Tuesday, September 1, 2015


A Golden Opportunity In Silver

Sep. 1, 2015 2:45 PM ET  by: QuandaryFX

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


  • The Federal Reserve is about to raise the discount rate and the dollar will probably fall.
  • As the dollar falls, silver and gold will rally.
  • Silver tends to rally at greater magnitudes than gold and the gold to silver ratio is at a multi-year high.
  • The best reward per unit of risk will probably be found by shorting gold and buying silver.

The past 3 years have been quite brutal for holders of silver, with the average position down around 50%. In fact, over the past 4 years, silver has only increased on a year-over-year basis in 5 months!

(click to enlarge)

With such a merciless sell-off many are doubtless tossing in the towel or considering exiting all remaining positions. While this is totally understandable, I believe selling now is a mistake. In fact, I think now is an excellent time to buy silver.

Recent changes in Federal Reserve policy indicate that in the very near future, the discount rate will be increased. The discount rate is the bedrock rate of the United States economy against which nearly all other interest rates are evaluated. When the Federal Reserve raises interest rates, ramifications are felt across the entire economy. Specifically, for the past 42 years, every time the Federal Reserve has raised the discount rate following a lengthy period of low stability, the dollar falls at some point by 10-12% over the next 2 years.

The economic significance of this change is profound. As the dollar weakens, basic economic theory teaches that it will take a greater amount of dollars to purchase the same amount of silver - leading to a higher price of silver. I only tend to believe economic theory if it can be quantified and proven through data.

(click to enlarge)

As you can see, economic theory is substantiated by reality - as the dollar falls, silver tends to rise. Over the past 42 years, every single time that the Federal Reserve has increased the discount rate, the dollar has declined by 10-12%. Historically, when the dollar falls by 10-12%, silver has risen by 40-60%. In other words, the data strongly suggests that it is time to buy silver.

The Gold Trade

Not only does the dollar suggest that silver is in for a strong gain, but also, the gold-to-silver ratio strongly suggests that we are at the end of a strong gold, weak silver cycle. You see, from a financial standpoint, gold and silver are very, very similar. Don't believe me? Here's the data.

(click to enlarge)

Gold and silver returns have historically exhibited fairly strong correlation. In other words, if gold increases over a time period, silver increases as well - but only in direction, not necessarily in magnitude.

(click to enlarge)

As you can see from the chart above, silver tends to experience stronger moves than gold, even though the direction is almost identical. I believe this is due to the heightened volatility associated with a less liquid instrument. A fund selling $1 billion of gold futures will not cause the same impact as selling $1 billion of silver futures - silver will move substantially more.

Since silver and gold are quite similar from a financial standpoint, we are afforded the ability to trade one instrument against the other.

(click to enlarge)

We are at the cusp of an excellent investing opportunity. Over the past 4 years, silver has witnessed a 50% sell-off while gold has only experienced a sell-off around 30%. This has driven the ratio of the gold price to silver price to the highest level since 2008. Since gold and silver are similar financial assets, their prices will eventually revert to a mean. In other words, the current ratio of gold price to silver price is too high and will tighten. As you can see in the chart above, this type of opportunity only occurs every 5 years on average. And in each of the previous occasions, silver has historically rallied against gold over the next 3-4 years. For an investor seeking the maximum reward for risk taken, I believe shorting gold (NYSEARCA:GLD) and buying silver (NYSEARCA:SLV) represents an excellent investment.

Don't get me wrong, I'm also bullish gold. I believe anyone purchasing either gold or silver is due for strong returns over the next 12-24 months. However, if you want to get the best Sharpe ratio, short gold, long silver is an excellent value proposition. Silver historically moves at greater magnitudes than gold, so as both gold and silver strengthen, the ratio of gold to silver will tighten.

Whichever way you decide to play it, the short of it is this - the Federal Reserve is increasing rates very soon. When rates rise, the dollar has fallen every single time. When the dollar falls, gold and silver rise.

The China Jinx—sent by aaajoker

Fresh factory data confirms slowdown in China's economy

  • 1 September 2015

Shanghai skylineImage caption There's growing economic concern behind the glitz of the Shanghai skyline

China's market slump

China's factory activity contracted at its fastest pace in three years in August, confirming fears that the country's growth is continuing to slow.

The official manufacturing purchasing managers' index (PMI) dropped to 49.7 from 50 in July.

A figure below 50 indicates contraction.

The weak data is likely to add to global concerns over China's economy losing steam and could send Asian and global shares down further.

A separate private Caixin/Markit index also released on Tuesday puts the PMI number even weaker, at 47.3, the weakest reading since 2009.

Fuelling market concerns

The fresh economic data is also likely to undermine efforts by Beijing to reassure investors and calm markets.

Chinese mainland stocks have been on a steep downward slope over the past months, shedding almost 40% since June.

Authorities have injected money into the markets, allowed the state pension fund to start buying up shares and lowered lending rates.

So far though, none of those measures have managed to push the markets back into positive territory and analysts have warned that the more Beijing's intervention fails to have an impact, the more likely it is that future ones will be shrugged off by investors.

China has also cracked down on people accused of spreading online "rumours", and who the authorities say have been "destabilising the market".

Is today a capitulation day?

I think the answer is yes, which means--chart-wise--that this morning's selloff will be a wave B of wave (2)--and that means--once this selloff exhausts itself, we will have a rally back to around 2000 on SPX.  After which wave (3) down will commence in earnest.  GL

Visit StockCharts.com to see more great charts.

Is ETF revolution the problem?

Rigor Mortis Of The Robo-Machines

by David Stockman • September 1, 2015

Tweet about this on TwitterShare on FacebookShare on LinkedInPrint this pageEmail this to someone

Call it the rigor mortis of the robo-machines. About 430 days ago the S&P 500 crossed the 1973 mark for the first time——-the same point where it settled today.

In between there has been endless reflexive thrashing in the trading range highlighted below. As is evident, the stock averages have not “climbed” the proverbial wall of worry; they have jerked and twitched to a series of short-lived new highs, which have now been abandoned.

Surely most thinking investors have left the casino by now. So what remains is chart driven trading programs, racing madly up, then down, then back up again—rinsing and repeating with ever more furious intensity.

^SPX Chart

^SPX data by YCharts

Accordingly, it goes without saying that the central bank driven casinos which now pass for financial markets are no place for savers, investors, rational speculators or any other known type of carbon unit. More than 80 months of ZIRP and nearly two decades of central bank financial repression have destroyed free market price discovery and eviscerated all of the normal mechanisms of stability and discipline that govern functioning markets.

Long ago short sellers were destroyed by the Greenspan/Bernanke/Yellen “put” and the endless cycle of buy-on-the-dip upswings that took the market averages to ever more lunatic levels. At the same time, speculators came to realize that their free money carry trades were not at risk because the academic pettifoggers who have usurped control of the central banks promised to give them months and months of warning before tampering with their guaranteed cost of carry by even so much as 25 basis points.

Needless to say, this kind of “forward guidance” is endlessly praised by the talking heads of bubble vision as some kind of enlightened form of central bank honesty and transparency. No surprises and all that.

Please! Transparency in manipulating and pegging the price of money is not constructive monetary statesmanship; it is a front runner’s dream and as anti-market as it gets.

For crying out loud, if you tell speculators that their overnight carry cost is pinned to the second decimal place for months into the future, they will bid anything in sight that has a yield or appreciation potential, fund it in the money market directly or indirectly, and roll the carry night after night.

At length, the upward momentum becomes so regular that the machines take over. What you have at that point is not a stock market; it is a chart plot fashioned by algos.

One of the most pernicious forms of this machine takeover is the ETF plague. Even the most inveterate human speculator of this generation, Carl Icahn, got that right when he properly denounced ETFs as a disaster waiting to happen. His CNBC interviewer almost lost his lunch when Icahn said so.

The truth is, ETF’s are not a natural product on the free market—notwithstanding all of the phony drumbeating about capitalist efficiency and innovation spewed out by their sponsors. If there were a natural investment propensity to invest in industries and sectors, as opposed to specific companies with discoverable profit prospects and appropriate discount rates, they would have been invented long before the mid-1990s when ETFs first appeared.

