The Economic and Monetary Affairs Committee of the European Parliament has approved gold to be used as collateral

If you listen closely you will be able to hear the crickets. Not a word about this story in the typical financial newspapers. I’ve unfortunately been listening to Bloomberg TV and CNBC all day and have yet to hear a discussion about this truly remarkable event. I have of course heard countless tales of impending doom for a non-existent bubble. And hours have been wasted on the ridiculous notion the Fed will stop the liquidity train come July first; a debate I fillet in the post titled, Debate of QE Termination a Head Fake; Expect Market Rallies Upon Completion of QE2

This momentous decision by the European parliamentary committee ushers in a new era of legitimacy for an investment that was often referred to as a “barbarous relic” only a few years ago. Lest we all forget Nouriel Roubini’s (Dr.Doom’s) rather recent Dec. 14 2009 piece,“Here’s Five Reasons The “Barbarous Relic” Gold is Going to Tank”. The price of Gold is only up over 35% since that reference; as The Heavy would say, “How you like me now” Nouriel?

The committee’s declaration may in retrospect set the stage for a dramatic revaluation of gold to rebalance (reliquefy) the debt laden treasuries of bankrupt western governments. A $10,000-$15,000/oz Gold price would probably do the trick and fix the U.S. treasury’s horrendous balance sheet.

Zero Hedge offers a different take on the matter:

Wonder why Europe is pressing so hard for Greece (and soon the other PIIGS) to collateralize its pre-petition loans on a Debtor in Possession basis? Here is your answer: “Yesterday’s unanimous agreement by the European Parliament’s Committee on Economic and Monetary Affairs (ECON) to allow central counterparties to accept gold as collateral, under the European Market Infrastructure Regulation (EMIR), is further recognition of gold’s growing relevance as a high quality liquid asset. This vote reinforces market demand for a greater choice of assets that can be used as collateral to meet margin liabilities.” Luckily for Greece, it has 111.5 tons of gold in storage (somewhere at the New York Fed most likely). Looking down the road, Portugal has 382.5 tons, Spain 281.6, and Italy leads the pack with 2,451.8 tons.

The press release from the World Gold Council reads:

Tags: barbarous relic, gold, nouriel roubine, PIIGS, precious metals, QE, QE2, World Gold Council, Zero Hedge

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The Japanese tragedy continues to unfold and I, like the rest of you, watch on in horror. Meanwhile, the toxic sludge spewing from the traditional financial media outlets is at full throttle with spigots wide open.  Nothing like a good tragedy to create hysteria and boost ratings.

I’d like to take it down a notch and offer a reality check:

1) We don’t know what will unfold, hence a deep breath is required to make the correct financial decisions. Is it possible Japan will cease to exist as we know it? So many talking heads on TV breathlessly report this apocalyptic angle. I humbly suggest most of the supposed ‘experts’ are not experts in the field of nuclear fusion and are most certainly not experts regarding the fluid situation unfolding in Japan.

2) “But they are experts”, you want to say. After all, CNBC, etc., all laud their words and the string of letters after names (i.e. Ph.D., etc.) implies intelligence. Alas, perspicacity is not guaranteed with extra book learning. In fact, evidence suggests arrogance is the common illness acquired. I will remind you that so called ‘experts’ were trotted out during the Gulf oil spill last year and they were almost all invariably proven wrong.

3) Today, ‘experts’ say Japan sits on top of seven volcanoes and another like magnitude earthquake will surely swallow the country whole. Last May similar ‘experts’ assured us the blown drilling platform and pipe were just the beginning of a chain reaction that would create an enormous fissure in the Gulf of Mexico and subsequent tsunami. I’m still enjoying the beaches of Florida, what about you?

4) Today, ‘experts’ say cesium will undoubtedly billow out from the Fukushima site ruining arable land in Japan – and even in the U.S. if the winds are right. Can this tragedy happen? I assume so. I’m not taking the situation lightly but (and here is the key), I don’t know. What I do know is that so called ‘experts’ assured us that a methane bubble was going to explode in the Gulf of Mexico last year and rain down acid in the farm belt of this country. Reality: No acid, just quality rain that created bumper crops this past year.

