Quantitative Uneasyness:

It has been reported  by the New York Times, that the S.E.C. is investigating giant Bond Fund Company PIMCO and its’ high profile manager, Bill Gross, for playing reckless with the truth in reporting the earned rate of return for an Exchange Traded Fund under management. The fund in question was designed to mirror  PIMCO’ s $220 billion  Total Return Fund so as to allow for, maybe, a better rate of return for smaller investors. Year to date figures for this ETF published by PIMCO indicate an earned annual rate of return of 5.46% as opposed to the benchmark  Index of  4.81%.

If it were not for the players involved and the subject matter, namely the true rates of return earned by the Fund Industry this latest rant might smack of a ‘storm in a teacup’ But my intuition tells me there is much more to it.

Bill Gross has the rather thankless task of managing huge amounts of money at a time when the Federal Reserve Bank of New York, and the US Treasury, are hell-bent on debasing the currency, and thus reducing the value of all bonds. As befitting his status, as a steward of his client’s money, Bill has been very verbal about monetary policy since the financial collapse of 2008.

He believes, as do many bond investors, that the US dollar will be downgraded from its triple A rating, and that the FED will not be willing, or able, to control the inflation that must surely follow the printing of trillions  of dollars in pursuit of the policy of “Quantitative Easing. In support of this belief PIMCO is no longer a buyer of Long US Treasury Bonds.

In reality,  Bill Gross has joined battle with the most powerful institutions in the World, and, on behalf of his Bondholders has fired the first shots in a war, he will likely, win.

I cannot match the wonderful and witty descriptions of the Bond Market as told by Michael Lewis in his books about Wall Street. (Liar’s Poker, The Big Short) He remains true to form with his conclusions that “the bond market always wins” and   I cannot see how it will be any different this time around.

The players are different and the numbers are much larger than they were in 1944 at Breton Woods when the US dollar was established as the standard currency of international exchange. Now the US  will have to contend with the fact that the nation has frittered away its financial might on useless wars, and, as a debtor of unimaginable proportions, can no longer solely dictate the terms of rescue.

An investigation of the number crunchers  of PIMCO has the earmarks of the LIBOR (London Interbank Offer Rate) investigation, in that small percentages on very large numbers are involved. PIMCO is owned by German Insurance Giant, Allianz, a huge company, not unlike Warren Buffets Re Insurance,  that has  reserves set aside for unexpected redemptions in its managed funds.

More likely than a grand conspiracy to rig returns, is the role of ‘the quants’ (mathematicians) in managing derivatives and odd lot trades for the Exchange Traded Fund, a practice only understood by other ‘Quants’ most of whom do not work for the SEC.

The subject of published rates of return claimed by money managers of all kinds is a very different proposition and one that likely deserves a critical appraisal.

It is a demonstrable  economic fact that the true long-term annualized real rate of return on capital adjusted for inflation is between 3.5 and 4.0%. This does not mean this rate is the norm, or the average, and annual rates may vary according to World Wide economic conditions in addition to the prowess of the investor. It may also be a useful  benchmark to try to wring some reason from the nonsense that is espoused by the money fund industry as they trumpet their results for the benefit of their sales force.

I suspect that If the majority of the published rates of return for the trillion-dollar Fund Industry accrued to the investor in cash, the deficit in US national accounts would be eliminated in short order. The proof of this hypothesis may be found in recent history. The last time  the US Treasury did not run a deficit was during the insanity of the DOT.COM boom (The period of Irrational Exuberance)

Assets Bubbles are very profitable for the taxing authorities, as they are with politicians, because it appears as though everyone is making buckets of money. The allusion only become clear after the bust, that follows the bubble, and this is when the investigations begin.

So when assets values correct, as they surely will, in the near future, when the Bond Market pushes up Interest rates we can expect an investigation of the lies that got us into the predicament, and stock market returns will front and center.

 

 

 

Poor Man’s Gold:

iI have always been fascinated by Silver or ‘Poor Man’s Gold ‘as it sometimes called by miners.

I once owned a large piece of the Keely Silver Mine near Cobalt Ontario reportedly the richest Silver Mine in the World, at least that’s what Murray Watts, the famous Canadian prospector told me. Murray had been involved a failed effort to put the old mine workings  back into production and was keen to find a financier who could take the project forward.

