Dan’s Blog

Danger Will Robinson

Dan Calandro - Sunday, September 28, 2014

It’s so easy to beat a dead horse. I mean, we can rehash the turmoil in the Middle East and President Obama’s foreign policy failures; we can beat the drum about lackluster global demand and zero growth economies, or we emphasize that point by highlighting the fact that China’s production posted the weakest quarter since the doldrums of the "financial crisis;" or we can lament about the paralyzed status of the U.S. government, the monetary ponzi scheme it has concocted, or its irresponsible fiscal dynamic. Indeed, we can talk about all of that, again, in the same way. 

Or we can approach the market condition from a different angle.  I was drawn to a recent Wall Street Journal headline, Fed to Hit Biggest U.S. Banks with Tougher Capital Surcharge. Isn’t this ironic, I thought, especially when considering that U.S. banks have been flooded with trillions of dollars of new capital since 2008 and have yet to do with the money what it was intended to do – to be lent to small and midsized U.S. companies to get the economy going. Because of this inaction, one would logically expect banks to have plenty of capital reserves lying around. But apparently that’s not the case, for if they did the Fed wouldn’t have to enact a "charge" on them to encourage larger capital reserves (less lending).

That is to say that Dodd-Frank has done nothing to correct bank practices that led companies "too big to fail" to fail. That is also to say that large U.S. banks continue to do the things that led to the last major financial meltdown.

To combat this poor state of regulatory policy, the Federal Reserve will enact the reserve charge to force U.S. banks to keep more capital on hand (and thus to lend less) to cover future and inevitable losses. The hope here is to avoid blatant taxpayer funded bailouts – because as we know, QE is a discreet way of doing just that – bailing-out banks.

Consider this…

It is common knowledge that the Federal Reserve is currently weighing its options and alternatives to exit QE, a long overdue event. To do so the Fed will have to tighten money and raise interest rates. Economic data, produced by the government mind you, is showing signs of "strength" – unemployment is "down"; economic growth, though weak and uneven, is "stable"; world governance is strained but not yet "failing"; and the U.S. dollar appears to be "strengthening." And though the Federal Reserve has pointed to an interest rate raise hike in 2015, the aforementioned data points are forcing a debate within the Fed to move sooner. 

Rates usually rise in advance of a rate hike, but bond yields are low and falling. The 10 year yield is just 2.5%. Below is a year-to-date picture of investment activity. Stocks are up 2% and yields are down 17%; gold, after being as high as +14%, is now up just 1% for the year. Chart below.

9-26-14a

Yields are down because institutional investors are scared. The economy is weak and the stock market remains over-heated and near all-time highs. And so grows a sentiment that U.S. bonds, and to be fair German bonds, are "safer than gold." In other words, investors would rather invest in government debt than commodities at the present time. This temporary dynamic will only last as long as inflation is low and governments remain stable and solvent.

In a nutshell, a flight to "safety" is causing bond yields to fall and a false sense of strength in the currency market is causing gold to move lower. Both are market anomalies. Currency isn’t strong and bonds are loaded with valuation risk, as yields can only move higher from here (a condition that causes bond values to fall).

Owning gold may not look like a "smart" move right now because so many extreme anomalies exist in the markets today. But that’s not why investors own gold. Investors own gold now because they accurately see what’s going on in the markets today, and because they want a hedge to the stock market when it takes a nosedive.

Again, hedging is about having an allocation in an asset class that normally runs in a contrary direction as the portfolio’s core holding. In other words, the hedging asset must increase when the other falls, and vice versa. The hedge now, against stocks and bonds, is gold because gold should fall when stocks are up, and vice versa. That is the current market dynamic. 

The easiest way to tolerate a falling gold position is to appreciate that it should be falling because the stock trend is rising. This can be seen much clearer in a longer view of the markets. In the last two-plus years the Dow Average is up 14%, 15-51 strength is up 21%, and gold is down 8%. See below.

9-26-14b

Again, when stocks go up gold should go down, and vice versa.

Now, I totally understand that it’s easy for new investors to think that there will never be another severe correction, another great opportunity to buy low – and that gold is a dead asset. But if another significant correction doesn’t happen sometime in the near future it will be the first time in history it hasn’t happened. Markets go up and down all the time; and more times than not they trade well above or below "fair value." Corrections are part of the game. It’s the nature of the beast.

QE has tightly tied the performance of gold to the stock market because the rise in stocks has been driven by the new money it has infused into "the market" – it’s a QE boom. So when stock values fall due to a tightening of money, gold will rise because tighter money does not automatically produce stronger money – because the underlying economy is weak.

Higher interest rates do not produce strong economies or currencies. That’s a false conclusion being made in the markets today. Instead, strong economies produce strong currencies and higher interest rates are a byproduct of that dynamic. Not the other way around.

