The
news rocked the global gold market when an almost obscure line item in
the back of a 216 page document released by an equally obscure
organization was recently unearthed. Thrust into the unwanted glare of
the spotlight, the little publicized Bank of International Settlements
(BIS) is discovered to have accepted 349 metric tons of gold in a $14B
swap. Why? With whom? For what duration? How long has this been going
on? This raises many questions and as usual with all $617T of murky
unregulated swaps, we are given zero answers. It is none of our
business!
Considering the US taxpayer is bearing the burden of $13T in lending,
spending and guarantees for the financial crisis, and an additional $600B
of swaps from the US Federal Reserve to stem the European Sovereign Debt
crisis, some feel that more transparency is merited. It is particularly
disconcerting, since the crisis was a direct result of unsound banking
practices and possibly even felonious behavior. The arrogance and lack of
public accountability of the entire banking industry blatantly
demonstrates why gold manipulation, which came to the fore in recent CFTC
hearings, has been able to operate so effectively for so long. It operates
above the law or more specifically above sovereign law in the un-policed
off-shore, off-balance sheet zone of international waters.
Since President Richard Nixon took the US off the Gold standard in 1971,
transparency regarding anything to do with gold sales, leasing, storage or
swaps is as tightly guarded by governments as the unaudited gold holdings
of Fort Knox. Before we delve into answering what this swap may be all
about and what it possibly means to gold investors, we need to start with
the most obvious question and one that few seem to ask. Who is this Bank
of International Settlements and who controls it?
Both
came to an end at the same time: the administration’s policy to Extend &
Pretend has run out of time as has the patience of the US electorate
with the government’s Keynesian economic policy responses. Desperate
last gasp attempts are to be fully expected, but any chance of success
is rapidly diminishing.
Before we can identify what needs to be done, what the administration is
likely to do and how we can preserve and protect our wealth through it, we
need to first determine where we are going wrong. Surprisingly, no
one has assessed the results of the American Recovery & Reinvestment Act
2009 (ARRA) which was this administration’s cornerstone program to place
the US back on the post financial crisis road to recovery.
We can safely conclude either:
1-
The administration completely under estimated the
extent of the economic crisis, even though we were well into it when the
ARRA was introduced.
2-
The administration was unable to secure the
actually required stimulus amount which was likely four to five times that
approved.
3-
The administration failed to implement the program
in a timely manner.
4-
The administration failed to diagnose the problem
correctly and that in fact it is a structural problem versus a cyclical
and liquidity problem, as they still insist it to be.
Greece’s austerity drive may pass its first test this week as a
European Union-led mission prepares to dole out more rescue funds
for a government trying to cut the euro-region’s second-biggest
budget gap and weather a recession.
Realistically, the worst cash-strapped states have little
hope of Washington DC coming to their rescue, at least not on
a major scale. A bill that would have provided a mere
$26 billion -- and yes, we mean mere, because in the grand
scheme of things, this is peanuts compared to both the
deficit, the Federal budget, and what the states need -- is
looking unlikely to pass the Senate, after a vote was delayed
yesterday. As
David Dayen at FireDogLake notes, the bill (largely
designed to help states with MedicareO0 would have added less
than $5 billion to the deficit, per CBO scoring, and yet that
was enough for opposition to marshall a filibuster.
Another vote is apparently scheduled for Wednesday, but in its
current form it will be radically different from a similar
version passed by the House, meaning it will be sometime
before it can be reconciled.
The Fed will consider a modest but symbolically important
change in the management of its giant securities portfolio when
members meet next week.
Interactive- Inside the Fed's Balance Sheet WSJ
See a full-size version. Click on chart in large version to sort by asset
class WSJ
See a full-size version. Click on chart in large version to sort
by asset class.
Assets on the Fed’s balance sheet contracted a bit in the
latest week, dropping to $2.308 trillion from $2.315 trillion.
Most of the decline came from a decline in the value of the Fed’s
mortgage-backed securities. The central bank had stopped new
purchases of the securities, and the portfolio has decreased as
some of the holding mature. But
policy makers are considering reinvesting those funds into MBS or
Treasurys, which may keep the balance sheet from declining as
much in the weeks or months ahead. Direct-bank lending has dropped
to the precrisis levels of 2007.
