Signs of the Economic Apocalypse, 8-25-08

From SOTT.nethttp://www.sott.net/

Gold closed at 828.10 dollars an ounce Friday, up 4.6% from $791.70 for the week. The dollar closed at 0.6769 euros Friday, down 0.7% from 0.6813 at the close of the previous week. That put the euro at 1.4774 dollars compared to 1.4677 the week before. Gold in euros would be 560.51 euros an ounce, up 3.9% from 539.42 at the close of the previous Friday. Oil closed at 114.57 dollars a barrel Friday, up 0.8% from $113.71 the week before. Oil in euros would be 77.55 euros a barrel, up 0.1% from 77.47 for the week. The gold/oil ratio closed at 7.23 Friday, up 3.9% from 6.96 at the end of the week before. In U.S. stocks, the Dow closed at 11,628.06 Friday, down 0.3% from 11,659.90 at the close of the previous Friday. The NASDAQ closed at 2,414.71 Friday, down 1.6% from 2,452.52 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.87% Friday, up three basis points from 3.84 for the week.

Gold recovered last week, rising almost 5% against the dollar, but it’s still a long way off its peak of $1000 an ounce. The euro stabilized as well, gaining a bit against the dollar after losing ground over the last few weeks. Movements in the price of gold have been hard to explain lately. Some of that is due to gold’s dual role as both a commodity and a currency. There also seems to be a divergence between real gold and paper gold lately. As gold prices dipped below $800 an ounce, it suddenly became hard to find real gold coins at near that price.

George Ure suggests that that is due to the bifurcation between real gold and paper gold:

Metals Markets Splitting?

Monday August 18, 2008

Gold and silver are up a little bit today, but not enough to explain some reader reports. Readers have been sending in all kinds of notes about the "odd behavior" of the precious metals. Here's one..

"George,

Unexpected consequences?

It's very interesting to witness supply-demand dueling with market price in the metals complex. Friday, I decided enough was enough, and went to the local dealer, intending to buy some bullion. Where in past I'd buy silver bars, now, I generally buy rounds, thinking it'd be easier to exchange for value when the spam hits the air-circulation device.

As I walked in the door, the fella was literally pulling boxes of silver out of his display cases. The place was otherwise pretty empty. We made some small talk about how clever he must have been to reduce stock at the recent high. Later it came out he, and other dealers in his network, just weren't going to sell at the depressed levels!

I have been trying to buy 2008 silver eagles (for gifts) since spot was at $18. He, the dealer, further explained if someone wanted to buy so the dealer was "right side up" trades might happen, otherwise no. I reminded about wanting the eagles for gifts, and would pay what was needed to get them. No joy.

Out of curiosity I checked eBay, same-same, no eagles. Non numismatics are also being pulled. When I saw the red announcement on Kitco the scene cleared. No one is selling. Sure, Kitco needs to keep taking orders, but metals dealers, like a gas station owner who filled tanks when oil was 147, won't sell at prices that lose money.

So, what's an ounce of silver worth? Is it $12? $13? Or, is it whatever it takes to get someone to sell? Might metals markets freeze up like credit markets? In past I'd have said no. Right now, evidence says yes.

What do you make of it ... and might this apply equally to other commodities?

A click over to the Kitco website this morning brings up this curious note at the top of their page:

"IMPORTANT NEW NOTICE: Due to market volatility and higher demand in the entire industry, we are anticipating delays in supply of all bullion products. Please note that you can continue to place orders and prices will be guaranteed; however, cancellation fees will still be applicable regardless of the length of the delay. Consequently once inventory is received there may also be delays in processing and shipping by our vaults. "

But wait! How can this all be?

Here's what I think is going on.

You know those gold and silver ETF's? What if - and this is only an if - they really don't have all the hard physical assets that their pieces of paper might attest to? What if they just have some actual physical and the rest is paper promising future deliveries? And further supposed this market is hedged six ways to Sunday.

Would that account for a momentary distortion where supply is heading toward unavailable and yet at the same time, price has also be collapsing? This flies right in the fact of economic reality. Something is truly amiss here.

