What Really Happened Last Week?

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Yes, but why was last week’s correction so pitiless?

Monday we put our finger on “passive investing.” That is an investing strategy that flows with the tides.

A rising market tide lifts all vessels — even the leaking, decrepit, unseaworthy hulks.

But when a strong gravity pulls the water the other way… all go down with it.

And it was an angry moon last week, exerting a mighty tug.

But passive investing may only tell a portion of last week’s harrowing tale.

We have clawed our way deeper into the facts — and deeper again — to arrive at a fuller explanation.

Details to follow. But here is your hint:

It implicates the Federal Reserve… despite our unshakeable faith in its infallibility.

First, today’s tidal reading…

Stocks Rise on a Surging Tide

We are pleased to report the water rose today. And high…

The Dow Jones rose 1,173 points — its second-highest (point) gain in history.

The S&P gained 127 points. And the Nasdaq, 334.

And so all three indexes have uncorrected. That is, they have all three emerged from correction.

But why?

Explains CNBC:

Stocks surged on Wednesday as major victories from former Vice President Joe Biden during Super Tuesday sparked a massive rally within the health care sector…

Tuesday’s primary results sent health care stocks flying. The S&P health care sector surged 5.8%, posting its best day since 2008. UnitedHealth and Centene jumped 10.7% and 15.6%, respectively. Shares of UnitedHealth had their biggest one-day gain since 2008.

Many investors have applauded Biden for his middle-of-the-road tact in contrast to the more progressive policies of Sanders and Sen. Elizabeth Warren.

Gold shed $6.10 today.

But the somber bond market merely shook its head… and sighed. 10-year Treasury yields remain under 1%.

But to proceed…

If passive investing does not fully explain last week’s fearsome correction… what does?

The Great Liquidity Flood

Our tale begins last September…

A main line ruptured deep within the financial plumbing. And liquidity ran dry in the critical “repo” market.

Pouring icy sweat, panicked, the Federal Reserve rushed in with the hoses… and let the valves out.

It emptied in so much liquidity over the next four months, it inflated its balance sheet $400 billion — a $1.2 trillion annualized rate.

Not even during the lunatic days of the financial crisis did it carry on at such a gait:


The stock market surged on the rising water, nearly perfectly, four months running:


And so the Federal Reserve inflated a bubble — a bubble within a greater bubble.

But here our tale gathers steam…

The Fed Closes the Hoses

In December, the Federal Reserve tightened the valves. And liquidity, formerly flowing in gushes, dwindled to a trickle.

And so the delirious stock market lost its energy… like an airplane that has lost its lift.

The thing went on momentum for a time. But nothing was pushing it along. And so it was vulnerable…

We introduced you to Mr. Graham Summers yesterday. In reminder, he is a senior market strategist at Phoenix Capital Research.

From whom:

From September 2019 to December 2019, the Fed provided some $100 billion in liquidity to the financial system every single month.

The Fed then stopped these policies on a dime in mid-December. From that point onward, the Fed’s balance sheet, which expands when the Fed is providing liquidity to the financial system, completely flatlined…

Lost amidst all the talk of the coronavirus and potential global economic contraction is the fact that the Fed’s balance sheet has been flat to down since early December. This tells us the Fed completely ended the aggressive liquidity pumps it was running from August through the end of the year…

You can see these developments in the chart below:


The “Pin” That Popped the Bubble

Then the coronavirus chewed through its leash… and ultimately through the ticker tape.

But it was merely the “pin” that punctured the bubble, says Summers:

Now, you can see the impact these policies had on the stock market in the chart below.

The Fed created this environment with its monetary policies. The fear of an economic slowdown due to the coronavirus was simply the “pin” that burst this mini-bubble.


What does Mr. Summers conclude?:

The big lesson here is this: The financial system is now completely addicted to Fed liquidity. The Fed can try to talk tough about withdrawing liquidity from the system, but at the end of the day, the market is going to force the Fed’s hands.

In turn, we conclude:

Passive investing — twinned with plateaued liquidity — conspired tp deal markets the swiftest, sharpest correction since 1928.

This fearsome combination sent markets careening from record heights to correction in a mere six days.

But you can be sure the Federal Reserve is preparing to unfurl the hoses yet again…

Liquidity Running Dry Again in the Repo Market

It appears the repo market is entering another drought. And the major banks — primary dealers, so called — have reacquired a panting thirst.

They have requested $111.48 billion in overnight loans from the Federal Reserve.

But the Fed can only dole out $100 billion under existing arrangements.

“Oversubscribed” is the term.

That $111.48 billion comes on top of the $108.6 billion dealers requested the night before — again, oversubscribed.

The Federal Reserve had intended to suspend repo operations next month. But reports The Wall Street Journal, in predictable understatement:

Those plans could change amid the rapidly shifting economic and financial outlook. Some in the market are already wondering if the Fed will increase the size of its temporary operations to accommodate the high level of demand from banks.

We wager high those plans will change. 180 degrees.

Will it reinflate the stock market?

We have no answer. The market faces a mighty foe in a miniature virus.

But little surprises us these days.

Dangerously Low on “Dry Powder”

Meantime, the Federal Reserve squanders what little “dry powder” that remains.

Yesterday’s 50 basis point blast reduced the federal funds rate to between 1% and 1.25%.

Goldman Sachs projects another rate cut when the FOMC huddles in two weeks. And another in April (each 25 basis points).

If true, the Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

And given the global economic outlook…

It will be unable to restock its magazines for years and years — and years.


Brian Maher
Managing editor, The Daily Reckoning

The post What Really Happened Last Week? appeared first on Daily Reckoning.

EXPOSED: The Fed’s Deepest Secret

This post EXPOSED: The Fed’s Deepest Secret appeared first on Daily Reckoning.

Today we don our reporter’s fedora, sit at our typewriter… and pursue a question truly scandalous.

We will be denounced for fanning “conspiracy theories.” Social media will excommunicate us for hawking “fake news.”

We expect fully to be tried for sedition… and packed off to the gallows for offending God and king.

But we will take the consequences as we must.

For we are hot to expose an illegal Federal Reserve manipulation of the stock market.

Today we haul forth forbidden evidence.

Doesn’t the Fed Already Manipulate the Market?

“But wait,” you say. “Isn’t it common knowledge that the Fed manipulates the stock market through interest rates and tricks like quantitative easing?”

Yes, it is. And it does.

Yet these are indirect influences, actions at distances, nudges at one remove.

We refer instead to a direct market intervention — and again, an illegal intervention.

It is as if the Federal Reserve has the stock market by the scruff of the neck.

And might it explain how the market came shooting from the depths late Friday… when all was in freefall?

The answer — the possible answer, in fairness — anon.