5) Today, traditional media outlets as well as the blogosphere love to direct our attention to a view of an empty Tokyo street and a Geiger counter. We are implored to watch this scene closely for impending doom. Of course, last spring these same fear mongers beseeched us to watch endless hours of a subsea oil pipe spewing energy. I’m still trying to figure out how that energy footage was useful, so I can’t even begin to get to the Geiger counter, sorry.

Conclusion: Two months and five days after the BP oil explosion hit the news wire BP’s stock price bottomed at $26.83. One month later the stock price was up 45% and today the stock price sits about 65% off the low. I’m not suggesting the duration and returns will be the same in this case.  Certainly, events could unfold that will make this tragedy worse. In fact, one could argue this situation is already more dire and I would not disagree. The time for recovery could be longer. However, I am trying to add a little perspective. Financially remain calm and if the opportunity presents over the coming weeks, look to build a portfolio of companies that will benefit from the rebuild of Japan.

Precious Metals Outlook: Meanwhile, the precious metals (Gold and Silver) continue to offer the best harbor amidst the financial tempest.  Gold remains marginally higher in all currencies since the tragedy began last Friday. I would wager any decline in the metal price can be tied directly to the unwind of the Yen carry trade.

As the reader may recall, the Yen carry trade is a favorite of the leveraged fund manager. Said manager borrows Yen at extremely low interest rates and invests in other assets he feels will outperform the cost of the borrow. In a simple example, the manager invests borrowed Yen into Australian government bonds at an advantageous spread (let’s say he borrows at .25% and receives 5% clearing 4.75% on the investment if held for 12 months). He sells borrowed Yen, buys Aussi $s and buys Aussi bonds. The problem occurs when this overly crowded trade hits the speed bump of a rising Yen.  If the Yen rises in value too quickly this highly leveraged trade begins to lose money at an alarming rate as the cost to buy back the borrowed Yen exceeds the 4.75% annual spread.

The real world tsunami in Japan has created the financial tsunami described above. The leveraged carry trade manager has been forced to buy back Yen and unwind said trade due to the crisis. The Yen reached all time post WWII highs against the US$ yesterday. How long this unwind panic goes on is anyone’s guess, but this explains why on some days (like Tuesday) all asset prices go down together as margin requirements are being met and the carry is unwound.

For those of you needing encouragement to stay the course with your Gold and Silver holdings, Gary offers the following thoughts:

1) World gold production is approximately 2500 metric tons (mt)

2) 2010 production in China was 341 mt

3) Thus, world production excluding China equals about 2159 mt

4) Chinese central bank buys all internally produced gold; thus, imports are bought by Chinese citizens

5) 9.3% of estimated world production of 2159 mt in 2011 was imported for Chinese consumers through Feb or 55.8% annualized

6) World gold production was flat to down over last 3-4 years and not expected to grow in 2011

7) The Industrial and Commercial Bank of China Ltd. (ICBC) started physical-gold linked savings accounts in December. Account openings have surpassed 1 million, with already more than 12 tons of gold stored on behalf of investors. The ICBC has more than 20 million accounts. If the savings account program is introduced throughout China, Chinese demand could easily overwhelm world gold output.

Tags: Australian, Australian bonds, BP, carry trade, Cesium, chinese, CNBC, earthquake, Fukushima, gold, Gulf of Mexico, ICBC, Industrial and Commercial Bank of China, Japan, Methane, Oil Spill, precious metals, Precious Metals Outlook, silver, Tokyo, tsunami, Yen carry trade

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Update: Three Phases of the Secular Bull Market in Gold – By Gary Rosenthal

In our first installment of the ‘Three Phases’ manifesto I wrote:

Phase II:

During phase II the rising pattern of gold will begin to accelerate .  However, the gold mining stocks will experience rising relative strength verses the metal as explosive quarterly earnings reports bring attention to the sector. Takeovers will begin to populate the landscape at substantial market premiums as the larger companies bid for the successful exploration companies that have toiled quietly for more than a decade. Sometime before the end of this phase the major Wall Street brokerage firms will scramble to rebuild a research presence and recommendation lists in an area they have long proselytized against. All of a sudden the smaller companies will successfully be able to come to market and new funds will flood into the exploration area. Very quickly a drilling equipment shortage will emerge and all participants in the industry will experience labor shortages.

