Monday, May 23, 2011

Cattle supplies could still end year 'very tight'


It is still possible that supplies of fattened cattle will be "very tight" in the US towards the end of the year, despite a jump in placements in April at twice the pace that the market expected, a leading analyst said.
Prices of live cattle - that is, those ready for slaughter - tumbled in Chicago, with some contracts including the August, October and December lots falling the exchange's maximum daily limit, on data showing the number of animals placed for finishing in US feedlots jumping 9.9% last month.
The rise was way above a market forecast of a 4.3% increase, and put placements at nearly 1.8m head, the second-highest April figure since the US Department of Agriculture began publishing this data series in 1996.
Market sentiment was further damaged by separate statistics showing a rise of 20%, year on year, to 442.8m pounds in the amount of beef in cold storage as of the start of this month – the highest figure for 37 years.
'Down sharply'
However, Steve Meyer, at Paragon Economics, said that the robust growth in placements could not continue given the declines in feeder cattle – those suitable for putting into feedlots - identified in separate USDA sector inventory reports, and falls in US calf numbers.
An alternative was that the inventory data themselves would prove erroneous.
"But most of us still think these [placement] numbers are going to go down pretty sharply," Dr Meyer told, adding that rebounding corn costs offered a disincentive for feedlots to take on animals too.
With the cattle placed on feedlots last month set to come ready for slaughter in October, there was still potential for numbers of fattened animals to dip into Christmas.
Dr Meyer said that he still expected the "'supplies are going to get very tight' idea" to come true later this year.
Drought and imports
The jump in April's placements was attributed in part to the deterioration of pasture conditions in America's drought-struck southern states, responsible for about one-third of the US cattle herd, and where winter wheat crops and cotton sowings have also suffered.
Placements in Kansas surged by 21%, in Texas by 28% and in Oklahoma, where some areas are suffering drier conditions than during the 1930s Dustbowl, by 33%, as farmers gave up on grass-finishing their animals.
Higher supplies from Mexico also played a role, although they "do not go anywhere near close to explaining all the difference" between the actual USDA number and market expectations, Dr Meyer said.
Live cattle slid 2.6% to 102.20 cents a pound in Chicago for June delivery, the weakest price for a spot contract since the run up to Christmas, and down nearly 17% from last month's record high.

See the original article >>

Monday May232011 All Three Major Indices Back Below 50-Day Moving Averages

by Bespoke Investment Group

This morning's sharp decline for the major indices has put them all back below their 50-day moving averages and below their lows from last week. The next level of support comes in at the market's low on April 18th, which is a couple percentage points below current levels. The May pullback continues.

See the original article >>

Market Looks Set To Test Key Support

The devastating tornado that wiped out Joplin Missouri this weekend may have been a bit of foreshadowing for what lies ahead for the financial markets in the next few days and weeks.

Indeed, the key to the whole market right now may be the action in the U.S. Dollar, which is rallying as fears of sovereign debt problems in Europe are again on the rise. The U.S. Dollar Index (USD) closed above 75 last week, as well as above its 20 and 50-day moving averages. This is a reversal of the short and intermediate term trend. And the action early Monday morning says that the up trend for the greenback is gaining ground.

A stronger dollar is viewed by Wall Street as a negative for U.S. multinational corporations, such as the ones in the Dow Jones Industrial Average and the S & P 500. Thus dollar strength likely means weakness in large cap stocks. And if there are enough margin calls on large cap stocks, traders will sell other things to raise money.
usd etf
Chart Courtesy of

The S & P 500 (SPX) failed to close above 1340 on Friday. Now it looks ready to test the 1328 support area near its 50-day moving average. A move below 1320 would likely lead to further selling.
spx etf
Chart Courtesy of

Over the last few days, we’ve been looking at the market’s breadth. We’ve focused on the Nasdaq Advance Decline Line (NAAD). That’s because there are fewer ETFs, preferred stocks, and closed end funds that trade on the Nasdaq.

That means that the picture of the number of actual stocks that are advancing and declining provided by this instrument is much clearer than that provided by the NYSE advance decline line (NYAD).

And last week’s action in NAAD got worse as the week went on, with the line making lower highs and lower lows, clearly showing a market where sellers had the upper hand.
naad etf
Chart Courtesy of

More interesting, though, is that the NYSE A-D line, despite all the distortions that it contains, also turned lower last week, in essence confirming the weakness that was being documented by NAAD.
nyad etf
Chart Courtesy of

When you add the wild and woolly sentiment from Investor’s Intelligence where the ratio of bulls/bulls + bears was over 69% skewed to the bulls, a correction in the stock market should come as no surprise.

Here’s it where it gets interesting, though. Traders have been bundling commodity, stock and currency trades into one package, now known as the “risk” trade. That means buying stocks, foreign currencies and commodities, and selling dollars at the same time. The rally in the dollar is making the “risk” trade too risky. 

That means that traders now have to unwind stock, commodity, and currency positions at the same time.
And that means volatility and margin calls in all three areas of the market.

Tales from The Road: Florida Gulf Coast Shows Signs Of Recent Weakness

We spent several days in the Tampa, Sarasota, Bradenton area of Florida this weekend. As always we looked around and see what the business climate was like, and we asked everyday working people about their jobs, the general outlook of things in their area, and what came up was familiar.

First, we start with the airport. It was packed, and much of it looked as if was vacation and necessary travel. There just weren’t that many families with large numbers of kids on their way to Disneyworld there. To be sure, we didn’t get to Orlando, so we can’t vouch for the Disney related traffic. What we saw were a lot of people that didn’t want to pay their luggage fees to the airlines. And many of them were getting turned back with large carry on bags to pay the fees. At $30 per bag, you can see how the airlines make up the revenues lost via discounted tickets. Nice.

Freeway traffic, though, was not very busy, given the number of people that were getting off airplanes and renting cars. Maybe we just went the wrong way.

Our driver, a married father and self employed businessman was very concerned about the school system, taxes, and the lack of any reasonable political alternative to what is already available. His take on real estate was that there were too many houses for sale and not enough people willing to buy them.

Restaurants had business, but there were no lines for lunch or dinner. The sit down casual diners had more business than the fast food places. And the local mom and pop restaurants were busier than the chains. The chains had their bargain specials prominently featured on the menus. Alcohol prices were higher at all restaurants, though, following a national trend in order to make up for loss revenues due to bargain meals.

Our hotel, a privately owned franchised Hilton property was full. Employees were happy, but noted that if it wasn’t for the weekend convention business, and a local college graduation, business wouldn’t have been as brisk, although they noticed that it was better this year than last year and were hopeful for a continued recovery.

Finally, the rise in “Bank owned” signs at commercial real estate sites was higher than we’ve seen in other places. We didn’t see much residential real estate so we couldn’t say much about it.


The risk trade is being unwound. And that’s likely to make life difficult for anyone on the other side. We have kept our portfolios hedged via ETFs that sell stocks short (SH and RWM). We have also positioned our commodity portfolios to profit from a fall in commodity prices.

Our trip to Florida this week was also an eye opener since we hadn’t been in that area of the country for some time. And the amount of “bank owned” commercial real estate was impressive. Not just empty buildings were “bank owned” but also empty lots and businesses that seemed to have closed recently were quite numerous, suggesting that conditions are actually worsening.

What’s our point? We may be headed for a significant correction on Wall Street and on Main Street.