I was impressed by the maps of underground workings that showed ore shoots that produced over 5,000 ounces of silver per ton  ($100,00 /ton at todays’ price for silver). I was also hopeful that the price of Silver would remain high enough to raise the capital to kick-start production once more. But it was not to be, as the events of ‘Silver Thursday’ and the debacle of the Hunt Brothers attempts to ‘corner’ the Silver Market got in the way.

No one knows for sure why Nelson Bunker, and William Herbert, two of  the famous Texas Hunt Brothers, tried to engineer a ‘corner’ on the market for Silver. It is said that they were very upset with the US Government for not compensating them for the seizure of Libyan Oil production owned by their Placid Oil. They had also been very verbal concerning the galloping inflation of  the 1970s’  bought on by the Vietnam War and President Johnson’s Great Society. But a snit and a minor dent in their net worth, hardly explains the suicidal risks of making a gigantic very public bet on a  well established market such as COMEX Silver.

Trading oil, an everyday commodity, is very different from trading silver, a precious metal with a large monetary component. The value of Silver has a very close historical relationship to that of gold. The Romans created Silver coins as specie with a fixed ratio to gold that provided a stable medium of exchange and store of value for three hundred years. Following the 16th century discovery of Bolivian silver Spanish Pieces of Eight formed a Silver Standard again with a fixed ratio to gold for the conduct of international trade.  In 1717 the master of he Royal Mint in London Sir Isaac Newton introduced a new fixed ratio for Stirling Silver of 15 ounces of silver to one ounce of gold. This had the effect of placing the country on the gold standard that was not formally adopted until 1821.

Since those halcyon days silver had gradually been debased as a currency, to the point where it now takes nearly 60 ounces of silver to buy one ounce of gold. The reasons for this lie primarily with the large industrial demand for silver, as opposed to the solely monetary use for gold. Silver values can and will diverge from this ratio in the short run but have shown a remarkable tendency of returning to the new norm.

The designation ‘corner’ is an old saying that was used in the early days of Wall Street, and the New York Stock Exchange. Most investors buy or ‘go long’ shares because they believe they will increase in value. There are a relative fewer investors who take the opposite approach and sell borrowed shares, or go ‘short,’ because they believe the value will go down. If they are right and the shares do go down in value they buy shares on the open market to repay the borrowed shares and take their profit in cash. A ‘corner’ is created when a player (long or short) miscalculates the available supply of shares and gets caught in a ‘squeeze’

The Hunt Brothers may not have acted alone in their insane caper. Rumor has it that they had partnerships with various mid-eastern oil interests who actually took delivery of the metal (as opposed to buying futures contracts on margin).  This legitimate step  may have saved the market from total collapse when matters spun out of control in 1979.

The buying frenzy had taken the price of silver from $6 per ounce to $48 an ounce, an  increase of over 700%. At this price industrial users of silver were forced out of the market, as were more traditional users  such as jewellers.  Now the Hunt Brothers had everyone’s attention and the Regulators stepped in.

In January 1980 COMEX adopted “Silver Rule 7” that placed heavy restrictions on the purchase of commodities on margin. The effect was a classic “corner’ when silver prices dropped over 50% in just four days and the Hunt’s were unable to meet their margin calls amounting to hundreds of millions of dollars.

In their exuberance the regulators failed to grasp the very real danger, that a possible Hunt insolvency would take down the agents, some of Wall Street’s better known brokers, who had foolishly granted the huge amounts of credit needed to make the “corner’ succesful.

In a bizarre twist, the New York Federal Reserve Bank caused several its member New York commercial banks to lend the Hunts $ 1.3 billion needed to unwind the COMEX trades and save the brokers.

If the practice of lending money to perpetrators of financial schemes gone wrong seems strange, it should not. The Federal Reserve Bank of New York is, above all, the head of a club of members that includes thousands of banks. When trouble strikes it is in all of their interests that the money be found (or printed) to save the criminals, so to save the system. The most recent example is the $85 billion rescue of A.I.G, the giant Insurance group that wrote the Credit Swaps that made the Sub-Prime Market debacle possible.