In an effort to track the Fed’s actions, Real Time Economics
has created an interactive graphic that will mark the expansion of
the central bank’s balance sheet. The chart will be updated as
often as possible with
the latest data released by the Fed.
In an effort to simplify the composition of the balance sheet,
some elements have been consolidated. Portfolios holding assets
from the Bear Stearns and AIG
rescues have been put into one category, as have facilities aimed
at supporting commercial paper and money markets. The direct bank
lending group includes term auction credit, as well as loans
extended through the discount window and similar programs.
Central bank liquidity swaps refer to Fed programs with foreign
central banks that allow the institutions to lend out foreign
currency to their local banks. Repurchase agreements are
short-term temporary purchases of securities from banks, which are
looking for liquidity and agree to repurchase them on a specified
date at a specified price.
According to WSJ, the Federal Reserve may make its first
shift to a more accommodative stance regarding its asset
portfolio. Specifically, rather than simply letting its
portfolio of mortgage-backed securities naturally dwindle
down, as they get paid off, the Fed may reinvest that cash
into more mortgage-backed securities. It's not a huge
move, but letting the MBS portfolio slowly burn off is
inherently tightening (cash goes into the Fed, it doesn't go
back out into the economy). Rolling over that portfolio,
therefore, maintains the status quo. We can't be
surprised at all that the Fed is considering this. There's
obviously a huge debate going on among the governors, and
Bernanke is well aware of the slowdown numbers, and the
compelling deflation arguments. This is, of course, an
incredibly minor move, and if things keep deflating, it won't
be nearly enough.
Probes of the collapsed mortgage-bond boom are shedding light
on how Wall Street firms, including Deutsche Bank, sometimes
created securities and sold them to some investors, while advising
others to bet against them.
Last week there was a widespread rumor that Washington was
thinking about a massive ReFi of home mortgages. I thought it was
ridiculous. There may be more to it then I first considered.
The story version I was told was that 50% of the borrowers
from Fannie and Freddie would get a letter that says,
“We are lowering your rate to 4.5% fixed. Just sign and return”.
I have a bunch of problems with this. Economics and fairness
come to mind. According to the Fed the 1-4 family mortgage market
is $10.7T (this is where the problems are). Of that Fan and Fred
have 4.6 T. The numbers:
If half of the GSE borrowers got the “Happy Letter” it would
mean that on average 12mm households would get 1% off their loan.
This comes to $23b a year or $1,900 per household. That sounds
nice, but $23b is chump change these days. It is about $150 per
month for the lucky winners. It really would not alter the course
of what will come for the economy. Also in this equation must come
the part that less interest paid to bondholders will have an
offsetting negative impact on demand. Net net I saw no compelling
upside to the economy in the rumor.
The plan as discussed
would have been subject to a lot of criticism. The idea that only
12mm out of 50mm are eligible for the FF Lotto is a nonstarter in
my opinion. You can’t win the Lotto because your mortgage is with
a Community Bank? It gets worse. The criteria for eligibility
would have to be based on payment history. If you paid your
mortgage these past few years your pal Uncle Sam was going to give
you a break. Translate this to mean that only those with higher
incomes who did not suffer in the last few years would get this
break. No Sale. The Administration would not like that result.
What bothered me is how broadly this issue was
discussed. It was not a rumor; it was a “talking point”. It had
legs and was even supported by the likes of Morgan Stanley. It
made no sense to me. I have been asking around and got a different
perspective from a few folks this afternoon.
One lady in
Washington told me that I had the numbers all wrong. The plan is
to:
- Include Freddie Mac’s $.9T in the program. - The
eligibility criteria would be based on payment history, but it
would be set at levels such that 70% of all Federal borrowers
would be eligible. - The interest rate incentive would be
substantial. The new rates would be below market. 4% is a possible
target.
By the numbers this would put $60b back into
households annually. So this adds up to a much bigger number. One
that would help repair household balance sheets. It would imply
that only 20mm out of 50mm would get a big win. It would mean that
those owners that got clobbered the past few years, the renters,
and the investors in mortgage securities would all get Dick’s
hatband.
