Like Old Times: Q2 2016 Flow of Funds

Doug Nolan

The first quarter seems ages ago.  Recall how securities markets fell under significant stress.
Global central bankers responded (Pavlovian) with more QE and lower rates. Here at home, the Fed suspended its rate “normalization” plan after one single little baby-step. As for the Fed’s Q2 2016 “flow of funds” report, it was almost Like Old Times. Rapid GSE growth helped to liquefy U.S. securities markets, spurring speculative leveraging and Wall Street finance more generally, including securities firms balance sheets, “repos”, funding corps and, even, mortgage lending. Credit inflated, securities markets inflated, Household Net Worth inflated and the mirage of great wealth endured.

For the second quarter, Total Non-Financial Debt (NFD) expanded at a 4.4% rate, down from Q1’s 5.4% (while matching Q2 2015). Household debt growth jumped to a 4.4% pace (from Q1’s 2.7%), the strongest expansion in two years. Total Business (including financial) debt growth dropped to 4.1% from Q1’s 9.4% pace (and vs. Q2 2015’s 7.9%), the slowest expansion in 10 quarters (Q4 2013). State & Local borrowings expanded at a 2.2% rate, up from Q1’s 0.8% to the strongest rate since Q4 2010. Federal government borrowings slowed slightly from 5.6% to 5.0%, which was about double the growth from Q2 2015 (2.7%).

In seasonally-adjusted and annualized (SAAR) dollars, NFD expanded $1.999 TN, right at my theoretical bogey for Credit growth sufficient to sustain the U.S. Bubble. During Q2, Household debt expanded SAAR $622bn, surpassing Total Business ($540bn) for the first time since Q1 2011. State & Local borrowings expanded SAAR $66bn.

Leading the Credit charge – once again - was the federal government. Federal borrowing jumped SAAR $751bn, down from Q1’s $852 but still the strongest Q2 borrowings since 2012. Federal expenditures rose to a record SAAR $4.137 TN, up 41% compared to pre-crisis Q2 2007. At SAAR $3.470 TN, Q2 federal receipts were up 30% compared to Q2 2007. Deficits have this year been running at the fastest pace since 2012.

Also keeping quite occupied in Washington, GSE holdings jumped SAAR $348bn. This was up sharply from Q1’s $9.9bn growth and Q2 2015’s $70.9bn. GSE holdings enjoyed their strongest quarterly expansion since Q2 2008. The second quarter saw FHLB (Federal Home Loan Banks) Loans increase SAAR $168bn (up from Q1’s $51bn), the biggest quarterly growth since Q3 2008. (Worth noting from FHLB financial statements, Advances to Member Banks expanded almost 9% in the year’s first half to $690bn). Again, Like Old Times.

Total Agency- and GSE-backed Securities expanded SAAR $581bn (GSE debt $422bn and MBS $159bn) during Q2, up from Q1’s $60.4bn and Q2 2015’s $216bn. Here as well, Q2 saw the strongest expansion in GSE Securities since Q3 2008. For perspective, GSE Securities increased $293bn in (bond crisis) 1994, $474bn in (Russia/LTCM) 1998, $593 in (Y2K) 1999, $642bn in (tech crash) 2001 and $547bn in (corporate Credit crisis) 2002. The big buyers of Agency securities during Q2? Money Market Mutual Funds increased GSE holdings by SAAR $403bn during the quarter. ROW snapped up SAAR $104bn.

Security Brokers/Dealer holdings expanded SAAR $301bn (strongest quarter since Q1 2012), up from Q1’s SAAR $195bn and Q2 2015’s SAAR $135bn contraction. Debt Security holdings rose SAAR $174bn and Repos surged SAAR $328bn. Miscellaneous Assets declined SAAR $250bn. On the Liability side, Repos rose SAAR $228bn and Misc. - Other increased SAAR $92bn.

Riding a nice GSE tailwind, securities finance enjoyed a banner quarter. Federal Funds and Security Repurchase Agreements increased SAAR $627bn, the biggest quarterly increase since Q1 2008. This reversed two quarters of Repo contraction, in what has been extraordinary quarter-to-quarter volatility. Funding Corps expanded SAAR $27bn during Q2, increasing one-year growth to $233bn, or 16.8%.

Corporate (and Foreign) Bond issuance slowed to $90.5bn during the quarter, down from Q1’s booming $494bn and Q2 2015’s $591bn. And while there may have been some temporary tightening of corporate Credit, the opposite was true elsewhere. Consumer Credit expanded SAAR $230bn, up from Q1’s SAAR $199bn and compared to Q2 2015’s SAAR $267bn. Trade Credit surged SAAR $250bn, up from Q1’s $53.1bn and Q2 2015’s SAAR $170bn.

Private Depository Institutions (banks) increased Debt Securities holdings SAAR $316bn, up from Q1’s $148bn and Q2 2015’s $142bn. Loans expanded SAAR $679bn, down from Q1’s $783bn and compared to Q2 2015’s $639bn. For comparison, Loans increased $261bn in 2013, $579bn in 2014 and $676bn in 2015. Notably, mortgage loans, held as bank assets, jumped $390bn during Q2, the strongest mortgage lending since Q3 2007 ($433bn).

Total Mortgage Debt expanded SAAR $521bn, the biggest mortgage debt increase since before the crisis (Q1 2008). Total Home Mortgage Debt increased SAAR $259bn (up from Q1’s $205bn and Q2 2015’s $215bn), matched by an almost equal amount of Multifamily and Commercial mortgage debt growth.

Rest of World (ROW) increased holdings of U.S. Financial Assets by a notable SAAR $1.193 TN during Q2, up from Q1’s $444bn to the highest level since Q1 2015. ROW Debt Securities holdings increased SAAR $417bn, led by the SAAR $324bn increase in U.S. Corporate Bonds. Foreign Direct Investment (FDI) jumped SAAR $606bn. Also noteworthy, ROW U.S. Liabilities jumped SAAR $1.061 TN, led by a SAAR $383bn increase in Repos. Like Old - 2006 and 2007 - Times.

