Bernanke Blinks - But Will It Matter?
Below is a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, August 13th, 2007.
Well, Bernanke was wrong, and those pointing out the credit crunch was contagious, including yours truly, were right. Of course it should have been no surprise hearing such an official forecast considering what's at stake, that being the global economy. Oh - and that's not all that's at stake. The Fed's future ability to affect the economy is also at stake, where many are watching to see how Bernanke stacks up in comparison to Greenspan under pressure, this being Bernanke's first big test. Here, if Ben were perceived to fail, where Greenspan is to this day viewed as a winner, there's no telling what to expect in financial markets this fall. A collapsing dollar ($), collapsing bond market, and quite possibly plunging stocks markets in turn certainly come to mind. And unfortunately, even he and the global Working Group on Financial Markets do stave off disaster in the short-term, which they will surely attempt, this would only postpone the inevitable, as already it's largely understood the credit crunch is for real, where no matter what measures are undertaken in defense of the system (including the suppression of gold), the dominos of disaster are already falling. Let's open this line of thinking up further below.
Certainly the fact Bernanke had to add emergency liquidity so soon into the budding credit crunch is already not being viewed positively. Is he blinking too soon? Should he not allow the crisis to unfold further before taking action so that when action is taken it has a material impact? Arguably this was Greenspan's talent, timing the bailouts, including his own. Of course in full measure it should be realized that as far as effort is concerned, failure here would not be Bernanke's fault, or anybody else's. Nope - here, and involving a great deal of irony in thinking about the full set of circumstances, all of the collapses taking place around the world today are one man's fault, with that honor lying squarely on the shoulders of Alan Greenspan, the maestro (heavy on the sarcasm). Like a spoiled child, the maestro was not going to see any blemishes on his record, so when trouble hit, he inflated, and kept inflating by multifaceted and sophisticated means to the point when added together, and counted correctly, it could be argued we have already been living in a quasi-hyperinflationary state for some time.
This is of course why Ben had to come in an add emergency liquidity last week, because not only are Bernanke and friends destined to doom in this regard, so are all the other losers (bankers and politicos) around the world that were drawn into a Greenspan style inflation game (meaning boundless), which of course requires ever increasing measures more frequently as process unfolds. A good example of how this works, and why total global and all-source numbers (think carry trade etc.) already point to an extreme situation currently, is the trillion Yen Japanese officials added to the banking system just today. (Hyperinflation anyone?) This is why all the current measures are doomed to failure, as it's just not possible to bail out a problem of this scale. Accelerating hyperinflation is possible for a period, which will only stave off collapse, and worsen things in the end. But unfortunately our bankers are spineless and greedy (as they have already proven under the Greenspan experiment), so we have little doubt this is the avenue they will choose. Oh yes, by all means, inflate at all costs is their motto. And here is the cost put as eloquently as I have read anywhere (or could conceive), by Nouriel Roubini, as follows:
"We are indeed at a "Minsky Moment" and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic - will not work; they will only postpone and exacerbate the eventual and unavoidable insolvencies."
What's more, the problems will multiply in real time now, where for example the hedge fund redemption window opens this week on the 15th, so expect price managers to be propping prices up here like there's no tomorrow. And who knows, if things are not going so well, we might even get one of those surprise rate cuts to really make Bernanke look inept by pandering the speculating idiots like Jim Crammer. And in terms of the Recipe For Disaster that appears to be coming together for Bernanke and friends, let's add the fact he's boxed in between a rising inflation profile set against a collapsing consumer, the worst possible picture a custodian of the currency could possibly have. Here, if he chooses to support the economy, hypothetically the currency would collapse due increased monetary largesse. And conversely, if the Fed defends the currency, the economy will collapse due to excessively hawkish official policy; whatever that means today with all the unofficial backdoor inflation taking place. Naturally then, it will be interesting to see if the inflation numbers are cooked this week when PPI and CPI are reported.
