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Financial markets are currently in a panic, bonds spiked last week (this continues at the moment), cash deposit levels up
sharply according to BNY Mellon, US debt downgraded by Standard and
Poor’s from AAA to AA+ and equities crashing. The Chinese rating agency Dagong Global Credit Rating Co. have now lowered their
rating on the US debt from A+ to A after lowering their previous US rating
from AA to A+ in November 2010.
All agencies are warning us that they are on “negative” in
their forward view of their respective US ratings.
Here we are again back at the edge of
the abyss …yet again. This
is not the first time we have not
enjoyed this view of this elusive abyss and nor will it be the last
unfortunately. This debt crisis
is far from over and this Gold Bull is far from over.
Over 10 years ago Gordon Brown was
rumoured to state that the reason he sold half (at the time) of the UK gold
hoard was; “We stared into the abyss and were concerned that a sharply
rising gold price would alert the world to the crisis that the world was
facing. That is why we sold our
gold”. The bottom of the
gold price in 1999 – 2001 is now known as the “Brown
Bottom” in gold circles.
This now famous quote is the reason that
you read the ‘staring into the abyss’ statement so much over
recent times. It will remain
popular for some time to come; it will surface every time we come back to the edge. The quote referred to here is actually
very old. Friedrich Nietzche stated “Battle not with monsters lest ye
become a monster; and if you gaze into the abyss the abyss gazes into
you”. It tells us that we can become what we fight if we are
not extremely careful. This is a
translation so allow me some slack here.
These days we just talk about not liking what we see in the abyss and
miss the relevance which is far more profound.
What do I
mean by that statement?
Monetary authorities are there to do
what they are doing and part of that purpose is to provide stability. They stare into this abyss at times
like this wondering how to unwind this debt bubble with a soft landing – in other words with relative stability. This is impossible at this time so
they “kick the can down the road”. Please forgive this other much touted
quote but it fits perfectly.
Unfortunately the authorities are
working with irrelevant financial modelling based on; fixed exchange rates,
different global dynamics and far lower levels of debt. They are also ill advised by those
with vested interests.
Unfortunately this leads them to add more debt to the mountain in the
hope that this financial mess does not blow up on their watch (cynical view).
Alternately they hope that growth will return or that the BRICS (Brazil,
Russia, India, China and recently South Africa) will grow large enough and
fast enough to absorb a major western slow down. At least this is the logic I am
reading into their actions; perhaps I am wrong on this point.
They stare into the abyss and the fall
is so unpalatable that they take drastic measures by pumping more and more
money (debt) onto the pile. They
are also maintaining official rates way below real price inflation; thereby
pushing the debt bubble way past the point of no return. This awful fact has now reached a
wider audience’s attention thanks to the debt ceiling debacle and
recent events in Europe. Sooner
or later the Piper has to be paid
guys – the debt mountain will implode if you keep adding stimulus. Their ability to add more QE is
diminishing. The irony is that
they are not only leading us into “that
which they are trying to fight” they are also making the abyss
bigger and bigger every time they back us away from this elusive yet
unavoidable consequence. The can kicking is all about containment,
their dilemma is when do you let go?
Where are we
now?
Now back to the current situation and
the big question for investors at the moment which is… “are we there yet”? Do we fall into the abyss right now or
back away yet again? You have to
look at history to see the clear trend here because it is stark. We have faced this situation many
times in the past and the authorities step in again every time. Many commentators believe this will
keep happening until it is no longer
viable, i.e. not their choice.
I am in this camp.
The actual leap or fall into that abyss
will eventually happen when the debt maturity profiles in the bond markets
converge and coincide with a total loss of confidence. To put it another way, we go over the
edge when we finally face a much larger version of what you now see with
Greece (see the extent of the situation in the Greek 2, 5 and 10 year bond
rates below). Alternatively
“it” happens when a rogue wave event of sufficient magnitude hits
the markets and the panic cannot be contained.
We are seeing a significant yet
partial loss of confidence now as a wider group of investors wake
up. This is not a total loss of
confidence. Fears of the debt
contagion spread to Italy in recent weeks, the US has been downgraded as
expected by the market but this is largely factored in now. The gold community have long wondered
how long the AAA Rating could possibly last so this is no surprise to
us. A few weeks back I was
looking at Greece and telling subscribers that it could not be allowed
to fail at this point because of the counter party risk throughout
Europe. Total collapse is
possible if this develops too far right now so this fire will have be
extinguished as well. With gold
up $48 an ounce as I speak you have to wonder when the next major
intervention will be announced.
There is a lot to the can kicking (and why) which I cannot cover in the limited
scope of this article so I will just point out the following facts and let
your mind do the rest. German and
French banks are not rolling over most of their Portuguese, Irish, Spanish,
Italian or Greek Bonds, or second tier corporate debt from these
countries. When maturity falls
due they redeem (take the cash) and this is why we have seen 10 Year Greek
bonds rise to 14.875%. One month
ago the same Greek bonds were at 16.2% and this implies that there is little
interest; an extremely high price is being paid for new funds to rollover old
debt.
Shorter term debt is even worse, 5 Year
Bonds at a whopping 22.666% and 2 Year are at 32.594%. A default is factored in. Portugal is at 12.1%, 13.6% and 12.75%
for 10 Year, 5 Year and 2 Year Bonds which is shocking but not yet at certain default levels. Italy is not great however it is
nowhere near as bad at 5.93%, 5.23% and 4.5% for 10 Year, 5 Year and 2 Year
Bonds.
