Buttonwood

Why are investors so relaxed about the tensions in Korea?

The markets have concluded Kim Jong Un and Donald Trump are blusterers


A ROGUE state has tested what may be a hydrogen bomb and has sent a missile over the territory of a neighbouring country. The American president has promised “fire and fury” if threats continue. The Security Council of the United Nations has been locked in debate. This sounds like the plot of a Hollywood thriller or a paperback potboiler in which the world is heading for conflagration.



But international investors are not thrilled, and seem barely disconcerted, by the crisis on the Korean peninsula. Gold has risen a bit, the yield on Treasury bonds has dropped and the MSCI World equity index has fallen since the start of August. However, the moves have not been huge. Even the South Korean stockmarket, surely the most sensitive gauge of war risk, is well above its level at the start of the year.

What explains this remarkable insouciance? One possibility is that the markets may simply not be very good at assessing political risk. After all, investors failed to foresee either the result of the Brexit referendum in Britain or the election of President Donald Trump.

Another possibility is that investors have learned in recent decades that geopolitical events—from the September 11th attacks and the invasion of Iraq to countless presidential elections—tend to have only very short-term impacts on the markets. Economic growth and corporate profits are far more important factors. For investors who use algorithms to trade, political risk probably has very little bearing on their calculations.

Go back far enough, however, and it is possible to find political events with huge financial ramifications—after revolutions in their countries, the Russian and Chinese governments defaulted on their debts, for example. A war that engulfed the Korean peninsula, dragging in China and Japan as well, would surely be one of those “fat tail” events that the models struggle to assess. But a few brave analysts are now trying to contemplate the effects.

Besides the terrible humanitarian cost in both North and South Korea, there could be immense damage in certain industries. The global economy is a lot more integrated than it was during the Korean war of 1950-53. Capital Economics points out that South Korea produces 40% of the world’s liquid-crystal displays and 17% of its semiconductors. If Japan was the target of missile strikes from North Korea, as it might be, the disruption would be even greater. A war with conventional weapons would be bad enough; the lasting impact of nuclear weapons’ use would be immense.

The limited reaction of investors to this terrible possibility suggests that they do not believe it will happen and that they feel the heightened rhetoric on both the American and North Korean sides is simply bluster. A recent example was a tweet from Mr Trump on potential trade sanctions. Rabobank, a Dutch bank, says that American counter-threats are not perceived to be credible. “The distinctly limited likelihood of the US cutting all trading links with China should the country continue to do business with North Korea is a case in point,” the bank adds.

Just because a war would have disastrous economic consequences may not prevent political leaders from stumbling into conflict, either by accident or because they have other priorities. In 1909, Norman Angell wrote a book called “The Great Illusion” which posited that war between nations would be futile because of their economic interdependence. Five years later, war broke out anyway.

But in the early 20th century, many nations were still ruled by hereditary monarchs, for whom economic issues were not the highest priority. By the late 20th century, most developed countries were ruled by professional politicians who recognised that economic success was their surest route to staying in office. Recent conflicts in Afghanistan and Iraq did not involve the same level of commitment as either the Korean and Vietnam wars, and thus did not have big economic consequences. This may help explain investors’ confidence that geopolitics will not interrupt the flow of goods and capital.

It is possible, in an age of populism and greater nationalism (and at a time when American hegemony is being challenged by China), that the calculations of political leaders have changed again, making conflict more likely. But no amount of number-crunching based on past data can properly assess whether this is the case; it is a judgment call. Investors have decided that a Korean conflict will not happen. Cross your fingers that this is one case where the “wisdom of crowds” will be proved right.


Big fingers

Financial-market index-makers are growing in power

Their role is facing greater scrutiny as a result
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IT WAS in 1896 that Charles Dow, co-founder of Dow Jones & Company, created the index that still bears his name. Today, indices such as the Dow Jones Industrial Average and the S&P 500 (for shares listed in New York), or the FTSE 100 (for London), are among the best-known brands in financial markets. The role they play has expanded massively in recent years. Index-makers have become finance’s new kingmakers: arbiters of how investors should allocate their money.
 
Stockmarket indices were devised as a measure of the overall market, against which those trading in shares could compare their performance. At first they were concocted by the press or by exchanges themselves. For bonds, indices were compiled by the banks that traded them.
 
Except for a few of the very earliest indices, such as the Dow, which is weighted by share price, nearly all are weighted by market capitalisation or, in the case of bond indices, by the volume of debt outstanding.
 