But first today’s urgent news…

Powell Rides to the Rescue

This morning we noted the Dow Jones was 250 points in red. Not 10 minutes later we glanced again — only to learn it was suddenly 300 points in green.

A 550-point sprint… in 10 minutes!

But why? Here is the answer:

Chairman Powell came charging over the hill this morning… and slashed interest rates 50-basis points.

It was the first 50-basis point cut since December 2008.

Declared Napoleon on his white horse, bloody sword in hand:

The magnitude and persistence of the overall effect on the U.S. economy remain highly uncertain and the situation remains a fluid one. Against this background, the committee judged that the risks to the U.S. outlook have changed materially. In response, we have eased the stance of monetary policy to provide some more support to the economy.

Alas, Mr. Powell’s gallantry offered only temporary inspiration…

Why the Market Retreated

Stocks were in swift retreat shortly thereafter, pulling all the way back to negative territory.

“Where are they going?” he must have shouted inwardly. “Didn’t I just give them what they wanted?

“I didn’t even wait for our FOMC meeting in two weeks. And I cut by a full 50 basis points, not a measly 25.”

But that is precisely why stocks likely fled the field of battle, Mr. Chairman. Your move suggests panic.

It tells them this coronavirus is a genuine menace, a true fee-fi-fo-fum, something really to watch.

The Dow Jones ended up retreating further still. It shed another 786 points on the day.

The S&P gave up another 87 points; the Nasdaq, 268.

An Historic Day

Meantime, the 10-year Treasury yield dropped beneath 1% today as the stampede to safety continued.

Not once in history has the 10-year slipped below 1% — not once.

And gold made a bid to reclaim safe haven status today, gaining a thumping $41.70.

But should the rout deepen…

Do not be surprised to see stocks rise unexpectedly under invisible influence — as if by conjury.

And so we return to our central questions:

Does the Federal Reserve directly intervene in the stock market?

That is, has it become its own Plunge Protection Team?

And does any evidence exist for it?

A Puzzling Market Anomaly

Graham Summers is senior market strategist at Phoenix Capital Research. And his researches have shoveled up some odd and exotic findings:

For years now, I’ve noted that anytime stocks began to break down, “someone” has suddenly intervened to stop the market from cratering…

[And] a year ago, I noticed that the market was behaving in very strange ways.

The markets would open sharply DOWN. Seeing this, I would begin buying puts (options trades that profit when something falls) on various securities, particularly those that had been experiencing pronounced weakness the day before.

Then, suddenly, and without any warning, ALL of those securities would suddenly ERUPT higher.

What made these moves even more bizarre were that they were happening at roughly the same time of day (9:50–10:00 a.m. EST). And as if that wasn’t odd enough, these violent rallies were occurring on almost NO volume, meaning that real investors were not driving them.

And this was happening almost every week.

I’m always looking for new ways to make BIG MONEY from the markets. So suffice to say, this discovery REALLY got my attention.

What followed was a labyrinthine journey into the guts of the financial system. It took several months, but after countless hours of research, I came to a startling conclusion.

Which was what, Mr. Summers?

I 100% believe the Fed is actively intervening in the stock market.

I don’t mean indirect interventions via rate cuts or quantitative easing (QE) programs… I mean that I believe the Fed is LITERALLY buying stocks directly to stop the stock market from falling.

But That’s Not Legal

It is true, some central banks such as the Swiss National Bank and the Bank of Japan are legally authorized to purchase stocks. Both take advantage in full.

But the Federal Reserve Act — Section 14 — grants our own central bank no similar authority.

It may purchase Treasury debt and mortgage-backed securities, yes. But not stocks.

You are alleging, Mr. Summers, that the Federal Reserve is acting contrary to the laws of the United States.

What evidence have you?

Look to Jan. 7., he instructs us:

Stocks opened in a sea of red based on increased tensions between the U.S. and Iran. Then, suddenly, stocks went absolutely vertical around 10 a.m.:


Your explanation, Mr. Summers?:

Fed interventions involve indiscriminate buying… Large financial institutions don’t place buy orders that move the markets… Whoever placed the buy order that triggered this wanted the market to rip higher.

Interesting. But certainly you have more evidence than that?

The Market Mysteriously Rebounds

Yes, we are told. Mr. Summers next directs us to last Friday, when markets were plunging once again.

During the previous five sessions, Microsoft, Apple, Alphabet (Google) and Amazon were tumbling faster than the overall S&P.

But early afternoon Friday, Apple and Microsoft mysteriously pulled up… and halted the S&P’s sell-off.

But why?

Microsoft had warned on Wednesday that manufacturing kinks in China would kink its bottom line.

Apple was similarly upset by the coronavirus.

Yet by closing whistle Friday, Microsoft posted a 2.42% gain. Alphabet, a 1.61% gain.

Meantime, Apple and Amazon nearly clawed even:


Again we ask… what prompted the about-face?

Perhaps Mr. Summers is correct.

Both the Dow Jones and S&P closed the day in red. But given their outsized weighting, these particular stocks halted the rout.

And both indexes ended Friday far higher than they otherwise would have.

Summers believes the Federal Reserve purchases these specific wagon-pullers to haul the freight along.

The Role of “Passive Investing”

The strategy relates directly to the “passive investing” we tackled yesterday.

Mr. Summers:

The Financial Times recently reported that according to data from JPMorgan and Lucerne Capital, only 10% of stock market volume comes from actual fundamental stock investors.

The other 90% of all market trading today is generated by passive funds/index derivatives. Meaning 90% of trading comes from automated computer trading programs that buy stocks passively. These programs buy individual stocks or entire stock indexes without thinking.

Because of this, the Fed knows it only needs a significant percentage of stocks to ratchet higher to get the entire market to rally.

Those stocks, again, are Microsoft, Apple, Alphabet and Amazon.

Please, continue. Do you have additional evidence of this ongoing — and illegal — operation?

The Evidence Mounts

Fed interventions occur at specific times of day. Real investors don’t arbitrarily place large orders at particular times of the day. [But] I’ve noticed time and again that these kinds of large indiscriminate moves occur at 10:00 a.m. on days when the market opens in the red. [Also]…

Trading volume falls during Fed interventions. Volume fell as the market ripped higher, indicating that there were few real buyers in the marketplace. If this had been a real market move based on real buyers coming into the markets, the trading volume would have stayed strong or only declined slightly.

Who else could this be but the Fed?

We have no answer. You present a compelling — dare we say, convincing — case.

We demand a Congressional investigation at once. The alleged conduct is again, illegal.

This is a nation of laws after all.

And who, besides the FBI, CIA, NSA, IRS  — and Department of Justice — is above the law?


Brian Maher
Managing editor, The Daily Reckoning

The post EXPOSED: The Fed’s Deepest Secret appeared first on Daily Reckoning.

Why Markets Plunged So Fast

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The market swung from record heights to “correction” within a mere six days.

