Leandro Taub's  Instablog

It sparks my interest whenever I read analysts and investors talking about gold. 

They put forward a compelling argument, which no other coinage in the world possesses: gold is an intrinsic value in itself. It is also the most classic value reserve known. 

These analysts let go of the annual returns notion for a while and simply say that it is by saving in gold material that they find themselves sheltered in the long term. It seems that what really matters to them is not the price of this metal but the amount of ounces they have against the total of their assets. 

There is truth and falseness in such view. It is quite relative. What I here propose is to go into this subject in more depth to see what we can get as a conclusion. Today we are still immersed into a trust crisis over currencies. 

I think that runs on the banks over the main currencies used as value reserves are unlikely to happen, mainly because none of the Central Banks would like to see its international reserves loosing value. The currencies that manage to keep such status are the dollar, the euro, the pound, the yen and the franc. 

I was convinced that, as consequence of the trust crisis, we were slowly going to observe an increase of the gold participation in the international reserves of the Central Banks at a global level. However, the IMF has announced that they are planning to sell gold again. In this case, they are parting with 191,3 tonnes of the precious metal – last November they had already sold about 200 tonnes. 

Then I start to wonder what will be the future of the golden metal, if there is any clear signal of the direction that its ounce price will follow. Then in my mind gold takes back the roles of an asset which is used to protect the value of our assets, and of the traditional hedge against inflation. 

At present, the market does not show any inflationary signs. What is more, deflationary risks are still pending. Ben Bernanke therefore keeps the rates low, and focuses his efforts on reflating the economy. Knowing that this is the direction that the economy is heading for, one can find a first valid reason for being attracted to gold (of course, if we believe that Bernanke will achieve his goal). 

Predicting the market performance of this commodity is not as easy as writing a few lines about it. There are many agents taking part. The result of the interests’ game in which the most influential agents in this market interact will determine the direction of the metal’s quotation. 

According to the last data reported by the World Gold Council, the supply volume of gold is made up by a 65 per cent coming from the Mine production and a 35 per cent from Recycled gold. Such mining production is performed in every continent of the world except for the Antarctic (not because they consider that gold cannot be found there, but because mining is not allowed in the ice continent). India, East Asia and the Middle East represent 70 per cent of the world’s metal demand. 

Specifically, 52 per cent of the demand volume of gold comes from the Jewellery market, 10 per cent comes from Industry (electronics, dentistry and others), and 38 per cent comes from financial investments. It is amazing to see how the share of this type of investments has raised on the total of the metal demand in the last three years. 

Gold is one of the many investment alternatives coexisting in the financial market. Whoever invests assuming a bullish position on gold through the financial market, is in search for a positive return, and considers that the demand volume will be higher than the supply one and price will rise. And I make this comment because this point should always be born in mind when this metal is under consideration. 

The main players in this market are the Central Banks through the gold variances in their reserves, the Jewellery industry in the United States and India, some big investment funds, and the ETF GLD, which is giving voting rights to most small investors who use this instrument as investment vehicle to get hold of the metal. The ETFs market alone represents around 15 per cent of the gold’s global demand. 

India’s Central Bank was the main buyer in the last big sale of 200 tonnes made by the IMF last year. Both India and China seem to be interested in the current 191 tonnes. And this last colossus has continued widening its metal reserves for decades. 

Now speaking of Central Banks, there is an interesting detail to mention. These institutions used to be net sellers of gold. This trend was reversed in 2008, when they became net buyers (coincidentally in the middle of the crisis). From that moment on, the policy of buying more than selling has been sustained. 

Quotation of the gold ounce has kept going up over the last decade. Unlike fiat currencies, gold is an intrinsic value in itself and preserves its value over time (space and shape, of course its quotation changes). It is considered as one of the main value reserves, recognized in the whole world. It is an effective hedge against devaluation, inflation, and many of the market temporary swings. 

Markets are still in panic although the worst has already passed. And many are dreaming dreams made of gold. 

