Business Insider’s Myles Udland just posted a chart, drawn from research by the Bank of England, showing interest rates for the past 3,000 years. And for all those who’ve been feeling like today’s “new normal” is actually profoundly abnormal, here’s your proof. It turns out that interest rates, both long and short-term, are lower than they’ve ever been. Not lower than in this cycle, or post-war or in the past century, but ever, going back to the earliest days of markets.

And they’re still falling in most of the world. Central banks are cutting rates on a daily basis (Turkey was today’s announcement), in some cases to less than zero. Something like $2 trillion of sovereign and corporate debt now trades with negative yields.

Virtually the only major entity considering raising rates is the US, and the incongruity of this threat has traders balking. See Bloomberg’s Traders still don’t believe the Fed is ready to raise rates.

If this is indeed uncharted territory and we’re going further in before we’re done, what are the implications for markets and, well, everything? A couple of thoughts:

The insurance industry, pension funds and money market funds all depend on positive yields to operate. A life insurance company, for instance, can keep premiums low because it can invest that cash for years before having to pay out on the policy. What happens if the bonds it buys start yielding nothing (or less than nothing)? What about a money market fund that can no longer find investment grade corporate paper yielding much more than zero? Pension funds, meanwhile, have generally promised 7%-8% returns to their members, but now have to get all of those profits from the equity and real estate sides of their portfolios.

For any of these entities to stay in business they now have to act like hedge funds, taking on extra risk, rolling the dice and hoping that the good years outweigh the bad ones. In other words, these formerly safest-of-the-safe investment vehicles become just as risky as the typical eTrade account.

Then there’s the impact of negative rates on the market’s price signaling mechanism for the rest of us. Interest rates are the price of money, and as such they tell investors, entrepreneurs and consumers what to do. Low interest rates generally say “buy, build, consume, take risks” while high rates say “save, sell, conserve, wait.” But zero or negative rates? Are they just an extreme version of low rates or is there a qualitative difference? Everyone has a theory about this but in the absence of historical precedent, we’ll have to wait and see.

Anyhow, the coming negative interest rate world will provide plenty of thrills, chills and blog post material. For now it’s enough to note that we’ve never, through depressions, world wars, bubbles and famines, seen anything like today’s economy.

We have shown so far that all ruble crises were accompanied by a strong U.S. dollar and low oil prices. We have concluded that Russia’s current problems resemble those from 1998, though possibly even more severe than seventeen years ago, because the biggest country in the world is cut off from the international funding. But what about the following banking crisis in Russia?

Let’s begin by explaining why the next full-blow financial crisis is coming, even though Russian public debt is very small (less than 10% of GDP). We have to remember that what really counts is future fiscal balance. It involves the role of expectations of the future stance of public finance and explains why governments in crises often have surprisingly large foreign currency reserves and run small or no deficits at all. The best example was the Asian countries in 1997. According to Eichenbaum et al., the Asian crises was caused by “large prospective deficits associated with implicit bailout guarantees to failing banks”. The same mechanism operated in Russia. Investors simply noticed that the oil and gas industry generates about half of Russia’s revenues, so the government, unable or unwilling to raise taxes or cut spending, will run deficits in the future. These expectations were enhanced by the implicit bailout guarantees of Putin’s cronies.

This is why Russian bond yields and credit defaults swaps with measuring bankruptcy risk for Russia and have already hiked (Russia’s government 10-year local bond yield jumped from 10% in November, 2014 to 14% in January, 2015, while CDS spiked in January, 2015 by 100 basis points to 630). 

This issue of prospective deficits is strongly linked with the credibility of monetary policy. Investors fear that the Central Bank of Russia will not withstand political pressure (remember: it is an authoritarian country which is cut off from the external funding) and will start printing money to monetize deficits. Anticipating future inflation, investors sell rubles today. On December 15, 2014 the central bank gave Rosneft, owned by Putin’s friend, 625 billion newly printed rubles. That supply of new money immediately appeared on the currency market, and the exchange rate collapsed, despite oil bouncing back that same day.