Only once in history has it plunged so violently so swiftly. In 1928 that was — not long before the great gale of ’29 blew on through.

The market has since endured 25 “swift” corrections over 75 years.

These are not extended, orderly retreats. They are rather lightning hysterias packing ferocious wallop.

On average — the phrase is necessary — you can therefore expect one of these frantic corrections every three years.

Yet four of these 25 hair-raisers have shaken Wall Street since August 2015.

That is greater than once per year — again, if you take the average.

(We doff our cap to macroeconomic analyst “The Heisenberg” for supplying the data.)

We must conclude the market is increasingly vulnerable to these sudden and violent shakings.

But why? Why the greater frequency since 2015?

Today we seek to drive a light through the puzzle… and penetrate the mystery.

But first, how did battered markets open the fresh week?

Stocks Roar Back

Dow Jones futures swung dizzily in overnight trading Sunday — over 1,000 points peak to trough.

Greater volatility, that is, was likely on tap this week.

But like a careening drunk who grabs something sturdy on the way down… the stock market steadied itself today.

Steadied itself? It went bounding up the nearest tree…

The Dow Jones vaulted 1,294 points today, regaining a healthful chunk of last week’s losses.

The S&P recaptured 136 points; the Nasdaq, 385.

Market-maker Apple recovered 6% this morning. The “FAANG” stocks also climbed to their feet today.

The Return of the “Dip Buyers”

Thus the “dip buyers” peeked out from their bunkers today… and concluded it was safe to come out.

Explains Brent Schutte, chief investment strategist at Northwestern Mutual:

“The sell-off was so fierce last week that you do have some buy-the-dip investors emerging.”

We suppose the immediate prospects of rate cuts put some heart into them.

Markets presently give 100% odds of a March rate cut. And not a 25-basis point rate cut… but a thumping 50-basis points.

And an April rate cut? Those odds exceed 70%.

Yet the bond market dismissed entirely the promise of additional empty fireworks…

The 10-year Treasury yield once again plummeted to record depths today, to 1.065% — a sweet distance below its July 2016 low of 1.27%.

Gold, meantime, surged $22.30 today after last week’s savaging. Perhaps it is poised to reclaim its “safe haven” mantle.

But returning to our central question… why are corrections growing more violent?

A Likely Answer

We believe “passive investing” holds the answer — or much of the answer.

As we have written before…

After the 2008 near-collapse, the water management team at the Federal Reserve inundated markets with oceans of liquidity.

The biblical-level flooding knocked down existing financial signposts. And “fundamentals” no longer seemed to matter.

The tide was rising — and all boats with it.

“Active” asset managers casting the water for losers hauled up empty nets.

Some 90% of all actively managed stock funds have underperformed their index during the last 10 years.

“Passively” managed funds — on the other hand — make no effort to pinpoint winners.

They instead track an overall index or asset category, not the individual components.

They are “passive” because they sit back on their oars… and let the flowing tide lift their boat.

Passive Investing Has Yielded Handsome Dividends

This strategy has yielded handsome dividends this past decade of generally rising waters. Tim Decker, president and CEO of ISI Financial Group, explains:

Passive management came into its own during the long bull market that started in late 2009, after the market had collapsed amid the financial crisis in 2007–08. Money had been flowing from active to passive vehicles in the preceding years, and investors — disillusioned by their losses in the crisis and the high fees they had paid — started turning to passive vehicles even more. That trend has continued to this day.

Passive investing has increased from 15% of funds in 2007 to perhaps half today.

Wall Street has poured into titanics like Facebook, Apple, Alphabet (Google), Netflix and Microsoft.

Their combined tonnage presently exceeds 10% of the stock market’s overall $34 trillion heft.

As long as the tides continue rising….all is peace.

But here is the risk:

When the tide recedes… that same handful of stocks can wash the market instantly out to sea.

For when they move, the market goes with them.

Panic selling begets panic selling. And none knows how far the waters might drop.

All Heading for the Exits at Once

Explains Jim Rickards:

In a bull market, the effect is to amplify the upside as indexers pile into hot stocks like Google and Apple. But a small sell-off can turn into a stampede as passive investors head for the exits all at once without regard to the fundamentals of a particular stock…

Or as analysts Lance Roberts and Michael Lebowitz of Real Inves‌tment Advice have it:

When the “herding” into ETFs begins to reverse, it will not be a slow and methodical process but rather a stampede with little regard to price, valuation or fundamental measures.

Importantly, as prices decline it will trigger margin calls, which will induce more indiscriminate selling… As investors are forced to dump positions… the lack of buyers will form a vacuum causing rapid price declines [that] leave investors helpless on the sidelines watching years of capital appreciation vanish in moments.

“Fast, Furious and Without Remorse”

These fellows remind us that investors hemorrhaged 29% of their capital over a three-week span in 2008 — and 44% over three months.

“This is what happens during a margin liquidation event,” they conclude.

“It is fast, furious and without remorse.”

Last week’s selling was fast… furious… and without remorse.

Microsoft plunged over 20% at one point last week, for example — as did Apple. Thus they were dragged into bear market regions, however briefly… defined as a 20% drop from their recent heights.

Facebook and Alphabet, meantime, posted double-digit losses.

And given their overall tug on markets… last week witnessed a thumping correction.

Why Should They Stop Now?

Again, only in 1928 did stocks plunge from record heights into correction in merely six days.

Goldman, in summary:

“Narrow bull markets eventually lead to large drawdowns.”

We do not know which direction the markets will take next. And we will hazard no prediction — as we have limited appetite for crow.

We will only say that deceased felines have been known to bounce.

But to our notion, passive investing at least partly explains these intensifying market spasms.

And we expect more of them.

Our concern is that the market may fall into spasm one day… and fail to come out.


Brian Maher
Managing editor, The Daily Reckoning

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The Economic Cataclysm

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To understand the economic cataclysm ahead, do the math. Those expecting the Covid-19 pandemic to leave the U.S. economy untouched are implicitly making these preposterously unlikely claims:

1. China will resume full pre-pandemic production and shipping within the next two weeks.

2. Chinese consumers will resume borrowing and spending at pre-pandemic rates in a few weeks.

3. Every factory and every worker in China will resume full pre-pandemic production without any permanent closures or disruptions.

4. Corporate America’s just-in-time inventories will magically expand to cover weeks or months of supply chain disruption.

5. Not a single one of the thousands of people who flew direct from Wuhan to the U.S. in January is an asymptomatic carrier of the coronavirus who escaped detection at the airport.

6. Not a single one of the thousands of people who flew from China to the U.S. in February is an asymptomatic carrier of the coronavirus.

7. Not a single one of the thousands of people who are in self-quarantine broke the quarantine to go to Safeway for milk and eggs.

