Saturday, July 12, 2008

commentary July 11.08...important.

www.lemetropolecafe.com    (james joyce table).

 

Good morning Ladies and Gentlemen:

 

Gold closed up by 18.90 to 959.10 and silver also rose sharply up by 48 cents to 18.72.

The open interest on the gold comex continues to rise.  When the dust settled OI increased by 7500 contracts  to 453000 contracts.  Silver went the other way down by 1500 contracts.  The OI basis Thursday with respect to silver rests at 135000.

 

The COT report released after the market closed indicated that the commercials in  gold were actively supplying the paper and the specs were buying the stuff.  In silver some of the commercials are feeling the heat and vacating the arena.

 

And now for the economic news of the day:

 

First of all, I would like to report to you today (this is not in the Midas report) that the Federal Insurers took over IndyMac Bank at 3 pm Pacific time Friday afternoon.  News of this event came after the posting of Midas.

We should all stand in silence for 1 minute in observance of the death of the usa’s second largest mortgage security behind Countrywide.  This bank had 32 billion dollars in assets and it is estimated that the FDIC will need to spend 6 to 8 billion dollars  to pay off depositors.

There are huge bets on this bank (credit default swaps) and this is going to cause ripple effects into derivatives on Monday.

 

The second biggest news of the day, is the fall in the stock price of Freddie and Fannie Mae.  These two large Government Sponsored Agencies  (GSE’s) have 5 trillion dollars of mortgages in which they own or guarantee.

Their borrowing costs have risen substantially over the last year basically making them insolvent.

 

I have highlighted the most important passage for you to read.

 
U.S. Weighs Takeover of Two Mortgage Giants
By STEPHEN LABATON and STEVEN R. WEISMAN
Under the plan, shares of Fannie Mae and Freddie Mac would be worth little or nothing, and any losses on mortgages they own or guarantee would be paid by taxpayers….

Officials have also been concerned that the difficulties of the two companies, if not fixed, could damage economies worldwide. The securities of Fannie and Freddie are held by numerous overseas financial institutions, central banks and investors…

-END-

Which leads to more of the same…

00:35 Executive branch considers having government take over Fannie Mae (FNM), Freddie Mac (FRE) - NYT
People briefed about the plan say officials are considering taking over either or both companies and placing them in a conservatorship -- but only if their problems worsen. The development would make shares worth little or nothing, and would mean taxpayers would pay losses on the mortgages the companies own or guarantee. The sources say the current administration is less enamored of a plan calling for legislation giving a government guarantee on the $5T of debt owned or guaranteed by the companies. The sources also stress that no action is imminent. Recall the Wall Street Journal reported the government was considering what to do 9-Jul (see comment).
Reference Link (registration required)     END

 

What is dangerous here are twofold:

1.      the massive amount of dollars that will have to be paid by the FDIC.

2.       the massive derivative losses that also must be paid.

 

The FDIC has room to bail out just one major bank.  A hit of this size will send the usa into the likes of the Weimar republic of 1923.

 

The Plunge Protection team issued a false statement at 3 o’clock yesterday afternoon suggesting that the Fed discount window was open to Fannie and Freddie.  The Dow was down 200 points at that point ,  turned upwards rising to positive 20 points where another selling wave brought the Dow down by 132 points on closing.

 

The Dow Jones news service after the market closed indicated that there was no meeting that would allow Fannie and Freddie to borrow from the discount window.

There is no question that the Paulsen and company tried to rescue the market.  They knew that Lehman Brothers had fallen badly and traded at 13.50 at the close.  Two weeks ago rescue money came to Lehman as they issued stock at 28.00.  I guess these new investors are not feeling very happy this morning. The SKF banking index rose to 174.50 at closing from 164.50.  A rise indicates banking weakness.  Two months ago the index was 96.00

I would also like to point out the Lehman brothers is a huge shareholder of  Fannie and Freddie and the demise of these two GSE’s would almost certainly bankrupt Lehmans.

The day also saw the usa dollar tank to around 72.00 and it did dip below 72.00  before the Fed engineered rescue of the Dow.  However what was not commented upon was the severe drop in bond prices.  They dropped a full 1 2/3 points despite the huge fall in the stock market.  This does not bode well for the usa  as generally when you see market turmoil, there is a exit to “safe haven status”.    It looks like the only safe haven is now gold, silver and oil.

 

Oil closed up by 3.50 to 145.30 on news of Israeli exercises in Iraq and the  Nigerian union calling for a strike in the oil patch over there.

In other economic news, the import prices component rose a huge 2.6% in June.  They were expecting 2.0%.  The cause was the huge rise in oil prices as this sets the stage for massive inflation to hit the shores of the usa.

The usa trade deficit narrowed slightly to 59.8 billion dollars from 60.8 billion but you have to take that number with a grain of salt.