What about the possible default on private debt? The ultra-low interest rates in developed economies resulted in the search for yields in the emerging markets. This led to a rise in Russian corporate debt denominated in foreign currencies from $325 billion at the end of 2007 to $502 billion in June 2014. The weaker the ruble, the higher costs for Russian companies to pay debts issued in other currencies. They need liquidity to pay interest and roll over debts, but sanctions cut off Russian businesses (and banks) from foreign financial markets where Russians used to get half of their capital. Therefore, they have to buy U.S. dollars in the market, which further weakens the ruble exchange rate.

The rise in the U.S. dollar caused the reverse of emerging markets carry trade – investors started to outflow their capital from them, including Russia which is additionally suffering from the Western sanctions. Although investors have been taking their capital out of Russia for a few years, a sharp rise in 2014 (around $150 billion in a full year compared to $63 billion in 2013 and $134 billion in 2008, during the global financial crisis) augmented the downward pressure on the ruble, which further decreased the confidence in the Russian economy and next entailed outflows of capital.  

Non-financial companies are not the only ones that suffer from the ruble’s weakening. Banks, who borrowed in foreign currencies, make a close second. Banks have $192 billion of external debt (about 10% of GDP), up from $170bn in 2008, and from $18bn in 1998, while having few dollar assets to balance against their dollar debts. About $130 billion of bank and corporate debt will be due this year.

Three more factors aggravate the banks’ situation. First, companies’ insolvency means more bad loans and losses for the banks. For example, overdue unsecured consumer debt of Russian banking sector rose by 2 percentage points between April and September 2014, to 11.3%, while Sberbank, the country’s biggest lender, has reported a 25% slump in third-quarter net profit on rising provisions for bad loans.

Second, depositors no longer trust the ruble and began withdrawing their money from the banking deposits. The share of Sperbank’s deposits held in foreign-currency increased from 13 percent to 17 percent in the second half of the year. Russians also started flying into real values, i.e. they are getting rid of rubles and buying foreign currencies, durable goods and obviously gold. Such behavior typically indicates the loss of trust in the domestic currency and entails high inflation.

Third, in response to hike of the CBR key rate (see graph 3), the interest rate on Russian three-month interbank loans rose to 28.3%, higher that it was even during the 2008 crisis. Consequently, Russian banks will need support in the near future. Actually, the first banks (Trust Bank, VTB, Gazprombank) have already been bailed out at a level of a few billion U.S. dollars. However, bearing in mind that banks and companies (whose operation must be financed by banks) will need to repay almost $100 billion of foreign debt this year, we may next expect more bailouts.

Graph 3: Russian benchmark interest rate from March to December, 2014

Source: tradingeconomics.com 

It is just a logical step during the currency crisis experienced by the developing country with large foreign-currency debt. According the Krugman, “…the initial effect of a drop in export prices is a fall in the currency, this creates balance sheet problems for private debtors whose debts suddenly grow in domestic value, this further weakens the economy and undermines confidence, and so on”.

Thank you.

Arkadiusz Sieron

Well, here we go again. I do not know how many times over the past year or so I have noted what looked like a chart breakdown in the US long bond. By that I specifically mean a close BELOW the 50 day moving average. Generally, that will get technicians to sit up and take notice and begin to approach a market from the short side. Each time I have noted this however, the bonds have done a flip-a-roo and back up they have gone continuing the bull streak.

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This time, maybe, just maybe, we are seeing an end to the ultra low long term interest rate environment. As badly at this market has tripped me up over the last year and a half, when it comes to turning negative on it, I am somewhat reluctant to get too worked up about a close below the 50 day moving average once more. This time however, it While it cannot be seen on this daily chart view ( look at the weekly chart below), we were up near ALL TIME HIGHS in the bonds. That translates to ALL-TIME LOWS in long term interest rates.

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The question I ask is how much lower can long term rates go from these levels? I suppose they could indeed head lower but I shudder to think what economic conditions would be like were that to occur as it would signify a near collapse in US economic growth and a huge failure on the employment front.

