The financial panic and collapse of the first decade of the century continues. We have never seen anything like this and most of us will never see anything like this again. Except for the boomer generation it is coming at a time when many of us are set to retire. This is our generations financial collapse just like the Great Depression and War was for our parents. The Great Depression and war that followed played itself out over some 16-20 years. If this one follows the same path we believe ours began with the top in the markets in 2000 so this could last anywhere up to 2020. And as we are already seeing it is also playing itself out against the backdrop of war. And the war may yet take on a more dangerous course given the current situations surrounding Iran and Russia.
While the financial collapse started and is centred in the USA it is a global phenomena. There is probably not a country in the world that has not been impacted by the collapse of the new world order of securitization. We were often told that the brave new world of securitization and financial derivatives was a sign of the growing sophistication of our global securities markets. These instruments were supposed to be the answer to the management of risk, the creation of a vast array instruments that will enhance yield, provide safety and allow millions of people to enjoy a better life through the access of these instruments and credit. Well it didn't. The risk management models blew up, enhanced yield means enhanced risk, there was nothing safe about any of it and instead of millions enjoying a more fruitful life they will now face only the misery of poverty.
Not since the Great Depression have we seen such a collapse in the housing market with record foreclosures, rapidly falling home values, record bankruptcies and the collapse of financial institutions. Yes in listening to numerous money managers on BNN and elsewhere the attitude instead is still one of complacency that this will pass we will come out of it fine that we are really not in any danger and sure our portfolios are down but these ups and downs are normal in the long term of markets.
Well yes ups and downs in markets are normal. Except it seems once every 50-75 years along comes a market that effectively wipes everyone out. The last one of course was the Great Depression. And by the time this one is over, and it is no where near over, it will be compared to the Great Depression.
There is a delightful (depending on your sense of humour) web site called the "Bank implode-0-meter". There is also one for mortgage companies and hedge funds as well. Oh it is an American one but they do pick up others as well. The list actually isn't that huge yet containing 7 general implodes (Freddie and 6 general implodes (Freddie and Fannie amongst them), 14 FDIC banks, 4 credit unions and 8 more credit unions placed into conservatorships. But the mortgage implode-o-meter contained 282 names and the hedge funds 81 names. As to the bank list two more are about to join the implode-o-meter - Lehman Brothers and Washington Mutual. We expect many more as there are some 200 names on the FDIC watch list and with the collapse of Freddie and Fannie we couldn't help but note that their preferred shares were allowed to be used as capital for banks. Since these preferred shares have collapsed some 90% we would expect the FDIC watch list to grow and in turn the implode list to grow.
Grant you all of this does need to be given a little perspective in that there are over 7,000 banks in the USA alone and under no circumstances do we expect any Canadian bank to fail. If there is a problem they will be merged.
But investors have been whacked thoroughly over the past several weeks. And it has not just been contained to North American markets. Each week the Economist publishes series of statistics including markets. A sampling in the most recent issue shows that this year the Dow Jones Industrials is down 13.3%, the S&P 500 is down 12.7%, the NASDAQ 10.2% and the TSX down only 2.2%. But that was only until the printing of the most recent issue to September 5. A sample of other markets shows that the Nikkei (Japan) is down 17.1%, China (SSEA) is down 55.5%, the FTSE (London) is down 14.4%, DAX (Germany) down 21.6% and CAC 40 (France) down 22.1%. If it has been bad here it has been worse elsewhere. We could go on of course but it is clear - no one has been spared. We desperately searched the list for any successes and we found one. But not where you expect. Venezuela, yes the Venezuela of Hugo Chavez is up 5.1%. That's it out of listed stock markets one - Venezuela is up. But don't get too excited. That was in local currency. In US$ it has been pounded down 32%.
No where to hide. And it seems not even the commodity markets have proven to be a place to hide of late. Beginning it seems in mid July the commodity markets went into freefall. Gold has fallen 21%, silver 40%, oil 30% and natural gas 46%. The stocks have been hurt badly since mid July - the TSX Gold Index down 37%, the TSX Energy Index down only 13%. What happened? Gold in particular was supposed to be the insurance policy for investors. Last March when the financial markets were roiling gold (and the gold stocks) were soaring with gold going to $1000. Gold was doing what it was supposed to do acting as the counterpart to reeling financial markets. Just own a bit of gold and it will offset the disaster in the financial markets. When calm was returned to the markets with the effective collapse of Bear Stearns gold backed off its run up to $1000.
