May 23, 2013 6:28 pm

Spain’s banks face €10bn more provisions

By Tobias Buck in Madrid

Spanish banks will need to put aside extra provisions of up to €10bn to cover loans that borrowers will struggle to repay, according to an internal estimate by the Bank of Spain.

According to recent data, Spanish banks rolled over more than €200bn of loans before they expired – often because corporate borrowers would be unable to repay their debt on time and in full. The €10bn estimate is the first official assessment of the likely impact of the central bank’s new approach towards these refinanced loans.

The Bank of Spain believes that the risks emanating from this practice, known as “extend and pretend”, have not been fully covered and is pressing all banks to reclassify their refinanced loans according to tighter standards by the end of September. The new regime will make it harder for banks to treat refinanced loans as if they were performing normally, in turn forcing lenders to take additional provisions.

“Our banks will need more provisions,” a senior official at the Bank of Spain told the Financial Times. “The provisions will affect their results, but the question is by how much. We cannot know for sure but we think the impact will be between €5bn and €10bn [in provisions] across the system.”

The new round of provisions is expected to make a significant dent in profits at a time when Spanish bank earnings are already under severe pressure in their home market. Spain is mired in a two-year recession, with both companies and households suffering the aftermath of a debt-fuelled housing bubble and soaring unemployment.

Analysts and Spanish officials believe the central bank’s tough new approach towards refinanced loans is likely to force weaker lenders – which are focused exclusively on the domestic market – to raise more capital through asset sales, capital increases or by tapping Spain’s bank rescue fund for more money.

However, the senior Bank of Spain official said the central bank’s view was that “the banks can handle it”.

Not all provisions would have to be taken in one go this year, the official added. Instead, banks would have to take the financial hit depending on the how soon their refinanced loans mature.

Officials familiar with the matter stress that the financial hit will be much harder on smaller banks than on large diversified financial groups such as Banco Santander and BBVA, which generate sufficient earnings to easily absorb the expected new spike in provisions.

There is particular concern about the loan book of lenders that were nationalised last year. Bankia, the lender that became the symbol of Spain’s banking crisis, accounts for the bulk of assets of banks currently in the hands of the state.

Copyright The Financial Times Limited 2013.

To say we're going through interesting times is an understatement, not only in precious metals but the overall market. However in this article I will stick to discussing the irrationality of precious metals. My point of view tackles this from an industry perspective that is overlooked by most.
In a previous article I wrote how understanding production costs would enhance anyone's view and further enhance one's insight on trading precious metals. While it is true that technicals can fly in the face of fundamentals, this is generally short lived as the underlying fundamentals will always drive direction.
The reason I say precious metals defy logic is that there is a clear divergence between the trading of physical gold/silver and electronic/paper trades.
Physical demand of the metals has been overwhelming with supplies run off the shelf. Mints around the world are too out of stock. Here is an article that gleans some information on it.
At the same time electronically traded Gold and Silver are at multi year lows and unsustainable at that too.
(click to enlarge)Gold ETF
There are a few reasons why gold isn't sustainable and at these levels it makes quite the bargain for those in the know.
To begin with, production cost is around the current value of gold. Previously I mentioned I'd be surprised to see gold dive under $1300/Oz and silver $21/Oz and if it did that it would be short lived. While production costs vary from speaking to industry experts it appears $1300 is average, however it can vary from $1000 to $1450 an ounce.
Australia is one of the major gold producers and the current price in gold is causing gold miners to hemorrhage and shut business. For more information take a look at this article on the shutdown of mines.
While it has been argued that gold has had a huge bull run and far exceeded inflationary pressures, this does not take into account the underlying costs of producing gold. In fact the costs have raised proportionately with the rise in gold price.
Next we'll look at supply. Gold discoveries are no longer keeping pace with production as all the easier found gold has been mined and with rising costs in production and exploration it isn't as feasible to produce as it has been in the past.
In the 1980s there was a surge in the supply of gold and this was due to a technology innovation called Carbon in Leach. This meant that lower grade gold previously not able to be mined was now able to be retrieved.
What about the existing gold? This is a common question and surprisingly a lot of the gold traded isn't gold already in existence and relies on new supply to the market. Countries like China, India and the Middle East make up most of the demand on precious metals. With the recent low prices, widespread demand has caused physical shortages. Their culture has always had a demand for precious metals for jewelry purposes and as the lower class moves up to the middle class, the demand is only going to become stronger.
Having a look at data from the World Gold Council, most gold demand is not for investment purposes and is used for jewelry.
(click to enlarge)Gold Demand
The next graph shows demand by category.
(click to enlarge)Gold Demand by Category
As mentioned earlier the amount of gold discoveries is rapidly diminishing and there is no technology on the horizon to mine the lower grade or harder-to-find gold.
(click to enlarge)Gold Discoveries
Gold Miners
Taking note of the above, how do gold miners remain profitable? Well quite simply they aren't and they have been struggling. Over recent times it really has been a case of survival of the fittest. Looking at the below graph comparing the Gold Miners ETF (GDX) with the Gold Index ETF (GLD), it shows quite the drop on the part of gold miners. However by now this shouldn't come as much of a surprise.
(click to enlarge)Gold Miners Vs Gold
While I have raised many points that may surprise a few of you, I merely wish to highlight the reality behind gold and where it is heading in the future. As for the recent correction in the gold price, that's another story.
While I'm not one for conspiracy theories, it should be noted that central banks up until the global financial crisis were net sellers of gold and since then they have been net buyers.
My view is that gold and silver are at bargain prices. For illustration purposes, it doesn't take an expert to realize if it costs $10 to make a brand-named shoe then purchasing it at $10 is a steal.
How you apply that view, however, is the question and there are numerous ways to express that. ETFs such as the Gold Index and Silver Index (SLV) are easy to gain exposure to the metals without the use of complex derivatives or options.
In summary I remain rather bullish on precious metals, however bearish on gold miners.

