February 17, 2015 6:52 pm

Unbalanced hopes for the world economy

Martin Wolf

It is futile to ignore the reality that we have an integrated global system

Ingram Pinn illustration
Why is the dollar so strong? It has soared 25 per cent on a real trade-weighted basis in the past four years, evoking memories of ascents in the early 1980s and again at the turn of the millennium. In the previous cases, the result was a widening of trade and current account deficits. What might be the outcome this time?

The answer to the first question is that the US has far stronger demand, relative to potential output, than the other big economies — the eurozone, China and Japan. The answer to the second is that it will impose strong deflationary pressure and weaken demand for US output, making it harder to tighten policy than the Federal Reserve imagines.
As Daniel Alpert of Westwood Capital notes: “No economy is an island.” This realisation is what was missing from the analysis of the current state of the eurozone offered last week by Jürgen Stark, a former member of the board of the European Central Bank. He argued:

“Germany has reliably pursued a prudent economic policy. While others were living beyond their means, Germany avoided excess.” Yet income and spending has to add up across the world economy. Some can live within their means only because others do not. The prudent depend on the imprudent.
Moreover, what one saw inside the pre-crisis eurozone was the combination of low interest rates with a burgeoning of cross-border net lending. As Michael Pettis of Peking University argues, it is nearly certain that the soaring excess of savings over investment in Germany caused excess borrowing and spending elsewhere.
The global economy is an integrated system. Ignoring that reality is futile. At present, among the most important realities is the chronic weakness of private sector demand relative to potential incomes, in important economies.

Martin Wolf 1

People who doubt this need only ask themselves how long-term nominal and real interest rates have remained so low so long. This is not the result of quantitative easing — a largely irrelevant bogeyman, as can be seen from the fact that rates are also low in the US and the UK, where central banks are no longer creating money to buy assets. The American and British governments can borrow for 30 years at 2.4 per cent and 2.6 per cent, respectively, in nominal terms; and at near zero, in real terms.
Imbalances between private income and desired spending are now huge in the eurozone, China and Japan. All these economies would be helped by running far larger current account surpluses. All are running, or are likely to run, monetary and other policies that might bring about just this result. The counterparts for these surpluses cannot now be emerging and developing countries: they are not creditworthy enough. The ideal counterparts are countries that can bear the risks of large net capital inflows. By far the most capable is the US, because of its size and ability to borrow in dollars, which remain the world’s money.

The drivers in each of these three giants are strong. In all three, the result is progressive easing of monetary policy, radically so in Japan and the eurozone.

Martin Wolf 2

In the eurozone, the “sudden stop” in lending to the vulnerable economies triggered crises and then retrenchment in both private and public sectors. In the absence of any offsetting expansion in the creditor countries — culturally, impossible, one is told — the eurozone as a whole has struggled to become a bigger Germany. Between 2008 and 2013, the current account of the eurozone swung from a small deficit to a surplus of 2.8 per cent of gross domestic product. This cushioned the collapse in GDP: while real domestic demand shrank by 5.9 per cent between the first quarter of 2008 and the first quarter of 2013, real GDP shrank by 3.5 per cent (although the drop was hardly small).

Today, the monetary policies of the ECB will work only if the falling euro helps promote a boom in net exports. It is hard to believe in a sustainable domestic spending boom, given the large debt overhangs in vulnerable countries, the absence of fiscal expansion and the fact that households and businesses in creditor countries are reluctant to spend.

China faces similar challenges. In the run-up to the crisis, it balanced the economy by running a trade surplus that peaked at 9 per cent of GDP in 2007. In the aftermath of the crisis, it replaced lost exports with a huge credit-fuelled investment boom, which saw investment rise to half of GDP — unsustainable in an economy whose rate of growth is falling rapidly.

How will China now manage its excess supply of savings without suffering a deep recession?

The answers are likely to include a rise in trade surpluses, promoted by a weakening exchange rate.

Martin Wolf 3

Finally, there is Japan. There, the corporate sector is the main source of excess savings. But, unlike Germany, Japan has been willing to offset the huge financial surplus of the corporate sector with a huge financial deficit in the public sector, the result being exceptionally high levels of government debt. Today’s ultra-loose monetary policy will not eliminate the excess savings.

A resurgence in the current account surplus would, however, alleviate the consequences. Again, the strong dollar and weak yen can only help the cause.

In a world in which the private sectors of big economies suffer chronic demand deficiency syndrome, we are sure to see a hunt for such scraps of demand as exist. In its World Economic Outlook of October 2008, the International Monetary Fund analysed the fall in the global imbalances and was inclined to believe that it would last (see chart). This may prove too optimistic. At the very least, US spenders will, once again, have to pull not only their own economy but much of the rest of the world. This time, this is unlikely to work for very long. It is also going to be quite hard work. The Fed must take due note.

Population Decline and the Great Economic Reversal

February 17, 2015 | 09:52 GMT 

By George Friedman

In recent weeks, we have been focusing on Greece, Germany, Ukraine and Russia. All are still burning issues. But in every case, readers have called my attention to what they see as an underlying and even defining dimension of all these issues — if not right now, then soon. That
dimension is declining population and the impact it will have on all of these countries. The argument was made that declining populations will generate crises in these and other countries, undermining their economies and national power. Sometimes we need to pause and move away from immediate crises to broader issues. Let me start with some thoughts from my book The Next 100 Years.