And it didn’t take high speed computers to make them possible. The pyramid schemes in the utility and other sectors during the late 1920s amounted to ETFs in the ink and ledger age.

What they do is provides just one more avenue for the machines to arb fleeting inefficiencies in price alignments between the stocks in the underlying basket and the ETF, and to trade still more chart points in the secondary market.

By contrast, there is no reason to believe that ETFs ever facilitated true market liquidity or facilitated the actual raising of primary capital, which is the actual function of the secondary market. After all, prior to the mid-1990s ETFs didn’t event exist, yet massive amounts of capital were raised by equity issuers in IPOs and secondary offerings accommodated by well functioning secondary markets.

Even as late as the dotcom bust in April 2000, there were only $100 billion of ETFs outstanding. Since then thousands of these gambling devices have been created by Wall Street dealers and their giant clients which dominate the so-called asset management business.

Fast forward to the third bubble peak this century, however, and there is more than $2 trillion of ETFs outstanding, representing a 20X gain in hardly 15 years. As was demonstrated during the ETF meltdown last Monday morning, they surely qualify for Warren Buffett’s famous description of derivatives as financial weapons of mass destruction.

Exhibit number one is the chart below for IBB, the ETF which tracks the NASDAQ Biotechnology index. It is a pure product of the robo-machines. Between July 2013 and its peak of nearly $400 per share last month, the index gained 130% or nearly $700 billion of market cap.

As is evident, the machines faithfully traded the 50-Day SMA and smartly bounced off the 200-Day SMA the two times that IBB modestly sold off. But what the chart does not reflect is anything having to do with honest price discovery or real value.

At the July 20th peak, the 150 companies which comprise the biotech index were valued at $1.2 trillion or 50X reported aggregate earnings for the underlying companies. Yet all of these earnings were accounted for by a handful of large cap biotechs such as Genentech and Amgen. In fact, 125 of the 150 companies in the index had no earnings at all, but were valued at $400 billion between them.

In recent weeks, however, IBB has plunged by 15% and has decisively broken the 200-day SMA that has provided support for the robo-trader buying spurts in the past. Moreover, the 50-Day SMA has already rolled over. So it is only a matter of time before the machines change gears and begin to sell the rips rather than buy the dips.
IBB Chart

IBB data by YCharts

What is quite certain is that the chart pattern above has nothing to do with what is actually happening in the biotech world.

(To be continued)

Gold set to soar?

Global Geopolitics

All Politics is now Global


Russian Military Forces Arrive In Syria, Set Forward Operating Base Near Damascus

Posted by aurelius77 on September 1, 2015

A game changing war set to open up a new chapter in world history seems right around the corner.

Note: As in other rare cases, for documentation purposes, the full article will remain here.

While military direct intervention by US, Turkish, and Gulf forces over Syrian soil escalates with every passing day, even as Islamic State forces capture increasingly more sovereign territory, in the central part of the country, the Nusra Front dominant in the northwestern region province of Idlib and the official “rebel” forces in close proximity to Damascus, the biggest question on everyone’s lips has been one: would Putin abandon his protege, Syria’s president Assad, to western “liberators” in the process ceding control over Syrian territory which for years had been a Russian national interest as it prevented the passage of regional pipelines from Qatar and Saudi Arabia into Europe, in the process eliminating Gazprom’s – and Russia’s – influence over the continent.

As recently as a month ago, the surprising answer appeared to be an unexpected “yes”, as we described in detail in “The End Draws Near For Syria’s Assad As Putin’s Patience “Wears Thin.” Which would make no sense: why would Putin abdicate a carefully cultivated relationship, one which served both sides (Russia exported weapons, provides military support, and in exchange got a right of first and only refusal on any traversing pipelines through Syria) for years, just to take a gamble on an unknown future when the only aggressor was a jihadist spinoff which had been created as byproduct of US intervention in the region with the specific intention of achieving precisely this outcome: overthrowing Assad (see “Secret Pentagon Report Reveals US “Created” ISIS As A “Tool” To Overthrow Syria’s President Assad“).

As it turns out, it may all have been just a ruse. Because as Ynet reports, not only has Putin not turned his back on Assad, or Syria, but the Russian reinforcements are well on their way. Reinforcements for what? Why to fight the evil Islamic jihadists from ISIS of course, the same artificially created group of bogeyman that the US, Turkey, and Saudis are all all fighting. In fact, this may be the first world war in which everyone is “fighting” an opponent that everyone knows is a proxy for something else.

According to Ynet, Russian fighter pilots are expected to begin arriving in Syria in the coming days, and will fly their Russian air force fighter jets and attack helicopters against ISIS and rebel-aligned targets within the failing state.

And just like the US and Turkish air forces are supposedly in the region to “eradicate the ISIS threat”, there can’t be any possible complaints that Russia has also decided to take its fight to the jihadists – even if it is doing so from the territory of what the real goal of US and Turkish intervention is – Syria. After all, it is a free for all against ISIS, right?

From Ynet:

According to Western diplomats, a Russian expeditionary force has already arrived in Syria and set up camp in an Assad-controlled airbase. The base is said to be in area surrounding Damascus, and will serve, for all intents and purposes, as a Russian forward operating base.

In the coming weeks thousands of Russian military personnel are set to touch down in Syria, including advisors, instructors, logistics personnel, technical personnel, members of the aerial protection division, and the pilots who will operate the aircraft.

The Israeli outlet needless adds that while the current makeup of the Russian expeditionary force is still unknown, “there is no doubt that Russian pilots flying combat missions in Syrian skies will definitely change the existing dynamics in the Middle East.

Why certainly: because in one move Putin, who until this moment had been curiously non-commital over Syria’s various internal and exteranl wars, just made the one move the puts everyone else in check: with Russian forces in Damascus implicitly supporting and guarding Assad, the western plan instantly falls apart.

It gets better: if what Ynet reports is accurate, Iran’s brief tenure as Obama’s BFF in the middle east is about to expire:

Western diplomatic sources recently reported that a series of negotiations had been held between the Russians and the Iranians, mainly focusing on ISIS and the threat it poses to the Assad regime. The infamous Iranian Quds Force commander Major General Qasem Soleimani recently visited Moscow in the framework of these talks. As a result the Russians and the Iranians reached a strategic decision: Make any effort necessary to preserve Assad’s seat of power, so that Syria may act as a barrier, and prevent the spread of ISIS and Islamist backed militias into the former Soviet Islamic republics.

See: the red herring that is ISIS can be used just as effectively for defensive purposes as for offensive ones. And since the US can’t possibly admit the whole situation is one made up farce, it is quite possible that the world will witness its first regional war when everyone is fighting a dummy, proxy enemy which doesn’t really exist, when in reality everyone is fighting everyone else!

That said, we look forward to Obama explaining the American people how the US is collaborating with the one mid-east entity that is supporting not only Syria, but now is explicitly backing Putin as well.

It gets better: Ynet adds that “Western diplomatic sources have emphasized that the Obama administration is fully aware of the Russian intent to intervene directly in Syria, but has yet to issue any reaction… The Iranians and the Russians- with the US well aware- have begun the struggle to reequip the Syrian army, which has been left in tatters by the civil war. They intend not only to train Assad’s army, but to also equip it. During the entire duration of the civil war, the Russians have consistently sent a weapons supply ship to the Russian held port of Tartus in Syria on a weekly basis. The ships would bring missiles, replacement parts, and different types of ammunition for the Syrian army.

Finally, it appears not only the US military-industrial complex is set to profit from the upcoming war: Russian dockbuilders will also be rewarded:

Arab media outlets have recently published reports that Syria and Russia were looking for an additional port on the Syrian coast, which will serve the Russians in their mission to hasten the pace of the Syrian rearmament.

If all of the above is correct, the situation in the middle-east is set to escalate very rapidly over the next few months, and is likely set to return to the face-off last seen in the summer of 2013 when the US and Russian navies were within earshot of each other, just off the coast of Syria, and only a last minute bungled intervention by Kerry avoided the escalation into all out war. Let’s hope Kerry has it in him to make the same mistake twice.

