Oct 31

King Dollar in a Bull Market

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But change your goggles and hey! Commodities in AUD not too bad…!

BORING as it sounds, I want to talk a bit about the end of US QE today, writes Greg Canavan in The Daily Reckoning Australia.
Because it’s very important to how markets are going to behave over the next few months.
As you probably know, yesterday the US Federal Reserve voted to end its policy of quantitative easing. But it will still be reinvesting the interest payments from its $4 trillion plus portfolio and rolling over any maturing treasury securities, so it’s balance sheet will continue to grow, albeit much more slowly.
On the surface, US markets didn’t seem too fussed about the end of an era. Shares sold off around the time of the Fed’s statement and then rallied towards the close. Probably a case of “algo’s going wild” as automated high frequency traders tried to make sense of the Fed’s statement.
And the Fed did its usual job of promising to hold rates as low as they possibly could, which markets seemed happy enough with.
But the real action took place under the surface. That is, the US Dollar spiked higher again. This is an important point because when the US Dollar rallies, it usually signifies tightening global liquidity.
Think of it as liquidity returning to the source (US capital markets) and drying up…or disappearing. That’s certainly what has been happening these past few months. Since bottoming in May, the US Dollar index (which measures the greenback’s performance against a basket of currencies) has increased by nearly 9%.
That might not sound like a huge spike, but in the world of currency movements, it is. Imagine if you’re an exporter and your product just became 9% more expensive…chances are it will lead to a drop in sales as customers look for a cheaper substitute.
This is the problem with the end of QE. It leads to liquidity evaporation as ‘punt money’ returns home…which leads to a strengthening US Dollar…which hurts sales of US multinationals.
It’s not going to happen right away though. Most companies have hedging strategies in place that protect them from sharp moves in the FX markets. But if Dollar strength persists…and the chart above says that it will, then you’ll see the strong Dollar hitting companies’ revenue line in the coming quarterly reports.
Not only that, but the evaporation of liquidity in general could lead to another bout of selling across global markets. QE is all about providing confidence. Liquidity is synonymous with confidence. Take it away and you’ll see the mood of the market change.
Getting back to the Dollar strength…it’s a headache for Australia too. It’s smashing the iron ore price, and the Aussie Dollar isn’t falling fast enough to keep up. In terms of the other commodities though, things aren’t quite so bad.
All you seem to hear lately is negative news about commodities. That’s because the world prices commodities in US Dollars, and as you’ve seen, the US Dollar is a picture of strength. But if you look at commodity prices in terms of Aussie Dollars, things look a little better.
The chart below shows the CRB commodity index, denominated in Australian Dollars. It’s a weekly chart over the past five years. And y’know what…it doesn’t look that bad! Since bottoming in 2012, it’s made considerable progress in heading back to the 2011 highs.
But you’ll want to see it start to bottom around these levels. If it doesn’t, prices could head much lower.
The thing to note about this chart is that it doesn’t include the bulk commodities – iron ore and coal. These commodities tend to dominate the headlines in Australia. Things like nickel, tin, copper and oil don’t get much of a look in.
Which reminds me, in case you missed it, Diggers and Drillers analyst Jason Stevenson recently released a report on some small Aussie oil ‘wildcatters’. With the oil price low, now could be a good time to sniff around the sector.
You could say that about commodities across the board. In the space of a few years, they’ve gone from hero to zero…or the penthouse to the…
That usually means there could be some good value around. One thing you need to look for in the current environment is a decent demand/supply dynamic. Iron ore in particular is heading towards massive oversupply next year. I reckon that makes it a poor investment choice for the next few years.
You’re better off to wait until the China slowdown and supply surge knocks out the juniors and all the marginal producers….leaving the market to BHP and Rio. You’ll then probably be able to pick these mining giants up at much lower levels.
Once you find a commodity with good supply/demand fundamentals, you need to make sure the producer is low cost. That protects it against further price falls…or a rise in the Australian Dollar.
It also protects it against foreign competition. One of the issues with the Aussie resources sector in recent years is costs. Other countries have much cheaper capital and labour costs and can therefore get stuff out of the ground cheaper than us.
That brings me to a final issue: Australia doesn’t really invest in its own resource sector. Via superannuation, we have a huge pool of capital. But this mostly goes into the banks or the major miners. Superannuation capital is not high risk capital.
That means a lot of the capital that flows into the resource sector is foreign. And when global financial conditions change…like the end of QE and the strengthening of the US Dollar…that capital departs.
This will create problems and opportunities for the sector. But given the bearishness towards commodities in general, it’s probably time to start getting interested again.
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Oct 20

The Fed Spots Inequality, Misses the Point

Gold Price Comments Off on The Fed Spots Inequality, Misses the Point
Janet Yellen says US inequality is worse than any time since, umm, the Fed was created…

IT DIDN’T take long did it? asks Greg Canavan in The Daily Reckoning Australia.
Now the Bank of England, the Federal Reserve’s old partner in crime, is at it too. On Friday, the BoE’s chief economist, Andy Haldane, said he favoured delaying interest rate rises in the United Kingdom.
That, along with comments from the Fed’s James Bullard on Thursday, helped global markets to rally late last week. It’s having a nice effect on our market so far today too. It was just as well. The situation looked extremely dicey on Wednesday.
Given US markets haven’t even had a 10% correction, the coordinated comments have a whiff of panic about them. What…can’t markets even have a half-decent correction these days without central bankers wetting themselves in panic?
While the minions were trying to hold things together late last week, boss Janet Yellen was inadvertently making a pretty decent argument to end the Federal Reserve altogether. She just didn’t know it.
In a speech on ‘economic opportunity and inequality’ in Boston on Friday, Yellen came out with some clangers. Unfortunately, most observers missed the irony of some of her comments.
Yellen drew heavily on data collated from the Fed’s Survey of Consumer Finances, which began back in 1989. Take it away, Janet…
“By some estimates, income and wealth inequality are near their highest levels in the past hundred years, much higher than the average during that time span and probably higher than for much of American history before then.”
Hmmm…the past 100 years you say? The Federal Reserve came into being in 1913. A coincidence, do you think?
Not convinced? Give us some more stats then, Janet…
“After adjusting for inflation, the average income of the top 5% of households grew by 38% from 1989 to 2013. By comparison, the average real income of the other 95% of households grew less than 10%.
“The lower half of households by wealth held just 3% of wealth in 1989 and only 1% in 2013.”
That’s interesting. Go on…
“The average net worth of the lower half of the distribution, representing 62 million households, was $11,000 in 2013. About one-fourth of these families reported zero wealth or negative net worth, and a significant fraction of those said they were ‘underwater’ on their home mortgages, owing more than the value of the home. This $11,000 average is 50% lower than the average wealth of the lower half of families in 1989, adjusted for inflation.”
Wow! The average net worth of 62 million US households is just $11,000…half of what it was back in 1989, despite 25 years of (mostly) economic growth?
Is it another coincidence that just two years before 1989 the Federal Reserve embarked on a policy of full-blown central banking activism? In 1987, Alan Greenspan had just taken the helm from the last great central banker, Paul Volcker, when ‘Black Monday’ hit, on the 19th of October (nearly 27 years ago to the day).
Greenspan panicked. He promised the market liquidity and support and whatever else he could. The Fed hasn’t looked back since. From that day on, it’s been the market’s socialist tormentor and benefactor…creating crises and then trying to solve them by throwing money at the problem.
And where does the money end up? In the hands of the already relatively well-off, which is why Janet Yellen’s statistics look so horrible.
The irony of a new Fed Chief pointing all this out is particularly…rich. Actually, it’s nauseating. If you didn’t know any better you’d think she was actually having a laugh. It’s either ingenuous or the work of the devil.
In truth, I think it’s genuinely ingenuous on Yellen’s behalf. You don’t set out to become the world’s biggest do-gooder by being a hard-nosed realist.
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Oct 16

