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Fri, Apr 27, 2012 - 4:04pm

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When Fundamentals No Longer Apply, Review the Fundamentals
By: Eric Sprott & David Baker


This may not come as a surprise, but we're still not seeing it. We're not seeing a US recovery.

Here we are, well into 2012, and the fact remains that the US housing situation is still a bust. There is simply no housing recovery happening in the United States. US New Home Sales fell for the fourth time in a row month-overmonth in March, representing a seasonally-adjusted annual rate of 328,000, down from 353,000 in February.1 Do you know what the annual rate of New Home Sales was back in 2006? About 1.21 million.2 No recovery there.

Same goes for US Existing Home Sales, which fell unexpectedly by 2.6% in March to an annual rate of 4.48 million units.3 Again - would you care to know where they were in the same month back in 2006, before the financial system fell apart? Approximately 6.92 million units.4 No recovery there either.

Then there's unemployment. Judging by all the recent earnings-release cheerleading, March's jobs numbers seem to have been forgotten, but they were plainly weak. The US Labor Department showed US hiring slowing to a mere 120,000 new jobs in March, below expectations of 200,000+.5 That's not a recovery. That's simply weak data.

Same goes for the most recent jobless claims numbers, which have been running above 380,000 for the last two weeks, above the 375,000 threshold that supposedly signals future unemployment increases.6 Again - this is not positive data, this is weak data. How high will it have to go before the economists admit that it's weak? 400,000? 425,000? We're asking - we'd like to know.

Then there are US tax receipts, which continue to point in the same direction. If the US is recovering so strongly, then why are employment tax receipts only up 2%? ($484 billion fiscal year-to-date as of March 2012 vs. $475 billion over the same period to March 2011).7 A 2% increase is explainable by inflation alone, which was last reported running at 2.7% according to the Bureau of Labour Stastics.8 Shouldn't the tax receipts be much higher than that? Wasn't unemployment down so far this year? As the Associated Press plainly states, "The unemployment rate has fallen to 8.2% in March [2012] from 9.1% in August [2011]. Part of the drop was because people gave up looking for work. People who are out of work but not looking for jobs aren't counted among the unemployed."9 Oh! Sorry,… now the numbers make more sense. There hasn't been any net new employment at all. Question: if everyone "gives up" looking for work next week, will the US unemployment rate go to zero? We're asking - we'd like to know.

Other economic indicators exhibit the same downward momentum that the pundits are loath to acknowledge. For example, the Economic Cycle Research Institute's (ECRI) Weekly Leading Indicator index, which had been rising from its 2011 lows earlier this year, has resumed its downtrend in April.10 More recently, US Durable Goods Orders were revealed to have dropped 4.2% in March, representing the largest decline since January 2009.11 To top it all off, China's most recent Purchasing Managers Index (PMI) indicated that China's manufacturing activity has now been in contraction for six months in a row.12



FIGURE 1: SPANISH BANKS - DEPOSIT AND EUROSYSTEM FUNDING (% OF TOTAL ASSETS),
1999 - FEB 2012
Note: Deposits of domestic ex credit institutions in Spanish MFIs. Eurosystem borrowing Eurosystem funding via Open Market Operations Source: Bank of Spain, ECB and Citi Investment Research and Analysis

Meanwhile, the situation in Europe continues to worsen. There's no point in mincing words: Spain is a complete disaster. This past week, the Spanish government managed to pull off two separate bond auctions, only to have the yield on their 10-year government bond shoot right back up the moment the second auction closed. Everyone's nervous because the Spanish banking system is up to its eyeballs in approximately €143.8 billion worth of delinquent loans, and the private sector is unwilling to lend Spanish banks the money to weather the potential write-downs.13 As we've seen before, the real culprit plaguing the Spanish banks is customer deposit withdrawals. It is estimated that €65 billion of deposits left Spanish banks this past March alone.14 People are taking their money out of the Spanish banking system, and without the help of the generous European Central Bank (ECB), the Spanish banks would likely be in a full collapse today (see Figure 1).15 As it stands, the Spanish banks have now borrowed a massive €316.3 billion from the ECB in order to meet the withdrawals and maintain the illusion of solvency.