1, the usa dollar is very weak and exports should increase with a low dollar.

2. the usa exported a little over 3  billion dollars of gold  and included this in the trade figures.  They only produce 1 billion dollars per month.  The Government has a habit of using foreign gold movement in their own figures for some arcane reasoning.

Thus:  either foreigners are moving gold from usa shores for fear of confiscation or Fort Knox is busy.

Ambrose Pritchard Evans in the UK Telegraph penned an article that is extremely scary.  I have highlighted the passage for you:


Ambrose Evans-Pritchard: BIS slams central banks, warns of worse crunch to come "The current market turmoil is without precedent in the postwar period. With a significant risk of recession in the US, compounded by sharply rising inflation in many countries, fears are building that the global economy might be at some kind of tipping point," it said.

"These fears are not groundless. The magnitude of the problems yet to be faced could be much greater than many now perceive," it said. "It is not impossible that the unwinding of the credit bubble could, after a temporary period of higher inflation, culminate in a deflation that might be hard to manage, all the more so given the high debt levels."

Given the constraints under which the BIS must operate, this amounts to a warning that monetary overkill by the Fed, the Bank of England, and above all the European Central Bank could prove dangerous at this juncture.

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/06/30/ccbis130.xml&CMP=ILC-mostviewedbox

I would expect that there are going to be an emergency meeting set this weekend concerning the fall out in Fannie and Freddie.  If we do not hear any news, expect a huge drop in the stock market on Monday. 

 

Expect gold and silver to continue its advances as the cartel are running out of ammunition.

I wish you all a wonderful weekend and I will speak to you on Monday.

Harvey.

 

 

 

 



Thursday, July 10, 2008

July 10.08 commentary.

www.lemetropolecafe.com

 

James Joyce table:

 

Good evening Ladies and Gentlemen:

 

Gold closed up by 13.90 in the regular session  to close at 940.20.  Silver rose smartly up by 17 cents to 18.24.

The open interest on gold continues to rise.  A further 3000 OI’s were added and the new total is now 346000.  Silver’s OI remains comatose at the relatively high level of 132000 contracts.

 

The big news of the day has to be two fold.:

 

When I arrived to work this morning I  turned my computer on and dialled up Bloomberg.  Staring me straight in the face was comments from former Fed Governor  William Poole  (St Louis Fed) who basically said that Fannie and Freddie are insolvent and they need government bailout  funds to continue.  I have highlighted the passage for all to read;

 

 

*Reuters) - Mortgage lenders Fannie Mae (NYSE:FNM - News) and Freddie Mac (NYSE:FRE - News) are "insolvent" and may need a U.S. government bailout, former St. Louis Federal Reserve President William Poole was quoted as saying in an interview with Bloomberg.
* * * * *

Fannie, Freddie insolvent, Poole tells Bloomberg

(Reuters) - Mortgage lenders Fannie Mae and Freddie Mac are "insolvent" and may need a U.S. government bailout, former St. Louis Federal Reserve President William Poole was quoted as saying in an interview with Bloomberg.

"Congress ought to recognize that these firms are insolvent, that it is allowing these firms to continue to exist as bastions of privilege, financed by the taxpayer," Poole was quoted as saying in an interview held on Wednesday.

Chances are increasing that the government may need to bail out the two mortgage companies, Poole was quoted as saying.

Shares of the two companies have taken a beating recently on worries about whether they can withstand more losses and support housing as well as concerns that they may need to raise massive amounts of new capital.

Freddie Mac shares tumbled 23.8 percent to $10.26 on the New York Stock Exchange on Wednesday, while Fannie Mae shares sank 13.1 percent to $15.31.

Poole could not be immediately reached for comment.

Then rumours started to pour into Wall Street that institutional investors were cutting off trading limits with major investment banks. The investment bank rumoured was  Lehman Brothers:

Here is the passage:

"Rumors are running rampant that a major US institutional investor has cut trading limits with one of the major investment banks. A variation of the rumor is that they have cut limits with a number of prime brokers. This is helping undermine the greenback across the board."

The major investment bank is Lehman Brothers. Their stock cratered too, making new lows. One of the investors was Pimco, which denied the rumors.

End.

Near the end of the trading session, news from Iran startled the Street.  Iran fired another missile capable of hitting Israel.  Oil climbed up by 5.00 to close at 141.50 per barrel.  All the base metals continued on the torrid pace as if totally oblivious to the fall in commodity prices on Monday.  Aluminium climbed  to record levels.  Lead rose a full 10% and copper climbed all the way back to 3.90. The CRB advanced a full 9.30 points to 458.30  close to record levels.

 

Even though the Dow climbed by 82 points for no apparent reason, one must look at these financials to get a real closer look at reality:

Lehman Brothers (LEH)fell $2.44 to $17.30.

Fannie Mae (FNM) dropped $2.11 to $13.20.

