Signs of the Economic Apocalypse, 3-5-07

From Signs of the Times:

Gold closed at 645.90 dollars an ounce Friday, down 6.2% from $685.70 at the close of the previous Friday. The dollar closed at 0.7580 euros Friday, down 0.2% from 0.7595 at the previous week’s close. That put the euro at 1.3193 dollars compared to 1.3167 at the end of the week before. Gold in euros would be 489.58 euros an ounce, down 6.4% from 520.77 for the week. Oil closed at 61.47 dollars a barrel, up 0.5% from $61.14 at the close of the previous week. Oil in euros would be 46.59 euros a barrel, up 0.3% from 46.43 euros at the end of the week before. The gold/oil ratio closed at 10.51 Friday, down 6.8% from 11.22 for the week. In U.S. stocks, the Dow Jones Industrial Average closed at 12,138.77, down 4.2% from 12,647.48 at the close of the previous Friday’s trading. The NASDAQ closed at 2,374.12 Friday, down 5.9% from 2,515.10 at the close of the Friday before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.51% down 16 basis points from 4.67 for the week.

The big story last week was the fall in stock markets across the world on Tuesday. In the United States the Dow had it’s biggest one-day drop since September 2001 while the housing market continued its slide and signs of recession mounted.

U.S. Economy: Home Sales Tumble, Growth Revised Lower

By Courtney Schlisserman and Joe Richter

Feb. 28 (Bloomberg) -- New-home sales in the U.S. tumbled last month by the most in 13 years and fourth-quarter economic growth was less than previously estimated, dousing speculation that the worst of the slowdown is over.

January new-home purchases fell 16.6 percent, the most since 1994, the Commerce Department said today in Washington. The department in a separate report said gross domestic product, the sum of all goods and services produced, grew at an annual rate of 2.2 percent, compared with the 3.5 percent reported on Jan. 31, and the 2 percent the previous quarter.

Federal Reserve Chairman Ben S. Bernanke played down the figures, saying the growth revision is in line with his estimates and predicting a rebound later this year. His remarks helped lift stocks after the biggest slide in four years.

“One by one, various growth indicators for the U.S. economy are tipping to the downside,” said Avery Shenfeld, a senior economist at CIBC World Markets Inc. in Toronto. “The housing market still looks decidedly in a downtrend. The Fed appears to be somewhat late in adjusting its views.”

A separate report showed a national business activity index unexpectedly dropped this month. The National Association of Purchasing Management-Chicago said its business barometer fell to 47.9 this month, the lowest since October 2002, from 48.8 in January. A reading lower than 50 signals contraction.

For all of last year, the economy grew 3.3 percent, compared with 3.2 percent in 2005…

Gold prices fell sharply as well last week, even more sharply than stocks did, dropping 6.2%. The drop in gold prices seemed to follow the logic of the stock market drop, a correction after a period of steady price increases.

Gold battered by stock market worries

By Daniel Magnowski
Fri Mar 2, 10:52 AM ET

LONDON (Reuters) - The global flight from risk knocked precious metals again on Friday, with gold falling below $650 an ounce for the first time in three weeks as shaky global stock markets prompted investors to reduce positions in commodities.

Investors often buy gold as a safe bet when financial markets look unstable, but investors are keen to unload the metal after plunges in global equity markets this week, analysts said.

Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.

"Gold is not glittering any longer as a safe haven," Dresdner Kleinwort analysts said in a market report.

"Commodities in general are perceived as risky assets...This asset class is just sold to reduce portfolio risk and to take profits in order to compensate losses suffered in other assets like equities," the bank said.

"Thus, as long as unwinding of yen carry trades continues and equity prices head south, gold and silver remain in the wake of bear markets."

As of 1537 GMT spot gold was at $651.50/651.95 per ounce, down sharply from $662.60/663.30 in New York on Thursday. It fell as low as $649.25 on Friday, the lowest since February 8 and down almost 6 percent from the nine-month high touched on Monday.

The pan-European FTSEurofirst 300 index was down 0.35 percent by 1536 GMT after losing 5 percent in the past three sessions, while in the United States the Dow Jones industrial average was down 0.22 percent.

A 9 percent fall in the Shanghai stock market on Tuesday triggered a global flight away from stocks into less risky assets.

Technical sentiment in gold deteriorated after the price went below several near- and medium-term moving averages.

Cash gold broke below its seven-day moving average of $674 and its 30-day average around $660.

