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Tuesday, 9 October 2007

Archiving previous articles

Just a quick note, the posts below are an archive of previously published letters with the earliest first and the latest letter at the bottom. The letters are connected by theme so any new readers will benefit from a quick (or not so quick) read through.

Hopefully thats the last time I have to do that.......

A First Sighting? Edition 4 of 2006

November 17, 2006

A recap of the scenario:

bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation.

It looks to me that we have gone beyond the discussion of stagflation, I see it rarely mentioned now on the newswires or in articles and I think I may know why. Unlike most, I postulated at the time when M3 reporting was withdrawn that rather than it being done away with to cover massive inflationary moves by the Federal Reserve it was more likely that it was disguising a drawdown of liquidity.

This disguising was required for domestic, political reasons because if it had been seen - in conjunction with some figures I have been watching closely - the Public may well have realised that the pain required to balance the economic ship was about to be visited upon them. Have a look at the following figures and remember your first reaction:






























These are the seasonally adjusted figures for M1 and M2 for 2006. Now what caught my eye was the relative difference that has occurred this year, you can see M1 (currency, travellers checks, current accounts etc) has declined, yet M2 (retail money mutual funds, small time deposits, savings,etc) has climbed. The amount of actual cash has halted its climb and reversed in....May 06. Anyone else hearing ringing bells? Just under $36 Billion of cash has vanished, in 4 months. Now these figures only go to September but I fully expect to see a continuing deterioration in the M1 figure. Why has M2 gone up? I suspect its more to do with interest received than an increase in saving.

All well and good, you say, and thanks for the explanation of some of the more boring numbers I have seen but what is the importance?

It is important, very important. Firstly it is simply saying that there is less physical cash around. Secondly its saying those who deal in cash, make cash purchases, have less of it. Third and most importantly its the first sign I have seen that confirms my earlier thoughts about why M3 was hidden.

You must bear in mind my reasoning about how I saw the US was going to rebalance the books. I do not believe the US is going to debase the $ by allowing it to plummet 30/40/50% from where it is now. On the other hand we know that the US has to stop the ever increasing flows of the $ and make its own domestic economy, both in the short term and the long term, balance well enough to ensure a systemic collapse is avoided. The problem in the US is one of credit, too much credit was created and given, in many cases, to people who never had a hope of repaying it, poor credit control on the behalf of Lenders, or so it seems. Trouble is if you are a Lender that has access to CDO's etc you repackage the loans, mix them up a bit, good with bad risk, and sell the obligation of the borrowers on to someone else, who buys the wrap hoping to earn nicely on the interest return. So Lenders have protected themselves and the risk is shifted. By doing this they don't need to increase any fractal reserve requirements, in fact the debt ends up being an asset on the books. So a massive amount of liquidity was created, and this is the important bit, not by The Fed or the US Govt (I have ignored tax breaks, the US Tsy has been pleasantly surprised by the larger than expected tax inflows of late) but by private lenders and banks.

I can almost hear the threats of burning at the stake being muttered by some, I am heretically moving the blame away from the US Tsy and The Fed. Don't worry, they share part of the blame, mainly through poor regulation and a lack of enforcement of standards.

Now though, good reader, I am going to spell out how all the above is connected together. The hard bit is for you all to realise that I do not think the Fed or the US Tsy are stupid. They may be late, lax in standards and have been too dazzled by worship at the Altar of Greenspan and the demonic forces of the Bubble but they are not stupid. There are 2 areas that need to be addressed, liquidity caused by credit and maintaining $ strength. I wrote awhile back that the Fed under AliG was not co-operative with the US Tsy. That has changed, both Snow and AliG have moved on. It means that the tools required can be unleashed upon both the domestic and international stage.

We know that to mop up liquidity, someone needs to give the markets something that they are willing to part with $'s for. That's the job of the Tsy, bond issuance is about to reach its maximum over the next few weeks, I hope you all noticed that rates have dropped? How unusual is that, a commodity hits the market and it becomes more valuable? The Tsy are seeking to soak up $'s from overseas first and then, through the primary dealers, soak up some domestic liquidity. Now this has 2 effects, it strengthens the $ and helps to curb credit creation, money given to the US Tsy cannot be lent out to, or by, private or commercial borrowers. Next is the Fed. It too will sally forth and fight this unbacked credit creation. Firstly it will start to make noises and then enforce lending practises to make sure that the standards are strictly applied, this has already started. It will also slow the repo machine. This too has already begun, forcing banks to ensure that short term shortfalls in reserves become less frequent, stopping excessive lending.(*DJ Fed's Poole: Not Fed's Responsibility To Bail Out Housing) These measures, when combined, will slow the economy by decelerating the velocity of money. With less liquidity around but demand still high, rates will go higher until the payment on the borrowed amount cannot be covered by the return on the relending (all money used is lent to someone) of the principal. Lending stops, or at least, slows down drastically. The $ keeps its strength, excess liquidity is drained. Inflation is controlled.

