Plummeting Oil Prices Could Destroy The Banks That Are Holding Trillions In Commodity Derivatives

Could rapidly falling oil prices trigger a nightmare scenario for the commodity derivatives market?  The big Wall Street banks did not expect plunging home prices to cause a mortgage-backed securities implosion back in 2008, and their models did not anticipate a decline in the price of oil by more than 40 dollars in less than six months this time either.  If the price of oil stays at this level or goes down even more, someone out there is going to have to absorb some absolutely massive losses.  In some cases, the losses will be absorbed by oil producers, but many of the big players in the industry have already locked in high prices for their oil next year through derivatives contracts.  The companies enter into these derivatives contracts for a couple of reasons.  Number one, many lenders do not want to give them any money unless they can show that they have locked in a price for their oil that is higher than the cost of production.  Secondly, derivatives contracts protect the profits of oil producers from dramatic swings in the marketplace.  These dramatic swings rarely happen, but when they do they can be absolutely crippling.  So the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now.  But who is on the other end of those contracts?  In many cases, it is the big Wall Street banks, and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.

It has been estimated that the six largest “too big to fail” banks control $3.9 trillion in commodity derivatives contracts.  And a very large chunk of that amount is made up of oil derivatives.

By the middle of next year, we could be facing a situation where many of these oil producers have locked in a price of 90 or 100 dollars a barrel on their oil but the price has fallen to about 50 dollars a barrel.

In such a case, the losses for those on the wrong end of the derivatives contracts would be astronomical.

At this point, some of the biggest players in the shale oil industry have already locked in high prices for most of their oil for the coming year.  The following is an excerpt from a recent article by Ambrose Evans-Pritchard…

US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015. 

Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production.

So they are protected to a very large degree.  It is those that are on the losing end of those contracts that are going to get burned.

Of course not all shale oil producers protected themselves.  Those that didn’t are in danger of going under.

For example, Continental Resources cashed out approximately 4 billion dollars in hedges about a month ago in a gamble that oil prices would go back up.  Instead, they just kept falling, so now this company is likely headed for some rough financial times…

Continental Resources (CLR.N), the pioneering U.S. driller that bet big on North Dakota’s Bakken shale patch when its rivals were looking abroad, is once again flying in the face of convention: cashing out some $4 billion worth of hedges in a huge gamble that oil prices will rebound. 

Late on Tuesday, the company run by Harold Hamm, the Oklahoma wildcatter who once sued OPEC, said it had opted to take profits on more than 31 million barrels worth of U.S. and Brent crude oil hedges for 2015 and 2016, plus as much as 8 million barrels’ worth of outstanding positions over the rest of 2014, netting a $433 million extra profit for the fourth quarter. Based on its third quarter production of about 128,000 barrels per day (bpd) of crude, its hedges for next year would have covered nearly two-thirds of its oil production.

Oops.

When things are nice and stable, the derivatives marketplace works quite well most of the time.

But when there is a “black swan event” such as a dramatic swing in the price of oil, it can create really big winners and really big losers.

And no matter how complicated these derivatives become, and no matter how many times you transfer risk, you can never make these bets truly safe.  The following is from a recent article by Charles Hugh Smith…

Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.

Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on. 

This illusory vanishing act hasn’t made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes. 

The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.

In recent years, Wall Street has been transformed into the largest casino in the history of the world.

Most of the time the big banks are very careful to make sure that they come out on top, but this time their house of cards may come toppling down on top of them.

If you think that this is good news, you should keep in mind that if they collapse it virtually guarantees a full-blown economic meltdown.  The following is an extended excerpt from one of my previous articles…

For those looking forward to the day when these mammoth banks will collapse, you need to keep in mind that when they do go down the entire system is going to utterly fall apart.

At this point our economic system is so completely dependent on these banks that there is no way that it can function without them.

It is like a patient with an extremely advanced case of cancer.

Doctors can try to kill the cancer, but it is almost inevitable that the patient will die in the process.
The same thing could be said about our relationship with the “too big to fail” banks.  If they fail, so do the rest of us.

We were told that something would be done about the “too big to fail” problem after the last crisis, but it never happened.

In fact, as I have written about previously, the “too big to fail” banks have collectively gotten 37 percent larger since the last recession.

At this point, the five largest banks in the country account for 42 percent of all loans in the United States, and the six largest banks control 67 percent of all banking assets.

If those banks were to disappear tomorrow, we would not have much of an economy left.

Our entire economy is based on the flow of credit.  And all of that debt comes from the banks.  That is why it has been so dangerous for us to become so deeply dependent on them.  Without their loans, the entire country could soon resemble White Flint Mall near Washington D.C….

It was once a hubbub of activity, where shoppers would snap up seasonal steals and teens would hang out to ‘look cool’. 

But now White Flint Mall in Bethesda, Maryland – which opened its doors in March 1977 – looks like a modern-day mausoleum with just two tenants remaining. 

Photographs taken inside the 874,000-square-foot complex show spotless faux marble floors, empty escalators and stationary elevators. 

Only a couple of cars can be seen in the parking lot, where well-tended shrubbery appears to be the only thing alive.

I keep on saying it, and I will keep on saying it until it happens.  We are heading for a derivatives crisis unlike anything that we have ever seen.  It is going to make the financial meltdown of 2008 look like a walk in the park.

Our politicians promised that they would do something about the “too big to fail” banks and the out of control gambling on Wall Street, but they didn’t.

Now a day of reckoning is rapidly approaching, and it is going to horrify the entire planet.

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5 Complete Lies About America's New $18 Trillion Debt Level

On October 22, 1981, the government of the United States of America accumulated an astounding $1 TRILLION in debt.

At that point, it had taken the country 74,984 days (more than 205 years) to accumulate its first trillion in debt.

It would take less than five years to accumulate its second trillion.

And as the US government just hit $18 trillion in debt on Friday afternoon, it has taken a measly 403 days to accumulate its most recent trillion.

