Where is the Gold Going?

Here’s some good news to calm your fears. According to the Financial Times:

Investors and financial markets have been too quick to believe the worst about the health of the global economy, raising the danger of a self-fulfilling and unwarranted downturn, leading economists said on Tuesday.

In a call for a “reality check”, Olivier Blanchard, former chief economist of the International Monetary Fund, and his colleagues at the Peterson Institute of International Economics say that global economic pessimism in 2016 has been in contravention of basic economic facts.

Interesting. The report continues:

They warn that financial markets are unlikely to be good predictors of a coming downturn and that falls in prices are better regarded as a stabilising force, rather than a harbinger of doom. Mr Blanchard and his colleagues argue that such price slides are a sign of a return to normality, since valuations were previously inflated by central banks’ attempts to stimulate the economy.

“The probability of another 2008 [financial crisis] is inconceivable,” Mr Blanchard said. “The banks are clearly much stronger than they were.”

You may suppose that we’ll completely disagree with Mr Blanchard.

You would be wrong. We broadly disagree with him, but not completely.

In fact, we wholeheartedly agree with the theory behind at least one of the things he says. Trouble is…he has the context all wrong.

When Monsieur Blanchard says that falls in prices are a ‘stabilising force’, he’s right. But only if central banks and governments haven’t acted to inflate prices to abnormally high levels.

In other words, falling prices are a stabilising force in a free market.

What we have right now isn’t a free market.

But that’s not the only thing. It’s a monumentally huge irony to hear about the ‘stabilising force’ of falling prices from an economic central planner when the IMF, central banks, and governments have spent the past seven years shrieking about the dangers of deflation.

He’s right in other ways. Markets aren’t always the best indicator of the future. If you buy stocks at the top of a bull market, you buy them because the market seems to indicate that prices are going higher.

It’s only later that you realise the market wasn’t a good indicator.

Of course, the biggest beef we have with Monsieur Blanchard is his comment that a repeat of 2008 is ‘inconceivable’. Wrong.

It’s more than conceivable; in our view, it’s downright certain.

And as for the idea that banks are ‘much stronger’, you could argue that, but it’s all relative.

Let’s take Commonwealth Bank of Australia [ASX:CBA] as an example. And let’s keep this really, really simple.

In 2008, CBA had $2.6 billion of ‘cash and cash equivalents’ on its balance sheet. As I say, to keep this simple, think of that as cash and coins in the safe.

At the same time, CBA held customers’ savings totalling $262.1 billion. So, the bank held ‘cash and cash equivalents’ to cover 1% of all savings. Put another way, for every $100 of savings in your bank account, the bank only has $1 in physical cash.

But the banks are much stronger now, right?

For the 2015 financial year, CBA held $15.8 billion in ‘cash and cash equivalents’. That’s a big increase in seven years.

But the amount of deposits has grown too. CBA has a total of $530.3 billion of customers’ savings in its care.

That means the bank hold ‘cash and cash equivalents’ covering 3% of savings.

For every $100 on deposit, the bank now holds $3 (in simple terms) in cash.

We’ll agree that, at least, it does make the CBA stronger than it was before. But how much stronger? So strong that the CBA wouldn’t come under any pressure at all during the next financial meltdown?

We’re sure there are plenty of folks who will argue that. And, in truth, they may be right. But we wouldn’t bet on it.

When a former IMF chief tells us that something is ‘inconceivable’, we start to think that it’s a matter of ‘when’, not ‘if’, the next crisis will happen.

It’s inconceivable

Ooh, this could interest the banks. Bloomberg reports:

Data has been showing regulators’ curbs on loans to property investors are starting to bite. Home loans to investors fall 1.6%. Value of loans to owner-occupiers drop 4.3%.

What could this mean? We could take a guess. But don’t worry — another financial crisis is, of course, inconceivable…

Or is it?

In more breaking news, in 2009 CBA had $292 billion of residential loans on its books. For the last financial year, that increased to $422 billion.

Again, don’t worry. It’ll be fine.


The old saying is that stocks tend to ‘go up the stairs and down in the lift’.

In other words, markets tend to rise steadily, and crash suddenly.

Looking at the action for the Dow Jones Industrial Average, we’re not sure that rings true — at least, not over the past year anyway.

To us, the market appears to be taking turns at going ‘up and down in the elevator’.

Source: Bloomberg

Click to enlarge

The market collapses in a heap in a few days and then appears to recover just as quickly.

That’s volatility for you folks.

The reason? You know the reason. Investors don’t know whether they’re coming or going. Not because they’re dumb, and not because they don’t know how to analyse markets.

It’s because they don’t know what to expect. Everything that’s happening in any market is directly, or indirectly, linked to the actions of central banks.

Nowhere is that more apparent than in bond markets.

If you’re scouring both news headlines and markets looking for clues about the ‘trigger point’ I described in Port Phillip Insider last week, then perhaps this is one story worth looking at.

As Bloomberg explains:

The shortage of benchmark 10-year Treasury notes in the market for borrowing and lending U.S. government debt has become so pronounced that uncompleted trades are soaring.

Such trades, known as fails, surged into the billions of dollars in recent days for the newest 10-year note, and may have been in the range of $6 billion to $12 billion, according to Treasury market participants… While uncompleted trades occur daily, sometimes because of computer glitches, it’s unusual for the level to be so high. There were $132 million in failures for all 10-year Treasuries in the week ended Feb. 24, the latest data from the Federal Reserve Bank of New York show.

Why is this happening? The article explains:

So many traders are amassing short bets on the on-the-run Treasury, or wagers that yields will rise, that they’re struggling to find the note to close out the positions.

Traders are short. In order to cover a short position to close the trade, they have to buy it from someone else and then deliver it to the market. But they can’t buy them from anywhere it seems. At least not in the number necessary to close the short trades.

The chart below shows how this trend is rising:

Source: Bloomberg

Click to enlarge

Granted, the fail rate is nowhere near the high in 2008 (not shown on this chart), but it backs our point about the influence of central banks in the markets.

Traders are only placing these bets in huge amounts due to central banking manipulation. If we may be so bold as to create a little rhyme to make the point: if the Fed didn’t meddle, the trades would easily settle.

The whole idea of failed trades in US Treasuries makes us wonder about the situation in other markets. The open interest (number of open futures contracts) on gold has remained relatively constant over the past five years.

However, as the chart below shows, the stock level of gold at the COMEX warehouse in the US has been in decline:

Source: Bloomberg

Click to enlarge

Value of contracts traded constant…amount of gold backing those contracts — down 43% in five years.

Where’s all the gold going? To China is the likely answer.

And why not? The West doesn’t need the useless metal.

But no need to worry. A financial crisis like 2008 is inconceivable.


Kris Sayce,

Publisher, Money Morning

Ed note: The above article is an edited extract from Port Phillip Insider.

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