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Market Report: PMs consolidating further

Fri, 05/27/2016 - 06:06


Gold and silver drifted lower this week, dollar prices falling approximately 2.5% and 1.5% respectively.

It is a continuation of the previous week’s trend, which saw larger falls. To date, from 1st January the dollar price of gold this morning in early European trade is up 15.14%, and silver 17.7%. So even though prices have fallen this month, holders of precious metals have done better than those exposed to other asset classes.

A notable feature has been the sharp contraction of gold’s open interest on Comex, which over the last eight trading sessions has contracted 71,400 contracts to a more normal 525,094 figure. This contraction broadly correlates with the fall in the gold price, as shown in our second chart.


The relationship between price and open interest shows that the ramp-up at the end of April, having initially failed to stop the price rising, managed to suppress it from the 4th May onwards. As an operation to stop the gold price rising, it appears that the bullion banks not only succeeded, but made substantial profits as well, closing their bears from the $1275 level into a falling market from 17th May onwards. This is beautifully illustrated in the next chart, of net swap positions, which rose to a record net negative 141,232 contracts on 17th May (the last recorded date at the time of writing).



At a guess, this category alone will have reduced its net position by about 50,000 contracts since 17th May / $1279, making profits between $150-200m. Oh, for the joys of being able to print short contracts without limitation!

The position in silver is notably different, with silver remaining overbought and open interest hardly reducing at all. This is shown in the next chart.


Notice the divergence between price and open interest. OI has fallen only 5,500 contracts since 17th May, while the price has dropped 8%. Could it be that the swaps will target silver next?

It cannot be ruled out, because the hedge funds are still net long to a significant degree. However, in day-to-day trading, silver has recently held up well when gold has been weak, which might indicate a pick-up in industrial demand, relative to physical supply, at current levels.

In analysing market trading in precious metals, we cannot ignore developments in the US dollar. After all, speculators do not so much buy or sell gold, rather they sell or buy the dollar. Gold is just one of the counterparty assets involved, the others being in a number of categories: US Treasuries, if it is an inflation or interest rate play, currencies for factors specific to the pairs, commodity indices for interest rates and prospective economic demand, and gold for interest rates and systemic risk. So it is no coincidence that the Fed’s attempts to jaw-bone markets away from negative dollar rates and back to “normalisation” has softened precious metals.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

Dealing Desk: Clients Take Advantage of Lower Market

Thu, 05/26/2016 - 10:28
This week, clients have continued to net buy silver and platinum, whilst net selling gold and palladium.

Clients have been seen taking advantage of the lower pricing on precious metals as silver still remains below $16.50/oz.

GoldMoney’s clients have favoured the Singapore and Swiss vaults this week, with less preference being shown for the London vault.

Kelly-Ann Kearsey, Dealing Manager at GoldMoney, said that this week has seen a continued pressure on the market, due to the release of the FOMC minutes for April. The odds of an early rate hike have now increased from 4% two weeks ago to 34% this week.

Precious metals have seen a downward fall over the past week, with gold seeing six consecutive days of losses, which was mirrored by silver. Platinum was seen back under the psychological level of $1,000/oz. However, on Thursday the downward rally paused before the release of the US Jobless figures.

The news of the FOMC had sent the US Index to a two month high and, to support this further, the US Jobless Claims released today showed the data had been better than originally expected.

26/05/16 16:00. Gold lost 2.2% to $1,221.85, Silver declined 0.8% to $16.27, Platinum decreased 1.8% to $990.85 and Palladium reduced4.6% to $535.72 Gold/Silver ratio: 72

Notes to editor
For more information, and to arrange interviews, please contact Emily Cornelius, Communications & PR Tel: + 1 647 499 6748 or email: Emily.Cornelius@GoldMoney.com

GoldMoney
GoldMoney is one of the world’s leading providers of physical gold, silver, platinum and palladium for private and corporate customers, allowing users to buy precious metals online. The easy to use website makes investing in gold and other precious metals accessible 24/7.

Through GoldMoney’s non-bank vault operators, physical precious metals can be stored worldwide, outside of the banking system in the UK, Switzerland, Hong Kong, Singapore and Canada. GoldMoney partners with Brink’s, Loomis International (formerly Via Mat), Malca-Amit, G4S and Rhenus Logistics. Storage fees are highly competitive and there is also the option of having metal delivered.

GoldMoney currently has over 20,000 customers worldwide and holds over $1billion of precious metals in its partner vaults.

GoldMoney is regulated by the Jersey Financial Services Commission and complies with Jersey's anti-money laundering laws and regulations. GoldMoney has established industry-leading governance policies and procedures to protect customers' assets with independent audit reporting every 3 months by two leading audit firms.
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Regulation – the hidden curse

Thu, 05/26/2016 - 05:37
Regulations are nearly always introduced with the best intentions.

In financial services, they aim to stop unscrupulous brokers and banks from ripping off the public through bad practices. Manufacturers are banned from making products which are dangerous to children, the environment, or which might fail through shoddy workmanship. However, state intervention in commercial matters is based on shaky grounds, consistent with denial of the role and workings of markets, and an overriding desire to interfere.

This contrasts with a true understanding of why free markets work, and the control the consumer exercises over prices and choice, subordinating them to his subjective decisions. Consequently, regulation is based on an unreasoned belief that the individual needs state intervention to ensure standards are maintained, and that bad practices will be eliminated. The incorrect assumption is that free markets encourage unscrupulous manufacturers and service providers to defraud the consumer, when in fact, reputation becomes the paramount relationship in trade.

Because private sector regulation tends towards monopoly practices, the state naturally sees itself as the independent arbiter to ensure fair play. But the state, having initially imposed regulations, finds it very difficult to stop there, with political pressures always to modify and intensify bureaucratic control. Furthermore, unintended consequences of earlier regulations are never corrected by abolishing them. Instead, more layers of regulatory control are introduced in an attempt to address ensuing problems. We therefore drift into greater and greater regulation, without being aware of the true economic cost.

Anyone who favours regulation needs to explain away Germany’s post-war success. Her economy had been destroyed, firstly by the Nazi war machine, and then by Allied bombing. We easily forget the state of ruin the country was in, with people in the towns and cities actually starving in the post-war aftermath. The joint British and American military solution was to extend and intensify war-time rationing and throw Marshall aid at the problem.

Then a man called Ludwig Erhard was appointed director of economics by the Bizonal Economic Council, in effect he became finance minister. He decided, against British and American misgivings, as well as opposition from the newly-recreated Social Democrats, to do away with price controls and rationing, which he did in 1948. These moves followed his currency reform that June, which contracted the money supply by about 90%. He also slashed income tax from 85% to 18% on annual incomes over Dm2,500 (US$595 equivalent).

Economists of the Austrian school would comprehend and recommend this strategy, but it goes wholly against the bureaucratic grain. General Lucius Clay, who was the military governor of the US Zone, and to whom Erhard reported, is said to have asked him, “Herr Erhard, my advisers tell me what you have done is a terrible mistake. What do you say to that?”

Erhard replied, “Herr General, pay no attention to them! My advisers tell me the same thing.”i

About the same time, a US Colonel confronted Erhard: “How dare you relax our rationing system, when there is a widespread food shortage?”

Erhard replied, “I have not relaxed rationing, I have abolished it. Henceforth the only rationing ticket the people will need will be the deutschemarks. And they will work hard to get those deutschemarks, just wait and see.”ii

The US Colonel did not have to wait long. According to contemporary accounts, within days of Erhard’s currency reform, shops filled with goods as people realised the money they sold them for would retain its value. People no longer needed to forage for the basics in life, so absenteeism from work halved, and industrial output rose more than 50% in the second half of 1948 alone.

Erhard had spent the war years studying free-market economics, and planning how to structure Germany’s economy for the post-war years. It goes without saying that his free-market approach made him a long-standing and widely recognised opponent of Nazi socialism, a fact that enhanced his credibility with the military authorities tasked with repairing the German economy. He became an early member of the Mont Pelarin Society, a grouping of free-market economists inclined towards the Austrian School, founded in 1947, and whose first President was Hayek.

Erhard simply understood that ending all price regulation, introducing sound money and slashing the burden of taxation, were the basics required to revive the economy, and that the state must resist the temptation to intervene and had to reduce its role in the economy. He remained a highly successful finance minister for fourteen years, before succeeding Adenauer as Chancellor in 1963.

Erhard not only allowed unfettered free markets to rapidly turn Germany around from economic devastation, but being publicly credited with this success he presided over the economy long enough to ensure that bureaucratic meddling was kept at bay subsequently. His legacy served Germany well, despite the generally destructive actions of his successors.

The contrast with Britain’s economic performance was stark, where rationing was not finally lifted until 1954, and her post-war socialist, anti-market government was nationalising key industries. The contrast between Germany’s revival and Britain’s decline could not have been more marked.

The point is that free markets are demonstrably more successful than regulated markets as a means of ensuring economic progress. The same phenomenon was observed in Hong Kong, where John Cowperthwaite succeeded in stopping his own local officials and London’s Colonial Office from imposing regulations on the island’s economy in the post-war years. Cowperthwaite was roughly contemporary with Erhard, retiring as Hong Kong’s Financial Secretary in 1971. Yet despite this indisputable evidence that free unregulated markets actually work best, the political class can never resist the compulsion to regulate.

Regulations are intended to take risks out of life, an objective at which the state demonstrably fails. Established businesses are happy to collude with the state in setting regulations, partly because they get to influence their scope, and partly because it allows them to disregard the emphasis they otherwise have to place on their reputations in a free market.

I will always remember a lunch I had with the managing director of a well-known spread-betting business before spread-betting became regulated in the UK. When I enquired of him if he saw proposals to regulate his business as an imposition, he replied to the contrary. He was looking forward to the legitimacy that regulation by The Securities and Futures Authority, which was the regulator at the time, would give to his business. And to this day, spread-betting and similar products remain regulated as investment products. It is a legitimate mainstream financial activity, instead of a casino for financial products.

A regulated business clearly does not have to trade on its reputation, since its customers are theoretically guaranteed by the regulations. The intention is that ordinary people no longer have to consider whether this or that broker, or bank, is safe to deal with. Equally, the broker and the bank no longer views the client or customer as their uppermost consideration. That relationship is with the regulator.

Clients and customers are now so used to regulation they find it hard to imagine how things would work without them. Who wouldn’t want the protection of a government regulator to ensure fair play? Well, there are some who have become disillusioned. Ask those who entrusted their money to a regulated Bernie Madoff, or those who found their margin deposits lost in a black hole called MF Global.

Doubtless there will always be those who suffer from business failures, when they thought they had the protection of the state. Of course, we cannot know the counterfactual, how many failures there would be in an unregulated financial services industry, but we do know that state regulations routinely fail to protect the public.

Regulations have also become extremely complex and costly, and to a large extent regulators have to trust regulated businesses to work within the spirit of the regulations. How naïve is that. It suits big businesses very well, because they can easily afford the lawyers to advise them how best to work the regulations they themselves drafted to advantage.

Smaller competitors, the principal threat to established businesses in free markets, are practically excluded from setting the rules. Take the arcane subject of the EU Biocide Directive. Manufacturers using elemental silver for the last twenty years have been required to work towards gaining EU-wide approval for its use as a biocide, despite this safe non-toxic use being already thoroughly proved and established. The legal and bureaucratic processes have required the businesses affected to spend roughly €1m each so far, and counting. Small beer perhaps to members of the silver task force such as Dow Chemical and BASF, but wholly disproportionate and unaffordable for smaller competing enterprises.

The battle between a business establishment that games regulation to the disadvantage of its less powerful competitors is the same underlying principal that governs relations between governments in the advanced and developing nations. Complex and costly regulation has long been a handy deterrent against cheaper, foreign competition. But uncompetitive practices only work for a time, and foreign upstarts, based in more efficient, unregulated or lightly regulated markets, have become too powerful for the western bureaucrats to deter. The same free-market dynamics that benefited Germany and Hong Kong in the post-war years are today exploited by a whole host of countries, notably led by China, Russia, and now India.

This is the underlying reason the west faces economic failure, while the newly-industrialised nations are so dynamic. The old world is sinking into a quicksand of bureaucratic, anti-competitive regulation, while the new order is based on the firmer ground of free markets.

Future historians recounting the relative decline of the EU, America and Japan will have some easy copy, assuming they make the connection between economic success and lack of regulation, so plainly demonstrated by Ludwig Erhard and John Cowperthwaite.

iEdwin Hartrich: The Fourth and Richest Reich.
iiibid. Both quotes recounted in The Concise Encyclopaedia of Economics: The German Economic Miracle, article by David Henderson.


The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

Market Report: Interest rate scare

Fri, 05/20/2016 - 09:02

Gold and silver had a down week, correcting some of their overbought condition.

Gold fell from Monday’s peak of $1288 to a low point yesterday (Thursday) of $1245, and silver from $17.40 to $16.35. Both metals rallied into Thursday’s close, and in early European trade this morning (Friday) gold was $1254 and silver $16.51.

Having been massively overbought in the futures market, it is hardly surprising that a correction of some sort has occurred. The correction was given added impetus when the Fed’s FOMC minutes were released, which caught complacent markets on the hop. It was generally expected that there would be no rise in interest rates following the June meeting, but these minutes were more hawkish. So much so, that unless there is a definite turn for the worse in the economy, it appears that the Fed funds rate will be raised in June, by one quarter of one per cent.

The result was US Treasury yields rose, and equities fell, with the S&P 500 Index sliding below the 2,040 level, breaching this technically important level. China didn’t help, because she devalued the yuan’s official fix the following day, a move that is best described as a forced revaluation of the US dollar, reminding investors of the time the PBOC did this last August. That move led to a nasty fall in global equity markets.

