June’s FMQ components have now been released by the St Louis Fed, and it stands at a record $13.132 trillion. As can be seen in the chart above, it is $5.48 trillion more than an extension of the pre-Lehman crisis exponential growth trend. At this point readers not familiar with the construction of FMQ and its purpose may wish to refer to the original paper, here.

It should be borne in mind that there may be seasonal factors at play, with dips in the growth rate discernable at this time of year in the past. So the slower growth rate of FMQ, up $44bn between April and June when it might have risen $150-200bn, is not necessarily due to tapering of QE3. If tapering was responsible for slowing growth in FMQ, we could expect to see some tightening in short-term interest rates. But as the chart of 3-month T-bill rates shows they have been in a declining trend since last November.

The chart confirms that tapering seems to be having little or no effect on money markets and therefore the growth rate of fiat currency.

Weakness in interest rates is also consistent with poor economic demand. This week the first estimate of Q2 GDP was released which came in at an annualised 4%, substantially above market estimates of 3.1%. This outturn conflicts sharply with the lack of any meaningful demand for money, until one looks at the underlying estimates.

Of this 4% increase, the change in real private inventories added 1.66%. In other words GDP based on goods and services actually sold was only 2.34%. That changes in unsold goods, which is what inventories represent, should be part of final consumption is a dubious proposition, but need not concern us here. According to the technical note accompanying the release, figures for inventories and durable goods (which showed an incredible rise of 14%) are estimated and not hard data, so are subject to future revision. On this basis, the surprise GDP figure is little more than a government econometrician’s guess until the real data is available. Suspicions that these guesses err on the optimistic side are confirmed by the experience of the Q1 GDP figure, which was revised sharply downwards from first estimates when hard data eventually became available.

Whichever way we look at FMQ, it continues to expand at a frightening pace irrespective of the GDP outturn and its flaws. Furthermore, a look at the most recent Fed balance sheet confirms this view, showing that the 1st August figure will be considerably higher, unless there is an offsetting contraction of bank credit.

There is little sign of any such contraction. We can conclude from short-term market interest rates that the US economy is going nowhere fast, contrary to this week’s GDP estimate, and that demand for credit continues to come from essentially financial activities. But given that GDP estimates turn out to be far too optimistic, what if the US economy stalls or even slumps? Won’t that lead to a reversal of FMQ’s growth trend?

This is essentially the argument of the deflationists. In a slump they expect a dash from credit into cash as asset prices tumble. The counterpart of credit is deposits, the major components of FMQ. And without Fed intervention FMQ would rapidly contract. But in the event of a slump the Fed cannot be expected to stand idly by without taking extraordinary measures: in the words of Mario Draghi at the ECB, whatever it takes.

Currencies:

The US Dollar Index was very strong in July…closing last week at its best levels since February…very close to a major chart breakout. The Euro closed at an 8 month low…we expect it to take out last year’s low (128) before the end of this year. CAD hit a 5 year low (8850) in mid-March…rallied to 9400 by early July but has since traded back below 9250. The 3 month CAD rally was fuelled by short covering…speculators actually became net long in July…we expect to see them reverse their positions again…we see 9400 as a roof and look for CAD to make new lows this year.

We think AUD and NZD are far too high and could easily slip 5 – 10% before the end of the year. Any news of China slowing would accelerate the move.

For our short term trading accounts we remain long the US Dollar Index, short CAD and AUD. We are staunchly bullish the US Dollar and we are looking for other opportunities to profit from that view. Longer term: We think the US Dollar will have a major multi-year rally against most currencies as global capital flows to the relative safety and opportunities in America.

Credit markets:

We are seeing growing evidence that the fabulous 5 year rally in junk and high yield bonds is over…we expect a possible rout in this market as so much money (and leverage)has been drawn here over the past several years as “everybody reached for yield.”

Stock markets:

It’s been an amazing bull market…33 months without so much as a 10% correction…people have been rewarded for buying dips…geo-political crisis don’t seem to matter…the obvious sentiment is, “Where else can you put your money?”

