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"We’re done when I say we’re done."
What you thought
When you first began it
What you want
Now you can hardly stand it though,
By now you know
It's not going to stop
'Til you wise up"
"Remove everything that has no relevance to the story. If you say in the first chapter that there is a rifle hanging on the wall, in the second or third chapter it absolutely must go off. If it's not going to be fired, it shouldn't be hanging there."
During my recent hiatus a number of things happened which I suspect will be the subject of feverish debate amongst the chattering classes (myself included) for months if not years to come.
Amidst it all was a bald, bearded man of a certain age, who had transformed himself from a lifelong academic into a feared and almost mythical leader, becoming in the process the focus of the world as he stared down all kinds of trouble in the name of protecting his "family".
This man did whatever he felt was necessary in order to further his agenda; and though it meant making many enemies, he dared look straight into the eyes of both his detractors and those who would defy him, and he never blinked.
He did what had to be done.
But lately he had been trying to find a way out. He didn't want the responsibility anymore, and he felt as though it was time to quit and leave the empire to whoever was bold enough to seize it.
Sure, he tried to quit, but that wasn't something he could just do on a whim. Loose ends needed to be tied up, and promises had to be made good and powerful people placated.
For anyone who doesn't know the outcome of this tale, don't worry that I might ruin the ending ... because that outcome hasn't been written yet. The best we can do is just guess at how it all plays out.
Wait? What? Oh... Breaking Bad? Nooooo... I wasn't talking about Walter White, I was talking about Ben Bernanke. Except, he DID blink...
Yes, whilst I was away the Fed announced to the world that, although they had done all the hard work to convince the world that the Dreaded Taper was a done deal that allowed both bond and equity markets to price in a reduction in the amount of asset purchases being made every month by Bernanke (or, as he has become known in financial circles, "Buysenberg"), when it came to crunch time, the Fed didn't have the guts to pull the trigger. To use the English phrase, "they bottled it".
Now, any self-respecting drug lord central bank head (hell, any parent) knows that, in order to maintain respect, in order to continue to be feared, you MUST be prepared to follow through with your threats, even if you don't necessarily want to. That's just how the world works. You don't threaten to rain down badness on people and then shy away. If you do that, your credibility is gone and your reputation is in tatters.
In this world, reputation is everything.
In the months leading up to the September FOMC meeting, the world was put on standby for a change in Fed policy, a process that had been innocuously labelled a "taper" by the Fed (check out the video interview with Elliot Management's Paul Singer in this week's videos section for an erudite — and I am willing to bet 100% accurate — assessment of how that phrase came to be chosen); and, as the Fed have come to expect in recent years, their preparatory jawboning was working its customary magic.
Source: NY Times
Between May 22, when Bernanke first uttered the T-word, to September 12th, on the eve of the FOMC decision, confidence in the Fed's beginning their taper climbed relentlessly higher, reaching 67% right before the hammer was supposed to fall.
But a funny thing happened on the way to the forum: the Fed pulled a Cassius Clay and shook up the world.
When the Taper was tossed on the table in late May, a couple of turbulent months followed; but immediately before the decision was due on September 12, markets were sanguine:
(WSJ, September 18, 2013): If investors are concerned about the imminent end to the Federal Reserve's monetary stimulus, the markets haven't noticed.
Despite widespread expectations that the Fed will announce a trimming of a bond-buying program aimed at pushing down interest rates and propping up the economic recovery, fund managers have been in a buying mood lately.
The blue-chip Dow Jones Industrial Average on Tuesday advanced for the 11th time in 14 trading sessions, and U.S. Treasury prices rose for the fifth straight day.
Many investors expect the Fed to decide to cut its $85 billion monthly purchases of bonds by about $10 billion to $15 billion. Markets were roiled in May and June after Fed chief Ben Bernanke said the U.S. central bank would consider reducing purchases in a process dubbed "tapering."
Some investors dismiss the prospect of much turbulence this time. They say players in stock, bond and commodity markets have had time to prepare for potential Fed action, assuming the Fed acts largely within market expectations, and that a selloff in bonds since Mr. Bernanke's comments means there is less potential for a large price decline now.
It's important to realize that this was absolutely the environment the Fed had sought to create in the preceding months: a market that had priced in a reduction in stimulus without falling apart. There had been juuuuuust enough uncertainty to keep people on their toes, but not so much as to cause panic.
The central banker's holy grail.
So imagine the market's surprise when the FOMC decision was announced. Actually, don't bother imagining it; I'll save you the trouble of taxing your imagination:
(UK Daily Telegraph, September 19, 2013): The Fed shocked markets across the world by leaving its $85bn-a-month asset purchase scheme unchanged on Wednesday, despite guiding traders to believe that so-called “tapering” would begin this month. Most Fed followers had expected the stimulus programme to be reduced by between $5bn and $15bn a month.
Markets soared on the promise of more stimulus...
Shook up the world, shocked markets... whatever; the point is this: surely, having done all the hard work to prepare the market for the onset of a reduction in stimulus, and having gotten it comfortable with less free money, it was almost foolish of the Fed to not go through with it, right? Well, it seems I'm not the only one who thinks so:
(UK Daily Telegraph): The US Federal Reserve has damaged its credibility and sown confusion about central banks’ communication strategies by surprising markets with its decision to keep quantitative easing on hold, economists have warned.
(AP): Stocks, bonds and precious metals are rallying following the Fed’s decision to keep its stimulus measures in place. But a slew of market watchers are concerned about the long-term ramifications of such a move.
Eric Green, global head of rates, FX and commodity research at TD Securities, says the Fed’s latest announcement shows the central bank is “running scared”.
“This FOMC edition feels less dovish than it does outright scared,” Mr. Green says. “Confidence in the outlook has dimmed. That Bernanke had a free pass to begin that tapering process and chose not to follow is telling. The Fed had the market precisely where it needed to be. The delay today has the effect of raising the benchmark to tapering and ultimately makes that first step harder to achieve.”
(Peter Boockvar): “The grand monetary experiment now going on 5 years continues full speed ahead … Bottom line, while the economic data over the past few months did not call for a taper according to the Fed’s econometric models, I believe they are making a massive mistake as this QE policy does nothing but manipulate and distort asset prices with no lasting positive impact on the economy. Rip this band aid off already I say. I will repeat again to the Fed, there will NEVER be the right time to cut back, and today was the perfect opportunity to do so because the market was ready for it. Playing games now over this with the market will not smooth the eventual ease. Either way, the US bond market has already started the tightening process, and that is what participants should be focused on.
