21 Jan 2012

Explaining Today's Silver Surge

A few days ago, Eric Sprott decided to take advantage of the record premium over NAV of his physical silver fund PSLV (or for some other arbitrary reason) and to issue a $300MM follow-onoffering, whose proceeds would be used to buy up silver to add to PSLV's existing physical holdings. Naturally, as soon as the news broke, the premium dropped to about 10%, making PSLV holders unhappy. This is not the first time that Sprott has done this: as a reminder after his April 2011 follow on offering in PHYS, we were fully expecting a comparable physical sequestration to occur via PSLV, to wit: "It appears to have already had an impact on silver, which jumped by $20 cents to another 31 year high on the news, as the market now likely expects a follow on offering in PSLV as well imminently." About 10 months later, it finally happened. As was to be expected, any short-term gains focused investors obviously became angry that by collapsing the premium, which we speculated was shortage driven, they have suffered a hit to their P&L (expressed in dollars of course, which as a reminder to the holders, should be largely irrelevant, especially to those who believe a PM-based barter system is imminent). Yet they forget the flip side to the equation: the money taken out of the premium, would be promptly used to take silver out of (hyper hypothecated) circulation, in other words, in the closed system, the drop in Premium would translate in a rising price in the underlying. Which according to UBS is precisely what has happened, and why silver moved as much as it did. Quoting from FMX Connect: "Today’s incredible move was the culmination of a comment made by UBS analyst Edel Tully. He stated that hedge fund manager Eric Sprott may be in the market buying spot futures in a private letter to his clients." And even as the premium dropped, the price of spot silver increased by over 5%, on the speculation of silver being taken out of the market and delivered to Sprott.

So to summarize: speculation that $300 million in physical silver may be taken out of circulation raises the price of the underlying by 5%. Does that mean that a $3 billion follow on would result in a 50% rise in spot; $30 billion in 500%, and so on? Something tells us the trade off of the premium collapsing to zero in exchange for $100+ silver would be equitable... And as we noted previously, the primary reason for the surge in in the NAV could be many things, but shortage of real physical silver is certainly the most likely one (and good luck trying to buy, transport, store, and insure $10MM or more in physical, without relying on some true physical representation such as PSLV). And if UBS' speculation is true, this has just been confirmed. Most importantly, it once again raises the spectre that anyone wishing to corner the silver market, can do so quite easily even in the aftermath of last year's parabolic move.

Full note from FMX Connect:

Market Recap:

As of the globex close, March Silver was up an astonishing 5.4% ($1.66) on the day, crushing big brother Gold (up .76% on the day). Silver was up an impressive 11 hours in a row, starting from 7 AM. Please enjoy our special commentary below.

Over the last week, and particularly today, silver saw heavy buying. FMX | Connect Managing Partner Vince Lanci discussed the potential for a breakout higher two days ago in an interview hosted by Kitco News (WATCH IT HERE). Of particular note, when asked his opinion on Silver was “If you’re bullish on Gold you should buy Silver.”

Today’s incredible move was the culmination of a comment made by UBS analyst Edel Tully. He stated that hedge fund manager Eric Sprott may be in the market buying spot futures in a private letter to his clients. With declining open interest in a rallying market, it didn’t seem likely to us, but over the last two days we noted open interest has flat-lined and started to turn upward, a bullish indicator.

Intraday moves did not care about how the Euro did or how gold traded. When Silver crossed the 50-day moving average at 30.90 it left Gold in the dust. While thousands of Call butterflies traded in gold over the last few days,they ended the week essentially unchanged.. But the hundreds of calls purchased over the last few days in Silver proved to be big winners for longs with the May 40 Strike garnering the most interest. Finally, note the commitment of traders shows an increase in commercial shorts (an increase of 1,320). This means the bullion dealers have not thrown in the towel and this could just be a market fading away from an impulsive buyer. We’ll wait and see.

