No Man's Land

On 26^th September morning I wrote that SPX will have trouble going past 1150. But when on 27^th September, it closed above 1190 readers questioned my calls and there were talks of 1200 or bust. Sure enough we closed the week and 3^rd quarter at 1131. So I can say that I have been vindicated.  

My theme has been consistent in this respect. That we shall be seeing continued weakness in the stock markets well in October and we might re-visit the lows of August. But at the same time, the bottom is not going to fall off yet.  I also expect weakness to continue in precious metals, at least till October. Those who are short on gold and silver might want to get out and close their position in the next two weeks or so.

Things are kind of messy all around and it is not a market for investors. On one hand ECRI is taking of imminent recession and there is enough doom and gloom to sink a battle ship. On the other hand, all the Central Bankers and governments of the western world are trying their best to re-inflate the stock markets. I think in the short term, the CBs and TPTB will win and they would be able to paint the rosy picture. But not before we have tested the lows of August and a new round of liquidity is injected in the stock markets.

I have been travelling and have reached India. Every time I come here, I cannot but marvel at the perfect example of chaos theory in operation. The roads are crowded as ever. The airports are teeming with travelers, things are noisy and chaotic. How anything works is anybody’s guess. But they work and India is making good progress despite the odds.

I plan to write a comparative analysis between India China and Brazil in the coming days. I think for the coming decade India offers the best growth opportunity and Investors would be wise to realize the potential of growth of Indian stock markets.

For now, let me try to shake off the jet lag with some more sleep. 

What Will Cause The Collapse?

Bear markets only end when price reaches a gut wrenching low. When speculators have been beaten down so much that mere mention of their favorite stock or commodity induces nausea and they do not want to touch it in their life time, ever. By that token the bear markets in the US stock markets will reach its nadir when S&P will be near 400, Dow near 3000. At these levels, 2008 will sure look like a trailer. At that level, there will be no safe haven except cash. That will be the ultimate collapse that the mega bears are hoping for.

Will that happen? If that were to happen, when will that happen? The global economy seems to be lurching from one crisis to another and still S&P has not breached 1000 yet. What we are seeing, is that a normal correction in a bull market or beginning of a bear market ? 

The Western civilization has modeled itself on the Keynesian theory where higher government spending has created an illusion of growth. In reality, there has been no wage growth in the USA in the last 20 years. The macro story is same in the USA or Greece or Japan. Only difference is, some countries can print their own money, some cannot. But printing money does not give the solution to the problem of solvency. If you do not believe, ask Robert Mugabe of Zimbabwe. With 200% debt to GDP ratio, Japan is trying for the last 20 years to bring in prosperity. And yet, the Nikkei is down from 38000 to 9000. 

The ZRIP and easy money policy that are being followed by the Fed or JCB indicates that the Central Bankers of the world are worried about deflation, not inflation. With the Balance Sheet contraction upon us, all the central banks are trying to inject as much liquidity in the financial system as possible. Their only hope of survival is to re-float the financial markets. 

What QE1 and QE2 did was just that. It helped re-inflate the collapsed bubble. There were no growth then, there is no growth now. So why then the markets are not collapsing, given that there is no QE3, there are sovereign default threats and GDP is barely moving. What is holding up the support level? 

The answer can possibly be found in the last G20 meeting. With the world economies so inter connected, it is a kind of MAD world. (Mutual Assured Destruction). Therefore, China wants to keep the markets going in the USA and in Europe so that it can keep its millions of rural poor employed and keep a lid on social unrest. US of A provide dollar swap lines to virtually dead European banks because not keeping them alive will de-stabilize the world economy big time. SNB pegs its currency to sick Euro so as to keep the Swiss Franc low. Every country is doing what it can to keep the music going.

Under such a situation, the world economy will lurch from one crisis to another, only to be propped up by more money. Volatility will be high. Even safe havens like gold swing between 2% to 7% in one market session. But TPTB (The Powers That Be) will not let the bottom fall off. The world markets are pushing on a string.

Only thing that can destroy this equilibrium is going to be something which is beyond the control of the CB and TPTB. A true black swan event. I do not think that the coming black swan event will be financial. Even if Greece defaults, it will not cause the system collapse. It has now been almost two years and the default has been priced in. The only black swan event I can imagine is going to be Geo-Political. For e.g. Israel Iran conflict. 

