Things That Make You Go Hmmm...

What If?

July 15, 2013

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What If?

"Every step that you take

Could be your biggest mistake

It could bend or it could break

But that's the risk that you take."




"Two questions form the foundation of all novels: 'What if?' and 'What next?'... Every novel begins with the speculative question, What if 'X' happened? That's how you start."



"There are known knowns: there are things we know that we know.

There are known unknowns; that is to say, there are things that we now know we don't know.

But there are also unknown unknowns — there are things we do not know we don't know."

"You see, the what ifs are as boundless as the stars."


THINGS THAT MAKE YOU GO HMMM... ....................................................3

Constitutional Crisis Pushes Portugal Closer to the Brink .......................................23

Italy's Baretta Says Budget Crunch May Require More from Rich ..............................24

"A Toxic System": Why Austerity Still Isn't Working in Greece ..................................25

France Loses Top Credit Rating as Fitch Cites Lack of Growth .................................28

The Sochi Olympics: Castles in the Sand ...........................................................29

US "Disappointed" with China for Letting Edward Snowden Leave Hong Kong ...............31

China Exports Slide Raises Doubts About Currency Policy .......................................32

When the Cracks Appeared ..........................................................................33

More on the German Gold Situation ................................................................35

We Can't Wave Goodbye to the Euro Crisis Just Yet ..............................................36

CHARTS THAT MAKE YOU GO HMMM... ..................................................38

The Fed's Bind: Tapering, Timetables and Turmoil ...............................................40

WORDS THAT MAKE YOU GO HMMM... ..................................................42

AND FINALLY ................................................................................43

Things That Make You Go Hmmm...

A few weeks ago, I put a chart with which I am acutely familiar up on my Bloomberg. It is a chart I have studied every single day for over a decade, so by now I know pretty much every dip, every rally, and every sideways channel that makes up this particular pattern.

I remember where I was when the big moves took place, and I recall with great clarity my varying degrees of comprehension and incredulity over every meaningful change in direction.

I have lived every Golden Cross and died every Death Cross, cheered every bottoming pattern, and despaired each time the chart patterns signaled a breakdown in an upward trend; but above all, I have continued to remorselessly reassess my view of the investment case for this particular instrument, looking for signs — not evident in the charts — that would suggest it had run its course.


As I stared at the chart again, almost absentmindedly, I put two vertical lines on it, one representing August 17, 2011, and one that marked January 14, 2013; and suddenly, a concept that had been gnawing away at me for a while crystallized in my mind as those two lines pulled in a whole bunch of known knowns, known unknowns, and even a couple of unknown unknowns. It was a truly Rumsfeldian moment.

By now, there is no doubt a distinct three-way split amongst those who have made it all the way to the third paragraph of this week's TTMYGH. There are some new readers who are wondering what asset the chart reflected, as well as many who are already rolling their eyes and muttering to themselves "Really? Gold? AGAIN?" — and finally there are the overwhelming majority who have already scrolled to the "...and finally" page, chuckled at the cartoon, and moved on to more edifying fare.

Yes, it's one of those weeks when I must ask your indulgence while I ramble on about a subject close to my heart that has recently been a source of great frustration. And yes, it's gold — particularly, the bizarre price action of the last six months, which has run counter to most logical assumptions, given the various macro factors bringing influence to bear on the yellow metal.

Cyprus should have been a hugely positive tailwind for gold. But it wasn't. The ongoing money printing should have provided support for gold. But it hasn't. The talk of tapering should have had a minor but noticeable effect on gold, given its healthy recent correction. But it didn't. Sustained data suggesting a voracious appetite for the physical metal not only in Asia but in Western countries, too, should have led to a bounce on the COMEX. But it hasn't.

The whole thing is as baffling as Kim Kardashian's fame.

But let's get back to that chart and those two lines — here it is and there they are.


Source: Bloomberg

You're going to hear about this chart a few more times before we're done today, so take a good long look at it.

The first vertical line, labeled August 17, 2011, marks the day that Hugo Chavez, then president of Venezuela, demanded the repatriation of the 99 tons of gold (worth $13 billion at the time) that was being held at the Bank of England on behalf of his country. That was roughly half the gold held overseas by Venezuela and about 27% of its total holdings, which amounted to 365 tons:

(Bloomberg): "We've held 99 tons of gold at the Bank of England since 1980. I agree with bringing that home," Chavez said today on state television. "It's a healthy decision."

Chavez, who has said he wants to eliminate the "dictatorship" of the U.S. dollar, has called on Venezuela's central bank to diversify its $28.7 billion in reserves away from U.S. institutions. Some cash reserves, which total $6.3 billion, will be shifted into currencies from emerging markets including China, Russia, Brazil and India, central bank President Nelson Merentes said today at a news conference.

Earlier today Chavez said he plans to take control of the country's gold industry to halt illegal mining and boost reserves.

The government is preparing a decree to stop illegal miners exploiting deposits of gold and coltan, an ore containing tantalum, used in mobile phones and video-game consoles, he said....

Venezuela's 365.8 metric tons of gold reserves makes it the 15th-largest holder of the precious metal in the world, according to an August report from the World Gold Council. Venezuela's gold holdings accounted for about 61 percent of the nation's international reserves, according to the report.

The Bloomberg article concluded with the following paragraph:

Gold futures for December delivery rose $8.80, or 0.5 percent, to $1,793.80 an ounce on the Comex in New York. Prices touched a record $1,817.60 on Aug. 11.

If we now take a look at a close-up chart of the gold price around the time of Chavez's announcement, something very interesting emerges.


Source: Bloomberg

As you can see, the immediate reaction to the commencement of the global game of central bank musical chairs was perfectly understandable and completely explicable: the price soared (to a new all-time high, no less). After all, that's what generally happens when somebody says "I want a large amount of a reasonably scarce commodity and I want it now" — or at least that's what generally happens if said commodity needs to be bought in the open marketplace.


In this case, essentially all that happened was that a stocky man in one country asked if a group of no doubt bespectacled men wearing white coats in another country would kindly return to him something they had been looking after for the last 19 years.

That something had been fully segregated and held in custody on the off chance that the stocky man might want to sell some of it to raise cash — or just for safekeeping, in case he were to be visited in the night by a random group of tall, thin men with a collective penchant for berets, facial hair, and cigarillos who seemed largely disinclined toward him.

And so, after the initial reaction that took gold to its new all-time high and through the $1900 barrier, the price began to fall. Fast.

Within 17 trading days the price had fallen 16%, bottoming at $1608 on September 28. During that time, nothing much happened in the world — unless you count the Arab Spring and the Libyan civil war, Moody's downgrading of Japan to Aa3 and the resignation of the Noda cabinet, Ben Bernanke's promising more QE at Jackson Hole, Hurricane Irene hitting New York City, the SNB's pledging to print unlimited Swiss francs in order to defend a peg to the euro at 1.20, or the beginning of the "Occupy" movement — so it was hardly surprising that the price would fall.

In one way, the gold market's reaction to the stocky man's request was surprising, but in another way it was understandable — it all depended on the underlying reality of the situation.

Reality 1:

The stocky man's gold was sitting in a cage beneath the Bank of England, untouched and untarnished, exactly where it had been left 19 years earlier.

In this event, the stocky man's request was hardly worthy even of a news headline; and even if, in their desperate need for constant tantalizing fodder, the 24-hour news channels felt compelled to report on it, it's hard to see past something mundane like:

"Stocky South American Man Decides to Move Something He Owns from One Place to Somewhere Else"

Hardly compelling.

OK, so the tabloids might have opted for something a little more ... creative, like:

"Hugo and Get My Gold!" or

"Venez-Wailer! Caracas Crackpot Brings Back Bullion" or even

"Victor Hugo! Chavez Gives BoE the Hump" (Hey, this is fun!)

... but it's difficult to understand how, in practical terms, the news should have elicited any measurable response in the price at all, unless...

Reality 2:

The stocky man's gold had been lent out many times over to bullion banks in order to generate a small return on an otherwise unproductive asset; and in order to deliver it to him as requested, its custodians would have to terminate leases, obligating the lessees to go into the market and buy it back in order to be able to deliver it.