Reasons for the Population Decline

There is no question but that the populations of most European countries will decline in the next generation, and in the cases of Germany and Russia, the decline will be dramatic. In fact, the entire global population explosion is ending. In virtually all societies, from the poorest to the wealthiest, the birthrate among women has been declining. In order to maintain population stability, the birthrate must remain at 2.1 births per woman. Above that, and the population rises; below that, it falls. In the advanced industrial world, the birthrate is already substantially below 2.1. In middle-tier countries such as Mexico or Turkey, the birthrate is falling but will not reach 2.1 until between 2040 and 2050. In the poorest countries, such as Bangladesh or Bolivia, the birthrate is also falling, but it will take most of this century to reach 2.1.

The process is essentially irreversible. It is primarily a matter of urbanization. In agricultural and low-level industrial societies, children are a productive asset. Children can be put to work at the age of 6 doing agricultural work or simple workshop labor. Children become a source of income, and the more you have the better. Just as important, since there is no retirement plan other than family in such societies, a large family can more easily support parents in old age.

In a mature urban society, the economic value of children declines. In fact, children turn from instruments of production into objects of massive consumption. In urban industrial society, not only are the opportunities for employment at an early age diminished, but the educational requirements also expand dramatically. Children need to be supported much longer, sometimes into their mid-20s. Children cost a tremendous amount of money with limited return, if any, for parents. Thus, people have fewer children. Birth control merely provided the means for what was an economic necessity. For most people, a family of eight children would be a financial catastrophe. Therefore, women have two children or fewer, on average. As a result, the population contracts. Of course, there are other reasons for this decline, but urban industrialism is at the heart of it.

There are those who foresee economic disaster in this process. As someone who was raised in a world that saw the population explosion as leading to economic disaster, I would think that the end of the population boom would be greeted with celebration. But the argument is that the contraction of the population, particularly during the transitional period before the older generations die off, will leave a relatively small number of workers supporting a very large group of retirees, particularly as life expectancy in advanced industrial countries increases. In addition, the debts incurred by the older generation would be left to the smaller, younger generation to pay off. Given this, the expectation is major economic dislocation. In addition, there is the view that a country's political power will contract with the population, based on the assumption that the military force that could be deployed — and paid for — with a smaller population would contract.

The most obvious solution to this problem is immigration. The problem is that Japan and most European countries have severe cultural problems integrating immigrants. The Japanese don't try, for the most part, and the Europeans who have tried — particularly with migrants from the Islamic world — have found it difficult. The United States also has a birthrate for white women at about 1.9, meaning that the Caucasian population is contracting, but the African-American and Hispanic populations compensate for that. In addition, the United States is an efficient manager of immigration, despite current controversies.

Two points must be made on immigration. First, the American solution of relying on immigration will mean a substantial change in what has been the historical sore point in American culture: race. The United States can maintain its population only if the white population becomes a minority in the long run. The second point is that some of the historical sources of immigration to the United States, particularly Mexico, are exporting fewer immigrants. As Mexico moves up the economic scale, emigration to the United States will decline. Therefore, the third tier of countries where there is still surplus population will have to be the source for immigrants. Europe and Japan have no viable model for integrating migrants.

The Effects of Population on GDP

But the real question is whether a declining population matters. Assume that there is a smooth downward curve of population, with it decreasing by 20 percent. If the downward curve in gross domestic product matched the downward curve in population, per capita GDP would be unchanged.

By this simplest measure, the only way there would be a problem is if GDP fell more than population, or fell completely out of sync with the population, creating negative and positive bubbles. That would be destabilizing.

But there is no reason to think that GDP would fall along with population. The capital base of society, its productive plant as broadly understood, will not dissolve as population declines. Moreover, assume that population fell but GDP fell less — or even grew. Per capita GDP would rise and, by that measure, the population would be more prosperous than before.

One of the key variables mitigating the problem of decreasing population would be continuing advances in technology to increase productivity. We can call this automation or robotics, but growths in individual working productivity have been occurring in all productive environments from the beginning of industrialization, and the rate of growth has been intensifying. Given the smooth and predictable decline in population, there is no reason to believe, at the very least, that GDP would not fall less than population. In other words, with a declining population in advanced industrial societies, even leaving immigration out as a factor, per capita GDP would be expected to grow.

Changes in the Relationship Between Labor and Capital

A declining population would have another and more radical impact. World population was steady until the middle of the 16th century. The rate of growth increased in about 1750 and moved up steadily until the beginning of the 20th century, when it surged. Put another way, beginning with European imperialism and culminating in the 20th century, the population has always been growing.

For the past 500 years or so, the population has grown at an increasing rate. That means that throughout the history of modern industrialism and capitalism, there has always been a surplus of labor. There has also been a shortage of capital in the sense that capital was more expensive than labor by equivalent quanta, and given the constant production of more humans, supply tended to depress the price of labor.

For the first time in 500 years, this situation is reversing itself. First, fewer humans are being born, which means the labor force will contract and the price of all sorts of labor will increase.

This has never happened before in the history of industrial man. In the past, the scarce essential element has been capital. But now capital, understood in its precise meaning as the means of production, will be in surplus, while labor will be at a premium. The economic plant in place now and created over the next generation will not evaporate. At most, it is underutilized, and that means a decline in the return on capital. Put in terms of the analog, money, it means that we will be entering a period where money will be cheap and labor increasingly expensive.