So investors would be rightly puzzled by the recent collapse in the gold markets. Trying to explain it when we are hearing nothing but rising demand (India is forecast to be using an additional an 100 tonnes of gold over last year), shortages (gold and silver eagles sales suspended, same with Krugerrands, a survey of coin dealers revealing no one has any product) and of declining mine production. Other forces were clearly at work. Our suspicion was that there was an unseen hand at work pushing the markets lower. We hated the thought that we were thinking like the conspiracy theorists but the collapse was illogical in the face of the unravelling financial crisis.
And initially gold, along with silver, oil etc. were all rising with a weak US Dollar and falling stock markets and rumours of the demise of Freddie Mac and Fannie Mae. Gold reached up to around $960 once again when the Fed came in with calming measures for Freddie and Fannie that they would be backed. But it was we believe as does well respected Chairman and Chief Strategist of Harris Investment Management in Chicago, Don Coxe that what happened was no accident. The calming measures for Freddie and Fannie in mid July were merely a part of a series of steps meant to calm markets and boost the US$. First the calming measures caught leveraged hedge funds and others short financials and long commodities. They had to quickly unwind the trade. The US Dollar rallied because now the risk of holding Freddie and Fannie had diminished sharply.
But there had to be more. In order to prevent a huge run on US financial assets they had to really boost the US Dollar. Inflation concerns gave the Fed an excuse to drop hints that they might hike interest rates. On the other side while many were bailing out of Freddie and Fannie debt there was a huge inflow of funds into US Treasuries from foreign central banks (probably primarily Japan and Europe) and the Fed or the US Treasury through the Exchange Stabilization Fund (aka the Plunge Protection Team) also helped by dumping Euros and buying dollars all designed to push the US Dollar higher. With the collapse of Freddie and Fannie and the threatened collapse of Lehman Brothers and so many other banks and dealers (we even hear Merrill Lynch is in trouble as well) the Fed could ill afford a systemic collapse in the US financial system as it would cause a global collapse of immense proportions.
So it was basically three pronged. Support Freddie and Fannie, dump Euros for Dollars to boost the US Dollar, talk up the US Dollar, support the US Dollar by buying US Treasuries (even as Freddie and Fannie were being dumped), put the hedge funds in an untenable position to cover financial shorts and dump commodity stocks as the US Dollar was pushed up rapidly. Whether the US Fed or Exchange Stabilization Group engaged in selling of commodities that is too difficult to ascertain. But the results worked anyway and when gold and silver in particular broke key support levels a panic set in. And as panics go it has been a screamer.
We have often talked in the past of an 8.5 year cycle low in Gold (Ray Merriman). A comparable cycle for Silver is one of 18 years so a half cycle would be 9 years. Given the limited history of trading gold and silver observations are therefore few. Gold lows were seen in 1976, 1985, 1993 and the double bottom in 1999 and 2001 (number 1 to 4 on our chart). For purposes of the low the second double bottom low in 2001 fitted better with the 8.5 year cycle. Therefore the next one 8.5 year cycle low was due theoretically anywhere from 2008 to 2010.
Similarly with silver we took the 9 year cycle and its half cycle is 4.34 years (Merriman) and we see lows in 1982, 1986, 1990 and 1993, 1997 and 2001 9 (labelled 1 to 5 with the double bottom in 1991 and 1993 3a and 3b). The next one was due in 2005 maybe 2006. Sure enough we had an important low made in 2006. So the next one wasn't due until sometime in 2010. This collapse caught us therefore out of the blue given its strength and ferocity.
But nonetheless due to the depth and the ferocity of this collapse we can only conclude that indeed we may be seeing the throes of the 8.5 year cycle low in gold. But the collapse in silver is we confess more baffling. We ploughed through even the 2006 lows. We can only conclude that this correction, and that is all we view it as because commodity markets are very long bulls up to 25 years, is a correction of the entire move up from 2001. Thus far Gold has corrected almost to the Fibonacci 38.2% of the entire move from 2001 to 2008 while silver has corrected the Fibonacci 61.8% of the entire move from 2001 to 2008. Silver is also near an important gentle long term uptrend line. While Gold plunged through one bull uptrend line we are still within range of the 38.2% correction point. It is not unusual to see these breaks. Key is that the follow through is weak.
