New From Sprott: "Have We Lost Control...Yet?"

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Fri, Jun 28, 2013 - 9:30am

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Have we lost control yet?
By Eric Sprott & Etienne Bordeleau


Recent comments by the Federal Reserve Chairman Ben Bernanke have shocked the world financial markets. It all started on May 22nd, 2013, at a Testimony to the US Congress Joint Economic Committee, where he first hinted at tapering the Fed’s quantitative easing (QE) program. Then, on Wednesday, June 19th, during the press conference following the FOMC meeting, the Chairman outlined the Fed’s exit strategy from QE.

Since the first allusion to tapering, volatility has been on the rise across the board (stocks, currencies and bonds) (Figure 1A). Moreover, the yield starved, hot money that had flown to emerging markets has been rushing for the exits, triggering significant declines in emerging market (EM) equity and bond markets (Figure 1B). Finally, the prospect of the end of monetary accommodation has triggered rapid and significant decreases (increases) in the price (yield) of longer dated Treasury bonds (also Figure 1B).

FIGURE 1A: VOLATILITY INCREASING FIGURE 1B: ASSET PRICES DECLINING


It has been clear to us for some time that the Fed was uncomfortable with the relative certainty (i.e. Bernanke Put) that has prevailed in the markets since the introduction of QE-infinity last fall. Officials definitely wanted the market to start thinking about a future without non-conventional monetary policy. However, we seriously doubt that the resulting chaos is what they had anticipated. This was evident in the Chairman’s response to a journalist’s question about the rapid rise in rates, saying the FOMC was “a little puzzled by that”.1 The genie is really out of the bottle now.

Indeed, we believe that the recent “market appeasement rhetoric” by James Bullard and Narayana Kocherlakota (Presidents of the St. Louis and Minneapolis Federal Reserve, respectively)2,3 are further proof that the Federal Reserve has realized it went too far and that it is now in damage control mode. (Update: William Dudley, President of the New York Fed mentioned in a June 27th speech that “asset purchases would continue at a higher pace for longer” if the economy was to grow slower than the FOMC’s estimate)4.

However, as the Bank for International Settlements (BIS) so elegantly put it in its most recent annual report, “[…] central banks continue to borrow time for others to act. But the cost-benefit balance is inexorably becoming less and less favourable.” To this they add: “expectation that monetary policy can solve these problems [deleveraging, financial stability] is a recipe for failure”.5 Clearly, the Federal Reserve knows this and wants to exit their QE program. But can they really?

A large portion of the current economic growth depends on housing. However, mortgage rates are closely tied to long-term treasury rates. While housing affordability is still relatively good because of low house prices, significantly higher mortgage rates might slow the housing market. Furthermore, banks are still very cautious about lending and most borrowers have difficulty accessing credit. While gentle increases in yields are good for banks (who lend long and borrow short), meteoric increases in yields (as in Figure 1B) are damaging because they are hard to hedge and create large losses on the banks securities portfolios (mostly composed of government bonds and mortgage-backed securities) as well as mark-to-market losses on their derivatives portfolios. So, the large and rapid increases in rates the talk of tapering has engendered will damage the economic growth the Fed has been working so hard to engineer, potentially requiring even more stimulus down the line.

The US government itself would also suffer from increases in yields. In its Annual Report, the BIS shows that even a small increase in interest rates would have a large impact on the projected government debt-to-GDP ratio. As shown in Figure 2, under the CBO’s base case scenario (bottom line), the US debt-to- GDP ratio would hover around 110%, whereas a 1% increase in rates would take it to 118% in 10 years (middle line). According to the Chairman’s comments, the fiscal drag that has been partly to blame for the lackluster performance of the economy should subside going forward. But, larger debt servicing costs (because of higher rates) will put more pressure on government finances, forcing it to spend an ever increasing portion of its budget on interest payments. This will have the effect of increasing the fiscal drag, going against the hopes of the Fed.

