Monday, January 4, 2010

A Rude Awakening


As we leave the 'Aughts and enter the 'Teens, the economy is still on the life support of government stimulus. Don't get too excited by the Bullish Euphoria swirling in the equity markets today. The equity markets were last this bullish at the market peak in the Fall of 2007. This does not bode well for the Bulls as we enter 2o1o.

"Hello Mr. Bear. Welcome back to the show."

2010 is set up now as The Year Of Rising Interest Rates. Despite what you may have heard, this does NOT bode well for the US Dollar. The entire World has now awakened to the fact that The Emperor Has No Clothes.

The US Federal Deficit is now at $1.6 TRILLION.

The officially recognized national debt is $12.1 TRILLION [and growing].

$3.5 TRILLION is owed to foreign investors.

Unfunded national obligations of $106 TRILLION.

$9 TRILLION in projected deficits over the next 9 years.

...and there's the matter of another $1 TRILLION needed for "health care reform".

Does an unfunded debt obligation of $133.7 TRILLION lend credibility to a New Bull Market in equities, or a "surge" in the US Dollar? Looks to me like The Emperor is naked as a jaybird. Too broke to afford even a fig leaf to save his dignity.

"Let's welcome the Bond Bear to the show!"

Selling US Treasury Bonds short just may be the trade of the forthcoming decade according to Bill Bonner at The Daily Reckoning.

"Yields have been going down (meaning, the price of debt is going up) since 1983. And now, despite a supply that seems to be going off the charts, demand for Treasury bonds, notes and bills has never been stronger. What's more...if our analysis of the US economy is correct...the supply of Treasury debt is going to continue to rocket upward for many years. Deficits of $1 trillion to $2 trillion per year are going to become commonplace. How long will it be before the market in Treasury debt crashes?

How long will it be before hyperinflation...or a debt default...sends investors running for cover? We don't know...but it seems a likely bet that it will happen sometime in the next 10 years."

Believe it. The World has wised up to the US Fed's money printing scam, and their intentions to stealthily default on the nations debt to foreign creditors by debasing the Dollar. The World will begin to demand higher interest rates to account for the growing risk of continuing to purchase US Debt.

To protect themselves from the eventual fallout from the the collapse of the US Debt Market, foreign creditors will begin to shift their wealth into anything that goes up when the Dollar falls. They will seek to substitute Dollars for Gold, Oil, hard and soft commodities, any and all tangible assets that can act as an alternative form of "money" for their national wealth.

The Dollar Bear may have chosen to hibernate this Winter, but he's sleeping lightly and could spring to life when the Dollar Bulls least expect it. Do not get caught in his trap, his intent entering this new decade is the destruction of the US Dollar as the Worlds Reserve Currency. The US Federal Reserve will to see to the Dollar Bears success.

Interest Rate Swaps. This will be the financial media's buzzword of 2010. By the end of the year it will seem like an obsession of theirs. Why is that you might ask? Interest Rate Swaps are the "other shoe to drop". Interest Rate Swaps are the backside of the Financial Hurricane still swirling around us.

In 2008 the Financial Hurricane came ashore as Credit Default Swaps and the Real Estate market blew up. 2009 the eye of the Financial Hurricane passed over us as the government applied butterfly bandages to sucking chest wounds and declared the financial system sound again. 2010 the backside of the Financial Hurricane will come back ashore and knock down everything the government has propped up as the $172 TRILLION Interest Rate Swaps market implodes. The destruction of the US Treasury Bond Market, the US Equity Markets, and the US Dollar are all real possibilities as 2010 and the 'Teens kick off this week.

"The spin is that the cratering bond market is due to economic recovery and the market "anticipating" higher interest rates from the FED. My interpretation is that it is due to a massive oversupply of more debt in a world that already fell apart due to too much debt. If bonds dropped the most in thirty years we just need to ask a simple question: Did the economy make the biggest improvement in 30 years or did the Government make the biggest borrow and spend operation in thirty years? The answer to that question tells you why the bond market is falling over a cliff."
-Adrian Douglas

Bond Basics: What Are Interest Rate Swaps and How Do They Work?
Interest-rate swaps have become an integral part of the fixed-income market. These derivative contracts, which typically exchange – or swap – fixed-rate interest payments for floating-rate interest payments, are an essential tool for investors who use them to hedge, speculate, and manage risk.

This article aims to explain why swaps have become so important to the bond market. It begins with a basic definition of interest-rate swaps, outlines their characteristics and compares them with more familiar instruments, such as loans. Later, we examine the swap curve, some of the uses of swaps, and the risks associated with them.

"We can’t solve problems by using the same kind of thinking we used when we created them. "
-Albert Einstein.

