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Credit Deflation Commences As Bonds And The Yen Turn Lower


European shares rallied higher, being driven by skyrocketing European Financial shares, while a fall in the Yen caused Oil, Gold, Base Metals, as well as Basic Material,  and Energy Stocks to close lower, today Tuesday July 27, 2010.

The decisive fall in the Yen today, July 27, 2010, to 112.68, starts a new dimension in debt deflation. Now in addition to stocks, every single currency is falling lower in value. Thus we are entering the era of ”competitive currency devaluations”, as the last currency holdout, the US Dollar, $USD, fell lower on June 8, 2010.

And not only does debt deflation involve stock deflation, commodity deflation, and currency deflation; it involves credit deflation, that is bond deflation as well, as aggregate debt, AGG,  has turned lower.  The world has commenced into “the end of credit” as it has traditionally been known where credit comes from the seigniorage of sovereign nations issuing sovereign debt and financial institutions securitizing bonds.    

Today’s Financial Market Report
The Japanese Yen, FXY, fell lower 1.2% today, causing carry trade disinvestment out of commodities.

Oil, USO, Gold, GLD, Base Metals, DBB, fell lower, causing solar stocks, TAN, basic material stocks, XLB, industrial stocks, XLI, and energy stocks, XLE, to fall lower as well.  

The currency traders in shorting the commodities went long the world currencies, DBV, which jumped higher to its 200 day moving average; and emerging market currencies, CEW, which yesterday rose above its 200 day moving average, moved higher again today. For the last four days the world currencies, DBV, have been outperforming the emerging currencies, CEW.  Chart of CEW and DBV.

The US Dollar, $USD, traded unchanged at 82.14 on the edge of its head and shoulders pattern; as can be seen in the chart of its 200% ETF, UUP.   

Today’s action is simply more debt deflation. Global debt deflation commenced on April 26, 2010 when the currency traders sold the worlds currencies, DBV, off against the Yen, FXY. This was just weeks after the Federal Reserve QE ended, and as the European Sovereign Debt Crisis was coming to a head. Debt deflation is the contraction and crisis that follows credit expansion.  One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

The Yen, FXY, started to fall lower on  July 19, 2010 when it closed at 114.04. The decisive fall in the Yen today, July 27, 2010, to 112.68, starts a new dimension in debt deflation. Now in addition to stocks, every single currency is falling lower in value. Thus we are entering the era of ”competitive currency devaluations”, as the last currency holdout, the US Dollar, $USD, fell lower on June 8, 2010.   

In addition to the Yen, the Swiss Franc, FXF, dropped. Poor Switzerland, like most countries, it has no sway whatsoever over its currency, its just that Switzerland is completely and utterly at the mercy of the currency traders.

The Euro, FXE, did not budge today; it closed at 129.58. Analyst by Setyo Wibowo writing in FXInstructor relates: “On EURUSC h4 chart below we can see that we may have a triple top formation around 1.3000,” Frankly to me it looks like a top is in for the EUR/USD.

The British Pound Sterling, FXB, rallied on news that the UK Health Service is facing dismantling as well as facing severe austerity cuts, causing UK shares, EWU to burst higher.  

Chart of the Euro, FXE,  the Yen, FXY, European shares, FEZ, World shares, VT, and US Treasuries, TLT shows that the Euro did not rise to support the rise in the European shares, and that US Treasuries have sold off for four days.

Click on chart of FXE, FXY, FEZ, VT, TLT to enlarge.

Not only does debt deflation involve stock deflation, commodity deflation, and currency deflation; it involves credit deflation, that is bond deflation as well, as aggregate debt, AGG,  has turned lower from its July 21, 2010 high. Today, with the fall of the Yen lower to 112.60, the world has entered into credit deflation; credit contraction has commenced. July 27, 2010 marks the date when interest rates began to rise globally.  Click on chart of AGG to enlarge

US Treasuries, TLT,  and IEF, both turned parabolically lower today, July 27, 2010, ending the flight to commonly perceived safe haven investment in US Government bonds. The chart of the 300% inverse of the 30 year US Government bond, TMV, is in its fourth day of breakout from a spiked down bottom on July 22, 2010. The rise in the Direxion bear bond market ETF TMV documents that US Treasuries are no longer a safe haven investment. 

Now that the world has entered into credit deflation, it would reasonable to expect that debt deflation will work quickly to destroy the value of US municipal bonds, such as California Municipal bonds, CEV

Corporate bonds, CFT, which have outperforming, fell slightly.

Emerging Market Bonds, EMB, burst higher again today. Tim Catts and Bryan Keogh of Bloomberg report in July 27, 2010 article report: The emerging markets bond spreads narrow. In emerging markets, company bond spreads fell for a third day, declining 6 basis points to 279, the lowest since May 12, according to JPMorgan index data. The yield difference has ranged from as low as 229 on April 15 to as high as 359 on May 25.