FIGURE 2: U.S. GENERAL GOVERNMENT DEBT PROJECTIONS UNDER ALTERNATIVE SCENARIOS - AS A PERCENTAGE OF GDP


To add to all this uncertainty, the situation in the Euro Zone’s periphery is far from stabilized. Following the surprise Cyprus bail-in, international bank regulators have made a push for a democratization of this alternative to outright government bail-outs of banks. This idea is quickly gaining traction amongst central planners. We recently discussed the shortcomings of the BIS’s “Template For Recapitalising Too-Big-To- Fail Banks”.6 The BIS, again in its annual report, reiterated that “we need resolution regimes to make it possible for large, complex institutions to fail in an orderly way.” As uninsured depositors and bank bond holders realize that they do not benefit from government guarantee anymore, bank funding costs will rise and funding might dry up for peripheral European banks.

Conclusion: At the last FOMC meeting, by prematurely announcing the timeline and the specifics of an exit from QE, Bernanke might have lost control of rates and volatility. The current US economic growth is still feeble and hinges on housing, which would be slowed down by raising rates. Banks, while better capitalized than pre-crisis, are still not lending to most borrowers and would be dearly affected by too fast increases in rates. Moreover, European woes still threaten the stability of the international financial system and the recent rush to the exit might further exacerbate funding pressures for weak European banks. Finally, the US government (amongst others) debt load, while already unsustainable, would keep on climbing if rates were to increase only by 100bps.

The chaotic reaction by market participants and the corresponding increase in yields now risks destabilizing this very fragile equilibrium. It is yet unclear whether or not the damage control from the other Fed Presidents will put a lid on yields and market volatility, or if the damage to the Fed’s (poorly executed) exit strategy is permanent.

1 https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20130619.pdf
2 https://www.stlouisfed.org/newsroom/displayNews.cfm?article=1829
3 https://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=5128
4 https://www.bloomberg.com/news/2013-06-27/dudley-says-qe-may-be-prolonge...
5 83rd Annual Report, Bank for International Settlements, Basel, 23 June 2013, pages 4 and 6.
6 We discuss this in the Sprott Thoughts article: “The Dijssel_Bomb”. https://sprottgroup.com/thoughts/articles/the-dijssel-bomb

About the Author

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turd [at] tfmetalsreport [dot] com ()

  147 Comments

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Kerbouchard
Jun 28, 2013 - 8:54pm

And this (purloined from LMC)...

*Well, Well! A reversal to the upside after TPTB shake out weak longs going into 1st Notice.

Good Evening:
I have been watching these markets for over 55 years. In that time, I never saw as much management of the gold and silver prices by the FED and inside politically affiliated banking institutions to line their own pockets at the expense of the public, non insiders and investors. To get a few more months of upside in the stock market and keep the public uninformed TPTB, these insiders will do anything to hide the real economy and the true financial situation of our country from the investing and general public. They even go to the Main Stream Media (MSM) and tell what to say to confuse the public and line their own pockets. Why anyone listens to the garbage coming out on CNBC or Bloomberg is beyond me.

As a Managing Director for 8 years with Touche Ross (now Deloitte & Touche) in charge of all Banks and Financial Institutions I know from where I speak and how the manipulation of the markets takes place. I always had hoped someday I could tell what really goes on in the markets, financial reporting and related government agencies such as the CFTC and the SEC. Now for the past few years I feel no compulsion to hold back. At 72 years of age, with just a few years left, what can happen to me that would hurt me for telling the truth. As owner of this website and a provider of real money to the public to replace the paper garbage out there, I feel that I may be in the right place at the right time to inform the public and my customers as to what is really going on. That is why I answer all questions from customers on accounting, taxes, banking system, markets and precious metals at no charge at any time during my office hours 7 days a week.

All of you should know that now that TPTB have brought the prices of precious metals lower to levels where they covered all their short positions, they are now going net long all of these precious metals and will over time take these same precious metals to new highs and prices most of us never even imagined in our wildest dreams ( like $3,250 - $5,000 gold, $144 - $377 silver). Does anyone alive know that the price of silver would have to go to $806 per ounce to match the price that existed in 1492 when Columbus discovered America. We are in for dramatic upside moves in these metals when the true situation of the world's financial problems start to surface over time. Be in physicaland be sure that all of it is in your possession and not on margin.