The Dec. 13 post concluded with our opinion that phase II had commenced. On Feb. 3rd, less than two months later, the following high profile acquisition occurred offering conclusive evidence that our Dec. 13 proclamation seems wholly accurate:

Fronteer Gold to be acquired by Newmont by way of a Plan of Arrangement. Under the Plan of Arrangement, shareholders of Fronteer Gold will receive Cdn$14.00 in cash and one common share in a new company (”Pilot Gold”), which will own certain exploration assets of Fronteer Gold, for each common share of Fronteer Gold.  The cash consideration represents a premium of approximately 37% to the closing price of the common shares of Fronteer Gold on the TSX as of February 2, 2011 and equates to a value of approximately Cdn$2.3 billion for Fronteer Gold (excluding Pilot Gold).

Fronteer Gold owns a 100% interest in the development-stage Long Canyon project, which is located approximately one hundred miles from Newmont’s existing infrastructure in Nevada.  The proximity of Long Canyon to Newmont’s Nevada operations provides the potential for significant development and operating synergies.  Fronteer Gold also owns a 100% interest in the Northumberland project and a joint venture interest with Newmont in the Sandman project in Nevada, among other assets.  Fronteer Gold has total attributable Measured and Indicated gold resources of 4.2 million ounces and Inferred resources of 1.7 million ounces.

Thoughts on the ramifications of this deal:

NEM is paying $2.3 billion for total attributable Measured and Indicated gold resources of 4.2 million ounces and Inferred resources of 1.7 million ounces and a great deal of attractive long term developmental potential.

The lion’s share of the purchase price is for future potential because FRG has no proven/probable reserves which is what the industry usually pays for.

NEM is very knowledgeable of the area and willing to pay a handsome price for potential located adjacent to its Nevada mining operations.

Analysts are going to have a difficult time using the terms of this deal as a yardstick to measure the takeover value of other junior exploration companies because FRG is such a special situation for NEM.

Nevertheless, I am certain it won’t take long before some enterprising young analyst points out that the total market value of one of our positions in both Fortune’s Favor I(FFI) and Fortune’s Favor Precious Metals(FFPM) (with inferred gold resources of  3.5 million ounces in Nevada) is “only” $28 million. That’s about as far as the comparison goes but the shares could easily multiply several times due to speculative “gold fever” and still not equal 3.5% of what NEM paid for FRG.

A more meaningful comparison would be with another favorite position of the Fortune’s Favor Family of Funds. This Company has proven/probable gold reserves of 14 million oz with more than $500 million cash and cash equivalents on the balance sheet. Said company is still relatively early in the exploration of the ______ Lake region with the potential of proving up more than 20 million oz of gold. If NEM was willing to pay $2.3 billion for FRG with no proven/probable what is the upside potential for this company with proven/probable gold reserves of 14 million oz , $500 million cash on the balance sheet and a current market value of only $2.5 billion?

I expect this type of “yardstick” analysis to rapidly emerge throughout Wall Street over the next few months. Furthermore, we look for more evidence of phase II in Feb/March as we expect signs of equipment strain(sharply rising rig utilization and daily rate increases) and explosive earnings guidance from the drilling companies. As the price of gold/silver march higher we expect additional deals to be announced and a gold/silver “recommendation frenzy” to engulf Wall Street.

Tags: drilling, Fortune's Favor Family of Funds, Fortune's Favor I, Fortune's Favor Precious Metals, FRG, Fronteer Gold, gold, NEM, Newmont, precious metals, silver, Three Phases

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The Three Phases of Every Secular Bull Market in Gold – By Gary Rosenthal

Phase I:

In the early years a rising gold price is greeted with suspicion, doubt and often complete disbelief. The market is dominated by speculators and traders seeking relatively quick short term profits. Although gold may double or even triple in price during this phase(which can last five or more years) the price is subject to periodic violent selloffs of 20%-30% as short term traders are easily routed by the bullion banks. During this period gold bullion dramatically outperforms gold mining stocks as the market is disciplined to distrust the rise and avoid buying assets in the ground.  Indeed, most investors completely avoid gold during this period.

How to recognize when phase I is coming to a close:

Throughout the first phase the periodic selloffs follow a specific pattern. During the early years the selloffs are frequent, deep and can last for months. The gold mining stocks often decline as much as 50%, underperforming the metal in both directions.  However as time goes on the frequency, intensity and duration of the selloffs moderate as physical bullion buyers gain in strength and gradually erode the capability of the bullion banks to raid and manipulate the paper gold futures market. The mining stocks continue to react but begin to close the gap of underperformance. Phase I will come to a close when paper gold futures sell off for a few days but the gold mining stocks give up little or no ground or even a few of the stronger issues appreciate. Of course, mass media and so called market pundits will continue to call the top in gold which will keep most investors on the sidelines.