What the Panic’s All About

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Stock markets are sinking for nothing. And everything…

As RON BURGUNDY said in Anchorman, writes Greg Canavan in The Daily Reckoning Australia, “Boy…that escalated quickly. I mean that really got out of hand fast.”
Indeed it did. It was a wild night of trading on US markets Wednesday. The S&P500 was down 3% at one point, before finishing just 0.8% lower. US Treasury yields plunged on fears of lower economic growth while gold momentarily surged $25 an ounce and closed out the session up nearly $20 an ounce.
An afternoon rally saved Wall Street. Apparently – and this is really pathetic if there’s any truth to it – rumours surfaced that Janet Yellen thought the US recovery was on track, despite worries coming from Europe.
There were no such comments from Mario Draghi in Europe. As a result, European stocks took a beating. French and Spanish stocks fell more than 3.5%, while German and British bourses fell nearly 3%. But the rally in the US came after Europe closed for the day.
So what’s all the panic about? Nothing in particular, it seems. Or nothing and everything, all at once.
These panic liquidations represent a psychological shift in trader positioning. It’s representative of complacency giving way to risk aversion. And it has given way big time in the past few weeks.
You can see this change in the volatility index, the ‘VIX’, in the chart below. Also known as the fear index, you can clearly see the ‘fear spike’ since the start of October. This comes just a few months after volatility levels were the lowest since early 2007.
In other words, something has clearly changed in the mindset of the market. In the short term, it’s probably gone too far…and you can expect to see a rally soon and a diminishment of the current high levels of fear.
But you should take the surge seriously. This is the highest level of fear since the Euro crisis of 2011. Except now there’s no discernible crisis. That’s the worrying bit. The market is saying that something is wrong. It’s not immediately apparent, but something isn’t quite right.
Maybe it’s fear of the effects of a slowing global economy…an economy that has a truckload more debt weighing on it than it did before the last downturn. The Telegraph in the UK reports:
“Morgan Stanley calculates that gross global leverage has risen from $105 trillion to $150 trillion since 2007. Debt has risen to 275pc of GDP in the rich world, and to 175pc in emerging markets. Both are up 20 percentage points since 2007, and both are historic records.”
Yep, debt levels are a major problem. And they become a very big problem when economic growth slows. That’s because to service debt, you need to generate growth.
When growth stagnates or falls, the debt servicing burden becomes a problem. Debt-to-GDP ratios rise and there is less money left over in the economy for investment, wages and consumption.
Debt, especially unproductive government debt, has detrimental long term effects on an economy. Let it grow large enough and it will eventually choke an economy into recession/depression.
That the only apparent response to a slowdown in a debt-based monetary system is to increase debt levels tells you something is seriously wrong with the world’s system of ‘wealth creation’.
The only question now is how long it will take the Federal Reserve to start back-tracking on its ‘interest rate hike for 2015’ talk. After they do that, I wouldn’t be surprised to see them dip into the QE playbook…again. The big question though, it whether it will be too late to inject another round of confidence into the speculating community.
They’re wheeling Janet Yellen out to speak at the end of the week, so we may get an idea of just what the Fed is thinking. Yellen must be careful to retain the market’s confidence. That the US Federal Reserve has no idea what it’s doing is beside the point. What’s important is that the market thinks the Fed knows what it’s doing.
Yellen must keep this con game going at all costs. Good luck with that. When you’ve got a bunch of panicked, slobbering trader yahoos in your face desperate for some sign that you’ve got it all under control, any minor slip-up can be dangerous.
When traders panic, liquidity disappears in the blink of an eye. That’s because confidence creates liquidity, and fear destroys it. And right now it’s the fear of huge debt levels consuming economies that is weighing on traders’ minds.
Why it’s happening right now, when the issue has been around for a while, is irrelevant. The important point is that the punters are beginning to wake up to the risks. The only question is how much longer the Fed can continue to pull the wool over everyone’s eyes.
Can another bout of QE do the job for another six or 12 months?
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Sep 18

Bad News for Gold from the Strong Dollar

Gold Price Comments Off on Bad News for Gold from the Strong Dollar
Expect a drop to $1200 near-term, says a man who called the bull market in 2001…

ERIC COFFIN is the editor of the HRA (Hard Rock Analyst) family of publications.
With a degree in corporate and investment finance, plus extensive experience in merger and acquisitions and small-company financing and promotion, Coffin has for many years tracked the financial performance and funding of all exchange-listed Canadian mining companies, and has helped with the formation of several successful exploration ventures.
One of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997, he also predicted the start of the current secular bull market in commodities based on the movement of the US Dollar in 2001 and the acceleration of growth in Asia and India. 
Now Coffin tells The Gold Report how the continuing strength of the US Dollar is bad news for the price of gold, and believes that in the short term a price of $1200 per ounce is possible, though there is room now for an oversold bounce…
The Gold Report: You told us last year you were “neutral” on the state of the US economy. Since then, the headline unemployment number has improved. Even so, as David Stockman, former director of the Office of Management and Budget, says, there have been no net new jobs created since July 2000, and jobs paying over $50,000 per year have disappeared by 18,000 per month since 2000. What is your view of the health of the US economy?
Eric Coffin: I’m more positive than neutral these days, but I do agree somewhat with Stockman. As unemployment falls toward 6%, we would expect an increase in wage gains. But we’re just not seeing that. And five years into the latest expansion, we’re not seeing the economic growth spurts that tend to occur coming out of a really bad recession. I don’t see how the US economy keeps reproducing the 4% growth of Q2 2014 if we don’t see higher wage gains and higher paying jobs created.
TGR: You’ve used the term “smack down” with regard to the recent falls in the gold price. What do you mean by this?
Eric Coffin: It’s a wrestling term and means being thrown to the mat. This is what has happened to gold time after time, after every uptrend. The current smack down is due more to strength in the US Dollar than anything else. Gold does trade as a currency sometimes and for the past few weeks it has held a strong inverse correlation to the US Dollar. I think physical demand will ultimately determine the price level, but ultimately it can be a long time when you’re trading.
TGR: Why isn’t physical demand determining the price now?
Eric Coffin: It’s because of trading in the futures market. When somebody dumps 500 tons there, gold has to drop $200 per ounce. The futures market can overwhelm the physical market in terms of volume and often does. Most traders in the futures market (NYMEX or COMEX) are not buying gold and taking delivery. They are trading as a hedge, or just trading. The physical market, the place where people actually buy bullion, coins and bars, is not predominantly in London or New York but rather in China and India. And because of the smuggling that has arisen in India to circumvent increased tariffs, and imports moving to cities that do not release import statistics in China, it is difficult to know how much bullion Asia is buying right now.
TGR: Large short-term trades in paper gold could be used to manipulate the market, and an increasing number of people believe gold is being manipulated downward in this manner. Do you agree?
Eric Coffin: I’m not really a conspiracy guy. That said, when we see things like the sale in August of 400 tons in about 10 minutes, we have to wonder what’s going on. Again, when Germany requests its gold from the US and is told delivery will take seven years, it makes you wonder how much of that gold has been hedged or lent already.
TGR: Where do you see gold going for the rest of the year?
Eric Coffin: I think we are going to be trapped in this currency trade cycle for a little while. The European Central Bank (ECB) cut its rates. One of its deposit rates is now negative. Mario Draghi, the president of the ECB, is talking about starting up quantitative easing. If that happens, or if traders believe it will, the Euro, which has already fallen from $1.40 to about $1.28 to the Dollar, could fall to $1.20 or $1.10. And this strengthening of the Dollar is not good for gold.
The other factor of gold being traded on a currency basis is the possibility of Scottish independence, fear of which has already resulted in a significant decline in the British Pound.
TGR: Will $1250 per ounce gold lead to gold miners suspending production?
Eric Coffin: If gold stays at $1200-1250 per ounce for an extended period, there will be mine closures. Obviously, not all mines have the same costs, but the average all-in cost per ounce for gold miners is about $1200 per ounce. Already, some mines are high-grading to keep profit margins up.
Most of the large miners have already cut exploration budgets pretty significantly. We can assume that the pipeline is going to get smaller and smaller when it comes to new projects, even high-quality projects.
TGR: How badly will this gold price decline hurt the junior explorers?
Eric Coffin: It’s hurt a lot of them already. It’s much more difficult to raise money than it was two or three years ago, although it’s probably slightly better now than early this year. That could change on a dime, of course, if the gold price falls to $1200 per ounce or rises back through $1300 per ounce. Already, quite a few companies are keeping the lights on but not much else. We desperately need a few good discoveries – companies going from $0.20 to $5/share and getting taken out. 
TGR: You’ve been visiting mine sites in the Yukon. What do you like about this jurisdiction?
Eric Coffin: It’s a great area geologically, but it has some challenges. It can be an expensive place to work, so being close to infrastructure or designing an operation that doesn’t require a huge amount of nearby infrastructure is critical. Power costs are a big item. There’s no end of places in the Yukon where hydropower could be generated fairly cheaply, but that is not going to happen on a large scale unless the federal government steps up, and that would be nice to see.
TGR: How does Alaska compare to the Yukon as a mining jurisdiction?
Eric Coffin: They’re similar in many ways. Alaska, like the Yukon, is not low-cost, but it is mining friendly and even farther down the road when it comes to settling aboriginal issues. The key to success in Alaska is being close to the coast or major population centers or infrastructure.
TGR: How do you rate copper’s prospects?
Eric Coffin: There are several large producers that have either recently come onstream or will come onstream in the next few months. So copper is probably going to be in at least a small surplus for the next year or two. The price could fall back to $2.50-2.75/pound ($2.50-2.75/lb). I’m not terribly concerned about that. Copper should be fine in the long term and a good copper operation can make plenty of money at those prices.
TGR: The bear market in the juniors is now 3.5 years old. Should investors expect a general upturn any time soon?
Eric Coffin: I doubt it if you mean a broad market rise that lifts all boats. My expectation at the start of this year, which is looking fairly dodgy right now admittedly, was for a 30% TSX Venture Exchange gain for 2014. That is possible with only a small subset of companies doing very well, which is my expectation. Investors always want to look for the tenbaggers. It doesn’t matter what the market is like and, obviously, potential tenbaggers often turn into actual one and a half or two baggers, which is just fine. You want to find the projects with the highest potential for resource growth or new discovery and management teams that know how to explore them and finance them on the best possible terms. That is the combination that gives you the potential biggest wins.
TGR: Eric, thank you for your time and your insights.
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Sep 16

