More Small Things

By Jeffrey Snider of Alhambra

On April 23, 2015, the US Treasury auctioned off $18 billion in inflation-indexed bonds maturing in April 2020. These 5-year TIPS stopped out at the lowest yield for that particular security class in almost a year before then. Coming as it did during the spring of 2015, it was met with the usual textbook applied commentary, where bond investors were supposedly pricing Janet Yellen’s “transitory” scenario. The oil and commodity crash of late 2014 was by convention nothing more than an aberration, and the auction results appeared to confirm as much.

The sharp bidding for inflation protection particularly without a similar move in the 5-year UST security (not TIPS) meant that inflation breakevens, a measure of market inflation expectations, jumped 10 bps after the auction. At 170 bps, the 5-year breakeven was about 65 bps off the low and at that moment more than half retracing the considerable pessimism that had been provoked by during the (initial) oil crash. Positivity was dominant again.

“The market likes TIPS,” said Edward Acton, a U.S. government-bond strategist in Stamford, Connecticut, for Royal Bank of Scotland’s RBS Securities unit, one of 22 primary dealers obligated to bid at U.S. auctions. “This disinflationary pressure has eased off, and we’re just waiting to see how strong and how quickly inflation pressures can surprise to the upside.”

That, of course, never happened. Inflation instead sunk much lower as did the global economy. Was it merely confirmation bias, that “everyone” simple saw what they wanted? The thing about auctions is that pricing is never strictly about fundamentals, in the case of TIPS meaning inflation expectations. Demand for TIPS (or any) OTR paper may be robust for reasons that have nothing to do with inflation or credit.

Almost exactly one year before, on April 17, 2014, the Treasury had auctioned, as it typically does, the previous year’s 5-year TIPS. The demand for that security (912828C99) was even further off the charts. The yield on the day before, admittedly in late stage OFR status, was -6 bps. The market was anticipating heavy demand, but the settled yield after the auction was -21.3 bps. That drop in TIPS yield coupled with a selloff in the 5-year UST left inflation breakevens for the 5-year maturity spiking higher by more than 22 bps in a single day.

The commentary produced that day was almost exactly the same as it would be one year after.

“The stats were off the charts,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer, said in a telephone interview…
“Break-evens had been very depressed ever since the March FOMC meeting,” Sun said. “Given how beat up they were, with consumer price index surprising to the upside this week, and after the strong auction investors are starting to catch up to the fundamentals.”

And once again, convention got it all wrong. Fundamentals were weakening and it was the bond market that showed as much (long, long before economists would realize it). What was going on in TIPS? I wrote a week after that particular auction coming from the opposite perspective:

That is what makes the move in 5-year TIPS so very eccentric; the typical move in inflation breakevens coincident to such tightening bias is in the opposite direction. Normally I wouldn’t even comment on such a brief change over only several days as this all may turn out to be absolutely nothing, but since the 5-year is the most active place right now, and TIPS aren’t the most vibrant and noteworthy pieces of credit, it seems worth watching.

What was truly unusual about that auction was who it was that did all the buying. The largest proportion was awarded to Indirect Bidders, a class of auction participants noteworthy for including foreign central banks (and other private banks acting on their behalf), far more than at any other auction for 5-year TIPS (to that point). They took nearly 60% of the allotment, compared to an average of 40% over the prior 10 years.

There was, however, no spill over into other areas of inflation trading and expectations. The 10-year TIPS and 10-year breakevens moved a little on April 17, 2014, but remained steadfast in the sideways action that had developed going all the way back to July 2013. That was an important clue, for a rise in the 5-year breakeven without one in the 10-year meant, fundamentally, the market was actually pricing increasing risk.

Continue reading More Small Things

The ECB is Getting Really Good at Leaking Shit to Reuters

By Heisenberg

As we learned in March, the ECB is getting pretty adept at leaking market-moving information about possible policy turns to Reuters.

You’ll recall that late last month, Reuters reported – citing unnamed sources – the following:

  • ECB policy makers wary of changing their message before June, Reuters reports citing unnamed officials.
  • One ECB person said to say message of March 9 press conference was over-interpreted

So that was really convenient because, when combined with Fed messaging designed to walk back the dovish nature of the March hike, it created a return to the policy divergence theme that had underpinned the dollar prior to March 15.

On Tuesday, Reuters is back, this time with 3 unnamed sources delivering this message:

European Central Bank policymakers are breathing a sigh of relief after the first round of France’s presidential vote put a pro-euro centrist in pole position, but they are not likely to change their policy stance until June.

