The Red Pill

[the cork]

The Great Unwind has finally arrived.
(courtesy Bill Holter/Miles Franklin)

50+ years of credit creation and living beyond our means year after year is finally coming to an end. Ben Bernanke spoke last week regarding "tapering" Treasury and MBS purchases some time next year, the market then immediately reacted. Stocks were sold, bonds were sold, commodities were sold and so were Silver and Gold (much more on this shortly). Did the Fed actually do anything? Did they tighten at all? Has their balance sheet shrunk or even stagnated at all? The answer(s) are an emphatic NO!. The bloodbath last week was merely "front running" on the fear that the Fed will back away and stop administering the crack credit doses that the financial community have become accustomed to. Basically free money and $ trillions of it, can you imagine what will happen should the Fed ACTUALLY slow down or stop giving out free cash so that banks can cover up losses?

Last week was only a preview to what is coming. I personally do not believe that any "tapering" will ever come about, last week's financial action only supports my thesis. Last week happened after only the mention of "tapering", do you think the Fed may now know the end result of an ACTUAL exit strategy? One where the markets would have to fend for itself and be self supporting along with the economy? They do know, the Fed knows that it will be forced again and again to not only continue QE but increase it exponentially. There is one minor "problem", the more they monetize, the less "collateral" (there's that word again) there is available to an economy and financial market that... runs on collateral. Can you imagine the immediate bloodbath of panic selling if the Fed not only stopped purchasing bonds but actually tried to sell some to reduce their own balance sheet? The are now purchasing more than half of the Treasury's new issuance, if they turned seller, who is left as the buyer?
What would happen should China's current "cash crunch" cause them to turn seller?

As a result of the mere murmur of slowing QE the most shocking action last week was in the Treasury market. The 10yr ended Friday night at 2.54%, This was a rise of .40 basis points or so and nearly equal to the rise in yield for all of May. May, if you recall was the month where the Fed lost about $115 billion on their bond holdings (certainly far more if they had to mark the non Treasuries to market). The volatility was staggering and without a doubt there are now some dead institutions out there because of how fast and violent the move was. There is $200 trillion outstanding in interest rate derivatives. This past week alone, these contracts on average probably moved more than 5% in value. This would indicate a movement of maybe $10 trillion (with a T) worth of net change from one side to the other in less than 5 days. Do you really believe that this type of "wins and losses" could have occurred without someone, probably "many one's" becoming insolvent? The Fed only purports to have $65 billion of equity capital, between May 1 and now their portfolio has dropped nearly $250 billion. Is this "insolvent"? Yes it is but they have the ability to run the presses so not to worry I guess?

Forget the stock market, the Fed has now lost control of the Treasury market. Interest rates on the 10 year have now gone from just under 1.6% to over 2.5% in a very short period of time. This is now a 60+% rise in rates. Were this truly because the economy was strengthening it would be bad enough but the selling that has come about has nothing to do with the economy.

The selling in reality started as "front running" by those smart enough to leave the party while the music was still playing. Now, it is evolving into one gigantic and global margin call. This will feed on itself, winners will not get paid, sovereigns will lose the ability to "fund" and ultimately the global real economy will suffer from the financial implosion.

Before getting to the Gold and Silver travesties I'd like to mention that market "don't just crash" on their own. If you look back to every crash (with the exception of the metals "forced" crashes) of any asset throughout all of history, they all have one thing in common...debt. TOO MUCH debt to be exact. We have now passed the peak of the "debt bubble", there is no question now. Debt got us into the 2008 calamity and the solution was ...MORE debt. Even though the bubble burst back then they were able to reflate it one last time. "They" being central banks and sovereign treasuries. Now, there is no ability anywhere on the planet to reflate. Why? Because there are no sovereign treasuries healthy enough or big enough to be able to issue enough new debt to reflate one more time. It's over, plain and simple.

