar has not been immune to debt, except that current instances reveal that the locus of market distresses have mainly been from ex-US dollar assets or economies, particularly the EU and China.

And since current predicament has been about debt deleveraging where central bankers have been fire fighting these with intensive money printing, then the pendulum of volatility swings from either asset deflation to asset inflation—or the boom bust cycles.

As one would note, gold has mostly moved in the opposite direction of the US dollar index. The euro has the largest weighting (about 58%) in the US dollar basket.

This simply debunks the flawed idea that gold is a deflation hedge under a paper currency system.

And as Professor Lawrence H. White aptly points out on an essay over monetary reforms,

We should not expect a spontaneous mass switchover to gold, or to Swiss francs, as long as dollar inflation remains low. The dollar has an incumbency advantage due to the network property of a monetary standard. The greater the number of people who are plugged into the dollar network, ready to buy or sell using dollars, the more useful using dollars is to you.

Where the US dollar continues to surge amidst staggering gold prices, then this only means central banking actions have been momentarily overwhelmed by apprehensions over debt mostly via political stalemates, whether in the EU or in China.

Yet we should not discount that central bankers to likely step on the inflation gas to save the current political institutions based on welfare-warfare state, central banking and the political clients—the banking sector.

Prices of commodities will now serve as crucial indicators as to the conditions of monetary inflation-debt deflation tug of war.

The Risk ON Risk OFF conditions may not last, we may morph into a stagflationary landscape.

Could Gold Prices be Signaling a Reprieve in Selloffs or a Bottom?

Over at the commodity markets, gold’s and silver’s recent bounce could yet signal a reprieve to the market’s selloff.

On the one hand, this bounce could signify a reaction to extremely oversold levels but may not be indicative of a bottom yet.

On the other hand, if gold and silver have found a bottom then they could likely be signaling the coming tsunami of inflationism, where the tendency is that gold leads other assets in a recovery, perhaps like 2008.

Also, the recent bounce came amidst Greek polls exhibiting improvements of the standings of pro-austerity camp, perhaps indicative of reduced odds of a Greece exit. A victory by pro-bailout camp government would allow the ECB to orchestrate the same operations that it has been conducting at the start of the year.

For most of the past 3 years prices of gold and the US S&P 500 have been correlated but with a time lag. Since March an anomalous divergence occurred, the S&P rose as the gold fell. For most of the past two weeks both gold and the S&P fumbled which seem to have closed the divergence gap.

But over the two days gold rose as stocks fell. Such anomaly will be resolved soon.

Again, gold cannot be seen as a standalone commodity and should be seen in the context of both the general commodity sphere and of other financial assets.

Focusing on gold alone misses the point that gold represents one of the contemporary assets that competes for an investor’s money. Such that changes in the gold prices would likewise affect prices of other relative assets.

Prices are all interconnected, the great Henry Hazlitt explained[1]

No single price, therefore, can be considered an isolated object in itself. It is interrelated with all other prices. It is precisely through these interrelationships that society is able to solve the immensely difficult and always changing problem of how to allocate production among thousands of different commodities and services so that each may be supplied as nearly as possible in relation to the comparative urgency of the need or desire for it.

To fixate only on gold without examining the actions of other assets would risk the misreading of the gold and other asset markets.

Let me further add that a Greece exit or a collapse of the Euro doesn’t automatically mean higher gold prices. This entirely depends on the actions of central banks.

Since gold is not yet money today, based on the incumbent legal tender laws, it would be totally absurd to argue that under today’s fiat money system—where financial contracts have been underwritten on paper currencies mostly denominated in US dollars or the foreign currency alternatives, European euro, British pound, Swiss franc, Japanese yen or even China’s renminbi—all debt liquidations, be it ‘calling in of loans’ or ‘margin calls’ will be consummated in paper money currency and not in gold.

This means that a genuine debt deflation would translate to greater demand for cash balance (based on Irving Fisher’s account of debt deflation[2]) which means more demand for the US dollar and other currencies of ex-euro trade counterparties.

