Friday, March 2, 2012

The Risks Inside Your Credit Card

Friday Charts: Bank Runs, Real Estate, Gas Prices

Happy Friday everyone!  I am pleased to once again offer the Friday chart fest for your viewing pleasure.

We begin of course with everyone's favorite topic: sovereign debt.  The following chart shows demand deposits for Greece, Portugal, and Ireland.  The trending chart down means that money is leaving these banking systems and either moving outside the country or moving under the mattress.  This is the equivalent of an electronic bank run and it is happening all across Europe in the weakest countries.

Next up we have the global central bank response to the sovereign debt crisis (and demand deposit run): money printing.  The chart shows the size of the G4 (US, Europe, Japan, the UK) central bank's balance sheets in relation to their GDP.  Balance sheets grow when they print money and purchase assets.  GDP (Gross Domestic Product) is the total measure or the size of an economy

We received a large amount of data this week on the housing market. I discussed the most popular index earlier in the week in Case Shiller Index: New Price Lows In All Indexes.  The following shows the total housing activity by combining new and existing home sales, permits, and starts.  This chart does not include completions (as many homes don't get there) which would make the numbers even uglier.

The following shows shadow inventory hanging over the housing market and the gap up to the red dot shows the coming shadow inventory from those that are underwater on their homes but still making payments.  I believe this chart, as scary as it is, actually underestimates the true size of the shadow inventory.  For my analysis on the topic you can review 2012 Real Estate Outlook Supply - Shadow Inventory.

CoreLogic released a graphic this week showing the percentage of homes underwater in each state.  The big surprise for me continues to be Georgia at close to 40%.  The peach state has also seen tremendous prices declines over the past few months.  While not known as one of the major "bubble" states on the way up, it is taking a tremendous beating on the way down.

A final piece to the housing "recovery" is the mortgage application index released this week from the mortgage bankers association.  You can see the number of home purchase applications remains at depression levels.

The following chart shows that Q1 Earnings Per Share estimates continue to decline as stock prices continue to rise.  This trend will not continue forever with stock prices falling to reflect realistic earnings or earnings rising to reflect the sky high stock prices.

The following shows the disconnect between the rise in stock prices and the individual investor who have stayed on the sidelines (and have been selling) through the entire rally.  Americans, now terrified of stocks, have moved all their assets into bond funds; the next great bubble set to burst.

Now we move on to oil.  The month of February showed a new record high for the month in gas prices (January prices were also at a record high for the month).  Jim Puplava has done tremendous research and writing recently discussing the idea that the price of oil and gas have now become the new Fed Funds Rate.  In normal times the Federal Reserve would raise rates to cool down the economy and lower them to give it a boost.  Now, with interest rates at 0% forever, the price of oil is creating this expansion/contraction process on its own.  When prices rise too high it contracts consumer spending slowing the economy.  As prices fall it provides a boost to the economy spurring investment and business demand.

The following cartoon illustrates this concept further showing how the economy is now literally tied to gas prices.  

Then there is the nationwide price of gasoline, which is closing in on an all time record high.
The VIX index, which measures volatility in the stock market, has once again come down considerably.  This shows the current complacency in the market.  Investors believe that everything is under control.

Zero Hedge threw up an excellent chart this week titled "Name That Credit Bubble"  Can you guess which area of debt expansion is now growing exponentially and unsustainably?  It is student loans, the debtors prison for America's younger generation.  Student loans are the only form of debt that cannot be wiped away in a bankruptcy.  They hang over you forever.

Sources: Zero Hedge, JS Mineset, The Big Picture, JP Morgan, Wall Street Journal

Thursday, March 1, 2012

Gold & Silver Plunge

Gold and silver were completely demolished yesterday afternoon.  At the worst point of the day, gold fell over $100 and silver was down 8%.  The size and scope of the move was extraordinary.

As I have done during every downdraft since this site launched in 2008, I will remind readers to take a deep breath, stay away from mainstream "gold bubble" headlines and just go on with their day.  I have spent the last 20 months telling readers to hold their positions (other than in December 2011 when I was begging and pleading for readers to buy) and this week is no different.

The ECB has injected over $1.4 trillion of new (printed) currency into the financial system in the past 3 months.  Yesterday, they injected over $700 billion in a single day.  A few hours later, Bernanke said that his next injection of printed currency is temporarily on hold and the gold market goes into a panic.

It is similar to someone punching you in the face while another person standing next to you tells you that they will not be punching you in the face this month, so you ignore the person who is currently hitting you and believe that all is well.