And then there's the report last week that the US Mint was suspending sales of Gold American Eagles.

Now here's the curious thing: I went to the US Mint site this morning and wanted to see if they would sell a one ounce Gold Eagle. Yup, they will. But the price for an uncirculated 2008 Gold Eagle is not anywhere near spot ($790). They are asking $1,119.95 for a one ounce coin.

A few other savvy financial writers are onto this - and I would draw your attention to Jason Hommel's piece posted over at Gold Eagle titled "Why Paper Silver is not as good as Physical Silver" as a fine example.

My "best guess" is that we are seeing a bifurcated market develop where on the one hand we're seeing a physical market develop and the almost separate paper market for silver & gold related instruments. The predictive linguistics team doesn't think it will pop for a while yet, but what happens when the public realizes that the gold and silver ETF's are shown to be paper-trading exercises and not backed by physical? And investors figure that what they thought was actually backed by physical is just another paper abstraction and like so many others, is being hedged/disconnected from reality of the marketplace?

…I called my friend who manages a whole pile of money expecting him to have some keen insight - the kind that comes from pushing 9-places left of the decimal point around. His answer - which I'll paraphrase loosely - went something like this:

"What's happening is that the price of the metal at retail has little to do with the exchange prices of silver because the physical is such a small part of the market.

In other words, the physical price is being swamped by the financial price. Sure, you can see shortages of physical, but that's such a tiny piece of the LEVERAGE game that it's almost insignificant."

Oh, oh. I'm starting to 'get it'. As long as there's enough paper in play, we can have a complete disconnect from physical prices.

Now that I think about it, I can see why. If a tracking fund has no convertibility for the small players, it becomes almost like walking up to a craps game in progress on the sidewalk where the stakes are physical silver, and then starting to trade shares based on valuation of the stakes in the craps game, and then to top it off, you convince yourself that you own silver, even though in order to get into the convertibility part of the game, you need 50,000 shares, to be authorized by the players, be a registered broker-dealer, participate in DTC and be able to deliver or accept silver in a London vault.

If you think that's crazy, perhaps you haven't been watching metals prices.

Mike Whitney weighed in on both the drop in gold prices and the rise of the dollar.

The Incredibly Shrinking Dollar? Think Again ... Greenback Surges, Euro Shrivels

Mike Whitney

August 20, 2008

The greenback has surged 6 per cent in the last month alone. The euro, on the other hand, has been caught in the same recessionary downdraft that is buffeting a number of other currencies, all of which are unwinding at the same time although unevenly. Currency markets don't move in straight lines, but don't be fooled, most paper money is steadily losing value due to the unprecedented expansion of credit. Investors are moving to cash and hunkering down; the stock and bond markets are just too risky and real estate is in a shambles. As the equity bubble continues to lose gas, balance sheets will have to be mended and lending will slow to a crawl. At present, Germany's slowdown and Spain's housing crash are drawing most of the attention but, the spotlight is shifting fast. Next week it could be shining down on the America's failing banking system or poor corporate-earnings reports in the US. Then it will be the dollar marching off to the gallows.

Europe's troubles have put to rest to idea that other countries can "decouple" from the US and prosper without the help of the US consumer. That might be true in the long-term, but falling demand is already visible everywhere. Retail and auto sales are taking a thumping and 2009 is shaping up to be even tougher. It's looking more and more like the Europeon Central Bank was faked-out by the early signs of inflation and missed the deflationary sledgehammer that was about to come crashing down. It was a catastrophic blunder by European Central Bank (ECB) chief Jean Claude Trichet and it could cost him his job. Raising interest rates while sliding into the jaws of recession is madness. Now all of Europe is headed for a hard landing and there's no way to soften the blow. The ECB doesn't have the same tools as the Fed; Trichet can't simply backstop the whole system with green paper and T-Bills like Bernanke. He can either slash rates or sit on his hands and hope for the best.