Phase II:

During phase II the rising pattern of gold will begin to accelerate .  However, the gold mining stocks will experience rising relative strength verses the metal as explosive quarterly earnings reports bring attention to the sector. Takeovers will begin to populate the landscape at substantial market premiums as the larger companies bid for the successful exploration companies that have toiled quietly for more than a decade. Sometime before the end of this phase the major Wall Street brokerage firms will scramble to rebuild a research presence and recommendation lists in an area they have long proselytized against. All of a sudden the smaller companies will successfully be able to come to market and new funds will flood into the exploration area. Very quickly a drilling equipment shortage will emerge and all participants in the industry will experience labor shortages.

Phase III:

Now the fun begins. This is the shortest but most explosive phase of the secular bull market in gold. This is the phase when all the sleepy financial institutions and the public finally wake up. Almost every week a new precious metals mutual fund or exchange traded fund will be launched as money pours into the sector. This is the inflection point when the public clamors to get aboard in true “gold rush” fashion and Wall Street is more than happy to accommodate with a constant flow of recommendations. Prices will continue to climb considerably beyond all prior fundamental benchmarks. Abrupt corrections will still occur as the COMEX will progressively raise futures margin requirements and so called pundits repeatedly try to foolishly call the top. But no top will be reached until the final excessive quantitative easing of fiat currencies (printed by the U.S. Federal Reserve, the European Central Bank and the Japanese Central Bank) finds its way into the gold market.

At Rosenthal Capital Management we recognize that QE has become a permanent drug of western central banks and believe no cure will be forthcoming for this long term addiction.  Over the last five years we have developed a considerable global research expertise in precious metals which has been a core focus in Fortune’s Favor I(our flagship fund) and guided Fortune’s Favor Precious Metals to significant returns since inception in the fall of 2006. Our primary focus has been owning bullion but we have recently begun to shift to the mining stocks as we enter the second phase outlined above. In addition to a mixture of the senior and junior issues we have broadened our approach to encompass what we believe is a global collection of the potentially most successful smaller exploration entities. While these issues collectively may occupy the smallest portion of our funds together they have the potential to have the greatest impact on the portfolio. We believe phase III of the current bull market may be able to yield a speculative exploration crop superior to the 1975-80 list below:

Name                         1975                      1980

Lion Mines              $0.07/share       $380/share

Bankeno                    $1.25                    $430

Wharf Resources   $0.40                    $560

Steep Rock                $.93                      $440

Mineral Resources $.60                       $415

Azure Resources     $0.05                    $109

An investment in Lion Mines of $700(10,000 shares) in 1975 would have netted a total profit of around $3,799,300 if held for the 5 years.

Final Comments:

First, we have purposely left out any comments on silver. Suffice it to say that if you research the archives of the Rosenthal Capital Management blog you will discover we believe silver will outperform gold in the current environment and is a major focus of our investment activities. Finally, in case you missed it, we believe Phase I of the current secular bull market in gold ended last week!

Positions: Long Gold and Silver assets. Not long stocks mentioned

Tags: bullion banks, central banks, COMEX, gold, precious metals, silver

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We disseminated the following letter in October. Due to the events of this week and subsequent market behavior I feel a reprint is in order.  

The Gold price approaches $1,400/oz and the Silver price is poised to breach $27/oz. A paradigmatic shift is occuring in the precious metals arena. Understanding and awareness will be required for those wishing to enjoy the parabolic price moves higher in the coming months…..

Dear,

September was a rewarding month for our investment philosophy. Gold crossed $1,300/oz and Silver $21.50/oz as the global currency debasement theme shifted into high gear. Our commitment to precious metals, emerging markets and selective domestic high growth companies made for an exciting month in our quest for Fortune’s Favor.

Attached please find an article titled, “Why QE2 + QE Lite Mean the Fed Will Purchase Almost $3 Trillion In Treasuries And Set The Stage For The Monetary Endgame”. This article expresses many of our own beliefs and can be viewed as a roadmap to $5000/ounce gold and $100/ounce silver.

