Dollar Set to Crumble from the Sub-Prime Market Fallout

By John Lee       Aug 3 2007 4:27PM www.goldmau.com

In our March GoldInsider newsletter I wrote the following piece:

“The Subprime Market and Blatant Market Support:

You must have heard about the subprime loan fallout by now. New Century Financials, America’s second largest sub-prime lender, was delisted so I could not grab the chart, but here is the company’s sister, Novastar, which is not far behind. The pace of the fall out is startling to say the least. These are $billion companies listed on NYSE. So what’s the story all about?

Updated Novastar Chart to July 2007

Non-bank companies like New Century and Novastar provide mortgages to lesser qualified home buyers, charging interest rates of around 10% instead of 6%. Then, they packaged those mortgages and sold them either to institutions or bigger mortgage houses such GM or Countrywide at 9%.  Those non-bank mortgage lenders borrow money from banks at a lower rate and lend to consumers at higher rate to make a profit. They rely on credit from banks to operate.

New Century’s mortgage production for 2006 was $60 billion. I would estimate the sub-prime mortgage market to be around 100 to 200 billion. This is nothing to sneeze at considering this is directly related to money creation. With America’s M3 growing at 1 to 2 trillion a year, 200 billion accounts for 10% of money creation and the hole, or the void must be filled.  It’s not a trivial issue.

What’s more, while those companies carry their own portfolio of mortgages, they sell most of the mortgages they create. Thus the problem doesn’t resolve itself upon the fallout of the subprime lenders, as many of those faulty mortgages have already passed onto the big lenders and institutions. This is a double whammy to the big lenders as they not only have lost a source of revenue/referral, but the quality of their existing portfolio of loans is in doubt.

The extent of the problem is unknown and I don’t think we will ever know. GM or Countrywide, however, cannot fail and issues with bad debt can be fixed by the Fed. There is surprisingly little disclosure from the banks regarding derivatives or CMO (collateralized mortgage obligations), paving the way for an easy fix by Bernanke, who can simply replace questionable CMO “assets” on GM’s balance sheet with dollars issued by the Fed. Under the disguise of structured products, there is no telling or predicting damage by outsiders.

I am also very surprised by how well the market has held up. Typically with a down leg like that seen on Feb 27, another leg down leg should ensue within three days.  This didn’t happen and the Dow is very resilient above 12,000. I watched the tape all day on March 5 and 6 and saw steady buying, which in my view is quite inexplicable – who would be buying while Asia is down some 4% the night before and while the problem could potentially jolt the financial system? What was interesting to me was that as mysterious buying surfaced gold quickly rebounded; perhaps the blatant market support left such distaste in some trader’s minds that they resorted to gold to make a statement?

My view is that the Fed will print their way out of every and all trouble. There is no other way.  Subsequently I see an interest rate cut as early as April by as much as 50 basis points to keep the money creation continuing. We have passed the point of no return. There is going to be no Volcker (who raised interest rates to double digits to save the fiat system). This is going to be very bullish for gold.”

August 3rd Update:

Since our last update, 3 mortgage related hedge funds from Bear Sterns totaling $16 billion had collapsed. American Home Mortgage Corp, the second largest non-bank mortgage lender, accounting for 2% of all newly issued mortgages had tanked 80%+ in one week as banks have refused to provide more credit to them.

The Deutsche Industriebank AG German fund involving American mortgages and financial obligations of US$11.07 billion required the government bail out. Australian Macquarie Fortress Investments, worth $873 million, was forced to sell assets to avoid breaching its loan agreements. And Europe’s biggest bank, HSBC, is to write off $11 billion to cover mounting losses in its troubled American offshoot, HSBC Finance Corporation.

Dow closed up 150 points on Wednesday, with American home mortgage issued warning on Tuesday afternoon. We find such market action incongruent and can only conclude that Plunge Protection Team was at work.

The conclusion from this is three fold:

1. The Fed will not be able to raise interest rate. Doing so will cause systemic collapse of all USD debt markets.
2. The Fed will bail out any mortgage problems, amounting between $100 billion to perhaps over $200 billion, estimated by analysts at Financial Times.
3. Plunge Protection Team is likely to guard equity and bond markets with fresh, newly minted liquidity. This will only further reduce the investor appetite towards US dollars. There is now disdainful taste in holding those hot dollar potatoes.