Note on this intermediate term chart (weekly) the MACD has not yet given a Sell signal. It has hooked down however.

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Let’s switch the indicator to look at the ADX/DMI however because there is something quite notable that we need to discuss. The ADX, that line which when rising indicates the presence of a strong trending move, has finally hooked lower and turned down. It has done that before but this is what has my attention – it is doing so from ITS HIGHEST LEVEL ever since 2009! Look at the horizontal red line I have drawn across that indicator. You might recall that was when the very first QE program was initiated by the Federal Reserve and traders reacted by pushing bond prices sharply higher. However, it was not until the full impact of all those longer term bond purchases was being felt in the interest rate markets that the long bond went on to make its all time high in the summer of 2012. Look and see – even at that point, the ADX was not nearly as high as it currently is.

The same can be said of the Positive Directional Movement Indicator (+DMI BLUE LINE). It too is at its highest level since that same time frame in early 2009!

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In other words, we have experienced one of the most powerful uptrends in market history in the bonds – a trend that goes back over 30 YEARS and this trend, may just possibly be finally coming to an end. I do not want to read too much into one week’s price action in a trend of this duration, nor even one month’s price action, but given the level at which the bonds are trading, and given the comparable incredibly low corresponding interest rates, I personally believe that we have seen long term interest rates go as low as I will ever see again in my lifetime.

The only thing that I believe will disabuse me of this notion, is as I stated earlier, a complete economic collapse. Barring that, one has to wonder if 30 years of falling long term rates has now become one for the history books.

About Dan Norcini

Dan Norcini is a professional off-the-floor commodities trader bringing more than 25 years experience in the markets to provide a trader’s insight and commentary on the day’s price action. His editorial contributions and supporting technical analysis charts cover a broad range of tradable entities including the precious metals and foreign exchange markets as well as the broader commodity world including the grain and livestock markets. He is a frequent contributor to both Reuters and Dow Jones as a market analyst for the livestock sector and can be on occasion be found as a source in the Wall Street Journal’s commodities section. Trader Dan has also been a regular contributor in the past at Jim Sinclair’s JS Mineset and King News World as well as may other Precious Metals oriented websites.

Bob’s perspective on the Credit Markets, Stock Market, Commodities, Currencies, Precious Metals from Pivotal Events that was published for his subscribers February 5, 2015.

Perspective

The first quote from the Bank of Italy reminds that one of the most magnificent defaults in history was that of LTCM in 1998. The extremely-leveraged hedge fund was so highly regarded that some senior central banks loaned directly to LTCM. The Bank of Italy was the only one to take an equity position.

Now the BoI is out to inflate the world.

Private Chinese lenders that are bypassing the Bank of China by funding margin accounts directly could be called “wildcat” bankers. It is not the first example. As credit naturally tightened up in the fateful spring of 1929, the Fed wanted to look in charge. Fed Chair Roy Young issued some warnings about excessive speculation. Then markets came under some pressure and Charles Mitchell, president of the National City Bank, defied the policy and poured money into the call market. Mitchell was also a director of the New York Federal Reserve Bank and a fully committed bull. He stated that his bank had “an obligation which is paramount to any Federal Reserve warning.”

Known as “Sunshine Charley”, Mitchell suffered a major setback as the Roaring Twenties ended. National City is now known as Citigroup.

On the other hand, Albert Wiggin, as president of Chase National Bank, personally shorted his own stock – in a timely manner. During the mania and bust, Chase’s economist Benjamin Anderson had a very good handle on inflation in financial assets.

Caught up in the confidence that goes with a perpetual boom, all classes of banks from central to commercial to investment have become overly ambitious. As with the workings of the US administration, checks and balances are not tolerated.

Stock Markets

It is uncertain if the confidence of central bankers is sublime or brazen. Perhaps some are just plain confident that their theories and practices will prevail over any risk. Others, perhaps aware of mounting risk, are belligerent in imposing remedies. As quoted above, the head of the Bank of Italy has joined Draghi.