Disclosure: No Positions

These last few weeks I found myself into one of the most burning issues of the European winter: Greece.

Greece’s budget deficit is remarkably high. It is estimated that they closed the 2009 with a deficit of 12,7 per cent of GDP and that their total fiscal deficit is around €254 billion (their product is nearly €240 billion).

According to the Maastricht Treaty, countries belonging to the European Union are allowed to a debt-to-GDP ratio no higher than a 60 per cent. In the case of Greece, this ratio is higher than 100 per cent, nearly 110 per cent.

These numbers started to make a lot of noise in such a sensitive market, always in search of new information that justifies its immense volatility.

Then the alarms began to ring. Greece’s stability was questioned as well as the European Union’s. It was stated that the Maastricht Treaty is clear enough regarding this point, and therefore the European Union will be very harsh on Greece for its irresponsible budgetary policy.

Besides, violation of the budget discipline agreements established by the bloc is a serious and grave matter, and Greece’s credibility consequently comes into play, as well as the Euro’s credibility and the continuity of the European Union.

For some analysts, Greece’s fiscal problems can be seen as deflationary risks for the rest of the world, and they can also delay the value recovery that financial assets are globally enjoying. But Greece is a relatively small country in terms of economy, with no key monopolies or industries. Then I consider that the possibility to see such risks crystallise is just remote.

There was even time for some Greek government employees to shout resentful phrases about their neighbors. There was also time for the Eurostat (Europe´s statistical office) to set up a research about the country after the news came into light about Greece not having declared that they utilised swaps to project their future payment obligations.

In the meantime, the Greek Credit Default Swaps jumped up more than significantly, indicating that the market demands an increasingly higher retribution in exchange for financing the Greek sovereign debt. It looks like the old empire will pay dearly for this.

Then the time came to consider the different options to sort out this situation. Each choice bears its own characteristics and potential consequences. There is the possibility to let the market decide.

That Greece finds its own way, without the need of the European Union’s intervention in its businesses. Greece will have to renegotiate its debt, probably offer more attractive rates to finance its deficit, and adopt a more serious long-term budgetary policy to be able to get its finances in order.

There is also the chance that the European Union decides to intervene, since Greece belongs to the bloc and thus, in theory, agrees to meet certain requirements to be part of it.

If the European Union decides to intervene, they can do it without setting any conditions, being flexible. The consequence of this policy would be that other countries facing delicate economic situations which are also part of the bloc (such as Spain, Portugal and Ireland) might find an incentive for disregarding their debts and budgets, following irresponsible policies in these matters, knowing that if they eventually reach a situation of stress they will be saved without facing major problems.

If the European Union decides to intervene with conditions, they will probably demand considerable budget cuts and changes in Greek budgetary policies.

And no matter how it is carried out, but with the European Union intervention there is also the possibility that many non-Greek citizens will be indignant at the idea that their tax payments are being be destined to finance irresponsible budgetary policies from the Greek government.

Finally, there is the chance that Greece withdraws from the European Union, either as punishment or as their own decision. The consequences of such measure would be devastating for the country, since it would mean to give up enjoying the fantastic economic and social advantages of belonging to the bloc.

Most probably the solution will be something more dynamic, a mixture of many possibilities; vital as life itself, as international economy and finances.

I consider that we should always start by a macroeconomic analysis before dealing with the microeconomic one, that we should take a strategic look at a global level before analysing the particular.

Greece represents around 2,5 per cent of the European Union’s total product. It is therefore a country which does not contribute a significant economic volume to the bloc. Then it cannot lead the bloc to a scenario of political risks of continuity of its agreements or of its currency.

Another key issue is that this country’s deficit has been higher than its output even before becoming a member of the European Union. This clearly shows that the subject we are discussing is no novelty whatsoever for the European policy makers. They all knew what Greece was like, and they still invited the country to join them because they saw the economic, political, social and cultural advantages of its participation.