See the original article >>

US farm prices may halve as rates rise, Fed warns


Farmland values could "plummet" in the US – potentially by one-half – if the market supports of low interest rates and high crop prices crumble, the US central bank has warned, heightening concerns over the market boom.
Record farmland prices, which in the Midwest increased at their fastest in 32-years in the first three months of 2011, appears rational as long as borrowing costs remain low, reducing investors' hurdle rates for returns, while elevated crop values keep actual profits high.
"Current farmland values reflect high farm revenues and low capitalisation rates," the US Federal Reserve system's Kansas bank said.
However, they "could fall sharply if crop prices sag or future interest rates rise", the bank added, warning of a "high risk" from interest rate moves.
'Values could plummet'
Indeed, higher interest rates are, besides making investors more demanding of returns from their purchases, likely to present the farmland market with a second blow of a stronger dollar which, in making US exports such as crops less competitive, would undermine agricultural commodity values.
"As the economy strengthens, interest rates could rise, which may lift capitalisation rates and lower farm revenues," the bank said in a report.
"Events such as these could become a recipe for falling land values and the erosion of farm wealth."
Indeed, the market could fare worse than in the early 1980s, when a jump in interest rates, coupled with lower US farm exports and weaker commodity prices, fuelled at 40% slide in US farmland values – even after taking inflation into account.
"If similar events occur in today's environment, farmland values could plummet," the briefing said, with this scenario implying as halving in Nebraska prices.
"Other regions face similar risks."
Market bubble?
Thomas Hoenig, the president of the Fed's Kansas City bank, has been for some while a sceptic of the rise in farmland prices, warning in February that ''history has taught us that it is nearly impossible to determine how much of the farmland boom may be an unsustainable bubble driven by financial markets".
Other observers who have voiced concerns include Robert Shiller, the Yale economist who warned in March that the farmland was a "dark horse" as the site of the next market bubble, while regulators at the Federal Deposit Insurance Corp have highlighted the sector's resilience at a time of weakness elsewhere in the economy.
"While we don't see a credit problem in agriculture at this time, the steep rise in farmland prices we have seen in recent years creates the potential for agriculture credit problems sometime down the road," Sheila Bair, FSIC chairman, said, also in March.
Alternative views
However, many other bankers are more sanguine about the market, with two-thirds of those surveyed by the Fed's Kansas City bank for a report two weeks ago believing prices would level off, rather than tumble, following growth of 20% in the first quarter.
A report from the system's Chicago bank last week showed more than half bankers expecting the market price growth to continue, while adding that farmers' borrowing, compared with deposits, remained comfortably below level triggering alarm bells.

Will the U.S. default? Is it really possible?

by Martin D. Weiss Ph.D

What happens on the day Uncle Sam runs out of money?

Or equally drastic: What happens when he’s no longer able to borrow from Peter to pay Paul and misses payments to countless creditors around the world? 

Treasury Secretary Geithner sent a letter to Congress earlier this month with some of the answers. In it, Geithner describes a scenario in which …
A broad range of government payments are stopped, limited, or delayed, including military salaries, Social Security, and Medicare payments, interest on debt, unemployment benefits, and tax refunds.
Interest rates and borrowing costs move sharply higher, home values decline, and retirement savings for Americans are reduced.
Geithner even warns of “a financial crisis more severe than the crisis from which we are only now starting to recover.” (See my commentary in “Doomsday Scenario” and also Geithner’s actual letter.)

But if the United States truly missed interest and principal payments on its debts, the actual scenario would likely be far worse:
Instead of acting as ultimate protector and benefactor, the government is increasingly perceived as the ultimate deadbeat and even public enemy. Government agents and agencies fail to respond when desperately needed or, worse, overreact to perceived threats to their power, harming innocents financially and even physically.
Local governments shut down libraries, county jails, even courts. Garbage piles up on the streets. Crime rates soar. But police enforcement is so scarce that the wealthy must pay bribes for adequate protection, while middle-class communities are left largely defenseless.
State governments gut budgets, lay off teachers, and close schools. Classrooms are so crowded, children are allowed on campus strictly on a first-come, first-served basis. Truancy is rampant but ignored.
The federal government cuts current Social Security and Medicare payments across the board or, worse, sends recipients greatly devalued checks. Veterans hospitals shut down. Unemployment benefits are slashed.
Fannie Mae’s and Freddie Mac’s lending operations are phased out. Affordable FHA mortgages are scarcer than hen’s teeth. Washington’s many foreclosure prevention programs are themselves closed. Millions of homes are repossessed and dumped on the market.
What Will Actually Happen? 

Let’s consider all the facts — coldly, objectively, and without political bias. 

Fact #1. Everyone — including Mr. Geithner and the Republican leadership in Congress — knows that the debt ceiling debate is mostly political posturing.

Everyone also knows that to overcome this hurdle, all Congress has to do is pass a simple piece of legislation. Therefore, we do not expect the U.S. government to default directly on its debts. 

But the U.S. is already defaulting indirectly by devaluing the U.S. dollar … and it will continue to do so! 

Fact #2. No government can repeal the law of supply and demand. No army or police can enforce laws that might seek to control global financial markets. 

They cannot stop investors all over the world from selling U.S. dollars. 

They cannot stop those same investors from dumping U.S. Treasury notes or bonds. 

And ultimately, they cannot force foreign creditors to continue lending money to the United States. 

Fact #3. The U.S. has already reached its debt limit, and a fundamental shift in global attitudes toward Washington is already under way. 

Meanwhile, Mr. Geithner is postponing the ultimate judgment day with a series of money-shifting shell games at the Treasury Department. 

The true, drop-dead deadline, he says, is August 2. If Congress doesn’t raise the nation’s legal debt limit by then, that’s when the shift will truly hit the fan. 

This gives Congress some more time. But no one knows how much time America’s foreign creditors will give us …

chart1m stocks
Fact #4. Even as early as the year 2000, the U.S. began to depend massively on borrowing from overseas — a total of $1 trillion.

China, the UK, Germany, and OPEC countries loaned America large sums, with the single largest loans coming from Japan. In fact, at that time, the U.S. borrowed more from Japan than the sum total of the other four. 

But it wasn’t enough to sustain the debt-hungry, bubble economy in the United States. 

Giant Internet and technology companies crashed. The Nasdaq lost three-quarters of its value. The American economy sank into recession. Unemployment soared.

Fact #5. To save the economy from collapse, then-Fed Chairman Alan Greenspan artificially shoved interest rates down to the lowest levels in a half century … and kept them there for nearly two years.

chart2 stocks
In addition, the U.S. was forced to borrow massively from overseas AGAIN — this time mostly from China. 

But it STILL wasn’t enough! 

The housing bubble burst. The economy collapsed. America’s largest banks went broke or needed giant bailouts. All of Wall Street nearly melted down. 

Total debts to foreigners as of the latest reckoning: $4.47 trillion, or more than QUADRUPLE the level of 2000 — by far the largest of all time. 

Fact #6. If you think borrowing trillions from overseas is a warning sign of big trouble, wait till you see what happened next. 

When the lowest interest rates in a half century and the biggest-ever borrowing from overseas were STILL not enough to rescue failing banks and finance ballooning federal deficits, Fed Chairman Ben Bernanke resorted to the greatest money printing in U.S. history (as measured by aggregate reserves of banks and the monetary base).

chart3m stocks
Heck, even in the most extreme circumstances of recent history, the Federal Reserve had never pumped in anything close to the amounts Bernanke created.
For example, before the turn of the millennium, the Fed scrambled to provide liquidity to U.S. banks to ward off a feared Y2K catastrophe, bumping up the monetary base from $557 billion on October 6, 1999 to $630 billion by January 12, 2000. At the time, that sudden increase was considered extreme — $73 billion in just three months. 

Similarly, in the days following the 9/11 terrorist attacks, the Fed rushed to flood the banks with liquid funds, adding $40 billion through 9/19/01. 

But Mr. Bernanke’s money printing since September 2008 has been a whopping 22 times larger than during in the Y2K episode and 41 times larger than 9/11!

Moreover, in the Y2K and 9/11 episodes, soon after the immediate crises had passed, the Federal Reserve promptly reversed its money infusions and took the excess amounts back OUT of the economy, restoring a semblance of normalcy. 

But now, Mr. Bernanke has done precisely the opposite! He has continued his money-printing binge virtually nonstop — first under the rubric of “quantitative easing round one” (QE1) and now under “quantitative easing round two” (QE2).

Total amount printed by Bernanke so far? $1.634 trillion! (From 9/10/2008 through 5/4/2011.) 

And that’s on top of Bush and Obama economic stimulus packages — not to mention countless government bailouts and guarantees.

But It’s STILL Not Enough!