Three large firms—FTSE Russell, MSCI and S&P Dow Jones Indices—dominate equity index-making. The amounts of money they influence are staggering. S&P Dow Jones reckons $4.2trn in assets are invested in “passive” funds that track its indices, with $3trn assigned just to the S&P 500. Another $7.5trn in actively managed assets use its indices as “benchmarks”: that is, they measure their performance against them. The two other big index-providers command similarly vast sums: $15trn in active and passive money follows FTSE Russell’s indices, and $11trn hug MSCI’s.
 
Index-makers insist they are less powerful than they look. Alex Matturri, head of S&P Dow Jones, points out that even though assets in exchange-traded funds (ETFs), virtually all of which are passive, have reached $4trn globally, that is only a “small part of the global investable universe” (estimated at around $300trn). Mr Matturri also emphasises the transparency and “rules-driven approach” of index construction and governance. Big changes are made only after consulting the market.
 
Moreover, argues Mark Makepeace, chief executive of FTSE Russell, index-making remains very competitive. Some smaller providers, such as Morningstar, give away data on most of their indices (on the weightings of their components, for example). They charge a fee only if a passive fund wants to track an index and use their brand. The big three charge both for access to data and for the use of their indices in passive funds.
 
Regulation also constrains the firms. From January 2018 index-makers in Europe will be directly regulated under the EU’s “Benchmarks Regulation”, which includes requirements such as an annual external audit for benchmarks deemed “critical”, and direct oversight by the EU regulator.
 
Nevertheless, index-makers’ power is considerable. It is boosted by the rise of passive investing.
 
In America, for instance, three-tenths of assets are now in passive funds. And though some smaller competitors survive, the index industry is becoming more concentrated. Many banks have quit the bond-index business, selling their brands. Bloomberg acquired Barclays’ indices last year; FTSE Russell has nearly completed the purchase of Citigroup’s.
 
Despite harping on the objectivity and transparency of their rules, moreover, many of the decisions that index providers make are, ultimately, subjective. Take the decision in June by MSCI to include Chinese shares in its emerging-markets equity index (followed by around $1.6trn in assets). Shares listed in mainland China had been excluded because of the opacity of China’s capital markets, and the restrictions foreigners face there. China’s capital controls remain in place, but, after consulting market participants, MSCI decided to include the shares—albeit at a weighting of only 0.73% (and even that in two phases) so as not to disrupt the index’s composition too quickly.
 
Snap slapped
 
Similarly, both FTSE Russell and S&P, in the wake of Snap’s listing on the New York Stock Exchange in March, chose to alter their rules to exclude companies that list only non-voting shares (as the tech firm did). This stemmed partly from pressure from investors such as Norway’s sovereign-wealth fund. FTSE Russell said that the majority of asset managers it consulted wanted a company’s shares to be included in an index only if the voting power of stockmarket investors passed a threshold of 25%, but the index-maker opted for a lower minimum of 5% and a gradual phase-in, again to avoid disruption.
 
The composition of bond indices has also come under scrutiny. Earlier this year, J.P. Morgan faced calls to exclude Venezuelan bonds from its emerging-market bond index (EMBI) in protest at the misdeeds of the government in Caracas. But index-makers are less mighty in the world of fixed income. Passive investment is less prevalent in bonds than in equities. Moreover, with so many bonds available, fund managers can replicate indices while maintaining some flexibility in the exact choice of assets. A bigger concern with bond indices is their weighting by volume: those who track them end up most exposed to the most indebted borrowers.
 
Index-makers enjoy the prestige that comes from compiling a market’s most recognised benchmark.
 
But they are keener to discuss their work in developing new and different sorts of indices (S&P says it now has over 1m), including for other asset classes. For example, a few indices are starting to provide reliable benchmarks for opaque asset classes like private equity (see box).
 
Other new indices slice up the universe of stocks and bonds in varied ways, such as whether the share prices are undervalued, whether firms are socially responsible or whether they are exposed to specific risks. Kensho, a startup, compiles share indices around trendy themes such as nanotechnology or drones. Some new products bear little resemblance to conventional indice. S&P Dow Jones’s new STRIDE index encompasses different asset classes whose weighting varies over time, to suit the needs of a worker preparing to retire. A few verge on the absurd. This week S&P announced an index containing only companies from which the Indian government wants to divest.
 