When the markets know that the governments are watching their back, they keep gambling. And they are doing exactly the same thing. Today, the US markets went up by 2% on no good news. Nothing fundamentally changed from last week. It is as if, yes they can. Right now, it is money moving from the pocket of one hedge fund and bank to another. Ordinary investors are not a part of it. The gamblers will continue to do so till such an external shock crashes the system. What will force that is anybody’s guess. Till that time, keep the good times rolling.

I will be travelling for the next two weeks and the posts will be somewhat irregular. But if I come across something interesting, I will do my best to bring it to your attention.

Hugh Hendry on the importance of social mood & failure

"I'd say 80% of my activity is engaged in the interpretation of social mood." - Hugh Hendry. 

That quote taken from this September 2010 BBC Hardtalk interview with Hugh Hendry. 

When asked about the need for regulatory control of financial markets and curtailing of risk, Hugh replies, "The best form of regulation is, 'If you mess things up, you fail.'".  

Hat tip: Kevin Kaiser at Hedgeye.

A New Wrinkle

The latest scheme out of the European political class is the idea of creating an SPV (Special Purpose Vehicle) that will "leverage up" the $ 400 billion fund that had been previously put in place to "stabilize" the sovereign debt crisis. How will this work?

The idea is that you create this SPV (think Fund) and put $ 400 billion into it in the form of equity capital. The SPV then borrows $ 1.2 Trillion from willing bond buyers. That gives you $ 1.6 Trillion to buy up Greek, Spanish, and Italian debt and stave off disaster. So, the theory goes.

So who provides the $ 1.2 trillion in debt capital? That is, who are the willing bond buyers who think investing in a vehicle that buys trash will be a winner? If you thought Wall Street cooked up outrageous schemes, try this one on for size.

This idea will not work. It is not the magic elixir. No one in his right mind would provide the debt financing for this vehicle. The US, no doubt, will volunteer to put money into this. (We love throwing money away). But, the rest of the world will balk at this silly idea. The Chinese will not fall for this.

What this scheme shows is that the politicians still haven't figured out that defaults are inevitable. Only defaults have any real shot of turning the situation around in Europe. Politicians can only make things worse by these kinds of dreams and schemes.

Hope Is Eternal and Futures Are Up

The futures are up in the morning and possibly we will see a gap-up opening. But I do not think we should jump back in the markets yet. Most likely this rally will be short lived. It is more of a dead cat bounce after a big sell off week. The EU has not yet come up with any definitive solutions and we can expect the volatility to continue well in October. I think SPX will have trouble going past 1150.

Corrections in Gold and Silver continue.  Silver can reach around $22 level or below. I am not sure about Gold and hence staying away from it for now. The funny thing is, historically, gold has performed better in a deflationary environment. If anyone cares to remember that gold was in a 20 year bear market when the stock markets were going up and inflation was much higher than it is today. So if we see a yearend rally from end of October, we might see a sharp selloff of gold.

For now, it is better to be in cash and wait for a good low in October before any buying opportunity comes up.

P.S; The markets opened gap up but now some are in red and some are struggling to keep the opening gain. In the mean time, I hear Cramer in CNBC that he is buying gold. Hmmmm. If the snake oil salesman is now pushing gold, may be it is time to seriously short gold.
This one is from Kitco at 10.45 AM on 26th Sept. 2011;

Did gold really go down 62.90?

Yes. The stronger US Dollar was responsible for 3.50 of that drop.

Gold price Change due to Strengthening of USD

-3.50

Gold price Change due to Predominant Sellers

-59.40

Gold Price: Total Change

-62.90

Mind The Gap

The so-called income gap between rich and poor is growing we are told. The rich are "sharing disproportionately" in the economic gains we are told. What does this mean? Should we do something about it? If so, what should we do?

Imagine, that adopting "Policy A" would double the income of the poorest sixty percent of the population, but, at the same time, quadruple the income of the richest forty percent of the population? Suppose that there was simply no other feasible way to double the income of the poorest sixty percent? Would you favor implementing "Policy A?" After all, "Policy A" increases inequality. The dreaded "income gap" widens under "Policy A."

One way to eliminate income inequality -- eliminate the income gap -- is to force the entire citizenry to live at the edge of starvation. This is, more or less, the experiment that the Soviet Union embarked upon in 1917. How did that turn out? The Soviet Union successfully eliminated the "income gap."