Directional Commentary:

Options: Gold volatility was lower going into the weekend and ahead of February options expiration next week. Skew was selectively higher. Options activity remains mostly neutral and is unlikely to manifest strong biases while futures trading is orderly. Conclusion: Neutral

Technical: Gold finished almost $10 higher on the day but still below the highly-cited 50-day moving average at 1673.60. We see this moving average as a strong impediment to gold’s near-term prospects. As a contrasting indicator, open interest has started to creep higher in Jnauary. This (and other factors) leads us to believe that Gold may be due for a near-term correction, but maintain it upward trajectory in the intermediate term. Gold’s objective to the upside is a settlement above 1674 and its objective to the downside is a return to 1600. Conclusion: Neutral

20 Jan 2012

Fed Expected to Enact $1-Trillion-Worth of Easing

In order to stimulate our economy, it sounds like the Fed plans to pump-it-up with a $1 trillion easing project.

And it could happen as early as this month...

CNBC reports:

"There seems little point in waiting to implement further easing, and to do so could confuse the message the Fed is trying to deliver at a point in time when it is trying to make its communication with the public clearer," he said.

Next week, the Fed's Open Market Committee will meet to discuss matters further. Meanwhile “expectations are rising that the languishing housing market will drive the central bank to buy up mortgage-backed securities.”

The aim of those purchases will be to push interest rates even further and to indirectly induce confidence that there are more “monetary tools” that can revive the economy.

Some experts hope that the announced will get stock prices rising again; similar to what happened in November 2010 when the Fed's most recent balance sheet expansion began.

Overall, experts think the easing is the only option remaining in order to effectively "trick" Americans into obtaining a sense of optimism again, viewing the recent stock market rebound as being “temporary” at best.

19 Jan 2012

Financial crisis: get ready for next wave

Click to play video
World Bank slashes global forecast

AUSTRALIA should brace for a return to the ''ugliest'' of times if the latest World Bank warning of a new financial crisis proves correct, a leading economist says.

The World Bank yesterday signalled a downturn so severe it would eclipse the chaos that followed the collapse of Lehman Brothers in 2008. Deloitte Access Economics director, Chris Richardson, said if there was not a sharp turnaround overseas, Australians were in for a rocky ride through a ''GFC Mark II''.

''If we get a re-run of last time, you get higher unemployment, sharp hits to company profits and a slowdown in the Australian economy without a technical recession, largely due to the momentum in the big mining construction projects,'' he said.

 "The past year was difficult and disappointing for the global economy. The outlook for 2012 looks even more challenging" ... acting Treasurer, Bill Shorten. Photo: Alex Ellinghausen

Launching the World Bank's latest six-monthly assessment of global prospects in Beijing, the bank's lead economist, Andrew Burns, called on vulnerable nations to prepare for the worst and refinance loans now rather than waiting until funds dry up.

The bank halved its previous 2012 forecast for economic growth in high-income countries and is forecasting negative growth for the collection of nations that use the euro as their currency. Its concern is that financial markets could stop working if lenders refuse to roll over European debts.

"A much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out," the report says. "Should this happen the ensuing global downturn is likely to be deeper and longer-lasting than the recession of 2008-09.

"Countries do not have the fiscal and monetary space to stimulate the global economy or support the financial system to the same degree as they did in 2008-09. While developing countries are in better shape than high-income countries, they too have fewer resources available. No country and no region will escape."

Australia, not specifically mentioned in the report, has a relatively good budget position and a better ability than most to ward off a downturn by interest rate cuts and increased government spending, as it did in 2008.

But the bank says commodity-exporting nations such as Australia will find their budgets hit by much lower prices.

Each of its scenarios are worse than envisioned in the government's December budget update, calling into question the government's forecast of a 2012-13 budget surplus.

The acting Treasurer, Bill Shorten, acknowledged the budget would "obviously be hit".

"The past year was difficult and disappointing for the global economy. The outlook for 2012 looks even more challenging," he said. "But the Australian economy is now around 7 per cent larger than it was prior to the global financial crisis … We have a proven track record having fought off the global recession and the worst the world can throw at us."

The World Bank is forecasting worldwide economic growth of just 2.5 per cent this year, down from its previous forecast of 3.6 per cent. Anything less than 3 per cent is commonly defined as a global recession.

Mr Richardson said the ''horror headline'' effect of reporting on the European financial fiasco was to blame for a sharp downturn in domestic consumer confidence.

''When you have the papers and the nightly news full of reports - and rightly - that Europe is in trouble, the banks are in danger of blowing up and all the dire outcomes that would produce, you get people worrying about their own situation, even though the economic settings are very different in Australia than those of overseas.''

Read more:

18 Jan 2012

They Are Actually Going To Let Greece Default!