Now if THAT were the case, the normal forces that used to apply to what were once referred to as "free markets"¹ (a quaint concept that dates back to the 20th century) would have dictated that the price would leap higher as those lessees chased a commodity in restricted supply amidst ravenous demand.

But no. That's not what happened. That's not what happened at all.

After the post-Chavez tumble, gold traded largely sideways (as can clearly be seen in the shaded blue "channel"), looking for all the world as though it were forming a base. But then came line #2:


Source: Bloomberg

¹ (Wikipedia): A free market is a market structure in which the distribution and costs of goods and services, along with the structure and hierarchy between capital and consumer goods, are coordinated by supply and demand unhindered by external regulation or control by government or monopolies. A free market contrasts with a controlled market or regulated market, in which government policy intervenes in the setting of prices.

Now, earlier this year I gave a presentation entitled "Risk: It's Not Just A Board Game", in which I laid out the mechanics of fractional reserve banking as they apply to gold and highlighted a trail of breadcrumbs that led those willing to follow it into a weird and wonderful forest where central banks lend out their gold to bullion banks who then sell it to fund lucrative carry trades of one sort or another whilst simultaneously helping keep a lid on the price of gold.

(If you haven't watched it and have 20 minutes to spare, may I suggest you pause your reading, click on the link above, and watch the video between the 14:28 and 33:50 marks? It lays out visually a lot of the ingredients for today's jambalaya.)

In this twilight world of gold manipulation, the central banks and bullion banks prosper and everyone else scurries around trying not to get stepped on.

The problem with this little arrangement is that, in a world where central bank ZIRP has sent trillions of dollars in search of any return greater than zero, trades that offer pretty certain payback profiles, such as this one, get extremely crowded, and people tend not to want to flee from the forest one at a time but rather all at once when the weather shifts.

Line #2 marked a major shift in the weather, it turns out.

January 14, 2013, was "The Day That Will Live In Give-It-To-Me", as the Bundesbank announced that it wanted its 300 tons of gold returned from the custody of the Federal Reserve Bank of New York to the far more comforting environs of the Bundesbank vault in Frankfurt. (If you'd like to see a short video of gold already sitting in that vault, the Bundesbank has very kindly put one, complete with heavy doors, big keys, metal cages, and creaking doors leading to shelves stacked with bullion, here).

Another close-up, this time of the price action of the metal in the aftermath of the Bundesbank's decision, throws up yet more confusion if we apply the two possible realities surrounding the original Chavez request:


Source: Bloomberg

Once again, an initial move higher quickly morphed into a concerted move lower; and this time, with the quantity of gold required to be delivered to satisfy the Bundesbank three times greater that demanded by Chavez, the downward move in the price was correspondingly greater — to a degree that has caused consternation amongst gold watchers all around the world.

Oh, by the way, it's probably nothing and hardly worth mentioning, really, but that 300 tons of gold demanded by the Bundesbank will, it seems, all be delivered safe and sound to Germany ... in seven years:

(Bundesbank): By 2020, the Bundesbank intends to store half of Germany's gold reserves in its own vaults in Germany. The other half will remain in storage at its partner central banks in New York and London. With this new storage plan, the Bundesbank is focusing on the two primary functions of the gold reserves: to build trust and confidence domestically, and the ability to exchange gold for foreign currencies at gold trading centres abroad within a short space of time.

The following table shows the current and the envisaged future allocation of Germany's gold reserves across the various storage locations:


31 December 2012

31 December 2020

Frankfurt am Main

31 %

50 %

New York

45 %

37 %...


Source: Boeing/

OK ... time for a little math, methinks:

The Bundesbank wants to repatriate 300 tonnes of gold, which is, of course, sitting, untouched, at the Federal Reserve in New York.

That 300 tonnes equates to 300,000 kilograms.

A Boeing 747-400, set up in a standard cargo freighter configuration, has, according to its manufacturer, a maximum payload of 112,630 kg, a range of 5,115 miles (4,445 nautical miles), and a typical cruising speed of 0.845 mach (560 mph).

The distance between New York and Frankfurt is 3,858 miles.

So the German government could charter three 747-400s, send them to New York, load them up with their gold, and still have 37,890 kg of space left, which would allow for the mother of all shopping trips to Woodbury Common Premium Outlets in Harriman, NY, where Angela Merkel could buy enough Ann Taylor outfits to ensure a fresh one for every EU crisis meeting between now and 2016 ... okay, 2015.

By way of additional perspective, between takeoff and landing, if those on board wanted to watch the entire Lord of the Rings trilogy (theatrical versions, minus the credits, NOT the extended versions), they would be forced to circle Frankfurt airport for fifteen minutes before touching down.

But ... seven years.



Now, I'm aware that there is a maximum amount of gold which is insurable in any one shipment (though I don't know exactly what that amount is), but if we go to extremes and assume it's as little as a single tonne (1,000 kg), that would mean flying our three 747-400s a total of 300 times; and with each plane flying once per day, that would take 100 days.

But not seven years.


And so, with all that in mind, let's jump aboard the good ship Hypothetical and play a little "What If?"

1: What if central banks don't lease their gold reserves out; and, in fact, all the gold they own is stored exactly where they say it is, in the exact quantities accounted for on their balance sheets?

Well, if that were the case, I think it's safe to say that we could probably make a few fairly basic assumptions, including the following:

A) The line items in central bank balance sheets that accounted for bullion reserves would all simply say "Gold" (as they do at the Bank of Japan and the IMF).

B) Central bankers would not make speeches that refer to gold leasing operations.

C) It would be impossible for any European central bank to make a €300mn profit over a 10-year period by leasing out its gold.

D) Any gold repatriation requests would be fulfilled as immediately as practicable.

So, those are a few of the assumptions associated with "What If #1", but how do they look in the cold light of day? Let's step through them again.

A) As far as their balance-sheet line items go, the world's major central banks differ to an extent:

The Federal Reserve lists its gold holdings as:
"Gold (including gold deposits and, if appropriate, gold swapped)"

The Bank of England has what's left of theirs as:
"Gold (including gold swapped or on loan)"

The ECB opts for:
"Gold (including gold deposits and gold swapped)"

And the SNB goes with:
"Gold holdings and claims from gold transactions"

B) In July of 1998, then-Fed Chaiman Alan Greenspan famously said the following before a Senate Committee:

"Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise."

But a far-less-publicized comment was made, again by Greenspan, at an FOMC meeting in 1993:

"I have one other issue I'd like to throw on the table. I hesitate to do it, but let me tell you some of the issues that are involved here. If we are dealing with psychology, then the thermometers one uses to measure it have an effect. I was raising the question on the side with Governor Mullins of what would happen if the Treasury sold a little gold in this market. There's an interesting question here because if the gold price broke in that context, the thermometer would not be just a measuring tool. It would basically affect the underlying psychology."

Alan! I'm surprised at you. Ayn would not be happy to hear you talk like that.

C) In November of 2012, the Austrian Central Bank governor held a press conference:

(BullionStreet): Austria announced earning a whopping 300,000,000 euros through leasing its 280 tons of gold in the last ten years.

Replying to questions in the country's parliament, Austrian central bank, National bank (OeNB) governor Wolfgang Duchatczek said 224.4 tonnes (around 80%) of Austrian gold reserves were in the United Kingdom, around 6.9 tonnes (around 3%) are in Switzerland and around 48.7 tonnes (around 17%) are in Austria itself.

The OeNB said that the reason to store gold abroad was that because in a time of crisis it could be speedily traded. Since 2007 Austria's National bank had had a constant reserve of around 280 tons of gold.

Through leasing of its gold the Austrian National Bank has in the last 10 years earned around 300,000,000 euros.

D) Seven years. S-E-V-E-N ... Y-E-A-R-S.

Which brings us to What If #2:

2: What if the gold in the central banks vaults has been rehypothecated and is no longer held in quantities even approaching those advertised? What would happen then?