When I pointed this out she responded, “You
don’t get it. This is not about the borrowers. This is about the
lenders”. I said, “Huh?” Her take:
D.C. is worried about defaults. Strategic or otherwise. They are
doing everything they can to hold it off. If the economy slows
they will get hit hard on new defaults. This reality threatens
everything. The objective of this plan is to ward off future
defaults at the GSEs. The hitch on the 4% ReFi will be that if one
fails to pay on a timely basis going forward the old rate is
reapplied. That is a powerful incentive, even if you are
underwater. At 4% your average house costs more to rent than own.
The “fairness” issue I thought was important, is in fact a
non-issue. This is not a solution to the nations housing problems.
Fairness is not the objective. It is a way to protect the GSEs. It
is the equivalent of a CDS purchase by Treasury. They are paying
the GSE borrowers not to default. From this perspective the Mega
ReFi plan has better optics. It might even make some sense. But it
is still a screwy idea. The fact that it is even being discussed
(including some of the ulterior motives) is a measure of just how
desperate the thinking has become.
The Wells Fargo/Gallup Small Business Index -- which measures
small-business owners' perceptions of six measures of their
current operating environment and future expectations -- fell
17 points to -28 in July. This is its lowest level since the
index's inception in August 2003.
Small Business
Index
Record Pessimism in Future Expectations
Most of the decline in the overall index came in the
Future Expectations Dimension of the index, which measures
small-business owners' expectations for their companies'
revenues, cash flows, capital spending, number of new jobs,
and ease of obtaining credit. The dimension fell 13 points in
July to -2 -- the first time in the index's history that
future expectations of small-business owners have turned
negative, suggesting owners have become slightly pessimistic
as a group about their operating environment in the next 12
months.
Small-business owners' future expectations for their
operating environment show significant declines in their
revenue, cash-flow, capital-spending, and hiring expectations
for the next 12 months. Forty-two percent expect it to be
"somewhat" or "very difficult" to obtain credit -- no
improvement from April and January. One in five (22%)
small-business owners expect their companies' financial
situations a year from now to be "somewhat" or "very bad."
Small-business owners are the embodiment of America's
entrepreneurial and optimistic spirit. As a result, their
increasing concerns about their companies' future operating
environment do not bode well for the economy in the months
ahead. Nor do small-business owners' intentions to reduce
capital spending and hiring: 17% of owners plan to increase
capital spending in the next 12 months -- down significantly
from 23% in April -- and 13% expect jobs at their companies to
increase, while 15% expect them to decrease over the year
ahead.
Big-firm earnings and global growth may drive
profits on Wall Street, but small business is the major source
of U.S. job creation. And most small-business owners are
unlikely to hire as long as they are becoming increasingly
uncertain about the revenues and cash flows of their companies
in the months ahead.
The attached slide deck from Morgan Stanley provides a
convenient 5 minute summary of the current state of the global
financial and economic picture. Discussing everything from fund
flows (nearly $300 billion in domestic equity outflows since the
beginning of 2007: strong like bull), to equity hedge fund
outflows in Q2 (and fixed income and macro fund inflows),
proceeding to the US economy, where the dip in final domestic
demand is expected to follow the GDP inflection point shortly
(does anyone even remember the disappointing Q2 GDP number posted
a long, long time ago last Friday?), a consumer spending number
that based on the current saving rate is unsustainable, to the
endless rally in corporate profit margins as firms fire any and
all non-essential overhead, to China's PMI drop, to Morgan
Stanley's reiteration of the bullish Chinese groupthink, to
observations of the exquisite correlations between the US ISM,
China's PMI, and the MSCI EM Total Perf, the unprecedented decline
in US manufacturing as a share of total world manufacturing
(charted below), to a hockeystick projection for Emerging Markets
where decoupling this time is most certainly different, and other
useful, if not particularly original, tidbits of data.