Now, nobody will convince me that the collective brains at the Federal Reserve wouldn't have figured out that, after all the talk, failing to taper would damage their credibility enormously. So one has to wonder, how bad must things really be in order that they would sacrifice their credibility so willingly? After all, they could have gone ahead with the Taper and then found another way to throw the market a bone later if they had to, but instead they chose to blink in the face of their toughest moment since the tarp was pulled off the printing press in the Fed basement back in 2008.
But before we go any farther, let's remind ourselves what sort of beast the Taper actually is.
Remember, the Taper is NOT the withdrawal of stimulus, it's simply a slowing of the existing stimulus. The way the press talks about the Taper, it is easy to forget that, once the Fed begin their program, all they will be doing is printing slightly less free money every month than they currently are.
Leave it to my friends at Zerohedge to lay this concept out in an easy-to-understand chart:
Yes, folks, that's right, the Taper (assuming it was as much as $20 billion a month) would mean a difference of just $300 billion by the end of 2014.
Now, I'll admit that $300 billion USED to be an awful lot of money. But now? Not so much.
In 1995, $1.3 billion was enough to bring down Barings Bank, the oldest merchant bank in London, amidst warnings that unless something was done the global financial system would be brought to its knees.
In 1998, Long Term Capital Management required a $3.6 billion bailout from 14 financial institutions after losing $4.6 billion in less than four months when the Russian debt crisis played havoc with its models. At the time, dire warnings were issued about the global financial system being brought to its knees unless action was taken immediately.
In March of 2008, Bear Stearns received a 28-day, $25 billion loan from the Federal Reserve in order to avert its collapse (and the global financial system being brought to its knees), and just days later that $25 billion loan to Bear Stearns morphed into a $30 billion loan to JP Morgan, who in absorbing Bear Stearns kept the global financial system from being brought to its knees.
Six months later, on September 15th, Lehman Brothers went belly-up; and in order to stop the global financial system from becoming the global financial system being brought to its knees, Buysenberg and then-Treasury Secretary Hank Paulson (or, as they were known back in those days, "Los Pollos Hermanos"), crafted a $787 billion bailout package (the Fabled TARP), which, thankfully, prevented the global financial system being brought to its knees.
Now, a mere five years on, we find ourselves in the position of requiring roughly three Bear Stearns bailouts every month just to keep things humming.
Put another way, we require 23.6 LTCM bailouts or 65.38 Baring Brothers bailouts every month, just to keep the global financial system from being brought to its knees.
"How does that stack up against CPI?", I hear you say. Well, I'm glad you asked.
The $1.3 billion tab for Barings in 1995, when adjusted for CPI, equates to $2 billion in 2013 dollars.
But the Fed is spending 42.5x that amount. Every. Single. Month.
No inflation, you say? Well some things are increasing in price at an annualised rate that belies the 1.8% core rate published by the BLS. We've already looked at bailouts, and there's never any shortage of press about wine auctions or fine-art sales breaking record after record, but what about... oh I don't know, diamonds, perhaps?
(Sky News): A "flawless" white diamond which is the size of a small egg has been sold at auction for a record $30.6m (£19m).
The 118-carat oval gem is the largest and most significant such diamond graded by the Gemological Institute of America.
It weighed 299 carats when it was mined in southern Africa in 2011 but Sotheby's will not name the country because the seller wishes to remain anonymous.
Two phone bidders competed for the diamond in six minutes of bidding until one dropped out.
It was bought for $27.3m at the jewellery auction in Hong Kong, but the total price including commission came to $30.6m.
That was more than the previous record of $26.7m (£16.6m) for a white diamond set in May at Christie's in Geneva, Switzerland.
Or maybe racehorses?
(Yahoo): A world record fee has been paid for a one-year-old filly which became the most expensive horse in history.
Qatari Sheikh Joann Al Thani successfully bid five million guineas (£5.25 million) for the yearling filly at the Tattersalls bloodstock auction in Newmarket.
The as-yet-unnamed filly is the daughter of the most sought-after stallion on the planet, 2001 Derby winner Galileo, and Alluring Park, and became the most expensive horse of any age sold at public auction in Europe, beating a record set in 2006 by Magical Romance (4.6m guineas).
But... tuna fish?
Last January, a world record was set for the most expensive bluefin tuna fish ever sold, when Kiyoshi Kimura, president of the Japanese chain Sushi Zanmai, bought a 593-pound fish for US$736,000. The previous record? $416,000.
This year, Kimura-san outdid himself:
(Eater.com): Kiyoshi Kimura, a businessman who owns the Sushi Zanmai chain of restaurants in Japan, has once again set the record for purchasing the most expensive bluefin tuna ever. According to the New York Times, Kimura paid 155.4 million yen (US $1.76 million) for the 488 pound fish. That's around $3,600 per pound. Kimura also set the same record about a year ago when he paid $736,000 for a 593 pound bluefin.
For those of you at home doing the math on a cost-per-pound basis, that's an increase of 290% in 12 months.
Inflation goes where the money goes — and the money is going to the wealthy, so is it any wonder we read pieces like this?
(UK Daily Telegraph): The second bi-annual Candy GPS Report, produced by Candy & Candy, Savills World Research and Deutsche Asset & Wealth Management, revealed that there was a 34pc jump in individuals worth more than $30m (£18.7m) between 2009 and 2012.
A 34% jump in the number of individuals worth more than $30m? In three years?
My great friend Simon Mikhailovich pointed out to me the last time we met that nowadays you can be worth $85 million and not be able to afford a penthouse apartment overlooking New York's Central Park; and he's right, this is the extreme inflation we have all suspected but couldn't find because we were looking in the wrong places.
But I digress... Back to Buysenberg and the weapon that gives this edition of Things That Make You Go Hmmm... its title.
Russian playwright Anton Chekhov, renowned as one of the greatest authors of short stories in history, fathered what has become a key dramatic principle when he stated:
"Remove everything that has no relevance to the story. If you say in the first chapter that there is a rifle hanging on the wall, in the second or third chapter it absolutely must go off. If it's not going to be fired, it shouldn't be hanging there."