Total Debt Securities (Fed’s compilation) ended Q2 at a record $40.581 TN, up a nominal $252bn for the quarter and $1.618 TN (4.2%) over four quarters. Total Debt Securities expanded $9.635 TN, or 31%, since the end of 2007. Over this period, Treasury Securities increased to $15.385 TN from $6.051 TN, for growth of 154%. The increase in Treasuries accounted for 84% of the growth of Total Debt Securities. Outstanding GSE Securities increased $926bn (13%) over this period to $8.324 TN. As such, the combined growth of “Washington finance” (Treasury & GSE) amounted to 92% of the Total Debt Securities expansion since the beginning of 2008.

Total Debt Securities ended Q2 at 220% of GDP. This compares to 200% to end 2007. Equities ended Q2 at $36.112 TN (down $1.415 TN y-o-y), or 196% of GDP. Equities peaked at $26.433 TN, or 181% of GDP, during Q3 2007.

Total (Debt and Equities) Securities ended Q2 at $76.693 TN, or 416% of GDP. Total Securities to GDP began the eighties at 117% ($3.086 TN) and the nineties at 193% ($10.937 TN). This ratio ended Bubble year 1999 at 360% ($34.753 TN) and Bubble year 2007 at 378% ($54.768 TN) - (peaked Q3 2007 at 379%).

The Household balance sheet remains fundamental to Bubble Analysis. Household Assets inflated $1.238 TN during Q2 to a record $103.750 TN, with both Real Estate ($25.6 TN) and Financial Assets ($72.3 TN) at record highs. Household Assets increased $3.053 TN (3.0%) y-o-y and were up $8.023 TN (8.4%) in two years. With Household Liabilities increasing $163bn during Q2, Household Net Worth jumped $1.075 TN during the period to a record $89.063 TN. Since the end of 2008, Household Net Worth has inflated $33.30 TN, or 60%. Household Net Worth had peaked previously at $67.744 TN during Q2 2007.

The ratio of Household Net Worth to GDP increased two percentage points to 483%. Net Worth to GDP peaked at 379% (1989) during the eighties Bubble; 435% (Q4 1999) during the “Tech” Bubble; and 473% (Q1 2007) during the mortgage finance Bubble period.

September 21 - Reuters (Leika Kihara and Stanley White): “The Bank of Japan made an abrupt shift on Wednesday to targeting interest rates on government bonds to achieve its elusive inflation target, after years of massive money printing failed to jolt the economy out of decades-long stagnation. While the BOJ reassured markets it would continue to buy large amounts of bonds and riskier assets, the policy reboot appeared to open the door for an eventual winding down of its huge asset purchases, and tried to repair some of the damage caused by its shock move to negative rates early this year. ‘The impression is that the BOJ is starting to pull back some of its troops from the battlefront,’ said Katsutoshi Inadome, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities. The BOJ's increasingly radical stimulus efforts are being closely watched by other global central banks which are also struggling to revive growth…"
It was another interesting week. No meaningful surprises from the Fed or the Bank of Japan (BOJ). A Bloomberg headline capture market sentiment: “Kuroda’s Journey From Shock-And-Awe to Bond Market Fine-Tuning.” The Fed again refrained from a second baby step, while forewarning the markets of a likely hike in December. Market participants chuckled as they bought stocks, risk assets and precious metals.

And it’s all been fun and games. Except for the harsh reality that QE hasn’t been working, and the markets know that policymakers know. Policymakers will never admit as much, but they’ve run short of options. Japan is an absolute policy debacle in the making. European bank problems continue to fester – in Italy, Germany and elsewhere. Here in the U.S., a potentially destabilizing election is now just about six weeks away. And let’s not forget the historic Chinese Credit Bubble that gets scarier by the week.

September 23 - CNBC (Katy Barnato): “Toxic loans in the Chinese financial system could be 10 times as high as official estimates suggest, Fitch Ratings has warned. The international ratings agency said in a report on Thursday that, as a proportion of China's total loan pool, non-performing loans (NPLs) could be as high as 15-21 percent. By comparison, official data put the NPL ratio for commercial banks at 1.8%... ‘There seems a high likelihood that banks' NPL ratios will continue rising over the medium term, in light of this discrepancy. There are already signs of stress, most obviously in the increased frequency with which banks are writing off or offloading loans, such as those to asset-management companies’… Solving China's bad loan problem would result in a capital shortfall of 7.4 trillion-13.6 trillion yuan ($1.1-2.1 trillion), equivalent to around 11-20% of China's economy, Fitch said.”

The Truth about China’s Role in Global Economic Turmoil

Brexit, European tensions over the migrant crisis, and the rhetoric of the U.S. presidential campaign are just the latest flashpoints in the anti-globalization move across the world. Many blame China, the world’s second-largest economy, for economic ills from flagging industries to deflation in their home countries. Both U.S. presidential candidates Hillary Clinton and Donald Trump, for example, have charged China’s exports for harming U.S. jobs. Republican candidate Trump specifically accuses China of intentionally manipulating its currency to drive its exports and vows to impose countervailing duties as high as 45% on U.S. imports from China in return. He and other critics also say China is spreading deflation to the rest of the world through low-priced, subsidized exports.

In a weak global economy, citizens of every country may feel more vulnerable, especially to external forces beyond their control. Yet, some of the claims about China’s role in harming other economies are outdated, while others present a more realistic scenario, say Wharton School and other experts.

“Trump should be glad China is ‘manipulating’ its currency,” says Minyuan Zhao, a Wharton management professor. “Otherwise, if it were up to market forces, the Chinese currency might have been more volatile or dropped much further in value than it is now.” Scott Kennedy, deputy director of the Freeman Chair in Chinese Studies at the Center for Strategic and International Studies (CSIS), a Washington, D.C. think tank, agrees. “Trump is about five to 10 years out of date in his concerns about the renminbi. There’s zip evidence China’s currency is undervalued now,” he says.

