Much is being made over the price of gold over the past few days and questions are being raised. The main question is; why is gold going up while the dollar is gaining strength? To me it is fairly obvious, there is no faith in any of the currencies of the world at the moment. It is not as if gold is making highs in only Euros or dollars, but it is making highs in most currencies at this point. Again, it is because of a complete lack of confidence of currencies rather than, but not completely devoid of, inflationary fears.
In short, the gold bugs were right and the jokes that many made are suddenly not so funny any longer. What we are witnessing is nothing short of spectacular and one should not underestimate the importance of what is going on either locally or on the other side of the world. It is not very often that we see developed world economies default or come to the edge of default which should make everyone extremely nervous. This is not Ecuador defaulting or the Congo, but we are talking about Greece, which is no surprise in itself, Portugal, Spain and Italy who are or were on the verge of default. It does not end there though, even though they are the countries grabbing the headlines, because if they go France, Germany and the UK could all go as well, this is serious.
This has all the making, as I have said before, of a currency crisis and contagion that can and will more than likely grip the whole world, ending in the U.S. at some point in the near future. To many this is news to them as they fell into the “that cannot happen here” crowd, but the gold bugs, like myself, have been saying for years that at some point the markets will tell you that you have borrowed too much and they will cut you off. When that happens the currency becomes worthless and inflation will inevitably set in making life miserable for the inhabitants of said countries. This is why gold bugs accumulate gold for years because they see it coming and this is why we are witnessing Europeans scramble to buy bullion now. Rumors are that European mints are almost out of bullion, both gold and silver, which may be one reason why prices are spiking. The rumors are not verified, but it would not surprise me one bit as the Euro continues its slide and I do not believe we have seen anything yet in terms of the decline in the Euro or the price of precious metals.
Many wonder why people run to gold for safety during times of stress and the answer is simple, it is a well known store of wealth with a 5,000 year history. It is recognizable, rare, relatively speaking, it cannot be diluted, it is inversely correlated to currencies and you can usually tell if it is fake or not as well as it is portable. All of those reasons make it attractive as an alternative to currencies during times of stress and why people are buying it now. The common reason people present, lately, for not buying gold is that it is not a safe haven because it got crushed in 2008 with everything else. That is true, but the world was in liquidation and seeking dollars to try and settle trades, dollars were tough to find remember, which is why everything went down, except for treasuries. Others claim that other commodities are better, like food, that is true, but food goes bad, you would need a lot of it, it is not as rare and people always need a medium of exchange, currency, to trade with which is exactly what gold is. I am not saying it is perfect or it will work, but I would rather own it than not own it at this stage of the game.
What does have me concerned is the fact that while the jokes about gold bugs have stopped the talk about gold has escalated dramatically lately as we are pushing new nominal highs. I am bullish long-term on gold, I mean, come on, the Fed by its very nature devalues the dollar by about 3% a year by design which makes gold a no brainer for the long-term, but shorter term when everyone is bullish I get bearish, kind of. I believe this time is different as we are facing, literally, a confidence issue if a major currency which is bullish for gold, but I am concerned that the price might get ahead of itself in the near-term. This happened the last time we got in this area and all the chatter stopped when it broke its winning streak, which I was happy about, and the same thing might happen again. However, the situation is different and unlikely to resolve itself.
What amazes me is that while all the talk is about gold no one is talking about silver. We are pushing almost $20/oz on silver right now, which is close to a breakout, and conditions are right for silver to really take off. With JPM making headlines about price manipulation, a currency issue, tight and dwindling supply, high demand, a metal no one recycles, a metal that is in everything we use makes silver, in my opinion, the trade of the century. I can see silver trading much higher than it is currently based on figures I have seen which estimates all the above ground silver consumed within the next 5 or 6 years. If that happens, $20/oz silver is a steal.