Freddie Mac (FRE) lost $2.26 to $8.

With 20 minutes to go in the session, Lehman brothers was trading at 15.90 and Freddie traded at 6.90.  The cartel boys called in the cavalry and they rescued the Dow and helped revive the mortally wounded banks.

 

Despite the brave heroics of our fearless leaders, the second largest commercial mortgage bank, IndyMac Bank  is succumbing.  It is gasping for vital oxygen at its stock fell to 30 cents.  They cannot raise any funds and thus they have been given its last rites. Funeral arrangements are being prepared as well as shiva services.

 

As far as Freddie is concerned, the President and CEO remarked that they are in need of urgent capital somewhere north of 7 billion usa dollars.  Their total Net Worth trading today represents 8 billion dollars  ( one billion shares x 8 dollars).   The company would thus have an immediate 50% haircut as they would have to issue 1 billion shares.  However nobody would lend them at 8 dollars without an audited statement.  My guess is that the Fed will guarantee all loans and hopefully postpone the crisis until later in August or Sept./

 

It is now crystal clear that the Fed cannot raise interest rates with such a deterioration in the housing scene.   This is why gold and silver are breaking out and the cartel are losing control.

Here is the news on home foreclosures:

U.S. June home foreclosures up 53 pct

NEW YORK, July 10 (Reuters) - U.S. home foreclosure filings jumped 53 percent in June from a year earlier, although they were down 3 percent from May, and foreclosures are expected to rise further, real estate data firm RealtyTrac said on Thursday.

Foreclosure filings rose on an annual basis in 39 states to a total of 252,363 properties during the month, with Nevada, California, Arizona and Florida posting the highest foreclosure rates.

One out of every 501 U.S. households received a notice of default, auction sale or bank repossession in June, RealtyTrac said.

"June was the second straight month with more than a quarter million properties nationwide receiving foreclosure filings," said James J. Saccacio, chief executive officer of RealtyTrac. "We have not yet reached the top of this foreclosure cycle." …

End.

 

The World Gold Council announced the sale of gold so far for the year.  Switzerland has so far sold 99 tonnes and this is the same 99 tonnes that have been sold up until March 31.08.  They have not sold 1 oz since that date.  France has sold 86 tonnes and they have stopped as of  Nov 07.  The ECB has sold 72 tonnes of gold including the 30 tonnes last week. The Netherlands has sold 14 tonnes and an unknown bank has sold 14 tonnes.  One bank has bought gold   for coins  (Germany).

\

It is now clear that there are two captive banks that has seen their gold collared.  By this we mean that options on the gold have been written and the counterparty to the trade exercises the option and takes possession of the physical metal.  The two banks are the Netherlands and the  red faced unknown bank who sold 14 tonnes.  (France never writes calls on its gold; however when asked it lent a small 86 tonnes to help the fiat cause).  France in late 2007 stated that it was through  loaning /and or selling any gold.

 

Expect much volatility from this day forward.  Next Friday is options expiry for shares.    The 28th day of July is the last day for the August gold contract.

On a side note:  My number one son and my number two son are both taking delivery of 3 contracts of silver.  Not one has been hit so far.  It is clear to all that there is a scarcity of silver metal around.

I will give a comprehensive review on Saturday.

All the best

Harvey.

 

 

 

 

 

 

Wednesday, July 9, 2008

July 09.08 commentary.

www.lemetropolecafe.com

 

James Joyce table.

 

 

 

Good evening Ladies and Gentlemen`:

 

Gold closed up by $5.30 to 926.30  Silver rose smartly up to the tune of 23 cents to 18.07.  Both metals advanced further in the access market where gold rose a further 3.00 and silver another 15 cents.

 

The open interest on gold comex fell by 3000 contracts as some of the weaker longs liquidated.  The volume yesterday was in excess of 140000 so a small drop in OI is quite ordinary.

 

However the silver Oi remained totally flat as there was no liquidation whatsoever.  The cartel in the silver arena are beginning to feel the heat.

 

The ECB made their statement on the sales of gold.  They first announced that they sold 333 million Euros worth of gold or  17.1 tonnes of gold.  However in the fine print they divided the sale into two categories:

 

  1. 61 million euros worth of gold were sold and this is classified as ``tranasactions``  *3.8 tonnes of gold.

 

  1. 272 million euros worth of gold were sold at month end and  this is classified as ``quarter end adjustments`  (13.38 tonnes of gold)

 

 

In plain English, the first sale was a captive bank selling gold outright.    The second category  (13.38 tonnes) was leased gold that can never come back.  They ECB decided to monetize the lease and announce a sale.  The leasing occurred 2 years or so earlier.

 

In economic news today, the Dow tanked big time falling by 232 points with the Nasdaq falling by 59 points.  The big losers were the banks, with the SKF rising a full 16 points to close at 166.50.  A higher price means banking share losses.  Freddie Mac fell by 19% as the stock tumbled to around 10.20 per share.  It was trading at 62.00 or so at the beginning of the year.