The Most Important Chart Right Now

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Dollar up, everything down. And the end of QE means it probably isn’t done yet…

I WANT to show you the most important chart in the investing world right now. It’s affecting the price of just about everything else, writes Greg Canavan in The Daily Reckoning Australia.
If the United States’ superpower status is on the decline, you wouldn’t know it by looking at the chart below – the US Dollar index. As you can see, it’s moved sharply higher over the past few months.
The momentum indicators at the top and bottom of the chart are severely ‘overbought’, and the index itself is well above the moving averages. This suggests a correction is imminent, but for now, everything denominated in US Dollars is weak.
The Aussie Dollar, gold, copper, oil and most other commodities have all been under pressure lately. And it’s why share markets around the world are struggling to push mindlessly higher…as they’ve been doing ever since late 2012 when Ben Bernanke and Co. got jiggy with it on the QE front.
But next month, it all changes. For a short time at least, global share markets will experience life without Federal Reserve QE for the first time since 2011.
In short, the market is having another ‘taper tantrum’ as the end of QE draws closer. The last such episode was back in June 2013. As you can see in the chart above, that was when the US Dollar last spiked to its current level.
Being the world’s reserve currency, US monetary policy is essentially global monetary policy. As the US Federal Reservewinds down QE, you can see the knock on effects starting to emerge.
US Dollar strength is just the most notable. Its strength since bottoming in May this year indicates tightening global liquidity. But until recently, the effects of this haven’t been all that obvious.
Emerging markets are usually most vulnerable to a strengthening Dollar. But that vulnerability only began to show in the past week or so, as you can see in the emerging markets index chart below…
Emerging markets rallied to new highs this year despite the strengthening Dollar. Until recently that is – when sharp falls took place, especially in markets like Turkey and Brazil. The Bank for International Settlements warned in its just-released quarterly report that these markets are particularly vulnerable because of increased US Dollar borrowing over the past few years.
As you know, borrowing in a strong currency while revenues and earnings are in a weaker currency doesn’t usually work out well. It places greater pressure on a company to service its debts, leaving less left over for shareholders.
You’ll have to wait and see whether emerging market resilience can continue, or whether the end of QE will finally have a more definitive impact on these peripheral economies.
I don’t know what the outcome will be. But I can say that markets often ignore issues for months on end and then all of a sudden worry about them acutely. Maybe this is just the start of an intense worry phase.
Whatever it is, Australia is a part of it. Our stock market and currency are under the pump, thanks to weaker commodities and a weaker iron ore price in particular. That, in turn, is because of a slowing Chinese economy, which, as it turns out, imports US monetary policy through a partially pegged exchange rate.
The US Dollar’s tentacles have a wide reach. And it touched China on the weekend with the Middle Kingdom announcing weaker than expected industrial production, fixed asset investment and retail sales growth.
The slowdown comes amid a deteriorating property market in China, which for years was the engine of growth for the country. But that engine is sputtering as China’s leaders grapple with trying to rebalance the economy without crashing it. It’s a tough task.
Which is why you can expect to hear calls for ‘more stimulus’ from China grow louder this week, because ‘more stimulus’ always works. If only we had done ‘more stimulus’ sooner rather than later, we’d not be in the position of needing ‘more stimulus’ now.
Economics really is that simple. Money may not grow on trees but it does lay dormant and abundant inside the computers of our heroic central bankers. (In case you need me to say it, yes…I’m being sarcastic.)
For that reason, all eyes will be on the Federal Reserve this week. They gather for a two-day meeting on the 16th and 17th, and boss Janet Yellen gets a chance to move markets with an accompanying press conference at the conclusion of the meeting.
Usually, the Federal Reserve provides soothing words about how interest rates won’t go up for ages and everyone can keep punting without any need to worry. That’s worked well for the past few years.
But the time is approaching where the Fed will actually start having to do something on the interest rate front. Or at least they’ll have to stop pretending they’ll keep interest rates low forever.
In other words, there are fewer rabbits in the hat. Or maybe there are no rabbits left at all?
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Aug 28

War Comes Home

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New targets for all that surplus military hardware…