Independent investors must guard against getting caught up in the dogma that this is a new "paradigm" where major market corrections aren’t possible, that gold has little value and profit potential, and that rapidly rising stock market values which in no way correlate to economic activity are totally legitimate. That’s a costly misnomer.

Based on current Market conditions and a rational market the Dow should be trading around 13,000 and gold should be about $2,000 an ounce. But logic is nonexistent in today’s investment markets.  

In today’s market a few things are clear: the upward movements in the stock market have slowed down significantly, the trading range is tighter, and new highs are obtained more tepidly. That’s because traders know how toppy this market is. And that’s why they’re scared and moving to Treasuries.

Gold is currently $1,200 an ounce, but if markets and currencies were as strong as some are programmed to suggest, it would be trading much lower than that, perhaps half the going rate; and yields would be much higher, perhaps twice their current level. 

Asset allocation is always key; patience is a virtue, and discipline is the bridge between goals and accomplishment - (Jim Rohn).

You should know that this is a dysfunctional market driven by easy money, irresponsible government spending and corrupt management; not economic wherewithal.  

And believing otherwise is where the danger is, Will Robinson. 

Stay tuned…

Shield The road to financial independence.™

Programmed Trading

Dan Calandro - Sunday, September 07, 2014

Gold lost more than a point last week when news broke the U.S. dollar had hit fresh new highs against the Euro and Japanese Yen. That was on the first trading session of the week, a day when gold lost 1.8%. Remember, the U.S. is the world’s reserve currency, and when currency is strong gold is weak.

Adding to the false impression of a strong currency market was the "raft of improving U.S. economic data" many media outlets were reporting. They cited improving consumer confidence and a bettering condition for labor and employment. Again, this news broke on the first day back from the Labor Day holiday, Tuesday, September 2, 2014.

Institutional investors that are programmed to trade on the newest news place trades according to logarithmic formulae. When the value of the Yen and Euro fall against the dollar the trade goes in: buy the dollar and sell gold; sell bonds and buy stocks, because a stronger currency indicates economic strength and increasing profit for enterprise. That’s why yields reversed course and rose 5.2% last week. See below. 

9-5-14

Logarithmic trades are performed by machines without hearts, eyes or ears. Everything is a number, and every situation can be defined in a series of 0’s and 1’s. But the language of computers, binary code, is not intuitive. It must be fed information by people, and that’s where the corruption begins. 

Information inserted to trading platforms is an instruction to act. But if the data never gets there – say, if it isn’t entered into a system to be considered – trading goes on as if the condition doesn’t exist. The computer, without a free and intuitive mind of its own, simply doesn’t know a new fundamental has been made available, and so it conducts no trade to compensate for the new condition. 

At eight-thirty in the morning on Friday, September 5, 2014, just three days after news broke about the "strengthening" U.S. dollar, the Bureau of Labor Statistics released is most recent jobs report - and it was awful. Employers added just 142,000 jobs in August, and numbers for July were revised down by 28,000 jobs. Through July employers had averaged just 226,000 jobs per month, a pathetic amount by any account, and well below what is required to truly correct the course of economic output. One would think this negative employment fundamental, a reoccurring theme in this "recovery", would have been considered during trading hours on Friday, September 5.—But no, stocks ended higher on the day. 

Perhaps the Wall Street establishment cut the Friday workday to instead head to the Hamptons for a little more R&R; maybe they spent the day at the golf club; or maybe they arrived to work late only to skip out early to a liquid lunch that consumed the rest of their day – whatever the case, the newest employment data was never automatically fed into their trading system for the shortened week of September 5.

That’s hard to fathom, isn’t it? – especially when considering that Wall Street brokers are always the first to preach that a team of dedicated people monitoring every piece of information every second of the day is required to invest successfully.

They clearly don’t practice what they preach. Look at my shocked face. 

More sadly, however, is that the Wall Street establishment is just as robotic as their programmed trading logarithms; and like computers, they too don’t have a heart, clear eyes or keen ears.

Wall Street players select and direct what information is considered for daily trading, and when. Their motives are geared to fortify their agendas - not the true market narrative, or what's in the best interests of their clients. But there’s no reason to be confused or misled.

Employment gains during economic booms normally average 500,000 per month. America hasn’t come close to that during the whole "recovery" – even though the stock market is indicating a boom greater than that of the internet driven tech-boom. While 226,000 job additions per month is bad enough, a 35% drop from that in August should have certainly caused the stock market to reverse the course of "stronger dollar" gains reaped earlier in the week. It should have been automatic, or should I say, programmed to be automatic.  

Point number one: stock market trading is choreographed by Wall Street players and manipulated through large institutional investors; always has been, always will be.