It therefore appears that the Fed is being controlled to a degree by the PBOC’s foreign exchange interventions. China is trying to manage a deflating credit bubble, and appears to have taken the view that she would rather have interest rate and currency stability while this happens. This is because she wants capital to be reallocated from legacy export industries to businesses dedicated to the Chinese consumer. Presumably, she does not want to see a weaker currency lending support to those legacy sectors. A possible threat to her plan is rising US interest rates at this critical juncture.

But there is another larger problem that appears to have been glossed over in the FOMC minutes, and that is price inflation expectations as measured by the CPI. The input from commodity prices has dramatically reversed in recent months, and it can be expected to drive the CPI higher more rapidly than consensus forecasts expect. This may be because US economic data and business surveys indicate a softening economy, so analysts do not generally believe the recent recovery in commodity prices will continue. If they do continue their recovery, it will be because of a fall in the purchasing power of the dollar, rather than an increase in manufacturing demand. This is a tough call for analysts who naturally understand price changes that emanate from commodities, and fail to identify changes that come from the currency.

If the purchasing power of the dollar is being called into question, then commodity and precious metal prices will benefit, after the short-term shock of a change in the interest outlook has been absorbed. Another way of gaining perspective is to look at a chart of the gold price, and this is the next chart.



Returning to our opening theme, it becomes obvious that after a run up of $250 from the December lows, some price consolidation would be natural. The consolidation so far has only been relatively minor, testing the 55-day moving average currently at $1250, with real support coming in at the $1200 level.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

Dealing Desk: Hawkish Tone Shakes Market

Thu, 05/19/2016 - 09:12
This week, clients have been net buying in silver and palladium, whilst net selling gold and platinum.

Clients have been speculating the market and have been taking advantage of the price reduction as silver dipped below the psychological level of $17.00/oz

GoldMoney’s clients have favoured the Singapore, Canadian, and London vaults this week with less preference being shown for the Swiss vaults.

Kelly-Ann Kearsey, Dealing Manager at GoldMoney, said that all eyes were on the release of the US Federal Reserve minutes from the April meeting. Gold dropped more than 1% on Wednesday after the release, hitting a spot session low of $1,262.45/oz whilst the US dollar reached a three-week high.

Markets had already priced in the expectations of an interest rate hike this year but the minutes provided a hawkish tone toward raising rates. This implied that the rate hike could be as soon as June, providing that economic data points to a stronger second-quarter growth compared to the 0.5% growth recorded for the first quarter.

On Tuesday, the US Housing starts data and industrial production data was released, which had been strong, potentially giving added support to the early rate hike, as stated by the FOMC.

Platinum prices have remained steady at around $1,000/oz. There is a possible expectation of stronger demand for platinum as it is used in catalytic converters. Due to the recent tighter environment controls, Europe will be applying Euro 6 emissions standards to all new diesel cars.

19/05/16 16:00. Gold lost 1.8% to $1,249.36, Silver declined 5.2% to $16.40, Platinum decreased 4.9% to $1,008.55 and Palladium reduced 6.8% to $561.45 Gold/Silver ratio: 72

Notes to editor
For more information, and to arrange interviews, please contact Emily Cornelius, Communications & PR Tel: + 1 647 499 6748 or email: Emily.Cornelius@GoldMoney.com

GoldMoney
GoldMoney is one of the world’s leading providers of physical gold, silver, platinum and palladium for private and corporate customers, allowing users to buy precious metals online. The easy to use website makes investing in gold and other precious metals accessible 24/7.

Through GoldMoney’s non-bank vault operators, physical precious metals can be stored worldwide, outside of the banking system in the UK, Switzerland, Hong Kong, Singapore and Canada. GoldMoney partners with Brink’s, Loomis International (formerly Via Mat), Malca-Amit, G4S and Rhenus Logistics. Storage fees are highly competitive and there is also the option of having metal delivered.

GoldMoney currently has over 20,000 customers worldwide and holds over $1billion of precious metals in its partner vaults.

GoldMoney is regulated by the Jersey Financial Services Commission and complies with Jersey's anti-money laundering laws and regulations. GoldMoney has established industry-leading governance policies and procedures to protect customers' assets with independent audit reporting every 3 months by two leading audit firms.
Further information:

Visit: Goldmoney.com or view our video online

 

The Eurozone is the greatest danger

Thu, 05/19/2016 - 05:30
World-wide, markets are horribly distorted, which spells danger not only to investors, but to businesses and their employees as well, because it is impossible to allocate capital efficiently in this financial environment.

With markets everywhere disrupted by interventions from central banks, governments, and their sovereign wealth funds, economic progress is being badly hampered, and therefore so is the ability of anyone to earn the profits required to pay down the highs levels of debt we see today. Money that is invested in bonds and deposited in banks may already be on the way to money-heaven, without complacent investors and depositors realising it.

It should become clear in the coming weeks that price inflation in the dollar, and therefore the currencies that align with it, will exceed the Fed’s 2% target by a significant amount by the end of this year. This is because falling commodity prices last year, which subdued price inflation to under one per cent, will be replaced by rising commodity prices this year. That being the case, CPI inflation should pick up significantly in the coming months, already reflected in the most recent estimate of core price inflation in the US, which exceeded two per cent. Therefore, interest rates should rise far more than the small amount the market has already factored into current price levels.

Most analysts ignore the danger, because they are not convinced that there is the underlying demand to sustain higher commodity prices. But in their analysis, they miss the point. It is not commodity prices rising, so much as the purchasing power of the dollar falling. The likelihood of stagflationary conditions is becoming more obvious by the day, resulting in higher interest rates at a time of subdued economic activity.

A trend of rising interest rates, which will have to be considerably more aggressive than anything currently discounted in the markets, is bound to undermine asset values, starting with government bonds. Rising bond yields lead to falling equity markets as well, which together will reduce the banks’ willingness to lend. In this new stagnant environment, the most overvalued markets today will be the ones to suffer the greatest falls.

Therefore, prices of financial assets everywhere can be expected to weaken in the coming months to reflect this new reality. However, the Eurozone is likely to be the greatest victim of a change in interest rate direction. The litany of potential problems for the Eurozone makes Chidiock Titchborne’s Elegy, written on the eve of his execution, sound comparatively upbeat. Negative yields on government debt will have to be quickly reversed if the euro itself is to be prevented from sliding sharply lower against the dollar. Bankrupt Eurozone governments are surviving only because of the ECB’s money-printing, which will have to restricted, and government borrowing exposed to the mercy of global markets. Key Eurozone banks are undercapitalised compared with the risks they face from higher interest rates, so they will do well to survive without failing. There is also a growing undercurrent of political unrest throughout Europe, fuelled by persistent austerity and not helped by the refugee problem. Lastly, if the British electorate votes for Brexit, it will almost certainly be Chidiock’s grisly end for the European project.

We know the powers-that-be are very worried, because the IMF warned Germany to back off from forcing yet more austerity on Greece, which is due to make some €11bn in debt repayments in the coming months. The only way Greece can pay is for Greece’s creditors to extend the money as part of a “restructuring”, which then goes directly to the Troika, for back-distribution. It will be extend-and-pretend, yet again, with Greece seeing none of the money. Greece will be forced to promise some more spending cuts, and pay some more interest, so the fiction of Greek solvency can be kept alive for just a little longer.

One cannot be sure, but the IMF’s overriding concern may be the negative effect Germany’s tough line might have on the British electorate, ahead of the referendum on 23rd of June. That is the one outlier everyone seems to be frightened about, with President Obama, NATO chiefs, the IMF itself, and even the supposedly neutral Bank of England, promising dire consequences if the Brits are uncooperative enough to vote Leave.

All this places Germany under considerable pressure. After all, her banks, acting on behalf of the government and Germany’s populace, have parted with the money and cannot afford to write it off. Greece is bad enough, but Germany must be even more worried about the effect that a Greek compromise will set for Italy, which is a far larger problem.

Officially, the Italian government’s debt-to-GDP ratio stands at 130%, and since the public sector is 50% of GDP, government debt is 260% of the Italian tax base. It is also the nature of these things that these official numbers probably understate the true position.

If the Eurozone is the greatest risk to global financial and systemic stability, Italy looks like being the trigger at its core. The virtuous circle of Italian banks, pension funds and insurance companies, funding ever-increasing quantities of debt for the government, is failing. Pension funds and insurers cannot match their liabilities at current interest rates, and importantly, the banks are under water with non-performing loans to the tune of €360bn, about 18% of all their lending. It also represents 19.4% of GDP, or because the NPLs are all in the private sector, it is 39% of private sector GDP.

Within the private sector, NPLs are more prevalent in firms than in households. And that is the underlying problem: not only are the banks undercapitalised, but Italian industry is in dire straits as well. The Banca D’Italia’s Financial Stability Report puts a brave gloss on these figures, telling us that the firms’ financial situation is improving, when an objective independent analysis would probably be much more cautious.1

All financial prices in the Eurozone are badly skewed, most obviously by the ECB, which will be increasing its monthly bond purchases from next month to as much as €80bn. So far, the price inflation environment has been benign, doubtless encouraging the ECB to think the inflationary consequences of monetary policy are nothing to worry about. But from the beginning of this year, things have been changing.

Because the recent pick-up in commodity prices will begin to show in the dollar’s inflation statistics, markets will begin to smell the end of negative euro rates, in which case Eurozone bond yields seem sure to rise steeply. Given their extreme overvaluations, price volatility should be considerably greater than that of the US Treasury market. Imagine, if instead of yielding 1.5%, Italian ten-year bond yields more accurately reflected Italy’s finances, by moving to the 7-10% band.

This would result in write-downs of between 40% and 50% on these bonds. The effect on Eurozone bank balance sheets would be obvious, with many banks in the PIGS2 needing to be rescued. Less obvious perhaps would be the effect on the ECB’s own balance sheet, requiring it to be recapitalised by its shareholders. This can be easily engineered, but the political ramifications would be a complication at the worst possible moment, bearing in mind all EU non-Eurozone central banks, such as the Bank of England, are also shareholders and would be part of the whip-round.

Assuming it survives the embarrassment of its own rescue, the ECB will eventually face a policy choice. It can continue to buy up all loose sovereign and corporate debt to stop yields rising, in which case the ECB will be signalling it has chosen to save the banks and member governments’ finances in preference to the currency. Alternatively, it can try to save the currency by raising interest rates, giving a new and darker meaning to Mario Draghi’s “whatever it takes”. In this case insolvent banks, businesses and the PIGS governments could go to the wall. The choice is somewhat black or white, because any compromise risks both a systemic failure and a collapse in the euro. And there is no guarantee that if the banks fail, the euro will survive anyway.

The ECB is likely to opt for supporting the banks and over-indebted governments, partly because that is the mandate it has set for itself, and partly because experience after the Lehman crisis showed it could expand money supply without destabilising price inflation. The danger, once it dawns on growing numbers of investors and bank depositors, is stagflation. In other words, rising goods prices, falling asset prices, and interest rates not being allowed to rise enough to break the cycle, all combining to further undermine the euro’s purchasing power.

Financial and economic prospects for the Eurozone have many similarities to the 1972-75 period in the UK, which this writer remembers vividly. Equity markets lost 70% between May 1972 and December 1974, cost of funding was reflected in a 15-year maturity UK Treasury bond with a 15.25% coupon, and monthly price inflation peaked at 27%. There was a banking crisis, with a number of property-lending banks failing, and sterling went through a bad time. The atmosphere became so gloomy, that there was even talk of insurrection.3

This time, the prospects facing the Eurozone potentially could be worse. The obvious difference is the far higher levels of debt, which will never allow the ECB to run interest rates up sufficiently to kill price inflation. More likely, positive rates of only one or two per cent would be enough to destabilise the Eurozone’s financial system.

Let us hope that these dangers are exaggerated, and the final outcome will not be systemically destabilising, not just for Europe, but globally as well. A wise man, faced with the unknown, believes nothing, expects the worst, and takes precautions.

1Banca D’Italia Financial Stability Report, Number 2, November 2015, Chapter 2.2
2Portugal, Italy, Greece and Spain.
3See General Walter Walker’s obituary for an entertaining read on this subject.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

The non-linearity of inflation psychology and the present danger of stagflation

Wed, 05/18/2016 - 14:01
The non-linearity of inflation psychology and the present danger of stagflation

Introduction

Ever since the 2008-09 global financial crisis there has been a lively debate between those anticipating a prolonged deflation and those predicting a transition to inflation. In certain respects, both sides of the debate have been correct, if sometimes confusing monetary, credit and price inflation. Recent data indicate, however, that the terms of debate are now shifting decisively in favor of those expecting price inflation or, more precisely, stagflation. Not only is US core CPI trending higher; the dollar uptrend has given way to a downtrend, implying the end of low headline CPI. The result could be CPI above 4% by 2017. The psychological effect of 4%+ CPI, combined with timid action by the Federal Reserve on rates, could represent a ‘tipping-point’ in public inflation expectations. Once this occurs, there is a risk that economic behavior changes in unpredictable ways that can damage real potential economic growth. Investors should prepare accordingly.

View the entire Research Piece as a PDF here...

The concept of a ‘tipping-point’ can apply to a wide range of phenomena.

One classic example is that of a crowded theatre slowly filling with smoke. At first, perhaps only one person notices the smoke and, comforted by the fact that others remain calm, remains seated, if slightly on edge. But then a handful of others also notice and become concerned. Finally, at some point, these folks stop watching the show and instead start watching each other. As the growing concern across the theatre becomes evident, someone finally makes for the exit, triggering a rush by others. Yet many of those rushing out might not have noticed any smoke. The critical point is reached not because more people notice the smoke; rather, more notice changes in others’ behavior and thus change their own.

The danger of inflation for economies and financial markets can also be understood in this way. As prices begin to creep higher, a few investors, businesses and households begin to notice. Rather than just going about their business as usual, they begin to watch the behavior of others more closely. Finally, a handful of economic agents suddenly change their behavior in a significant and highly visible way, triggering similar responses by others, who might not even have noticed that prices were rising.