Deflationary pressures due to the slowing Chinese economy and industrial overcapacity, though, are a more possible threat. The export of products in Chinese industries with overcapacity, from steel to textiles, is depressing prices of those products and threatening competitors in other countries, say experts. But most of the effects are sector-specific at the moment, rather than a broad impact on prices across economies, and affect primarily countries that compete directly in those sectors, they say. “There’s no good evidence that China’s exports have had a macro effect on the global economy and brought down prices overall,” says Kennedy. Instead, says Derek Scissors, resident scholar at the American Enterprise Institute (AEI), a Washington, D.C. think tank: “The single biggest driver of global deflation is cheap oil,” a phenomenon that many experts say is due more to OPEC overproduction and the U.S. shale gas revolution than China’s slowing demand.  

For now, stresses in China’s own economy provide a more accurate explanation for both its currency moves and deflationary pressures than any deliberate attempt to beggar its neighbors, say Wharton and other experts. China itself is in deflation because of a domestic economic downturn resulting from a global economic slowdown that has reduced demand for Chinese products. China’s rate of export growth has declined since 2010 and fell to zero or below for a few months this year, notes William Adams, senior international economist at the PNC Financial Group in Pittsburg, Pa.  The reduction in both domestic and global demand, in turn, has prompted a drop in industrial prices and overcapacity. But closing foundering factories risks widespread unemployment and unrest. “It’s more a problem for China than the rest of world,” says Scissors.

Consequently, despite President Xi Jinping’s desire to shrink overcapacity, government-sponsored banks are keeping many failing firms alive by rolling over their debt, creating the potential for financial crisis, says Marshall Meyer, a Wharton emeritus professor of management. “There’s a lot to worry about in China’s economy, in particular, the debt level,” he says. “Should there be a breakdown in the banking and financial system, things become very unpredictable, especially since household savings are all in banks or the inflated real estate market.” Given the potential dangers, “stability is of the utmost importance,” and that explains both renminbi policy and the potential for deflation in China, says Wharton’s Zhao.

Renminbi Dynamics: Overvalued  

Ironically, for all the criticism of it, the yuan is overvalued today, harming Chinese exports. “China is doing the opposite of what it’s criticized for,” says AEI’s Scissors. “Today, China is intervening in the credit market to keep the yuan artificially high. If they were not to intervene, the yuan would fall against the dollar, and there would be more deflationary pressure” in the world. PNC’s Adams agrees: “With China’s export industry weak and its economy in deflation — arguably worse than in other economies — a more market-determined exchange rate would mean a weaker, not stronger, yuan in relation to the dollar.” In its May 2016 report on world currencies, the Peterson Institute for International Economics, which has long advocated against an undervalued yuan, finds no misalignment in the currency.

Why is China keeping its currency from falling further? Since 2013, after nearly a decade of yuan appreciation against the U.S. dollar when the Chinese economy was going strong, China started allowing its currency to depreciate to stay in better tune with market realities. The move was a reflection of underlying domestic economic downturn, as domestic wages rose and China’s trade advantage shrank. Meanwhile, the U.S. dollar surged 20% against other floating currencies.
But the road to depreciation has not been smooth. In August 2015, the yuan took its biggest one-day dive since 1994 when global markets interpreted a yuan devaluation move as a salvo in global currency wars. Instead, the devaluation was an effort to allow the market greater say in setting exchange rates so that the International Monetary Fund (IMF) would include it in the basket of currencies in its Special Drawing Rights reserve currency. The IMF accepted the yuan as part of the SDR basket in December 2015.

Renminbi depreciation also set off a spate of capital outflows that started to drain China’s foreign reserves in a cycle that could easily spin out of control. In 2015, China’s foreign reserves stood at $3.3 trillion, compared with $3.8 trillion in 2014. “If people think the exchange rate will go down, they’ll ship their money out; then the rate goes down more in a self -fulfilling prophecy,” says Meyer.

“The hot money that came into China for RMB appreciation and higher interest rates is going out now.”

Market volatility has since continued to dog Chinese economic policymakers. In January, new data showing the fifth straight month of slowing domestic manufacturing sent the Shanghai stock exchange plummeting by 6.9%, triggering a worldwide market rout. The yuan also tumbled in January.

Market volatility and capital outflows prompted by a more market-determined exchange rate have chastened China policymakers, who now seem to be pursuing a more controlled path to financial market liberalization as a result, say experts. Says Wharton’s Zhao: “The renminbi exchange rate is maintained at today’s level, to the credit of policymakers in China who believe stability is in the best interest of China and the rest of the world. Since depreciation may lead to panic, capital outflow and further depreciation, the government is trying at all cost to maintain stability.”

Meanwhile, says Scissors, the yuan-dollar exchange rate has never had much impact on U.S. unemployment. Just before China devalued its currency in 1994, the U.S. unemployment rate stood at 6.5%, he says. After the devaluation, U.S. unemployment fell below 4%, instead of rising. In June 2005, just before the yuan’s steady rise, U.S. unemployment was 5.6% and then grew to 7% in 2014, instead of falling with the stronger yuan, because of the U.S. and global financial crisis. “The value of the yuan against the dollar has gone up, down, and sideways and jobs here remain almost entirely a function of what the U.S. does, not what the PRC does,” writes Scissors.

Deflation: A Bigger Specter

In contrast, say experts, China’s economic slowdown and resulting industrial overcapacity have a greater potential of harming world economies than its exchange rates. China, for example, produces half the world’s steel. “Because the product is traded globally, it is bringing worldwide deflationary pressure and has gotten the most attention,” says Scissors. The world has about 33% excess capacity in steel, according to the Organization for Economic Cooperation and Development (OECD), and steel prices have fallen from about $1,100 a ton in 2008 to about $350 to $400 a ton today, notes Wharton’s Meyer. In January, China vowed to lay off 1.8 million coal and steelworkers.

But other sectors with overcapacity may not have as wide an impact outside of countries that are direct competitors, such as South Korea and Japan in shipbuilding, and Vietnam and Bangladesh in textiles, says Scissors. The U.S. is not as affected as these countries, he notes. “Although there may be deflationary pressure, we [in the U.S.] don’t worry about it, because we don’t find it negative” in clothing and consumer electronics, where we enjoy lower prices, he says. However, says Kennedy of CSIS: “This concern about deflation will become more serious as China’s comparative advantage increasingly overlaps with that of industrialized countries, and China can do to semiconductors what it did to steel. A problem that is limited to specific industries at the moment could become a wider problem.”

