Despite the GOP"s tax reform victory, over the past few weeks, Congress once again punted on a formal decision how to keep government funded and what to do with America"s debt ceiling and as a result US legislators simply kicked the can on the agreement of raising the nation’s borrowing limit for another few months. However, with the Treasury expected to breach the ceiling as soon as late March, today"s $45 billion 3-Month Bill auction was closely watched as it serves as a fresh gauge of investor anxiety about the ongoing impasse.
As a reminder, in the first week of December, the Treasury deployed a series of extraordinary measures to stay under the debt ceiling cap since it was reinstated on December 8. But T-bill investors, in both the primary and secondary market, remain especially wary given questions over what’s known as the debt ceiling’s drop-dead date. Today"s Bills mature March 29, within the Congressional Budget Office’s late-March to early-April window for when Treasury will exhaust the extra capacity it’s using to keep below the $20.5 trillion limit.
Quoted by Bloomberg, Justin Mandeville of Inveso said that the late-December bill auctions “speak volumes to investors being cautious as to when the potential drop-dead date will be,” adding that “we saw it back in July when we had concerns about the October bills.”
And sure enough, having just concluded, the 3M bill was especially ugly, pricing at 1.445%, or a 3bps tail to the 1.415% When Issued, with Indirect Buyers fleeing, and taking down just 20.1% of the finally allotment, down from 30.8% in the last 6 auctions, while Primary Dealers had no choice but to step up aggressively from 61.9% in the 6MMA, to 74% as Direct interest also fizzled from 7.3% in the last 6 auctions to just 5.9%. But nowhere was the revulsion quite so visible as in the bid to cover, which plunged from 3.04 in the past 6 auctions to just 2.71 on Dec. 26: this was the lowest Bid to Cover since January 2009.
As Bloomberg reminds us, at the government’s July 24 auction, the US Treasury sold $39 billion of three-month bills at 1.18 percent, then the highest rate since 2008. The bid to cover for that particular sale also matched the lowest for the maturity since 2009. Congress wound up passing a three-month debt-ceiling suspension Sept. 8, weeks before Treasury Secretary Steven Mnuchin estimated the government would run out of cash.
However, revulsion to paper that could be impacted by the debt ceiling was not just in the primary market: it also hit the secondary Bill market, as the previously noted kink that has emerged in the bill curve between securities maturing in late March and those in early April, has gotten even more pronounced. For several days after the Dec. 18 auction of bills maturing March 22, the rate on these securities was higher than debt maturing a week later. Since then, the rate on securities expiring March 29 has climbed to 1.44%, exceeding those on bills due the following week by nearly 10 bps as shown in the chart below.
And so, looking at the debt ceiling fight that refuses to go away despite the can being kicked every few months, while there is still a chance the issue could be resolved without going down to the wire, it is unlikely: while lawmakers hammered out a spending bill this week to keep the government open through Jan. 19, they didn’t include a provision to lift or suspend the debt ceiling. The longer a resolution remains at the bottom of Congress’s to-do list, the larger the T-bill dislocations could grow. Sooner or later, the bond market - which has been crying wolf on a technical US default - will eventually be right.
China"s working age population is clearly defined as those aged 16 to 50 years old for females (55 for "white collar" females) and 16 to 60 years old for males. China mandates retirement at these outer age limits. Perhaps of some interest should be that this working age population peaked in 2011 and has been declining since. This decline will continue indefinitely as China has a collapsing childbearing population (detailed HERE), net emigration (outflow), and a still decidedly negative birthrate.
There is no evidence to believe the working age declines will abate any decade soon. As the chart below shows, China"s potential workforce will be shrinking indefinitely... and by 2030 China"s potential workforce will be over 100 million fewer than the 2011 peak (an 11% decline)...and only further down from there.
China has one of the youngest average retirement ages in the developed world. On average, according to a recent study (HERE), Chinese leave the work force by age 55 compared to age 63 in the US (Norway has the latest average departure at age 67). So, perhaps China will be raising the retirement age to curb the ballooning 60+yr/old population entering retirement (chart below)? More on that later.
Comparing the working age population versus the 60+yr/old population (chart below). A shrinking potential workforce since peaking in 2011 and a rapidly growing elderly population.
Below, that elderly growth versus the working age depopulation as a % of all adults (chart below)...think hockey stick. After nearly six decades of maintaining a consistent 60+yr/old % of the adult population...the elderly explosion is just beginning.
If we take the now declining total potential working age population vs. China"s still rising total number of employed individuals (according to Statista)...the chart below shows that if China adds just a mere million employees a year (about a third of the annual average employment growth seen from "06 through "16)...that by 2030 China"s employment will exceed 100% of the potential workforce. Wait...what?!? Or perhaps working from the premise that people who don"t exist can"t be employed...it"s time to start considering China"s employed population is set to begin falling.
This idea that there are "millions upon millions of Chinese just waiting to be incorporated into the workforce"...not so much. While a continuing shift from rural to urban is likely, China has already or will soon experience peak employment. Simply put, there will be fewer consumers of everything (homes, cars, appliances, etc.) every year than the year before.
Whatever overcapacity exists now will be joined by massive increases in excess housing, excess production, excess shopping malls as this depopulation plays out over the coming years and decades.
Five big points here:
1) China ends one child policy, with little to no impact...
Although China implemented its one child policy in 1979 and officially phased it out in 2015, China"s birthrate was actually consistently higher than most of the other major economies in East Asia (Japan, S. Korea, Taiwan, Singapore...chart below) and only N. Korea"s fertility rate is currently higher.