What sorts of behavioral changes might those be? Perhaps investors begin to favor assets which protect against inflation. Perhaps businesses take out loans in order to finance stockpiles of inventories, in anticipation of higher prices. Perhaps consumers begin to do the same with durable household goods. By these very actions, investors, businesses and consumers all begin to reinforce a vicious inflationary circle, limiting the available market supply of broad ranges of goods and thereby driving up prices. Regardless, once the inflation tipping-point is reached, the rush to the exit–to protect against rising prices in some way–is damaging to economic efficiency, especially within the highly specialized global economy of today, implying the onset of stagflation. The consequences for potential economic growth and real (after inflation) corporate profits are strongly negative, with clear implications for financial assets.

Cast your eyes around the globe and it is clear that, in a growing number of countries, tipping points have already been reached. Indeed, stagflationary economic conditions already obtain across much of the developing world. The inflationary aspect in developing economies relates to local currency weakness. But with the dollar no longer strengthening and US core inflation having already re-established a rising trend in 2015, the stagflation is migrating from abroad to whence it in fact originated: The highly expansionary monetary policy of the US Federal Reserve, provider of much of the world’s de facto monetary base, namely US dollar reserve balances. Extrapolating these trend reversals could well carry US headline CPI to above 4% y/y by 2017.

The reality of rising consumer price inflation in the US and around much of the world shifts the terms of debate between those expecting a prolonged debt deflation and those anticipating a transition to stagflation. To understand why, let’s briefly explore the background of the inflation vs deflation debate and then return to recent developments.

First, it's important to define inflation. In classical economics and into the early 20th century, inflation and deflation were defined as changes in central bank base money. This need not have any direct relationship with the general price level. It is the creation of commercial bank credit that expands the broad money in circulation, hence monetary inflation or deflation can also be caused by commercial banks. In fact, most money today is created by commercial rather than central banks. The term inflation, however, is now mostly used to describe changes in the price level rather than money and/or credit. Hence, we need to understand clearly the difference between monetary inflation/deflation, credit (or asset) inflation/deflation and, finally, commodity or consumer price inflation/deflation.

Credit (or asset) inflation/deflation is difficult to define precisely because there are so many different forms of credit, ranging from fractionally-reserved bank time deposits–a form of broad money–to loans, leases or other forms of secured or unsecured debt. This is made all the more complicated because banks don’t normally mark their assets to market and the so-called ‘shadow banking system’ largely relies on derivatives of various kinds for financing. Indeed, near the end of the financial crisis, regulators gave banks additional flexibility to mark assets to ‘make-believe’ rather than actual market prices. Whereas the price of a dollar is a dollar, that of a loan, a bond or other risky asset is uncertain and fluctuates with investor confidence that the issuer of the asset will be able to make the contracted interest and principal payments.1

One way to approximate growth in credit (or asset) inflation/deflation, other than to follow broad money aggregates, is simply to look at the growth in bank lending, marked as is, be it to market or make-believe. One reason why we can simplify in this way is because policy-makers in major economies have made it crystal-clear that, to the extent that financial institutions are at risk of insolvency, they will be bailed out in some fashion, such that the market price of distressed assets will never be properly marked-to-market but, rather, suddenly or gradually monetized over time. As such, it is not a great leap to assume that the growth (or shrinkage) in bank lending in general is reasonably indicative of whether credit inflation (or deflation) is taking place.2

Finally, there is commodity or consumer price inflation/deflation, normally measured by official price indices. But such indices are at best approximations and, at worst, are designed in ways which understate real world price inflation through so-called hedonic adjustments, substitution effects or by underweighting or excluding entirely volatile components such as food and energy.3

Turning now to the debate, the arguments of the deflationists have generally focused on the credit (or asset) definition of deflation. As long as credit is contracting, so the thinking goes, it matters not whether the central bank is growing the narrow money supply. Banks will simply sit on so-called ‘excess’ reserves indefinitely as the credit contraction runs its course. Therefore, central bank money creation merely stabilizes the financial system; it does not transmit into fresh credit creation or real economic activity and, therefore, does not necessarily contribute directly to commodity or consumer price inflation down the road. Certainly this seems an accurate description of what happened in 2008 and 2009. Credit markets collapsed; banks stopped lending; the Federal Reserve and other central banks created huge amounts of narrow money; yet while financial systems stabilized in the end, this narrow money did not flow into fresh credit creation, economic activity or consumer prices.

The inflationists, it would seem, were wrong, at least for a while. But to be fair, many of the inflationists focused primarily on monetary inflation, which has indeed been substantial, as pointed out above. In some cases the inflationists did predict a rapid or even simultaneous transmission from money creation into credit creation and along to commodity and consumer price inflation. Events since 2008-09 have shown this view to be false. But economic history generally as well as contemporary developments demonstrate that there is not a stable relationship over time between monetary inflation, credit inflation and commodity or consumer price inflation.

Mainstream, neo-Keynesian economics tends to place little value on monetary analysis for exactly this reason, that the link between money growth and consumer price inflation is impossible to model with reasonable accuracy and, as such, cannot usefully inform central bank monetary policy decision-making, focused as it supposedly is on maintaining a stable level of consumer prices.4 But just because something is difficult to model does not mean that it does not exist. After all, it is impossible to model precisely the ‘tipping point’ behavior of people in a crowded theatre as smoke accumulates or, alternatively, that of investors, businesses and households amidst growing evidence of rising prices. But would anyone deny that these phenomena are real and that they can pose large if unpredictable risks?

Thinking along these lines, I believe there is now ample evidence that, over the course of 2015-16, there was a transition from consumer price disinflation to inflation coinciding with the peak in dollar currency strength. As such, there is a growing risk of reaching a tipping point beyond which rising inflation expectations will fundamentally alter economic calculation and action from the largest global businesses down to the smallest households, with stagflationary economic consequences.

The evidence is thus that the entire monetary transmission mechanism, from narrow to broad money; from broad money to credit and asset growth; from credit and asset growth to commodity and consumer price inflation; is indeed functioning in a narrow sense, even if it has failed to restore sustainable economic growth. It has just taken much longer to play out than the inflationists had generally expected, at least in the US.

In this context, it is perhaps curious why the Fed remains so timid when it comes to raising interest rates. The official current Fed position is twofold: First, inflation–at least based on how they prefer to measure it–is still quite low; second, the economy appears to be cooling. Thus the Fed will most probably only raise rates slowly, if at all, over the coming months.

In my view, the real reason why the Fed continues to stoke the inflationary fire with near-zero rates has more to do with the still-perilous state of the US financial system and the massive debt overhang which, naturally, needs to be serviced. It is much easier to service a debt which is depreciating in real terms, even if it is growing in nominal terms. The Fed may claim to be aiming for just slightly higher inflation but it is possible that they are, in fact, seeking a significantly higher rate to help service the huge accumulated public and private debt burden. Only when this task is more or less complete, the Fed may raise rates sharply and perhaps even publicly admit that they made a (convenient, wink wink) ‘mistake’.

With informed observers of all kinds–investors, businesses and consumers–now beginning to smell the inflationary smoke of rising consumer price inflation, the Fed’s continuing, unwavering commitment to create inflation could at any moment lead to dramatic changes in behavior. Indeed, once the tipping point is reached, the Fed will have lost the ability to control inflation without raising interest rates to punishing levels that will cause a major recession and possibly a financial crisis greater than that which struck in 2008. Why?

Consider how rational economic agents are likely to respond to the onset of clear and present inflation. Prices are already rising and the Fed has not shown a willingness to reconsider its expansionary monetary policy. Investors, therefore, will keep right on chasing returns in asset markets, seeking to remain ahead of the inflation curve. Businesses will stockpile inventories of real assets in an attempt to do the same. Finally, households may begin to stockpile consumer goods. What will be the combined result of these activities? Well, by driving up demand for all manner of assets, and wholesale and consumer goods, they are going to exponentially reinforce the price inflation already underway. But as this sort of demand is not for consumption, but rather for stockpiling (or hoarding), it is not positive for growth but rather quite the opposite; it is, rather, economically inefficient and stagflationary. Real final consumption is not going to increase. Indeed, as prices rise, it is going to fall. (Amidst weak economic growth real wages are also likely to fall.)

The Fed, already deep into a dilemma largely of its own making, is about to find itself facing an even more unpalatable choice before long: Accommodate the surge in demand for real goods with a continuing easy money policy or, alternatively, slam on the brakes sufficiently to force an end to the incipient behavioral changes behind the growing stagflation, thereby running the risk of causing another financial crisis perhaps more severe than that of 2008-09.

So what is the Fed going to do? Take responsibility? Well that would be rather out of character given that the Fed so far has steadfastly denied any blame whatsoever for the massive credit bubble that it facilitated with a prolonged period of excessively easy monetary conditions in 2003-07. More likely, the Fed will simply hope that somehow inflation will rise moderately to a level which helps to reduce the real debt burden on the economy and then normalize policy. But if an inflation tipping point is soon reached and consumer price inflation ratchets sharply higher, no doubt the Fed will deny that such inflation is in any way a monetary phenomenon, notwithstanding the analysis above and Milton Friedman’s famous dictum to the contrary.

The Fed’s denials will by no means stop there. They will also deny that this inflation is harmful, using a range of arguments such as “Price increases are indicative of firming economic activity,” or “Recent spikes in volatile food and energy prices are isolated to those markets and not indicative of rising core inflationary pressures.” No doubt the Fed will take comfort that real wages are likely to remain stagnant or even decline amidst weak economic growth. But for people who work for a living, the combination of rising food and energy prices on the one hand and stable or declining real wages on the other will not be cause for comfort, rather the opposite.

It is easily forgotten that the global economy grew extremely rapidly in 2006 and 2007, thus entering 2008 on the verge of overheating. It is easy to attribute the sharp slowdown in economic activity in 2008 and early 2009 to the US-centric global credit crisis but history demonstrates that sharply rising commodity prices–a classic indicator of economic overheating–have preceded all major modern recessions, including those of 1973-74, 1980-82, 1991-93 and of course 2008-09. It may thus be too early for to expect a full–bore ‘stagflation’ in the US; rather, a greater degree of dollar weakness may first be required. Given recent developments, this should give investors cause for concern. As evidence piles up that one major global economy after another is slowing down, the prospect of a global recession arises. Indeed, the US equity market has long appeared an outlier in a global trend toward lower equity market valuations. Is the US equity market perhaps the last stagflation shoe to eventually drop?

Sadly, defensive investors have few options. Fleeing into bonds, when some 1/3 of the developed world bond market offers negative yields, is hardly an attractive option for preserving wealth in a rising inflation environment. The fact is, in a world of negative rates, rising price inflation and possible fiat currency devaluations or bank bail-ins, gold provides an alternative, superior store of value. While many investors consider gold and silver ideal in this regard, other commodity prices may now have bottomed and could provide additional diversification benefits. The problem with most commodities, however, is the storage costs and/or the negative carry associated with positively-sloped (contango) commodity price curves, as generally observed at present. Gold, by contrast, has storage costs that, even for highly secure storage, are close to zero.

Thinking farther ahead, I remain confident that, in the event of a general global economic slowdown, policymakers in heavily-indebted developed economies will continue to follow generally inflationary policies in order to support growth, notwithstanding the evidence, both historical and contemporary, that such policies are at best ineffective and, at worst, counterproductive. Indeed, I lean towards the latter view. Yes, a correction in equity markets may be coming in time but if sufficiently large, so is another round of fresh stimulus. Just where it is going to go, and how long it will take to get there, is anyone’s guess. But we know from where such ‘money’ is ultimately being covertly taken: The earnings and savings of working people the world over. While it is the responsibility of investors to grow wealth when conditions are favorable–and at least protect it when not–we should all remember that inflation is not merely a monetary phenomenon but, much more importantly, an immoral one.

View the entire Research Piece as a PDF here...

1.There are even times when it is difficult to value on a bank deposit. If a bank is at risk of failure, then deposits are at risk. Even insured deposits can be difficult to value. How long until the insurance is paid out? Will interest be paid in the interim? At what rate? If an entire banking system fails, will the government really be able cover all insured deposits? If not, will the government devalue the currency? If so, by how much? Back in Q4 2008, investors were beginning to ask these sorts of questions.
2.Those familiar with the details of the credit bubble and bust of recent years are well aware that much of the bubble was not visible in traditional bank lending or balance sheet statistics but, rather, was growing within the so-called ‘shadow banking system’. Nevertheless, I believe that banking lending data are at least indicative of the direction of credit growth, if not the actual rate. More detailed analyses than that presented here are certainly possible but are unnecessary to the basic point.
3.Hedonic adjustments are intended to incorporate the impact of productivity improvements in goods. For example, if the price of a computer is unchanged over the year but the newest version is twice as fast, a hedonic adjustment would calculate that the price of the computer had in fact declined by 50%. While this sounds nice in theory, in practice it can be messy, misleading and hugely biased. For example, just because a computer is twice as powerful, does that really mean that it is twice as useful? Who is going to make that judgement? Is a car that is twice as fast twice as useful? Also, hedonic adjustments are never made in reverse. Think about rail fares for example. If rail fares are unchanged over the year but overcrowding, delays and cancellations increase by 50%, do hedonics measure this negative productivity as an increase in prices? No, they don’t. In all applications of hedonic adjustments it is always assumed that there can be only positive, not negative changes in productivity, hence the obvious and potentially large bias.
4.While most central banks claim to pursue a policy of maintaining consumer price stability, there is substantial evidence that, in fact, this is not the key policy objective. The most obvious piece of evidence is the nearly universal poor track record of most central banks in meeting their price stability mandates. For a more thorough discussion of central banks’ policy objectives, please see the Amphora Report, A Century of Money Mischief, Vol 1/14, December 2010.

 

The views and opinions expressed in this article are those of the author(s) and do not reflect those of GoldMoney, unless expressly stated. The article is for general information purposes only and does not constitute either GoldMoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, GoldMoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. GoldMoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.

 

 

Dealing Desk: May you hold the cup?