Three sources on and close to the bank’s Governing Council told Reuters that with the threat of a run-off between two eurosceptic candidates in France averted, and with the economy on its best run in years, many ratesetters see scope for sending a small signal in June towards reducing monetary stimulus.

There is, however, little appetite to change at this Thursday’s meeting the pledge to buy bonds at least until the end of the year and to keep rates at rock bottom until well after that.

A move in June, however, might mean changing the wording of the ECB’s opening statement to reflect improved prospects for the economy.

Some or all the references to prevailing downside risks to the outlook, to the possibility of further rate cuts or to larger asset purchases may be taken out, the sources said.

“The discussion will be on removing some of the easing biases,” one of the sources said. “I can’t say how quickly it will happen because that depends on the data.”

You can probably guess what happened next. Here’s Bloomberg:

  • EUR/USD rose to a fresh high at 1.0925 while gaining to a one-month high versus the yen as model-driven demand for the cross continues to push through markets ahead of Thursday’s ECB meeting.
  • EUR gains accelerated after a Reuters report that French election result may prompt a change in the ECB’s language in June
  • Market continues to speculate on whether ECB will use more upbeat language to describe the economic outlook; to be sure, Draghi on Friday reiterated that the inflation pick-up remains unconvincing and risks for euro-area growth “remain tilted to the downside”
    • At same time, EUR and JPY continue to see unwind of haven trades set before French vote, muddying the FX picture
    • EUR filled offers at 1.0900/05, faces further supply around the Monday high at 1.0937, traders said



This is particularly amusing because now, instead of anonymous Reuters leakers trying to walk back a perceived hawkish message, you’ve got unnamed Reuters leakers apparently attempting to telegraph a hawkish shift in June. Last month, policy meeting preceded Reuters leak. This month, Reuters leak precedes policy meeting. All kinds of fucked up forward and backward (mis)guidance.

Continue reading The ECB is Getting Really Good at Leaking Shit to Reuters

Volatility Crash

By Tim Knight

Everywhere you look – – green, green, green, lifetime highs, soaring charts, with one notable exception. Volatility, of course! The fear index $VIX has, in just 1.5 years, collapsed from 53.29 to almost the single digits. Indeed, there is only ONE time in the past decade it’s been even a little bit lower, and that was back on January 27th. This is about as low as it goes, folks.


Long-Term Price Targets Are Meaningless

By Steve Saville

Many commentators like to speculate on where the dollar-denominated gold price is ultimately headed. Some claim that it is destined to reach $3,000/oz, others claim that it won’t top until it hits at least $5,000/oz, and some even forecast an eventual rise to as high as $50,000/oz. All of these forecasts are meaningless.

Long-term dollar-denominated price targets are meaningless because a) they fail to account for — and cannot possibly account for, since it is unknowable — the future change in the dollar’s purchasing power, and b) the only reason a rational person invests is to preserve or increase purchasing power. To further explain by way of a hypothetical example, assume that five years from now a US dollar buys only 20% of the everyday goods and services that it buys today. In this case, the US$ gold price will have to be around $6,500/oz just to maintain its current value in purchasing power terms. To put it another way, in my example a person who buys gold at around $1300/oz today and holds it will suffer a loss, in real terms (the only terms that matter), unless the gold price is above $6,000/oz in April-2022. Considering a non-hypothetical example to make the same point, in 2007-2009 a resident of Zimbabwe who owned a small amount of gold and not much else would have become a trillionaire in Zimbabwe dollars and would also have remained poor.

The purchasing power issue is why the only long-term forecasts of gold’s value that I ever make are expressed in non-monetary terms. For example, throughout the first decade of this century I maintained that gold’s long-term bull market would continue until the Dow/gold ratio had fallen to at least 5 and would potentially continue until Dow/gold fell to 1.

The 2011 low of 5.7 in the Dow/gold ratio wasn’t far from the top of my expected bottoming range, although I doubt that the long-term downward trend is over. In any case, none of the buying/selling I do this year will be based on the realistic possibility that the Dow/gold ratio will eventually drop to 1. Such long-term forecasts are of academic interest only, or at least they should be.

If I were forced to state a very long-term target for the US$ gold price, it would be infinity. The US$ will eventually become worthless, at which point gold will have infinite value in US$ terms. But then, so will everything else that people want to own.