The only circumstance in which this would not be the case would be a growth in productivity so vast that it would leave labor in surplus. Of course if that happened, then we would be entering a revolutionary situation in which the relationship between labor and income would have to shift.

Assuming a more incremental, if intensifying, improvement in productivity, it would still leave surplus on the capital side and a shortage in labor, sufficient to force the price of money down and the price of labor up.

That would mean that in addition to rising per capita GDP, the actual distribution of wealth would shift. We are currently in a period where the accumulation of wealth has shifted dramatically into fewer hands, and the gap between the upper-middle class and the middle class has also widened. If the cost of money declined and the price of labor increased, the wide disparities would shift, and the historical logic of industrial capitalism would be, if not turned on its head, certainly reformulated.

We should also remember that the three inputs into production are land, labor and capital. The value of land, understood in the broader sense of real estate, has been moving in some relationship to population. With a decline in population, the demand for land would contract, lowering the cost of housing and further increasing the value of per capita GDP.

The path to rough equilibrium will be rocky and fraught with financial crisis. For example, the decline in the value of housing will put the net worth of the middle and upper classes at risk, while adjusting to a world where interest rates are perpetually lower than they were in the first era of capitalism would run counter to expectations and therefore lead financial markets down dark alleys.

The mitigating element to this is that the decline in population is transparent and highly predictable.

There is time for homeowners, investors and everyone else to adjust their expectations.

This will not be the case in all countries. The middle- and third-tier countries will be experiencing their declines after the advanced countries will have adjusted — a further cause of disequilibrium in the system. And countries such as Russia, where population is declining outside the context of a robust capital infrastructure, will see per capita GDP decline depending on the price of commodities like oil. Populations are falling even where advanced industrialism is not in place, and in areas where only urbanization and a decline of preindustrial agriculture are in place the consequences are severe.

There are places with no safety net, and Russia is one of those places.

The argument I am making here is that population decline will significantly transform the functioning of economies, but in the advanced industrial world it will not represent a catastrophe — quite the contrary. Perhaps the most important change will be that where for the past 500 years bankers and financiers have held the upper hand, in a labor-scarce society having pools of labor to broker will be the key. I have no idea what that business model will look like, but I have no doubt that others will figure that out.

Copper: A Lot Of Red In Store For The Red Metal

  • A good week for a weak commodity.
  • An ugly medium-term picture.
  • The global economic landscape is not positive.
  • Dr. Copper is likely to be a patient.
Copper is a metal that is a barometer for global growth. As a raw material with applications for infrastructure building around the world, copper has had a rough time since it broke through long-term support at $2.72 per pound back on January 13. In fact, since breaking that key level, the red metal has not even come close to testing what has now become the major resistance level for the commodity. Last week, as the U.S. dollar corrected a bit lower, the price of copper moved marginally higher. However, the upward momentum of the key industrial commodity was tepid at best and a disappointment to any waiting for a recovery in the price of the metal.

A good week for a weak commodity

Copper did rally last week; it closed on Friday February 13 at $2.6050 per pound up 1.95 cents on the week.

(click to enlarge)

Since copper fell through support in January, it has been in a sideways trading range between lows of $2.4190 and highs (made Friday 2/13/15) at $2.6420. Copper continues to trade at the lowest price since the summer of 2009. Open interest, the total number of open long and short positions on COMEX copper futures, has increased as the price fell. Open interest currently stands at 186,022 contracts, which is an increase of just under 16% for 2015. A momentum indicator, the slow stochastic, is currently bullish reflecting the recent price recovery however it has moved into overbought territory. Relative strength for copper is neutral, recovering from oversold territory. After a spike in volatility when the price fell in January, daily historical volatility has dropped back down to 23% from over 40%, which is more reflective of historical norms and closer to monthly historical copper volatility, which currently stands at 17%. There is presently a mixed technical picture for copper, however, while the price has staged a recovery, it has yet to challenge the level from which it broke down and remains more than 10 cents below the $2.72 resistance level. The technical picture for copper is not very bullish nor is the fundamental state of the market at this point.

An ugly medium-term picture

One of the problems facing many industrial commodities these days is rising inventories. We witnessed this in iron ore where increased production led to big inventories; lower prices followed. The same happened in crude oil where huge inventories caused prices to halve over a nine-month period. A quick look at a short-term trend in copper inventories held on the London Metal Exchange (LME) illustrates a similar problem for the red metal.

(click to enlarge)

Over the past 30 days, LME copper stocks have increased from 194,000 metric tons to 295,300 - an increase of over 52% in a month. Granted, some of the metal that has come into the official reported stock numbers was probably sitting in warehouses as off-warrant material but the increase is big enough for us to take notice.

China is the world's number one consumer of copper. Last year growth in China was a disappointment at 7.4%. The Chinese government recently announced a policy, which they call the "new normal." Under this policy, which tempers growth expectations, the government seeks Chinese growth at a sustainable pace. As part of the policy, the government will be stimulating the economy through lower interest rates and investing in the country while at the same time cracking down on corruption. This brings into question the practice of financing copper in China, which has created demand for the red metal in recent years. These financing deals used copper as collateral in order to arbitrage between interest rates in China and the rest of the world. China has cracked down on this practice after discovering that several of the financing deals were fraudulent. This has decreased demand for physical copper in China. At the same time, lower copper prices have affected collateral value in other financing deals forcing the sale of the copper held as collateral. This has increased copper inventories and led to lower prices.

