Bernanke's Conundrum What it Might Mean for Gold

By: Michael_J_Kosares

Central banks sold a record amount of US Treasury debt last week and bond funds suffered the biggest investor withdrawals on record as global markets shuddered at the prospect of the US Federal Reserve ending its quantitiative easing program.”

“People are throwing in the towel. It’ll drag the market down lower over the course of the summer.” Markus Rosgen, chief Asia equity strategist at Citigroup

Link

If “people are throwing in the towel” as Mr. Rosgen suggests, Bernanke will find himself in an all-new conundrum quite the opposite of the one in which Alan Greenspan found himself in 2005.

For the Fed, the Treasury debt selling creates a twofold problem:

First, the supply of bonds in the open market will continue to drive up rates. When the goal is to keep rates down, it presents a new kind of conundrum - a Bernanke version the exact opposite of Greenspan’s. Greenspan wanted higher rates. The market gave him lower rates by accelerating its purchases of Treasuries, thus the conundrum. Bernanke wants the exact opposite, that is, lower rates. The market is giving him higher rates by accelerating the sale of U.S. government debt - a conundrum opposite to the one Greenspan encountered. Then and now, the market pundits fret that the Fed is losing (has lost) control of interest rates.
Second, if the world is selling Treasuries, some entity will have to pony up with the purchases of newly-issued U.S. government debt. That entity is the Federal Reserve - the government’s lender of last resort. The new Bernanke conundrum will force the Fed to continue its QE program until such time that other private and public sector buyers of U.S. debt materializes. Ironically, the stock market, like the bond market, might already be reacting to the new rate reality, while gold’s sudden demise, if indeed caused by the so-called “paring down of quantitative easing,” might have been false. If that is the case, a make-up rally could be in the offing.....in fact it might already have been launched.

In an earlier article, I advised that we should take heed of what the Fed does, not what it says. In a certain sense, as you see in the two graphs below, the Federal Reserve may have already launched QE4 while simultaneously talking about ratcheting monetization down. The two graphs together show cause and effect and tell the real story of what is happening at the Fed. For a while, it wasn’t clear why bank reserve credit (QE) was rising. When you marry that chart to 10-year Treasury maturity rates, the reason becomes quite clear. The Fed is battling the market to keep rates low and the government financed at favorable rates.

Sign-up here

See the original article >>

Can Bernanke Brake Without Derailing U.S. Economic Recovery?

By: Frank_Shostak

According to most commentators, reducing monetary stimulus and winding down the balance sheet of the Fed without major economic disruptions is going to be a major challenge for US central bank policy makers. On Wednesday, June 19 Fed Chairman Ben Bernanke, said that given an improved outlook on the economy, the US central bank may moderate the pace of monetary pumping. According to Bernanke, by mid-2014 the Fed may even end the purchasing of assets.

Is it possible to slow down the pace of monetary pumping without major side effects?

According to the popular way of thinking, on account of major shocks prior to 2008 emanating from disruptions in the credit markets, the US economy was severely dislocated from a path of self-sustaining economic growth.

As a result, since 2008 the Fed has had to step in with massive monetary pumping to bring the economy onto the path of economic growth.

Now in this way of thinking, the spending of one individual becomes the income of another individual whose spending in turn gives rise to the income of other individuals, etc. In the absence of shocks, this process tends to become self-sustaining. The role of the central bank here is to make sure that the process does not get disrupted and to prevent bad dynamics. (Thus if, on account of a shock, consumers curtail their spending, this could lead to an implosion in economic activity.)

Note that the central bank is expected to intervene not only in response to negative shocks but also on account of positive shocks that tend to move the economy strongly above the path of self-sustaining economic growth.

Now, the manifestation of negative shocks is considered to be a decline in the growth momentum of prices and a fall in economic activity. In contrast the manifestation of a positive shock is overheated economic activity and a rising growth momentum of prices of goods and services.

With this way of thinking if the central bank is not careful enough in its response to negative shocks, this could push the economy into a so-called “overheated” zone.

It seems that although not an easy task, experienced and wise policy makers should be able to navigate the economy away from various disruptions and keep the economy on a healthy growth path.

Hence policy makers must carefully monitor key economic data in order to make sure that the economy, once it is brought onto a self-sustaining economic growth path, stays there.

Policy makers are probably watching a few key indices. For example, the Builders Expectations Index jumped to 52 in June from 44 in May. The growth momentum of housing starts shot up in May from the month before. Year-on-year the rate of growth of starts climbed to 28.6 percent from 13.5 percent in April.

