Linkage roundup

Some reading material for you from my twitter stream:


RT @zerohedge: "It was grim. The worst mood I have ever seen, a complete mess," said one eurozone finance minister. http://t.co/NnHreVRK


RT @TBPInvictus: My fave homemade chart on labor market slack and why inflation's a long way off: http://t.co/BKBGjFeO #FRED


RT @FactSet: What do yield curves tell us about the outlook for the world #economy? We take a look: http://t.co/r4ucgUfl -- Inverted Yield Curves are bad....


RT @simonsinek: Blow Up Your Business Before Someone Else Does http://t.co/rqdZ8GEW 


TED spread going the wrong way -- http://t.co/6vmUhc60


RT @EpicureanDeal: This Switchblade drone is scary as hell: http://t.co/buFmf6BF Long-distance, remote-controlled , tightly targeted antipersonnel munitions.


Good commentary by GaveKal on the current european situation. http://t.co/9zYX6Wgj


RT @BreakingNews: Biographer says Steve Jobs refused early and potentially life-saving surgery on his pancreatic cancer - @CBSNews http://t.co/YFX7AJOo


RT @NicTrades: FT: French banks curbing credit lines for commodities trading http://t.co/62sZhIkB -- What do you think will happen to all the base metals when Greece goes POP!  ??


#copper getting crushed today. Will it completely break down or bounce off the bottom again? http://t.co/2h0LKT31 -- looks like it bounced.


Italian bond yields going wrong direction. http://t.co/6TP2ixgp


RT @lessig: Ben Smith is brilliant: An Occupy Wall Street/Tea Party Venn diagram http://t.co/AWNNhlBg #rootstrikers #tpp

Ray Dalio on the challenges in front of us

Ray Dalio of Bridgewater Associates has recently appeared on the Charlie Rose show as well as written a piece for the Financial Times. I think he does a good job of describing how we got here (continually borrowing money to improve our standard of living) and the tenuous situation we find ourselves in (Greece, falling home prices, etc.)

From FT.com

We are in the midst of a deleveraging, we are nearly out of ammunition and we are at each other’s throats. Being in a deleveraging and nearly out of ammunition is a very difficult position to be in. But, being at each other’s throats is our biggest problem.
Our character and our political and social systems are now being tested in ways that have typically been tested in past deleveragings. In deleveragings bad economic conditions typically lead to emotional reactions, social and political fragmentation, poor decision-making and increased conflict. When this occurs in democracies, the checks and balance system, which is intended to yield the best decisions for the whole, can stand in the way of thoughtful leadership and lead to ineffective “mob” rule. This dynamic can lead to a self-reinforcing downward spiral.

The video goes into a little more detail of his philosophy of knowing what you don't know and being willing to have your ideas and conclusions challenged throughout the corporate structure.  I suggest you read both the article and watch the interview.

Thanks to The Intrigued Trader and Also Sprach Analyst

Linkage roundup

Some reading material for you from my twitter stream:

RT @pdacosta: World's first malaria vaccine works in major trial http://t.co/XLq02ns1

Custody of your assets is ALWAYS important, no matter what... http://t.co/ynICJv56

RT @planetmoney: New podcast: The price of default. Argentina's default in 2001 offers a cautionary tale for Greece. | http://t.co/levA26eW

RT @niubi: China reveals size of copper inventory - http://t.co/qUyGrZgW http://t.co/LdEoxqtr huge news $$


RT @NicTrades: Japan 'offers 10,000 free trips to foreigners' in an attempt to boost tourism - Telegraph http://t.co/9nJb9dxo


Paging radioactive swan, paging radioactive swan... http://t.co/jRDpJ4Ug


From @ProfSteveKeen We are still screwed and the Doctors have no clue what's wrong http://t.co/G55dEaCJ HT @stacyherbert


Worried about radiation? There's an app for that. http://t.co/3zSl9mut


Prehistoric kids left marks in caves. http://t.co/0uyyp620

You don't buy the last bounce, especially when Mars Attacks

I don't usually comment on the price of the equity markets but considering what I'm seeing I thought I'd bend one of my self imposed guidelines. Remember you are hearing this from someone who does not see any positive forces influencing the market right now.