The cost? It starts to show up in little things. Things that seem unconnected at the time. A drawdown of real cash, as electronic numbers are no longer converted into "real" cash. Tightened credit standards stop people from getting mortgages that they cannot afford, it might cause a housing crash but in the scheme of things that helps, the lessened worth of the assets means less $'s are around, electronically wiped off the slate. Even those that default on their loans play a part, the debt gets written off, the $'s disappear, the flippers lose deposits, spending slows and profits fall. Less $'s, better balanced economy. The banks are happy, they sold the now defaulted debt to the Institutions (some of whom, of late, have been very angry, demanding the sellers of the CDO's take them back and refund the Insts money because the risk has suddenly shot up. We can see who is scared now.) It helps the Foreign Central Banks too. All those consumers, burdened with paying off expensive debt or defaulting, won't have money to spend on cheap imports, a relief for those FCB's drowning in $'s that need a home (US TBills), they no longer need to recycle the supply, which helps the US Tsy who don't need to issue the paper to mop it up. A consequence of all this is the lack of inflation, disinflation they call it, its a real bonus because wage demands will be kept down. In fact, with all this lack of spending, lay offs will also keep wage margins competitive, no need to attract workers, they will be grateful of the work at almost any price. That's good, less $'s to have to mop up domestically too.

There will be other markers, signs to view as we walk the path to economic nirvana. Watch gold and oil, both will see a withdrawal of speculative funds and a recognition of a strengthening $ as the US heads to fiscal responsibility. Stock markets, once the watchdog of economic health, have now become short-sighted, driven by hedge funds and mutual funds seeking to enjoy the trend, they too have a part to play in rebalancing the books, they too will help reduce the amount of $'s. All they have to do is commit too much cash into the assets, turn it into electronic numbers, ready to have the slate wiped when the time is ripe. Just now the bonus hunters and those tied to performance options drive down the same street. Until the fuel runs out.

For some, the fuel has already dried up. Here is a newswire reaction, from someone who wears rose tinted specs:

Via HFE's Ian Shepherdson - "October retail sales fell 0.2%, less than the -0.4% consensus. Sales ex-autos fell 0.4%, well below the consensus -0.2%. September sales were revised down by 0.4% headline, 0.7% ex-autos. The ex-autos number was pulled down by a 6.0% drop in gasoline sales, reflecting the drop in prices. But when this is stripped out, along with food and autos, our measure of core sales rose only 0.1%. Core sales are now believed to have risen only 0.3% in Sep, compared to the initial 1.0% estimate. These are much softer numbers than we had expected in the wake of the drop in gas prices, and suggest people are being very cautious despite the rebound in sentiment. In addition, the housing crunch is now hurting: Sales of building materials were down at a 10.6% annualized rate in the three months to Oct. Ouch, all round."

That's good stuff, all that spending has stopped, all those $'s will never reappear. Its good to see a permabull seeing the effects of the tightening and how it will help the US.

A lack of cash, driven down by tighter, more expensive credit, a lack of liquidity that starts at the bottom and works its way higher up the food chain, until even those, referred to in whispered tones as daz boyz, see that the health of the US economy is going to require a donation of wealth from everyone. Even them.

Can you see what I have caught a first sighting of?

And out there, somewhere in Hedgeland, someone is finding it more and more difficult to sleep at night, thinking about all those CDO's sitting on the books. No one to lay it off to, a one way bet on liquidity. The signs are there too. Someone once said the economy has a copper roof. Anyone looked up recently? Still, as long as the Japanese don't raise there is still the carry trade.......

I hope you enjoyed this letter. I have tried to say what I am thinking but its difficult to express without sounding like a doom monger. In many ways what I am saying is positive, in the long run. The pain along that road though is what will cost the unprepared. I hope this letter helps you to think about how to preserve your wealth.

As usual, I shall set up a thread with the same title on so that we can discuss points brought up.

The Shape of Things Now - A Follow On Letter 3 of 2007.

