By Gary Dorsch (
Global Money Trends
):
As former Fed Chief "Easy Al" Greenspan used to say,
I guess I should warn you. If I turn out to be particularly
clear, you've probably misunderstood what I've said.
Recognizing the fact that financial markets place a heavy value
on their words, former Fed chiefs Arthur Burns and Paul Volcker
were known for blowing smoke, both literally and figuratively, when
appearing before Congress, in order to prevent their words from
becoming self-fulfilling prophecies. They developed a language
called "Fed-speak," which is the use of ambiguous and cautious
statements that are purposefully made to obscure the meaning of a
statement. Greenspan is credited with turning Fed-speak into a fine
art form.
Having served under six presidents in four different jobs,
Greenspan became one of the most entrenched and powerful figures in
Washington. He was a shrewd political operator, a man who was
handed his job by political allies in exchange for political
loyalty. Greenspan used to hold his cards very tight. The secret
meetings he held with presidents and the secret deals he offered
them only added to his mystique. By custom, Greenspan could
overrule the other Fed governors, which meant that he controlled a
critical portion of the world's money supply, and he could use this
leverage to influence public opinion ahead of an election.
On June 7th, Greenspan's protégé, Fed chief Ben "Bubbles"
Bernanke, spoke to a congressional panel, and traders were
listening carefully to his every word, trying to discern if the Fed
would unleashQE3 ahead of the upcoming elections set for Nov 6th.
The Fed could pump up the money supply, buy more Treasury bonds,
and in turn, jolt the stock market sharply higher. In theory, a
stock market rally could boost consumer confidence, and influence
American public opinion into thinking that an economic recovery is
on the horizon.
As always, the Federal Reserve remains prepared to take action
as needed to protect the US financial system and the economy in
the event that financial stresses escalate
Bernanke told the Joint Economic Committee. That suggested the
Fed would only unleash the nuclear option, "quantitative easing"
[QE], if (1) Greece opted to leave the Euro, or (2) if European
politicians failed to hook up the zombie banks in Italy and Spain
to artificial life support.
If neither of these "Black Swan" events were to occur, then in
the opinion of Global Money Trends, the Fed is expected to stay
politically neutral ahead of the Nov 6th elections and abstain from
a third round of QE. Staying neutral could include a token gesture
to extend the Fed's "Zero Interest Rate Policy" [ZIRP] beyond 2014.
Extending "Operation Twist," in which the Fed sells short-term
notes and swaps into longer-term bonds, would help keep bond yields
submerged at artificially low levels. However, neither of these
token gestures would materially increase the money supply, which is
what Wall Street and Gold Bugs are thirsting for.
Bernanke did say to a skeptical Republican Congress thatQE3
could inflate the value of the stock market:
...and therefore, increase wealth effects for consumers in
order to spur more spending.
That's a dubious claim, since the top 10% of the richest
Americans control 80% of the listed shares on the NYSE and Nasdaq.
Only the wealthiest Americans benefit from QE. The rest of the US
population gets stuck with paying higher gasoline prices at the
pump with QE.
However, Bernanke did pour some cold water on the simmering
speculation overQE3:
There may be some diminishing returns to further [QE] action.
I'd be much more comfortable if Congress would take some of the
burden from us.
Republicans at the hearing were quick to criticize the Fed
chief, saying thatQE3 would be tantamount to spiking the punch bowl
in order to help the Democrats and President Barack Obama ahead of
the upcoming Nov 6th elections. Texas Rep. Kevin Brady said:
I wish you would takeQE3 off the table. I wish you would look
the markets in the eye and say that the Fed has done too
much.
(click to enlarge)
The month of May and the first week of June were brutal for
President Barack Obama. Government apparatchiks said that the U.S.
economy grew at a sluggish +1.9% annual rate in the first quarter
of 2012. Worse yet, the U.S economy, which created an average of
226,000 jobs per month in the first quarter, only created an
average of 73,000 in April and May. Alarmed by the ominously weak
U.S. jobs report, the Dow Jones industrial nosedived on June 1st,
plunging 275 points lower, its biggest daily loss since last
November. The sudden selloff towards the 12,000 level wiped out the
Dow's gains for the year. Also signaling fears of a recession, the
yield on the 10-year Treasury note fell below 1.50%, a record
low.
Likewise, on-line bettors at Intrade.com lowered the odds of
Obama winning his re-election bid to 53.5% on June 10th, down from
a 60% chance on May 1st. Conversely, for the Republican challenger,
Mitt Romney, his odds of winning the presidency increased to 43.1%,
compared with 37.4% at the beginning of May. Apparently, bettors at
Intrade.com think the outcome of the Nov 6th election will hinge
upon the value of the U.S. stock market in the months ahead.