Regardless, metals make sense right now and while one should wait for a better entry point the idea is to be looking for that entry point to begin with. This is not rocket science as metals have fixed extraction costs and then it is supply demand after that. With the world’s population growing precious metals make complete sense especially since the vast majority of the world’s population considers precious metals the ideal investments. That in itself should make you think of adding some to your portfolio since the emerging markets population dwarfs the developed markets by a long shot and I would rather be selling it to them at a profit rather than trying to buy it from them at inflated prices.
We are not talking about bailing out Citi or Bank of America, but whole countries now. What is wrong with this story? Greece is a tiny portion of the EU’s GDP and has always been a problem child for Europe, but this is insanity. What happens is Greece gets bailed out will the EU bailout the rest of the PIIGS as well? They would have to because no matter what deal you give Greece those other countries will demand similar treatment.
This is how moral hazard develops into a currency crisis because you cannot be selective on who you bailout and let the rest fail. It is also an extremely complex problem since none of these countries can print their way out of this mess. Typically, a country in these types of problems would simply devalue its currency and be done with it, but the PIIGS cannot do this under EU rules. If they drop out of the EU they are stuck with debt priced in Euros which would utterly destroy the country forcing a true default. There is simply no way out for these countries and we may be seeing the whole EU dissolve right in front of our eyes.
The ramifications for what is going on are enormous to say the least. From my lens it looks and feels like a currency crisis in the making as the entire EU is becoming unstable at best. Germany cannot single handedly hold up the Euro nor can they bailout all of the problem children in the group. The charter of the European Union, as Rosenberg pointed out today this was one of the latest versions of a European Union, the others failed, does not allow for countries to be bailed out. However, an individual country can help out its neighbor if it so desired. This was the rumor today, Germany was going to bailout Greece, but that would have killed the German Bund, which reacted negatively to the news.
The reason why the EU proper cannot bailout of country was established for a reason. Bailing out a country would mean a devaluation of the Euro currency and the EU wanted individual countries to be held responsible for their own troubles. The interesting thing is that Greece totally benefited from the EU versus what it contributed to the rest of the union. However, their benefit was to the detriment of the union itself. Regardless, think about it a country needs a bailout and people think this is not a big deal?
This is probably one of the biggest deals I can think of especially as it is hitting the Euro as hard as it is. I have been expecting a currency crisis for some time now, but always figured it would be the UK followed by either the US or Japan. It does appear that the Euro is first and this is a major problem for everyone, whether you realize it or not. Think about 1997 when Thailand devalued its Baht and what happened there and then magnify that problem by 1000 and you can begin to see the problem this situation can become. I would be very cautious on what you do with your money at this stage of the game, this rally is low quality and based on rumor. I am keeping my shorts.
I have talked about this before, but figured I would bring it up again as it is making headlines that the US may lose its coveted AAA rating. Does it really matter if the US loses this rating or not? It does from an ego point of view, but that is about it since it is highly unlikely that the US will default on its debt. Instead the US will more than likely simply inflate our way out of the mess we are in rather than actually default, but that would still count as a “default” to a certain degree.
What you need to know about rating’s agencies and how they rate sovereign debt is that the game is rigged. We know these agencies did a bad job with the mortgage debt and other private debt in the recent past, but Green Light Capital wrote a great piece on how Moody’s in particular rates sovereign national debt. Basically, the firm only looks about a year out to see how these countries can finance themselves and they do not tax demographics or tax policy into account yet they are predicting some 5 to 7 years out. It was a very interesting read and I will post the article below. Essentially, Moody’s is telling everyone that there is nothing wrong until there is something wrong and then they downgrade the paper, sound familiar?
I could also point to Executive Life which carried AAA ratings right up until the day it filed for bankruptcy, but I would be dating myself. This is what ratings agencies do, they have a CYA policy and then try to argue that their service is covered under the 1st Amendment, when clients pay for it which is not how the real world works. Anyhow, getting back on point, would the US lose its AAA rating? More than likely we will, but not because of default, but because of devaluation of the currency.