For as long as indices have acted as shorthand for the markets they seek to capture, index-makers have received attention. Their importance has grown to match their profile. Being the source of “authoritative guidance” on what should even count as an asset class (as Norway’s sovereign-wealth fund puts it) brings new responsibilities. Index-makers will have to get used to ever more scrutiny.


Major Gold-Stock Breakouts

By: Adam Hamilton



Major Gold-Stock Breakouts

The gold stocks are off to the races again, with big gains mounting.  They just staged major breakouts, shattering a vexing consolidation that had trapped them for an entire year.  Such momentum early in gold’s strong season is a very-bullish portent.  As higher prices improve both technicals and sentiment, buying begets more buying.  With gold-stock prices still quite low in secular terms, their upside remains huge.

Gold stocks are a small contrarian sector without a wide following.  So their latest surge has surprised many investors and speculators.  But it shouldn’t have.  In the markets knowledge is profits, so staying informed about gold stocks’ fundamentals, technicals, and sentiment is crucial.  The traders who did their homework this summer and bought in low when few others were willing are now sitting on fat unrealized gains.

Nearly every summer like clockwork, gold stocks slump to a summer-doldrums low.  Gold miners’ profits and hence ultimately stock prices are driven by prevailing gold prices.  And gold investment demand has always tended to slump seasonally in summers.  On July 7th, the flagship HUI NYSE Arca Gold BUGS Index, which is closely mirrored by the leading GDX VanEck Vectors Gold Miners ETF, hit a demoralizing low of 178.9.

The gold-stock sector was down 1.9% YTD in a year where gold had rallied 5.4% over that span. 

That very day, I published an essay titled Gold Stocks’ Summer Bottom.  I explained why summer gold-stock weakness is a great buying opportunity, concluding “So smart contrarians willing to fight the herd to deploy when it’s unpopular are subsequently richly rewarded when gold stocks’ seasonal rallies march much higher.”

From that typical summer-doldrums low, the HUI has already surged 21.7% higher as of this week! 

But sadly not many traders rode that whole rally, as most people hate buying low.  In early August when just a third of gold stocks’ recent rally had happened, I wrote another essay explaining gold stocks’ bullish autumn seasonals.  This sector has always tended to rally sharply with gold from summer lows into late September.

A week later when less than half of gold stocks’ latest surge was accomplished, I dug into their technicals to illustrate why this sector was a coiled spring.  The gold stocks had just peeked their heads above their key 200-day moving average, and major breakouts were imminent.  Now a month later they have indeed come to pass just as expected.  These big breakouts were highly probable, leading to big profits for the informed.

Now it’s important for all investors and speculators to understand these major breakouts’ significance and implications going forward.  Such events are very bullish, happening early in major new uplegs

This first chart looks at HUI technicals since early 2016, when a new bull market in gold stocks was birthed out of extreme secular lows.  Today’s breakouts are the biggest and most important since February 2016, super-bullish.




Back in mid-January 2016, the gold stocks were universally despised and bearishness was off the charts.  They were battered to fundamentally-absurd 13.5-year secular lows, trading at levels last seen when gold was near $305.  Yet it was actually 3.6x higher at $1087!  Gold-stock prices couldn’t stay radically disconnected from their underlying earnings fundamentals forever, thus that incredible anomaly couldn’t last.

So gold stocks reversed hard and took off like rockets, blasting the HUI 182.2% higher in just 6.5 months!  That certainly left them very overbought last summer, which I warned about at the time.  So they started correcting, which is perfectly normal in all bull markets.  But that healthy correction snowballed to truly monstrous proportions thanks to another epic anomaly.  Trump’s surprise election victory indirectly crushed gold.

Gold investment is so important in all portfolios because gold tends to move counter to stock markets, which is rare.  Gold is effectively the anti-stock trade, the ultimate portfolio diversifier.  So the incredible Trumphoria stock-market surge in the election’s wake decimated gold investment demand.  That dragged the gold stocks far lower than they deserved to be fundamentally.  The HUI plunged 42.5% in 4.4 months.

That left this small sector seriously out of favor as 2016 wrapped up, which was ridiculous.  Despite an ugly Q4, the HUI still blasted 64.0% higher last year!  Gold stocks were the best-performing sector in all the stock markets, yet traders foolishly shunned them.  That irrational hyper-bearish sentiment in the wake of the post-election gold rout bled into 2017.  That trapped the gold stocks in a vexing consolidation.

