Credit Markets

 

Poor, Forlorn, and Neglected

Neither stocks nor gold moved much on Tuesday… “Wait and see,” remains the order of the day. The Greeks, for example, have 48 hours to come to terms with their creditors. We wait to see what will happen.

We wait to see what happens in the bond market, too. Have bonds topped out? Hard to say …   For six years the Fed and other major central banks have made a bad situation worse.

By promising to keep the cost of carrying debt ultra-low, they have encouraged governments and businesses to add trillions of dollars in debt to an already debt-drenched economy.

 

abeShinzo Abe, armed with his three arrows. He has so far managed to pump up the stock market and stomp on the currency, but he the third arrow has yet to find a worthy target.

Image via The Economist

 

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The Fuse Is Lit

We’re not the only ones giving Neanderthal advice about holding on to physical cash. British newspaper the Telegraph reports:

 

The manager of one of Britain’s biggest bond funds has urged investors to keep cash under the mattress. Ian Spreadbury, who invests more than £4bn of investors’ money across a handful of bond funds for Fidelity, is concerned that a “systemic event” could rock markets, possibly similar in magnitude to the financial crisis of 2008…

The best strategy to deal with this, he said, was for investors to spread their money widely into different assets, including gold and silver, as well as cash in savings accounts. But he went further, suggesting it was wise to hold some “physical cash,” an unusual suggestion from a mainstream fund manager.

 

gold certificateA 100,000 dollar gold certificate issued in 1934 – or what the dollar once was.

 

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The Story of Our Times

Dow up 180 points on Thursday. Gold rose $16, once again breaching the $1,200-an-ounce mark. The first number measures the value of America’s business. The second measures the measure.

We watch the two, but not closely. Most often, nothing important happens. There is no information content in the numbers. Just “noise.” Then, occasionally, they say something…

Many investors and analysts spend their time trying to figure out what the numbers will say next. That is like trying to guess what will come out next from the mouth of a raving lunatic.

 

6-blind-men-hansInvestors busy figuring out where things stand …

Cartoon by Hans Moeller

 

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An Interesting Background Noise Amid Increasing Bubble Talk

As we have previously pointed out, a sharp increase in “bubble talk” is often a danger sign (see “Circular Bubble Logic” for details). There is some anecdotal, as well as some quantifiable evidence for this (such as Google search statistics). There has certainly been quite a bit of talk about certain bonds having reached unsustainable levels, but generally our impression was that there was actually a lot of complacency as well. This is especially true with regard to low or even negative yielding European government bonds, which reflected one of the most egregious central bank-directed market distortions yet (more on this further below).

 

Bond-Bubble

 

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The Tip of the Iceberg

The dollar is always losing value. To measure the decline, people turn to the Consumer Price Index (CPI), or various alternative measures such as Shadow Stats or Billion Prices Project. They measure a basket of goods, and we can see how it changes every year.

However, companies are constantly cutting costs. If we see nominal – i.e. dollar – prices rising, it’s despite this relentless increase in efficiency.

 

small-dollarPhoto credit: Hirkophoto

 

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The Madness of Negative Bond Yields

As we have frequently discussed in these pages, time preference must always be positive on a society-wide basis – it is a praxeological law that future goods and/or satisfactions are valued at a discount to identical present goods. We emphasize “identical” here because sometimes people are asserting that there are exceptions, such as in the famous example that men would prefer having ice in the summer over having it in the winter (thus, in wintertime, ice available in the future would be valued more highly). However, “summer ice” is not identical to “winter ice”, even though it has the same physical properties. The reason is that the satisfaction if provides is not the same.

 

bank

 

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An Accelerating Trend

While the euro itself has recovered a bit from its worst levels in recent sessions, euro basis swaps have fallen deeper into negative territory. In order to bring the current move into perspective, we show a long term chart below that includes the epic nosedive of 2011. We are not quite sure what the move means this time around, since there is no obvious crisis situation – not yet, anyway.

A negative FX basis usually indicates some sort of concern over the banking system’s creditworthiness and has historically been associated with euro area banks experiencing problems in obtaining dollar funding. This time, the move in basis swaps is happening “quietly”, as there are no reports in the media indicating that anything might be amiss. Still, something is apparently amiss:

 

1-euro basis swapsParty like it’s 2011: Three month, one year, three year and five year euro basis swaps – click to enlarge.

 

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The Final Chapter in the Credit Bubble Story

Before we get to that, we note that the Dow fell 60 points, or 0.3%, on Friday. Gold was more or less unchanged. An ounce of the yellow metal traded at $1,242 at last check.

Not to leave our dear Diary readers in doubt, we expect a crack… or even a crash… in stocks sometime this year. But that won’t be the end of the story. We suspect it will mark the end of one chapter and the beginning of another – the final chapter in the credit bubble story that began in the early 1970s.

It’s a long story. And it’s a big story. Too bad it has been so overshadowed. Watergate … Vietnam … massacres from Hanoi to Bombay … Boy George and J-Lo. The plain people have time for the Super Bowl, but certainly not for the Super Bubble … even though it is more important to them.

 

Nafea-Faa-Ipoipo-1892

A famous – and horrendously expensive – painting by Paul Gauguin (Nafea faa ipoipo?). In fact, it just became the most expensive art work in all of history.

 

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Soaring Prices of Government Debt

As the WSJ reports on government debt yields in Europe:

 

“As much as €1.5 trillion ($1.7 trillion) of euro area debt maturing in more than a year now pays a negative yield, according to J.P. Morgan. That compares to none whatsoever a year ago.

German government bonds offer negative yields on maturities up to six years, according to Tradeweb, along with those in Denmark. For five years, the Netherlands, Austria, Sweden and Finland are in the club. For four years, add France and Belgium. In Switzerland, bonds out to a whopping 13 years in length have negative yields.”

 

Approximately €220 billion in bank reserves are subject to negative deposit rates as well (this is actually less than it once used to be, as banks have moved excess reserves from the deposit facility to the current account facility at the ECB, which at least yields zero instead of the 20 basis point penalty rate applied to the deposit facility).

 

15-2-2-Gold-coin-634Photo via moneyweek.com

 

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A Disturbance in the Farce?

We usually like to keep an eye on indicators that are not getting a lot of attention, in an attempt to circumvent the “what everybody knows isn’t worth knowing” problem. Recently, several noteworthy things have happened with the $VIX, or rather, the derivatives traded on the VIX. The VIX is a measure of implied volatility, referring to front month options on the S&P 500 Index (it used to be the S&P 100 back when OEX options were still the most liquid index options – the OEX version is these days called VXO). While the first OEX version used only at-the-money options expiring 30 days hence, the calculation has been expanded over time. Now it is a blend of front and second-month at-the-money and out-of-the-money options. Those interested in the precise calculation procedure can take a look at it here: CBOE VIX White Paper (PDF). The aim is to calculate the expected 30-day volatility of the SPX at a 68% probability (one std. deviation) as expressed by the options market.

 

gi-takingstock01rb1

Image credit: James Steidl / Thinkstock)

 

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