Therefore, each time copper spikes lower, the potential for collateral liquidation increases. Given rising LME stocks, a slowdown and in some cases unwind of copper financing deals in China and a generally lethargic global economy, the medium-term picture for the red metal remains ugly.

The global economic landscape is not positive

Lower growth in China, the world's largest consumer of copper, continues to weigh heavily on the metal. Add to that deflationary pressures in Europe and the picture gets even bleaker.

While the United States is a bright spot in the global economic landscape, the industrial demand for copper on a global basis is likely to continue to suffer. While interest rates will remain low in Europe due to the recently instituted policy of quantitative easing and rates may move lower in China, copper continues to be a dollar-based commodity. As such, the prospect for higher short-term U.S. interest rates is yet another negative for the red metal.

Lower energy prices will cut the overall production cost for copper. However, major producers are likely to sell more metal as the price moves lower in order to secure market share and keep cash flow levels stable. Codelco, the Chilean company that is the world's largest copper producer, recently announced it is planning to reduce costs by $1 billion in 2015. The company plans to trim costs by renegotiating energy expenditures due to lower oil prices and by boosting copper production by 35,000 tons this year. Codelco's CEO Nelson Pizarro recently told reporters that the slump in the price of copper is not dampening their expansion plans. By 2018, the company plans to invest $22 billion in its mining operations. Codelco produces roughly 10% of the world's annual copper supply, and to maintain market share, they need to expand operations and replace mines with dwindling ore grades with new ones in order to stabilize and increase annual output. Other top copper producers including BHP Billiton (NYSE:BHP) (NYSE:BBL), Rio Tinto (NYSE:RIO), Glencore (OTCPK:GLNCY) and others are all investing in new copper mining projects around the globe in order to boost production. These low-cost producers are likely to sell more copper the lower prices fall to maintain market share and force high-cost producers out of the game.

Dr. Copper is likely to be a patient

While copper is struggling to crawl back up to the price level it broke down from last month, the fundamental picture continues to look bearish. A combination of factors is likely to weigh on the price of the red metal in coming months. Continued global deflationary pressures, lower growth in China, a crackdown on financing deals using the metal, lower production costs and producers willing to sell more metal at lower prices is not bullish for the red metal.

Right now, it seems that the global economy is the doctor and copper is the patient, the prognosis is not positive for the medium term. I expect the price of copper to continue to fall in 2015; my initial target is the $2 per pound level. There is more red ink in store for the red metal this year

Is Another Banker Bust Coming?

By: Captain Hook
Tuesday, February 17, 2015

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, February 2, 2015.

So we got a sell signal on the January Barometer this year yet again, with stocks being down on the month; however, as speculated previously, it may not be a contrary indicator this time around. As you may know, the stock market was down Friday because of a hawkish statement out of a chief Fed mouthpiece, James Bullard. The question then arises, why did he do this if he knew stocks would not like what they heard? Answer: Because given the truly fragile state of the US economy, being almost completely hollowed out, the bond market is more important, bonds and the dollar($). The liquidity junkie the US economy has become is now at a point where it needs a fix every day.

And just about everybody in the money game knows this by now, or at least they should.

Certainly those expecting never-ending money printing do, expecting the party to go on forever.

And it's the third year of the Presidential Cycle, with the odds heavily in favor of gains into the September area; not to mention it's a year ending in 5, where stocks have been up for the past 100-years with no exceptions. So, on the surface there are good reasons to think stocks should be up again this year if one is naïve. Because when not scripting official storyline for the mainstream media, even Fed members know they can't keep this act up forever, not once they lose dollar hegemony demand.

Because again, money flow is imperative in a vibrant economy, and if it's not coming from constituents, central authorities must make up the difference via fiat. Another aspect, which is not discussed anywhere near as much, but is equally important, is the integrity of market mechanisms, where it should be understood that with high frequency trading (HFT) machines programmed to exploit human frailties (sentiment), along with the interventions, for all intents and purposes Western markets are completely broken today in terms of real world supply / demand price discovery function. Thus, if the wrong cocktail were to finally arrive for Western price managers one day, worldly constraints that finally supercede manmade (paper / contrived) machinations, the status quo could be put on life support far quicker than officials can envision at the moment.

Below is analysis on how a lasting turn off developments in the tech sector appear to developing for last week I want to include again because they remain germane, as follows:

"And while increasing measures to thwart a lasting turn lower in stocks should be expected by the status quo; and, speculators may act predictably by returning to negative betting practices, still, 2015 is shaping up to be a transition year back to secular real trends, which are (on a macro level) stocks down and precious metals higher, as not only will the populous lose faith in government at some point (which is what causes gold to go up), but this will also lead to higher prices as the world eventually begins to lose faith in America, and its currency, the dollar($).

Therein, at some point the fact the US looks like the safest room in a burning house won't matter because decentralization forces, forces that will bring on more regionalized trading relationships, will take over. This has been my thesis for some time now.