Lehman brothers also tumbled and its stock broke the 20 dollar barrier for the first time.

 

Other big losers were Citibank,  and Fannie Mae as well as Morgan Stanley and Goldman Sachs.

 

Hedge Funds turned in their worst performance in over  two decades with a fall of .75% in the month of June. 

 

However the big news of the day has to be this:

 

Fannie, Freddie Downgraded by Derivatives Traders

July 9 (Bloomberg) -- Fannie Mae and Freddie Mac, ranked Aaa by the world's largest credit-rating companies, are being treated by derivatives traders as if they are rated five levels lower.

Credit-default swaps tied to $1.45 trillion of debt sold by the two biggest U.S. mortgage-finance companies are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group. The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months…

http://www.bloomberg.com/apps/news?pid=20601087&sid=
aH32O9bJZSlw&refer=home

end.

We also learned that Goldman Sachs eliminated 18 billion dollars of Level 3 assets.  What is strange is that they did not take a charge against this.

Where did these assets go. They did not sell any of these assets.   Looks to me like a fraud in the making here!!

 

Ron Kirby has just analyzed the data from the Office of the Comptroller.  Interestingly he found that Citibank is vacating the gold and silver arena.  However HSBC is taking Citibank`s place.  It looks like Citibank experienced a ```near death experience`` and had to vacate the precious metals arena.

 

We also are witnessing JPMorgan increase its derivatives in silver.   It looks like HSBC and Mocatta are asking for  help from fellow fraudster JPMOrgan in the silver arena.

 

You may want to look at ECU a small junior with impressive gold and silver.  The banks have massively shorted this company for the last few years.  However they keep coming up with great discovery holes.  It now looks like the banks are starting to cover.

I estimate that these guys have a minimum of 30 dollars of silver equivalence.   The cost of getting it out of the ground is around 15.00 so they are worth anywhere between 15-20 dollars per share.  They are trading at 1.82.  They are getting higher grades of gold the deeper they get.  This is exactly what we expect.  These guys have already done a bulk testing on their ore and the grades at the bulkhead are better than anticipated.

This will be a good mine if they can go into production without interference from the banks.

I will speak to you on Saturday.

Harvey.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tuesday, July 8, 2008

commentary July 8. 08

www.lemetropolecafe.com

 

James Joyce table.

 

 

Good evening Ladies and Gentlemen:

 

Gold closed down by 5.00 to rest at 920.90 and silver fell by one cent to 17.84.

The open interest on gold rose  by 400 contracts to 446100 and silver’s OI rose a further 700 contracts to 137000.

Remember that gold and silver were plastered yesterday so open interest rising on a fall in price is indicative of massive short selling.

Today we saw the same drill as the cartel supplied the paper and investors continued to pile on. 

 

I strongly believe that we were victorious today.  All other commodities were hit pretty hard including oil dropping by 5.00 dollars and copper whacked for a loss of 15 cents. Gold and silver did pretty good despite the fall in all other commodities.

The Fed did another auction for  loans with a further 25 billion dollars added.  On top of that additional repo pool money was added  to the mix as the additional capital found its way into the markets.

 

Today, the money was used to prop up the Dow and  hit commodities. The Dow rose by a full 152 points and the SKF banking index fell from 172 to 150.00 as bank shares rose big time.

This will be temporary.

 

In the news today, the second largest mortgage lender IndyMac Bank laid of 3800 workers and then announced after the market closed that they are unable to raise capital.

This stock last year traded at 45.00 usa.  Today it traded at 40 cents.  It is basically bust.

 

IndyMac is second only to Countrywide who also have financial trouble.

 

If both of these banks go bust, then the usa will enter into a huge debt spiral.

 

Over in England, we are witnessing similar events with  the largest mortgage player, Bradford and Bingley having trouble with its rights offering.  It stock is plummeting and nobody wishes to step up to the plate and buy on the rights offering.  Last year we saw Northern Rock fail and it was gobbled up by the Bank of England.

 

Other mortgage players in trouble include the large HBOS  (The  Halifax Bank of Scotland)  with a huge amt. of mortgages in default.  The Royal Bank of Scotland has seen their stock fall to a low of 2 pounds yesterday as did the other large bank, Barclays.

 

The mortgage problem is global.  Spain has overbuilt and this country has whole cities with no one occupying buildings.  The central bank in Spain has seen its reserves fall to zero.

 

In other news, usa pending home sales plummeted in May down a full 4.7%.  We are seeing home prices fall sharply and this is the collateral that banks are using.

 

Pension funds are reporting huge losses as the credit crunch has drained 280 billion from pensions. This is putting the largest of financial companies in a deep financial hole.