8. Not a single person who came down with Covid-19 after arriving in the U.S. feared being deported so they did not go to a hospital and are therefore unknown to authorities.

9. Even though U.S. officials have only tested a relative handful of the thousands of people who came from Covid-19 hotspots in China, they caught every single asymptomatic carrier.

10. Not a single asymptomatic carrier caught a flight from China to Southeast Asia and then promptly boarded a flight for the U.S.

I could go on but you get the picture: an extremely contagious pathogen that is spread by carriers who don’t know they have the virus to people who then infect others in a rapidly expanding circle has been completely controlled by U.S. authorities who haven’t tested or even tracked tens of thousands of potential carriers in the U.S.

These same authorities are quick to claim the risk of Covid-19 spreading in the U.S. is low even as the 14 infected people they put on a plane ended up infecting 25 passengers on the flight.

These same authorities tried to transfer quarantined people to a rundown facility in Costa Mesa CA that was not suitable for quarantine, forcing the city to file a lawsuit to stop the transfer.

Do these actions instill unwavering confidence in the official U.S. response? You must be joking.

Do the math. The coronavirus is already in the U.S. but authorities have no way to track it due to its spread by asymptomatic carriers. People who don’t even know they have the virus are flying to intermediate airports outside China and then catching flights to the U.S.

None of the known characteristics of the virus support the confidence being projected by authorities. The tests are not reliable, few are being tested, carriers can’t be detected because they don’t have any symptoms, the virus is highly contagious, thousands of potential carriers continue to arrive in the U.S., etc. etc. etc.

The network of global travel remains intact. Removing a few nodes (Wuhan, etc.) does not reduce the entire network’s connectedness that enables the rapid and invisible spread of the virus.

Second, what authorities call over-reaction is simply prudent risk management. When an abstract pandemic becomes real, shelves are emptied and streets are deserted. It doesn’t take thousands of cases to trigger a dramatic reduction in the willingness to mix with crowds of strangers. A relative handful of cases is enough to be consequential.

Human psychology is exquisitely attuned to risk once it moves from abstraction to reality. Why take a chance unless absolutely necessary? For many people, the first handful of local cases will be enough to cancel all exposure to optional public gatherings: cafes, bistros, theaters, concerts, etc.

But many of the new jobs created in the U.S. economy over the past decade are in the food and beverage services sector, the sector that is immediately impacted when people decide to lower their risk by staying home rather than going out to crowded restaurants, theaters, bars, etc.

Many of these establishments are hanging on by a thread due to soaring rents, taxes, fees, healthcare and wages. Many of the employees are also hanging on by a thread, only making rent if they collect big tips.

All the official reassurances won’t be worth a bucket of warm spit. After being assured the risk of the virus spreading in North America was “low,” the arrival of the virus will destroy trust in official assurances. People will awaken to the need to control their own risk factors themselves. And as empty streets and shelves attest, people taking charge of risk has dire economic consequences.

Central banks can borrow money into existence but they can’t replace lost income. A significant percentage of America’s food and beverage establishments are financially precarious, and their exhausted owners are burned out by the stresses of keeping their business afloat as costs continue rising. The initial financial hit as people reduce their public exposure will be more than enough to cause many to close their doors forever.

As small businesses fold, local tax revenues crater, triggering fiscal crises in local government budgets dependent on ever-higher tax and fee revenues.

A significant percentage of America’s borrowers are financially precarious, one paycheck or unexpected expense away from defaulting on student loans, subprime auto loans, credit card payments, etc.

A significant percentage of America’s corporations are financially precarious, dependent on expanding debt and rising cash flow to service their expanding debt load. Any hit to their revenues will trigger defaults that will then unleash second-order effects in the global financial system.

The global economy is so dependent on speculative euphoria, leverage and debt that any external shock will tip it over the cliff. The U.S. economy is far more precarious than advertised as well.

The economic storm hasn’t passed; the false calm is only the eye of the financial hurricane.


Charles Hugh Smith
for The Daily Reckoning

The post The Economic Cataclysm appeared first on Daily Reckoning.

Why the Fed Won’t Save the Market

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A very convenient conviction is rising in the panicked financial markets that the Federal Reserve will “save the market” from a COVID-19 collapse. But they won’t.

“Buy-the-dip” punters are placing bets on the belief the Fed can’t possibly let the current bubble pop.

Oh yes they can and yes they will. Why?

It’s about control. Here’s what I mean…

Just as the Fed gets panicky if interest rates start getting away from its control, the Fed also gets nervous when its speculative bubbles get away from it, even though it causes them in the first place.

When speculators no longer fear a downturn because of their faith in eventual Fed “saves,” the Fed has lost control. And that’s not what the Fed wants.

The COVID-19 pandemic is actually a godsend to the Fed.

To reestablish control, the Fed must let the current euphoric faith in its “guarantee” to rescue markets crash to Earth.

The Fed’s foolish but not stupid. They understand speculative bubbles always pop, so the COVID-19 pandemic is just the excuse they needed to let the air out of the current grossly unsustainable bubble.

All bubbles pop. That leaves the Fed with an unsavory choice: Either be viewed as responsible for the bubble bursting or engineer some fall guy to take the blame and give the Fed cover for its incompetence.

It’s also instructive to note, as many have, that the Fed enters this global recession with very little policy ammo.

Interest rates are so near zero already that a couple of rate cuts will do very little good in the real economy.

Panicky punters expect the Fed to blow its wad on saving their hides, but what would that leave the Fed for the real recession that’s just getting underway? Nothing. If the Fed starts cutting now, it’ll have nothing left.

Would the Fed be so shortsighted and stupid as to blow their last ammo just to save speculatively insane punters from the inevitable bursting of a moral hazard-driven bubble?

In a word, no.

What about the possibility of negative interest rates?

Japan and Europe have effectively proven that negative interest rates do essentially nothing to boost spending in the real economy.

All negative interest rates accomplished was further boosting speculative bubbles and wealth inequality, which threatens to destabilize the social order — something the Fed cannot control.

The reality is the COVID-19 pandemic promises to be much more consequential than the run-of-the-mill financial excesses of the past 20 years, but we already know one important thing:

All bubbles pop.

We also know this: The greater the excesses, speculative euphoria and moral hazard, the greater the reversal.


Charles Hugh Smith
for The Daily Reckoning

The post Why the Fed Won’t Save the Market appeared first on Daily Reckoning.

Gold Is a Chameleon

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Is gold a commodity, an investment, or money?

The answer is…

Gold is a chameleon. It changes in response to the environment. At times, gold behaves like a commodity. The gold price tracks the ups and downs of commodity indices. At other times, gold is viewed as a safe haven investment. It competes with stocks and bonds for investor attention. And on occasion, gold assumes its role as the most stable long-term form of money the world has ever known.