Also economic activity in general appears to be gaining strength. The Philadelphia Fed Business Index had a big increase in June from May rising to 12.5 from minus 5.2. The New York Federal Reserve economic activity index had a visible strengthening rising to 7.84 in June from minus 1.43 in May.

It is against this background that one can understand the logic of Ben Bernanke and his colleagues when they say that given the strengthening in economic activity and the likely strengthening in the labor market, US central bank policy makers are likely to trim the pace of monetary pumping in the months ahead.

Note again that what is required here for the successful accomplishment of the Fed’s monetary policy is the correct assessment of the future course of the US economy.

Even if one were to accept this way of thinking, the dynamics of events are never possible to predict with great accuracy. The Fed’s policy makers are likely to be in the dark as to whether the economy is approaching the self-sustaining growth path or has already surpassed this path and has entered a rising inflationary path.

Note that policy errors are likely to add to various shocks that these policy measures are meant to counter. (The key policy measures of the Fed are monetary pumping and interest rate manipulations.)

On this score, whenever the Fed changes the pace of pumping, the effect on various markets is not instantaneous. The newly injected money moves from one market to another market and there is a time lag.

For some markets, the time lag is short; for other markets it can be very long. Whenever the new money enters a market, it means that now more money is chasing a given amount of goods in that market. The monetary expenditure, or the monetary turnover, in the particular market is now higher.

Now, various economic indicators depict changes in monetary turnover in various markets. For instance, changes in money supply after a time lag of nine months will manifest in changes in the so-called gross domestic product (GDP). Note that the alleged economic growth in this indicator has nothing to do with true economic growth but comes in response to past increases in the money supply rate of growth.

Given that the time lags are variable, various indicators such as price indices might be responding to changes in monetary policy that took place several years earlier.

Hence a situation could emerge that on account of the variability in the time lags, there could be a variety of responses in various indicators at a given point in time. (For instance a strengthening in the yearly rate of growth of the CPI whilst economic activity is declining.)

We know that Fed policy makers tend to be—most of the time—reactive to changes in economic indicators, which means that most of the time policy makers are responding to past policies. (It is like a dog chasing its own tail.) Needless to say that such types of policies tend to amplify rather than mitigate shocks.

We are of the view that the entire framework of thinking regarding the existence of some kind of a growth path that the Fed supposedly could navigate the economy onto is erroneous. There is no such thing as an economy as such, apart from individuals that are engaged in various activities to maintain their lives and well-being.

Whenever the central bank raises the pace of monetary pumping in order to bring the economy onto a self-sustaining growth path, it in fact sets the stage for various non-productive bubble activities. The increase in these activities, which is hailed as economic prosperity, sets in motion the diversion of real wealth from wealth generators toward bubble activities. It weakens the process of wealth generation.

Whenever the Fed curbs its monetary pumping this weakens the diversion of real wealth towards bubble activities and threatens their existence. Note that bubble activities cannot support themselves without the monetary pumping that diverts real wealth from wealth generators. This leads to an economic bust.

Obviously then there is no way that the Fed could somehow curb the monetary pumping without setting in motion an economic bust. It would contradict the law of cause and effect. The severity of the bust is in accordance with the percentage of bubble activities out of overall activities. The larger this percentage is the greater the bust is going to be.

This percentage in turn is dictated by the magnitude and the length of the loose monetary stance of the Fed. Once this percentage gets out of hand the pool of real wealth comes under pressure. Consequently, banks’ willingness to engage in the expansion of lending despite the central bank’s loose stance is reduced. This leads to a decline in the growth momentum of the supply of credit out of “thin air,” which in turn leads to the decline in the growth momentum of money supply. After a time lag this works toward a decline in economic activity, i.e., sets in motion an economic bust.

Meanwhile after closing at minus 1.4 percent in September 2012 the yearly rate of growth of the Fed’s balance sheet jumped to almost 20 percent in June. On account of banks reluctance to lend (surplus cash stood at $1.963 trillion in June) the downtrend in the growth momentum of US AMS remains intact. (After closing at 14.8 percent in November 2011 the yearly rate of growth stood so far in June at 7.7 percent). We suggest this has already set in motion an economic bust.

Summary and conclusion
According to most commentators, although not an easy task, experienced and wise policy makers should be able to navigate the US economy away from various bad side effects that come in response to a tighter Fed stance. We suggest that whenever the Fed raises the pace of monetary pumping in order to “revive” the economy it in fact creates a supportive platform for various non-productive bubble activities that divert real wealth from wealth generators. Whenever the US central bank curbs the monetary pumping this weakens the diversion of real wealth and undermines the existence of bubble activities—it generates an economic bust. We suggest that there is no way that the Fed can tighten its stance without setting in motion an economic bust. This would defy the law of cause and effect.