AMERICA’s attention recently turned away from the violence in Iraq and Gaza toward the violence in Ferguson, Missouri, following the shooting of Michael Brown, writes former US Congressman Ron Paul.
While all the facts surrounding the shooing have yet to come to light, the shock of seeing police using tear gas (a substance banned in warfare), and other military-style weapons against American citizens including journalists exercising their First Amendment rights, has started a much-needed debate on police militarization.
The increasing use of military equipment by local police is a symptom of growing authoritarianism, not the cause. The cause is policies that encourage police to see Americans as enemies to subjugate, rather than as citizens to “protect and serve.” This attitude is on display not only in Ferguson, but in the police lockdown following the Boston Marathon bombing and in the Americans killed and injured in “no-knock” raids conducted by militarized SWAT teams. 
One particularly tragic victim of police militarization and the war on drugs is “baby Bounkham”. This infant was severely burned and put in a coma by a flash-burn grenade thrown into his crib by a SWAT team member who burst into the infant’s room looking for methamphetamine.
As shocking as the case of baby Bounkham is, no one should be surprised that empowering police to stop consensual (though perhaps harmful and immoral) activities has led to a growth of authoritarian attitudes and behaviors among government officials and politicians. Those wondering why the local police increasingly look and act like an occupying military force should consider that the drug war was the justification for the Defense Department’s “1033 program”, which last year gave local police departments almost $450 million worth of “surplus” military equipment. This included armored vehicles and grenades like those that were used to maim baby Bounkham. 
Today, the war on drugs has been eclipsed by the war on terror as an all-purpose excuse for expanding the police state. We are all familiar with how the federal government increased police power after September 11 via the PATRIOT Act, TSA, and other Homeland Security programs. Not as widely known is how the war on terror has been used to justify the increased militarization of local police departments to the detriment of our liberty. Since 2002, the Department of Homeland Security has provided over $35 billion in grants to local governments for the purchase of tactical gear, military-style armor, and mine-resistant vehicles.
The threat of terrorism is used to justify these grants. However, the small towns that receive tanks and other military weapons do not just put them into storage until a real terrorist threat emerges. Instead, the military equipment is used for routine law enforcement. 
Politicians love this program because it allows them to brag to their local media about how they are keeping their constituents safe. Of course, the military-industrial complex’s new kid brother, the law enforcement-industrial complex, wields tremendous influence on Capitol Hill. Even many so-called progressives support police militarization to curry favor with police unions.
Reversing the dangerous trend of the militarization of local police can start with ending all federal involvement in local law enforcement. Fortunately, all that requires is for Congress to begin following the Constitution, which forbids the federal government from controlling or funding local law enforcement. There is also no justification for federal drug laws or for using the threat of terrorism as an excuse to treat all people as potential criminals. However, Congress will not restore constitutional government on its own; the American people must demand that Congress stop facilitating the growth of an authoritarian police state that threatens their liberty.
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Aug 03

War Coming in Europe

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So says a Moscow insider dismissing the $50bn Yukos Oil fine…

ONE HUNDRED years ago a feisty little Bosnian Serb, Gavrilo Princip, shot and killed the Archduke of Austria, Franz Ferdinand, and his wife Sophie in the city of Sarajevo, writes Greg Canavan in The Daily Reckoning Australia.
It was the “shot that rang out across the world”. A month later, the world was at war.
While historians have subsequently shown that the war was a long time coming – the result of rising imperialism of the great powers and the faltering old Austro Hungarian and Ottoman Empires – no one saw it at the time.
Take this contemporary account from Austrian novelist and playwright, Stefan Zweig, recounted in his memoir, The World of Yesterday. In the days following the assassination, Zweig was holidaying in the Belgian seaside resort of Le Coq…
“The happy vacationists lay under their coloured tents on the beach or went in bathing, children were flying kites, and the young people were dancing in front of the cafes on the digue (a bank or dike). All nationalities were peaceably assembled together, and one heard a good deal of German in particular…The only disturbance came from the newsboy who, to stimulate business, shouted the threatening captions in the Parisian papers: L’Autriche provoque la Russie, L’Allemange prepare la mobilisation.
“We could see the faces of those who bought copies grow gloomy, but only for a few minutes. After all, we had been familiar with these diplomatic conflicts for years; they were always happily settled at the last minute, before things grew too serious. Why not this time as well? A half hour later, one saw the same people splashing about in the water, the kites soared aloft, the gulls fluttered about and the sun laughed warm and clear over the peaceful land.”
Within a few days, Belgian soldiers arrived on the beach, with machine guns and dogs pulling carts. Then Austria declared war on Serbia. The resort town become deserted. Zweig quickly booked a train back to Austria.
Early in the journey, the train stopped in the middle of an open field. It was dark, but Zweig saw freight trains – open cars covered with tarpaulins – heading in the opposite direction. They were full of German artillery heading for Belgium. The war was underway.
What’s the point of recounting this story? Well, there’s the regional conflict in Ukraine that’s heating up. But the main point is that no one knows what the future holds.
In early 1914, the (Western) world had experienced a long period of economic expansion and freedom. Zweig travelled freely around the world without needing a passport or ‘papers’. Capital and labour mobility were high. There was virtually no income tax (nor was there a welfare state), the Federal Reserve had only just come into existence, and government involvement in all areas of life was minimal.
But that all changed with the Great War. It led to the rise of larger governments, the welfare state, and the unions. It led to greater state control of financial markets and it led to systematic inflation.
The world changed massively in 1914, and no one at the time would have picked the direction it was heading. Even after the war started, the general consensus was that it would be over by Christmas. As it turned out, it endured nearly to Christmas 1918.
These days, people seem pretty certain that the Fed has things under control. That interest rates will stay low for many, many years, stocks won’t have a meaningful decline. They seem confident in China’s ability to manage an historic credit boom, and confident that Australia’s 25 year property bull market will keep on giving. That could well be true. No one knows.
But history tells you that things change…often dramatically. It tells you that bear markets follow bull markets…that cheap prices follow expensive prices. That you can’t see the catalyst doesn’t mean it won’t happen. And just because governments and central banks around the world are trying desperately to levitate markets, doesn’t mean they will succeed.
And who would’ve thought that 100 years after the peak of the British Empire, the Commonwealth Games would still be going, or more unbelievably, that people still care? Seriously, what a strange little tournament it is.
Getting back to the 1914/2014 parallels (which may be a little closer than you think), last week the Permanent Court of Arbitration in The Hague awarded former shareholders in Yukos Oil US$50 billion in damages for having their assets taken from them by the Russian state.
Will Russia pay? It’s unlikely. They’ll just see this as a Western attempt to apply further economic sanctions over the standoff in Ukraine. As the Financial Times reported:
“But if Russian state businesses find themselves hit both by western sanctions and attempts to seize assets by Yukos shareholders, relations between the Kremlin and the West could sour further.
“One person close to Mr Putin said the Yukos ruling was insignificant in light of the bigger geopolitical stand-off over Ukraine. ‘There is a war coming in Europe,’ he said. ‘Do you really think this matters?’…”
Maybe that’s just a bluff. But economic sanctions are often a path to war. Russia is an energy powerhouse and can inflict great damage on Europe if it wants to.
The repercussions for investors are obvious. It all comes down to confidence. When confidence (the belief that, y’know, everything will be fine) evaporates, so does liquidity. And it can go very quickly.
In 1914, the two largest exchanges in the world – the London and New York Stock Exchanges – closed for the first time in their history on July 31 to stop capital flight. New York remained closed for four months, London five months. At the time, no one thought such an occurrence possible.
That’s the problem. People, even experts, lack imagination during important historical turning points. Following the global financial crisis, the Queen asked a bunch of experts how no one saw this crisis coming. The response was along the lines of, ‘It was a failure of imagination.’
Hubris and overconfidence often inhibit the imagination. And if you look around markets and investors today, well, hubris and overconfidence are leaking out all over the place.
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Aug 03

Fish, Fuel, News & Price

Gold Price Comments Off on Fish, Fuel, News & Price
The stakes are rising in Asia-Pacific saber-rattling…