 

In the silver world, Ted Butler has written a paper on the silver shorts.  The 8 largest silver traders are short 79 per cent of all silver to the tune of 353 million oz.  On top of that the SLV over in London has a further 60 milllion oz of naked short sales.  Barclays is short for the simple reason is that there is no silver for them to obtain.  So instead of buying the silver they remain short.

The total physical  silver left in the world is estimated to be around 150 million oz so the regulators, HSBC and Scotia Mocatta will have a lot of explaining to do when this thing is exposed.

 

It is getting a little late so I will let you go.

See you tomorrow.

Harvey.

Monday, July 7, 2008

commentary July 07.08

http://www.lemetropolecafe.com/james_joyce_table.cfm?pid=7016

 

 

Good evening Ladies and Gentlemen:

 

Gold closed down by 6.00 dollars to rest at 925.90.  Silver closed down by  43 cents to 17.85.

 

The open interest on gold climbed  Thursday basis by 6600 contracts.  Silver’s OI also increased by 1600 contracts.  The Gold comex Oi is now at 445000 and silver is 136000.

 

The huge increases in the OI on both metals certainly influenced cartel members to bomb these metals.

 

I would like to point out that the 200 day moving average of gold comex is now 871.00 and it will be climbing by 1.00 each trading day.  Europe pays close attention to this and I doubt very much if this price will ever be penetrated.

 

Today, we received many stories on the deterioration in the economy.

 

The first story came from the very respected Bridgewater Associates who warned  that financial losses could top 1.6 trillion dollars.  I have included the passage for you to read:

 

Financial market losses could top 1,600 billion dollars: report

Posted:Sun, 06 Jul 2008 17:01:01 GMT
Author:DPA

Geneva - The global financial crisis could lead to losses of 1,600 billion dollars for financial institutes, according a report in the Swiss Sunday newspaper Sonntags Zeitung. It quoted a confidential study by the hedge fund Bridgewater Associates as saying losses for banks holding risky assets could be four times greater than the 400 billion dollars previously estimated.

The hedge fund expressed doubts that the financial institutes would be able to drum up enough funds to cover the losses, something it said could exacerbate the crisis.

Bridgewater,one of the world's biggest hedge funds, based its calculations on the state of risky debt-based US assets, such as mortgages, credit and credit card demands.

The value of such risky assets is 26,600 billion dollars, according to the hedge fund. The losses would amount to 1,600 billion dollars if these assets were valued at market rates and not in the form of securitization, the newspaper said.

The second article came from the very respected author  Theodore Forstman who basically states that the credit crunch is far from over.  I have included the passage for you to read as well:

 

Theodore J. Forstmann

The Credit Crisis Is Going to Get Worse

By BRIAN M. CARNEY
July 5, 2008; Page A9

New York

Twenty years ago, Ted Forstmann contributed a scathing – and prescient – op-ed to this newspaper warning that the junk-bond craze was about to end badly: "Today's financial age has become a period of unbridled excess with accepted risk soaring out of proportion to possible reward," he wrote in October 1988. "Every week, with ever-increasing levels of irresponsibility, many billions of dollars in American assets are being saddled with debt that has virtually no chance of being repaid."

Within a year, the junk-bond market had collapsed, and within 18 months Drexel Burnham Lambert, the leading firm of the junk-bond world, was bankrupt. Mr. Forstmann sees even worse trouble coming today.

For a curmudgeon, he is a cheerful man. When we met for lunch recently in a tony midtown restaurant, he was wearing a well-tailored suit, a blue shirt and a yellow tie. He spoke with the calm self-assurance of someone who has something to say but nothing left to prove.

"We are in a credit crisis the likes of which I've never seen in my lifetime," Mr. Forstmann warns. He adds: "The credit problems in this country are considerably worse than people have said or know. I didn't even know subprime mortgages existed and I was worried about the credit crisis."

Mr. Forstmann denies being an expert in the capital markets. But he does have some experience with them. He was present at the creation of the private-equity business. The firm he co-founded, Forstmann Little, rode the original private-equity boom in the 1980s while skirting the excesses of the junk-bond craze in the later years. It was for a time the most successful private-equity firm in the world, renowned for both its outsize returns and its caution. For two years after Mr. Forstmann wrote his 1988 op-ed, Forstmann Little sat on $2 billion in uninvested funds, waiting for the right opportunities. Savvy investments in Dr. Pepper and Gulfstream, among others over the years, helped make Mr. Forstmann a billionaire.

These days, he devotes most of his professional attention to IMG, the sports and entertainment agency. But the economy has him worried.

Mr. Forstmann's argument about the present crisis starts with the money supply. After Sept. 11, 2001, the Federal Reserve pumped so much money into the financial system that it distorted the incentives and the decision making of everyone in finance. He illustrates this with what he calls his "little children's story": Once upon a time, when credit conditions and the costs of borrowing money were normal, the bank opened at 9:00 a.m. and closed at 5:00 p.m. For eight hours a day, bankers made loans and took deposits, and then they went home.