HYG, traded down slightly. Tim Catts and Bryan Keogh of Bloomberg report in July 27, 2010 article report: Returns of 2.99 percent this month (in junk bonds) are prompting a surge in U.S. speculative-grade offerings with Advanced Micro Devices Inc., the second-largest maker of microprocessors, and Vantage Drilling Co. leading $12.5 billion of July issuance, according to data compiled by Bloomberg. Junk bonds returned 1.3 percent last month after losing 3.52 percent in May, Bank of America Merrill Lynch index data show. The economy is showing signs of strengthening with more than 83 percent of companies in the Standard & Poor’s 500 Index exceeding the average analyst profit estimate this quarter. The U.S. speculative-grade default rate will decline to 2.7 percent by the end of the year, from 6.3 percent at the end of the second quarter, according to Moody’s Investors Service.  High-yield bond funds attracted inflows of $948 million in the week ended July 21, following $1.1 billion in the previous period, according to EPFR Global, the Cambridge, Massachusetts-based research firm. “Investors are looking at the 7 to 8 percent yields on offer from high-yield issuers and seeing the large pick-up compared to investment-grade debt or government bonds,” said Andrew Sheets, Morgan Stanley’s head of European credit strategy in London. “There’s a strong incentive for high-yield companies to keep chipping away at the wall of refinancing and taking advantage of investors’ demand for higher returns.”

Tetsushi Kajimoto of Reuters reports Japan To Cap Spending And New Bond Issuance For Next Fiscal Year. 

Both yesterday, and today, July 27, 2010, EMFN, the emerging market financial shares blasted like a rocket higher to their April 26, 2010 level, being driven higher by the European Financials, EUFN, in their rally, which carried the financials, XLF, higher.  The resistance clearly seen in XLF at 14.80 to 14.99, coupled with shut-down of  Russell 2000, IWM, at 66 to 67, strongly suggests that the current rally cannot be sustained 

The burst in the European Financials, EUFN, popped Italy, EWI, Spain, EWP, Austria, EWO, and the European shares, FEZ, higher. The  chart of FEZ, EWI, EWP, EWO.   

MarketNews reports EUR Libor at Highest in 11 months, hits 0.8275%. And Tyler Durden in ZeroHedge writes article Euribor Higher, European Bank Liquidity Lower, Spin Endless: “In the context of the massive (and insolvent) European banking system, this is yet another indication that all is unwell with Europe’s banks, even as the Goebbels brigade goes into overdrive.The interbank lending market does not lie.”

Tim Catts and Bryan Keogh of Bloomberg report in July 27, 2010 article:  ”The cost of insuring against losses on European bank bonds fell to the lowest in three months after UBS AG and Deutsche Bank AG posted earnings that beat analyst estimates and regulators softened proposed capital rules. Credit-default swaps on the Markit iTraxx Financial Index of 25 European banks and insurers fell 7 basis points to 110.5 as of 11:51 a.m. in London, the lowest since April 21, according to JPMorgan Chase & Co. The gauge has rallied 22.5 basis points since the European Union’s stress tests on July 23 that judged 84 out of 91 of the region’s lenders to be in good enough shape to survive another financial crisis. Corporate bond spreads narrow. The difference between Markit’s financial gauge and the broader European corporate benchmark also shrank to the narrowest since April. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 2.25 basis points to 102.5, JPMorgan prices show.

There is no ETF for Greece, a reasonable proxy would be Hellenic Railways.  Landon Thomas in New York Times article Greek Rail System’s Debt Adds to Economic Woes, reports: In 2009, bankers for Goldman Sachs and Morgan Stanley pitched the Greek government on a plan to overhaul its money-losing railway system. Among the ideas was to lay off half of the system’s 7,000 workers and have the government take on roughly half of the company’s 8 billion euros in debt. The suggestion did not fly. It was an election year in Greece, after all, and the country was already struggling to keep up the payments on its debt, which is higher in proportion to economic output than in any other nation in the European Union …  The plan was shelved, soon to be overshadowed by the country’s close brush with bankruptcy. Losses at Hellenic Railways, however, continue to mount at the rate of 3 million euros ($3.8 million) a day. Its total debt has increased to $13 billion, or about 5 percent of Greece’s gross domestic product … The average salary of a rail employee is over $78,000. Employees benefited from politically inspired pay increases over the last decade. Between 2000 and 2009, the cost of the company’s payroll soared by 50 percent even as overall personnel decreased by 30 percent. 

However, Japan stocks, EWJ, Asian stocks, DNH, and the US stocks, DIA, SPY, QQQQ, and IWM all manifested resistance to the financials rally in their chart patterns. Surprisingly the Russell 2000, IWM, which usually trade up with financials, traded down, presenting a strong “no go” statement to the financials. IWM, closed at 66.22.  Chart of DNH, EWA, EWY, EWH, EWS.