Chekhov believed that every element in a narrative should be both necessary and irreplaceable and that everything else that is in any way extraneous to the story should be removed.
Nowhere should that principle be applied more diligently than in central bank communications to the markets, but it appears that the opposite tack is adopted more often than not.
Alan Greenspan was famous for introducing "Fedspeak" to the markets during his tenure. Described by Alan Blinder as "a turgid dialect of English", Fedspeak had many critics:
"Known as Fed Speak, the convoluted rhetoric has befuddled even the wisest of interpreters."
— Wealth Building Strategies in Energy, Metals and Other Markets:
(Wikipedia): The deliberately confusing and carefully rehearsed cryptic language described as an "indecipherable, Delphic dialect" is meant to "give people a sense that there's no way they could understand economics and finance" and thus allow the Federal Reserve and government to manage the economy with less interference from the general public...
The notion of fed speak originated from the fact that financial markets placed a heavy value on the statements made by Federal Reserve governors, which could in turn lead to a self-fulfilling prophecy. To prevent this, the governors developed a language, termed fedspeak, in which ambiguous and cautious statements were made to purposefully obscure and detract meaning from the statement.
As recently as July of this year, in a conversation with the NBER, Bernanke explained his own feelings about clear communication:
(WSJ): Well, as I said in my remarks, I’m a very big believer, the Fed Reserve is a very big believer, in transparency and communication. I think transparency in central banking is kind of like truth-telling in everyday life.
You got to be consistent about it. You can’t be opportunistic about it.
Now, in Breaking Bad, at the opening of the final season, creator Vince Gilligan begins with a scene in which a dishevelled Walter White opens the trunk of a 1977 Cadillac Sedan de Ville to find an M60 and a couple of hundred rounds of ammunition sitting there, plain as day.
No spoilers here — but you'd better believe the M60 gets used.
So why, having set the stage for the Taper, did the Fed not pull their own trigger? What did they see in the data that made them feel that buying "only", say, $65 billion every month would mean the "recovery" would falter?
Was it inflation?
“Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable...”
“The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall...”
Well that's the dual mandate taken care of. What else could it be, then?
Ahhhh...... of course.
The Fed has painted itself into an almighty corner with QE, and it looks as though we are finally getting to the point in the process where that fact begins to (a) occur to people and (b) matter.
Bill Fleckenstein has often spoken about the Fed's reaching the point where it "loses control of the bond market", and it is quite possible that we are rapidly approaching that point (the signs have certainly been strong in Japan). We may be there already. We won't know until we can look in the rearview mirror, I'm afraid; but the nonvirtuous circle the Fed has created is extremely clear:
The simple truth, as you can see from the diagram above, is that the economy and the markets are now 100% dependent on the largesse of the Federal Reserve to sustain them.
What you CAN'T see from the diagram is the scary proposition that the Federal Reserve in turn is entirely dependent upon hope to get itself out of this unholy cycle.
The Fed is hoping (as are the ECB, BoE, and BoJ) that the economy recovers sufficiently through massive stimulus so that the recovery will be "self-sustaining"; but, as can clearly be seen by the action of the markets in recent weeks and months, that strategy (such as it is) appears doomed to failure.
Fortunately, Obama has finally been left with just nominated Janet Yellen as the new Fed chair, and she can be relied upon to continue Greenspan & Bernanke's work in conjuring unlimited free money out of thin air:
(Zerohedge): Now that Janet Yellen has been named to lead the Federal Reserve the global financial markets should factor out any possibility that the Fed will diminish their Quantitative easing program anytime during her tenure. In fact, financial forecasts should assume that not only is a taper off the table, but that the QE program is now more likely to be perpetuated and expanded.
Unlike her predecessors, Janet Yellen has never had a youthful dalliance with hawkish monetary ideas. Before taking charge of the Fed both Alan Greenspan, and to a lesser extent Ben Bernanke, had advocated for the benefits of a strong currency and low inflation and had warned of the dangers of overly accommodative policy and unnecessary stimulus. (Both largely abandoned these ideals once they took the reins of power, but their urge to stimulate may have been restrained by a vestigial bias against the excesses of Keynesianism.) Janet Yellen, who has been on the liberal/dovish end of the monetary spectrum for her entire professional career, has no such baggage. As a result, we can expect her to never waver in her belief that stimulus is the answer to every economic question.
Which is great for the status quo, but if we take another look at that chart of the US 10-year Treasury yield again, we see something that ought to set alarm bells ringing:
The retracement of interest rates AFTER the Fed's refusal to follow up their tough talk with a Taper has been far less marked than the rout that ensued after the subject was first tabled; and that spells trouble, because the housing market — the engine of the US "recovery" — cannot stand higher rates without being choked off.
Already, we have seen the average rate for a 30-year mortgage ratcheting higher.
In September 2012 that average rate stood at around 3.60%, but a year later it was 4.5%. Now I know that doesn't sound like much, but a 25% increase in the cost of a mortgage will most definitely crimp activity.
If you don't believe me, then check out the chart below, which shows the average 30-year mortgage rate in the USA as calculated by Bankrate.com.
As you can see, we have come a long, long way from the levels before the housing "recovery" took hold. And we are definitely not in Kansas anymore:
As for how the higher rates translate into activity in the housing market, well, there's an easy way to take a look at that, too, courtesy of the Mortgage Bankers Association's monthly Mortgage Refinance Index:
(MBA): Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013. This week’s results included an adjustment for the Labor Day holiday....
The Refinance Index decreased 20 percent from the previous week. The Refinance Index has fallen 71 percent from its recent peak the week of May 3, 2013 and is at the lowest level since June 2009. The seasonally adjusted Purchase Index decreased 3 percent from one week earlier.
Source: MBA/Calculated Risk
Bill McBride of Calculated Risk chips in with his own 2c:
(Calculated Risk): The refinance index is down 71% since early May.
The last time the index declined like this was in late 2010 and early 2011 when mortgages increased sharply with the Ten Year Treasury rising from 2.5% to 3.5%. We've seen an even larger increase over the last few months with the Ten Year Treasury yield up from 1.6% to over 2.96% today. We will probably see the refinance index back to 2000 levels soon.