Of course all western economies are essentially in the same boat as the US, a condition that was made evident last week with collapse of a major German bank, Westdeutsches Landesbank. Here, the ECB added 95-billion euros to the system Thursday, along with closing the interbank money market for hours in the morning for the first time in history. This is why worrying about the dollar ($) is not a concern in relation to other fiat currencies because globally we are all in the same boat. Greenspan made sure of that. So, the choice appears clearer then. However, also considering how much water has already gone under the bridge inflation wise (think Yen Carry Trade, monetizations, etc.), again, the big question remains, short of all out hyperinflation and / or rate cuts, just how effective these measures will be this time around. Would a rate cut be effective immediately? Not if history is a good guide, and especially not so soon, where again such a move would infer panic (and inexperience) by Bernanke and his counterparts, potentially spooking some observers, and emboldening others. Today, there are far too many people who know about these measures, which may only serve to embolden speculators to bet on the long side of the stock market attempting to catch the bottom. And you know what will happen if that occurs. Put / call and short ratios will plunge, and so will stocks in turn. One must remember, short of hyperinflation, maintaining high short positions against stocks is a critical element of the formula of keeping prices supported. If these short positions are lost for whatever reason, stocks will plunge, which as you will remember, we have been pointing out is why the market can't catch a lasting bid these days.
In turn then, if Bernanke makes it worse by repeatedly making it apparent he's pandering the cake eaters by acting in dovish fashion, by either covert or official means, it doesn't matter anymore, increasingly short positions will be covered, and in fact both he and the Fed will be perceived to have failed. Just watch gold explode after this hits everybody's radar screen, which will be after the dust settles in whatever sort of stock / bond market debacles transpire in coming days. This is why in spite of perceived weakness in the cards, everyone should maintain a core position in precious metals, because when the turn comes, you will be unable to react, as prices will shoot higher quickly. Pertinent technicals for gold are seen on the weekly plot attached here, where as you can see solid support exists at $640. If gold were to close below this measure for three consecutive days in a row, we would be forced to move our official intermediate-term view from neutral to bearish however. And in not putting the cart before the horse, and the metric currently being tested, if $660 goes, we will be compelled to move our short-term outlook from bullish to neutral, and then to bearish if $640 goes of course.
We bring these negative technical considerations up because stressed hedge funds might be forced to sell holdings to raise capital in coming days, where if they have any gold (especially paper gold like an ETF), they will surely sell because it's liquid. The big question here is of course exactly how much gold do they hold? If the sharp fall in COMEX open interest is any indication of how much paper gold they hold over there, where a conclusion of 'not much' can be assumed. But they must own a 'mitt full' of streetTracks [the New York Stock Exchange (NYSE) Exchange Trade Fund (ETF)]. So to me, the next big concern is this possible selling, which could potentially take gold through support at $640. And just look at silver, with its indicators all coiled up and ready to break in one direction or the other, as seen on the daily silver plot. Here, the bulls are thinking if we are truly in a bull market, which of course we are, then silver should resolve higher in coming days. And undoubtedly, aggressive speculators are betting in this fashion. The only problem is if the stock market were to snap off to the downside at some point in coming weeks, which again, will surely occur if enough investors throw in the towel and redeem their hedge fund positions, at least to some extent one would be wise to expect deferential weakness here too, as silver does have a generally positive correlation to both equities and industrial metals. What's more, it should also be noted stochastics on both the weekly and monthly suggest further consolidation is required at this time.
Here, and just like speculators that are buying the dip in stocks based on the predication price managers are filling the system with liquidity, which of course they are, expectations such measures should have an immediate positive effect on prices could be proven 'too optimistic' in the end, as increasing bullish bets on stocks would cause prices to continue tanking. And again, as process unfolds, this in turn would cause more redemption notices to show up at hedge funds, where selling begets more selling, until finally panic sets in, and all price supports are erased. Moreover, as hedgers reduce leverage, fewer protective puts would be required, which as you know is a very large part of the greater price support mechanism. The fact brokers, with even the mighty Goldman Sachs now in the picture, are handing hedge fund investors big losses at present will also hinder their ability to sell disaster insurance (puts) to the managers because of course, they will be going out of business. So you see, the self-supporting nexus could unravel if the above circumstance set were allowed to unfold, which again, is why one should expect to see a concerted effort to support stocks into options expiry this coming Friday. Of course it would be what happens afterward, if too many shorts are forced out of the market and not replaced for the September options cycle, that is the big risk riding along side what hedge fund managers are forced to do over the next month.