However, there's a big disconnect between the value of the U.S.
stock market and the health of the U.S. economy. The S&P-500
index has doubled from its March 2009, amid the weakest economy
recovery since the Great Depression. Instead, the boom in the stock
market has only served to widen the gulf between the rich and the
poor in America, where the number of food stamp recipients has
doubled since 2008.
Given the political realities in Washington, bond dealers on
Wall Street that deal directly with the Fed are equally split on
the likelihood ofQE3. Those betting onQE3 think the Fed would
unveil a $500 billion printing spree at its upcoming June 19th
meeting. The other half thinks the Fed would stay politically
neutral, and opt for extending Operation Twist. The stakes are
high. Without the artificial life support ofQE3, the U.S. stock
market could sink ahead of the upcoming election and torpedo Mr
Obama's chances. On the other hand, a $500 billion printing
operation could lift the Dow Industrial above the May 1st highs,
and tilt public opinion in favor of the president over his
Republican challenger.
Mr. Romney has already sent a public warning to the Fed to keep
its hands off the money printing press between now and Election
Day. Romney told CNBC on June 1st, that the Fed's actions to boost
the economic recovery have "really run their course."
QE-2 was not able to yield the economic benefit which they
hoped it would be able to yield. I don't think we're looking for
more. AQE3 if you will, I don't think that will have any more
impact than QE-2 did. The central bank should focus just on
keeping prices stable.
During the GOP presidential debate on Sept 7, 2011, Former House
Speaker Newt Gingrich was asked if he would reappoint Ben Bernanke
to run the Fed. He answered:
I would fire him tomorrow. I think he's been the most
inflationary, dangerous, and power-centered chairman of the Fed
in the history of the Fed. I think the Fed should be audited. I
think the amount of money that he has shifted around in secret,
with no responsibility and no accountability, no transparency, is
absolutely antithetical to a free society.
Romney concurred:
I'd be looking for somebody new. I think Ben Bernanke has
overinflated the amount of currency that he's created. QE-2 did
not work. It did not get Americans back to work. It did not get
the economy going again. We're growing now at 1-½%.
Thus, the Fed chief must consider that he would certainly lose
his job if he takes the risk of launchingQE3 and Obama loses the
election. Worse yet, if Romney wins, many Tea Party Republicans
could push for a full-fledged investigation into the Fed's secret
dealings over the past few years, including trillions of dollars of
loans to the Wall Street banking Oligarchs. There could be an audit
of the Fed's secret intervention tactics. The Fed could be stripped
of its dual mandate and left with a single goal of fighting
inflation. For these reasons,
the Fed is likely to vote against the risk of
launchingQE3.
Still, many gunslingers in the Dow Jones industrial futures
markets are betting heavily on the unveiling ofQE3. The Dow
finished +3.6% higher at 12,554 last week, a remarkable feat. That
puts the Dow +150 points above the level that prevailed just prior
to the lousy June 1st jobs report. It seems as though economic data
has a shelf life of only 24 hours before it's etched-a-sketched
away from the memory of psychotic traders. The Dow's gains were
accompanied by signs of a stabilizing Euro on ideas that Europe's
political elite would rescue the zombie banks in Spain. However,
while the zombie banks can exist on artificial life, as zombies,
they will hoard their cash, and would be very reluctant to lend to
worthy borrowers, thus prolonging the Euro-zone's ongoing
recession. Still, the recession in Europe is of little concern for
hallucinogenic Bulls, anxiously awaiting theirQE3 fix.
However, U.S. retail investors were fleeing stock mutual funds
for 14 straight weeks. They've yanked $46 billion out of the market
since the start of the year. Just 53% of U.S. households owned any
stocks in April, the lowest since 1998. As such, the average daily
trading volume in U.S. stocks on all exchanges has shrunk to 6.5
billion in April, compared with 12.1 billion at its peak in 2008.
Those who are left are high-speed trading firms, which now account
for as much as two-thirds of all the volume on the stock market.
Yet high frequency traders are mostly scalpers, seeking to pocket a
few pennies or $1 per share during the day. The rest of the players
are money managers for high net worth individuals, hedge fund
traders, mutual funds and agents of the "Plunge Protection Team."
In thinly traded markets, the actions of a few big players can have
bigger impacts on the market's increasingly strange behavior.