The markets have been pretty much stuck in a rut since early August and seems to be driven by the constant stream of contradictory rumors coming out of Europe. Will they save Greece? (no, they can't) Will the European banks be nationalized?  (no idea, but I'm not hanging out to find out)  Meanwhile China's negative real rate maneuver and excessive credit creation is coming back to haunt them.  And America is slowing down.

Stuck in a rut for the last two months.

Here are some of the indicators I look at to assess financial market risk and as you can see all of them are going the wrong way.

Ted Spread

Notice how the TED (Treasury - Eurodollar spread, an indicator of banking stress) peaked and started healing before the market bottomed in early July 2010; showing a positive divergence.

Emerging market bond spreads, dollar denominated

The spread for emerging market bonds also shot up before the correction in 2010 and also showed a similar positive divergence. Right now spreads continue to widen.

My own proprietary indicators are not showing any sort of improvement either, again the opposite of 2010.

Note how in 2010 risk stopped going up.

Compare to 2011 where the RiskMeter keeps going up. 

Do I think the market is going to crash? I can't answer that question.  If the European situation looks like it can be truly resolved we could get a serious rally. I'm waiting to see what my fundamental indicators of market health tell me before I get back into the stock market.

Right now they are saying wait.

Remember, no matter what happens there's someone out there who'll be trying to convince you to buy stocks right now.

Video scene from Mars Attacks

Additional Reading:

http://www.businesscycle.com/news_events/event_details/1476/4 - He's been calling for a slowdown for a while and he just upgraded to calling for a recession this week.

Humble Student of the Market - Germany engaging in expensive can kicking. We may get a bounce but it does not fix the fact Greece has too much debt. Who owns it is immaterial.

Linkage roundup

Some links I found interesting today:

Gillem Tulloch video on Chinese money supply, lending, and housing problems.  As I mentioned previously negative real rates in a growing economy create massive distortions:
http://video.ft.com/v/1186054970001/Bubble-in-Chinese-property

ECRI calls for another recession in the US:
http://www.bloomberg.com/news/2011-09-30/u-s-is-heading-toward-another-recession-ecri-s-achuthan-says-tom-keene.html

Can the long bond go further?

The recent drop in long term yields is impressive and historic.  While the 30 year treasury yield has backed up a bit it is still very low, currently in the range seen during the depth of the financial crisis of 2008.

I'm not trying to convince you of whether it can go lower in this post even though I currently own long term treasuries. I'm considering selling of some of my position and this blog post is part of me thinking aloud about the situation.

What is interesting about this current phase of declining interest rates is how the 10 year has broken new lows while the 30 year, while low, is not in record territory yet.  (Note the 30 year was not issued for part of the 2000's. You'll see gaps in the data during that period)

30 and 10 year yields

Looking at the difference between 30 and 10 year yields provides a very different picture.

30 year less 10 year yield

While the spread has declined recently we are still in rare territory when the difference between the 30 and 10 is greater than 1%.  What this all means I honestly don't know yet but I thought I'd share with you yet another example of  how our unique our current situation is.

The author owns long term treasuries and is considering paring back his position.

Kicking Copper while its down

A little more than six months ago I laid out a bearish case for the red metal, also known as Dr. Copper by those in the markets for its ability to predict future economic change.  With the recent thrashing copper and many other risk assets have taken I thought revisiting the topic would be a good idea.

While China is a large factor in all base metals prices let's start with the Old World and the seemingly mundane issue of actually counting how much copper inventory is on hand.  While this would appear to be as simple as looking up the LME (London Metal Exchange) and COMEX (US futures) inventory numbers it really isn't.  The BBC ran a three part series on rising commodity prices in late May and spent nearly a third of the program on copper.

BBC Radio - Bubble Trouble - Part 1 - May 28,2011
BBC Radio - Bubble Trouble - Part 2 and 3
Ft.com blog highlighting the inventory issue
In part 2 around the seven minute mark the presenter takes a tour of a well known base metals warehouse in which the warehouse representative reveals only about 40% of the copper in the warehouse is registered as LME inventory.  When I heard the words I had to replay it several times to ensure I understood that correctly; my brain almost rebelled at the concept of anyone just coming out and publicly stating such a figure.  Now I'm not suggesting the LME reported amount is under counting European stocks by 40%, just that this one warehouse has a lot more copper inside its walls that is reported to LME.  Please listen to at least part 2 of the radio series to get the full details.  If it can happen in one warehouse in Rotterdam what is preventing it from happening elsewhere in the world?

