"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Thursday, May 15, 2014

CME Lowers Gold and Silver Margin Requirements

In a move that is sure to raise the ire of the GIAMATT crowd, ( insert sarcasm here ), the CME announced a reduction in margin rates for gold by 7.7% as of the close of trading today ( Friday ). Speculative margins are now being lowered to $6,600 from the previous initial margin of $7,150. Maintenance margin drops to $6,000 from the current $6,500.

Silver margins are now cut 8.3%. Specs must put up $9,075 for an initial margin down from the current $9,900. Maintenance margins have been lowered to $8,250 from $9,000.

The recent range trade in both precious metals has resulted in lower volatility and that is being picked up in the exchange's computer program which measures that and either raises or lowers the margin requirements accordingly.

I am always amused by the reaction to these events by the GIAMATT crowd because inevitably, whenever the precious metals begin to make big trending moves ( in the upward direction ) , the swings in price begin to intensify. That ramp up in volatility, especially when gold is in a strong uptrend, can easily wipe out smaller, underfunded traders. The exchanges then respond in order to safeguard the Clearinghouse and to make sure that the process is protected. The perma gold bull camp then screeches to high heaven that it is all the more proof that the powers that be are manipulating gold by trying to force out the speculators.

Given the current low volatility by recent comparisons, this move by the exchange will actually make it easier for both longs and shorts, to increase the number of positions. If one is bullish, it actually makes it cheaper to increase the number of long positions in either metal. With the current positioning of the speculative community being net long, this benefits the bulls. Don't expect to hear a negative peep out of the GIAMATT crowd about this however. It is only when the exchanges raise the margins that they begin making noise.

One could easily make the equally bogus argument that the exchanges are making it much easier for specs to pad their current net long positions by lowering these margin requirements thus providing solid evidence that the exchange is working overtime to manipulate the price of gold higher, which is evidently a dastardly thing to do to the poor, friendless gold bears.

In overnight trading this evening, traders are expecting a victory in the Indian elections which is viewed as favorable for gold demand in that big consuming nation. Gold has popped up a few dollars as a result. The metal continues to hold above key support near the $1280 region.

Risk Aversion sends Global Equity Markets lower, Bonds higher

One never knows what the markets are going to focus on any given day ( which is the reason this never gets boring) but today seemed to be one of those days in which investors/traders were given to experiencing a sudden case of "risk aversion".

News out of the Eurozone set the mood with Euro-area growth up a mere 0.2% for Q1 when market expectations had been for a 0.4% increase. While hardly the stuff of legend at 0.4%, at least the estimate was up slightly. When the actual number came out and investors realized that the Eurozone was barely avoiding an overall contraction, equity bulls got nervous. Heck, it seemed as the entire world was suddenly itching to get out of stocks and into bonds.

Ever since China news has been less than stellar there have been concerns about a slowdown in global growth.

Even here in the US, players seemed to hone in on the Industrial Production number, which was down as they overlooked a friendly Initial Jobless Claims number.

The lousy Euro-area number increases the pressure on the ECB to "do something" at their next meeting in June. Already talk is ramping up of their own version of QE to stave off deflation. Keep in mind that in the past the ECB has surprised the markets by announcing an interest rate reduction apart from their actual meeting. It could happen again if we get any further unexpectedly weak numbers out of that region.

No matter the reason, most global equity markets were weaker today. Bonds, on the other hand, here in the US, were higher with interest rates falling below the 2.5% level at one point on the Ten Year Treasury. There remain an awful lot of speculative shorts in the bond markets and it appears that they are getting squeezed in a big way right now. When that many bets are all on one side of a market, it does not take much to get the ball rolling in the opposite direction. These things tend to feed on themselves as short covering begets more short covering until all that is left is the strongest of hands.

To illustrate why I believe we currently have a risk off trade occurring in the markets, take a look at a rather simplistic, but helpful, comparison chart I use to gauge investor demand for risk. It is essentially comparing the Russell 2000 index to the S&P 500 index.

The Russell 2000 is comprised of small cap stocks and by its nature, tends to be much more sensitive to sentiment in regards to risk than its bigger cousin, the S&P 500. This can be seen in the chart.

Notice how the two indices can practically be laid directly over the top of the other and the pattern is almost identical. Both tended to rise and fall in harmony beginning at the date shown on this chart all the way up until this month.

Can you see how recently, the Russell 2000 has been underperforming its larger cousin in a very big way? Look at the February low for the Russell 2000 and you can see that the index actually fell to that level today before it rebounded. Compare that to the S&P 500 which remains well off its February low.

If we take the high point of the Russell 2000 back in March of this year which was up near 1212 ( the best close was near 1208) and compare that to its current level, near 1096, the index has fallen some 9.3% from its best CLOSING LEVEL. The S&P 500 on the other hand closed today near 1867, down 25 points from its best CLOSING LEVEL near 1892. That is off a mere 1.3%. Another way of saying this is that the Russell 2000 is very close to achieving an official "correction". That requires a drop of 10% off the best close.