In terms of the coming week, with the marked increase in the NDX open interest put / call ratio last week, we are likely to see more sideways price action in the broads until options expiry this coming Friday. After that, we have a five-week options cycle running into February, which means anything can happen up until month's end no matter what the larger options related world says about sentiment. Updated short interest numbers will be out on Thursday this week, making them particularly important this time around because they should govern the trade between then and month's end given options influence will be curtailed with the extended cycle for the February series.

Therein, if we see a preponderance of continued declines in key short interest ratios, this would suggest a higher probability of weakness running into month's end, especially if the NDX (NASDAQ 100) / Dow Ratio is still sporting a head and shoulders pattern at that time. (i.e. now it's a double top.)

Such an outcome could trigger the head and shoulders pattern (H&SP) (now it's a diamond, which could be more profound than originally contemplated) in the SPX (measuring to who knows what now) that could be go slanted, if the S&P 500 (SPX) decides to go to new highs this week in testing the bottom of the long-term growth channel (see Figure 3), which is unlikely.

This could happen latter on, beginning next month if the $ decides to continue spiking higher (this is unlikely now with its continued strength), meaning a decline in equity markets of this degree could spark a rush out of other currencies / economies / equities, which would benefit the US once again."

Continuing into this week now, and again, as postulated in last week, we have the Dow / Gold Ratio (DGR) impulsing lower in what appears to be a larger degree five-wave affair off a triple top that could easily morph into a head and shoulders pattern, removing any possibility stocks can move to new highs once again within the present sequence. Therein, it should be noted that like the NDX and SPX, the Dow is also working on a diamond top, where if it were to break lower accompanied by the Bank Index (see below) putting in a bearish five-wave impulse lower, we would have true confirmation stocks are trending lower. (i.e. after the BKX goes back up to correct the five-waves down, meaning the diamond breakdown may appear false at first, similar to the year 2000 sequencing, where it took months of testing before the Dow accelerated lower.) As you will see below, the precious metals believe the breakdown in stocks is going to happen, possibly because our banker buddies and status quo have finally met their match in Greece (oops - looks like we can add France to what is likely to be a growing list). (See Figure 1)

Figure 1

All it would take to signal a lasting turn is a monthly breakout on the CBOE Volatility Index (VIX) to signal this, where as you can see below, it's poised to do so in February. In finishing above 20 this past month, it has, for the first time since 2011, triggered a buy signal. What's more, and another technical feat not witnessed since 2011, we also had the S&P 500 (SPX) / CBOE Volatility Index (VIX) Ratio close below the 21-month exponential moving average (EMA) two-months in a row, which historically has served as an early warning of a trend change. So, although 2015 is supposed to be an up year if you are reading the traders almanac, if early constraints and gambler betting practices are not aligned in the stars, the status quo boys could be in for quite a surprise this year. Therein, although this might not be a crash scenario for stocks with the Fed ready to jawbone them back up on a daily basis, still, it would not be good for an economy addicted to ever rising prices, never the less. (See Figure 2)

Figure 2

So if this is true, that the broad stock market could see declines this year, but well short of a crash, if the Dow / Gold Ratio (DGR) has turned lower for real (back on secular trend), then maybe, just maybe, the big money will be made in precious metals this year, and more specifically beaten down but well positioned juniors. Because I mean some of these stocks have been nothing short of obliterated due to an assortment of factors, not the least of which is solvency of course. This is why it's important to buy the good ones, companies with strong balance sheets that are positioned to springboard with a turn in sentiment. Up to this point I thought the juniors should be avoided until the CDNX got down to 400 (this is still my target led by the oils which are still overvalued), my long-term target based on the head and shoulders pattern in the trade, however I am not so sure this is such a good idea anymore considering the above reasoning, the monthly signals some of these stocks produced in January, and bullish looking technical formations in some of the charts discussed in our last meeting. (See Figure 3)

Figure 3

Further to this, what is particularly constructive about the current move higher in precious metal stocks in general is the fact the larger caps are leading, showing proper respect for risk has returned to the sector. Therein, the GDX has recovered the 200-day MA, where as the GDXJ has not. What's more, while the monthly candle for the GDX was strong, closing the month close to the highs, again, the GDXJ did not, compounded by the fact gamblers took the open interest put / call ratio up considerably on Thursday. Of course, this will make it very difficult for the bureaucracy's price managers to keep any kind of panic in the sector for very long - not if the shares catch a bid again - which is what will happen if the gamblers have turned bearish for real. You will remember I said it would take the gamblers turning bearish on the sector when the deflation talk started circulating, and here we are - the speculators continue to provide the correct contrary signal.

And on top of all that, based on the way gold bounced on Friday in spite of dismal COT numbers, like many stocks across the sector, this opens the possibility of an inverse head and shoulders pattern forming here too, measuring up to $1550. That being said, gold will need to continue consolidating for some time yet while the long futures speculators are burned off to a sufficient degree (think 50 to 70 thousand contracts) before this can become a reality no matter how bullish the fundamentals are getting. This does not mean gold has significant downside from here, however it will likely need to go sideways to somewhat lower in order to get the futures market aligned properly to support a continuation higher. It's the interplay between good and evil if you will, the manipulative influence of a faulty and fraudulent Western pricing mechanism (COMEX), against the fundamentals.