Perhaps it's Euro-crisis fatigue, or maybe just plain denial, but the equity markets appear unwilling to acknowledge how close we are now to yet another round of Eurozone upheaval. Spain's economy is almost five times that of Greece. Spain also has over four times the amount of externally-held nominal debt outstanding.16 If the bond vigilantes choose to punish the Spanish 10-year bond (currently trading precariously close to a 6% yield), we could soon be back where we were this past September, only with a problem four times as large.

The rest of Europe isn't looking so hot either. Italy's bond market is in a similar situation to that of Spain, with the Italian 10-year bond trading perilously close to the 6%-yield threshold. Recent data showed the European Purchasing Managers Index (PMI) falling to 47.4 in March, well below the 50 mark which signals growth in industrial activity.17 German PMI recently confirmed this move with its April release of 46.3, down from 48.4 in March, representing the fastest rate of contraction since July 2009.18 These declines in economic activity, combined with the austerity measures most Euro countries are currently attempting to impose, almost guarantee more printed money will be pumped into the European bond markets before the year is over. It's simply a matter of time.

As expected, the powers that be are busy parading around in preparation for the next round of Eurozone panic, with the IMF using the renewed concerns as an opportunity to re-establish its relevance as a firewall provider. The IMF most recently secured $430 billion worth of new "pledges" from various G20 member countries to increase its potential lending capacity to $700 billion in the event of further problems in the Eurozone.19 Not unsurprisingly, the BRICS countries have expressed irritation at the disproportionate voting power held by Western powers within the IMF at the expense of themselves and the other developing nations. In prepared remarks at an IMF press conference, Brazil's finance minister criticized the skewed quotas that dictate voting power, stating that, "The calculated quota share of Luxembourg is larger than the one of Argentina or South Africa… The quota share of Belgium is larger than that of Indonesia and roughly three times that of Nigeria. And the quota of Spain, amazing as it may seem, is larger than the sum total of the quotas of all 44 sub-Saharan African countries."20 This unbalance used to make sense when the IMF was designed to help fund ailing third world and developing countries through economic crisis. But that is clearly no longer the IMF's main purpose.

It must be difficult for the BRICS countries today. On one hand, they continue to jockey for respect among the Western powers, insisting on participating in quasi-European bailout funds like the IMF. On the other hand, they are also clearly aware of the Western nations' continuing efforts to surreptitiously devalue their domestic currencies, and the pernicious effect that has had on them as exporters and as lenders of capital. In that vein, it was interesting to note that during the latest BRICS Summit held this past March in New Delhi, the main topic of discussion centered on the creation of the group's first official institution, a so-called "BRICS Bank" that would fund development projects and infrastructure in developing nations. Although not openly discussed, reports suggest what they were really talking about was creating a type of BRICS central bank - an institution that could facilitate their ability to "do more business with each other in their local currencies, to help insulate from U.S. dollar fluctuations…"21 Given the incredible scale of western central bank intervention over the past six months, the BRICS' increasing frustration with their printing efforts should be a given by now. The real question is what they're doing about it, and what assets they're accumulating to protect themselves from the inevitable, which brings us to gold.

Although the paper gold price has been range-bound over the past month, the physical gold market has been undergoing staggering change. Earlier this month it was revealed that Hong Kong gold imports into China totaled nearly 40 tonnes in the month of February, representing a 13-fold increase over the same month last year (see Figure 2).22 40 tonnes annualized equates to 480 tonnes per year - a massive number in a market that only produced 2,810 tonnes of mine supply in 2011.23



FIGURE 2: CHINA'S GOLD IMPORTS FROM HONG KONG
Source: Hong Kong Census and Statistic Dept, Reuters
Reuters graphic/Catherine Trevethan, Rujun Shen 11/04/12