Suppose "taxing millionaires and billionaires" meant that unemployment for the rest of us would rise to double digits and stay there for the next thirty years. Is it still worth it, so that we can make "the rich pay their fair share," even if such a policy would guarantee that large numbers of people cannot find jobs?

Why does anyone care about the income gap? The issue is not how to divide a fixed pie after all. The issue is how to grow the pie. Suppose our only concern is with people whose income and wealth puts them in the bottom 50 percent of the pile. It might be necessary to enrich a few folks in order improve the lot of the bottom 50 percent. Who cares if the rich get richer?

Isn't it the right policy to try to improve the lot of the poorest 50 percent of our population regardless of how rich the rest of the folks get? It just might turn out that income inequality is a by-product of improving the lot of the poorest folks in society and that deliberate policies to reduce inequality damage the economic prospects of the poorest half of the population. So, why the interest in the income gap?

What we should be concerned about are policies that improve the economic prospects of the half of the population with the lowest income and least amount of wealth. If improving the prospects of the less fortunate increases income and wealth inequality, so be it.

Correction in Gold & Silver And Coming Year End Rally.

In my last post I wrote; “I am not sure if the corrections are over or we shall see renewed weakness again. …….. The weakness in the market may continue till October.”  That was after the markets rallied for a week and people were hoping for a trade-able bottom and there were talks of new Bull Run.  However Euro did not live up to the hype and came down couple of hundred pips.  I said that the big money is leaving Europe and they want to keep that flight low key and orderly and the correction in precious metal may have just started.

Right on cue, price of gold came down by over 5% in the week. Everyone is speculating why the price of gold and silver came down. The easy answer that is being talked about is that CME hiked the margin. But that is not the complete answer. Yes, margin hike deter additional position taking and sometimes forces the weak speculators to liquidate. But the more compelling reason was the position liquidation and margin call by the Mutual Funds and Hedge Funds. I think most funds were caught by surprise by the violent plunge in the stock market.  So when the sell orders came in, they held on to their loss positions and liquidated the position in precious metal which was in profit. Moreover, there were widespread disappointments with the Fed action.  Again, in the last post I said that the rally was “in anticipation of Santa Clause coming early on September 21st. There may be some disappointments and we might see some selling the news.”

I would like to show two charts. First the gold chart.

If gold falls below $1550 by next week, the next support is around $ 1050 / $ 1100. But even that kind of correction would keep gold on a long term bull run. Whether that will happen or not, is anybody’s guess. But the chances of the continued correction are high.

The 2^nd chart is of Silver. 

Silver has already broken the trend line big time and the next support is around $ 25. I think even that support will be broken. By the same token, gold may also suffer. My favourite chartist Chris Kimble has this Eiffel Tower chart for gold. So make your own conclusion.

Coming back to the stock markets, I expect the weakness to continue in October, till the Europeans show some guts and political will to throw more good money after the bad. The Obama administration is pushing Germany hard and want a trillion euro rescue fund. The problem is that Madam Markel is losing the political capital and the German population is becoming sick of supporting Greece.  But the cost of not supporting Euro is very high and Germany may just want to buy more time. That Greece will default is given. The European banks, particularly the French Banks are going to suffer the most. The most important question is, is Greece going to be the only sovereign default? The Euro Zone may be able to handle Greek default but if Ireland and Portugal and Spain are added to the equation, then it is a different ball game.

I do not expect the markets to fall much below from here onward. My short term downside target is around 1125 in SPX.  If that is broken, the next support level is around 1050 in SPX. A close below that would mean big trouble. However I do not expect the bottom to fall off yet and most likely we would see a bounce of the lows.

The central bankers and the world governments are missing the woods for the trees. For them everything is a liquidity problem when in fact the problem facing the world is solvency problem. The only way they are trying to solve the crisis is by pumping in more money in the banking system. But it s a giant black hole sucking the life out of the world economy. The balance sheet contraction is on us, however much the central bankers and governments may try. Remember the QE2? After $ 600 billion, the US stock markets are now below the level of QE2. The desperate fight is on to save the system and for a while PTB (Powers That Be) will succeed. I am expecting a yearend rally to start from end of October which may well take the stock markets to a new high in 2012 before the game is over.

For now, let us see how low gold goes.