Gold. For those of you who can remember years back the "4 pillars" that Jim Sinclair always talked about, this, what is happening now, is exactly what he was talking about. The 4th pillar was the U.S. Treasury market and it has now been "pulled". This was the last horse big enough and strong enough to "pull" (push) the economic cart. The only description of the Treasury market last week was "panic" selling and this coming week should be interesting to see how the margin calls are handled. We got a preview back in 2008 and '09 how firms treated each other which ended with Lehman (and many others) being devoured.

So Gold got hit for another $80 and we are told it has no direction to go but down because interest rates are going up...because the economy is so strong. First off, yes I call bullshit on the strong economy story. Secondly, even if the Fed DID want interest rates to go up (they don't) they would never want rates to move like they just did last week. They know that "fast" is a killer (remember the JPM London whale) and firms cannot "adjust" when market prices (yields) move quickly (think margin calls and delta hedging). Firms blow up when this happens and of course then makes the panic selling that much worse. As an interesting aside, "usually" money flows INTO Treasuries when there is fear but not this time, the "fear" IS the Treasury market!

But something just does not add up here. First, we know that physical demand was huge going into this week and now we hear that physical off take has again increased with this latest price takedown. Secondly, if the COMEX numbers are to be believed, the open interest numbers actually went up Friday a whopping 10,000+ contracts in Gold and in Silver over 2,000 contracts...but how can this be? If everyone was selling to get out then the open interest would have dropped by these amounts or more, they did not which means that more and more "shorts" piled on. Again, if the CME numbers are to be trusted and are correct then we also have a clue as to "who" the shorts are...the specs (hedge funds) and the commercials look now to finally be on the long side after 15 years on the short side.

Here are a couple of speculations on my part. Is this a trap being set for the shorts? A trap for the commercials (banks) to clean out the hedge funds? Follow this through, in the past the CME would raise margins to pressure the prices of Gold and Silver. I believe that 100% of the time after the CME has raised margin rates, Gold and Silver would get hammered, why didn't they get hammered on Friday? If history was any guide at all they should have but they did not, why? Surely there were margin calls issued Thursday night to be met on Friday and a margin hike on top of that. What the heck happened? Why the difference?

...Maybe because the longs are a different group now than in the past? Maybe because in the past the longs were the hedge funds who would receive margin calls and then cut and run, now maybe the longs have deeper pockets?

And speaking of "deeper pockets", the open interest in Silver continues to stay very high...and even after a 50% drop in price. The longs have now effectively PAID for more than half of the Silver if they met each and every margin call and now stand for delivery. Will July be the month that Silver defaults on the COMEX? There are still 50,000 July contracts outstanding with 1st notice day this Friday. This represents 250 million ounces...the dealers only hold about 40 million for delivery.

Who, other than a sovereign government (China?) or a collective of sovereigns could have met the margin calls over the last 6-8 months? Have they allowed the short specs to build up and get bolder in their sales? On the Gold side it is interesting to note that JP Morgan has not reported 1 single ounce of Gold entering their dealer depository so far this year...they have 1 week to go before June deliveries must be made and they have a negative 80,000+ ounce deficit to cover. Where will this Gold come from? Could we be set up for the Chinese to stand for delivery from under stocked vaults...and at the same time sell some of their Treasury holdings?

This upcoming week could be a doozy. So many potential train wrecks from so many different directions to keep your eyes on all of them. Just remember that "credit" is what runs everything and it looks like "credit" is now at the center stage of problems. Should rates continue to rise this week in U.S. Treasuries you should expect to see some very major firms run into trouble.

This time around it will be real as there are no solvent white knights left with the ability to leverage up and save the day.

The U.S. Treasury and Fed are now in the cross-hairs, they need to catch a bid this week or they will be at the center of the biggest one time margin call ever! Regards, Bill H.

http://harveyorgan.blogspot.com/2013/06/comex-dealer-gold-falls-to-all-time-low.html