This was posted at my blog on Tue. July 27, and I just now got around posting on zh.  To those bullies chasing my post all over net: I stand by my opinion, so let it rip!!

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By Dian L. Chu, Economic Forecasts & Opinions

There is no shortage of news from BP on Tuesday:

• The oil major reported its first quarterly loss--$17.15 billion--in eighteen years, and will sell about $30 billion in assets. 
• The company also announced that CEO Tony Hayward will step down on Oct. 1 to work at TNK-BP--BP’s joint venture in Russia.
• Bob Dudley, an American BP executive, will succeed Hayward as the new Chief Executive

The more eyebrow-raising news; however, is that BP plans to claim almost $10 billion in U.S. tax credit as a direct result of the Gulf oil spill. Here is how the tax code and math work.

Under the U.S. corporate tax law, companies can take credits up to 35% of their loss. Since BP reported $32.2 billion charge related to the cost of the spill, 35% of that will give you roughly $10 billion in credit. So BP’s claim is pretty much what its spokesman said.

"This is the accounting process, we are going by U.S. laws.”

The intention of the tax code is to encourage investments and to help companies even out profit and loss, along with the associated taxes. Lawmakers just forgot to incorporate a rider clause for public safety and/or environmental damage related expense. 

The tax credit, if claimed, could mean $10 billion of the Gulf aftermath costs would come out of taxpayers’ pocket. This could potentially be quite an embarrassment for the Administration as President Obama vowed that BP will "pay every dime owed" for the spill damage.

Of course, BP could conceivably “do the right thing” and drop its tax credit claim to avoid a crashing tsunami of public anger and outrage. However, don’t expect BP to give up on this sizable cost offset that easily, since BP has made considerable concessions such as a voluntary $20 billion oil spill fund, and speculation of U.S. government’s involvement in Hayward’s dismissal and Dudley's appointment.

As reputation goes, it is hard to imagine the IRS would let this $10 billion slip by.  Could revenge of the IRS be in the cards, or as Leona Helmsley famously said “Only the little people pay taxes”?

Dian L. Chu, July 27, 2010

Just because "extended" and "exceptional" is so H1, 2010. With three brand new doves on the board of the Fed, it was only a matter of time before the printers realized that there is no reason why ZIRP should hold the central bank back, now that even hotdog vendors know all about the deleveraging double dip the US finds itself in. Up on deck we Nomura, which issued the first official change in a call for QE-Light. The firm's economists David Ressler and Zach Pandl, no doubt after consulting with Richard Koo, say, "we now expect the FOMC to 'ease' at the 10 August meeting. Exactly what form this easing might take is debatable. Our assumption is that they will change the language of the statement to signal that the balance sheet will remain expanded, and change policy around the MBS program to start reinvesting paydowns." It won't be the last. Should the Fed telegraph further easing, expect stocks to surge at least another 10% as the 10Y approaches 2.5% as nothing makes sense any more.

More from Market News:

Nomura Friday became the first major firm to formally anticipate a change in Fed policy as soon as August 10 to alter course toward some renewed quantitative easing, arguing that without thechange, Fed policy is becoming less accommodative week by week.

"We think there will be something in the (FOMC) language that maybe reverts back to the language of 2009, around the first time they made this statement, that the Federal Reserve needs to maintain an expanded balance sheet," David Resler, chief North American economist for Normura, told Market News International.

"That begs the question, what does that mean to expand," he continued. "We don't think they will actively buy things," he said, but
that they will have to "back up their language."

While the Fed now is committed "only to rolling over guvvies," he said, "they are becoming less accommodative each week. Mortgages are not being replaced" and other shrinkage is taking place.

"They need to have a strategy for preserving (the balance sheet's) size. Does that mean they will reinvest paydowns. I don't know, and we're agnostic on how they will do it."

Just lowering rates "is not on the table any more," he said, and changing the rate of interest on excess reserves "is the last option they would resort to." At present "they are losing assets, so I think they would not want to lose them."

Getting into the practical implementation issue, "do they offset dollar for dollar every prepay they at the time they get it?" Resler asked. "They may not be able to do that."

In any event, the change in language, while having its own effect, won't be enough. There will have to be activity, he said.

Resler and colleague George Goncalves have dubbed whatever is to be done "QE light," with a risk of other actions, such as cutting the rate on excess reserves.

Overall, the Fed must do something because of the deterioration in the data since March and the downward revision in the Federal Open Market Committee's outlook, Resler said. Nomura does not see another recession, but a sufficient case based on economic performance for some manner of easing.

Courtesy of Libanman Futures

 

Submitted by RCS Investments

Bullish

+ Global trade continues to expand.  Industrial production in emerging market economies is up more than 10% from their prerecession peak. (Link Courtesy of News-to-Use). 

+ Chicago PMI shows an increase in activity during the month of July. Manufacturers continue to report expansion in the Mid-West, a very important manufacturing hub.  All sub-components rose, particularly the all important “New Orders” implying that activity is set to increase in the months ahead.  (Links Courtesy of Briefing.com )   
+ Earnings reports continue to impress and various global trade bellwethers cite improved outlooks in the quarters ahead.  These negative macro trends that the bears cite are not affecting company bottom lines.  In fact, revenues are showing more signs of life.

+ Continued reports of Eurozone financial tensions easing as yield spreads continue to contract and the Euro is near a 2.5 month high.  Eurozone sovereign woes? Where?  Meanwhile more countries are finding themselves having to raise rates as economies are overheating in growth. (Courtesy of The Big Picture)

+ The American Staffing Association’s staffing index shows that demand for temporary workers continues to rebound.  Demand levels are quickly approaching 2006 & 2008 levels.  This shows that demand for labor is out there and will soon translate to more robust job reports.

+ Mortgage Applications for purchase rose again for the second week in a row and lends more credence that a floor for demand has been formed. 

+ Case-Schiller Home Prices Index shows that property values are stabilized and will help reinforce consumer confidence and spending.
 