But after 9/11, the Fed opened the spigot. Short-term interest rates went to zero in real terms and then into negative territory. When real interest rates are negative, borrowing money is effectively free – the debt loses value faster than the interest adds up. This led to a series of distortions in the financial sector that are only now coming to light. The children's story continues: "Now they [the banks] have all this excess money. And they open at nine, and from nine to noon or so, they're doing all the same kind of basically legitimate things with it that they did before."

So far, so good. "But at noon, they have tons of money left. They have all this supply, and the, what I would call 'legitimate' demand – it's probably not a good word – but where risk and reward are still in balance, has been satisfied. But they're still open until five. And around 3:30 in the afternoon they get to such things as subprime mortgages, OK? And what you guys haven't seen yet is what happened between noon and 3:30."

Straightforward economics tells us that when you print too much money, it loses value and prices go up. That's been happening too. But Mr. Forstmann is most concerned with a different, more subtle effect of the oversupply of money. When it becomes too plentiful, bankers and other financial intermediaries end up taking on more and more risk for less return.

The incentive to be conservative under normal credit conditions is driven in part by what economists call opportunity cost – if you put money to use in one place, it leaves you with less money to invest or lend in another place. So you pick your spots carefully. But if you've got too much money, and that money is declining in value faster than you can earn interest on it, your incentives change. "Something that's free isn't worth much," as Mr. Forstmann puts it. So the normal rules of caution get attenuated.

"They could not find enough appropriate uses for the money," Mr. Forstmann says. "That's why my little bank story for the kids is a fun way to put it. The money just kept coming and coming and coming and coming. What are you going to do with it? IBM only needs so much. The guy who can really pay his mortgage only needs so much." So you start thinking about new ways to lend the money, which inevitably means riskier ways.

"I don't know when money was ever this inexpensive in the history of this country. But not in modern times, that's for sure."

Combine this with loan syndication and securitization, and the result is a nasty brew. Securitization and syndication allow the banks to take the loans off their books and replenish their capital. They then use this capital to make new loans, which they securitize or syndicate and sell to the hedge funds, which buy them with the money they borrowed from the banks. For a time, everyone makes money.

 

 

In fact, for six years, a lot of people made a lot of money in this environment. So much money that, as Mr. Forstmann notes, the price of admission to the Forbes 400 list of the richest Americans has gone from $500 million 10 years ago to over $1 billion today. (Mr. Forstmann was bumped from the list two years ago, his reported 10-figure net worth no longer enough to keep pace.)

At the same time, both the size and the number of hedge funds and private-equity funds have ballooned. "I used to have one of the biggest private-equity funds in the world," he says matter-of-factly. "It was, I don't know, $500 million or a billion dollars. If you don't have a $20 billion fund now, you're kind of a [nobody]," Mr. Forstmann says. (The term he used to describe those of us without $20 billion PE funds was both more colorful and less printable than "nobody.") "And so what does that tell you?"

Mr. Forstmann hasn't raised a new fund in four years. But he doesn't blame the hedge funds or the private-equity funds – they are not the villains in his story. "Fundamentally, I don't see them as a cause," he says. "Obviously the proliferation of hedge funds and private-equity funds has created its own dynamic. But this proliferation is simply a result of the vast increase in the money supply."

Mr. Forstmann has been around a long time, so he's seen a lot. But is it possible that he's simply fallen behind the times? By his own description, he's a bit of a figure from another age – "a bit like Wyatt Earp in 1910."

But it would be a mistake to dismiss Mr. Forstmann's pessimism too quickly. After all, he knows something about both credit and crises.

"You've got [Treasury Secretary Henry] Paulson saying 'Oh, you see the good news is it's over.'" The problem, according to Mr. Forstmann, is that it's far from over. "I think we're in about the second inning of this." And of course, the credit crisis wasn't even supposed to last this long. "This all started in August [of 2007], and it was going to get cleared up by October. It hasn't gotten cleared up at all."

One reason is that the proliferation of new financial instruments has left the system more closely intertwined than ever, making a workout, or even a shakeout, much more difficult. Take what happened to Bear Stearns. "What should the health of one brokerage firm in America mean to the entire global financial system? To an ordinary person, probably not much. But in today's world, with all the interdependence, a great deal."

This circular creation of new credit, used to buy more newly created debt, all financed by ultracheap money and all betting with each other, has left the major firms hopelessly intertwined. "It's very interrelated," he says, locking his fingers together. "There's trillions and trillions of dollars that slosh around between all these places and if one fails . . ." He doesn't finish the thought.

Early in our conversation, Mr. Forstmann describes his conversational style as "Faulknerian." The word fits. He jumps between thoughts, examples and anecdotes in a pure stream of consciousness. One such aside is about Warren Buffett and the rule of the three "I"s.