As Mike Larson explains in “The Forgotten Crisis,”
“The massive economic stimulus package from a few quarters back, plus the Federal Reserve’s unprecedented wave of money printing, didn’t buy us much. We printed, borrowed, and spent more than $2 trillion. And all it bought us was a few quarters of tepid GDP growth.
“Now the end of QE2 is looming in just six weeks. The federal government is tapped out, what with the debt ceiling pressure. So we’re left with an economy that has to stand on its own two feet … and it appears it just can’t!
“GDP growth already slowed from 3.1 percent in the fourth quarter of 2010 to 1.8 percent in the first quarter of this year. Now it looks like things could be even worse in the current quarter.”
Meanwhile, Mike points out that …
  1. Housing starts have just plunged 10.6 percent, leaving the market stuck at a dismal level of about 500,000 to 600,000 starts for two-and-a-half years — DESPITE hundreds of billions of dollars in aid being thrown at the market by Washington.
  2. Home prices are down again. They fell apart in the housing bust. Then they recovered a bit. Now, they’ve fallen back down and are dangerously near their lowest levels reached during the depth of the housing bust in early 2009!
  3. Industrial production flatlined in April, confounding economists who were looking for a gain of 0.4 percent.
  4. The Empire Manufacturing Index, which measures activity in the greater New York area, plunged to 11.9 in May from 21.7 a month earlier.
“Bottom line,” concludes Mike, “the American economic engine is starting to sputter again!”

Time Is Running Out! 

The U.S. dollar has already been plunging against nearly all major currencies of the world.

The cost of food, energy, and imports are already going through the roof.
Mr. Bernanke’s second big round of money printing is already about to end. 

Even if he embarks on a third round, he will have to step up the pace dramatically, risking even bigger price surges … or cut back the pace, risking an economic tailspin. 

Which will it be? Right now, Bernanke’s on track to ramp up the printing presses even further.
Our advice:
  • Stay away from medium-term notes or long-term bonds of any kind, whether issued by local governments, the U.S. Treasury, or corporations. Remember: Even a moderate acceleration of inflation can significantly erode their value.
  • To protect yourself against inflation, buy, hold, and accumulate gold and other hedges.
  • The best defense is to go on the offense. And the best way to go for substantial profits is with ETFs that are most likely to rise as the dollar falls.
Prime example: ETFs tied to the most in-demand tangible assets, the strongest foreign currencies, and the most stable, fastest-growing economies.

See the original article >>

Corn demand tops the list of China's agriculture priorities

by Commodity Online

China, the world’s second-biggest consumer of corn, is all set to expand planting this year as the industrial use of corn is increasing rapidly and farmers seek to profit from strengthening prices.

China’s demand for corn is expected to grow faster than supply over the next 10 years. A dramatic increase in the industrial use of corn to produce ethanol would require increased output of the grain and will lead to higher prices.

Bloomberg has reported that China is limiting corn use by the biochemical and sweetener industry to ensure sufficient supplies for livestock feed. On the other hand, processors are barred from buying more corn than they consumed in 2009 since most of the large processors anticipated government policies and bought supplies quite early the industrial use of corn is not expected to drop significantly.

According to National Grain and Oil Information Center, total domestic corn consumption in China has been growing at 2.4 percent annually surpassing the 1.7 percent annual growth in production--trends that have sharply effected its stocks of corn.

The surging industrial demand have caused corn prices to rise sharply since the latter half of last year.

According to the official data, China's total corn consumption was over 180 million tons in 2010, increasing by over 5% over 2009. With the recovery of Chinese economy, the demand of China's feed and processing industry for corn will see a sharp increase in 2011-2012.

Stock Market Wave Counts

This week I want to spend some time on some long term views, as I have received some questions about my views to the long term trend. Whilst I am not really a fan of long wave term counts, we are following a couple of ideas.

I am sure there are readers asking themselves is this a bull or bear market?

By definition there can be no doubt that the past 2 years the markets have been a bull market in the sense that price has moved up, traders in my opinion should not be dazzled with the reasons why it's a bull market, but more interested in what price is doing.

However price is starting to show some cracks and whilst it started to look aggressively bullish a few weeks back, a lot has happened and there is some definite flaws with the aggressive bullish stance that many have adapted.

Price action is not lending itself to the aggressive nature you would expect if this was to be in what Elliotticians refer to as a "3rd of 3rd" in this case it would have been to the upside.

What we are seeing and especially since Feb 2011 is a bunch of noise and chop, which further supports the ideas I am showing here.

Now like everything in the markets, nothing is ever a definite, and we will adjust as necessary, but we are starting to see a clear image going on in the past few weeks, whilst this recent chop has been anything but friendly for traders, if you stand back and look at the big picture shown here, you can see the potential shape of wedge that could be signaling an impending reversal and one that could be ending the rally from March 2009.

An alternative bearish wave count

This is not the general coconscious in the Elliott world, I am sure many readers are familiar with the DOW 1000 wave count and the end of the world wave count that some bears are following. Personally I am not really in that camp, overall it wouldn't make much difference as this idea shown here is suggest a trip back to the March 2009 lows.

Now Elliotticans that are reading this article or even readers with a grasp of Elliott wave theory will note the obvious 3 wave move from the March 2009 lows, what most important is what's going on now with price action. If you look carefully you will note the wedge potential of price action recently, that's showing a real battle ground taking place, and is generally associated with the top of a trend in a market, hence the potentials I will show in this article.

The bear case is that the market is still ongoing in a bear market, and I am sure readers are fully aware of the money printing and debt that many countries have took on over the past few years, and most know that the reasons why the market is where it is, it's because of POMOs and suchlike, as the US government via the FED is supporting the stock market, that's pretty much common knowledge, but again regardless of the reasons, price is still moving higher, just like back in 1999, the market simply shrugged off any cracks that were showing up until one day it fell apart, and again like back in 2007, the same setup, cracks were beginning to show back then, its most likely the same now, the market is not listening to the fundamentals of the real world, hence you can't use the fundamentals when trading price, which is why traders rely on technical analysis, as if you based your decision on trading the fundamentals you would have been run over with the path the markets have been on over the past 2 years.

But now we are starting to see some cracks, you have seen that over the past few weeks from Feb 2011, when you look at a daily scale we notice the potential for this to start to wedge or a triangle, but we tend to think this has the makings of an ending diagonal taking shape. If price starts to wedge that's a bearish sign and the market is trying to signal the trend is coming to an end.

What traders need to be asking is, what is the shape that is going to take place here. Forget about the labels, they are only relevant to an experienced Elliottican. What's important is what price is doing, the past week has been one chop fest of whipsaw, and here is where it's important to look at what's going on in a larger time scale, if you look carefully, we have chopped around for a few weeks and no side is really getting the advantage.

What more important is what price is doing, it's not moving higher in an impulsive aggressive action as we saw before, that's a slight characteristic change, hence the aggressive bullish idea of seeing an imminent aggressive move higher is lacking in the right price action.

So the ideas that really standing out here, is a potential triangle or an ending diagonal (wedge).

The very fact we are seeing chop and whipsaw at the top of a trend is a characteristic of both those patterns, which further suggests, is that we are likely in a topping phase, as the bears and bulls are fighting it out, but the fact that's its gone from very aggressive upside to chop is a characteristic of one of those patterns and something that the bulls do need to be aware of.

Whilst we are still bullish here we are not as bullish as we was a few weeks back as we see the cracks here as the character has changed, so we are watching for which idea becomes favorite, both imply higher prices, but it's the chop and whipsaw that will become a problem for traders in the near term, we are already seeing 15 handle daily swings, you don't see that in aggressive bullish trends, you only have to look back to before the Feb 2011 high to see that day after day we saw straight up price action, that's the hallmark of an aggressive trend, not what we are seeing now.

As traders you can only trade what you see, but the predictability of using Elliott is its usefulness in patterns especially with patterns such as the ending diagonal or triangle.