A return to 2000 levels in refinance activity is NOT conducive to a strong housing market, and a weak housing market is not conducive to a strong economy. What's more, a weak economy is not conducive to any kind of tapering, yet a lack of tapering is most assuredly not conducive to the Federal Reserve's credibility.
So what next?
Well, Janet Yellen might well confound everybody and launch the Taper as her first order of business. Or Buysenberg may even begin it as his last act in power; but either way, the market will now likely call the Fed's bluff, because it knows that the gun hanging on the wall in the shape of the Taper is not guaranteed to be fired. It may even turn out to be completely superfluous to the narrative; and if that is the case, then chances are it will never be fired.
Just as Walter White's honest intentions in trying to protect his family ended up trapping him in an ever-worsening spiral where countless millions of dollars only made his situation worse, Ben Bernanke is in a similar prison of his own making.
Eventually, this pile of dollars is going to be the thing that sinks Bernanke... or Yellen... or whoever has the helm on the fateful day when reality reasserts itself. That may not be tomorrow or next week; but, based on recent events, that day is a lot nearer to hand than most people thought just a few short months ago.
The Fed realizes the truth of that — hence the abandonment of both the Taper and their own credibility — but their chances of averting catastrophe are receding daily.
The ending of Breaking Bad has been hailed by many critics as perhaps the most perfect, most satisfying denouement in television history, and in large part that praise is due to Vince Gilligan's masterful ability to follow the principle of Chekhov's gun and make sure that every dramatic device employed throughout the series had a reason and a purpose. No misdirection, no unnecessary devices, just brilliant, honest storytelling.
That is the vital difference between Breaking Bad and a Freaking Fed.
Rather than write the story and end it in a manner of their own choosing, they are now prisoners of the narrative.
I fear the worst.
OK ... so my extended break is at an end, and it feels as though I never left.
I have somehow managed to not touch upon the debt-ceiling fiasco this week and to dwell only briefly on the appointment of Janet Yellen, but I suspect both those subjects will feature heavily in coming weeks. In the meantime, plenty of other activity has caught my eye.
This week, Ambrose Evans-Pritchard kicks things off with an explanation of the potentially disastrous outcome for a divided United States; and from there we head to Mongolia to observe a very public legal spat, to Moscow to learn out about the secrets held within the walls of the Kremlin, and to Germany, where Spanish jobseekers are finding that reality doesn't match promise.
Jim Grant explains why America's default on its debt is inevitable; the IMF forecasts bleaker times ahead for Australia; and the FX markets are the latest to be awarded the dubious honor of a criminal investigation.
Frank Holmes explains the fire fueling gold; we read the bewildering story of mistaken identity surrounding the upcoming Twitter IPO; and we look at charts of Fed holdings of securities, the gold price versus the debt ceiling, and all the creditors of the United States of America.
The videos section presents three giants of the industry — Paul Singer, Bill Fleckenstein, and Ray Dalio — and we wrap up with some invaluable advice for anyone visiting New York City, courtesy of Johnny T.
Until Next Time ... get outta the way!
The US Founding Fathers abhorred factions. The 10th Federalist Paper by James Madison in 1787 is a study of how to defend the fledgeling republic against the dangers of organised zealotry, the curse that blighted earlier republics in world history.
Madison defined factions as groups of citizen "united and actuated by some common impulse of passion, or of interest, adverse to the rights of other citizens, or to the permanent and aggregate interests of the community".
The bone of contention was thought to be disputes over the "unequal distribution of property", and so it has proved to be as we see today in the bitter fight between debtors and creditors, or between those who live off government and those who pay for it.
Madison believed a powerful continental Congress — rooted in Washington rather than state legislatures — would work against factions. Regional diversity would muddy the ideological waters. This is in fact what happened.
For much of the 20th Century the Democratic Party was a coalition of blacks, Jews, and Irish, Italian, and Polish Catholic immigrants in the North, and "Bol Weevil" conservatives in the South.
They had little in common. This allowed for fluid political deals on Capitol Hill, with alliances crossing party lines. Gridlock was mostly avoided even though the US constitution fosters divided government.
This coalition no longer exists. Democrat dalliance with "leftist" social doctrines since the 1970s — Roe v Wade, gun control, et al — has turned the South into a Republican stronghold. While Northern cities have become more militantly Democrat.
The numbers of voters who split their tickets fell to 11pc in the 2012 elections, an all-time low. A record number identify themselves as hard-core Democrats or Republicans, and they are more concentrated in their bastions.
"Republican districts are redder than ever: Democrat districts are bluer. Ideological polarisation in the House is wider than it has ever been," said the Washington Post.
A Princeton study said the rift is even more extreme than under Reconstruction after the Civil War. The rancour is off the charts. This is why the clash over the debt ceiling has become so unpredictable, and so dangerous. Neither side has much incentive to reach across the divide. Each is looking to its own militant core.
The Obama Administration has made matters worse by alarmist hyperbole. The Treasury claimed last week that a US default after October 17 would lead to a collapse of the dollar and a catastrophic spike in US Treasury yields, all ending in another Lehman crash "or worse".
It might indeed go horribly wrong, but not by this mechanism. The dollar would more likely surge — and US yields would plummet — in the frantic scramble for safe havens, just as occurred in the Lehman crisis.
This in turn would cause havoc for emerging markets, and another spasm of the European debt crisis. No serious investor thinks the US will actually walk away from its debts. That is not what the debate is about....
The U.S. Justice Department has opened a criminal investigation of possible manipulation of the $5.3 trillion-a-day foreign exchange market, a person familiar with the matter said.
The Federal Bureau of Investigation, which is also looking into alleged rigging of interest rates associated with the London interbank offered rate, or Libor, is in the early stages of its currency market probe, said the person, who asked not to be identified because the inquiry is confidential.
The U.S. investigation comes as the U.K. Financial Conduct Authority said in June it was reviewing potential manipulation of exchange rates. That month, allegations that dealers at banks pooled information through instant messages and used client orders to move benchmark currency rates were reported by Bloomberg News. Regulators are probing the alleged abuse of financial benchmarks used in markets from oil to interest rate swaps by the firms that play a central role in setting them.
Swiss regulators said last week they were “coordinating closely with authorities in other countries as multiple banks around the world are potentially implicated.” The probes include alleged manipulation of ISDAfix, a benchmark in the $379 trillion market for interest-rate swaps.
