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Foreigners Turning on the US

Dow down, gold up. That’s two days in a row. We don’t know what to make of it! Actually, we’re not sure many people know what to make of the overnight action. Markets were all over the shop and the usual explanations for why things happen didn’t seem to stack up.

It just goes to show that market’s move to their own rhythm. It’s just that we demand a daily explanation for what happened and so the media throws one up, regardless of its veracity. It proves the old Wall Street adage, ‘Markets make opinions.’

That was certainly the case last night. Firstly, unemployment claims fell to a six year low. This is good news, but not in the market’s eyes because it increases the fear of ‘tapering’. Tapering means less liquidity, which is the lifeblood of Wall Street.

But employment data is a lagging indicator, so it’s not exactly telling you what’s happening right now. US claims for state unemployment benefits dropped 15,000 last week to 320,000, the lowest level since…October 2007. That was hardly an auspicious time to buy stocks, and there are some eerie peak market parallels with that period right now. We point some of those out in our latest presentation.

But if the market sold off on tapering concerns, then why was the US dollar under pressure? The theme lately has been for the dollar to strengthen as investors price in higher interest rates.

And the experts have told us for months now that tapering concerns are the reason why the gold price is under pressure. Yet gold spiked higher overnight, punching through an important level of resistance.

So just what is going on?

Our guess is as good, or bad, as the next person’s. But it seems like there is a decent shift of capital going on. Is the market catching a whiff of future inflation and trying to position for it by allocating capital to the beaten up precious metals sector? From a purely cyclical basis, it would make sense to take some money out of the S&P500 (at all-time highs and up 150% since the 2009 bottom) and allocate some to the precious metals (gold is up around 95% from its 2008 low of around US$700, but nearly 30% off its all-time high)

And it also makes sense from a bigger picture macro perspective. Overnight, the US Treasury released its ‘Treasury International Capital Data’ (TIC Data) for June. The data provides a monthly look at foreigners’ purchases of US securities. Below, we focus on movements in the all-important long term securities segment, which includes Treasury, agency and corporate bonds, and equities.

The data showed that foreigners were net sellers of US long term assets in June, which is worrying because the US needs foreign capital to sustain its excess consumption. So the gold rally could well have something to do with the lack of foreign financing of US deficits, which means the government will have to rely on the Fed to continue monetising treasuries, which is dollar negative. 

  On a net basis, foreigners sold US$67 billion of long term US securities in June. It’s the largest monthly sell-off since August 2007.

More concerning is the trend though. Foreigners have been net sellers of long term securities since February, one of the longest selling streaks on record. In the year to June, inflows totalled just US$171.8 billion, which is a huge reduction on recent years.

For example, in the year to June 2012, foreigners bought $519.5 billion in long term US securities. In the year before that, they bought $588.7 billion.

So we’re looking at a huge drop off in foreign financing of US excess consumption. This is a very big deal. The ‘excess consumption’ shows up in the US trade deficit, which over the past 12 months was around $500 billion. Large trade deficits are pretty standard for the US. It’s a product of the ‘exorbitant privilege’ of having the US dollar as the world’s reserve currency.

It means that foreigners will demand the dollar as a reserve asset, which enables the US to pay for surplus goods and services with cheaply produced dollars…year after year after year.

But the flow of long term financing is now drying up. The US still has a $500 billion trade deficit to finance, but a seeming reluctance by foreigners to continue financing it.

If this trend continues, one of two things will happen. Either the US will begin to live within its means, because the lack of foreign financing will not allow them to consume so much, or they will continue along the same path and have the Fed monetise ever greater amounts of debt to try to sustain their standard of living.

We’ll assume the US will take the short term gain for long term pain option. That won’t be good for the dollar. And it might just be what the gold market is getting a sniff of. It’s probably still a few years away, but markets discount the future and we think gold might have just gone from discounting deflation, to discounting a dollar crisis and higher inflation in the years ahead.

Since we’ve been on the gold theme this week, we may as well finish on it too. So we’ll leave you with a thought on an issue that seems to get plenty of attention in gold bug circles — the threat of an ‘imminent’ default on the COMEX.