I wish that I had an "aha moment" to share with you today, but instead all I have is an "ack moment" to share.  As I was analyzing all of the info coming out of Europe in recent days, I came to the following realization: "Ack! They are actually going to let Greece default!"  The only question is whether it is going to be an orderly default or a disorderly default.  Of course the EU (led by Germany) could save Greece financially if it wanted to.  But Germany has decided against that course of action.  Many in the German government are sick and tired of pouring bailouts into Greece and then watching Greek politicians fail to fully implement the austerity measures that were agreed upon.  At this point a lot of German politicians are talking as if a Greek default is a foregone conclusion.   For example, Michael Fuchs, the deputy leader of Angela Merkel's political party, recently made the following statement: "I don't think that Greece, in its current condition, can be saved."  But that is not entirely accurate.  Greece could be saved, but the Germans don't want to make the deep financial sacrifices necessary to save Greece.  So instead they are going to let Greece default.
Many prominent voices in the financial world that have been watching all of this play out are now openly declaring the Greece is about to default.  Moritz Kraemer, the head of S&P's European sovereign ratings unit, made the following statement on Bloomberg Television on Monday: "Greece will default very shortly. Whether there will be a solution at the end of the current rocky negotiations I cannot say."
You might want to go back and read that again.
One of the top officials at one of the top credit rating agencies in the world publicly declared on television that "Greece will default very shortly."
That should chill you to your bones.
If the EU allows Greece to default, that would be a signal to investors that the EU would allow Italy, Spain and Portugal to all default someday too.
Confidence in the bonds of those countries would disintegrate and bond yields would go through the roof.
Right now, confidence in government debt is one of the things holding up the fragile global financial system.  Governments must be able to borrow gigantic piles of very cheap money for the system to keep going, and once confidence is gone it is going to be incredibly difficult to rebuild it.
That is why a Greek default (whether orderly or disorderly) is so dangerous.  Investors all over the world would be wondering who is next.
At the end of last week, negotiations between the Greek government and private holders of Greek debt broke down.  Negotiations are scheduled to resume Wednesday, and there is a lot riding on them.
The Greek government desperately needs private bondholders to agree to accept a "voluntary haircut" of 50% or more.  Not that such a "haircut" will enable the Greek government to avoid a default.  It would just enable them to kick the can down the road a little farther.
But if Greece is able to get a 50% haircut from private investors, then why shouldn't Italy, Spain, Portugal and Ireland all get one?
Once you start playing the haircut game, it is hard to stop it and it rapidly erodes confidence in the financial system.
This point was beautifully made in a recent article by John Mauldin....
So our problem country goes to its lenders and says, "We think you should share our pain. We are only going to pay you back 50% of what we owe you, and you must let us pay a 4% interest rate and pay you over a longer period. We think we can do that. Oh, and give us some more money in the meantime. And if you refuse, we won't pay you anything and you will all have a banking crisis. Thanks for everything."
The difficult is that if our problem country A gets to cut its debt by 50%, what about problem countries B, C, and D? Do they get the same deal? Why would voters in one country expect any less, if you agree to such terms for the first country?
But if Greece is able to negotiate an "orderly default" with private bondholders, that would be a lot better than a "disorderly default".  A disorderly default would cause mass panic throughout the entire global financial system.
One key moment is coming up in March.  In March, 14 billion euros of Greek debt is scheduled to come due.  If Greece does not receive the next scheduled bailout payment, Greece would default at that time.
But the EU, the ECB and the IMF are not sure they want to give Greece any more money.  There are a whole host of austerity measures that the Greek government agreed to that they have not implemented.