The International Organization of Securities Commissions, the Madrid-based group representing regulators from more than 100 countries, set tougher guidelines for publishing benchmarks in a July 17 report, including making prices based on “observable” deals where possible to increase transparency.
Regulators, including European Union Competition Commissioner Joaquin Almunia, may examine commodities markets, having already increased investigations of manipulation of benchmarks for oil, interest rates, derivatives and foreign exchange.
EU investigators searched the offices of Platts, the unit of New York-based McGraw Hill Financial Inc. that assesses the price of Dated Brent, the benchmark for more than half of the world’s crude. Kathleen Tanzy, a New York-based spokeswoman for Platts, said in an Oct. 4 e-mailed statement that the company’s “aim is to bring transparency to price discovery by publishing as much detailed and meaningful information as possible.”
In a Bloomberg News survey conducted over eight weeks, commodities traders who buy and sell as much as $5.67 trillion of raw materials a year say the benchmark prices for everything from oil to iron ore to gasoline are wrong as often as 27 percent of the time.
The person familiar with the U.S. currency market probe didn’t say which banks may be under scrutiny. Peter Carr, a spokesman for the U.S. Justice Department, declined to comment on the investigation....
FOR want of a letter, a fortune was lost. Shares in Tweeter, a bankrupt electronics retailer, briefly soared 1,800% on October 4th because some investors mistook its ticker symbol TWTRQ for TWTR, the shorthand chosen by Twitter ahead of the microblogging service’s planned stockmarket flotation. Trading was halted after the regulator stepped in. But those who bought at the peak price will be regretting their foolishness.
So what happened to the idea of an efficient market, in which prices are set by rational investors in command of all pertinent public information? Those who piled into the stock failed to grasp two important facts: first, Twitter has yet to float and second, when it does list, the issue price is highly unlikely to be a few cents.
Academics accept there will always be irrational, or foolish, investors but argue that these will be driven out of business by arbitrageurs who can profit from mispricings. In theory, there was money to be made on October 4th by shorting Tweeter stock (ie, betting on a falling price). In practice, however, arbitrageurs may not be able to take advantage of such opportunities: it may be impossible to borrow the stock needed to establish a short position.
Furthermore, regulators tend to dislike short-sellers, fearing that they transform market downturns into routs. So they impose all sorts of restrictions on the practice. But short-selling is a precarious profession. Dedicated short-sellers need to make money in falling markets so they can be around to contain “irrational exuberance” in rising ones. If it were easier to sell short, there would be fewer bubbles.
The dotcom boom of the late 1990s contained some classic examples of investor irrationality. Companies could add millions to their market value merely by adding the letter “e” to the start of their name, even though they had no coherent internet strategy. 3Com, an electronics company, floated a stake in its subsidiary Palm, a maker of hand-held computers; its remaining holding in Palm was soon worth more than 3Com itself. In other words, investors were applying a negative value to the underlying business of 3Com, which was profitable at the time.
Investors flocked to buy internet incubators, the 20th-century equivalent of the South Sea bubble’s “undertaking of great advantage but no one to know what it is”. The incubators promised to buy stakes in unspecified dotcom companies. They resembled closed-end funds and might expect to trade at a discount to their asset value, to allow for tax and other costs. But often they commanded huge premiums: one company, Oxygen, floated on the market with 2p per share in cash and closed the first day at 65p. In effect, investors were buying pound coins for £32.50 a throw.
Nor were these mispricings as temporary as the Tweeter affair. The 3Com/Palm discrepancy persisted for months. Those fund managers who stood aside from the dotcom foolishness, such as the late Tony Dye at Phillips & Drew, lost clients and eventually their jobs as a result.
Of course, when a new technology such as the internet bursts upon the scene, a great deal of uncertainty is inevitable. Investors will feel sure that some companies will emerge as stockmarket giants, but will not know which. That will encourage the tendency to spread their bets, backing almost any company with a plausible strategy. The net effect will be that, in aggregate, the valuation of the sector will be ridiculously high; dozens of companies will be priced as if they will become the next Microsoft or Google, even though only a couple will manage it....
The latest World Economic Outlook released by the IMF on Wednesday was a bit of a sobering document. Given that the IMF has been delivering pretty sober assessments for more than four years now, it's not that surprising.
This time the outlook also involved a bit of looking back at how good things were expected to be before the GFC/great recession hit, and how bad they were predicted to be once it did. What is striking is that for many countries and parts of the world, 2013 finds them in a worse position than where they were expected to be in April 2009 when the IMF issued its first bleak outlook after the tumult of the GFC.
So while there has been some joy in the UK because the IMF has revised its prediction for growth in 2013 from the meagre 0.7% expected in the April WEO up to 1.4%, it is worth remembering that back in April 2009 the IMF expected the UK to be growing about 2.8% by now. For the next three years it kept revising down that prediction. Only in the past year has the IMF been too pessimistic.
For Australia, the reverse is true. If we look at the predictions for GDP growth from 2007 onwards, the IMF in 2008, before the GFC hit, was rather buoyant about Australia's future. It expected by the end of 2013 Australia's economy would have grown 20% above where it was in 2007. When the GFC hit, the IMF got real gloomy and revised this down to a mere 9.2%. And yet on Wednesday the IMF reported Australia's economy growing by 16% since 2007.
In fact, if you look at a comparison of where the IMF expected advanced economies to be by 2014 when the GFC hit and where they are now, Australia has performed better than all but Singapore, Taiwan and Israel.
Countries like Korea and China have grown faster than Australia, but they were expected to do so. Back in April 2009 the IMF expected Australia, the US and Canada to get through the GFC with much the same growth, but only Australia performed above expectations.
So Australia has gone through the GFC much better than expected, but interestingly, back in 2010 the IMF thought we would be in better shape than we are now. Moreover, the latest outlook has revised down the estimate for Australia's GDP growth in 2014 from its April estimate of 3.3% to 2.8%.