The lesson? Investors appear to be nervous right now and seem to be fearing SLOWDOWN fears at the moment. This is one of the causes of the big rush into bonds. We are apparently back to caution as the name of the game. I think many are wanting to see confirmation of an improving economy here in the US, especially in the employment area, before getting too aggressive on the buy side in stocks again.

Along this line, the VIX or volatility index rose today. It still remains quite tame however.

There is also a bit of chatter out there that holders of European-based bonds are jettisoning them in favor of US Treasuries. That talk has picked up as sentiment increases that the ECB is going to act on the stimulus front next month. If they do, and if the Euro weakens as a result, some of those bond holders would prefer to own US Treasuries as they expect the Dollar to strengthen against the Euro. We'll see about that but it is a plausible theory.

One last thing, I do not currently have the time to do this, but some of you more enterprising readers out there might be able to do some research to see if you can track money flows INTO TREASURY ONLY FUNDS. It would help to confirm that we are seeing a shift out of stocks temporarily into the safety of bonds. Demand for bonds is very strong right now. I continue to marvel how the Fed has been able to reduce their bond buying and not upset the interest rate market. First they get a geopolitical event to induce safe haven buying into bonds and now they get some fears over slowing global growth. Boy howdy are these guys good! Their reduced buying has been more than offset by investor demand.

Keep in mind that the nature of today's markets is that all it will take to completely turn this sentiment around is a piece or two of solid economic news. Again, I want to caution you traders out there, do not overtrade right now and watch your position size closely. You can have your trading career end very quickly if you become foolish right now.

CPI numbers

Yesterday we got a surprise PPI number. Today we got a CPI that came in right on expectations. It showed a seasonally adjusted 0.3% rise over April, which was the biggest increase since June of last year.

Much is being made of the rise in food prices which were up 0.4% compared to last month, and which have increased four straight months now. Meat prices in particular have risen sharply putting in their largest increase since 2003.

However, as I have made clear many times here recently, the CPI is a BACKWARD looking indicator. It measures "that which has been" not "that which shall be".

Just today, corn prices fell to a SIX WEEK LOW. Wheat prices have hit a three week low as widespread rains have put a halt to the drought/heat induced deterioration in the crop.

The spread between old crop beans and new crop beans is nearly $2.60 bushel. Just today Informa raised expected soybean acreage to a stunning 82.1 million acres. Looking FORWARD, barring any severe weather issues this growing season, there will be more than enough soybeans around to meet existing demand.

Incidentally, soybean crush was 132.67 million bushels compared to last month's 153.84. High prices continue to eat away at demand.

By the fourth quarter of this year, meat prices will begin to ease lower with supplies increasing in Q1 2015.

What I am saying is that price pressures in the food component of the CPI should ease later this year.

Energy remains a wild card. Gasoline prices rose 2.4%, which was the first gain since December of last year. If you observe the price chart however, gasoline prices spiked higher during the month of April pushing above December's level but have since fallen back somewhat. We will want to monitor this key commodity as it has such a big impact on both the consumer and on business. I am surprised that crude oil prices have been able to stay above the $100/barrel level but the market is proving to be rather resilient. I personally would love to see it move closer to $92 - $93 as it would push the price of gasoline lower and we consumers love that. Right now that appears to be rather unlikely.

Medical costs are worth noting - They rose 0.3% last month and are up 2.4% compared to a year ago.

In other economic news - the Philly Fed May Business Index came in at 15.4 compared to April's 16.6. New orders were at 10.5 versus 14.8.

US April Industrial Production was down -0.6% compared to the market expectation of a -0.1% decline. The March number was revised upward however to a 0.9% increase from the previous 0.7% increase.  Capacity utilization fell  0.7% to 78.6%. The market was looking for 79.0%.

Jobless claims were the big mover today - the number for initial unemployment claims plunged by 24,000 to a SEVEN YEAR low of 297,000. The market had been looking for a slight increase to 320,000. This number is notorious for its volatility so we will want to see next month's numbers but for right now, traders are interpreting the data as further evidence that the employment situation in the country is slowly improving. The Labor Department did issue a report showing that INFLATION ADJUSTED average weekly earnings actually fell 0.3% in April from March. Without the adjustment, wages were flat.

There still appears to be a great deal of slack in the labor market and that is working to hold down inflationary pressures. This phenomenon seems to be widespread in the Western economies at the moment and is one of the reasons that Central Bankers do not appear particularly concerned about the about of widespread inflation pressures at the moment.

Equity markets were pummeled lower today with the S&P 500 down nearly 1.5% as I type these comments. The HUI is down even harder ( near 1.67%).

The key index is perched precariously above a key chart support zone once again. So far it is holding but it does seem that general equity weakness tends to impact the mining shares more severely than the S&P 500 itself.

Bonds of course are going in the opposite direction and having yet another huge rally with the yield on the Ten Year falling below 2.5% at the moment.

I find it absolutely amazing at how skillful these Central Bankers have become at scaling back bond buying programs all the while without impacting the demand for bonds in the slightest. Remember all the talk coming from the perma gold bull community that as soon as the Fed stopped or scaled back their QE programs, that interest rates were going to soar because no one would be left to buy bonds? Well guess what - that is another prediction that has been proven to be completely and utterly wrong. Demand for bonds is still very strong at the moment. It should be borne in mind that the Fed is still buying bonds - albeit at a reduced level - and that its balance sheet is still growing. For whatever the reason, demand for bonds is currently exceeding the available supply and thus the price of the bonds is rising with interest rates moving correspondingly lower.