Bret and I struggle every day trying to balance the opposing forces of government market support intervention and deteriorating economic fundamentals in structuring our investment philosophy. Until and/or unless we see evidence to the contrary, we believe Bernanke will press forward with aggressive monetization with the goal of inflating all asset classes.

In addition, we believe that U.S monetization will force all other central banks to follow suit or face the prospect of a rapidly deteriorating trade position (which would be unacceptable). In a world of inflating money supply and close to zero interest rates (an impossible scenario in the textbooks of my generation), one of the best usages of free corporate cash flow would be to stockpile inflating industrial raw materials and/or acquire other companies.

The Chinese have cornered the market on rare earths (critical industrial and military raw materials) and have already announced their plans to favor domestic usage. As you know, silver is also a critical industrial/military raw material and, while larger than rare earths, its total market size is quite small relative to its strategic importance. The entire above ground world silver supply (in deliverable condition) is estimated to be less than one billion ounces (there is evidence that naked shorting of silver may exceed above ground supplies several times) and would be inelastic to a sharp change in demand for several years. Therefore a move toward industrial stockpiling may easily lead to a run on silver and a material change in price.    

For the last few years we have worked diligently to protect capital and position ourselves for what we believe will be the “end game”. It is now more important than ever to access our website (www.rosenthalcapital.com) and read Bret’s blog (http://blog.rosenthalcapital.com) as world events that affect our markets are likely to unfold at an accelerating pace.

Warmest Personal Regards,

Gary Rosenthal

Tags: Emerging Markets, gold, precious metals, Precious Metals Outlook, QE2, silver, stock market strategy

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Precious Metals Outlook: A look at seasonality suggests the best of 2010 is in the offing…

My last post, A Trifecta of PBOC Announcements Gives Owners of Gold a Winning Ticket, focused on the compelling fundamental developments emerging in the precious metals arena. We have witnessed a 3.5%+ increase in Gold prices since that post on August 4th.  Today, I’d like to add the proverbial fuel to the fire by examining the seasonality of Gold. Spend some time studying the chart below and meet me on the other side…

The monthly chart of GLD clearly illustrates the seasonal strength of Gold prices from September to January. As the yellow highlights indicate, often aggressive moves higher in gold prices begin in September. Furthermore, by studying 2008 we can see even during a difficult year, one fraught with mass financial disaster, Gold prices were higher at the end of the Sept.-Jan. time period.

The key take away from this post: Please hold on to the bar!

Tags: gold, gold prices, precious metals

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Precious Metals Outlook: Bloomberg TV Headline: Goodby Gold

Bloomberg TV ran the above story yesterday morning, interviews were conducted and a consensus was formed. Based on this simple indicator I would say that Gold Prices bottomed yesterday at around $1159.  We will call this indicator the ‘Fin. TV’ indicator. You may recall how unbelievably accurate the Fin. TV indicator was in early July when identifying the equity market low.  I explained this phenomenon in the post titled , Stock Market Strategy: The More Things Change the More They Stay the Same . The bottom line of the explanation reads: “Rosenthal Investing Axiom: When CNBC et all call for imminent market demise expect instantaneous market rally.”

So, by applying the Fin. TV rule to Gold prices we should not be surprised to see Gold trading at $1175 as I write this note. Yesterday’s cacophony of calamitous Gold comments leads to the current $15+ comeback; categorically classic!

Stock Market Strategy: Data and Comments Continue to Point Towards Q.E.2

This morning’s disappointing GDP news dovetails nicely with voting Fed member Bullard’s comments yesterday.  The Zero Hedge story, “GDP Misses Expectations, Comes At 2.4%, Plunges From Revised Q1 GDP Of 3.7%” Offers a good breakdown of the details. I would, however, caution readers who believe this news is negative for the equity markets. Please remember the all important equation: Liquidity Expands + Credit Markets Improve = Equity Market Rally . News such as disappointing GDP numbers leads Fed members to speak out openly about the need for more liquidity…            

Bullard comments on deflation: St. Louis Fed President Bullard issued a paper arguing that the Federal Open Market Committee’s extended period language may be increasing the probability of a Japanese-style deflationary outcome for the U.S. within the next several years. Bullard concludes that an appropriate quantitative easing policy offers the best hope for avoiding a low nominal interest rate, deflationary outcome. Bullard frames his discussion in the context of theoretical analysis by Benhabib et. al. 1 that emphasizes two possible long-run outcomes for the economy: one which is consistent with monetary policy as it has typically been implemented in the U.S. in recent years, and one which is consistent with the low nominal interest rate, deflationary regime observed in Japan during the same period… See report here

…And comments about more liquidity are being backed up by actual growth in worldwide liquidity as seen in the chart below. While this cycle persists expect higher equity prices at best and consolidation of gains at worst….