Since the Greeks have not fully honored their side of the deal, the "troika" is considering cutting off financial aid.  The following comes from the New York Times....
Officials from the so-called troika of foreign lenders to Greece — the European Central Bank, European Union and International Monetary Fund — have come to believe that the country has neither the ability nor the will to carry out the broad economic reforms it has promised in exchange for aid, people familiar with the talks say, and they say they are even prepared to withhold the next installment of aid in March.
But the austerity measures that Greece has implemented so far have pushed the Greek economy into a full-blown depression.  Greece is experiencing a complete and total economic collapse at this point.  The following comes from the New York Times....
Greece’s dire economic condition can hardly be overstated. After two years of tax increases and wage cuts, Greek civil servants have seen their income shrink by 40 percent since 2010, and private-sector workers have suffered as well. More than $75 billion has left the country as people move their savings abroad. Some 68,000 businesses closed in 2010, and another 53,000 — out of 300,000 still active — are said to be close to bankruptcy, according to a report issued in the fall by the Greek Co-Federation of Chambers of Commerce.
“It’s an implosion — it’s an endless sequence of implosions from bad to worse, to worse, to worse,” said Yanis Varoufakis, an economics professor at the University of Athens and commentator on the Greek economy. “There’s nothing to stop the Greek economy losing 60 percent of its G.D.P., given the path it is at.”
But Greece is not the only one in Europe with major economic problems.  The unemployment rate for those under the age of 25 in the EU is an astounding 22.7%.  And as I have written about previously, there are a whole host of signs that Europe is on the verge of a major recession.
Greece is just the canary in the coal mine.  The truth is that the entire European financial system is in danger of collapsing.
Today, it was announced that S&P has downgraded the European Financial Stability Facility.  It is pretty sad when even the European bailout fund is getting downgraded.
Of course most of you know what happened on Friday by now.  Very shortly after U.S. financial markets closed, S&P downgraded the credit ratings of nine different European nations.
Only four eurozone nations (Germany, Luxembourg, Finland, and the Netherlands) still have a AAA credit rating from S&P.
But even more importantly, the nightmarish decline of the euro is showing no signs of stopping.
Right now, the EUR/USD is down to 1.2650.  It is hard to believe how fast the EUR/USD has fallen, but if a major financial crisis erupts in Europe it is probably going to go down a whole lot more.
So what happens next?
Well, if there is a Greek default all hell will break loose in Europe.
But even if Greece does not default, the coming recession in Europe is going to put an incredible amount of strain on the eurozone.
Many have been speculating that Greece or Italy could be the first to leave the euro, but actually it may be the strongest members that exit first.
The number of prominent voices inside Germany that are calling for Germany to leave the euro continues to increase.
In addition, public opinion in Germany is rapidly turning against the euro.  Onerecent poll found that only 47 percent of Germans were glad that Germany joined the euro, and only 36 percent of Germans want "a more federal Europe".
As this crisis continues to unfold, there will probably be even more "ack moments".  European leaders have mismanaged this crisis very badly from the start, and there is no reason to believe that they are suddenly going to become much wiser.
Once again, it is important to emphasize the role that confidence plays in our financial system.  The entire global financial system runs on credit.  Banks and investors lend out money because they have confidence that they will be paid back.  When you take that confidence away, the system does not work.
Let us hope that the folks over in Europe understand this, because right now we are steamrolling toward a credit crunch that could potentially make 2008 look tame by comparison.
Now another of the three major credit rating agencies, Fitch, is publicly sayingthat Greece will default....
"It is going to happen. Greece is insolvent so it will default," Edward Parker, Managing Director for Fitch's Sovereign and Supranational Group in Europe, the Middle East and Africa told Reuters on the sidelines of a conference in the Swedish capital. "So in that sense it shouldn't be a surprise to anyone."

