I’m back…hopefully for real this time
My absence over the past two weeks can be blamed on a?combination of being extremely busy catching up with “stuff” and major technical problems with both my internet connection and email. Fortunately, the technical problems seem to be on the cusp of being resolved at this point so I will try to go back to posting and answering emails effective immediately. If you sent an email in the past few days or weeks, I will hopefully be able to get back to you in the next day or two. If you haven’t received a reply by the end of this week, please assume I did not receive your email. So if the matter?is important or urgent, please send me another email.
Also, I hope to shortly post the last day of the GSUL session for “remote” and Founding Member attendees.
Okay, now let’s get to the silver and gold markets. Truth be told, very little of new substance has occurred in the past two weeks. The PM markets seem to be stuck in “washing machine” mode with a lot of churning, twisting, turning and spinning but not much in the form of directional movement lately. Both the silver and gold charts continue to show a downtrend with no clear bottom, but gold’s repeated refusal to stay below $730 along with silver’s affinity for $10 are signs that a “stealth” bottoming process may in fact be in play.
On November 13, I mentioned the possibility of an incipient price move that I felt could play out before December COMEX option expiration. That move obviously came one day too late (the day after option expiration) and didn’t amount?to anything of major significance?(yet)?whereas the intervening period?prior to option expiration was among the least volatile of the past few months. This price action provided early warning that the much-anticipated COMEX deliveries for December gold and silver would be nowhere near the market busting spectacle that many have been predicting.?Indeed the deliveries to date have been unremarkable. There are, however,?still a significant number of December contracts outstanding, especially in gold, which could presumably be held for delivery. Thus?it is too early to pass final judgment on the strength of December deliveries but it should now be abundantly clear to everyone (as it has always been to me) that no run on COMEX gold and silver warehouse stocks is?going to take place this December, or any other December for that matter.
While most fundamental indicators of the gold and silver markets are tepid at the moment, it is important to keep an eye on the gold and silver basis as it hovers near backwardation for both. At the same time, we should be prepared to recognize the possibility that a major component of the shrinking contango may turn out to be not the result of an unusually high level of spot demand but rather an unusually low level of forward and futures demand. Indeed, the open interest for COMEX silver futures?is now around a paltry 85,000 contracts, down from?almost 190,000?contracts in?February 2008. The current level of open interest has not been seen since late 2004 when silver was trading under $7. In COMEX gold, the COMEX open interest for gold futures is about 275,000 contracts, down from around 500,000 contracts in July 2008. The last time the open interest in gold futures was this low, it was 2005 and gold was trading under $500.
This represents an extreme reversal in speculative interest in gold and silver!?Obviously,?this decline in futures open interest has been a major factor in the price weakness, but given how much “hot money” has left the monetary metals, it is actually very encouraging that the price decline has not been even more severe (especially in the case of gold). Furthermore, the decline in speculative interest is a very positive?development in terms of market structure.
But there is more. The price of gold has declined by about 25% from peak while open interest fell almost 50%. Meanwhile, the price of silver has declined by about 60% from peak while open interest decreased by well over 50%. By contrast, crude oil has now declined in price by?almost 70%?from its peak?with futures open interest?being down less than 30%. We see figures?for many other commodities that are comparable to oil — a moderate decline in futures open interest along with a collapse in price. Clearly, there is something different happening with commodities in general as compared to gold and silver. The most obvious?indication of this is that the monetary metals are nearing?backwardation whereas crude oil and many other commodities are headed in the other direction. Why is this the case? I believe it has to do with the relative levels of physical supply and demand: in gold and silver, demand has remained strong and supply has been relatively static; in many commodities, demand has fallen off while secondary supplies (excess inventories) have entered the market.
Please keep in mind, the basis in gold and silver?have been shrinking for?just a little over two months and this occurred after?both metals had?essentially reached?their lows for the current move. At the time (late September), many commodities like crude oil and copper were still relatively strong (oil was still over $100). In retrospect, the late September period marked the positive divergence of monetary metals from the?commodity sector. In other words, this?period?represented the?start of gold and silver outperforming other hard assets. Unfortunately, between July and late September, gold and especially silver underperformed.
Personally speaking, I plan to keep this episode in mind for the future. This is now the second straight major commodities bull market where a midterm pullback was led by silver, then followed by gold?with?other commodities bringing up the rear: in particular, silver peaked in early 1974 and had already hit bottom before many commodities, including corn and crude oil, reached their mid-70’s peaks.
