February 3, 2014
- 2008 redux? Making sense of the emerging-markets mess
- The six stages of crisis… and where we are right now
- Why the market might be in for a continued rough ride, and the S&P number to watch
- After the real crisis in emerging markets, here comes a manufactured one at home
- The $250,000 penny… making sense of “rehypothecated” gold… two big winners in less than a week… and more!
“The current crisis reminds me, in a way, of how the 2008 financial crisis got its start,” says our Chris Mayer — getting the new week off to a rollicking start.
“It begins with what seems like a brush fire. But in the months that follow, it spreads quickly and becomes an inferno.”
We turn to Chris this morning to make sense of the mess in emerging markets. No better source to turn to, considering how many of them he’s visited. We daresay he wrote the book on emerging markets.
“The 2008 crisis took some time to get going,” Chris reminds us.
Some market historians date the start to February 2007 — the first time a major bank (HSBC) “wrote down” its losses on subprime mortgages.
In April of that year, the subprime lender New Century Financial failed. “In July,” says Chris, “Bear Stearns liquidated two hedge funds that invested heavily in subprime mortgages. In August, there was another bankruptcy: the American Home Mortgage Investment Corp. This was a big one. It was the 10th largest mortgage lender in the country.
“But think about that timeline… At that point, we were months into the worst crisis since the Great Depression. Warnings signs were everywhere. The biggest events and failures were just around the corner. Yet the market would make an all-time high in October. It would then get cut in half.”
“Markets can be slow to appreciate that the game is up,” Chris summarizes. And so it goes in the emerging markets.
“The list of countries with suddenly worrisome problems is long and growing. As creditors and investors worry (sell stuff), the currencies of these countries plunge.”
That said, emerging-market currencies have been in trouble for a while…
“There’s a common element among many of the countries in trouble,” Chris explains: “They run big current account deficits.” That’s the case in all of the “Fragile Five” — Brazil, India, Indonesia, Turkey and South Africa. Chile, too.
James Mackintosh of the Financial Times mashed up all six of those nations’ currencies and compared them with five currencies whose nations have big surpluses — China, Malaysia, the Philippines, South Korea and Taiwan. “I added in light blue the EM surplus countries without China,” Mackintosh adds, “just to show the stability isn’t all about the management of the renminbi.”
So… will the trouble set off a wider global crisis?
“It’s hard to know,” says Chris. Beware anyone who says otherwise.
“The financial markets are bound up with each other in all kinds of ways. Who knows who is holding, for example, Turkish paper or who isn’t. In time, I’m sure we’ll find out.”
For all the chatter about Turkey in recent days, it doesn’t even show up on this “top 10” list of the governments bond traders worry about most, based on action in the credit default swap market.
And as for Argentina, its probability of default is little higher than it was a year ago.
Still, “no market — not even the U.S.’ — is quarantined from the damage,” says our Dan Amoss.
“Many U.S. companies sell into emerging markets. After currency crashes, imports become unaffordable. Economies downsize and de-globalize.
“Such are the consequences of credit bubbles. Credit bubbles cannot inflate to economy-wrecking scales if they weren’t built on a foundation set by central banks.”
Dan lays out a six-step sequence of how the process unfolds…
- Central banks manipulate interest rates below where they would have been established in a free market.
- Bankers and borrowers go wild.
- Near the peak of the bubble, central banks tighten mildly.
- Awareness spreads that central banks — not genuine savings — funded the credit bubble.
- Investors sell and/or repatriate their assets.
- Calls for renewed central bank easing grow louder and louder.
“Right now,” Dan suggests, “we are somewhere between steps three and four in the above sequence. Last week’s additional QE taper of $10 billion per month will prompt more investors to look for the exits.”
As indeed they are this morning. As we write, the major indexes are all well into the red, some of them more than 1%.
The concern of the moment is a stinko ISM Manufacturing Survey for January. Among dozens of economists polled by Bloomberg, the average guess was that the number would ring in at 56.0.
Whoops, it’s only 51.3 — above the 50 dividing line between a growing factory sector and a contracting one, but still a huge disappointment. Within the survey, new orders collapsed from a robust 64.4 to 51.2. Ouch.
Back to Chris Mayer: “With emerging markets struggling and currencies imploding, it ought to take some bite out of the earnings U.S. companies make abroad.” The ISM numbers are starting to bear that out.
With today’s sell-off, the VIX has popped above 20 for only the third time in the last year.
The VIX, as you might know, is the market’s “fear gauge” — based on the action in S&P 500 index options. And this time, the move above 20 might stick, suggests our Greg Guenthner.
“For the past two years as the current rally has matured from its 2011 bottom, the VIX has turned back at its 200-week moving average. With today’s surge, the VIX is now ramping off its lows.
“We won’t see the completed candle until Friday — but if it does close above its long-term moving average, this could be the beginning of a very volatile period for stocks.”
But in the meantime, the long-term uptrend going back to November 2012 remains in place, says our Jonas Elmerraji. The number to watch on the S&P is 1,750: “Until that level gets broken, the broad market is still in the exact same mode it’s been in for the last year.”