Technically dollar index is set to break down beneath 80 shortly. Gold is antithesis to the dollar, and gold’s breakout over $700/oz is imminent.

John Lee,
CFA john@maucapital.com

Moment Of Truth For GoldBoris Sobolev
Resource Stock Guide
www.ResourceStockGuide.com

Equities fell off a cliff last week and gold along with gold stocks followed. We think parachutes will open to ensure a safe landing as the financial authorities will yet again come to the rescue.

Over the last year, fuel for the equity markets has largely been coming from cheap debt available to private equity firms mostly due to the yen carry trade. The Dow Jones "Private Equity Analyst" reports that the US private equity firms raised $137 billion during the first half of 2007, a 42% increase over the first half of 2006. The cash from Leveraged Buyouts (LBOs) flooded the markets and was reinvested pushing stocks to their all-time highs. The key point here is - the stock market is being pushed up by borrowed funds. Since a lot of the debt will have to be repaid in yen, the sharp rise in the Japanese currency last week spooked all markets.

Careful market observers will note that European markets took a bigger hit than US markets last week:

• Europe 350 iShares down 7.2%
• Emerging Markets iShares down 6.4%
• S&P 500 down 5.4%

As an example, the above chart shows that the German Dax Composite underperformed the S&P 500 Index primarily due to the strength of the Japanese yen. This is the third time since last December. To us, this signifies that the yen carry trade global unwinding has now become the most serious issue among some others, such as the US subprime problems we discuss below.

Subprime Worries and Rising Credit Spreads

Additional warning signs recently emerged in the US markets that the subprime worries are starting to spill over into the private equity fundraising efforts. The latest bombshell fell when Bill Gross of Pimco commented that "enough is enough" referring to the liquidity glut that has caused artificially low interest rates for high risk debt. He warned that this debt is going to be re-priced as investors begin to realize that the subprime problem may not be an isolated event.

A crowd of highly leveraged sellers rushed for the doors causing panic selling last week. Credit spreads rose all across the board, from high quality corporate debt to junk bonds.

In fact, anyone looking to sell corporate paper with less than AAA rating would have had a very difficult time. The chart below shows a ratio between the US treasury bonds and investment grade corporate bonds indicating the biggest credit spread jump in years.

Of course, Mr. Paulson, Mr. Bernanke and crew realize the risks involved. The Treasury Secretary made a few speeches last week to reassure the markets that the government remains vigilant and will prevent the problem from developing into a crisis or a panic. While many skeptics are smirking at the government's response, we think the message Mr. Paulson is sending to Mr. Gross is that "it's not yet enough" - the liquidity bubble will continue.

The government and the Fed are concerned that a further decline in the stock market could be a catalyst for an economic slowdown or even a recession. Corporate profits will dry up causing LBO related loans to turn not only to junk but to trash. As a result liquidity will plunge and yields spreads will rise further. A dry out of liquidity will in turn increase defaults among the speculative grade issuers and cause the stock market to plunge even further. A credit crunch is a nightmare scenario for any banker.

To show that it is serious about avoiding such a scenario, the Fed pumped more than $8 billion into a non-government and agency debt paper last week. Given the strength of the emerging economies and the Bank of Japan's reluctance to change its long term inflationary policy, the Fed should not have a problem this time in restoring liquidity to the market to avoid a crash scenario.

While cracks in the worldwide financial system are starting to appear, its collapse is very hard, if not impossible to time. The waiting game continues.

Implications for Precious Metals Stocks

The US stock market is extremely oversold based on a number of indicators. A rebound in the markets should happen this week, but such a recovery, we expect, will be relatively short-lived. August and September are seasonably bad months and a retest of lows set by stocks last week is highly likely.

As far as the precious metals stocks are concerned, while the correction last week may seem sharp and brutal, the technical picture remains positive. A rebound along with the rest of the market should happen shortly.

The moment of truth for the precious metals sector will occur when the next stock market decline commences. This decline will happen during a steepening yield curve environment, which is very bullish for gold. At that time, the smart money should start reallocating into the real safe haven - gold, not the US treasuries. As a result, gold and gold stocks will not follow the general market to the downside. This will mean that the new leg of the gold bull has begun.

At this critical situation we remain bullish and see this decline as another buying opportunity.