The European Union, Japan, the UK, and the United States are currently bankrupt with no possible way of repaying the government debts they have borrowed.  They have two options:

1.  Tell voters and citizens that they will default on their debts.  Social security, medicare, pensions, food stamps, unemployment, and government pay stop or are cut drastically to balance the budget.  Taxes will need to be raised significantly.  Banks will fail, and the world will move into a deflationary depression.

2. Tell voters that they will continue to receive government support and that the worst is behind us.  Print the money to continue making the payments.

Some people strongly believe that the governments will choose the first option.  I believe they will choose the second.  I obviously am not certain of this outcome, and if you think that politicians will choose the option that will bring immediate pain and cost them their own job and source of income, then precious metals are not the investment for you.

Gold and silver are going to get far more volatile as we move forward.  They will experience downdrafts far bigger than what we experienced yesterday and for periods much longer than a few hours.  This will be an opportunity to add to your positions.  I will continue to monitor the sentiment levels and alert you when they reach extreme lows.

Wednesday, February 29, 2012

LTRO Part 2: Central Banks Are Making Their Last Stand

This morning at 5:00 AM the European Central Bank released the results of their second LTRO program.  This program allows any European bank to show up at the door of the ECB and request an unlimited amount of money.  The banks must pay 1% interest annually on the money borrowed and promise to return it in full in 3 years.

The European Central Bank under its mandate is not allowed to print money and purchase assets, which is known in the United States as Quantitative Easing (QE).  Under the LTRO program the ECB prints money and allows banks to "borrow" it.  This allows them to bypass the Quantitative Easing ruling.

The first of these programs was conducted back in December where 523 banks borrowed 489 billion euros.  The second program this morning had 800 banks show up to the window and borrow 529 billion euros.

That is 1,018 billion euros total or 1.34 trillion dollars in printed currency to help you imagine to the size.

Now the banks can take this free money and re-invest it into an asset that yields greater than 1%, allowing them to keep the spread.  What has a greater than 1% return?  Let's take a look.

Exxon Mobile currently pays investors 2.16% annually for purchasing their stock.  This is called a dividend payment.  A European bank can take their fresh cash, buy Exxon stock, and keep a 1.16% annual spread in free money.  (2.16% Exxon payment - 1% they owe ECB = 1.16%)

A 30 year government bond in the United States currently pays 3% annually.  A European bank can purchase US government bonds and keep the 2% annual spread.

This is called a "carry trade."  This funding is what has sent all "risk assets" soaring as banks around the world continue to take their free money and re-invest it back into the assets with higher yields.

Is there a problem with this?  Yes.  There is a reason why Exxon Mobile and a 30 Year government bond have the yield they do.  While they are not as risky as some municipal bonds, corporate bonds, or a commercial real estate building (which provide yields above 4%) they still have some risk.

For example, what if a European bank purchases stock in Exxon Mobile and the stock is 10% lower in 3 years when their bill comes due?  What if the 30 year US treasury bond has fallen in value by 10% (bonds fall in value if interest rates rise)?

How about interest rate risk?  What if the value of the asset has stayed the same but the US dollar has fallen by 10% over the next 3 years?  When they exchange their currency back into euros to pay back the ECB they must pay out this loss.

This is the danger in a carry trade.  So the question is, in 3 years from now what will the ECB do if banks cannot pay back the money?  It is the ECB's responsibility to make sure the banking system stays solvent and runs smoothly.  By demanding the banks take losses it would create massive damage to the system.

The truth is at this point it does not matter.  The central banks, private banks, and governments are all working together to keep the broken system moving forward for as long as possible.  They have pushed almost all their chips into the pot at the poker table and have no choice but to push everything they have left and then bluff, hoping that the financial system believes the lie.

You will see another round of Quantitative Easing in America.  You will see another LTRO program in Europe.  You will see another response from Japan and China who both want their currencies to trade lower and boost exports in the currency wars.

The problem is so large and so far beyond repair that the only solution is to continue to move forward and hope that the system holds together.  The truth is that the central banks have lost control of the financial system, which has only been masked but a market that has behaved orderly so far.  

Back in 2008 the financial system foundation which can be thought of as the foundation on a home began to be eaten away by termites.  The solution to this problem over the past four years has been to remodel the exterior of the home and add a new landscaping package.  Those driving by have no understanding of what is taking place to the home under the surface, a rotting foundation only waiting for a trigger to collapse.

Please do not get complacent because the stock market is rising, real estate professionals tell you the housing market has bottomed, and interest rates are at all time record lows.  The financial system is more vulnerable today than it was in August of 2008.