Deficits are expected to soar in the European south (particularly Spain, Greece and Italy) while growth in the industrial north, e.g., Germany, will continue to shrink. Also, Spain, Ireland and England are undergoing the biggest housing meltdown in history after indulging in the same mortgage hanky-panky that took place in the US. Billions of dollars of low interest loans, that were issued to unqualified mortgage applicants, are gumming up the whole system and sending foreclosures skyrocketing.

Now the losses have to be written down and thousands of unoccupied houses sold at auction. The perception that the dollar is getting stronger is mostly an illusion. Deflation is "dollar positive" because investors who flee from toxic assets naturally move into cash. But that doesn't mean they have faith in the dollar; far from it. The fundamentals for the greenback get worse by the day. Fiscal and trade deficits are out of control, the national debt is tipping $10 trillion, foreign investment is drying up, and confidence in US leadership has never been lower. Paper currency is a country's IOU; and foreign central banks are wary of taking checks from a country that no longer wins wars or has the capacity to pay off its debts. That's why, for the first time, there's serious talk about the US losing its triple A rating on government debt. And it could happen sooner than anyone thinks. Every time the Fed uses the dollar to prop up the faltering banking system or provide limitless capital for defunct GSEs like Fannie Mae and Freddie Mac, the dollar comes under greater and greater pressure.

As the US housing market continues to collapse, trillions of dollars in equity and credit are disappearing in a deflationary bonfire. When a $400,000 home--with no down payment and negative equity--goes into foreclosure; $400,000 vanishes from the digital-pool of credit and has to be written down as a loss. So far, much of the losses have not yet been accounted for because the banks are using their own internal models for determining the value of their downgraded assets. Two weeks ago, Merrill Lynch sold $30 billion of mortgage-backed junk for 20 cents on the dollar. But they also financed the deal, which means that they really only got 5 cents on the dollar! This reflects the true "market value" of these assets. They are virtually worthless. Naturally, Merrill's sale sent tremors through Wall Street where banks and other financial institutions are sitting on trillions of dollars of this garbage marking it down at a few percentage points every reporting period rather than doing what Merrill did and putting it all behind them. As a result, the banks have less capital to lend, which means economic activity will continue to slow and the country will go into a deep recession. The point is, that the Federal Reserve now holds about $400 billion of this junk-paper on their balance sheets and the US Treasury is planning to take on hundreds of billions more (perhaps as mush as $800 billion more under the new legislation!) to prop up Fannie Mae and Freddie Mac. The Bush administration is using the credibility of the dollar as collateral in its plan to bail out the most reckless, high-stakes Wall Street gamblers.

So, how does this affect the dollar?

The nation's debts are entirely balanced atop its currency. The greenback is like a circus strongman holding a barbell precariously over his head; as the weight is increased, the sweat begins to appear on his brow while the veins in his neck and forehead begin to bulge. Finally, the knees buckle and the and the over-matched weightlifter crashes to the canvas in a heap. That's the future of the dollar in a nutshell.

But how does that explain the sudden fall in gold prices; after all, gold is the logical alternative to paper money, right?

Wrong. Gold is "real money" alright, but it's also a commodity. And when commodities are smashed by a deflationary tidal wave--as they have been the last few weeks-- gold will follow them into the basement. In truth, gold has taken an even worse pasting than the euro; free-falling from $980 per ounce in mid-July to $786 at Friday's market close. $194 in a month.

When the economy is in the grips of deflation; all asset-classes get dragged down, gold included. Many of the hedge funds and other big market players are selling their gold positions recognizing that the commodities boom is over and it's time to move on. That doesn't mean that gold won't rebound sharply when Bernanke slashes rates or if Bush blows up some new part of the globe. It simply means that in the short term, "cash is king". Pension funds and hedge funds will continue to deleverage to reduce their credit exposure to put themselves in a better position to roll over their debt. That means that gold's slide could last a while. This doesn't look like a conspiracy to me, but I have my tin-foil hat in hand just in case.