There’s so much misinformation and propaganda about this; let’s examine some of the biggest lies out there about the US debt:

1) “They can get it under control.”

What a massive lie. Politicians have been saying for decades that they’re going to cut spending and get the debt under control.

FACT: The last time the US debt actually decreased from one fiscal year to the next was back in 1957 during the EISENHOWER administration.

FACT: For the last several years, the US government has been spending roughly 90% of its ENTIRE tax revenue just to pay for mandatory entitlement programs and interest on the debt.

This leaves almost nothing for practically everything else we think of as government.

2) “The debt doesn’t matter because we owe it to ourselves.”

This is probably the biggest lie of all. Two of the Social Security trust funds alone (OASI and DI) own $2.72 trillion of US debt.

The federal government owes this money to current and future beneficiaries of those trust funds, i.e. EVERY SINGLE US CITIZEN ALIVE.

I fail to see the silver lining here. How is it somehow ‘better’ if the government defaults on its citizens as opposed to, say, banks?

3) “They can always ‘selectively default’ on the debt”

Another lie. People think that the US government can pick and choose who it pays.

They could make a bing stink about China, for example, and then choose to default on the $2 trillion in debt that’s owed to the Chinese.

Nice try. But this would rock global financial markets and destroy whatever tiny shred of credibility the US still has.

Others have suggested that the government could selectively default on the Federal Reserve (which owns $2.46 trillion of US debt).

Again, possible. But given that the Fed (the issuer of the US dollar) would become immediately insolvent, the resulting currency crisis would be completely disastrous.

4) “It’s the NET debt that’s important”

Analysts often pay attention to a country’s “net debt” instead of its gross debt. If you have a million bucks in debt, and a million bucks in cash, then your ‘net debt’ is zero. It washes out.

Problem is, the US government doesn’t have any cash. The Treasury Department opened its business day on Friday morning with just $71.9 billion in cash, or just 0.39% of its total debt level.

Apple has more money than that.

5) “They can fix it by raising taxes”

No they can’t. Just look at the numbers. Since the end of World War II, US government tax revenue has consistently been roughly 17% of GDP.

They can raise tax rates, but it doesn’t move the needle in terms of revenue as a percentage of GDP.
In other words, the government’s ‘slice of the pie’ is pretty consistent.

You’d think with this obvious data that, rather than try to increase tax rates (ineffective), they’d do everything they can to help make a bigger pie.

Or better yet, just leave everyone the hell alone so we’re free to bake as much as we can.

But no. They have to regulate every aspect of people’s existence: How you are allowed to educate your children. What you can/cannot put in your body. How much interest you are entitled to receive on your savings.

All of this costs time, money, and efficiency. So do never-ending wars. The bombs. The drones. The airstrikes.

This isn’t about any single person or President. The problem is with the system itself.

History shows that every leading superpower from the past almost invariably fell to the same fate.
Great powers often feel that their wealth and success entitles them to spend recklessly and wage endless, arrogant wars. The Romans. The Ottoman Empire. The British.

History may not repeat but it certainly rhymes. And the lesson here is very clear: debt weakens a nation. It weakens a society.

Generations that will not even be born for decades will inherit these debts by complete accident of birth.

And the people in charge of the system have backed themselves into a corner where there is no way out other than to default– either on their creditors (creating a global financial crisis), the central bank (creating a currency crisis), or on the citizens themselves (creating an epic social crisis).

Bottom line: this is not a consequence-free environment. And while you can’t fix the debt problem, you can certainly reduce your own exposure to what happens next.

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Reuters Discovers the Great Convergence of Global Stock Market Stimulation

Stock markets set to take off as Europe, Asia abandon austerity ... The Great Divergence is a term coined by economic historians to explain the sudden acceleration of growth and technology in Europe from the 16th century onward, while other civilizations such as China, India, Japan and Persia remained in their pre-modern state. This phrase has recently acquired a very different meaning, however, more relevant to global economic and financial conditions today ... Far more important than a likely difference next year of a quarter or half a percentage point between short-term interest rates on both sides of the Atlantic, though, is the convergence of economic philosophies and objectives for the first time since the 2008 economic crisis. In the past two months, Japan, Europe and China all moved toward further aggressive monetary stimulus and reversed previous commitments to fiscal austerity. – Reuters 

Dominant Social Theme: Stock markets are value-based environments that go up when economies rev. 

Free-Market Analysis: This Reuters article states clearly what we've been pointed out in our Wall Street Party meme: It's not just a US phenomenon. 

 We noted this as quantitative easing began several years ago in the US. The EU, too, was stimulating European economies at the time as best it could, especially Southern European ones. China meanwhile printed massive amounts of money to counteract the 2008 crisis, and then continued to do so even after officials said monetary policy had turned less aggressive. 

Eventually Japan joined in with Abenomics, which was a form of the same Keynesian economics being applied in the US and Europe. Thus, the world's major economies for the most part were harmonized, and that harmony was constructed around printing billions and trillions of dollars. 

Reuters has now observed the same phenomenon. 

The important trends today, especially after October policy changes in Japan and Europe, are not divergence but convergence. 

This Great Convergence of macroeconomic policies between the United States and the rest of the world will drive financial markets and dominate business conditions in the year ahead. It is not yet reflected, however, in asset prices or market trends. Investors continue to obsess about the tiny gap that may or may not open up between U.S. and European policies sometime next year, when the Fed starts gently raising interest rates. 

Though it is true that these global policy shifts coincided with the end of the Fed's quantitative-easing program, this accident of timing does not imply that the United States is diverging from Europe and Asia. What is really happening is that Europe and Asia are finally — and reluctantly — following Washington's road map out of the Great Recession. 

In the eurozone, Britain and China, hawkish central bankers have been silenced and monetary policy has been reset for full-scale stimulus — most recently by the European Central Bank, which has belatedly accepted the principle of U.S.-style quantitative easing. In Japan, where money-printing presses were already running at full throttle, they have speeded up even more. 