There is growing suspicion that the "President's Working Group,"
otherwise known as the "Plunge Protection Team," is covertly
intervening in stock index derivatives on a daily basis in order to
place a safety net under the market when risky bets go sour. For
the past 15 years, traders have relied on the "Greenspan and
Bernanke Put" to bail them out of tough situations. The Fed has a
long history of springing into action to inject liquidity into the
money markets, or "Jawboning" timely messages to the financial
media, aiming to prevent the emergence of steep corrections on Wall
Street that, if left unchecked, could snowball into an outright
Bear market, and plunge the U.S. economy into a nasty
recession.
The "invisible hand of the Fed" causes short squeezes that lead
to the sudden emergence of "miracle rallies," that defy logic. This
conspiracy theory isn't based upon hard evidence that's known to
the public. Instead, it's supported by a "negative proof," or
rather, the law of improbability. For instance, on June 6th, the
Dow Jones Industrial surged +286- points to close at 12,414, its
biggest gain of the year. The rally started early and gathered
force in the final hour of trading, as short sellers scrambled for
cover. The outsized gain had more than erased the biggest loss of
the year: the -275-point plunge set off just a few days earlier.
One floor trader was quoted by the media as saying:
In market language, it's called a technical bounce. There's no
bad news today, so the market goes up. Frankly, it's that
simple.
Such an improbable explanation however, keeps conspiracy
theories of Fed intervention alive.
Likewise, on June 12th, the Dow staged its second biggest rally
of the year, shooting up +162-points, and erasing a big -142-point
decline from the previous day. The big rally on Wall Street was
highly improbable, because in the background, the yield on Spain's
10 year bond jumped to as high as 6.81%, and up more than 60-basis
points since a €100 billion bailout of Spain's banks was announced.
At 7%, big debtor nations are pushed to the brink of default. Yet
the negative news was ignored, and the U.S. stock market surged
higher anyway. Chalk that outsized rally up to big bets on the
launching ofQE3, or what Wall Street analysts like to call, "value
investing" in the world's biggest casino.
The past year was very tumultuous for stock markets around the
world. Yet the S&P 500 index has managed to defy the law of
gravity, by posting a +3.5% gain from a year ago, while most of the
world's markets tumbled, succumbing to the turmoil that's roiling
Europe. Compared with a year ago, Brazil's Bovespa has lost -32%,
Germany's DAX-30 index is -24% lower, the Toronto Stock Exchange is
-16.5% lower, Korea's Kospi index has lost -16%, Hong Kong's Hang
Seng index fell -15.8%, and Japan's Nikkei-225 is -11%. Even the
Footsie-100, the Siamese twin of the Dow Industrials is trading -5%
lower from a year ago.
The S&P-500's superior performance is surprising,
considering a quarter of its companies' revenues come from Europe.
Moreover, a stronger U.S. dollar translates into weaker earnings
for U.S. Multi-Nationals that earn 45% of revenues overseas. Yet
the S&P 500 index is outperforming its foreign rivals. Is one
company, Apple Inc (
AAPL
), responsible for the S&P 500's supremacy in world markets?
Most likely, the Fed is juicing up the stock market, while central
bankers in other countries are not playing that game.
On Aug 17th, 2011, two Fed chiefs said they're opposed to
efforts of trying to prop up the stock market. Philadelphia Fed
chief Charles Plosser said:
Taking action after stocks have tumbled signals that we are in
the business of supporting the stock market.
Likewise, Dallas Fed chief, Richard Fisher warned that the
Fed
...should never enact such asymmetric policies to protect
stock market traders and investors. Some traders might view the
easing of monetary policy as a "Bernanke Put," or the idea that
the central bank will loosen credit after a stock-market
decline
Fed intervention can buy some precious time for the White House
by placing safety nets under the market. Yet it would require a
blast of nuclearQE3 to lift the U.S. stock market to new heights
and extend its 3-¼ year Bull Run.
Commodities are being hurt by a weaker Euro, a slowdown in
China. The Continuous Commodity Index [CCI], measuring an
equally-weighted basket of 17 commodities, has been caught in the
grip of a year-long slide. Its value is -21% lower than a year ago.
The deepening recession in the Euro-zone, and a slowdown in the
Chinese economy is blamed for undercutting the demand for
industrial commodities, such as copper, iron ore, rubber, steel and
crude oil. There were big losses in the soft agricultural markets,
for cocoa, coffee and sugar.