Mind the “Le Spread” Eurphoria

By Heisenberg

Earlier today we noted the “big league” compression in the all-important OAT-bund spread, the market’s preferred gauge of French political risk and thus, a go-to measure of EMU breakup risk.

Here’s the 10Y spread:


And the 2Y spread:


Finally, here’s Bloomberg’s technical analyst Sejul Gokal on why this matters:

OAT Futures and ‘Le Spread’ Euphoria May Risk Fading at 200-DMA

Notable moves in OAT market have sent futures and France-Germany 10-year yield spread near key equilibrium levels that may drive tactical reversal in post-French vote reaction, Bloomberg technical analyst Sejul Gokal writes.

  • OAT1 topside gap and high at 149.90 close to the YTD high and 200-DMA at 150.08-12; levels could still come into play in a last gasp move before potential accumulation of overbought reversal sessions
    • 9-day RSI tests multi-mo. highs at ~81
  • OAT-Bund spread narrowed to 48bps vs. 64bps Fri. close
    • 200-DMA at 45bps could limit further spread compression as oversold conditions warrant corrective unwind
  • As a risk factor, watch out for any consecutive daily breaks of the longer-term average line which should indicate strong behavioral change in OATs; such development should override current overbought market warnings

To Frexit or Not to Frexit?

By Keith Weiner of Monetary Metals

This was also a holiday-shortened week.

As we write this, the big news comes from the election in France. The leading candidate is a banker named Emmanuel Macron, with about 24% of the vote in a 4-candidate race. The anti-euro Marine Le Pen came in second with just over 21%. From the sharp rally in the euro, which was up about 2% at one point, we assume that observers believe the odds of France leaving the euro have just gone down.

Of course, France (and the other European countries) faces a false alternative (well they ought to consider Keith’s gold bonds proposal, but that is not on the table). Staying with the euro means ongoing wealth destruction, and a downward slope that leads to nowhere good. However, that raises the question. What would happen if they were to try to leave?

We believe that no matter which theory prevails, and what measures are taken by les dirigistes (central planners), all roads lead to an accelerated default of trillions in bad credit. To understand why, consider the balance sheets of the banks and other financial intermediaries in France.

Suppose the new French franc goes down relative to the euro (we won’t address here whether it is likely to go up or down). This means that any French entity who had borrowed from a bank in Germany or Italy or Spain now sees its liabilities spike up relative to its assets which are now redenominated in francs. It would not take that much leverage or a very large decline in the franc to cause some major bankruptcies. The initial round of bankruptcies could cascade causing yet other bankruptcies in a highly interconnected financial system.

On the other hand, suppose the franc rises. Then the French banks get hit the other way. Their euro-denominated assets outside France are going down, but their domestic liabilities to depositors and bondholders are firm.

A regime of floating currencies sounds good in Milton Friedman’s argument about being an easy way to adjust wages downwards which are otherwise sticky. However, an actual currency revaluation means a wealth transfer from parties A, B, and C to parties X, Y, and Z. That may seem to be good for the latter, until you realize that they are creditors of the former. And the former were already leveraged, and already surviving on thin margins compressed after decades of falling interest rates. There is scant capital to absorb such a shock.

Then there is the question of who will buy French government or corporate bonds? No matter how you slice it, inserting a new currency into a block that currently has one adds friction, which means trade and production will further slow. The market will shrink (and this could in itself push some marginal corporations under).

And there are other serious problems. One is the intra-euro balances. Will these be redenominated? Another is the political response by the European Central Bank and the members of the European Union. What will they do? Will they try to shut off funds flowing to and from France? It would be naïve to assume there will be no response, and France will get away with it consequences-free.

The euro patient may have cancer, and the cancer may be terminal. But that does not mean blowing up the patient with dynamite is going to help.

Of course, traders want to know how this will affect gold and silver. As we write this, we see that silver went down 30 cents before rallying back up to where it closed on Friday. Gold went down about $20, and then half way back up.

At this point, we are not sure if the metals are supposed to go up because more printing. Or go down because the euro constrains France from printing. Or silver at least should go up because the economy is going to be better with France remaining in the Eurozone. Or go down because the ongoing malaise will only progress as it has been. Or some other logic… and the price gyrations this evening show that traders don’t agree either.

Continue reading To Frexit or Not to Frexit?