A real chameleon changes color based on the background on which it rests. When sitting on a dark green leaf, the chameleon appears dark green to hide from predators. When the chameleon hops from the leaf to a tree trunk, it will change from green to brown to maintain its defenses.

Gold also changes its nature depending on the background.

Let’s first look at gold a commodity…

Gold does trade on commodity exchanges, and it tends to be included in commodity industries. The common understanding here is that gold is a commodity. But I don’t think that’s correct.

The reason is that because a commodity is a generic substance. It could be agricultural or a mineral or come from various sources, but it’s a substance that’s input into something else. Copper is a commodity, we use it for pipes. Lumber is a commodity, we use it for construction. Iron ore is a commodity, we use it for making steel.

Gold actually isn’t good for anything except money. People don’t dig up gold because they want to coat space helmets on astronauts or make ultra-thin wires. Gold is used for those purposes, but that’s a very small portion of its application.

So I don’t really think of gold as a commodity. But nevertheless we have to understand that it does sometimes trade like a commodity.

As far as being an investment, that’s probably gold’s most common usage.

People say, “I’m investing in gold,” or, “I’m putting part of my investment toward bullion gold.”

But I don’t really think of gold as an investment either. I understand that it’s priced in dollars, and its dollar value can go up. That will give you some return, but to me that’s more a function of the dollar than it is a function of gold.

In other words, if the dollar gets weaker, sure the dollar price of gold is going to go up. If the dollar gets stronger, then the dollar price of gold may go down.

So if you’re using the dollar as the measure of all things, then it looks like gold is going up or down. But I think of gold by weight. An ounce of gold is an ounce of gold. If I have an ounce of gold today, and I put it in a drawer, and I come back a year from now and take it out, I still have an ounce of gold. In other words it didn’t go up or down.

The dollar price may have changed, but to me that’s the function of the dollar, not a function of gold. So again, I don’t really think of it as an investment.

One of the criticisms of gold is that it has no yield. You hear it from Warren Buffet, you hear it from others, and that’s true. But gold is not supposed to have a yield because it’s money. Just reach into your wallet or your purse and pull out a dollar bill and hold it up in front of you, and ask yourself what’s the yield? There is no yield. The dollar bill doesn’t have any yield. It’s just a dollar bill, the way a gold coin is a gold coin.

If you want yield, you have to take some risks. You can put that dollar in the bank, and the bank might pay you a little bit of interest, but now it’s not money anymore. People think of their money in a bank deposit as money, but it really isn’t money. It’s an unsecured liability of an occasionally insolvent financial institution. The risk may be low, but there’s some risk, and that’s why you get a return.

Of course, you can take more risk in the stock market or the bonds market and get higher returns (or losses, as the stock market is currently proving). The point is, to get a return you have to take risk. Gold doesn’t have any risk. It’s just gold, and it doesn’t have any return. But again, it’s not supposed to.

Gold’s role as money is difficult for investors to grasp because gold hasn’t been used as money for decades. But gold in recent years has been behaving more like money than a commodity or investment. It is competing with central bank fiat money for asset allocations by global investors.

That’s a big deal because it shows that citizens around the world are starting to lose confidence in other forms of money such as dollars, yuan, yen, euros and sterling.

When you understand that gold is money, and competes with other forms of money in a jumble of cross-rates with no anchor, you’ll know why the monetary system is going wobbly.

It’s important to take off your dollar blinders to see that the dollar is just one form of money. And not necessarily the best for all investors in all circumstances. Gold is a strong competitor in the horse race among various forms of money.

Despite the recent price action, which is far more a function of the stock market rather than gold itself, this is great news for those with price exposure to gold. The price of gold in many currencies has been going up as confidence in those other currencies goes down. Confidence in currencies is dropping because investors are losing confidence in the central banks that print them.

For the first time since 2008, it looks like central banks are losing control of the global financial system. Gold does not have a central bank. Gold always inspires confidence because it is scarce, tested by time and has no cre‌dit risk.

Lost confidence in fiat money starts slowly then builds rapidly to a crescendo. The end result is panic buying of gold and a price super-spike.

We saw this behavior in the late 1970s. Gold moved from $35 per ounce in August 1971 to $800 per ounce in January 1980.

That’s a 2,200% gain in less than nine years.

We’re in the early stages of a similar super-spike that could take gold to $10,000 per ounce or higher. When that happens there will be one important difference between the new super-spike and what happened in 1980.

Back then, you could buy gold at $100, $200, or $500 per ounce and enjoy the ride. In the new super-spike, you may not be able to get any gold at all. You’ll be watching the price go up on TV, but unable to buy any for yourself.

Gold will be in such short supply that only the central banks, giant hedge funds and billionaires will be able to get their hands on any. The mint and your local dealer will be sold out. That physical scarcity will make the price super-spike even more extreme than in 1980.

The time to buy gold is now, before the price spikes and before supplies dry up. The current price decline gives you an ideal opportunity to buy gold at a bargain basement price. It won’t last long.


Jim Rickards
for The Daily Reckoning

The post Gold Is a Chameleon appeared first on Daily Reckoning.

From a Correction to a Crash?

This post From a Correction to a Crash? appeared first on Daily Reckoning.

Yesterday the Dow Jones was savaged with its single greatest point loss ever (yet not its largest percentage loss, in fairness).

Today it shed another 357 points, despite a late afternoon counterattack.

It has now heaved up 3,500 points on the week. It is the index’s ghastliest week since the nightmare depths of the financial crisis.

The S&P only lost 24 points today. The Nasdaq — by God’s grace — even scratched out a 0.89-point gain!

The “correction” presses on nonetheless… running a red pencil across the market’s errors of the past several months.

Now this question:

What if it keeps on drawing… and proceeds to correct all the errors of the past several years?

That is, what if it corrects into an authentic crash?

And which asset will let you know if it does?

Gold, bonds, cryptocurrencies, soybeans… pork bellies?

None of the above is the answer. Then what is?

Answer anon.

But first, the chairman of the Federal Reserve has emerged at last…

There he was this afternoon, girding for action, Napoleon readying to mount his steed:

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.

But what is appropriate?

Mr. Powell does not say. But it doubtlessly includes rate cuts. More false fireworks, that is.

Markets presently give excellent odds — 91.6% odds — of a March rate cut.

They further project as many as three rate cuts by year’s end.

And so the Federal Reserve will likely squander much of its remaining “dry powder.”

Little remains as is. Come the inevitable recession none will remain.

But to return to today’s central questions:

Are markets careening from correction… to crash? And how will you know?

A Seeking Alpha scarehead seized our attention this morning, bearing this title:

“We May Be in a Crash, and Here’s Why.”

Beneath it appeared an article. A fellow named Michael Gayed, an analyst, was its author. From whom:

I think the speed and viciousness of the decline lends itself to the possibility that this more than a “correction” of 10% or more in the S&P 500. We may very well be in a crash.

