Buttonwood

Like chess, only without the dice

It is hard to find an economic explanation for gold’s sharp fall

Apr 20th 2013
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GOLD suffered its biggest two-day fall in 30 years on April 12th and 15th. When an asset falls so sharply in price, it is tempting to believe that significant economic changes must be afoot. But an examination of the background to bullion’s decline simply produces puzzlement.
One potential explanation is that investors have at last recovered their risk appetite and are selling gold to buy equities. But although that may have been true in the first three months of the year, it was hardly the case on April 15th, the day of gold’s biggest decline, when the S&P 500 dropped as well.

In any case, what would explain this sudden optimism? Some investors believe that America grew robustly in the first quarter but the latest data—from unemployment and retail sales to consumer confidence and the purchasing managers’ survey of manufacturing—have been disappointing. The same is true of other parts of the world, including China, where first-quarter growth was below expectations, and Germany, where the ZEW survey of economic sentiment fell sharply in April. The IMF lowered its global-growth forecast for the year on April 16th.

Commodity prices in general have been suffering, not something you would expect if investors believed that the world economy was rebounding. The price of a barrel of Brent crude oil has fallen by 10.6% so far this year. Copper, often seen as a bellwether of global activity, has dropped by 8%.

Furthermore, if economic sentiment were improving significantly, you would expect investors to sell government bonds as well as gold. But the ten-year Treasury-bond yield has fallen by more than a third of a percentage point since March 11th. The latest survey of fund managers by Bank of America Merrill Lynch shows that they have become less optimistic about growth in recent months, and have increased their holdings of cash.

Another potential explanation for gold’s fall is linked to central-bank policy. The most recent set of Federal Reserve minutes suggested that the pace of quantitative easing (QE), the creation of money to buy assets, would slow later this year. Many of the most enthusiastic buyers of gold believed that QE would ultimately lead to rapid consumer inflation. So far that has not come to pass: expectations for American inflation over the next ten years, as measured by the difference between the yields on normal and inflation-protected bonds, dropped to 2.4% on April 16th, the lowest level since November. If QE is tapering off and inflation is low, the case for buying gold is weaker.

Yet the obituaries of QE seem premature. First, the Fed has said in the past that the policy is likely to continue until the outlook for jobs improves substantially. Given the recent turn for the worse in economic data, which occurred after the Fed’s last policy meeting, that point still seems a long way off.

Second, the Bank of Japan has just unveiled a highly aggressive form of QE. With the yen declining in response, many analysts have been talking about a Japanese liquidity boost for the world. That ought to make gold bugs salivate.

In short, it is hard to find a rationale in the current economic outlook that would simultaneously send gold and bond yields down, and stockmarkets up. Perhaps investors are simply as confused as Lukas Podolski, a German football player who described the game as “like chess, only without the dice”.

The usual explanation for sharp price movements, when an economic rationale seems lacking, is that someone is selling off their holdings at any price. Some have pointed at Cyprus, which may have to sell gold in response to its debt crisis. Although Cyprus’s gold holdings are small, the fear is that other troubled eurozone nations may follow suit.

But the biggest sell-off so far is in the private sector. During gold’s long bull run (see chart above), retail and institutional investors piled into the metal via exchange-traded funds (ETFs). Some of these purchases were seemingly driven by the belief that gold was a one-way bet. Now that the price is falling, investors are fleeing. According to Morgan Stanley, ETFs have sold 249 tonnes of gold this year, compared with the 14 tonnes of reserves that Cyprus is able to sell.

Gold, having no yield or earnings, is hard to value. That was a help when the price was rising, since the sky seemed to be the limit. But now that the metal is falling, the lack of valuation support is a curse. Like the government-backed paper money that gold bugs despise, gold is precious only so long as enough people agree that it is.


Sprott Asset's John Embry: Don't Sell Your Metals

Apr 20 2013, 02:00

by: Patrick MontesDeOca




On April 17, 2013, I had the opportunity to interview John Embry, Chief Investment Strategist for the Sprott Gold & Precious Metals Fund, about the state of the gold and silver markets. His advice, "Don't sell. You must hold your position."

His advice echoed what Rick Rule, Eric Sprott and Andrew McGuire recommended in recent interviews, as well as advice from our analysts at the Equity Management Academy.

Mr. Embry said the wide attention the fall in gold and silver prices has attracted in the mainstream media has "created a wonderful buying opportunity." He predicts that, "When the carnage is over, and we're probably a lot closer to the end than to the beginning, I think this will represent the finest buying opportunity of the entire bull market, which is in its thirteenth year."