Well, if that were the case, there might be a great need for this or that central bank to buy a lot of gold in a hurry, and in such dire straits that the bank(s) would at least want the price not to take the inevitable path higher that would normally accompany such a set of circumstances. If there were some way to make it actually go down in the face of such demand, well, that would be amazing, not to mention remunerative — but surely that's impossible, right?


Apart from peculiar moves in the gold price, there have been some absolutely extraordinary developments regarding the world's biggest stockpiles of physical gold.

First up, the COMEX warehouses.

Metal stored in the various COMEX warehouses is split into two designations: "eligible" and "registered". The difference between them is crucial:

(COMEX 101): Eligible [metal] that has been purchased (and paid for) by a long at some point in the past (that they are currently paying storage fees for) and is eligible for delivery at any point that the client wants. It has been assigned to the clients, who have the serial numbers of their bars.

Registered [metal] that is sitting in the COMEX warehouse and can be used to settle a contract. Apparently, shorts can buy this [metal] from bullion banks at the current price and use it to settle the contract.

If holders of metal in the warehouses want to take delivery of their gold, it is first designated as "eligible". This is essentially a "hands off" notice, so that the metal won't be used to meet other deliveries. Once designated as such, it can be delivered to the owners at their instruction.

The COMEX and the LBMA (London Bullion Market Association) hold two of the world's three largest stockpiles of gold, with the third being the aggregated totals of the various ETFs (the largest of which, GLD, stores its gold at HSBC's vault in London in what are called LBMA Good Delivery Bars, each one weighing 400 oz. and conforming to various standards of purity, etc.).

OK, so far, so good. Now we need to venture a little deeper into the twilight forest, folks. So stay with me, no stragglers, and those of you at the sides and rear of the group might want to fashion these sheets of tinfoil into some sort of headgear.

It all began, bizarrely enough, on April Fool's Day, with a letter from ABN Amro, a Dutch state-owned bank:


Source: Silver Doctors

The letter was translated by, amongst others, the Silver Doctors:


Source: Silver Doctors

Paraphrasing, ABN declared that any holders of physical gold that had custodied their metal with the Dutch bank would, henceforth, be cash-settled and could not request physical delivery of their gold (or silver — TTMYGH is very definitely an inclusive publication).

There's a word for that where I come from: confiscation.

Next up were rumours of wider metal shortages at the LBMA (the London Bullion Market Association, where ABN transacted) which were highlighted by Andrew Maguire in an interview with King World News:

... over the years, basically what you would do is you would sell gold, sell silver, financed almost for nothing, take that money and invest it. Then, obviously incentive was there because it had built up to such a large (short) position, they were so over-collateralized, that it was important to defend the price (of gold and silver) from rising because they didn't actually have the physical.

What's happened now is they are in a position where that leased gold is being asked for, and they don't have it. I know of a very large client who actually turned up for his bullion, was refused his bullion, and told he would be settled in cash. I felt I should go public with that (on KWN).

I must say I had some really distressed emails. What they were asking is, "What should I do?" All I could say to them is, "If I had physical stored in any bullion bank related warehouse, whether it be COMEX or LBMA, I would remove it right now."

We all know that default will not be called a default. It will be settled with cash. I do not believe for a minute that the Fed can't print a few billion (dollars), whatever it costs, to bail out the bullion banks for cash. Why wouldn't they just bail them out with cash? It's just an electronic keystroke. People will be sitting on the sidelines and they will not get any physical [gold]....

[ABN AMRO] really was the tip of the iceberg. What happened was that we saw that first bullion bank create the first visible default of the LBMA fractional reserve system ...

Not good. Not good at all. But coincidentally (of course), the bars at the LBMA which were supposedly in dangerously short supply are the exact same type of bars that sit in the vault of HSBC London on behalf of the GLD ETF.

More on that later.

OK... so now we have the set-up. Regular readers will remember the massive takedown in gold that we saw in April. For any new readers, I wrote about it HERE, so I won't go over it again today. Instead, let's take a look at some of the other bizarre action I mentioned, and that will require a trip to the warehouses and the assistance of the great Nick Laird of, who is the single best resource for precious metals charts anywhere on the web. Nick has very kindly allowed me (and by extension you, dear reader) access to his work this week, so if you click on the source links beneath the charts on pg. 17, you will go to his site.

Let's begin our little foray into the warehouses with a look at what has happened to COMEX gold inventories thus far in 2013:


Source: Bloomberg

A steady decline. However, the extent of that fall becomes clearer if we take a step back and look at the COMEX inventory over the last five years, at which point "steady" becomes "precipitous":


Source: Bloomberg

That's the overview, but what does it look like in the individual warehouses? Well, initially it was JPMorgan that was seeing steady outflows (chart, below left), but that has now spread to Brinks (below, right):


Source: Sharelynx (requires registration)

LBMA data isn't available, BUT everybody's favourite chart of the holdings of the various gold ETFs most definitely IS available. Much ink has been spilled over it, but before we dig into that, let's take a look at the chart:


Source: Bloomberg

That's another steep decline, and it has been interpreted as implying a bearish attitude to owning gold via ETF; but in reality, due to the mechanics of the GLD ETF, it is anything but that. All it DOES show is that a lot of gold is leaving the warehouses, yet again. Where it is headed, we don't know.

Oh... did I mention that the bars held on behalf of the GLD ETF at HSBC's vault in London (right next to the LBMA) have the exact same specifications as the bars in short supply over at the LBMA itself? I did? Oh... OK.

Let me attempt to explain the idiosyncracies of the GLD ETF.

Although every ten shares of GLD are supposed to be a proxy for one ounce of gold, in order to exchange your shares for that gold, you have to have what is termed a minimum "basket" size. That is 100,000 shares. These shares are created (and redeemed) by only a limited (but mostly rather familiar) group of "authorized participants":

JPMorgan, Merrill Lynch, Morgan Stanley, Newedge, RBC, Scotia Mocatta, UBS, and Virtu Financial

These authorized participants transfer gold to the trustee (HSBC London) for share creation and receive the shares in return. The redemption process works the same way but in reverse and can only be activated in round "baskets" of 100,000 shares (with a basket currently equating to around $13,000,000 — hardly a retail trade).

It is worth noting that any and all trades on the NYSE consist of a buyer and a seller of paper. Period. Even if a 100,000-share block trades, it is, at that point, still paper.

Things get a little interesting here, so I'm going to turn it back over to Andrew Maguire, who does a fantastic job of explaining some of the peccadilloes of this mechanism:

... there are a number of ways this "allocated" gold backing the shares in the ETF can be diluted/hypothecated in order for the bullion banks to "manage" their physical reserves.

If, as is often the case, there is insufficient allocated inventory available to the bullion bank at the current Comex driven & discounted spot fix price to create the necessary new GLD shares backed by allocated gold, then it is possible for a bullion bank to borrow short these GLD shares from the ETF instead of providing the required Allocated physical to the trustee to meet this obligation, thereby "fly wheeling" this physical demand in order to meet obligations elsewhere, likely at the day's gold fix. This obviously has the effect of manipulating price lower vs. the true immediate supply/demand fundamentals, as no allocated physical metal has to be bought on the open market at that day's fix to meet this new share demand, as should be the case.

This is now the point where transparency evaporates. The AP claims to be short GLD while concurrently claiming to be backing it with an equal size long "UNALLOCATED" spot gold position. However, LBMA unallocated gold accounts are run upon a fractional reserve requirement and leveraged around 100/1, so there is very little need to back this transaction with any real physical at this point; this is left until later.... To unwind this short GLD position, the bullion bank has to ALLOCATE the required amount of unallocated gold and then transfer this gold back to the trustee, thereby receiving back the required # of shares in order to repay the original GLD shares sold short.

(You can read the entire explanation from Andrew HERE.)

So, to recap, we have the following set of facts in place:

    1.Central banks have, over the years, leased out an undetermined amount of their gold.

    2.In January, Germany demanded repatriation of a large amount of gold from the NY Fed.

    3.That repatriation will take an extraordinary (and unexplained) seven years to complete.

    4.The price of paper gold futures contracts has been hit incredibly hard since April.

    5.Physical gold is being withdrawn at a phenomenal pace from multiple custody locations.

