Chapman: Gold, Silver, Economy + More
by Bob Chapman
International Forecaster
Sunday, 17 August 2008
US MARKETS
After $500 billion in losses that will eventually end up in the trillions, Gerald Corrigan, former Vice Chairman of the NY Fed, has submitted a report that proposes to place server limits on derivatives, bring them under regulation to protect retail investors from their more egregious products. This is something Alan Greenspan and his Fed fought against ferociously. Banks now realize the game is up. The mega profit center is history. We do not think the proposal goes far enough, but it is a step that Wall Street and banking won’t like and that non-financials should welcome. It will lead to the downsizing of finance and a cutback in globalization. The report proposes a prohibition on selling auction-rate-securities to retail investors.
The disaster that is symptomatic of what went wrong is the auction-rate-securities. There was preferred stock issued by corporations and particularly financial institutions and auction-rate municipal bonds, issued by municipalities.
The first auction rate preferred stock was issued in 1984 by Citigroup. In 3 years the market had grown to $12 billion. In 24 years it had reached $300 billion. In February 2008 the market collapsed. As a result of banks refusing to continue to make markets in securities they created, leaving everyone particularly municipalities hung out to dry.
In the end the banks were forced by state attorney generals to buy back the paper from which they had walked away from. The only reason the banks bought the preferreds and ARS’ back was that they figured out the settlements were a pittance of what they would have to pay in settlement of class action suits.
Switching gears slightly here we deal with the credit default swaps. They are supposed to represent a hedging transaction to reduce risk. All Corrigan recommends is transactions be cleared through a clearing house. Overall corporate debt in the US is $20 trillion, yet the principal amount of CDS outstanding exceeds $60 trillion, thus 2/3’s of the volume is speculative and has nothing to do with hedging. This is a major profit center for banks. As a result, there are trillions of dollars of losses not yet declared in these instruments.
The foundations of preferreds, ARS and CDS are gambling instruments in a casino and they confer no value to our economy. Having central clearing only reduces counterparty risk, but that action overlooks the massive speculative risk to players and to our economy. The risk is still out there and hasn’t been addressed and these derivatives can easily take down the entire financial system. Short selling of credit should be banned and the only parties who should be allowed to use CDS’, should be those who can show a definite need to hedge risk.
We brought to your attention four years ago how these CDS vehicles would take down Fannie Mae and Freddie Mac. We were right they did. Wait until the total losses are tallied then you will get the picture. As usual no one wanted to listen. What Fannie and Freddie were doing was over-leveraging and they got away with it because of an implied government guarantee, which unfortunately became reality. On top of that they were not properly regulated due to politics and campaign contributions. They had become a system of largess mainly for Democrats. In time their losses will exceed $2 trillion.
You can then include on top of these horrible pending losses the day to day losses in purchasing power by the 17% increase in money and credit that translates today into 13-5/8% inflation. Lies, lies and more lies.
The only reason Corrigan has proposed anything is that ARS, CDS, SIVs, CDOs and ABS are all unsound. All of Wall Street knows it and now the public does. They all have to be eventually terminated. Once Wall Street and banking comes to terms with this the stock and bond markets will take a big hit, one that will last for years.
Since 1992 we have lived in an illusion of prosperity. Free trade, globalization, offshoring and outsourcing have dismantled our industrial base dropping workers from $31 an hour to $10 to $12 an hour. The illusion was kept alive by the Fed via massive creation of money and credit and unnaturally low interest rates. The result is that consumers spent far beyond their means. Who would want to save dollars that depreciated daily versus gold and other currencies?
We have been in recession 1-1/2 years and it is getting worse. This will be the worst recession since the Great Depression.
In addition to recessionary problems we are saddled with a coming bailout of debt. If you add all the agencies together we are looking over $2 trillion that we’ll have to pay back.
John Williams: Adjusted to pre-Clinton (1990) methodology, annual CPI growth rose to roughly 8.6% in July from 8.3% in June, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to a 28-year high of roughly 13.4% in July, up from 12.6% in June. Real July Retail Sales declined 0.9% m/m and are down 2.47% y/y. This bears out our new estimate of 13-5/8%.
The dollar is rallying for US political, geopolitical, economic, financial and technical reasons. The main reason for the dollar’s robust rally is that global dollar flows are constricting due to recession, financial asset price implosion and the busted US financial system. Financial asset prices are collapsing much faster than the Fed can create credit; and the US financial system is hoarding liquidity. Ergo the multiplier effect is inoperative and Fed credit cannot get into the economy.
The dollar rally on a receding economy and busted financial system is similar to Japan’s ‘lost decade’ experience of the ‘90s. It’s ironic that US officials desire to elongate the corrective process ala Japan. During Japan’s depression/debt deflation of the ‘90s, the yen soared, which blindsided many operators.
The most striking differences between Japan of the Nineties and the US now are: Japan had very high internal savings while the US has record debt – both consumer and government; and the Nineties were a period of global deflation due to the bankruptcy of the communist world.
