The Historic Gold and Bond Bull-Market Tango

Under the Gold Standard, or any other metallic standard, the value of money is not really derived from gold. The fact is, that the necessity of redeeming the money they issue in gold, places upon the issuers a discipline which forces them to control the quantity of money in an appropriate manner; I think it is quite as legitimate to say that under a gold standard it is the demand of gold for monetary purposes which determines that value of gold, as the common belief that the value which gold has in other uses determines the value of money. The gold standard is the only method we have yet found to place a discipline on government, and government will behave reasonably only if it is forced to do so--Friedrich A. Hayek 

The Historic Gold and Bond Bull-Market Tango 

Remember my outlook on Gold last February? 

What you are about to see is a defining monumental process in financial history!  

Lo and Behold, Gold’s phenomenal rise against central banking’s Fiat Money standard! 

Aside from all other (fiat) currencies, gold prices broke to record highs this week against the last holdover, the USD.  

Oh, Gold!!!! February 23, 2020  

 

From the US perspective, record USD gold prices have been attained as USTs hit record low yields amidst a flattening curve. Furthermore, gold prices have surged along with a resurgent buildup of global negative-yielding bonds, even as personal savings rate hit record highs.  

There are those who want to excoriate Nobel Laureate Milton Friedman for saying that inflation was everywhere and always a monetary phenomenon. But he also proposed the Permanent Income Hypothesis. The Permanent Income Hypothesis, according to the Wikipedia, supposes that a person's consumption at a point in time is determined not just by their current income but also by their expected income in future years—their "permanent income". In its simplest form, the hypothesis states that changes in permanent income, rather than changes in temporary income, are what drive the changes in a consumer's consumption patterns. Its predictions of consumption smoothing, where people spread out transitory changes in income over time, depart from the traditional Keynesian emphasis on the marginal propensity to consume. It has had a profound effect on the study of consumer behavior, and provides an explanation for some of the failures of Keynesian demand management techniques. 

Though the monetary mechanism is necessary for inflation to occur, it is insufficient. Other real factors are material to its existence. 

The surge in personal savings appears to reinforce Friedman’s PIH theory.   

The deflationary impact of a recession must be remedied by an increase in savings.  

Wrote the dean of the Austrian school Murray N. Rothbard*,  

Furthermore, deflation will hasten adjustment in yet another way: for the accounting error of inflation is here reversed, and businessmen will think their losses are more, and profits less, than they really are. Hence, they will save more than they would have with correct accounting, and the increased saving will speed adjustment by supplying some of the needed deficiency of savings. 

*C. Secondary Developments of the Business Cycle; Man, Economy, and State, with Power and Market 

Even in the Philippines, the same process is in motion. This excerpt showcases how businesses are likely to react to the disruptions caused by work stoppage policies to contain the virus. 

From Philstar (August 2): Enterprises hit by the pandemic may have to pause operations temporarily once their cash flow turns negative and consider other opportunities in agriculture and digital space, Presidential Adviser on Entrepreneurship and Go Negosyo founder Joey Concepcion said. “My advice to many of our MSMEs (micro, small and medium enterprises) and I always share this with them: You have to have a plan. You have to remain cash flow positive and if you turn cash flow negative, at a certain point in time, don’t wait until it depletes your entire working capital or even your family’s savings.” “Close the business for the time being because it’s not going to be worth wasting all your family’s savings and it will create more problems for you. That’s my advice to many of our entrepreneurs,” he said in an interview on the The Chiefs aired on One News.” This counsel goes against the mainstream ivory tower based ludicrous prescription that one should take advantage of low rates and borrow to spend. 

Furthermore, based on the analysis of sectoral balances, fiscal deficit equates to net private saving or private sector surplus. So the financing of the US record deficit would translate to massive increases in domestic and or foreign private savings. 

That buildup of savings appears to be consistent with the recent spike in deficits. 

However, the US isn’t the only nation experiencing unprecedented deficits. Most of the world have ramped up public spending such that McKinsey and the IMF expect the global deficit to reach a historic $11 trillion in 2020! That’s about 12% of the $90 trillion global GDP. 