None of these other East Asia nations ever implemented birth restrictions. Instead, their populaces chose not to replace themselves responding to the availability of birth control, surging costs of child rearing, and inclusion of females into the workforce, etc. Simply put, the one child policy was inevitable and has now organically gone global. The phase out of this policy will have little to no impact of China"s fertility rates.
2) China to raise retirement age, but no time soon...
In early 2015, China suggested it would detail in 2017 (which I still have not seen) a gradual, multiyear process to raise the retirement age (China"s version of political suicide). Suggestions focused on slowly, incrementally, raising female retirement ages to match males and likewise, pushing retirements out by a month or two per year. However, none of this was even suggested to start within the next five years and like most things, almost surely be back-end loaded so any real impacts are overstated. Regardless Communist or "Capitalist" politicians, the game is the same. A little "razzle-dazzle" that ensures any negative policy impacts never occurs on your watch.
3) China to institute Universal Pension Plan...
In late 2015, China said "We will achieve a basic pension for all employees nationally". Currently, about 800 million of China"s 1.3 billion are eligible for state pensions. According to Sinosphere, pensions for non-state employees vary widely, as high as 3000 RMB ($480) month in Beijing to as little as 80 RMB for rural farmers. Civil Servants pensions are generally higher than those of non-state employees. The party statement said, China would be;
“Building a fairer and more sustainable social welfare system.
Implementing plans for every person to take part in social insurance.
Diverting capital from state-owned enterprises to social security funds.
Offering all urban and rural residents insurance for serious illness.”
4) Chinese wages & average per capita disposable income rising but gains are hugely variable...
While Chinese factory wages in tier 1 urban areas are now inline with Portugal or S. Africa, this terrific rise has created it"s own problems. The rise in wages has been met with inflationary spikes in rents, fuel, food, etc. etc. Average disposable income has risen in the urban areas but flat at best across rural China. However, the response of employers to the spectacular rising wages has been automation, a shift away from labor intensive production, and outsourcing to lower cost countries. This is at odds with the generally low skill/low education rural population looking for opportunity in the urban areas. The breadth and size of further gains in disposable income is likely to be limited. Economically, a declining total number of workers making marginally more money will not provide the desired growth.
5) China cannot export its way out of this...
The annual change to the 0-64yr/old combined populations of the 35 OECD nations (US, Canada, Europe, Japan, S. Korea, Australia/NZ) plus China, Brazil, and Russia begin declining in 2018 (chart below). The core populations of the nations responsible for consuming 80%+ of all Chinese exports have peaked and begin shrinking. Fewer consumers every year than the year before, indefinitely. As for the nations that are doing all the growing, India and Africa, they consume about 4% of all Chinese exports. BTW, the chart below shows when each nation/region 0-64yr/old population began declining.
Simply put, China is offering to increase and broaden it"s pension system to a ballooning population of elderly but will have a decreasing potential number of employees from which to pay for that increase?!?
How will China achieve this? Well, as the chart below shows, as Chinese core population growth has been decelerating, Chinese debt growth has been accelerating.
While China"s GDP and energy consumption have led the world, they have not responded in kind to China"s debt explosion and exponentially more will be necessary to continue to show "growth". Over a third and perhaps half of all the debt has been mal-invested in a housing bubble for a population that is never coming.
What comes next isn"t going to be good for China nor the rest of the world as China looks to flood a depopulating nation with new debt only creating more housing overcapacity... China will look to beat the Japanese at the debt game.
For instance, the Chinese public-pension system as of 2014, took in 2.33 trillion yuan in revenue and paid out almost 2 trillion...with 3 trillion in net funds. The net outflows and drawdown of those net funds is imminent.
But not to worry, the Communist Party explained that..."We will look at some opportunities with higher yields but will contain risk". Again, no details were offered. However, one asset it is clear the Chinese will not be buying...US Treasury"s (chart below, showing the net purchases since the debt ceiling debate of July 2011 according to TIC). Since that date, China has been a net seller of US Treasury debt despite running record US dollar surplus" (BLICS = Belgium, Luxembourg, Ireland, Cayman Island, Switzerland).
From 2000 "til July 2011, China recycled 50% of its dollar trade surplus into US Treasury debt accumulating over $1.3 trillion. Since July 2011, China has net sold over $100 billion and as of October, held about $1.2 trillion (chart below).
But I"m pretty sure those dollars aren"t sitting fallow and are finding their way into some asset, probably one in particular that is selling on the cheap about right now.
There is a Disinformation War taking place in the silver market as certain industry analysis is confusing individuals by purposely disregarding the tremendous impact of rising investment demand. Not only do I find this troubling, but I am also quite surprised how much the silver industry pays attention to this faulty analysis. So, it"s time once again to set the record straight.
Setting the record straight has now become a new mission for me at the SRSrocco Report because the amount of disinformation and faulty analysis being published in the mainstream and alternative media is quite disturbing. I decided it was time to say enough was enough, so I started by destroying the myth about the 1 million tons of gold hidden in the Grand Canyon in my recent article, THE BLIND CONSPIRACY: The Gold Market Is Heading Towards A Big Fundamental Change.
If you haven"t read that article and are still confused on whether or not there are billions of ounces of gold hidden in the Grand Canyon, I highly recommend that you do. Now, if you read the article and still believe the U.S. Government decided to make the Grand Canyon a national park to protect all that gold, then you have my sympathies. However, the reason certain individuals in the U.S. Government decided to make the Grand Canyon a national park because it was probably a GOOD IDEA to keep a beautiful part of the country off-limits from those who had no problem with destroying the banks of the Colorado by trying to extract gold at a pathetically low uneconomical yield.
