If there is one thing I’ve learned in my years of watching over the gold (GLD) and equity markets since Ben Bernanke took over as Chairman of the FOMC it is to ignore nearly everything said and focus on the reaction by the markets. Wednesday’s statement contained nothing at all worth remembering no less reacting to but the markets have reacted badly to this nothingness as if it is the end of the Fed’s coming to its rescue. So, what does this mean for gold?
In the short term it means that there will be more volatility, possibly more action to the downside. Why? Because there is a growing lack of liquidity in the markets and gold is always sold during liquidity stress, which is why buying now is the right play.
This liquidity seizure may have begun in China over the PBoC s desire to break the shadow banking system and unwinding the literal mountain of copper collateralized financial contracts. It may have its roots back in Cyprus and the rush to physical gold that ensued after the depositor impairment scheme created the cascading assault on gold in mid-April, the fallout from which we are still dealing with. But, the one thing it is not being caused by, as I will show with one simple chart, is the Fed backing off from its asset purchasing program.
How Do You Know a Fed Chairman is Lying…
In my last article I went over the latest T.I.C. Report in detail and linked the data to the current acceleration of capital flight from Southeast Asia. At the time there were a couple of unanswered questions about what the Fed was willing to accept on the long end of the yield curve as it looked like the verbal intervention by Fed mouthpieces and strengthening yen (FXY) had arrested rising bond yields. Unfortunately, that no longer looks like the situation.
As everyone is aware now, since the Fed’s statement everything has sold off with the exception of the US Dollar (UUP) and the Chinese Yuan (CYB) as liquidity concerns are running rampant. The PBoC has refused to use the blunt instrument of monetary policy to stave off the liquidity crisis brewing among many of its banks, instead preferring to adhere to that age-old governmental practice of picking winners and losers by selectively bailing out certain banks behind the scenes.
… His Lips Are Moving.
So, now with the US 10 year note (IEF) rising to 2.4% and TIPS (TIP) rising even faster – as noted by the rapidly falling breakeven rate – the air is finally coming out of the bond bubble… and the equity bubble… and the new housing bubble.
When asked about this situation in bond yields at the press conference after the FOMC statement Chairman Bernanke replied:
Well, we — we were a little puzzled by that. It was — it was bigger than can be explained, I think, by changes in the ultimate stock of asset purchases within reasonable ranges, so I think we have to conclude that there are other factors at work, as well, including, again, some optimism about the economy, maybe some uncertainty arising. So I’m agreeing with you that — that it seems larger than can be explained by a changing view of monetary policy.
Remember what I said about ignoring what the Fed says? Ignore the bolded. There is no way that bond yields are rising like this because people are rejoicing over getting a minimum wage job as a cashier at Home Depot (HD). Because they certainly aren t getting high paying jobs. But his last sentence may mean he knows exactly what is happening and why. This is capital flight, Mr. Chairman and he knows it when he sees it. I ended my last article saying that I would be watching US/Singapore yield spreads for signs that the stress in Southeast Asia’s markets was lessening. As of last night the 10 year spread finally turned negative with Singapore’s 10 year yield now above that of the US’s and the Singapore Dollar (FXSG) is now trading well above S$1.27.
So, the bond markets are now screaming deflation which is causing a huge flight to the dollar. This, in turn, is causing dishoarding of U.S. Treasuries by emerging market central banks to defend their currencies. I note while I’m writing this article that Singapore’s bond yields are blowing up but the Singapore Dollar is strengthening versus the USD. This tells me the MAS is selling treasuries like mad. Thanks to the T.I.C. report being 2 months out of phase with reality I’ll have to live with my suspicions for the next two months.
From QEterity to the ‘Taper’ Tantrum?
So, is all of this happening because the Fed is slowing down its asset purchases and some savvy hedge fund guys are front-running it? The chart below blows that idea out of the water. The Fed is beginning to accelerate its credit expansion again, adding $54.376 billion this week. That brings the three week total in June so far to $65.7 billion. We can expect, by the normal 4 week pattern here, that next week will bring another ~$20 billion into existence and put us right at $85 billion for the month. If next week’s number comes in higher than that then the Fed is having to accelerate its purchasing to soak up the selling happening overseas and still yields are rising.
Bernanke made the point in the quote above that he believes that a certain amount of bond buying will correlate with a certain yield target – that the stock of Fed purchases is what affects bond yields.
He would be right if there was no other source of supply of U.S. Treasuries other than the Treasury Department. But if there is a structural shift in the demand for Treasuries then it’s an entirely different market that will require different thinking. So, no, Dr. Ben, it is the flow that matters.
What should be obvious at this point is that we are beginning to witness the drying up of liquidity across multiple asset classes which is why everything is being sold in order to raise dollars and Yuan. This is why it is the amount of dollars flowing through markets that matters not the nominal amount of bonds Bernanke buys with his printing press. And this is where the disconnect between what the Fed says and what it is reaping with its policy lies. Bernanke is talking about stock, the reserve of bonds, but the markets run on flow of dollars.
Look at what is happening right now. The Fed is expanding credit like mad and yet bond yields are continuing to spike higher. This is the worst case scenario that I’ve discussed previously and, erring on the side of caution, expected the Fed to respond to with accelerated buying. It has not been enough. If Bernanke is confused about why this is happening then there is no protection for the average investor at this point beyond cash and gold because once the prisoner’s dilemma of central banks buying treasuries because everyone else is ends, there will be a mad scramble for hard assets.
If that doesn’t sound like what is happening today to you, then you must still have Bernanke’s soporific speech patterns rumbling through your brain.
I said watch the 10 year yield above 2.2%. It’s 2.42% and rising. I said watch the Singapore/US 10 year spread for continued stress indicators. It’s gotten worse. SE Asian currencies and equity markets continue to deteriorate versus the dollar. Fed Credit is expanding at an $85 billion rate in June, the same as in May and bond yields keep rising, same as in May. This implies the flow argument trumps the stock argument. Even a huge $54.4 billion injection in one week was not enough to even slow the rise in yields, no less reverse them. This further implies that the selling in emerging markets is accelerating.
What this means is that if the Fed does not want to lose all control of the bond market it better start accelerating its QE program fast or risk a flood of Treasuries hitting the market at a rate which puts the U.S. budget back under the microscope due to rising interest payments on debt.
Remember, no matter what gets parroted around the financial press about the U.S. budget, May’s deficit came in at $139 billion versus expectations of $110 billion. The CBO’s projections have never been accurate and as of tonight the 10 year yield is 0.3% above the projected yield for Q3 of 2.1%. Right now with the Fed talking down its hand in the future markets, how else is it going to get rates down without accelerating its buying, since everyone else is selling?
Far be it for me, as an Austrian economist, to tell the Fed to print more money and expand the credit base. But for it to not do so at this point means abandoning everything it has sworn to protect, namely the banks, which are still scared to lend – excess reserves continue to rise – and multiply base money. For gold investors, this latest shock is yet another liquidity-related shake out, but with the COMEX raising margins on Thursday and the commercials net long this is a recipe for margin-related short covering there as the speculative players are the ones net short on margin.
The next major hurdle in the 10 year note is where we are now at 2.42%. A monthly close above that would be bearish and indicative of a trend change. Gold will need to re-capture $1320 immediately while the need for protection from these events that tangible assets offer is higher now than it’s been since Lehman Bros. fell.