So, the idea is to be picky and patient here, going with the best prospects, because who knows, if COMEX speculators don't puke up their positions fast enough, and the heat comes off, failure could still occur. With the COT related raid on gold and silver last week (which we warned about several times), the status quo boys got what they wanted. Stocks didn't crash and precious metals are still contained, and they will do anything to keep it that way. (ex. the big margin increase on silver last week.) Again, this is why it's so important for the BKX to make that final drop in tracing out the larger degree five-wave pattern. (See above.) This will not only set the head in the potential triple top head and shoulders pattern in the DGR discussed these past weeks, but also, and more importantly, this would signal the bankers boys have lost control because their currency (stocks) would be trending lower in what could possibly be a fatal move for some.

Fast forward to today, and although the BKX may not make new highs along with the broad measures of stocks (because of not enough short sellers / put buyers to generate a dynamic short squeeze), still, the banker boys have escaped doom once again temporarily - but this pulling a money out of their collective butt business will end at some point (when short sellers / put buyers of broad stock measures become exhausted).

So in the interim, the banker boys and their ilk have yet another temporary reprieve.

Enjoy it because it won't last.

Markets Insight

February 18, 2015 4:58 am
Sub-zero bonds will change risk calculation
The hunt for yield is entering new territory. The European Central Bank’s landmark decision to unleash quantitative easing marks the beginning of a precarious phase in this erratic financial cycle.
Precarious because the move appears to eliminate the distinction between what is risky and what is safe.
Government bonds may have been tolerable investments when their yields were near zero, but they are unlikely to be so now. Buying sovereign debt today often means locking in a loss at redemption.
That is not to say yields cannot dip further into negative territory. The ECB, some tightly-regulated financial institutions and banks could continue to buy government debt whatever the price. And should deflation prove a more stubborn foe than central banks envisage, sovereign bond yields could indeed fall further.
But the predicament facing investors in need of some capital protection is the toughest in living memory.

Thanks to central banks’ increasingly aggressive financial repression — the deliberate driving down of interest rates to levels below inflation — negative bond yields have never been so widespread.

After the ECB went public with its QE plan, nominal bond yields turned negative across vast swaths of the sovereign debt market.

At one point, about 16 per cent of the bonds in JPMorgan’s government bond index, some $3.6tn, and one in four eurozone sovereign bonds were offering negative yields.

Meanwhile, investors wishing to lend money to the Swiss government over a period up to 10 years have found themselves having to pay for the privilege. The trend has also spread to the corporate debt market, where yields on consumer food group Nestle’s four-year euro bonds briefly fell below zero.

It is doubtful that investors can put up with this for much longer. To avoid an almost certain loss, it is possible they will end up taking on more risk.

There is a large body of evidence testifying to investors’ powerful aversion to loss. This was demonstrated more than 30 years ago by the behavioural economist and Nobel laureate Daniel Kahneman, who found individuals were prepared to take on more risk than normal if the alternative — doing nothing — meant accepting a loss. Tellingly, the pain of a $100 loss was found to be far more intense than the satisfaction from a $100 gain.

In other words, when the probability of suffering a loss is high, individuals’ natural aversion to risk gives way to a powerful risk-seeking impulse. This is the central tenet of Prospect Theory.

From this vantage point, it is easy to see how investors might respond to central banks’ latest dose of financial repression. Asset classes once considered risky could plausibly acquire haven-like qualities,
There are certainly plenty of candidates vying for the title of new haven. This is another distinguishing feature of this financial cycle: unlike the deflationary periods of the past, investors are spoilt for choice when it comes to fixed income investment options.

Emerging market sovereign bonds are contenders — developing economies remain less indebted than their developed counterparts, possess favourable demographics and are probably better governed than they have ever been.

Corporate bond markets, meanwhile, are evolving into a rich hunting ground, particularly in Europe, where bonds are replacing loans as the funding vehicle of choice for a wide array of companies. And so far, default rates have remained well below the historical norm.

Dividend-paying equities — or quality stocks with bond-like characteristics — clearly lie at the riskier end of the spectrum but, as investment flow patterns show, they are favoured for their defensive attributes. Since 2011, net inflows into global equity income funds have averaged €4.2bn per year.

So the blanket search for yield will evolve into a flight from near-certain loss. That is sure to underpin the prospects for credit securities and defensive stocks over the medium term.

Longer term, the picture might not be quite so healthy. Taking on additional credit will require investors to be more discriminating. The credit standing of high yield companies, for instance, is hardly set in stone.

What is more, as central banks continue to experiment, inflation expectations will probably become more volatile over the long run. Bonds may prove the asset of choice if inflation remains low, but they will not offer capital preservation should it accelerate. Shrewd tactical asset allocation will be a must.

Percival Stanion is head of multi assets at Pictet Asset Management

Greece Isn't Really The Problem

By: John Rubino

Tuesday, February 17, 2015

The euro's fatal flaw was always people. The fact that most eurozone countries are at least nominally democratic and keep having elections means that the more complicated and draconian the process of merging them into one entity ruled by unelected bureaucrats in Brussels becomes, the harder it is to elect people at the national level who want to keep going.

Greece is an obvious example, and will provide some thrills and chills as its debt negotiations lurch to the inevitable extend-and-pretend resolution. But much bigger things are brewing as the euro's issues bite other constituencies in other ways.