Certainly the correction has been swift and vicious and accomplished in a very short period of time. There is some room for a bit more downward correction in gold to say around $725. If that level were to fall then we would have to look at the 50% correction level near $635. It is also a large congestion zone. We doubt it because of the big collapse in silver to the 61.8% correction level and the bull uptrend. Naturally sentiment and indicators have quickly moved to extremes we have rarely ever seen.
And some gold bulls such Jim Sinclair www.jsmineset.com and Sprott Asset Management have taken a beating both in the market and verbally. The anti gold crowd have crowed at the sectors woes and have pointed and said that gold has no correlation to a financial crisis and that it was a bubble. We disagree of course but in the short term it is painful and we admit it caught us by surprise not so much that it happened but the timing was definitely a surprise.
So what now. Well this actually might be the worst. The culmination of this wave could in theory be the A wave of a larger correction. Usually these waves go in an ABCDE type of triangle. Given the short time this wave played out the next four waves could be over sometime next year. Meanwhile we are optimistic given the extremities in sentiment and indicators that the B wave could soon get underway. It will correct a big chunk of this collapse. The CDE waves will be short in length. For a good example of that pattern see the huge 1929-1949 market that traced out a multi year ABCDE pattern. The A wave of course was the worst 1929-1932. Given the short time that it took for this to happen the duration should be considerably shorter measured in months.
One has to be realistic here with regard the US Dollar. The US Dollar rally may be just about over. We couldn't help notice that while we witnessed a huge inflow into the US over the past couple of months in looking at the money flows from foreign official and international accounts overall we see a net inflow in but it came out of agency bonds - Freddie and Fannie and into US Treasuries. In the latest numbers this week we saw an outflow out of some $8.5 billion. This is the second week in a row that it has fallen. It primarily came out of agency paper with some flow into US Treasuries. Result we believe the US Dollar is about to reverse to the downside and that in turn will turn gold and silver up.
The collapse in the financial market is unprecedented. Rather than praise the nationalization of Freddie and Fannie it raises even more questions. Freddie and Fannie took mortgages from other financial institutions. They already had around half the US mortgage market .Could they take the rest and in essence this is the nationalization of the US mortgage market? As well this adds some $5.4 trillion of debt to the US who already has $9 trillion of debt. Some percentage of Freddie and Fannie is unrecoverable. They say as low as $100 billion but it could in a worst case be as high as $1.6 trillion. The US Taxpayer will pay for this. Some have called it a bailout for the super rich (we know Bill Gross and PIMCO must be happy and reportedly had a $1.7 billion gain from this as they held a lot of Freddie and Fannie debt in their $133 billion portfolio). But others just want out. It is reported that China wants out of its $350 billion agency debt and Russia who has already sold a chunk of theirs wants out of the remaining $60 billion.
Some are worried that the US may face a downgrade on its entire debt. With a 60% jump in its debt overnight and a budget deficit of $400 billion and sure to be added to from the Fannie and Freddie debacle is suddenly looking like some third world country. Think Argentina a few years back. More financial institutions are in trouble and contrary to some claims the financial crisis still has a long way to go. Bear Stearns is gone and Lehman is about to be gone. More banks will fail. The Fed is letting anybody come to the window and they exchange good debt (US Treasuries) for bad debt (mortgage backed securities) through an auction process. This past year alone the Fed has shed some $300 billion of good debt (US Treasuries) and replaced it with considerably lower grade non Treasury paper. Sure it provides a lot of liquidity to the market but it weakens the Federal Reserve. A downgrade of US Debt would of course be earth shattering not to say the impact it would have on all current holdings in the worlds central banks.
So with almost a crisis de jour more drastic action will be taken. Maybe another rate drop and more liquidity adding games. All of it does threaten the potential for hyper inflation. And all of that of course is positive for gold. Gold is currency. It has been for 3000 years .The US Dollar has only been a reserve currency for 63 years and the past 37 years it hasn't even had gold backing it. It is just paper. Would you rather own US$ a possibly bankrupt piece of paper or Gold. Protect your assets and this sell off gives you the opportunity to pick it up cheaply.
Of course many will deride this. The US debt is still not a problem. One wag said it has lots of assets so you have to net it and once you net it the debt/GDP ratio is only around 40%. Reasonable. But without the netting it is now 115%. With Britain at the level in the early 1990's they pounded the British Pound almost into oblivion. So again would you rather own US$ or Gold. Over the past month they have been trying to tell us to own US$. Well we are not buying that dance.
We live in interesting times. We have attached a monthly chart of gold and silver.
Note: Chart created using Omega TradeStation. Chart data supplied by Dial Data.