Tags: Fed, Fin. TV, GDP, gold, precious metals, Q.E.2, Rosenthal Investing Axiom, stock market strategy, Worldwide liquidity, Zero Hedge

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Guest Post by Don Coxe (courtesy of Zero Hedge)

Don Coxe Dissects Gold, As “The Oldest-Established Store Of Value Moves To Center Stage”

…We think that future historians may well report that the moment when gold once again became a store of value was when the dollar began soaring in response to the stench of seared Greece—and gold climbed right along with it. The asset classes that have been inversely correlated since Keynes’s time suddenly united….

… So why didn’t inflation come roaring back when Bernanke doubled the Monetary Base and M-2 was climbing at double-digit rates?

And why didn’t inflation come back when central banks across the OECD were growing their monetary bases and money supplies were climbing? And why did gold take off to record levels when money supply growth began to dwindle and actually turn negative?

… What we believe is unfolding is a rush into gold by individual investors who look at the astronomic growth in financial derivatives—particularly collateralized debt swaps—and government deficits at a time when the effects of demographic collapse are finally being understood. According to some guesstimates we have heard, the supply of outstanding financial derivatives may be in the $70 trillion range, dwarfing the combined value of money supplies and debts. The total value of gold is so minuscule in comparison to the supply of these software-spawned instruments that it cannot be any real help in stabilizing global finances—but it can be a haven for investors seeking to protect themselves against an implosion of majestic proportions.

… So…as a store of value for future generations,

If you can no longer believe in residential real estate,
and you can no longer believe in bank deposits,
and you can no longer believe in the dollar,
and you can no longer believe in the yen,
and you can no longer believe in the euro…
What can you believe in?
How about gold?

It’s so old, it’s new again.

… Among the arguments routinely adduced against it is that it pays no interest—but with interest rates in the zero range, the opportunity cost is minimal.

Read More…

Stock Market Strategy: Follow Up – Credit Check

Michael Johnson (a.k.a Credit Guru) weighs in on recent credit market performance and shifts his stance:

Last Wednesday we turned from tactically bearish to neutral. We went completely bullish Friday morning. The equity market’s ability to ignore the recent improvements in bank and non-financial CDS profiles appears to be faltering…. and this could lead to a sustained equity rally… …Credit market performance so far this morning indicates that the SPX should be trading in the +25pt range….that would match the note we sent out Friday morning

Bears About to be Gored

Summary:

We now believe investors should be Tactically Bullish as well as fundamentally bullish

Bears should be getting nervous…credit market is improving

GS Credit curve has steepened

New Issue Market reopened

Bank CDS Spreads tightening

Credit market volatility decreasing

How many times do you think credit will tighten before the equity markets jump on the bullish bandwagon? It’s probably sooner rather than later…

Gored… As our readers know, during the recent sell-off we have remained fundamentally positive while turning tactically bearish. We have written numerous pieces highlighting the differences between the feared “sovereign credit crisis that will never be” and the onset of the 2007-2009 credit crisis. The fear of Greece and of Euro viability concerns short-circuiting the global economic recovery is wishful thinking by the bears. This is like the bank nationalization argument….politicians will allow the Euro to fail because they know it will cause global havoc….politicians will nationalize the banks because they know it will cause global havoc…investing based on the hope that politicians will make stupid mistakes does not seem appropriate.

However, the ability of FINREG to destabilize the bank’s access to the credit markets is a truly scary, and much more likely to happen, in our opinion. The inversion of the GS credit curve and the widening of larger US bank credit spreads began a week before the overall equity and credit markets began to sell off. In our opinion, the weakness in the money center bank’s credit profiles made it a lot easier for sovereign risk concerns to find a willing audience.

The combination of the sovereign credit crisis headlines along with money center bank credit fears caused the correlation between banks CDS spreads and CDX IG Index spreads to increase. Credit market volatility materially increased and appeared to spill over into the equity markets. Many of the equity market’s worst sell-offs immediately followed large credit market sell-offs.