For our short term trading accounts we sold the S+P 500 short last week…let’s call it trader’s “gut feel” that this market is ripe for at least a modest correction…but we’ve got very tight stops…we respect the momentum of this rally…but…we sold it short.

Risk On / Risk Off:

We’ve been expecting the runaway “Risk On” Market Psychology to end…either from a geo-political shock and/or from a realization that the Fed will be raising rates faster and sooner than the market wants to believe. We expect this “switch” to “Risk Off” to manifest in:

1) A US Dollar rally as capital “comes back to the center,”
2) Credit spreads to widen as people “bail out” of weaker credits, and
3) A correction in the stock market.

We think the smart money is getting defensive…witness the US Dollar rally and the widening credit spreads…we expect a break in the stock market.

Oh yeah and there is a lot of perspective out there!

This is stated anecdotally with the growing list of headlines recording reckless financial and policy behaviour. This is being accompanied by technical measures of the action in stock and bonds that confirm compulsive behaviour by investors and central bankers.

And as the saying goes, “The tattoo machine does not have an eraser”. So both the technical and anecdotal sides are indelibly recorded.

And what we are seeing is “ending action”, which will be reviewed in our usual sections.

All players should be working to make sure they are on the right side of posterity on the developing contraction.

The quip in our shop yesterday morning was that the bond future, crude oil, most other commodities and precious metals get to trade from “overbought” to “oversold”, and back. Junk bonds and the S&P get to go from “overbought” to “overbought”.

The latter is outstanding and is becoming very precarious.

As individuals, some central bankers have been uttering cautionary statements and could be showing their concerns about personally being on the right side of financial history. However, the reversal, as in previous examples, won’t be due to a material change in Fed policy. The “taper” is in the market and we don’t consider it or the buying program to be instrumental in any market change. It has added to the confidence of the leveraged crowd, which behaviour will time the reversal. The Fed won’t trigger the reversal but once the credit markets start to change there will be FedSpeak about increasing rates. This will be an attempt to look in charge of the markets.

As the mania for risk fades, the bond future continues its rally. The low was 134.85 set early in the month and it has made it to 138.25 today. There is some resistance at this level. However, the action is not overbought and around 140 seems possible.

Going the other way, JNK set its high at 41.62 on July 24th and has declined to 41.15 earlier today. This has had a pause so near-term support has been taken out. Also taken out is the 50-Day ma that has provided support a couple of times this year.

Taking out the 40-Week, which is around 40.25 would signal serious trouble in global credit markets.

The low in the DX with the financial party cycle was set at 78.93 in early May. Of importance is that this week’s rise has broken above both the 50-Day and 200-Day moving averages. At 80.6 now, rising through resistance at 80.9 would be a significant  breakout.

This would also signal a step towards the next contraction.

The anti-Fed crowd which includes gold and silver bugs still believes that with the full catastrophe, the dollar will crash to zero. History suggests otherwise. A catastrophe of any dimension will be highly inflated assets going down as the dollar heads up.

Last week we changed our positive on the Canadian dollar to negative. Friday accomplished a big reversal from 94.10 to 93.3. At 93 now, both 50-Day and 200-Day moving averages are at 92.6. Taking that out would suggest a decline to support at 91.

“[The] 1901 [bull market] was . . . speculative demonstration based . . . on the assumption that we were living in a new era; that the old rules and principles and precedent of finance were obsolete; that things could safely be done today which had been dangerous or impossible in the past. The illusion seized on the public mind in 1901 quite as firmly as it did in 1929. It differed only in the fact that there were no college professors in 1901 who preached the popular illusion as their new political economy.” – Alexander Dana Noyes, 1930

In the 1920s, Noyes was the pre-eminent financial journalist in America and his backward look on the 1929 Bubble is a classic. It is doubtful that he could imagine anything as reckless as a non-banker running the Fed, let alone a college professor. Mister Noyes, wherever you are, please meet Professor Bernanke.

Our case has been that the precious metals sector is completing the bottom of a cyclical bear market that followed the measurable blow-off of 2011.