Full article: Russian Military Forces Arrive In Syria, Set Forward Operating Base Near Damascus (Zero Hedge)

Monday, August 31, 2015

Message: Central Banks, don’t even try

Global Geopolitics

All Politics is now Global


Central banks can’t save the markets from a crash. They shouldn’t even try

Posted by aurelius77 on August 31, 2015


Financiers have come to expect central banks to help them out. Illustration: David Simonds for the Observer

Alarming data from China was met with a soothing hint about monetary policy. But treasuries cannot keep pumping cheap credit into a series of asset bubbles

Like children clinging to their parents, stock market traders turned to their central banks last week as they sought protection from the frightening economic figures coming out of China. Surely, they asked, the central banks would ward off the approaching bogeymen, as they had so many times since the 2008 crash.

The US Federal Reserve came up with the goods. William Dudley, president of the bank’s New York branch, hinted that the interest rate rise many had expected next month was likely to be delayed.

A signal that borrowing costs would remain at rock bottom was all it took. After Black Monday and Wobbly Tuesday, the markets recovered to regain almost all their recent losses.

It was just as if they had said to themselves: who cares if China’s economy is slowing; the “Greenspan put”, which so famously propped up US stock markets during the 1990s and early 2000s with one interest rate cut after another, is still in operation.

The meeting of the world’s most important central bankers in Jackson Hole, Wyoming, this weekend only confirmed the need for Britain, Japan, the eurozone and the US to keep monetary policy loose.

Yet the palliative offered by the Fed is akin to a parent soothing fears with another round of ice-creams despite expanding waistlines and warnings from the dentist and the doctor.

According to some City analysts, the stock markets are pumped with so much cheap credit that a crash is just around the corner. And they worry that when that crash comes, the central banks are all out of moves to prevent the aftershocks from causing a broader collapse.

But China, which has borrowed heavily to keep its economy moving, is running out of steam. Beijing has said it does not want to encourage another borrowing boom. But to prevent a crash, it is doing just that. In the last two weeks it has cut interest rates and loosened borrowing limits. It has even invested directly in the market, buying the shares of smaller companies.

So we face the shocking prospect of central bankers, in thrall to stock market gyrations, making the world a more unstable place with promises of yet more cheap credit.

Full article: Central banks can’t save the markets from a crash. They shouldn’t even try (The Guardian)


If You Need To Reduce Risk, Do It Now

Aug. 31, 2015 3:40 PM ET  |  by: John Hussman

The single most important thing for investors to understand here is how current market conditions differ from those that existed through the majority of the market advance of recent years. The difference isn’t valuations. On measures that are best correlated with actual subsequent 10-year S&P 500 total returns, the market has advanced from strenuous, to extreme, to obscene overvaluation, largely without consequence.

The difference is that investor risk-preferences have shifted from risk-seeking to risk-aversion. That may not be obvious, but in market cycles across history, the best measure of investor risk preferences is the behavior of market internals, as measured by the uniformity or divergence of market action across a wide range of individual stocks, industries, sectors, and security types, including debt securities of varying creditworthiness.

Our observations on that are not new at all. Extreme overvaluation coupled with deterioration in market internals was the same set of features that allowed us to avoid the 2000-2002 and 2007-2009 market collapses. Given our success in prior cycles, why did we stumble in the advancing half of this one? The fact is that in 2009, I insisted on stress-testing our methods of classifying market return/risk profiles against Depression-era data, setting off a sequence of inadvertent but related challenges in the recent cycle, which we fully addressed last year. I’ve detailed the central lessons in nearly every weekly comment since mid-2014. The full narrative is detailed in our 2015 Annual Report. As I observed in the accompanying letter:

If there is a single lesson to be learned from the period since 2009, it is not a lesson about the irrelevance of valuations, nor about the omnipotence of the Federal Reserve. Rather, it is a lesson about the importance of investor attitudes toward risk, and the effectiveness of measuring those preferences directly through the broad uniformity or divergence of individual stocks, industries, sectors, and security types. In prior market cycles, the emergence of extremely overvalued, overbought, overbullish conditions was typically accompanied or closely followed by deterioration in market internals. In the face of Fed induced yield-seeking speculation, one needed to wait until market internals deteriorated explicitly. When rich valuations are coupled with deterioration in market internals, overvaluation that previously seemed irrelevant has often transformed into sudden and vertical market losses.

If you review my concerns in recent years, prior to mid-2014, you’ll notice that they focused on the extreme nature of the “overvalued, overbought, overbullish syndrome” that had emerged. Examining these syndromes across history, these overextended conditions were typically accompanied or quickly followed by deterioration in market internals, and then by vertical air-pockets, panics or crashes. Because of that regularity (which was picked up by the methods that emerged from our stress-testing efforts), we shifted immediately to a defensive outlook when those overvalued, overbought, overbullish syndromes emerged. The problem, in this cycle, was that the Fed aggressively and intentionally encouraged persistent yield-seeking speculation regardless of valuation extremes. One needed to wait until market internals deteriorated explicitly before taking a hard-negative outlook on the market – a requirement (“overlay”) that we imposed on our methods last year.

It may not be obvious that investor risk-preferences have shifted toward risk aversion. It’s certainly not evident in the enthusiastic talk about a 10% correction being “out of the way,” or the confident assertions that a “V-bottom” is behind us. But a century of history demonstrates that market internals speak louder than anything else – even where the Federal Reserve is concerned.

Why did stocks lose half their value in 2000-2002 and 2007-2009 despite aggressive and persistent monetary easing? The answer is that monetary easing doesn’t reliably support speculation when investors have turned toward risk aversion, as indicated by the state of market internals. Why was I admittedly wrong in having such a defensive outlook during much of the advance in recent years? Because regardless of obscene overvaluation and historically offensive extremes in sentiment and overbought conditions, market internals suggested that investors and speculators were buying every shred of the risk-seeking recklessness that the Fed was selling. Why has the market become much more vulnerable to vertical losses since last summer? Because market internals have turned negative, indicating that investors have subtly become more risk averse, removing the primary support that has held back the consequences of obscene overvaluation. If the Fed is going to launch QE4 and QE5 and QE6, or if zero interest rate conditions are going to support speculation as far as the eye can see, those policies will only have their effect on stocks by shifting investors back toward risk-seeking, and the best measure of that shift will be through the observable behavior of market internals. We don’t expect that sort of shift at these valuations, but we can’t rule it out, and in any event we’ll respond to the evidence as it emerges. Given continued extremes in valuation, our own response would likely be to shift our outlook to something that could be described as “constructive with a safety net.” For now, our outlook remains hard-negative.

If you need to reduce risk, do it now

It’s important to recognize that the S&P 500 is down only about 6% from its record high, while the most historically reliable valuation measures are double their historical norms; a level that we still associate with expected 10-year S&P 500 nominal total returns of approximately zero. We fully expect a 40-55% market loss over the completion of the present market cycle. Such a loss would only bring valuations to levels that have been historically run-of-the-mill. Investors need not expect, but should absolutely allow for, a market loss of that magnitude. If your investment portfolio is well-aligned with your actual risk tolerance and the horizon over which you expect to spend the funds, do nothing. Otherwise, use this moment as an opportunity to set it right. Whatever you're going to do, do it. You may not get another opportunity, and if you're taking more equity risk than you wish to carry over the completion of this cycle, you still have the opportunity to adjust at stock prices that are close to the highest levels in history.

The chart below offers a good idea of how little conditions have changed in response to the recent market pullback. The blue line shows the ratio of nonfinancial market capitalization to corporate gross value added, on an inverted log scale (so that equal movements represent the same percentage change). The slight uptick at the very right hand edge of the chart is barely discernable. That's the recent market selloff. Current valuations remain consistent with expectations of zero nominal total returns for the S&P 500 over the coming decade.