European Union embodies a highly significant set of values at a global level, which will prevail over a quarrel of this nature. This Union represents a step towards evolution of the organisational systems at all levels. In its current development I see something which I consider particularly attractive: countries that accept to give up part of their sovereignty in exchange for being part of a common good, of a superior goal for their peoples.

The European Union represents a giant footprint in history, when many countries which were rivals in the past realized that cooperation was, undoubtedly, more beneficial than fighting.

This is nothing but a matter of public finances which can be solved, and I am sure it will be done easily. It is worth though, understanding what it is about, which are its causes and possible consequences.

But there is no point in getting panic-stricken. All this is part of the economy’s game and international finances. Greece will survive and its public finances too.

...
by Leandro Taub for Alrroya.com


Disclosure: No Positions

Bank credit is a key issue. When policy makers consider it necessary to stimulate the economy, and they decide to generate inflation, what they are actually aiming at is injecting liquidity into the market. One of the main ways to inject liquidity is by lowering interest rates. What makes such rates to fall is that the price of money becomes cheaper, credit becomes more accessible and by this way individuals have a greater stimulus to take credits and consume, while businesses have a greater incentive to take credits and invest.
Due to the crisis lived in these last years, credit, consumption and also prices have contracted. As a result, Bernanke decided to lower the economy reference rate to a minimum, with the intention of injecting liquidity into the market and thus stimulate the economy: reactivate consumption, investment and prices. The means to achieve this was credit! ... But something is happening.

Bank credit in the United States is in constant crunch. This scenario involves commercial and industrial loans, as well as real estate and individual consumption loans.
We can say that it is ‘normal’ for credit policy to contract in times of crisis because individuals and business paralyze for a moment their usual cycle of taking credit.
Today, when we find ourselves on the road to recovery, credit policy is still paralyzed not only due to lack of trust, but also because the average level of credit quality has been severely damaged.

What the economists take into account when analyzing the expansion (or contraction) of the monetary supply is the monetary multiplier. This same multiplier has experienced over a 50% contraction during the 2007-2009 crisis. We can read between these lines that what has decreased is actually the capacity of the financial system to generate money and credit. The money multiplier was therefore functioning like a deflationary engine. Today that engine remains low, maintaining extant deflationary pressures. This is a variable that policy makers are paying attention to.

Around 60% of the entire American credit market comes from debt instruments (known as direct credit), while the remaining 40% comes from loans (known as indirect credit). Nowadays, most companies’ first choice is direct credit, avoiding bank loans. As the financial multiplier remains low, this tendency of finding financing through debt instruments is most likely to increase, resulting in the reduction of bank loans. As a result, we run into an equity market increasingly attached to the debt market. 

The phenomenon we are experiencing is highly interesting. Although liquidity is actually growing, short-term availability of credit is still contracting.

Banks are just not lending money. They seem to have abandoned that business for the moment; and to be honest it is understandable. The global context has created a terrific scenario for them: borrowing money at almost 0% rates and buying Treasury bonds at 3.5%.
 
Banks have absorbed most of the monetary stimulus. Commercial Bank cash assets went from 340 billion in September 2008 to 1,2 trillion dollars at present. Around that same time the Federal Reserve balance sheet went from 900 billion to 2,2 trillion dollars.

A very recent and highly important indicator is credit card loans, which have plummeted by 17 billions during December 2009, Christmas’ month with the highest stationary consumption levels.

Why is it that the extraordinary monetary stimulus from the Federal Reserve has not reached bank loans yet? The answer is that banks are devoting their time to recovering their balances, and carrying out this extraordinary spread rate business mentioned above.

In the meantime, those American states, which are in crisis, spend all their time and funding in recovering their balances and emerging from stressful situations.

The good news is that the market has claimed that the worst is over. It is possible that, through this path of pricing and valuation recovery, banks may be gaining solidity to get back to business, so that credit may begin to expand.

Nowadays, one of the main goals of the Federal Reserve is to create inflation. In order to accomplish this, they have to get banks to inject liquidity into the economy. One way to do this is by the expansion of credits. Hopefully, that is where we are heading for.


Disclosure: "No Positions"