Bearish

- Durable Goods Orders surprised to the downside.  The one sector that was keeping this recovery alive is fading.  The demand side of the equation is still a no show.  The last line of defense for the bulls is looking quite tenuous at this point.

- Chicago Fed’s National Activity Index (one of the best proxies for GDP) came in negative as production and employment related indicators led the deterioration.  This further confirms that employment is not making a significant rebound and end-demand has not taken the baton from the “inventory-bounce-led” recovery.

- GDP growth comes in lighter than expected and the recession was deeper than once thought.  Meanwhile the consumption sub-component grew at a measly 1.6% vs. an already weak 1.9% increase in the first quarter.  Consumption = 70% of the economy and unfortunately it is slowing.  End demand continues to not show and this is what ultimately drives everything else.  A good breakdown can be found here (Courtesy of CalculatedRisk Blog)  

- Beige Book confirms what the Bears (at least me) have been saying: “Economic growth is decreasing rapidly a double-dip is coming much much sooner than anyone is expecting”.  Investors are not prepared for this scenario as most, if not all “pundits” write it off.

- Evidence of a fall in consumer confidence continues to mount as this time the UMich Sentiment survey confirms that confidence took a turn south in the last month. Despite the “better than expected” headline, let’s not forget that this level is far below last month’s closing level of   Cautious consumers = Wallets held close.  

- Dangerous  signs are surfacing that foretell a possible sharp drop in economic activity in the immediate months ahead.  The lights from the oncoming train are getting bigger quickly. (Courtesy ZeroHedge)

- The housing “supply-restraint” dam, which had been in place to buoy home prices, is beginning to crack.  Foreclosures are set to increase a good bit, and with recent underwhelming performance of purchase mortgage applications, prices have nowhere to go but down.  Banks will be under renewed pressure as their "extend-and-pretend" schemes blow up in their collective faces.

 
Observations/Thoughts

>This is welcomed news for the whole country.  Perhaps further good news will actually work to increase overall psyche given that we’ve had solid evidence that confidence has taken a turn for the worse.  Why this recent bout of pessimism?  Perhaps everyone is collectively realizing how big of a mess we are in and how long it will take to actually resolve the structural imbalances.     

> First, an example of what I’ve feared for a while now and mentioned in my Q1 Outlook.  Look for it to get worse.  Second, this is an interesting story in the continued move for more fiscal austerity (something I expect to happen in the quarters ahead: see my Q2 Outlook).  I believe that letting the Bush tax cuts expire on the wealthy would hurt consumption.  Even though it may affect approx. 2% of the population, those 2% account for a large portion of consumption.  However, Obama and the democrats, looking more desperate by the day it seems, may have hit the political hot button they’ve been looking for.  Letting the tax cuts for the wealthy expire is something that they support, and by the way, most of the nation supports as well.  The growing division between the wealthy and the rest is alarming and will no doubt cast a shadow on the build up to the big decision.  I believe that tax cuts for the wealthy will be allowed to expire.  However it is way too soon to be completely confident in that outcome.  If recession hits before the November elections, this sentiment may change quickly. 

>India seems to be having some trouble containing inflationary pressures.  Stimulus and loose monetary conditions are now biting back.  China is having these problems as well.  Various reports of labor unrest (higher wages) and inflationary CPI/PPI reports are becoming daily fodder over there.  I believe they are in a particularly tough spot.  Raising interest rates would help contain inflation, but at the expense of possibly popping a real estate bubble, while letting the Yuan rise would cause another headwind for their already pressured export sector.

> So we have Barton Biggs who nailed the recent bottom with his “I’m off risk” after touting risk all the way over the edge and now we have Barton Biggs &“perma-bear” Richard Russell announcing to get back in.  Since then the market has gone down.  Like Rosenberg says, a “meat-grinder” market is what we have on our hands here.  It loves making fools out of us all doesn’t it?! (Links Courtesy of Zero Hedge and ETF Daily News)

> So we’re in a sustainable recovery?  Yawn…

Via Pension Pulse.

Luca Di Leo and Darrell Hughes of the WSJ report, U.S. Growth Slowed in 2nd Quarter:

The U.S. economy slowed in the second quarter as the government said the recession was deeper than earlier believed, adding to concerns over the recovery's strength.

The Commerce Department Friday said U.S. gross domestic product, or the value of all goods and services produced, rose at an annualized seasonally adjusted rate of 2.4% in April to June. In its first estimate of the economy's benchmark indicator, the government report showed growth was lifted by business investments and exports. Consumer spending, a key growth engine for the U.S. economy, made a smaller contribution to growth.

 

Economists polled by Dow Jones Newswires were expecting GDP to rise by 2.5% in the second quarter. Stock futures weakened after release of the data; Standard & Poor's 500 futures were recently down about 11 points to 1086; Dow Jones Industrial Average futures were off 82 points to 10327.

 

In the first quarter, the economy grew by 3.7%, revised up from an originally reported 2.7% increase. But growth estimates all the way back to the start of 2007 were revised lower.

 

The report showed a bright spot continuing in the economy: the growth of business spending on equipment and software. This spending continued to surge, increasing by 21.9% in the second quarter, compared with a 20.4% rise in the first three months. The figures highlight the contrast in the economy between high company profits and a persistently feeble jobs market keeping consumers at bay.

Business spending actually climbed at the fastest rate since 1997, but the big story was the downward revision in the level of real GDP in Q1 2010, a point that Yanick Desnoyers, Assistant Chief Economist at the National Bank, addressed in his comment on the report:

The U.S. economy increased 2.4% in the second quarter, slightly below market expectations. Q2 delivered slower GDP growth compared to Q1 but with a marked acceleration in real domestic demand from 1.3% to 4.1%. We prefer to see a weaker GDP growth due to a rise in imports with strong domestic demand than a weaker GDP growth due to a weaker domestic demand.

 

That said, what was more striking in today’s report was the BEA’s annual revisions to the National Income and Product Accounts. The level of real GDP in the first quarter of 2010 was revised down by $100 billion. From a component perspective, consumption registered the largest revisions in dollar terms with a decrease of $134 billion. Accordingly, U.S. consumption is not in an expansion mode as originally reported but rather still in the recovery stance.