In Italy, for instance, the new government recognizes that the country's only chance of functioning under a stable currency is to make serious reforms in pretty much every corner of the economy, especially its almost child-like labor laws. Here's a brief overview of those laws from the National Center For Policy Analysis:

• Cassa Integrazione Guadagni is a scheme that allows Italian businesses who need to shave their workforce to put a worker on "standby" rather than fire him outright. The government will pay the worker a large portion of his lost salary until he is rehired. Such a program keeps workers from moving to new jobs while businesses struggle to compete.

• Firing a worker in Italy for poor performance is incredibly difficult, and employers have to convince a judge that there is no alternative option available to the employer short of firing the worker. These hearings can take months, and litigation is not cheap.

• According to the World Economic Forum, Italy ranked 141st out of 144 countries in terms of its hiring and firing practices.

• Italian unions are stubborn, and businesses -- in order to avoid having to negotiate with them -- stay small. Of all the countries in the European Union, Italy has the largest number of small businesses because companies are concerned about what growth would mean in terms of union negotiations.

But of course the Italians don't like the idea of a free market in work, so they're taking some personal days to make the point. See Hundreds of thousands rally in Rome in protest over 'anti-job' reforms.

Governments, meanwhile, don't like having to deal with dissent, so in Spain and elsewhere they're trying to make it harder to organize -- which simply creates a new issue for demonstrators to protest. See Spaniards take to streets to protest 'draconian' new security laws.

For Germans the situation is a little different because they until recently have benefited from being able to sell things to the big-borrowing eurozone periphery. But now the debt thus created is looking like it will have to be covered by German taxpayers, and they're starting to regret their past decisions. See Angela Merkel's conservatives suffer worst election result since WWII.

So here's a modest prediction. After a bit more brinksmanship, Greece gets an extension and disappears from the headlines for a while. Then the focus shifts to the eurozone's real threats, which are the bigger countries where anti-euro forces on both left and right are gaining popularity. With Podemos (Spain, radical left) and National Front (France, radical right) now leading in opinion polls, sitting politicians will start doing all kinds of crazy things to keep their jobs. Negative interest rates will spread, debt monetization will expand, and the euro will get even weaker.

Then Greece will resurface, having failed to transform itself into a fully-functioning capitalist economy, and the whole thing will start again. But from an even more precarious place.

UPDATE 2-Russian researchers expose breakthrough U.S. spying program

Mon Feb 16, 2015 5:07pm EST

By Joseph Menn

SAN FRANCISCO Feb 16 (Reuters) - The U.S. National Security Agency has figured out how to hide spying software deep within hard drives made by Western Digital, Seagate, Toshiba and other top manufacturers, giving the agency the means to eavesdrop on the majority of the world's computers, according to cyber researchers and former operatives.

That long-sought and closely guarded ability was part of a cluster of spying programs discovered by Kaspersky Lab, the Moscow-based security software maker that has exposed a series of Western cyberespionage operations.

Kaspersky said it found personal computers in 30 countries infected with one or more of the spying programs, with the most infections seen in Iran, followed by Russia, Pakistan, Afghanistan, China, Mali, Syria, Yemen and Algeria. The targets included government and military institutions, telecommunication companies, banks, energy companies, nuclear researchers, media, and Islamic activists, Kaspersky said. (reut.rs/1L5knm0)

The firm declined to publicly name the country behind the spying campaign, but said it was closely linked to Stuxnet, the NSA-led cyberweapon that was used to attack Iran's uranium enrichment facility. The NSA is the agency responsible for gathering electronic intelligence on behalf of the United States.

A former NSA employee told Reuters that Kaspersky's analysis was correct, and that people still in the intelligence agency valued these spying programs as highly as Stuxnet. Another former intelligence operative confirmed that the NSA had developed the prized technique of concealing spyware in hard drives, but said he did not know which spy efforts relied on it.

NSA spokeswoman Vanee Vines declined to comment.

Kaspersky published the technical details of its research on Monday, which should help infected institutions detect the spying programs, some of which trace back as far as 2001. (bit.ly/17bPUUe)

The disclosure could further hurt the NSA's surveillance abilities, already damaged by massive leaks by former contractor Edward Snowden. Snowden's revelations have hurt the United States' relations with some allies and slowed the sales of U.S. technology products abroad.

The exposure of these new spying tools could lead to greater backlash against Western technology, particularly in countries such as China, which is already drafting regulations that would require most bank technology suppliers to proffer copies of their software code for inspection.

Peter Swire, one of five members of U.S. President Barack Obama's Review Group on Intelligence and Communications Technology, said the Kaspersky report showed that it is essential for the country to consider the possible impact on trade and diplomatic relations before deciding to use its knowledge of software flaws for intelligence gathering.

"There can be serious negative effects on other U.S. interests," Swire said.


According to Kaspersky, the spies made a technological breakthrough by figuring out how to lodge malicious software in the obscure code called firmware that launches every time a computer is turned on.

Disk drive firmware is viewed by spies and cybersecurity experts as the second-most valuable real estate on a PC for a hacker, second only to the BIOS code invoked automatically as a computer boots up.

"The hardware will be able to infect the computer over and over," lead Kaspersky researcher Costin Raiu said in an interview.

Though the leaders of the still-active espionage campaign could have taken control of thousands of PCs, giving them the ability to steal files or eavesdrop on anything they wanted, the spies were selective and only established full remote control over machines belonging to the most desirable foreign targets, according to Raiu. He said Kaspersky found only a few especially high-value computers with the hard-drive infections.

