Wednesday, June 3, 2009

Gold Stops To Catch Its Breath

The Big Collapse Could Be Very Near
The Federal Reserve appears to be increasingly nervous about the long term bond market. This is serious. How panicked are they? After leaking a story on Friday, they are back at it on Sunday.

The Federal Reserve leaked to CNBC's Steve Liesman on Friday that they weren't targeting long rates. Why such a leak? Probably because the Fed did not want to appear impotent in controlling the long rate. So they put out the word through Liesman that they weren't targetting the long rate. Can you imagine what would happen to the markets if it sensed long rates were beyond the control of the Fed?

The Fed can of course print money to buy up every Treasury bond in existence, but the inflationary ramifications would be Zimbabwe like, and crush the dollar on international currency markets. Are we near the phase where all hell breaks loose? I have never even answered, maybe, to this question before. It's always been, "no." Now it's maybe.

The Fiat Currency Doomsday Machine
By Rob Parenteau
Our view has been unless the commercial banks start putting some of their $1 trillion in cash holdings into Treasuries (thereby picking up net interest income to rebuild profitability and balance sheets), the Fed will be forced into taking steps that imply a ceiling in Treasury yields is in place. The only other way out we can see is if the US macro news flow relapses and private portfolio preferences shift back to less risky assets, which puts equity indexes at risk of a sell-off.

So from a strategic point of view, we believe equity investors want and need to see stronger economic and earnings results to drive indexes higher, while bond investors need just the opposite to calm Treasury yields down. In addition, through near-zero interest rate policy (ZIRP) and quantitative easing (QE) approaches, the Fed has been trying to push private investors into riskier asset classes while the Treasury’s debt issuance calendar implies they need private investors to prefer owning Treasury bonds, which are generally not the asset of choice in an economic recovery scenario.

In other words, we have contradictory crosscurrents here. If the Fed doesn’t intervene to slow or halt the Treasury yield backup, there is a chance the stabilization in unit home sales will wither away. If the Fed does step up QE operations to halt the Treasury yield rise, professional investors taking the “green toilet paper” view will continue to sell dollars and buy commodities. Down the line that implies higher energy prices for consumers and higher input prices for manufacturers, neither of which we would consider growth supportive developments.

Our concern is the green toilet paper contingent has the Fed in a corner for the moment with a trade that initially could look self-fulfilling, along the lines of the infamous Soros 1992 trade against the British pound and the Bank of England. At the moment, we honestly cannot see an easy resolution unless some Goldilocks growth path (not too hot, not too cold) develops, but we would we need to monitor this one very closely.

To wit, we can envision the following scenario feeding on itself.

You cannot have

· A central bank pursuing near ZIRP and QE, which, after all, are designed to trash cash and force private investors out the risk spectrum into equities, corporate bonds, mortgage bonds, lower rated debt, etc…

· And have the Treasury issuing loads of public debt at the same time from a massive fiscal ease designed to reaccelerate the economy without expecting Treasury yields to increase…

unless the central bank and commercial banks are willing to soak up Treasury issuance with money creation, or unless the Treasury can get away with “underfunding” – that is, direct monetization of the deficit. There is a policy incompatibility problem, in other words, or at least really incoherent expectations management.

And that puts the Fed on the spot. Do they choose to cap Treasury yields by explicitly stepping up QE operations and buying more Treasury bonds in the open market (or possibly more mortgage-backed securities, to thereby decouple mortgage rates from rising Treasury yields)? Or do they just let Treasuries find their own equilibrium, accepting the risk the economy may relapse again as 10-year US Treasury yields sail through 4%?

Gold Panic Inside The Oval Office
I was watching the NBC special called "Inside the White House" last night and was struck by a meeting with Larry Summers and the President.

It was touted as an "all access" day in the life of the President but at 7:15 minutes into Part 1 Larry Summers and a man who I believe is Austan Goolsbee come into the Oval Office for a call with "the Germans". Summers is obviously on edge and shuts down the cameras when he begins to discuss the problem.

Summers: "Life has changed..ahh..since the briefing…ahh”

Obama: "For the better or for the worse?"

Goolsbee: "Net-net for the better…wouldn’t you say Larry?" (Goolsbee speaks loudly and unconvincingly for the cameras.)

Summers: “(nervous laugh)..there’s elements of both. The Germans...actually we should stop (the cameras) here."

On May 28th, the night before the White House taping, Jim Willie of posted an article called “The Hitman Cometh” where he claimed the Germans are trying to withdraw all their physical gold from US control and several “hit men” have been hired to take down the COMEX and the LME:

"The Germans have demanded that gold bullion held in US custodial accounts be returned to their owners, with physical gold shipped back to Germany ."

I'll bet my last gold Kruggie that the Oval Office phone call was a desperate plea to buy more time before the Germans destroy the physical gold manipulation scheme.

German chancellor attacks central banks
Unconventional monetary policies being pursued by the world’s main central banks could aggravate rather than ease the economic crisis, Angela Merkel, Germany’s chancellor, suggested on Tuesday.

Her surprisingly strong attack on the US Federal Reserve, the Bank of England and the European Central Bank was remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition of never commenting on monetary policy.

“What other central banks have been doing must be reversed. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,” she told a conference in Berlin.

“Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds.”

She added: “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.”

Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting on monetary policy out of respect for central bank independence – suggested Berlin is far more concerned about the ECB’s approach than has so far been apparent.

Meanwhile, Berlin is anxious that central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and fears the long-term inflationary potential of hyper-loose monetary policies.

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