The most recent example of an ending diagonal was on oil just a few week back before it literally fell apart.
If the market continues to overlap over the coming days and weeks, we suspect we have one of 2 patterns working, either a triangle which we rate at 35%, a potential ending diagonal, which we rate at 45% or the lows odds flat towards 1240SPX rated at 20%.

In order to really see an aggressive upside move here, it will need to do something special that is going to have to surprise traders, that means aggressive price action and buyers coming and buying with both hands, what we have seen recently is lack a luster performance, that's not something we wanted to see for an aggressive move, hence we are cautiously bullish and looking at one of the patterns above.

As shown above, here is what we think could be going on over the coming weeks, the clue is that price action continues chop around, and overlap, and more importantly starts to wedge, as that the key to the ending diagonal, lower volume, and less and less participation as the trend is coming to an end to reverse.

In order to get the trend back into the aggressive bull mode, it's going to need something far different than we have seen over the past few weeks, something like the back end of last year.

We still are bullish medium term, as it will need to do a lot more damage on the downside to suggest an aggressive bearish idea, but we are cautious and following one of 2 potential patterns as seen in this article.


If you look at the recent price action of the DAX and FTSE, they both too have the potential for an ending diagonal, the aggressive idea of seeing a big move higher from here is looking weak, as the price action over the past few weeks is not something I would consider, is a characteristic of a "3rd of 3rd" it's more likely towards the end of a trend.

So we will be following price action over the coming days to see if they start to wedge to provide the clues we need to see if an ending diagonal setting up here over the coming weeks.

See the original article >>

Stocks Bear Market Rally and Market Manipulation

As I have stated all along, my research suggests to me that the rally out of the March 2009 low has been a bear market rally. Nothing has occurred to change that point of view. In light of that view, I have received a number of e-mails asking about manipulation and if “they” could prevent such an event from happening. 

All throughout the period between 2003 and 2007 I explained that we were seeing a stretched 4-year cycle. I also explained that the efforts by the powers that be to hold things together would ultimately only serve to make matters worse. There is no doubt that the manipulative efforts seen during this period contributed in a very negative way to the credit and banking crisis. In my eyes, this was largely accomplished through the unscrupulous lending practices and mass financial irresponsibility, resulting in the housing bubble, which Greenspan tried to tell us did not exist and which I called, in writing, in late 2005, before the top became apparent.

In October 2007 the equity markets peaked. My subscribers were informed of that fact as we knew what we were looking for and as it occurred we knew exactly what was happening. As the decline took root the manipulative efforts became even more drastic than what was seen into the 2002 low. But, cyclically, none of this mattered as the market continued lower until the cyclical events required to make the 4-year cycle low and the Phase I low were achieved. It was from that point that this bear market rally began. In the eyes of most people and the politicians, they believe that they have “saved” the market and that the economy has bottomed. This is not so. The market and the economy merely reached a temporary bottom in March 2009, in which the rally that should ultimately prove to separate Phase I from Phase II of the bear market began. This rally has served to give the public a false sense of security and hope that the economy is now on the road to recovery. This rally has also given the powers that be a false sense of power in that they think they have every thing under control as a result of their manipulative efforts. According to the historical bull/bear market relationships and the longer-term phasing of Dow theory, this is not likely the case. Once the proper setup occurs, the bear will have his opportunity to cap this advance. Unfortunately, in the meantime, the hope and hype of Wall street and Washington keeps the public blindly optimistic.

I have gone back to 1896 and have identified a very specific cyclical “DNA Marker” that has occurred at every major market top. If the Dow theory phasing is right about this being a bear market rally, this DNA Marker will appear in accordance with very specific statistics, which will set the stage for the suspected Phase II decline in this ongoing secular bear market to begin. These details are being covered in my monthly research letters. Once this DNA Marker is in place it won’t matter what the powers that be do or say because the bear will have his way. The bailouts were a waste of money and were only associated with a temporary low. The powers that be cannot manipulate the entire world out of the natural forces and cyclical events that have to play out. Their efforts only serve to make matters worse and to postpone the inevitable. Again, the most recent example of this occurred as a result of the efforts to keep things going between 2003 and 2007. Were things not worse in 2008 and early 2009 than they were in 2001 and 2002? Yes, they were. Did the efforts between 2003 and 2007 prevent the downturn into the 2009 low? Did “they” warn you of the downturn in 2000, or of the housing bubble, or of the 2007 top? Have the efforts in 2008, early 2009 and the time since not been more extreme than they were in the 2003 to 2007 period? Yes, they have been and I look for the fall out from those extreme efforts to be worse than the fallout of the 2003 to 2007 efforts. So, if we see this DNA Marker occur, then we will have the proper setup in place for a meaningful correction. Such correction should at least correspond with 4-year cycle top and the decline into the next 4-year cycle low. The greater risk to the market is that if the longer-term Dow theory phasing is correct, this should also correspond with the Phase II decline. Just as I warned of the 2000 top, the 2007 top, the top in housing in 2005 and of the top in commodities in 2008, I am now warning that another surprise is coming. It is the appearance of the proper setup that will set the wheels into motion and the manipulation is once again not going to matter.

The following text on Manipulation was taken from Robert Rhea’s book, The Dow Theory.

“Manipulation is possible in the day to day movement of the averages, and secondary reactions are subject to such an influence to a more limited degree, but, the primary trend can never be manipulated.

Hamilton frequently discussed the subject of stock market manipulation. There are many who will disagree with his belief that manipulation is a negligible factor in primary movements, but it should always be remembered that he had, as a background for his opinions, a most intimate acquaintance with the veterans of Wall Street, and the advantage of having spent his life in accumulating facts pertaining to financial matters.

The following comment, taken at random from his many editorials, affords convincing proof that his views on the subject of manipulation did not vary:

‘A limited number of stocks may be manipulated at one time, and may give an entirely false view of the situation. It is impossible, however, to manipulate the whole list so that the average price of 20 active stocks will show changes sufficiently important to draw market deductions from them.’ (Nov. 29, 1908)

‘Anybody will admit that while manipulation is possible in the day-to-day market movement, and the short swing is subject to such an influence in a more limited degree, the great market movement must be beyond the manipulation of the combined financial interests of the world.’ (Feb.26, 1909)

‘…the market itself is bigger than all the ‘pools’ and ‘insiders’ put together.’ (May 8, 1922)

‘One of the greatest of misconceptions, that which has militated most against the usefulness of the stock market barometer, is the belief that manipulation can falsify stock market movements otherwise authoritative and instructive. The writer claims no more authority than may come from twenty-two years of stark intimacy with Wall Street, preceded by practical acquaintance with the London Stock Exchange, the Paris Bourse and even that wildly speculative market in gold shares, ‘Between the Chains,’ in Johannesburg in 1895. But in all that experience, for what it may be worth, it is impossible to recall a single instance of a major market movement which depended for its impetus, or even for its genesis, upon manipulation. These discussions have been made in vain if they have failed to show that all the primary bull markets and every primary bear market have been vindicated, in the course of their development and before their close, by the facts of general business, however much over-speculations or over-liquidation may have tended to excess, as they always do, in the last stage of the primary swing.’ (The Stock Market Barometer) ‘…no power, not the U. S. Treasury and the Federal Reserve System combined, could usefully manipulate forty active stocks or deflect their record to any but a negligible extent.’ (April 27, 1923)

‘The average amateur trader believes the stock market is guided in its trends by a certain mysterious ‘power,’ this belief being the one factor, next to impatience, most responsible for his losses. He reads tipster sheets avidly; he scans the newspapers industriously for news likely, in his opinion, to change the trend of the market. He does not seem to realize that by the time the news of real importance is printed, its effect, so far as the basic trend of the market is concerned, has long ago been discounted.’

‘It is true that a flurry in the price of wheat or cotton may influence the day to day movement of stock prices. Moreover, sometimes newspaper headlines contain news which is construed as bullish or bearish by market dabblers, who collectively rush in to buy or sell, thus influencing or ‘manipulating’ the market for a short period. The professional speculator is always ready to help the movement along by ‘placing his line’ while the little fellow timidly ‘lays out’ a few shares; then, when the little fellow decides to increase his commitments, the professional begins to unload and the reaction ends, and the primary movement is again resumed. It is doubtful if many of these reactions would ever be caused by newspaper headlines alone unless the market was either overbought or oversold at the time---the ‘technical situation’ so dear to the hearts of financial news reporters.’