In a strange twist of fate, the U.S. dollar has been getting
stronger against the second most actively traded currency, the
Euro, by default, or by virtue of the fact that it looks less ugly
than the Euro currency. In turn, a stronger US$ against the Euro is
exerting selling pressure on a wide array of commodities. Some of
the biggest casualties in the commodities markets have lost as much
as half of their value from their peak levels of 2011. The price of
cotton and natural gas are -53% lower than a year ago. Coffee is
-41% lower, rubber is -34% lower, corn is -26% lower, sugar and
silver are both -21% lower and wheat is -18% lower. The wholesale
price of unleaded gasoline is -12% cheaper than a year ago.
Virtually all of the top exchange traded commodities are lower
in price than a year ago, with the exception of live cattle, up
+16%, Gold and soybeans, that have scratched out gains of +5% from
a year ago. In turn, there's been an unwinding of inflationary
pressures worldwide. In Emerging nations, where commodities account
for most of the consumer price basket, the drop in commodity prices
could knock the official inflation rate to zero-percent by year's
end. In order to reverse the deflationary trend in commodities, it
would require another big blast of QE from the Fed, which in turn,
would flood the world with cheaper U.S. dollars.
In the past, China's finance ministry has complained about the
Fed's QE money printing operations. At a G-20 meeting in South
Korea on Oct 26, 2010, Chinese Finance Minister Xie Xuren said that
"issuers of major reserve currencies" -- code words for the United
States --
... must follow responsible economic policies. Because the US'
issuance of dollars is out of control and international commodity
prices are continuing to rise, China is being attacked by
imported inflation. The uncertainties of this are causing big
problems. If other countries allow their currencies to appreciate
freely against the U.S. dollar, then their exports will
deteriorate. If they maintain rigid exchange rates against the
dollar, their central banks will have to buy more dollars on the
foreign exchange market, and this will increase liquidity in
their own currencies, and further inflate commodity and stock
prices.
Soon after Chinese Finance Minister Xie Xuren issued his warning
to Washington, the People's Bank of China (PBoC) began to embark on
a tightening campaign, which included five rate hikes, lifting its
1-year loan rate to 6.56%, in order to offset the inflationary
effects of higher commodity prices that were fueled by the Fed's
$600-billion QE-2 scheme. China's inflation quickened to a 3-year
high of +6.4% in June 2011, and factory prices were +7.5% higher in
July 2011. China's inflation was boosted by rising food costs,
which soared +14.4% in the year through June. Pork, a staple meat
for Chinese, and the most closely watched commodity, shot up +65%
from a year earlier. Beijing is especially sensitive to rising food
and energy prices that might stir social unrest and threaten its
leadership.
As fate would have it, the PBoC's last rate hike to 6.56% in
July 2011 coincided with the completion of the Fed's QE-2 money
printing operation. Since then, the global commodity rally began to
sputter out, as QE addicts were forced to go cold turkey. As Europe
sank into recession, commodity markets fell into a year long slide.
In China, the producer price index has gone into negative
territory, and was -1.4% lower in May compared with a year earlier.
With a negative inflation rate, there's less incentive for Chinese
traders to buy Gold.
Last week, on June 7th, the PBoC lowered its one-year loan rate
25-bps to 6.31%, confident that inflation pressures would stay
tame. The PBOC also lowered the required reserve ratio [RRR] for
the biggest banks by 150-basis points to 20% in three moves since
November. That has freed an estimated 1.2-trillion yuan
($190-billion) of fresh liquidity into the Shanghai money markets.
So far, the liquidity injections haven't led to higher prices for
commodities or the Shanghai red-chips market. Instead, turmoil in
the Euro-zone, the slowdown in China's economy, and a weaker Euro
have kept commodity markets under siege.
Euro Currency Crisis weakens Commodities
The initial knee-jerk reaction to the EU's €100-bailout of
Spain's troubled banks was one of euphoria and relief. However, it
only took a few hours before the alarm bells began to ring over the
mushrooming size of Spain's public debt. In Madrid, Spain's 10-year
bond yield hit 6.83% on June 12th, edging closer to the 7% danger
level that triggered bailouts for the governments of Greece,
Ireland and Portugal. There are also lingering worries that Greek
voters might opt to throw off the yoke of EU austerity, and default
on €423-billion of debts to foreign lenders.
The €100-billion bailout might prevent the collapse of the
Spanish banks, unless depositors make another major run on the
banks. Jittery depositors withdrew €66-billion from Spanish banks
in April. However, the bailout would add to Spain's debt pile,
taking it +10% higher to 90% of the country's GDP. And that's not
good news for anyone holding Spanish bonds. If the bailout comes
from the ESM rather than the EFSF, then the €100-billion debt
incurred would be senior to Spanish government bonds. This means
that existing government bonds already trading on the secondary
market would become junior bonds to the ESM loans, and would lose
value. Furthermore, owners of subordinated Spanish bank bonds could
be forced into taking a big haircut. That could trigger another
flight from the Euro.