A final note on the impact of interest rates on expected and actual subsequent market returns, also from our Annual Report:

“It is important to recognize that while depressed interest rates may encourage investors to drive risky securities to extreme valuations, the relationship between reliable valuation measures and subsequent investment returns is largely independent of interest rates. To understand this, suppose that an expected payment of $100 a decade from today can be purchased at a current price of $82. One can quickly calculate that the expected return on that investment is 2% annually. If the current price is given, no knowledge of prevailing interest rates is required to calculate that expected return. Rather, interest rates are important only to address the question of whether that 2% expected return is sufficient. If interest rates are zero, and an investor believes that a zero return on other investments is also appropriate, the investor is free to pay $100 today in return for the expected payment of $100 a decade from today. The investor may believe that such a trade reflects ‘fair value,’ but this does not change the fact that the investor should now expect zero return on the investment as a result of the high price that has been paid. Once extreme valuations are set, poor subsequent returns are baked in the cake.”

Be careful to understand that argument correctly. Yes, low interest rates may encourage investors to drive stocks to extremely high valuations that are associated with low prospective equity returns. We certainly believe that as long as investor preferences are risk-seeking (as we infer from market internals), monetary easing and QE can encourage yield-seeking speculation that drives equities to recklessly extreme valuations. The point is that once valuations are driven to those obscene levels, low interest rates do nothing to prevent actual subsequent market returns from being dismal in the longer term. The low subsequent returns are baked in the cake.

One might like to think that, well, maybe interest rates will be just as low a decade from now too, so valuations can remain high indefinitely. The problem is that there is a very strong correlation between the interest rates at the end of any 10-year period and nominal economic growth over that same period. So even if low rates a decade from now might support higher valuation multiples, interest rates will remain this low only if economic growth turns out to be dismal (our total return estimates generally assume nominal growth of 6% annually – see Ockham’s Razor and the Market Cycle for details on that arithmetic). Because those two effects tend to cancel out, it turns out that the relationship between reliable valuation measures and actual subsequent returns is highly insensitive to the level of interest rates. Again, yes – low interest rates may encourage higher valuations. But once those rich valuations are established, the nearly direct correspondence between valuation levels and actual subsequent market returns is largely unaffected by the level of interest rates.

The following chart from May is a reminder of two things. First, the relationship between interest rates and valuations is much weaker than many observers seem to assume; and second, the close relationship between valuations and actual subsequent market returns is largely unaffected by the level of interest rates.

The upshot is this. Current valuations continue to imply approximately zero nominal total returns for the S&P 500 over the coming decade, coupled with the risk of a 40-55% market loss over the completion of the present market cycle – a loss that would only bring valuations to run-of-the-mill historical norms. An improvement in market internals would suggest a shift back to risk-seeking speculation among investors, and would defer the immediacy of our concerns. In the absence of that improvement, we continue to view the market as vulnerable to steep losses. As I noted early this year (see A Better Lesson than “This Time Is Different”), market crashes “have tended to unfold after the market has already lost 10-14% and the recovery from that low fails.” Prior pre-crash bounces have generally been in the 6-7% range, which is what we observed last week, so I certainly don’t see that bounce as having removed any of our concerns. We remain extremely alert to the prospect for much more extended market losses. Our outlook will change as the evidence does.

Again, if your portfolio is well aligned with your risk-tolerance and investment horizon, given a realistic understanding of the extent of the market losses that have emerged over past market cycles, and may emerge over the completion of this cycle, then it's fine to do nothing. Otherwise, use this opportunity to set things right. If you're taking more equity risk than you can actually tolerate if the market goes south, setting your portfolio right isn't a market call - it's just sound financial planning. It's only fun to be reckless if you also turn out to be lucky. Market conditions are now more hostile than at any time since the 2007 peak. If you want to be speculating, and you can tolerate the outcome, then you're not taking too much equity risk in the first place. But it's one or the other. Can you tolerate a 40-55% market loss over the next 18 months or so? If not, take this opportunity to set things right. That's not the worst-case scenario under present conditions; it's actually the run-of-the-mill historical expectation.

Silver will lead the way—up

Silver Is Still Searching For A Bottom

Aug. 30, 2015 6:29 AM ET  by: Prudent Finances

Disclosure: I am/we are long SLV. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


  • Silver failed to overcome the 50 dma and fell to lower lows this week.
  • The catalyst was the stock market crash in China; China is the most important source of demand growth for commodities.
  • A low-inflation and low-growth environment in the world is bad for silver.
  • Mining supply is still not being reduced.
  • The Fed will raise rates this year, but it won't hurt silver as much as the market believes.

By Ivan Y.

After an unsuccessful attempt to break above the key 50 dma, silver sold off and made lower lows this past week. Last week's damage was due mainly to the continued deflating of the stock market bubble in China in the early part of the week, which also triggered some dramatic movements in global equity markets. From the close on Friday, August 21st to Wednesday, August 26th, the Shanghai Composite Index dropped 16.5% and iShares Silver (NYSEARCA:SLV) dropped 7.2%. SLV dropped to lows not seen since 2009. Interestingly, SPDR Gold Trust (NYSEARCA:GLD) held up much better during this period, dropping only 3.1%. This is likely due to the fact that silver is more of an industrial metal than a monetary metal, whereas gold is viewed significantly more as a safe haven asset during times of financial distress. Platinum and palladium, the other two precious metals whose main usage is also as an industrial metal, also had significant declines during this period.

China has been the world's largest consumer of most commodities in the past several years due to the government's effort to build up the country's infrastructure, as well as the growing size and wealth of the middle class. In 2014, China was second only to India as the world's largest consumer for silver. China was the largest consumer previously, but a decline in jewelry and investment demand last year dropped it to second.

A slowdown in economic growth in China is a contributing reason for the bear market we have seen in industrial commodities like silver. Weakness, or an outright crash, in the stock market is not entirely indicative of the overall economy in China, but nevertheless is perceived by the markets as being negative.

I think the action we saw in silver last week was an over-reaction to what happened in China and in the global markets, and that silver should continue to recover some of those losses this week. I do not think though that silver has gotten past this bear market yet. At this point, the bears and the short-sellers appear to be winning. The rest of this article will look at some of the factors that support the bearish thesis for silver. Although I am long SLV, every investor should play devil's advocate once in a while and consider the arguments that go against your investment thesis.

The Bear Case

For the bears and short-sellers, they can point to the continued low inflationary and low economic growth environment in the world, a slow-down in economic growth in China, stubbornly high silver production by the miners, and the looming Fed rate hike.

The core inflation rate in the U.S. for July was reported to be 1.8% year-over-year. Over nearly the last six decades, core inflation in the U.S. has averaged about 3.7%. Elsewhere around the world, we have core inflation rates that are similar to the level in the United States: (Year-over-year for July unless otherwise noted)

  • Australia 1.98% (June)
  • Canada 2.4%
  • France 0.7%
  • Germany 1.14%
  • Italy 0.75%
  • Spain 0.78%
  • U.K. 1.2%

Inflation is low in Asia as well:

  • China 1.7%
  • Japan 0.0%
  • South Korea 2.0%

(Source: Trading Economics)

This is happening despite the fact that there is ongoing quantitative easing in Europe and Japan, as well as low interest rates around the world. Global Inflation should not be this low given these conditions, but it is, and that is contributing to the extended duration of silver's bear market. This is likely due to the fact that deflationary forces such as the huge amount of debt that has been built up are countering the easy monetary policies around the world. At this time, inflationary and deflationary forces appear to be canceling each other out, which is good in a sense for the world, but that's not good for gold and silver investors.

In addition to economic factors, another problem supporting the bear case is the fact that the mining companies refuse to cut production even though we are four years into a bear market already. The sector I follow most closely is the primary silver miners and instead of cutting production, some of them are actually raising production:

  • SilverCrest (NYSEMKT:SVLC): 681k oz. (2015 Q2) vs 173k oz. (2014 Q2)
  • Silver Standard (NASDAQ:SSRI): 2.44 million oz. (2015 Q2) vs. 2.04 million oz. (2014 Q2)

These mining companies are not doing any favors to investors in silver bullion, futures, SLV, or any other exchange-traded product. It's easy to understand why they are increasing production. They need to make up for lost revenue due to lower silver prices, and the only way to do that is to increase volume. You see this strategy implemented by oil & gas producers right now as well to compensate for low oil and gas prices. Silver producers can maintain a reasonable amount of operating cash flow and revenue by increasing volume, but in the long-run it will benefit silver investors because silver is a depleting resource. Every ounce that is mined today is an ounce that won't get mined in the future.