China demand drives Asian gold bar premiums to record highs

Gold is seeing some renewed demand in China after falling on Tuesday for the eighth time in nine sessions.

Author: A. Ananthalakshmi
Posted: Wednesday , 22 May 2013

Premiums for gold bars hit a record high in Asia on Wednesday as lower spot prices lured more buyers, mainly in China, the world's second biggest consumer of the precious metal, amid tight physical supplies.

Premiums for gold bars in Hong Kong touched a new all-time high of $6 an ounce over spot London prices, up from $5 last week. Singapore premiums rose to $5.

Banks in China were quoting up to $7 in premiums, two traders in Singapore said.

"China premiums remain high because of a shortage in supply of the physical metal," said a Hong Kong-based trader.

"Unless we see more supply coming into the market, or spot prices trading much above the current level, premiums will stay relatively high."

Spot gold was up 0.9 percent at $1,387.8 by 0918 GMT on Wednesday, but still near two-year lows last seen in April, when bullion fell the most in 30 years on fears of gold liquidation by European countries.

Shanghai gold prices rose slightly on Wednesday to stand around $30 higher than spot gold, indicating strong Chinese demand.

Gold is seeing some renewed demand in China after falling on Tuesday for the eighth time in nine sessions. The metal is down nearly 18 percent for the year.

"In China, the premiums have improved over the last couple of days," said a trader based in Singapore. "Demand for gold bars is really strong and there is a shortage at the moment."

Chinese gold imports are likely to swell further, after more than doubling to an all-time high in March, the China Gold Association said this month.


Singapore is also seeing a shortage of supply, pushing premiums to new highs of $5 from $3.50 last week.

"Currently, there are no kilo bars in the market," said Brian Lan, managing director of GoldSilver Central Pte Ltd in Singapore, adding that 100-gram bars were also in short supply.

Supplies were also constrained in India, the world's biggest consumer of gold, not so much because of strong demand but new curbs imposed by its central bank.

The Reserve Bank of India limited gold imports by banks on a consignment basis, except to meet genuine demand from jewellery exporters in a bid to reduce the country's deficit. (Reporting by A. Ananthalakshmi; Editing by Clarence Fernandez)

Schizophrenic investors expect slump: bet on boom

By Ambrose Evans-Pritchard Economics

Last updated: May 21st, 2013

The latest poll of Morgan Stanley's top clients from across the world says it all.

Chief economist Joachim Fels tells us that not a single investor at the bank's Florence forum thought the world economy would rebound with any strength later this year.

Just a quarter expect a return to trend growth. Some 57pc think there will be no escape from the "twilight" conditions afflicting the western world, and 20pc expect an full-blown global recession. That is a remarkably bearish set of views. Yet the same investors are overwhelmingly bullish on stocks and property.

This schizophrenic exuberance seems entirely based on the assumption that QE and central bank largesse will keep the game going, flooding asset markets with liquidity. Indeed, 80pc think the ECB will cut rates again, and half think it will have to swallow its pride and join the QE club in the end.

Four fifths think equities will gallop on upwards over the next year. Complacency is rife. "It became very clear – and many investors were quite explicit about this – that markets are lulled by the lure of liquidity resulting from negative real interest rates and global QE," said Mr Fels.