‘Those who believe the primary trend can be manipulated could, no doubt, study the subject for a few days and be convinced that such a thing is impossible. For instance, on September 1, 1929, the total market value of all stocks listed on the New York Stock Exchange was reported to have amounted to more than $89,000,000,000. Imagine the money which would have been involved in depressing such a mass of values even 10 per cent!’

Today’s total market cap is some 50,000,000,000,000 and QE 2 was valued at 600,000,000,000, which is 1.2 percent of the estimated total US market cap. So again, the manipulation will not matter.

See the original article >>

Key Markets And Indicators Divergence: Stocks, Copper, Treasuries, Bonds, Investor Sentiment and Commodities

I posted a few charts this week showing some extreme levels and or divergences and wanted to combine them into one follow up post. The equity markets are at a very important juncture right now and confusion is rampant in every trader's mind.

The markets have fooled almost everyone over the past two years and with QE2 ending in six weeks the headlights draw near as the deer stand in the middle of the road unsure which way to run.

Copper: Copper has been a very good indicator of equity direction even during Fed QE when other correlations have broken down. We currently have a very large divergence with the SPX and the question becomes did copper put in a bottom based on last week's price action or was that a similar bounce as previously witnessed since the February 2011 high of 4.6495. 

I believe the answer to the above question regarding the future of copper was answered on Friday with the COT report (found here). Commercial accounts have positioned themselves for a major correction in copper. In fact the last time they were positioned as such was April 2010 when QE1 was ending and copper was trading at $3. These are not traders but rather producers and users of copper. They know what's going on in the market as they are the market.

The chart below shows the correlation between the SPX and Copper Commercial Net Positions.

Corporate Bond Spreads: Amazing how the spread between high yield and investment grade corporate debt bottomed in 2011 at 80 basis points (bp) while in 2007 it bottomed at 79 bp. They could trade lower as high yield catches even more of a bid but they are at multi year lows after an impressive move since 2009.

Treasury's: Using history as a guide bonds caught a bid in April of 2010 a full two months before QE1 ended and have begun to show a similar pattern in 2011.

AAII Investor Sentiment: The divergence is at an extreme and someone is clearly wrong. History would say it is sentiment as the lower the number of bulls the higher the market will move. The divergence is absolutely massive though and remains the one big thorn in the side of the bears.

Commodities (data as of May 18, 2011): Commodities have peaked. Why would they peak now other than to fade QE2 or as economic data weakens? 
Commodities peaked in the summer of 2008 on average two to three months before the markets began their correction. The other question is why did Glencore, the largest commodity trader go public now and why has the IPO price already be taken out to the downside as investors bring down their valuations?

Copper – Peaked on February 15 – down 11.8%

WTI Crude – Peaked on May 5 – down 12.9%

Corn – Peaked on April 11 – down 4.3%

Wheat – peaked on February 9 – down 8.2%

Soybeans – peaked on February 9 – down 37.2%

Cotton – peaked on March 7 – down 28.2%

Sugar – peaked on February 2 – down 36.2%

Cocoa – peaked on March 4 – down 20.6%

QE History: With the second round of QE coming to an end we now have three of four events to use as a historical guide. Two times are the beginning of QE and one is the end of QE. All three times markets faded the news. History would then say the end of QE2 will also be faded. It is quite possible 1,370 on the SPX was in fact the beginning of that fade.

See the original article >>


This week we take a look at some inflation numbers from the EU and UK, and while on the topic have a check in on commodity prices. Then we review the latest GDP numbers from Japan, before finishing up with a check in on global monetary policy.

1. EU Inflation
The EU saw a continued spike in inflation, with Euro Area annual inflation at 2.8%, vs 2.7% in March (1.5% in April 2010), while EU annual inflation rose to 3.2% vs 3.1% in March (2.0% in April 2010). Meanwhile Euro Area Core inflation was perhaps the most remarkable, rising to 1.6% in April, from 1.3% in March, and just 0.8% in April 2010. The highest rate of inflation was seen in Romania (8.4%), followed by Estonia (5.4%); while the lowest rate of inflation was recorded in Switzerland at just 0.1%, followed by Norway with 1.3%. While there is a degree of divergence in results, inflation is broadly creeping upwards in the Euro Zone and Core inflation is fast approaching the ECB inflation target.

2. UK Inflation
Over in the UK, a similar theme of rising inflation was seen with April annual consumer price inflation of 4.5%, up from 4.0% in March, and 4.0% in April 2010. The spike in inflation in the UK has caused some to speculate on a sharp rise in interest rates from the Bank of England, with inflation still well above its official inflation target. However the Bank of England, by and large, is not particularly set on aggressive tightening, particularly when the UK economy is still struggling along in recovery mode. The most likely policy path will be a steady path of rate increases, perhaps commencing later this year, depending on how the broader economy fares.

3. Commodities
On a rolling 12 month return basis, the latest data shows commodities were up 35.6% as measured by the Reuters/Jefferies commodity index. On a rolling monthly basis though the figure was -6.6% driven by a sell-off in a few commodities, particularly Silver. Commodity prices continue to be the key variable for 2011, as rising prices have catalyzed uprisings and social unrest, driven surging inflation in emerging markets, and have begun to have an increasing impact on inflation in developed markets. There’s also the growth risks that high commodity prices present. But commodities are probably a good example of mean reversion in practice as high prices generally lead to a supply response, thus prices shouldn’t be able to run up too high for too long unless structural changes have taken place in the global economy.

4. Japan GDP
Japan had a disappointing Q1 GDP figure, with GDP declining -0.9% on a quarterly basis (annualised -3.7%) , compared to -0.8% in Q4 2010, while Q1 2010 was 2.2%. On an annual basis this mean contraction of -0.7%, compared to 2.4% in Q4 2010, and 5.5% in Q1 2010. Much of the negative results can be explained by the impact of the earthquake as the disaster weighed heavily on private consumption and caused supply chain disruption impacting on net exports, and general uncertainty limiting capital spending. As with most large scale disasters the economic pattern is a short-term hit, but a medium term spike. So, provided the Japanese government can manage the process well, the rebuilding phase should help Japan’s economy return to growth later this year, with 2012 likely to see much stronger economic activity levels.

5. Monetary Policy
The past week in monetary policy was relatively quiet with only 5 central banks announcing monetary policy decisions, and of those, only 1 adjusting its policy stance. Vietnam was the only bank to adjust monetary policy settings; increasing its reverse repurchase rate by 100 basis points to 15.00%. Meanwhile those that held their monetary policy interest rates unchanged were: Serbia (12.50%), Hungary (6.00%), Sri Lanka (7.00%), and Japan (0.10%). So there was somewhat of a theme of emerging markets beginning to ease off on aggressive policy tightening (with the exception of Vietnam, which is still seeing rampant inflation) as some inflation pressures begin to ease, if not peak, and as the growth outlook comes to fore in terms of policy risk. Monetary policy, and by extension inflation, remains one of the key factors for the growth and financial market outlook in emerging markets this year.


So we saw the pace of inflation beginning to show a more marked uptrend in the Euro Zone, which may well mean that the ECB’s interest rate increase in April will likely be repeated in the near term. Meanwhile the UK also saw a continued high rate of inflation, but the Bank of England is still unlikely to budge as the UK economy is still on the go-slow. On a related topic, commodity prices saw surging 12-month returns in May, but with monthly returns diving into negative territory, perhaps heralding an easing in commodity prices over the medium term. In Japan, first quarter GDP results were disappointing, driven into negative territory by the disaster impact. On monetary policy, further signs of a peak in monetary policy tightening for emerging markets surfaced as the growth-inflation risk mix is becoming increasingly finely balanced.