Point number two: just because markets move on news doesn’t make the news, or the move, valid. Consider this…

The Euro Zone has been a chaotic mess that has been well chronicled in these blogs. Adding to its sordid history, European Central Bank chief, Mario Draghi, recently launched a QE effort and surprised the region by cutting lending rates again (to .05%) and placed a charge (.20%) on deposits. That is to say lenders won’t receive interest income as usual on deposits they hold; instead they will be charged interest expense for the cash they keep on hand. This is a move to encourage banks to lend, and to penalize them if they don’t.

The EU needs banks to start lending so enterprise can grow and expand. But lower interest rates won’t do this, nor will a charge on deposits. No one wants to borrow money over there because enterprise doesn’t see a worthwhile return on investment. Monetary policy can’t fix that.

Levels of investment and lending are at all-time lows in Europe because the EU’s economy is dying a slow death due to massive government regulations, poor fiscal policy and incompetent management, and extraordinarily high taxes. As a result, their currency should be falling against the U.S. dollar.

Japanese Prime Minister Abe followed the U.S. lead and adopted easy money policies to make their currency more competitive in a devaluing world. The Yen was too strong, and their goods were too expensive in overseas markets like the U.S., the Euro Zone, and China. This, of course, was Abe’s intention when his government employed easy money policies. So it should be no surprise that the Yen is falling as compared to the U.S. dollar. That’s what Japan was trying to do. 

But this dynamic does not make for a strong currency market, or a strong U.S. dollar. Monetary strength cannot be derived from currency devaluation. Instead, monetary strength is derived from vibrant economies. And unfortunately there aren’t many of those in today’s world market.

News of a strengthening U.S. dollar is misplaced. Ditto to last weeks moves in gold and yields.

In fact, the only way investors can mistake a monetary race to the bottom as strength is to be blindly programmed like the binary code of an unseeing, unhearing, heartless machine.

Conditions remain ripe for gold and a significant correction in stocks.

Stay tuned…

 ShieldThe road to financial independence.™

Their Side

Dan Calandro - Monday, September 01, 2014

The S&P 500 closed the month at another all-time high, ending over 2,000 points for the first time in its history. The Dow Jones Industrial Average and the 15-51 strength indicator also remain extremely elevated, though a shade off their respective all-time highs. Stocks are still hot, no doubt – and so are bonds.

Yields continue to fall. The ten year U.S. Treasury is now at just 2.34%; and in a recent auction across the pond Germany sold $5 billion of two year bonds at zero percent. This dynamic (falling yields and rising bond values) indicates economic weakness. That’s a different picture from the stock market, where its high and rising stock prices are indicating economic strength.

Which is telling the right story?

Truth be told, the global economy is flat. The entire Euro Zone (a collection of markets that place it as the world’s second largest economy) reported zero growth in the most recent quarter; and Germany, its largest economic component, contracted in the quarter.

While it is true that the world’s largest economy posted a "strong" second quarter (4% annualized growth), America’s first quarter performance was dismal (-3% annualized contraction). This is not to mention that early indications for third quarter market activity aren’t so good: July retail sales were flat and consumer spending declined. All of this puts the U.S. economy on pace to grow at best 1% for this year – a no-growth condition.

And then there is escalating global strife. Russia stepped up its aggression in the Ukraine and according to President Obama the U.S. has "no plan" to counter global terror threat, ISIS, who is destabilizing the entire Middle Eastern region – you know, where much of the world’s oil supply resides. Those two aggressions, Russia and ISIS, threaten the top two economies through energy price and supply instability.

Bonds indicate this peril (yields are down 15% in the most recent twelve months) but stocks seem not to care. The Dow Average is up 15% in the same time and 15-51 Strength has gained 18%. See below.

8-29a

Among other things, falling yields signify an increase in demand for them. With rates as low as these, and by lending money to "safe" governments like Germany and the U.S., the message investors are sending is that their appetite for risk is mute and principal protection is more important than return on investment. Why else would investors flock to the safety of low yield bonds while the stock market has been gaining 15% per year for three years running?  See below.

8-29b

The stock market looks strong, but as the bond market shows, many investors have little confidence in it. The reason for that is simple.

Massive regulations and taxes strangle an economy. Global strife closes some markets, threatens others, and extorts still more. All of this leads to a higher tax environment and minimizes room for free-markets to operate and profit – which is a goal, of course, of central government planners and social justice advocates. To them, and to terrorists, the free-market is a common enemy.

The problem with fiscal "stimulus" and burgeoning social welfare is that they’re short-term in nature and do nothing to expand the Market, freedom, and prosperity. For instance, when roads are repaired the economy temporarily expands by the amount of labor and materials used during the process. However, once the project is completed the economy shrinks by the same amount. Indeed, the process can be repeated again and again to artificially inflate an economy; but the results will always be the same: a short-term burst of economic activity.