“IF IT’S in the news, it’s in the price,” goes the old phrase, says Dan Denning in The Daily Reckoning Australia.
Last week, I engaged in a friendly debate with Cycles, Trends, and Forecasts editor Phil Anderson over whether it’s really true that a security’s price represents all that is currently known by the market at any given time.
Phil’s contention – and he has a lot of company on this point – is that the chart of a stock price is the visual expression of everything the market knows. I’ll come back to that point at the end of today’s episode. But keep it in mind when you look at the chart below.
Market Vectors Indonesia Index Exchange Traded Fund (NYSEARCA:IDX)
If Indonesia traded as a stock, it would look like the chart above. That’s the Market Vectors Indonesia Index Exchange Traded Fund (NYSEARCA:IDX). It’s an index of 53 companies that are either headquartered or earn 50% of their revenue in Indonesia.
The fund has $242 million in assets. Its main holdings are what you’d expect from a country fund: banks, a large telecom, a basic materials stock (cement), and some conglomerates with exposure to retail stocks. But what about the chart?
Indonesia’s presidential elections took place on Wednesday, July 9th. The ‘reformer’ Joko Widodo (Jokowi) beat the ‘nationalist’ Prabowo Subianto. Jokowi is due to be sworn in October 20th. As the leader of the world’s fourth-most-populous country, let’s hope he builds a good working relationship with Tony Abbott. The last 10 months haven’t exactly been smooth sailing between the countries, with Aussie naval vessels breaching Indonesian territorial waters.
But yes, the chart. The index began a rally in late June. In early July – still before the election – the 10-day moving average crossed over the 35-day moving average. The technical momentum was bullish. You can also see that the relative strength index (RSI) dipped to nearly 30 in late June. A reading of 30 or below usually suggests a stock is ‘over sold’.
On that basis, the chart predicted the winner of the election before it even happened. The ‘price’ of Indonesia went up as the market expressed its collective vote of confidence in the reformer over the nationalist. Price action, then, does tell you something about what people are thinking.
Where I get off the boat, however, is the belief that every objective fact affects the price of every security and is instantly ‘priced in’ to every security. Not all facts matter equally. Or more to the point, not all facts (or news stories) affect the intrinsic value of a business or its ability to grow earnings for shareholders.
Figuring out which facts are more important than others is the job of a good analyst. Figuring out what those facts actually mean is the job of really good analyst. As a general rule, it’s probably true that if you’re reading about something in the news for the first time, it may already be too late to profit from it. Somebody else already knew. And that somebody has already done something with that information.
But what about objective facts that don’t have a clear meaning? How can you price in something you don’t fully understand? How can you price in something you can’t understand because the situation is still too fluid? Is it even possible?
Let’s take a concrete example. Take China’s live-fire naval exercises in the Gulf of Tonkin in the South China Sea this week. The People’s Liberation Army Navy is also holding naval drills in the East China Sea, near the disputed and uninhabited Senkaku Islands (the dispute is with Japan, but also, by extension, with the US and even Australia via treaty obligations). The drills have blocked off a large chunk of commercial air space in the region.
Maybe it’s a show of strength after the recent ‘Rim of the Pacific’ exercises hosted by the US near Hawaii. Maybe it’s intended for domestic consumption. Maybe it’s a routine drill. And maybe it’s a trial-run for naval operations to seize control of disputed waters and establish new ‘facts on the ground’.
Maybe it’s all of these things. Or none of them. My point is that, if a given set of facts is susceptible to different (and often quite different) interpretations, then it’s only reflected in the price as confusion. Not as a fact. In this case, the facts are pretty murky to being with. Australian academics Alan Dupont and Christopher Baker have written an article on the matter to explain what’s at stake for Australia. It’s called East Asia’s Maritime Disputes: Fishing in Troubled Waters. As you might guess from the title, the authors conclude that China’s moves are as much about food security as they are national security.
Or put another way, because the Communist Party of China values political stability and social harmony, a well-fed populace is a matter of national security. They write that:
“In Chinese eyes, the rich fishing grounds of the East and South China Seas are as critical to China’s future food security as oil and gas are to its energy future. With wild fish stocks in decline and demand rising, fish has become a strategic commodity to be protected and defended, if necessary, by force…Beijing is using its fishing and paramilitary fleets for geopolitical purposes by pursuing a strategy of ‘fish, protect, contest, and occupy – designed to reinforce its sovereignty and resource claims over contested islands in the Western Pacific and coerce other claimants into compliance, and acceptance, of China’s position. If this policy does not reverse or moderate – and there are few signs that it will – the consequences could endanger regional stability and even China’s own long-term security.”
Whether its fish, fuel, or plain old geopolitical power, the stakes are rising in Asia Pacific. 
Friday saw Australia’s Defence Department release an interim discussion paper, explaining what the ‘establishment’ thinkers would like to do. The big issue is whether to build or buy the next generation of submarines to replace the fleet of six Collins-class boats. But don’t rule out the F35-B. Finance minister Mathias Cormann travelled to Fort Worth, Texas last month to see Australia’s first two F35 Joint Strike Fighters (JSFs) roll off the assembly line at Lockheed Martin. They are the first of dozens.
However, the two planes the Minister saw in Texas last week were the F35-A version of the plane. That’s a plane designed to take off and land in a conventional way. Tony Abbott wants to look at the F35-B. THAT plane – operated in the US by the Marine Corps – is a short-take off and vertical landing variation of the F35-A.
Think of it as ‘jump jet’ and it makes more sense. It also, in theory, means that with a few expensive modifications, Australia’s Canberra-class Landing Helicopter Docks (LHDs) could be turned into aircraft carriers. Presto change-o. Force projection in South China Sea!
Now, before you get all excited, Australia only has two LHDs. The first, Canberra, is scheduled for commissioning later this year. The second, Adelaide, is still under construction. And although it’s theoretically possible to land an F35-B on either of the ships, the ships aren’t yet kitted out to store the fuel, munitions, and crews required for the permanent presence of ‘jump jets’.
What’s more, critics of the F35-B say that version of the JSF carries less fuel than the F35-A. For that reason, it can’t carry as many weapons, has a shorter range, and can spend less time over a target than the conventional version. As I noted in my newsletter on the plane, the whole point of the JSF is to identify and destroy a target from long-distance before they even know you’re coming. Shorter range doesn’t help with that goal.
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Jul 20

What’s the True Rate of Inflation?

Gold Price Comments Off on What’s the True Rate of Inflation?
Watch commodities, and wages, for unmassaged price-level reports…