    6.Rumours have been rife of shortages at LBMA and COMEX warehouses.

    7.Investors & central banks are buying physical in record amounts.

    8.In the face of massive physical buying, "the gold price" continues to fall.

Given that knowledge, one might assume that, in the rush to perfect ownership of physical gold, certain "interests" that happen not to be in a position to deliver said commodity to large, important, and extremely powerful customers might want to try and "shake the trees" a little to see what drops out.

The trees have been shaken mightily, and it certainly looks as though some weak holders of the GLD shares have delivered bullion into the hands of the authorised participants — but is it enough? I doubt it.

Meanwhile, over at the COMEX, gold is being removed from the warehouses, bound for destinations unknown. We can't tell for certain where it is headed, but I suspect a significant amount is being placed in private storage, out of the grasp of the bullion banks who need it the most.

So what does all this look like if we put it together on one chart? Well, it looks like this:


Source: Bloomberg

As you can clearly see, virtually from the day that Germany demanded to have its gold delivered back to the Bundesbank, three very clear phenomena have occurred:

    1.The gold price, which had been trending sideways, has plummeted.

    2.The physical gold held at the COMEX has been pouring out of the warehouses.

    3.The amount of physical gold held by the ETFs has stopped rising and started falling. Fast.

Coincidence? I very much doubt it.

Wanna know what I think, folks? I think the central banks have been leasing their gold out for decades to the bullion banks and now find themselves in the rather precarious position of needing to reclaim that which they are supposed to own before the shortfall is exposed. I think that creates a big problem for both sides of that little scheme.

I think the smash in paper was specifically designed to shake out loose holders — and it has worked to a degree, but only amongst the weaker holders of the ETFs, who tend to "rent" gold rather than own it. I think the stronger hands have been getting their gold out of the official warehouses as fast as they can; and central banks in places like China, Russia, and all over the rest of Asia and South America have been trying to buy and, crucially, to take delivery of physical gold while they still can.

I also think that retail investors — particularly here in Asia — are, unfortunately, compounding the banks' problems by using the weakness in the paper markets to acquire as much physical metal (or, as it's known in this part of the world, "wealth") as they can.

To paraphrase Everett Dirkson, "A few hundred ounces here, a few hundred ounces there, and pretty soon you're talking real problems."

Now, call me old-fashioned if you will; call me a conspiracy theorist, a goldbug, a wacko — whatever you like — but if you do, will you please give me an explanation as to why this gold is vanishing, where it is going, and who is taking delivery of it? Because, from where I stand, the evidence points to the beginning of the unraveling of the fractional gold lending market, and THAT spells trouble.

There's one last puzzling development that does however fit neatly into the scenario laid out here today, and that is the curious action of something called the GOFO rate. GOFO is the Gold Forward Offered Rate, and it is the rate used for gold vs. dollar swap transactions. If you hold gold and want dollars in a hurry, you can use your metal as collateral, which reduces your rate significantly.


Source: Bloomberg

Ths week, the GOFO rate did something it has only ever done a handful of times in its long history: it went negative out to three months, which means somebody was willing to pay to have gold instead of dollars right now.

The FT takes up the story:

(FT): The cost of borrowing gold has risen to the highest since the post-Lehman Brothers scramble for supplies, as the bullion market adjusts to a new era in which western investor demand is less dominant.

The niche gold lending market, largely the preserve of a few big banks and central banks, has been uneventful in recent years as investors have built up large holdings and lent them out on the market, keeping rates depressed.

But as investors have turned sellers in recent months, availability of gold in the lending market has been squeezed, bankers said.

The squeeze has triggered a sharp rise in gold leasing rates — the implied interest rate for lending gold in the market in exchange for dollars. The one-month gold leasing rate has risen from 0.12 per cent a week ago to 0.3 per cent on Tuesday, the highest since early 2009.

The move reflects the dramatic shift in the gold market over the past few months as investors have liquidated their holdings en masse, triggering a 25 per cent collapse in prices since the start of the year.

Strong buying in Asia has created additional demand for physical gold, with refineries operating at full capacity to meet orders.

The lack of liquidity in the leasing market has pushed gold forward rates, known as "gofo", into negative territory, meaning that gold for future delivery is trading at a discount to physical market prices — a rare situation that has occurred only a few times in the past 20 years. The last time forwards were negative was in November 2008, when a scramble for physical gold spurred a sharp price rally.

The degree to which the underlying structure of the physical gold market has changed over the last few months has yet to make itself apparent; but the first time we get an "event" that makes it necessary for people who don't have gold to buy some, and for people who do own it to have more, we will see how things have changed.

The gold price has been falling heavily for several months, but when the need to own gold jumps again — and it will; this is a long way from over — all the pieces of this jigsaw puzzle of the weird and wonderful forest of gold manipulation that we have dropped onto the table will slot neatly into place.

What if, when that happens, there just isn't enough gold to go around?


OK... even though it was chart-heavy, that was a far longer introduction than usual, for which I apologize. I hope you found it a useful summary.

If you still have the time or the inclination to press on from here, you will find a run-down of all the news in Europe, where Portugal is crumbling again, Italy is about to soak the rich once more, France is finding A's hard to hang onto, and Greece is ... well, still Greece, I'm afraid.

The Sochi Olympics highlight one of Russia's traditional strengths: graft; and the US is peeved at China for allowing a certain Mr. Snowden to leave Hong Kong, but the most populous nation on earth has a few problems of its own to worry about. We investigate the stress in the Chinese interbank market and explain why we may soon see the yuan join the emerging global currency war.

After all that, Lars Schall waxes lyrical on the German gold situation; we look at the staggering decline in building permits amongst the PIGS, the reserves problem facing the Fed, and the similarities between 1994 and today; and we take another, depressing look at the European debt crisis that we were assured had gone away (hint: it hasn't).

Bill Kaye, Art Cashin, and Edward Snowden grace our interviews page; and that, dear reader, is all he wrote.

Until Next Time.


Constitutional crisis pushes Portugal closer to the brink

Portugal's borrowing costs have spiked dramatically after key political parties failed to agree on a national salvation front, raising the risk of a snap election and an anti-austerity revolt.

Yields on 10-year Portuguese bonds jumped more than 100 basis points to 7.85pc in a day of turmoil, kicked off by a government request to delay the next review of the country's EU-IMF Troika bail-out until August.

President Anibal Cavaco Silva set off a constitutional crisis on Thursday when he vetoed a reshuffle by the two conservative coalition parties, insisting on a red-blue national unity government with greater legitimacy to see through austerity cuts until mid-2014.

Socialist leader Antonio José Seguro has so far refused to take part, demanding fresh elections to clear the air. "We must abandon the politics of austerity, and renegotiate the terms of our adjustment programme.

The prime minister must accept that his austerity policies have failed," he said.

Some Socialist leaders have threatened debt repudiation as a way of fighting back at Germany and the creditor powers, though that is not the party position.

Standard & Poor's downgraded Banco Comercial, and placed a string of banks on negative watch. The agency appeared to endorse warnings that austerity overkill was making matters worse, saying continued fiscal cuts "are eroding the resilience of the private sector". It said banks were building up a "high volume of problem assets".

Ricardo Santos from BNP Paribas said it was unclear whether Portugal could withstand a further €5bn of cuts ordered by the Troika. "The bottom line is that the policy is not reducing the debt ratio. We think public debt will reach 130pc of GDP in 2014. The country is near the tipping point," he said.

"Everybody has been saying that Portugal is so different from Greece but if this political crisis goes on for long, that won't be so clear anymore."

President Cavaco Silva has limited powers to force a deal on recalcitrant parties, but experts say it is hard to see how the current government can soldier on after such a blow to its authority. He may have to resort to the "nuclear option" of snap elections, opening the way for a fragmented parliament.

Sovereign bond strategist Nicholas Spiro said the events of the past 10 days had left premier Pedro Passos Coelho a "political cripple", and brought reforms to a "screeching halt". The crisis was prompted by the exit of finance minister Vitor Gaspar, the chief architect of Portugal's crisis strategy, who stormed out complaining that he had been undercut by the junior CDS party in the coalition.