And that’s what has been happening lately to the marketplace, the US dollar (USD) and US Treasuries 10 year prices (UST) has risen opposite to falling gold prices and other financial assets.

This means part of the global system has been enduring stresses from debt liquidations, which again bolsters the relative effects of money and boom bust cycles.

As pointed out before[3], it would be mistake to equate the 1930 eras (gold bullion standard) or the 1940 eras (Bretton Woods standard) with today’s digital and fiat money system. That would be reading trees for forest when gold was officially money then.

And given that gold has long been branded a “barbaric relic” and has practically been taken off the consciousness of the general public in Western nations, gold has hardly been appreciated as money, perhaps until a disaster happens.

It has only been recently and due to sustained gains of gold prices where gold’s importance has begun to percolate into the American public[4].

Yet the Americans see gold more of an investment than as money

But of course, this is different with many Asians who still values gold as money. For example, many Vietnam banks are even paying gold owners fee for storage[5] in defiance of government edict.

Gold’s rise would be premised from central banking inflationism designed to protect the certain political interests, which today have represented the banking institutions and the Federal and national governments.

As proof, the latest quasi bank run in Greece, which I pointed out above, has reportedly been due to concerns over devaluation of the drachma, should Greece exit from the EU and NOT from deflation.

While I remain long term bullish gold, short term I remain neutral and would like see further improvements in gold’s price trend and subsequently the relative trends of other “risk ON” assets.

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[1] Hazlitt Henry How Should Prices Be Determined? , May 18, 2012

[2] Wikipedia.org Fisher's formulation, Debt Deflation

[3] See Gold Unlikely A Deflation Hedge June 28, 2012

[4] Gallup.com Gold Still Americans' Top Pick Among Long-Term Investments, April 27, 2012

[5] See Vietnam Banks Pay Gold Owners for Storage, April 12, 2012

Is this the End of the Gold Bull Market?

Over the past few days gold prices has been whacked.

Gold prices have breached the 200 day moving averages.

Immediately gold bears scream “This heralds the end of the gold bull market!”.

Not so fast.

As I earlier said, gold has been reflecting signs of global liquidity conditions which may have been affected by perceptions of inadequate actions by the global central bankers, a China slowdown (or perhaps a bubble bust?) and the MF Global fallout.

Heavily politicized and inflation addicted markets tend to selloff when policymakers declare “discipline”. For instance, last night Ben Bernanke said that the FED won’t be bailing out Euro banks.

From the Bloomberg,

Federal Reserve Chairman Ben S. Bernanke told Republican senators the Fed plans no additional aid to European banks amid the region’s sovereign debt crisis, according to two lawmakers who attended the meeting.

Senator Bob Corker, a Republican from Tennessee, said Bernanke made it “very clear” in closed-door comments today the central bank doesn’t intend to rescue European financial institutions. Lindsey Graham, a South Carolina Republican, said Bernanke told lawmakers that “he doesn’t have the intention or the authority” to bail out countries or banks. Both senators spoke to reporters after leaving the one-hour session at the Capitol in Washington.

In setting boundaries to Fed aid, Bernanke referred to steps beyond the currency-swap lines that were revived in May 2010 to help Europe alleviate its crisis, Corker said. Last month, the Fed led six central banks in announcing a half percentage-point cut in the cost of emergency dollar funding for financial companies overseas through the Fed’s swap lines.

Ben Bernanke has been under fire for having to bailout Euro banks, aside banks of other nations, in 2008. So the act to project an image of nonpartisanship is understandable.

Of course there are many ways to go about conducting a bailout…

The same Bloomberg article observed,

While the Fed may not be able to lend directly to banks outside the U.S., it can provide loans to their U.S. branches through the discount window. The Fed’s currency-swap lines also provide indirect dollar funding to overseas banks through the ECB and other central banks who assume the credit risk.