The ChartWorks has had a series of pieces outlining the building of an important bottom in gold’s price. This is within the “model” of a post-bubble collapse pattern such as followed 1929, or the Nikkei in 1989, etc.

The latest was yesterday and it noted that rising above 1326 would mark the breakout. Today’s New York high was 1325.

However, the rally in both gold and silver is on exceptional developments in Gaza and with the shooting down of a commercial airliner over Ukraine.

Silver outperformed gold and this may not last too long. The real reason for a significant advance in gold would be the advent of another cyclical credit contraction. This could soon be discovered and we should watch for another momentum high in the silver/gold ratio.

On the silver stocks, SLW declined from 27.66 to 25.53 on Tuesday. A test of the high was required and so far it has popped to 26.78.

It is interesting that gold has outperformed the CRB today which will advance our GCI.

We will stay with our theme that gold, in real terms, will continue to act contra-cyclical to orthodox markets. This is presenting a cyclical opportunity to buy the gold stocks.

Today is not that opportunity, as the big stock market is getting close to rolling over. Spreading liquidity pressures could put a lid on gold stocks and could even drive them down.

The invasion of Gaza will soon be completed.

• The Rising Wedge pattern records an increasing urge to get into the play.
• In the examples shown, the break below the lower trend line was followed by a
• significant setback.
• This was associated with tradable declines in the stock market.
• HYG broke below the line at the first of the month.

• We use our Gold/Commodities Index (GCI) as a proxy for gold’s real price.
• The index was established to avoid having gold above and below the divisor.
• Besides that gold is not a commodity.
• Major reversals in the GCI have anticipated major changes in the financial markets.
• The turn up on June 21, 2007 was associated with the reversal in credit spreads and the yield curve.
• This integrated change was behind our observation that “The greatest train wreck in the history of credit” had started.
• The turn down on February 20, 2009, nicely led the end of the financial panic on March 9.
• As we have been noting, the turn up on June 2nd would likely lead the end of the financial party by around four weeks.
• JNK and HYG seem to be failing.

Today the HYG/TLT has taken out the May low. Credit spreads are widening.

Link to July 18 Bob Hoye interview on TalkDigitalNetwork.com: http://talkdigitalnetwork.com/2014/07/chinese-corruption-threatening-world-markets/

BOB HOYE, INSTITUTIONAL ADVISORS

E-MAIL bhoye.institutionaladvisors@telus.net

WEBSITE: www.institutionaladvisors.com

Quotable

“You are a slow learner, Winston.”
“How can I help it? How can I help but see what is in front of my eyes? Two and two are four.”
“Sometimes, Winston. Sometimes they are five. Sometimes they are three. Sometimes they are all of them at once. You must try harder. It is not easy to become sane.” 

George Orwell, 1984

 [I think of the US Federal Reserve Bank when I read Orwell’s quote.]

Commentary & Analysis

Aussie could suffer a lot more if Chinese debt matters

“Overall credit growth continues to outstrip growth in value added, which is not sustainable,” said Stephen Green, chief China economist at Standard Chartered.

 Financial Times

The Financial Times reported yesterday Chinese debt/gdp is now at a whopping 250%.  I thought it was only the slovenly West that doled out debt in such large quantities in order to save its respective economies?  Nothing like Westernizing is there…

The total debt-to-gross domestic product ratio in the world’s second-largest economy reached 251 per cent at the end of June, up from just 147 per cent at the end of 2008, according to a new estimate from Standard Chartered bank.

Even GaveKal, who seem to be quite smitten by China, sound concerned: “China’s current level of debt is already very high by emerging markets standards and the few economies with higher debt ratios are all high-income ones,” said Chen Long, China economist at Gavekal Dragonomics, a research advisory. “In other wordsChina has become indebted before it has become rich.”