Derivatives Interest Rate Swaps, The Elephant In the Room: More Pieces of the Puzzle
By: Rob_Kirby
I’d like to delve into the numbers, or math, showing how J.P. Morgan’s derivatives book cannot be ‘hedged’.

Interest Rate Swaps create demand for bonds because bond trades are implicitly embedded in these transactions. Without end user demand for the product – trading for “trading sake” creates ARTIFICIAL demand for bonds. This manipulates rates lower than they otherwise would be.

So, in the latest quarter it took 41.4 billion in bonds per day JUST TO SATISFY HEDGING OF THE GROWTH in their SWAP BOOK.

J.P. Morgan is but one of 20 primary dealers of U.S. treasury securities.

50 % of all Treasury Securities auctioned over this period were 2 yr., 20 yr, or 30 yr. – so they were not used to hedge swaps. This leaves a balance of around 50 billion bonds suitable for hedges.

Treasury also tells us foreign participation in U.S. bond auctions typically tops 20 %. So you’re now left with 40 Billion in “net new” U.S. Treasury Securities – suitable for hedges - to distribute among all domestic players for an entire quarter. The growth component of J.P. Morgan’s book alone, if it’s hedged, requires more than 1.4 billion more than this amount every day!

Bonds required to hedge the growth in Morgan’s Swap book are 1.4 billion more in one day than what is mathematically available to the entire domestic bond market for a whole quarter?

This interest rate swap book is not hedged. J.P. Morgan is the FED.

DOW 1000 Is Not A Silly Number[MUST READ]
It’s generally been accepted that new stock bull markets begin from low price-earnings ratios (6 or 7) and high dividend yields (6%-7%). These were precisely the numbers that were evident in August 1982, which was the start of one of the greatest stock bull markets in history.

When the bull market peaked in March 2000, the dividend yield had sunk to a paltry 1.1% and stock prices were 32 times earnings. At the double top in October 2007, the price earnings ratio had dropped to 18.39%, due in no small part to financials, homebuilders and other companies directly associated with the Greenspan induced boom; the dividend yield however had not been increased to reflect these large earnings and remained at less than 2%.

In March 2009, at the bottom of the initial leg of the bear market with the S & P down 56% from its peak, dividend yields had risen to 3.5%, indicating that dividends had not been cut. At the same time, the price-earnings ratio stood at 23.77, which was higher than they were at the stock market peak in October 2007.

And today? ... PEs have risen to a mind boggling 144.81%, reflecting a crash in earnings. The yield is just below 2, indicating that companies have been reluctant to cut dividends and must be hoping for a rapid recovery in the economy. That’s not going to happen.

This truth is ... that companies are paying out three times more in dividends than they are earning. -"This cannot continue long." If earnings don’t recover in short order, dividends will have to be cut and by as much as 75%.

We can assess value in another way. We know that at bear market bottoms, dividend yields typically reach 6% or even 7%. They are currently just below 2%. To reach a 6%yield, the S & P 500 would have to fall to about 375 points 65% below where it stands at present. This assumes no cut in dividends, which as we have just discussed, is a virtual impossibility.

The Outlook for 2010
By James Turk
Gold will reach $2000 per ounce ($64.30 per goldgram) some time during 2010. Gold will not fall back below $1000. In fact, it is likely that a floor has been put under the market around $1050, the price at which India made its recent gold purchase from the IMF, though I don’t expect gold to fall below $1080. Like 2009, the low point for gold will probably occur early in this year’s first quarter.

There will be two forces driving gold higher. The first will be the continuing purchases of government paper by the Federal Reserve as the dollar moves ever closer hyperinflation. The second will be the growing demand for physical metal in preference to paper-gold.

In this regard, an important tipping point occurred in July when Greenlight (a major US-based hedge fund whose decisions are widely followed) announced that it was converting its large position in GLD (the big NYSE-listed gold ETF) into physical metal. Greenlight's decision was a wake-up call for investors and asset managers who began to study Greenlight's decision.

These investors and asset managers are now realizing that there is a fundamental difference between owning ‘physical gold’ and ‘paper gold’ in its different forms (ETFs are one of those paper forms). With paper gold you do not own gold. You only own a derivative that gives you exposure to the gold price, and this exposure comes with counterparty risk. Paper gold is a financial asset. Physical gold of course is a tangible asset and therefore does not have counterparty risk.

Also, these investors and asset managers are realizing that the annual carrying cost of ETFs is considerably higher than owning physical metal. For example, the annual management fee, administrative costs, shareholder reporting, etc. of GLD is in the aggregate about 3-times more expensive than owning physical gold in GoldMoney. But here is the key point that the market is only now starting to understand.