Lending through the swap lines peaked at $586 billion in December 2008. The swaps are separate from Fed emergency loans to banks and other businesses that peaked at $1.2 trillion the same month, including about $538 billion that European financial companies borrowed directly, according to a Bloomberg News examination of available data.

And once conditions worsens, you may expect the FED to reverse tune.

And paradoxically, Ben Bernanke’s has been signaling that the FED may ease further (QE 3.0) if contagion risks from the Europe escalates [Businessweek/Bloomberg]—a sign of ambiguity.

Besides, the EU has been preparing to mount another grand rescue scheme.

From the Economic Times.

Germany is reactivating its financial sector rescue fund as the eurozone debt crisis raises increasing questions about how banks can cover their capital needs.

Chancellor Angela Merkel's spokesman, Steffen Seibert, said the Cabinet decided Wednesday to reopen the (euro) 360 billion ($474 billion) fund, first established at the height of the 2008 financial crisis.

The fund closed to new applications at the end of 2010. But much of the money _ which totaled (euro) 60 billion for potential capital injections and (euro) 300 billion for loan guarantees _ remains untapped.

European authorities have determined that German banks require a total of (euro) 13.1 billion in new capital to comply with tougher new requirements. The country's second-biggest bank, Commerzbank AG, has been told it needs (euro) 5.3 billion.

And Japan and possibly ex-European nations will be part of the rescue operations. Reports the AFP

Japan has purchased 13 percent of the eurozone rescue fund's latest bond sale, a government official said Wednesday, as the region continues fundraising to help contain its sovereign debt crisis.

The Japanese government bought 260 million euros ($338 million) of the three-month bills, or 13 percent of the 1.972 billion euros raised by the bailout fund, the official said.

Data published by Germany's Bundesbank showed there was strong demand for the debt issued by the European Financial Stability Facility (EFSF).

The sale was oversubscribed by more than three times with investors bidding a total 6.286 billion euros, the German central bank said.

So as I have been saying, you can’t depend on reading current trends and use these to make forecasts. Policymakers will be responding to market developments which will have repercussions.

And I will like to further emphasize that the recent drop in gold is being accompanied by a slump in developed economy equity markets

Chart from Bespoke

Correlation between gold and stocks has intensively tightened.

This exhibits more evidence that in an environment faced by liquidations, margin calls and increased demand for money for safekeeping reasons, gold won’t likely function as refuge. This isn’t the Great Depression era of the 1930s where the gold was money.

In short, gold isn’t a refuge against deflation under a fiat paper money system

Here is a graph of the ECB’s deposits in relation to margin calls (from the Financial Times Blog) [hat tip Bob Wenzel]

We can expect that political authorities will continue to refuse adjustments from the markets, because these would imperil the interests or the beneficiaries of the incumbent political economic system—the political and banking class.

Thus, we will see them resort to accelerating inflationism or policies that will “extend and pretend” or “kick the can down the road” which only exacerbates the current problems. We can construe that most of the signals of “discipline” represent political posturing.

What will happen is that funds will be provided by political institutions (central banks or rescue funds) to allow banks to buy sovereign debt (to keep down yields) which will be used by banks as collateral for acquiring loans from the ECB. This will be like two drunks attempting to prop up one another. (to borrow the analogy from Professor Arnold Kling)

And banks will profit from arbitrages on the manipulated yield spreads.

So inflationism will be a policy that should be expected to continue.

For all of history commodities/gold has served as money or as refuge against inflationism. Thus we should expect gold to eventually find a bottom and begin to reverse the current downtrend once such policies are announced and triggered.

As a final note, the US dollar is the world’s premier currency reserve, which means global banks, finance companies and governments hold as reserves [The US dollar and the Euro make up 90% of Allocated Reserves globally. Unallocated Reserves are not included in this graph, although they make up over 45% of total world foreign exchange holdings-Wikipedia.org] and comprises about 70% of the world trade/transactions [China Daily].