Production cuts are also not happening yet because costs have been driven down. Besides cutting costs like exploration expenses, lower oil prices have greatly benefited mining companies. Mining is an energy intensive business. Diesel fuel is the main source of energy for mining equipment. Here are some examples of how costs have been reduced this year:

  • Cash cost for Pan American Silver (NASDAQ:PAAS): $9.41 (2015 Q2) vs. $12.51 (2014 Q2)
  • All-in cost for Coeur Mining (NYSE:CDE): $16.8 (2015 Q2) vs. $19.89 (2014 Q2)

Cutting expenses and buying diesel at lower prices are great for the mining industry, but it's not good for silver itself because supply cuts, if there had been any, would've eventually provided a lift to silver prices because in the long-run supply and demand fundamentals do matter despite the fact that current silver pricing is largely based on sentiment and technicals.

The Fed: Rate Hike(s)

Adding to the bear thesis is that the market perceives that a Fed rate hike will hurt gold and silver prices. Whether it comes in September, October, or December, I think the Fed has to raise rates this year in order to preserve their own credibility. Although the market views this negatively, I think it will have more of a neutral or positive affect on silver. There's been so much talk of raising rates that the first rate hike has almost certainly been priced into every asset including silver. A few weeks ago, I showed here how historically the Fed raising rates has actually benefited gold prices because the anticipation of a rate hike was actually worse than the rate raising cycle itself. Historically, silver has not responded to Fed rate raising cycles as well as gold, but it's fair to say that raising rates hasn't really hurt silver that much. During the 2004-2006 period, silver rose from around $6 to as high as $15 even though the Fed raised rates several times during this period.

(click to enlarge)

Prior to 2004-2006, the next most recent period of rate hikes was from June 1999 to May 2000. Silver had a few spikes higher, but ended the period slightly down.

(click to enlarge)

These two examples show that silver does not respond as negatively to rate hikes as the market believes.


Although I only discussed the bear case for silver, I think the risks for bears and bulls are roughly balanced, but the bearish arguments are more prominent right now, while some of the bullish arguments (e.g. the potential for QE4) will be more prominent in the future. Thus, even though silver is already very deep into a bear market and most of the damage has already been done, I would not rule out the possibility that silver could still drift another couple dollars lower. The October 2008 closing low was $8.79 for spot silver. I don't see silver falling that low because in 2008 we were in a full-blown economic crisis that affected every asset, but a final low price, perhaps occurring in a final capitulation during the thinly-traded after hours market, between $8.79 and the current price is a possibility. There's no way to pick a bottom which is why buying in tranches on the way down makes the most sense strategically. One thing that is guaranteed is that silver won't go to zero. In a worst-case scenario, the mining and royalty companies could all go to zero, but not silver.

In the very near-term, I think silver can move a little higher. The most recent CoT report is still favorable for the bulls and the seasonality from September all the way to March has been historically favorable as well. I would keep an eye on the 50 dma which is currently at $15.11 ($14.47 for SLV). That is an important resistance area and silver needs to break above it. If it does, then maybe we have already seen the final bear market low. If not, it would be a bad defeat for silver and would indicate that the bear market will keep going.

Bravo, David Stockman

Stanley Fischer Speaks——-More Drivel From A Dangerous Academic Fool

by David Stockman • August 31, 2015

Tweet about this on TwitterShare on FacebookShare on LinkedInPrint this pageEmail this to someone

With every passing week that money markets rates remain pinned to the zero bound by the Fed, the magnitude of the financial catastrophe hurtling toward main street America intensifies. That’s because 80 months—– and counting—–of zero interest rates are fueling the most stupendous gambling frenzy that Wall Street has ever witnessed or even imagined. Sooner or later, therefore, this mother of all financial bubbles will splatter, bringing untold harm to millions of households which have been lured back into the casino.

The truth is, zero cost in the money market is irrelevant to main street. As we have repeatedly demonstrated the household sector is stranded at “peak debt” and, consequently, there is no interest rate low enough to elicit a spree of pre-crisis style consumer borrowing and spending.  Based on the clueless jawing that occurred this weekend at Jackson Hole, the following simple chart that I laid out last week bears repeating:

On the eve of the financial crisis in Q1 2008, total household debt outstanding—including mortgages, credit cards, auto loans, student loans and the rest——– was $13.957 trillion. That compare to $13.568 trillion outstanding at the end of Q1 2015.

That’s right. After 80 months of ZIRP and an unprecedented  incentive to borrow and spend, households have actually liquidated nearly $400 billion or 3% of their pre-crisis debt.

Likewise, zero money market rates are irrelevant to legitimate business finance. That’s because no sane executive would finance the life blood of his enterprise—–the working stock of raw, intermediate and finished goods——in the overnight money market; and, self-evidently, free overnight money is beside the point when it comes to funding long-term, illiquid but productive assets such as plant, equipment and software.

In fact, the only impact that free money market funding has on corporate America is round-about and perverse. To wit, it flushes money managers into a desperate quest for yield and provides stock speculators with endless opportunities to load up their trucks with zero cost carry trades, thereby driving the stock averages to lunatic heights.

As a result of this double-whammy, the C-suites of corporate America have been turned into glorified gambling parlors. The stock option obsessed executives domiciled there are endlessly and overpoweringly presented with the opportunity to sell cheap corporate credit to yield-hungry fund mangers and use the proceeds to buyback their own over-priced stock or to acquire at a hefty premium the equally over-priced stock of their competitors, suppliers and customers, or any other company that Wall Street bankers happen to be peddling.

Again, as I demonstrated last week, after 80-months of the absurd proposition that money has no natural and inherent economic cost the pettifoggers who held forth at Jackson Hole betrayed no clue whatsoever that they are aware of the obvious:

On the margin, all of the gains in business debt since 2008 has been flushed right back into Wall Street in the form of stock buybacks and debt-financed takeovers.

Non Financial Business Net Debt- Click to enlarge

The evidence that zero interest rates have not promoted business borrowing for productive investment is also plain to see. During the most recent year (2014), US business spent $431 billion on plant, equipment and software after depreciation. That was 7% less than net business investment in 2007.

And these are nominal dollars! So all other things being equal, net business debt could have fallen over the past 7 years. The actual gain in net debt outstanding shown above self-evidently went into financial engineering—-that is, back into the Wall Street casino.

Here’s the thing. You don’t need fancy econometric regression analysis or DSGE models to see that ZIRP is an macroeconomic dud. Simple empirical data trends show that it hasn’t goosed household borrowing and consumption spending, nor has it stimulated business investment.

So this is how it boils down. The only thing zero money market interest rates are good for is to subsidize financial market speculation. ZIRP means that the speculator’s cost of goods (COGS) is essentially zero whenever yielding or appreciating assets are funded in the repo market or its equivalent in the options pits and Wall Street confected OTC trades.

Accordingly, after 80 months of showering Wall Street with what is a wholly unnatural and perverse financial windfall—-that is, zero cost in the money market—–the Fed has ignited a rip-roaring inflation. But the inflation is in the financial market, not the supermarket.

Needless to say, there was not even a faint trace of recognition of this fundamental reality in Stanley Fischer’s much heralded Jackson Hole speech on inflation. As usual, it was an empty bag of quasi-academic wind about utterly irrelevant short-term twitches in various inadequate measures of consumer inflation published by the Washington statistical mills. Indeed, Fischer went so far as to acknowledge that one of the more plausible consumer prices indices—–the Dallas Fed’s “trimmed mean” measure of the PCE deflator—–was up 1.6% in the past year.