Speaking of crude oil, the annualized contango for?outer?3-month spreads?(e.g., the?June and?September 2009 contracts) is now?over 20%. As I noted in?a late October?posting, when contango for the major commodities starts to approach historic levels, we should expect that the commodity sector as a whole is approaching a bottom. For the reason why, please see the posting. In any case, the contango in crude oil?was around 50% during the summer of 2001, which was a historic extreme. No, the current 20% contango is not very close, but it has increased from?under 10% in late October. Moreover,?the nearest 3-month contango (January and April 2009) is now over 30%. I think?the remaining gap could easily close without much more of a decline in oil prices and therefore we could actually be closer to a bottom in commodities than most people realize. The bottom, however, is unlikely to?form a sharp V barring some major market-shaking event like Iran announcing that it has a working nuke.
Practically the only market that has made a substantial move on a net basis during?the past several weeks has been U.S. government bonds, which have rallied spectacularly. There are a number of complicated?explanations as to why bond interest rates are falling but?there is a single, simple reason that should?suffice for most intents and purposes:?demand for bonds currently exceeds supply. This is quite an incredible phenomenon if you think about it — fiat dollars and dollar-denominated government bonds?being in high?demand?while the system underlying them is apparently on the verge of collapse — but entirely consistent with the widespread (and therefore wrong, in my opinion at least) deflationary expectations. And not really that surprising in the end. Indeed,?duing the past few months I’ve warned quite a few readers away from investing in bearish bond funds precisely because the deflationary expectations that have been driving yields lower don’t tend to vanish very quickly. Yes, there will come a time when China and other exporting nations will no longer underwrite our national debt (primarily because they will not be able to afford it). And while?that?could mark a final bottom in?interest rates, it is important to keep in mind that the Federal Reserve can buy an unlimited quantity of U.S. Treasury securities by simply printing money, helicopter-style.?
For now, what’s relevant is that the Federal Reserve and U.S. Treasury are still trying to figure out incremental methods to re-inflate the monetary system without any sign of success. The FDIC and other?government agencies?are?also increasingly getting into the?act lately but to no avail so far. No doubt yesterday’s unsurprising announcement that the current recession officially began in the fourth quarter of 2007 will lead to an orders-of-magnitude?increase in the rescue?efforts. For now, however,?they continue to be?nothing more than death by a thousand paper cuts despite a fancy new name — “Quantitative Easing” or “QE”.
QE?is the term dejour for central bank attempts to inject liquidity?when short-term interest rates have effectively?reached zero percent. I’m not a big fan of this phrase “QE”. For one, it doesn’t?precisely describe what the?Federal Reserve and U.S. Treasury?have been?doing for the past three or so months?and what they will be doing for the foreseeable future. For two, QE?describes classically?how the Bank of Japan tried to?solve?its deflation problem?and clearly that?approach has?not worked. Bernanke knows this?as evidenced by his famous and tragically?myopic?speech in which he proclaimed deflation in the U.S. was all but impossible in part because: “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” Remarkably, that’s about the only thing he seems to have got right in the whole speech.
A better?description for the recent?Fed and U.S. Treasury actions is “Monetization”, which is?the government’s buying — using fiat money — of assets held by the private sector. While QE encompasses all methods of injecting net liquidity into the system while interest rates have reached the “zero boundary”, including sterilized injections, Monetization (in my book at least) refers very specifically to only those actions where the government and/or central bank increases money supply by?purchasing assets from the private sector. True, the?Monetization so far has been?primarily of banking assets (through TAF, TARP,?Citibank bailout, etc.) but clearly the effort will have to be expanded given the fact that banks are not willing to lend newly-acquired reserves as long as?survival is?deemed paramount?in comparison to?profits.
As soon as?survival of the banking system is sufficiently assured by government (it is not yet but will be sooner than later), bank asset Monetization?should start to percolate into the financial system. But until then,?the Fed and U.S. Treasury will be forced to?increasingly Monetize?non-banking assets (new Freddie Mac and?Fannie Mae mortgage loans, AIG, money markets, commercial paper). Before it’s all over, it is very possible?that much of corporate America will be?Monetized as well (the proposed “bailout” of the U.S. auto industry is?probably the?first of?many future examples). Perhaps even the residential real estate sector will be directly Monetized via subsidized mortgage loans to individuals at very low, below-market?interest rates.