Thus, we shouldn’t be surprised, as this would be intuitive if not commonsense, that the US dollar will serve as temporary lightning rod against the current turbulence, in an environment where demand to hold money increases (again from liquidation, margin calls or safety reasons).

It will take the US Federal Reserve to hyperinflate to drastically reduce the role of US dollar, an event which has not been happening yet.

So I would rather use this opportunity to accumulate gold or gold related investments.

The Catastrophe Portfolio

Many of the world’s wealthiest families have reportedly been hedging their portfolios from the risks of financial meltdown via a ‘catastrophe portfolio’.

From the Reuters

The world's wealthiest families have embarked on damage limitation rather than seeking to boost their fortunes as financial turmoil erodes their riches, with some so worried they are putting their money in 'catastrophe' portfolios.

"We have to explain to our clients, it's not about making money these days, it's about keeping wealth," said Ivan Adamovich, head of the Geneva operations of Swiss bank Wegelin.

With inflation eating away at people's nest eggs and rock-bottom interest rates making living off capital increasingly difficult, many rich people are taking new risks just to stand still, private bankers said.

"We have already inflation higher than interest rates in many markets ... Unless you take some risk you will not achieve a level of return just maintaining (wealth)," Pierre de Weck, head of Deutsche Bank's private wealth management business, said at the Reuters Wealth Management Summit in Geneva.

Adamovich said a model portfolio designed to protect people's wealth in the face of global catastrophe has attracted more interest as financial turmoil spread in recent months.

The "catastrophe portfolio" allocates one third of money to gold, one third to defensive and internationally diversified blue chip company shares and a third to the debt of ultra safe developed countries.

In my view, there is NO such thing as a catastrophe portfolio or a portfolio designed to weather the proverbial storm. That’s because whether it be cash, bonds, gold or blue chips, all are subject to market or systematic risks which entirely depends on the character of the coming crisis.

Hyperinflation would be good for gold and bad for cash, but a systemic deflation from a major banking system collapse contagion would likely do the opposite. On the other hand, wars may adversely impact blue chips or transnational companies, while ‘ultra safe government debt’ could be a delusion if their welfare system has soaked up on too much debt from having an economy that consumes more than she produces or earns. Of course there are possible gray areas, such as debt defaults.

Also, since the conventional markets have been greatly influenced by pervasive bubble policies and political interferences, then my conjecture is that the ramifications from the actions of political authorities will remain as major factors in determining the risk environment.

This makes taking action from reading and analyzing the political tea leaves a better and a more flexible approach than a one-size-fit-all portfolio.

Market Crash Confirms Some of My Thesis on Gold and Decoupling

The recent market meltdown confirmed many realities of the several thesis that I have been writing about.

Aside from the boom-bust cycles, the recent crisis debunks the decoupling theory.

When faced with the increased risks of a global liquidity contraction, market actions have converged to tighten correlations of the risk asset markets almost across the board.

As almost every markets fell, the US dollar and US treasuries became the temporary safehaven.

ASEAN markets, whom initially seemed defiant from the unfolding crisis in the West, has not been spared; even debt default risks, represented by prices of Credit Default Swaps (CDS), of ASEAN and Asian bond markets have begun to rise.

The US Dollar’s Temporary Role as Flight to Safety Haven

I’d like to further point out that the temporary status of the US dollar as refuge is largely due to the unraveling crisis of the Eurozone, or that the relative immediacy of the impact of the Euro debt crisis has been more than that of the US.

The US is NOT and will NOT be IMMUNE to the laws of economics as absurdly suggested by political zealots; the US also faces a prospective fiscal crisis from the continuing profligate ways of the welfare-warfare addicted government. The recent S&P downgrade[1] has been portentous of this.

The current record low or near zero rates almost across the yield curve, which for some represents as opportunity for the US government to further rack up expenditures, is not and will not be a permanent state. More welfare based extravagance ensures the erosion of the US dollar as safehaven status overtime.

Also since the US has largely been less reliant on cash transactions, thus US sovereign securities have temporarily assumed the role of moneyness or as an alter ego to cash.