In this case the brokers led by Prudential Bache were rescued so that they could be bought out by some of the same commercial banks who provided the rescue funds, who in turn were rescued after the financial collapse in 2008.

As for the Hunts they lost a large portion (but by no means all)  of their fortune. They were later found responsible;e for civil charges of conspiracy to manipulate the price of Silver and forced to pay fines of $134 million to a Peruvian Mineral company. No criminal charges were ever bought.

And so the system lives on.

 

Dollar Crisis Redoubt:

The Breton Woods post Second World War monetary system, designed and maintained, at great cost by the Americans, fell apart in August 1971. This is when the convertibility of the dollar into gold at a fixed price of $35 was officially ended.

The beginning of the end started much earlier in 1967 /68 when a crisis in monetary confidence bought on by the devaluation of the British Pound, created a run on gold and the depletion of almost half of the 650 million ounce gold reserve of held by the Americans at Fort Knox Kentucky.

There had been a serious wobble before, when the Cuban Missile Crisis caused a buying panic on the Gold Bullion Market in London. The sudden and unexpected demand for gold, as a safe haven against possible nuclear Armageddon, led to the formation of the London Gold Pool. This unofficial agreement between Central Bankers, known only to a few, was to lend reserves of gold bullion held in the national accounts, of  The US, Britain, a few European Countries, so as to maintain order in an unregulated market.  This seemed to work for a while but was totally inadequate  when the dogs of speculation were let loose on the International Markets in 1967.

The Stirling crisis had been coming for some time because the Socialist  Labor Government of Britain  was unable, or unwilling, to enact  the austerity measures required to pay for the massive nationalization of industry  and infrastructure that had taken place following the declaration of peace in 1945. Sharply increased wages had rendered much of Industry uncompetitive and the  national balance of payments had suffered accordingly. An initial devaluation of 40% against the  US Dollar had not been enough to reflect the dire condition of the nation’s balance sheet.

Breton Woods was greatly influenced by Keynesian Economics that favored fiscal rather than monetary discipline, and a belief that elected governments could and would keep their budgets in balance In this utopian world  bankers were seen as a second line of defence only to be called upon when needed. Experience, almost from the beginning, had shown the fallacy of this dogma and the monetary system had only survived to this point because of the hegemony of the US Dollar freely convertible into Gold.

In 1967 Britain was required to maintain a trading range for the Pound Stirling, of two cents either side of official rate of $ US 2.80   using reserves of gold and dollars held  by The Bank of England to buy and sell Stirling as required. The problem arose because the reserves of the B.O.E. were inadequate for the task at hand. So the bankers, arranged to borrow huge sums of dollars (3 billion) to throw into the caldron should the need arise. The lead banker for this rescue was the Federal Reserve Bank of New York that pledged a billion dollars and the backing of all the gold in Fort Knox to the cause.

The rescue worked for a while, but the fates were not on the side of the angles and very soon speculation about a further devaluation of the pound began once more. This time in spite of the continuing efforts of bankers to maintain the status quo the British Government capitulated and the pound was devalued to a new official rate of $US 2.40.  The effect, totally unexpected, was a loss of confidence in the dollar and a run on gold, this time on scale never anticipated.. In a matter of a few days the market for gold spun out of control with buyers shorting the dollar and forcing the American Treasury to make good on its promise to deliver gold in exchange for dollars.

So dire was the situation that The Federal Reserve Bank of New York, along with the US Treasury, was forced to suspend  gold for dollar transactions, and allow an unofficial or floating rate to prevail. The immediate effect was a spread between the official rate and the actual rate or a devaluation of the dollar of approximately $5 or 14%.

Suddenly the American dollar was vulnerable, and nobody, it seemed, knew what to do, other than suspend the market for gold. The French Government under President Charles De Gaulle , having recently created the  New Franc  to purchase the tons of gold held by French Citizens, was intransigent and refused to cooperate. Also the members of the newly formed O.P.E.C.(the Oil Cartel) who suddenly realized that they were being paid for their oil in depreciating dollars thus reducing the value of the commodity. Their answer was to hedge future deliveries by selling dollars and buying gold.