At this point, it appears that the Fed believes the banking system has for now received sufficient liquidity to meet near-term lending and reserve requirements because in the latest Factors Affecting Reserve Balances report, there was a net decrease in “Monetization”, or banking sector “Quantitative Easing” if you prefer. Week after week, the Fed has been injecting $50 to $100 billion in additional reserves and now it appears they will wait and see what happens with the banks while the?policy makers?practice their “monetary magic”?outside the banking sector.
Well, as far as the banks go,?the incipient movement in money supply aggregates I noted a couple of weeks ago has not translated into a sustained trend and therefore we should not expect a monetary tsunami immediately. In fact, most monetary measures continue to remain stable or even decreasing slightly despite the massive liquidity injections that have taken place. In helicopter parlance, the dropped money is still caught in the updraft of the helicopter rotor and has not (yet) fluttered to the ground.
Proof of Life, Love it! Thanks Tom. Do you have a timeframe for the Augmentor to be up and running?
Eerily familiar…
http://www.financialsense.com/editorials/conrad/2005/1222.html
Welcome back Tom.
Can we say that by this drop the spread between digital and printed dollars is decreasing? Or in other world, is it true that the midsection of the exeter pyramide is still widening while the top has started narrowing?
Or is it just breathing?
For commodities it is 1935 - 1939 all over; I would not be surprised to see Gold/Silver approach 100 and the Dollar index 92.
I also expect bond yields to remain between 0 and 5.25% for the rest of the decade and beyond. Similar to the period 1930 - 1950.
Tom
QE hadn’t worked for Japan because
1. Banks there weren’t lending to the productive sector and therefore reflation wasn’t possible
2. Investors were taking loans at 0% and investing in USTs and pocketing the difference. This is the famous Yen Carry Trade.
With the US there are important differences
1. Investor’s would never take a loan from the US at 0% and invest in say Emerging Economy bonds.
2. Nobody would take a loan to invest in derivatives as Prof. Fekete says because of counter-party risk.
There would be no private takers for the Fed loan at 0%. Instead, SWFs & other governments would take those dollars to invest in their ailing economies. There would be announcement of massive dollar swap programmes.
Even the US govt would take those dollars WITHOUT issuing new treasuries. This would simultaneously keep a cap on yields and also reflate the economy. Stocks would be purchased. Bridges would be built.
This time around, QE would be inflationary unlike the Japanese experience. I believe this is the logic used by Jim Sinclair.
Look like oil has to test $40 afterall…not good for PM
Tom
You can see that the bond bull IS the cause of deflation since money is directed from productive economy into the bond market. So much so that, countries without well developed bond markets escape deflation.
Thus, if the US short circuits the bond market by lending directly to the govt. without buying USTs reflation is ignited. QE would supply fresh new notes and handed over DIRECTLY to the US govt for spending. This will ignite inflation like hell. Then the excess liquidity might be mopped by issuing new USTs. How’s that for a change?
I know it sounds crazy & unconstitutional and the like. But who cares?
I recommend this article
http://www.merkfund.com/merk-perspective/insights/2008-12-02.html
Monetizing the Debt
Axel Merk, December 2, 2008
Excerpts…..
“After all, the massive stimuli under way should be highly inflationary; but if the Fed helps to engineer that markets cannot price inflation into bond prices, there has to be a valve. This valve, in our view, will be the U.S. dollar; we cannot see the dollar hold up in face of the types of intervention that are under way and that we see play out. Incidentally, a substantially weaker dollar may be exactly what Fed Chairman Bernanke wants. He has repeatedly praised Roosevelt for going off the gold standard during the Great Depression to allow the price level to adjust to the pre-1929 level; this is Fed talk for praising the pursuit of inflationary policies. His only criticism has been that he didn’t act fast enough. Similarly, his criticism of the Japanese encounter with deflation has been that the Japanese have not acted forceful and fast enough to fight it; what he may underestimate is that the Japanese have traditionally financed their deficits domestically. In the U.S., these days, most of the deficit is financed abroad; the U.S. is lucky that at least the debt is U.S. dollar denominated so that it can, at any time, repay its debt by simply printing more money. However, the value that foreigners may place on the U.S. dollar may be substantially less the more inflationary the policies are the U.S. is pursuing.”
