Monday Post #3: Epic day on stock market

If you thought you would never live to see another day like we saw during the 2008 Financial Crisis, today you learned never to say never.

Today's -634.76 plunge in the Dow Jones Industrial Average (DIJA) was the 6th largest absolute point drop in DJIA history and it followed last Thursday's massive 500 point drop.

Of the five previous and larger historical drops, four came in 2008 and one back in 2002.

All the gains from QE 1 and QE 2 (whose entire purpose according to Ben Bernanke on CBS's 60 Minutes was to inflate the stock market and create a wealth effect) is now gone.

Politicians and the establishment are looking for a scapegoat for today's stock massacre. And all eyes are on the ratings agency Standard and Poor's.

But America’s credit rating was punished by S&P because US politicians failed to reach an adequate solution to the country’s massive debt woes which are nearing 100% of GDP. The deal to raise the debt ceiling did nothing to significantly deal with the debt issue.  10 years from now America will have a $26 Trillion dollar debt instead of a $28 Trillion debt... big whop!

That's why S&P downgraded.

World governments have gone on the offensive against S&P, slamming the rating agency and trying to discredit the firm’s financial calculations without acknowledging the underlying premise– that America lacks a credible plan to deal with its crisis.

But the one defender of S&P has been PIMCO's Bill Gross, the hugely successful bond fund manager and the co-chief investment officer of the company's flagship, the Total Return fund, which has $158 billion in assets.

Gross says S&P has said what everyone is thinking but afraid to say it for fear it would insult the US administration. Because let's face it... everyone criticized S&P over being far too late to properly rating the subprime mess.  At least they have the guts to finally step against the tide of conventional sycophantic wisdom and tell everyone even a modest part of the whole truth.

Said Gross:

• "I have been criticizing them and Moody's and Fitch for a long time. Moody's and Fitch are on the "S" list. I think S&P finally demonstrated some spin. S&P finally got it right. They spoke to a dysfunctional political system and deficits as far as the eye can see. They are enforcing some discipline. My hat is off to them."

So what comes now?

The G7 finance ministers have pledged to take any steps necessary to calm markets and “avert collapse in world confidence.” But here’s the thing: All governments can do is print, borrow, or steal from taxpayers via taxes.

These are exactly the policies that created a loss of confidence to begin with, and now they are pledging to restore confidence by doing the exact same things. If they take action, the situation will only get worse. If they don’t take action, the markets will panic and the situation will only get worse.

Trillions of dollars are sloshing around in the financial system right now desperately seeking some modicum of safety. With the wave of downgrades and money creation that’s coming, few asset classes look stable.

Thus as nevous investors panic, Gold and Silver will start to look even more attractive to a lot of investors.

And in a shocking turn of events, a member of the JP Morgan staff (Colin Fenton) came out with a client note that predicted Gold hitting $2,500/oz before year end:

• "Gold and sugar have potential to run a lot higher. It has been clear for weeks that the prompt CMX gold price has been building in a rising probability of a reflaring of financial crisis, gaining by 9.7% since June 30 as the MSCI World Equity index dropped by 10.1%. The correlation in daily price changes between these two assets has dropped to –0.09 from +0.29 over the prior year. Gold’s correlation against TIPS has doubled to 0.35 from 0.18. Against Italian and Spanish 5-year sovereign CDS prices, the gold correlation has moved to 0.27 and 0.32, from 0.07 and 0.04, respectively. Before the downgrade, our view was that cash gold could average $1800 per oz by year end. This view will likely now prove to be too conservative: spot gold could drive to $2500 per oz or higher, albeit on very high volatility."

The US Federal Reserve meets tomorrow.

Will they act to try to counter the negative psychology in financial markets with some  from of QE3?

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Should I bail? (Updated)

Yesterday I wrote how we would probably see Silver, as options expired today, drop to $45.50 or even $45.00.

That prediction played itself out and Silver even dipped into the $44.80 region.