To me, this increasingly looks like we are in a crash. First, we need to define what a crash is though… A crash to me isn’t about percentage (20% as often cited in the media).

A crash isn’t about percentage? What is a crash about then?

Instead, it’s about time…

I don’t define a stock market crash by a set percentage. To me, it’s more about how far back in time you go. The 1987 crash took stocks back to levels not seen in the prior 10 months. Similar in the Summer Crash of 2011. So a crash [today] almost wipes out 2019’s gains…

If… this is more about time than percentage, then this is NOT a crash yet. Stocks have retraced us back to levels last seen in November in just one week.

But it’s possible the decline takes us back to prior crash period time reversals — back 9-10 months. That would take the Dow down by another 2,000 points from here.

Bottom line here? Yes it looks like a correction, but a correction becomes a crash if it happens too quickly. The major concern here is that the other indicators I track… are only just now turning negative. That makes me nervous that this may get uglier.

Which asset will alert you to the transition, in Mr. Gayed’s telling?

Again, it is not bonds. It is not gold. It is not cryptocurrencies. Or soybeans. Or pork bellies.

Then what?

The answer is… lumber. Yes, lumber:

What would truly confirm that this may be a crash is a sudden breakdown in lumber… lumber weakness has historically preceded big declines in the stock market, such as the 1987 Crash, Long-term Capital Management, the tech wreck, Lehman, and the summer crash of 2011.

Why lumber?

Lumber is highly sensitive to housing in the United States, and is, therefore, a reliable indicator of economic performance…

But it is not lumber in isolation. Lumber’s ratio to gold is the telltale:

Gold is a traditional, safe-haven asset, used by investors in times of uncertainty. Thus, when the gold/lumber ratio is high, it is a leading indicator that the economy is slowing down, or even contracting, and the market is becoming more risk-off…


When looking at lumber relative to gold, the ratio is only just now looking like it may turn south.

We will therefore maintain close vigil over this lumber-to-gold ratio.

Should it “turn south”… perhaps it will drag the market down to the toastier climates.

Maybe — even — all the way to a very, very hot place.


Brian Maher
Managing editor, The Daily Reckoning

The post From a Correction to a Crash? appeared first on Daily Reckoning.


This post Help!!! appeared first on Daily Reckoning.

The stairs up… and the elevator down.

Through Presidents Day, the stock market was trading at record heights — and pacing for a 20% year.

Not two weeks later… that same market is enduring its worst yearly start since 2009.

As we razzed on Monday:

The stock market is an ingenious device constructed to inflict the greatest suffering upon the most people within the least amount of time.

And it is performing exquisitely to specification.

We would normally report the whys and wherefores. But you are fully aware of the reasons. And we are precious tired of discussing the coronavirus.


The Dow Jones plunged another 1,191 points today. Never in its history has it hemorrhaged so many points in a single day.

On the way down it crossed into “correction” for the first instance since December 2018.

A correction — commonly defined — is a 10% decline from the market’s most recent heights.

And there you have it. From record highs to correction… in a mere six days.

The fine people of NatAlliance Securities inform us of the following:

Only once in history has the market plunged from record heights to correction in six days: 1928.

“In other words,” Zero Hedge reminds us, “the only other time the Dow Jones entered a correction this fast from an all-time high was months before the start of the Great Depression.”

Meantime, the S&P plummeted another 138 points today. The Nasdaq, 414.

Both indexes have likewise entered correction.


How Come Stocks Only “Correct” Lower?

Stocks are never said to “correct” higher. Only lower.

That is, corrections run in one direction only — down.

But why?

Is not an undervalued market by definition… incorrect?

Then should not an accurate reappraisal — a rising market — represent a correction?

But in the popular imagination it does not. Corrections only correct downward.

Here is our theory…

Getting Away With Something

The term is a subconscious recognition of the market’s tendency to overexcitement, of its constant efforts to slip its leash…

Of the animal spirits’ chronic ambition to go amok.

When the market rampages, a fellow is dizzied by the thrill of it. And so he lets go. He lets his throttle out.

But he is besieged by an inner suspicion. A suspicion, that is, that he is getting away with something…

It is as if his employer has mistakenly added a zero to his paycheck. Or that he has come into possession of stolen property. Or that the mailman has left the neighbor’s package at his door.

He knows he must hand it back.

And so comes the correction — the inevitable correction. He knows he must hand it back.

He is presently handing it back royally… incidentally

Thus conclude our reflections on the word “correction.”

But no more windy philosophizing today, no more aimless woolgathering.

Let us instead return to the drama unfolding before us…

The “Yield Curve” Is Inverted Again

Investors went hoofing for the safety of United States Treasuries again today.

The inrush crushed 10-year Treasury yields to another record low this morning — 1.27%.

Recall, bond yields fall as bond prices rise.

And plunging bond yields are omens of economic distress, of a lean season ahead.

Meantime, a telltale segment of the “yield curve” is once again inverted…

Three-month Treasury yields actually nosed higher today to 1.51%.

But the aforesaid 10-year yield (1.27%) has slipped beneath it.

In a healthful economy it would not.

An Omen of Lean Times

As we have argued before…

Inverted yield curves precede recessions nearly as reliably as days precede nights, as horses precede carts… as lies precede elections.

The 10-year Treasury yield has dropped beneath the 3-month Treasury yield on six occasions spanning 50 years.

Recession was the invariable consequence — six times of the six — a 1,000% batter’s average.

The 3-month/10-year yield curve is the Federal Reserve’s preferred recession indicator.

And it is the Federal Reserve that sets interest rate policy.

Will Mr. Powell and his mates swing into action next month?

Odds of a Rate Cut Rise Dramatically

The market presently places 76.4% odds on a March rate cut (of 25 basis points).

76.4% is plenty handsome when you consider these facts:

Two days ago, that same market gave only 33.2% odds. And one week ago? Merely 8.9%.

Meantime, we understand some option traders are wagering high on an even deeper cut — perhaps 50 basis points.

The former president of the Minneapolis Federal Reserve even argues Mr. Powell should not wait for the March meeting. The present dangers are too great.

We are convinced rate cuts are pending. We hazard 25 basis points — but we allow for 50.

But will rate cuts meet their advertising?

The coronavirus has pushed Goldman Sachs to slash its first-quarter GDP forecast… to a guttering 1.2%.

An “Economic Cataclysm”

But our own Charles Hugh Smith fears far worse. Charles is up on his rooftop today, shouting about a looming “economic cataclysm.”

And the Federal Reserve cannot steer it off course:

Many of the new jobs created in the U.S. economy over the past decade are in the food and beverage services sector, the sector that is immediately impacted when people decide to lower their risk by staying home rather than going out to crowded restaurants, theaters, bars, etc.