However, the reason we are becoming tactically bullish at this point is the reduced likelihood that FINREG will be passed with its most destructive portions. This opinion is working its way through many of the money center banks CDS credit curve profiles and credit spread volatility is decreasing. Additionally, continued improvements in nearly every consumer loan asset class will likely force even the most bearish bank analysts to reduce their loss estimates….

Conclusion:

Being fundamentally bullish and tactically bearish has been a relatively solid approach to the recent sell-off in our opinion. However, the recent decrease in credit market spread volatility and the stabilizing of money center bank CDS profiles makes it difficult to remain tactically bearish when we remain bullish fundamentally. We are now fundamentally and tactically bullish. The recent trend in which the equity markets ignore credit market strength is not likely to last.

Tags: CDS, Credit, credit market volatility, credit markets, euro, finreg., gold, GS, Michael Johnson, precious metals, stock market strategy, Zero Hedge

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Over the last couple of weeks we have witnessed a series of conflicting reports from all over the media complex as to why equity markets are under pressure. Predictably, as soon as the markets recover a bit these same pundits come up with all sorts of reasons to cheer.  Needless to say these hysterical reports, bullish or bearish, are entirely worthless.  CNBC, with its ridiculous “fat finger” report, has proved its irrelevance as a financial news source. In fact, this embarrassing story (released with less than an 1/2 hour to go in the trading session) stinks of manipulation and seems to implicate CNBC as a pawn in a propaganda ring.

But I digress, my purpose today is to offer a little clarity to the situation. So without any further ado, let’s map the market developments and see what, if any, conclusions may be reached.

Support:

Government support is the primary reason equity markets have traded higher over the last year. That support has taken the form of, to name a few, ‘cash for clunkers’, foreclosure prevention, home buyer credits and a myriad of Fed liquidity programs.

The result of this support has been the release of government supplied economic numbers that appear promising and suggest GDP expansion (Did you pick up the sarcasm in that sentence? Sorry!).

To sum up, large quantities of Fed-provided quantitative easing and rosy economic numbers are the fuel driving markets higher.

Now Europe and the European Central Bank (ECB) have joined the fray. Supposedly close to $1trillion of liquidity will be thrown into the gaping mouth of the debt monster.

Pressure:

Abysmal – as in the size of an abyss – amounts of world debt are swallowing up prodigious amounts of liquidity.

China - China’s equity markets have for some time been a leading indicator for US markets and risk assets in general.  Recently, the Shanghai Index reached into bear market territory with a 20% decline from the highs of the year.  This is not a good omen.  Moreover, China’s economic expansion could be labeled the lynchpin of world economic growth and the recent measures by China’s central bank to tighten liquidity is, to say the least, problematic for a world drowning in debt. The recent increase in consumer prices of 2.8% in China only exacerbate the problem as it would appear inflation is accelerating.

GS – Common knowledge suggests the markets swooned because of violence in Greece. This is absolutely not the case.  We can draw a direct line to the beginning of this most recent market drop and the day Goldman Sachs faced the Senate tribunal.  Government crucifying of the financial space is heating up and will only get worse as senators fight for re election this November.  GS is the undisputed heavyweight champ of the financial space and if they fall the financials as a whole will experience painful P.E. multiple contraction.  In the last few weeks GS’s credit curve has inverted. Credit protection on GS cost more for 1 year than 5 years. If this trend persists a debt downgrade for GS could be in the offing which would in turn send financial shares tumbling.

This Just In: As I write this the “Senate Finance Committee votes on amendment to create a new ratings agency; yay’s have it 64-35, amendment agreed to…” Can you hear that? That’s the sound of a GS debt downgrade being written. The congressionally approved ratings body will likely remove the conflict of interest inherent in the current private rating agencies business model. Hence, we would not be surprised to see Moody/Fitch/S&P make a preemptive downgrade.

Financial Group (FINs) – FINs have always been a leading indicator for overall market direction. If GS drags the FINs down the rest of the market will suffer. Make no mistake, as the volume of negative news and behavior towards the FINs grows louder the equity markets will suffer.