See the original article >>


by Cullen Roche

In his most recent letter, Richard Russell of the Dow Theory Letters discussed why he is growing increasingly concerned about the state of the bull market. Russell believes there is “technical deterioration” when looking under the hood at the market:
“Late yesterday I was playing around with various formations on the stock averages, and, to my surprise, I came up with the pattern that you see below. Here is the Dow over a period of a decade. What we see here is a so-called “Broadening formation” or “megaphone pattern.” This pattern often appears towards the end of a bull market (as it did in 1919).”
“The broadening formation is made up of five successive reversals, four of which you see on the chart below. The rationale behind the it attempts to “find” the true trend. The broadening pattern represents an semi-hysterical market that first discounts one trend, then changes its mind and discounts an opposite trend.
At the fifth reversal (we’re not there yet) the item rallies to a new highs and then executes a final reversal prior to a collapse. Anything is possible where markets are concerned, and I’m wondering whether what we’re seeing now is a text-book example of a broadening formation. If so, I would expect the Dow to advance to a new high and then reverse violently to the downside.
Another Russell worry — Below we see a chart of the bullish PERCENTAGE of stocks on the NYSE. Here we see a picture of technical deterioration. The bullish percentage is now down to 66.67%, and it is below the March bullish percentage of 67%”

See the original article >>

Measuring systemic financial risk

On a recent visit to UCSD, NYU Professor and Nobel Laureate Rob Engle called my attention to the NYU Stern Volatility Laboratory, a great resource that anyone can use to get some very interesting real-time analysis. Here I’d like to describe some of the features available for assessing the systemic risk posed by financial institutions.

The first step that Engle and colleagues propose is to calculate what they call the Marginal Expected Shortfall (MES) associated with a given financial institution. This is an estimate, based on recent dynamic variances and correlations of observed stock prices, of how much the stock valuation of a given institution would be expected to fall today if the overall market were to decline by more than 2%. This is essentially a time-varying tail-event beta, details of whose estimation can be found here.

They next used a dynamic simulation to extrapolate from the MES an estimate of how much the stock would fall in the event of a full financial crisis, defined as a 40% decline in a broad market stock index over a space of 6 months. They estimate this number to be around 18 times the daily MES.

The last step is to compare the magnitude of the decline with the firm’s current equity and liabilities, and calculate how much more capital the firm would need to raise in order to remain solvent in the event of another financial crisis. This measure, which they describe as the “systemic risk” associated with the firm, can either be reported in terms of how big the shortfall of that firm would be (in billions of dollars), or in terms of the percentage of the shortfall across all financial firms contributed by that single institution.

For example, here’s what their calculation gives you using Friday’s stock market data. If we were to experience a new financial crisis, three institutions– Bank of America, Citigroup, and JP Morgan Chase– would each need to raise about $100 billion, and between them would account for about half of the financial sector’s capital shortfall in the event of a major downturn.

Financial institutions with highest estimated systemic risk as of May 20, 2011. Source: NYU Stern Vlab.
vlab1 economy

By clicking on the heading for the Vlab page from which the above screenshot was taken, you can alternatively sort firms by any measure you like.

Another neat feature is you can go back in time to any date of interest. For example, here’s where things stood on August 29, 2008, right before the financial crisis, with firms sorted by MES. At that time, three firms: Fannie, Freddie, and Lehman– each had MES above 12, though several other institutions (remember AIG?) are assessed to have posed a bigger systemic risk.

Financial institutions with highest estimated dynamic MES as of August 29, 2008. Source: NYU Stern Vlab.
vlab2 economy

And here’s a plot of the path followed by the estimated MES for Lehman leading up to the crisis. Correlations among stock returns signaled Lehman’s growing vulnerability to a downturn.

Historical graph of estimated MES for Lehman Brothers as assessed on August 29, 2008. Source: NYU Stern Vlab.
vlab3 economy

I view these measures as a supplement to, rather than replacement for, other analyses based on direct linkages and derivative exposure. CDS could offer another useful market indicator. But the advantage of the NYU Stern approach is it can immediately draw out some of the implications of the latest stock market valuations and comovements for real-time use by regulators, investors, and business planners.

All for One Euro and One Euro for All?

By John Mauldin

Economic versus Political Theory
Trichet Says “Non!” Again
What Will the EU Do?
All for One Euro and One Euro for All?
We’re Off to Europe

I have been doing a lot of reading this week, and today we look at some of the thoughts that keep coming to my mind. We’ll think about the declining importance of economic theory (which is a tragedy) and then cast our eyes to Europe, where a truely tragicomic drama is being performed. Who needs the movies when you have the EU? There is a lot to talk about.

But first, some of my thinking has been deeply colored by some recent Conversations I have had with Neil Howe, Lacy Hunt, Dylan Grice, and George Friedman. Those audios and transcripts will soon be on the Conversations website, and others will join them shortly.

Conversations with John Mauldin is my subscription service, where I offer subscribers audio and transcripts of conversations I have with thought leaders about the topics of the day. It is just as if you were sitting at the table with us, listening in on our exchange. The service has been very popular, and the reviews are quite good. And the education you’ll get, the ideas that are generated, will help you as you create your own investment strategy.

You can go to and type CONV in the coupon code to get a discount. And the Conversations I am lining up for later this summer will be just amazing, I assure you! Now, let’s jump into the letter!

Economic versus Political Theory

Speaking of conversations, Dr. Woody Brock called me to say very nice things about my latest book, Endgame ( He used words like tour de force. Coming from Woody, who has one of the more powerful intellects I know, it made my day. Woody has so many degrees. He is a master (and the doctorates that come with them) of game theory, economic theory, and political theory. His multidisciplinary approach to markets is a thing of beauty to listen to; and since I had him on the phone, listen I did. It triggered the following thoughts.

I remember it was not so long ago when I was asked a question about how some government policy would affect the stock market. The question was in the context of which presidential candidate would be better. My answer was that presidents get way too much credit if the stock market goes up and way too much blame if it doesn’t. Bill Clinton got elected at a very good time to be elected, as did Reagan. Carter didn’t. If Gerald Ford had won, the economy would still have experienced turmoil and high inflation. It was Volker who made the difference, and then Greenspan’s (and now Bernanke’s) incessant easing. And Congress and their rule making, plus the (insert your favorite expletive) bureaucracies, have much more influence on the economy in the long run than presidents. It is the same in most democracies.

That is why, although we pay attention to politics, including Congress, we run models on our investments. We worry about long-term valuations, inflation/deflation, currencies, etc. Our primary tools for thinking about our investments are economic and financial tools, flawed though they may be. As business people and entrepreneurs, we are more focused on executing our business plans than worrying about politics, although one does pay attention to what they are doing, as regulations can change our plans. As a value investor, I want to know how the executives of a company are going to create cash flow and use that money to grow the business. When I invest in biotech, I want to think about the intellectual property and demand. And so on.
But all that is changing. I mentioned to Woody that it seems like we have to pay more and more attention to politicians and what they are doing and less and less to our economic theory. But that is the nature of the Endgame. And this is not just in the US, but all over the world. The choices that voters make, and then the things the politicians do, are becoming ever more important. Those choices can mean the difference between Muddle Through and a recession here and there, a full-on Depression 2.0, or even hyperinflation in some countries, with voters (and most assuredly politicians!) not thoroughly understanding the unintended consequences of their reactions.

Woody responded that it is now more about political and game theory than economic theory. How do politicians work through the trade-offs they will be forced to make? Can they even make them? Let’s turn our eyes back to Europe to see what happened just this week.

Trichet Says “Non!” Again

I wrote sometime last year about a speech that Jean-Claude Trichet gave last May, and said:
“On Thursday of last week Jean-Claude Trichet, president of the European Central Bank, said three times “Non! Non! Non!” when asked in a press conference if the ECB would consider buying Greek bonds. His exclamation was accompanied by a forceful lecture on the need for eurozone countries to get their fiscal houses in order, some of which I quoted in last week’s letter. Trichet was remonstrating about the need for the ECB to remain independent, and was rather definite about it.