It is readily evident in this chart, the triangle pattern running for an entire year until recent weeks.  The gold stocks enjoyed some big rallies with gold, but they sequentially failed at lower highs.  That really spooked technically-oriented traders.  But the action wasn’t wholesale bearish, as the gold stocks per the HUI were generally carving higher lows as well.  The result was this massive triangle consolidation pattern.

Unfortunately there wasn’t much hope of a breakout during the summer.  Gold’s summer doldrums lead to parallel sideways action in gold stocks in most summers.  For gold-stock investors, summers are just something to be endured.  They usually end up being barren sentiment wastelands where traders give up on this sector entirely.  So material gold-stock gains in summers are rare, they can’t be expected in any year.

The HUI drifted 3.5% lower in June, really damaging sentiment.  This was much weaker than normal in early summers, as the HUI saw average gains of 1.2% in Junes in the modern bull-market years of 2001 to 2012 and 2016.  Even the HUI’s 5.6% rebound in July, far better than its 0.7% average losses, wasn’t enough to restore sentiment.  So the gold stocks generally drifted lower this summer within that same triangle.

Interestingly the upper resistance line of that big chart pattern closely paralleled the HUI’s important 200-day moving average.  Chart patterns like this triangle consolidation are subjective, they can be drawn in different ways.  So while the general resistance line was evident to all technically-oriented traders, the timing on a breakout wouldn’t be universally recognized.  But 200dmas are hard mathematical constructs.

200dmas are the most-important and widely-followed technical lines in all the markets.  They smooth out the daily volatility to highlight long-term trends.  Prices below their 200dmas are often considered to be in bear markets, leaving traders expecting further weakness.  But once prices forge decisively above their 200dmas, traders assume they are reentering bulls.  That generates bullish psychology which fuels buying.

The HUI first started flirting with its 200dma again in late July.  But it wasn’t until mid-August when it started to break out decisively, closing more than 1% above that key level.  And those gains weren’t solidified until late August, when traders started to realize this 200dma breakout was the real deal and not a head fake.  That 200dma breakout in recent weeks is the most important of the new major gold-stock breakouts.

But because the upper resistance line of that vexing triangle consolidation paralleled the HUI’s 200dma, a simultaneous breakout from that chart pattern happened.  Gold stocks have not rocketed above their bull-bear-psychology-dividing 200dma, or broken a major downtrend resistance line like this, since February 2016.  And that was early in a monster upleg where this sector would nearly triple in just over a half-year!

Major breakouts are so darned bullish because they soon become self-feeding.  The great majority of investors and speculators aren’t contrarians, they lack the discipline and toughness to fight popular fear and buy low.  Instead most prefer chasing momentum, buying where gains are already happening.  So breakouts quickly shift sentiment to bullish which drives a lot more buying.  And that buying expands the breakouts.

In all markets, buying begets buying.  The faster prices rise, the more traders want to buy in to ride the momentum.  The more traders buy in, the faster prices rise.  Major breakouts kindle this virtuous circle of buying, leading to big and growing capital inflows.  Everyone loves winners, and these major gold-stock breakouts are leading to the best gains in the entire stock markets.  Traders are increasingly taking notice.

All this gold-stock buying in recent weeks is just now triggering the most-important technical buy signal of all, the fabled Golden Cross!  Golden Crosses are one of the most-powerful and most-widely-followed signals of new bull markets.  They happen coming out of lows as a 50dma crosses back above a 200dma.  As the white and black lines in this chart show, the first Golden Cross since early 2016 is triggering right now.

That last Golden Cross in February 2016 led to months on end of big capital inflows into the beaten-down gold stocks.  This week’s second Golden Cross ought to lead to a similar outcome.  Recent weeks’ major breakouts have just flashed an irresistible major buy signal to technically-oriented traders.  Whether this is the second major upleg of last year’s bull or an entirely new bull, gold stocks are early in a major rally higher.

Their upside from here remains huge.  That short-term chart above makes it appear like gold-stock prices are getting to the high side, but nothing could be farther from the truth.  This next chart zooms out to the massive gold-stock bear that started in late 2011.  The small shaded zone in the lower right is the entire area of the first chart.  After a brutal secular bear persisting for years, gold stocks’ bull remains little and young.