"Gaspar did make strenuous efforts to curb the budget deficit, but Portugal's debt ratio kept on rising. There has to be a risk of another macroeconomic calamity on the scale of Greece and Cyprus," said Tim Congdon from International Monetary Research.

Portugal has until now been held up as a poster-child of EMU austerity, praised for sticking to its bail-out terms. Failure at this stage would be a grave indictment of EU strategy itself. It would also force the eurozone to clarify its own crisis policies, exposing deep rifts. Europe's leaders have vowed never again to force a sovereign debt haircut on banks and pension funds, deeming the experiment in Greece to have been calamitous.

This means they may have to violate the pledge or impose losses on their own taxpayers for the first time if Portugal needs debt relief.

A study by Eric Dor from IESEG business school in Lille says an orderly debt restructuring by Portugal would cost taxpayers €16bn in Germany, €13bn in France, €11bn in Italy and €7bn in Spain, and twice as much in an EMU exit crisis. "There is a big probability that Portugal will need debt relief, unless you believe in fairytales," he said....

*** Ambrose Evans-Pritchard / link

Italy's Baretta Says Budget Crunch May Require More From Rich

Italian Finance Undersecretary Pier Paolo Baretta said the government is considering shifting the tax burden to the wealthy in order to satisfy demands for broad-based fiscal easing and meet its 2013 deficit target.

"The truth is we've got a real bottleneck of issues to deal with" this year, Baretta said yesterday in an interview in his office in Rome. In order to raise funds, Italy is seeking spending cuts and may limit the tax deductions higher-income households take on medical visits and other expenses, he said.

Prime Minister Enrico Letta is bracing for a tax-policy showdown that threatens to destabilize his two-month-old parliamentary coalition. Lawmakers in Letta's alliance have demanded tax cuts and spending measures that, taken together, total more than 7 billion euros ($9 billion). That's more than Italy can afford as its recession deepens, Baretta said.

"The financial wherewithal for 2013 is less than the sum of all these issues," Baretta said.

Extra resources won't come from new taxes or increased rates, after the government introduced a levy on electronic cigarettes last month, Baretta said. Instead, Letta is focusing on spending cuts and curbs to personal tax deductions and incentives for companies, Baretta said. Deductions amount to about 250 billion euros a year, he said.

Deductions on medical expenses like the purchase of eyeglasses or trips to the veterinarian could be maintained for lower income families, while being canceled or scaled back for wealthier Italians, Baretta said. The government could evaluate curbs to other incentives, such as those for mortgages, he said.

"We have to take a series of measures tied to income, or qualitative factors," Baretta said. "There is room, obviously to distinguish between a pensioner with minimal income who has to get new glasses that cost him a month's pension, if not more, and those people with a medium to medium-high income."

Letta, 46, is squeezed between his allies' calls for stimulus and his commitment to European Union allies to bring the budget deficit below 3 percent of gross domestic product.

Baretta, a member of Letta's Democratic Party who serves under Finance Minister Fabrizio Saccomanni, is helping identify options for savings and additional revenue. The final decisions will be made by Letta's Cabinet in September or October.

Silvio Berlusconi, the three-time premier and a partner in Letta's coalition, has pushed for the abolition of property taxes on primary residences, which would cost the state about 4 billion euros annually. Other members of the coalition have called for the cancellation of an increase to the value-added tax planned for Oct. 1. Postponing the VAT increase by three months would cost the government about 1 billion euros.

Requests to modify a waste-management tax would cost about 1 billion euros and boosting unemployment funds would take as much as 1.5 billion euros, Baretta said. Lawmakers are also seeking reductions to the payroll tax and more funds for local governments.

*** bloomberg / link

"A Toxic System": Why Austerity Still Isn't Working in Greece

Despite drastic austerity measures, a new Greek debt haircut looks unavoidable. The old system has proven resistant to reform and billions in emergency aid hasn't been enough to turn things around.

After making a lot of money manufacturing swimming pools, Stelios Stavridis has redirected his entrepreneurial talents toward saving his country.

The 66-year-old Greek business executive with aristocratic features recently became the head of the country's privatization agency, which has been charged with selling off hundreds of government-owned real estate, companies, marinas and airports.

Stavridis is the third man to hold the position in only a year, but this doesn't reduce his professional confidence. He says he has just had "excellent" conversations with observers from the so-called troika, consisting of the International Monetary Fund (IMF), the European Commission and the European Central Bank (ECB), who regularly review the country's progress.

However, Stavridis also had to confess to the troika that his agency is unlikely to meet its goals for this year. The planned sale of the national gas company to the Russian Gazprom conglomerate fell apart at the last minute, and now a €652 million ($839 million) deal for the privatization of gambling company OPAP is also on the rocks, because the buyer feels that he is being cheated.

This means Stavridis will almost certainly fail to reach his original 2013 privatization goal of €2.6 billion. Because of these and other difficulties, the financing plan for Greece now faces a large shortfall of €11.1 billion by 2015.

Greece's euro partners have already pledged more than €230 billion in aid, and government spending has also been slashed by dozens of billions. Representatives of Greek business are now convinced that the country cannot survive without yet another debt haircut.


Source: Der Spiegel

The subject is politically sensitive, especially in Germany, because this time a debt haircut would also affect public creditors, which already hold 80 percent of Greek sovereign debt. In other words, a large share of German assistance loans would be irretrievably lost.

German Chancellor Angela Merkel is still strongly opposed to a debt haircut, fearing that Greece's enthusiasm over reforms will vanish once financial pressure subsides. The country needs more than money alone to get back on its feet. Even the IMF is critical of the devastating effects of austerity programs on the country's economy. But that is only half the truth. The fact is that while Greece has drastically cut spending, efforts at structural reform are stagnating. This also hampers economic success.

When the troika observers first arrived in the country in 2010, they were surprised at just how overregulated the economy was, at how inefficient the entire government and judicial apparatus had become. Not even the estimated government deficit for 2009 was correct. When it was recalculated, 6 percent turned into 12.7 percent and eventually even went up to 15.6 percent.

Six austerity programs later, the deficit is expected to decline to about 4 percent for this year. Greece's euro partners attribute this success to the efforts of conservative Prime Minister Antonis Samaras. "The current government is finally strongly committed to bringing order to the state," says Panos Carvounis, a representative of the European Commission in Athens. "Things are moving."...

*** der spiegel / link

France Loses Top Credit Rating as Fitch Cites Lack of Growth

France lost its top credit rating at Fitch Ratings, which highlighted concern about lack of growth and the buildup of debt in Europe's second-largest economy.

France was cut by one step to AA+ from AAA, Fitch said today, joining Moody's Investors Service and Standard & Poor's in removing France from the shrinking club of top-rated governments. The outlook is stable.

Budget risks "lie mainly to the downside, owing to the uncertain growth outlook and the ongoing euro zone crisis, even assuming no wavering in commitment to fiscal consolidation," Fitch said in a statement.

The downgrade is a reminder of the challenges President Francois Hollande faces in reviving an economy that has barely grown in more than two years and cutting the highest unemployment since 1999. The International Monetary Fund expects French gross domestic product to shrink 0.2 percent this year.

France was cut one level to AA+ from AAA in January 2012 by Standard & Poor's. Moody's followed in November, reducing France to Aa1 from Aaa. Investors have largely shrugged off those announcements, reflecting a shift from reliance on ratings agencies to a focus on in-house analysis.

Through July 12, French government bonds had gained 9.6 percent since the S&P decision and 0.3 percent since the statement by Moody's, according to the Bank of America Merrill Lynch France Government Index.

France's 10-year government bond yield was at 2.193 percent today at the close, compared with 1.56 percent for Germany's equivalent security. Its peak this year was 2.533 percent in June, up from a low of 1.659 percent in May.

Yields on sovereign securities last year moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook, according to data compiled by Bloomberg published in December.

Hollande nevertheless faces pressure from France's international partners to revamp the economy following a decade in which the nation lost its share of world exports to countries ranging from Spain to China and Germany.