However, traders said gold might receive support from firm energy prices.
U.S. crude oil futures hit a 2007 high on Thursday on tightening fuel supplies in the United States.

On Friday, U.S. crude traded firmly above $62. It was quoted at $62.15 at 1540 GMT, up 15 cents from Thursday’s close. On Thursday it hit $62.40, its highest since December 26.

Gold hit a nine-month high of $689 on Monday as firm crude oil and tensions between Iran and the United States raised the metal’s appeal as a haven and a hedge against inflation.

Traders were watching whether gold could hold above $655.40 -- a low reached on February 20.

The so-called flight to safety was a flight to bonds (bond prices increased sending yields down sharply) not a flight to precious metals. As the above article put it, “Many investment funds were seen to have bought commodities, including gold, over the past month with the proceeds from stocks as Wall Street reached record highs last month.” Meaning that, as George Ure observed, the drop in gold came from investors selling gold to cover other positions. Like Ure, I can’t help but think that the storm clouds hanging over the stock market and the larger economy will be good for gold.

As for the continuing problems in housing, these will have more effects on stock prices than some might think, due to the massive amounts of bad paper being held (usually as funds holding securitized debt and derivatives connected to those markets) as assets by most all of the top financial institutions:

General Motors and the housing bust

Back at the dawn of the automobile era, banks generally refused to loan money for such things as buying a car. It wasn’t considered prudent. This was frustrating to companies such as General Motors, which naturally wanted as many people as possible to have the wherewithal to purchase Cadillacs and Oldsmobiles and Pontiacs and Chevrolets. So GM decided to solve the problem by, in effect, becoming its own bank. In 1919 GM created the General Motors Acceptance Corp., a financial arm of GM that specialized in offering credit to car buyers and allowing them to buy on installment plans.

GMAC was a huge success. So much so that, over the years, it gradually expanded its operations, becoming a significant bottom-line contributor to GM’s profits. In 1985, GM’s execs decided, hey, if we’re loaning money to our customers to buy cars, why not go ahead and loan them money to buy homes as well? GM promptly purchased two large mortgage lenders and instantly became the second largest mortgage bank in the U.S.

Along the way GMAC also became an early player in the world of "structured finance" or derivatives, by taking the income streams generated by all those car and mortgage payments and turning them into bonds, through the process known as "securitization," which it then sold off to investors. All very state-of-the-art, all very emblematic of the career arc of the modern American corporation.

Why should we care about all this history? Well, with the Dow just finishing its worst week in four years, down another 120 points on Friday, it would behoove us to look for explanations as to what is continuing to spook investors. To wit: On Thursday, GM shook up Wall Street by announced that it was delaying filing its 2006 Annual Report by a couple of weeks. The reason, said analysts, had to do with GMAC’s significant exposure to the ever-popular subprime lending debacle. Like so many other players in the mortgage business in the last few years, GMAC’s home lending subsidiary, ResCap, apparently got pretty deep into making risky loans to homeowners with bad credit, and now is paying the price.

How bad is it? According to the Houston Chronicle, "At the end of the third quarter, ResCap, long viewed as the crown jewel in GMAC’s businesses, held $57 billion of subprime mortgages for investment, or 77 percent of its total loans held for investment. Its exposure to ‘residual interest’ in mortgage securities -- the high-yielding slices that suffer some of the first losses if loan defaults are higher than expected -- was $1.4 billion as of Sept. 30."

There are two primary schools of thought on how the subprime lending saga will play out. One side says that financial woes are limited to just that segment of the mortgage industry that dealt with the riskiest loans, and the problems will spread no further. But the other side contends that we’re only at the beginning of a chain reaction that could end up causing serious damage to some of Wall Street’s biggest players.

GM, the largest car maker in the world, is a pretty big institution, and GMAC is a pretty big financial player. But due to the opaque nature of the derivatives trading business, no one, not even, apparently, GM itself, is clear on exactly what ResCap’s subprime woes might mean for the larger picture. But it can’t be good.

From the Chronicle:

ResCap said in January it will eliminate 1,000 positions by October to reduce costs as the mortgage lender grapples with the continued deterioration in the subprime mortgage sector. The company now has 14,000 employees worldwide. In a filing with the SEC, ResCap estimated that it would incur about $10 million in severance and related costs associated with the work-force reduction.