All the best, with a little glitter and shine in your lives!
Ed Sheldon (CPA retired)
www.SheldonsFinestCoins.com 1-888-786-5678

tmosleySpartacus Rex
Jun 28, 2013 - 8:49pm

@Spartacus

I was planning to, but the vehicle sale that is funding the purchase was put on hold until late this evening.

And no, the results of this experiment will have no bearing on my purchase, because I can't be sure that I will get my metal if I wait for lower prices. I plan to buy this weekend, because I have a feeling that there will be a short squeeze come next week, and event which I am thinking will put off "PMs to zero" for a year or more, possibly indefinitely, if prices rise enough.

Kerbouchard
Jun 28, 2013 - 8:46pm

From flop to...

...flip!

Richard Russell, 6/28/2013:

Don't give up. It's well known that JP Morgan held the biggest short position in gold and silver on the Comex. Writes Theodore Butler -- "It's hard to conceive of the emergence of JP Morgan as the big gold long as being anything but bullish. JP Morgan being on the long side of gold is a game changer."
........................................

"Nothing is normal, not the economy, not the financial system, not the financial markets and not the political system. The financial system still remains in the throes and aftershocks of the 2008 panic and near-systemic collapse, and from the ongoing responses to same by the Federal Reserve and federal government. Further panic is possible and hyperinflation remains inevitable." John Williams, economist.

Have we seen the bottom on the precious metals? The sentiment is what I would expect at a bear market bottom. I note many predictions for $1,000 gold and ten cent silver. Today GLD bounced a bit (see chart below), which nobody paid attention to. If the metals start to rise, people are so bearish on the metals that gold and silver could have big rallies and nobody would get aboard.

What we have seen is one of the biggest snow jobs I've ever seen out of Wall Street. First we are told that the precious metal rise is over, and the metals are headed for ground zero. Then I hear that the biggest short seller, JP Morgan, has switched to the buy side. If the metals now head higher, JPM will make a killing.

Edit: Once again, the originally italicized text flips back to normal. In other words, the entire post is from RR.

Spartacus Rex
Jun 28, 2013 - 8:43pm

@ Tmosley

So, ie you didn't back the truck up YESTERDAY? R U Waiting for outside "confirmation", before making a decision?

tmosley
Jun 28, 2013 - 8:34pm

Testable prediction time: 1.

Testable prediction time:

1. If the market continue to behave as they have in the past (ie quasi-normal markets that aren't manipulated much more than they have been for the last 30 years), we will probably see a short squeeze in the PMs. Likely an epic one. This would likely lead to a renewed bull run. A short squeeze is fairly strong evidence for markets acting as they have for the last XX years (whether they have been manipulated or not is not in question here).

2. If manipulated markets are falling apart (ie paper prices are headed to zero), we will see PMs continue to fall with no apparent reason behind it, or with reasoning that runs contrary to equity bullish reasoning, with short interest continuing to rise, above levels that could ever be reached by free markets. This scenario is fairly strong evidence of central bank intervention on behalf of the shorts.

In the case that PMs plunge at the open, we don't get any strong evidence either way, as that is likely just a continuation of whatever force has been driving PMs down since QE(inf) was announced.

If anyone disagrees with these cases, please let me know so we can move closer to understanding exactly what we are dealing with here. Other hypotheses are welcome, so long as there is some type of price or technical movement increases or decreases its likelihood come Sunday.

Spartacus Rex
Jun 28, 2013 - 8:34pm
Spartacus Rex
Jun 28, 2013 - 8:31pm

The Great Comex Paper Gold Dump:

Gordon Gekko's Blog

Friday, June 28, 2013

The Great Comex Paper Gold Dump: Online Real-Time Physical Gold Price Datasource https://www.gekkosblog.com/2013/06/the-great-comex-paper-gold-dump-online.html

Spartacus Rex
Jun 28, 2013 - 8:26pm

Who killed the American dream? byRex Nutting, MarketWatch

[Edit: Gee, that would be the District of Criminals who lets Wall Street Ass Rape the World!] WASHINGTON (MarketWatch) – Who killed the American Dream?

