Dow down, gold up. That’s two days in a row. We don’t know what to make of it! Actually, we’re not sure many people know what to make of the overnight action. Markets were all over the shop and the usual explanations for why things happen didn’t seem to stack up.
It just goes to show that market’s move to their own rhythm. It’s just that we demand a daily explanation for what happened and so the media throws one up, regardless of its veracity. It proves the old Wall Street adage, ‘Markets make opinions.’
That was certainly the case last night. Firstly, unemployment claims fell to a six year low. This is good news, but not in the market’s eyes because it increases the fear of ‘tapering’. Tapering means less liquidity, which is the lifeblood of Wall Street.
But employment data is a lagging indicator, so it’s not exactly telling you what’s happening right now. US claims for state unemployment benefits dropped 15,000 last week to 320,000, the lowest level since…October 2007. That was hardly an auspicious time to buy stocks, and there are some eerie peak market parallels with that period right now. We point some of those out in our latest presentation.
But if the market sold off on tapering concerns, then why was the US dollar under pressure? The theme lately has been for the dollar to strengthen as investors price in higher interest rates.
And the experts have told us for months now that tapering concerns are the reason why the gold price is under pressure. Yet gold spiked higher overnight, punching through an important level of resistance.
So just what is going on?
Our guess is as good, or bad, as the next person’s. But it seems like there is a decent shift of capital going on. Is the market catching a whiff of future inflation and trying to position for it by allocating capital to the beaten up precious metals sector? From a purely cyclical basis, it would make sense to take some money out of the S&P500 (at all-time highs and up 150% since the 2009 bottom) and allocate some to the precious metals (gold is up around 95% from its 2008 low of around US$700, but nearly 30% off its all-time high)
And it also makes sense from a bigger picture macro perspective. Overnight, the US Treasury released its ‘Treasury International Capital Data’ (TIC Data) for June. The data provides a monthly look at foreigners’ purchases of US securities. Below, we focus on movements in the all-important long term securities segment, which includes Treasury, agency and corporate bonds, and equities.
The data showed that foreigners were net sellers of US long term assets in June, which is worrying because the US needs foreign capital to sustain its excess consumption. So the gold rally could well have something to do with the lack of foreign financing of US deficits, which means the government will have to rely on the Fed to continue monetising treasuries, which is dollar negative.
On a net basis, foreigners sold US$67 billion of long term US securities in June. It’s the largest monthly sell-off since August 2007.
More concerning is the trend though. Foreigners have been net sellers of long term securities since February, one of the longest selling streaks on record. In the year to June, inflows totalled just US$171.8 billion, which is a huge reduction on recent years.
For example, in the year to June 2012, foreigners bought $519.5 billion in long term US securities. In the year before that, they bought $588.7 billion.
So we’re looking at a huge drop off in foreign financing of US excess consumption. This is a very big deal. The ‘excess consumption’ shows up in the US trade deficit, which over the past 12 months was around $500 billion. Large trade deficits are pretty standard for the US. It’s a product of the ‘exorbitant privilege’ of having the US dollar as the world’s reserve currency.
It means that foreigners will demand the dollar as a reserve asset, which enables the US to pay for surplus goods and services with cheaply produced dollars…year after year after year.
But the flow of long term financing is now drying up. The US still has a $500 billion trade deficit to finance, but a seeming reluctance by foreigners to continue financing it.
If this trend continues, one of two things will happen. Either the US will begin to live within its means, because the lack of foreign financing will not allow them to consume so much, or they will continue along the same path and have the Fed monetise ever greater amounts of debt to try to sustain their standard of living.
We’ll assume the US will take the short term gain for long term pain option. That won’t be good for the dollar. And it might just be what the gold market is getting a sniff of. It’s probably still a few years away, but markets discount the future and we think gold might have just gone from discounting deflation, to discounting a dollar crisis and higher inflation in the years ahead.
Since we’ve been on the gold theme this week, we may as well finish on it too. So we’ll leave you with a thought on an issue that seems to get plenty of attention in gold bug circles — the threat of an ‘imminent’ default on the COMEX.
In the past few months, gold inventories stored at COMEX warehouses have declined to very low levels. This has got the gold bugs talking about an inability of the banks to deliver against outstanding claims.
This makes for a good story, but we think it’s a non-event. Gold inventories held against futures contracts are low because there is a low ‘net long’ position in the market. That is, the trend over the past few months has been to bet on falling prices…that is, to go ‘short’ the market. If you’re short, you’re not going to take delivery at the end of the contract.
The counterparty to these ‘shorts’ is, in many cases, the banks — the market makers. So they are ‘long’ gold (which they probably hedge elsewhere so they are really positioned neutrally, neither long nor short) and they have no intention of taking delivery of any physical gold.
And the other point to note is that most investors who are long gold futures have no intention of taking delivery. They want leveraged exposure to gold, not gold itself. And because you have to stump up a hefty amount of additional cash to take delivery, it rarely happens.
Focusing on COMEX and warehouse inventories is interesting, but it’s a sideshow really. Gold bugs have been talking about delivery defaults for years. We’re not saying it won’t happen, but if it does it will mean something major has gone down in another part of the world…namely London. That’s still the centre of the gold universe. It’s why the gold trade there is cloaked in secrecy.
The paper trading schemes conjured up by the bankers and elites will no doubt go wrong at some point in the future. But it’s a waste of time guessing when. In the meantime, if you’re a gold bull, take some comfort in the fact that the gold price is again heading in a north easterly direction.
for Markets and Money
From the Archives…
Treasurer Bowen: Australian Economy in Crisis
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Australia’s Shadow Banking Sector is Collapsing
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Diesel Goes to Caulfield and Callum to the Alfred
5-08-2013 – Nick Hubble