In AN AGE when governments of every political leaning and ideological stripe distort economic data to promote their parties’ interests, it is hardly surprising that the nation’s inflation rate is reported in a manner that best suits their political needs, writes Gary Dorsch, editor of the Global Money Trends newsletter.
By the same token, in an age of near universal cynicism on the part of citizens towards their corrupt politicians, it is entirely natural for official inflation data to be wildly at odds with the reality faced by consumers and businesses, and in turn, to be regarded with utter disbelief.
Since the days of the Clinton administration, the US government has tinkered with the methodology of computing the inflation rate, and therefore, the CPI is no longer considered to be an objective gauge of the prices of a fixed basket of goods, that consumers normally buy. Instead, the US government has a vested interest in understating the true rate of inflation, because it enables Washington to lower cost of living allowances for Social Security checks, helps the Fed to keep interest rates artificially low, weakens wage demands, buoys confidence in the US Dollar, and artificially increases the “real” rate of US economic output.
The tens of thousands of government apparatchiks who work for the Bureau of Labor Statistics, Bureau of Economic Analysis, US Treasury, Office of Management and Budget, Economics and Statistics Administration, and countless other agencies, massage their spreadsheets day in and day out, and fudge the numbers. It’s hard not to notice that the inflation rate is reported with distortions caused by seasonal adjustments, hedonic deflators, chain-weighted substitutions, skewed sampling, delayed reporting, and with a twist of political bias. Yet perhaps the simplest advice on how to resolve contradictions between the costs that households face everyday, and the phony CPI, is to watch the Dollars and cents flowing through the global commodity markets, and to map their longer term price trends. Who are you going to believe, the commodity price charts or the skewed data from government apparatchiks? 
According to the Bureau of Labor Statistics, in 2012, US households spent 40% of their total expenditures on commodities, and the remaining 60% was spent on services. Thus, the commodities markets have become less of a leading indicator of future trends of inflation than in the past, when commodities made up 58% of expenditures in 1980 and 64% in 1970.
Still, the alternative to relying on the commodities markets for clues on inflation, is to blindly adopt the Fed’s favorite gauge of inflation, the “personal-consumption-expenditures” price index, (the PCE), which strips out the cost of the basic essentials of life, and is conjured-up by apparatchiks. The PCE was reported to be 1.8% higher in May from a year earlier, or -0.3% less than the CPI. 
On 17 June 2014, the US government reported that consumer prices increased 0.4% in May – the biggest monthly increase in more than a year – saying the cost of food and gasoline showed big gains. Airline fares jumped 5.8%, their largest monthly increase in 15 years. The cost of clothing, prescription drugs and new cars all showed increases. Overall, the consumer price index was 2.1% higher compared with a year earlier. That left prices rising at slightly above the Fed’s so-called 2% inflation target, and traders questioned if the uptick would sound the alarm bells at the Yellen Fed.
The increase in the consumer inflation rate was preceded by a sharp upturn in the market value of the Continuous Commodity Index (CCI), a basket of 17-equally weighted commodities – that started in January ’14. Six months later, the CCI was trading 9% higher than a year earlier. For the first time in 2-½ years, the CCI has emerged from deflation territory (or negative year-over-year returns). However, commodity prices are notoriously volatile, and so, the outlook for inflation can often turn on a dime.
Commodity markets are notoriously volatile from month to month, and from year to year, quite often due to unforeseen acts of nature or military conflict. However, in order to filter out the “noise” of the markets, a simple approach is to take a much longer-term view of price trends. And for a wide array of commodities, their prices have trended significantly higher.
For some of the basic staples of life, the market price of rough rice is up 83% higher, Butter is up 69%, and unleaded gasoline is up 67%, compared with 8.5 years ago. Milk and cattle prices are up 63%, and the cost of wheat is up 61%. So when Americans are driving to the grocery store, they are feeling the pinch of accumulated rates of inflation.
But what about the wages of the US worker, have they kept pace with the increasing cost of living? According to the Labor Dept apparatchiks, the average wage is up 19% compared with 8.5 years ago, for an increase of 2.2% per year, on average. However, for many Americans, their incomes are actually declining and that could put a squeeze on discretionary spending.
For example, in the month of June ’14, the BLS reported that the number of higher paying, full-time jobs plunged by 523,000 to 118.2 million while lesser paying, part-time jobs increased 799,000 to over 28 million. That suggests that many US workers’ are being forced into part-time work, and their income is decreasing. Thus, the hallowing out of the US middle class and the impoverishment of the lower income groups is worsening.
As such, the Fed is already talking about moving the goal posts again, from targeting inflation to targeting wage increases. “Signs of labor-market slack include slow wage growth and low labor-force participation,” Fed chief Yellen said on 15 July. Earlier, on 11 July, Chicago Fed chief Charles Evans said on Bloomberg TV that it would not be a “catastrophe” to allow the inflation rate to overshoot the Fed’s 2% target.
“Even a 2.4% inflation rate, I think that could work out,” he said.
So the message is; the Fed would be tolerant of above target inflation, since lower paying part-time wages are supposed to keep inflationary pressures in check. For the Fed, with the passage of time, many of its sins of the past, in the form of a higher cost of living, are seemingly washed away into obscurity.
When asked about the recent uptick in the consumer inflation rate to 2.1% in the month of May, Fed chief Janet Yellen downplayed the threat saying; “So I think recent readings on, for example, the CPI index, have been a bit on the high side, but I think it’s – the data we are seeing is noisy. It’s important to remember that, broadly speaking, inflation is evolving in line with the Committee’s [ie, politburo’s] expectations. The Fed [ie, a politically appointed Politburo] has expected a gradual return in inflation towards its 2% objective, and I think the recent evidence we have seen…suggests that we are moving back gradually over time to our 2% objective, and I see things roughly in line with where we expected inflation to be,” she said.
However, the reality for the 48 million Americans that are receiving food stamps is their monthly stipend is buying a lot less butter, cheddar cheese, chocolate, and milk, these days. At the Chicago Mercantile Exchange, the nearby futures contract for Milk futures is 23% higher, compared with a year ago, and up 75% compared with 8.5 years ago. However, in the Fed’s view, the soaring cost of dairy products is only transitory. After all, according to the Law of Gravity, what goes up must eventually come down, right? 
From Asia to South America, the demand for US dairy products processed foods containing milk, such as cheddar cheese, is up 19% compared with a year ago, according to the US Dairy Export Council. Exports of cheese jumped 46% in the past year, led by a 38% increase to Mexico, the biggest buyer of US dairy products, and a doubling of sales to China.Exports of dry milk now account for 16% of all dairy sales, compared with 5% a decade ago. As such, dairy farmers’ revenue soared 35% last year to $584 million.
So far this year, rising dairy and meat costs are the biggest sources of inflation. Safeway, the second-largest US supermarket operatorwith a network of more than 2,400-stores and 250,000 employees, said on April 23rd, that it plans to pass along the higher costs for meat, produce and other staples on to shoppers at its US grocery stores in the second quarter.
Hershey (NYSE:HSY) – the No.1 candy maker in the United States – said it would increase prices of its instant consumable, multi-pack, packaged candy and grocery lines by about 8% to tackle rising commodity costs, with Cocoa futures trading at a 3-year high.
However, higher prices for dairy products have widened profits margins for farmers, and in turn, they are already decreasing their dairy cow culling rates, in order to boost the supply of milk. New Zealand, the world’s top dairy exporter, is expanding its output of milk to an all-time high, in order to meet growing demand in China, and is setting the stage for a surplus of milk, in the months ahead.
Increased output in New Zealand has already rattled the milk futures market on the Chicago Mercantile Exchange. The nearby contract has slumped 12% from a record high of $24.32 per hundred pounds in April. Class III milk, used to make cheese, closed at $21.42 per hundred pounds this week. The price of nearby Cheddar Cheese futures have dropped from an all-time of $2.35 per pound to $2.04 today.
In a year when American dairy farmers are enjoying windfall profits, other US farmers can expect to see lower earnings than in 2013. US farmers will suffer a 21% drop in net-cash income, on average, due to sharply lower prices for their biggest cash crops, corn, wheat and soybeans. At the same time, dairy farmers will earn 28% more or roughly $334,100 on average, this year, the USDA predicts.
Two years ago, on the Chicago Board of Trade, Corn futures sold for as high as $8.43 per bushel shortly after the US Dept of Agriculture gave its assessment of the effects of the historic drought plaguing the Farm Belt. The USDA lowered its estimate of the US’s corn production at 10.8 billion bushels, or 13% below 2011, and the lowest since 2006.
However, US farmers figured that drought like conditions would last for a long time, and many decided to profit from record high prices by boosting output. In turn, the collective actions of the farmers created a huge glut of supply in today’s grains markets.