Echoing what metals whistleblower Andrew McGuire commented last week, Mr. Embry believes that the drop in gold and silver has been intentionally engineered. They both said bullion banks and central banks have been on the short side of the gold market for a very long time. They want the price to go down.

Mr. Embry explained that there are huge problems in the world's financial and economic systems. He believes that the powers that realize that they're going to have to print so much money to keep this thing from imploding, the last thing they want is gold and silver rising sharply in price because that would be a tell of what they're having to do and would lead pretty rapidly to higher interest rates. He said, "The one thing this system can't stand is higher interest rates."

Supporting what I have written in the past on Seeking Alpha, Mr. Embry focused on the almost $200 trillion worth of debt in the world and $250 trillion dollars of derivatives, which makes the system leveraged to a degree that is "almost unfathomable."

I asked Mr. Embry if there is a way out of this mess. He thought that no option was good, but the easiest option is to gradually wind our way towards hyperinflation, which might put the inevitable off for a considerable period of time. However, he said, US authorities have no intention of pursuing any austerity measures.

Turning to the case of Cyprus, Mr. Embry agreed that seizing depositors' money was a "very bad precedent." Stories that Cyprus might be forced to sell its gold, however, he said, were just misinformation. Even if Cyprus sold all of its gold, it would be "like a flea bite" on the global gold market. If Spain and Italy, in order to receive a bailout, were required to sell their gold, it might have some effect.

However, a lot of their gold is already leased and isn't available. Mr. Embry argued that such information was just part of a broader propaganda campaign to drive gold prices down.

Turning to mining stocks, Mr. Embry said that for some time he has believed that we are at peak production levels for gold. Old mines are being played out and there are few new sources. Mining shares "have been crushed" and any exploration that is being done is being conducted by juniors. On this basis, Mr. Embry argued that we face "a very real probability that gold production will fall dramatically in the next few years."

Mr. Embry sees some of the cheapest valuations of mining shares he has ever seen, which may be an excellent buying opportunity.


Is the gold bull market finished?


Mr. Embry agrees with our analysts, Rick Rule, Eric Sprott and Mr. McGuire. Mr. Embry said, "I am absolutely sure the gold and silver bull market has not ended.

If you don't like gold prices here, then you must like the value of paper money and you're getting next to zero interest on it." With governments printing money around the world, he said, "I don't see how you can possibly make that argument."


What should investors do?


"Do not be sucked in by this," Mr. Embry said. "Sell is just what they want you to do. You must hold your position. If you have cash, I think this is a wonderful opportunity to dollar-cost average in."

Although we are in a bottom area, he said, "You can't pick the bottom because you can see what these guys can do in a short period of time."

Mr. Embry predicted, "I'd be surprised if they (precious metals) were not back in favor by the fall, because I don't think these guys can maintain this façade of everything's fine. There isn't a robust recovery going on at all."

Based on recent interviews with Mr. McGuire, Rick Rule and Eric Sprott, as well as the analysis of our own research at the Equity Management Academy, there is growing consensus that the gold market is being pushed down by bullion banks and central banks which are short. It will not last, however, and a rebound is on the way, soon.


Disclaimer: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.


China’s economy

Speed isn’t everything

The hidden consolation of disappointing Chinese growth is a more modern economy

Apr 20th 2013
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FOR years, critics of China have complained that it prizes speed over balance. The economy’s expansion has been heedless as well as relentless, breakneck as well as headlong. Rapid development has turned fishing villages into factory towns and factory towns into financial hubs, but it has also taken a toll. Heavy investment has crowded out consumption, and heavy industry has muscled out services, as if making stuff mattered more than serving people.

This week, however, China faced a less familiar complaint: it is not growing fast enough. New figures showed the economy expanding by 7.7% in the year to the first quarter, marginally slower than the previous quarter’s pace and notably slower than expected. The loss of momentum was a puzzle, given the spectacular surge in credit in January and March. The fact it came at the same time as a lull in the American economy and a relatively gloomy set of forecasts for most big economies from the IMF did not help the mood. China’s stockmarket reacted unhappily.

However, just as fast growth masked underlying strains, so China’s disappointing growth has obscured two encouraging trends that may matter hugely for China’s future. Consumption, although still low, made a bigger contribution than investment to China’s growth in the first quarter. That sustains a break with investment-led growth that dates back to 2011. Even more notable, services have trumped industry’s contribution to GDP in the past three quarters and have almost matched it over the past four—which has not happened since the 1960s.