If you have seen some of the episodes of the Discovery Channel"s Gold Rush show, the result of gold dredging operations isn"t pretty. Here is a picture of the beautiful landscape outside of Dawson City in the Yukon that shows the effects of placer mining and gold dredging. Now, how many families in the U.S. and abroad would have taken their kids on vacation to the Grand Canyon if it looked like this? I am quite amazed at the lack of dignity and respect by individuals who only seek at the almighty Dollar.
(aerial photo of Dawson City, Yukon - picture courtesy of Peter Mather)
To tell you the truth, I am glad that Teddy Roosevelt had the foresight to dedicate the Grand Canyon as a national monument back in 1908. At least some politicians had the wisdom to keep OFF LIMITS parts of the country, so we weren"t able to destroy it by mining it for ultra low-grade gold or bulldoze it, pour concrete and build another million suburban homes.
Okay, let"s get back to subject at hand... Silver Market Disinformation.
The motivation to write this article came from several of my readers who sent me an interview by CPM Group"s Jeff Christian, at the San Franciso Gold and Silver Summit. In the video, Jeff claims that there has been a silver market surplus for ten years and those industry analysts, who have reported deficits, "Are simply wrong." Jeff goes onto to say, "they have been wrong the entire time they have been on the silver market."
Jeff continues by explaining that to analyze the silver market correctly, you must look at surplus and deficits based on total supply versus total fabrication demand. Furthermore, he criticizes industry analysts who may be promoting metal by throwing in investment demand to arrive at a deficit. He says this is not the proper way to do "commodities research analysis."
Jeff concludes by making the point, "that if you keep silver investment demand as an "off-budget item," then the price matches your supply-demand analysis almost perfectly." Does it? Oh... really?
If we look at the CPM Group"s Supply & Demand Balance chart, I wonder how Jeff is calculating his silver price analysis:
This graph is a few years old, but it still provides us with enough information to show that the silver price has nearly quadrupled during the period it experienced supposed surpluses. According to the CPM Group"s methodology of analyzing total fabrication demand versus supply, how on earth did the silver price rise from an average of $5.05 during the deficit period to an average of $19.52 during the surplus period? I arrived at the silver prices by averaging the total for each time-period.
Again, Jeff states during the interview that their supply-demand analysis, minus investment demand, provides an almost perfect price analysis. According to the CPM Group"s 2016 Silver Yearbook, the total surplus for the period 2008-2016 was approximately 900 million oz. With the market enjoying a near one billion oz surplus, why would that be bullish for a $20 silver price?? It isn"t... and I will explain why.
As I have mentioned in many articles and interviews, the price of silver has been based upon the price of oil which impacts its cost of production. If we look at the following chart, we can plainly see how the price of silver has corresponded with the oil price going back until 1900:
You will notice the huge price spike in the 1970"s after Nixon dropped the Gold-Dollar peg causing inflation to run amuck in the United States. Now, the oil price didn"t impact just silver; it also influenced the value of gold:
As with the oil-silver trend lines, the gold and oil price lines remained flat until the U.S. went to a 100% Fiat Currency system in 1971. So, if we decided to throw out all gold and silver supply-demand forces, we can see that these precious metals prices paralleled the oil price. Now, the reason the price of silver shut up to an average of $19.52 from 2006-2017 was due to its average cost of production. Today, the market price of silver is $16.42, and the average cost of primary silver production is between $15-$17 an ounce. According to my analysis of the top two gold mining companies, their cost of production is about $1,150. Hence, the 71-1 Gold-Silver price ratio.
Did Jeff Christian include the cost of production in his analysis of the silver price? How many silver mining companies are producing silver for $5 an ounce and making an $11 profit? Or how many silver mining companies are producing silver at $35 and losing nearly $20 an ounce? I will tell you... ZERO.
The only way an individual would believe that the primary silver mining companies are producing silver at $5 an ounce is if they believe in the investor presentations that report CASH COSTS. Anyone who continues to use CASH COST accounting needs to get their head examined. It is by far the most bogus metric in the industry that has caused more confusion for investors than anything else... well, if we don"t include faulty analysis by certain individuals.
I find it utterly amazing that the CPM Group entirely omits silver investment from their fundamental analysis. Here is a chart of their total world silver fabrication demand from their 2016 Silver Outlook Report:
If you are a silver investor, your demand doesn"t count. It doesn"t matter if you purchased 100 of the half a billion oz of Silver Eagles sold by the U.S. Mint since 1986. How many Silver Eagles have been sold back, melted down and returned to the market to be used for industrial applications?? According to the 2017 World Silver Survey (GMFS), total Official Silver Coin sales were 965 million oz (Moz) since 2007. If we add Official Silver Coin sales for 2017, it will be well over one billion. I highly doubt any more than a fraction of that one billion oz of Offical Silver Coins were remelted and sold back into the market.
Moreover, what term do we give to companies who produce Silver Eagles or private silver rounds?? Aren"t companies fabricating silver bars and coins? While it is true that physical silver bar and coins can be sold back into the market, a lot of new demand is coming from fabricating new silver bullion products.
CPM Group only values silver as a mere commodity for the sole purpose of supplying the market for industrial, jewelry, silverware, photography and photovoltaic uses. I gather 2,000+ years of silver as money no longer matters. Yes, I would imagine some precious metals investors are feeling a bit frustrated as they watch Bitcoin go vertical towards $12,000. But a word of caution to Bitcoin investors who are dreaming about sugar plums dancing in their heads and dollar signs in the eyes.
There is a wonderful scene where a pole dancer is explaining to a fund manager how she"s buying five houses.