In the past few months, gold inventories stored at COMEX warehouses have declined to very low levels. This has got the gold bugs talking about an inability of the banks to deliver against outstanding claims.

This makes for a good story, but we think it’s a non-event. Gold inventories held against futures contracts are low because there is a low ‘net long’ position in the market. That is, the trend over the past few months has been to bet on falling prices…that is, to go ‘short’ the market. If you’re short, you’re not going to take delivery at the end of the contract.

The counterparty to these ‘shorts’ is, in many cases, the banks — the market makers. So they are ‘long’ gold (which they probably hedge elsewhere so they are really positioned neutrally, neither long nor short) and they have no intention of taking delivery of any physical gold.

And the other point to note is that most investors who are long gold futures have no intention of taking delivery. They want leveraged exposure to gold, not gold itself. And because you have to stump up a hefty amount of additional cash to take delivery, it rarely happens.

Focusing on COMEX and warehouse inventories is interesting, but it’s a sideshow really. Gold bugs have been talking about delivery defaults for years. We’re not saying it won’t happen, but if it does it will mean something major has gone down in another part of the world…namely London. That’s still the centre of the gold universe. It’s why the gold trade there is cloaked in secrecy.

The paper trading schemes conjured up by the bankers and elites will no doubt go wrong at some point in the future. But it’s a waste of time guessing when. In the meantime, if you’re a gold bull, take some comfort in the fact that the gold price is again heading in a north easterly direction.       

Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

From the Archives…

Treasurer Bowen: Australian Economy in Crisis
9-08-2013 – Nick Hubble 

Bonner For Fed Chairman Over Larry Summers
8-08-2013 – Bill Bonner 

Interest Rate Troubles and a House Price Bubble
7-08-2013 – Nick Hubble

Australia’s Shadow Banking Sector is Collapsing
6-08-2013 – Nick Hubble

Diesel Goes to Caulfield and Callum to the Alfred
5-08-2013 – Nick Hubble

Greg Canavan
Greg Canavan is a feature editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Sound Money. Sound Investments, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

2 Comments

  1. Ross says:

    There are sufficient supplementary strategies in place that the surplus countries are not required to buy or even hold their UST’s. The USG can buy its own debt in perpetuity as long as the USD is the defacto global exchnage currency.

    US public debt delinquincy and inflation just floats away. In the case of US domestic deflation however there is no other stabiliser beyond printing/QE’ing.

    Sitting in AU DR should better. We are a carry traded and USD priced commodity risk market washing machine for the USD.

    If anything the inflationary heat will get heaped on the risk market middle men like us when China and Japan etc stop rolling over the short term stuff.

    The problem is that bond markets don’t believe QE is effectively driving sufficient growth in the US economy for the US treasury to clip the ticket. This latter issue also drives the tactical decisions of the Chinese co-investors etc who would gladly keep supplying the dope for the US consumer like the Brits supplied the opium if they too believed in Ben’s helicopter drops.

  2. watcher7 says:

    * Martin Armstrong, More Bernanke Confusion & Turbulence, armstrongeconomics.com, July 11, 2013:

    Here is the Forecast Array for the Dow Jones Industrials. We can see how this is going to start going nuts next week going into the ECM Turning point 08/07/2013. We are looking at high volatility generally in August.

    * Martin Armstrong, The False Move, armstrongeconomics.com, August 1, 2013:

    Just as they say there is the calm before the storm, there is always the false move before the breakout. As we approach the midpoint on the Economic Confidence Model August 7th, which is curiously 31.4 days from the low, we should keep in mind that this is the midpoint and not the climax peak. Resistance still stands at the 16000 level. The Dow has been crawling sideways buying time.

    The timing arrays are also now lining up with August 7th. This is independent of the ECM and is the collection of 72 models. Thus, as we move close to this target, we also see a Panic Cycle and volatility rising the week after.

    Capital will begin to shift and start to make its decision. If we see a high on the 7th in the Dow [high was on the 2nd], we may see the classic False Move to the downside for the typical time period of 1 to three units. This is what we may see. A brief correction with all the bears yelling I told you so, then followed by a rally that wipes them out. This market has not peaked yet and it is destined for much higher prices ahead going into 2015.75.