 

There are mainly two consequences with the BEA’s revisions. First, it means that the savings rate probably was higher than first thought and job creation is more than ever needed to sustain consumption growth (conversely it means that the U.S. consumer is deleveraging more quickly than expected). Secondly, the U.S. output gap is deeper in excess supply territory than before the BEA’s revision.

 

Bottom line: The Fed is on the sidelines for a longer period of time.

The output gap is deeper than we previously thought, but there is another reason why the Fed will remain on the sidelines for longer than we think: it wants to see asset reflation translate into mild inflation and avoid a protracted deflationary scenario at all cost.

Importantly, Fed policy remains geared entirely towards banks, allowing them to continue borrowing on the cheap to invest in risk assets all around the world as they shore up their balance sheets. This is why I remain bullish on stocks.

But what about bonds? I recently wrote a comment asking whether or not we're on the cusp of a global bond hiccup. My point was that global growth will put upward pressure on bond yields, and I thought the US economy was in better shape than what most analysts thought.

Obviously today's downward revisions in US GDP will continue anchoring down long-term inflation expectations. Some strategists think that Treasuries are still a buy:

Treasury yields fell Friday, with the 2-year note hitting a record low 0.55%, after the government said U.S. GDP grew a weaker-than-expected 2.4% in the second quarter.

Get used to both more weak economic data and lower Treasury yields says, Yves Lamoureux, investment advisor at Macquarie Private Wealth.

 

"If you're looking at leading [economic] indicators, they are pointing down," he says.

 

"There's no doubt the next quarter and the one following are going to be disappointing." (On Friday, the ECRI said its weekly leading index rose to 121.1 for the week ended July 23 from 120.6 the prior week; but the index's growth rate fell for an eighth-straight week.)

 

With the economy slowing, the "secular bull market" in Treasuries should continue, Lamoureux says, predicting 30-year bond yields will fall as low as the average of comparable debt in Japan and Germany, which is currently 2.575%.

 

Furthermore, he argues the high rates of the 1970s and 1980s were the "black swan" resulting from the Fed's mismanagement of the money supply. Excluding that period, Treasury yields have mainly been in the 2-4% range since the 1900s;

 

Lamoureux calls that the "natural equilibrium" for yields, while expressing faith the Fed has learned its lesson of the 1970s.

 

"I believe the Fed won't make the same kind of mistake again," he says. "From a long-term perspective, inflation is coming down. You will not get a big inflation shock."

Lamoureux's reasons for why Treasuries are still a good buy (and not in a bubble) also include:

 

Financial deflation: While the price of many goods and services continue to rise, Lamoureux estimates there has been a 2-4% annual contraction in the money supply since 2008. In other words, deleveraging is overcoming the expansion of the Fed's balance sheet.

 

Diversification: Treasuries are "the only asset class that compensates you" if stocks go down, he says, calling U.S. debt the "last diversifier left."

You can watch the interview with Mr. Lamoureux below. His views on financial deflation are echoed in Hoisington Investment Management's Q2 economic letter.

Also, his point on diversification is important because in a low interest rate environment, asset classes tend to be a lot more correlated than investors think. With so much pension money flowing into real estate, private equity, commodities, and infrastructure, this should worry us.

If a protracted period of deflation does materialize, it will ravage private markets. The Fed will do whatever it takes to avoid such an outcome. Bottom line: We might be in for a long period where both bonds and stocks trade in a range. Better pick your spots carefully.

The capital markets, which are celebrating accelerating deflation and inflation at the same time, are now officially insane, as the Dow has diverged from its credit implied fair value by about 170 points! This will all end in lots and lots of tears. We hope the computers enjoy trading with each other as much as all carbon based lifeforms relinquish the en masse abandonment of the stock market.

Geoffrey Raymond's art, just like fine wine, only gets better with time. This is particularly true if the art is subjected to accelerated aging via repeated days of annotations. Raymond's latest piece: the Naked Cramer, is now on its day four of soliciting random and assorted  commentary, and the prevailing sentiment on CNBC's permabullish stockpicker is certainly starting to shine through. The results are below.

Investors are understandably scared of the sovereign debt crisis unfolding in Europe. Amid their angst, however, they are ignoring a more likely, and significantly larger, debt catastrophe that is about to hit the nation with the second-largest economy in the world — Japan. Two decades of stimulative, low-interest-rate fiscal policy have made Japan the most indebted nation in the developed world, and as new Prime Minister Naoto Kan recently said, in his first address to Parliament, that situation is not sustainable. Japan has little choice but to raise interest rates substantially, with dire consequences far beyond its shores.

The prelude to the current crisis began in the early 1990s, after Japan’s housing and stock market bubbles burst and its economy slipped into recession. For the next 20 years, using flashy names like Fiscal Structural Reform Act, Emergency Employment Measures and Policy Measures of Economic Rebirth, the government cut taxes, increased spending and borrowed money to finance itself. Today, Japan’s ratio of debt to gross domestic product stands at almost 200 percent, more than twice that of the U.S. and Germany and second only to Zimbabwe.

A country with ballooning debt needs to have an expanding economy to outgrow the burden. Economic growth is driven by two factors: productivity and population growth. Although the Japanese economy may continue to reap the benefits of productivity gains, population growth is not in the cards.

Japan has one of the oldest populations in the developed world — every fourth person is 65 or older — and its number is on the decline. The Japanese birth rate is one of the lowest in the world, a meager 1.2 children per woman. To maintain its current popu­lation level, the average woman in Japan would need to give birth to 2.1 children. (Of course, only economists know how a woman can give birth to a fractional child.)

The severity of the debt problem in Japan has been masked by the fact that government spending on interest payments has not changed over the past two decades, as the average interest rate paid on the country’s debt declined to 1.4 percent in 2009 from more than 6 percent in the 1990s. This is about to change. Historically, more than 90 percent of Japan’s government-issued debt has been consumed internally by its citizens, directly or through its pension system. But the savings rate in Japan, which was in the midteens in the 1990s, today is approaching zero and will likely go negative in the not-so-distant future.