This then is the bull market of May 2013. Remember the infamous words of Citi's Chuck Prince in July 2007. "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."

I defy anybody to explain what liquidity is. At the end of the day, it is really just risk appetite. It can vanish in a second. (If people mean the quantity of money, that is a different story, and not uber-bullish right now).

Stephen Lewis from Monument Securities says markets seem to think they are in a "no-lose" play: if the economy gains traction, stocks will rise: if it doesn't, central banks will pump in more money.

Mr Lewis said they overlook a nasty possibility that the Fed will start to wind down QE before the US economy has fully recovered. He cites the minutes of Fed's 19-20 March meeting showing growing worries about a new asset bubble, a worry shared by the BIS and the IMF: "A number of participants remained concerned about the potential for financial stability risks to build".

The concerns were spelt out in a landmark paper for US Monetary Policy Forum published by the Fed in February: "Crunch Time: Fiscal Crises and the Role of Monetary Policy".

The paper was by co-written by former Fed Governor Frederic Mishkin, Ben Bernanke's alter ego. It warned that the Fed could struggle to extract itself from QE from 2014 onwards. The longer it goes on, the more dangerous it becomes.
It argued that rising long rates could lead to a bond market rout, inflicting big losses on its $3 trillion portfolio. This could "wipe out" its capital base several times over.

Mishkin said the Fed is badly exposed because it has stretched the average maturity of its bond holdings to 11 years, and the longer the date, the bigger the losses when yields rise. Trouble could compound at an alarming pace by the middle of the decade, with yields spiking up to double-digit rates by the late 2020s.

By then Fed will be forced to finance federal spending directly to avert the greater evil of default. By then, the US really will be facing the sort of hyperinflationary denouement long-feared by QE sceptics.

Just to be clear, this the Mishkin concern, not mine. I think exit risks are greatly exaggerated. The Fed extracted itself from Great Depression policies without any losses, and such losses are in any case irrelevant. They are an electronic accounting fiction. There may be many good reasons for opposing QE, but fretting about the Fed's capital base is not one of them.

But this is the view of several Fed governors and regional presidents, so it matters. And it may have got under Ben Bernanke's skin as well.

As for the Morgan Stanly investors who think that central bank policy is "expansionary", they are wrong. Market monetarist Scott Sumner reminds us in this self-described rant that global money is in fact tight, especially in Europe.

There seems to be a near universal assumption – shared by most governors at the ECB – that low rates necessarily mean loose money. This is antediluvian. Japan had near zero rates for sixteen years, yet descended ever deeper into deflation and an as asset slump. Zero means nothing.

Milton Friedman taught us long ago that zero rates can be extremely tight, which is why central banks then have to step in to expand the broad money supply (M2 in his day, now M3). And what do you know? Eurozone M3 has contracted over the last three months (M-on-M), and US M3 is no longer growing briskly.

We will find out tomorrow from Ben Bernanke's testimony to Congress whether he aims to "taper" QE sooner or later. The markets are all on one side betting that it will be later. They are probably right, but they had better be.
As Warren Buffett said, it will be the shot heard around the world the day Bernanke hints at anything else. By the way, Mr Buffett is not dancing right now. Berkshire Hathaway is sitting on a record $49bn in cash. Speaks for itself.


Is the United States the Next Argentina?

By Garrett Baldwin, Money Morning Economist, Money Morning -- May 23, 2013

Drive the streets of Buenos Aires, and you will see regal architecture that rivals wealthy European enclaves in Monaco or London.

And along tree-lined walkways, you will witness monuments that speak of the legacy of Argentina's finest moments.

But all of it is just a façade-a reminder of what used to be.

Despite having one of the most educated and entrepreneurial populations in the world, an abundance of natural resources, and a dynamic agricultural sector, Argentina has been in steep decline now for eighty years.

And things are only getting worse.

Without a doubt there's a lesson here-- even though I recognize U.S. businesses have it comparatively easy when it comes to government mismanagement.

Even still, after spending the week immersed in Argentina's business culture, it's hard to argue the U.S. isn't on the same unsustainable path.

With the U.S. debt and obligations reaching new heights, new arbitrary regulations making it increasingly harder to conduct business, and examples of ruthless big government gone array in the AP and IRS targeting scandals, the parallels are too great to ignore.

This is far different from the recent comparisons to Greece--and actually much worse.

The truth is the United States is in danger of becoming the next Argentina.

Here's why: It's about business, always business.