    * Martin Armstrong, It’s a Tinfoil Hat Conspiracy, armstrongeconomics.com, July 5, 2013:

    These types of economic crisis unfold in slow-motion. It is not rapid in the least. Each event is like a domino. One must push the next down. We MUST see Europe and Japan fall first. That puts the pressure upon the dollar sending it higher…

    * Martin Armstrong, Domestic Myopic Excuses – The Worst is yet to Come, armstrongeconomics.com, May 31, 2013:

    All this talk, talk, talk, about Fed monetization and pent up inflation that has not materialized, has other explanations when you look at the world as a single entity. We may yet see a bubble in the US into 2015.75 if we in fact see the dollar RISE as did the yen going into 1989. A rising dollar will increase the profits for foreign investors and drawn in even more capital globally creating massive capital concentration and global civil unrest. The Fed will go nuts and be forced to raise interest rates fearing a bubble and that will blow out the deficits and the entire system will collapse 2016-2020. So hold on to your socks. This is likely to be a wild ride.

    * Martin Armstrong, A Normal Market, armstrongeconomics.com, June 1, 2013:

    Gold is currently falling in dollars demonstrating (1) there is no pent up inflation and (2) it is capital fleeing into the dollar (bonds & stocks). BEFORE you will see a bull market resume in gold, sorry – you have to wait for the currency to catch up. If you are brainwashed and constantly presume the dollar will collapse any moment because the Fed increased the money supply, I suggest you are married to the mental conditioning you have been subjected to, have a closed mind, and will lose your shirt insisting you are right when the markets are proving you wrong. Gold declined in a basket of currencies, which is why it fell into 1999. This is about surviving – not punishing the world for its sins. Don’t worry. A rising dollar will cause far more damage than rising gold. Gold is a ting, tiny, fraction of the world economy. The capital flows are in trillions of dollars. Even 500,000 contracts at $1500 would be $75 billion. It is way too small of a market to harbor all the refugee cash in the world. That is bond and stocks – the only markets capable of absorbing trillions of dollars.

    * Martin Armstrong, Global Recap, armstrongeconomics.com, May 18, 2013:

    The dollar MUST rise sharply OVERALL between now and 2015.75. This is what we need to reverse the economic fortunes of the US so the entire global economy then turns down 2015.75-2020.

    The Fed Stimulus will end. As the Dow rises and they see the problems of Europe after the German elections, the efficacy of continued (bond) purchases will cause a reversal of fortune. Ultra low interest rates and hundreds of billions of dollars of Fed stimulus money led to the gold promoters calling for higher prices for gold and other commodities on a perpetual basis. This has been purely a domestic view ignoring the global consequences of Europe and the failure of the Euro that has led to the underlying support for the dollar and introduces the risk of it even making new highs above 1985 by 2015.75…

    The critical problem in Europe remains the faulty capital base of the banks. This is substantially different from the US where that is not an issue. The European banks have sovereign debt among the member states that created a structural flaw, which is why the ECB is touting to take depositor’s money because this is a political crisis that they intend to blame the banks for. This is similar to the S&L Crisis where Congress directed the S&Ls to lend on real estate and then the Democrats raised taxes reducing the amortization schedules creating a one-way sellers market. Then they locked up S&L owners for fraud when they created the mess. Europe has done the same thing and is trying to blame its banks for buying their debt that they cannot pay. The European banks will have to suck up the losses and recapitalize as Tim Geithner did in the US back in 2009 by threatening the banks that that had 6 months to do it or the government would take them over. Geithner was probably bluffing but the Fed then opened the window and the politicians looked the other way as banks cut what they would pay people but failed to lower what they were charging. They increased the spread between bid and ask to historical levels and recapitalized themselves.

    The US economy is in far better shape than the EU and the US banking system is now cashed up. So ironically, the risk of US bank deposits being seized is minimal before 2015.75 when things start to get questionable again…

    The US is the only game in town and it will continue to attract capital both from Japan and Europe. The rising dollar with a rising stock market is creating the international boom much like Japan saw going into 1989…

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