Fri, 05/13/2016 - 07:42
This week, clients have been net buying gold whilst net selling silver, platinum, and palladium.

GoldMoney’s clients have favoured Hong Kong and Singapore vaults this week with less preference being shown for the London and Swiss vaults. This is fairly typical with gold as, when the price retreats, our Asian-based clients tend to take advantage of a price discount to accumulate more metal.

Geoffroy Buffetrille, Dealing Manager at GoldMoney also added that, while GoldMan Sachs has closed its "Short Gold" Recommendation with 4.5% Loss, JP Morgan sees 1,400 USD as a new target. Macroeconomics clearly favour gold at the moment; on one hand, central banks are stuck with low growth and de facto cannot increase their interest rates and, on the other hand, if growth was to kick in, it would lift the demand on commodities.

With regard to the gold price action, another "cup and handle" has been drawn when looking at the daily chart, which is considered as a bullish pattern by chartist. But the second pattern has a smaller size, indicating that the push has slightly less steam.

Platinum Prices also hit a 10-month high when it reached over $1,080/oz during on Tuesday 3 May, a price which has not been seen since July 2015.

12/05/16 16:00. Gold lost -0.3% to $1,272.4, Silver slightly lower -0.3% to $17.3, Platinum just increased 0.1% to $1,060.1 and Palladium gained 0.6% to $602.2 Gold/Silver ratio: 73.54

NOTES TO EDITOR
For more information, and to arrange interviews, please contact Emily Cornelius, Communications & PR Tel: + 1 647 499 6748 or email: Emily.Cornelius@GoldMoney.com

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GoldMoney® Roundtable History of Banking & Gold Bullion As Currency | Part 2

Fri, 05/13/2016 - 05:23
In Part 2 of the GoldMoney® roundtable recorded in Toronto, our panel discusses the history of other items of value—such as salt—and how they fare compared to gold over time. The history and evolution of the banking system is also explored in depth in this lively chat. Participating in the discussion, from left to right: Alasdair Macleod, Roy Sebag, James Turk, Josh Crumb, and Stefan Wieler.

Click here to view GoldMoney® Roundtable History & Importance of Gold | Part 1

 

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not co

Market Report: Q1 gold demand 1,290 tonnes - WGC

Fri, 05/13/2016 - 04:28

Yesterday, the World Gold Council released its estimate of gold demand for the first quarter of 2016, which compared with supply estimated at 1,081 tonnes.

While the WGC collects its figures assiduously, the demand figures are only those that are known from trade associations, central banks, and ETFs. Drilling down into the figures, according to the WGC, Chinese demand for the quarter totalled 241.3 tonnes, whereas according to the Shanghai Gold Exchange, it delivered 516 tonnes to the public from its vaults. The substantial difference cannot be satisfactorily identified as far as the WGC is concerned, but this illustrates the difficulties in tracking down accurate figures.

One category that is easy to identify is ETF demand for physical metal, and this increased to 364 tonnes, the highest net inflow since 2009. There can be little doubt this is down to two factors: the improved technical position with the establishment of a new bull phase, and negative interest rates in both the euro and the yen. But while this has spurred demand for securitised gold, there is no such increase recorded in demand for bars and coin. That cannot be right. Physical demand must be considerably higher than the WGC figures reflect.

On futures markets the gold price fell on Monday from last Friday’s close of $1287, hitting a low point of $1257 on Tuesday. A rally took the price back up to $1280 at one stage yesterday, before slipping back to $1263 last night. However, in early trade this morning gold and silver opened higher at $1274 and $17.09 respectively in early European trade.

Gold had become very overbought, with the Managed Money category noticeably long, as the next chart shows.



Net contracts stood at a positive 218,895 contracts, within 10,000 contracts of the all-time high. Meanwhile, Open Interest is also very high at 585,890 contracts, and the swaps (mostly second-line bullion banks) are record short at -124,993. The correlation of the swaps net position with the gold price has been almost perfect for the last two years. This is shown in our next chart.



At some point this correlation must cease. Either the swaps will be forced to turn net buyers, or they will conquer the speculators (mainly hedge funds). If it was as simple as that the hedge funds will be wiped out. But hedge funds usually see gold as one side of a trade, with the risk exposure to the gold price partly or wholly hedged. That is why they are called hedge funds.

The involvement of hedge funds is therefore part of a bigger macro picture, linking trades to wider risk-on/risk-off positioning. There is little doubt that the hedge fund community is betting on greater risk in the future, with notable fund managers short of bonds and equities. It is reminiscent of the film, The Big Short, where some big bets were placed against asset-backed securities and collateralised debt obligations. It has become an argument of right or wrong, rather than overbought/oversold.

Meanwhile, in Europe the volcano that is the Italian banking crisis is in danger of erupting, which could play into the risk-on crowd.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

 

The Endgame

Thu, 05/12/2016 - 11:14
And how we got here

There is a growing fear in financial and monetary circles that there is something deeply wrong with the global economy. Publicly, officials and practitioners alike have become confused by policy failures, and privately, occasionally even downright pessimistic, at a loss to see a statist solution. It is hardly exaggerating to say there is a growing feeling of impending doom.

The reason this has happened is that today’s macro-economists are a failure on the one subject about which they profess to be experts: economics. Their policy recommendations have become the opposite from what logic and sound economic theory shows is the true path to economic progress. Progress is not even on their list of objectives, which fortunately for us all happens despite their interventions. The adaptability of humans in their actions has allowed progress to continue, despite all attempts to discredit markets, the clearing centres for the division of labour.

Ill-founded beliefs in the magic of unsound money have been shattered on the altar of experience. Macro-economists are discovering that the failure of monetary and fiscal planning are becoming a policy cul-de-sac that has generated a legacy of unsustainable debt. Those of us aware of a gathering financial crisis are discovering that governments have tamed only the statistics and not what they represent.

There is evidence that central bank intervention began to irrevocably distort markets from 1981, when Paul Volker raised interest rates to halt the slide in the dollar’s purchasing power. It was at that point the free market relationship between the price level and the cost of borrowing changed, evidenced by the failure of Gibson’s paradox. That was the point when central banks wrested control of prices from the market. This is explained more fully below.

The errors have been multiple. In this article I explain how and why they have arisen. This knowledge is the necessary background for an understanding of how the financial and economic crisis that increasing numbers of us expect, is likely to develop, and what action we must take as individuals to protect ourselves.

Markets versus governments
The starting point for today’s errors is the belief that markets sometimes fail, and that monetary and/or fiscal policies can steer markets towards a better outcome. The modern incarnation of this myth started with JM Keynes, who by the mid-thirties believed he had enough cause to overturn Say’s law, or the law of the markets. So the roots of today’s crisis go deep, and originate long before Volcker’s interest rate hike in 1981.

Say’s law states that we produce to consume. Therefore, production is bound tightly to consumption, including deferred consumption, otherwise known as savings. And if someone consumes without producing, someone else has to produce the wherewithal. The medium of exchange that translates wages and profits arising from production into consumption is money, so we can say without contradiction that money represents the temporary storage of the profit from production, or ordinary people’s labour. It is an iron law, which invites trouble for any attempt to stimulate consumption.

There can be no net stimulation into the private sector economy by the state, because everything has to be paid for, one way or another. For simplicity, we will disregard cross-border government subsidies, such as foreign aid. When a government pays benefits to a group of individuals, it either borrows the money from someone else, or alternatively it creates the money out of thin air. In the latter case, the benefit payments are covered by the debasement of the existing money stock, which is a hidden tax on everyone else’s money. To argue otherwise, as do those who deny Say’s law, is a fallacy that relies on a concept of financial perpetual motion.

Keynes’s motivation was partly driven by his belief in the honest intentions of democratic government, and as we can glean from his writings, his emotional dislike of savers, the usurious rentiers who rake in interest without soiling their hands through honest work. In his General Theory, the first major work after Keynes was confident he had dispatched Say’s law to oblivion, he expressed his hope for the gradual euthanasia of the rentier, and that capital would be increased by communal saving through the agency of the State, so that it would no longer be scarce. The term, rentier, is itself a put-down in English, suggesting usurious lending. Keynes hoped that entrepreneurs, “who are certainly so fond of their craft that their labour could be obtained much cheaper than at present”, would be harnessed to the service of the community on reasonable terms of reward.

His General Theory is proof that Keynes despised markets, and did not understand prices (see Chapter 21). With his ignorance of this most fundamental element of economics and all the other half-truths that follow, the true purpose of this propaganda is revealed: the justification for state intervention and the end of free markets. It is a thoroughly bad book, yet it has become the bedrock of mainstream economics today, even for those who deny being Keynesians.

Upon this unsound basis, layer upon layer of further untruths have been built. When an economist conjures up a course of action based on these fairy-tales, the honest critic is at a loss where to start, because the thread of errors leading to the economist’s judgement has become so long and convoluted. Few are prepared to listen to a lengthy critique on this matter, so it is far easier for the layman and politician alike to assume that a scion of Oxford and Harvard must know what he is talking about.

It’s both the line of least resistance, and a cop-out. The language of modern economics takes us in so completely, we often don’t realise we ourselves perpetuate the mistakes. It is time for those who wish to understand the seriousness of these cumulative errors to draw a line, and to face up to them, because to not do so could be very expensive for those with assets to protect.

The root of the problem is in a misunderstanding of the nature of economics itself, and in the application of modern analytics.

The analytical mistake
The misuse of statistical information is a great evil, which has become increasingly prevalent over the years, taking a great leap forward in its destructive force with the development of computers. Computers are a wonderful facility, but they have come to replace soundly reasoned theory by advancing the role of inappropriate statistics, and their supposed mathematical relationships.

Mathematics is appropriate for the physical sciences, but wholly inappropriate for social sciences, such as economics. Maths has an important role in business: there is an essential role in book-keeping as a means of measuring any enterprise’s progress. But it is another thing entirely to attempt to banish the uncertainties inherent in future human action by mathematical means. A businessman who fails to distinguish between mathematics as an accounting tool and its lack of predictive value will not remain in business for long. Yet there is no limitation, seemingly, on the employment of mathematics in the less certain world of a national economy.

The mistakes, while subtle, are at least threefold.

Even if the capture of economic activity is total and correct at a past moment in time (which it never can be), it cannot be valid thereafter, because economic activity continually evolves. No economy statically churns on an unchanging basis. The information gathered by econometricians is not only incorrect thereafter, but it misleads state planners into believing they have the evidence to manage economic activity. Misused aggregates such as gross domestic product are just accounting identities, and not the measure of progress that so many believe.

Statistics are continually amended to show monetary and fiscal policies in the best possible light. Price inflation and unemployment numbers have evolved to the point where they do not reflect reality, yet because they are issued by a government department, they retain credibility. The result is the statistics have themselves been tamed, not what they represent.

Meaningless averages are routinely invoked as evidence to support state intervention and planning. Thus, the CPI’s “basket of goods”, and an “average wage” are not connected to reality and conceal the fact that economic actors are individuals with diverse needs and wants. Averages should not be used as analytical tools upon which to base monetary and fiscal policy.

It was George Canning, nearly two centuries ago, who said he could prove anything with statistics, except the truth. The attraction statistics confers for the slow-witted analyst is they avoid him having to apply original thought. It means he or she never feels the need to consider the underlying motivations of economic actors.

A good example of this error is contained in the Barsky and Summers attempt, published in The Journal of Political Economy in 1988, to explain Gibson’s paradox . Gibson’s paradox is the observed correlation between the price level and wholesale borrowing costs, and the lack of correlation between borrowing costs and the rate of inflation. The relationship came to an end in the late seventies in the UK, where it was statistically observed from 1730 onwards. Barsky & Summers incorrectly assumed it was a phenomenon of the gold standard, and then used a mathematical model of their devising to arrive at a partial conclusion, which they admitted would require further research. In other words, their method led them into a blind alley.

To be fair to Barsky and Summers, they are not the only high-flying economists who have failed to explain Gibson’s paradox. It was so named by Keynes after an earlier economist, and he also failed to resolve it. The evidence was plain and simple, but being unresolved Keynes simply dismissed it and its important implications as well. Milton Friedman also failed.

By putting myself in the shoes of an entrepreneurial businessman looking to finance his production, I found the paradox was easy to resolve and explain. The businessman’s calculation is comprised of the difference between his costs of production and the selling price for his product. What does he know of the prospective selling price? He knows what similar items sell for in the current market, and it is that that sets the level of interest he is prepared to pay to finance his production. That is why interest rates correlated with the price level, and not the rate of inflation, for the two hundred years in the original study by Alfred Gibson.

Unfortunately, this cuts across the cherished beliefs of monetary economists, who believe in the control of economic activity by managing interest rates and the expansion of the quantity of money and bank credit. For monetary policy to be valid, there must be a positive correlation between price inflation and interest rates, which Gibson’s paradox demonstrated was not true. I would also postulate that Keynes was not temperamentally inclined to understand the solution to Gibson’s paradox, because he cherished the belief that it is idle rentiers who demand usurious rates of interest and set them, not the borrower with his calculation of an investment return.

This is why it is vital to understand the motivations of economic actors, and to not hide behind the sterile world of ivory-tower mathematics. But we have become so used to statistical modelling, that even some followers of Say’s law are subverted. The confusion of accounting identities such as GDP with the indeterminate concept of economic growth is a case in point. And many are the times we read the writings of economists, who take dodgy statistics, and use them as the basis for an equation between disparate elements to create a relationship where none actually exists. You cannot say apples are pears, but you can say they are different. You can turn apples equals pears into an equation, if you introduce a factor that always represents the difference between the two. Nonsense, of course, but this is what economists routinely do.