A lowly paid pole dancer who survives on unpredictable tips should not be able to afford multiple houses, but this was the sub-prime USA where the ability to repay a loan was apparently not a prerequisite.
What a coincidence... ah?? Pole dancers buying five homes and becoming a Bitcoin Guru. What"s next? LOL.
Regardless, the notion by CPM Group that investment demand shouldn"t be included in supply and demand forecasts suggests that the gold market has experienced a total 418 million oz (Moz) surplus since 2006. Yes, that"s correct. I calculated total global gold physical and ETF investment demand by using the World Gold Council figures:
The reason for the drop-off in net gold investment in 2013-2015 was due to Gold ETF liquidations. For example, 915 metric tons (29 Moz) of Gold ETF inventories were supposedly liquidated into the market. Even though the gold market experienced a record 1,707 metric tons of physical bar and coin demand in 2013, the liquidation of 915 metric tons of Gold ETF"s provided a net 792 metric tons of total gold investment. Please understand, I am just using these figures to prove a point. I really don"t care if the Gold ETFs have all their gold. I look at Global Gold ETF demand (spikes) as an indicator for gauging the amount of fear in the market.
The CPM Group does the same sort of supply and demand analysis for gold. They omit investment demand from the equation:
(CPM Group Chart Courtesy of Kitco.com)
Again, according to the CPM Group, gold bar and coins aren"t fabricated. They must be produced by Gold Elves in some hidden valley in the Grand Canyon. No doubt, under the strict control by the NSA department of the U.S. Government.
For anyone new to reading my work... I am being sarcastic.
Moreover, the significant change in gold investment demand is a clear sign that investors are still quite concerned about the highly inflated bubble markets. If we go back to 2002, total gold investment was a paltry 352 metric tons compared to 358 metric tons of technology consumption and 2,662 metric tons of gold jewelry demand. However, in 2011, the gold market experienced a massive 1,734 metric tons of total gold investment versus 2,513 metric tons of jewelry and technology fabrication.
What is significant about this trend change? In 2002, global gold investment was a mere 10% of total gold demand. However, by 2011, gold investment demand surged to 41% of the total, not including Central Bank demand. Even in 2016, global gold investment demand was still 40% of the total. As we can see, investors still represent 40% of the market, whereas they were only 10% in 2002.
Precious metals investors need to understand there is a huge difference between Gold and Silver versus all other metals and commodities. The overwhelming majority of commodities are consumed while gold and to a lesser extent, silver, are saved. And, they are being purchased as investments and saved for an excellent reason.
The world continues to add debt at unprecedented levels. In just the month of November, the U.S. Government added another $137 billion to its total debt. This doesn"t include the $610 billion of additional debt added since the debt ceiling was lifted on September 8th. So, the American public is indebted by another $747 billion in less than three months.
Getting back to silver, according to the GFMS team at Thomson Reuters, who provide the World Silver Survey for the Silver Institute, the market will experience a small annual silver surplus this year for the first time in several decades:
The reason for the surplus has to do with a marketed decline of silver investment demand this year. With the election of President Trump to the Whitehouse and the "Pole Dancing Guru" Bitcoin market moving up towards $12,000, demand for the silver investment fell by 50% this year. However, I don"t look at it as a negative. Oh no... it"s an indicator that the market has gone completely insane.
This reminds me once again of the movie, The Big Short. In the movie, the main actor bets big against the Mortgaged-Backed Securities. Unfortunately, just as the housing markets start to crash and the mortgage-back security market begins to get in trouble, the bets that the main actor in the movie made, began to go against him. That"s correct. His short bets against the market should have started to gain in value, but the banks wanted to dump as much of that crap on other POOR UNWORTHY SLOB INVESTORS before they would let it rise.
We are in the very same situation today. However, the entire market is being propped up, not just the housing market.
It is impossible to forecast a more realistic gold and silver price when 99% of the market is invested in the wrong assets. So, for the CPM Group to value gold and silver based on their fabrication demand totally disregards 2,000+ years of their use as monetary metals.
Thus, it comes down to an IDEOLOGY on why Gold and Silver should be valued differently than mere commodities, or even most STOCKS, BONDS, and REAL ESTATE. Valuing gold and silver can"t be done with typical supply and demand fundaments. The only reason I analyze supply and demand fundamentals is to understand what is happening to the market over a period of time.
For example, if we look at total global silver investment demand and price, there isn"t a correlation:
But, if we look at what happened to silver investment demand since the 2008 Housing and Banking collapse, we can spot a significant trend change:
As we can see, world physical silver bar and coin demand nearly quadrupled after the 2008 Housing and Banking collapse. This is the indicator that is important to understand. While silver investment demand after 2008 has increased partly due to the higher price, the more important motivation by investors is likely a strategic hedge against the highly-leveraged fiat monetary system and stock market.
Investors who follow the CPM Group"s analysis on gold and silver based upon fabrication demand only, are being misinformed. Jeff Christian who runs the CPM Group has no idea about the Falling EROI - Energy Returned On Investment or does he understand the dire energy predicament we are facing. Thus, Mr. Christian and the CPM Group still look at the markets as if they will continue business as usual for the next 50 years.
We are heading into a future that we are not prepared. The economy and markets will likely disintegrate much quicker than anything we have experienced before. I believe the Bitcoin-Cryptocurrency market is going to collapse shortly due to what I see as extreme leverage in the system with very little in the way of cash reserves. I hear stories that trading in and out of cryptos isn"t a problem until you want to receive a substantial amount of funds in your bank. That is a huge RED FLAG.
So, take this warning... as well as the knowledge that pole dancers are becoming Bitcoin gurus. If it"s too good to be true, it"s likely too good to be true.