... The upshot is that every advanced economy is now following broadly the same macroeconomic policies as the United States: maximal monetary stimulus combined with fiscal neutrality and the suspension of counterproductive budget rules. 

Assuming that Europe and Japan continue to pursue with conviction these Washington-style expansionary policies, they should eventually achieve similar results — gradual improvements in employment and financial conditions, powered by faster economic growth. This trend was confirmed in the United States again this week by the upward revision of 3rd-quarter gross domestic product growth to 3.9 percent. 

While agreeing with the thrust of the Reuters article, we "diverge" when it comes to this last paragraph. Whatever so-called improvements are generated by monetary stimulation will be neither longlasting nor fundamental. 

Instead, like the tech boom of the 1990s or the low-end mortgage boom of the early 2000s, the gains made economically or in stock averages will surely, eventually, be given back, at least in large part. The mainstream media will begin to debate about various bubbles and then the discussion will proceed, futilely as always, to who is to blame. 

The kind of bubble economy that is present around the world today is extremely wasteful and prone to destructive consolidations of power and wealth. Printing more money can certainly stimulate industry but the stimulation will generate products and services that will be seen sooner or later as in part unnecessary or over-expanded. 

This is, of course, a description of the modern business cycle itself. Over-printing money causes tremendous booms and busts and we've seen two of them occur in the past 15 years, first in 2001 and then in 2008. 

We've also predicted that the current harmonizing of countries and monetary policy will eventually create an extraordinary financial disaster ... though not yet. But the Wall Street Party we've been writing about is going to lapse at some point and when it does the unraveling could be significant indeed. 

In the meantime, this sort of harmonization may well drive markets around the world to new heights. Monetary stimulation's main impact, in fact, is usually on securitized assets. The Reuters article recognizes this possibility: 

Stock markets around the world would start to perform better than Wall Street if investors became convinced that Europe, Japan and China were as committed as Washington is to expansionary policies. The first signs of this sentiment shift could be detected in Japan, after Abe's reflationary measures in late October, and in China, after the surprise monetary easing last week. If ECB President Mario Draghi can convince investors that he has political support for aggressive monetary stimulus, European equities could also start to outperform. 

This is all fairly transparent, is it not? We're supposed to believe that stock markets are indicators of prosperity but the current upturn is an orchestrated one that began in the US with low rates and regulatory revisions that supported investor activity, especially when it came to IPOs. 

Now the orchestration is spreading around the world and a new meme is being developed: The current market upsurge is just beginning. 

This is a typical VESTS conundrum. Does one trust one's eyes and ears when it comes to this ongoing market upsurge or does one accept that those who are orchestrating this rise are in control of it, at least for the near term? 

We've suggested that fighting the trend may be futile, for now at least, if one wants to participate in profits that continue to be made. Prudent hedging, diversification and a concentration on certain equities and IPOs may be one way to play this equity surge ... bearing in mind that the market is at heights that can precipitate a significant downturn. 

But what we see in terms of memes and market manipulation leads us to suspect that there are immensely powerful forces committed to continued market gains. The real question is not whether this bias exists but for how long it can play out. 

Higher averages need not lull the senses. Instead, if you wish, approach the market in a prudent way. A disciplined strategy is called for and a commitment to participate within the context of an "exit" plan. 

Conclusion But this market could continue it seems for another year or two, or perhaps longer, hard as that is to fathom. And then again, well ... perhaps it won't. But the meme that is being constructed seems to focus on the longer term. That's something to consider within a larger VESTS construct. 

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Guess What Happened The Last Time The Price Of Oil Crashed Like This?…

There has only been one other time in history when the price of oil has crashed by more than 40 dollars in less than 6 months.  The last time this happened was during the second half of 2008, and the beginning of that oil price crash preceded the great financial collapse that happened later that year by several months.  Well, now it is happening again, but this time the stakes are even higher.  When the price of oil falls dramatically, that is a sign that economic activity is slowing down.  It can also have a tremendously destabilizing affect on financial markets.  As you will read about below, energy companies now account for approximately 20 percent of the junk bond market.  And a junk bond implosion is usually a signal that a major stock market crash is on the way.  So if you are looking for a “canary in the coal mine”, keep your eye on the performance of energy junk bonds.  If they begin to collapse, that is a sign that all hell is about to break loose on Wall Street.

It would be difficult to overstate the importance of the shale oil boom to the U.S. economy.  Thanks to this boom, the United States has become the largest oil producer on the entire planet.

Yes, the U.S. now actually produces more oil than either Saudi Arabia or Russia.  This “revolution” has resulted in the creation of  millions of jobs since the last recession, and it has been one of the key factors that has kept the percentage of Americans that are employed fairly stable.

Unfortunately, the shale oil boom is coming to an abrupt end.  As a recent Vox article discussed, OPEC has essentially declared a price war on U.S. shale oil producers…

For all intents and purposes, OPEC is now engaged in a “price war” with the United States. What that means is that it’s very cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. The result? Oil prices will stabilize and OPEC maintains its market share.

If the price of oil stays at this level or continues falling, we will see a significant number of U.S. shale oil companies go out of business and large numbers of jobs will be lost.  The Saudis know how to play hardball, and they are absolutely ruthless.  In fact, we have seen this kind of scenario happen before…

Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.” Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.” This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986.

But the energy sector has been one of the only bright spots for the U.S. economy in recent years.  If this sector starts collapsing, it is going to have a dramatic negative impact on our economic outlook.  For example, just consider the following numbers from a recent Business Insider article…

Specifically, if prices get too low, then energy companies won’t be able to cover the cost of production in the US. This spending by energy companies, also known as capital expenditures, is responsible for a lot of jobs. 

“The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,” Goldman Sachs’ Amanda Sneider writes.

Even more troubling is what this could mean for the financial markets.