Notwithstanding all of the debate at high levels about what central bank should do what, the financial markets are actually sorting it all out. For the stock market it has been sentiment and momentum numbers seen only at cyclical peaks. These have been registering since June and the NYA represents the broad US market.

The action is building a Rounding Top with key highs at 11105 in June, 11108 in September and 11068 in late November. The 40-Week ma provided frequent support on the way up to the Top in 2007 when late in that fateful year it was taken out. The same moving average provided similar support on this cyclical bull market. For the last few weeks this has been providing resistance.

It seems to be running a month or so behind the similar pattern in 2007.

Another guide in 2007 was the cyclical reversal in credit spreads that began in June. When credit markets are excited the seasonal turn in mid-year can reveal vulnerable positions. This was the case last June and while the trend is concerning it is not severe. It seems to be a month or so behind 2007.

So far, flattening of the yield curve has been constructive. Often booms have run some 12 to 16 months against flattening and when the curve reverses it signals the start of the contraction.

This is Month 13.

Sector Opportunity:

The bull market in REITS has been impressive with the index (IYR) rallying from very depressed at 59 in 2013 to 83 at the end of January.

The last outstanding rally reached a Weekly RSI of 81 in May 2013 at an index high of 71. It fell to 57 in that October.

On the big cyclical high the RSI reached 78.65 on February 15, 2007. The index crashed from 67 to 16.

This year’s rally drove the Weekly RSI to 83.19 on January 26th. The index reached 83.54 and dropped to 79.56 at the first of the month. The rebound has made it to 82.23 earlier today. Taking out 80 would break an outstanding speculative thrust. Taking out 76 would likely push REITS into another bear.

The action in REITS has become vulnerable and the IYR trades rather well off of Weekly overbought signals.

Credit Markets

The “pause” in crude’s slump has prompted a rally in Junk. JNK’s plunge to 37.26 in December was sharp enough to register a Springboard Buy and the rebound made it to 39.17. The next decline was to 38.19 and now it is at 39.15. This is somewhat above the 50-Day ma, which is constructive.

However, the decline has been the most significant since 2008 and. merits close watching.

Credit spreads (chart follows) widened into a mini-panic in December, corrected and have resumed the trend. Quite likely, this has been a cyclical trend and the recent pattern seems similar to September 2007.

Long-dated Treasuries have accomplished an outstanding rally, which for the past month we have been describing as “ending action”. That “Special” was sent out on January 20th.

The ChartWorks reviewed the action on February 2nd and on the 3rd. These reviewed the excesses and the one on Wednesday provided an initial target at the 143 level. The high was 151.80.

We had the “buy” in January last year. We are on the “Sell”, which means getting defensive. We have been out of lower-grade bonds since June, and investors in this sector were advised to position 3 to 4-year US high-grade corporates, essentially for the currency play.

Commodities

Using a couple of determinants, January was likely to record the end of the initial plunge in crude oil prices. A “pause” has been possible and this has involved some impressive swings. Previous crashes in crude ran for some 6 to 7 months and that counted out to January. Previous crashes have taken a number of months to set an important bottom. A “V” bottom seems unlikely.

Although crude’s swings have been wild, it should net out to a sideways trend before starting an intermediate rally.

As this works out other commodities would firm up.

Currencies

It was last May (How the time does fly!) when we noted that the rally in the DX could go from overbought to super-overbought. The latter could have been reached a few weeks ago when a more recent target of 92 to 94 had been exceeded.

Last week we noted that the Weekly RSI has reached 84 and was overbought. A period of correction for the DX is possible.

Today’s ChartWorks noted that the plunge in the Canadian dollar is severe enough to register Downside Capitulations. That’s on the Daily, Weekly and Monthly readings. A rare “Trifecta” of extreme action. An intermediate rally seems likely.

Precious Metals

The precious metals sector has built what appears to be a solid base. In November the HUI became the most oversold in a year. The action since has been constructive.