Here’s the thing. No one except the modern equivalent of medieval theologians counting angels on the head of a pin could think that the difference between this reading and the Fed’s arbitrary 2.0% inflation target is of significance to any economic actor in the real world. That fleeting and miniscule difference would never in a thousand years impact the wage and price behavior of firms competing in the world market for tradable goods where cheap labor and mercantilist FX and subsidy policies drive the competition for customers.

Nor would it alter the behavior of the overwhelming share of purely domestic service firms that inherently face an elastic supply curve owing to low entry barriers. There is an unlimited supply of nail salons and yoga studios because folks need work and the Fed’s financial repression policies have fueled a fantastic over-expansion of strip mall real estate.

Likewise, firms with deep brand equity everywhere and always try to raise prices to capture the heavy marketing and other investments which go into creating their brands’ value and consumer franchises. But only clueless academic modelers like Fischer would ever think that 40 basis points of shortfall in the short-run consumer inflation trend would impact the pricing strategy of brand name service firms——-such as Amazon and Wal-Mart, for example.

In short, Fischer’s entire meandering discourse on this and that inflation index and his speculations about immeasurable “inflation expectations” was irrelevant drivel. It could have been delivered by any student who had passed Economics 101 at Podunk College.

And besides that, the man has the gall to cite the “Survey Of Economic  Projections” (SEP) as one key indicator showing that inflation expectations have remained “anchored”. For crying out loud, the SEP is the quarterly stab in the dark about the inflation outlook concocted by the 19 members of the Federal Reserve itself!

In fact, the only real value of Fischer’s pretentious bloviation was that it was a reminder that the financial system of the world is in thrall to a tiny, insuperably arrogant posse of Keynesian academics who have invented  from whole cloth a monetary theory of plenary control. They have effectively ended free market capitalism in the financial system and beyond and made democratic fiscal governance essentially irrelevant.

Here’s why. It all starts with the Fed’s specious mantra that the “Humphrey-Hawkins” dual mandate makes them do it.

No it doesn’t!  Nowhere does it instruct the Fed to keep its fat foot on the neck of liquid savers and depositors for 80 months running.

In fact, Humphrey-Hawkins is a content-free expression of Congressional sentiment crafted under the far different economic conditions of the mid-1970’s. It essentially says price stability and fulsome employment are devoutly to be desired national objectives ranking right up there with motherhood and apple pie.

Indeed, the Humphrey-Hawkins Act, which I voted against in 1977, is no more meaningful than the plethora of “captive nations” resolutions, which I voted for that same year——-and just as archaic, too.

In today’s globalized economy, the Fed’s ballyhooed 2% inflation target is no more warranted by the statute’s rubbery language on “price stability” than is 3%, 1% or 0%. And the Fed’s preference for the PCE deflator index of consumer inflation, as measured over a never explained or defined period of time, is no more mandated by the Act than is use of the Cleveland trimmed median or the indices of the MIT Billion Prices Project, as measured monthly, quarterly, yearly or for any other arbitrarily defined period.

In short, the Fed’s 2% target as practiced in the Eccles Building and gummed about by Fischer last Saturday is nothing more than the arbitrary concoction of one demonstrably erroneous and obsolete school of economics. Over the past two decades these Keynesian statist throwbacks to the 1930s have infiltrated the boards and staffs of most of the world’s central banks——and have used their unlimited resources to hire most of the worlds so-called “monetary economists” to write self-justifying studies and perform “research” that is more in the nature of what used to be called “agit prop”.

At the same time, how could the legions of financiers, fund managers, economists, strategists and traders who inhabit Wall Street possibly object——-even if they have no use whatsoever for the Keynesian religion of Fischer and his sidekicks?

The answer is in the chart below. Under the guise of its silly and arbitrary Humphrey-Hawkins targets the academic fools and crony capitalist opportunists who inhabit the Fed have been delivering a relentless drip of monetary heroin to the casino gamblers 80% of the time over the last 25 years.

The Fed's Addiction To The 'Easy Button': Rates Falling Or Flat 80% Of The Time Since 1990 - Click to enlarge

The Fed’s Addiction To The ‘Easy Button': Rates Falling Or Flat 80% Of The Time Since 1990 – Click to enlarge

So with academia on its payroll and Wall Street on its gift list, there is no one left to state the obvious. Namely, that by fueling the most fantastic inflation of financial assets in world history the Fed and its convoy of global central banks have sown its opposite in the real main street economy.

To wit, there is now a massive deflationary tidal wave cresting on the planet, and it was manufactured entirely by the central banks. In the DM world, consumers and governments are stranded at “peak debt” and can no longer live beyond their means by leveraging their balance sheets to the breaking point, as they did in the 30 years leading to the financial crisis.

Likewise, the EM world has buried itself in “peak investment”. This condition is owing to the massive repression of capital costs instituted over the last three decades by their mercantilist central banks in the process of buying dollars and euros to peg their exchange rates, thereby flooding their economies with cheap domestic credits.

As a consequence, the world economy is drowning in malinvestment and excess capacity for virtually every commodity from oil to iron ore and for every stage of downstream industrial production from refineries to blast furnaces, pipe and tube mills, ship-building facilities, car plants and container ships, ports and warehouses.

Moreover, two decades of lunatic money printing have also drastically roiled the global capital and currency markets.  During the last 20 years of financial inflation, the Keynesian central bankers have forced DM world money managers to scour the globe looking for yield regardless of risk——a toxic form of malinvestment which is now violently reversing.

That is, credit-saturated EM economies are now imploding, causing their exchange rates to crash, as in Brazil; or is forcing their governments to dump massive amounts of dollar assets——accumulated over the long decades of monetary inflation—–in desperate efforts to prop-up their currencies, as is now happening in China.

Yet the clueless academic who has spent a lifetime contributing to this disaster—–first at MIT where he superintended Bernanke’s misbegotten thesis claiming that the Fed’s failure to massively crank up the printing presses during 1930-1932 was the cause of the Great Depression, through his work as a certified monetary apparatchik at the IMF, the Israeli central bank and now the Fed——effectively confessed in his Jackson Hole speech that he can’t see the forest for the trees.

Well, goodness, gracious. Yes, tumbling commodity prices and the on-going scramble to cover the massive global “dollar short” is roiling the sundry US consumer prices indices. But that is simply the feedback loop of central bank monetary repression and systematic falsification of financial asset prices.

Yet central banker obliviousness to these self-created interferences with and repudiation of their Keynesian bathtub models of macroeconomics knows no bounds. So they continue to equivocate, bloviate and insist that they will keep subsidizing the casino——presumably until it finally blows sky high so that they can resume tilting at “contagion”, which is to say, the violent re-pricing of asset bubbles that they caused in the first place.

Here is Fischer’s concluding paragraph. It leaves no doubt that he is oblivious to the financial firestorm brewing everywhere in the world, and that he is one of the most dangerous academic fools every to gain immense power over the fate of millions of ordinary citizens:

The Fed has, appropriately, responded to the weak economy and low inflation in recent years by taking a highly accommodative policy stance. By committing to foster the movement of inflation toward our 2 percent objective, we are enhancing the credibility of monetary policy and supporting the continued stability of inflation expectations. To do what monetary policy can do towards meeting our goals of maximum employment and price stability, and to ensure that these goals will continue to be met as we move ahead, we will most likely need to proceed cautiously in normalizing the stance of monetary policy………

When the next financial bubble crashes it can only be hoped that this time the people will grab their torches and pitchforks. Stanley Fischer ought to be among the first tarred and feathered for the calamity that he has so arrogantly helped enable.

Gold still an option

January as Stock Market Rout Lifts Safe Haven

Submitted by IWB, on August 31st, 2015

by GoldCore

Today’s Gold Prices: Bank Holiday in UK today
Friday’s Gold Prices:  USD 1,125.50, EUR 998.23 and GBP 730.99 per ounce.

Last week gold and silver prices fell and gave up some of the gains from the previous week. Gold was 2% lower on Friday and indeed 2% lower for the week and closed at $1134.40 per ounce. Silver was 4.5% lower for the week and closed at $14.59 per ounce but is just 1.8% lower for the month of August.