Similarly, it has changed its expectations of our unemployment. In April it thought unemployment in 2014 would reach 5.2%, now it says 6.0% is the more likely outcome. Treasurer Joe Hockey noted this increase, saying, "Worryingly, the IMF forecasts Australia's unemployment rate to rise from 5.6 per cent in 2013 to 6.0 per cent in 2014." As Michael Pascoe observed, however, the IMF's forecast on unemployment is actually rather more optimistic than that of the Treasury, which in the pre-election economic and fiscal outlook predicted unemployment to reach 6.25% by June 2014....
“There is precedent for a government shutdown,” Lloyd Blankfein, the chief executive officer of Goldman Sachs, remarked last week. “There’s no precedent for default.”
How wrong he is.
The U.S. government defaulted after the Revolutionary War, and it defaulted at intervals thereafter. Moreover, on the authority of the chairman of the Federal Reserve Board, the government means to keep right on shirking, dodging or trimming, if not legally defaulting.
Default means to not pay as promised, and politics may interrupt the timely service of the government’s debts. The consequences of such a disruption could — as everyone knows by now — set Wall Street on its ear. But after the various branches of government resume talking and investors have collected themselves, the Treasury will have no trouble finding the necessary billions with which to pay its bills. The Federal Reserve can materialize the scrip on a computer screen.
Things were very different when America owed the kind of dollars that couldn’t just be whistled into existence. By 1790, the new republic was in arrears on $11,710,000 in foreign debt. These were obligations payable in gold and silver. Alexander Hamilton, the first secretary of the Treasury, duly paid them. In doing so, he cured a default.
Hamilton’s dollar was defined as a little less than 1/20 of an ounce of gold. So were those of his successors, all the way up to the administration of Franklin D. Roosevelt. But in the whirlwind of the “first hundred days” of the New Deal, the dollar came in for redefinition.
The country needed a cheaper and more abundant currency, FDR said. By and by, the dollar’s value was reduced to 1/35 of an ounce of gold.
By any fair definition, this was another default. Creditors both domestic and foreign had lent dollars weighing just what the Founders had said they should weigh. They expected to be repaid in identical money.
Language to this effect — a “gold clause” — was standard in debt contracts of the time, including instruments binding the Treasury. But Congress resolved to abrogate those contracts, and in 1935 the Supreme Court upheld Congress.
The “American default,” as this piece of domestic stimulus was known in foreign parts , provoked condemnation in the City of London. “One of the most egregious defaults in history,” judged the London Financial News. “For repudiation of the gold clause is nothing less than that. The plea that recent developments have created abnormal circumstances is wholly irrelevant. It was precisely against such circumstances that the gold clause was designed to safeguard bondholders.”
The lighter Roosevelt dollar did service until 1971, when President Richard M. Nixon lightened it again. In fact, Nixon allowed it to float. No longer was the value of the greenback defined in law as a particular weight of gold or silver. It became what it looked like: a piece of paper.
Yet the U.S. government continued to find trusting creditors. Since the Nixon default, the public’s holdings of the federal debt have climbed from $303 billion to $11.9 trillion....
They were promised new jobs in Germany — but their hopes have now been quashed. Nearly 130 would-be Spanish workers are stranded in Erfurt after private employment agencies apparently failed to follow through.
When night falls in Erfurt, Diego Lopez has to go into the "hole." That's what the 21-year-old Spaniard calls the cellar of an old school where he and 20 of his countrymen have been sleeping in recent weeks. Bunk beds are crammed next to each other in two small rooms, which smell like sweat and dirty socks, Lopez says. The ventilation system doesn't work properly, and they all have to share a single shower, he adds.
But unlike their last accommodations, at least the heat works and they don't have to sleep on the floor. Furthermore, Lopez can still afford to stay here. A night in the "hole" costs €3.50 ($4.74).
A trained geriatric nurse, he is one of 128 Spaniards who have been stranded in Erfurt after being promised jobs that didn't come through. Full of hope, they struck out for Germany two weeks ago to take part in a program that the Federal Employment Agency calls "The job of my life." The new initiative promises young people from ailing southern European countries either dual vocational training or employment as a skilled worker, along with language courses and lodging — all subsidized by the German state. And it was this program that two private job placement agencies used to lure the Spaniards to the eastern German state of Thuringia.
Their dream jobs never materialized, though. "They deceived us shamelessly," Lopez says. He's talking about Kerstin S. and Sven K., the heads of the agencies X-Job and Sphinx Consulting. "Sven told me that I would earn €818 per month and live in a four-bedroom shared apartment," he says.
Instead of a work contract at an Altenburg care facility and a flat share, however, he was placed in a grim building with no running water. The companies put other fellow jobseekers in unheated barracks in an industrial part of town. Some program participants report having to spend the night in cars. Meanwhile, they haven't seen a cent of the funding they were promised.
But far worse for the Spanish jobseekers was finding out that there weren't jobs waiting for them after all. Hardly any of them received the job contracts they were promised, and often the companies had been given hardly any information about the newcomers at all. The applicants, companies and politicians all agree: Both placement agencies failed.
"Fundamental due diligence was obviously violated," says Matthias Machning, Thuringia's economy minister. Machning, of the center-left Social Democratic Party, is alarmed: Spanish journalists are coming to Erfurt by the dozen to report on their fellow countrymen. "Germany is not paradise," the radio station Cardena Ser called one of its segments. On Wednesday, Machning convened an initial crisis summit with representatives of the region's business community and the Spanish Embassy. "This is about the image of Thuringia and of Germany," said the politician.
"These agents overreached hopelessly," says Dirk Ellinger, head of the German Hotel and Restaurant Association (Dehoga) in Thuringia. "They didn't even manage to produce accurate name lists of the program participants." Kerstin S. set out to place 70 Spanish trainees with restaurants, hotels and large-scale culinary companies. For a nominal premium of €250 the agent pledged a comprehensive, worry-free package: from the pre-selection of qualified candidates, to the organization of German classes, to accommodation in Thuringia.
But Kirsten S. repeatedly botched appointments with the businesses, missed deadlines and made false claims, says Ellinger. "And then when the first Spanish person arrived, she sent me an email asking how quickly I could draw up an internship contract" — ostensibly to enable her to apply for the government subsidies of several hundred euros per month held out as a prospect to the "Job of my life" participants....
Everyone has some idea of what the Kremlin is. The red stars and the ring of Gothic-looking walls and towers have represented Russia and its government so many times that they are like a trademark.