So if sopping up of savings wouldn’t be sufficient, global central banks are likely to be filling in the vacuum through debt monetization. Global debt hit a record of $258 trillion or 331% of the Global GDP in the 1Q. But debt issuance picked up speed in the 2Q, according to the Reuters, "Overall gross debt issuance hit an “eye-watering” record of $12.5 trillion in the second quarter, compared with a quarterly average of $5.5 trillion in 2019, the IIF said. It noted that 60% of those issues came from governments". 

Nevertheless, the current amount of money printing may be inadequate to offset structural deflationary forces embedded in the system, such as excessive debt, overcapacity in several significant sectors, and zombie financing, as well as, recent policies used to constrict the spread of the pandemic.   

For instance, even after the $2.2 trillion bailout package called the Cares Act and the $3 trillion expansion of the Federal Reserve’s assets, the US GDP suffered a 9.5% YoY (32.9% quarter annualized)! But their stock markets rocketed instead. 

For a broader purview of the economic damage caused by recent policies to contain Covid-19:  Singapore suffered a 41.2% contraction quarter on quarter and 12.6% year on year. Hong Kong shrank by 9% YoY. The Euro-zone area declined by 12.1% YoY while the US suffered a 9.5% YoY (32.9% quarter annualized) even after the $2.2 trillion Cares Act and the $3 trillion expansion of the Federal Reserve’s assets. China escaped a recession by posting a positive 3.2%. 

As an aside, the Philippines will be reporting its 2Q GDP on August 6th. Based on the PSA’s data on Gross Regional Domestic Product, the NCR and CALABARZON area contributes about 52% of the total statistical economy (2018).  Along with the rest of Luzon, during the ECQ or MECQ period, economic activities were mostly suspended within these areas.  And strict quarantine policies were also implemented in parts of Visaya and the Mindanao region.  If only 30% of the capacity of the CALABARZON and NCR had been in operations in 2Q, not counting other parts of the nation, how much loss of output will these translate to?    

Lastly, inflation is not set on the stone by Federal Reserve asset purchases or QE as exhibited by the immediate post World War II era. Though monetary actions matter, again, many other factors will determine inflation’s appearance.   

 

As the Eurodollar wiz Alhambra Partner’s Jeffrey Snider wrote of the Fed’s inflationary panic episodes post-World War II:  

Like the 1947-48 bond buying episode (the Fed’s inflation panic), we’re supposed to believe that the central bank played the pivotal role in keeping the financial situation orderly, trading off that priority by risking an inflationary breakout. Bullshit. That’s the myth that has been conjured, hardly in keeping with the reality of the situation. 

Sure, the Fed monetized the bills during WWII, but so what? The depressionary conditions rampant throughout the markets and economy led the private system to easily monetize everything else, the vast majority. Even the Fed’s inflation panic in bond buying was a tiny drop in the bucket. 

Yields said so. 

Furthermore, record money supply’s transmission into street inflation represents a time-consuming complex process that will have to confront opposing forces that may offset its impact. And there will be action-reaction feedback loops that contribute to the process.   For instance, if money creation adds to the money supply, debt defaults subtract to it. 

That is, should global central banks succeed in the re-combusting of inflation, this would only happen when inflationary monetary forces overwhelm deflationary structures, which would take time. 

As I concluded last February, 

Whether street inflation surges or not, in reaction to the massive supply-side disruptions from a crucible of real adverse forces in the face of central bank actions, the escalating uncharted experiments on monetary inflation have pointed to the magnification of uncertainty on a global scale. 

The bottom line: Gold's uprising against central banking fiat currencies warn that the world is in the transition of entering the eye of the financial-economic hurricane! 

PSYEi Bank Profits Surge in 2Q But Savings Deposit Growth Halves in June to Drag Bank Deposits and Liquidity Lower and The Silent Bailout!

Economists are like soldiers selected and trained for only rituals and parades. But they are very good with rituals and parades—Nassim Taleb

In this issue

PSYEi Bank Profits Surge in 2Q But Savings Deposit Growth Halves in June to Drag Bank Deposits and Liquidity Lower and The Silent Bailout!

-BSP’s Diokno Befuddled by Liquidity Strains, Treasury Boom Spurs Profit Surge of PSYEi 30 Banks Only!