The banks are going home, they renew local debt (own country) and will avoid
the rest but they still need more time to reduce this risk. This debt crisis is also a banking
crisis and there is also unacceptable debt default risk exposure in the
insurance industry. The same
applies to Bond Funds and the giant Sovereign funds.
Just as I told you Greece would not
fail, I again lean towards the view that this current crisis of confidence
will get stamped out again to some degree. Spain and Italy have been involved in
rescue bond purchases of Greece and Ireland which I find quite bazaar, yet
such is the cooperation to contain this crisis at this stage. Now their Bond yields have been
increasing, so their own repayment burden becomes even less sustainable. This has come to the attention of the
market at great concern to the ECB which has now stepped in and offered to
buy Italian and Spanish bonds to contain the risk. Yields have already come off a little
as a result.
The whole notion of “sustainable
growth” will come into disrepute by the time this crisis is over. Debt will become a dirty word too as
the world realizes you can’t print wealth and that they cannot
turbo-boost growth with huge gobs of debt and call it a success.
The world will not end when we go into
the abyss however politicians will not fix the mess until we fall over the
edge either. Then they will be forced to do something realistic on their own
watch. So where are we now? Let’s take a look at some
interesting charts before I sign off.
Here is the 5 year / weekly 10 year US
Bond Rate chart. I lifted it from
the recent GoldOz Newsletter and you can see the
last two times the yield was smashed as hard as this we soon went into
reverse. This creates a massive capital wave that has to find a home, so
where does it go?
You will notice the RSI is heavily
oversold on the Bond chart (upper) however there is a little room for more
downside compared to last August 2010 – but we are very close. As a bond trader you just don’t
want to sit here at the moment you want to take your profits now. Bonds are looking very expensive so
perhaps the flight to safety has been overdone right now.
The probability is now that the bonds
form a reversal formation soon and reverse. In the chart above I highlighted last
August for an important reason.
One place the capital wave finds itself going is equities.
I have included the weekly chart of the
XGD below and what do we see from August 2010? This anniversary is obvious; here we
can break out from the latest green ellipse into a new upside rally with the
leading gold stocks ahead of the charge.
The exact date for the last blast off point to the upside is later
this week. Further correlation of this phenomenon can be seen back in
December 2008 when Bonds were at the last major low; this is when the XGD
took off as well.
Will it happen again this time? There is no guarantee, just as there
is no guarantee the XGD will not fall back to the 7000 level or below. These stocks are extremely cheap
relative to gold and getting cheaper, stretching that invisible elastic band
of value off the charts. Gold
stocks are undated options on the future gold price. They present excellent value as
leveraged investments into the gold market and if you pick the larger
unhedged profitable producers with a growth profile the risk is lower. This investment class is extremely
attractive now. Anyway here is
the XGD chart and the correlation to the bond prices.
The US currently has a moderately
growing economy, well below the longer term average. Pimco have
been saying however that this long term average growth rate is gone and they
are obviously right. The old
growth rates were boosted by the long term debt binge as we (collectively)
built the debt bubble. As the
bubble stops’ expanding it begins to contract and this is called
deleveraging. This slows growth
and Pimco now calls this the “new
normal”. Therefore it is a
mistake to assume that flattening growth is the old “stall
speed”. No it isn’t
the old “stall speed” it is the new normal. Low growth rates will become very
acceptable once investors adjust to this new normal.
What will reverse the markets right
now? Hard to say but I await the
latest edition of the greatest show on Earth, the finance markets. We still have our special discount
offer on Gold Membership if anybody has interest. Now the AUD: USD ratio is back in the
support range it is certainly a better time for US dollar holders to invest
in our gold stocks.
Good trading / investing.
Neil Charnock
Editor, Goldoz.com.au
REGISTERED ADVISOR – WHO THE ADVICE COMES FROM
IN THE GOLDOZ NEWSLETTER:
Colin Emery is currently a Branch Manger and Senior
Client Adviser of a Stock Broking Company in Queensland Australia. Prior to
his work in Share broking he spent nearly 20 years in Senior Management and
Trading positions in Treasuries for major International Banks such as Bank Of
America, Banque Indosuez, Barclays Bank, Bank Of
Tokyo and Deutsche Bank AG. He spent a number of years as a Senior trader in
New York, London, Singapore, Tokyo and Hong Kong with these institutions. He
also was Global Head of emerging energy, emission and commodity products for
the leading Energy and Commodities brokerage firm of Prebon
Yamane Ltd – Prebon Energy for four years
before moving to Cairns in 2003 to focus on the Stock market and Private
consulting work. The private consulting and advisory work currently
undertaken is with companies involved in Resources, Energy and Renewable
Energy and Forestry.
Neil Charnock is not a
registered investment advisor. He is a private investor who, in addition to
his essay publication offerings, has now assembled a highly experienced panel
to assist in the presentation of various research information services. The
opinions and statements made in the above publication are the result of
extensive research and are believed to be accurate and from reliable sources.
The contents are my current opinion only, further more conditions may cause
my opinions to change without notice. The insights herein published are made
solely for international and educational purposes. The contents in this
publication are not to be construed as solicitation or recommendation to be
used for formulation of investment decisions in any type of market
whatsoever. WARNING share market investment or speculation is a high risk
activity. Investors enter such activity at their own risk and must conduct
their own due diligence to research and verify all aspects of any investment
decision, if necessary seeking competent professional assistance.
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