If there's one thing we now know for certain, it's the fact that the market has completely missed the importance of the demand-side changes currently taking place in the physical gold market. China has now imported 436 tonnes of gold through Hong Kong over the past eight months.24 This compares to imports of a mere 57 tonnes over the same eight month-period a year earlier (July 2010 - February 2011). The net new demand implied by this increase is 379 tonnes, which when annualized equates to 568 tonnes of new demand in a market that supplies 2,810 tonnes per year in mine production. These are astounding numbers. Recent IMF data also shows that at least 12 countries increased their physical gold reserves by 58 tonnes in the month of March, with Mexico, Turkey, Russia and Kazakhstan making sizeable purchases.25 58 tonnes annualized equates to 696 tonnes of demand per year. We know that central banks bought 439.7 tonnes of gold in 2011, and if the pace of recent central bank purchases continues, it will equate to another 256 tonnes of net new change in the physical gold market.

The significance of this demand shift is striking. If we combine China's implied net change of 568 tonnes with the central banks' net change of 256 tonnes, we're left with a demand shift of over 824 tonnes vs. an annual mine supply of 2,810 tonnes. That represents close to a 30% net change in the physical gold market in 2012. If we remove the portion of global gold production produced by China and the other non-G6 central bank gold buyers (like Russia and Mexico - because we know they're not sellers), we're now dealing with over 824 tonnes of demand change hitting an annual global mine supply of a mere 2,170 tonnes - representing a 38% shift.26 Although we have been continually reminded that 'fundamentals don't matter' in today's marketplace, there isn't a physical market on earth that can withstand that type of demand increase without higher prices over the long-run, and the gold market is no different. There are no sellers of physical gold that we know of who can satiate that scale of new demand, and global gold mine supply has been virtually flat for over the last ten years. Even if we incorporate the estimated 1,600 tonnes of "recycled gold" that the World Gold Council insists on including in its annual gold supply estimates, the numbers above still suggest a net change of 19%.27 Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because we don't actually know.

We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market, the investing public would lose their minds. Could you imagine, for example, if the demand shifts described above were applied to the global oil market? What would happen if a single country came in from nowhere and increased its oil purchases by a factor equivalent to 30% of the world's annual oil supply? We are students first and foremost of the physical market, and the numbers stated above speak for themselves. We remain confident about gold for the simple reason that the demand we are now seeing for physical is completely unsustainable without higher prices, and we do not see that demand abating in the coming months. The US recovery is not happening. Europe is poised for yet another full-fledged economic crisis, and the BRICS countries continue to aggressively convert to hard assets like gold in order to protect themselves from currency debasement. The paper market for gold can continue its charade, but demand in the physical market will soon overpower it through sheer momentum - there's only so much physical to go around, and it appears that there are some very large buyers that are eager to take it.

About the Author

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  230 Comments

57Goldtop
Apr 27, 2012 - 7:15pm

Sprott - reposted from other thread

Today's KWN interview with Mr. Sprott featured yet another call for people to get out of the banks. I suppose it's not an unusual message for Turdland.

People should worry significantly about having money in a bank. They should have a good part of their portfolio in physical gold or the mining shares. It’s so obvious they should be a winner.

(note - I'm with Ranting Andy on the mining shares)

It prompted me to go back and look at his talk at the 10th anniversary of the Sprott School of Business at Carleton U. The video was marked 'private' for a while but they've since opened it up again.

Imagine: Speaking at the business school in his name, in the nation's capital, and giving two powerful messages:

  1. Your money is not safe even in Canada's banks (sure sounded like an invitation for a bank run to me).
  2. The business school education sucks.

Given the context, this is one powerful message. The whole thing is worth watching, but THE MAN starts at about 37:40.

https://www.youtube.com/watch?feature=player_embedded&v=vO6SvWq_tOY#!

Fred Hayek
Apr 27, 2012 - 7:32pm

Sprott must be wrong. Otherwise Victor was completely off

At numerous points, Sprott talks about rampant money printing by the ECB and imminent money printing on a massive scale.

But . . Victor said that the Euro is strictly backed by gold.

So, I see only three possibilities.

A) Sprott is right. The ECB has printed at a disgustingly Fed-like pace and will do more in the near future.