A prime example is the fallacy of the velocity of money. The assumption is that a change in the quantity of money will change the level of prices. So, ∆m~∆p. But, it was found to the inconvenience of monetarists from David Ricardo onwards that prices p varied independently from the money quantity m, particularly in periods of less than an indeterminate long run. Therefore, the equation was modified to include another variable, dubbed the velocity of circulation to give it meaning, and it became the basis of Irving Fisher’s equation of exchange,

M*V=P*Q

where M is the total amount of money in circulation, V is its velocity of circulation, P is the price level, and Q is an index of final expenditures. Presented like this, we are drawn into believing that the concept of money going round and round the economy is a concept with meaning. It is not. It has no more meaning than the interposition of a variable to make an equation between apples and pears balance.

Not once does the monetary economist stop to think that everything an individual makes from his production, besides a necessary cash float, is consumed, either today or at some time in the future. What matters is not the size of an individual’s cash balance, but the profit from his labour. That is the Say’s law relationship, denied by the monetarist.
Ignorance in academic circles over price theory, which after all is the bedrock of economics, is staggering. It is as if Carl Menger, who convincingly proved the full subjectivity of prices back in the 1870s, never existed. This is despite the fact that for all of us the exchange of the fruits of our labour, in the form of money, for the things we individually decide we want, is our most important daily activity.

We also ignore the fact that there are two variables in any price, changes that emanate from the goods or services being exchanged, and that of money itself. We are all aware of changes that emanate from goods and services. But few of us are aware that changes can also emanate from the money side as well. There is a reason for this. The role of money, traditionally sound money, is for it to be taken for granted. It allows us to value diverse products, and to account for our own production. It acts as the objective exchange value in a transaction. However, the purchasing power of money is never a constant and continually varies, the more so when it is unsound. So, the default assumption that all price moves come from the goods and services being bought and sold, is incorrect.

In the old days of sound money, when gold was freely exchangeable for paper currency, price movement from the currency side was fairly minor, even over prolonged periods of time. But in today’s paradigm of fiat monetary debasement, the movement can be considerable. Consider a situation where personal preferences for holding currency a shift towards zero. The price of a good which does not move when measured in a stable currency b, will shift so that the price measured in currency a tends towards infinity. We recognise this phenomenon when talking about Zimbabwean dollars, or Venezuelan bolivars, but our minds refuse to admit to the same dynamics operating for the dollar and the other major currencies used by advanced westerners.

Changing values for the currency may not be noticed much day-to-day, but they do interfere with annual comparisons, because the currency’s purchasing-power last year differs from this year’s. Neither does the law recognise any variance in a fiat currency’s purchasing power, a fact which central banks exploit to the full.

Central banks print money, and they license the banks to loan credit into existence. By ignoring Say’s law, they think they can stimulate demand by cheapening and expanding credit. For a time, this trick fools people, but repeated often enough they begin to lose confidence in the currency and alter their preferences against holding it, so its purchasing power declines.

The rate at which an inflating currency’s purchasing power declines varies from product to product, depending where the increase is applied. Since the financial crisis of 2007/08, it has been obvious that prices of financial assets have seen the bulk of monetary inflation applied to them, and prices of bonds and other securities have risen accordingly. The prices of ordinary goods and services have risen considerably less, but it is arguable how much. The officially tamed CPI has consistently recorded price inflation to be well below the Fed’s target in recent years, yet independent calculations, such as the Chapwood Index, records price inflation at about 9%. We cannot take any of these averages too seriously for the reasons mentioned above, other than to observe that price rises on Main Street appear to be significantly higher than state-sponsored econometricians tell us.

The monetary link between prices and the quantity of money is tenuous at best, and takes no account of intertemporal factors, such as where monetary expansion is initially applied. There is little attempt to understand the implications of changing preferences for money relative to goods. It is easy to see why not only the evidence, but also sound economic reasoning, warns us that modern macroeconomists, in their desire to do away with the law of the markets, have led us to the brink of financial ruin. What is surprising is economies have survived this persistent meddling based on inappropriate information for so long, but that is explained by the extraordinary capacity of human action to adjust to and accommodate government intervention.

The Consequences
The endgame is now shaping up. Central banks have progressively tightened their grip on markets since Paul Volcker took control of markets by jacking up interest rates in 1981. It was at about that time Gibson’s paradox failed. The result is that debt-driven activity, encouraged by falling nominal interest rates, replaced the market-driven activity demonstrated by Gibson’s paradox over the previous 250 years.

There are limits to excessive debt, and financial analysts are about to find out that the old adage, markets always win out in the end, is still true. The dominant market risk is over-valued government bonds, from which all other financial asset valuations flow. Therefore, a large enough rise in government bond yields is likely to create a systemic crisis in the banking system, which depends on these assets for loan collateral. The most vulnerable banks are in the Eurozone, where bond markets are at their most over-priced, and the banks most highly geared.

When yields on government bonds rise above an as yet unknown level, central banks will have a decision to take. Are they prepared to support the entire financial system at the ultimate expense of their currencies, or do they preserve the currency? The choice has become that binary, and any fudging of this choice is unlikely to prolong the survival of the global financial system.

When things have become this delicate, anything from Greece’s debt negotiations, Italian banking insolvencies, trouble in the physical gold market, or even just a bad statistic somewhere can act as a trigger. Brexit would certainly undermine European cohesion with potentially destabilising results, which doubtless is why all the great and the good are imploring the British electorate to vote to remain in. So far, central banks have been deferring all these problems successfully, so it will probably take something else to trigger the endgame.

A likely culprit is the accumulating effect of monetary debasement on the finances of ordinary people. Monetary inflation transfers wealth from savers to debtors, debtors who then generally invest it inefficiently. Government spending, financed by high taxes, also destroys private wealth. Monetary inflation reduces the purchasing power of ordinary people’s wages as well, an effect which limits their ability to consume. Governments of advanced nations are simply running out of their citizens’ wealth.

The transfer of wealth through monetary inflation is the unrecorded burden borne by the ordinary person. There is little doubt that it has affected the GDP number, which so far has shown disappointing growth in the majority of advanced nations. However, it has held up sufficiently to fool mathematical economists that there is no crisis, only disappointing growth. It bears repeating that GDP is only an accounting identity, which is increased by monetary inflation. Any offset by a price inflation deflator tends to lag the statistic, and given government desires to suppress recorded inflation, is calculated inadequately. Indeed, if one accepts that price inflation is actually far higher than that indicated by official measures of price inflation, adjusted GDP estimates in real terms have been contracting in most advanced nations ever since the financial crisis.

The situation in Japan and the Eurozone is worse than in the US, and the destruction of private wealth has been more aggressive. The paradox is that temporarily, the yen and the euro are strong, but that is unlikely to last. The reason the yen and the euro are strong is that liquidity in the shadow banking system is being squeezed by central bank purchases of government bonds, leading to an increase in cash demand as positions financed in these currencies are unwound.

The legacy of monetary and credit expansion since the financial crisis has actually led to a greater overall preference for holding money relative to buying goods. This is reflected in the increase in the level of bank deposits and checking accounts, the counterpart to the expansion of bank credit. In the US alone, bank deposits and checking accounts have increased from $2.33 trillion in July 2008, just before the Lehman collapse, to $10.17 trillion today, an increase of 336%, compared with an increase in official GDP of only 22% for the whole period.

The accumulation of this money is in fickle hands, being for the most part financial. It is what used to be called hot money. Having pumped up these hot money totals, central banks have been trying to bottle them up as bank deposits, so that in aggregate, there is no escape route from zero and negative interest rates, and also in the hope that financial stability will be maintained during the implementation of further “extraordinary measures”.

This raises a question, which no one appears to have seriously considered: what happens, when bank depositors stop increasing their preference for money relative to goods or assets, and begin to reduce it instead? The only outcome can be an unexpectedly sharp increase in the prices of whatever goods and assets the money is exchanged for, because sellers of currency will by far outweigh the buyers. In the past there has always been an escape route for investors from this problem, such as exchanging Argentinian pesos for dollars. This time it is the dollar itself, with all the other major currencies tied to it.

It is already leading to a financial move into commodities and raw materials, which started last December. Some key commodities, most notably oil, have risen in price substantially as a result. Sellers of dollars so far have been foreign governments, particularly the Chinese, and speculative traders. But the conditions driving relative preferences against currencies seem set to accelerate. Core inflation in America is already above the Fed’s target, and almost certain to go higher, so unless the Fed starts to raise the Fed funds rate soon and significantly, the pace of the fall in purchasing power for the dollar will almost certainly increase. That binary choice, to save the system or the currency, is looming.

Unfortunately, both the damage earlier monetary policies inflicted on the masses’ wealth, as well as the encouragement to the accumulation of unproductive debt by both private and public sectors, have between them eliminated the central banks’ room for manoeuvre. The introduction of a trend of rising interest rates, however moderate, will undermine overvalued bond markets, in turn triggering a new wave of debt liquidation by weaker borrowers. These are financial stresses that the Eurozone banks are particularly ill equipped to survive. They are so poorly capitalised and over-exposed to outrageously expensive Eurozone government bonds, it cannot be denied they are already an alarming systemic risk, even without a rise in interest rates.

The difference between today’s impending financial crisis and the last one is that the last one drove the ordinary public away from the uncertainty of financial commitments into a preference for monetary liquidity. This time, low wage earners and small savers will probably react the same way, at least initially. But the wealthier savers and speculators now dominate the system. They have been accumulating deposits and checking account balances since 2008, and are exposed to bank counterparty risk, a point which they will quickly understand if things start sliding. Therefore, fiat currency held in the banking system is the one asset corporations, investors and the rich will most likely seek to ditch in the coming months. Their preferences will work against not only the dollar, but all other currencies as well.

In short, growing evidence of price inflation and stagnant production can be expected to materially increase the risk of a global banking and currency meltdown. The best escape-route is ownership of anything other than purely financial assets and fiat currency deposits. No wonder the price of gold, which is the soundest of moneys, appears to have entered a new bull market.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

Market Report: Gold tests $1300

Fri, 05/06/2016 - 03:55
On Monday, gold rallied to test the $1300 level, and silver $18.00.

Given the sharpness of the move up in the last week of April, it was hardly surprising that some consolidation was in order. Underlying this performance was the recent weakness of the dollar, which had a mini-bounce aided by a weaker yen, the yen having been rising strongly against the dollar this year so far.

Bearing in mind that a lower rate quoted in the foreign exchange markets means a weak dollar and strong yen, the yen has risen from 121 to the dollar to 105.6 last Tuesday since 30th January, an increase of over 10%. Therefore, a technical correction for the dollar is due, which can be expected to put some pressure on the gold price.

Gold’s stand-out feature this week was the record expansion of Open Interest on Comex, shown in the next chart.

On the six trading days from the previous Wednesday to last Wednesday, open interest jumped 70,338 contracts. This represents 7,033,800 ounces, 218.77 tonnes, or about $9bn in paper money. Over the same time-scale gold jumped from $1240 to test $1300. This tells us that paper supply of $9bn were not sufficient to absorb buying demand without a $60 rise in the price.

As markets grasp these dangers, it is likely that the gold price will rise further. Market analysts will almost certainly attribute such a move to a receding fear of interest rate rises. If so, they will miss the probability that it is the dollar weakening, rather than gold rising. At least for European traders, this will clear the way for them to buy physical gold, with negative to zero cost of carry. It’s rather like being paid by the insurance company to insure yourself against financial disaster.

Having risen $250 from $1048 last December, one would have expected sales of that quantity to drive the price back towards $1200 at least. The market is very overbought technically, mirroring the dollar’s oversold condition described above, and consequently equally vulnerable to near-term profit-taking. And indeed, the OI chart shows that the final increase in open interest appears to have taken the top off the gold price.

Yesterday, there appeared to be a few attempts by traders to drive the gold price lower, culminating in a dip to $1269 at about 18.30hrs London time, when Europe and the East were effectively out of the market. It didn’t last long, and within a few hours the price recovered to $1278. To see buyers on the dip in such a technically overbought market is unexpected. This morning in early European trade, gold opened steady.

So much for Comex. The problem with analysing demand for gold is not only having to take into account the split between paper and the real stuff, but Comex is a fraction of the market. The hidden over-the-counter market is simply enormous, and only this week, the Bank for International Settlements released the year-end numbers for 2015. OTC gold derivatives totalled $286bn, or 269,811,321 ounces, or 8,392 tonnes, or nearly forty times larger than Comex. To the BIS figure should be added a further $109bn of gold options. These figures are an increase on the previous half-year.

Given the relatively small amount of deliverable gold in the market at any one time, the gold price has the potential to be extremely volatile with this level of off-market speculation hanging over it. On balance, the financial system tends to be on the short side of gold derivatives as initiating grantors, partially covering through forward delivery contracts from the mines and out-of-the-money options. But to these totals must be added the unallocated accounts in the bullion banking system, representing further short positions. The buy side is generally comprised of refiners and processors, as well as investment funds. This gives the current and generally unexpected resumption of a bull trend for precious metals an added piquancy.

The news seems to be going gold’s way, with a growing realisation even in official circles that the normal economic levers are failing to elicit a response. The wider public is slowly waking up to the horrors of negative interest rates, and that escape routes from this pernicious savings tax are likely to be closed. Only this week, the ECB announced the end of the €500 note, which will no longer be issued after 2018. Negative interest rates and withdrawal of high-denomination bank notes will almost certainly increase demand for physical gold.

Finally, lest the reader thinks it’s time to take profits, I offer the last chart, which is technically encouraging.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

 

Dealing Desk: Gold Reaches 15-Month High as USD Hits 15-Month Low

Thu, 05/05/2016 - 12:33
This week, clients have been net selling gold whilst net buying silver, platinum, and palladium. The spot gold and silver highs experienced on Monday may have sparked more selling activity from our clients as they took advantage of the higher pricing.

GoldMoney’s clients have favoured the Canadian and Singapore vaults this week with less preference being shown for the London, Swiss, and Hong Kong vaults.

Kelly-Ann Kearsey, Dealing Manager at GoldMoney, said that, on Monday, for the first time since January 2015, gold reached $1,300/oz which is a 15-month high. This was possibly due to speculation that the central banks in the US and Europe would maintain lower interest rates. Gold continued to attempt crossing the psychological level of $1,300/oz on Tuesday but failed to hold above this price level.