Two years removed from a devastating drought that sent US grain prices soaring, the price of Corn has dropped in half, tumbling to $3.75 per bushel today, and its lowest level in four years. It’s estimated that the average cost of production is around $3.50 for a bushel of corn, which could act as a floor for corn prices. Soybean prices have plunged from a record high of $18 per bushel two years ago, to $11.80 per bushel today, its longest slump in 41 years. The farther dated Nov ’14 contract is priced below $11 per bushel. The USDA says US farmers will harvest 3.8 billion bushels of soybeans this year, compared with last year’s crop of 3.3 billion. Amid a bumper crop that is expected to boost global stockpiles to the highest level in 14 years, corn futures are down 44%, wheat is 24% lower, soybeans 20% lower, and rice is down 18%
Of more than 50,000 edible plant species in the world, only a few hundred contribute significantly to food supplies. Just 15 crop plants provide 90% of the world’s food energy intake, with three rice, maize (corn) and wheat – making up two-thirds of this. 
Whether birthed from Indian soil, or in China or Japan, rice is a staple food for nearly one-half of the world’s population. Today, rice and wheat share equal importance as leading food sources for humankind.rice provides fully 60% of the food intake in Southeast Asia and about 35% in East Asia and South Asia. The highest level of per capita rice consumption is in Bangladesh, Cambodia, Indonesia, Laos, Thailand, and Vietnam.
Yet only 5% of the global rice crop is available for export. Thus, rice commands a higher price than wheat on the international market, because a higher percentage of the wheat crop (16%) is available for export. That leaves small rice-producing countries such as Thailand, Vietnam, and the US as the top exporters of rice. On the basis of yield, rice crops produce more food energy and protein supply per hectare than wheat and maize. Hence, rice can support more people per unit of land than the two other staples.
With its invaluable status as a staple food source in two of the most populous nations on earth and the domination of its export share by relatively small producers, rough rice futures have attracted both hedgers and speculators. In July ’12, China, the world’s top rice producer and consumer, launched the early Indica rice futures contract on the Zhengzhou Commodity Exchange – a world bellwether.
Since the inception of the contract, early Indica rice futures have been gripped by a grizzly bear market, losing 28% to 2,050 Yuan per ton this week. Yet Rough Rice futures traded on the CBoT were remarkably stable over the past few years, gyrating within a narrow range between $14 and $16 per hundred weight (cwt). However, starting in late May ’14, Chicago rice began to tumble, plunging 10% over a two-week period to as low as $14/cwt, before crashing to $12.85/cwt this week. This is certainly good news for citizens residing in the Emerging countries, where households spend as much as 30% of their income on purchases of food.
A pickup in the US’s official consumer inflation rate towards the central bank’s 2% objective has some Fed officials warning about the danger of risking faster inflation in the future by waiting too long to start raising interest rates.
The Fed hawks argue that the central bank must move to tighten its monetary policy sooner, rather than later. The way Philly Fed chief Charles Plosser sees it, the Fed is sitting on a ticking time bomb.
“One thing I worry about is that if we are late, in this environment, with $2.7 trillion of excess reserves, the consequences might be more dramatic than in previous times. If lending begins to surge and those reserves start to pour out of the banking system, that’s going to put pressure on inflation.”
However, Janet Yellen – the money printer in chief – is not swayed by the hawkish view.
“Inflation has moved up in recent months” she acknowledged, “but decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook,” Yellen told Congress on 15 July.
“The Fed does need to be quite cautious with respect to monetary policy. We have seen false dawns in the past.
“With wages growing slowly and raw material prices generally flat or moving downward, firms are not facing much in the way of cost pressures that they might otherwise try to pass on,” the Fed said in a report accompanying Yellen’s testimony.
It’s true that the most economically sensitive commodities, traded in Shanghai, such as steel, iron ore and rubber, are trading at sharply lower levels than compared with a year ago, and thus, helping to keep a lid on factory-gate inflation. 
Free-falling cotton futures hit fresh two-year-plus lows to close around 68 US cents, amid expectations for a buildup in US stockpiles and growing world inventories outside China. In June, the World Bank cut its projection for global growth to 2.8% this year, from its earlier estimate of 3.2%.
That’s half the growth rate of the pre-financial crisis economy.
The World Bank also downgraded its outlook for the US economy to 2.1% for 2014, down from 2.8% earlier. Commodities such as copper, rubber and iron-ore have meanwhile been commonly used in China for collateral, where traders or investorsborrow against the commodity with the aim of investing Yuan in real estate or sub-prime loans in the shadow banking sector. Some estimates put the portion of inventories of iron-ore that is used as collateral at 40%. Now that Beijing’ is cracking down on shadow lending and weakened the yuan – a deliberate move by authorities – Beijing is trying to push these deals under water. As such, some of these commodities held in storage can find their way back onto the market and weigh on prices. 
China produces as much steel as the rest of the world combined and it’s most actively traded steel futures contract – Shanghai rebar – dropped to a record low of 2,800 Yuan per ton on June 30. That’s down nearly 50% from a record high of 5,450 hit 3 years ago.
Chinese steelmakers suffer from chronic lack of profitability and overcapacity of close to 200 million tons. Despite weak end demand and Beijing’s attempts at consolidation and its crackdown on polluting industries, steel production continues apace because regional authorities are fearful of closing down plants that provide tax revenue and employment. 
In Shanghai, the spot market for iron ore briefly fell below $90 per ton on 16 June, for the first time since September 2012. If sustained below $90 per ton, about one fifth of China’s iron ore miners would be forced to shut down around 80 million tons of output per year.
In contrast, Rio Tinto breaks even at $43 per ton, and BHP stays in the black at $45. Brazil’s Vale’s break even is $75 per ton, due to the greater distance to ship ore from Brazil to China. Iron ore has since rebounded to $97 per ton, but is still trading -23% lower than a year ago. 
The cartel that controls the majority of the world’s rubber production, Thailand, Indonesia and Malaysia has urged its exporters not to sell the commodity below $1.90 or 62.70 Thai Baht per kilo, as the average output cost for growers in Southeast Asia is about 60 Baht. The price of natural rubber is 16% less than a year ago, and at 13,750 Yuan per ton in Shanghai, has lost about two thirds of its value. Stockpiles of rubber at the Shanghai Futures Exchange are at the highest in 10 years, and a global surplus of 241,000 tons is expected in 2014.
Prices for thermal coal are expected to remain weak, with oversupply continuing to plague the market until producers curb output further. Coal prices in Europe and Asia have lost more than half their value since spring 2011, with European physical coal for September delivery was trading at $72.65 per ton, near five-year lows. New-Castle coal prices mined in Australia have also fallen below $70 per ton, bumping along five-year lows, as record output in Q’1 coincided with slowing import needs from China, the world’s biggest coal buyer.
Gold meanwhile is building a base, and eyeing these volatile commodities. History shows that rapid growth of the money supply usually fuels higher rates of inflation. Yet while the Fed increased the size of the MZM Money supply $700 billion in 2013, and $350 billion in the first half of 2014, what has surprised traders is the lethargic behavior of the US’s rate of inflation.
The CPI increased 1.5%, on average, in 2013, and bumped up to 2.1% in May ’14. However, given the -6% slide in the Continuous Commodity Index since the start of July, led by a drop of 20-cents in the price of unleaded gasoline on the Nymex, it’s a good bet that the consumer price index will start to edge lower again, with a lag time of 2-3-months.
Former Fed deputy Alan Blinder explained why the Fed’s QE-scheme didn’t spark an upward spiral in inflation. “The monies the Fed pumped into the banking system didn’t circulate in the US economy. Instead, it all got bottled up in the banks, and essentially, none of it got lent out,” he explained. Because the Fed began to pay 0.25% interest on excess reserves, the banks agreed to park the QE-monies at the Fed itself, instead of lending and creating deposits and increasing the money supply. Therefore, QE didn’t contribute to inflation. And if banks aren’t lending, there’s no boost to the economy. However, there is reason to believe that the $.35 trillion of QE-injections were funneled into the US bond and stock markets.
The meltdown in the yellow metal in 2013 left many gold bugs licking their wounds. However, in hindsight, the collapse in the Continuous Commodity Index (CCI), in the first half of 2013, was probably the biggest contributing factor behind gold’s slide to the $1200 level. And it’s the narrative about low inflation and/or deflation, and weak gold prices that enables the endless printing of money by central banks.
Bubbles in the European and US bond and stock markets can be sustained in the stratosphere, as long as inflation is said to be running near-zero. In fact, the Bank of Japan, the ECB and the Fed all say they must print money to counter the threat of deflation. As for the price of gold, the average break-even point for gold miners worldwide is estimated to be around $1200 per ounce, and it’s this figure, that gold investors believe is the “rock bottom” price for the yellow metal.
Gold bugs have been building a big base of support for the past 12-months, but a sustained rally to $1400/oz and beyond, might require the revival of the “Commodity Super Cycle.”
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Jul 17