So why is the copper 'hiding'? Some of it is because costs are cheaper to store it in a non registered warehouse versus an official LME warehouse. Another factor may be what is suspected to be going on in China. FT Alphaville has discussed import/export trading firms there are using copper as a credit funding vehicle because other more official forms of credit are drying up.

From ft.com blog

Here’s the gist of it.In the first instance, our source says, the strategy is not exclusive to copper markets but goes on across most commodity markets.
The banks call it “inventory financing”. And of course, we should stress, it is completely legal. The practice mainly involves pledging an asset in return for an exchange warrant or cash.
According to our source, traders can deposit copper in an exchange warehouse in order to receive a warrant which can then be used to gain financing, usually via a broker, and less a 15 or 20 per cent haircut needed to cover futures margin deposits (sometimes called margin or warrant financing).

Read the whole article to get the full weight of what they are doing. This copper-as-financing would help explain why copper continues to be imported even though for most of 2011 it has been cheaper on the domestic Shanghai exchange. For the credit focused copper trader the money created by the transaction has greater value than the actual copper, it is just a funding mechanism.

LME vs Shanghai premium/discount

While the discount has been steadily falling one must understand China is a net importer of Copper; so why has it been cheaper to buy copper inside China?

Izabella Kaminska followed up a few weeks later with more details on the same copper-as-collateral trade

More worryingly however is that the primary use of copper in bonded warehouse appears to be as a financing mechanism to provide cheap working capital for various types of business often unrelated to the metallic industry.

Another copper financing entry at ft.com

Simon Hunt, of Simon Hunt strategic services actually goes to China and tries to see what is happening on the ground and his opinion is not bullish.  An audio interview from March 29 is very interesting.

Having just come back from China my impression is that more and more people are beginning to understand that a lot of copper that has been imported has not gone into furnaces, that it is held by both foreign and Chinese financial institutions and others and I do think that even at the top level in government there is now starting to be a concern of the impact of this speculation on China's economy.  Because it is not just copper - it goes much deeper than that.  With money which has been so freely available in recent years, and with negative deposit rates, any company or individual is very reluctant to hold funds on deposit.  So they are looking for other means of investment and it goes into commodity markets generally - the stock market, it goes into manufacturing investment and so on so forth.  Whether government does anything to stop this game going on I've no idea, but there is at least a realisation at a pretty senior level that these developments are ongoing. 

Mr. Hunt also brings up the insidious problem of negative real interest rates in a growing economy.  Empty cities such as Ordos are an example of what happens when people respond to the obvious distortion of losing money when you put it in a bank account.

Even the Chileans are publicly talking about the excess inventory in China

The world No.1 copper producer, Chile's state-ownedCodelco, sounded a warning shot at the CESCO copper industrygathering in Santiago on Monday, saying copper stocks in China were abnormally high and needed to be watched carefully.

Figures are tossed about regarding how much inventory has been tied up in these financing deals but one never really knows how much until the real washout hits and people are forced to dump their positions.

That being said, some analysts are putting out huge numbers as to the extent of hidden inventory, again from ft.com blog

The ICSG data shows an increase in Chinese demand of 99% for the four years between 2005 and 2009 when Chinese GDP probably rose by about a third. Obviously, there cannot possibly have been such a massive rise in copper’s intensity of use in China. You can look through all the intensity of use curves for every commodity for every economy in history and you will never find a doubling in consumption against a one third increase in GDP over so short a period of time.  

The numbers are large, around 4 million tonnes since the end of 2006. This dates from when global fabricators and others started to understand that a new paradigm in the copper market had begun. It was the involvement of the financial community by buying copper directly from producers and others and warehousing the metal outside the reporting system.