The Japanese economy operates on the assumption, soon to be proved false, that the government will always be able to borrow at low interest rates. As internal demand evaporates, the government will have to start hawking its debt outside Japan — in a more realistic world, where interest rates are a lot higher. Japanese ten-year Treasuries currently yielding 1.3 percent will not stand a chance against U.S. or German bonds of the same maturity, which yield 3.5 percent and 3 percent, respectively. Japan will have to offer rates far in excess of its U.S. and German counterparts. Although they have their own set of problems, the U.S. and Germany still have much lower indebtedness and superior demographic growth profiles.

Higher taxes and the austerity measures that undoubtedly will follow, combined with higher interest rates, will further slow Japan’s economy and drive the country toward insolvency. Unlike Greece, which because of its size could be bailed out by Germany and friends — with a little help from the ever-willing International Monetary Fund — Japan is too big to be bailed out. Defaulting on its debt, especially when the majority of it is held by its own citizens, is a political impossibility. But unlike European nations that socialized their currencies and cannot print euros on their own, Japan has complete control over its currency printing press. And print it will! Decades of deflation will turn into hyperinflation, which will destroy the purchasing power of Japanese citizens’ savings and collapse the yen.

The consequences of the economy’s slow but sure unraveling in Japan will spill over to the rest of the world. Japan is the second-­largest holder of U.S. government debt, and most likely it will start selling Treasuries. To make matters worse, Japan will start competing with the U.S., not just in cars and electronics but for buyers of sovereign debt. As Japan exports inflation, interest rates around the globe undoubtedly will rise.

Timing bubbles — and Japan is in the late stages of an enormous debt bubble — is very difficult. They tend to last longer than rational observers expect. But as Japan’s debt continues to swell, the eventual bursting of the bubble grows more catastrophic.

Japan is proof that a country cannot borrow itself to prosperity. The U.S. and other developed nations still have a chance to make the politically difficult but right decision to cut fiscal spending and stop looking for government to be the source of sustainable growth — which it never is.

The latest and most damning confirmation that it is none other than the president and his errant policies that are the primary cause for the credit crunch spreading among individuals and small and medium businesses like a paperborne version of the plague, comes direct from the Minneapolis Fed, where in a paper titled "Come and get it--please: Banks and credit unions say they have money to lend, but credit markets are still struggling for a variety of reasons" the Ninth Fed district puts the blame for the credit freeze flatly where it belongs: the president himself, and more specifically his destructive economic advisors. "The most-cited reasons—though only by a small margin—were organizational uncertainty about future financial system reforms and regulatory restrictions on bank lending. A Minnesota institution stated flatly, “The regulatory environment has impacted our willingness to make loans.” And stunningly enough, the desire by an ever-greater portion of Americans to forgo future credit and to splurge on idiotic purchases like iPods even as they no longer pay their mortgage and destroy their credit rating is having repercussions. "Said a South Dakota institution, 'We have money to lend, but cannot always fund applicants due to inability to borrow. Their poor credit histories keep them from obtaining credit.'" Who would have thunk that while Wall Street is immune from the causal relationship between action and reaction, and in fact blowing itself (and being rescued by taxpayers) up leads to infinite creditability by the US government, the opposite is absolutely not true, as Americans are now less able than ever to procure loans from these very same bailed out banks

Full Minneapolis Fed paper:

Come and get it--please

Banks and credit unions say they have money to lend, but credit markets are still struggling for a variety of reasons.

Ronald A. Wirtz - Editor, fedgazette
July 2010

As the weather has warmed in the Ninth District, credit conditions have barely thawed, according to a recent poll of bank and credit union executives in district states by the Federal Reserve Bank of Minneapolis.

Financial institutions report that they have money to lend, thanks to growing deposits. However, there’s not a lot of demand for loans and other credit—a situation exacerbated by the fact that creditworthiness continues to sag among businesses and consumers. Financial institutions also continue to tighten their credit standards, with banks reporting a decline in small business lending, in part, due to concerns about the current and future regulatory environment.

Show me the money

There’s little doubt about the liquidity of financial institutions, as 70 percent reported that insured deposits had increased over the previous three months, while only 11 percent said they had declined.

But banks and credit unions reported that consumers and businesses are not asking to put much of that available credit to work (see Charts 1 and 2). Business borrowing appears to be mostly a wash, as fairly even numbers said the volume of credit to business was higher (35 percent) and lower (39 percent), and unchanged (26 percent) over the previous three months; responses from the Dakotas and Wisconsin were more upbeat than those from Minnesota and Montana. Consumer borrowing was markedly down; 50 percent of respondents said consumer borrowing had dropped, 29 percent saw an increase and the rest reported no change.

Large Chart

Large Chart

One Minnesota institution commented, “People are still saving more than borrowing.” A Wisconsin credit union added, “We have an enormous amount of liquidity to lend out to our members when they are confident enough in the economy to start borrowing again.” Finally, a Montana bank noted, “We have observed a trend that our best, most highly qualified borrowers are choosing to not borrow.”

Tighter credit standards and poorer credit quality also explain some of the lower demand for credit, according to those surveyed (see Chart 3).

Large Chart

Almost universally, credit standards have either tightened or remain unchanged from three months earlier (see Chart 4). Among the responses, not a single institution said it had loosened credit standards for business applicants, while just six of 307 institutions reported relaxing credit standards for consumers.

Large Chart

A Minnesota bank said it was “not seeing the opportunity to lend. When we do, we are much more stringent.”

Among various credit standards, collateral requirements and documentation were most frequently tightened (by almost half of respondents); about one quarter also tightened the size and number of credit lines. The only standard that saw even the slightest loosening was interest rates; the percentage of institutions that loosened interest rates was slightly less than the proportion that tightened them. In fact, significantly more Wisconsin institutions reported loosening (32 percent) interest rates compared with tightening (19 percent), and about half left interest rates unchanged.