See the original article >>

Mesch Market Outlook Commentary for July: Gold

By Robin Mesch

Gold spent the first half of June locked in development between the 1415-1365 as the market used price against the developing bottom of value, forming a pronounced mode as time was spent accepting this lower range as fair value.  By mid month, the sell order flow was reignited with the directional initiation out of this high usage area (as noted on the Profile).  Last month's breakdown should have cured any remaining doubt that the Bull market in Gold is over.  Once the Bears cracked through the long-term high usage ledge of 1330-1335, trapped Bull-believers were finally flushed out of the market which triggered what we anticipated would be a rapid plunge to 1250 and lower.  While most of the trapped buyers look gone, this decline has likely reversed enough of the bullish mindset to trigger a change of psychology that will invigorate new selling on rallies.  We anticipate that the new Bears will have the strength of conviction to carry the market down to our next major downside target of 1015-930, which we expect to see over the course of the next 6-8 months.  Coming into July, there is a small ledge of high usage from 1270-1290 that is apt to serve resistance and we see this area as a viable spot to short if offered early this month.  The short term downside target for this sell is around 1140. 

The charts included in this report are Price Usage charts which depict the usage of a given price over time. The vertical left axis represents price, while the horizontal axis represents time. Price Usage charts display where the market has 'used' price, thus accepting - or rejecting - value. The result of this market auction process are Bell Curve shaped composite Profiles, which indicate phases of development and create a top and bottom of perceived value in the market.

See the original article >>

Oppenheimer: "Time To Cover All Shorts In Gold And Gold Miners" Because "Gold Stocks Are So Bad, They're Good"

by Tyler Durden

Whether lucky or good, Oppenheimer's Carter Worth was accurate in calling for a drop in gold back in January of 2013. From his note at the time: "For those without the time or inclination to read past the first page (we're told by the marketing experts that many people don't read past the first page of most research reports) here is the summary, in one word, of today's edition of "Money in Motion" focusing on Gold Bullion: SELL."

Fast forward to today, when the technician pulls a U-Turn, and says that "at this time, we believe gold and gold miners represent good risk/reward. Indeed, the recent extreme weakness is judged to be the reciprocal or correlative of the extreme strength witnessed in the summer of 2011. The "despair" relating to gold now is as palpable as "euphoria" then."

And always one with a witty turn of the phrase, Worth summarizes his shift in sentiment as follows: "The bottom line, by our work, is this: at this time it is right to cover all shorts in gold and gold miners… and we would look for opportunities on the long side.... The charts of the individual equities are atrocious. And that is the circumstance that compels today's report. The stocks are judged to be "so bad, that they're good"."

Worth's short-term target, based on charts and squiggles: $1,395.

Some more squiggles...

And even more squiggles:

There are many more squiggles in the full report, leading Worth to also give a "buy" reco on the following miners:

Of course, as we showed over the weekend when we demonstrated the unprecedented technical sentiment dislocations behind gold with a stunning amount of gross gold shorts, should the long-overdue gold squeeze indeed take place, then $1395 will be merely the first stop.

See the original article >>

Performance of Precious Metals in 2013

By Peter Fertig

Most analysts polled by the London Bullion Market Association at the start of 2013 were optimistic for precious metals in 2013. They predicted annual average prices to be higher for another year. However, after the first half of 2013 is over, it looks rather unlikely that average prices in this year will be above the average price of 2012.

The table below shows the spot price of the four precious metals as well as the percentage change over the end of the previous end of quarter and also the percentage change in the first half. The development of gold and silver in the first quarter of 2013 could still be interpreted as a correction after the end of the festival season, which is not uncommon. Platinum and palladium moved higher due to the development in South Africa and fears of supply shortage. But the second quarter had been a disaster for all precious metals. 

Based on our quantitative fair value model for gold, we investigate whether this plunge of precious metals in Q3 could be explained by the major fundamental factors driving the price of gold. Our model is based on weekly data. As also financial and commodity markets show seasonal influences, we did not use weekly, but annual percentage changes. Thus, there was no need to include also further seasonal adjustments in the model equations. All fundamental factors were included in the equations for the four precious metals. These factors are the 1) the US dollar Index, 2) the price of crude oil (WTI), 3) the S&P 500 composite index, 4) the yield on 10yr US Treasuries and the net long position of non-commercials in the futures traded at the Comex division of the Chicago Mercantile Exchange (CME). For the US Treasury yield, instead of percentage changes, the absolute yoy-change in basis points had been used. The net-long position has been divided by 1000.