Whatever happened to the promise that anyone could build a better life by honest labor? That my life would be better than my parents’, and that my kids’ lives would be better than mine?

That America is gone, now seen only in old Frank Capra movies late at night.

Today in America, the rich are pulling away from the rest of us, taking almost all of the gains for themselves, leaving the middle class scrambling just to stay where they are, and forcing the poor to survive on an increasingly frayed safety net.


Piketty and SaezEnlarge Image The share of national income earned by the top 1% has soared since the 1970s and is back to levels seen in the 1920s.

A lot of attention has been given to the issue of the widening of inequality of opportunities and outcomes, in part because a chilling new book by New Yorker writer George Packer, “The Unwinding,” which tells the horrifying story of how the dream was lost.

More recently, an academic debate in a forthcoming issue of the Journal of Economic Perspective has brought inequality back in the news, thanks to a bluntly argued (and titled) paper “Defending the One Percent” by Harvard economist Greg Mankiw (who is a former adviser to George W. Bush, John McCain and Mitt Romney).

In his paper, Mankiw explains why the top 1% are doing so well while the rest of us sprint hopelessly to catch up: The rich are simply better than us. They make more money because they contribute more to society than we do. They are smarter, have the skills that are in high demand, have better entrepreneurial instincts, and work harder. What’s more, their kids inherit these traits genetically.

Not only are the rich better than us, the world is also increasingly becoming their kind of place. Technological changes over the past 30 years have made their advantages even more rewarding than before.

The top 1% really do earn their money, and any effort to reduce inequality would make us all poorer, Mankiw says. We’d have to do without the innovations of people like Steve Jobs, J.K. Rowling and Greg Mankiw.

Mankiw takes it as a given that compensation equals marginal product. The rich earn their money because someone pays it to them, and that someone must have a good reason to pay that much. The markets decide pay, that’s just Econ 101, and on that topic.

Plenty of pundits have responded to Mankiw’s thesis, but none more effectively than Josh Bivens and Larry Mishel of the Economic Policy Institute, who also contributed a paper to the special issue of the JEP.

It turns out that it’s not so much what you know, as Mankiw argues, but how much power you have, especially the power to extract economic rents. Bivens and Mishel show that the increase in the incomes of the top 1% over the past 30 years owes more to successful rent-seeking than it does to efficient and competitive markets rewarding education and skills.

Click to Play

What do economists mean by “rents”? Simply put, it’s the income that’s received over and above what would be required to induce the person to supply their labor or capital.

For instance, Bevins and Mishel say, ”it seems likely that many top-level professional athletes would continue to supply essentially the same amount of labor to their sport, even if their salary was reduced by some substantial fraction, because even the reduced salary would be much higher than their next-best options.” https://www.marketwatch.com/story/who-killed-the-american-dream-2013-06-28

the_circle
Jun 28, 2013 - 7:56pm

Bullion banks pay mines

For years bullion banks paid mines to produce gold. They are paid well, regardless of the spot price for gold. The mines don't set the price- they are simply paid to mine it. So if the price of gold rose or fell, the mines would still be paid the same. Of course this isn't the case with junior mines.

The mines get paid to produce gold for the arabs in exchange for oil. At the same time, the western paper price was kept low to keep the dollar strong, and keep gold quiet. So, the arabs are happy to get their gold (which they are fully aware is worth many times more than the spot price), the west is happy with cheap oil (as they, also, are fully aware that gold is worth more than the price they set), and the mines are happy as they are paid handsomely.

But China saw that there was an opportunity here, and started taking delivery of huge amounts of gold around 10 years ago (which wasn't meant to happen, and this has spurred the rise in gold).

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I thought Turd was on vacation? Lol ... you must be having withdrawal symptoms being away from the site!

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