As I mentioned above, energy companies now account for close to 20 percent of the entire junk bond market.  As those companies start to fail and those bonds start to go bad, that is going to hit our major banks really hard…

Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis. 

Why could that happen? 

Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.

It would be hard to overstate the seriousness of what the markets could potentially be facing.

One analyst summed it up to CNBC this way…

“This is the one thing I’ve seen over and over again,” said Larry McDonald, head of U.S strategy at Newedge USA’s macro group. “When high yield underperforms equity, a major credit event occurs. It’s the canary in the coal mine.“

The last time junk bonds collapsed, a major stock market crash followed fairly rapidly.
And those that were hardest hit were the big Wall Street banks…

During the last high-yield collapse, which centered around debt tied to the housing sector, Citigroup lost 63 percent of its value in the following 60 days, Kensho shows. Bank of America was cut in half.

I understand that some of this information is too technical for a lot of people, but the bottom line is this…

Watch junk bonds.  When they start crashing it is a sign that a major stock market collapse is right at the door.

At this point, even the mainstream media is warning about this.  Just consider the following excerpt from a recent CNN article…

That swing away from junk bonds often happens shortly before stock market downturns. 

“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report. 

Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.

If you have been waiting for the next major financial collapse, what you have just read in this article indicates that it is now closer than it has ever been.

Over the coming weeks, keep your eye on the price of oil, keep your eye on the junk bond market and keep your eye on the big banks.

Trouble is brewing, and nobody is quite sure exactly what comes next.

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Mainstream Media Negativity On Swiss Gold Referendum Conceals the Truth

Gold prices may surge if Swiss vote on reserves passes ... Global gold prices may surge in the coming week if Swiss voters approve a controversial measure that would force their country's central bank to keep at least a fifth of its assets in gold. If the referendum Sunday passes and the Swiss government is forced to start beefing up its reserves, the price of gold could jump to more than $1,350 an ounce — an increase of 18%, Bank of America predicts ... – USA Today 

Dominant Social Theme: This referendum won't pass. The Swiss are too smart to approve it. 

Free-Market Analysis: USA Today has weighed in on the upcoming gold referendum in Switzerland with a predictable anti-gold article. 

In fact, the anti-gold tone when it comes to the mainstream media is overwhelming. Central bankers hate the yellow metal because it restricts their freedom to manipulate fiat currency as they choose – and the media reflects this prejudice. 

There are many reasons to believe the plight of gold is not so grave as it is being made out to be, but you wouldn't know that from the USA Today article, or other recent ones in the mainstream media. 

The paper reminds us that the latest poll, now a week old, by Swiss Television and the GFS Institute showed 38% in favor of the referendum, 47% opposed and 15% undecided. These numbers are actually lower than those in previous polls. ZeroHedge provides a more detailed breakout, as follows: 

The poll shows that in Italian speaking areas, the yes vote was actually ahead with 47% in favour, versus 28% against. In the German speaking region, the results were 40% yes versus 50% no, while in the French speaking region it was 29% yes versus 41% no. The 'Undecided' were a low 10% in the relatively decisive German speaking region, 24% in the Italian region, and a significant 30% in the relatively indecisive French speaking region. 

Importantly, support for the gold referendum diminished after the Swiss National Bank made statements indicating that holding so much gold with no ability to sell it would severely limit the flexibility of monetary policy. 

Here's more from the article:

 ... Investors apparently are not too bullish about the referendum passing, as gold prices have risen less than 5% in the last few weeks. 

Still, Sunday's vote is setting off alarm bells within the Swiss parliament and among business groups. They argue that forcing the central bank to stockpile gold it cannot sell would diminish the bank's ability to set monetary policy and react quickly to changes in the market. In recent years, for instance, the central bank had printed 400 billion Swiss francs ($412 billion), deflating its value against the euro and capping the exchange rate below 1.20 francs ($1.24) to the euro. 

The central bank took that step to protect Switzerland's economy from the European debt crisis and boost its exports to the European Union, but the Swiss People's Party has been critical of the move. "To tie the franc to a weak currency like the euro and a weak economic area like the Eurozone is a recipe for disaster," the party claims on its website. 

Backing up the currency with increased gold reserves, the group argues, would keep the franc strong and the Swiss economy impervious to global financial crises. 

Some analysts counter that a law requiring increased and unmovable gold reserves might have a negative effect on the currency market and the economy in general. "The (central bank) will think twice about buying unlimited amounts of foreign currencies in order to keep its cap for the euro at 1.20 francs," says Teodoro Cocca, professor at Swiss Finance Institute in Zurich. "Most likely, the cap would have to be lifted, the franc will appreciate, and that would be a burden for Swiss exports." 

Always, we learn that a strong currency is a hindrance to national economic health. In fact, this doesn't seem to make a lot of sense. A strong currency would attract investment and that in turn would create additional industry for the country in question. 

Could the additional industry sell goods and services abroad? Probably so. The market itself would adapt to higher prices and strategies to lower those prices would be pursued. The net effect of a strong currency might be increased by industrial might and prosperity not national penury. 

These are perhaps academic arguments, but the reality is that at some point central bankers may have to get used to a resurgence in the yellow metal, given continued demand. 

In fact, the negativity of the mainstream media is concealing some interesting developments. Over at Sprott Money, as posted at ZeroHedge, we find the following article, entitled, "Global Gold Demand Will Overwhelm the Manipulators." 

The article makes the startling point that the European Central Bank may become a net buyer of gold: 

Western central banks know that they need to massively increase inflation. This is the only way in which they can alleviate the huge debt levels that have been accumulated by their misguided wars and spending. 

To help assist in increasing this inflation the ECB has indicated that it may begin acquiring gold, shares and ETF's. This news comes as a shock to many, given the ECB's previous resistance to all things gold and the fact that their fiat currencies are in direct competition with the yellow metal. 

The article also summarizes current gold demand worldwide, something we have reported on several occasions. 