Most importantly, the US dollar remains as the world’s premier foreign currency reserve as shown above where the US dollar represents about 60% of reserves held by governments and various institutions[2]. In addition, the US dollar represents 85% share of forex transaction in April 2010 down from a peak of 90% in 2001[3]. And of the $95 trillion size of global bond markets in 2010, the US accounted for the largest share at 39%[4].

This means that in a period of dramatic loan margin calls, redemptions or liquidations, and where most of the international payments and settlement system have been based on the US dollar, then it would be OBVIOUS that the US dollar becomes the de facto safe haven. The liquidations in the Eurozone only amplify on such dynamics.

It would be foolish to believe that the US is protected by some mantle of magical or supernatural powers. The only forces that has been giving the US dollar its current strength has mainly been the relatively worst current conditions of the Eurozone, global financial market’s perception of insufficient liquidity* and Ben Bernanke’s dithering on QE 3.0.

*Banking and state insolvencies are valid issues but central banks have been covering such shortcomings with the panacea of liquidity injections. Except that today, financial markets seem to discern that the current state of liquidity injections has not been enough.

Debunking Gold as Hedge Against Deflation and Fear

Another myth demolished by the present crisis is the assumed role of gold.

Many say that gold will function as hedge against deflation. Another camp says that gold functions as refuge against fear.

Both have been proven wrong.

The day Ben Bernanke inhibited the deployment of QE 3.0, gold prices along with the broad based commodity spectrum came crashing down together with global financial markets.

Where the perception that monetary expansion will not be applied, asset liquidation has dominated and gold prices had not been exempt.

So much for the deflation refuge. May I emphasize that asset deflation does not automatically suggest of consumer price deflation or an economic wide deflation-recession.

Also crashing equity markets around the world has been coincidental with falling gold prices. Essentially this discredits the idea that gold serves as refuge against fear.

True, many central banks will continue to inflate—such as the ECB, Swiss National Bank, National Bank of Denmark, Bank of Japan and others—but current state of markets suggest that their actions has not been satisfactory to warrant maintaining lofty record gold prices.

Either these central banks would have to inflate intensively, or more importantly, that team Bernanke joins the bandwagon to deliver the meat of what the market expects.

Also, while gold may be in a natural correction mode given its previously severely overbought conditions, I would think less about the importance of the technical conditions.

I believe that the Fed’s current inaction is temporary. Ben Bernanke would want to see more market pressures to justify QE in order to stave off deflation. In his recent public appearance he again raise the deflation bogeyman[5]

"If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation"

And since price trend of gold seems correlated with the actions of ASEAN markets, a wobbly gold price trend would translate to an uneasy or apprehensive markets for the Phisix or ASEAN equities.

Thus, unless I see gold prices make a substantial recovery, I am predisposed to say that ASEAN equity markets could be susceptible or vulnerable to significant price retrenchments for the time being

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[1] See Misleading Discussion on US Debt Downgrade Crisis, August 9, 2011

[2] Wikipedia.org Reserve currency

[3] Marketwatch.com Daily foreign-exchange turnover hits $4 trillion, September 2001

[4] Wikipedia.org Bond Market Size Bond market

[5] See Ben Bernanke: Falling Markets will Justify QE 3.0, September 30, 2011

Poker Bluff: No Quantitative Easing 3.0?

It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of the fiduciary medium must necessarily lead to its breakdown. Once common principles for their circulation-credit policy are agreed to by the different credit-issuing banks, or once the multiplicity of credit-issuing banks is replaced by a single world bank, there will no longer be any limit to the issue of fiduciary media.-Ludwig von Mises

The US Federal Reserve’s Quantitative Easing programs will be terminated at the end of this month and some have suggested that this program will be discontinued for good.

I’ll say they’re dead wrong.

Same Old Song

I have heard this music before. In late 2009 going into 2010, as the markets recovered the mainstream blabbered about “exit strategies”.

I called this Bernanke’s poker bluff[1].