The major US Stocks sectors failed to rally today.  The chart of  IYR, SMH, XLI, XLB, XRT, XHB, TAN.

In as much as the solar stocks, TAN, were up until recently, a stock market loss leader, it would be reasonable to sell these short now.

Nasdaq biotechnology stocks, IBB, fell lower. Chart of IBB shows that the age of profitable investing in life science stocks is over and done. The dislocation of Nasdaq biotechnology stocks from technology stocks commenced July 7, 2010; these stocks will now fall faster than the technology stocks in general.  A short of this ETF will not produce quick results; instead it will provide slow steady gains at low volatility risk.  

Small cap value shares, RZV, fell more than small cap growth shares, RZG, suggesting a market downturn is at hand. Chart of RZV and RZG.    

There have been several exceptions to debt deflation; these include the mortgage financing REITS, the health care REITS, utilities, and some basic material stocks, because they pay dividends.

ANH Anworth Mortgage Asset Corporation’s gains cannot be sustained as it manifested bearish engulfing on the fall of the US Treasuries and as its competitor NLY has fallen lower. Once US Government debt fails to auction, or is perceived to be monetized, then this provider of and servicer of mortgage debt will fall heavily. Be aware that this is a REIT and short sellers pay the dividend if they hold the stock when dividends come due. Anworth Mortgage Asset Corporation is right at the top of my suggestion list for short selling. It is done excellently both as an investment and as service to the economy, it is just that the need for its services will be less profitable and less in demand now that we have entered into the end of credit with Aggregate Bonds, AGG, turning lower.  

TGP The massive bearish engulfing candlestick in the daily chart of 7% dividend payer Teekay LNG Partners, suggests that the end of its rising has arrived. And, the weekly chart of TGP will go in the investment textbooks as a unique example of three white soldiers at the top of an ascending wedge. Demand was strong for this stock. For the last three months it has been the exact opposite of debt deflation. Chart of TGP,  WMZ,  HCP,  GXG, BCH, SXL shows the strong demand for investments that have been clear of debt issues or that pay dividends.

WMZ The turn down from resistance in an ascending wedge in the daily chart of dividend payer Williams Pipeline Partners shows that it has ended its rise. And, the weekly chart of WMZ shows an ascending wedge, which suggests that its rise is now complete. 

Utilities, XLU, popped 1.5% higher. And the chart of diversified utilities ED, WEC, NU, NI and WR suggests these are approaching the end of their rise. Today’s chart of ED shows three white soldiers suggesting that a reversal is at hand. 

The chart of health care REITS  HCP, OHI, VTR, and NHP suggests these are approaching the end of their rise..

The chart of natural gas pipelines SXL, HEP and ETE suggests these are approaching the end of their rise. These dividend paying stocks have risen on a dividend rally and based upon the perception that they are like bonds, CFT

Columbia, GXG, jumped up and out of an ascending wedge moving 1.6% higher.  Thailand, THD, Turkey, TUR, and Chile, ECH, shares, moved higher. Chart of emerging market leaders GXG, THD, TUR, ECH. show their rise which comes on rising emerging market debt, EMB, and rising emerging market currencies, CEW.

I recommend that institutional investors sell short the emerging market bank leaders, Banco de Chile BCH, and four banks, BMA, CIB, BCA and SAN, now that the European Financials stress test rally is likely over.  Chart of BCH, BMA, CIB, BCA, SAN

The emerging markets financial currencies and stocks have had no sovereign debt or liquidity troubles as of yet; up until this week, the currencies of the emerging countries, CEW, have been performing better than the overall currencies, DBV.  

Therefore up until now, the outperforming emerging market currencies have been relieving the debt deflation distress on the emerging markets, EEM, and BRICs, BKF, shares compared to the overall market shares, ACWI.

Chart of the HUI precious metal mining stocks relative to gold, GDX:GLD, shows that the gold mining stocks have disconnected further from the price of gold. GDXfell more than GLD establishing that the gold mining stocks can no longer preserve wealth as well as physical gold. Today’s close of the gold mining shares at 47.09, which is substantially below their pivot point of 49.99, together with the chart of GDX, communicates the gold mining shares to be a failed investment. Unlike many newsletter writers, I’ve consistently warned people to sell-out of gold mining shares.  

Gold’s, $GOLD, fall today is simply a very much-needed correction. GLD fell towards its 200 day moving average and closed at 113. This is normal in gold corrections. GLD could easily fall lower to its April 1, 2010 break out price of 110 before moving higher, that is much, much higher as debt deflation wears on, destroying stock, other commodity, currency and bond values.