On Wednesday, silver prices lost some of last week’s gains as US economic data added pressure after reaching a spot price high of $18 on Monday.

Platinum Prices also hit a 10-month high when it reached over $1,080/oz on Monday, a price which has not been seen since July 2015.

The US Dollar index reached a 15-month low this week against a basket of international currencies. The Japanese Yen strengthened as the central bank confirmed that there would be no additional stimulus measures to the monetary policy.

05/05/16 16:00. Gold gained 1.6% to $1,276.66, Silver jumped 0.1% to $17.35, Platinum increased 2.4% to $1,059.06 and Palladium lost 2.9% to $598.40 Gold/Silver ratio: 72

Notes to editor
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T-TIP: Salvation or trash-tip?

Thu, 05/05/2016 - 05:58
President Obama weighed into the Brexit debate on his recent visit to the UK, saying that if Britain left the EU, she would be at the back of the queue when it comes to a free trade agreement.

If this was intended to scare voters into voting Remain, the tactic seems to have failed, with the subsequent swing in the polls favouring Brexit. However, this intervention has drawn widespread attention to the current trade negotiations between the US and the EU, known as T-TIP.

It stands for Transatlantic Trade and Investment Partnership, and is intended to be a free trade and investment agreement between the United States and the (currently) 28 member states of the EU. It makes eminent sense to have free trade between these two economic powers, which account for over 50% of world GDP. Both sides recognise the economic benefits, hardly surprising for America which experienced the disaster of the 1930 Smoot Hawley Tariff Act. It is a little surprising that the EU’s leaders, who genuinely dislike Anglo-Saxon concepts of free markets, and therefore the concepts behind free trade, also accept it will improve prospects for the EU economy.

Let us pass on the subject of the EU leadership’s grasp of basic economics. The EU already trades relatively freely with the US, with tariffs where they are applied, reckoned to average about 3%, a rate that has fallen over time. More difficult will be harmonising regulations, a subject which is very contentious. Left-wing and environmental groups in Europe are already warning us about public sector services being opened up to privatisation favouring American service providers, lower standards on food and environmental safety, loss of EU jobs to lower-cost American labour, and the possibility that European governments will be sued by litigious American corporations. The list of objections seems endless.

The framework for TTIP is so contentious that negotiations are held in secret, which is why it had had so little publicity, until President Obama’s Brexit intervention. But many vested interests will have to be compromised, so it is hard to see it getting past the US Congress, and if it requires the unanimous support of all 28 EU member states, it will be a dead duck. Then there’s the fifty-fifty chance that Donald Trump will be elected President before anything is signed, which could set back negotiations even further.

Therefore, frightening would-be Brexit supporters over missing out on T-TIP, which might never be concluded, is a thin argument. In fact, the concept of multilateral trade agreements between multiple parties has long proved impractical. Doubtless, this is why the EU hardly has any free trade agreements worth mentioning. With the other G-20 nations, she has only two, with South Korea and Mexico.

Why free trade works
The free-market, sound-money approach is to let private individuals manage their own affairs, and if they want to buy goods and services from abroad, they must be free to do so. Ordinary people make the money to buy goods by earning it. To make the money, they produce goods and services that others, including foreigners, wish to buy. It matters not whether spending is from current income or from savings. So long as money is sound, total savings for a given population remain relatively stable anyway.
It is therefore not possible for the private sector on its own to create persistent imbalances in trade. Trade imbalances must therefore originate from government, the consequence of unsound monetary and fiscal policies.

A government licences the banking system, which creates both money and credit. By expanding the sum of these two monetary components, trade imbalances will quickly arise, because the extra credit allows an immediate increase in consumption to develop without a matching increase in domestic production.

An expansionary fiscal policy, not funded by an increase in savings, also results in trade deficits for the same reason, which is why a trade deficit is more often than not accompanied by a budget deficit. The exception is in countries where there is an overriding tendency to increase savings instead of spending, such as in Germany and Japan in the past, and in China today. In these cases, an initial increase in imports fuels production, not consumption, and is subsequently followed by an offsetting increase in exports.

Therefore, trade imbalances are solely an unintended consequence of government intervention, and cannot be blamed on ordinary folk and the businesses they run. This simple theoretical deduction appears to be missed by government economists, who have turned their backs on free markets. These are the so-called experts advising politicians. Furthermore, politicians are also under pressure from lobbying interests, intent on restricting foreign competition. No wonder they turn to restricting cross-border trade as a remedy for the evil of the day.

Nowhere is this more contentious than in allegations of dumping products in foreign markets by selling them below the cost of production. The first mistake here is to regard cost as the factor that sets prices. This is incorrect: prices are subjectively set by buyers. To regard cost of production, or more specifically the cost of labour, as setting market prices, is one of the principal errors behind Marxian philosophy. This mistake has been passed down into modern macroeconomics, and seized upon by uncompetitive manufacturers.

The second mistake is to describe dumping of basic industrial products as unfair competition. As is always the case, what is unfair to one person is fair to another. If we accept this reality, we can then look at dumping of steel, for example, for what it is, which is the benefit it gives consumers of steel, from either the temporary distress caused by global overcapacity, or from a deliberate policy of a government subsidising steel production. Consumers of steel, such as engineering industries, will welcome lower input prices for this basic raw material. If this was better understood, it would be recognised that anti-dumping tariffs are counterproductive. And it was an important reason the Smoot Hawley Tariff Act, which sought to penalise imports, backfired. It prevented the acquisition of raw materials for American industry, hampering their production, which intensified the 1930s slump.

Another way of looking at trade restrictions is they are designed to disfavour emerging economies, who always have lower labour costs. The wealthy nations, through the Bretton Woods apparatus of the World Bank and the IMF, together with the newer World Trade Organisation, have between them dictated terms of trade essentially to protect their own economies. An illustration of this cabal’s dominance was the fight China had to get her currency included in the SDR, despite being the world’s largest economy in terms of international trade. The bureaucracy is also stifling: Algeria’s application for membership of the WTO, tabled in 1987, is still in negotiations.

Consequently, China, Russia and the rest of Asia, plus their key commodity suppliers, are forging their own way and by-passing the old order. Russia still has trade sanctions imposed for political reasons, and China is turning away from the west, having recognised it is easier to create her own Asia-wide market. The successful progress made by the Shanghai Cooperation Organisation towards bonding the whole of Asia into an economic powerhouse, containing more half the world’s population, has caught the established economic order unawares.

Brexit
If the British people people vote for Brexit, there is little doubt that trade relations with the EU, even before the two-year grace period is up, will become very contentious, and there will have to be a complete rethink by government in trade policy. Realistically, there would be little alternative to embarking on a policy of freer trade, encouraging British business to raise its sights beyond Europe, particularly towards Asia. This is, in fact already the chosen path, with George Osborn a repeat trade visitor to China. The City of London has already been selected by China to provide its international financial services, and Britain was the first western nation to join the Asia Infrastructure Investment Bank.

There would be an initial opportunity to bridge the gap between emerging and advanced economies by offering free trade agreements to the Commonwealth, which includes the emerging Indian power-house. This could be followed by free trade agreements with China, and any other nation that wishes it. Consumer protection need not be compromised, because imports would be required to satisfy British consumer and safety standards.

The trade unions would almost certainly hate it, seeing free trade as a threat to jobs. However, industry as a whole would rapidly switch its focus to benefit from the opportunities created, and it would forget it ever thought of remaining in the EU, just as it has forgotten its near-unanimous, misguided support for Britain to join the euro in the 1990s. The City of London would love it, with supporters for Remain clamouring for the new opportunities.

In the event of Brexit, Britain’s politicians could be forced to move towards free trade with everyone, just as Robert Peel did when his government abolished the corn laws in the 1840s. If the British government took that free-market view, the economic benefits that would follow could rival those following Peel’s reform, not just for Britain, but for all other nations prepared to join in. Perhaps an independent Britain opting for free trade will even encourage other EU members to rethink their trade policies. After all, they seem to recognise there are some economic benefits, otherwise they would not be negotiating T-TIP.

For the moment this is only wishful thinking. The British Conservative-led government is emotionally inclined to free markets, but even its leaders do not appear to be fully persuaded of an unhampered free-for-all in trade. And as for T-TIP, it is an ugly acronym for an unworkable arrangement, and it should be consigned to the trash-tip of history’s failed projects.

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

GoldMoney® Roundtable History & Importance of Gold | Part 1

Tue, 05/03/2016 - 13:57
GoldMoney® Founder James Turk, CEO Roy Sebag, CSO Josh Crumb, Head of Research Alasdair Macleod, and Vice President of GoldMoney® Insights Stefan Wieler sat down for a round-table discussion to discuss the history and importance of Gold. 

Gold Bullion is the world's oldest asset class and the century's best performing currency. In this brand new GoldMoney Inc roundtable recorded in Toronto, top executives from the company explore the history of gold as currency and how the banking system evolved over time. Participating in the discussion, from left to right: Alasdair Macleod, Roy Sebag, James Turk, Josh Crumb, and Stefan Wieler.

 

The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

Something’s got to give in the oil market

Tue, 05/03/2016 - 07:00
Something’s got to give in the oil market

Introduction

Crude oil time-spreads have completely dislocated from inventories. Historically, such dislocations have proved to be short lived. We expect that either spot prices will sell-off again or the back end of the curve will move sharply higher. As per our proprietary gold pricing model, the latter would be very supportive for gold prices.

View the entire Research Piece as a PDF here...

Oil prices have rallied sharply from their January lows. At the time of writing, ICE Brent and NYMEX WTI front month prices are up 64% and 71%, respectively. While the media and commodity analysts have focused mainly on the recent rally in the spot price, in our view the more interesting development was in the curve structure. The entire move up happened in the front end of the curve. Longer-dated oil prices have remain almost unchanged. This has led to a sharp rally in crude oil time-spreads; 1-60 month ICE Brent time-spreads moved from -USD20.64/bbl in January to -USD8.82/bbl at the time of writing. In commodity markets, the shape of the forward curve is primarily a function of inventories. In our view, the inventory time-spread mechanism is the strongest and most robust relationship in commodities. Any divergence presents a physical storage arbitrage opportunity which will inevitably be exploited quickly by the market. Hence any deviation between spreads and inventories is typically very short lived. And this is where the oil market is now completely out of balance in our view. The rally in front month prices combined with the lack of any price action in the back has pushed time-spreads roughly 20-30% above the levels they should normally be. This is the largest discrepancy between time-spreads and inventories we have witnessed over the entire time-horizon in which 5-year forward prices are available. In our view, either near-dated crude oil prices will sell off again or longer dated prices appreciate.

The two possible outcomes described above point to an interesting opportunity in gold. Gold prices are driven by longer-dated energy prices while changes in oil spot prices have little to no effect. Hence a renewed sell-off in the front end of the curve would in our view have little impact on the gold price. A move higher in the back end however would be positive for gold prices. We estimate that in order for time-spreads to move back in line with inventories, either front end prices have to sell off by USD10-15/bbl or the back end has to appreciate USD15-20/bbl. Given the parameters of our gold pricing model, the latter would imply roughly a USD100-150/oz rise in the gold price.

 

Oil prices have rallied sharply from their January lows. At the time of writing, ICE Brent and NYMEX WTI front month prices are up 64% and 71%, respectively. Interestingly, the whole price rally took place even as petroleum inventories continued to rise. Total global commercial petroleum stocks are now at an all-time high, up 285 million barrels year-over year and 550 million barrels above the 5-year average (see Figure 1).

The market however focuses on a host of production outages in Iraq, Venezuela, and Nigeria. This hasn’t led to any decline in inventories though. Arguably more recent high frequency storage data indicates that the inventory build has slowed down on the back of a sharp decline in US crude oil production. More specifically, over the past two months, stock builds in North America, Europe and Japan have been roughly in line with the seasonal average and Singapore stocks actually drew compared to the seasonal average. But because seasonal inventories tend to build well into summer, stocks continued to build in absolute terms.

Some market participants would argue that the market is looking through current fundamentals and is pricing in future deficits. However, oil, like any other commodity, is not a financial asset. Changes in prices and price relationships have physical, real world implications:

  • Higher prices encourage production. Rising spot prices will help producers, particularly in the US shale industry, to survive longer, meaning the declines in US output could be slower. Some might even bring production back. Pioneer Resources announced in their recent earnings call that they would add rigs once oil prices reach USD50/bbl.
  • Crude oil time-spreads (the delta between the spot price of oil and the futures price) are a function of inventory levels. High inventories require storage holders to be compensated, which happens though a steep enough contango term structure (more about this below). The lack thereof leads to barrels coming out of storage.

While there can be a lag (and potentially a very long one) between supply and price, the interplay between inventories and time-spreads tends to be much more instantaneous. In our view, the inventory time-spread mechanism is the strongest and most robust relationship in commodity markets. Any divergence between the two presents an arbitrage opportunity which will inevitably be exploited quickly by the market (unless there is government intervention to subsidize or penalize market participants).

While the media and commodity analysts have focused mainly on the recent rally in the spot price, in our view the more interesting part happened in the curve structure. The entire move up happened in the front end of the curve. Longer-dated oil prices have almost not moved at all. This has led to a sharp rally in crude oil time-spreads; 1-60 month NYMEX WTI spreads moved from -USD20.54/bbl in February to -8.10/bbl at the time of writing. Brent time-spreads had a similar run from -USD20.64/bbl in January to -USD8.72/bbl as of now (see Figure 2).