Bottom line: Interest Rate Derivatives, Expanding GSE Operations, Economic Ideology Record Debt Issuance, Rollover and Interest Payments, Devaluation as an unofficial policy, Political Influences On Policy Making and the Question Of Having To Conduct Successful Policy Withdrawals all poses as huge factors or incentives that would drive any material changes in the Federal Reserve and or the US government policies.

In knowing the above, I wouldn’t dare call on their bluffs.

In November or 10 months later, Bernanke’s Fed unraveled the QE 2.0[2].

Have any of the above variables changed for the better?

The short answer is NO.

All of the above factors seem in play and some may have turned for the worst.

One, while growth of derivatives (see right window) have slowed they remain sizeable. Importantly growth in interest rate contracts has reached pre-crisis highs.

Reports the Economist[3],

Interest-rate contracts, which make up the bulk of the market, reached $465 trillion in December 2010, exceeding their pre-financial-crisis level. While notional amounts are one measure of market size, the BIS says that gross market values, which measure the cost of replacing all existing contracts, more accurately assess the amounts that are actually at risk. The gross market values fell by 13% in the six months to December 2010, to $24.5 trillion.

So even if growth in gross market values of derivatives has been slightly reduced, an environment of higher interest rates will still risk unsettling the derivatives markets for its sheer size and complexity. That’s the reason why investment guru Mark Mobius currently warned that derivatives may trigger the next financial crisis[4]. For me, derivatives as shown by the sensitivity to interest rates movements represent a symptom rather than the cause.

Second, the average maturity holdings of US treasuries has declined to all time lows, which according to Zero Hedge’s Tyler Durden, just hit 62 months[5] (see left window)

This only means that aside from financing the current fiscal record[6] deficits, the shorter maturities adds to the financial burdens of rolling over of some of these old debts. In short, the US treasury will deal with new debts as well as old ones.

Yet considering that the foreign official sector represents as the only parties (aside from the Fed) that have significant control on the supply holdings of US treasuries to materially influence prices, their recent actions does not indicate continued support to finance of US spending programs.

Foreign buying of US treasuries have been on a decline based on yearly change basis and as % of overall ownership (chart from yardeni.com[7]).

Faced with the risk of bond auction failure, the US government will likely try to avert this or get some insurance by having another round of QE.

Proof of this, as I presented last week, exhibits that nearly 100%[8] of US treasury issuance has been presently financed by the US Federal Reserve.

Morgan Stanley’s David Greenlaw estimates FED buying has accounted for 88% during the first quarter of 2011[9]. He also mentions that QE 1 reduced interest rates by 50 basis points on longer maturity securities, according to a Fed study which has on their calculation.

There seems to be a deepening relationship of dependency taking hold. And this certainly is not an auspicious sign.

The private sector as I earlier mentioned have accounted for as a marginal buyer. In addition, new regulations have financially repressed these institutions which compels them to finance (or acquire) government debts to comply with capital adequacy ratios that would meet with the Basel standards[10].

The record debt levels should also mean higher interest rate payments which should place additional burden on the economy.

Thus, the existence of the central bank has been to manipulate rates to benefit the government, aside from the banking sector, which intermediates such financing in behalf of the government.

More Rationalization and Signaling channel

Of course, I have also pointed out that the US housing appears to have regressed to a recession[11]

And all these are being vented on the equity prices of banking and financial sector.

As the US property sector staggers, such dynamic impairs or adds pressures to the values of the banking system’s balance sheets. The S&P Bank Index (BIX), the Dow Jones Mortgage Finance Index (DJUSMF), S&P 500 Financials (SPF) and the (XLF) Financial Select Sector have all been rolling over.

To say that NO quantitative easing would be in the pipeline would either mean an apostasy in economic ideology or the recognition of the mistakes from the past policies.