Deflation Theory & Fact

Gold Price Comments Off on Deflation Theory & Fact
When the financial crisis MkII shows up, expect 1930s-style deflation…

SOFT inflation numbers. Australian interest rates are at a fifty year low. Possibly going lower. This is not how the script was meant to go, writes Vern Gowdie, editor of Gowdie Family Wealth in Dan Denning’s Daily Reckoning Australia.
The Australian market will be waiting with bated breath on second quarter CPI numbers. Perversely, a softer number could see the market rise. Lower interest rates makes fully franked dividends look even more attractive.
However, a lower number means our economy is stuck in a lower gear and cannot produce enough revs to change to a higher gear. 
The sixth anniversary of the Lehman Brothers collapse is fast approaching. And after all the central bankers’ antics since then – suppressed interest rates and trillions of newly minted electronic money – the global economy is still barely treading water.
Time after time, nearly every growth forecast from the RBA, the Fed, the ECB, JCB, IMF, etc. is eventually wound back to a lower number. This cycle of optimism followed by realism has become a joke.
Here’s the Australian telling…
“Australia’s first quarter inflation surprisingly soft”
CNBC 22 April, 2014
“RBA boss Glenn Stevens hints official interest rates could drop lower than record low of 2.5%”
The Daily Telegraph 4 July, 2014
And the latest rolling joke…
“US GDP expanded at a 0.1% annual rate Q1” – Reuters, 30 April, 2014
“US GDP Dropped 1% In The First Quarter 2014, Down From First Estimate” – Forbes.com, 29 May, 2014
“US GDP Dropped 2.9% In The First Quarter 2014, Down Sharply From Second Estimate” –  Forbes.com, 25 June, 2014
A 3% difference in US GDP first quarter growth in the space of two months. How can you get it so wrong? Leave it to the government.
Even in Australia we are constantly revising our expectations on when the economy may gain sufficient traction to warrant an uptick in interest rates.
The following graph (courtesy of The Guardian) shows the market’s continual revision on when rates may rise. In February 2014, the expectation was for a rate rise around November 2014. With each passing month, the timeline has been extended. The latest bet is on a May 2015 rate rise. We’ll see.
My forecast several years ago was for rates to fall well below 2% by the time the GFC had run its full course.
The reason for this interest rate prediction was twofold. Debt contraction and demographics (aging boomers) combining to create The Great Credit Contraction – a deflationary scenario not witnessed since The Great Depression.
Much like a balloon, the economy inflated when debt was ‘blown in’ and it’ll deflate as the debt ‘escapes out’.
The following chart from the Reserve Bank of Australia website shows Australia’s GDP growth rate since 1993.
From 1993 to 2008 (with the exception of 2000 due to the dotcom bust), GDP growth remained in the 2 to 5+ percentage range. During the latter part of this period, the Howard Government was paying down public debt. Therefore, the growth was being achieved largely by the private sector through debt funded consumption and the escalating mining boom.
Since 2008, those driving factors have softened. GDP growth has generally fallen into a lower band of 1.5 to 4%. A good deal of this ‘growth’ was on the back of our former treasurer’s carelessness with the public cheque book. Government expenditure via the Rudd/Gillard/Rudd era of harebrained stimulus schemes – $900 cheques to dead people, school halls, pink batts, etc. – gave a quantitative boost to our economic growth numbers. But not enough to get us back into the higher range of the 1993-2008 period.
The prospect of deflation is something most economic commentators dismiss. The common belief is inflation will once again reignite the global economy, and it’ll back to business as usual. In 2002, Ben Bernanke thought he could create inflation by simply ‘dropping money from a helicopter’. The GFC taught Bernanke the difference between theory and reality.
In spite of Bernanke’s unprecedented and epic money printing efforts, inflation has not yet reared its head. However, there are those who believe the Fed’s relentless money printing is bound to eventually unleash high inflation, even hyperinflation. In their opinion, we are destined to experience a 1970s style (or even worse, a Weimar Republic) period of double digit inflation.
In my opinion, the high inflation scenario is unlikely. The current period has some distinct differences to the 1970s.
For starters, the 1970s experienced two distinct oil shocks from the Middle East – both times sending the oil prices north of US$150 per barrel. The high cost of energy fed into every nook and cranny of the economy. Prices and wages rose in tandem to offset the rising cost of oil.
This contrasts sharply with 2014. The US is set to become a net exporter of light crude. The US is no longer beholden to the Middle East for oil supply. The alternative energy sources – wind, solar and nuclear – also make us less dependent on oil.
Second, the 1970s was a period of high wage growth (see chart below). The post-WWII manufacturing boom still meant employees and unions held sway over employers who needed workers to man the machines. Rising energy costs provided the platform for wage increase demands.
The employment scene in 2014 is vastly different. China has suppressed incomes in the manufacturing sector. Technology has driven workplace efficiencies. Union membership is at record lows. The social security safety net – unemployment benefits, disability payment, food stamps – has enabled more people to opt out of work force engagement. This explains why the right hand side of the FRED chart shows post-GFC wages growth tanking. Globalisation means we are competing against the labour costs from emerging and emerged economies of China, India, South Korea, and soon to be, Africa. The prospect of a 1970s style wages outbreak against these very powerful forces is unlikely.
Finally, although interest rates were high in the 1970s household balance sheets were still in the debt expansion phase. The following chart shows US household debt expanded threefold during the 1970s, from around $440 billion in 1970 to $1.3 trillion in 1980.
Since 2008, US household debt accumulation has taken a breather. The likelihood of a 300% expansion in household debt from current levels is remote. After four decades of heaping loan upon loan, there’s debt fatigue out there – even with the lowest interest rates in history.
The 1970s has been defined as a period of stagflation (high inflation with moderate growth). We do not appear to have either of these components in today’s economy. And as outlined above, we are unlikely to witness them.
When the artificial US share market bubble pops and GFC MkII unleashes its fury, the era it’ll most likely resemble is that of the 1930s. So stay tuned for the latest CPI numbers and listen for more talk of subdued trading conditions making the road back to recovery more difficult than expected.
The Great Credit Contraction is an unrelenting force the authorities are struggling to contain and outmaneuver. Nearly every trick in the central bankers playbook has been thrown at this vice like force, yet nothing has permanently altered the low inflation and possible deflationary course we are on.
The only inflation out there is in the egos of central bankers and IMF officials who think they can control markets. When the secular bear market wakes from its slumber, it is certain to deflate these as well.
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