Investors will always get back the face value of the debt they buy from the treasury, I would guarantee that, but the US never guarantees the value of said dollars. Hell, Zimbabwe guarantees you will get back the face value of their debt, but, well you get the point. In a nut shell, even if get taken down to a AA rating it will not even impact our interest rates since we set them. Until we actually have a real crisis, meaning a currency crisis or consistent failed treasury auctions which would force higher interest rates – see Argentina – then the borrowing costs will remain wherever we set them.
Essentially, until the market says otherwise we still call the shots, but I will be the first to tell you that we cannot and will not be able to call the shots forever. With the total public debt, including intra-government debt, at $11.9T, according to treasurydirect.gov, which is 83% of 2008 GDP, we are getting up to a level when people are going to question are ability to pay them back. I mean, it’s not like we were really going to pay them back to begin with, but at least we gave them the illusion of repayment with debt-to-GDP well below 100%.
With the administration and CBO, I never give estimates much weight because they are always wrong as in way too low, calling for trillion dollar deficits for the next 10 years and that is if we have an actual recovery I think we need to think worst case scenario. If we do not recover in the next year or two then double those numbers and then we are talking reality or close to it. That is when the market will tell us that we know you are full of it and will demand higher returns on their loans to us. Basically, a credit rating means nothing on sovereign debt as it is still market driven and a great example is Japan who lost most of its AAA ratings already.
My big fear is and I think we are far away from this unless something funky happens in the currency market is a failure in the USD. However, in my opinion I think we would need to see treasury auction failures happen well before we see a currency failure occur and based on demand right now that simply is not going to happen. China, Russia and India can talk all they want, we are listening, but they are still buying and that is all that matters right now. Yes, we need to get our act together, I am not denying that, but it is not as severe as many are saying, unless the DXY slips below the 71 level then I will be a bit worried and you should be too.
There is no question that the cheap dollar has had its benefits for the US in the short-term. It has propelled earnings higher for most firms who deal internationally, narrowed the trade deficit and pushed stocks higher at the expense of our buying power. It has also pushed oil and commodity prices, mainly gold and other metals higher, as well as the dollar continues to touch new 52 week lows.
There is a point where the cheap dollar begins to lose its appeal and begins to concern traders and we have to wonder if we are there yet. After we breached the 76 level on the DXY I actually expected to see a rebound in the greenback simply because it is such a crowded trade and other countries have also printed vast amounts of their currencies as well. However, this seems to not be happening and we are at the point where the 75 handle is in jeopardy of being breached.
Frankly, at this rate we are heading right to the 2008 lows of the 71-72 levels and there is not much there to stop it from going lower. All I have to say is if you thought $147 barrel oil was bad, try $200 or more a barrel. Yes, it could get that bad and food prices could go up as well, even though we technically have deflation energy prices would and could create inflation. This would be catastrophic considering we have massive wage deflation and a huge unemployment problem right now. I am inclined to believe that the treasury or the Fed would intervene if we breached those levels, but my faith is not strong and given the trading programs and deep pockets of the banks, ironically, because of the Fed it could become a crisis.
The odds are against this happening, but it does exist. If this does happen it would also not be good for stocks as there is a difference between cheap money and worthless money. It is not like I am the first to warn of such a problem, Jim Rodgers warned of this type of currency crisis in the recent past and thought it could be either the USD or the Sterling, since we both started down the same destructive paths. I will say that I believe the next 2 weeks will be critical for the greenback and everyone should keep an eye on it for an indication of its direction. A steep move in either direction would mean a selloff in equities.
I am back from vacation, sorry for the lack of notice, but one has to do what one has to do. I wanted to give my continuing views on what is going on and why I think we are seeing perhaps the greatest sleight of hand account in the history of the world. I realize this flies in the face of what we are being told, but it just cannot be ignored and we deserve real answers.