Standard Chartered puts the amount of hidden inventory lower, but still extensive, April 28

 High inventories in bonded warehouses point to the possibility of destocking, which could hit copper prices on the London Metal Exchange (LME). As of this week, we estimate that total copper stocks in bonded warehouses in Shanghai (usually 80% of the national total) have hit 650 thousand tonnes (kt) – equivalent to roughly four weeks of China's domestic use, a record-high level (Chart 2). This is significantly higher than 550kt in late February and the 200kt average over the past three years.

Who's the sucker? If you don't know, its probably you.

ETFs have been a useful tool to allow banks to move risk off balance sheet. When a bank takes on risk through lending to or financing a big commodity player, say for an acquisition, there is a need to hedge potentially huge commodity exposure — so as sell to lock in the commodity price, and you couldn’t sell that volume easily into the terminal market; although you could transfer a large amount of exposure to investors through an ETF more easily. The only way this used to be done is by the bank taking proprietary risk, but they now have other risk issues and aren’t prepared to carry that sort of exposure.
Using ETFs becomes a mutuality of interest, with everyone moving to launch products to investors – retail and institutional – so that they can carry the risk instead. It’s all about de-risking your book. And you saw it in the dot com bust when investment banks pushed dotcoms, but offloaded the risk to investors. When the NASDAQ crashed the investors carried the bulk of the exposure.It all has similarities to the Abacus CDO. If you want to short the market you have to create the demand, like Paulson did. If you are an institutional advisor you can do that by hyping the commodity.

The actual import numbers going into China for both refined and scrap do not mesh well with the meme of voracious demand. On a year over year basis both are falling.

Furthermore the reported inventory numbers have been wandering around the 600k number for a while. Ironically the last time year over year inventory numbers dipped into negative territory for a while was 2008.

I'm not the only one who is not a copper bull.  The Reformed Broker sums it nicely while debating a copper bull:

I will admit some of my thesis is based upon information that is not reported as cut and dried numbers that can easily be looked up on a computer screen but what I do find does not add up to the template of China hoovering up all known copper deposits in the universe:

• Copper is cheaper in Shanghai than in London
• Copper imports of all kinds are dropping
• Public reports of a LOT of hidden copper stocks, in the Old Word as well as China and confirmed by Chileans

I could go on but you need to put in some work as well. Read over the links below. I saved a few bombshells  for your discovery...

Additional reading:

http://ftalphaville.ft.com/blog/2011/05/11/565696/chinese-commodity-imports-are-falling/
http://macro-man.blogspot.com/2011/05/commodities-are-crap.html
http://ftalphaville.ft.com/blog/2011/05/16/569436/chinas-copper-collateral-and-covert-credit/
http://www.bloomberg.com/news/2011-06-15/copper-users-in-china-plunder-stockpiles-as-goldman-forecasts-record-rally.html
http://ftalphaville.ft.com/blog/2011/05/24/576131/and-now-goldman-says-the-commodities-correction-is-over/
http://pragcap.com/on-the-conflict-of-interest-that-exists-between-research-and-commodity-traders
http://traderightuk.wordpress.com/2011/06/01/guest-blog-david-threlkeld-on-copper/
http://ftalphaville.ft.com/blog/2011/06/21/601061/coppers-inventory-inconsistency-charted/
https://customers.reuters.com/community/newsletters/metals/MetalsInsider20110729.pdf -- Page 2 -- If the warehouses are about to be empty of any metal, why buy them?
http://ineteconomics.org/blog/money-view/copper-standard
http://ftalphaville.ft.com/blog/2011/08/31/665791/a-new-development-in-chinas-copper-collateral-trade/
http://ftalphaville.ft.com/blog/2011/09/07/671416/more-than-2-8m-tonnes-of-hidden-copper-stocks/ - another estimate in an SEC filing guessing there's 2.8 million metric tons in hidden copper stocks.
http://traderightuk.wordpress.com/2011/09/07/guest-blog-simon-hunt-on-copper/ - More on the 2.8 million ton question.
http://blogs.wsj.com/chinarealtime/2011/09/19/dr-copper-gets-a-check-up-in-shanghai/
http://www.economist.com/node/21530107?frsc=dg|a

The Author is long precious metals and short base metals