30 July 2007

Boris Sobolev
Denver, Colorado
Resources Stock Guide
Contact@ResourceStockGuide.com

Swiss Central Bank Sold Around 35 Tons Of Gold In July

Wed, Aug 8 2007, 16:50 GMT
http://www.djnewswires.com/eu

 

Swiss Central Bank Sold Around 35 Tons Of Gold In July

LONDON (Dow Jones)--The Swiss central bank sold around 35 metric tons of gold in July, data released by the Swiss National Bank showed Wednesday.

The bank said gold holdings fell by CHF917 million to CHF31.81 billion in July.

Allowing for exchange rate and gold price movements, this implies sales of around 35 tons last month, which is more than double the 13.9 tons sold in June, analysts said.

Recently, Switzerland proposed to sell up to 250 tons by September 2009 as part of a strategy to shift its reserves into more profitable fixed-income instruments.

(MORE TO FOLLOW) Dow Jones Newswires

August 08, 2007 12:50 ET (16:50 GMT)


Copyright 2007 Dow Jones & Company, Inc.

 

Kitco In Focus: The Consumer Price Index and the Spot Price of Gold

By Kitco's Wendy Ip       Aug 8 2007 9:16AM www.kitco.com

Purpose of Kitco In Focus

The purpose of Kitco In Focus is to bring to our viewers a perspective regarding the precious metals market with the hope of shedding clarity on the complex nature of this market. At least initially, the aim for this series of articles is to pull out those relevant factors that play some role in the market and explain them each in turn so that we can gain a better understanding of key concepts introduced by various authors who have worked diligently within the precious metals industry. 

It is in my hope that Kitco In Focus will also be inspired by our readers in terms of what they would like explained or the questions they would like to bring to the table. In regards to this, I am sure we all know that there are various ways to understand, explain, and analyze any given topic and that these various ways can be competing bodies of knowledge. I really want to be clear on this because there is no universal or agreed upon way of understanding all of those important and not so important factors that influence the precious metals market. I hope to bring most of these perspectives to the table, although not all at once or within one article, so that our readers can have a comprehensive understanding of the dialogue that exists within this industry. I want to stress that even in my attempts to do this, others may not share the perspective that is presented and that I think this is completely natural and heal thy in any honest dialogue that exists on any given topic. We all want to arrive at the best understanding of the market we are all so very passionate about, myself included.

With this said, Kitco In Focus is written as a tribute to all of those who frequent our site and for those who would like a deeper understanding of those economic factors that are commonly assumed to play some role in our market. I hope that you enjoy.

Often times, in the media, we will hear various explanations on why we are observing the spot price of gold to be at some given level and why we should make an investment in gold now rather than later. Included in this reasoning are a collection of macroeconomic aggregates, which are nothing more than a set of economic variables, that are readily observed to be of either direct or indirect influence on gold’s price. For this week’s In Focus, I will consider one macroeconomic aggregate, inflation as measured by the Consumer Price Index, CPI.

If you are new to the market for gold, you may wonder what does the data on inflation supposed to tell us and does the CPI do a good job of giving us the information we need in order to make an investment decision. Here, I will briefly address whether the CPI is a good measure of inflation as well as present one argument detailing how concerned we should be about inflation in light of the daily volatility that is clearly seen in the price of gold. [As a side note, I will mention that there are other authors such as Greg Tkacz, David Ranson, Mahdavi and Zhou who have argued for the use of the price of gold as a leading indicator of inflation. Studies have shown that this can be applied in a limited fashion, but only for a few selected countries. Obviously, there is a reversal in causation here: the price of gold gives us an indication of inflation and not vice versa. Also, here in this reasoning, expected or future inflation is what is to be deduced from the current price of gold. Next week’s In Focus will be devoted to this very interesting subject].

To start at the beginning, one of the most widely referred to measurements of inflation is the CPI. Actually there are various forms of this Laspeyres Index. Typically, a price index can be measured either by using a fixed basket of goods and services, referred to as a Laspeyres Index, or by using a variable basket, referred to as a Paasche Index. Among the various measurements of the CPI, there is the fixed-base Laspeyres Index, such as the CPI-U (a CPI for all urban consumers) and the chained Laspeyres Index, such as the C-CPI-U (which is just a chain weighted CPI for all urban consumers). The chain weighted CPI was developed to minimize any measurement bias that exists as a result from not accounting for new products entering into the market (like computers), improvements in the quality of a good, and substituting towards a cheaper good within the same category. The result of these biases is that the fixed CPI tends to be higher than its chain weighted counterpart giving us an imprecise measurement of inflation. For example, this year’s initial statistics on the monthly US percentage change in the CPI reveals that the CPI-U has been greater than the C-CPI-U by at least 0.2 percentage points. Some argue that fixed or chain weighted, the CPI does not do a good job of capturing inflation. I will take the position that, yes the CPI is an imperfect measurement; however, it may still give us a rough idea of changes in the overall level of prices. I also say this with the notion that any consideration of inflation regarding the role it plays in our decision making should make us think more about the long-run than the short. I will explain shortly.