And from Reuters today, trouble in the Chinese construction industry indicating the real estate market is losing momentum at the least:

SHANGHAI, July 22 (Reuters) – Yields on a short-term bond issued by atroubled Chinese construction company have more than doubled in recent days as hope fades that the firm can avoid defaulting on Wednesday.  On July 16, unlisted Huatong Road & Bridge Group Co Ltd announced that it was uncertain about its ability to make payment on a 400 million yuan ($64.4 million) one-year bond issue that matures July 23, after its chief executive was placed under investigation for illegal behaviour.

“The real estate sector in China accounts for 15 percent of China’s economy and impacts 40 other business sectors,” says Reuters.

So how is this debt problem and real estate linked?  A great chart of this dynamic comes from the FT

But many analysts imply rising debt in China doesn’t really matter much because China will keep rolling over bad debt problems into the balance sheets of Chinese banks.  But Prof. Michael Pettis thinks it does matter; here is why…

At any rate for several years I have been arguing that the main reason analysts have managed to get China so wrong is because of their failure to understand the basic distortions driving the economy and one of the major consequences of these distortions is the creation of debt, which itself further impacts the evolution of these distortions. All rapid growth, Albert Hirshman argued in the 1960s and 1970s, is unbalanced growth, and in many if not most cases the kinds of imbalances that result from rapid growth may be acceptable and even necessary in a growing economy.

But as the economy changes, the nature and extent of the imbalances change too, and it is inevitable that eventually the system forces a reversal of the imbalances. This is especially true in countries, like China, with highly centralized decision-making. In these countries the imbalances can be taken to extremes impossible in other countries, thus creating all the more pressure for a reversal of the imbalances.

This means that in China, if you can figure out how the growth model works and how the model generates imbalances and debt, you can pretty much figure out logically, albeit fairly broadly, the various paths that the country must follow in order the reverse the imbalances.

Pettis, I believe correctly, argues China at this stage of development (and given the global backdrop) has two options: 1) sharp slowdown in GDP growth, or 2) continued unsustainable increase in debt.

Some implications of hiding the bad debt in China, according to Prof. Pettis:

1. China’s GDP may be overstated by as much as 20-30%.
2. Productivity numbers are biased upwards.
3. Losses rolled over do not just disappear [there are real implications even in a command-control economy.]
4. Effective transfer of this bad debt has fallen on the household sector; it reduces their consumption [which is the sector vital in making the transition to a more balanced economy.]
5. Bad debt must be assigned somewhere; socializing debt does not change this.
6. When debt stops being hidden, which seems part and parcel to real financial reform in China, GDP growth will become biased downward.
7. Three places China can assign the bad debt: households, business, or government.
8. Assigning debt and slowing GDP does not necessarily lead to crisis.  If the household sector is not assigned, income will grow despite a lower GDP.  Rising household income equals a stable social environment and aids the transition to more healthy domestic demand.

Thus, it seems likely sooner rather than later China’s GDP growth will decelerate faster than is now expected.  And though this may be a healthy change for China as malinvestment is reduced, it will likely not be a healthy change for its raw-material satellite country, aka Australia. 

This resource demand aspect of the China story triggered by rising debt and overinvestment, which to reiterate doesn’t necessarily lead to crisis for China, is the a big part of why I expect the Aussie to grind lower in the months ahead (which would be quite welcomed by the Australian central bank by the way).  Here is our weekly chart view for the Aussie possibly heading to the low 80’s:

If you would like to sample our forex service, I will set you up for a two week trial and you can see more of what we do and determine if Black Swan Forex could be a resource to help you make real money in the currency market.

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Jack Crooks

President, Black Swan Capital

www.blackswantrading.com

info@blackswantrading.com

Twitter: @bswancap

Today, the U.S. dollar declined to a fresh five-and-a-half month low against its Canadian counterpart as yesterday’s disappointing U.S. gross domestic product data continued to weigh. With this downswing USD/CAD dropped to key support lines. Will they withstand the selling pressure?

USD/CAD

On Friday, we wrote the following:

(…) USD/CAD declined below the 23.6% Fibonacci retracement, the 2010 high and more importantly, under the lower border of the consolidation. Taking this bearish event into account, we think that the pair will extend losses and test the strength of the previously-broken long-term red support line (currently around 1.0700).