And what of precious metals shares with all this liquidity potentially disappearing? Answer: Expect precious metals shares to de-leverage as well, at least until as with the broad averages, price stability due to a truly panicky Fed and friends finally kicks in down the road set against increasingly bearish speculators, not the other way around. That is to say after speculators buying this dip in stocks find religion, meaning prices don't necessarily rocket higher right away, true fear associated with the credit crunch should hit the tape, meaning stocks should crash, and in process become washed out. To me, this is the dip you want to buy precious metals shares, where on top of everything else, the market will be reacting to a perceived failure on the part(s) of global monetary authorities married to the understanding these characters will necessarily wish to see gold rising in sending out the message their inflation efforts are working, and 'price stability' is returning to the system. So, although the monthly GDM plot is suggestive of an impending bottom matching seasonals at month's end, it may take longer for the entire process described above to work out, where it should be remembered hedge fund redemptions could cause selling right into September this year, potentially thwarting seasonal strength normally enjoyed in gold at this time. You may remember in the year 2000, the secular (important and higher degree) turn did not essentially occur until December that year. Tax loss selling is yet another reason that coincides with this timing. And if that's not enough, lest we forget a match of the 20-month mid-term correction in gold seen in the 70's (see Figure 4), would also put us into the December timeframe for a bottom, Perhaps this is where we test an initial bottom witnessed in September, who knows?
Only the shadow truly knows just how long this process could take, because if for example indicators shown here on the weekly HUI plot were to in fact break out of diamond structures to the down side, given false breaks are frequent in the metals due to prices being so heavily managed, one would need to consider carefully just what such an occurrence would imply. Would this simply be a reflection of panic selling by hedge funds, or is the credit cycle crunch for real, set to include margin debt, which in turn would force many over-exposed players in precious metals shares out of the market as well. Accentuating this risk is the daily GDM plot that is showing we are at a reliable time line related topping point at present. Again however, it should be noted prices could break either way at present, as a good case could be made that with short sellers having gone hog wild with all this talk of Armageddon, if the Fed were in fact to provide the cake eaters with the rate cut they are clamoring for with increasing intensity, another noticeable short squeeze could be engineered here. Certainly any improvement of official inflation data this week could also spark a rally without any movement by the Fed just on anticipation. And isn't it funny how official data is often just what the doctor ordered these days when the chips are down. Well - I guess it wouldn't be that funny if one were a short seller. Moreover, don't be surprised to see the metals get a lift this week too if conditions in the general equity complex improve.
All that being said, one thing I do know for sure is the value of a physical ounce of gold under current circumstances. I know the intrinsic value of an ounce of gold is a heck of a lot more than what it's going for in terms of present fiat currency regimes. I know that if were not for the excessive short positions in the stock market that the systemic risk present in the system would far closer to the forefront of attention than we are currently witnessing, and that price managers would be unable to stop the eventual flood of investors into the safety of gold. In this respect, and in taking this concept a bit further in terms of preparing for the inevitable, which again, will surely come once the stars are aligned (all the short sellers are squeezed out of stocks), it's probably not a bad idea to begin measuring the worthiness of financial institutions you are doing business with given the apparent failures of some big banks of late. Perhaps now you can see the greater virtues of gold, where sure, we may be subject to a little liquidity risk, but in the end, it will never go out of business. Further to this, it should also be recognized that in terms of attempting to preserve wealth required for day-to-day needs, all financial institutions would get dragged down in an eventual credit crunch, but that some will fair far better than others. Here, bigger is definitely better than small in general, as governments will support key institutions to the end. Of course any money not required for more immediate needs should technically be held in gold bullion against this risk, where balancing all ones needs is the task at hand then.
And you know, if short positions had not absolutely exploded in this last reporting period, I would be far more bearish than one can be against such a backdrop considering the obvious blundering mistakes Bernanke and friends are making right now, not the least of which is their apparent willingness to pander a cake eating mob on Wall Street up to their eyeballs in not only margin, but greed. Yes, normally this would be a sure fire recipe for disaster tout suite; but again, with all the short positions on, one would be foolish to be betting in such a manner.
So, although it's recommended one use restraint here in terms of ensuring margin exposure is minimized / eliminated, at the same time it must be recognized the cake eaters may get their way yet again, at least for a while. Thus, it must be concluded a reasonable probability the general markets get squeezed higher in coming days does exit, with precious metals shares possibly shining to some extent as well, albeit continuing to play second fiddle to the broads. Accordingly then, and as suggested all along as the credit crunch was / is unfolding, one should maintain a properly structured / diversified / balanced portfolio including a core position of precious metals investments, where again, nobody knows when investors will decide to begin discounting mounting systemic risks growing in the larger financial system. Perhaps this process will begin in earnest during September. We can only hope so for the sake of our core positions.
Good investing all.