Tim Geithner was on CNBC last night for a town hall meeting on top of testifying in front of the oversight committee for the EESA. Mr. Geithner basically refused to answer any meaningful questions, so both meetings were pointless. We also saw the President deliver a speech about health care reform a day earlier, but frankly the Presidents math does not add up, more on that later. I want to first talk about the credit crisis and what I think is going on. Considering this is merely my thoughts this does not mean its true and I could be wrong, but they are valid points.
I do not think the crisis is over and to assume everything is just fine is crazy. The problem in MBS was not just a sub-prime problem it was a problem with all mortgages as prime mortgage defaults are currently rising rapidly. There are no firm numbers to the market size of the residential mortgage backed securities, but it is a huge number, into the trillions, and according to Lawrence McDonald he thought the number was close to $10 trillion in securitized RMBS. However, that number seems high to me, but as of right now, no one knows.
When these securities started to blow up default rates were higher than normal, but within reason. This begs the question where are we with pricing today considering default rates have only increased over the past 12 months, not decreased. My point is that if these securities were worthless with a 3% default rate do they have any value with a 5-6% default rate? They cannot based on what we were told.
This leads to another question, if these securities have no value why are banks reporting profits when they, supposedly, are still sitting on tens of billions of CDO, CLO and LBO debt which are worthless or valued at a substantially lower bid. If they are not on the balance sheet of banks are they on the Fed’s balance sheet? Could the Fed take credit losses, which a Fed governor indicated yesterday? There are zero answers to those questions and, frankly, we as Americans should be outraged that we do not know where or who owns these things and what are their real prices.
It is impossible to think that we are past the crisis when these things are out there, somewhere, losing someone money. If defaults and foreclosures are at record highs then there is a major problem with these things. However, the Fed and Treasury refuse to tell us if we, the taxpayer, own these things or if they are still at the banks. Regardless of where they are someone is taking a hit and it is either you and I or BoA and Citi, I prefer the latter to be true, but I digress. Basically, I believe we have just seen the largest sleight of hand in the history of accounting take place.
Congress, Treasury and the Fed are totally complicit in this scheme as well since they forced the FASB to alter the mark-to-market rules. I believe that if these things are worthless and they are on the banks books they need to write them down. If this means BoA and Citi go under, so be it. If we let these banks go on like this then we are going to repeat Japan’s lost decade here in America. Whether we like it or not, we have a zombie banking industry right now. I believe this is true based on the lack of credit and the lack of interest in lending.
Making things worse is the fact that consumer credit is shrinking at a much faster rate than estimated. There is simply no way we can have a recovery when we are being fed a rosy picture that is completely false. Banks are insolvent, period. The consumer is out of the game, period. The last GDP number was clearly false as it was reported that if government spending was taken away we would have suffered negative 3.3% growth. The Fed and FDIC has extended their programs to loosen the credit markets, clearly this is a sign of significant weakness. The market refuses to go down, why?
I think what is going on is that the powers that be think if they can continually drive the market higher people will forget what happened just a year ago. Perhaps they are right because Americans have horribly short memories, but there is a problem with that theory. By the time people forget about last year all those mortgage backed securities will rear their ugly head again taking down the markets, again, in another crisis. Regardless, the markets will correct the last 6 months of irrational exuberance sometime in the future, that is a given, but no one knows when that will be. I believe I was close to calling a top on August 7th as we have only traded a few points higher over that days close. Time will tell who was right.
However, what I think is more of an immediate problem is the dollar. The dollar’s decline is perhaps the greatest reason for the market’s advance, but 5 straight days of declines should make the biggest bull cringe, but it is not. Yes, a weaker dollar is great for multinational companies, but a worthless dollar is bad for everyone. I believe that is where we are headed since the Fed has pigeon holed itself and cannot defend the dollar through higher interest rates. Peter Schiff said this would happen and as the DXY makes a new 12 month low it is just proof that he was right, again. We still have a credit crisis and now we are facing a currency crisis is in the making and no one is doing anything about it.
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