China’s industrial overcapacity will take a long time to unwind if the country wants to avoid mass firm closures, unemployment and social instability, say experts. “It will be a slow cycle to play out,” says Adams. “There’s not enough pickup in global demand to absorb the excess production capacity in China and elsewhere in the world in the near term.” However, China’s investment in industrial production capacity is falling somewhat, he notes: In the industrial Northeast, it fell by 31% year over year in the first seven months of 2016, according to the National Bureau of Statistics. Says Scissors: “Overcapacity is really a labor force issue in China, where the labor force is getting older and shrinking. If China wants overcapacity to unwind in a very orderly fashion, it will happen at demographic speed, which is a matter of years or decades.”

Meanwhile, the cost of an orderly correction is a dangerous buildup in corporate debt, as failing firms receive more funds to keep going, and investment capital ends up propping up losing ventures, instead of building more viable enterprises that can speed China’s transition to a more sustainable consumption-based economy less dependent on heavy manufacturing and exports. Chinese President Xi is a proponent of shrinking excess capacity and corporate debt, but he faces political opposition from every side, says Meyer. “I’m moderately certain that Xi doesn’t want to pursue a race to the bottom [of global deflation], the economic equivalent of nuclear war that leaves everybody miserable,” says Meyer. “But Xi has more internal opposition than anything I’ve seen in years.” In addition, local politicians are fighting to keep their factories in business and people employed.

Thus, if China finds itself in desperate straits, it could resort to a “doomsday option,” says Meyer, where it exports its overcapacity and deflation. “It won’t be a pretty picture for the rest of the world, but I’m not sure it would be a purposeful or deliberate strategy,” he says. Meyer says China’s first option is to cut capacity, and the second is to export capacity to new markets, such as Central Asia through the proposed “One Belt One Road” initiative. The third is to set up corporate operations overseas, which would then purchase input products from China. The final is wide-scale exporting of its overcapacity. “You’ve got a debt bomb ready to detonate,” says Meyer. “The question: Does China’s debt bomb or industries in other countries collapse first?”

Trade War?

Yet, to pick a trade war with China is not the wisest option, says Mauro Guillen, Wharton management professor and director of the Lauder Institute. “It doesn’t make sense to start a trade war between the U.S. and China, the two largest trading nations when there are already too many tensions and frictions in the global economy,” he says. “It will end badly for the global economy.” He notes that only three large economies have a trade surplus with China — Japan, South Korea and Taiwan — because China buys inputs from them to make its export products. “If you hurt China, you also hurt Japan, Korea and Taiwan, and that makes no sense from the U.S. national security perspective,” he says.

Ironically, for the U.S., the Trans-Pacific Partnership (TPP), derided by both U.S. presidential candidates, is America’s best weapon against China’s exports, says Meyer. “We’re going to lose jobs if we enter the trade agreement is what they [the U.S. presidential candidates] think,” he says. “What they should think is we’re going to trade with TPP countries or China is going to trade with them.”

In the end, both China and the U.S., the world’s two largest economies, must take responsible actions or risk bigger perils. “The world economy is now so integrated, if you hurt one country, you hurt everybody,” says Guillen

Janet Who? An Important Driver Shift Is Occurring In The Gold Market And Investors Need To Be Prepared

by: Hebba Investments

- Speculative bullish positioning over the past week declined just as gold was about rise.

- The Fed meeting was a let-down and that was shown in the rising gold price, but we still expect a pull-back.

- Moving forward, the Fed will take a backseat to some major geopolitical events over the next few months such as US elections and the Italian referendum.

- Gold investors need to re-establish some previously sold positions but wait for the pull-back before getting fully invested again.

So, we finally made it through the highly anticipated Fed decision, and in this week's Commitment of Traders report, we see speculative traders choosing their sides - and it seems most of them chose wrong. Additionally, we will take a look at the Fed decision and what it means for gold moving forward.
We will give our view and will get a little more into some of these details, but before that let us give investors a quick overview into the COT report for those who are not familiar with it.
About the COT Report
The COT report is issued by the CFTC every Friday to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.
The big disadvantage to the COT report is that it is issued on Friday but only contains Tuesday's data - so there is a three day lag between the report and the actual positioning of traders. This is an eternity by short-term investing standards, and by the time the new report is issued it has already missed a large amount of trading activity.

There are many different ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won't claim to be the experts on it.
What we focus on in this report is the "Managed Money" positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
This Week's Gold COT Report
This week's report shows that speculative longs continued their declines by a significant amount for the second straight week as they closed out 26,490 contracts. Once again, shorts have not shown much in the way of courage as their positions only increased by 3,234 contracts for the week - much less than we would have anticipated considering the decline in speculative bulls.
This suggests to us that much of the action in gold right now (at least for paper traders) is all on the long side with movements in the gold price primarily driven by longs initiating and closing positions.
That is in stark contrast to when we see shorts driving the market and is probably why we have not seen many of those "waterfall type declines" that gold investors may remember from the past few years (see the example below).
The reason being that when shorts are in the driver seat of the market, their purpose is to drive the market lower because that's how they make their profits. Thus, despite the questionability of it, they concentrate their trading on these types of "shock and awe" gapping price declines to initiate long selling - no gold long, speculative or not, would decide to abandon positions so suddenly.

Thus, our takeaway here is that with longs driving the gold market and shorts MIA, we don't expect to see these types of massive gap declines - until we see speculative shorts re-join the market.
Moving on, the net position of all gold traders can be seen below:
The red line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, speculative traders continued closing out their position in preparation for the Fed meeting. Currently, those positions sit at a net long position of around 219,000 contracts, but obviously, with the post-meeting rise in the gold price, that was the incorrect decision and we expect next week's report to show a large increase in speculative positions.
As for silver, the week's action looked like the following:
The red line, which represents the net speculative positions of money managers, saw a slight decrease on the week but nowhere near the decline we saw in gold for the week. In fact, it was a bit strange as gold speculative positioning got hit hard but silver traders barely did anything on the week.
Gold Moving Forward and Our Conclusion for Gold Investors
Another week and another Fed driven gold market as the FOMC met this week and they decided to keep interest rates on hold - pretty much what we predicted last week with their "Lainard Telegraphing." Yes, it was the first time since December 2014 that we had three dissenters, but of course that had no immediate consequences as interest rates didn't rise for another year.

The big takeaway here is that the Fed either doesn't have the courage to raise rates or is very concerned about the consequences for the economy with a rate rise. That is awfully strange considering the supposed improvements in the labor market and stable economy - we aren't talking 5% interest rates here that would suffocate the economy, just an itsy-bitsy .25% rise in the fed funds rate. Something's up and we believe gold's uncertainty hedge antenna are perking up and that's why investors are buoying the gold market despite relatively weak physical demand from the East.
Since the Fed meeting ended with a whimper, we think the gold story is going to shift from "What is the Fed going to do with interest rates?" to "Who is going to win the US elections?"
That is a key shift because there is some major uncertainty in US elections and one of the candidates has the potential to really shake up the world economy if he does what he says.
Additionally, both candidates have promised to increase infrastructure spending to stimulate the economy, which may put some pressure on the US dollar as deficits will increase. As we get closer to the US elections in early November, if Clinton's lead over Trump starts to narrow further (which we think it will), then we believe the gold price will gather strength.
We do still expect a bit of a pull-back as sentiment is extremely bullish, which we see clearly in the COT speculative positioning and even in some of the surveys of analysts and investors. The Kitco survey below for next week shows everybody bullish on gold.
  Source: Kitco
Despite expecting a pull-back, investors need to own at least some gold at this juncture moving forward as there's a lot of significant economic and geopolitical uncertainty in the world that may come to a head over the next few months. We wouldn't completely buy back all of our previously sold positions, but we certainly are re-establishing many of the positions in the gold ETFs such as the SPDR Gold Trust ETF (NYSEARCA:GLD), the ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), and the iShares Silver Trust (NYSEARCA:SLV) that we sold earlier.

In summary, investors should not buy back all previously sold gold positions as the likelihood of a pull-back is high, but they definitely could reinitiate some of their previously sold positions.

lunes, septiembre 26, 2016



Gold Unleashed by Fed

By: Adam Hamilton

Gold surged sharply this week after the Yellen Fed yet again chickened out on raising its benchmark interest rate. Gold-futures speculators' irrational fear of Fed rate hikes has been a major drag on gold.

And rate-hike risks just plummeted in the coming months, since the Fed can't risk acting heading into this year's critical US presidential election. So gold's next major upleg was likely just unleashed by the Fed.

Oddly, Wall Street's expectations for a rate hike at this week's latest meeting of the US Federal Reserve's Federal Open Market Committee were surprisingly high. The interest-rate target directly controlled by the FOMC is the federal-funds rate. Commercial banks are required to hold reserves at the Fed. They lend these reserves to other banks overnight in the federal-funds market, at the FOMC's federal-funds rate.

This market is so important that federal-funds futures contracts trade on the CME. No one has more knowledge about federal funds than the hedgers and speculators trading in this market.

Parsing their collective bets yields the implied odds of Fed rate hikes, which the CME conveniently calculates and summarizes in real-time with its FedWatch Tool. It revealed this week's rate-hike expectations were totally wrong.

On Tuesday's close before this latest Wednesday FOMC meeting, these futures-implied rate-hike odds were running just 18%. Thus any hike would have been a big surprise for the markets, almost certainly igniting a major stock-market selloff.  Historically the FOMC hasn't hiked before these odds are running 70%+.  That only happens after top FOMC officials have spent months warning of an impending rate hike.

Before the Fed's first rate hike in 9.5 years last December, these futures-implied rate-hike odds were way up near 80%! So it was strange to see many economists and analysts ignore federal-funds futures in expecting a probable rate hike this week. Given their strong gold buying after the Fed did nothing for the umpteenth time, futures speculators obviously also believed this week's rate-hike risks were higher.

Even more perplexing, these American gold-futures traders who dominate short-term gold price action have long believed Fed rate hikes are gold's nemesis. Gold-futures trading is exceedingly risky, so only elite and sophisticated traders participate in this market. At $1350 per ounce, each 100-ounce futures contract controls $135,000 worth of gold. Yet the maintenance margin required to trade it is merely $5400!

So the maximum leverage available in gold futures now is 25.0x, vastly higher than the decades-old legal limit in the stock markets of 2.0x. At 25x, a mere 4% adverse move in the gold price would wipe out 100% of the capital risked by a fully-margined trader! So you'd think that these guys would take the time to seriously study gold's historical price action and drivers before taking such outlandish risks betting on it.

Historically gold actually thrives during Fed-rate-hike cycles! As I pointed out in depth last December just days before that first Fed rate hike in 9.5 years, Fed-rate-hike cycles are actually very bullish for gold. There have been 11 since 1971, and gold's average gain across the exact spans of all was way up at +26.9%. Gold rallied in a majority 6 of these 11 Fed-rate-hike cycles, enjoying huge average gains of +61.0%!

And in the other 5 where gold retreated, its average loss was an asymmetrically-small 13.9% over their exact spans. The lower gold's price entering Fed-rate-hike cycles, and the more gradual their hiking pace, the better gold performs as the Fed forces interest rates higher. So this newest Fed-rate-hike cycle couldn't be any more bullish for gold. Gold entered it at major secular lows, and it is the most gradual ever.

Even if the goofy gold-futures speculators can't be bothered to spend a day digging into gold's historical price action during Fed-rate-hike cycles, they should consider the last one. Between June 2004 to June 2006, the FOMC more than quintupled its FFR to 5.25% through 17 consecutive rate hikes totaling 425 basis points. Surely that slaughtered gold, right? Nope. Over that exact span, gold still powered 49.6% higher!

So this popular belief in recent years that Fed rate hikes are going to crush gold is ridiculous, a totally-false myth. Yet gold-futures speculators still hang on every word from the FOMC and its top officials. Whenever the Fed does something hawkish or jawbones about it, gold-futures speculators flee in terror. Conversely when the Fed is perceived as more dovish, these traders rush to buy gold just like we saw this week.