Today, it is the flag of the Russian Federation that flutters from a handsome cupola inside the walls; the implication is that Putin's Russia is as mighty and immutable as any historic empire. But that is not the only message written in the stone and brick. The secret is to look behind the dazzling facades.
In the eight centuries of its existence, the Kremlin has been used to symbolise everything from Soviet dictatorship and proletarian revolution to imperial tsarism and even an inscrutable theocracy. The palaces are opulent, but there is menace here, as well as power. In 1839, a celebrated French traveller called the Marquis de Custine described the fortress as a "satanic monument", "a habitation that would suit some of the personages of the Apocalypse". "Like the bones of certain gigantic animals," he concluded, "the Kremlin proves to us the history of a world of which we might doubt until after seeing the remains."
But there is far more to the Kremlin than a pile of ancient bones. Its timelessness is the result of careful image-management. Parts of the citadel are truly old, including its most sacred building, the Cathedral of the Dormition whose structure was completed in 1479. The paved square around this is the focus of most guided tours, and it includes two other cathedrals, a 16th-century belltower and a palace that looks like a giant jewel-box.
If you stand here for long enough, you might imagine golden-robed boyars, but the present setting would have been entirely alien to them. Today's Kremlin is Stalin's creation, an expurgated version of a mid-19th-century complex that was in turn unrecognisably transformed after Napoleon abandoned it in 1812. And there had been innumerable programmes of rebuilding before that. The Kremlin may well be a perfect symbol of the Russian past, but what it embodies is not some romance of eternity, but disinformation, upheaval and loss.
Founded in the 12th century, the fortress started life as a collection of timber palaces and churches on a hill between two riverbanks. Its main defence back then was not its ugly, clay-smeared wooden walls but its remote location in the heart of dense and uninviting virgin forest.
The place came close to ruin many times. But Moscow's princes always managed to survive, they kept their Mongol overlords on side, and their victories over neighbours, cousins and overmighty courtiers were rewarded with a steady flow of cash and manpower. By the time the Mongol empire started to unravel in the 15th century, Moscow's citadel was home to the region's dominant military power.
The Kremlin of the guidebooks dates from this moment. It was built on the orders of Ivan III, a prince whose calculating use of sovereignty exceeded even 15th-century European standards. When he turned his mind to a new fortress, Ivan did not rely on the skills of local men. The future symbol of Russian statehood was designed by Italian contemporaries of Leonardo da Vinci, including a Milanese straight from the Sforza court and an architect from Bologna who doubled as cannon-founder, mint-master and all-purpose magician....
Gold took quite a beating in September, bucking its seasonal average monthly return of 2.3 percent. The political battle between President Barack Obama and Congress, China’s Golden Week, and India’s gold import restrictions likely weighed on the metal.
September’s correction only adds to the negative sentiment toward the precious metal. The assumption from many market pundits is that gold is no longer attractive as an investment. With rising rates and continuing low inflation, U.S. investors believe they have a solid case for selling their holdings.
However, this could be a premature assessment, causing these bears to potentially lose out on a lucrative position.
Allow me to use an ice cube to explain.
One of the strongest drivers of the Fear Trade is real interest rates. Whenever a country has negative-to-low real rates of return, which means the inflationary rate (CPI) is greater than the current interest rate, gold tends to rise in that country’s currency.
Our model tells us that the tipping point for gold is when real interest rates go above the 2-percent mark.
Consider the ice cube, which shows how new equilibriums can have significant effects. At 31 degrees, H2O is a solid chunk, but when the temperature increases, the mass slowly begins to turn into a liquid. Above 32 degrees, ice changes form from solid to liquid, but it’s still made of hydrogen and oxygen.
Because money is like water, when many other economic dynamics, such as population growth, urbanization rates and changes in government policies, reach their tipping point, the velocity of money tends to be altered.
As global investors, we watch for changes in these trends to know how to invest in commodities and markets, find new opportunities and adjust for risk.
So, how close to gold’s tipping point are we? In other words, what is the real interest rate today? As you can see below, Treasury investors continue to lose money, as the 5-year bill yields 1.41 percent and inflation sits at 1.5 percent. This is nowhere near the 2 percent mark.
I would be worried about gold if real interest rates solidly crossed the 2 percent threshold for an extended amount of time, because it would have a dramatic effect on gold as an asset class. In a high interest rate environment, gold and silver lose their attraction as a store of value.
In order for that tipping point to happen, rates would need to continue rising above inflation, and inflation would need to remain low. These are the forecasts made by many gold sellers today; however I wouldn’t get too trigger happy just yet, as recent data challenges these assumptions...
Then there’s the suggestion of inflation manipulation. Even though the U.S. has been reporting a low inflation number, things feel more expensive to many Americans. Disposable income has been growing less than inflation in recent years; perhaps that’s why many people feel “squeezed.”
Also consider Williams’ chart below. It shows monthly inflation data going back for more than a century. The blue and grey shaded areas represent BLS’ historical Consumer Price Index (CPI). You can clearly see the wild swings of inflation and deflation, especially during World War I, the Great Depression, and World War II, as well as the stagflation of the 1970s and early 1980s.
Source: US Global Investors
However, shortly after disco, bell bottoms, and episodes of “All in the Family” faded from memory, the U.S. adjusted CPI, not once but twice, first in the early 1980s and again in the mid-1990s. If you use the pre-1982 calculation, you end up with a much different inflation picture. This is the area shaded in red....
(Hohhot) — "Your honor, I wish to report on somebody," Du Wen said loudly.
One day at the end of 2011 during his trial in the Intermediate People's Court in Hohhot, Inner Mongolia, defendant Du suddenly proclaimed he had something to announce to the court and requested an audience with leadership of the autonomous region in northern China. The presiding judge granted the request and called a recess.
The person Du denounced was Wu Zhizhong, vice secretary of the region's government and director of the Inner Mongolia's Office of Legislative Affairs. On May 4, 2010, Wu had placed a call to the criminal investigation department of the region's public security bureau reporting Du for illegally possessing firearms. That call led to Du's arrest.
Wu and Du were once as close as father and son, but now the two both find themselves in prison.
On September 16, trial proceedings began in the Hohhot Intermediate People's Court for Wu and his wife, Yu Huilong, on suspicion of corruption, accepting bribes, embezzling public funds, holding large sums of money from unidentified sources and concealing foreign bank accounts from officials.