"We continue to believe GM equity is complacent about the potential impact of such subprime exposure," Bear Stearns auto analyst Peter Nesvold wrote in a note. He said the weakness at GMAC due to subprime problems is one of the key risks facing GM.

Last fall, GM sold 51 percent of GMAC to Cerberus Capital Management, in a cash-raising effort aimed at bolstering the company’s shaky finances. But the two parties have since been squabbling over the fine print. There now appear to be some questions as to whether GMAC was properly valued at the time of the deal.

All in all, not a good week for Wall Street. Monday morning should be interesting.

Indeed, the exposure to severe risk is unprecendented throughout the top levels of the corporate system:

Goldman, Merrill Almost ‘Junk,’ Their Own Traders Say

By Shannon D. Harrington

March 2 (Bloomberg) -- Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody’s Investors Service. For Goldman, Morgan Stanley and Merrill that’s five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

Traders of credit derivatives are more alarmed than stock and bond investors that a slowdown in housing and the global equity market rout have hurt the firms. Merrill since 2005 has financed two mortgage lenders that subsequently failed and bought a third, First Franklin Financial Corp., for $1.3 billion.

“These guys have made a lot of money securitizing mortgages over the years in a mortgage boom time,” said Richard Hofmann, an analyst at bond research firm CreditSights Inc. in New York. “The question now is what is the exposure to credit risk and what are the potential revenue headwinds if they’re not able to keep that securitization machine humming along.”

Credit-default swaps on the debt of Goldman, the world’s biggest securities firm, have risen to $32,775 per $10 million in bonds, up from $21,500 at the start of the year, according to prices compiled by London-based CMA Datavision. The price touched $35,000 on Feb. 28, the highest since June 2005.

Spokesmen and spokeswomen for Goldman, Lehman, Merrill and Morgan Stanley declined to comment. A spokeswoman for Bear Stearns didn’t immediately return calls for comment.

Conceived to Protect

Morgan Stanley and Goldman were among the top five traders of credit-default swaps in 2005, a group that represented 86 percent of the market, according to a September Fitch Ratings report. Lehman, Merrill and Bear Stearns were among the top 12.

Credit-default swaps that trade at such wide gaps below actual ratings tend to rally, said David Munves, director of Moody’s credit strategy research group.

The contracts were conceived by Wall Street to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to debt agreements. An increase in price indicates a decline in the perception of creditworthiness; a drop means the opposite.

Contracts tied to Morgan Stanley, Merrill, Lehman Brothers Holdings Inc. and Bear Stearns Cos. also are at 19-month highs.

Rising Prices

Morgan Stanley credit swaps have risen $10,000 to $32,775 this year, CMA data show. Contracts on Merrill jumped $16,500 to $33,000. For Lehman, they are up $12,440 to $34,440, and the swaps on Bear Stearns have climbed $12,080 to $33,830.

By contrast, Deutsche Bank AG in Frankfurt, Germany, is trading near a record low at 9,800 euros, according to data compiled by Bloomberg. And, a Standard & Poor’s index of investment bank stocks has fallen 6.29 percent this year.

The increases were larger than an index that measures credit risk for investment-grade companies in North America. The cost of protecting $10 million in debt included in the Dow Jones CDX North America Investment Grade Index has risen $1,250 to $34,750 this year, according to Deutsche Bank prices.

Lehman and Bear Stearns credit swaps traded as if their debt were rated four levels lower than their A1 rankings. High-yield, high-risk notes, or junk bonds, are rated below Baa3 at Moody’s and lower than BBB- at S&P.

More Bearish

Credit-default swap investors are more bearish than bondholders, data from Moody’s Market Implied Ratings service shows. As of Feb. 28, the bonds of Goldman and Morgan Stanley were trading as if the debt were rated a step below Moody’s official rating. Goldman has $171.6 billion in bonds outstanding, according to data compiled by Bloomberg. Morgan Stanley has $168.5 billion.

Last year was the best ever for the five biggest Wall Street firms, whose combined profit rose 33 percent to $132.5 billion.

Subprime mortgages, loans taken out by homebuyers with poor or limited credit histories, typically charge rates at least two or three percentage points above safer, so-called prime loans. They made up about a fifth of all new mortgages last year, according to the Washington-based Mortgage Bankers Association.

Subprime Turmoil

At least 20 lenders have shut down, scaled back or been sold this year. Countrywide Financial Corp., the biggest U.S. mortgage lender, yesterday said borrowers were at least 30 days past due at the end of last year on almost a fifth of the subprime loans that it serviced for others.