Small biz on the sidelines

Credit quality among business and consumer applicants continued to deteriorate; only about 10 percent of respondents said that business or consumer credit scores had risen, while about half said they had declined for both groups. Said a South Dakota institution, “We have money to lend, but cannot always fund applicants due to inability to borrow. Their poor credit histories keep them from obtaining credit.”

The survey also asked specifically about credit conditions for small business. Results showed that demand for small business loans and lines of credit was mostly a wash across the district as a whole; those institutions seeing an increase were offset by those seeing a decline. However, responses were positive for every district state, save for Minnesota, where responses were much more pessimistic.

Those reporting a decline in credit to small business were also asked about the underlying source. The reasons cited for tight credit were all over the map, including a decline in demand and sagging creditworthiness among small businesses.

The most-cited reasons—though only by a small margin—were organizational uncertainty about future financial system reforms and regulatory restrictions on bank lending. A Minnesota institution stated flatly, “The regulatory environment has impacted our willingness to make loans.”

Not all respondents felt that way about the role of regulators, however. The percentage of respondents saying regulator influence was the most important factor for the decline in small business lending (27 percent) was slightly lower than those saying it had no role or influence (29 percent).

http://watch.bnn.ca/featured/#clip327942

 

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles my email, click here.

Today, the FT provided some additional information on the BIS' "goldgate" as relates to its 346 tonnes of gold disclosed as swapped recently by the ubercentral bank. As the FT says, "Investors have bought physical gold in record amounts during the past two years and deposited it in commercial banks. European financial institutions are awash with bullion and some are trying to pledge gold as a guarantee." There was nothing necessarily new in the article, and as expected the swap was merely put in place to collateralize a dollar funding crunch ahead of the European insolvency, allegedly resolved by the guaranteeing of $1 trillion in the world biggest bail out fund by the IMF and the ECB. Nonetheless, at least now we can end speculating as to who benefited: it was not entire countries that had pledged their gold reserves to the ECB (contrary to the rumor that Portugal had given Bernanke a lien on its gold), but merely ten banks, of which HSBC, Société Générale and BNP Paribas were the biggest. While HSBC's presence is somewhat surprising, the latter two banks having found themselves in a massive currency crunch makes sense: as Zero Hedge had previously noted, this is confirmation that it was precisely the French banks that had found themselves on the wrong side of some major euro trades (one need only to recall BNP's call for subparity in the EURUSD from a month ago). Yet what is without doubt is that physical gold will play an increasingly prominent role as a hard collateral asset. In light of this, we present to you the thoughts of Sprott's John Embry on the precious metal, titled "Gold's on the cusp of parabolic move up" whose conclusion fits with the implications of the BIS action: "Central banks can no longer supply the amount needed  to balance supply and demand while mine production continues to stagnate at best. It is imperative that investors ignore the volatility created by the anti-gold cartel and use every opportunity that is created by them to purchase more physical gold." Yes John is conflicted, and yes, he has said comparable things in the past... maybe, as more and more piece of the puzzle come into place, this time he will finally be right?

Full Embry essay

06_23_2010 Gold's on the cusp of a parabolic move up

h/t Kyle

 

One of the world's most realistic people (which for some reason the permabulls take as an indication of extreme bearishness: which is fine - after all they themselves live in an imaginary world populated with market marking unicorns and benign computer programs), David Rosenberg has shared ten things that would make him bullish. Alas reading through these gives one the impression that Hades would first turn endothermic before any of these actually were to come true. And for some more practical views from Rosie, we also include his spot on interpretation of today's GDP data.

I was recently asked to provide a list of developments that would make me more bullish on the macro and market outlook. Here are a few:

1. Initial jobless claims below 400k on a sustained basis. This would lead to job growth strong enough to generate organic wage growth.

2. Improvement in housing inventories to a 5-6 months’ supply backdrop. This would help establish a floor under home prices.

3. Signs of a turnaround in the money multiplier, money velocity and the ratio of commercial bank non-liquid assets/total assets. Any sign that the debt deleveraging cycle has run its course.

4. A new "killer app" or some major technological breakthrough would be nice.

5. A sustained decline in oil prices that is induced by new supplies (or peace in the Mideast?) as opposed to demand destruction would act as a de facto tax cut.

6. Structural economic reforms in the world's "surplus saving" countries like China, India and Germany that stimulate their domestic demand, and hence bolster our exports and reduce the global reliance on the U.S. as the consumer of last resort, would be a huge plus.

7. A peaking out in the personal savings rate (the sooner we get to 6%-8%, the better) – get to a level consistent with pent-up demand.

8. Consumer confidence closer to 100 (typical of expansion) than the current 50 reading.

9. An end to the steep cutbacks at the state and local government level.

10. New and more effective political leadership globally – could the Cameron victory in the UK be a leading indicator towards fiscal probity?

And here is Rosie's take on today's most important economic data point:

The economy underperformed expectations in the second quarter with the initial estimate of real GDP growth coming in at a 2.4% annual rate. The revisions to the back-data also showed the Great Recession to be even greater than initially thought with the economic loss now totaling 4.1% from 3.7% previously. And the revisions also reveal a policy- and inventory-induced recovery that is now losing steam at a faster rate than was thought before, especially with respect to consumer spending – the 2.4% GDP pace is down from 3.7% in the first quarter and 5% in the fourth quarter of last year.

There are legions of economists out there who claim that it is normal to see the economy take a breather at this stage of the cycle, but in truth, what is “normal” in the context of a post-WWII recovery is that four quarters into it, real GDP expands at over a 6% annual rate. That puts 2.4% into a certain perspective. And with the revisions now showing the downturn deeper, the level of economic activity in real terms is still 1% below the pre-recession peak. Again, when you look back at 55 years worth of post-war data, what is normal 2-1/2 years after a recession begins is that by now we are at a new peak already (breaking above the prior high in GDP by 8%, on average).