The European Commission told Hollande in May that he needs to press ahead with an overhaul of the pension system and labor market, while the IMF said the French government has no more room to raise taxes to plug its budget deficit.

Since winning office a year ago, Hollande pushed through measures making it easier for companies to sign labor contracts outside the framework of national union accords and offered a payroll tax credit to businesses.

He plans changes to the pension system for later this year. More has to be done to create flexible contracts for low wage earners and to reduce legal uncertainty for companies in firing procedures, the IMF said.

"France has more than just cyclical problems, it has structural problems," the IMF's Edward Gardner told journalists in Paris last month. "But the number of reform that have been passed in the past six months shows that the government appreciates it has problems. But we see it as a first step in a long process."

*** BLOOMBERG / link

The Sochi Olympics: Castles in the sand

With seven months to go before the 2014 winter Olympics, Sochi is a gigantic construction site. Lorries run up and down dusty roads, excavators turn earth inside out, and 70,000 workers from every corner of the old Soviet Union dig, lift, pull and churn day and night. Imagining the finished venue is hard. "This is where bird lakes are supposed to be," says Svetlana, a local activist, pointing to a pile of dirt.

The whole place resembles nothing so much as a Communist-era construction project. Cost, efficiency, nature and human lives never stood in the way of Soviet rulers who reversed Siberian rivers, built cities in permafrost and planted corn in virgin land — often to ruinous effect. In scale, Sochi 2014 is similar, yet the amount of public money it will cost makes Soviet projects pale in comparison.

In many ways Sochi is an odd choice for the winter games. It has a subtropical climate and is one of the very few places in Russia where snow is scarce. The opening and closing ceremonies will be held close to the Black Sea on swampy ground, once infested by malarial mosquitoes. Temperatures there rarely fall below zero. The lower slopes of the Caucasus Mountains are not guaranteed snow, so the organisers have stored last winter's.

Sochi is also worryingly close to the north Caucasus, a predominantly Muslim part of Russia that has been immersed in a bloody civil conflict for two decades. Last year Russia lost 296 soldiers and civilians in the north Caucasus, according to Caucasian Knot, a monitoring organisation, almost as many soldiers as America lost in Afghanistan. "Imagine holding the games in Kabul," one American official says.

Yet President Vladimir Putin sees Sochi 2014 as his own pet project: a sign of his power over people and nature, and of his international legitimacy. That Mr Putin spends a lot of time in Sochi adds a personal touch. Yet, as Boris Nemtsov, a former deputy prime minister and opposition leader who has written several reports on Sochi, argues, far from being a model of fair play, Sochi has emerged as a model of crony capitalism, lawlessness, inefficiency and disregard for nature and people. "The Sochi Olympics are an unprecedented thieves' caper in which representatives of Putin's government are mixed up along with the oligarchs close to the government," Mr Nemtsov writes.

Sochi has already set one record. At an estimated cost of $50 billion, these will be the most expensive games in history. When Russia placed its bid in 2007 it proposed to spend $12 billion, already more than any other country. Within a year the budget had been replaced by a seven-year plan to develop Sochi as a mountain resort. Most of the money is coming from the public purse or from state-owned banks.

Allison Stewart, of the SAID Business School at Oxford, says that Olympics tend to have cost overruns of about 180% on average. For Sochi the overrun is now 500%. But Russia made clear that money was not an issue, says Ms Stewart. She also notes that relations between the government and construction companies appear closer in Sochi than in other games.

Large construction projects often have a side-effect of corruption. But in Russia corruption is not a side-effect: it is a product almost as important as the sporting event itself.

The quality of the work is patchy. The ski jump has been redone many times, and the cost has risen sevenfold. Newly laid sewage pipes have burst, so a nasty smell drifts over a kindergarten playground. Sea-coast fortifications cracked soon after installation.

The work has been carried out with little concern for the environment. The river flowing into the Black Sea has been polluted by construction waste and protected forests have been cut down. A green whistle-blower was prosecuted and chased out of Russia.

The attitude towards workers is little better. Low-skilled migrants get $500 a month, working 12-hour shifts with no contracts, safety training or insurance. Even so, wages are not always paid in full, are often delayed and sometimes not paid at all, according to Human Rights Watch. Some employers withhold workers' passports, so they cannot leave the site. Last year at least 25 people died in accidents and many more were injured. "Perhaps I would be more enthusiastic about the Olympic games if they treated me better," comments one worker.

Most of the construction is overseen by Olympstroy, one of Russia's state corporations. Alexander Sokolov, who wrote a doctoral thesis on these opaque bodies, argues that they are run under the informal influence of a rent-seeking group of people for whom the extraction of government funds is the main purpose. Many of Olympstroy's employees appear to be selected on the basis of their relations with powerful officials and paid above market rates. Over the past six years Olympstroy has had four bosses. Changes at the top have been accompanied by criminal investigations, yet nobody has been brought to trial. Attempts by Communist deputies to bring Olympstroy under parliamentary control were blocked by United Russia, the ruling party. The Audit Chamber, a government watchdog, said the bosses of Olympstroy had created conditions for unjustified cost increases. Yet its own reports are marked as "classified information"....

*** economist / LINK

US 'disappointed' with China for letting Edward Snowden leave Hong Kong

US has said it is disappointed with China over its refusal to extradite the NSA whistleblower Edward Snowden and instead allow him to leave Hong Kong.

William Burns, the deputy secretary of state, said: "China's handling of this case was not consistent with … the new type of relationship that we both seek to build." He said the US was "disappointed with how the authorities in Beijing and Hong Kong handled the Snowden case".

The remarks came after two days of high-level talks on security and economy and the announcement of plans to negotiate a bilateral investment treaty and more co-operation on combating climate change.

Barack Obama also expressed disappointment about the Snowden case when he met the two leaders of the Chinese delegation in the Oval Office on Thursday, a White House statement said.

The state councillor Yang Jiechi retorted that the handling of the Snowden case by authorities in semi-autonomous Hong Kong was "beyond reproach".

Yang also rejected US criticism of China's rights record in the ethnic minority areas of Tibet and Xinjiang, saying people there were "enjoying happier lives and they enjoy unprecedented freedom and human rights". He added: "We hope the US will improve its own human rights situation."

About 120 Tibetans have set themselves on fire since 2011 to protest against Chinese policies in Tibet and call for the return of the Dalai Lama, their exiled spiritual leader. In the far western region of Xinjiang, minority Muslims are agitating against Beijing, and clashes in recent months have killed at least 56 people.

The stark differences of opinion on those issues did not prevent kind words on both sides too. The US treasury secretary, Jacob Lew, hailed the "personal approach" of China's new generation of leaders under Xi Jinping, who ascended to the presidency in March in a once-in-a-decade power transition.

China's vice-premier, Wang Yang, whom US officials say has demonstrated a keen sense of humour in this week's talks, joked that Lew was smarter than he was and they had become good friends.

Obama welcomed China's commitment to open its economy to US investment in the bilateral investment treaty, a pact that Washington has been urging Beijing to negotiate in earnest for years. The Chinese also agreed with him on the importance of co-operating to get North Korea to abandon its pursuit of nuclear weapons.

But Obama said the US would continue to speak out in support of international norms such as the protection of universal human rights, the White House statement said....

*** UK guardian / link

China exports slide raises doubts about currency policy

China's bet that it could reap the benefits of a more powerful yuan without paying a price in competitiveness is looking increasingly risky.

An unexpected slump in exports in June marked the latest worrying sign of a slowdown in the world's second-biggest economy and raised the prospect that regulators may be forced to drag the yuan back down after a massive rally this year.

Unfortunately for policymakers, while a weaker yuan might improve the price of Chinese goods sold abroad, it will not be the cure all for exporters. Other factors are driving up production costs at Chinese companies and undermining their competitiveness abroad.

Still, economic reformers at the People's Bank of China (PBOC) will come under pressure to use brute-force exchange rate manipulation to stave off a potentially destabilizing round of factory layoffs.

Liu Ligang, Greater China chief economist at ANZ bank in Hong Kong, said some sort of adjustment — including pushing the currency lower — was likely since policymakers were behind the curve in dealing with a longer downturn in exports demand than expected.