In commodity markets, the shape of the forward curve is a function of inventories. In a market with very low inventories relative to demand, consumers - for example a manufacturer of a consumer good - of that commodity will be willing to pay a premium for immediate delivery. The alternative is to risk running out of the commodity that is an input good in the manufacturing process. The result is that the consumer (manufacturer) would have to shut in production, which represents the worst case scenario. Hence the consumer is willing to pay a higher price for the commodity if needed. For example, a battery producer needs copper in the production process. He can sell one battery for USD100 and production costs are USD90 given current prices for raw materials, labor etc. The copper that goes into one battery costs USD10. Now imagine on a global scale, copper consumption exceeds production and inventories are declining. The battery producers begins to realize that he might not be able to buy enough copper in order to keep battery production steady. There might be new copper mines being built to alleviate the shortage, but those will add new copper supply in 3 years from now while he needs copper now. So he is willing to pay more for the immediate delivery of copper even if the price for copper delivered in 3 years is still USD10. In the end, he knows that if inventories continue to fall, not all the demand can be met. Hence, the lower the stocks are, the larger the premium for immediate delivery as consumers compete for the available inventory. The battery producer will be willing to pay up to USd20 for the copper all else equal, at which point his profit become zero. But another consumer might have a higher utility from the copper and is willing to pay even more. In such a market, the spot price will be higher than the future price for delivery one month out, and that price will trade above the price for delivery two months out and so forth. This forms a downward sloping futures price curve which is called ‘backwardation’ (see Figure 3).

The opposite of backwardation is ‘contango’, where the front month (or spot) price is trading at a discount to the forward price. Contango price curves occur when inventories are high relative to demand. In a commodity market with high inventories, the likelihood for a commodity consumer to run out of the input good is very small. Hence there is no incentive for a consumer to pay a premium for immediate delivery. Quite the contrary, storing commodities costs money (to rent the storage capacity, cover insurance and the opportunity costs of money). Hence the holder of the commodity needs to be compensated for these costs. This compensation comes in the form of contango. In a contango market, an owner of storage capacity can buy the commodity at a discount now, store in and sell it forward simultaneously at a higher price. Similarly to backwardation, the higher the stocks are, the larger the discount. This is due to the fact that the cheapest storage is filled first. As inventories continue to rise, more expensive storage capacity has to be utilized. For example, when crude oil inventories rise, tank farms and refinery storage tanks fill up first. But once all that capacity is exhausted, alternative forms of storage have to be used. For example oil tankers that normally would be used to move oil from oil producing regions to oil importing regions are rented out by traders to store oil, which is significantly more expensive than storing oil in onshore tanks. And not all tankers are equal, so the more oil that has to be stored, the more expensive tankers will move to storage.

Inventories are clearly the most important driver for the shape of the forward curve. And this is true for almost all commodities (As a side note, it has typically no significant impact on the gold forward curve, as the available supply of gold is so stable. That is circumstantial evidence that gold is not a commodity; rather, it is money).

There are other drivers that impact the shape of the forward curve as well which go into our model:

  • 1. The size of storage capacity: higher capacity requires less contango given the same amount of inventory.
  • 2. Inventory seasonalities: Inventories follow seasonal patterns. For example, when oil stocks decline in winter, the curve doesn’t necessarily become more backwardated as long as the decline is in line with seasonal pattern.
  • 3. Positioning in the futures market: Higher net speculative positions are consistent with stronger time-spreads. The common explanation is that speculators on aggregate form an opinion about future inventories and position themselves accordingly. An increase in net speculative positioning therefore would have an anticipatory effect on time-spreads, meaning that in some instances spreads can move before inventories move. When stocks subsequently decline, net speculative positioning should decline as well (because the market no longer expects even lower stocks in the future) which brings time-spreads and inventories back in line. However, we find there is an alternative explanation for the relationship between net speculative positions and time-spreads. The market on aggregate is neither long nor short. For every producer that is short, there has to be a speculator that is long, or vice versa. An increase in net speculative length can also be interpreted as producers getting shorter. If producers increasingly hedge their forward production because they expect more production next year, they will add pressure on the back end of the curve. Hence the curve strengthens, not because inventories are declining or speculators expecting them to decline, but because there is more producer hedging activity.
  • 4. Interest rates: As interest rates change, the opportunity cost of money – and thus discounted storage costs – changes. This effect is relatively small in comparison to all other drivers
  • 5. Credit availability / financial stress: In 2008, crude oil time-spreads crashed to levels beyond what inventories alone could explain (20% in first to second month at some point). The reason was that the credit crisis severely impacted commodity traders to take advantage of the apparent arbitrage opportunities as they found themselves cut off from financing. Credit became scarce for everybody, but even more so for traders of a good that had just dropped 80% in value in a few months. Hence, in such a situation, the limit contago is set by how low spot prices can fall until producers shut in supply.

By using these drivers in a regression analysis, we can predict the level of crude oil time-spreads extremely well. We find that while the other variables help to explain some discrepancies, inventories remain the main driver of spreads. Any deviation between spreads and inventories is typically very short lived. And this is where the oil market is completely out of balance in our view. The rally in front month prices combined with the lack of any price action in the back has pushed time-spreads roughly 20-30%, or roughly USD10-15/bbl, stronger than they should be, (see Figure 4). This is the largest discrepancy between time-spreads and inventories we have witnessed over the time-horizon where 5-year forward prices are available.

Such a dislocation happened almost exactly a year ago with reversed signs. Crude oil time-spreads crashed at the end of 2014 to levels inconsistent with stock levels. At the time, the market gave a price signal in form of spreads that inventories are so high that crude oil had to be stored on oil tankers, similar to what happened in 2008-2009. But that was simply not the case. Inventory capacity had increased substantially over the past 5 years, and there was actually plenty of storage capacity left. With the crash in spreads, crude oil spot prices had crashed too. And as spreads recovered and moved back in line with fundamentals, oil spot prices rallied. Later that year spot prices plunged again and reached new lows as inventories eventually built to a level consistent with those spread levels.

The situation this time is exactly the opposite. Crude oil time-spreads have rallied while inventories hit all-time highs. Clearly the market is expecting a tighter crude oil market in the near future given all the production outages. However, this alone does not warrant the move in spreads. It seems that the move up in oil prices was exacerbated by a general move up in commodity prices overall. Since the lows in mid-February, prices of copper, aluminum, zinc, nickel have all been moving up in a similar fashion to oil (see Figure 5).

It thus appears that investors have been pouring money indiscriminately into commodities of late. This is visible also in positioning. Open interest in WTI has reached an all-time high. Net speculative positions and open interest in WTI and Brent are near all-time highs (see Figure 6 and 7). In our view, it is investor flows that have pushed time-spreads up, hence time-spreads will ultimately revert back to fundamentals (inventories).

We can speculate about the rationale of the buyers. Some would argue that ever-more dovish central bank policies in Europe and Japan, as well as the clear shift away from the promised hawkish path in the US have heightened inflation concerns again. Arguably this should have the exact opposite effect on commodity forward curves though, as this should drive up longer-dated prices while spot prices should remain unaffected by inflation expectations.

However, while correct in theory, one has to look at how the market can express an inflation view in practice. Trading longer-dated futures is something typically reserved to hedge funds. The bulk of asset managers such as pension funds are only allowed to invest in securities, and thus if a pension fund or an insurance company seeks exposure to commodities they typically have to buy a commodity index product. Plain vanilla commodity indices are very simple products. Being long a commodity index is equivalent to being long the most near-dated future of a basket of commodities and roll the position to the next month as that contract nears expiry. While commodity index products have become more complex over the past years, allowing exposure that is further out in the curve, a large move into commodities will still mean that most money will end up in the front of the curve. In our view such an investment strategy completely defies the purpose of trying to hedge a portfolio against inflation. The performance of a plain vanilla commodity index has often very little to do with the price of the underlying commodity. This has not so much to do with the fees investment bank charge – decades of fierce competition have pushed them down to almost nothing – but more with the principal mechanics of indices (mainly negative roll yields as investors are heavily exposed to very volatile first-to second month spreads). For example, NYMEX natural gas prices are roughly at the same levels as they were over the past 20 years ago. Yet the inherent index lost 99.78% since inception. There is no arguing that this is not an efficient hedge for rising gas prices (see Figure 6).

However, that doesn’t stop investors from buying these products to express bullish views on inflation. This pushes front month oil prices higher, which is what we think has happened over the past couple weeks and what is partly behind the sharp rally in front month crude oil prices. But why is the back end of the oil curve not moving? If market expectations for inflation are shifting higher, why is the smart money that can buy the back-end of the curve not doing it? The answer is that they actually might be doing it, but there are enough sellers of the back end to keep a lid on prices for now. US shale oil producers are in a dire state. Bankruptcies are accelerating and those who have so far survived are struggling to maintain financing. Banks demand that producers hedge their production in order to keep credit flowing. So any demand for longer dated futures is currently met by producers more than willing to sell.

So what gives?

We are confident that this discrepancy between inventories and time-spreads will self-correct in the near future as well. However, the question is how. There are two ways how stocks and time-spreads could realign, either inventories drop sharply or spreads will weaken dramatically again.

We strongly doubt that inventories can be the correcting factor in the short run. While there are multiple short term production outages around the world, there has yet to be a real impact on inventories. We ran dozens of models using different type of inventories as input variables (total petroleum, excluding NGLs, just crude etc.) and they all come roughly to the same result. Total industrial petroleum inventories would have to be more than 250 million barrels below current levels to justify current spreads. Crude oil inventories (without NGLs) alone would have to be about 100 million barrels lower. Even should current production outages as well as the declines in US output persist, inventories are unlikely to fall to these kind of levels until well into 2017.

In our view, the risk to the global oil balance is that stocks decline a lot slower, or don’t decline at all. So far the focus has been on the supply side. Demand growth was very strong over the past two years, thanks to sharply lower prices. But supply growth was simply too strong, hence stocks built up. More recently the low prices have finally led to a decline in US shale oil production, one of the main sources of the oversupply (the other being OPEC). But demand growth is no longer boosted by lower prices, as prices are now basically flat year-over-year. In addition, global economic growth is stuttering. Even in the US, which was the only bright light in the global economy, there is increasing evidence that the US economy is slowing down materially. (Q1 GDP growth was a mere 0.5% annualized)

Hence, in order for time-spreads and oil inventories to realign, we believe time-spreads will have to weaken again. But there are two ways how this can happen as well. Either via a renewed sell-off in front month prices or a move higher in the back end of the curve. In our view, both can happen:

The back end of the curve is too low in our view in order to encourage enough investment in replacement production. At roughly USd50-55/bbl, there aren’t enough oil project sanctioned to ensure that future demand can be met. According to Wood MacKenzie, an energy consultant, oil companies put on hold or scrapped oil projects worth USD380 by January 2016. This accounts for 27 billion barrels in oil reserves. To put this into perspective, the US Energy Information administration (EIA) states that US crude oil reserves increased by only 15.7 billion barrels from 2009 to 2014 (17.7 including lease condensates) thanks to shale oil. And given the price collapse, a large junk of these reserves are likely no longer economical viable. The oil from these abandoned projects will be missing at some point in the future. Hence ultimately we expect longer-dated oil prices to move higher so that some of the global projects become economical again. However, what speaks against a sudden appreciation in the back end is the need of producers to hedge their forward production. Thus, any immediate rally in the back end will likely be sold. So that would suggest that the reversal in spreads will be driven by a renewed collapse in prices in the front-end.

Hence either outcome is possible in our view: either near-dated crude oil prices will sell off again or longer dated prices appreciate. What does that mean for our readers? Not many people have the ability or feel comfortable trading crude oil time-spreads. But the two possible outcomes described above open an interesting opportunity in gold. As we outlined in our framework report: Gold Price Framework Vol. 1: Price Model, gold prices are driven by longer-dated energy prices. Importantly, we found that changes in oil spot prices have little to no effect on gold. Hence a renewed sell-off in the front end of the curve would in our view have little impact on the gold price. A move higher in the back end however would be hugely positive for gold prices. Hence, the expected reversal in the crude-oil time-spreads creates an optionality for gold prices. If oil spot prices sell off, nothing happens with gold, if longer-dated oil prices go up, gold most likely goes up.

We estimate that in order for time-spreads to move back in line with inventories, either front end prices have to sell off by USD10-15/bbl or the back end has to appreciate USD15-20/bbl. Given the parameters of our gold pricing model, the latter would add roughly USD100-150/oz to the gold price. In the end, we think something has got to give in the oil market and a clever way to take advantage of this move is to build a long position in gold.

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Market Report: Dollar down, gold up

Fri, 04/29/2016 - 05:06
Silver continued its spectacular run, and gold had a good week as well.

Underlying this performance was a weaker dollar. So far this year, measured in dollars, silver is up 28% and gold up 20%. On the week, gold rose from a low of $1228 to $1275 by early this morning (London time), and silver from $16.82 to $17.75. Sentiment has continued to improve.

The dollar’s weakness coincides with a growing realisation that the Fed is trapped when it comes to raising interest rates. Following a two-day FOMC meeting, there was no change in the Fed Funds Rate, with the usual jaw-jaw about conditions not deteriorating, so we can expect a rise in rates perhaps mid-year.

The lack of action from the Fed is curiously disappointing, given there were two FOMC meetings under “expedited measures” and Ms Yellen went to the White House to brief the President. So what was all that about? A decision to keep rates on hold, and an unchanged outlook? Perhaps we will never know.

It is becoming apparent that the Fed is in as much of a bind as the BoJ and the ECB, the only difference being the Fed still has positive interest rates (just). One can only assume that the Fed’s analysts have worked out why it is that the euro and the yen have been strong, when they should have been weak. The most likely cause is the contraction of shadow banking in these currencies, leading to demand for cash. If this is so, negative dollar rates could depress financial activity in the US, with negative, instead of positive consequences. Equally, the Fed must be frightened to raise rates, for fear of setting off a debt liquidation.

As markets grasp these dangers, it is likely that the gold price will rise further. Market analysts will almost certainly attribute such a move to a receding fear of interest rate rises. If so, they will miss the probability that it is the dollar weakening, rather than gold rising. At least for European traders, this will clear the way for them to buy physical gold, with negative to zero cost of carry. It’s rather like being paid by the insurance company to insure yourself against financial disaster.