Andrew Cuomo Investigating Whether Banks Duped Rating Agencies – Huffington Post

Senators Seek Proprietary Trading Ban for Big Banks – WSJ

Greece – I would be remiss if I didn’t include this component as part of the pressure on the markets. The proposed Trillion $ bailout seems dubious at best.  Lest we forget weeks were required to raise just $30 billion and now somehow the finance ministers got together over the weekend and $700 billion was pledged?! Now these ministers must go back to their respective countries and try to get funding. This funding request should be a tough sell. After all, the German people recently voted the ruling party out of one house after the first 40 bil Euro bailout.  In fact, rumor has it a reintroduction of the German Mark may be in the offing. How about England? They have yet to participate in any bailout and now elections have created a coalition (read: do nothing) government.

The simple fact remains that all this talk of bailouts is actually missing the real point: Greece has a solvency issue not a liquidity issue.

Conclusions/Questions:

Q: Will liquidity expansion trump debt implosion?

Q: Will excess liquidity continue to find its way into the equity markets?

Q: Will Chinese tightening and supposed European austerity plans actually drain marginal liquidity?

C: As my mom would say, “we must live the questions and the answers will reveal themselves.” So, remain vigilant, defend principal and let the markets be your guide. Don’t force your will on the market and avoid complacency at all costs.

C: No matter which is the victor, the Tidal Wave of Liquidity or the Trench of Debt, one asset class will not only survive but flourish.  The precious metals, Gold and Silver, are now advancing to new highs against all fiat currencies. I have written repeatedly over the last few years that the true inflection point for Gold and Silver will arrive when their values increase even in the face of a rising US$.  The time is now.  Please hold on to the Bar!

Tags: China, Credit, ECB, euro, Fed, financial, gold, Goldman Sachs, Greece, GS, Inflation, precious metals, silver, US$

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Today, I’d like to address a curious phenomenon developing in the Treasury market.

March 31st supposedly marked the end of the Fed’s quantitative easing (Q.E.) phase. We were told the Fed would no longer print money and buy mortgage backed securities. There was, of course, no discussion about the Fed printing money and buying other assets. However, ‘ending Q.E.’ carries certain implications and it would not be a stretch to say market participants were led to believe Q.E. in all forms was coming to an end.

Enter ‘curious phenomenon’: Treasury market behavior since March 31st would suggest Q.E. is alive and well. During the month of April, long rates rallied from about 4% to roughly 3.7%.  Treasury prices went up as rates went down after the Fed allegedly stopped Q.E.?! Needless to say this is not the response most market participants would expect.

I’m sure we can come up with more than one reason for this Treasury strength. Perhaps the issues emanating from Europe have driven investors into the relative safety of  US debt. Or maybe Goldman Sachs led financial fears are responsible for the Treasury bid.

However, the following excerpt from ‘The Privateer’ (A favorite publication of ours) offers a compelling argument supporting the theory that the Fed is continuing a Q.E. assault on the credit markets. If this theory is accurate, we would expect any equity market selloff to be contained to a normal uptrend retracement. Moreover, precious metals prices should continue to advance as more Q.E. equals further currency debasement which is a tasty recipe for higher Gold and Silver prices….

The US Treasury auctioned $11 Billion worth of “TIPS” on April 26. They started to sell the regular stuff on April 27 with an auction of $44 Billion in two-year paper. With the Greek debt downgrade to “junk”, hardly anyone noticed. Hardly anyone, that is, except the bidders for US Treasury paper. Indirect bidders (read foreign central banks and governments) bid for only 28 percent of the paper, down substantially from the average demand in 2009.

But much more troubling was the massive 24 percent of the paper on offer taken by the so-called “direct bidders”. The rest was presumably taken by the “primary dealers” in Treasury paper. The “direct bidders” had taken as much as 10 percent of the auction on only 12 of 42 auctions since July last year. They had taken that much only six times in all the auctions held by the US Treasury in the FIVE years from the beginning of 2004 until the end of 2008.

Even more disquieting, the identity of those who are included as “direct bidders” is never disclosed. The fact that the amount of Treasury debt taken by “direct bidders” has blown out since the Fed officially ended its quantitative easing at the end of October 2009 has led to speculation that the Fed has not REALLY ended its policy of monetising Treasury debt after all. More and more analysts (including some mainstream analysts) have come to the conclusion that the “direct bidder” is none other than the Fed. They are almost certainly right, but nobody can know for sure because the “direct bidders” are secret….

Tags: Fed, gold, Goldman Sachs, precious metals, Q.E., Quantitative Easing, silver, treasury market, U.S. Debt

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