"PBOC policy needs to be corrected according to the changed external environment," he said.

While the yuan, or renminbi, has only risen 1.5 percent against the dollar so far this year, it has posted significantly greater appreciation against other Asian currencies, Liu said.

"If you look at the renminbi crosses against the yen, Asian currencies, the Korean won, you see gains of 10 to 20 percent. It is the crosses that are so worrisome because China has to compete with ASEAN economies... We may see more layoffs by Chinese manufacturing as a result."

The currency factor could have a particular impact on China's heavy equipment and shipbuilding sectors, which compete with Japanese and Korean products, analysts said.

The vulnerability of some Chinese companies was underlined by China Rongsheng Heavy Industries Group (1101.HK), China's largest private shipbuilder, which appealed for financial help from the Chinese government and big shareholders on Friday.

Chinese export figures have been on a roller coaster ride in 2013, and the currency has played an outsized role. Officials widely blamed a strong performance in exports earlier this year on speculative inflows of currency disguised as exports, a maneuver to get around capital controls.

Exports in June declined 3.1 percent from a year earlier, flabbergasting a market that had expected 4 percent growth.

But Bank of America Merrill Lynch economists Zhi Xiaojia and Lu Ting argue June's fall was attributable in part to possible statistical manipulation by Chinese customs.

"Customs might have had to deflate trade data in June to neutralize previous over reporting," they wrote in a research note. In short, exports in June might have been stronger than the official data, they said.

They predicted the yuan will stop appreciating against the dollar and could even depreciate mildly in upcoming months.

Currency traders suspect that Beijing had expected global demand to pick up this year before the exchange rate became an issue. They may have let the yuan market get carried away and are now paying the price, the traders say....

*** reuters / LINK

When the Cracks Appeared

Along with the sudden emergence of a cash crunch, the somewhat obscure interbank market has never garnered more attention, ranging from that of government leaders to individual investors.

Since late June, there have been dramatic fluctuations in the interbank market, with interest rates skyrocketing and rumors of financial institutions defaulting. Stocks and bonds prices fell for days. On June 24, the Shanghai Composite Index fell 5.13 percent, then hit 1,849 points a day later, the lowest since August 2009.

The storm has not been limited to financial institutions that make transactions on the interbank market. Since the Shanghai Interbank Offered Rate hit a new high of 30 percent, a so-called cash crunch has become almost a household topic.

Interbank market rates were high, but capital supply froze. Also on June 24, the China Development Bank made a rare, sudden cancellation of a scheduled issuance of floating-rate bonds. The policy bank was not alone. Since mid-June, at least 22 bond issuers have postponed issuance or changed terms.

The situation continued to escalate and banks scrambled for capital. Around June 25, a number of banks decided to suspend offering loans until July 15, including even the highest quality type of loans — personal mortgages. Companies began receiving requests from banks to repay loans on a tight schedule, and were told that their loans would not be renewed for the time being. Through loan-borrowing companies, tight liquidity spread from the financial market to the real economy, hampering China's already sluggish economic growth.

Many fingers were pointed at the People's Bank of China (PBOC). At first, the central bank was silent. Then, after the close of the market on June 24, it took to a high-profile position, assuring the market that it would inject liquidity when necessary. The behemoth, state-owned commercial banks followed its lead. The chairman of Industrial and Commercial Bank of China (ICBC), Jiang Jianqing, told the media his bank would act as a stabilizer. Smaller joint-stock banks, such as Industrial Bank and Minsheng Bank, were in the teeth of the storm and thought to be in more dire situations. They held emergency teleconferences to appease the market.

The next day, a number of members of the State Council, the country's cabinet, met with people in the financial sector and discussed responses.

On the same day, the central bank injected liquidity into the interbank market and committed itself to safeguarding the stability of the money market. Although the size of the liquidity was unconfirmed, market insiders speculated that the central bank had carried out a targeted reverse repurchase at a small number of institutions to inject liquidity. Moreover, that week saw 25 billion yuan in central bank notes reach maturity, representing a small-scale injection of liquidity. Short-term interbank market interest rates fell significantly in the wake of these moves.

Thus, the market panic gradually ended. But its shadow remains. Via bonds, the tight liquidity caused by short-term factors will last until July 15. Meanwhile, market short-term interest rates have stabilized. But the 14-day and 21-day interbank market repurchase rate is still high, at 8 to 9 percent.

After years of glorious results, the fragile side of the Chinese banking sector was finally exposed in the unexpected cash crunch. When institutions begin to worry about liquidity and are suspicious of each other's ability to pay, panic shoots through the market. The chief strategist of the domestic investment firm China International Capital Corp. (CICC), Huang Haizhou, said that problems in the country's financial industry are just beginning to appear; a financial crisis within three years is inevitable; and all that China can strive for is a "controlled, minor crisis."

The central bank was severely criticized throughout the episode. The mildest blame is that the PBOC failed to communicate with the market to guide expectations. The harshest criticism is that it was failing to act as a lender of last resort.

At the same time, many people support the central bank for not indulging the high-risk behavior of individual institutions. They say now is the time to sound the alarm regarding banks with weak liquidity positions and poor management of their assets and liabilities. A source at ICBC said: "Some institutions were excessively risk-taking in the past. The central bank is now using open market mechanisms to punish reckless institutions and using the pricing mechanism to force institutions to be more cautious, to deleverage and to better their risk management."

However, the central bank said that "so-called stress-tests and punishment of radical institutions" were only the market's interpretations. There is no shortage in the total amount of liquidity and the recent liquidity crunch is a structural issue, it said. The PBOC is the only player who can see the cards every bank is holding, so unless banking institutions are reporting fraudulent numbers en masse, the central bank's judgment is the most authoritative....

*** caixin / link

More On the German Gold Situation

Journalist Lars Schall was kind enough to forward this excerpt from one of his articles that is printed below.

I think it "frames up" the situation with regard to the repatriation of Germany's gold from the US very nicely.

How sovereign is Germany relative to the US? Indeed how sovereign are a number of the western nations vis-à-vis the Anglo-American establishment? The recent search for the elusive Snowden cast some light on the issue of sovereignty.

And as a corollary, how complacent and compliant are the western people to the Banks? Have the Banks quietly assumed the role of government, without proper accountability to the people?

And secondly, what exactly is the problem with the gold? Is it there or gone? And if it is there, is it already spoken for, in the manner of modern banking rehypothecation? And if so, why?...

This is the excerpt of Herr Schall's interview. You may make up your own mind as events unfold, but it does seem to parse the subject quite nicely.

Lars Schall: In January this year, the Deutsche Bundesbank announced that it wants to repatriate some of its gold holdings at the NY Fed and all of its gold from the Banque de France. Do you consider it a bit strange that apparently it will take seven years to bring roughly 300 tons of gold from New York City to Frankfurt and five years to bring roughly 370 tons from Paris to Frankfurt? Moreover, the Bundesbank will leave a huge amount of its gold in New York City and London to have in the event of a currency crisis "the ability to exchange gold for foreign currency […] within a short space of time." Does this argument convince you?

Norbert Haering: The specifics of the plan for partial repatriation of gold seem to be designed to quash the public discussion about gold storage abroad. For many years to come, the Bundesbank will be able to answer these calls by saying: we are already working on it. And that will work well as a communication strategy. But the truth of the matter is that there is no good reason to store your national gold treasure abroad.

The issue and the way in which the Bundesbank got itself tangled up in conflicting statements and justifications during these discussions makes one suspicious that either there is a problem with the gold or that Germany might not be as sovereign a state as we like to think. I do not know which one is true.

Lars Schall, Money Lies Disguise Banking Truths: An Interview with Norbert Haering

I find the refusal of the Federal Reserve to release the national gold of Germany for repatriation for seven years to be one of the most remarkable of recent developments in the world of money. And it is all the more remarkable in that so few are willing to even ask the most fundamental of questions regarding the custodial integrity of the bankers.

It is truly the dog that did not bark.

Stand and deliver. Either the bullion, or the truth.