The high prices achieved over the weekend were nominal highs. Gold reached $1,518.30 per troy ounce, a nominal record, while silver climbed to $49.79 per ounce, its highest nominal level since the short term parabolic spike in 1980.

By dropping over $5, Silver has suffered a 10% correction and has people asking, "Is it time to bail?"

The fear, of course, is that Silver will quickly collapse in the same fashion it did after it's dramatic run-up in 1980.

But as I said to two colleagues last night, 2011 is not 1980.

In 1980, Silver's rising price was the result of the Hunt brothers manipulating the price upward.  When their ability to manipulate the price ended... Silver collapsed.

In 2011, Silver isn't being manipulated upward.

Quite the opposite.

In 2011 Silver's price is being manipulated downward via the price manipulations of JP Morgan and their unbacked paper silver contracts (their massive silver short position is a situation unparalleled in any commodity).

When the ability to manipulate the price ends, Silver will explode upwards not collapse.  And the pressures on that manipulation are so great that the price is rising dramatically despite the shorts.

As analyst Dan Norcini has said,  "Nothing will unnerve the paper shorts more quickly and do more to undercut their confidence than to strip them of the real metal and force them to come up with more hard bullion to make good on deliveries."

And it's the demand for the physical metal which is the key here.

Should you bail on Silver right now?

Ask yourself what, if anything, has changed to stem the demand for physical metal? 

• Has the United States resolved it's massive debt situation?
• Are China et al prepared to buy huge amounts of US Treasuries again?
• Have the PIIGS (Portugal, Ireland, Iceland, Greece, Spain) resolved their debt issues?

The answer, of course, is NO!

All that has happened is that unbacked paper short contracts to the tune of almost 10 years worth of worldwide annual mining production have been dumped on the market in the last week.  This has been combined with a hiking of margin requirements on those who use leverage to trade large amounts of Silver, forcing them to close out positions because they suddenly don't have the cash to meet the margin requirements foisted on them in the midst of a trading day.

It's a desperate, albeit temporarily successful, attempt to keep the price of Silver down. But has it stemmed the demand for physical Silver?

Consider Bill Gross's observations this week (Gross is pictured above).  The world's biggest bond manager (PIMCO) came out with these stunning comments:

• "Just as Charles Ponzi needed donuts to turn back a suspicious crowd of investors, the Fed needs “donuts” in order to fill the bellies of the literally millions of investors worldwide who worry about the alarmingly large U.S. budget deficit and the impact that the U.S. debt dilemma could have on their Treasury holdings...Their collective buying has created what we believe to be a profit illusion with many investors mistakenly believing they can continuously reap profits from perpetually falling bond yields and rising bond prices, just as they have had opportunity to do over the past 30 years, amid the great secular bull market for Treasuries and the bond market more generally...For many reasons, this “duration tailwind” for Treasuries can’t last, particularly because the United States has reached the Keynesian Endpoint, where the last balance sheet has been tapped."

Gross's comments come from his latest report, The End of QEII: It’s Time to Make the Donuts and it is an absolute 'must read'.

As I have said ad nausem, the financial earthquake we suffered in 2008 was of such breadth and depth that we still do not fully understand, nor appreciate, what has happened.

There is still many acts left to play out.

The foundation for the belief that Silver and Gold will continue to rise are still intact.  But it is going to be a wild roller coaster ride.

Silver's 'correction' will probably end by Thursday (at the latest) and the metals will start a rally that will probably carry on until Friday of next week when Silver will trade back near $50.

Then it will be gut-check time again. 

Many analysts think the metals will roll-over again and you will probably see Silver drop back to today's level of $45.

Everyone will be screaming that we have hit some sort of double-top and the rally is over and that YOU need to get out.

But the critical question will remain: what has changed on the debt front?

Until something does, worldwide demand for Silver as an investment will continue to surge and the price will be forced higher from the simply supply/demand dynamics we have outlined at lengths in other posts.