What about the role of the CPI in the determination of the price of gold? You may have seen media explaining that the increase in the price of gold was the result of the latest data on inflation where the CPI for the country has been reported, which revealed an increase in the monthly average of the overall level of prices. You are also likely to have been informed that the reasoning for this is because gold is seen as an inflation hedge. That is, gold helps to preserve or even enhance an individual’s wealth or purchasing power during a period of inflation, when other assets fail to perform this function. The result is that the demand for gold has increased given new information about the state of the economy leading to an increase in its price. What is interesting about this statement is that new information regarding inflation for a particular country is actually rather old information, since, for example, the current CPI is reflecting what happened last month plus some measurement error, beyond the bias mentioned above, that will require a few more months to iron out. You see, CPI data for the month prior comes out, at least for the US and Canada, around the middle of the current month and that is just for the initial estimate. So, if CPI data is an imperfect measure of current inflation, why do people care about this statistic enough to say that it had a current day impact on the US dollar price of gold? I will wager it is because they view the data as a statistic that helps to establish people’s expectations about the near future state of the economy. Peoples’ expectations, well founded or not and by that I mean well founded on good information or not, help to foster their consumption in the current period; thereby, affecting the demand for gold in the current period. Of course, the demand side is only a partial representation of this particular market, a market where individuals are interested in gold as a commodity and a medium of exchange. Moreover, by how much new information, such as monthly CPI data, may influence or build peoples’ expectations is virtually impossible to measure, but we can deduce that CPI data, in the short-run, may play a very minor role in the determination of the spot-price of gold and that the role it does play is that of forming only part of people’s expectations.    

Lines in grey help us to see the trends the USD spot price of gold and the CPI - U

You may have noticed that the seeming effect of the announcement of new CPI statistic has a very short lived effect on the current price of gold. At other times, you may have noticed that the news has brought no effect on gold’s price. Looking at the graph above, we can see that the announcement of the CPI-U data around mid-February of 2007 regarding the increased rate for the month of January did not result in the expected increase in spot price at the time of the announcement. Instead, this additional information had no effect on the spot-price of gold for the month of mid-February to March, as we observe a severe decline in the spot price instead. How do we reconcile this information? In these cases, some authors have been able to pin-point causes that weigh more heavily in its price determination. As an observer of this particular market, we must always take into consideration that there exists a multitude of factors, some readily measurable and some not, such as consumer preferences and expectations, as mentioned above, or the effect of political unrest, that will play an ultimate role in the final price.

So, you may be asking, what is information on inflation good for? Well, first of all, I must stress that inflation is a long-run statistic. That’s one of the reasons why we shouldn’t be too concerned about the fact that last months data came out only by the middle of this month and that we are still waiting for the figures to be finalized. I think that regarding inflation as a long-run statistic is crucial. When the rate of inflation is stable on a yearly basis, we can focus our attentions on making plans for the long-run and, here, information on inflation can be used to help us determine our long-run investment position. In saying this, it can help us to determine the long-run support for the price of gold.

``When markets have an initial or sudden difficulty, you many times see a move toward Treasuries instead of gold,'' said A.C. Moore, who manages the $500 million Dunvegan Growth fund, which has about 20 percent in gold and gold-related stocks. ``That's the easiest choice. Short-term Treasuries also provide income where gold doesn't.''

The fund is based in Santa Barbara, California.

U.S. Treasuries rose today, led by short-maturity notes, which are more sensitive than longer-maturity debt to possible changes in monetary policy. Yields on the two-year note fell 18 basis points. The benchmark 10-year note's yield declined almost 11 basis points to 4.77 percent. Prices move inversely to yields.

Rising Treasuries drove the dollar higher against a basket of six major currencies. Gold generally moves in the opposite direction of the dollar.