No longer are people fooled by the paper price of precious metals. Premiums have remained relatively high through this price correction and demand has been so intense, that the US Mint was forced to cease sales of their ever-popular Silver American Eagles. 

Nation states, such as China and Russia are well known for their affinity to gold and have also continued their accumulation of precious metals. Russia, which officially became the fifth largest holder of gold recently, announced that it has once again increased their gold reserves by another 150 additional tonnes in 2014. An increase of 8.4% year over year. 

The demand from China, Russia and India are well known, but now a previous seller of gold products could be entering the arena. The ECB, a long time disbeliever in precious metals is currently battling stubbornly low inflation and may be forced into a very unconventional strategy. 

The current price of the dollar against gold is a mystery considering worldwide demand – one that has given rise to predictable charges of manipulation. Price anomalies are rife; demand seems to exceed supply despite a surging dollar price against gold. Even the Sprott article doesn't mention the inability of German officials to repatriate gold from US safekeeping. 

When the Swiss referendum doesn't pass – and it seems likely not to – we will no doubt be treated to more negativity regarding gold and its place in the modern economy. But as the Sprott article points out, gold remains a historical and established international money. 

The idea that gold and silver, too, are outdated barbaric metals has already proven to be questionable, given gold's ascension to US$2,000 an ounce not so long ago. But there are so many stresses and strains on the current global fiat system that we wonder along with Sprott how long the dollar can be propped up against either metal. 

Sooner or later, the value of these metals will see another resurgence. Of course, we don't know when that will be. But we do know the mainstream media is not telling the truth about gold's role in the world, nor about the demand for gold and silver worldwide. 

Conclusion The failure of the Swiss referendum may constitute another opportunity to bash gold and "gold bugs" but such observations will be facile ones. The truth is a good deal more powerful: Gold is a historical money and in all likelihood will remain so, no matter endless negative reports in Western media. 

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Presenting Bubbleology: The Science Of Bubble Money

On the 12th November 2014 - some 10 years after it was launched - lander module Philae which accompanied the Rosetta spacecraft touched down on Comet 67P/Churyumov-Gerasimenko (67P) to begin extra-terrestrial scientific observations. The on-board telemetry communicated back to Earth some 28 light-minutes away revealed that the lander had bounced twice off the surface of 67P. The first bounce may have lasted two hours and over 1 kilometre and is considered the largest space bounce in history which we would put it on a par with the incredible bounces in the US and Japanese stock markets this past month!

Back here on Earth Japanese monetary policy has similarly taken a giant leap forward for mankind by conducting its own scientific experiment. On the 31st October 2014 Bank of Japan Governor Kuroda-san implemented an addition to his ‘Qualitative & Quantitative Easing’ (QQE) policy begun a year ago. The surprise event was less the timing and magnitude but the clear brazen coordination of monetary and fiscal policy using the conduit of the Japanese Government Pension Fund to implement it. The QQE drove stock markets into a frenzied rally.

Central banks have been conducting a seemingly coordinated financial program of unconventional monetary policy – assuringly scientific in its nomenclature of QE and QQE – media commentators marvel at the boldness (stupidity) of policymakers ‘to go forth where no man has gone before’ and eradicate the spectre of debt deflation.

Policymakers have been studying and implementing ‘Bubbleology’ – the science of bubble money. The impact of this earthly science on both economies and financial markets has been truly dismal. It is clear it is creating a divergence between economic and financial reality.

Far from eradicating the perils of debt deflation it is clear this program has merely initiated more fiscal and private sector balance sheet irresponsibility, as both continue to lever up. The capital (‘near money’) allocation of such leverage has resulted in rising asset classes, primarily housing stock, equity and bonds where the pursuit of yield has ignored all credit risk sensibilities. All this has occurred at the expense of daily living standards and the misdirection of capital.

We are witnessing the continuation and completion of the financialization of our economies and markets which began at the instigation of governments and central bankers in the years leading up to the 2008 crisis. There is no attempt to foster sustainable capital and income through innovation and production which ultimately drives healthy employment. Rather financialization of asset classes driving elevated prices which creates an inequality of wealth, albeit illusionary wealth. Land, housing stock and excessive equity price growth in reality drains productivity away from entrepreneurship and the employment which enables sustainable taxable income for nations to run prudent fiscal surpluses.

We are in the butterfly vortex of a momentary illusion of ‘hyperinflated’ wealth - for the value of money is sinking rapidly - destroying the purchasing power of the global majority. Markets have a memory and from the first moment central banks expanded their balance sheets the flap of Lorenz’s wing has cast a shadow over financial and economic stability. In this HindeSight I endeavour to highlight where the echoes of monetary history are manifesting themselves in systemic risk across the globe.

The Delicious Science of Bubble Money

About 15 years ago I went on a three week stint to Tokyo to cover the overnight US Treasury trading seat at Greenwich NatWest. I remember many cultural delights about that trip, not least of all the clubs and hostess bars of Roppongi! But one of my abiding memories was Bubble Tea. I was addicted to it but other than the side-effects of a sugary rush it’s fair to say this was perhaps a less troublesome elixir for a young single gaijin and one with a rather large company expense account at that.

Bubble Tea, also known as 'pearl milk tea' actually originates from Taiwan. It is essentially a tea mix of your choice infused with rich creamer served cold with natural large, chewy tapioca balls which you suck up through a big fat straw. The term bubble is an anglicized derivation from the Chinese word 'boba' which itself refers to the 'large' tapioca balls or pearls.

Fast forward 15 years and whilst meandering around London I saw a bunch of neon Bubbleology signs. Turns out they are Bubble Tea shops and they practice the ‘science of bubble tea’ making. Imagine my joy. I have finally been reunited with my favourite beverage on my home soil.

In an era of serial financial bubble blowing I thought to myself how apt to use this name to refer to central bank money printing on account of its clear ability to create one asset bubble after another with rich infusions of money.