GoldCore Bullion Coins & Bars

August has been a tumultuous month with stocks seeing sharp losses and gold has again protected investors from sharp losses. Gold has had a 3.36% gain for the month so far (see table below).

Gold is on track for the best monthly advance since January after most market participants were surprised by the devaluation of China’s currency. This has fueled concerns about further currency wars and about the world’s second-largest economy and indeed the global economy may be vulnerable to a recession – potentially a severe one.

Gold exchange-traded fund holdings rose to a one-month high last week on safe haven demand. The MSCI All-Country World Index of equities is headed for the worst monthly performance since May 2012 and a gauge of 22 raw materials was set to decline for a second month.

Month to Date relative performance Gold
Monthly Asset Performance – Finviz.com

Inflation Hounds Disappointed

Euro zone inflation defies expectations, unchanged in Aug vs July

BRUSSELS Aug 31 Euro zone inflation was the same in August as in July year-on-year, defying market expectations of a slowdown as rising prices of unprocessed food and services offset some of the downward pull from much cheaper energy, a first official estimate showed.

The European Union's statistics office Eurostat said euro zone prices rose 0.2 percent year-on-year this month, the same as in July. Economists polled by Reuters had expected inflation at 0.1 percent year-on-year.

Cheaper energy was the biggest factor lowering the overall index, with energy prices 7.1 percent lower in August than a year earlier. Unprocessed food had the biggest upward impact on inflation as its prices rose 2.3 percent in annual terms.

Excluding both the volatile energy and unprocessed food price -- a measure the European Central Bank calls core inflation -- consumer prices rose 0.9 percent year-on-year in August, the same as in July. (Reporting By Jan Strupczewski)

Saturday, August 29, 2015

Gold anyone?

Rick Rule: “Scary Times Are Upon Us – Capitulation Is Beginning in This Market”

Submitted by IWB, on August 29th, 2015

Rick Rule & Henry Bonner, Sprott Global, Released on 8/25/15

Click Here to Listen to the Interview

“The capitulation we’ve been talking about for a couple of years is beginning to occur,” Rick warns.

“I suspect that this capitulation will be over by the end of October. And it could get much worse before then. The point is – any ‘junk’ you have left, sell it if you can.”

“Hold lots of cash,” he suggests. “Cash gives you the means and the courage to take advantage of poor market conditions and the mistakes of others.

“If the Fed cancels a rate hike or announced ‘QE4,’ it would damage the US dollar. It would be good for gold and precious metals,” says Rick.

What will FED do about China?–sent by aaajoker

Why QE4 Is Inevitable

Tyler Durden's picture

Submitted by Tyler Durden on 08/28/2015 22:51 -0400

One narrative we’ve pushed quite hard this week is the idea that China’s persistent FX interventions in support of the yuan are costing the PBoC dearly in terms of reserves. Of course this week's posts hardly represent the first time we've touched on the issue of FX reserve liquidation and its implications for global finance. Here, for those curious, are links to previous discussions:

And so on and so forth.

In short, stabilizing the currency in the wake of the August 11 devaluation has precipitated the liquidation of more than $100 billion in USTs in the space of just two weeks, doubling the total sold during the first half of the year.

In the end, the estimated size of the RMB carry trade could mean that before it’s all over, China will liquidate as much as $1 trillion in US paper, which, as we noted on Thursday evening, would effectively negate 60% of QE3 and put somewhere in the neighborhood of 200bps worth of upward pressure on 10Y yields.

And don't forget, this is just China. Should EMs continue to face pressure on their currencies (and there's every reason to believe that they will), you could see substantial drawdowns there too. Meanwhile, all of this mirrors the petrodollar unwind. That is, it all comes back to the notion of recycling USDs into USD assets by the trillions and for decades. Now, between crude's slump, the commodities bust, and China's deval, it's all coming apart at the seams.

Needless to say, this "reverse QE" as we call it (or "quantitative tightening" as Deutsche Bank calls it) has serious implications for Fed policy, for the timing of the elusive "liftoff", and for the US economy more generally. Of course we began detailing the implications of China’s Treasury liquidation months ago and now, it’s become quite apparent that analyzing the consequences of China’s massive FX interventions is perhaps the most important consideration when attempting to determine the future course of global monetary policy. 

On that note, we present the following from Deutsche Bank’s George Saravelos, which can be summarized with the following snippet:

The potential for more China outflows is huge: set against 3.6 trio of reserves, China has around 2 trillion of “non-sticky” liabilities including speculative carry trades, debt and equity inflows, deposits by and loans from foreigners that could be a source of outflows (chart 2). The bottom line is that markets may fear that QT has much more to go.   

What could turn sentiment more positive? The first is other central banks coming in to fill the gap that the PBoC is leaving. China’s QT would need to be replaced by higher QE elsewhere, with the ECB and BoJ being the most notable candidates... Either way, it is hard to become very optimistic on global risk appetite until a solution is found to China’s evolving QT

In other words, first according to Deutsche, and soon according to virtually all sellside strategists who are slowly but surely grasping the significance of what we have been warning for month on end, QE4 is inevitable. The only problem is that when the Fed pivots from "imminent rate hike" to QE4, it will loose the last shred of credibility it had left. The Fed is now completely trapped.

*  *  *

Beware China’s Quantitative Tightening

Why have global markets reacted so violently to Chinese developments over the last two weeks? There is a strong case to be made that it is neither the sell-off in Chinese stocks nor weakness in the currency that matters the most. Instead, it is what is happening to China’s FX reserves and what this means for global liquidity. Starting in 2003, China engaged in an unprecedented reserve-accumulation exercise buying almost 4trio of foreign assets, or more than all of the Fed’s QE program’s combined (chart 1). The global impact was indeed equivalent to QE: the PBoC printed domestic money and used the liquidity to buy foreign bonds. Treasury yields stayed low, curves were flat, and people called it the “bond conundrum”.

Fast forward to today and the market is re-assessing the outlook for China’s “QE”. The sudden shift in currency policy has prompted a big shift in RMB expectations towards further weakness and correspondingly a huge rise in China capital outflows, estimated by some to be as much as 200bn USD this month alone. In response, the PBoC has been defending the renminbi, selling FX reserves and reducing its ownership of global fixed income assets. The PBoC’s actions are equivalent to an unwind of QE, or in other words Quantitative Tightening (QT).

What are the implications? For global risk assets, they are clearly negative –global liquidity is falling. For fixed income, the impact on nominal yields is ambivalent because private safe-haven demand for bonds may offset central bank selling. But real yields should move higher, inflation expectations lower, and there should be steepening pressure on curves. This is indeed how markets have responded over the last two weeks: as if the Fed has announced it is unwinding its balance sheet!

The potential for more China outflows is huge: set against 3.6trio of reserves (recorded as an “asset” in the international investment position data), China has around 2trillion of “non-sticky” liabilities including speculative carry trades, debt and equity inflows, deposits by and loans from foreigners that could be a source of outflows (chart 2). The bottom line is that markets may fear that QT has much more to go.

What could turn sentiment more positive? The first is other central banks coming in to fill the gap that the PBoC is leaving. China’s QT would need to be replaced by higher QE elsewhere, with the ECB and BoJ being the most notable candidates. The alternative would be for China’s capital outflows to stop or at least slow down. Perhaps a combination of aggressive PBoC easing and more confidence in the domestic economy would be sufficient, absent a sharp devaluation of the currency to a new stable. Either way, it is hard to become very optimistic on global risk appetite until a solution is found to China’s evolving QT.

Thursday, August 27, 2015

All quiet . . . in the eye of the storm

Top JPMorgan Quant Warns Second Market Crash May Be Imminent

by ZeroHedge • August 27, 2015

Tweet about this on TwitterShare on FacebookShare on LinkedInPrint this pageEmail this to someone

Last Friday, when the market was down only 2%, we presented readers with a note which promptly became the most read piece across Wall Street trading desks, which was written by JPM’s head quant Marko Kolanovic, who correctly calculated the option gamma hedging imbalance into the close, and just as correctly predicted the closing dump on Friday which according to many catalyzed Monday’s “limit down” open.