*** jesse's cafe americain / link

We can't wave goodbye to the euro crisis just yet

Since last summer, the euro crisis has apparently abated. Optimists have believed that it has finally been laid to rest.

The more cynical among us have thought this particular parrot was merely sleeping. All along, despite the markets' quiescence, the fundamental economic problems which underlay the crisis have failed to improve.

And then last week the crisis flared into life again. Portugal's finance minister resigned, citing, among other things, a decline in public support for the austerity policies the government has adopted in return for its bail-out. He was followed by the foreign minister.

While the coalition government will probably hold together, the latest developments have highlighted growing rifts over austerity policies. The chances of the government lasting until the end of its term (October 2015) seem pretty slim. More importantly, these events reduce the chances of the government successfully exiting its bail-out.

Meanwhile, it has become clear that Greece is in trouble again. Actually, the economic numbers have recently improved. The reduction in the budget deficit even appears to be running a bit ahead of schedule.

But the Troika (the IMF, the ECB, and the European Commission) is, once again, increasingly concerned that Greece is failing to implement the reforms demanded of it. In particular, that it is backsliding on the targeted reductions in public-sector employment.

If it remains dissatisfied with Greece's progress, then at today's Eurogroup meeting, eurozone finance ministers will be unable to sanction the release of the next loan payment from the European Stability Mechanism (ESM).

Since eurozone finance ministers are not scheduled to meet again until September, a failure to sign off the latest loan disbursement could mean that Greece has to wait another three months until its next ESM loan is disbursed, potentially leaving her unable to meet a €2bn (£1.72bn) bond redemption in August.

What's more, the IMF has voiced concerns that the current bail-out may not fully cover Greece's financing needs for the next 12 months. Unless this hole is filled, either by Greece or the eurozone, the Fund could also suspend its loan payments.

Even if Greece bows to the Troika's demands, the government's wafer-thin majority in parliament suggests that it may struggle to implement these measures.

Now both Portugal and Greece are relatively small economies. Although their economic position is dire, it is quite easy to imagine some sort of euro fudge which enables them to get their money somehow, thus postponing the denouement. The German chancellor, Angela Merkel, calls the shots. For her, it is most important to put any crisis off until after the elections in September.

Meanwhile, the other peripheral countries remain in a bad way. Italy is deep in recession. In the first quarter, GDP was 2.3pc lower than a year earlier and 8.7pc below its Q3 2007 peak. It looks as though the economy will contract further this year.

Last year, the Italian budget deficit was just 3pc of GDP. Based on misleadingly optimistic GDP forecasts, the government expects the deficit to edge down slightly this year. By contrast, I expect it to rise to about 4pc of GDP. By 2015, public debt will probably exceed 140pc of GDP.

Admittedly, at just over 12pc, the unemployment rate is low by the standards of other peripheral economies. But, if anything, the labour market downturn appears to have intensified recently....

*** roger bootle / link

Charts That Make You Go Hmmm...


Source: Datastream/Eurostat/Natixis

This amazing chart came to me from my Twitter pal Dave Collum (@DavidBCollum), who, whilst not a finance professional, has a better grip on the machinations thereof than most people making a living from them. (If you follow finance and tweet, then you should also follow Dave). Dave in turn sourced it from Jacob Wolinsky (@jacobwolinsky). It shows the utter destruction of the building industries in the PIGS. These economies relied so heavily on that sector for growth that it is hard to see how any of them will be getting off their knees anytime soon.



Source: Der Spiegel

Der Spiegel analyzes the situation in Europe's PIGS as only the Germans can. The results? Frightening! Anybody still think that Europe is going to somehow "muddle through"?

This is one crisis that just won't go away.


Source: ZeroHedge

The Fed's Bind: Tapering, Timetables and Turmoil

There are striking parallels between the dramatic recent sell-off in U.S. Treasuries and the Great Bond Crash of 1994. But the summer of volatility now facing financial markets is no doomsday scenario. Instead, it puts the Fed in a bind. Higher interest rates will reduce housing affordability, which is especially troublesome since housing is the primary locomotive of U.S. economic growth. That means the Fed, despite Ben Bernanke's recently announced timetable, may be forced to expand or extend quantitative easing if the housing market's response to recent events becomes more acute and starts to negatively affect the job market recovery.

At the start of June, I waxed nostalgic about the canary in the coal mine. In the aftermath of a string of downside moves in financial markets, I wrote about how early mines lacked ventilation and so miners brought caged canaries into new seams to detect deadly gasses. The story went that if the canary stopped singing, or even worse, died, the mine would be evacuated until the gas buildup could be cleared to make work safe again. My point was that markets were foreshadowing worse trouble ahead. Now, I regret to tell you, my prognosis was all too accurate. The canary is certainly dead. And, in the sudden market rout that has marked the beginning of the summer season, the chirpy yellow bird was far from the only casualty.

I see striking parallels between the dramatic recent sell-off in U.S. Treasuries and the Great Bond Crash of 1994. To make matters worse, today's bond market is even more sensitive to fears about tightening thanks to the U.S. Federal Reserve's unprecedented expansionary program since the 2008 crisis.

*** Scott Minerd (via ZeroHedge) / link

The Fed continues to be divided over the next steps for its unprecedented monetary expansion program. Varying interpretations and conflicting headlines in the press leave the public bewildered and frustrated....

But now the Fed has a new problem. The central bank's securities purchases are financed with bank reserves, which have been rising steadily in 2013 (chart below).


And to many on the Fed that was justifiable as long as US commercial banks continued to expand their balance sheets. But recently that expansion has stalled.


To some this calls into question the effectiveness of the whole program, since the transmission from reserves into credit is so weak. The Fed is now facing the following choices:

1. slow the purchases and run the risk of shrinking credit and rising interest rates or

2. continue with the program and risk QE "side effects" without the needed credit expansion

That's why we are likely to see the Fed even more divided going forward, adding to more uncertainty and frustration by investors (including those outside the US) as well as the public.

*** sober look / link

Words That Make You Go Hmmm...



William Kaye talks to Eric King about the gold market and addresses a lot of the issues I have written about this week.

Bill pulls no punches at all. He is a man with an exceptional grasp of the gold market, so when he talks I listen. You should, too; this is a fabulous interview.

(I know — it's Danny. You try to find a picture of Bill.)


Art Cashin is not just a legend on the floor of the NYSE but also a great guy. His thoughts are always worth listening to, and this week's are no exception.

The dreaded "taper", the negative effects of QE, gold, silver, and the bond market all get the benefit of Art's decades of experience. As always, his words convey the kind of wisdom that can only be earned the hard way.




Edward Snowden is now one of the most recognizable faces on the planet (hardly ideal, given his desire to make himself scarce), but few people have actually heard him speak.

In the second part of the UK Guardian's interview conducted in HK last month, Snowden proves himself to be a smart, erudite man with a solid grip on his situation.

Definitely worth watching before making up your mind about him.


and finally...

One of the very best cartoonists around today, Matt of the UK Daily Telegraph, came up with this beauty a couple of weeks ago. Check out his other work here.




Grant Williams

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.

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A walk around the fringes of finance


By Grant Williams

15 JULY 2013


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Discuss This


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Thomas Wolf

July 21, 2013, 2:05 p.m.

Really brilliant lesson from a great teacher. Prescient and timely. Hope I get straight Au (plural).

July 15, 2013, 4:23 p.m.

Just wish to thank you for including the link to whistle-blower Edward Snowden’s interview - a surprise even in your often surprising publications! 

As you say, he’s clearly smart with a solid grip on his situation - as well as mind-bogglingly courageous. 

Sadly, his smartness seems in contrast to our sneaky Administration, whose policy, in facing the embarrassing dilemma Snowden presents, has been to emphasize to us and to the world their role as jack-booted international enforcers (pretty incompetent ones at that).

Relatively few of us at home (or in our media) seem to care about that.  Hope it doesn’t mean most of us are now locked into the same narrow authoritarian mindset - with by far the main concern being to silence and punish Snowden and intimidate other would-be whistleblowers who might threaten our society’s security. 

Should we not be at greater pains to clarify the important questions for our society today that Snowden has dared to bring into the open?  George Warburg