No one knows where the bottom is for gold, but one thing is certain; its future prospects are a lot brighter than the dollar's. The Bush administration has yet to demonstrate that it can enforce Dollar Hegemony via military intervention. That is a very big deal indeed. If the dollar isn't backed by Middle East oil, then the $6 trillion stockpile of dollars and dollar-denominated assets that are languishing in foreign central banks and sovereign wealth funds, will continue to dwindle until the dollar's position as "reserve currency" comes to an end.

That's one doomsday scenario, but there is another one, too. If Bernanke and Paulson continue to pile all of the nation's credit problems (bad paper) on top of the greenback; foreign capital will head for the exits and the dollar will crash. Either way, the dollar's troubles are mounting and something's got to give.

Meanwhile, the troubles of Fannie Mae and Freddie Mac, the two government-sponsored mortgage companies, continued last week as their bond ratings were lowered.

Moody's ratings cut latest blow to Fannie, Freddie

Lynn Adler

NEW YORK (Reuters) - A major credit rating agency cut the preferred share rating on Fannie Mae and Freddie Mac amid mounting concern about the ability of the two largest U.S. home funding providers to access capital, in the latest blow before a widely expected government bailout.

Early in the day, influential stock market investor Warren Buffett told CNBC there is a "reasonable chance" that Fannie Mae and Freddie Mac stock will get wiped out in a government rescue, reflecting market sentiment that has slammed the companies' shares toward 20-year lows this week. The shares closed mixed on Friday.

In the ratings cut, Moody's Investors Service cited concern that market turmoil has hurt the mortgage finance giants' ability to get fresh capital. Moody's made a ratings adjustment that suggests a greater likelihood the government sponsored enterprises, called GSEs, will need "extraordinary financial assistance" from the government or shareholders.

"Given recent market movement, Moody's believes these firms currently have limited access to common and preferred equity capital at economically attractive terms," Moody's analysts said.

Many analysts expect the government will have to exercise new abilities to recapitalize the companies, effectively nationalizing them. Those worries yanked their stock closer to zero this week from more than $65 a year ago.

Fannie Mae shares rose 2 percent to $4.98 while Freddie Mac stock dropped 4 percent to $3.03. Freddie's shares had fallen about 20 percent at one point on Friday.

A source familiar with Treasury's thinking said on Friday that any backstop would aim to keep the shareholder-owned status of these GSEs, erasing sharper earlier losses.

The debt these companies issue to fund their mortgage purchases benefited, in contrast, from the view that a federal rescue assures repayment for bonds even if not for shareholders. Fannie and Freddie own or back nearly half of all outstanding U.S. mortgages.

"The institutions are too big to fail and the government needs them operating," said Jeff Given, portfolio manager at MFC Global Investment Management in Boston. "It's the only part of the mortgage market that's even remotely working right now.

"At the end of the day probably the U.S. government's going to come in," he added. "I wouldn't want to be a preferred share owner or a common stock owner, but if you own the debt or the MBS you're going to be okay…"

Fannie Mae and Freddie Mac were set up to serve the public interest by making mortgages more available to those wanting to buy houses. In a process of corruption followed in many areas, they ended up being little more than a way for insiders to steal money. The financial press won’t put things so bluntly, so we will have to turn to the pro football columnist for the sports news site ESPN (and Brookings Fellow), Gregg Easterbrook:

Government Policy Rewards CEO Lying, So We Get More of It

Increasingly Fannie Mae and Freddie Mac are looking like little more than devices to transfer money from the pockets of taxpayers to the pockets of Fannie and Freddie senior executives. Former Fannie Mae boss Franklin Raines paid himself about $50 million for years in which, we now know, the company lied about its earnings in order to inflate executive bonuses, while management was playing fast and loose with other people's money. Beginning in 2007, Fannie Mae and Freddie Mac went off the cliff, their stocks plummeting to less than 20 percent of their previous values, and taxpayers were put on the hook as guarantors of the firms' bad management decisions. The Congressional Budget Office estimates the Mae-Mac debacle will cost taxpayers $100 billion or more. Yet Freddie Mac CEO Richard Syron was paid $14.5 million for 2007, including a $2.2 million "performance bonus." Syron has taken home $38 million total from Freddie in the past five years. Fannie Mae CEO Daniel Mudd got $14.2 million for 2007, plus a substantial prepaid life insurance policy and other perks including "financial counseling, an executive health program and dining services," the Washington Post reported. Hey, $49,000-a-year median U.S. households, you are being taxed for millionaire Mudd's "dining services." Bon appetite.