Many of these establishments are hanging on by a thread due to soaring rents, taxes, fees, health care and wages. Many of the employees are also hanging on by a thread, only making rent if they collect big tips.

Cannot the Federal Reserve make them whole? No, says Charles:

Central banks can borrow money into existence but they can’t replace lost income. A significant percentage of America’s food and beverage establishments are financially precarious, and their exhausted owners are burned out by the stresses of keeping their business afloat as costs continue rising. The initial financial hit as people reduce their public exposure will be more than enough to cause many to close their doors forever.

As small businesses fold, local tax revenues crater, triggering fiscal crises in local government budgets dependent on ever-higher tax and fee revenues.

A significant percentage of America’s borrowers are financially precarious, one paycheck or unexpected expense away from defaulting on student loans, subprime auto loans, credit card payments, etc.

What about the corporations?

A significant percentage of America’s corporations are financially precarious, dependent on expanding debt and rising cash flow to service their expanding debt load. Any hit to their revenues will trigger defaults that will then unleash second-order effects in the global financial system.

The global economy is so dependent on speculative euphoria, leverage and debt that any external shock will tip it over the cliff. The U.S. economy is far more precarious than advertised as well.

Concludes Charles:

The economic storm hasn’t passed; the false calm is only the eye of the financial hurricane.

More tomorrow…


Brian Maher
Managing editor, The Daily Reckoning

The post Help!!! appeared first on Daily Reckoning.

The Real China Story

This post The Real China Story appeared first on Daily Reckoning.

With China grabbing all the negative headlines lately, I thought it would be a good idea to step back and look at the big picture, highlighting the great triumphs of this country.

Some of my readers worry that I am “soft” on China, too optimistic about the prospects for freedom there and unwary of the Chinese threat to the U.S.

As one reader recently wrote, “At the end of the day China is still a communist country” that “does not recognize the right to private property” and therefore can steal our intellectual property without any twinge of conscience.

I love this comment because it gets us right to the heart of things: Is China still a communist country?

Not: Does China have lots of politicians who ritually declare themselves communists? (It does.)

Or even a few who deep in their hearts still yearn for the good old days of Mao? (They exist.)

But is China a communist country, a nation of 1.4 billion people living under anything we would recognize as communism?

My answer is: “By their fruits, you shall know them.”

Let me explain…

Not Your Average “Communist” Country

What China has achieved over the past three decades could not have been accomplished by a communist nation.

My reader makes clear in the rest of his letter that he grasps the economic power and moral imperatives of capitalism. He knows that genuinely communist regimes have always and everywhere impoverished their people, that command and control economies fail miserably and murderously, destroying more wealth than they create.

Every long-standing communist regime has survived only by tolerating some free market activity, even if only the black markets that sprout up everywhere when real free markets are suppressed.

Yet here we have China, for several decades now the fastest-growing economy in the world and now the second-largest economy, and certainly the most innovative of any large economy. (Tiny Israel dominates the welterweights.)

Wealth That Cannot Be Stolen

Chinese insurance companies are bringing diagnostic tools powered by artificial intelligence (AI) to tiny Chinese medical clinics around the country, setting up same-day appointments with medical specialists in a country in which previously many people went a lifetime without ever meeting a real doctor.

Furthermore, the Chinese internet and social media companies combine every offering of Facebook, Google, Amazon, Spotify and more and do all of them better.

Are these conceivably the fruits of communism?

American politicians love to accuse China of stealing our technology. They attribute Chinese economic growth not to the growth of freedom but the rewards of larceny.

But as upholders of capitalist morality, they should know that in the hands of a thief, all gold turns to lead and all diamonds revert to the coal from which they came.

Technological leadership is not a static thing to be stolen and hoarded. Innovation can never be completed — or the innovators allowed to rest on their laurels — for the same reason innovation can never be planned: It always comes as a surprise.

The Chinese have surely benefited from the explosion of learning in the capitalist world sparked by the invention of the transistor at Bell Labs in 1947.

Yet all the crucial advances flowing from that moment have been thoroughly documented in prestigious journals and textbooks, debated in industry conferences open to the world and pitched by sales forces whose job is not to conceal technological advances but to reveal their wonders.

That interchange of ideas — and the furious competition it powered — was not a threat to American prosperity but rather its very source.

Now come the Chinese, suddenly more free than anyone of my generation ever expected. And because they are more free, because capitalism (and Christianity) are on the rise in China and communism in any genuine sense in general retreat, the Chinese have become powerful competitors — and great innovators.

And as innovators, the Chinese are a blessing to America, challenging American companies to adopt Chinese innovations and surpass them.

This sudden, astounding change in the plot of the story — China free and rich, rather than poor, enslaved and angry — is a blessing almost beyond imagining. China enriched will enrich America and the world.

Should we regret how much China has changed in three decades or pray that the change continues?

To me, the answer is clear.

But one dynamic to worry about with U.S.-China relations is the so-called “Thucydides trap.”

Beware the “Thucydides Trap”

That’s when an established power fears that a rival is gaining in power and will soon overtake it. War is often the result.

Among the earliest of historians, Thucydides wrote 2,500 years ago about the Peloponnesian War between Athens and Sparta and the events that finally doomed both of these powers.

Harvard’s Graham Allison sums up the concept: “It was the rise of Athens and the fear that this instilled in Sparta that made war inevitable.”

He considers 16 instances over the last 500 years in which a hegemonic power such as the U.S. was confronted by a rising power such as China. War resulted 75% of the time.

In the case of Britain and the U.S. after World War II, no conflict erupted. Therefore, Allison has some hope that war avoidance is possible in this predicament. But he sees China and the U.S. on a collision course.

Chinese Influence Is Inevitable

In reality, Chinese influence in the South China Sea is as inevitable as U.S. influence in the Gulf of Mexico. To flaunt American naval power in the region is needlessly provocative and gratuitous.

Last year in the academic journal Humanitas, Villanova political science professor Lowell Gustafson explained the real “trap” depicted by Thucydides in his account of the Peloponnesian wars:

It may be that great powers do indeed desire to rule, but they learn to restrain themselves by accurate calculation of their own power and that of others. They do not engage in wishful thinking and grandiosity. Pluralism, not domination, is the proper end of power politics since power is always distributed to some degree. The trap that Thucydides worries about is not a rear-end collision, but that a great power deludes itself into seeking domination of all others.

Both China and the U.S. should take note.

Gustafson continues: “Graham Allison and American policymakers need to be as self-reflective about America as they are about the rise of China…

“If there is to be real American greatness, it needs to be drawn from the vision of an international system of free independent nations who peacefully trade with each other, learn from each other’s cultures and show restraint.”

My rule is that real threats to the U.S. come from failed states with nothing to lose, not from an ascendant country such as China with huge trading interests around the globe.