Lastly, I want to thank everyone who continues to support the SRSrocco Report site. Those who have become members of my site or Patreon might wonder why the membership count does not rise that much. This is because while I receive new members, some fall off each month for various reasons. However, I sincerely appreciate the support and believe the SRSrocco Report site is providing analysis, information, and data not found anywhere else on the internet.
The recent (bear) flattening of the US yield curve to levels not seen since before the GFC, a move which has only accelerated in recent weeks as the stock market hit all time highs, has prompted some to question the strength of the US economic cycle, and others to ask outright how long before the curve inverts, signaling an imminent recession. Here, as Citi"s Jeremy Hale notes, just as "Dr. Copper" can sometimes be viewed as a stock market precursor, so "Professor Curve" (particularly when inverted or aggressively flattening) can be viewed as a signal of that policy is too restrictive relative to economic fundamentals (especially when using term premium suggests the curve should already be inverted). That said, during an expansion it’s generally normal for the curve to flatten, as the economy expands and the output gap closes, as shown in the chart below. This can be attributed to expectation of a higher Fed funds rate, but also a lower term premium, or more ominously, an inability to pass through inflation to the broader economy, leading to tighter financial conditions which ultimately manifest in an economic contraction.
Putting the recent 2s10s flattening in context (blue line on chart above), assuming this cycle started at the December 2013 steepness of 264bps, the curve has flattened for the past 60 months. On average, historic flattening cycles last for 2-2.5 years and flatten ~270bps from peak to trough. As Citi notes, we have flattened three quarters on the way there, or roughly 204bps so far in this cycle, therefore in comparison to previous episodes; perhaps this flattening dynamic is growing grey hairs... but it’s certainly not finished yet.
Indeed, if history repeats, then another 67 bps flattening is implied before we see an inversion of the curve. And while this cycle of curve flattening has been particularly slow, assuming a runrate of 40bps of flattening per year, then we could see a flat curve within 18 months (Figure 3, left). So "should we be worried?" Citi asks and answers that, rightly or wrongly, market participants with grey hairs would preach that all is well until the curve begins to invert. Ah yes, but that"s not the full story, as Citi explains below:
Sometimes inversion provides a timely signal for the economic cycle a la 2000, where Professor Curve predicted almost the ding-dong high in the SPX. However the 2006 episode of inversion dished up 7 months of pain for equity bears, with 18% further upside for the SPX. Ditto for the 1989 episode where equities continued to rally 22% into the 1990 recession (Figure 3, RHS). For now, we’re comfortable with the flattening dynamic with regards to other markets but would become increasingly cautious as the curve approaches zero.
In other words, once the curve inverts, it could either mark the top-tick of the market right there... or leave up to 22% more in equity upside before stocks finally crash.
Citi"s optimism - for now - aside, one notable distinction about the current flattening is that, unlike much of the curve move in 2016, this one has been driven by the front end, i.e. a bear flattening. The front end of the US curve has significantly re-priced since September with the extension of the debt ceiling and the realization that fiscal easing could be achieved by the Trump administration.
Also worth noting is that while the short end has been driving curvature, the long end has been relatively rangebound, at least over the past year. What Citi finds particularly interesting is that even with ‘impending’ fiscal expansion in the US and balance sheet normalization by the Fed, term premia are actually still negative and suggest that the nominal 10y UST should trade closer to ~1.6% if the priced in forward short rate was at end pre-Election levels (Figure 6, LHS). This would suggest that there is, of course, a risk that the unusually low term premium - pushed to near record low levels by foreign central banks QE and NIRP, herding investors into long-term US duration - could suddenly rise; of note, perceived inflation risk could reverse its course quickly if inflation suddenly trended up.
Some Fed estimates suggest that term premium is ~0.9% lower than it would be without the Fed’s large securities holdings, and that this term premium effect will gradually diminish with the reduction of the Fed’s balance sheet. But the Fed’s normalization has been well telegraphed; therefore the market has had the opportunity to anticipate this for several months (this goes back to another point made by Citi"s Matt King that the market has lost the ability to discount the future). In fact, the central bank depresses the term premium by limiting the uncertainty surrounding monetary policy. In short, Citi is skeptical of the material impact that BSA may have on nominal yields given a relatively hawkish Fed. Furthermore, as the Fed continuing to tighten, it is possible the US economy is ‘locking in’ any gains that may be passed through to CPI. It is worth noting that in the last two cycles, US firms (and others) have had trouble - if not found it impossible - passing wage costs through to prices.
So even if a curve inversion does not spell imminent recession, what is next for the (shape of the) curve? Well, more of the same flattening it appears, as the curve takes more aggressive steps to flatten.
As Hale explains, the term premia and the forward curve suggests further flattening ahead (Figure 10 bottom LHS and top RHS). It’s also worth noting that in the past throughout Fed hiking cycles, the curve flattens on average between 100-125bps (Figure 10 bottom RHS), we’re currently around half way through on that basis assuming the Citi Fed call is right. But relative to other cycles at this stage, perhaps we have moved far enough for the time being. Citi"s fair value model using ACM term premium, the breakeven curve and a proxy for the r* also suggest flattening is close to fair value for now (Figure 10 top LHS).
But more medium term as the Fed keeps tightening, the curve will likely continue to flatten, and may even begin to bull flatten, should inflation expectations fall further. Ironically, Citi concludes, if the Fed wants higher long-term rates, and with them a steeper yield curve, it may need to hold back on further interest rate hikes until inflation surpasses the target/ backward driven inflation expectations rise.