This also means disregarding the trillions thrown to support the banking sector during the last crisis (Neil Barofsky, special inspector general for the Treasury’s Troubled Asset Relief Program says $23.7 trillion[12] or CNN says $11 trillion committed and $3 trillion invested[13])

The fact that the Fed has been obstinately denying the causal linkages between QE and the commodity price increases coupled with patent serial interventions in the commodity marketplace by private regulators (most likely from indirect political pressures applied) via continuous increases in credit margins further suggests that part of the pre-deployment of QE 3.0 has been to condition or rationalize to the public of its necessity[14].

That’s hardly signs of conversion.

Furthermore, political authorities have been addicted to inflationism, which I have argued as signifying economic ideology and path dependency. This seems not only confined to the Fed but likewise to every major governments around the world.

Proof of this is the second round of bailouts being worked out for Greece[15].

And perhaps in anticipation of this cyclical slowdown, China has been in the process of threshing out a new massive bailout scheme[16] for local governments and their banking system, as well as, partially implementing new stimulus measures aimed at boosting the economy with large scale low cost housing projects[17]. Combined, these two grand projects could even surpass in scale, the 2008-9 $586 billion stimulus[18].

Adding to such bailout fad has been Russia and IMF’s rescue of Belarus[19] which appears to be on the brink of hyperinflation[20].

To top it all, the current signs of weakness in the US[21] or in China[22] or in the Eurozone[23] appear to be changing market’s sentiment everywhere.

Like addicts to illegal substance, even a local (Philippine) broadsheet carried a foreign report which appears to be subtly arguing for the rational of QE 3.0[24].

Meanwhile even the commodity marketplace, which has been under duress from the recent spate of interventions, doesn’t seem to be suggesting of the end of QE.

Gold continues to swiftly recover lost ground, while silver appears to be consolidating. The Reuters CRB (CCI[25] is an equal weighted index representing 17 commodities) seems to chime with gold but to a lesser degree. Importantly, natural gas which has been the perpetual laggard among the commodity spectrum seems likewise in an ascendant mode.

Gold Says QE 3.0

Rallying gold prices are not emblematic of desistance of QE, but rather a continuity of currency debasement activities conducted by global governments especially by the country which holds the principal privilege of seignorage—the US dollar.

We are not in a gold standard. While gold has shown incredible improvement in its reception as part of the financial system, where gold has recently been reckoned as collateral eligible[26], it is not money yet. Not yet anyway. We don’t use gold in payment and in settlement transactions.

Having said so, a disinflationary environment from a cessation of QE will lead to its price decline. Since markets operate as information discounting mechanism, then gold prices should not be rallying.

This will even be more pronounced if debt deflation does occur. Gold is unlikely a debt deflation hedge[27] as demand for cash would vastly increase under such conditions. Such dynamic was clearly evident in 2008[28] until the US Federal Reserve began its QE operations.

I’d further add that surging natural gas prices would imply as the deepening of inflation cycle. As I wrote in November 2010[29]

I’d be convinced of the deepening risks of the inflation cycle, when Natural Gas chimes in. So far, this hasn’t been so.

Well, the bull market in natural gas prices could have just begun.

It’s important to point out that many people, as the great Ludwig von Mises said[30],

think that there are higher and more important aims of economic policy than a sound monetary system. They hold that although inflation may be a great evil, yet it is not the greatest evil, and that the state might under certain circumstances find itself in a position where it would do well to oppose greater evils with the lesser evil of inflation. When the defense of the fatherland against enemies, or the rescue of the hungry from starvation is at stake, then, it is said, let the currency go to ruin whatever the cost.

This has also been manifested by the mainstream doctrine, which mistakenly believes that currency devaluation signify as an important tool to solve the economic problems. QEs has, thereby, worked as part of this measure to devalue the US dollar for purported economic ends.

Thus, the current lust for inflation signifies as a severe misunderstanding of the economic phenomenon which the mainstream mistakenly sees politics as a facile means to attain an economic end, from which usually backfires.

One should not also forget that in the US, policymakers are biased towards rising stock markets which for them serves as the trickle down multiplier from the “wealth effect” that works to boost spending and likewise triggers the “animal spirits” of the marketplace.