If we didn’t constantly harass the Chinese over their Uighur Islamist problem (over 1,000 incidents, 500 dead), they might well be our allies against real terrorist threats.

The best strategy for Americans is to support capitalist companies in China, not needless adventurism in the South China Sea.

I’m in China right now looking for investment opportunities — and innovations American companies can learn from.


George Gilder
for The Daily Reckoning

The post The Real China Story appeared first on Daily Reckoning.

How Gold Is Manipulated

This post How Gold Is Manipulated appeared first on Daily Reckoning.

Is there gold price manipulation going on? Absolutely. There’s no question about it. That’s not just an opinion.

There is hard statistical evidence to make the case, in addition to anecdotal evidence and forensic evidence. The evidence is very clear, in fact.

I’ve spoken to members of Congress. I’ve spoken to people in the intelligence community, in the defense community, very senior people at the IMF. I don’t believe in making strong claims without strong evidence, and the evidence is all there.

I spoke to a PhD statistician who works for one of the biggest hedge funds in the world. I can’t mention the fund’s name but it’s a household name. You’ve probably heard of it. He looked at COMEX (the primary market for gold) opening prices and COMEX closing prices for a 10-year period.

He was dumbfounded.

He said it was is the most blatant case of manipulation he’d ever seen. He said if you went into the aftermarket, bought after the close and sold before the opening every day, you would make risk-free profits.

He said statistically that’s impossible unless there’s manipulation occurring.

I also spoke to Professor Rosa Abrantes-Metz at the New York University Stern School of Business. She is the leading expert on globe price manipulation. She has actually testified in gold manipulation cases.

She wrote a report reaching the same conclusions. It’s not just an opinion, it’s not just a deep, dark conspiracy theory. Here’s a PhD statistician and a prominent market expert lawyer, expert witness in litigation qualified by the courts, who independently reached the same conclusion.

How do these manipulations occur?

Currently the price of gold is set in two places. One is the London spot market, controlled by six big banks including Goldman Sachs and JPMorgan. The other is the New York gold futures market controlled by COMEX, which is governed by its big clearing members, also including major western banks.

In effect, the big western banks have a monopoly on gold prices even if they do not have a monopoly on physical gold.

The easiest way to perform paper manipulation is through COMEX futures. Rigging futures markets is child’s play. You just wait until a little bit before the close and put in a massive sell order. By doing this you scare the other side of the market into lowering their bid price; they back away.

That lower price then gets trumpeted around the world as the “price” of gold, discouraging investors and hurting sentiment. The price decline spooks hedge funds into dumping more gold as they hit “stop-loss” limits on their positions.

A self-fulfilling momentum is established where selling begets more selling and the price spirals down for no particular reason except that someone wanted it that way. Eventually a bottom is established and buyers step in, but by then the damage is done.

Futures have a huge amount of leverage that can easily reach 20 to 1. For $10 million of cash margin, I can sell $200 million of paper gold.

Hedge funds are now large players in the gold market. To a hedge fund, gold may be an interesting market in which to deploy its trading style. To them, gold is just another tradable commodity. It could just as well be coffee beans, soybeans, Treasury bonds, or any other traded good.

Hedge funds use what are called “stop-loss” limits. When they establish a trading position, they set a maximum amount they are willing to lose before they get out. Once that limit is reached, they automatically sell the position regardless of their long-term view of the metal.

Perhaps they don’t even have a long-term view, just a short-term trading perspective. If a particular hedge fund wants to manipulate the gold market from the short side, all it has to do is throw in a large sell order, push gold down a certain amount, and once it hits that amount, these stops are triggered at the funds that are long gold.

Once one hedge fund hits a stop-loss price, that hedge fund automatically sells. That drives the price down more. The next hedge fund hits its stop-loss. Then it sells too, driving the price down again. Selling gathers momentum, and soon everyone is selling.

Another way to manipulate the price is through gold leasing and “unallocated forwards.”

“Unallocated” is one of those buzzwords in the gold market. When most large gold buyers want to buy physical gold, they’ll call JPMorgan Chase, HSBC, Citibank, or one of the large gold dealers.

They’ll put in an order for, say, $5 million worth of gold. The bank will say fine, send us your money for the gold and we’ll offer you a written contract in a standard form. Yet if you read the contract, it says you own gold on an “unallocated” basis. That means you don’t have designated bars.

There’s no group of gold bars that have your name on them or specific gold bar serial numbers that are registered to you.

In practice, unallocated gold allows the bank to sell the same physical gold ten times over to ten different buyers.

It’s no different from any other kind of fractional reserve banking. Banks never have as much cash on hand as they do deposits. Every depositor in a bank thinks he can walk in and get cash whenever he wants, but every banker knows the bank doesn’t have that much cash. The bank puts the money out on loan or buys securities; banks are highly leveraged institutions.

If everyone showed up for the cash at once, there’s no way the bank could pay it. That’s why the lender of last resort, the Federal Reserve, can just print the money if  need be. It’s no different in the physical gold market, except there is no gold lender of last resort.

Banks sell more gold than they have. If every holder of unallocated gold showed up all at once and said, “Please give me my gold,” there wouldn’t be nearly enough to go around. Yet people don’t want the physical gold for the most part.

There are risks involved, storage costs, transportation costs, and insurance costs. They’re happy to leave it in the bank. What they may not realize is that the bank doesn’t actually have it either.

Gold holders should expect these games to continue until a fundamental development drives the price to a permanently higher plateau.

How does the individual investor stand up against such forces?

In the short run, you can’t beat them, but in the long run, you always will, because these manipulations have a finite life.

Eventually the manipulators run out of physical gold, or a change in inflation expectations leads to price surges even governments cannot control. There is an endgame.

History shows manipulations can last for a long time yet always fail in the end. They failed in the 1960s London Gold Pool, with the United States dumping in the late 1970s, and the central bank dumping in the 1990s and early 2000s. The gold price went relentlessly higher from $35 per ounce in 1968 when the London Gold Pool failed to $1,900 per ounce in 2011, the all-time high.

Price manipulation always fails. And the dollar price of gold will resume its march higher. The other weakness in the manipulation schemes appears in the use of paper gold through leasing, hedge funds, and unallocated gold forwards.

These techniques are powerful. Still, any manipulation requires some physical gold. It may not be a lot, perhaps less than 1% of all the paper transactions, yet some physical gold is needed. The physical gold is also rapidly disappearing as more countries are buying it up. That puts a limit on the amount of paper gold transactions that can be implemented.

My advice to investors is that it’s important to understand the dynamics behind gold pricing. Understanding these dynamics lets you see the endgame more clearly and supports the rationale for owning gold even when short-term price movements are adverse.

Gold will win in the end.


Jim Rickards
for The Daily Reckoning

The post How Gold Is Manipulated appeared first on Daily Reckoning.