Our November 5th study on gold “Caveat Venditor” outlined the possible end to the bear market in precious metal stocks. Essentially, this was based upon gold’s real price, which had been increasing since its cyclical low in June. The real price continues its advance and it will soon prompt a bull market for gold miners.

The bottom for the sector was dependent upon gold stocks beginning to outperform the bullion price and silver beginning to outperform gold. Both continue favourable.

The advice on November 5th was to begin to accumulate gold and silver stocks on weakness as equities would likely outperform the prices of silver and gold.

Representing real gold stocks, the HUI set its low at 146 in early November and tested it at 150 in the middle of December. The break above the 50-Day ma occurred in early January and the rally made it to 211, which was right at the 200-Day ma. That was a couple of weeks ago and the 200-Day has constrained the advance.

A correction down to the 50-Day at 180 could offer another buying opportunity.’ Gold’s real price is in a cyclical bull market and the stocks should soon set a technical bull market.

Credit Spreads

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• Spreads narrowed into June which was seasonally ideal for a significant reversal.
• The widening trend is well established, which we take as a cyclical trend.
• The sharp spike to the middle of December was impressive and the correction was modest.
• Recent trading swings seem similar to September 2007.

Link to February 6 Bob Hoye interview on TalkDigitalNetwork.com: http://talkdigitalnetwork.com/2015/02/canadian-dollar-relief-rally

Greek and Eurozone officials failed to reach an agreement over Greece’s debt crisis yesterday in Brussels at an emergency Eurogroup meeting. Although Jeroen Dijsselbloem, the chairman of Eurogroup finance ministers, said that seven hours of talks were “constructive”, the euro zone finance ministers were unable to agree even a joint statement on the next procedural steps. How may the Greek problems affect the gold market?

The negotiations stem from the fact that the current EU-IMF bailout for Greece expires on February 28 and a new four-year reform plan is needed. The problem is, however, that the new Greek government, led by the radical left-wing Syriza party, says the conditions of the $272 billion bailout have impoverished Greece and resists its extension and co-operation with the hated ‘troika’. The new leftist government has proposed to overhaul 30% of its bailout obligations, replacing them with a 10-point plan of reforms, including, for example, the reduction of the primary surplus target of 3 percent of GDP to 1.49 percent or getting a ‘bridge loan’ that would enable Greece to stay afloat once the current bailout deal expires and until a new program is agreed. However, Greece’s creditors in the EU, led by austerity-focused Germany, have insisted that the terms of the bailout cannot be altered.

Is Greece going to default on its debt? On the one hand, Greece is currently running a primary surplus, which makes default

on its debt more probable. On the other hand, the European Central Bank has recently increased pressure on Greece by banning the Greek banks from using their government’s bonds to get liquidity from the ECB. It has not yet affected Greece significantly, however the signal was clear.

Assuming that negotiations will fail and Greece will (partially) default on its debt (a Grexit seems not to be on the cards), what are the implications for the financial markets and gold investors? It seems that direct effects would not be significant, because banks or other private investors generally do not possess Greek debt anymore (only about 12%). The biggest creditors are the ECB, IMF and EU (state debts and proceeds from the European Financial Stability Fund), therefore the possible default would only affect official institutions and Eurozone states. This is why Germany opposes so strongly any alterations to the bailout program.

To sum up, the failed bailout talks will be continued on Monday, however the time to find a deal is tight and the future is uncertain. As we have already written, a Grexit is rather not probable (Greek banks would lost the cheap funds from the ECB), however some form of debt restructuring is on the horizon, especially that Greece is currently running a primary surplus. Because the debt is held mostly by official institutions, the direct impact on the gold market should not be too strong. However, prolonged negotiations or any default on debt would increase market uncertainty (for example, uncertainty about the future actions of other peripheral countries in the Eurozone) and volatility, supporting the gold price. It’s unclear whether this factor alone will be enough to prevent gold from sliding further, though.

Arkadiusz Sieron
Sunshine Profits‘ Market Overview Editor