Between September 2011 and January 2016, the gold stocks as measured by their flagship HUI index plunged a breathtaking 84.1% in 4.4 years!  That colossal bear was driven by an extreme anomaly. 

The Fed’s radically-unprecedented open-ended QE3 campaign levitated the US stock markets, slaughtering demand for alternative investments led by gold.  The gold stocks plummeted on massive gold dumping.

They finally bottomed in epic despair early last year, heralding a new bull market.  It soon staged major breakouts from two separate bear-market resistance lines, which are rendered here.  That young gold-stock bull rocketed higher, leading to that near-triple in about a half-year.  But despite those wicked-fast gains, the gold stocks merely hit a 3.2-year high.  At best they were only back to mid-2013 deep-bear levels.

Even after these major breakouts of recent weeks, the gold-stock sector is still languishing way down at late-bear levels from late 2014.  Bull markets after exceptional bears usually see prices at least revisit the previous bull’s top, which was 635.0 on the HUI in September 2011.  That implies huge upside of 196% remains from even this week’s levels.  What other sector in these overvalued stock markets has tripling potential?

But if fundamentals are strong enough after exceptional bears to support symmetrical bull markets, those tend to ultimately drive prices to new all-time record highs.  I strongly suspect gold stocks’ current bull will run for years, eventually pushing the HUI above its previous peak.  That would take a total gold-stock bull of just 531% from gold stocks’ deep 13.5-year secular low in January 2016.  That’s nothing by this sector’s standards.

During gold stocks’ last secular bull from November 2000 to September 2011, the HUI skyrocketed an epic 1664% higher!  That made early contrarian investors including our subscribers rich.  We only need to see a bull a third as large to propel the HUI back to new all-time record highs.  And the gold miners’ fundamentals already support secular-bull-level gains, as evidenced by their latest quarterly results just reported.

Gold-mining profitability is simply the difference between prevailing gold prices and operating costs.  In Q2’17, the elite gold miners of that leading GDX gold-stock ETF reported average all-in sustaining costs of just $867 per ounce.  That was already $391 below Q2’s average gold price, pure profit.  And at this week’s higher $1339 gold levels, those major-gold-mining profits have already ballooned to a hefty $472!

The smaller mid-tier gold miners of the related GDXJ junior-gold-stock ETF looked nearly as good in Q2, with average AISC of $879.  That implies big profitability of $460 per ounce at this week’s gold prices.  These fat margins coupled with the low gold-stock prices have left many gold miners trading at low price-to-earnings ratios today.  This sector is wildly undervalued fundamentally, supporting a new secular bull market.

Thus odds are the major gold-stock breakouts in recent weeks are merely the beginning of a massive new gold-stock upleg.  As gold stocks keep powering higher, more and more investors and speculators will want to buy in to chase those gains.  Their capital inflows will push this small sector higher still, widening its circle of appeal to even more traders.  Once gold stocks finally get moving, they tend to run for a long time.

Since most traders inexplicably choose to be uninformed, the bullish implications of these major gold-stock breakouts still aren’t widely known.  So it’s certainly not too late to buy in, even though big gains have already been won since summer.  Gold stocks’ strong season tends to run from now until next spring, driven by gold’s own strong season.  The gold stocks will likely be considerably higher by year-end.

This young new upleg should get supercharged as gold investment demand surges when the stock markets inevitably roll over.  With the Fed on the verge of starting to reverse its quantitative easing that levitated stock markets for years with ominous quantitative tightening, that long-overdue major stock-market selloff is likely sooner rather than later.  As gold is bid higher on weaker stocks, gold stocks will soar.

The greatest gains in this young gold-stock upleg won’t be won in the popular ETFs like GDX and GDXJ, as they are far-overdiversified and burdened with way too many under-performing gold miners.  So it’s much more prudent to deploy capital in the best individual gold miners with superior fundamentals.  Their gains will handily trounce the ETFs, further amplifying the already-huge upside potential of this sector as a whole.

The bottom line is gold stocks just enjoyed two parallel major breakouts in recent weeks.  They shattered a vexing consolidation that’s trapped them for a year, and more importantly burst back above their critical 200dma.  The resulting quickly-improving technicals are rapidly shifting sentiment back to bullish, driving more buying as traders return.  Since buying begets buying, major gold-stock uplegs soon become self-feeding.