You could almost understand the irrational exuberance of 1999-2000. That"s because everything was seemingly coming up roses, meaning that cap rates arguably had rational room to rise.
But eventually the mania lost all touch with reality; it succumbed to an upwelling of madness that at length made even Alan Greenspan look like a complete fool, as we document below.
So doing, the great tech bubble and crash of 2000 marked a crucial turning point in modern financial history: It reflected the fact that the normal mechanisms of honest price discovery in the stock market had been disabled by heavy-handed central bankers and that the natural balancing and disciplining mechanisms of two-way markets had been destroyed.
Accordingly, the stock market had become a ward of the central bank and a casino-like gambling house, which could no longer self-correct. Now it would relentlessly rise on pure speculative momentum---- until it reached an asymptotic top, and would then collapse in a fiery crash on its own weight.
That"s what subsequently happened in April 2000 when the hottest precincts of the stock market---the NASDAQ 100 stocks----began a perilous 80% dive; and it"s also what happened in the broader markets-----including the S&P 500---in 2008-2009, when a thundering 60% plunge unfolded in a hardly a year"s time.
So with the market raging in self-fueling momentum at the 2600 mark on the S&P 500, we reflect back to the great dotcom crash for vivid reminders of what happens next. That earlier meltdown is especially pertinent because in many ways today"s stock market mania is far less justified than the one back then.
Moreover, the dotcom version was also the first great central bank fueled bubble of modern times---a creature that market participants understandably did not fully grasp. Yet to its everlasting blame, the Fed"s subsequent experiments in reflationary bailouts of the casino gamblers has only caused Wall Street"s muscle memory to atrophy further.
Indeed, after 30 years of Greenspan-style Bubble Finance and two devastating crashes, Wall Street is even more credulous today than it was on the eve of the tech crash. Back then, in fact, there was a considerable phalanx of Wall Street old-timers who warned about the dotcom insanity. Now almost no one sees this one coming.
Indeed, today"s nutty forecast by Goldman Sachs that the S&P 500 will hit 3,100 by the end of 2020 makes Greenspan"s earlier bubble blindness look clairvoyant by comparison.
In hindsight, Alan Greenspan did see it coming early on--- when he broached the "irrational exuberance" topic in passing during a speech in December 1996. Unfortunately, he has mostly been dinged for being allegedly way too early in making the call.
In fact, we don"t think he was making much of a call at all---he"s was just musing out loud with no intention of reining-in the then rampaging bull. What he actually did was to conduct several gumming fests at subsequent Fed meetings and then diffidently raised interest rates a single time by a pinprick 25 basis point in April 1997.
After that the Maestro (so-called) apparently forgot all about "irrational exuberance" even as that very thing soon began infecting the entire warp and woof of the financial system.
In fact, Greenspan"s fatuous amnesia became so pronounced that by the very eve of the dotcom crash in April 2000, he proved himself blind as a bat when it comes to central bank created bubbles.
Said the Maestro to a Senate committee on April 8 when asked whether an interest rate increase might prick the stock market bubble:
That presupposes I know there is a bubble....I don"t think we can know there is a bubble until after the fact. To assume we know it currently presupposes we have the capacity to forecast an imminent decline in (stock) prices".
At least he got the latter part right. After the NASDAQ had risen from 835 in December 1996 to 4585 on March 28, 2000---or to an out-of-this-world 5.5Xgain in 40 months----Greenspan wasn"t even sure he was seeing a bubble!
Accordingly, he apparently didn"t have that capacity to predict an imminent decline---although the 51% crash to 2250 by the end of the year would seem to have been exactly that.
Indeed, after unloading the above tommyrot at the tippy-top of the NASDAQ-100 bubble, Greenspan proved himself a clueless, pitiable fool when this giant bubble deflated by 81% over the next two years.
In fact, the index ended up in September 2002 almost exactly where it had been when Greenspan spoke the words "irrational exuberance" and then moved along with the Fed"s printing press at full speed---claiming there was nothing to see.
Still, back then you could almost have made a (lame) excuse for the Fed chairman"s bubble blindness. The Maestro was operating in the early days of monetary central planning and wealth effects management, and its potent capacity to unleash rampant speculation in the financial system was not yet fully understood----even if the underlying monetary theory defied all the canons of sound finance.
Moreover, in addition to rampant bubbles in the financial market, the Fed"s money pumping during the 1990s did also seem to be producing some seemingly robust real world effects on main street and in the booming new tech part of the economy.
And, in turn, these positive macroeconomic developments were unfolding in a global political/strategic environment that had suddenly become more benign that at any time since June 1914.
Indeed, the outside world fairly buzzed with positive developments. These included the fact that the internet/tech revolution still exuded adolescent vigor, the government"s fiscal accounts were nearing balance for the first time in two decades, the vast market of China was convincingly rising from its Maoist slumber and the Committee To Save the World (Greenspan, Summers and Rubin) had just rescued Wall Street with alacrity from the Long-Term Capital Management (LTCM) meltdown.
Likewise, Europe was launching the single currency and expanding the single market. In place of the Soviet Union, which had disappeared from the pages of history in 1991, Russia, its breakaway republics and the former Warsaw Pact (captive) nations were all bursting out of their statist chains and experimenting with home grown capitalism and reaching out to the west via rising trade and capital flows.
In the US, the combination of the end of the cold war and the internet revolution contributed a doubly whammy to growth and prosperity. When defense spending fell from 7% of GDP on the eve of the Soviet collapse to under 4% by the year 2000, substantial domestic resources were released for private investment and a resulting substantial productivity uplift.