But now over-levered dollar shorts are being squeezed out of the market. The dollar covering is not limited to speculators. Exporters, including US companies that hedge dollars, must now buy back dollar- forward sales due to reduced dollar flows from the global recession. OPEC will be doing the same.
And you can bet that numerous US and foreign non-financial corporations ‘got cute’ with their forward dollar sales over the past several years and shorted dollars far in excess of their anticipated dollar flows because shorting the dollar was a guaranteed profit generator.
To be clear, the rabid dollar rally is a sign of economic and systemic weakness, not strength. It is not ‘a change in economic fortunes’ relative to Europe as some pundits assert.
Public pension funds in the U.S. are increasing bets on high-risk hedge funds and real estate in an attempt to fill deficits in retirement plans and make up for their worst performance in six years. “Chasing performance, especially in a public fund, can be a dangerous thing,” said Stan Rupnik, the chief investment officer at the Teachers' Retirement System of the State of Illinois. [Desperate times call for desperate measures. Under-funded plans with growing obligations must gamble. What possibly could go wrong?]
Wells Fargo Stirs Doubts; Close Examination Of Balance Sheet Reveals Problems - But new financial disclosures, contained in a quarterly financial filing released Friday, bolsters the fear that Wells Fargo's earnings aren't all they are cracked up to be.
The first area of concern is illiquid assets, termed "level three" assets, that the bank values mostly using its own estimates and models. As markets have dried up, more assets are being classified as level three…In the second quarter, Wells Fargo's holdings of level-three mortgages increased substantially, but the bank's write-down on those mortgages looked small. Level-three mortgages jumped $3.3 billion to $5.28 billion, but in the quarter Wells Fargo booked only a $43 million net loss on them. Wells Fargo declined to give more detail.
Consumer prices jumped again up 0.8% in July, or 5.6% annually – the biggest yoy increase since January 1991. This is official. We are now raising our inflation estimate to 13-5/8%.
Last month foreclosure filings grew 55% as more than 272,000 homes received one foreclosure-related notice, up from 175,000 yoy and 8% from June. More than 77,000 properties were reposed by lenders nationwide in July with Nevada, California, Florida, Arizona, Ohio, Georgia and Michigan leading the pack. That is one in every 464 households.
The banks and mortgage investors are facing a growing home inventory. They have more than 750,000 for sale or 17% of the 4.5 million for sale.
GOLD, SILVER, PLATINUM AND PALLADIUM
The mark-to-market valuation of the global gold hedge book shows a loss still on the books of $9 billion. Producers have been taking heavy losses to cover. Hedging has been, as we predicted since 1992, a disaster for producers and their shareholders. You sell low and buy high.
Part of Thursday’s downside in gold and silver that carried into Friday was Goldman’s lowering of its gold price target. They are short gold and silver big time.
The only thing good about Friday’s gold market is that gold closed $11.00 off its interday low at $786, off $22.30 as silver collapsed to $12.81, off $1.42 due to margin and hedge fund selling. Either we are entering a Third World War or some terrible financial event is about to unfold. Goldman said yesterday the dollar was going higher and gold lower and we are sure that had some affect on today’s prices. Read the link on silver. It is very hard to find physical yet the price plunges. Copper rose $0.02 to $3.33, platinum fell $111.40 to $1,377.70 and palladium fell $22.85 to $285.15. Oil fell $1.25 to $113.76, gas fell $0.06 to $2.86 and natural gas was unchanged at $8.12. The yen fell .0053 to $1.1050, the euro fell .0130 to $1.4677, the pound fell .0051 to $186.23, the Swiss franc fell .0017 to $1.0973, the Canadian dollar rose .0041 to $.9440 and the USDX rose l.45 to 77.12. The 2-year yield was 2.39% and the 10s were 3.84%. The Dow rose 44 to 11,660, S&P rose 47 and Nasdaq fell 6 Dow points.
Gold open interest rose 2,381 to 371,637, as silver OI rose 1,445 to 139,894. The big Tocom gold shorts increased their positions by 3,399 to 44,586 as Goldman increased by 27 to net 4,988. The same group increased their net silver shorts by 79 to 1,357.
Gold is more oversold than in June of 2006. This is the sharpest correction in the 48 years I’ve been tracking these markets. In May and June gold fell 25% and silver 41%. The HUI fell 33% and this time silver 35%. As we said it is de-leveraging, central bank lease-sales and naked shorting. When real interest rates, that is bond yields less CPI, gold soars. The rate is minus 0.3871, which tells us that the Fed may be planning to drop interest rates. If that were to happen gold would rocket, which could explain the preemptive gold attack.
The US Mint has suspended sales of 2008 1-oz. Gold American Eagles. This is in addition to the shortage of 1-oz. Silver Eagles.
http://news.goldseek.com/InternationalForecaster/1219009358.php
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