After a weekend meeting of the monetary powers, this time including Switzerland,and the gold backed Swiss Franc, along with Japan and the Yen, a new form of specie was invented to supplement gold, as the principal monetary reserve. The specie, or new currency, took the form of Special Drawing Rights (SDRs) issued by The International Monetary Fund created in 1944 at Breton Woods as the sole arbitrator on International Currencies.  At the same meeting it was decided to do away with fixed exchange rates, that had been at the heart of Breton Woods, and allow currencies to find their own value.

The initial stated value of an SDR was 0.888671 grams of pure gold. This provided a continuing  link to hard currency and gold, and had the desired effect of stabilizing the gold market, that now traded independently from the US Dollar.  But it would not be long until the final link with gold was broken and the daily value of SDRs’ was calculated based solely upon the trading range of a basket of four currencies, The Dollar, the Pound, the Yen and finally the Euro, thus excluding gold.

The number of issued SDRs’ is now a very far cry from the original stop-gap issue, and is thought by the New York Federal Reserve Bank and the other central bankers to be sufficient to curb excessive currency speculation. But no one really knows, and herein lies the problem.

What will happen if all four major currencies, are depreciated or devalued at the same time, as it appears they maybe at this time. If unlimited amounts of dollars, yen, pounds and euros are created to stop deflation and start inflation what happens to the Basket 

Stay tuned.

The Race to the Bottom:

I recently wrote a three-part series entitled “The Skin of the Gods” a very unprofessional attempt to trace, down through the ages, the folly of debasing currency by the unwarranted printing of specie.

Well my friends it now looks as though Armageddon is approaching, in the form of massive and pervasive attempts to re inflate the economies of the E.U. Japan and of course the U.S.

The form of battle appears to be low or sub-zero rates of interest and action by the Central Banks to force liquidity, or create ‘asset bubbles’  by the purchase of, mostly government, debt with ‘funny money’, sometimes referred to as  “quantitative easing”. Central  Bankers are, therefore in a race to the bottom  by following a course that can only devalue their currencies,  in terms  of other paper currencies and, of course gold and other ‘hard’ assets.

The losers in all of this will be the holders of these Y.E.D. (Yen Euro Dollar) currencies, the biggest by far, being the Chinese, who are ‘long’ massive amounts of these currencies due to their export driven economy.  This, no doubt, is why the Chinese  central planners continue to subsidize the purchase of gold, mostly in the form of concentrates containing Arsenic and other impurities, scorned by most industrial nations. The Chinese are also exporting Silver, a non-reserve currency, and importing Gold, a reserve currency, as are the Swiss,  who are going one step further, and actually repatriating gold held by the Federal Reserve Bank of New York.

It is no surprise that China encourages its S.O.E.’s (State Owned Enterprises) to make massive investments in far corners of the globe in liberated Y.E.D. Currencies. The planned US $ 2 billion Paradise Island Gambling Resort in the Bahamas, thought to be the largest civil project in the World, is a typical example. Apparently the country risk, being that of a small independent Island Nation, at almost constant war with the US Treasury, is insufficient to offset the urgent need to place fast depreciating paper currency with hard revenue generating assets.

This is the strange new World that follows the collapse of the Breton Woods Monetary System in August 1971. This is when the  pledge of convertibility of the mighty US Dollar into gold was abrogated in favor of the ‘dirty float’ a term that no one understands or adheres to.

It might well be that the Central Bankers or the Presidents of the Federal Reserve System in the US now are the sole determinants when it comes to the trading ranges of the major currencies. They do so however without any reference to gold or any other reserves. Rather they blather on about percentage s of debt to GDP (gross domestic product) as being the correct measuring stick. This policy smacks of the adage of ‘the blind leading the blind’ and ‘it must be alright because everyone goes along with it’. But  we all know what will happen if just one influential player or creditor  breaks ranks and refuses to accept a currency as settlement for trade.

Will this happen? and if so when? My guess is sooner rather than later. Most likely after the 2016 Presidential Election in the US, or maybe when a major player such as France breaks ranks with the EU Monetary Union. Then we will once again have a new world order based upon a basket of currencies and commodities to which all the major Western countries will swear allegiance, for a little while anyway.