“Then on Sunday he said, in effect, “Mais oui! Bring me your Greek bonds and we will buy them.” What happened in just three days?

“Basically, the leaders of Europe marched to the edge of the abyss, looked over, decided it was a long way down, and did an about-face. It was no small move, as they shoved almost $1 trillion onto the table in an ‘all-in’ bet.”

So this last week, The Financial Times reports that Trichet walked angrily out of a meeting chaired by Jean-Claude Juncker, in protest over Juncker’s proposals to reprofile Greek debt. Reprofile is a nice word for default. Side note: I had to add reprofile to my MS Word dictionary. How many more synonyms/words will I need to add for default before this is over?)
From Eurointelligence:

“FT Deutschland reports this morning that Trichet told finance ministers on Monday night that the ECB would respond to a reprofiling by refusing to buy any new Greek debt instruments (meaning it will not be part of any voluntary arrangement in respect of its own Greek debt portfolio). Furthermore, the ECB would refuse to supply the Greek banking system with any further liquidity. (This is something we suspected would happen. A reprofiling would be considered by the rating agencies as a default, which would lead to an instant downgrading of all Greek securities, government and banks, to C, which would make them no longer acceptable to the ECB.) This means that the ECB will effectively boycott Juncker’s silly plan. That, in turn, would force Greece to quit the eurozone within days.)

“Other ECB executive board members also went nuclear on this issue. J├╝rgen Stark said a restructuring would destroy the capital of the Greek banking system, and Greek bond would no longer count as acceptable collateral. Lorenzo Bini Smaghi called the term ‘soft restructuring’ an empty slogan.”
Ouch. The European Central Bank is trying its best to channel its inner Bundesbank spirit. And if you listen to the new head of the German Bundesbank, his inaugural address made all the right statements about the need for central banks to control money supply and inflation. A brief quote from some emails going around the inner circle of GaveKal:

“Look at the May 2nd inauguration speech by Jens Weidmann, the new Buba [the German Bundesbank) president. In front of former Buba presidents Pohl, Schlesinger and Weber, Jens Weidmann made a pledge of “no compromise on monetary stability” and expressed a wish for a “correction back to monetary policy normality” and for “full separation between monetary and fiscal policy.” Another interesting aspect of the speech was how Dr. Weidmann constantly referred to his predecessor, Axel Weber, in the familiar ‘Du’ form. Clearly, it seems that the new Buba president is cut from a very similar cloth to the departing one. And as inflation rates in Germany continue to creep higher, we can expect Dr. Weidmann’s voice to become ever more audible. Looking ahead, this could prove disruptive for fragile European markets.”

And the markets are continuing to hammer Greek debt. The Greek two-year bond yields 24.56%, up 39 basis points on the day, while the four-year bond yield rose by 76 basis points to 21.04%. The ten-year bond is now at 16.37%.

Greece will need another 30 billion euros early next year, on top of the current 330 billion euros they owe and on top of the 80 some odd billion already committed. To get access to that money, the Greeks will have to make asset sales of state-owned companies worth some 50 billion, plus even more cuts in government spending, coupled with more taxes.

The chair of the eurozone finance ministers committee, Jean-Claude Junker, acknowledges what everyone knows. Greece cannot pay its debt under the current debt burden, and the private market is not going to give Greece any more money (debt) at anything close to terms that make sense for Greece.
Last week I talked about how Europe would keep kicking the can down the road until they came to the end of the road, and then they would bring in road-building equipment. This week it appears they are seeing the end of the road in the not too distant future.

“Lorenzo Bini Smaghi, a member of the central bank’s executive board, warned in a speech in Milan that restructuring by any nation would put all of Europe in jeopardy by potentially wrecking the banking sector.
“Time has been lost talking about how to come up with a way to reduce the debt, but if we accept this we’ll jeopardize all of Europe,” he said, according to Bloomberg. “A solution for reducing debt but not paying for it will not work.”

“Juergen Stark, also a member of the executive board, insisted at a conference in a resort south of Athens that any attempt to restructure the nation’s debt would be a ‘catastrophe,’” Dow Jones Newswires reported.
“It is an illusion to think that a debt restructuring, a haircut, or whatever kind of rescheduling you have in mind would help to resolve the problems this country is facing,” Stark said. “There is no other way than to continue with fiscal consolidation, and I would even say to double the effort in fiscal consolidation.” (hat tip Mike Shedlock!)

Fiscal consolidation? That is a code word for loss of political independence. That is a code word for the Germans controlling Greek budgets and being in charge of collecting taxes. And if you go down that path with Greece? How fast do you come to Portugal, which just got a major financial commitment from the EU and IMF?

If the ECB did follow through with its threat, Greece’s banking system would fail, said Jacques Cailloux, an economist at Royal Bank of Scotland. Greek banks have borrowed some €88bn from the ECB. “This is the last card in the hands of the ECB in warning about the implications of a restructuring,” he said.
“The central bank is vehemently opposed to a restructuring of Greek debt, worried about a possible chain reaction through Europe’s financial system and the losses it would face on the up to €50bn of bonds on its own books.”

Fifty plus 80 is €130 billion (with possible double counting of some of this, as some Greek bank debt may be Greek government bonds. Note that the paid in capital to the ECB is only €10 billion. The market is pricing in a 50% haircut to Greek debt, which technically would make the ECB far more insolvent than Lehman! Member states (including Greece, Portugal, and Spain) will have to pony up tens of billions more to recapitalize the ECB, or the ECB will have to print money. Now do you understand why the Germans and the board of the ECB are so against restructuring?

The London Telegraph reported that “Most thought the ECB was unlikely to carry out its threat. ‘It is a way by which the ECB expresses its disagreement,’ said Luca Cazzulani, a strategist at UniCredit. Nonetheless, eurozone sources said governments were now considering asking holders of Greek debt to ‘roll over’ the bonds – buy new ones when older ones mature – rather than extend the length of the debt.”

What Will the EU Do?

Seriously, will Trichet really say “non” when they once again peer down at the abyss? He blinked last time. But if the desire is to acknowledge in private what they cannot say in public – that Greece should leave the eurozone and go back to the drachma – there is no better way than to not take Greek debt onto the ECB’s books. It is not a matter of whether Greece defaults, but when. It may be easier in the long run to clean up the mess they have now than continue to create even more debt that cannot be paid.

I am going to end this section with a long quote, which is essentially an email conversation between my good friends Louis and Charles Gave (son and father) and Anatole Keletsky (all founders of GaveKal) on this whole issue. It is just so powerful that it is better to quote in full rather than summarize.

Charles: Can the ECB continue to support the Euro through open refinancing operations—or are we not reaching a point where the whole system is stretched beyond credulity? Look at it this way: Greek issued debt is €330bn (forget the off balance sheet liabilities as the numbers get too scary) . This debt is now trading at 55c on the Euro on average. So there is a paper-loss of roughly €150bn on Greek debt alone floating out there. For the sake of argument, let us agree that there is probably another €150bn paper loss (conservative estimate) on Portuguese and Irish debt together. So European institutions face some €300bn of paper losses on Irish, Greek and Portuguese debt alone.

Now have these losses been taken? Or are the bonds still being marked at par in books? And how much of the unrecognized loss is on the ECB’s balance sheet: €50bn? €100bn? Whatever the number is, it is bound to be much higher than the ECB’s €10bn of paid-up equity capital. In fact, on a “mark-to-market” basis, the ECB is more bust than Lehman or RBS ever were; begging the question of whether there is a limit to how much paper the ECB can take on its balance sheet and pretend that it is worth par?

Wasn’t this how everything got re-started anyway? Back in November, the ECB basically said they would no longer take Irish paper (remember Tietmeyer’s promise back in the 1990s that, when the Irish needed help, they best not coming knocking on the ECB door?). Since then, the spreads on Greece, Ireland and Portugal have barely looked back!

Louis: At this stage, this much is obvious:
• Greece is bust and the maths on Ireland and Portugal are very challenging.
• There is a massive battle going on behind the scenes between those who want to avoid a restructuring at all costs (even if that means years of misery for Europe’s weaker nations) and those who would rather bite the bullet, clean the slates and start again.