The same can be said for irresponsible expansions of social welfare programs like food stamps, subsidized housing, healthcare, and unemployment. Indeed, this may increase money available to circulate in the economy; but it creates dependence, minimizes the market to need-based spending, corrupts pricing, and lasts only as long as the next congressional budget. Social welfare programs take hard earned dollars from free people against their will and places it in the hands of others according to the political agenda of central government planners. These actions control, manipulate, and corrupt free markets while incubating an environment of higher taxes and tariffs.

By taxing producers to benefit takers (i.e. central government planners and social welfare recipients), the government limits the amount of capital available to expand Markets. This diminishes the free-market and expands the authority of central government planners with corrupt agendas. (PS: Approximately 40% of Americans are now on some form of social welfare.)    

Terrorists like ISIS take control of markets through force. They seize oil fields, airports and rights of passage, and private property; then through a central hierarchy of government dictate what products can be produced, sold, and distributed – to whom, when, and in what quantity. They excessively tax the populous under their control and dictate market growth and wealth redistribution according to their political agenda – a complete diversion from free market principles.

Central government planning, in any form, is too corrupt, political, and inefficient to have a dominant role in a robust economy. For proof of this follow the money…

The Federal Reserve’s quantitative easing (QE) program, for instance, was a multi-trillion dollar effort – a dominant position in the financial marketplace. Its purpose was to keep interest rates at historic lows to incentivize borrowing and robust market expansion (a demand-side approach). As usual, success again eluded them.

Simply put: the Fed printed new money and handed it to Wall Street banks under the condition that half the money had to be used to finance central government deficit (U.S. Treasury securities); the other half could be used any-which-way.

In practice we have seen the central government get their dominant share (the national deficit is now $9+ trillion higher and the economy hasn’t moved), and the other half went God knows where. However, one thing is for sure: it never got down to small U.S. businesses and entrepreneurs (see: Small Business Lending is Slow to Recover, Wall Street Journal on-line, 8/17/2014).

Free markets are where prosperity resides. Long-term growth is derived from new businesses, new products and service lines, and a vibrant consumer base – all of which require money (capital) and freedom. Entrepreneurs, free from government intervention, are the most effective and efficient investors in new ventures that add long term employment. But they haven’t been able to get the money during this "recovery." Why?

Interest rates were too low and provided too little incentive for Wall Street banks to supply debt to small American businesses; so they looked overseas for higher yields (see: Your Money and Argentina). Fortification of this point arrived just today, September 1, 2014, as news broke that Goldman Sachs lent $835 million to Portuguese lender, Banco Espirito Santo, just one month before it failed (see: Too Little Room). It was a desperate attempt at realizing higher yields, which is what happens when central planners look at only one side of the market equation (in this case, the demand side.)

The Fed’s low yield policy hasn’t helped American business, the American people, or the American market. One can only wonder: What are they really trying to do?   

Consider that Wall Street banks are currently lobbying the Federal Reserve to delay a portion of the Dodd-Frank financial regulation called the Volker Rule, which limits the amount of money Wall Street banks can invest in high-risk private equity ventures. This portion of Dodd-Frank is good. Why should Wall Street banks have the freedom to invest in high risk ventures when they can get bailed-out by taxpayers should those investment go bad? – And let’s face it, much of that money came from the Federal Reserve via QE. That’s not their money, it’s ours: We the People.

Shame on the Fed if they cave. 

But the chess match of corruption between the government and Wall Street runs much deeper than misplaced money. On August 12, 2014, two stories crossed the Wall Street Journal wires: SEC Launches Examination of Alternative Mutual Funds, and Banks Retreat from Market That Keeps Cash Flowing. Isn’t that interesting? One government agency is investigating "alternative" mutual funds sold by Wall Street for possible criminal action, and in retaliation thereof, the Wall Street establishment is abandoning another government agency’s "alternative" investment tool to keep interest rates low – the Federal Reserve’s reverse repo (see: QE Forcing Fed’s Hand).

In any event, the Federal Reserve won’t be happy about Wall Street’s stance on the repo; they feel they need the repo market to unwind QE.

In a similar vein, and because QE is ending, the Wall Street establishment feels they need to sidestep the Volker Rule to unwind more high risk investments. Remember, under QE the Wall Street establishment sold "toxic" investments to the Federal Reserve in exchange for the newly printed money.

So a deal between the two villains will most likely be struck. They need each other. And it doesn’t matter if their action goes against the best interests of the American People, again. 

That’s how big government central planning is bad for We the People. They only look at one side of the equation.

Theirs.

Stay tuned...   

ShieldThe road to financial independence.™


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