In short China is modernising, becoming more like a Western economy, with consumers and services to the fore. And these two promising trends reinforce each other. Because services are more labour-intensive than industry, their growth boosts wages and household income. Fatter pay-packets then encourage consumption, and consumer spending, in turn, favours services. In economic life, as one economist has put it, “Result becomes cause and cause becomes result.”

Some of the results reflect political causes. By passing stronger labour laws in 2008, China’s government bolstered workers’ bargaining power and thus their consumer power. By allowing its exchange rate to appreciate, it has directed China’s energies inward, away from exports and towards services, which are often consumed at the point of production. The regime is also busy easing the fiscal burden on the sector, replacing a clumsy turnover tax with a lighter value-added tax.

Slower can be better
 
 
If China’s growth slows too sharply, throwing lots of people out of work, such structural improvements will count for little. Better balance is scant consolation to an economy on its knees. But the slowdown has not yet hurt employment. According to Nomura, a bank, the number of job vacancies per applicant in the first quarter was 1.1, the highest since records began in 2001. Urban employment grew by 3m.

This tightness in the labour market suggests that China’s economy is operating close to its limits. Ultra high-speed growth” is no longer feasible, let alone desirable, as Xi Jinping, China’s new president, points out. Rather than chasing growth at any cost, his government has imposed regulations on shadow banking, persevered with curbs on property speculation, and clamped down on government extravagance, such as the schmoozing and boozing, kowtowing and Maotai-ing that accompanies so much official business.

As China’s economy matures, its pace will slow. Fighting this economic law will only invite inflation, excess and harder reckonings. Growing fast is a poor alternative to growing up.


April 18, 2013 6:41 pm


Italy: Lost in stagnation
 
The ruined city of L’Aquila epitomises the despair of a nation paralysed by political and economic torpor
 
Notes in remembrance of the 2009 earthquake are sticked on a closed bar on October 22, 2012 in L'Aquila. Six Italian scientists and a government official were found guilty the same day of multiple manslaughter for underestimating the risks of a killer earthquake in L'Aquila in 2009, and sentenced to six years in jail in a watershed ruling in a case that has provoked outrage in the international science communit©AFP
Notes of sorrow: residents stuck messages on a shut bar in 2012 to commemorate the earthquake


Silence hangs over the ruins of L’Aquila when 83-year-old Aldo Di Bitonto returns to inspect his shattered home. It is the fourth anniversary of the earthquake that devastated the city and he does not know when or even if he will cross the threshold of his home again.

Reconstruction has all but ground to a halt, through lack of money and paralysing politics that have made medieval L’Aquila the ultimate symbol of Italy’s great stagnation.
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Italy by the numbers


“We are in the hands of incompetent, arrogant and conceited politicians who count for nothing. The right speaks badly of the left, the left of the right and we the people are caught in the middle like pressed fish,” laments Mr Di Bitonto, captain of the city’s football team half a century ago, strolling through the desertedred zone” of the historic centre. Steel girders prop up teetering buildings and churches, and some streets are still entirely closed off.

Candles and fresh flowers mark the places where 309 people were killed as they slept in L’Aquila and nearby villages in the early hours of April 6, 2009. Some 22,000 left homeless are still in “temporaryaccommodation.

Massimo Cialente, L’Aquila’s despairing mayor, is threatening to haul down the national flag from the city hall and dismiss the prefect representing the central government. “You can let us die in peace,” he says. “This city has been condemned to death without resources.”

Despite an outpouring of grief and hand-wringing pledges by national leaders, L’Aquila has become a monument to Italy’s economic and political paralysis. Small construction companies won tenders to rebuild, started work and then went bankrupt when the state failed to pay them – a pattern that is repeated across the country where the public administration owes €100bn in arrears to the private sector.

But, like the rest of Italy, L’Aquila is rich in suffocating bureaucratic impositions. Gian Antonio Stella, a reporter known for exposing the waste and corruption of the elite known as the “caste”, counts 1,109 laws, directives and ordinances passed to deal with the city’s revival. Some aim to prevent the Mafiaone branch of the Italian economy that is flourishing amid crisis – from taking the spoils of reconstruction.

Families are still lodged in a police barracks outside the city that were used to host the 2009 G8 summit after Silvio Berlusconi, then prime minister, shifted the venue to L’Aquila, ostensibly to draw attention to its plight. The summit budget, Mr Stella notes, included €26,000 for 60 limited edition pens and €22,500 for 45 silver Bulgari ashtrays.