Corey Rosenbloom presents a helpful Gold, $GOLD, chart article Gold Finally Takes a Tumble – Levels to Watch.

Jesse presents a helpful chart article as well Daily Gold Chart.

The chart of gold relative to stocks, GLD:VT, gold relative to currencies, GLD:DBV, and gold relative to bonds, GLD:AGG, confirms that gold has arisen as a currency, in fact the sovereign currency, as well as means of sole means of preserving wealth.

On April 26, 2010, the world entered into stock debt deflation. Now today, July 27, 2010, with the fall of the Yen, FXY, to 112, the era of ”competitive currency devaluations” has commenced; and with the today’s fall of Aggregate Bonds, AGG, to 107, credit deflation has commenced. The world has commenced into “the end of credit” as it has traditionally been known, where credit comes from the seigniorage of sovereign nations issuing sovereign debt and financial institutions securitizing bonds. 

Thus total debt deflation is underway: stocks, VT, currencies, DBV, and bonds, AGG, are progressively falling lower in value.  The unrelenting nature of the European sovereign debt crisis, and a rising yield curve since, $TYX:$TNX, will continue to support an investment demand for gold.

Over time, the chart of gold, GLD, gold mining stocks, GDX, small cap value, RZV, and small cap growth, RZG, will be helpful in documenting the investment value of gold. 

Gold mining stocks and US Treasuries always make market turns lower together as is the in the chart of $HUI:$USB

Mike Mish Shedlock relates that the bears are back in hibernation and Stock Short Sales at 2-Year Low, Data Explorers Says.

Google Finance reports that Volatility, VXX, is at 22.64.

Institutional investors should consider the Morningstar report that The Profunds UKPSX, 200% short Japan, and the Direxion DXRSX, 200% Small Caps  have been a consistently good performing bear mutual funds. And the investment prospects look good for TMV, 300% inverse of the 30 Year US Government Bond as well.  

What Is It That Six Of The Fourteen German State Banks Are Hiding In Not Publishing Details Of The Debt Holdings As Required By The Stress Tests Standards — An Editorial by Theyenguy
The Irish Times notes that six of the fourteen German banks tested – Deutsche Bank, Postbank, Hypo Real Estate, mutual groups DZ and WGZ, and Landesbank Berlin – did not publish the expected detailed breakdown of sovereign debt holdings, fuelling suspicion they had something to hide.

Arnoud Vossen, Secretary-General of the CEBS, said it had agreed with all supervisory authorities and with the banks in the exercise that there would be a bank-by-bank disclosure of sovereign risks but officials from the German regulatory authorities – Bafin and the Bundesbank – said local law meant they could not force banks to publish such details.

Wikipedia relates tha the Landesbanks, that is the Landesbanken are a group of state-owned banks unique to Germany. They are regionally organised and their business is predominantly wholesale banking. They are also the head banking institution of the local and regional bases.

What they are hiding is the great size and plummeting fall of the shadow banking system, that is, the once lucrative seigniorage money creation system, that sprung up from financial deregulation that accompanied the repeal of the Glass Steagall Act, and operated in parallel with the traditional central bank sovereign debt seigniorage system.

The debt deflation of the shadow liabilities, that is those assets kept off balance sheet in SIVs, creates systemic risk as they impair traditional current account deficit funding. The plunge in shadow liabilities that has recently accelerated, will likely be the major contributing factor in a bond market collapse led by US Treasury bonds failing at auction as Nassim Taleb relates, ”We Are Going To Have, At Some Point, A Failed Auction”.

It is the credit deflation of the shadow liability system, identified in “Shadow Banking,” a staff report authored by Zoltan Pozsar, Tobias Adrian, Adam Ashcraft and Hayley Boesky, that could easily make the day of the failed auction come very soon, and the economic dislocation be more severe.  The wholesale funding markets have closed. I have no hope, repeat no hope whatsoever that these will reopen. Yes, Thank God, they are likely closed forever. And I fully expect that Banks to start once again to rely on ECB liquidity or else there will be extreme deflation in their stock values. 

Suggested reading for inquiring minds about credit deflation and the shadow banking system includes the following articles:

Tyler Durden, ZeroHedge article Will The Record Plunge In Shadow Liabilities Impair Current Account “Shadow” Deficit Funding And Guarantee A Double Dip?  … and

 Ezra Klein of the Washington Post article 5 Places To Look For the Next Financial Crisis … and

 Annaly Salvos, SeekingAlpha article NY Fed’s Paper On The Shadow Banking System Of Vast Importance … and

 Possner Pinch Minyanville article Liquidity in Economy Never Higher, Yet Banks Growing More Illiquid 

Andrian Ash, Daily Reckoning article Credit Deflation Lands In Britain relates how the UK is going to recapitalize and re-liquify its financial institutions:

Disclosure: I am invested in gold coins