B) Victor is right and the Euro is a work of unfathomable genius always carefully calibrated in its issuance to the ECB member's gold reserves in new york, london and in their own countries, all of which they will have no trouble repatriating. None whatsoever.

C) The ECB is going to buy thousands of tons of gold to maintain the painstakingly calibrated backing of their currency with gold despite spewing euros out a rate to compete with the profligacy of a Bernanke.

Which one seems more likely? Hmmm. Tough, tough choice. ;)

The Death Ceiling
Apr 27, 2012 - 7:37pm

I can't take it any more.

Over the past few years I've had to change the way I think about government, democracy, the markets, money, the media and the environment.

Now I'm expected to believe that reindeers fart?

SE question
Apr 27, 2012 - 7:50pm

"http://thearchdruidreport.bl

"https://thearchdruidreport.blogspot.com/

A very good write up of the situation; prepare your rafts."

What might be a bigger problem for us in Texas is hot weather during the summer. See, we lost half a BILLION trees last year alone from the droughts and fires, just in Texas. An obscure study done recently found a correlation between temperatures in general and the course of natural history during Europe's Little Ice Age. This study put forth the theory that temperatures were what they were before the decimation of the Native American population, dropped after the decimation of the population, and then rose again as the lands in North America was being repopulated again, only this time with foreign peoples in the westward expansion of the US. The study bases this on the following:

Pre-contact - Indians cleared land for use, reducing the number of trees present as the population grew in North America.

Post-contact - Indians were being decimated by wars, disease, and displacement. This gave the formerly-used land the chance to regrow trees. This may have contributed to more scrubbing of carbon from the atmosphere than has occurred in the previous centuries, leading to a cooling around the globe.

Westward expansion - The land that had trees were being cleared again for use by foreign peoples, breaking the cooling period for Europe. NASA notes that this is a 300-year period between 1550 and 1850. This is just over 50 years since contact was made and ended just before the American Civil War. It would make sense.

Since we lost an unprecedented number of trees in Texas as far as recorded history goes, it remains to be seen if we're going to see desert-like temperature highs this summer (110-130 temps like in Arizona) or if it will remain like it always has. It would probably explain the very mild winter that we had this year. Hard to say, but I'm not sure I want to find out.

SE

bbacq The Death Ceiling
Apr 27, 2012 - 7:51pm

@The Death Ceiling

Santa's Reindeer Fart Merry Christmas
Video unavailable

Delighted to hear you have a mind that when presented with fact is able to revise its position.

bbacq

The Death Ceiling
Apr 27, 2012 - 8:05pm

Dear Lord

Loved the first video, the second one's a little rich for the newly awaken.

¤
Apr 27, 2012 - 8:11pm

Already Gone

Already Gone by Puddle of Mudd
Wizard
Apr 27, 2012 - 8:32pm

A Question For The Geo-Strategic Leaning Amongst Us

Something that has been rattling around in my head for awhile now is....

What is the Geo Strategic significance of Utah ?

With an awful lot of Federal Government Installation construction going on there, It seems like Utah residents are going to be getting a large amount of new neighbors soon

bbacq Wizard
Apr 27, 2012 - 8:42pm

@Wizard: Utah?

If secession or revolution were to occur in the 'States, where would it occur first?

I'm not saying Utah, I ask. Utah?

Wizard
Apr 27, 2012 - 9:03pm

NSA to build huge facility in

NSA to build huge facility in Utah

https://www.sltrib.com/news/ci_12735293

Is one facility and there are more that do not seem to be quite as open and in the public eye

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Key Economic Events Week of 7/22

7/23 10:00 ET Existing home sales
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7/24 9:45 ET flash Markit PMIs
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7/10 2:00 ET June FOMC minutes
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Key Economic Events Week of 6/24

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6/28 8:30 ET Personal Income and Consumer Spending
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Key Economic Events Week of 6/17

6/18 8:30 ET Housing Starts and Building Permits
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Key Economic Events Week of 6/10

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Key Economic Events Week of 6/3

6/4 All day Fed conference in Chicago
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Key Economic Events Week of 5/28

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Key Economic Events Week of 5/20

5/20 7:00 pm ET CGP speech
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