‘Click image for larger chart

As you see on the above chart, currency bears realized the above-mentioned scenario as USD/CAD reached its downside target. On one hand, if this strong support line encourage forex traders to push the buy button, we will see a corrective upswing in the coming week. On the other hand, if the major support is broken, we may see further deterioration and a drop to around 1.0645 where the 38.2% Fibonacci retracement is.

Having discussed the above, let’s move on to the daily chart.

Click image for larger chart

In our last commentary on this currency pair, we wrote the following:

(…) USD/CAD moved lower once again and almost reached its downside target, hitting an intraday low of 1.0716. (…) although the pair rebounded slightly and came back above the 50% Fibonacci retracement, it still remains below the lower border of the declining wedge (marked with brown). This is a bearish signal, (…) and (…) as long as the pair remains under its resistance, another attempt to move lower can’t be ruled out.

From this perspective, we see that the exchange rate reached its downside target, declining to 1.0710, where the size of the downswing corresponds to the height of the consolidation. If this support holds we’ll likely see a rebound to the previously broken lower border of the declining wedge. However, if this area is broken, the next downside target will be around 1.0600, where the 61.8% Fibonacci retracement (based on the Sept.-March rally) is.

Very short-term outlook: bearish
Short-term outlook: bearish
MT outlook: mixed
LT outlook: bearish

Trading position (short-term): In our opinion no positions are justified from the risk/reward perspective at the moment.

EUR/USD

The situation in the medium term hasn’t changed much as EUR/USD is still trading in the consolidation between the support zone (created by the 38.2% Fibonacci retracement and last week’s low) and the June high, which is slightly below the long-term declining line at the moment. What can we infer from the very short-term chart?

Click image for larger chart

Quoting our last Forex Trading Alert:

(…) slightly above the recent highs is the 200-day moving average, which successfully stopped further improvement on Thursday. Therefore, even if the exchange rate moves higher, it seems to us that history will repeat itself and we’ll see a pullback (especially when we factor in the proximity to the 50-day moving average and a sell signal generated by the Stochastic Oscillator). If this is the case, the initial downside target will be Friday’s low and if it is broken we’ll see another try to reach the upper line of the declining wedge.

As you see on the above chart, currency bears realized the above-mentioned scenario partly as EUR/USD reversed and declined sharply after an increase to the 200- and 50-day moving averages. With this downswing, the exchange rate invalidated a small breakout above the upper line of the consolidation, which suggests that we may see further deterioration and a drop to the lower border of this formation (especially when we take into account sell signals generated by the CCI and Stochastic Oscillator). Please note that even if the exchange rate moves higher once again, it seems to us that the strong resistance zone created by both moving averages will be strong enough to stop further gains in the nearest future.

Very short-term outlook: mixed
Short-term outlook: bearish
MT outlook: bearish
LT outlook: bearish

Trading position (short-term): In our opinion no positions are justified from the risk/reward perspective at the moment.

AUD/USD

The situation in the medium term hasn’t change much. Today, we’ll focus only on the very short-term changes.

Click image for larger chart

Looking at the daily chart, we see that although AUD/USD moved higher, the medium-term resistance line successfully stopped further improvement, triggering a downswing. From this perspective, it seems to us that the nearest downside target will be the support line based on the June 3 and June 18 lows. If it holds, we’ll see another attempt to break above the major resistance. However if it is broken, the next downside target will be around 0.9341, where the red declining support line is. Please note that we are still convinced that even if the pair move higher from here, the combination of the resistance zone and the green support line will be strong enough to stop currency bulls.

Very short-term outlook: mixed with bearish bias
Short-term outlook: mixed
MT outlook: bearish
LT outlook: bearish

Trading position (short-term): In our opinion no positions are justified from the risk/reward perspective at the moment.

EUR/USD: none
GBP/USD: none
USD/JPY: none
USD/CAD: none
USD/CHF: none
AUD/USD: none

Thank you.