“Many still believe in the infallibility of the Fed. Foremost, many support the massive liquidity push because they are firmly convinced that the Fed will mop up the excess liquidity when markets normalize. Indeed, without this confidence, the markets might overwhelm the Fed and cause a disorderly outcome for inflation or the dollar. Even we don’t doubt that the Fed has the best of intentions. The Fed believes that the end justifies the means; however, we doubt the end will be as intended, thus questioning whether the means are justified. But just as the past 22 months have shown that the markets do not act exactly as Fed official have anticipated, we cannot see that the Fed, Treasury and other government programs will work as designed. While we don’t rule out that an inflationary boom is possible, once the liquidity is starting to be mopped up, we are afraid, economic growth is likely to collapse once again. Unless real wages can be improved, consumers must de-leverage. Propping up a broken system will simply make the later crash even more severe.”
“Similarly, if Asian governments continue to support the dollar, they will seriously weaken their own position; in a best-case scenario, we will then face the same challenges again in 10 to 15 years, but then a country like China won’t have $2 trillion in reserves, but have great difficulty to stabilize its economy. The U.S. has taken the attitude that other countries must support the dollar because it is in their interest. But there’s a limit to what other countries can do; there’s also a limit when it seizes to be in their interest. In particular, it is irresponsible for the U.S. to pursue a policy that is destructive to the dollar while counting on Asian governments to prop it up. In the meantime, responsible savers in the U.S. have their savings put at risk due to all the bailouts.”
“A substantially weaker dollar may cause price levels to rise; as a result, the dollar may be a better indicator of inflationary pressures to come than the yield curve that is distorted because of the various Fed programs. Fed Chairman Bernanke may want to have a weak dollar and inflation, but may ultimately be getting more than he is bargaining for.”
Treasury bond prices have been strong because of the CDS crisis. They call a credit default swap (CDS) a ‘SWAP’ for a reason. Essentially, the CDS contract obligates the SELLER of the CDS to ‘Swap’ the subprime defaulted almost worthless mortgage security bundle for a good ‘bundle’ of US Treasury bonds.
Given the gigantic default of CDS’s, is it any wonder where the demand for Treasuries is coming from???? and why the US dollar is rising???
If the US bond market is such a haven, then why is the US 10 year CDS spread rising?
http://www.reuters.com/article/companyNewsAndPR/idUSL140725720081201
worldskipper: The actual web development is still holding things up and if everything was within my control, I could provide an exact timeframe for the website being ready but unfortunately that is not the case. In the meantime we will continue with reports in email format and posted here under the “founding member” heading. In addition, I have been working on some content with respect to the gold and silver basis and will be sharing that shortly. Please keep in mind the actual one year subscription does not start until the website is officially launched so at least that should be a minor consolation.
tzo: Deliveries as of today (12/3) are not running anywhere close to December 2005. The vast majority of delivery notices come in the first week so we should not hold our breath that the numbers will increase by a huge amount in the days ahead.
Andras: As dieuwer notes, the cost of credit default swaps on US Treasuries are the biggest ever at over 60 basis points (0.6%) which approaches the rate on private-issue A rated debt from just a couple years ago. This would imply that the tip of the Exter pyramid (gold and silver) is actually floating away from the body, which itself is widening as the government guarantees all forms of money. Perhaps the way to represent this would be a telescoping section that connects the tip to the rest of the pyramid, which is very wide and flat. The telescoping section is a constriction point that will make it very difficult and expensive to move wealth from the wide fat portion of the pyramid to the tip.
dieuwer: My opinion is that for commodities it will be much like the 1970’s but for most other markets there will be no historical comparsion. I would say that for U.S. bonds, the buyer of last resort will be the Fed and in fact Fed buying (in order to keep rates low) will be one of the major factors in the hyperinflationary events that likely await. For now, we can talk of U.S. bonds in terms of relative safety with the only better alternative being gold. The rise in CDS on Treasuries is in part being driven by the rise of CDS on the rest of the bond market. Indeed, one could argue that the cost of CDS on Treasuries is still too low given the disproportionate flows of funds into government bonds. At the same time, keep in mind not everybody purchases CDS so it is not a very good indicator for the overall market.