There exists a huge amount of paper gold outstanding relative to the available stock of physical gold at these prices. Therefore, to keep supply and demand in the gold market in balance as the demand for physical metal rises, gold's price has to rise in order to entice present holders of physical metal to sell and hold some national currency instead. After all, physical gold cannot be ‘printed’ by central banks to satisfy the demand for physical metal.

So how high does the gold price have to rise? My sense of it is that this scramble for physical metal could lead to a vicious short squeeze. Regardless whether or not one occurs, the demand for physical metal won't abate until gold hits at least $2000, which I expect will happen some time in 2010. A huge short squeeze could send gold to that price in a matter of weeks. Otherwise, a continuous demand for physical metal will put gold in a steady climb throughout the year that sends it to $2000 by year-end.

Gold is cheap to buy at $1,100/oz: Marc Faber
"Gold remains the best bet as a currency these days because of the fact that the yellow metal supply is extremely limited. Gold at the current price of $1,110 per ounce is less expensive than it was sold for less than $300 per ounce years back,” Faber said batting for the bullish run that the yellow metal is in during 2010.

Faber explained that gold price should be treated in the same way that a company’s stock is being treated by investors. “A company’s stock could be less expensive at $100 than when it was selling for $10, because earnings growth has outpaced the appreciation of the shares and therefore its P/E has declined, gold could be cheaper at the current price than when it was at less than $300 because of the explosion of foreign exchange reserves in the world, zero interest rates, the huge debt overhang, and the expectation of further money printing,” he said.

According to Faber, global reserves of gold have grown from about $1 trillion in 1995 to over $7 trillion.

”Therefore, the share of gold in the world’s official reserves has declined from 32.7 per cent in 1989 to a current record low of 10.3 per cent,” he pointed out.

Faber said that he is still puzzled by the deflationists, who cannot understand that the explosion in foreign exchange reserves over the last 15 years is a symptom of a massive monetary inflation. “Ergo, I could argue that gold is now actually less expensive than when it sold for around $300 per ounce,” he said.$1100oz-Marc-Faber-24401-3-1.html

The Federal Reserve Is Openly Telling You to Buy Gold and Silver
Consider these numbers: Right now, today, without counting any of the unfunded liabilities of our government (which are very real obligations, by the way), our national debt is $12 trillion. There are roughly 100 million American households. So that's a national debt of roughly $120,000 per family. That's more than the average American owes on his mortgage.

Think about what this means in terms of interest payments. Even with interest rates at all-time lows around the world, the U.S. will spend almost $400 billion on interest to service our existing national debt – that's a 3.3% interest rate. Currently, the U.S. takes in roughly $2 trillion in taxes, half of which come from income taxes. So the interest on our debt is already consuming 20% of all tax receipts, or 40% of all income taxes.

It seems obvious to me this money will never be repaid – could never be repaid. The only real question is how much of a "haircut" our creditors are willing to accept in terms of the loss of purchasing power of the U.S. dollar. So far, inflation remains relatively benign. Our creditors don't seem to be losing very much. But we know this will change and could change rapidly, as the Fed continues to expand its balance sheet with less and less creditworthy assets. At what point will our creditors finally decide they can't finance any more of our deficit spending because we're simply not worth the risk?

Fannie Debt Merger Monetization
By: Jim Willie CB,
... ponder the following. The USTreasury Bonds are at risk of higher bond yields. They will likely not shoot up rapidly, since the JPMorgan machinery is still in operation, namely the Interest Rate Swaps. Check the Office of Comptroller to the Currency for basic evidence. A reversion to the mean, a reversal of the lopsided positions, a return to normalcy would clearly involve over a $1 trillion loss to the JPMorgan monster. The IRSwap contracts are firmly in place, ramped up, heavily fortified by Printing Pre$$ activity without scrutiny or bounds, never properly audited since done by venerable JPMorgan. While we all decry the rise of credit derivatives, few complain about low interest rates in today's age of speculation. Artificially low cost of money has fueled two decades of asset bubbles and the ruin of the US industrial base. My view is that the USFed is desperate to end their 0% rate, since they realize it caused the housing & mortgage bubbles in 2003-2007. But the USFed has returned to the scene of the crime with entrenched 0% rates, stuck for over a year. The USFed definitely does NOT want long rates to rise. They are scared witless of rising mortgage rates, since they would kill the housing market altogether, or at least put it under a massive wet blanket for an indefinite time. The IRSwap detonation could happen at either end, on the short rate or long rate, much like a stick of dynamite with a fuse at each end. Risk is acute if the USFed were to hike the FedFunds rate, since they would directly set off IRSwap explosions. The USGovt borrowing costs would triple also.

Regarding Health Care
"No one (in Congress) can explain to me what's in the bill, and for Congress to vote on a bill that they don't understand whatsoever, you got to question...what kind of government we have," New York Mayor Michael Bloomberg told The Huffington Post.

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