Liquidity Supernova and the Big Ugly Flaw

By Doug Noland

Credit Bubble Bulletin: Liquidity Supernova and the Big Ugly Flaw

April 21 – Reuters (Vikram Subhedar): “The $1 trillion of financial assets that central banks in Europe and Japan have bought so far this year is the best explanation for the gains seen in global stocks and bonds despite lingering political risks, Bank of America Merrill Lynch said on Friday. If the current pace of central bank buying, dubbed the ‘liquidity supernova’ by BAML, continues through the year, 2017 would record their largest financial asset purchases in a decade…”

From the report authored by BofA Merrill’s chief investment strategist Michael Hartnett: “The $1 trillion flow that conquers all… One flow that matters… $1 trillion of financial assets that central banks (European Central Banks & Bank of Japan) have bought year-to-date (= $3.6tn annualized = largest CB buying in past 10 years); ongoing Liquidity Supernova best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro.”

A strong case can be made that Q1 2017 experienced the most egregious monetary stimulus yet. No financial or economic crisis – and none for years now. Consumer inflation trends have turned upward on a global basis. Stock prices worldwide have surged higher, with U.S. and other indices running to record highs. At the same time, global bond yields remained just off historic lows. Home prices in many key global markets have spiked upward. Meanwhile, central bank balance sheets expanded at a $3.6 TN annualized pace (from BofA) over the past four months.

With U.S. bond yields reversing lower of late, there’s been a fixation on weaker-than-expected Q1 U.S. GDP. Meanwhile, recent data have been stronger-than-expected in China, Europe and Japan. EM has been buoyed by strong financial inflows and a resulting loosening of financial conditions. Thus far, Fed baby-step normalization efforts have been overpowered by the “liquidity supernova”.

April 21 – Reuters (Balazs Koranyi): “Global growth and trade appear to be picking up strength but risks for the euro zone economy remain tilted to the downside, so ‘very substantial’ accommodation is still necessary, European Central Bank President Mario Draghi said on Friday. In a statement largely reflecting the bank’s March policy statement, Draghi said that while the risk of deflation has largely disappeared, underlying inflation has shown no convincing upward trend.”

April 20 – Reuters (Leika Kihara): “Japan has benefitted from global tailwinds that boosted exports and factory output, [Bank of Japan Governor Haruhiko] Kuroda said, describing its economy as ‘expanding steadily as a trend’ – a more upbeat view than last month. But he offered a bleaker view on Japan’s inflation, saying it lacked momentum with no clear sign yet it was shifting up. ‘That’s why the BOJ will continue its ultra-easy monetary policy to achieve its 2% inflation target at the earliest date possible,’ he said.”

Continue reading Liquidity Supernova and the Big Ugly Flaw

Money in America

By Jeffrey Snider of Alhambra

In 1830, France was once more swept up in revolution, only this time at the end of it was installed one king to replace another. Louis-Phillipe became, in fact, France’s last king as a result of that July Revolution. The country was trying to make sense of its imperial past with the growing democratic sentiments of the 19th century. Despite being one of the richest men in all Europe and aligned with the Bourbons, he was Duke of Orleans and married to a Neapolitan princess, the reign of Louis-Phillipe I was supposed to be a milder form of dominion, the so-called citizen king or bourgeois monarch.

Caught up in the upheaval of 1830 were many who had been aligned with the deposed Charles X. Because the citizen king was viewed as a usurper throughout much of France, his time on the throne tended to be more repressive, particularly toward those who had at least been in the Charles court and government. Among them was a Versailles lawyer named Gustave de Beaumont, who, sensing that the political winds had shifted despite the grand upheaval toward (outwardly, at least) more liberal sentiments, gained permission to get out of the country.

Beaumont would travel to the United States ostensibly to study in grand and comprehensive detail its penal system. He set out in April 1831 taking with him a young 25-year old friend, a former magistrate who had similarly found himself of disfavor under the bourgeois monarch. The two landed in Rhode Island and traveled all over the country doing quite a bit more investigation than strictly prison life in the United States. It was, in fact, an examination of this country’s political soul.

The pair returned to France in 1832 to the stark contrast of what must have been near constant unsettled dynamics, from political to economic life (though in those days there was no difference between politics and economics). Beaumont was largely responsible for the authoring the official work derived from their journey, On the Penitentiary System in the United States and Its Application In France. His partner, Alexis de Tocqueville, was more interested in America as an ideal, completing in 1835 the first part of what would be one of the most influential books of the whole 19th century, Democracy In America.