Thus the US stock markets constitute part of the coverage of the Fed’s policies[31]. To end the QE would extrapolate to the end of the support on the confidence transmission mechanism and to severe what they see as an important wealth effect multiplier.

Bottom line: NONE of the premises I wrote about in 2010, where I accurately predicted QE 2.0, has improved or has been resolved. In some instances they have worsened.

Thus for many reasons, especially applied to the US—the risk of bond auction failure, risk of imploding derivatives from higher interest rates, debt rollover risks and higher interest payments on sovereign liabilities, the implied policy of devaluation, risks of deterioration of the balance sheets of the major banking institutions, dogged refusal to instill fiscal discipline, ideological leanings and the path dependency of central bankers, risks of a downturn in the stock markets, rallying gold prices—all of which are strongly suggestive that there will be QE 3.0, 4.0, 5.0 until the nth.

It would take another monumental catastrophic crisis or a major transformation of people’s belief to embrace sound money and eschew the principle of inflationism for such policies to end.

And this won’t be happening anytime soon.

Lastly never trust government’s words, they always seem mellifluous but are usually laced.

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[1] See Poker Bluff: The Exit Strategy Theme For 2010, January 11, 2010

[2] CNN Money QE2: Fed pulls the trigger, November 3, 2010

[3] Economist.com Global OTC derivatives, May 31, 2011

[4] See Will Derivatives Cause the Next Financial Crisis? May 31, 2011

[5] Durden, Tyler Fed Balance Sheet And Monetary Base Update - New Records All Around, Zero Hedge, June 2, 2011

[6] Financial Times, Record US budget deficit projected, January 26, 2011

[7] Yardeni.com, US Government Finance

[8] See How External Forces Influence Activities of the Phisix, May 29, 2011

[9] Greenlaw David Who Will Be the Marginal Buyer of Treasuries Post-QE2?, Morgan Stanley June 2, 2011

[10] See Financial Repression Drives The Bond Markets, May 23, 2011

[11] See How could the Euro be so strong? June 1, 2011

[12] See $23.7 Trillion Worth Of Bailouts?, July 29, 2010

[13] CNNMoney.com CNNMoney.com's bailout tracker

[14] See War on Commodities: Intervention Phase Worsens and Spreads With More Credit Margin Hikes!, May 14, 2011

[15] See Serial Bailouts For Greece (and for PIIGS), June 4, 2011

[16] See China Prepares For Massive Bailout!, June 1, 2011

[17] See China’s Bubble Cycle Deepens with More Grand Inflation Based Projects, June 2, 2011

[18] Wikipedia.org Chinese economic stimulus program

[19] Bloomberg.com Belarus to Receive $3 Billion Russian-Led Loan, Kudrin Says (1), June 4, 2011

[20] See A Crack-up Boom in Belarus, May 26, 2011

[21] Businessinsider.com United States: Brace For The Slowdown, June 1, 2011

[22] Wall Street Journal, China Shares End At 4-Month Low; Slowdown Concerns Dominate, June 2, 2011

[23] Reuters.com GLOBAL ECONOMY-Asia's factories feel the chill as U.S., Europe cool, June 1, 2011

[24] Businessworldonline.com US Federal Reserve mulling third QE?, June 2, 2011

[25] Wikipedia.org Continuous Commodity Index (CCI)

[26] See Two Ways to Interpret Gold’s Acceptance as Collateral to the Global Financial Community, May 27, 2011

[27] See Gold Unlikely A Deflation Hedge, June 28, 2010

[28] See Gold Fundamentals Remain Positive, January 31, 2011

[29] See Oil Markets: Inflation is Dead, Long Live Inflation, November 4, 2010

[30] Mises, Ludwig von Monetary Policy Defined, Part 2 Chapter 13 The Theory of Money and Credit, Mises.org

[31] See The US Stock Markets As Target of US Federal Reserve Policies, May 12, 2011