"Buffett once told me there are three 'I's in every cycle. The 'innovator,' that's the first 'I.' After the innovator comes the 'imitator.' And after the imitator in the cycle comes the idiot. Which makes way for an innovator again." So when Mr. Forstmann says we're at the end of an era, it's another way of saying that he's afraid that the idiots have made their entrance.

"We're in the third 'I' for sure," he interjects an hour after first introducing the "rule." "And that always leads to something. Innovators don't just show up. Some disaster takes place because of the idiots, and then an innovator says, oh, look at this, I can do this, that or the other thing." That disaster is now.

In other words, "In order to fix what's going on in the United States there's going to have to be a certain amount of pain. The market's going to have to clear somehow. . . and it's hard for me to believe that it gets fixed without" upheaval in the financial system, the economy and the country as a whole. "Things are going to fail. Enterprises are going to fail. The economy is going to slow," he warns.

To be clear, although Mr. Forstmann talks about "fear and greed" getting out of whack, his is not a condemnation of "greedy speculators" or a "culture of greed" or any of the lamentations so popular among the populists in Washington. It is a diagnosis of the ways in which the financial sector responded to a government policy of printing money that was free, or nearly so. "The creation of much too much money caused all of this excess," he says. In other words, his is not an argument for draconian regulation, but for sound money.

Nor does he blame Alan Greenspan, even though he argues that this all started with the dot-com bubble and 9/11. "Greenspan," he allows, "had really tough decisions to make, so I don't think it's a black-and-white kind of thing at all." It was, and is, rather, "a case of first impression." Mr. Greenspan, he says, admits that he was "totally sure" that what he was doing was right. But he had "no idea what the consequences [were] going to be."

According to Mr. Forstmann, we are now living with those consequences. And the correction has only begun.

Mr. Carney is a member of the editorial board of The Wall Street Journal.

 End.

 

The big news of the day is the collapse of the financials.  We had Fannie Mae and Freddie Mac falling by 22% and 15% respectively.  Lehman Brothers stock fell another 2.00 today to close at 20.80.  The Banking index SKF rose a full 6 points indicating huge problems in the banking sector.

Not only that but Goldman Sachs sold a massive 3000 contracts of S and P on Thursday and this was announced this morning. Goldman is betting big time that the stock market will collapse.

No wonder the banking sector collapsed today.  Late in the day, we learned that Platts has suspended all of Lehman brothers tradings in oil.

It looks like Lehman brothers  have engineered massive losses.  It will be a race to see who will collapse first:  Lehman brothers or Citibank.  Citibank closed down 34 cents to 16.24 very close to its all time low.

 

Dennis Gartman in his Gartman letter announced that he was selling all of his gold holdings if gold broke 930.00  .  It looks like this well informed individual knew in advance of a gold raid and he liquidated his gold holdings while the cartel attacked this morning.

In other news, the Comex raised margin requirements on  gold contracts.  This  added  further selling pressure on gold.

 

Expect further volatility in the precious metal markets tomorrow.  We should also see further deterioration in the banking and mortgage sector.

Speak to you tomorrow

Harvey.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sunday, July 6, 2008

Deflation, Hyperinflation or Both?


Deflation, Hyperinflation or Both?

If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.

- Attibuted to Thomas Jefferson in many places on the Internet

On June 30, respected commentator Mike “Mish” Shedlock posted “Deflationary Hurricanes to Hit U.S. and U.K.” on his blog, inciting a firestorm of controversy in the gold community. John Mauldin and Louis-Vincent Gave of GaveKal fame have also weighed in with their point of view that deflationary forces will win out over inflationary forces in the western world. This is generally at odds with most commentators in the pro-gold community, like Addison Wiggin, Peter Schiff, Bill Bonner, most commentators on Gold Eagle and Le Metropole CafĂ©, who are predicting a complete implosion of the U.S. Dollar (and a meteoric rise in the gold price) driven by the Fed’s monetization U.S. debt and reflation of the severely impaired financial system; essentially the hyperinflation force will overwhelm the credit crunch and derivative explosion deflationary forces.

The “deflation-wins” line of thinking goes as follows:

- Credit is contracting all over the globe as many banks and borrowers are bankrupt.
- The Fed can pump as much liquidity as they want, but the primary means of reflation occurs through bank lending, and they can not / will not lend. Capital seeks the best balance of risk and reward and lending domestically does not offer this. Japan 1990-2002 revisited.
- Fed monetization and private credit is actually decreasing in velocity and current inflation is an overhang of past monetary expansion sins.
- U.S. current account deficit is increasingly a function of petroleum imports, and when this situation corrects, the U.S. will be exporting less dollars, hence less inflation, around the world.