Executives receiving very high pay justify their deals on two grounds: that they are risk-takers in high-pressure situations, and that they have valuable expertise. Now we know that no one at the top of Fannie Mae and Freddie Mac took any personal risks -- everything was federally guaranteed, and all mistakes billed to the taxpayer. Here, the New York Times reports that Syron was repeatedly warned in 2004 that the organization was taking on bad loans, and did nothing. Syron justified his inaction by complaining to the Times that he was under pressure from various Fannie constituents. That's why he was paid so much, to take the heat! Yet he took no heat, rather, devoted himself to avoiding responsibility. If things go well, executives are lavished with money and praised as risk-takers. If things go poorly, executives are lavished with money and blame others.

And just what incredible expertise do Syron and Mudd possess? They made billion-dollar blunder after billion-dollar blunder; they failed to realize things as basic as buyers borrowing without documentation of income may not be able to repay loans. People chosen at random from the phone book could hardly have performed worse. Yet the federal bail-out legislation just signed by George W. Bush does not require them to give back any of their ill-gotten gains.

This is the core lesson of CEO overpay scandals: The corrupt or incompetent executive always keeps the money. He may be caught and embarrassed by bad press, but he keeps the money while someone else -- shareholders, taxpayers, workers -- is punished. Raines recently settled a federal legal complaint by agreeing to return about $3 million of his $50 million, but kept the rest; his employment contract was worded such that even if he was malfeasant, whatever he took from company coffers was his. Hilariously, federal prosecutors claimed victory because Raines "surrendered" to the government a large block of stock options -- options now worthless, owing to the Fannie Mae decline Raines helped set in motion by lying about Fannie numbers. Until Congress enacts a law that allows money taken by corrupt or incompetent executives to be recovered, the lying will continue. Lying by CEOs is what society rewards!

Why does Congress tolerate the swindle aspect of Fannie and Freddie? For the standard reason: Congress is on the take. Here, Lisa Lerer of Politico reports that in the past decade, Fannie and Freddie spent almost $200 million on campaign donations to Congress and on lobbying members of Congress, some of the lobbying money going to former members. This year, for instance, Fannie gave the legal max of $10,000 to Speaker of the House Nancy Pelosi and to Republican House Whip Roy Blunt, neither of whom face meaningful re-election challenge. As for costly lobbying, the implied deal is: Don't rock the boat while in office and someday you too will be a former member getting easy money to lobby former colleagues. During Senate debate on the Mae-Mac bailout, Majority Leader Harry Reid refused to permit a vote on an amendment that would have barred Fannie and Freddie from giving money to members of Congress. Reid did not merely oppose the measure, he refused to allow the Senate to vote on it -- so that members of Congress could remain on the take, without having to go on record about the matter.

Now that taxpayers are covering Fannie and Freddie's cooked books, the $200 million diverted to Congress in effect came from average Americans, forcibly removed from their pockets -- and thanks to Senator Reid, more will be forcibly taken from your pocket and placed into the accounts of senators and representatives. This is what TMQ calls a Sliver Strategy. The Sliver Strategy is a means to disguise embezzlement. Congress looked the other way while Fannie and Freddie approved vast amounts of bad debt, in order to shave off a sliver for itself -- in this case, the $200 million in lobbying and donations. Had Congress simply awarded itself $200 million, editorialists would have been outraged. Because the money was slipped in to a larger fiasco of much greater sums wasted, Congress got away with it.

The problem is that when such corruption becomes the norm, when it seems normal, it becomes hard to even imagine a state of affairs where such things are not tolerated. The will of the public to oppose these practices then becomes enfeebled, allowing more corruption which further weakens any healthy opposition, and so on.