So Bubbleology – the new ‘delicious science of bubble money’ - looks to serve grateful market participants with rich creamy rushes of infused tea, intravenously administered through the conduits of repressed and fiscally dominated financial institutions.

Every central bank has its own set of magical ingredients. The BoJ administers a rich elixir of ‘Macha Bubble Money’ adding more creamer to every new infusion by which to keep the Pavlovian market salivating. The FED and BoE offer their own special potion of ‘English Breakfast Money’ superbly rich in its enunciation, crisp and firm on the pallet, whilst the PBOC offers up a soothing medication of ‘Oolong-some Bubble Money’. The ECB version, however, is somewhat more fruity and zesty in its consistency - more Tapioca ‘Money Balls’ than bubbles – well, at least for now.

Monetary Echoes, Memories & Markets

Greenspan was the maestro of bubble money science and presided over almost two decades of monetary bubble infusions in an attempt to save us from perceived threats of dastardly deflation. Except a decade ago the debt levels were trivial in comparison with what exists today. Greenspan initiated the largest global bubble money experiment on earth being implemented on Earth today. It is risible to me that he now promotes ‘gold’ – the ultimate anti-bubble money asset.

It is the echoes of this monetary history which reverberates strongly today creating a seemingly stable equilibrium of economic and financial asset growth. Nothing could be further from reality.

Markets have a memory effect whereby future price movements have a higher probability of repeating recent behaviour than would otherwise be suggested by a purely random process. At the moment I believe market behaviour is a reverberation of the memory of past credit cycles propagated by central bankers who never fully allowed the cycles to complete from boom to bust. So the cycle heights either run higher and/or longer until such time as no amount of credit keeps the well-oiled financial markets rising and the economy ticking over.

This is a classic example of the law of diminishing returns - each new dollar printed exacts less and less return or output.

I have always intuitively believed that markets have significant order in their chaos and that we could predict this by looking at the relationship between credit cycles and market behaviour. I believe the inherent structure of a market carries a multitude of participants (economic agents) all with different rationale for making a purchase or a sale. Rational or irrational is in the eye of the beholder; what seems rational to one person may seem quite the opposite to another. Linear systems of econometrics that follow equilibria models do not allow for human action which is why the efficient market hypothesis has long been disproved.

This classic financial theory which assumes markets are efficient was first introduced by Louis Bachelier (mathematician) in the 1900s. The concept assumes that competition among a large number of rational investors eventually lead to equilibrium and the resulting equilibrium reflects the information content of past, present and even anticipated events. So an event of the magnitude of 19th October 1987 statistically should never occur if one were to subscribe to conventional financial wisdom. This was the day the Dow Jones Industrial Average plunged more than 20% in one day, an unlikely 20-standard deviation event whose probability of occurrence is less than one in ten to the 50th power. It is intuitive to me that the financial markets are one large consciousness - a conscious mind. The price and 'value' beliefs that are embedded in a market have a memory and a history based on decades of interconnected economic agents, all with different agendas, motivations and needs. Traders/ Investors think themselves largely independent souls but they are not. They are interconnected by a neural network, figuratively and actually both in the past and present which all impacts a future outcome in the markets.

Its rather analogous to a field of mushrooms which appear to be individual plants, when in fact they are a merely the temporary component of a fungal network, known as a mycelium, that exists underground all year round almost indefinitely.

What is increasingly evident is that market participants are increasingly embroiled in a reflexive relationship between central bank actions, guidance and price action. The more the market moves contrary to central bank desires – ie downwards - the more the central bank injects the bubble money and reassures markets with the promise of more infusions of its rich elixir. This reflexive behaviour has led to a mindset that extends beyond institutional traders and investors but to populations as a whole. We are observing a complete financialization of the global economy and markets by this mindset. The speculative mindset that my house is now my investment, that my 401K or pension pot is my productivity for the future or that oil is some kind of arcade game rather than a highly productive resource for our economy is accepted as normal behaviour. This is the behaviour of the maddening crowd.

An Austrian economic scholar and market participant quipped to me - "after six years and trillions of dollars of intervention, the only truly unconventional policies that remain are those which practice sound money, official inscrutability, and an approach which is a good deal less Hjalmar Schacht and a good deal more Adam Smith."

Although humorous, this is a deadly serious point to consider. As you will see from the economic charts in the following sections this enormous global experiment is not working. The overhang of too much debt and moribund growth continues to threaten national balance of payments and the well-being of populations.

Much more in the full presentation, including numerous pretty charts, which can be found here

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Who Will Wind Up Holding the Bag in the Shale Gas Bubble?

We’ve been writing off and on about how the sudden fall in gas prices has been expected to put a lot of shale gas development on hold. In fact, quite a few analysts believe that one of the big Saudi aims in refusing to support oil prices was to dent the prospects for competitive energy sources, not just renewables like wind and hydro power, but shale gas.

Even though OilPrice reported that US rig count had indeed fallen as oil prices plunged, John Dizard at the Financial Times (hat tip Scott) gives a more intriguing piece of the puzzle: the degree to which production is still chugging along despite it being uneconomical. The oil majors have been criticized for levering up to continue developing when it is cash-flow negative; they are presumably betting that prices will be much higher in short order.

But the same thing is happening further down the food chain, among players that don’t begin to have the deep pockets of the industry behemoths: many of them are still in “drill baby, drill” mode. Per Dizard:

Even long-time energy industry people cannot remember an overinvestment cycle lasting as long as the one in unconventional US resources. It is not just the hydrocarbon engineers who have created this bubble; there are the financial engineers who came up with new ways to pay for it.

And while the financial engineers will as always do just fine, lenders are another matter:

By now, though, there is an astonishing amount of debt that continues to build up on the smaller E&P companies’ balance sheets. According to Gavekal, the research group, even before the oil price plunge, aggregate debt-to-equity ratios in the smaller publicly traded energy companies are now at 93 per cent, up from around 70 per cent in 2012 and 2013, and around 50 per cent between 2005 and 2011. This in a highly cyclical industry that used to go through periodic banker-driven shakeouts and even bankruptcies.