Gold-futures speculators chaining themselves to the Fed is readily evident in this gold chart of the past couple years or so. American futures speculators' total long contracts, upside bets on gold, and short contracts per the CFTC's weekly Commitments of Traders reports are also included. This year's young new gold bull has been heavily influenced by how futures traders perceive the Fed's stance on rate hikes.

Gold Futures Specs 2015-2016

On a lazy summer Sunday night in July 2015, gold was crushed to artificial lows by an extraordinarily-manipulative giant short sale. Within a single minute around 9:30pm Sunday July 19th, a gargantuan 24k-contract gold-futures sell order was placed. That was so extreme that twice within that single minute 20-second trading halts were triggered! Gold was blasted $48 lower to $1086 in one minute, shattering support.

As I explained in depth at the time, this was obviously an extreme shorting attack. No long-side trader would dump so many contracts so quickly at such a low-volume time, as it would have a huge adverse impact on their exit price. Impressively despite the horrendous gold sentiment back then, this brazen attempt to manipulate gold lower failed. Soon after that gold entered a major new multi-month uptrend.

Between early August and mid-October 2015, gold powered 9.6% higher out of that shorting attack.

It was carving a nice uptrend, until a hawkish surprise from the FOMC's October 28th meeting last year. In its usual post-meeting statement, the FOMC warned of an imminent rate hike -at its next meeting-which was coming in mid-December. Consider this precedent before gold-futures speculators' kneejerk selling reaction.

In the 10.2 years since its last rate-hike cycle ended in June 2006, the Fed has only hiked rates a single time last December. And in the very FOMC statement from the meeting immediately preceding that one with the rate hike, the FOMC directly warned one was impending. Since the Yellen Fed didn't warn again in this week's FOMC statement, there is no chance it is planning to hike at its next early-November meeting.

Back to that late-October-2015 FOMC statement's hawkish surprise, futures speculators dumped gold with reckless abandon. Their total long contracts shown above in green cratered, and their shorts in red skyrocketed. It was American futures speculators' irrational fear of rate hikes that drove gold's major 6.1-year secular low in mid-December. Gold actually bottomed the day after the Fed's first rate hike in nearly a decade.

But rate-hike-cycle fears are not misplaced at all for the general stock markets.  Still back in December, I looked at the benchmark S&P 500 stock index's performance during those same 11 Fed-rate-hike cycles since 1971. Its average gain in them was merely +2.8%, an order of magnitude less than gold's. And considering these overvalued stock markets directly levitated by extreme Fed easing, rate hikes are a real threat.

During the first couple trading days after that mid-December rate hike, the S&P 500 plunged 3.3%.

But with a new tax year approaching in a couple weeks, most sellers waited until 2016 to exit in response to a tightening Fed. That would push the big taxes due on their realized gains out another entire year. The moment January 2016 arrived, the Fed-rate-hike-driven stock-market selling resumed with a vengeance.

During the first 6 weeks of 2016 in the wake of the Fed's initial rate hike off that 7.0-year-old zero bound, the S&P 500 plunged 10.5%! That was its biggest selloff in 4.4 years. So as I predicted on the final day of 2015 when gold languished at $1060, investors soon started to flock back. Gold is a unique asset that moves counter to stock markets, so investment demand soars when stock-market fortunes are deteriorating.

It was this gold investment demand that fueled 2016's strong new bull market! Last week I discussed this in depth if you want to get up to speed on this essential foundation.  Investment capital steadily returned to gold in the first half of 2016, before stalling out in the third quarter. While all this investment demand has overwhelmingly been this gold bull's primary driver, futures speculators still drive major swings.

Gold suffered a sharp selloff on heavy gold-futures selling in mid-May. There wasn't even an FOMC meeting that entire month, but 3 weeks after each meeting the Fed releases its minutes.

While the FOMC's statement from its late-April meeting had been considered dovish with no explicit hints of any potential rate hike at its next meeting in mid-June, those April minutes were more hawkish than expected.

So gold-futures speculators again rushed to sell, their total longs plummeting, driving gold's sharp May pullback. This metal didn't start to recover until the first Friday in June, thanks to a colossal miss in the US-monthly-jobs data. Economists were looking for 164k jobs created in May, but the actual was just +38k! This was the worst jobs report in 5.8 years, so the data-dependent Yellen Fed couldn't risk hiking in June.

Thus futures speculators flocked back into gold again, catapulting it higher on plunging odds of the next Fed rate hike. Indeed at its mid-June meeting, the FOMC held fire. There was do dissent among the FOMC members, and their future projections for federal-funds rates in the coming years dropped by about 50 basis points. Gold's strong June rally came because futures speculators expected no rate hike.

Then on the last Friday in June, gold soared after the British people shocked the world by courageously voting for independence from their unelected, unaccountable, meddling EU overlords.

Speculators and investors alike rushed to buy gold, so it shot higher. The futures speculators weren't buying because of Brexit uncertainty per se, but because they believed Brexit uncertainty would stay the Fed's hand on rate hikes!

See the pattern here? Gold surges higher when futures speculators aggressively add longs and cover shorts in response to lower perceived odds for near-future Fed rate hikes. I suspect this week's latest FOMC meeting will prove a similar major buying catalyst for gold, igniting its next major upleg.

While the federal-funds-futures traders didn't expect a rate hike, they did expect the FOMC to talk a bit hawkish.

But that didn't happen! There was no explicit hint for an imminent rate hike at the FOMC's next meeting like its gold-crushing warning late last October. This week's FOMC statement was actually shocking in that the Fed didn't even offer up an excuse like usual for not hiking rates. It said even though the rate-hike case - has strengthened, it simply decided, for the time being, to wait. Yellen just doesn't want to hike.

On top of all this, at every other meeting the FOMC releases a summary of the FFR projections by each of the FOMC members and regional Fed presidents. These so-called dots got much more dovish again, with the FFR levels for the next couple years plunging another 50 and 75 basis points or so! This Fed led by uber-dove Janet Yellen is getting more and more dovish all the time, unleashing serious gold buying.

There were 3 regional-Fed presidents on the 10-person FOMC who dissented, the first time this has happened since December 2014. But due to the rigged nature of the FOMC, that's no indication that a rate hike is coming anytime soon. The colorful regional-Fed presidents, God bless´ em, have no power at all on the FOMC. They only occupy 4 of its 10 seats on a rotating basis, so Yellen's cohort always outvotes them.

Yellen and 4 closely-allied Fed Board of Governors' members always control 5 votes, and the president of the New York Fed has the only permanent voting seat for any regional Fed as the 6th.

Naturally he is always very dovish too, since rate hikes hurt the financial markets that are so critical to his Fed district's economy. Yellen's dovish faction dominates the FOMC with iron fists, regional presidents be damned.

And this is super-bullish for gold in the next few months, because now the Fed's hands are tied until after the early-November US elections. There is zero chance for a rate hike or even much hawkish talk until after all Americans cast their ballots on November 8th. The FOMC's next meeting is right before that on November 2nd, so it can't even warn in that statement about a hike at its following mid-December meeting.

So we have at least 3 months now before the Fed can even start getting hawkish again, a fantastic and long window for gold's next major upleg to surge higher on heavy investment and speculation buying. Contrary to Janet Yellen's feeble assertions otherwise, the Fed is highly political. The results of this upcoming presidential vote have huge implications for the Fed, and Yellen certainly wants Hillary to win.

Yellen is a hardcore lifelong Democrat appointed by Obama. One of her governors with a permanent FOMC vote is Lael Brainard. She served in Obama's Treasury department, and earlier this year actually made multiple donations to Hillary Clinton's presidential campaign up to the personal limit!

Democrats who love easy money dominate the FOMC, and they know a rate hike or enough talk of one will tank stock markets.

Almost since the FOMC made the unprecedented move to force the FFR to zero in December 2008, the Fed has been under heavy if not withering attack from Republican lawmakers. They hate the fact the Fed has grossly distorted the economy, and decided to subsidize debtors and Wall Street by robbing blind hardworking American savers. Congressional Republicans want to drastically limit the Fed's power.

Remember soon after last December's initial rate hike, the stock markets plunged dramatically.

Given how fake today's lofty Fed-goosed stock markets are, there's no doubt another rate hike or sufficient threat of one will do the same thing.  And it turns out that US stock-market performance in the final two months leading into early-November elections is exceedingly important for their outcomes.  The Fed knows this.

Since 1900 there have been 29 US presidential elections. When US stock markets rally in Septembers and Octobers leading into these early-November elections, the incumbent party has won the presidency 16 of 17 times! But when stock markets sell off in those final couple months before the elections, the incumbent party has lost 10 of 12 times. Stock-market fortunes have 90% odds of predicting election results!

Why is this the case? 40% to 45% of voting Americans will always vote Republican, while an opposing 40% to 45% will always vote Democrat. But in the middle are 10% to 20% of swing voters with no strong party affiliation. They often vote based on how they perceive their own economic prospects. Higher stock markets have always bred optimism, making them more likely to vote for keeping the status quo.

Any Fed hawkishness at all risks pushing stock markets lower heading into the November 8th US elections, including at the FOMC's next meeting on November 2nd. As I've been telling our newsletter subscribers for months now, there is absolutely no way the heavily-Democrat Yellen FOMC will risk doing anything at all that ups the chances of a hostile-to-Yellen Donald Trump winning the presidency!

So not only just unleashed by the Fed again, gold is entering a few-month-or-longer period where there is virtually no risk of anywhere-near-enough Fed hawkishness to spook futures speculators.

Gold just got the green light for a major new upleg driven by investment and speculation buying.

Every major gold selloff in the past year was driven by Fed hawkishness's impact on futures trading, and that risk has vanished.

Thus I strongly suspect this week's FOMC meeting will soon prove to be the catalyst igniting the next big upleg in gold's strong young bull. Investors can certainly play this with physical gold coins or by buying shares in that flagship GLD SPDR Gold Shares gold ETF.

Provocatively nearly all the capital fueling gold's bull market this year has come from American stock investors aggressively buying GLD shares.

But at best GLD will merely pace gold's coming gains. Meanwhile the stocks of the best gold miners will really amplify gold's gains due to their great inherent profits leverage to gold. Gold-mining stocks have been 2016's best-performing sector by far, and that dominance will once again accelerate as gold's next major upleg gets underway. The elite gold stocks still remain very undervalued relative to prevailing gold levels.

That's why we've been taking advantage of the recent gold weakness at Zeal to aggressively add many great new gold-stock and silver-stock trades. After spending tens of thousands of hours researching the markets, our understanding of what to trade and when is exceptional. This research has resulted in 845 stock trades recommended in real-time to our newsletter subscribers since 2001, with spectacular results.

Their average annualized realized gains including all losers are running way up at a stellar +23.9%!

The bottom line is this week's dovish FOMC likely just unleashed gold to start powering higher in its next major upleg. For years futures speculators' perceptions of the likelihood of imminent Fed rate hikes has battered gold around. That's proved very true in this year's young gold bull too. But with the critical US presidential election rapidly approaching in early November, the Fed can't risk sending any hawkish signals.

The heavily-Democrat ruling dovish faction of the FOMC won't risk doing anything that could incite a stock-market selloff. US history has proven abundantly that weak stock markets leading into presidential elections greatly lower the incumbent party's chances of winning. With the Fed bowing out, gold is just starting to enjoy a rare multi-month window devoid of Fed hawkishness to retard buying or spark selling.

How to save capitalism from capitalists

The cross-border activities of big companies make it harder to map a level playing field

by: Philip Stephens

Once in a while capitalism has to be rescued from the depredations of, well, capitalists.

Unconstrained, enterprise curdles into monopoly, innovation into rent-seeking. Today’s swashbuckling “disrupters” set up tomorrow’s cosy cartels. Capitalism works when someone enforces competition; and successful capitalists do not much like competition.

Theodore Roosevelt understood this when, as US president, he deployed the Sherman Act against the industrial titans at the turn of the 20th century. Henceforth antitrust, or competition, law has served, sometimes effectively, sometimes less so, to protect the interest of consumers and thereby legitimise the profits of big business. US president Ronald Reagan, scarcely a leftie, presided over the break-up of AT&T.

Technology and globalisation have changed the game. The cross-border activities of the world’s biggest companies make it harder to map a level playing field. Globalisation has multiplied the opportunities for tax avoidance, and tax competition between states has diluted the political will to uphold competition in the marketplace. Timid national politicians are reluctant to take on the global behemoths and their armies of well-heeled lobbyists. Yes, they would like these companies to pay a little more tax, but not so much so that they threaten to take investments and jobs elsewhere. Consumers and less privileged taxpayers are the losers. So is the market economy.
Step forward the European Commission. Margrethe Vestager, the commission’s competition chief, has been in the news lately after ordering Apple to pay €13bn in back taxes to the Irish government. If that seems like a whopping figure it should be measured against an estimated $215bn that Apple holds offshore beyond reach of tax authorities.

After a lengthy investigation, Ms Vestager concluded that its labyrinthine tax arrangements with the Irish government gave Apple advantages not available to other businesses and thus undercut competition by breaching the EU’s state aid rules. The company, she said, had been paying a tax rate of just 0.005 per cent — though that figure is disputed by Apple, which is contesting the ruling.

The iPhone manufacturer is not the only company in the commission’s sights. Investigations are under way into the impact on competition of the tax arrangements of Starbucks, Amazon and McDonald’s. Ms Vestager is heading a three-pronged antitrust probe into the European activities of Google, a company that enjoys immense market dominance and whose tax affairs are under scrutiny in several EU member states.

It would be something of an understatement to say that these businesses are angry about the probes.

The banker John Pierpont Morgan thought he could treat Roosevelt as an equal. With something of the same righteous indignation, Tim Cook, Apple’s chief executive, lambasts the European Commission’s ruling as “political crap”. Never mind that Apple funnels revenue though “stateless” entities unaccountable to any tax authority. Mr Cook seems to believe his business operates on a higher plane than that occupied by mere politicians or regulators.

Government should just get out of the way. To my mind, Apple makes stylish, clever digital gadgets, but this scarcely bestows a special status.

Google, like Apple, always insists that it is scrupulous in meeting its legal tax obligations. There is no reason to doubt its word. What this misses is that the responsibilities of business go beyond strict adherence to the statute book. The societies in which markets flourish are those that afford respect for a more complex tapestry of conventions and norms. It may be legal, say, for Google to minimise its tax bill by routing UK sales to an Irish subsidiary. It is not the act of a good citizen. And it invites a populist response. To borrow from Roosevelt: “When aggregated wealth demands what is unfair, its immense power can be met only by the still greater power of the people as a whole.”

So far politicians have been at the sharp end of the populist insurgencies across rich democracies. But behind these movements lies deep public disgruntlement with globalisation and the behaviour of big business. Whether it is Donald Trump in the US, Marine Le Pen in France or Beppe Grillo in Italy, the populist credo is economic nationalism: the system is rigged, so throw up the barricades against global capitalism.

The public perception is that the companies reaping the rewards of globalisation are beyond reach of the rules that apply to everyone else. All the insecurities of globalisation fall on ordinary citizens.

Populists exploit declining faith in the marketplace. Their remedy — snake oil — is more state control.

There will always be business leaders true to the tradition of the old robber barons who think theirs is a superior calling and that democratic politics is, well, “crap”. They find support among libertarians and free-market literalists who believe that the only role of business is to maximise profits.

Roosevelt was no socialist. His insight was that capitalism requires legitimacy. It would thrive over the long term only if it were seen to be on the side of the welfare of the nation’s citizens.

This is as true now as it was then. It is too soon to pass Roosevelt’s mantle to Ms Vestager. But everyone who supports the liberal market economy that made possible the success of Apple, Google and the like should be applauding her courageous effort to reset the balance.

lunes, septiembre 26, 2016



Bread And Circuses

 9-23-2016 3-00-55 PM

“The evil was not in the bread and circuses, per se, but in the willingness of the people to sell their rights as free men for full bellies and the excitement of the games which would serve to distract them from the other human hungers which bread and circuses can never appease.”
Marcus Tullius Cicero

I guess we could substitute MacDonald’s and iPhones these days. The point being little has changed historically since Cicero who lived in 106 BC. That’s a depressing view of conditions perhaps then and now. Perhaps worse still is the following satirical comment from the poet Juvenal. He lived much later; the 2nd century AD:  

“The fools did not realize that they were merely recovering a portion of their property, and that their ruler could not have given them what they were receiving without having taken it from them.”

Ok, you’re thinking me a warped old man with too much time on hands. You might be right but then there’s the haunting truth that comes through these legends—nothing given greed and the lust for power changes.

How does one live with these painful realities? We must go forward given these realities and deal with the hand we’re dealt.

Meanwhile back to the markets. Stock prices dropped as oil prices cratered on beliefs an upcoming OPEC meeting won’t deliver anything meaningful to boost oil prices. Nevertheless, stocks were able to hang on to weekly gains of over 1% despite a mixed picture overall. Clearly many feel the upcoming presidential debate will do much to clear the views of the electorate. If Clinton holds on to her slight lead it would soothe fears of the establishment nothing will alter current bullish trends. Trump on the other hand remains a  wild card especially with his momentum rising.

Below is the heat map from Finviz reflecting those ETF market sectors moving higher (green) and falling (red). Dependent on the day (green) may mean leveraged inverse or leveraged short (red).

9-23-2016 3-02-03 PM

Volume Friday was impressively on the light side. Breadth per the WSJ was negative.
9-23-2016 3-07-11 PM
12-17-2015 9-04-44 PM Chart of the Day
9-23-2016 3-09-14 PM USO

Charts of the Day


































































    The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60 markets are extended short-term.


    The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.


    The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". Our own interpretation has changed due to a variety of new factors including HFTs, new VIX linked ETPs and a multitude of new products to leverage trading and change or obscure prior VIX relevance.

9-23-2016 5-21-30 PM
9-23-2016 5-22-06 PM MONTHLY 

Bread & Circuses were on my mind recently. Why? It should be obvious the ruling class, no matter their belief structure, remain in control of things. It’s telling upon reading historical precedents that nothing has changed in a thousand years even though changing generations take little note of it. Those egos are fixed on the beliefs that they can always do things better despite overwhelming evidence to the contrary.

Let’s see what happens.