Given that the market is already down ~2%, we expect the market selloff to accelerate after 3:30PM into the close with peak hedging pressure ~3:45PM. The magnitude of the negative price impact could be ~30-60bps in the absence of any other fundamental buying or selling pressure into the close.

We bring it up because Kolanovic is out with another note, one which may be even more unpleasant for bulls who, looking at nothing but price action, were convinced that after the biggest two day market jump in history, the worst is behind us.

In the just released note, the head JPM quant warns that a large pool of assets controlled by price-insensitive managers including derivatives hedgers, Trend Following strategies (CTAs), Risk Parity portfolios and Volatility Managed strategies, which is programmatically trading equities regardless of underlying fundamentals, is about to start selling equities, “and will negatively affect market in coming days and weeks.” For good measure, he casually tosses the word “crash” in the note as well.

By way of reference, JPM notes that a good example of how price-insensitive sellers can cause market a disruption/crash is the price action on the US Monday open. It says that technical selling related to various hedging programs, in an environment of low (pre-market) liquidity indeed caused a ‘flash crash’ on Monday’s open. S&P 500 futures hit a 5% limit down preopen, and then a 7% limit low at 9:31 and 9:33. The inability of hedgers to short futures spilled over into large cap stocks that were still trading and could be used as a proxy hedge. Had it not been for the futures limit down event, the selloff would likely have been worse as indicated by the price of the index implied by individual stocks. The figure below shows the S&P 500 futures, SPY ETF and S&P 500 replicated from
the largest stocks that were trading near the market open.

Kolanovic correctly takes credit for his prediction and notes that “in our Friday note we forecasted end-of-the-day selling pressure due to option gamma hedging. We saw similar price impacts on Thursday, Friday, and Monday (pushing the market lower into the close) and an upside squeeze on Wednesday. Our estimate is that up to 20% of market volume was driven by hedging of various derivative exposures such as options, dynamic delta hedging programs, levered ETF stop loss orders, and other related products and strategies (note that levered ETFs have gamma exposure of only ~$1bn per 1%, i.e., much smaller than that of S&P 500 options). We estimate the cumulative selling pressure from options hedging during the market selloff to be ~$100bn. Options gamma is expected to remain substantially (in excess of $20bn) tilted towards puts while the S&P 500 is between 1850 and 2000.

The figure below shows Put-Call Gamma assuming current open interest and different spot prices. JPM expects high volatility to persist (should we stay in this price range) and cause quick intraday moves up or down, particularly towards the end of the trading day.

According to the quant, it is not only derivative hedgers who are pushing the market around like a toy with barely any resistance: :in fact, there is a much larger pool of assets that is programmatically trading equities regardless of underlying fundamentals.”

It is these investors who, “in the current environment” are selling equities and “will negatively impact the market over the coming days and weeks.

Trend Following strategies (CTAs), Risk Parity portfolios, and Volatility Managed strategies all invest in equities based on past price performance and volatility. For instance, in our June market commentary we showed that if the equity indices fall 10%, these trend followers may need to subsequently sell ~$100bn of equity exposure. These types of ‘price insensitive’ flows are starting to materialize, and our goal is to estimate their likely size and timing. These technical flows are determined by algorithms and risk limits, and can hence push the market away from fundamentals.

This is where it gets scary for the bulls who thought we may be out of the woods, and that the crash was behind us. If Marko is right, as of this moment we are merely in the eye of the hurricane:

The obvious risk is if these technical flows outsize fundamental buyers. In the current environment of low liquidity, they may cause a market crash such as the one we saw at the US market open on Monday. We attempt to estimate the amount of these flows from three groups of investors: Trend Following strategies (CTA), Risk Parity portfolios, and Volatility Managed strategies. These investors follow different signals and have different rebalancing time frames. The time frame is important as it may give us an estimate of how much longer we may see selling pressure.

So, how much longer may we see the selling pressure?

1. Volatility Target (or Volatility Control) strategies provide the most immediate selling as a reaction to the increase in volatility. These strategies adjust equity leverage based on short-term realized volatility. Typical signals are 1-, 2-, or 3-month realized volatility. Volatility target products are provided by many dealers, index providers and asset managers. Volatility targeting strategies also became very popular with the insurance industry. After the 2008 financial crisis, many Variable Annuity (VA) providers moved from hedging their equity exposure with options to investing directly in volatility target indices (e.g., 10% volatility target S&P 500). It is estimated that VA issuers have ~$360bn in strategies that are managing volatility; some of these use options to manage tail risk, some buy low volatility stocks, and some invest in volatility target strategies. We estimate that strategies that are targeting a particular level of  volatility or managing to an equity floor could have $100-$200bn of assets.

Assuming that, on average, these strategies follow a 2-month realized volatility signal, we can estimate their selling pressure. 2M realized volatility increased over the past week from ~10% to ~20% (i.e., doubled), so these strategies need to reduce equity exposure by up to ~50% to keep volatility constant. This could lead to $50-$100bn of selling, and it likely started already this week. There is often a delay of 1-3 days between when a signal is triggered and trade implementation, and positions are often reduced over several days. We think  this could have contributed to the ‘unexpected’ selloff that happened in the last hour of Tuesday’s trading session. While these flows may continue to have a negative impact over the next few days, they would be the first to reverse (start buying the market) when volatility declines.

2. Trend Following strategies/CTA funds have an estimated ~$350bn in AUM. We modelled CTA exposures in our May and June commentaries, and estimated flows under different scenarios for asset prices. In particular, under a 10% down scenario in equites we estimated CTAs need to sell ~$100bn of equities. In our model, the bulk of selling was in US markets, some in Japan and relatively little in Europe. S&P 500 futures did underperform Europe (by ~3%) and Japan (by ~2%) over the last two trading sessions (European hours), which may indicate that CTA flows have started to impact equity markets. The rebalance time frame for CTA strategies is typically longer than for volatility control strategies. CTA funds may act on their signal in a period that ranges from several days to a month. We believe that selling from CTAs may have just started and will continue over the next several days/weeks.

3. Risk Parity is one of the most popular and (historically) successful portfolio construction methodologies. Risk Parity allocates portfolio weights in proportion to assets’ total contribution to risk (a simplified version, called Equal Marginal Volatility allocates inversely proportional to the asset’s realized volatility). In a survey of quantitative investment managers (~800 clients in US and Europe), we found that ~50% prefer a Risk Parity approach (vs. 15% for traditional fixed weights (e.g., 60/40), 20% Markowitz MVO, and ~20% active asset timing). Estimated assets in Risk Parity strategies are ~$500bn and ~40% of these assets may be allocated to equities. Risk Parity portfolios may also incorporate leverage, often 1-2x. Risk parity funds often rebalance at a lower frequency (e.g., monthly, vs. daily for volatility target) and use slower moving signals (e.g. 6M or 1Y realized volatility). The increase in equity volatility and correlation would cause Risk Parity portfolios to reduce equity exposure. For instance, 6M realized volatility increased from 11% to 15% and a modest increase in correlations would result in approximately a ~20% reduction of equity exposure. Based on our estimate of Risk Parity equity exposure, this could translate into $50bn-$100bn of selling over the coming weeks.

In summary, JPM estimates that “the combined selling of Volatility Target strategies, CTAs and Risk Parity portfolios could be $150-$300bn over the next several weeks. Rebalancing of these funds may appear as a persistent and fundamentally unjustified selling pressure as these funds execute their programs. In addition, there may be a positive feedback loop between all of these sellers – Gamma hedging of derivatives causes higher market volatility, which in turn leads to selling in Risk Parity portfolios, and the resulting downward price action invites further CTA shorting. All of these flows pose risk for fundamental investors eager to buy the market dip. Fundamental investors may wish to time their market entry to coincide with the abatement of these technical selling pressures.”

* * *

In other words, if JPM is right, yesterday and today are merely the eye of the hurricane – enjoy them; tomorrow is when the winds return full force.