HIGH FREQUENCY TRADING (HFT) High Frequency Trading ( HFT)began with the observation that
there is structure to the movement f stock prices. It was
first based on a lot of the stuff you read here, Elliott wave
patterns, different technical chart patterns, and that these
patterns could be predicted and therefore profited from. But to
profit from these predictable patterns, you had to be fast and you
had to be unemotional. You had to go in and buy when no one else
was buying, at the bottom of bad market declines and sell at the
height of euphoria. Humans tried to do this and were unsuccessful,
letting emotions get the best of them. So the HFT traders decided
to hire computer programmers and aerospace engineers and let them
come up with complex formulas to put these patterns into computer
code and let the computers do the trading. As long as these
patterns could be written into algorithmic formulas using complex
code, and as soon as computers recognized these patterns, they
would automatically buy and also sell stocks that instant. “Bots”
didn’t care that the market opened up 100 points higher. Humans
may sell that move locking in small profits. But the bots kept
buying because something in that algorithm told them to and that’s
all that mattered. No emotion, just buy 100 points higher and then
buy some more 200 points higher. Because of this new style
of trading, computers or “bots” as they are known at trading
desks, became a larger and larger part of total trading volume and
while volatility increased due to this trading, the NYSE loved HFT
traders because they paid them lots of fees and they claimed
provided liquidity to the markets. But HFTs were not
satisfied with just digesting simple patterns so they developed
new strategies, more complex
algorithms. HFTs wanted to not just look at patterns displayed by
the markets in general, they wanted to develop an algorithm that
looked at the patterns and structure that other HFT “bots” use,
their competitors, to exploit them and therefore gain an edge, not
just on the market in general but on other competitive HFTs and
their “bots”. They wanted to exploit the weakness in their
competition and use any means to weaken them.
That leads us to what is happening now and that is a war between
HFT “bots “ and their firms. It
is bot vs. bot as HFT computers battle each other for short term
profits. There are many ways to do this but the newest technique
and one that may have caused the May Flash Crash is called “quote
stuffing.” Quote stuffing first came to light in
a report by Nanex, one of the leading market trading analytics
firm in a report about the Flash Crash. In this report, Nanex
presented irrefutable evidence of quote stuffing by HFT algorithms
in tens of stocks in which thousands of cancelled quotes would
reappear each second with regularity right around the time of the
May Flash Crash. It is ILLEGAL to indicate a quote without a trade
intent but according to Nanex it was happening at an alarming
rate. Worse, Nanex concluded that this type of quote
stuffing is in fact manipulative and can end up “pushing bid/offer
range up to 10% HIGHER without even ONE TRADE EVER HAVING
OCCURRED.” This is BLATENT UPSIDE market manipulation and to
make matters worse, the S.E.C has turned a blind eye to it. They
refuse to investigate on the terms that all of these HFTs are
providing needed liquidity to the system and there has been no
formal request by the exchanges to investigate this matter.
Here is the exact quote from Nanex and their report…. “In our
original FLASH CRASH ANALYSIS REPORT, we dedicated a section to an
observed phenomenon we termed “quote stuffing”, in which bursts of
quotes at very high rates with extremely unusual characteristics
were observed. As we continue to monitor the markets for evidence
of quote stuffing and strange sequences (Nanex calls these “Crop
Circles”) we find that there are dozens, if not hundreds of
examples to choose from on any given day. The common theme with
the charts, which are obviously generated in code and are
algorithmic, that some demonstrate bizarre price or size cycling,
some demonstrate large bursts of quotes in extremely short time
frames and some will demonstrate both. In most cases, these
sequences are from a single exchange with no other exchange
quoting in the same time frame.” Examples of the charts in
the report show a chart called a “flag repeater” where 15,000
quotes appeared in 11 seconds, dropping the “ask” price 1 penny
each quote from 9.36 to 8.58 and back up again….in 11 seconds!
They show charts of patterns called “Stubby” where quotes were
posted at a rate of 380 times a second moving “ask” prices in a
huge range. “Flutter” is a pattern of over 4000 quotes in 2
seconds alternating the bid price/size in 3 full increments and
then back down and then back up over this time frame.