The big story in the second quarter as has been the case for much of the past year was the contribution from inventories – there was a “build” of $75.7 billion and this added over a percentage point to headline GDP growth. This follows a “build” of $44 billion in the first quarter so this is no longer the case that companies are merely reducing the pace of inventory withdrawal. Businesses actually added to their stockpiles at the fastest rate in five years. And with sales lagging behind, this inventory contribution is likely to fade fast in coming quarters. Real final sales – representing the rest of GDP (excluding inventories) – came in at a paltry 1.3% annual rate last quarter and has averaged 1.2% since the economy hit rock bottom a year ago in what is clearly the weakest revival in recorded history.

Normally, real final sales are expanding at closer to a 4% annual rate in the year after a recession officially ends. Then again, we haven’t heard anything official just yet about the one that began in December 2007 – and so the fact that it is averaging at around one-third that typical pace in the face of unprecedented policy stimulus is rather telling. And frightening.

Looking at the components of GDP, it appears as though the economy is set to slow even further and a flattening in Q3 and perhaps even contraction by Q4, barring some positive exogenous shock, cannot be ruled out. First, one of the primary contributors to the renewal in economic growth, business capital spending, which has expanded at a double-digit annual rate for three quarters in a row – expanding at a 22% annual rate in Q2 – is starting the current quarter at a pace that is closer to high single-digit growth. That alone may trim a halfpercentagepoint from headline growth this quarter.

With durable goods inventories-to-sales ratios rising to eight-month highs and most manufacturing diffusion indices rolling over, it would stand to reason that the inventory contribution to growth is over. Though to be fair, that will also mean that the import boom will subside and provide some offset (foreign trade actually subtracted 2.8 percentage points from GDP growth last quarter). The government sector added 0.9 percentage points to second-quarter GDP growth with an apparent seasonal skew from defense spending and there was a rare increase in state & local spending, which is hardly going to be repeated this quarter as the budgetary cutbacks deepen. The housing tax credits triggered – get this – a 28% annualized surge in residential construction in the second quarter and while a tiny share of the economy now, this still added 0.6 percentage points to the headline. All the incoming data point to a huge reversal in the real estate sector in the current quarter.

In the final analysis, it is the consumer that is key. With a 70% share of GDP, even a tepid 1.6% annualized growth rate in Q2 – the consensus was looking for 2.4% – can end up adding 1.2 percentage points to GDP growth (which is almost as much a contribution as a 22% surge in capital spending).

But after back-to-back months of declining retail sales and consumer confidence running at half the level it usually does in the context of an economic expansion, the data are pointing to virtual stagnation in household spending this quarter. In fact, what really came to light in the revisions to the data was just how lacklustre the pace of consumer spending has been over the past year – so much so, in fact, that the savings rate is now estimated to have risen to 6.2% in the second quarter from 5.5% in the first (revised sharply higher than the prior estimate of 3.5%). We have long highlighted consumer frugality as crucial deflationary secular theme and the revisions to the savings rate go a long way towards bolstering that view – underscored by the near-0% annualized trend in the pricedeflator for Gross Domestic Purchases last quarter.

So even though the second quarter corporate earnings season was decent, one reason why the equity market is struggling of late is because you can only drive and gaze through the rear-view mirror for so long. At some point, you have to look through the front window, and the prospects for a double-dip or some facsimile thereof were bolstered, not hindered, by the contours of the second quarter GDP report.

If indeed, the inventory cycle is behind us, then what we have on our hands is an underlying baseline trend in GDP of 1.2% at an annual rate. And if we are correct in our assumption that the looming withdrawal of fiscal stimulus at the federal level and the cutbacks at the state and local government level subtract 1.5% from growth in the coming year, then it begs the question: How exactly does the economy escape a renewed moderate contraction over the next four to six quarters, barring some unforeseen positive boost? In turn, how does a strong possibility of such a contraction square with consensus views of a 35% surge in corporate profits to new record highs as early as next year? The answers to these questions are as painful as they are obvious.

Perhaps it bears pointing out that one may consider adjusted Rosie's new frugality concept: as Bloomberg pointed out, US consumers are only frugal if they can default on existing payment obligations. Because buying iPads while broke is not quite the frugal behavior one would expect out of rational, or in fact even normal, consumers (although it confirms what we have been saying for about a year now, that any marginal purchasing power in the US exists only courtesy of defaulting on mortgages, credit cards and other deferred payment plans by the evaporating middle class).

Yesterday may go down in the history books for being the only day in months in which the daily decoupling, either between risk and FX, or risk and Bonds did not occur. Alas, today the binary market hijacking mutants are back to their signal chasing momentum ploys, as a result despite the 10 year about to plunge below 2.90, stocks are flat. As either stocks are rich (no question there) or bonds are (yields are low), the intraday recoupling surefire trade is back, and promises to pay a few nickels to those willing to short stocks and short the 10 year (and pray there is no steamroller in the vicinity).

Mike Krieger, who has been a staple poster at Zero Hedge courtesy of his willingness to speak the truth no matter how gory or controversial, was on the Max Keiser show, discussing everything from trivial items such as Goldman Sachs movie casting, to far more serious issues such as Obama's failed presidency, corporatism, information oligopolies, the overturn of various core fundamental democratic principles, consumer culture, the Federal Reserve, and gold as the one true money standard. As always an objective and highly informative discussion between Mike and Max.

Fast forward to 14 minutes in the clip below for the full Krieger interview.

 

The boarding of a Turkish ship by Israeli commandos and the international brouhaha that it sparked has thrown a searing spotlight on that emerging nation. Several hedge fund friends and not a few readers of this newsletter in Istanbul have urged me to explore this intriguing nation further. So I thought I would use this otherwise glacial news day to do exactly that.

I first trod the magnificent hand woven carpets of the Aga Sophia in the late sixties while on my way to visit the rubble of Troy and what remained of the trenches at Gallipoli, a bloody WWI battlefield. Remember the cult film, Midnight Express? If it weren’t for the nonstop traffic jam of vintage fifties Chevy’s on the one main road along the Bosporus, I might as well have stepped into the Arabian Nights. They were still using the sewer system built by the Romans.