One example is a KKR deal gone a cropper, Samson. As an aside, it is hard to think of an industry less suited to private equity investing than oil & gas development, since the companies have a great deal of operating leverage and the industry is highly cyclical. KKR apparently did not learn that lesson in bankruptcy of its giant energy play turned mega bankruptcy TXU. Or maybe it did. While the other lead investor in that deal, TPG, has had a hard time fundraising as a result of the TXU debacle, KKR has sailed on unscathed. This early November Reuters article describes how KKR is struggling to rescue this transaction*:

KKR & Co which led the acquisition of oil and gas producer Samson Resources Corp for $7.2 billion in 2011 and has already sold almost half its acreage to cope with lower energy prices, plans to sell its North Dakota Bakken oil deposit worth less than $500 million as part of an ongoing downsizing plan, according to people familiar with the matter. 

KKR, one of the world’s biggest private equity firms with $96 billion in assets under management, overpaid for Samson, and persistently low natural gas prices have hampered its ability to finance the company and added to its debt burden, the people said. KKR’s plan was to shift Samson’s assets from natural gas production more into oil and liquids. 

With U.S. crude oil futures down 25 percent since June, Samson has hired Bank of Nova Scotia (to sell the Bakken assets, and the company is contemplating more asset sales to raise cash, the people said, without specifying which other assets. 

In the medium-term, Samson may look at acquiring higher-income properties, turning to its private equity owners or external investors for financing, one of the people said.

KKR closed on Samson in November 2011. Industry experts believe one of the reasons they overpaid is they used conventional oil and gas models that showed much longer production lives for each well. Yet by spring of 2012, there were reports in conventional media about how shale gas wells have short production lives. So how could KKR have missed this issue?

In the new normal of lower energy prices, developers are apparently playing a game of chicken, hoping that competitors will cut production first. Dizard again:

Particularly in the gas and natural gas liquids drilling directed sector, every operator (and their financier) is waiting for every other operator to stop or slow their drilling programmes, so there can be some recovery in the supply-demand balance. I have been hearing a lot of buzz about cutbacks in drilling budgets for 2015, but we will not really know until the companies begin to report in January and February. Then we will find out if they really are cutting back, using their profits on in-the-money hedge programmes to keep their debt under control, and taking impairment charges on properties that did not really pay off. 

One gas-orientated industry man in Houston I know thinks that the banks are going to call a halt to the madness of permanent negative operating cash flows. “What is the timing of their borrowing base renegotiations (with the banks)? That is the most important thing; can they borrow more money?” If not, he believes drilling and producing on uneconomic terms will slow or stop, and with the high depletion rates of unconventional reserves, such as shale gas, supplies will fall and gas prices will rise.

In other words, if the industry doesn’t discipline itself, the money sources will. Or will it?

If the bankers reduce the borrowing base for the E&P companies, there could be a lot of private equity or high-yield investors with covenant-light deals to offer who might take their place. Not to mention cash-rich majors who would like to take the billions they can no longer put into Russia or Venezuela, who would not mind picking up more North American properties on the cheap.

Although Dizard does not discuss the downside directly, he sets forth a fact pattern that could lead to some ugly ends. US shale gas production needs to get to $6 per mBtu or more for players who aren’t very leveraged to get to break-even cash flow; they hope to make more two to three years after that on presumably higher prices.

But if super low interest rates keep money flowing into the shale bubble, another set of issues emerges: US production is set to considerably outstrip domestic uses:

So much gas is being developed in the Marcellus and Utica resources of the northeastern US that it really cannot be absorbed by the US market. Suzanne Minter, manager of oil and gas consulting at Bentek in Denver points out: “Over the next five years, daily production in the US is forecast to grow by more than 16bn cubic feet per day, with about 10bcf of that coming from the northeast. Of that, at least 8.5bcf has to be exported. Domestic demand does not grow enough.”

That means a lot of infrastructure like pipelines and storage facilities needs to be built. But that requires regulatory approvals and possibly government intervention. And even then, with US shale gas production projected by the IEA to peak in 2020 and fall slowly over the next decade, this extraction boom is nowhere near as durable as development of conventional oil has proven to be.

An additional question is whether investment in infrastructure will look attractive if fracking continues to be shown to have safety risks (water supply contamination, earthquakes). The New York Times just released an impressively-researched story on regulatory abuses in North Dakota. It does not make for pretty reading. And if Dizard is right, that bottom-fishers swoop in to pick up producers gone bust, headlines about bankruptcies and distress are not conducive to downstream development.

In other words, there’s a not-trivial possibility, as Dizard explains, that US production does not get throttled back much by falling oil prices, that the wall of money willing to invest in energy overcomes normal supply and demand factors. If that takes place, there could be a further leg down if US producers lack the capacity to send enough production overseas.

Now remember, Dizard already warned that smaller E&P players were already overlevered. Some, perhaps many, lenders will take losses. Private equity bottom fisher-wannabes will also come in using other people’s money. But cheaper doesn’t necessarily mean cheap enough. Recall all the sovereign wealth funds that took equity stakes in banks in 2007 thinking they had gotten a good deal.

A reader points out that this all feels a lot like the last oil boom gone bad. I’m old enough to remember how pretty much every bank in Texas was sold as a result (and that helped speed the liberalization of interstate banking, since no one in state had the wherewithall to act as a rescuer). Via e-mail:

This whole situation is very similar to the oil and gas boom of late 70′s and early 80′s. It was driven by letters of credit deals which were used to secure debt. A little bank called Penn Square Bank upstreamed those loans to Continental Illinois and Sea First in Seattle. All financed by debt and wells being drilled which were not economical. When the music stopped the debt came crumbling down taking down Continental and Sea First (two of the ten largest banks in the US) as well as many others. Many banks did not even know they were lending to oil and gas because they were lending on like real estate. Well when the oil and gas industry collapsed so did real estate. Practically every significant bank in Oklahoma and Texas failed due to this.