The Cornerstone of Every Nation

A nation's success and the strength of its middle class rests on the ability of its people to have the freedom to conduct trade and business. It also relies on a political structure that ensures long-term sustainability.

From my trip there, I can tell you the business and political climate in Argentina is utterly dismal.

For a week, I drove through the heart of Mendoza wine country, dined with Board of Trade members who ship their grains, and circled through the public markets along the Buenos Aires parks.
Given the nation's beauty and reputation as a global destination, you wouldn't know it unless you sat down and spoke with individual business people. After hundreds of conversations, not one person I spoke to championed the Argentine government's positions on improving the business climate.

This is what happens when solutions to problems created by government action is always to add more government regulation or to centralize power.

It is also what happens when the populist government has focused exclusively on a social justice platform that emphasizes benefits to the 40% of its citizens who live in poverty.

In fact, on three occasions, I was told that advocates of President Cristina Fernández would offer a pair of shoes to voters in the slums. Voters would receive one shoe before the vote, and the other when they returned and showed their ballot.

When you hear these stories, you realize that elections are not so much about fixing problems as they are about the ascension to power that politicians seek.

Argentina's core problems stem from a financial crisis in 2002, where the country effectively defaulted on its sovereign debts. Widespread panic, rioting, a devaluation of the peso against the U.S. has led to a staggering erosion of wealth across the nation. Unemployment had soared to 25%, and 60% of the country fell below the poverty level. Horrific tales of scavenging and bartering became the norm.

But 10 years later, the business climate still remains stagnate in the face of trying to keep food and product costs down and things "more fair.”

Overregulation, steep export taxes, and import bans have led to a stifling effect. Policy decisions have made it impossible to conduct business, have facilitated the destruction of its middle class, led to rampant black markets, and incentivize the offshoring of capital by the wealthiest members of society.

And while the entrepreneurial spirit of Argentina is very alive and well, the government has done everything it can to tie one arm behind business leaders' backs, while chopping the other off at the elbow.

For example, take the flight we took from Mendoza to Buenos Aires.

Our regional flight was on LAN, a Chilean carrier and competitor to the government-owned Aerolíneas Argentinas. Our midday flight was delayed by a half-hour, but not because of the rainclouds circling above Buenos Aires. It was well known by my co-passengers that the Argentine government has ordered its flight towers to delay rival airlines flights in order to raise Aerolineas' on-time arrival score in comparison to companies like LAN.

Not only was that delay induced to enrage customers, but we also faced another 30-minute delay with our baggage, which was strange considering that all of the bags were off of our plane before we were (for some reason it took an extra 20 minutes to get access to a staircase to deplane).

So it shouldn't surprise anyone that LAN pulled out of the Argentine market this week. This will only drive price increases and provide fewer options for travelers. It will also do little to improve the on-time arrival scores of a poorly run state enterprise.

Why should any of this concern Americans?...

Here' s one of the connections: During the 2009 healthcare debate, we heard quite a bit from the Left about how the U.S. needed a public-option to compete against private healthcare companies.

But the reality is that private companies can never compete with politically advantaged, crony companies or options that have no true interest in market competition. A public option would make it virtually impossible for the private market to function properly.

And over time, you will witness a downward trend where private firms go out of business, and the politically advantaged companies rise but ultimately begin to fail overtime due to a lack of competition and market accountability.

The United States already operates the V.A. healthcare system with a pathetic track-record (as repeatedly noted by Jon Stewart and the Daily Show). We also see the U.S. Post Office, the de facto version of a shipping public option. Just think about how it bleeds cash, can't break union influence, and fails to provide quality or value in its services.

Meanwhile, private companies UPS and FedEx operate efficiently, despite persistent regulations to protect the U.S. Postal Service. And these aren't the only parallels

A Myriad of Problems

In fact, Argentina's state-run airline was just the first of many logistical problems that I witnessed.

The biggest problem that I saw facing Argentinean businesses in agricultural production was the lack of a railway system. Argentina does not just lack proper rail infrastructure to ship goods from remote farming regions to its ports. It pretty much does not have any access to ship goods from anywhere by any other method but trucks.

This is because the trucking union has such an influence on the Argentine government, that they have effectively blocked any future train infrastructure. Instead of shipping goods in a more cost-effective manner, trucks dominate the logistical network, which is more costly, less environmentally sound, and leads to serious bottlenecks in logistical operations.

Cronyism has stifled market opportunities to improve its logistical network, which will only lead to long-term shortfalls as the agro-sector attempts to compete with its neighboring rival in Brazil that is solving its infrastructure problems as I write this.