“Periscopes…8000 quotes in 3 seconds changing the bid price on
every quote, “Double Dip”…10,000 quotes in 4 seconds, and my
favorite, “60 – Step” where you take 60 steps up…. a penny at a
time and then one step down…all .60 cents of the move and keep
repeating it at about 700 times a second. Then there is “Ask
Mountain” where over 56,000 quotes happen in 10 seconds all with
the same ask price and the ask size increasing or decreasing by 1
to almost 40,000. So why is this important? It is important
because these HFT traders are not trading off of patterns or
fundamentals or anything related to investing. They are playing a
huge video game. As one HFT trader
put it…”the ticker symbol is just a name on my screen. I don’t
even know what the company does. The name is just a line in
the computer code.” Later he says that because they just trade
symbols, they don’t even know the name of the company these days!.
So there is no correlation with investing and stock
prices to the largest group of traders on the exchange today.
All they are doing is trading patterns in nano seconds. The
average time in the trade for this firm is 17 seconds. That’s
right 17 seconds. And this quote stuffing is simply computer
sabotage and a form of hacking by other computers to simply stuff
the system with so much information that the other computers slow
down and the HFT bot that is creating these fake quotes disregards
them (because this bot knows these quotes are not real) and cleans
up in the market. As
all of us have experienced this phenomenon on our home PCs, when
we have too many programs open and running, our system slows down.
This is exactly the principal behind quote stuffing.
The other bots slow down because they are processing so many
quotes. But the bot that is spewing these false quotes, ignores
them and is operating at lightening fast speed raking up profits
before the other computers can even see them. This is just one
technique being used today out of many out there.
The real point is that there is no way to know whether or
not the quotes is real or made up by the bots.
And if it is made up and you buy, you are surely going to
overpay for your trade. And if enough people overpay for the
trade, the price starts to run higher, especially in a low volume
market like this one and prices will ramp up fast and as the
report says, sometimes at 10% increments. So this is why we have
these huge overnight and intraday moves just coming out of nowhere
and based on nothing. The bots are starting to battle each other
because the HFT traders are bored and want a new video game to
play. They call this game, stock market trading. Now
here is why this is so negative for stocks and why I think another
Flash Crash will happen. For anyone
who has written code…my son is an aerospace engineering student at
Iowa State and writes lots of code….it is a very time consuming
but more importantly, an error prone process. It is a challenge to
say the least to write any defect free code. You would need
thousands of Iowa State “aeros” to even attempt to write an error
free code for HFT bots and even that would be prone to error.
Therefore, when an HFT shop employs 3 people to write their code
24 /7 I think that the chance of major flaws in the code are
pretty high. And therefore, these flaws expose the entire
market to “unintended consequences” when these flaws appear which
we know they will. The Flash Crash was basically
caused by these HFT bots sensing that something was wrong and they
were programmed to basically shut down. They pulled all of the
bids and offers from the exchanges and prices literally in free
fall until the bots decided to turn back on again. So while
everyone was searching for an economic reason, or were blaming it
on human error…the notorious “fat finger”…the real reason was the
machines turned off. So when you look at the flaws in the
program code as well as the possibility that the machines will
decide to just turn themselves off again, why wouldn’t there be
another crash? It is already in the program! Now that we have made the
machines in control and they are now fighting among themselves,
where does that leave us humans?
My first conclusion is that day trading or any short
term trading for that matter is not wise in this environment.
My Dell computer cannot compete with theirs. My speed is not fast
enough to compete with them. In the old west, they would outdraw
me and kill me dead. No contest. Therefore, position trading
is where it is at. My old friend “Doc” in Rhode Island pointed
this out to me last week. In his view, looking at the daily charts
and longer term ones, all the technicals and Elliott patterns work
just fine. Markets over the longer haul, still follow tried and
true technical patterns and therefore, that is where your focus
can be. Doc says to use the short term charts and indicators to
“time” your entries and exits but the longer term patterns are
there for your serious positioning. Today, stock prices
don’t necessarily go up because of economic reasons or company
developments. Now, they can go up because there is a war on
between HFT bots and a sabotage mission has started and will
continue for a while. The market rising 35 points over 8 minutes
today was not because of an economic report or some event that hit
at that time. It was probably a bot war. The market dropping 32
points in 4 minutes this afternoon was not because of a bad
earnings report but pobably because of a bot war. So my
strategy is not to play the game for a while until either the
S.E.C steps in or other exchange action is taken..