But since this small contrarian sector is largely ignored, most investors and speculators don’t yet realize how bullish these major breakouts are.  Despite their big gains since early 2016, the gold stocks remain very low and their young bull is still little in secular context.  So it’s not too late to get deployed.  With gold itself likely to rally far higher as these lofty stock markets roll over, gold stocks’ upside potential is huge.


The Post-Crisis Elephant in the Room

Antonio Foglia
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Bank Popular in Spain

LONDON – The global financial crisis that began in August 2007 resulted from a massive, unavoidable cognitive mistake on the part of regulators and bankers. It is now ten years later, and yet few are willing to admit this fact, let alone explore appropriate remedies.
 
In fact, the opposite has happened: regulators have piled on ever-more complex rules, and too-big-to-fail banks have become still bigger. Even worse, the wrong-headed response to the crisis threatens not just the financial sector, but open societies generally.
 
To be sure, the financial crisis had different catalysts in different countries, including subprime loans, real-estate bubbles, sovereign debt, and economic downturns that affected small and medium-size enterprises. But there was also a common denominator: a structural weakness in the banking sector – already one of the economy’s most regulated sectors – that left highly regulated banks unable to withstand economic perturbations as well as unregulated financial institutions.
 
According to a 2012 study by Andrew G. Haldane of the Bank of England, the financial crisis caused failures in around half of the 101 banks with balance sheets larger than $100 billion as of 2006. The vast majority of these banks, including Lehman Brothers in the US, had not breached any of the prudential regulations already in place before the crisis. Moreover, 11 had already met the capital requirements that are currently being introduced as part of the new Basel III regulations. And yet four of those 11 still failed.
 
These findings imply that the new post-crisis rules are inadequate. For more proof, consider Spain’s Banco Popular, which passed the European Central Bank’s Asset Quality Review in 2014 and the European Banking Authority’s stress test in 2016. As of last December, Banco Popular still had a tier 1 capital ratio of over 12%, which is only slightly below average and 50% above the minimum requirement. Six months later, it went bankrupt, wiping out many bondholders’ assets along the way.
 
Despite such red flags, few have demanded an explanation from financial authorities for why the new regulations are falling short. As a result, Mark Carney, the governor of the Bank of England and the chairman of the Financial Stability Board (FSB), had no problem boasting in a letter to G20 leaders this July that “the largest banks are required to have as much as ten times more of the highest quality capital than before the crisis.” This claim, whether true or not, points to a serious mistake before the crisis that has not been sufficiently investigated, much less corrected.
 
The capital of the top 55 US and European banks has about doubled since 2006,both in absolute terms and relative to risk-weighted assets. But despite the Banco Popular episode, bankers on both sides of the Atlantic are lobbying for the new capital rules to be relaxed further, and for permission to increase leverage and returns.
 
Why are regulators and bankers apparently seeking to double down on their mistakes? For starters, banking authorities never adequately investigated their own role in the previous crisis, because they had no incentive to do so. On the contrary, they jumped at the opportunity to hide their responsibility when disoriented politicians blamed other non-bank financial activities, which they have misnamed “shadow banking.”
 
Such labels only confuse the problem with the solution, because they do not address the central fact that the banking-supervision system itself caused the last crisis. Market-based financial intermediaries, such as hedge funds, may be relatively unregulated, but they are also responsible for their own destiny. As a result, they almost always operate with far more capital than what banks are required to have for the same level of risk. No wonder they proved way more resilient in the crisis.
 
Bankers, on the other hand, are presiding over large institutions that have many lines of business in a wide variety of jurisdictions. Given this complexity, they are unlikely to comprehend the overall risks run by their institutions. Instead, they are likely to rely on the prudential rules they are given, happy to see that they remain profitable.
 
When banks enjoy extraordinary profitability even while playing by the rules, bankers assume that they are doing something right, and they compensate themselves accordingly. That reduces the post-bonus return on shareholders’ capital to a more normal level. Regulators are now targeting excessive compensation with a new set of intrusive rules. But excessive compensation is just another direct consequence of the regulators’ own mistake of setting insufficient minimum capital requirements.
 
We all seem to have missed a basic fact. The economy is a complex, adaptive system populated by fallible agents with imperfect knowledge. And within that system are other complex systems, such as today’s financial-regulatory regimes and the large financial institutions themselves. In such systems, policies may not be nearly as effective as models would suggest, and they will often backfire or lead to unintended consequences.
 