Central banks may be selling gold reserves to push down the price and calm investors, said James Turk, founder of GoldMoney.com, which manages $191 million of investments in gold and silver. Some investors buy gold during times of financial turmoil.

`Capping the Price'

``A rising gold price warns of troubles ahead,'' Turk said. ``That's why central banks are capping the price of gold.''

The Bank of Spain sold 25 metric tons of gold in July. It has sold a total of 149 tons in the third year of the Central Bank Gold Agreement, London-based research firm GFMS Ltd. estimates. Spain sold 30 tons in the first year and 62.5 tons in the second year.

Under the accord, banks in Europe can sell as much as 500 metric tons a year. The ECB said on Aug. 7 that one member bank sold gold worth 29 million euros the previous week after member banks sold 483 million euros worth in the preceding two weeks.

The banks had reported selling 294 tons as of June 12, according to the producer-funded World Gold Council. The banks sold 497 tons in the first year and 396 tons in the second year of the five-year accord.

To contact the reporter on this story: Pham-Duy Nguyen in Seattle at pnguyen@bloomberg.net .

Last Updated: August 9, 2007 11:21 EDT

www.sharelynx.com/chartsfixed/600yeargold.gif

diesistkeineaufforderungzuirgendetwas

Nationale Goldreserven haben auch in einer Währungsunion eine vertrauens- und stabilitätssichernde Funktion für die gemeinsame Währung. Diese Funktion ist angesichts der geopolitischen Lage in der jüngeren Vergangenheit und der Risiken, die sich aus den globalen Leistungsbilanzungleichgewichten ergeben, eher noch gewachsen. Weitere Risiken hängen mit der zunehmenden globalen Verflechtung von Güter-, Kapital- und Finanzmärkten und mit dem ausgeprägten Appetit nach Risikoanlagen der Finanzmarktteilnehmer zusammen. Abrupte Veränderungen der Weltwährungsrelationen können wegen dieser latenten Gefahren in Zukunft nicht ausgeschlossen werden. Der deutliche Goldpreisanstieg reflektiert die Zunahme dieser Risiken und zugleich das wachsende Sicherheitsbedürfnis risikobewusster Anleger. Gold stellt für die Bundesbank auch vor diesem Hintergrund einen Vermögenswert dar, der ihren Ansprüchen nach Werthaltigkeit und Diversifikation ihres Portfolios - bestehend aus Devisen und Gold als Währungsreserven - gerecht wird.

www.bundesbank.de/presse/presse_aktuell_goldreserven.php

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und mal ein bisschen durchklicken:

www.chartsrus.com/

diesistkeineaufforderungzuirgendetwas

 www.finanznachrichten.de/nachrichten-2007-08/artikel-8892049.asp

Die aktuelle Schwäche beim Gold führt Edelmetallexperte Curtis Hesler, Herausgeber des US-Börsenbriefs „Professional Timing Service“, vornehmlich auf saisonale Effekte zurück. Mittelfristig ist er von steigenden Goldpreisen überzeigt und hat auch einige Empfehlungen parat.
Hessler sagt: Ich erwarte kurzfristig noch eine Fortsetzung der Schwäche beim Gold und auch bei den Minenwerten. Ich erwarte aber keine verheerenden Folgen. Wir nähern uns den saisonalen Tiefständen im August. Die Aussichten bei Gold und Silber für den Rest des Jahres sind aber sehr gut. Sollte ich aktuell eine Goldaktie auswählen, dann würde ich weiterhin Yamana Gold (ISIN: CA98462Y1007) unter 13 Dollar zum Kauf empfehlen. Beachten Sie aber bei Ihren Edelmetallpositionen, dass das Depot ausgewogen ist und keine starken Über- oder Untergewichtungen einzelner Metalle oder Sektoren aufweist.
Bei Silber habe ich erst kürzlich einen neuen Wert vorgestellt Endeavor Silver (ISIN: CA29258Y1034). Dieses Unternehmen erwartet schon in diesem Jahr eine Produktion von 2,8 Millionen Unzen Silber und 7.500 Unzen Gold. Die Hauptaktivitäten von Endeavor Silver liegen in Mexiko. Unsere Empfehlung ist, von der aktuellen Marktschwäche zu profitieren und die Aktie bis zu einem Kurs von 4,60 Dollar zu kaufen. Dies ist eine aussichtsreiche Spekulation auf einen Junior Silber Produzenten - eine Chance, die man nicht so schnell findet.

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