First published on the 15th March 07

Interesting times eh? I won't delve into the complexities of what caused the moves in the markets, you are probably getting to the point of saturation with all the speculation as to the whys and wherefores. So instead I'll just do a quick update, mostly involving charts. As I am an unknown "uurg" let me point you to the original article that this letter is an update to:

So, as you have just read, I am following a wedge type pattern that I referred to as the shape. This shape has occurred at various times throughout market history, in various classes of assets. Over on I have a bulletin board running where I posted up charts as the pattern completed its topping action, in various markets. I was not surprised by the global drop on the 26/27 Feb.

Okay - that?s enough patting my own back, let me redress the balance - I got silver wrong at the time, a timely warning in the current environment and it cost me 50 points. You can imagine my somewhat peeved attitude when it finally did let go from its recent high....gurus eh? I'm just glad I didn't charge myself subscription to give myself a duff call. It does however point out that patterns. shapes and fractals are only good until they are not. Blindly following someone else can cost you money. A lot of money. (and if anyone starts on about FRNs, fiat this, unbacked that, I shall ignore them, I use the term money in the uneducated sense.)

Now I am waffling, enough! Here are some charts:

The Nikkei 1997-2000 was drawn up by Dan Basch.

Want some more? Of course you do....

The "or" count is the alternative for this chart, please take a few seconds to realise what I think may happen.

The following chart is the FTSE 100, what I liked about this one was the small pattern/shape that formed from the 3rd March, the chart was posted on the 12th.

The call was to re-visit the low.

So we are at the stage now where, if the pattern is going to break down, it'll happen very soon, we are either going much lower imminently or, if that R2K pattern plays out, a new high and then a revisit the 2003 lows. Simple observation will show us the way. I do like inflection points in the markets, don't you?

Gone In Sixty Seconds Letter 4 of 07

A recap of the scenario:

bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation.

This article was originally published on the 27th June 07

So it came to pass that the power moved from the West to the East.....yeah right, enough of that blah. Its time to face some rather disturbing but relevant facts. Firstly you might find time to read the letter at this link as background for the following letter.

If you have debt you are bending over and picking up the soap.

Straightforward, no nonsense, in the prison block showers, soap collecting. Hopefully coffee has been spat at screens, wives/delicate husbands have been offended and stopped reading within 60 seconds. Because what I'm about to impart to you should make you feel this way. You, Joe Public, are about to be ridden into the oblivion. No one can save you, no one really cares. Big boyz, from companies like mine are going to take your possessions away. Faceless corporations are going to take your home away. All because you have debt.

Now don't get me wrong, oh offended reader, I'm on your side. I may be in the repo game but that doesn't mean I haven't got enough business already, without adding more names to the list. It'll wreck my tax returns to take on much more. So to help save me the work on my returns, I'm going to let you into a few secrets, things you should know.

Firstly lets talk inflation. As a debt owner inflation is good. It erodes the true worth of the debt over time. What you borrowed 5 years ago at twice your annual salary is now only equal to your salary.

Oh, you worked in Autos? And you worked in Real Estate? Well for most the debt has devalued as their earnings have climbed, even whilst we have low interest rates, can't be bad eh? Well except for the Auto guys and the RE people, who now earn nothing and still have debts. Oh, you have an AltA and a piggyback loan and a sub-prime mortgage? Annnnddd they all go from teaser rates to full on, hardcore top of the range (13%!!!) rates this summer? Who the hell talked you into taking that lot on as a debt Bro? Well okay, other than your own self greed and desire, who else can we blame?

Am I holding back some punches here? Yeah, like Tyson on a date I am.

I'm going to get serious now. Some people out there reading this are probably genuinely worried for their future, for their families future. A man has responsibilities, he has to look after his family. Women often don't have that man around. They have it all to do. Be that as it may, if you have large debt hanging around your neck, the love you feel, the protection you want to give to those you love will come to nought.

These are not easy words to write, this is macro-econobabble coming home to roost, to hurt ordinary men, women and children, policies laid down by almost faceless autocrats are going to ruin our way of life. Sounds strong? You need to know how this happens and then you need to know who to blame.

I failed to mention the way out of the problem? I'm not qualified to tell you that. I can only say, if it was me, that unsecured debt can take a flying , I’ll pay what little I can. They can take me to court and I'll show the best I can do is to pay back 1/100 of the debt (interest frozen) a month at a time. It shows willingness too.