-Tumbling Interest Margins and Sinking Loan Growth Portfolio

-Treasury Boom Inflates Bank Assets, The Silent Bailout of the Banking System!

-Despite Interest Rate and RRR Cuts, Financial Liquidity Remains Strained

-Savings Deposits Growth Crashes to 2% Pulls Down Total Bank Deposit Growth! Bank Bond Borrowings Rockets Anew!

-Savings are Finite, Expect BSP’s QE Soon

-Tail Pieces: Historic Mark-The-Close Pump, $16 Trillion of Negative Yielding Bonds, 50% of Global Bonds Inverted!

PSYEi Bank Profits Surge in 2Q But Savings Deposit Growth Halves in June to Drag Bank Deposits and Liquidity Lower and The Silent Bailout!

BSP’s Diokno Befuddled by Liquidity Strains, Treasury Boom Spurs Profit Surge of PSYEi 30 Banks Only!

Before the 2nd rate cut last August 8th, the BSP Chief expressed puzzlement over the lack of positive response by the financial system to the stimulus implemented by BSP involving the reduction in Reserve Requirement Ratio (RRR) and policy interest rate.

Here is a striking excerpt from the Inquirer (August 5) [bold added]: “As the Philippines’ inflation rate eased early this year, thecountry’s banking industry lobbied the central bank to ease monetary policy and—after a short period of regulatory hesitation —got what it asked for. But almost three months after the Bangko Sentral ng Pilipinas cut its key interest rate by 25 basis points and more than two months after it initiated a multiphase 200-basis-point reserve requirement reduction, the latest data showed that liquidity growth in the local financial system remained sluggish. Now BSP Governor Benjamin Diokno wants to know why. “I share your concern,” the central bank chief told the Inquirer, when asked about the last week’s money supply and bank lending growth data for June, which showed the former being flat and the latter slowing down on an annual basis. In particular, Diokno said he wanted to know where the almost P200 billion in extra cash went since it was freed up by the monetary-easing moves as well as the expectations for more easing created by his clear statements favoring the infusion of more liquidity into the system.”

Haven’t we have been discussing this for the longest time?

It’s either the incumbent BSP Chief has little clue about the actual health conditions of the banking system, unlike his predecessor, or his remark evaded the issue. Why has liquidity in the financial system been depleting, an ongoing trend since 2013?

Nevertheless, media headlines have recently screamed about the extraordinary rate of net income growth posted by banks.

Figure 1

True, net income of all listed banks roared by 22.43% in the 2Q and surged by 20.92% in the 1H. (Figure 1, upper table)

But that’s almost entirely been from the PSYEi bank’s which spiked 35.12% and 29.45% over the same period. The meager net income growth of non-PSYEi banks at 2.2% and 5.6% exhibits such highly skewed or distorted distribution.

The numbers tell that the big 4 raked in a boatload of moolah, while the rest jostled for the crumbs. So has the big-4 banks been more efficient in handling their portfolios, or has the boom in profits been really about puffing up the income growth of the PSYEi?

Bank profits zoomed 26.35% in the 2Q following a 22.89% spike in the 1Q, the highest profit rate since 2013, as per BSP’s data. (Figure 1, lower window)

Interest income jumped 31.74% in the 2Q, but this was down from 36.13% in 1Q, both growth rates are at multi-year highs. Net interest income expanded 15.32% and 18.32% over the same period, which represented 2014 highs.

Tumbling Interest Margins and Sinking Loan Growth Portfolio

Great stuff right?

Figure 2

Only if one considers the headlines.

You see, while interest income growth performed spectacularly, interest expense growth outclassed it; the latter rocketed 82.47% 1Q and 89.11% in 2Q, as a consequence, operating interest margins slipped to 2010 levels even as net interest income outperformed. (figure 2, upmost window)

That’s not all. Listed banks interest margins fell 14.4% in the 2Q and 15.25% in the 1H. PSYEi banks saw their margins contract 10.49% and 10.47% respectively, lower than their peers.

If interest margins fell, could it be that the banking system’s loan portfolio experienced a frenzied growth rate to have substituted for it?