Argentina is also crippled by its own trade policies. The nation has extremely high business taxes, including a massive VAT and export tax on raw commodities.

In an effort to keep food costs down across the country, the nation has made it financially unfavorable to export grains by producers. As a result, investments into the agricultural sector remains stagnate.

And, again, while the country is doing its best to suppress rising food costs, the nation is about to find itself uncompetitive as neighbor Brazil creates a more favorable environment to international investment, infrastructure development, and more liquid financial markets.

But it's the last problem facing the Argentinean economy that is the most troubling.

And we'll cover that portion tomorrow in Part Two of this examination into the Argentine Crisis and how to profit from two successful global investment strategies.


May 22, 2013 10:22 am

Markets Insight: Fed’s QE exit must avoid collateral damage

By Manmohan Singh

With a quantitative easing exit now being eyed, many are beginning to worry about the possibility that the Federal Reserve will struggle to unwind its huge balance sheet in a controlled way. In reality, however, there is no reason to fear runaway rates provided authorities keep collateral market rates in mind during the exit process.

Among the unconventional tools the Fed introduced during the peak of the crisis was a “floor” mechanism known as “interest on excess reserves”. Less high profile than other unconventional policies such as asset purchases, IOER’s role in controlling rates has been under-appreciated by the market. Indeed, it is because of IOER that liquidity has been reabsorbed into the central bank system so efficiently. Above all, IOER has played an important role in ensuring that short-term rates did not fall too far below the critical floor of 0.25 basis points, despite all the additional liquidity that was pumped into the system.

Contrary to popular understanding, the Fed has in this sense been propping up the short-term rate market, not suppressing it. IOER’s power to steer rates could now be used to help manage money-market rates during the exit process. But IOER’s ability to influence money market rates for depository institutions has come at a cost. The short-term rates market is increasingly bifurcated, as it is only depository institutions that can really benefit from these freely distributed positive rates.

In contrast, non-depository institutions keen on keeping money invested in liquid and safe investments have to fight over an ever-smaller pool of good collateral. This is partly because quantitative easing has sucked a significant sum of quality collateral out of the public market, and partly because the risk averse are less inclined to part with the quality collateral that remains.

Both these changes lead to collateral scarcity in the private money markets, which is important because only the collateral markets can provide deposit-like safe investments, without unsecured bank credit risk, for non-depository institutions. This has caused a disruption in the market for repurchase (repo) agreements.

In a repo trade, an institution either pledges collateral for funding and pays for the privilege to receive those funds, or alternatively – on the other side of the trade – receives collateral as a guarantee for funds lent out.

Collateral shortage lowers the repo rate; collateral abundance increases it. In today’s market, repo rates arguably represent the true cost of money for non-depository institutions that do not have access to the Fed’s reserve system.

A central bank such as the Fed can try to dictate the cost of money by setting target interest rates for unsecured funds, but if the repo markets do not comply, the central bank can in some sense be judged to have lost control.

While the Fed has managed to influence the cost of Fed funds for depository institutions – in large part due to IOER, it has found it much harder to ensure those rates are available to all parts of the market.

In fact large cash positions of such non-banks in the midst of collateral shortage have now started to influence the key Fed funds rate, seeing it trade below the IOER “floor”.

But it is not just the Fed that has been suffering from such collateral pressures.

In the eurozone, collateral scarcity in German, French and Dutch short tenor bonds has even seen rates turn negative. The same has also been witnessed in Danish and Swiss bonds. So far the US has managed to avoid rates turning negative because IOER has helped to maintain short-end rates – both money and repo. It has been successful precisely because the average repo rate has tended to be lower than the IOER rate.

It is true that if the Fed was to release collateral and take in money as part of its unwinding process, there is a risk that the repo rate could begin to increase and start to influence market rates widely. However, provided the average repo rate remains near IOER, there is no real reason why other rates should rise precipitously, given the IOER incentive for depository institutions to keep liquidity parked at the central bank.

The repo rate overshooting IOER can lead to inflation, or expectations thereof, since depository institutions may switch liquidity from IOER to repo markets, thereby increasing the money multiplier. This is why any unwind should be focused on steering collateral to those non-bank areas that are currently suffering shortages, depressing rates, rather than to depository institutions whose cost of money can continue to be much more effectively controlled by using IOER. The Fed has been developing tools to do just that, including a programme of trading repo directly with large money market funds.

Manmohan Singh is a senior economist at the International Monetary Fund; views expressed are his own and not those of the IMF

Copyright The Financial Times Limited 2013.