(click to enlarge)
The sovereign debt crisis in Italy and Spain is exerting
downward pressure on the Euro versus the US$, which in turn, is
weakening commodity prices. Matters for the Euro-zone are much
worse than politicians are willing to admit. On May 29th, the
Egan-Jones Ratings agency lowered its sovereign credit rating of
Spain to single-B from BB-, citing the country's deteriorating
economic outlook:
The nation's 9.6% budget deficit, 24% jobless rate and bank
losses of as much as €260-billion weigh on the economy
.
Spain will inevitably be faced with payments to support a portion
of its banking sector and for its weaker provinces. The assets of
Spain's largest two banks exceed its GDP. We are slipping our
rating to 'B'; watch for more requests for support from the banks
and money creation.
Indeed, foreign investors cut their holdings of Spanish debt to
37% of the total in circulation in April from 50% at the end of
last year. However, Spanish banks were very active players in the
ECB's 3-year loan program, having borrowed €300-billion. Much of
that money was used to buy Spanish government bonds. As a result,
Spanish banks now own about 67% of the government's debt. Now that
those bonds are plummeting in value - prices fall as yields rise -
Spain's banks and government are chasing each other in a financial
tailspin. Among the largest holders of Spanish bonds are the
country's international banking giants Santander and BBVA, which,
through February, owned €60-billion and €49-billion,
respectively.
Italian banks were also enthusiastic buyers of government's
bonds; they own 57% of Italy's €2 trillion of bonds outstanding. As
in the case of Spain, foreigners have been obliging sellers, having
dumped €242 billion worth of bonds to local Italian banks, and
whittling their share of Italian bonds outstanding to 35% as of
March compared with 51% late last year. Bond traders figure that
Italy would be next in line for a bailout, because of its 120% debt
to GDP ratio and its shrinking economy, despite reforms initiated
by Prime Minister Mario Monti. Yields on Italy's 10-year note
jumped to 6.17%, up from as low as 5.66% the previous week.
Gold Bugs betting Big on QE3
So far this year, Gold has largely been held hostage to the
gyrations of the broader commodity indexes. However, on June 1st,
the price of Gold suddenly surged spectacularly higher, following
the dismal U.S. jobs report. Hedge fund traders figured that the
weak jobs report would be the smoking gun that pushes the Fed into
launchingQE3 at the upcoming June 19th meeting. The price of Gold
soared $80 /oz higher, above its intra-day low on June 1st, before
settling at $1,625 /oz. However, on June 7th, Fed chief Bernanke
stayed silent on the topic ofQE3. Gold quickly plunged $40 /oz
within a few minutes, and skidded to as low as $1,561 /oz, before
strong hand buyers stepped in.
(click to enlarge)
Seeking shelter from the Italian and Spanish bond markets, many
global investors shifted from Euros and into Gold, especially when
the yellow metal found solid support at the $1,540 /oz level in the
month of May. The slide to $1,540 equaled a -20% correction from
Gold's all-time high set in August of 2011. Thus, Gold fell to the
threshold of a bona-fide Bear market, but escaped the claws of the
grizzly bear. The Gold market has since rebounded for a second time
towards overhead resistance, seen at the $1,630 /oz area, buoyed by
big bets that the Fed would vote to launchQE3 at its upcoming
meeting. A $500 billion blast of nuclearQE3 would weaken the value
of the U.S. dollar and in turn, boost commodity prices.QE3 could
signal the end of the deflationary trend that been plaguing
commodities, and signal the beginning of an intermediate rally in
the Gold market that could be sustainable.
However, in the opinion of the Global Money Trends newsletter,
the Fed is trapped in a political minefield, and won't offend the
Republican Party. Therefore, the Fed is expected to stay
politically neutral ahead of the Nov 6th elections, and leaveQE3 on
the back burner (assuming Greece does not exit the Euro). If
correct, it would be difficult for a Gold rally to gain traction.
Barring a shift toQE3, other possibilities that could lift Gold
higher are "Black Swan" events, such as a Euro currency crisis,
triggered by Greece's Far-Left, or a surprise military attack on
Iran's nuclear facilities this summer. The good news for Gold Bugs
is that a sustainable bottom for the yellow metal appears to be
firmly in place.
Disclaimer:
SirChartsAlot.com's analysis and insights are based upon data
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complete and accurate. However, no guarantee is made by
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attempts to analyze trends, not make recommendations. All
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Disclosure:
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initiate any positions within the next 72 hours.
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