If the debt is secured on property you have a few more options. I would tell them I can't pay, I want to, I'm trying to, I'm sending you every penny I've got, but its not enough. Show me a Judge in the soon to be coming hard times who would not force an agreement on a Lender to come to terms and arrange new payment strategies.....if it was me, that’s what I would do. But hey, I might be wrong, who knows?

Now, all this talk is well and good but what does this have to do with the markets? Do I have to spell it out?

Okay, I will. Merrill Lynch went to market last week with a whole bunch of top rated tranche MBS and ABS derivatives (they ain't bonds, trust me, put it this way, by basing the derivative on sub-prime they lowered the risk on the tranche. How? Because part of the risk is early pre-payment, ie you pay your mortgage off early. Not likely if you need a sub-prime mortgage eh?) ) that are based on the expected returns on your mortgages. Yes, your lender sold the return on your debt to the Institutional Cabal, the JPMs, ML, BS, Citi, Barclays etc blah of this world. And they are worried, indeed scared. Its brown trouser time in the MBS/ABS/CDO/CDS world. Hedge funds are using more toilet paper than normal too. Do you want to know why? Its because of you, deeply indebted Joe Public.

See, its like this, if you take the road to non- / reduced payment then the Cabal don't get the returns they need to service the debt they have incurred. Oh, did I not mention that to maximise returns, they borrowed against your payments by a leverage factor between 10 and 20 to raise credit (electro-money) to invest elsewhere? I didn't want to overburden you. Trouble is if you don't pay then not only is the return on the Tranche of debt they bought reduced but, in theory, the debt itself is priced lower.

Now this was okay for the Cabal as long as no one decided to attempt to sell this debt on the open market. No sales, no price, they can mark it in portfolios at the price they bought it at. If though anyone sells the debt, then a real price is set.

That’s what happened in the past 2-3 weeks. Yes, one of the Cabal grabbed the top layer of debt, the highest rated, away from a hedge fund that had reneged on it debt repayments and attempted to sell this debt to recoup its losses. They grabbed $800m. They sold $100m of this top tranche of debt and then stopped. Maybe its was because the best they could get was 50c on the $ for the top grade. Maybe it wasn't, maybe they didn't want to facilitate a bond market collapse. Who knows?

So you see, its all the fault of Joe - AltA,Sub-Prime - Public that bond markets are teetering on the brink. You, the ordinary people, will be blamed for bringing about Global Financial Armageddon because you got greedy, because you wanted a house, a car, a credit card. You should have known rates were going higher, even if Alan Greenspan said for you all to use adjustable rates and instruments of innovation to achieve your dreams, even if it was at the low point of the rate cycle. Its not his fault, is it?

If only this was the easy part but its not. Its going to get much worse than this for those in debt.

The problem is that as all these Institutions and Banks look over their books and attempt to reconcile enormous losses in the derivative portfolios and realise that the Insurance they bought to protect against default is worthless because it was itself resold as an ABS and has itself become a victim of pricing default (i.e., if you claim on it, you set a price, which will be much lower than you were sold to) then 2 things will happen, regardless of bank, institution or hedge fund collapse. Firstly they will attempt to get possession of the original asset that the derivatives are based on, i.e. the property, to offset the losses in the derivative portfolios. Secondly, they will restrict lending. They need the liquidity for themselves and to bail out any hedge fund enterprises they may have set up or any sub-prime business they bought, thinking it was cheap.

hat means no credit, no lending, nothing for anyone. That means deflation. So all those who have read though this letter feeling smug because they can afford the debt they incurred are about to see a problem looming. Their debt will not be devalued by inflation. It will, in fact, become more burdensome as time goes by. Rates may fall to new, lower levels but that will be offset by the fact that the debt itself will become worth more.

Now I’ve probably gone an alienated everyone. And its not even my fault, its yours, because you borrowed too much. You are going to destroy the wealth of a generation. Or at least, that what the Cabal would have you believe.

I was going to say I hoped you enjoyed this read, as the author I find it depressing, so it would be a facetious question. If you found it thought provoking that’s a different matter. I hope someone out there decides to get rid of as much debt as possible. That would make this scenario a lot more cheerful.

Now, anyone got a flash, fast motor that needs repossessing?

Good luck.

Monday, 8 October 2007

The Second Sighting - Letter 5 of 07

A recap of the scenario:

bubble, easy money, inflation in fiat money supply, inflation in commodities and hard assets, inflation, fear of inflation, rising rates, YC inverting, flattening, rising and inverting again, tightening, withdrawal of liquidity, corrections, crashes, talk of stagflation, FEAR, withdrawal of speculative funds, further corrections and crashes, demand collapse.......Deflation.

