An article on Bloomberg appears today entitled “Dudley Says QE2 Critics Don’t ‘Understand’ FED’s Exit Plan”, in Which Federal Reserve Bank of New York President William Dudley tries to convince us that we just don’t get Bernanke; I guess it is obvious to the FED that they are losing credibility and these interviews are the solution. This reminds me of the shareholder calls I listened in on when I owned Enron shares back in the day where they were trying to convince us how they were going to make money by building excess fiber capacity; after hearing that I sold at a teeny tiny profit (whew!). Of course we should all listen to and believe Dudley because he is one of the smartest guys in the room.
Dudley thinks that the market is underestimating the FED’s ability to raise interest rates when needed. He also would like us to believe that the FED can have an enlarged balance sheet without a long term inflation problem. He then breaks into song “Don’t Worry Be Happy” as the FED is confident of their ability to exit when the time comes. I am sure just like with the Y2K debacle and the more recent housing bubble where the FED knew just what to do. As I said in my post “The New Alchemists” the tools at the FED’s disposal are old and worn with limitations that even the FED can’t change because they are still bound by the laws and principles of economics; although Bernanke, Dudley and Yellen would like you to pretend otherwise.
In the meantime the Dollar is gaining because of the current Trifecta China, Korea and the Euro. The Chinese have raised rates as you know dear reader and the Koreans Followed suit. The EU zone is a mess because the markets want the Irish to accept a bailout, which the Irish for reasons of both pride and the fact that they feel they don’t need a bailout since they have funds to operate well in to 2011, are saying no. The whole EU is in a tizzy and as remarkable as it sounds the Europeans are running to the safety of the Dollar. The ECB plays these games from time to time with member countries and the large banks seize the opportunity to speculate driving the Euro down. Suddenly the Euro picks up since problem child du jour, this time being Ireland, accepts the bailout and bonds are issued. The Euro rallies as the bonds are sold because it sells well, all the while the ECB is printing up Euros to make the purchase. The Europeans at the moment are cleverer than old “B52 Ben” as their QE is more like a covert Black Ops campaign put together by Activision.
Back in Gotham City, dear reader, the Bond Market has taken a path of its own, even with “B52 Ben” hitting the Nitrous button revving the QE engine beyond the red line; pumping another $5.4 Billion in to Treasury Coupons today. In spite of all the extra juice the FED has jammed in to the bond market traders and analysts are puzzled as to why it is selling off. This could be the beginning of the implosion I talked about in my post “MOAB – Mother of all Bubbles”; I believe that the US Government Debt Bull was one of the two remaining “ultimate bubbles”, to steal turn of phrase from George Soros. This rise in rates has caused the dollar to climb and investors to sell off gold, silver and commodities. If rates were rising due to a hot economy then I would buy the gold and commodities sell off scenario, but our economy is not booming instead it is limping along like some poor 3 legged dog. I have said earlier the only reason we don’t have RAGING inflation here is because we export it to the inflation capacitors in the emerging markets, like China and Korea who recently raised rates…”I am shocked, shocked to find inflation going on in emerging markets here” as Captain Renalut from Casablanca might say.
I would argue that the largest part of the selloff is due to the CME rule changes that go in to effect today. The CME is implementing a rise in margin requirements as a way of protecting the exchange; however the new margin level increases the carrying costs of those involved and CME has spread the rise across the whole of the metals sector. The rises range between 5% to roughly 11% per contract and it varies by metal and size of contract. I believe that the rise in contracts greatly exacerbated the selloff since the price was being adjusted to reflect the new realities of cost on top of the world monetary gyrations; similar to the way a stock drops after a dividend is paid.
Normally falling bond prices mean higher interest rates and therefore commodities tend to sell off; this however is not always the case. Back when I was a kid in 1979 I can still recall we had rising rates a la Paul Volcker and yet we had rising gold and commodities. At the time traders believed that the dollar would rise and everything would fall but it did not work out that way. The people involved in the bond market know the jig is up at this point and even Bill Gross the notorious bond bull from PIMCO has been telling anyone that will listen that bonds are history and he has shifted his portfolio. The US is living beyond its means and the FED is enabling it while saturating the bond market with QE that will not enhance GDP or create much needed jobs. The net result of the overcrowding in this trade is that interest rates have nowhere to go but up. At the moment rates are ticking up and affecting the mortgage market QE2 be dammed; I am sure that this will hurt the poor housing market yet again.
I believe that we are about to enter another period of aberrations where interest rates will rise, but the dollar rallies will be sold as the reason for the dollar rise is the unloading of the newest risk asset over-monetized US Treasuries. The net result is there will be a flood of dollars looking for new homes to store value, in other words be converted to something of value. So even as rates are high the resulting inflation of dollars seeking escape from treasuries here and aboard will keep a lid on the dollar as people will not want their currency to be in dollars at least not for more than transactions.
In the meantime we have had in the past couple weeks, the “Vampire Squid” sucking the life from the economy ,Goldman coming out calling for $1650 gold and others as well; you know dear reader that if there is money to be made Goldman is there taking their slice of the pie from whatever is circling the world’s drain. The way for them to make the most is to be long things from commodities to gold. They are already long and continuing to buy on weakness I am guessing, so they are setting the trap and just waiting for the rush in which is why they put out these articles. You have to give them and the House of Morgan some respect after all what other companies do you know that can go quarter after quarter with 0 to 1 days of a trading loss; unlike the rest of us mere mortals. In the meantime it will be interesting to review this week’s COT reports to see who is going short on this down leg; I would contend that it is not the banks or big boys but instead the speculators who will be used as cannon fodder. I am betting that Goldman and the other boys are getting longer things while the rest of the frightened “sheeple” are going short thinking that it is a one way express to easy moneyville. Remember you have to ask yourself who is selling here and for every seller there is a buyer. Sure commodities of all flavors could go down from here it is possible, however I believe that the Goldman gang will keep acquiring and at some point be able to put the screws to the shorts and drive prices much higher like the big boys did in the 1979 rising interest rate and dollar environment. The difference is that the economy today is weaker and rates will have to keep ratcheting up causing dollars to keep rolling in stateside; the higher rates will make all the QE and defcit financing ever more costly for the FED and Treasury all the while putting upward pressure on inflation as the dollars are repatriated.