Kaspersky's reconstructions of the spying programs show that they could work in disk drives sold by more than a dozen companies, comprising essentially the entire market. They include Western Digital Corp, Seagate Technology Plc , Toshiba Corp, IBM, Micron Technology Inc and Samsung Electronics Co Ltd.

Western Digital, Seagate and Micron said they had no knowledge of these spying programs. Toshiba and Samsung declined to comment. IBM did not respond to requests for comment.


Raiu said the authors of the spying programs must have had access to the proprietary source code that directs the actions of the hard drives. That code can serve as a roadmap to vulnerabilities, allowing those who study it to launch attacks much more easily.

"There is zero chance that someone could rewrite the [hard drive] operating system using public information," Raiu said.

Concerns about access to source code flared after a series of high-profile cyberattacks on Google Inc and other U.S. companies in 2009 that were blamed on China. Investigators have said they found evidence that the hackers gained access to source code from several big U.S. tech and defense companies.

It is not clear how the NSA may have obtained the hard drives' source code. Western Digital spokesman Steve Shattuck said the company "has not provided its source code to government agencies." The other hard drive makers would not say if they had shared their source code with the NSA.

Seagate spokesman Clive Over said it has "secure measures to prevent tampering or reverse engineering of its firmware and other technologies." Micron spokesman Daniel Francisco said the company took the security of its products seriously and "we are not aware of any instances of foreign code."

According to former intelligence operatives, the NSA has multiple ways of obtaining source code from tech companies, including asking directly and posing as a software developer. If a company wants to sell products to the Pentagon or another sensitive U.S. agency, the government can request a security audit to make sure the source code is safe.

"They don't admit it, but they do say, 'We're going to do an evaluation, we need the source code,'" said Vincent Liu, a partner at security consulting firm Bishop Fox and former NSA analyst. "It's usually the NSA doing the evaluation, and it's a pretty small leap to say they're going to keep that source code."

Kaspersky called the authors of the spying program "the Equation group," named after their embrace of complex encryption formulas.

The group used a variety of means to spread other spying programs, such as by compromising jihadist websites, infecting USB sticks and CDs, and developing a self-spreading computer worm called Fanny, Kasperky said.

Fanny was like Stuxnet in that it exploited two of the same undisclosed software flaws, known as "zero days," which strongly suggested collaboration by the authors, Raiu said. He added that it was "quite possible" that the Equation group used Fanny to scout out targets for Stuxnet in Iran and spread the virus.

(Reporting by Joseph Menn; Editing by Tiffany Wu)

Heard on the Street

Central Banks and the Perils of Sub-Zero Conditions

The longer such conditions persist, the greater the risk of perverse consequences

By Richard Barley

Feb. 18, 2015 5:37 a.m. ET

Stefan Ingves, governor of Sweden's central bank which last week cut its main interest rate into negative territory for the first time. Stefan Ingves, governor of Sweden's central bank which last week cut its main interest rate into negative territory for the first time. Photo: Bloomberg News

The monetary-policy anchor keeps on slipping.

Until recently, it was broadly thought that zero was the final frontier beyond which central banks wouldn’t or couldn’t cut interest rates.

But negative rates are now all the rage. The European Central Bank’s deposit rate is negative 0.2%, although its main refinancing rate remains just above zero. The Danish certificate of deposit rate is negative 0.75% in an effort to prevent the krone appreciating. The Swiss National Bank has gone negative to reduce the allure of the franc. The Swedish Riksbank has cut its key rate to negative 0.1% and says it could go further.

Even central bankers who aren’t cutting are thinking about the lower bound. The Bank of England is talking about raising rates. But it still explained last week that if needed, it thinks it could now cut rates below 0.5%, previously a limit it hadn’t wanted to breach for fear of damaging the banking system.

How strange are zero and negative rates? Bond markets are proving that financial math works just the same with negative yields, even if paying a borrower for the privilege of lending to it looks fundamentally odd. The Swedish Riksbank says that cutting rates below zero, at least if the cuts aren't very large, is expected to have similar effects to cuts when the rate is positive. Others go further:

Willem Buiter, Citigroup’s global chief economist and a former Bank of England monetary policy maker, said in a January note that an interest rate of minus 5% should be no harder to set than a positive rate of 5%.

But theory, as ever, can clash with reality. There is some real lower bound: the point at which it becomes rational to hold physical cash rather than putting money in the bank. That rate is below zero, as keeping large amounts of cash is risky, requiring storage, security and insurance.

But it isn’t clear how far below zero it is. There are ways around this, but they are radical: Mr. Buiter suggests abolishing currency as one route. Even with the rise of electronic payment systems, that seems unlikely to make it as a real-world policy option.

One thing to consider is how long negative rates might persist. Brief periods may be regarded as an anomaly. But over time, negative rates could change the behavior of savers and borrowers and the way they make use of the financial system. In a system that is basically set up to operate under positive nominal interest rates, that could be a problema.

More cuts could yet come. The Riksbank says it will be watching for the effect of its first cut as a factor in deciding how much further to go. Many expect further action from the Danish and Swiss central banks.

The upshot is that central bank policy is deep into experimental territory. Experiments can yield valuable insights, but they can also cause accidents.