Linear regression models based on time series of financial asset or commodity prices often lead to residuals, which are serially correlated. Therefore, the models include a first order autoregressive term for the residuals and the parameters for the exogenous fundamental factors and the autoregressive error term have been estimated simultaneously. The model was first developed in 2006, and therefore, data from January 1997 until September 2006 was used in the estimation. The regression coefficients are all significant at the 5% level and have the expected sign.

The following chart shows the development of the yoy percentage change of the spot gold price and the estimated values. At a first glance, the model appears to predict the development of the gold price still quite well. However, this good fit could be the result of the autoregressive error term, which might deviate further away from the fair value instead of oscillating around it.

Since the end of 2012, the yoy percentage change of gold dropped from 2.47 to -22.07% at the end of June 2013, which is a change of 24.54 percentage points. Thus, we investigated how much the five fundamental factors contributed to the dismal performance of gold. The US dollar index firmed on the strength of the US dollar against the Japanese Yen and thus contributed a -0.64 percentage points. Also the drop of the net-long positions held by the large speculators contributed with -2.15 percentage points to the negative performance of gold. However, crude oil, the S&P 500 index and the yield on the 10year US Treasury notes all made a positive contribution. In total, the five fundamental factors indicated that gold should have shown a decline of the yoy percentage change by 0.92 points to 1.55% instead of falling to -22.07%. 

This already indicates there must have been a structural change in the precious metals markets. Relationships collapsed, which held before the financial crisis and even in the first few years after the crisis.

One possible reason for a structural change might have been the speech by ECB president Draghi held in July 2012 in London, where he pledged to do everything necessary to keep the euro intact and announced what later became known as OMT.  A second reason might have been the introduction of Abenomics in Japan in the final quarter of 2012. Thus, the regression coefficients have been estimated again, but based on data from July 2012 until the end of June this year. Most of the variables or lag structures are no longer significant at the 5% level. Only the US dollar index and the S&P 500 index remained significant factors. However, the regression coefficient of the S&P index increased and changed the sign from positive to negative.

Slight modifications of the lag-structure led to a model, where the five fundamental factors are significant again. However, now also the regression coefficient for the annual change in the 10year US Treasury yield changed sign and magnitude. Rising yields, which had earlier been interpreted as a sign of rising inflation rates, are no longer positive for gold. They now lead to falling gold prices, which reflect the fear that an end of QE would eliminate any reason for holding gold.

Crude oil was the only one of the five factors, which made a positive contribution of 4.75 percentage points. The US dollar and the S&P 500 index both contributed less than one percentage point to the decline. The rise of the 10year US Treasury yield contributed -6.7 percentage points. The fall of the net-long position held by large speculators had the strongest negative impact on gold's negative performance with -8.75 percentage points. All in all, according to the adjusted and re-estimated model the five fundamental factors contributed -12.45 percentage points to the fall of the yoy percentage change of the gold price in the first half of 2013.

The chart above shows the development of the yoy percentage change of the gold price and the estimate based on the adjusted model fitted for the period from July 2012 until June 2013.  It is obvious, that a good fit is only obtained for the period from early 2012 onwards. For the time before, the fit is worse. This clearly indicates that the structure of the gold market has changed last year.

It is uncertain, how long the US stock market and the US Treasury yield will have a negative impact on the development of the gold price performance. However, even if the regression coefficients of the adjusted model remain valid beyond the estimation period, the fundamental factors explained only 12.45 of the 24.54 percentage point drop in the yoy gold price change. Thus, almost half of the plunge could not be explained by the major fundamental factors of the model. This implies that gold overshoot on the downside. If the fundamentals don't deteriorate further, there is some potential for a recovery. But the sentiment in the gold market is seriously damaged and the famous knife is still falling. Thus, it appears too early to try catching the knife now.

See the original article >>

Banks benefiting from "taper" on both sides of the balance sheet

by SoberLook

US equity markets are continuing to price in higher premiums for bank shares relative to the overall market. The increased steepness of the yield curve will mean higher net interest income, as banks borrow at historically low rates from depositors and lend longer term at the highest rates in two years. The chart below compares the S&P bank index (KBE) with the S&P500 index (SPY) over the past 5 days.

Not only are banks increasing the longer term rates at which they lend, but they also have lowered rates they pay on various types of deposits.

Checking accounts that pay interest (source: Bankrate.com)

Money market accounts (source: Bankrate.com) -
Note: these are bank savings accounts, NOT money market funds

Even without growing their balance sheets - and for now US banks' balance sheet growth has stalled - banks can improve their margins simply through lower interest expense. That's part of the reason for bank share ongoing outperformance.
In the mean time, in spite of higher rates elsewhere, US savers are hurting.

See the original article >>