Wu was charged with corruption involving over 10.66 million yuan, taking over 5.45 million yuan in bribes, and embezzling 34.2 million yuan. The indictment also said that Wu was unable to prove the origins of over 28.17 million yuan, HK $19,757 and US$ 1.15 million in his possession. He is also accused of concealing CA $1.77 million and US $5.1 million in overseas accounts.
Wu, an ethnic Mongolian and native of Baotou, turns 62 this year. A veteran of the Inner Mongolia court system, he has served as head of the Baotou Intermediate People's Court and associate director of the Inner Mongolia Supreme People's Court's standing committee, in addition to other positions. He has long been considered a big shot in Inner Mongolian legal circles.
More recently he served as vice secretary and director of the Office of Legislative Affairs of the Inner Mongolia government.
Du, a native of Chifeng, Inner Mongolia, is 34 years old. He served in the military in the late 1990s, until he discovered a passion for the law and began studying to become an attorney. Around 2000, Du left the military and began practicing law.
Du met Wu through his law practice in Chifeng and quickly became his right-hand man.
Sources said that despite the age difference, Du and Wu formed a close relationship. Du carried out Wu's orders, and Wu was good to him. At one point Wu tried to find Du a position in the Office of Legislative Affairs as a government functionary, but his idea was shot down.
In March 2006, Wu and Du set up the Inner Mongolia Dianzhang Law and Sociology Research Institute under the name of Wu's daughter-in-law, Ao Youna. Ao fronted 51 million yuan, Du contributed 49 million and served as legal representative.
The region's Office of Legislative Affairs presided over the decision to allow the institute to be established as a private nonprofit organization under its umbrella. In August 2010 Wu was appointed chairman of the institute's board.
The consultancy soon began managing legal affairs for the Inner Mongolia government.
In March 2008, a parcel of land in Shenzhen owned by the Inner Mongolia government was, by order of a local court, to be sold to a Shenzhen company to repay a 6 million yuan debt.
A vice chairman of the Inner Mongolia government convened a meeting with members of the government's General Office and Wu to discuss countermeasures. After the meeting, Wu took Du and others to Guangzhou to handle the situation.
Even though the Inner Mongolia government claimed ownership of the land, the lease was in the name of a private company.
Wu and Du obtained support from Inner Mongolian courts and the Shenzhen Bureau of State Land Resources and Housing. After detailed planning, the Inner Mongolia Supreme People's Court quickly approved a case to have the land sequestrated and the matter adjudicated. The Shenzhen Bureau of State Land Resources and Housing quickly processed the ownership transfer procedures to endorse the regional government as the owner.
The work in the land case gave rise to a considerable amount of bribes and kickbacks. It was these expenses that opened the rift between Wu and Du.
Prosecutors say that in November 2008, Wu filed a report on the Shenzhen land case with the Inner Mongolia leadership, requesting 22 million yuan in fees to be paid to Du's legal consultancy. On November 24, 2008, the region's Department of Finance paid 22 million yuan in "special case-handling fees" to Wu's institute.
The money was designated as compensation for the parcel of land in Shenzhen. Wu earmarked about 6.1 million yuan of that sum to Du to be paid to grease the palms of relevant people in Shenzhen. However, Wu soon became suspicious that Du had stolen a large part of the sum. Du denied having stolen any public funds meant to be "given as gifts," but was nevertheless unable to explain where 4 million yuan of the fees had gone....
As discussed previously ... US commercial banks have been scaling back on their loan portfolio growth. Banks have been even more aggressive however in reducing growth of their securities holdings. The year-over-year growth is at the lowest level since the financial crisis. The reasons vary. In some cases it was simply about trimming treasuries and MBS holdings as rates rose sharply this summer. In other cases, such as with corporate bonds, it is due to the various regulatory pressures, e.g. the Volcker Rule.
And while banks are cutting their securities inventory, the Fed keeps buying. Recently the Fed' holdings of securities (mostly treasuries and MBS) materially exceeded that of all US banks combined. Prior to the financial crisis banks owned 2.5 times the amount of securities held by the Fed. The chart below puts it in perspective. Before the securities buying program is over however, the differential is expected to widen even further....
Gold Versus The Debt Ceiling
Presented without comment ... except to say thanks to my buddy Nick Laird of www.sharelynx.com for yet another fantastic illustration of the madness.
Everyone the U.S. government owes money to, in one graph, broken down by category and by how much government debt they hold — courtesy of my buddy Barry Ritholtz at The Big Picture.
Source: NPR/The Big Picture
Paul Singer of Elliot Management is absolutely one of the smartest minds in finance, and it's always enlightening to hear him speak. In this great interview with the WSJ's Gerald Baker, Paul discusses why the Fed should just admit that they've done enough, and he takes us inside the meeting at which the term taper was coined... great stuff.
Regular readers know that in my opinion, Bill Fleckenstein is one of the best market observers around, and his level-headed approach to sometimes utterly perplexing markets is a real breath of fresh air. This week he discusses those markets, along with the Fed and gold, with Eric King.
Rounding out the financial titans for this week is another of the true greats, Ray Dalio of Bridgewater Associates.
This 30-minute video is a fantastic primer on the economy that will appeal to everyone. Watch it yourself and forward the link to anybody who understands (or, more importantly, doesn't) what makes the world tick.
Meet Johnny T. Johnny has a few friendly and helpful pieces of advice for anyone visiting New York City.
If you've been, you'll get it. If you've lived there, you'll love it.
If you haven't? Go! ... but get outta the way.
Grant Williams is the portfolio manager of the Vulpes Precious Metals Fund and strategy advisor to Vulpes Investment Management in Singapore — a hedge fund running over $280 million of largely partners’ capital across multiple strategies.
The high level of capital committed by the Vulpes partners ensures the strongest possible alignment between the firm and its investors.
Grant has 28 years of experience in finance on the Asian, Australian, European, and US markets and has held senior positions at several international investment houses.
Grant has been writing Things That Make You Go Hmmm... since 2009.
As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time to time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm... may reflect the positioning of one or all of the Vulpes funds—though I will not be making any specific recommendations in this publication.
A walk around the fringes of finance
THINGS THAT MAKE YOU GO
By Grant Williams
14 OCTOBER 2013
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