At the heart of the battle is the question of whether a right balance can be struck which a) puts enough pain/humiliation on Greece to satisfy the Germans, and b) is not so much pain that the Greeks decide to take it rather than leave the Euro/ renegotiate their debt. It is a tough balance to strike and, a year into the process, we seem no closer to striking this balance. And so Greek bond yields continue to make new highs in spite of ECB purchases, IMF intervention, creation of the ESM and the EFSF, etc. With that in mind, it seems to me that the prospects of the above balance being reached and a deal being struck are getting more remote…

Anatole: What you are saying in effect (and I agree) is that as time goes on a durable solution, or even an orderly restructuring, becomes less likely, whereas EU politicians and most market commentators believe the opposite—that the longer they can keep this process going the more likely a solution becomes. I agree with you not because of Charles’ belief that the Euro is inherently an incurable Frankenstein Monster, but for three other reasons:

1. Some powerful elements in the debtor countries will be more likely to stop their adjustment programs the longer the pain continues without sufficient evidence of economic recovery.

2. Some powerful elements in the creditor countries will be more likely to stop their lending programs the longer the lending continues without sufficient evidence that the financial problem has been solved.
3. The passage of time itself is evidence of how difficult it is to reach a political compromise between the debtor countries and the creditor countries. Thus the longer this process continues, the clearer it will become to some powerful elements in either the debtor or the creditor countries that no political compromise can be achieved.

This is why I became much more bearish after the failure of the March 24th European summit to agree on a credible funding and legal structure for the post- 2013 resolution mechanism (ESM). The official message from the EU was that the failure of the March summit was just due to lack of time and technical issues that would be resolved at the late June summit. In my view however these “technical” issues now seem much more daunting than they did before the March summit. As such, I would bet that the main outcome of the June summit will be to postpone a final decision until September, which will then decide to postpone to December and so on.

You will note that in each of the three paragraphs above I have deliberately used very similar phrases—”powerful elements in the debtor countries” and “powerful elements in the creditor countries”. This I to emphasize two points that most people keep missing:

• The risks to the Euro come symmetrically from both debtor and creditor countries – this not just about Greece, Ireland and Spain or about Germany, Finland and Holland but about both – and a radical change in any of these countries’ politics would be enough to blow up the entire process.

• “Powerful elements” in any of these countries would be sufficient to sabotage the system. To blow up the Euro will not require a majority vote in a referendum—merely a change of mind by just one powerful political group in just one of the creditor or debtor countries—e.g., the trade union movement in Ireland or the Bundesbank management in Germany or maybe even a single political party, as we are seeing in Finland.
So far there is not much evidence of the above happening but to rely on such an unstable equilibrium lasting for many more months, or even years, seems rather optimistic.

Charles: On your comment about my obsession on the “Euro being a Frankenstein,” I do believe that the fact that Europe’s polic makers do not seem to know what a currency is, or how it works, is indeed deeply problematic. Let me explain:

Our investing business is all about “value”. Why do things have values and why on earth do these “values” move over time? To measure values we use currencies, though it is very hard to explain to me why currencies themselves have any value, since, in our world of fiat money the marginal cost of producing them is zero. So
I think that our business has two sides:

• The easier one is trying to understand how the values are going to move vs. one another (bonds vs equities, or oil vs coal etc…), making in the meantime the assumption that the value of money will not move.
• The more difficult one is trying to understand whether the value of currencies themselves are about to change.

Now currencies have two prices: a domestic price (interest rates), and an international price (the exchange rate). Finally, as we have discussed many times in the past, the only way for a fiat monetary system to work is if the different currencies, each one corresponding to a different economic and political system, can compete freely with one another.

The problem is that when Jacques Delors devised the common monetary zone, the two most important prices (interest rates and exchange rates) were locked together for countries with very different debt levels, demographics, culture, productivity, institutional set-up, etc. This is why we have argued in the past that the Euro was always going to lead to too many factories in Germany, too many houses in Spain, and too many civil servants in France.

Unfortunately, after more than a decade of blatant misallocation of capital, mostly financed by increases in government debt in almost all European nations, the consequences of the capital misallocation cannot be addressed democratically through the structures which have thus far been devised, especially in the countries that have financing problems today.

The only answer Europe’s elites have so far come up with is to take away various countries’ sovereignty and give it to an unelected foreign technocracy. This is very dangerous as local populations love their sovereignty (centuries of European wars illustrate that plainly enough).

This is why the Euro is a Frankenstein: what started as an earnest attempt to foster greater European integration is instead pitting age-old nations against one another and reviving dangerous nationalisms and populism (watch for Marine Le Pen to make a massive score in the French presidential election, or for the rebirth of the far-left and anarchists in Greece, Italy, Spain, Sinn Fein in Ireland etc.). It is the law of unintended consequences at work!

For the above reasons, it seems to me that it is increasingly irrelevant to be talking about “Europe” as an aggregate. What we now have is a Europe of “winners of the Euro” and a Europe of “Losers of the Euro” and instead of convergence between those two Europes, the divergence is getting ever larger.

All for One Euro, One Euro for All?

I have long said that the euro is not an economic currency but a political one. The question now before the voters and politicians in Europe is whether the EU evolves into something that looks more like the US, with limited state sovereignty and market-imposed limits on sovereign debt, where states and cities can fail and bond holders are at their own risk, and where the ECB takes over regulation of all national banks and becomes the backstop, as with the Fed, or devolves into something else.

Have the powers that be in the ECB quietly decided to let Greece go, as they should never have been allowed it into the eurozone to begin with, and because Greece clearly cheated on its statements about its debt and balance sheet in order to get in? You will never hear that in public from the leaders. It is simply not politically correct in “all for one, one for all” Europe. But that may be the outcome if Trichet really means “non!”
It really is the political class all over the world we have to watch. I will be glad when we get through the Endgame and can go back to worrying about balance sheets and consumer spending. What a quaint time that now seems. Think it is interesting now? Have you watched Spanish debt spreads? Wait until the market turns on Spain. Stay tuned.

(Woody assigned me some books on political theory to read on vacation. Hope I can get them on my iPad. Seems like a good time to start reading up on what the masters have to say.)

We’re Off to Europe

I leave Monday for Philadelphia and Boston, and then its on to Tuscany (where the euro is way too strong!) for a few too-short weeks, where I hope I can catch up on some reading and get my next book outlined and started. I really have to get into Schumpeter and his thoughts on change. Most of my kids (5 out of 7) will already be there when I arrive; and then when they leave Tiffani (and Ryan and Lively and the nanny) and I will stay for a working holiday, with friends dropping in to see us. I am planning on not going more than a hundred meters from the villa, except for power walks. The little village of Trequanda (pop. 1,000) has a 4-star restaurant, Il Conte Matto ( ), an awesome pizza place, and a bar; and you can get local chefs to bring fresh food most nights and cook, so we can eat out on the patio watching the sun set over the Tuscan hills. It hardly gets any better. This is the first place I have gone back to for a vacation in my adult life.

I do travel a lot, and work on the road, but this is kind of an experiment for Tiffani and me to see if we can work and really get things done while not in Texas. I am usually not as productive on the road as in my office, so we will see if I can move my office to Tuscany. If you see us at a large table at Il Conte Matto, come by and say hello! I can recommend some great local chardonnays!

It is time to hit the send button. But I must confess that I am not pleased with the results of the Mavericks-Thunder series so far. Somebody forgot to tell Oklahoma City they are supposed to roll over. But I will say it has been great basketball. I will miss that while I am on the road.

Have a great week. If we have a week. Once again we have some guy getting a lot of press here in the US with his prediction that the world ends tomorrow (really, why is Fox News among others covering this nut case?). I can say with some certainty that all previous such predictions have been bad bets, and since I am writing this letter late at night, I guess we can say that I am doubtful of this one as well. Now, predicting the end of the euro as we know it? Or that Greece will default? That is an “end of the world” I can believe in.
Your assuming you did not get raptured if you are reading this analyst,

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