Along this same line however, the Bank of Canada's Schembri today was quoted saying that these "low interest rates pose a serious challenge for pension funds". Ain't that the truth and do not forget senior citizens and those living on fixed incomes. Those of you who have senior parents alive are all too sadly aware of this. Many hedge fund managers however are thrilled with these low rates as their fears of slowing global growth have most of them singing from the same hymn book.

Back to gold for a moment - the price chart continues to show the metal range bound but that series of lower highs is also continuing. Rallies are being sold. The giant gold ETF, GLD, now has reported gold holdings at 780.46 tons, that is down from the ending level last week of 782.85 tons. Thus far the ETF has shed 2.4 tons of gold this week. It will be interesting to see what the number comes in at by the end of trading this Friday, especially if gold fails to recapture the psychological "13" handle.

One last comment for now, the Treasury's International Capital Flows data ( TIC ) showed that Russia's US Treasury holdings fell $25.8 billion in March to $100.4 billion. Their holdings as of February had been $126.2 billion.
This can be explained as investors, fearing the impact of Western-backed sanctions, yanked money out of Russia. The exodus of capital caused the ruble to fall and this induced the Russian Central Bank to intervene in the forex markets. To do so, they would have needed to sell US Treasuries to raise the Dollars needed to sell those to keep the ruble from dropping even more sharply than it did.

In looking at the report, China's holdings are essentially unchanged from this same time last year ( 1272.1 billion to 1270.3 billion). Japan's holdings are up from 1114.3 billion to 1200.2 billion, an increase of $85.9 billion.

The chatter going around is that Belgium is taking up the slack in Treasury buying brought about by the Fed's tapering program. Belgium holdings are at $381.4 billion compared to last year's 188.4 billion, an increase of $193 billion. That is a big increase over the last year.

However, in going through the data, I have decided to start with the month of June 2013 and do some examination. Why? Because that is the month during what all adjustments are made in the TIC data. You see, many foreign buyers of US Treasuries, will do their buying through banks IN OTHER COUNTRIES other than their own. That shows up in the country in which the banks are located. However, that data does not show the originating buyer of the Treasuries but only the country in which the transaction was conducted. In June of each year, the Treasury Department will then properly credit the actual ownership of the Treasuries to the host country. Generally at that time, we will then see a big adjustment in the reported holdings of the various countries. That is the data I am interested in seeing. In the past, we have seen big buying out of the United Kingdom which then, during June, has been moved out of the UK and credited to China. In other words, a great deal of Chinese Treasury buying had been done through London banks which when properly credited, ends up in China.

I suspect we might have some of the same thing occurring with this Belgium deal but of course we will have to wait until the report showing the June updates is released. That will be three months from now unfortunately.

But let's go back to June of 2013. It reported Belgium holdings were at $176.2 billion. As of March 2014, those holdings are at $381.4 billion. That is a $205.2 billion increase. That certainly is a big increase.

China lowered their holdings by around $3.7 billion.

Japan's reported Treasury holdings as of June 2013, were at $1083.3 billion. They are currently sitting at $1200.2 billion. That is a 116.9 billion increase, a fairly sizeable jump.

The Caribbean Banking Centers were at $286.3 billion and increased by $26.2 billion to $312.5 billion. Those are often used by hedge funds.

Brazil registered a slight decrease in holdings from June ( about $8 billion). Taiwan dropped about $10 billion and Switzerland lowered their holdings by about $5 billion. Opec dropped by around $19 billion.

Those were mostly offset by increases in the UK of about $13 billion and Hong Kong by some by some $21 billion.

So what does all this mean? Right now, not much because we do not know where the final destination of those holdings are going to end up in June this year when Treasury does its annual adjustments.

But the fact that it is Belgium, the headquarters of the European Union doing the buying is interesting. That is because the various European nations, Germany, France, Italy, etc. that make up the EU are listed separately. We can speculate what is going on with that but one thing that I am wondering is whether or not the ECB might be buying US Treasuries as a way to undermine some of the stubborn strength that has been seen in the Euro.

Back in March of this year, the Euro was quite strong, trading near the 1.39 level for some time that month. I am only guessing as I have no proof whatsoever, but it is no secret that many European based political and monetary leaders do not want a strong Euro. Perhaps, that Treasury buying has been to derail some of the Euro's strength in relation to the US Dollar. I simply do not know but the fact that ECB President Mario Draghi felt compelled to talk down the Euro last week is rather revealing if you ask me.

One last thing - while this TIC data is interesting, the majority of US Treasuries are still owned internally here in the US. By that I mean private investors, pension funds, mutual funds, etc. Those investors, looking to take some of the gains that they have made in equities and put that aside into something more conservative while they try to get a sense of what the next direction in the broader equity markets might be, should not be underestimated.

Perhaps my friend Eric de Groot might be able to shed a bit of light on this as he is very good at studying money flows.