16 Jan 2012

Eurozone crisis live: Greece battles default as markets digest S&P downgrades

The euro
Financial traders and analysts will be reflecting on S&P's credit rating downgrades, and the worsening situation in Greece. Photograph: Michael Probst/AP
8.43am: The amount of money being stashed overnight with the European Central Bank has hit yet another record high this morning -- and is approaching half a trillion euros.
The ECB reported this morning that it accepted€493.2bn in overnight deposits from European banks on Friday evening. The amount being borrowed through its overnight loan facility also increased, to €2.38bn (from almost €1.5bn).
The overnight deposits figure has been hitting record levels in recent weeks, ever since the ECB pumped almost €500bn of cheap loans into the system. So what does this mean?
Some analysts say it is a clear sign of stress in the financial sector -- with banks choosing to leave their assets with the ECB at a very low rate of return rather than lending them.
ECB head Mario Draghi has rubbished suggestions that the ECB's plans have backfired. Last week, he insisted that the banks who took advantage of the cheap loan splurge are "by and large" not the same banks who are now depositing their funds with the ECB overnight.

Either way, €493.2bn is a lot of money to be switching between commercial banks and the ECB's electronic vault.

Either way,
German finance minister Wolfgang Schauble at the G20 Finance Summit in ParisGerman finance minister Wolfgang Schäuble: Germany won't increase its bailout guarantees. Photograph: Ian Langsdon/EPA
8.28am: Germany's finance minister took to the airwaves this morning to insist that Europe's bailout fund will not be thwarted by S&P.
Wolfgang Schäuble told German radio channel Deutschlandfunk that Germany will not be forced to increase its guarantees to the European Financial Stability Facility (EFSF), to make up for France's downgrade.
Schäuble insisted that Germany's current pledge of €211bn will be quite sufficient, because:
The heads of government and states have decided to get the ...permanent European Stability Mechanism (ESM) to supersede the EFSF already this year...
For the job that the EFSF has in coming months, the sum of guarantees is easily sufficient.
S&P stated on Friday night that the EFSF could still keep its own AAA rating if other countries increased their guarantees to make up for France's loss of firepower [France and Germany are the two major backers of the EFSF, which raises funds for countries frozen out of the markets].
Schäuble appears to be suggesting that Germany won't cough up -- so an EFSF downgrade could soon follow.....
8.18am: Europe's financial markets are open, and there's no sign of panic.
In fact, the FTSE 100 has broken into positive territory (up 4 points at 5641).
Other markets are stuck in the red, though, with the Spanish IBEX down almost 1% in early trading and the French CAC losing 0.5%.
Nothing to get alarmed by, though. That reflects the fact that the S&P ratings cuts were expected.
As Stan Shamu of IG Markets commented this morning:
These downgrades should not have come as much of a surprise. In retrospect we may look back on them as the most flagged and blatantly obvious downgrades in history.
8.08am: It's not a particularly busy day for economic news, but the bond markets should be busy. The highlight is probably an auction from France -- will the AAA downgrade push up its borrowing costs?
Here's today's agenda:
• Italian inflation data for December - 9am GMT (10am CET)
• Italian government debt for November - 10am GMT (11am CET)
• France auctions up to €8.7bn of short-term debt. 1.50pm GMT
• Netherlands auctions three and six-month bills. From 10am GMT
• Slovakia auctions €2bn of 12-month bills. From 10am GMT
+ George Osborne visiting Hong Kong
+ Wall Street is closed for Martin Luther King day
7.54am: What do you think about Standard & Poor's decision to downgrade nine eurozone countries?
Economic affairs commissioner Olli Rehn was quick to criticise, calling the move "inconsistent" at a time when the eurozone was taking "decisive action" to tackle the debt crisis.
Portugal also took badly to being relegated to Junk status, saying it "disagrees with S&P's assessment".
So is it simply a case of shooting the messenger? Or are ratings agencies simply taking on too much power? Should we even be worried about S&P's views?

Here's a reminder of the nine countries downgraded by S&P:

France: Downgraded by one notch, from AAA to AA+. Negative Outlook.
Austria: Downgraded by one notch, from AAA to AA+. Negative Outlook.
Malta: Downgraded by one notch, from A to A-. Negative Outlook.
Slovenia: Downgraded by one notch, from AA- to A+. Negative Outlook
Slovak Republic: Downgraded by one notch, from A+ to A. Stable Outlook
Cyprus: Downgraded by two notches, from BBB to BB+. Negative Outlook
Italy: Downgraded by two notches, from A to BBB+. Negative Outlook
Portugal: Downgraded by two notches, from BBB- to BB. Negative Outlook
Spain: Downgraded by two notches, from AA- to A. Negative Outlook.
7.45am: Good morning, and welcome to another day of rolling coverage of the eurozone financial crisis.
Two issues dominate the agenda today - Greece, following the breakdown in debt reduction negotations, and the aftermath of last Friday's mass downgrades by Standard & Poor's.
The situation in Greece worsens by the day. Talks between the Greek government and private lenders over a plan to reduce Greece's debt by $130bn are now frozen until Wednesday. But the political pressure will continue to build on Lucas Papademos's government, with speculation over a disorderly default growing.
Traders and analysts will also be reacting to the loss of France and Austria's triple-A ratings, and the seven other downgrades announced by S&P after the markets closed last week. We don't expect a major panic - the French downgrade was a real non-surprise - but will be tracking all the reaction.
There's also a few debt auctions to look forward to. And, in the UK, warnings that the British economy is falling back into recession.