“There’s been a little bit of a reappraisal of the financial sector, with a strong desire to get away from subprime exposure,” said Scott MacDonald, director of research at Aladdin Capital Management LLC in Stamford, Connecticut, which manages $16.5 billion in assets.

What they are telling us here is that the signal has been given to start a severe recession. If the “financial sector” stops lending massive amounts of money to everyone (that’s what they mean by ‘getting away from subprime exposure’), the whole system will crash.

The web bot linguistic analysis folks at http://www.halfpasthuman.com/ deserve credit for predicting the exact date of the correction, February 27th. I also like their “rolling iceberg” metaphor:

Markets - Iceberg Rolls Over, Gold Floats on Debt

The [illusion] of (prosperity) that has propped up the Bush administration these last 6/six years is breaking up. Unlike previous market situations, our data suggests that no mere correction is underway, rather what is happening is akin to the [economic] and [financial] iceberg of the USofA rolling over. The vastly disparate ratio of wealth transfer these last few decades, which accelerated to gigantic proportions under the Bush decider-ship, and which has resulted in the top 1/one percentile of the populace controlling 99/ninety-nine percent of the wealth, is about to [flip] or roll over. As with real icebergs, the process is observable only at the point rolling begins, and by then it is way too late to react. As with real icebergs, it is entirely unequal distribution of ‘mass’ which results in the flip. As with really big icebergs, the actual flipping can take minutes.

The data suggests that the economy of the USofA based markets, and specifically all forms of [usofa dollar] associated debts are rolling over, and the actual visible signs of the roll will be apparent on February 27, 2007… The coming period of 8/eight days leading up to the Ides of March release period will also be presenting more [visible] (manifestations) of financial crumbling, but by that time, it is far too late to react to stem the process. In fact, as of this interpretation, ...alea jacta est/the die is cast. Start running now, just guess correctly as to which way the iceberg will roll.

As part of the [economic] degradation, soon to be exacerbated by political degradation, the populace of the USofA is going to have to endure a Spring of [employment] (crashes). The data sets are quite clear about the projection, and it is very dire. The data being interpreted has been showing up for over the last 6/six months and has been posted in previous ALTA report series.

The fundamental core of our modelspace is the replacement of words. These words are showing up in basically the same sorts of conversations about the same kinds of things, but the nature of the words used to discuss all this same-old at the same-old, is different. So as an instance, since early July (2006) the Markets entity has been moved through modelspace by the replacement values associated with words used to describe 2/two very large {linguistically, that is lots of verbiage’s on the internet} general areas. The dominant of these has been [housing], with the subordinate element being [instruments, paper/debt]. In this last area there are all the references to such things as stocks, bonds, derivatives, notes, et al. Further the lexicon for this group naturally contains references back to the other element [housing] just as within the [housing] lexical structure are supporting aspect/attributes which include [paper debt] and [note] references. This brief description is to provide a certain sense of the muddy nature of our interpretations. That is to say, the data sets are not usually very cleanly separated, and thus a certain amount of bleed-through on the interpretation will occur.

At this time the Markets entity is exhibiting what we have termed in the past "splitting behavior". We have seen this most frequently within the Bushista entity as the various layers of support feel away from the BushCo entity and subsequently the linguistic descriptor set was split or pared down to its current shape. Within the Markets entity, and specifically within the [usofa] sub set, a split of direction is becoming visible as the [housing] lexical element is now dropping below the neutral line. This occurs as a result of the summation of the emotional values associated with the words now linked to this [housing] aspect. As the summation drops past 0/zero and into the negative range, it has a tendency to drag down the entity as a whole by lowering the many related summations which compose an entities movement through modelspace. All that just as clear as crystal at the bottom of a lake on a cloudy day?

Well, here is the developing issue within the Markets entity. The [housing] sub set, a large sub set, is now dropping into negative territory, and this is JUST as the [paper debt] sub set is roaring along on a [stressed] (run up/climb). Further, the [housing] section of the data set is larger than the total [paper debt] sub set in several key ways within our modelspace. The data sets and processing that we use tend to put humans first over information. So the emotional component of [housing] in the real world will be several orders of magnitude more impacting than that of [stocks/bonds/et al] since more humans have houses than ‘own’ paper debt…

None of what’s happening should come as any surprise. Now we at least have a date for when it all happened.