On Comex, demand for paper gold continues to be healthy, with open interest holding near record levels at the 500,000 contract mark. The next chart shows how the price and open interest are moving in tandem.

This is as it should be. Doubtless, price management by the bullion banks has diminished, partly as a result of the overall cut back on OTC derivative positions, and partly as a result of the discovery of earlier manipulation, to which Deutsche Bank has now confessed.

Deutsche Bank promised to spill the beans on its manipulation of both gold and silver markets, implicating other banks. That being so, we can expect outstanding OTC positions to continue to contract, a trend already established over the last two years as banks continue to downsize their trading activities. The fact that Comex open interest is at a record is only the visible part of this bigger picture.

Silver’s open interest on Comex is also behaving well, which is shown in our last chart.


 

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Dealing Desk: FOMC Boosts Precious Metal Prices

Thu, 04/28/2016 - 13:25
This week, clients have been net buying gold, silver, and palladium.

Wednesday’s FOMC release seemed to spark more buying acitivity from our clients as they took advantage of the lower pricing in advance of the FOMC statement. Clients have also been net selling their platinum positions to take advantage of the current platinum price which has risen to over USD1,030/oz this week.

GoldMoney’s clients have been in favour of the Hong Kong, Swiss, and Singapore vaults this week with more or less preference being shown toward the London and Canadian vaults.

Kelly-Ann Kearsey, Dealing Manager at GoldMoney said that throughout the week the gold prices have been regaining their losses from last Friday, where a low of roughly $1,230/oz was seen. Silver has remained relatively stable to start the week, sitting at around USD17.00/oz.

The market has been watching for the FOMC statement which was released on Wednesday evening. In the last update, they confirmed that rate decision was to remain unchanged as was expected. They have now dropped comments of concern for the surrounding global outlook and remained confident of the labour markets but did also acknowledge that economic growth seemed to have slowed. They will continue to monitor as inflation is still below the 2% target.

Aftrer the comments released by the FOMC, gold made a quick recovery as it moved back towards USD1,250/oz moving into USD1,260/oz throughout Thursday. Silver also received support as it jumped to its highest in almost 1 year as it was boosted to roughly USD17.30/oz which has then increased to a spot high of USD 17.45/oz throughout the day.

The US dollar was also affected as it drifted lower against major currencies which also provided more support for the gold pricing. US data for pending home sales also had no impact in strengthening the US Dollar. The Dollar was then seen losing more than 2% against the Yen, as the markets were surprised by the Bank of Japan keeping its monetary policy steady.

28/04/16 16:00. Gold gained 0.5% to $1,256.11, Silver jumped 1.6% to $17.33, Platinum increased 0.9% to $1,033.74 and Palladium gained 2.1% to $616.00 Gold/Silver ratio: 72

Notes to editor
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Taking the petro out of the dollar

Thu, 04/28/2016 - 07:01
Saudi Arabia has been in the news recently for several interconnected reasons. Underlying it all is a spendthrift country that is rapidly becoming insolvent.

While the House of Saud remains strongly resistant to change, a mixture of reality and power-play is likely to dominate domestic politics in the coming years, following the ascendency of King Salman to the Saudi throne. This has important implications for the dollar, given its historic role in the region.

Last year’s collapse in the oil price has forced financial reality upon the House of Saud. The young deputy crown prince, Mohammed bin Salman, possibly inspired by a McKinsey report, aims to diversify the state rapidly from oil dependency into a mixture of industries, healthcare and tourism. The McKinsey report looks like a wish-list, rather than reality, particularly when it comes to tourism. The religious police are unlikely to take kindly to bikinis on the Red Sea’s beeches, or to foreign women in mini-shorts wandering around Jeddah.

It is hard to imagine Saudi Arabia, culturally stuck in the middle ages, embracing the changes recommended by McKinsey, without fundamentally reforming the House of Saud, or even without a full-scale revolution. Nearly all properties and businesses are personally owned or controlled by members of the extended royal family, not the state, nor by lesser mortals. The principal exception is Aramco, estimated to be worth $2 trillion.

The state is subservient to the House of Saud. It is therefore hard to see how, as McKinsey recommends, the country can “shift from its current government-led economic model to a more market-based approach”. The country is barely government led: a puppet of the Saudis is more like it. But the state’s lack of funds is making it increasingly desperate.

It was for this reason the Kingdom recently placed a $10bn five-year syndicated loan, the first time it has entered capital markets since Saddam Hussein invaded Kuwait. It proposes to raise a further $100bn by selling a 5% stake in Aramco. The financial plan appears to be a combination of this short-term money-raising, contributions from oil revenue, and sales of US Treasuries (thought to total as much as $750bn). The government has, according to informed sources, been secretly selling gold, mainly to Asian central banks and sovereign wealth funds. Will it see the Kingdom through this sticky patch?

Maybe. Much more likely, buying time is a substitute for ducking fundamental reform. But one can see how stories coming out of Washington, implicating Saudi interests in the 9/11 twin-towers tragedy, could easily have pulled the trigger on all those Treasuries.

Whatever else was discussed, it seems likely that this topic will have been addressed at the two special FOMC meetings “under expedited measures” at the Fed earlier this month, and then at Janet Yellen’s meeting with the President at the White House. Yesterday’s holding pattern on interest rates would lend support to this theory.

The White House’s involvement certainly points towards a matter involving foreign affairs, rather than just interest rates. If the Saudis had decided to dump their Treasuries on the market, it would risk collapsing US bond markets and the dollar. Through financial transmission, euro-denominated sovereign bonds and Japanese government bonds, all of which are wildly overpriced, would also enter into free-fall, setting off the global financial crisis that central banks have been trying to avoid.

Perhaps this is reading too much into Saudi Arabia’s financial difficulties, but the possibility of the sale of Treasuries certainly got wide media coverage. These reports generally omitted to mention the Saudi’s underlying financial difficulties, which could equally have contributed to their desire to sell.

While the Arab countries floated themselves on oceans of petro-dollars forty years ago, they have little need for them now. So we must now turn our attention to China, which is well positioned to act as white knight to Saudi Arabia. China’s SAFE sovereign wealth fund could easily swallow the Aramco stake, and there are good strategic reasons why it should. A quick deal would help stabilise a desperate financial and political situation on the edges of China’s rapidly growing Asian interests, and keep Saudi Arabia onside as an energy supplier. China has dollars to dispose, and a mutual arrangement would herald a new era of tangible cooperation. The US can only stand and stare as China teases Saudi Arabia away from America’s sphere of influence.

In truth, trade matters much more than just talk, which is why a highly-indebted America finds herself on the back foot all the time in every financial skirmish with China. Saudi Arabia has little option but to kow-tow to China, and her commercial interests are moving her into China’s camp anyway. It seems logical that the Saudi riyal will eventually be de-pegged from the US dollar and managed in line with a basket of her oil customers’ currencies, dominated by the yuan.

Future currency policies pursued by both China and Saudi Arabia and their interaction will affect the dollar. China wants to use her own currency for trade deals, but must not flood the markets with yuan, lest she loses control over her currency. The internationalisation of the yuan must therefore be a gradual process, supply only being expanded when permanent demand for yuan requires it. Meanwhile, western analysts expect the riyal to be devalued against the dollar, unless there is a significant and lasting increase in the price of oil, which is not generally expected. But a devaluation requires a deliberate act by the state, which is not in the personal interests of the individual members of the House of Saud, so is a last resort.

It is clear that both Saudi Arabia and China have enormous quantities of surplus dollars to dispose in the next few years. As already stated, China could easily use $100bn of her stockpile to buy the 5% Aramco stake, dollars which the Saudis would simply sell in the foreign exchange markets as they are spent domestically. China could make further dollar loans to Saudi Arabia, secured against future oil sales and repayable in yuan, perhaps at a predetermined exchange rate. The Saudis would get dollars to spend, and China could balance future supply and demand for yuan.

It would therefore appear that a large part of the petro-dollar mountain is going to be unwound over time. There is now no point in the Saudis also hanging onto their US Treasury bonds, so we can expect them to be liquidated, but not as a fire-sale. On this point, it has been suggested that the US Government could simply block sales by China and Saudi Arabia, but there would be no quicker way of undermining the dollar’s international credibility. More likely, the Americans would have to accept an orderly unwinding of foreign holdings.

The US has exploited the dollar’s reserve currency status to the full since WW2, leading to massive quantities of dollars in foreign ownership. The pressure for dollars to return to America, when the Vietnam war was wound down, was behind the first dollar crisis, leading to the failure of the London gold pool in the late sixties. After the Nixon Shock in 1971, the cycle of printing money and credit for export resumed.

In the seventies, higher oil prices were paid for by printing dollars and by expanding dollar bank credit, in turn kept offshore by lending these exported dollars to Latin American dictators. That culminated in the Latin American debt crisis. From the eighties onwards, the internationalisation of business was all done on the back of yet more exported dollars, and wars in Iraq and Afghanistan echoed the earlier wars of Korea and Vietnam.

Many of these factors have now either disappeared or diminished. For the last eighteen months, the dollar had a last-gasp rally, as commodity and oil prices collapsed. The contraction in global trade since mid-2014 had signalled a swing in preferences from commodities and energy towards the money they are priced in, which is dollars. The concomitant liquidation of malinvestments in the commodity-exporting countries has been contained for now by aggressive monetary policies from China, Japan and the Eurozone. The tide is now swinging the other way: preferences are swinging out of the dollar towards oversold commodities again, exposing the dollar to a second version of the gold pool crisis. This time, China, Saudi Arabia and the BRICS will be returning their dollars from whence they came.

In essence, this is the market argument in favour of gold. Over time, the price of commodities and their manufactured derivatives measured in grams of gold is relatively stable. It is the price measured in fiat currencies that is volatile, with an upward bias. The price of a barrel of oil in 1966, fifty years ago, was 2.75 grams of gold. Today it is 1.0 gram of gold, so the purchasing power of gold measured in barrels of oil has risen nearly three-fold. In dollars, the prices were $3.10 and $40 respectively, so the purchasing power of the dollar measured in barrels of oil has fallen by 92%. Expect these trends to resume.

This is also the difference between sound money and dollars, which has worked to the detriment of nearly all energy and commodity-producing countries. With a track-record like that, who needs dollars?

It is hard to see how the purchasing power of dollars will not fall over the rest of the year. The liquidation of malinvestments denominated in external dollars has passed. Instead, the liquidation of financial investments carry-traded out of euros and yen is strengthening those currencies. That too will pass, but it won’t rescue the dollar.

The views and opinions expressed in this article are those of the author(s) and do not reflect those of GoldMoney, unless expressly stated. The article is for general information purposes only and does not constitute either GoldMoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, GoldMoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. GoldMoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.

 

 

 

Market Report: Silver roars, and gold stirs

Fri, 04/22/2016 - 10:32

Silver continued its stellar run this week, trading as high as $17.60 overnight in Asia on Thursday morning, and in mid-morning European trade today was 24.3% on the year, overtaking gold.

Gold finally caught a bid yesterday as well, running up as far as $1261 at the same time. Both metals opened strongly in US trading yesterday, with gold running up further still to $1270 and silver to $17.70, before someone dumped about 8,000 gold contracts and 3,750 silver contracts on Comex, driving prices down to $1250 and $17 respectively.

Preliminary Comex open interest figures for gold yesterday increased by 8,562 contracts on a net down day. This reflects the new bear sale described above, and is not symptomatic of profit-taking. At the same time there was an exchange of 9,251 June contracts for physical recorded. Could it be tied into an arbitrage into the new yuan contract, which requires the maintenance and delivery of physical metal in Shanghai?

Most likely, not. This is the first week of the Shanghai Gold Exchange’s yuan-denominated gold fix, which commenced on Tuesday. The price is fixed twice daily, morning and afternoon, priced in yuan per gram. There are thirteen fixing members, and six reference price members, of which the only foreign banks are Standard Chartered and ANZ. Any US bank dealing at the yuan fix will have to go through the fixing members.

Developments in Shanghai are for future consideration. In current markets, private sector physical demand in China has tailed off slightly, and a gold processing and jewellery strike (now just ended) had paralysed the Indian market. So overall demand for gold could have fallen significantly on these factors alone. However, there has undoubtedly been an offsetting increase in European demand, fuelled by negative interest rates.

The ECB yesterday announced no change in interest rates or to the €90bn monthly QE, though there was some currency volatility after the announcement.

But there is another factor, which may have had a more important market impact. Saudi Arabia appears to be in financial difficulties, stemming from last year’s collapse in the oil price and the sharp rise in state spending in recent years. Saudi Arabia is also fighting a proxy war against Iran in the Yemen, so is not surprising that Iran refused to attend the OPEC meeting in Doha this week, increasing the financial pressure on Saudi Arabia.

Saudi Arabia has two types of financial reserves, US Treasuries and gold. The rumours that she would sell USTs were very strong this week, and there have also been rumours in recent months that she has been selling bullion. That being the case, there was potential for China to lend Saudi Arabia yuan against future oil sales, perhaps as part of a package including the purchase of some gold. Saudi also announced a $10bn five-year loan, the first time it has entered credit markets for a very long time. This loan would have eased her immediate liquidity problems, given that any loan from China may take longer to put in place, and may involve time restrictions on selling yuan.

If Saudi Arabian sales of gold have come to an end, it might explain some of the recent strength in the gold price. It will be interesting to see if this is confirmed by price action in the bullion markets in the coming weeks.


The views and opinions expressed in the article are those of the author and do not necessarily reflect those of GoldMoney, unless expressly stated. Please note that neither GoldMoney nor any of its representatives provide financial, legal, tax, investment or other advice. Such advice should be sought form an independent regulated person or body who is suitably qualified to do so. Any information provided in this article is provided solely as general market commentary and does not constitute advice. GoldMoney will not accept liability for any loss or damage, which may arise directly or indirectly from your use of or reliance on such information.

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