Although markets are almost always wrong, they are nevertheless a powerful mechanism for holding individuals and entities responsible for their own mistakes. Regulatory technocracies do the opposite: by diluting accountability and privileging collective decisions, they stymie the individual talent that populate them.
 
Of course, this is all very disorienting for the public. We know that in a complex system, the proverbial butterfly flapping its wings on one continent can cause a hurricane on another. But we don’t blame butterflies for the weather, and we are generally ready for its vagaries. Yet we tend to search for scapegoats when things go wrong, and we share the illusion that tighter controls are always better. This explains the establishment of new post-crisis entities with impossible missions, such as the FSB. We would do just as well to establish a Fair Weather Commission to ensure that there is always sunshine on weekends.
 
When politicians and technocrats seek more power to deliver results, citizens have to sacrifice some freedoms. But more often than not, achieving the promised outcome is beyond our leaders’ control.
 
When they fail, they blame factors other than their inability to deal with the complex system they have created, in order to avoid undermining their own authority. But this will always end in widespread frustration and discontent, giving fodder to populists the world over.
 
 


What a Korean Agreement May Look Like

By George Friedman


It’s a toss-up whether the United States and North Korea will sue for peace or opt for war. Still, there appears to be interest on both sides in easing tensions. U.S. Secretary of State Rex Tillerson has even intimated a possibility for direct talks. Informal talks have taken place for the past few months, of course, but these would have clearer imperatives: that Pyongyang not fire missiles at Guam and that the United States reduce the amount of military exercises it holds with South Korea. But is it even possible to reach a settlement on the terms they want?

The U.S. demand is easy to state but difficult to implement. It wants North Korea to reverse course on its nuclear weapons program. Merely halting the progress Pyongyang has already made would enable North Korea to resume development at a later date. In fact, earlier agreements fell apart because they neglected to include such a provision, and so the North Koreans were able to pick up exactly where they left off. Hence the current crisis.

Correcting that mistake would entail dismantling certain facilities and, since the U.S. would never expect North Korea to honor its commitment, Washington would demand permanent inspectors with unfettered access to every facet of the program to remain in the country. So while the U.S. demand may seem modest, it is in fact radical. Simply forfeiting a nuclear weapons program would give Pyongyang nothing. The government is unlikely to accept peace on these terms unless it can demand some substantial concessions from Washington.

This brings us to North Korea’s demands, which are much broader than Washington’s. Pursuing a nuclear weapons program, one meant to discourage any threat to the regime and thus ensure its survival, demanded a huge amount of resources. The North Koreans have not come this far simply to walk away with nothing to show for it. If they were to agree to abandon their program, they would do so only if another means of security were in place.

North Korean soldiers look at South Korea across the DMZ in 2011 in Panmunjom, South Korea. CHUNG SUNG-JUN/Getty Images

This would likely require a new regional framework whereby the U.S. would enhance North Korea’s position at the expense of its allies. The framework would also have to weaken U.S. influence in the region, perhaps by relinquishing its relationship with South Korea and withdrawing its forces from the peninsula, or perhaps by keeping its Navy out of the Sea of Japan. Maybe U.S. aircraft would be prohibited from flying near Korean airspace, and maybe Washington would have to rework its treaties with Japan so that its troops there did not threaten North Korea. In short, if North Korea must abandon its military capabilities, so too must the United States, or so the thinking of Pyongyang would go. The U.S. will not alter the regional balance of power lightly. And even if it did, it would have to consider the financial burden of propping up the government in Pyongyang. The United States is unlikely to accept this.

War is the one option the U.S. has to prevent North Korea from completing its nuclear weapons program – if it has not done so already – without giving up anything (except blood) in return. But, as has been widely discussed, this option would be difficult and bloody, and if success is measured by the elimination of all nuclear facilities, there is no guarantee that it would be successful. North Korea is not particularly keen on the prospect of war, either – it knows war introduces the possibility of annihilation. But it has come to read the fear in South Korea, which would likely bear the brunt of the war, as a check on U.S. intent. This dramatically reduces the chance of war.

That means North Korea has options and therefore the upper hand in negotiations, at least for now. It can press on with its nuclear program, or it can, in theory, negotiate a redeployment of U.S. forces. If there are no negotiations, North Korea gets a nuclear weapons program. If there are negotiations, and the negotiations fail, North Korea gets a nuclear weapons program. If there are negotiations, and the negotiations succeed, North Korea will lose its nuclear weapons program but gain a tremendous amount of concessions from the United States. Either way, North Korea comes out ahead.

Of course, agreements have been made and broken before. If North Korea surrendered its program, the U.S. could renege on whatever promises it made, re-establish military ties with South Korea, and re-deploy its naval and air forces. The government in Pyongyang understands as much – even expects as much – so it is highly unlikely to reverse course on its program.

It is easier to hold talks than to reach a settlement. It is easier to reach a settlement than to honor it. And this is why wars happen. Wars create a finality that diplomacy can’t. Sometimes.

lunes, septiembre 11, 2017

GLD: THE DECLINES ARE OVER / SEEKING ALPHA

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GLD: The Declines Are Over

by: Dividend Investors
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- Geopolitical tensions and topping stock markets have generated new rallies in GLD.

- Low-interest rate environment and falling US Dollar suggest that the declines in GLD are over.

- Any short-term declines should be bought as next upside target come in at 131.20.

 
In the stock market rallies of 2017, one important asset that has been largely overlooked is the SPDR Gold Trust (GLD). The instrument is typically used as a safe haven during times of elevated political uncertainty and volatility in centralized stock benchmarks (i.e. the S&P 500 or the Dow Jones Industrials). These market elements have been missing most of the year, and because of this GLD has fallen under the radar for many investors. But as markets start to regain full strength (in terms of trading volumes), there is a strong possibility that many of these trends will change. Geopolitical tensions and topping stock valuations have led to rounds of profit-taking in equities that have already helped generate small rallies in GLD. We expect this type of activity to continue and even accelerate once sentiment builds in momentum.
 
Ultimately, this means that the post-2011 declines have completed, and the long-term bull moves in GLD are ready to begin. Our current stance is that dips should be viewed as buying opportunities, and should be taken incrementally into critical support levels through 120.60.
 
 
 
 
Gains in GLD on a year-to-date basis put the instrument higher by 12% and while this could be viewed as a relatively strong performance, we believe we are still in the early phases of a much larger move. The earliest indication that a paradigm shift is in place can be seen in the CBOE VIX index, which has developed a reputation for being a 'dead' instrument over the last year.
 
 
In the chart above, we can see that geopolitical turmoil in the month of August led to fairly substantial spikes in volatility in percentage terms. Moves in the VIX toward the 15-16 levels occurred as geopolitical tensions were reaching extremes in North Korea. There are a few aspects that are important to note here, given the fact that trading volumes were still subdued during this period and the actual events involved nothing more than hawkish jawboning between the Trump Administration and Kim Jong Un.
 
 
 
 
If we start to see North Korea resume with actual ballistic missile tests, these moves could be much more pronounced. In the chart above, we can see the number of ballistic missile tests that have been conducted by the current regime in North Korea and when we look at the rhetoric that has been used, it should be clear that there is no real evidence these clashes will be ending any time soon. If we see the headlines move beyond the 'rhetoric' phase, we can expect downside moves in the S&P 500 and upside moves in GLD.
 
 
 
 
At the monetary level, investors bullish on GLD will also need to consider the most likely trajectory of US interest rates and the effect this will likely have on the US dollar into next year.
 
At most, markets are expecting one more interest rate hike from the Federal Reserve and there is a substantial portion of the analyst community that has argued we will not even see that.
 
Lower interest rate levels make precious metals assets more attractive to investors, and without some significant changes in the language that is used by Janet Yellen and other members of the Fed we will be caught in a scenario that only pushes prices upward in GLD.
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Of course, lower interest rate levels also put downside pressure on the US Dollar. One of the most comprehensive ways to track valuations here is through the PowerShares DB US Dollar Index Bullish (UUP), which tracks the value of the greenback against a broad range of currencies. In the chart above, we can see that UUP is now trading dangerously close to very critical support levels near 24 and if this level is broken we could start seeing some major weakness in the US Dollar. Gold assets are priced in Dollars, so any significant changes here would add bullish elements to market valuations in GLD.
 
GLD Chart Analysis: Dividend Investments.com
 
 
The weekly chart in GLD is starting to look very encouraging, as prices are currently grinding through important resistance levels near 123. This area currently marks a triple top and falls in close proximity to the 61.8% Fibonacci retracement in the fall from 131.10. A clear break here will suggest that the paradigm has truly shifted and that the long-term declines in GLD are over. We will look to build long positions on any dip from here anticipating a run higher from here into the mid-130s.