(This letter was originally published on the 11th Sep 07)

Its been a few months since I did an update and thats been deliberate. As I'm not trying to sell anything then I have the luxury to allow my letters to be occasional. As an aside, you will see a link in this letter to, its a free financial bulletin board which helped me acquire the technical means to be able to publish my thoughts. Its well worth a visit and deserves a mention.

If I can grab an extra 5 minutes of your time, I want to demonstrate the difference between my approach to financial thinking compared to most other writers. This isn't a boast, its just a reflection of the fact that my work is new to you, the readers. So before I continue with this letter, I would appreciate it if you read this article first, it lays the groundwork for the rest of this article: or visit the archives at Safehaven and look for Mick P. My last letter, written in June, is also part of this ongoing thread of thought.

I was going to talk about why I thought the Federal Reserve shouldn't cut rates but it looks like ever increasing attention is being pointed at this matter and adding my voice wouldn't help. It seems more valuable to examine what the consequences will be of a Fed cut / non cut and how its going to affect the economy.

I've been saying for sometime that the Fed is stuck, not because it cannot do anything but because the 2 choices left are both going to be poisonous to the economy. Simply put, the Fed will either inflate liquidity or will follow a path that allows for a US domestic recession. You notice I say "allows" rather than forces. The Fed is not as omnipotent as many think.

The Fed seems to be following the path I laid out back in November last year (now you have to read the link) which allows for a cut at the September meeting. I think the cut will be 0.25% (discount rate will be 0.5%) but it will not make any difference to the outcome for the economy.

It does mean the Fed is seen to be doing the right thing for a domestic audience without overly hurting the foreign holders of US debt. Foreign holders can continue to sell off debt at a controlled pace. In the US it won't make any difference. Rates are set by the markets not the Fed. Rates are also set by risk. So whilst Treasuries are attracting a bid, thanks to the safe haven label, other areas of debt are pricing risk the other way, building in a risk premium into the yield, forcing yields higher. We are seeing that with 3 month LIBOR. The yield is rising to build in a risk premium and this is on the rate Banks charge to lend to each other.

Come to think of it, if the Banks don't trust each other with lending funds, why should you? Surely a risk premium on your savings, giving you a higher yield, should be in place? Maybe its time to check out your Bank, do a bit of research and confirm its health and what protection your cash has?

So if Banks are having to pay higher yields to each other and will be forced to pay higher rates to savers, whats going to happen to the rates charged by Banks on borrowings, you know, mortgages, loans and credit cards? How much higher will rates have to go to keep the system running? Maybe its time for a look at real yield curves, rather than the yield curve produced by US Treasuries.

This leads us back to a rather large problem. In fact its huge problem and its not being talked about out there in Medialand. What happens to a tapped out consumer, loaded with debt, trying to roll a teaser/innovative (thanks AliG) mortgage if rates are going up? Its not going to happen, its a train crash. Borrowers are already operating under tighter credit controls so the ability to re-fi is curtailed for many. Add in much higher rates and the situation becomes impossible. Banks are going to suffer from a curtailed income stream, as debt default rises, just as the teaser rates for the Banks’ borrowings come to an end and reset much higher. Can you see the irony?

Banks are no better off than over stretched sub-prime mortgage borrowers. They need an income stream from lending to ensure they can pay the liabilities they owe to savers, savers that will demand higher yields. Its unsustainable and its going to stop, soon.

An enormous amount of money (liquidity) is just going to disappear as the debts are defaulted. Credit will become a luxury, given only to those who can truly afford it (and probably don't need it). When credit is withdrawn from a fiat money based economy then the dynamics of money change. The withdrawal of credit based liquidity means that a fiat based currency has to realign to the fundamentals. That means deflation.

You can see the end game clearly now.

The Banks will have no option but to drop saving rates, they simply will not be able to afford to pay higher yields. Savers will move cash into assets that provide a higher return, shunning deposit accounts. Banks are hit with a double blow, as a lack of income leaves them either unable to service their own debt and default or forces them into repaying the debt using capital holdings or returns from assets sold in the markets. Either way, credit for business and consumers becomes impossible to provide. A massive contraction of activity is a given.

Its been noticeable of late to see the recession word crop up, even in the mainstream media. I think they are wrong. I think the future contains a scenario much worse than a recession.

So, my forewarned reader, will you be leaving your money in a "sub-prime" bank?