As my brother Steve said today, if you were a kid on a playground
and saw what was happening, would you even want to play the game?
The answer NO. The game is short term trading and the answer is
No. But there is a way to get around the HFTs. The way to get
around these HFT traders is to look out longer term and let them
work for you in the short term. For example, if
you have a bearish view, as I do, then use days like today to add
to your shorts or inverse ETFs. If you have a bullish view,
then just sit back and let days like today increase your profits
or give you opportunities to take some profits on winning trades.
As Doc says, use these short term charts to help you time your
buys or sells, but focus on the longer term to set up your true
positions CONCLUSIONS. I believe that this is a
market that will fall hard in the future and HFT trading will just
exaggerate that fall. This is reminding me of the 2000
NASDAQ market where there was no research being done by people on
any of the .com stocks. As long as
it had “.com” after its name, it was bought and these stocks were
trading in the $200 or $300 range after being IPOed at $20. They
had no earnings, no business model, just a .com after their name.
Most are not in business today and the unintended consequences
are that ALL of the NASDAQ got crushed not just the .com darlings. Traders kept running these stocks higher, always confident that
they had the fastest draw in the west, and they would be able to
get out first. Like a game of “Musical Chairs” when the music
stopped, everyone scrambled and unfortunately, most found out they
were not as fast as they thought. This is the same game being
played today by these HFT traders. And unfortunately for some,.
When the music stops, or in this case, the computer code flaw is
exposed, there are going to be a lot of bad feelings about
computers, trading and the markets as Flash Crash II is being
investigated. Maybe I am too bearish on the economy. Maybe
we are headed out of the woods. But the leading economic
indicators I have followed for years, and the same ones that
warned of the 2008 debacle are flashing red right now and giving
me the same warnings. As a responsible logical human, how can
I disregard the tried and true leading indicators that have worked
so well for a long period of time, and suddenly believe and go
with the logic of short term market momentum and high frequency
trading where traders admit they don’t even know the name of the
stock they are trading. It seems that is not the logical choice. I was early selling stocks in 2007 and 2008 and the market
moved against me then, making a new all-time high in October 2007
and making me look pretty foolish.
But my leading indicators kept getting worse and telling me to
hang in there. So I did and eventually, did alright in
sidestepping the 2008 debacle. So my only thought here, is that I
am early again and while we may have another month of upside
action……and we may not, timing is getting very difficult….I
think eventually the longer term leading indicators will win out
and stocks will be lower by year end and into 2011. The longer term Aussie is still on track for lower prices into
January 2011. The monthly charts are also still pointing lower. We
are now 15 S&P points from the middle of the minor wave 2 rally.
So let’s see where we end up the week.
MARKET WARNINGS
For
the week that ended on July 22, insider sales at 78 large companies
exploded to $447 billion — stock valued at nearly ONE-HALF OF ONE TRILLION
DOLLARS was just dumped onto the market in a single week!
Just as disturbing:
The average stock liquidation per company was a whopping $5.7 million.
Any way you look at
it, this is clearly a “NO-CONFIDENCE” vote — not just in these individual
companies, but in the U.S. economy as a whole.
Gordon T Long is not a registered advisor and
does not give investment advice. His comments are an expression of opinion
only and should not be construed in any manner whatsoever as
recommendations to buy or sell a stock, option, future, bond, commodity or
any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, he recommends that you consult with a
qualified investment advisor, one licensed by appropriate regulatory
agencies in your legal jurisdiction, before making any investment
decisions, and barring that, we encourage you confirm the facts on your
own before making important investment commitments.
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Gordon T Long
is not a registered advisor and does not give investment advice. His comments
are an expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he believes his
statements to be true, they always depend on the reliability of his own
credible sources. Of course, we recommend that you consult with a qualified
investment advisor, one licensed by appropriate regulatory agencies in your
legal jurisdiction, before making any investment decisions, and barring that,
we encourage you confirm the facts on your own before making important
investment commitments.