Beyond L’Aquila, Italy’s crisis is deepening as the economy enters its eighth consecutive quarter of contraction, the longest recession since the war. In the decade to the end of 2012, the eurozone’s third-largest economy recorded 15 quarters of decline.

An array of statistics attest to Italy’s slide during that period. In education, Italy has slipped down the table so that only Greece spends less. Prisoners do even worse than students, with 140 crammed into communal cells built for 100, the most overcrowded in Europe. Packed even more solidly are commuters on trains, among the slowest on the continent. Opening a business? According to the World Bank, it costs far more to start a business in Italy than in France, Germany or the UK.

What meagre growth has been eked out over the past decadedominated by Mr Berlusconi’s two centre-right governments – has been largely driven by an influx of immigrants compensating for Italy’s own declining population. But even they are starting to leave, joining an exodus of tens of thousands of young Italians, many of whom now serve in the bars, banks and businesses of London. The Goethe Institute is overbooked with would-be students of German heading for Berlin.

These days, the front pages of Il Sole 24 Ore, Italy’s main business daily, are a tombstone to failure. Last Wednesday it recorded that 4,218 companies had gone bankrupt in the first three months of the year, up 13 per cent from the first quarter of 2012. Families, too, are being impoverished, their purchasing power falling nearly 5 per cent last year, returning to levels last seen in the 1990s.

The sense of entrenched stagnation is mirrored in political paralysis. Eight weeks after elections resulted in a divided parliament, Italy is still waiting for a new government as politicians bicker over who should run it.

“We cannot waste time any more. Time is over,” declared Giorgio Squinzi, head of the Confindustria business lobby, warning that failure to agree on a government and going back to the polls within months could condemn Italy to missing out on the economic recovery projected for the rest of Europe.

Gian Maria Fara, sociologist and president of the Eurispes think-tank, dates the start of Italy’s long stagnation to the fall of what is known as the “first republic” in 1992, when the postwar establishment collapsed under the twin pressures of corruption scandals and the end of the cold war that spelt the demise of western Europe’s largest communist party.

“The political leadership was exhausted. The country was suffering. We dismantled a system that we thought we could rebuild in a few years but it took much longer,” says Mr Fara. “This is not a political crisis in essence. It is a crisis of the country’s political and business and academic leadership in general, of which the politicians are an expression.”

Dominated by a handful of big corporations with their ownprotectionistinstincts at heart and by politicians who use their parties as vehicles for their own careers, Mr Fara says Italy is left without a project or a vision and the “logic of small towns, where everyone just thinks about their own garden”.

“We are a country destined for stalemate. We are a Gulliver, a big body tied down by thousands of ropes held by the Lilliputians. A huge bureaucracy is holding us down,” he says.

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The stunning success of the anti-establishment Five Star Movement in the February elections, coming from nowhere to capture a quarter of the vote and become the third-largest force in parliament, is a reaction to what Mr Fara calls Italy’ssickness”. But under the idiosyncratic leadership of Beppe Grillo, a former stand-up comic and the country’s most popular blogger, the movement appears to be losing its way, unable to hew a clear identity out of its heterogeneous mix of idealists, rightwing extremists and leftwing activists.

Investors hope that the Five Star Movement will inject a sense of urgency into the mainstream parties to implement political and economic reforms, as well as jolt Europe into loosening the grip of austerity that Mario Monti, the caretaker prime minister, admits has plunged Italy deeper into recession.

But neither Italy’s political elite nor Brussels’ show much sign of responding. However, the fear of markets – that Mr Grillo will win a rerun of elections and embark on a programme of reneging on Italy’s debt and holding a referendum on leaving the euro – also appears unlikely to materialise.

What the elections did demonstrate, however, is that Italy’s move towards a bipolar party system has failed and that an anxious and mobile electorate is looking for change. Perhaps Matteo Renzi, the youthful and reformist rising star of the centre left, can harness that restless energy, or the 76-year-old Mr Berlusconi, a billionaire media mogul, will finally find an heir for the centre-right. But for the moment fresh elections early July or October are the dates most mentioned – could lead to a similar stalemate.