Four decades later, and I find Turkey among a handful of emerging nations on the cusp of joining the economic big league. Q1 GDP grew at a blazing 11.4% annualized rate, second only to China, exports are on a tear, and the cost of credit default swaps for its debt is plunging. Prime Minister Erdogan, whose AKP party took control in 2002, implemented a series of painful economic reform measures and banking controls which have proven hugely successful. Since the beginning of this year, Turkey’s ETF (TUR) has outperformed BRIC poster boy China’s ETF (FXI) by a whopping 11.8%.

Foreign multinationals like general Electric, Ford, and Vodafone, have poured into the country, attracted by a decent low waged work force and a rapidly rising middle class. The Turkish Lira has long been a hedge fund favorite, attracted by high interest rates. With 72 million, the country ranks 18th in terms of population and 17th in terms of GDP, some $615 billion. It has a near perfect population pyramid; with young consumers greatly outnumbering expensive retirees (click here for more depth in my “Special Demographic Issue” at http://www.madhedgefundtrader.com/november_6__2009.html ).

Still, Turkey is not without its problems. It does battle with Kurdish separatists in the east, and has suffered its share of horrific terrorist attacks. Inflation at 8% is a worry. The play here long has been to buy ahead of membership in the European Community, which it has been denied for four decades. Suddenly, that outsider status has morphed from a problem to an advantage.

Growing economic power brings political influence with it. The last year has seen Turkey broker settlements in the Balkans and facilitate the Iranian uranium swap with Russia. Some analysts claim this new flexing of diplomatic muscle has a pronounced Islamic, anti American bent. Remember, Turkey refused transit rights to US forces during the invasion of Iraq.

The way to play here is with an ETF heavily weighted in banks and telecommunications companies, classic emerging market growth industries (TUR). You also always want to own the local cell phone company in countries like this, which in Turkey is Turkcell (TKC). Turkey is not a riskless trade, but is well worth keeping on your radar.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

Dear Mr. President,

 

You don’t know me, but I was one of the millions of Americans who voted for you in the last election. I have since been fairly critical of your Presidency largely because I, like many others, feel betrayed by the policies you have enacted upon winning said election.

 

However, rather than simply becoming yet another “I voted for Obama and regret it” commentator who has a lot of complaints but no ideas, I thought it better to do my duty as a citizen of this country and try to offer a solution to some of the problems plaguing the US today.

 

The following is a plan that I believe would bring about a significant change not only in the US economy, but in the US mindset. The last 30+ years in this country have been dominated by an overall regression in moral character and beliefs.

 

Somehow, and I’ll leave the “how” up to the historians, our nation’s moral framework seems to have shifted from asking ourselves “is this right or wrong?” to “is this legal or illegal?” Even worse, we now seem to be shifting from “is this legal or illegal?” to “can I get away with this?”

 

This is most obvious in the financial community where a small sliver of our citizenry continues to make billions, if not trillions, of dollars, through ill-gotten means. I won’t bother going into details here, because the “ill-gotten means” have been well documented by others.

 

For now I will simply state that it is absolutely OBVIOUS that the market is manipulated, that insider trading and front-running of investor orders is permitted with impunity, that Americans got a RAW deal on the bailouts (that’s putting it mildly), and that the worst thing that happens to those who break the law in the financial and large corporate sectors is a fine equal to maybe a few days’ worth of profits.

 

The fact that this activity continues to be permitted and that those who engage in it make salaries in the six if not seven or eight figures sends several very clear signals to Americans, particularly those young ones looking to get ahead in life. They are:

 

1)   Those who work for financial institutions and large corporations are above the law.

2)   You should try to make money by any means possible.

3)   Look out for yourself and forget about everyone else.

 

I ask you, what do the above observations say about the American economy/ financial system? Moreover, what kind of mentality are we fostering in our nation’s character?

 

Here’s my proposal to change all of this.

 

First of all, I would create a new financial law in the US. It would be the following:

 

Any financial gain reaped by insider trading, manipulation, fraud, stealing, etc. would result in 100% of the gains generated by the action being confiscated by the Government and the company that committed the action being fined an amount equal to 10% of its (the company’s) net value.

 

Today, the most common punishment for financial or corporate entities that break the law is a small fine. A perfect example of this is the recent Goldman Sachs lawsuit in which the firm paid a $550 million settlement on a deal that helped the firm generate billions in profit. To put this in perspective, Goldman generates $500 million in profits in about a week of trading.

 

These fines accomplish little if anything. They are akin to fining someone $5 for running a stop sign. If that was the worst punishment for running a stop sign, no one would bother following motor traffic laws at all. So why do we impose similarly modest sums on those organizations that generate billions of dollars? It’s not like they DON’T have the money handy to pay off a sizable fine.

 

A fine of this size (10% of market capitalization or total assets, or Enterprise Value or whatever) as well as confiscating 100% of the ill-gotten gains, would act as a MAJOR DETERRANT to corporate and financial crime. It would, in plain terms, clean up Big Business’s (well, every business’s) act in no time.

 

 So how do you go about enforcing this new law?

 

I propose the creation of a government agency titled The Bureau for Corporate and Financial Integrity or some such thing. This agency would be a kind of Department of Homeland Security devoted solely towards insuring that the money made in the financial and corporate sectors, is made honestly.

 

I realize that we already have several financial regulatory bodies in the US. However, it is clear from the ongoing fraud, corruption, and theft occurring today that these organizations are overwhelmed.

 

On top of this, the markets and economy today are very, VERY different from those that existed at the time most of these organizations were created. Changing markets call for changing mentalities and attitudes. Which is why I propose the creation of a new organization rather than simply reshuffling the ones already in place (this organization could work with the pre-existing ones too).

 

By creating a new organization you would create new jobs. More importantly, these would be permanent jobs rather than temporary jobs such as those created by the census and other temporary programs.

 

However, rather than simply offering the usual cushy public position consisting of a very stable salary and benefits, I would suggest you offer the employees at this new organization the following deal:

 

The employees involved in bringing about a case to fine a corporate entity take home 1% of the money brought in from the settlement should the case win.