Because of the age in which they landed, there was at the time really no single America. It was still a collection of states but grouped in binary arrangement by the economic ends of its politics. There was the slavery South of agriculture and plantations set against the industrial North with its factories. These two vastly different systems collided at several points, but most especially along the Ohio River. It struck de Tocqueville as one of the most rigorous juxtapositions in all of his journeys:

On the north bank of the Ohio, everything is activity, industry; labor is honored; there are no slaves. Pass to the south bank and the scene changes so suddenly that you think yourself on the other side of the world; the enterprising spirit is gone.

He further described Kentucky as a place where “society has gone to sleep…it is nature that seems active and alive, whereas man is idle.” The South had accumulated a vast wealth, to be sure, but it was of a static sort that was more in keeping with the 18th century than the modernizing world of the 19th.

The economic issue, as always, is labor. The difference North to South in those terms was not really plantation versus factory, but specialization versus sameness. Capitalism is what sets the creative minds of industry free by allowing people to do what they do best. Slavery, quite obviously, by treating most as interchangeable blunt instruments is forever limited in its capacities.

Continue reading Money in America

Look! More Crazy ETF Charts

By Heisenberg

It’s not entirely clear when the “enough is enough” moment will come in terms of highlighting charts that illustrate the epochal (and increasingly dangerous) shift to passive versus active management, but I don’t think we’re there yet.

It may just be me, but it certainly seems as though ETFs are getting a lot more attention over the past several months and that’s saying something because they’ve been a hot topic for years.

We – and a lot of other folks – have tried our best to stay abreast of the latest in what’s becoming a vociferous debate. Here are some recent posts for anyone who might have missed them:

Well admittedly, we’re going to milk this topic for all it’s worth and not because we necessarily think you need to see anymore charts, but rather because given the rampant proliferation of these vehicles and the associated danger they pose to markets, this is a topic that quite literally can’t get enough attention.

Via BofAML

Below we update our report from July. The trend of flows shifting to passive investments has been impacting equities for over a decade (Figure 8, Figure 9). For fixed income the shift accelerated following the Taper Tantrum rise in interest rates in 2013, and re-accelerated again in November of last year (Figure 10, Figure 11, Figure 12, Figure 13). In high yield, on the other hand, the share of passive funds and ETFs remains relatively low (Figure 14, Figure 15).



How to Add Breadth to GDXJ

By Otto @ IKN

Your humble scribe has been spending the morning catching up with market things after a couple of days on the road and reading up on the whole GDXJ snafu. The basic problem is that the ETF is getting to the stage where it threatens to collapse in on itself due to its own excess gravity, black hole style. When money flows into the ETF, is has to distribute that around its component part shareholdings and as a lot of these juniors don’t have much market cap heft compared to the massive ETF NAV, we’re now at the stage where GDXJ holds more than 10% of stock in many of its components and gets close to the all-important 20% in some of them.

So trouble’s been brewing for a while and the VanEck solution, just announced, is to widen the number of companies included in the GDXJ universe. It’s the obvious move but due to the fact that the big player needs liquidity in holdings as well as size, we’re now into the weird-assed situation in which companies like Kinross, Pan American, Gold Fields, Buenaventura and a whole lot more like them are being added to the “juniors” precious metals ETF. Now you can call those companies a lot of names (and I often do), but “juniors” they are not.

Real juniors, ones outside the GDXJ universe, find themselves excluded due to size, float, price, market cap restrictions. That’s something I also understand, you can’t have GDXJ piling into a stock that trades 50k avg per day as its metrics will immediately go wappy. So here’s a potential solution for some or other intrepid brokerage or insto (and I’d wager it would be extremely profitable for the first footer too). The framework can be summed up in three simple stages:

1) Create a whole bunch of “mini junior ETF” vehicles. You could do it by geography, e.g.:

  • Canadian exploreco ETF
  • Canadian junior producer ETF
  • Asia exploreco ETF
  • Asia junior producer ETF
  • Latin America exploreco ETF, etc

Or you could do it by metal:

  • Copper exploreco ETF
  • Copper smallcap prodicer ETF
  • Uranium exploreco ETF, etc

2) Then choose a bunch of smallcaps from each junior sub-sector and weight your ETF. These in effect become bundles of stocks that together, under a larger (but still small) ETF umbrella get the necessary size to become attractive to GDXJ as a part of its holdings.

3) The result is that after time GDXJ gets to broaden its share base and the money filters down into the junior section, instead of money theoretically destined for the junior mining world filtering up into midcaps. The type of cash flow that would benefit the mining industry at a grassroots level.

FWIW, I could see Sprott doing this.