Is the Fed teeing up an even bigger energy boom and bust? Admittedly, several adverse scenarios have to play out in succession for the downside case to kick in. But the first one, of shale gas producers not cutting very much despite the plunge in energy prices, is already under way. One might peg the odds of a major levered energy bust at 20%. That’s still uncomfortably high for the amount of damage that would result.

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Global Business Outlook “Darkest Picture Since Financial Crisis”

The plunging price of oil since June has been a leading indicator: global economic growth is in trouble, despite six years of unprecedented central-bank free-money policies that caused asset prices to soar but has accomplished little else. This scenario has now been confirmed by businesses that help drive the economy forward – not by economists and Wall Street hype mongers: their outlook for the next 12 months has plummeted since June to the worst level since crisis year 2009.

Business leaders are an optimistic bunch. Projecting a 12-month period that is worse than the past 12 months is frowned upon; because business leaders are supposed to make their business grow, even when it looks tough out there. They’ve been optimistic over the years, despite multiple recessions in the Eurozone, a slowdown in China, a quagmire in Japan, and disappointing growth in the US, where “escape velocity,” dangled out in front of our noses for five years, has become a figment of Wall Street imagination. Throughout, business optimism has been fairly strong, according to Markit’s Global Business Outlook, a survey taken in February, June, and October.

But results from the October survey, released today, are a doozie. The number of businesses around the globe that expect activity to rise over the next 12 months exceeded the number expecting a decline by 28%, the worst in the survey history going back to 2009.

This “net balance” was down from 39% in June. The peak of global business optimism in the survey’s history was in February 2011, when the net balance hit 48%. Manufacturing wasn’t that much of a problem; optimism fell “only” to the level of June 2013. But in the all-important service sector, by far the largest sector in most economies, optimism plunged to the lowest level in the survey’s history.

It was all-around lousy. In the UK, where businesses were among the most upbeat, so to speak, optimism about future activity fell to the lowest level since June 2013. In the Eurozone, which has been battered by a series of apparently intractable problems, optimism dropped to the already low levels of June 2013. The big drags on optimism in the Eurozone were in the two largest economies, Germany and France.

In France, the number of businesses expecting activity to rise over the next 12 months exceeded the number expecting a decline by only 12.6%. This was the second worst net balance of all countries in the survey. These businesses were the only ones in the survey projecting on average a cut in staffing levels. The report described the mood as “gloomy.”

In Japan, optimism hit a two-year low and came to rest even below the low level in the Eurozone, as businesses “have become increasingly disillusioned” with Abenomics.

In the emerging economies, business expectations about future activity plunged to new lows. While optimism edged up in China, it was barely off the near-record low in June. In India, it stagnated at low levels. In Brazil, optimism fell to match the previous record low. And Russia, oh my!

Russian businesses have struggled with sanctions, the swooning ruble, the shrinking price of oil, high interest rates, and waning domestic demand. They’ve been cut off from crucial Western funding sources. And key partnerships with Western companies have been thrown into turmoil. So the number of Russian businesses expecting activity to rise exceeded the number expecting it to drop by a tiny 9.8% – the most pessimistic of any country in the survey.

But the biggest hit on a global scale came from the largest economy, the US. While manufacturing businesses showed a decline in optimism, the big problem was the far larger service sector.

The Flash Service PMI for November, released today, hammered home the point: service sector growth slowed with nerve-wrecking consistency for the fifth month in a row, from its peak of 61 in June (above 50 denotes expansion) to 56 now. It was, the report said, a signal of “a sustained loss of momentum since the post-crisis peak seen in June.”

And so the outlook of US companies about future activity – “reflecting domestic concerns and a subdued external demand environment” – dropped to the worst level since the survey began in 2009. While hiring intentions remained positive, expectations for corporate profits fizzled, and the already weak link in the US economy, plans for capital expenditures, established a new post-crisis low.

The net balance of US businesses expecting an increase in activity over the next 12 months plunged from 69% in February 2012, when post-crisis hopes of escape velocity were at their peak, and from 51.4% in June this year, to 31.2% now, the worst on record. While manufacturers were hanging in there, with a net balance of 42.5%, the all-important service sector saw its net balance descend to a new low of 28.9%.

These businesses listed among their concerns “fragile global economic growth, heightened geopolitical risk, ‘Obamacare,’ domestic policy uncertainty, and strong competition for new work.”

On a global basis, businesses in the survey had a “long list of worries,” including:

• Fears of a worsening global economic climate
• A renewed downturn in the Eurozone
• Prospect of higher interest rates in the UK and US
• Geopolitical risk from crises in Ukraine and the Middle East
• Growing political uncertainty in many countries, notably the US, UK and Japan.

“Clouds are gathering over the global economic outlook, presenting the darkest picture seen since the global financial crisis,” explained Markit Chief Economist Chris Williamson. “Companies’ hiring and investment intentions have both fallen to post-crisis lows alongside the bleakest outlook for future business activity seen over the past five years.” And the rapid deterioration in US business optimism and expansion plans was “of greatest concern.”

The plunge in business outlook since June parallels the plunge in the price of oil, indicating that businesses expect a tough slog going forward, even in the US, the engine, presumably, of global economic growth. None of this, nor anything else other than central-bank jawboning and the continued flood of free money, seems to have any impact on the stock markets where the shares of these increasingly gloomy companies are being traded at record high prices.

But even as big money is gushing from all directions at US startups, there are new – and in my opinion, hilarious – indications that the resulting excesses are hitting limits. Read…  This Is a Sign the Startup Bubble Is Totally Maxed Out: It Resorts to (um, Sexy) Junk Mail to Disrupt.

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