The short answer is no.

With a 58.5% share of total assets, Total Loan Portfolio inclusive of Interbank Loans and Repos grew at 10.16% in June slower than 10.27% in May and 12.54% in April.

Shortly put, the Banks were lending less in 2Q. Since peaking in May 2018 at 23.5%, bank lending growth rate continues to head south. June lending growth rate of 10.27% represents a 56.7% decline from the May 2018’s growth rate zenith of 23.48%! (figure 2, middle window)

Treasury Boom Inflates Bank Assets, The Silent Bailout of the Banking System!

On the other hand, with about 22.06% share of total assets, banks total investment growth in June registered jumped 17.18% but was slightly lower than 19.75% in May and 20% in April, the latter signifying a 10-year high.

That’s right. The superb growth in interest income had been generated, not by loans but from the boom in Treasuries.

The BSP defines interest income as referring to “to interest earned and/or actually collected from the following financial assets: (a) Due from BSP, (b) Due from Other Banks, (c) Financial Assets HFT, (d) Financial Assets DFVPL, (e) AFS Financial Assets, (f) HTM Financial Assets, (g) UDSCL, (h) Loans and Receivables, (i) LRARA, (j) Derivatives with Positive Fair Value Held for Hedging, (k) Sales Contract Receivable, and (l) Others”

Total asset growth was down to 9.8% in June, the slowest growth since 2015. Having peaked in May 2018, Total asset growth has been trending down.  It registered 9.88% in May, 11.12% in April and 10.99% in March.

Of the BSP’s Net investments, Financial assets DFVPL having been expanding the fastest. Growth of Financial assets designated at fair value through profit or loss (DFVPL) jumped 32.04% in June, slower than 36.5% in May and 23.7% in April. Financial assets are defined by the BSP “debt instruments as measured at fair value through profit or loss in accordance with the conditions mentioned under PFRS 9”.

Growth in Held for Trading (HFT) assets has likewise been booming, growing at a frenzied rate of 26.3%, 28.8% and 18.52% in the 3-months of the 2Q compared to 10.95% in March, .45% in February and 10.87% in January.

Growth in Available for Sale (AFS) assets likewise expanded 16.6% in June, 12.94% in May and 12.43% in April compared with 21.12% in March, 24.58% in February and 9.54% in January.

Accounting deficits were camouflaged less through HTMs. Growth in Held to Maturity (HTM) assets continued to moderate at 18.45% in June, 24.15% in May, and 26.51% in April. Culminating with a 57.36% clip in November 2018, HTM growth has fumbled fast in 7-months. (figure 2, lowest window)

Still, HTMs accounted for most of Total Net Investments with 60.4% share, AFS followed with 25.07% share, next, were equity investments in Joint Ventures 7.7%, Held for Trading 6.27% and DFVPL .51% share as of June.

The record cash hoarding by the National Government through restrained public spending looks likely an engineered bailout of the banking system.

A silent bailout of the banking system it has been.

As the former BSP chief, the late Nestor Espenilla Jr. led FSCC wrote in their 2017 Financial Stability Report: “While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.”

Despite Interest Rate and RRR Cuts, Financial Liquidity Remains Strained

Figure 3

Despite oozing profits from the Treasury Boom, the BSP’s RRR and policy cuts implemented last May, cash reserves to deposit ratio continues to hemorrhage to highlight sustained liquidity strains in the banking system.

Also, the magic from the Treasury boom appears to manifest signs of corrosion. Following a peak in March, Liquid Assets to Deposits ratio has declined in the last 3-months. Cash and due banks contracted by 2.02% or by Php 48.8 billion in June and fell Php 46.5 billion month-on-month. (figure 3, upmost window)

And interestingly, the sustained depletion in cash reserves and deposits have been prompting banks to obtain more funding from the capital markets, which has resulted in a spike in funding cost, which hit a record last June. (figure 3, middle window)

And it doesn’t end there. The treasury incited profit boom has barely eased the banking system’s Net NPLs, which fell slightly but remains at multi-year highs last June. (figure 3, lowest window)

Savings Deposits Growth Crashes to 2% Pulls Down Total Bank Deposit Growth! Bank Bond Borrowings Rockets Anew!