UPDATE

From COMEX analyst Harvey Organ:

• The total silver COMEX Open Interest surprised everyone, rising from 149,899 to 152,945 for a huge gain of 3046 contracts despite Part A of the raid. Part B was today... The options to purchase a silver contract went off the board tonight. The estimated volume today was very heavy, it came in at a huge 250,247. The confirmed volume yesterday was a monstrous 319,204 contracts. [Note: each contract represents 5,000 ounces of Silver.] This is an all time record volume at the silver comex. If the total Open Interest standing tomorrow is around the same number as today, the bankers will assemble for more [intervention]. They are getting quite exasperated.  

You should also take time to check out this article on Seeking Alpha.

Some excerpts:

• It was only a matter of time. Now the talk of silver price conspiracies has shifted from long buyers to those on the other side of the fence.
• [While] order was reestablished among the short side conspirators [when] the COMEX trading floor opened on Monday morning. After silver prices had temporarily risen to over $49 per ounce during Asian trading, they were beaten down again to about $47 in a flood of newly opened short positions.
• In practical terms, however, the only thing they will have accomplished is to cause a few speculators to lose money while helping well-financed market vigilantes to buy more bars of physical silver for the same money.
• The massive losses that short sellers have been taken has naturally led to some new urban myths. Some now claim that "evil" long side billionaires are out to "ruin" the market. Yet, even the Financial Times article points out the ridiculously paranoid nature of this theory. The author notes that silver prices were rising even as speculative positions at COMEX were reduced by 8.4%. This illustrates that the COMEX is now just a sideshow. A lot of people are simply buying physical silver.
• The silver buyers do include some billionaires, undoubtedly, but most of them are simply folks who realize The banks were ostensibly "selling" and then "storing" so-called "unallocated silver bars" for silver investors. In reality, they seem to have been maintaining a fractional banking system in which only one physical ounce is really purchased for every 100 ounces they supposedly sell.

• Let's go over that again...because once you understand the particulars, the reaction of the price of silver becomes perfectly understandable. 1) Bank sells silver, a very precious item, for big money; 2) Bank doesn't buy the silver it sells, or, if it does buy it, leases out or sells 99 ounces for every 1 ounce in the vault; 3) Bank gets paid "storage fees" from all its customers, even though their silver is not in the vault; 4) Bank profits are equal to 99 times what it sells initially, and then, the value of the stream of storage fees after that. Nice work if you can get it.
• But, then there's the downside. 1) The market might discover your scam and you'll need to deal with investigations; 2) Leverage so high that, if discovered, it is a recipe for disaster; 3) Courts may deem the arrangement a fraud, in spite of disclaimers that say otherwise, and whereby customers waive liability for fraud; 4) the market will inevitably punish you severely with heavy losses after discovery of the scam. 

As Seeking Alpha notes,  "Had the worldwide silver scam remained a secret, suppression of precious metals prices might have gone on forever. But the genie is now out of the bottle and mortal men, not even those who run casino-banks, cannot hope to put him back in. Once it became clear that the bullion banks were leveraged 100 to 1 in a silver based fractional banking scheme, it was only a matter of time before the market clobbered them. That is what is happening."

And that's what why this blog has been telling you. The scam has been revealed and, as a result, Silver has been such a great investment opportunity.

And it's another reason why you shouldn't bail on your Silver position.

Tomorrow I will outline details of that Silver storage scam mentioned in this Seeking Alpha story and how it is that this fraud has become public knowledge.

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Mid Morning Update: Run Turkey Run - it's a Ponzi Scheme!

(This is the 2nd post of the day: below is a post on collapsing new unit real estate sales)

Bill Gross is a hugely successful bond fund manager and the co-chief investment officer of Pimco. He personally manages the company's flagship, the Total Return Fund, which has $158 billion in assets.

Gross is highly influential and US Treasury secretaries call him for advice. Warren Buffett, the Berkshire Hathaway chairman, and Alan Greenspan, the former Federal Reserve chairman, sing his praises.

So keen attention is being paid to comments Gross made today in an investment outlook report he put out this morning.

He calls next Wednesday's planned QE2 by the Federal Reserve an attempted hypodermic straight to the economy’s heart; an adrenaline injection with a following morphine drip.