In fact, real private nonresidential investment grew at 7.3% per year from the 1990 pre-recession peak through 2000. That was more than double the still respectable 3.4% rate recorded between 1967 and 1990; and causes the anemic 1.4% real growth of fixed investment between the pre-crisis peak (2007) and 2016 to pale into insignificance.
Notwithstanding all of these positives, however, the great bull stock market of the late 1990s ended-up getting way ahead of itself. That was especially the case during the next 18 months after the Fed"s heavy-handed and somewhat panicked bailout of LTCM in September 1998 had confirmed to the newly energized casino gamblers that the Greenspan Put was most definitely operative.
In the Great Deformationwe tracked 12 of the highest-flying big cap stocks ("Delirious Dozen") during the period between Greenspan"s December 1996 speech and the April 2000 dotcom bust. During this 40-month period, the combined market cap of these 12 leading momo stocks---including Microsoft, Cisco, Dell, Intel, Juniper Networks, Lucent, AIG, GE and four others---soared from $600 billionto $3.8 trillion.
That eruption did indeed give the notion of trees which grow to the sky an altogether new definition. To wit, the total market cap of the Delirious Dozen grew by 75% per annumfor nearly 4 years running; and the future outlook was claimed to be even more fantastic.
For instance, as of mid-2000 Intel was valued at $500 billion and traded at 53X its $9.4 billion of LTM earnings. Yet it was argued that this nosebleed multiple was more than warranted because the company had grown its net income from $1 billion to $9.4 billion during the previous decade, and that there was nothing but blue sky ahead.
Here"s the thing, however. Intel was and is a great company that, in fact, has never stopped growing.
But during the 17 years since mid-2000, its net income growth rate has sharply slowed to just 1.79% per annum; and its $12.7 billion of LTM net income for September 2017 is valued at only 15.7X or $210 billion.
In short, at the peak of the tech bubble Intel"s market cap had vastly outrun its long run-earnings capacity. Even today it has only earned back 40% of its bubble peak valuation.
Likewise, Cisco was valued at $500 billionin July 200 and sported a 185X PE multiple on its $2.7 billionof LTM net income. And it, too, has continued to grow, posting LTM net income of $9.7 billionfor September 2017.
Yet today"s earnings are accorded only a 19X multiple after 17 years of 2.4% per annum growth; Cisco"s current $181 billion market cap, in fact, sits at just 36% of its bubble peak.
Even the mighty Mr. Softie has experienced pretty much the same fate. Back in mid-2000, it posted $8.3 billionof LTM net income and was valued at $600 billion or 72X. Today its net income has tripled to $23.1 billion, but its PE multiple has receded to just 29X.
Stated differently, Microsoft"s net income has grown at 6.1% per annum since the company vastly outran it true value back in early 2000. Accordingly, its market cap gained just 0.4%per annum during the last 17 years. That is, it has taken one of the greatest tech companies of all time upwards of two decadesto earn back its peak dotcom era bubble valuation.
And when it comes to the industrial and financial conglomerate empire that Jack (Welch) built, the story is even more dramatic. GE"s mid-2000 market cap of $500 billion stands at just $155 billion today; and its PE multiple of 60X has shrunk to just 22X.
In short, that was irrational exuberance back then, and it did not take long for the vast quantities of bottled air in the market cap of the Delirious Dozen to come rushing out. By the bottom in September 2002, four of these companies had vanished into bankruptcy and the market cap of the survivors had imploded to just $1.1 trillion.
That"s a fact and you can look it up in the papers. In less than 30 months, $2.7 trillion of market cap had literally ionized. And these were the leading companies of the era.
None of them, it might be noted, were valued at 280X shrinking net income, as is Amazon today; or at infinite PE multiples like much of the biotech sector and momo hobby horses like Tesla.
More importantly, the promising macro-economic situation at the turn of the century has given way to a world precariously balanced on $225 trillion of debt and the tottering $40 trillion Red Ponzi of China.
Likewise, the benign geo-strategic environment of that era has long since disappeared into the madness of RussiaGate, endless wars in the middle east and Africa and the incendiary confrontation between the Fat Boy and the Donald on the Korean peninsula.
Finally, after 30 years of rampant monetary expansion the central banks of the world have been forced to reverse direction and begin to normalize interest rates and balance sheets.
And that now incepting and unprecedented experiment in massive demonetization of public debts is coming at a time when----after 8 years of business cycle expansion---the US, Japan and most of Europe are running monumental "full-employment" budget deficits.
Even then, these reckless fiscal policies are happening in the teeth of a demographically driven tsunami of pension, medical and welfare spending.
For the period just ended, the S&P 500 companies earned $107 per share on an LTM basis---or just 2% more than the $105per share posted back in September 2014; and also only modestly more than the $85 per share recorded way back at the June 2007 pre-crisis peak.
Stated differently, on a trend basis S&P 500 companies have grown their earnings at 2.33% per annum over the last decade. How that merits a 24.3XPE multiple on today"s 2600index price is hard to fathom---let alone Goldman"s 3100 target for 2020.
Indeed, just to retain today"s absurd PE multiple would require $130 per share of GAAP earnings by 2020 at the Goldman target price.
That"s right. By the end of 2020 we would be implicitly in the longest business expansion in recorded history at 140 months (compared to 118 months in the 1990s),
Furthermore, the term structure of interest rates will be 200-300 basis points higher according to the Fed"s current policies, while the US treasury will be running $1 trillion plus annual deficits and experiencing recurring debt ceiling and financial crises.
Even then you would need 7% annual earnings growth to hold onto today"s 24.2X PE multiple at the Goldman S&P 500 target.