Figure 4

Banks pulling back on lending has similarly caused a decline in money supply growth. With outsized or record debt exposure, a retreat in money supply growth has not only slowed businesses but also given rise to the banking system’s published Non-Performing Loans. (figure 4, upmost window) What of the non-published ones?

And since non-performing loans are inherently deflationary, the banking system has to look for new sources to reinflate its balance sheets. And the liquidity starved banking system lobbying for the easing of RRRs and rate cuts as cited by the BSP’s Diokno corroborates on such developments.

One of the cheapest sources of funding is deposits, aside from interbank loans. Unfortunately, overall bank deposit growth continues to emaciate.

Total deposit growth was 5.8% in June, a rate seen last in 2012, and lower than the 6.22% in May and 6.61% in April. Total deposits growth has been in a downtrend since 2013.

Growth in peso deposits clocked in at 6.01% in June, which likewise was a 2012 low, and was similarly lower than 6.58% in May and 6.7% in April. Peso deposits constitute 83.33% of total deposits. The downfall in June’s deposit growth was due primarily to the stunning crash in savings deposit growth, which tumbled to 2.16%, from 4.35% in May and 6.52% in April! Savings deposit growth rate halved in June! Savings deposit accounted for a 45% share of total deposits.

Meanwhile, foreign currency deposit rose marginally by 4.75% in June from 4.44% in May, but was down from 6.12% in April.

Banks have been shifting its source of funding from the short-term to the long-term.

Growth in bills payable grew 36.93% in June to Php 905 billion, slower from the 51.71% clip in May and 54.87% in April.

On the other hand, the booming growth in bond payable accelerated 160% to Php 423.8 billion from 117.91% in May and 112.31% in April.

As one would note, banks are borrowing from the public at a frantic pace.

The booming bank profits are no more than an accounting mirage.

Savings are Finite, Expect BSP’s QE Soon

With a growing black hole in the banking system’s balance sheets, competition for access to savings between the banking system and the National Government will only intensify.

And more easing and liquidity injections are unlikely to resolve the financial vortex plaguing the banking system.

Unfortunately, savings are finite. So unless banks begin to resume lending at the pace of the last 5-years, access to savings will become even more constrained. And so is the NG’s ability to raise financing coming at the cost of the real economy. The thing is, the current Treasury boom is unsustainable.

That leaves the BSP’s printing and digital press as the last option.  When the BSP reopens its QE, it is likely to do it on aggressively, expect the USD should fly.

Tail Pieces: Historic Mark-The-Close Pump, $16 Trillion of Negative Yielding Bonds, 50% of Global Bonds Inverted!

Figure 5

Protecting the 9-month trend line is a must. Otherwise, a breakdown could unleash an avalanche of selling that would further wipe away a significant source of the banking system’s non-interest income revenues.

So, index managers launched the biggest ever one-day rescue of the headline index with a 102.84 points or 1.34% pump, which majestically erased 2.18% in losses for the benchmark to magically close down by only -.84%!!!

The aggressive-coordinated mark-the-close pump had been pulled off on some of the 15 largest market cap issues led by Meralco, JG Summit, Aboitiz Equity, and Security Bank. Of course, Sy companies SM and BDO were part of them but were eclipsed by their smaller peers. (figure 5, upmost window)

Nonetheless, index managers decided to pare down their support, on Friday, August 16. After a relentless intraday pump to the close, the headline index suffered an 85.02 points plunge to eradicate a .66% gain and close down by .42%! Another incredible pump and dump!

Only in the Philippines!!!

Next, negative-yielding global bonds rocketed to a record over $16 trillion last week on a bond panic bid on a worldwide scale! (figure 5, middle window) Additionally, distortions of the global bond markets have been intensifying as the “Percentage of yield curves inverted around the world now over 50%”!  (figure 5, lowest window)

A yield curve may not always signal a recession, but how about half of them?

The Philippines just had its inverted curve in the 1Q. However, NG cash hoarding and global bond panic buying have helped inflated bank assets, profits, and steepen the curve.

Will the Philippines be immune from a global recession, as implied by some of the local experts?