A few people out there – and I would put my father Harvey Organ and brother Lenny Organ in this camp – believes that both can happen simultaneously. Assets that have been pumped up with too much credit will deflate, while commodities will continue to inflate.

I do not see how such opposite forces of increasing and decreasing prices can exist simultaneously for too long. Money is fungible between different classes of assets and commodities. As Jim Willie points out, eventually one force will dominate over the other, even as both forces act on the economy simultaneously.

This is not just an academic question. Understanding which force will win, and when, is critical for placing the right asset class bets that will preserve and possibly even generate new wealth over the difficult next few years.

I believe that the inflationary force will dominate over the next couple of years, and this period will be followed by domination of deflationary forces.

The main reason for why I believe the inflationary forces will win in the short term is that foreigners increasingly do not see the U.S. as a safe haven for their capital, and this will drive a demand for converting dollars into assets … “the dollars will come washing back on our shores”. U.S. as a safe haven has been the main reason for inflation not spiralling out of control over the past few years, as foreigners have opted to buy huge quantities of US debt with their surplus of US dollars. The health of U.S. banks, and the U.S. itself, is increasingly highly questionable. Also, the U.S. government is placing limits on ability of foreigners to purchase U.S. assets with their dollars (Chinese and Unocal, UAE and the ports, etc.). These two issues make the massive holding of U.S. dollars very uncomfortable for the foreigners who hold trillions of them.

It will not take long for the U.S. to erect whatever protectionist barriers it can to save the dollar as the hyperinflation rages out of control and the banks/housing market is dead anyway. This may be the shift from the inflationary to the deflationary phase of the bust, mirroring the two phases of the Great Depression in 1929-1931/1931-1933. A President Obama and a Democratic Congress will undoubtedly hasten this process, like Roosevelt in 1932, with his liberal ideals. New policies may include a new currency, massive nationalization of industries, and trade barriers – all potentially very deflationary.

Take a look at the following diagram. It is sourced from GaveKal with my annotations in red, plus the circular arrow.

While GaveKal did not link these phases together, it really struck me how sequential they appear in the fiat currency world. Clearly the 90’s were a deflationary (in terms of consumer prices, not asset prices) boom, driven by Asian export achievement, driven in turn by undervalued Asian currencies. Gold was the last asset class you wanted to be in then, and global “platform companies” like Dell, Ikea, Li & Fung, etc were the best places to be. Greenspan inflated his way out of the Nasdaq bubble collapse, driving a boom in nominal terms in the 2000’s. If you invested in emerging markets and commodities you were the big winner. If the cycle repeats itself again as it has since the founding of the Federal Reserve in 1913, then the time is right for an inflationary bust.

Certainly this is what the markets are pricing in, with the USD plumbing new lows, gold close to all-time highs, commodities very high, and bond yields threatening to increase sharply. In an older article, Gave mentions that “Copper is the only mineral with a PhD in economics” and uses that to add credence to his deflationary-wins scenario – at a time when the metal was failing to achieve new highs. Well, Prof. Copper has spoken loudly as he has climbed over the $4/lb level for the first time recently.

So what does this mean for placing investment bets? Gold (and silver) certainly shine here. Not only is gold the best asset class for an inflationary bust, it also does surprisingly well in a deflationary bust, although for different reasons. It does well in an inflationary bust as people question the value of paper money; in a deflationary bust it holds its value as cash while everything else declines in value. As deflationary forces begin to win over inflationary forces in 2010-11, it would be prudent to carefully convert gold-related holdings into safe, high-yielding assets, such as government bonds and high dividend paying stocks (particularly those that target Asian domestic consumption). By then yields should be in excess of 10%.

At the same time, going short on high flying companies, such as the global technology, consumer retail, and commercial real estate firms should produce excellent returns over the next year. Shorting financials should be profitable as well although with somewhat more risk, as these stocks have already fallen some 60%. I would expect these stocks to fall another 50% from here.

The two tricky asset classes are non-monetary commodities such as oil, potash, food, materials, etc. and government bonds. This is because they behave very differently in inflationary and deflationary busts. To maximize returns, an investor would go long commodities and short bonds in the inflationary bust, and reverse these positions for the deflationary bust. But how to know when to switch? It’s unclear at this point. I am planning on going short T-bonds after another 10-15% is whacked off the Dow, when the index is at 118 or so, and try to ride it down below 110. I don’t think that I have the guts to go short on commodities though. I can envision oil easily going to $200 and certainly do not want to get in its way.

One final note on gold, and an important one. I believe that the probability is high for governments to confiscate it, as the US government did in 1933, if the deflationary bust appears after the inflationary bust. It would be wise to have gold holdings in coin form, as numismatic gold was not confiscated in ’33; also consider having some gold held in secure digital form subject to different political laws, such as GoldMoney.

Best of luck to all of you navigating the choppy waters ahead!



- Mark Organ

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