As we said, relative to today"s casino madness and the Goldman fairy tale hockey stick, Alan Greenspan circa April 2000 looks like a model of sobriety by comparison.
So if that was Irrational Exuberance back in April 2000, what we have now is surely the mother thereof.
The recent spate of back-to-back hurricanes in the US is expected to compound the economic damage of an already over-extended debt. As the stock market braces for a correction, traders are inclined to sell out of riskier stock markets and take refuge in safe havens like gold.
Although it will take months for the impact of the hurricane season to be apparent, investors are already losing appetite for risk and investing in secure assets as gold. This was evident from the figures leading up to the hurricane season this year. Gold watchers have seen this precious metal on a summer turnaround, spiking up to $1300 even as markets remained uncertain.
The performance of gold from 2016
An 18-month gold chart: April 2016 - September 2017
The historical 5-year volatility of gold witnessed a brief 2016 July surge in the aftermath of the surprise Brexit vote. Gold prices rose sharply driven by macroeconomic uncertainty caused by the unexpected EU referendum. Prices peaked at $1372 in August but dived 7.63% in November 2016 to finish at a record low of $1133. Presidential pro-business policies buoyed the equity markets and strengthened the US dollar driving investors away from gold. Gold prices plunged by nearly 5 % to notch a record low of $1143 in early January 2017. According to aForbes commentary, this can be “attributed to fluctuations in the investment demand for gold”. Another reason why gold prices remained under pressure was a strengthened dollar, which makes the commodity more expensive for investors.
However, the post-presidential-election unstable scenario brought back the sheen of gold. Since January this year, gold prices have been slowly rising along the $1200 mark with rates clinging to the $1260 - $1300 range. TheUS Federal Reserve’s interest rates hike of June, followed by July, resulted in the gold price dipping to a rock-bottom $1210. The end of July saw gold staying put at $1270. Since August, the sluggish trend of gold finally got over with a 4 % surge to trade at $1290. This trend continued despite hurricane warnings and the escalating US-North Korea tensions and a globally uncertain geopolitical landscape.
The significance of the gold price turnaround cannot be overlooked. It can be partly attributed to hedge investor wariness with the American and European economies, particularly the US, where debt-based assets are at an all-time high.
Usually, near-term losses to an economy are offset by a medium-term boost to growth, but with the US parliament functioning in silos and government support programs yet to kick-in amidst the political instability, private investment in rebuilding the economy has taken a beating. Safe investing in gold became the option.
What was seen prior to the hurricane weekend of Irma was an upsurge in the gold price as investors sought to take the safe route. As perInvesting, “the dollar remained under pressure amid doubts over prospects for a third Federal Reserve rate hike this year”. With the U.S. debt ceiling talks getting postponed and a rate hike doubtful, the optimism on gold has kept up
According toThe Street, “a $300 billion hit from hurricanes Harvey and Irma is likely to affect jobs, growth and inflation in the months ahead”. The U.S. dollar hovered near a two-and-a-half year low last Friday on the 8th September when the Irma touched upon Florida. The dollar index slipped to the lowest since January 2015, coupled with a two-year high jobless claims data, mostly coming from the hurricane-hit Texas.
After rising to a three-year high in August-September, gold prices took a hit on Friday. Soon after the weekend as the hurricane risk damage of Irma was downsized, gold prices fell with risks receding in the markets. As the stock market rebounded and the dollar joined the recovery, the double impact had “the gold prices reeling at this point of time” as perNASDAQ. The prices recorded a $23 drop touching $1328. This was a short-term effect. Recovery from threat perceptions of the double whammy of hurricane Irma and North Korea missile launch may have triggered the downslide of gold prices. The sudden optimism post Irma weekend and apprehensions of North Korea dwindling, helped the stock markets and the dollar to rebound and consequently the prices of gold to move lower
Gold Prices in Q4 after the hurricane season
The fall of gold prices post-hurricane weekend cannot be seen in exclusion to other situations plaguing America. The dip during the week till 13th can be seen more as a knee-jerk reaction. This weak trend will not last long as is evident from the recovery from 14th. The hurricane season will soon be over by the end of Q3 and so will the uncertainties revolving around it. The short-term status of dipping gold prices as seen this week is already witnessing a correction which will continue through Q4. Another reason why one can expect a high demand and buying to continue is the festival season across gold consuming countries.
Notwithstanding the market expectations in the US and Europe, gold can be expected to steady and rise. Even as this goes to print, the dipping price has stabled and recovered. Safe havens such as gold will continue to be in demand, with prices of the precious metal surging to a one-year high.
Gold is considered secure from an investment point of view to hedge against macroeconomic uncertainty. The GDX, as well as the currently over-valued stock markets, may be due for a correction shortly, which will again impact gold prices, causing another surge. According to theForex Time market analysis, “Investors are likely to continue buying stocks with overstretched valuations because when compared to treasuries, they still look much more attractive”.
Presently, it appears that the gold prices will hold up during the Q4, despite unpredictability, as two constants remain – a weakening dollar and a low interest/credit position.
After the Q3 the gold prices can be expected to surge along comfortably till the end of 2017, although whether theGlobal Intergold prediction of 1,515 $ per ounce come true, it remains to be seen. The year 2017 will go down in gold history as the year ofthe breakout from the 6-year downward trend. The bottom line is that gold prices will be largely unaffected by the hurricane season in the mid and long-term. AsHubert Moolman suggests, the current situation for gold is similar to that of May 1979, when prices of assets like gold and silver soared while bonds and stock market collapsed. An event likea stock market crashis also likely to push many banks to that point of failure With the likelihood of such major monetary events around the corner, gold is likely to spike much higher over the coming 12 months.