Gross then makes a stunning statement. He says:

• We are, as even some Fed Governors now publically admit, in a “liquidity trap,” where interest rates or trillions in QE2 asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole

Gross supports Bernanke's moves because "it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do."

But while Gross gives Bernanke his 'qualified endorsement', he admits bondholders will likely eventually be delivered on a platter to more fortunate celebrants.

• (Cheque) writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic.

Then Gross delivers this stunning conclusion which so many bloggers have been saying for over two years now. Remember... this is not a tin foil hat blogger, but a respected confidant of both Buffet and Greenspan:

• Now, however, with growth in doubt, it seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time.

The Ponzi of all Ponzi schemes. Couldn't have said it better, Bill.

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Uphill Climb

Interest rates.

As has been noted time and time again on this blog, the story of Vancouver Real Estate has been the story of interest rates... and as they go, so with R/E in the Village on the Edge of the Rainforest.

The stunning rise in land values in our humble utopia have been shaped by a historic 30-year decline in the cost of borrowing.

But as the New York Times noted on Sunday, consumers are about to face a new financial burden: a sustained period of rising interest rates.

It's a paradigm shift that is the inevitable outcome of ballooning sovereign debt levels and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

“[North] Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The comments of Bill Gross are significant. He is a hugely successful bond fund manager and the co-chief investment officer of Pimco. He personally manages the company's flagship, the Total Return fund, which has $158 billion in assets.

Gross is highly influential and US Treasury secretaries call him for advice. Warren Buffett, the Berkshire Hathaway chairman, and Alan Greenspan, the former Federal Reserve chairman, sing his praises.

And with the collapse of Wall Street, Mr. Gross has emerged as one of the nation's most influential financiers.

In 1999, Mr. Gross warned in his monthly investment column that the dot-com bubble would soon burst. The next year, it did. Despite the market downdraft, Mr. Gross's fund ended 2000 up 12%, and that same year he and his partners sold Pimco to Allianz for $3.3 billion.

In an October 2005 letter to investors, Mr. Gross made one of the most prescient calls of the last decade, warning of the looming subprime mortgage crisis.

And for Gross the next big financial story is going to be the tale of interest rates.

Gross sees the run-up in rates quickening as investors steer more of their money away from bonds and as Washington unplugs the economic life support programs that kept rates low through the financial crisis.

Mortgage rates and car loans are linked to the yield on long-term bonds.

Besides the inflation fears set off by the strengthening economy, Mr. Gross said he was also wary of Treasury bonds because he feared the burgeoning supply of new debt issued to finance the government’s huge budget deficits would overwhelm demand, driving interest rates higher.

Nine months ago, United States government debt accounted for half of the assets in Gross’s flagship fund, Pimco Total Return. That has shrunk to 30% now — the lowest ever in the fund’s 23-year history — as Gross has sold American bonds in favor of debt from Europe, particularly Germany, as well as from developing countries like Brazil.

And as other bond traders follow Gross's lead, the results are starting to impact rates.

Last week, the yield on the benchmark 10-year Treasury note briefly crossed the psychologically important threshold of 4%. Though still very low by historical standards, the rise of bond yields since then is reversing a decline that began in 1981, when 10-year note yields reached nearly 16%.

From that peak, steadily dropping interest rates have fed a three-decade lending boom, during which consumers borrowed more and more.

But those days are ending.

And for young home buyers today (who can consider 10-year mortgages with a stunningly low rate of just 5%), it is inconceivable that rates could migrate to those days of in the fall of 1981 when mortgage rates peaked at 21.5% in Canada.

And while few are willing to forecast rates to return to anything resembling 1981 levels, to those tuned in on Wall Street the question is not whether rates will go up, but rather by how much.

The consensus in the high level financial community is clear. As Terrence M. Belton, global head of fixed-income strategy for J. P. Morgan Securities, summarized, “everyone knows that rates will go higher.”

Just try telling that to anyone around this town.

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