At last check, the index sits at 1,766.
Gold popped as soon as the ISM number came out, traders perhaps sniffing out a pause to the Fed’s “tapering” next month now that Janet Yellen has moved into the chairman’s office.
As we write, the bid is $1,272.
“Time is short,” Treasury Secretary Jack Lew said this morning of the latest debt ceiling drama.
Hey, why should emerging markets be the only thing giving traders the heebie-jeebies?
The ceiling on the national debt was suspended when lawmakers reached agreement to halt the partial government shutdown last October. It kicks in again on Friday. At that point, the Treasury will once again resort to “extraordinary measures,” like borrowing from government pension funds, and we’ll be treated to another legislative spectacle.
But the extraordinary measures will buy less time than usual, Lew warns: “We expect our outlays over the coming weeks to exceed our net inflows,” he says — owing mostly to tax refunds. Weeks, not months, he says.
For the record, the national debt this morning stands at $17,249,265,796,405.00.
And now for a penny that might be worth $250,000 or even more.
In 1973-4, rising copper prices prompted the U.S. Mint to strike more than 1.5 million aluminum pennies at the Philadelphia Mint, dated 1974. But then the Mint thought twice and the coins never saw the light of day. Most were destroyed… although a handful sent to members of Congress and other government officials were not returned as requested. One now resides at the Smithsonian.
Then last year, it was discovered there was also an issue from the Denver Mint. The former deputy superintendent hung on to one of the coins for himself. He died in 1980… and it wasn’t until 2013 that his son realized what he had.
“My father sometimes received coins as gifts during his government service,” Randy Lawrence recalled, “and I kept them in that same plastic bag in a desk drawer for 33 years.”
He sold them to a dealer in La Jolla, Calif., who couldn’t figure out where the 1974-D aluminum cent came from. Long story short, it’s now been authenticated, and it was on display last weekend at an expo in Long Beach, Calif.
One of a kind: The 1974-D aluminum cent
It will be auctioned off during the Central States Numismatic Society convention in the Chicago area. Dealer Michael McConnell will split the proceeds with Lawrence (“I wouldn’t be able to sleep without notifying him”), and they plan to donate a portion to help the homeless.
[Ed. note: As we mentioned a few days ago, the Mint is rethinking every coin it makes right now — especially nickels, dimes and quarters. Among those three, there’s one in particular you’d do well to start saving before the Mint makes its final recommendations to Congress by year-end. Look here for the full story.]
“Help me understand,” a reader implores after a fellow reader dived deep into the murky waters of gold leasing on Friday.
At issue: Whether the gold that’s been leased by central banks to commercial banks is the same gold that’s being sold off to China.
“My confusion about this scenario,” the reader goes on, “has been around the physical location of leased gold. So a central bank leases out gold to bullion banks at rates of around 1%. The bullion bank can then use the gold as collateral to fund arbitrage in a market of their choosing offering better returns or lease it out themselves again, even though they don’t own it.
“Does the gold actually leave the central bank vaults in physical form, or is it just on paper saying the bullion banks have leased it? I can’t imagine that the gold is being physically shipped all over the place from the central banks and then to the bullion banks and then to China or anywhere else.
“If it is still held at the central bank, then how can the bullion bank sell the gold it doesn’t physically hold without the knowledge and approval of the central bank that actually holds and owns it? I could go on with the intricacies of all the possible scenarios, but I think you get my point.
“I recall this scenario being discussed numerous times but have always been fuzzy on this point. Thanks for any clarity you can bring.”
The 5: Uh… You’re asking for a degree of transparency that no one any side of these multisided transactions will agree to.
The central banks are keeping mum, the bullion banks are keeping mum and the Chinese refuse to disclose their gold imports coming through Shanghai.
But they do disclose their imports via Hong Kong, and they totaled 1,108.8 metric tons in 2013 — up 33% from the year before. Some of the gold has to be exiting the vaults.
But yes… other bars likely remain at the New York Fed, and who knows whom they belong to. Consider that the pittance of gold returned to Germany last year after the Bundesbank asked for repatriation: The serial numbers on the bars don’t match up with the Bundesbank’s records. Who knows where Germany’s gold ended up?
Bottom line: If you don’t own gold in your possession, the institution that does must be people you know and trust.
“Just a big ‘atta boy’ to you guys,” a reader wrote Friday, “after reading all the reader comments this week.
“You do such a great job; the newbies will learn and catch on, hopefully. Does make you wonder where they get their news and info, though. Scary thoughts, huh? Go out, have some good food and a few drinks; you guys deserve it this week.”
The 5: We took you up on that very suggestion!
Cheers,
Dave Gonigam
The 5 Min. Forecast
P.S. While the market tanks, Options Hotline readers are sitting pretty. Two of Steve Sarnoff’s bearish plays are up substantially. One, on the small-cap space, is up 87% in a week. The other triggered this morning and is already up 31%.
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