keseri: Understand your points about QE and Japan and also mostly agree with them, but it is the Treasury, not the Fed, that will conduct most QE or Monetization. Whether this turns out to be inflationary depends on how much the Fed needs to act in order to keep interest rates low, by purchasing “excess” Treasuries. This act, not the actual QE or Monetization, will be primarily responsible for any hyperinflation. Here is specifically the steps I foresee: (1) Treasury issues new securities. (2) Treasury uses funds to acquire targeted assets with proceeds (GSE debt, banks, auto companies, mortgages, etc.) (3) So far, not inflationary but (4) at some point Treasury yields will increase as the market is flooded with new securities so (5) the Fed will have to buy some of these Treasuries and (6) that will increase the money supply. There is nothing “direct” about this. Of course there will be other factors in play as well because for one the Fed can inject at least another $1 trillion in liquidity by simply buying up commercial paper under it CP program. Keep in mind, however, the Fed has already built a war chest of over $500 billion in bank reserves that it is in a position to unleash (move the helicopter so that the money can drop to the ground) if and when it so desires. Some of this unleashed money could first go to Treasuries but in fact one of the reasons it is still in reserves is because ST Treasury rates are near zero so the banks see no benefit. This, however, is easily rectified although the consequences will be painful. Much of the Merk article you quote is stating the same thing only from a different angle.
mike: If oil has a “weak” test of $40 meaning it only gets down to $42 or $43, gold and silver should be fine.
eddysharpe: I don’t believe there is a lot of Treasuries demand because of subprime defaults that are backed by CDS. The vast majority of demand for Treasuries is a movement up the safety ladder but as government guarantees are now being extended to all sectors I think we will see demand for Treasuries moderate, which could force up their rate and bring the Fed into play (buying Treasuries to keep their rate down).
Anybody have any insight on how the proposed Dubai ETF may affect the silver market? Where will the metal come from?
does anyone think that the fed has supercomputers that model what is going on? to me it seems reasonable. i believe acer is going to be selling a household super computer for about 15k.
i do believe they know exactly what they are doing but are trying to thread the needle, and the biggest problem is that unlike weather, peoples actions change as circumstances change.
ultimately, i do think the fed is trying to devalue the dollar to about 40-50 on the usdx and then inflate a little here, and deflate a little there, and voila, back to 199x.
everyone knows that the dollar has to go down in value to balance the trade deficit. no?
silveraxis: I stick to my conviction that we have some sort of replay of the late 30’s and early 40’s. Remember that then as now, the FED capped the rate of US T bonds by monetization, while commodities were strong into the 40’s.
A few more similarities between 1932 - 1942 and 2002 - 2012:
*bond yields low*
*rising, falling, and rising commodity prices*
*declining dow/gold ratio*
*peaking gold/silver ratio*
P.S. What do you make of this statement: “…for December delivery the COMEX has registered sales for 15 million ounces against inventory of only 8.5 million. ”
http://www.financialsense.com/Market/daily/wednesday.htm
Could have been the open interest before it rolled forward against the warehouse inventory?
tim: Impossible to model what cannot even be documented (the over 1 quadrillion in OTC derivatives).
dieuwer: Thanks for pointing out similarities, but I think the big gorilla in the room is the need to get handle on the credit and OTC situation which did not exist then. Commodities were strong into the 40’s due to buildup for war, which was a one-off event (one-off at least until the next war). Current commodity boom is due to resource constraint and modernization of 2/3rd of world’s population. This is not a one-off but rather an over-riding theme. I’m sure we’ll have more episodes like we’ve had in the past few months but we are now on a different path. Fundamentally we are much closer to what happened in the 1970s than the 1930s. with respect to “registered sales of 15 million ounces” the guy is off by a factor of 10: there are 11,758 contracts with notices times 100 ounces is 1.2 million ounces, not 15 million ounces. On the other hand, the total registered warehouse stocks of gold are 2.9 million ounces, not 8.5 (the latter number includes eligible which may not be available).
The big difference of course with the 70’s is that now workers do not have bargaining power with respect to wages. Also, interest rates are now very low.
Besides, in the early 70’s the gold/silver ratio was below 40 (RISING from 17 to 40 from 1967 to 1980). Now, the gold/silver ration is relatively high.
In the 20’s and 30’s there was leverage too. Actually, the small guy could “gamble” in bucket shops with a small amount or borrowed money.
Anyone who has been monitoring the silver market for any length of time would have realised that zilch would happen in the December month. Such rumours and speculation of defaults are part and parcel of the PM community and should be shrugged of as the emotional, married to my opinion type thinking that they are. If a default was coming it would have shown up on the charts in advance. I also remember recently talk of week long bank holidays surfacing on the net. My take is Comex will not close, their will be no defaults and even debate whether the much talked about hyperinflation will evolve are premature at least. I have come to learn that most in the PM sectors talk hot air.
john #2
“hot air” word-up. soo much hot air.
‘be right and sit tight”
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