 

I can tell you Mr. President, there are MILLIONS of smart, intensely analytical young Americans who would jump at the chance to stop corporate crime if you offered this type of compensation package.

 

For instance, the guys who took on Goldman Sachs in this recent case would receive $5.5 million to split up among them. That kind of pay is handsome in any jobs market… but in one as tough as today’s? Let’s just say you’d be overwhelmed with applications.

 

But what about the rest of the money and the money confiscated  (the money the company made via fraud or some other financial crime)?

 

I propose that you use it to:

 

1)   PAY OFF THE NATIONAL DEBT

2)   Fund various public programs (NEW ones, NOT old ones that don’t work)

 

Doing #1 would send a clear message that America is an honest, financially prudent country. Rather than lecturing other countries about finance when we ourselves are running a deficit and debt level that would take a private organization bankrupt, we would LEAD BY EXAMPLE.

 

This would also STRENGTHEN the US Dollar. I know many folks in the various economic bureaus and our central bank don’t like the idea of a strong Dollar… but I can assure you that the 300+ million rest of us WOULD LIKE IT VERY MUCH.

 

Regarding #2, by using the money fined/confiscated from organizations that break the law, you would find a large, ample supply of money to fund various governmental programs, which in turn would allow you to CUT TAXES.

 

After all, if the government didn’t have to rely on taxes to fund its programs and budget, it could lower taxes for its citizenry.

 

This would not only GUARANTEE you a 2012 re-election win, but would jump start the economy as it would mean MORE money available for private sector spending and consumption (particularly with a stronger Dollar) as WELL AS THE PAYING OFF CONSUMER DEBT (mortgages, credit cards, etc).

 

Obviously, there are a lot of details that would need to be worked out in my plan. But its results would be TREMENDOUS. Among other things, it would do the following:

 

 

1)   Rein in the corruption and fraud that is polluting our capital markets and economy (not to mention our national character on the world stage).

2)   Re-instill a notion of “right and wrong” to our nation’s public conscience.

3)   Create new, potentially high paying jobs for our best and brightest.

4)   Teach Americans, particularly the young, that you don’t need to break the law to get ahead in life, that you can do right by doing the right thing.

5)   Help with our debt and deficit issues while sending a strong message to the world that the US doesn’t just talk about prudence and solvency, IT LEADS BY EXAMPLE (this would also impact our national character as it would re-instill the old virtue of living a debt free life).

6)   Strengthen the US Dollar.

7)   Help jumpstart the economy by lowering taxes which would permit consumers to pay off their debts, and spend more if they chose.

8)   And of course, JUMP START YOUR APPROVAL RATINGS LEADING TO A GUARANTEED 2012 WIN (I know you’ve got to consider your political career in your policy-making).

 

I do not view this plan as a “fix all” remedy to our nation’s ills. The US economy and political/ financial systems are in dire straits and there are some issues which will simply require us to “take the medicine” if we do the right thing.

 

However, I strongly believe this plan would be the first step towards shifting our country’s course from one of corruption, greed, immorality, and lawlessness, to one of honesty, integrity, transparency, financial prudence AND solvency.

 

In plain terms, it would re-instill notions of doing the right thing and of making an honest living. It would also re-instill our confidence as a nation as we become proud members of a country that is financially prudent, virtuous, and which leads by example.

 

I realize there is a small portion of our population that would STRONGLY oppose this plan. However, I can assure you that the vast majority of Americans (99% of us) would be ALL FOR IT. If you put this matter to a public vote, it would likely be the BIGGEST VICTORY IN US HISTORY.

 

And, finally, I can guarantee you that introducing this plan would immediately JUMP START your approval ratings AND almost certainly guarantee you of a 2012 victory (I know this matters to you). If anything it would be a great start towards a new future in this country, one of strong national, corporate, and individual moral character.

 

 

Yours Respectfully,

 

Graham Summers

 

 

PS. For more scathing critiques of the socio-political structures in this country as well as hard-hitting investment insights revealing the real reasons the market moves as it does, join me at#1e439a;">www.gainspainscapital.com

 

The ECRI Leading Indicator has just moved further into certain recession territory, hitting -10.7 for the most recent week (the previous revised number is -10.5). The market goes green on the news, as the Liberty 33 traders have done their job for the day and are off to the Hamptons. And what is so odd about the market reaction one may ask - bad news are as always priced in, as the apocalypse is nothing that a little money printing can't fix, while minimal upside surprises (soon to be revised far lower) are sufficient to move the market higher by over 100 points intraday. Hopefully the HFT operators unionize and go on strike soon in demanding greater pay, and get the Greek trucker treatment as a result, because this market is not even a joke anymore.

After surging to a several week high, the 2s10s has plummeted to a one week low in the matter of hours, dropping back down to 236 bps. This follows a day of fireworks in the curve, in which as Market News discusses below, we saw some pretty aggressive hysteria in flattener unwinds. Oddly enough, the collapse in the curve has occurred as the 2s have hit another record low yield, indicating that no matter how much of a spin opportunity any given diffusion index headline provides, the bond market is increasingly pricing in deflation (and in fact the yield on various classes of TIPS was negative earlier today).

For Market News' Talk from the Trenches summary on the moves int he curve below, read on:

Over the last two days, the 5-year/30-year Treasury curve has steepened about 16 basis points and many players that were involved with the flattening trade got crushed.

Remember that this market has had a flattening bias for a very long time given the premise that the Federal Reserve will be on hold for a long, long time. Therefore, in order to earn returns, people have been relying on the carry trade: in other words, borrow short and invest long to earn the spread.

The trade is clearly overpopulated and it only took a few trades in the opposite direction to send these players into a tizzy. When prices went against them, they bailed.

The move began Wednesday when the 5-year auction received stellar demand. A prominent bond fund and a large central bank were believed to have bought. Soon flattening trades were being unwound and the prominent bond fund advocated the buying of 5-year notes.

Steepening trades ensued, sending the curve even steeper. Many black box accounts also had to bail.

Then on Thursday, a large hedge fund was said to have unwound a large flattener and the steepening continued.