Looking at the bald numbers and grim political outlook, economists are increasingly doubtful that Italy will succeedwithout a bailout or restructuring – in meeting its payment obligations on €2tn of public debt, which Mr Monti’s exhausted technocrat government projects will rise to 130.4 per cent of gross domestic product this year from a record 127 per cent in 2012. Mr Monti, whose newly formed centrist alliance took only 8 per cent in the February polls, told parliament he could not wait to leave office.

“Can Italy survive? Probably not,” says Pepper Culpepper, professor of political science at the European University Institute in Florence. “The state is paralysed and political parties are in free fall. No political system even under international pressure is capable of changing things.”

“It is hard to think of anywhere as uncompetitive as Italy. No one is allowed to compete here.

Berlusconi and his friends as well as the unions all fight against reforms, defending entrenched interests,” says David Levine, professor of economics at EUI, suggesting that Italy should restructure its debt sooner rather than later.


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Mr Fara at Eurispes begs to differ, arguing that the official statistics do not tell the whole story.

Italy, he says, survives because it has three GDPs: the “officialGDP of €1.54tn but also the “hidden GDP of the black economy that adds another 30-35 per cent and then the “criminal GDP of the various mafia organisations he estimates at more than €200bn.

“There is a lot more wealth than described in statistics. So, despite all the problems, the country goes on. Why have the people not stormed parliament with their pitchforks? Because they have the hidden economy,” he explains. “These two other GDPs are our social shock absorbers of the crisis.”

But the wealth that Italians have accumulated, rather than investing, over generations – which makes them among the richest in Europe in terms of mostly property-based assets – is dwindling. The country is also in the process of what Eurispes calls the bigsell-off”, as its most famous brands and companies, particularly in food and luxury, fall into the hands of foreign buyers.

The list is long, including power company Edison founded in 1884 (French), Roma football club (American), Buitoni pasta (Swiss), Peroni beer (South African), Ducati motorbikes and Lamborghini cars (German), Ferretti luxury yachts (Chinese) and Valentino fashion (Qatari).

Rumblings of discontent, among voters and business leaders, are not new. But now even the military is starting to speak out. Admiral Luigi Binelli Mantelli, chief of the defence forces, last month took the extraordinary step of publicly slamming Mr Monti’s government for sending two Italian marines back to India for trial on charges of killing two Indian fishermen while protecting an Italian tanker on anti-piracy duty. The case, said the admiral, “is looking always more like a farce”. In private, officers said his comments reflected a broader view that the pillars of the state were crumbling.

Not that this means Italy risks a military coup, even if many Italians yearn for the emergence of a strongman to lead the country out of crisis. Italy is caught in a vicious circle. Political dysfunctionality, a grinding recession, a lack of bank credit and deep social malaise are all feeding off each other,” comments Nicholas Spiro, a sovereign risk analyst who closely follows the country. “Italy’s political, economic and institutional crisis not only endures, but is going from bad to worse.”


Emigration: A Roman regrets his return


Millions of Italians have emigrated in search of a better life since the founding of their modern state in 1861. First they filled transatlantic liners, taking their cheap labour and their cardboard suitcases, but more recently they exported their brainpower carrying laptops.

One Italian who decided to return to Rome after spending years in France is Massimiliano Fuksas, an architect. With his interior-designer wife, Doriana, he has established one of the country’s most successful brands. “It has been a 20-year nightmare,” he says of his time back in Italy.

Mr Fuksas, 69, is still involved in various French projects and, with President François Hollande, has just inaugurated the National Archives he designed in Paris. In July he will see the opening of Shenzhen’s giant airport in southern China, which he designed, and he has won a competition for Moscow’s Polytechnic Museum and Educational Centre.

France gave me the possibility to do experimental projects, with new materials. I love France,” he says. “France is a country with laws. The government is a state. It takes care of you. At dinner no one speaks of money or politics and never about sex.”

But his best-known project in Italy, a convention centre in Rome known as The Nuvola (Cloud), has been dogged by funding problems and is four years overdue.
 
The executive in charge has been arrested on corruption charges related to a separate contract.
“In Italy we have a huge bureaucracy but no state, an administration of nothing,” he says. “In Italy you start a project without money. In France politicians say you have to do this and the bureaucracy organises with public and private money and then there is the tender and building. A linear process. But here it is not like this.”

What is our democracy in Italy, that the richest man wins elections?” asks Mr Fuksas, who does not hide his disdain for Silvio Berlusconi, billionaire leader of the centre-right since 1994. Mr Fuksas threatened to leave Italy again if Mr Berlusconi won the February elections.
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Copyright The Financial Times Limited 2013.