Michael Lewis: Don't Let Big Banks Hold US Hostage

Michael Lewis, author of "Moneyball", "The Blind Side", "Liar's Poker", and "The Big Short" sat down for an interview this week to discuss the madness that is our financial system.  We will look back on this period, just as we do now on the subprime housing era, as a time of lunacy.

Tuesday, February 28, 2012

Will Greece Trigger Credit Default Swaps?

LONDON, February 28, 2012 – The International Swaps and Derivatives Association, Inc. (ISDA), as secretary to the Determinations Committees (the DCs), today announced that a question relating to a potential credit event with respect to the Hellenic Republic has been submitted to, and subsequently accepted for consideration by, the EMEA Determinations Committee.
In accordance with the Determinations Committee Rules, a meeting will be held at 11AM GMT on Thursday, March 1 to determine whether a credit event has occurred.
Further information regarding the question is available at

The ISDA's decision over the next 30 days on whether or not Greece's debt write down will trigger a "credit event" that will trigger Credit Default Swaps (CDS) is the most important policy decision for the global financial markets since March of 2009, when the US removed the mark to market accounting for our banking system (we now run under a mark to myth system that is still is place). This accounting change allowed banks to mark their toxic assets at full value and (combined with QE1) put a bottom in the S&P 500 at 666.  The market has since (with the help of QE2) gone on to double in just under three years.

If the ISDA determines that the Greek bailout is a "credit event", that means insurance contracts (Credit Default Swaps known as CDS) will be triggered.  This will set the precedent used for the coming bailouts of Portugal, Italy, and Spain.  This is far more important than the actual Greece CDS contracts which are minimal in size.

If the ISDA determines the bailout does not constitute a "credit event", it means the insurance contracts will not be triggered and will not be forced to pay out.  The much used analogy on this site is to think of it as your home or car getting destroyed and your insurance not making the payment for the damages.

For a more complete discussion on Credit Default Swaps, you can review my post from last Tuesday titled The Greece Bailout: Do Not Trigger The Bomb.

Tomorrow (Wednesday) we will have the details of the LTRO program from the European Central Bank.  I will discuss the results of the program and its implications for the markets this week (for a sneak preview, look at a two month chart of silver).  For a review on what the LTRO program is and estimates on its size, see Behind The Curtain: The European Bank Bailout.

Scoreboard: 5 Year Return Of Major Global Assets

The "bubble" in gold, silver and oil continues to grow, confounding the media, who has called the "bubble popping" in these markets every year for the past 12 years.  Ironically, when these commodities actually enter their bubble stage sometime this decade, the media will be their biggest cheerleader (and we will be selling).

For a reminder of the sentiment toward precious metals in December (two months ago) and the media's most recent call on the "bubble bursting" see: 

December 29, 2011: Precious Metals Fear & Panic

December 14, 2011: Precious Metals Liquidation

Case Shiller Index: New Home Price Lows In All Indexes

This morning we received the most recent Case Shiller Home Price data (for the month of December), and the numbers once again shocked those waiting and calling for a housing bottom.  From David Blitzer, managing director and chairman of the S&P index committee:

"In terms of prices, the housing market ended 2011 on a very disappointing note.  With this month's report we saw all three composites hit new record lows.  Up until today's report we had believed the crisis lows for the composites were behind us, with the 10-City composite originally hitting a low in April 2009 and the 20-City composite in March 2011.  Now it looks like neither was the case, as both hit new record lows in December 2011.  The national composite fell by 3.8% in the fourth quarter alone, and is down 33.8% from its 2nd quarter 2006 peak.  It also recorded a record low.  If anything it looks like we have reentered a period of decline."

10 Cities saw a 1% decline month over month (12% decline annualized).

For an in depth discussion on housing finance, inventory, and future price direction see 2012 Real Estate Outlook.

Sunday, February 26, 2012

Ben Davies Interview: Greece Is Just A Preview

Ben Davies spoke with Chris Martensen this week regarding the European debt crisis, the implications on the derivatives market, and how it will impact all asset classes including precious metals.

Ben Davies also spoke with King World News this weekend, which you can listen/download in audio format here.

China Moves From Paper To Gold

In a recent post titled From Paper To Things: A Global Awakening, I discussed the subtle trend taking place around the world of foreign governments no longer recycling their surplus back into US paper treasuries, but instead purchasing "things."  These "things" are commodity producing companies such as miners and resource producers or commodities themselves (such as gold).

Eric Sprott provided an excellent graph this week showing China's total US treasury holdings vs. their gold imports from Hong Kong.  This chart should be on the wall of every finance manager's office around the world.  Click for larger image: