Click here to read this article in pdf format: August 12 2012

In our last letter, we made some comments on high-frequency trading. Today, we want to briefly analyse, from a macroeconomic perspective, the underlying ideas thrown in its favour, as well as the impact this activity has on the capital markets. Why is this important? Because more than half of the trading volume in equities in the main world exchanges is driven high-frequency trades today (More than 70% of volume in the US exchanges alone).

What is high-frequency trading? We will never exhaustively address this issue here. We recommend that you do your own research on the subject. There are numerous articles on this topic. High-frequency trading (HFT) consists in using sophisticated technology to trade securities. It is highly quantitative, employing algorithms to analyze incoming market data. HF investment positions are held only very briefly, with HF traders trading in and out of positions intraday tens of thousands of times. The important feature is that at the end of a trading day there is no net investment position. Processing speed and access to the exchanges are critical.

HFT strategies can be broadly thought in terms of three main groups: Those that provide liquidity, those that trade headlines and those that trade statistics. The statistical ones are the easiest to understand (at least for us): They are based on technical analysis, correlations. The headline strategies seek to profit from momentum trading, filtering information that describes intra-day action in the exchanges. The so-called liquidity strategies are either based on market making (to profit from bid/ask spreads) or from rebate trading. Operationally, HF traders collectively send millions of orders, the most part of which (we understand above 90%) are cancelled before they are even hit. This often causes delays in the exchanges that receive them, potentially creating arbitrage opportunities in those stocks that trade in multiple exchanges.

Two main factors have been put forward in support of HFT. We will quickly dismiss them:

a) HFT provides liquidity to markets

We think this point has been misunderstood, because at a macro level, one must not refer to the liquidity of a particular asset, but of liquidity in general or, more properly, liquidity preference, since liquidity is not a condition intrinsic to any asset, but the result of preference by market participants.

Indeed, HFT may and does provide liquidity to a particular asset, but it is a different thing to say that HFT provides liquidity to the market, at an aggregate level. At an aggregate level, the liquidity preference of market participants is what matters. If they want to be liquid, they have the means to do so either by holding money or by changing it for commercial paper or short-term obligations of borrowers with a solid and steady cash-flow stream. Collectively, for market participants to allocate some of its savings to liquid assets, there is no need to see millions of quotes a day, for instance, on a risky junior mining company with assets overseas, thereby creating the illusion that the junior mining equity space is liquid.

Market participants do not need to see the universe of liquid assets expanded to satisfy their respective liquidity preferences. And if they have to get their savings out of an asset which until a minute ago seemed liquid but now is not, they will be able to do that with or without HFT, because there is no reason to believe that under a shock, the HFT bid will not disappear in a nanosecond, making the situation even worse.

Having said this, it is clear that the impact of the quoting activity by HF traders generates a distortion in the capital markets and particularly, in the capital structure of an economic system. Companies that, given the nature of their businesses, would have been forced to raise secured long-term bank debt to fund their capital expenses before the influence of HFT, may now find it easier and cheaper to raise equity. And those with investable assets captive in the system (i.e. registered funds, 401ks) will now fall prey to very risky projects, under the belief that they are protected by electronic stop-loss orders. Banks that might have been willing to provide secured lending to these equity issuers, will now find that they can only bid for less profitable working capital lines, under the belief the loans are protected by stock pledges! And it gets even worse: Those who invest in this equity may decide to pledge it under, say a 3x coverage ratio, to borrow funds and invest in even riskier, “more profitable” assets!

The liquidity argument in favour of HFT is just one more Keynesian version of the notion that inventing purchasing power ex-nihilo can get us somewhere better, but this time, applied to the capital markets in particular.

How does HFT invent purchasing power? The liquidity premium embedded in assets that wouldn’t otherwise be liquid or would not even exist, is the purchasing power we refer to. For this same reason, those who defend HFT now fear that by prohibiting it (just like their fear to prohibit fractional reserve lending) we will see a collapse in valuations. Unfortunately, that collapse will eventually take place, only still bigger and affecting global capital markets.

b) HFT facilitates the process of price discovery

What media and those in favour of HFT commonly refer to price discovery is nothing else but algorithms sniffing stop losses, causing volatility in the process. There really isn’t anything particular about HFT with respect to pricing, which human beings cannot achieve on their own. Throwing orders to exchanges that are immediately cancelled to test floors or caps on the price of a certain asset cannot be credited with price discovering. Indeed, efficient markets are those which always challenge valuations and in the process, prevent the misallocation of resources from further growing. But the challenge of valuations always represents the challenge of their underlying assumptions: Sales, leverage, productivity, management, etc. Shaking the nest, the way HFT does (with the sudden introduction of millions of quotes) to “discover” key levels is hardly the feature of a healthy capital market.

Let us bring an analogy: Human lives are not traded. Yet, if a criminal kidnapped somebody’s daughter and asked for a ransom, he would certainly be “discovering” the price of her life: The parents of the girl, having offered all they had in immediate liquid assets, would have told the criminal what the price for their daughter is. Now, this is exactly what algorithms do when testing price levels in the absence of economic news, as we have painfully seen across a myriad of asset classes.

This is not a healthy way to price assets, because just like the parents had never thought of trading her daughter for money, market participants not challenged by economic developments but by millions of fake orders, were forced to do so. A trade actually took place in an otherwise illiquid market but…what will happen next time? Neither the daughter will be left alone by the parents nor our market participants will be there for the criminals to profit from them, which is why retail money will keep flowing out of the stock exchanges (the system) as long as the status-quo is not changed.

Perhaps too, our fictional criminal will regret not having given the father more time to liquidate more assets, but of course, that would have come at the cost of higher risk. There is no difference between the criminal’s short-term line of reasoning and that which keeps HF traders from keeping positions for longer than seconds or minutes. Therefore, if we were really thinking about price discovery, neither our criminal nor HF traders did discover the true price. In the end, all we ended up with was volatility that will exponentially increase, as the exchanges impacted by HFT see participants leave to over-the-counter markets (like real estate?)…Is this the actual reason behind the high percentage of HFT volume in exchanges? Is it because we are leaving the exchanges all to HF traders?

The market crashes driven by HFT, like that on the NYSE in May 2010 or the recent one affecting the Knight Capital Group should be a big wake-up call. This is a new technological change which the Austrian School of Economics should further analyse. We, at “A View from the Trenches”, just wanted to leave our two-cent contribution with our thoughts. We leave with an interview on the subject, to Scott Patterson, author of “Dark Pools”, dated August 8^th:

 

Martin Sibileau

Click here to read this article in pdf format: July 23 2012

We have not written for the past two weeks. We were vacationing but at the same time, nothing really changed a single dot of the macro picture. Perhaps the main development has been the collective (but still minimal) realization that markets are being manipulated either by governments or banks. The starting line, it seems, is the manipulation of the London Interbank Offered Rate (LIBOR). We are not going to add to this. We expressed our comments in our last letter. Those interested in following the issue can do so at Zerohedge.com.

The relative calm therefore affords us the opportunity to reflect upon a topic that has and continues to personally bother us, with respect to the comprehension of the ongoing crisis. We are referring to the circular reasoning behind every proposed solution to this crisis.

We remember affectionately the first time we were confronted with circular reasoning. It was courtesy of Antoine de Saint Exupéry’s famous book, “The Little Prince”. In its chapter 12, the Little Prince meets a tippler, a drunkard (original drawing from the author, below), and the dialogue goes like this:

“What are you doing there?” he said to the tippler, whom he found settled down in silence before a collection of empty bottles and also a collection of full bottles.

“I am drinking,” replied the tippler, with a lugubrious air.

“Why are you drinking?” demanded the little prince.

“So that I may forget,” replied the tippler.

“Forget what?” inquired the little prince, who already was sorry for him.

“Forget that I am ashamed,” the tippler confessed, hanging his head.

“Ashamed of what?” insisted the little prince, who wanted to help him.

“Ashamed of drinking!” The tippler brought his speech to an end, and shut himself up in an impregnable silence. And the little prince went away, puzzled.

“The grown-ups are certainly very, very odd,” he said to himself, as he continued on his journey

Later in life, we also faced (but don’t remember so affectionately) other circularities: The logics of the US immigration system (where one needs to have a visa to work, but needs to have a work offer to apply for a visa) or the beginnings of our career, when it was difficult to land our first job because we had no previous work experience…

The most damaging of all circularities however, can be found in the policies undertaken by central banks, regulators and governments in general, worldwide. Where to begin? Since we are deductive, let’s start at the core of the problem, which is the way macroeconomics is conceived by the establishment:

In the minds of those who lead the world (at central banks, finance ministries, regulatory agencies and business schools), markets, at one starting point, are in equilibrium. A shock (in today’s case, of a financial nature) shakes the status quo and it is commonly perceived that it’s the governments’ duty to restore equilibrium. The shock, of course, they think is exogenous: it came from outside the system, could not be forecast in advance, but can be prevented in the future, with more regulation.

The first mistake here is to believe in the existence of equilibrium. We will not say more about this (but there are entire books available on this topic). Humans are constantly acting, trading, and they do this based on price signals. Profit and loss therefore are essential features in the system, that tell us whether what we do is indeed of value to the market or not. As long as we leave profit and losses unrepressed to guide us, we will get as close to that elusive equilibrium as we can possibly get. Why?  If  we do something of value for the market, the market will tell us to do more of that: How? By making us profitable. If we don’t, the market will tell us to stop and to rather allocate the resources we used, including our mental capital, to better uses. How? By making us unprofitable. If we insist with the wrong course, we will go bankrupt. Paraphrasing Gordon Gekko: Bankruptcy, for lack of a better word, is good for the system!

Having said this, we acknowledge, financial shocks are caused by market bubbles. All asset price bubbles were the deliberate (not coincidental) result of some sort of signal suppression, price suppression. All of them. But to begin with, the worst price suppression we have today is in the banking system, where loans, which are multiple times the actual value of deposits, are not marked to market, but carried on an accrual basis. The Euro zone is learning right now about the consequences of this, as their banks carry depreciating sovereign debt. The system there has fallen into the vicious circularity of governments guaranteeing or capitalizing these institutions that go bankrupt precisely because they are creditors of the same who provide the guarantees or equity injections.

But the story doesn’t end here. Leaders conclude that the bubbles were caused not by the suppression of prices but by irrational behaviour. This idea has become so popular that during the 20^th century we have seen the birth of a new branch in economics: Behavioural Economics. The whole notion has become so ridiculous that in 2002, Dr. Daniel Kahneman received the Nobel Memorial Prize in Economics, despite being a research psychologist, for his work in Prospect theory! None of this would be really needed, if we understood that failures and losses are a good thing because in the “system”, they mend mistakes before they reach systemic proportions. The regulations proposed to mitigate irrational behaviour therefore do nothing but to exponentially increase systemic problems, exposing us to another circularity.

Take for instance the insistence imposed upon banks worldwide, that in times of stress, their creditors be converted to equity holders, to strengthen the capital structure of these institutions. This policy is also an exercise in circular reasoning: It leaves banks without access to credit (either senior or subordinated, unsecured or ultimately secured) and with worthless equity. The only ones holding the bag are depositors which, as in the Euro zone, end up demanding unconditional guarantees of their governments and even after getting these, they withdraw their monies (i.e.Spain). Therefore, governments end up trapped in the circularity of causing bank runs by their own policies.

There is another circularity, which is perhaps the least understood. The Fed and a myriad of other central banks have not only a mandate on inflation but also on maintaining a target level of activity, or employment. These central banks therefore focus on the so-called excess capacity of their respective currency zones to reach a decision on their benchmark interest rates.  We will show that this is circular reasoning in hiding, because it makes no sense to think that a company that produces, say, 10,000 cars per month but has the capacity to be producing 15,000 should be producing those 15,000 cars per month.  However, given the cost structure and prices the company gets for its produce, the optimal amount they choose to produce is 10,000. Period. Because if they produce more, they may incur into a loss and may even go bankrupt. Think about it in your own terms…At the given income you earn…would you work and additional half-time, for no other reason that if you “invest” in doing so, you will simply earn the same per hour of work or less? Clearly you wouldn’t, unless your marginal salary rises. So, why would the rest of the world do so?

The key thing is then to ask: What set of relative prices were present back at the time when the company decided to invest to have a capacity to produce 15,000 cars per month? Who created those artificial relative prices? Could we not say that the 0% interest rate imposed by a central bank is one of those artificial prices? But if we are right, is it not clear that there is a circularity when a central bank sets a rate following data on capacity? After all, the additional unused capacity was driven by a low interest rate policy and encouraging the build up of more capacity only exacerbates the problem.

At the heart of all these circularities is the fact that the world has fiat currencies and the world’s reserve currency is used to support a Ponzi scheme, where the US Treasury gets into debt to repay the outstanding debt and its interest. Like all lies, this one will be exposed when the fact is confronted with the story. Today, the story is still winning over the fact, thanks to the existence of futures markets, through which commodity spot prices are manipulated (think oil, gold).

Why? Because, central planners believe in managing expectations. Remember, they think that markets act irrationally and if one can manage expectations, as in the case of inflation expectations, one can get away with printing money. They believe that the prices of commodities are one of the main drivers of inflation expectations and by maintaining these prices suppressed, people will not think the current policies will end up in high inflation.

How is this done? The existence of futures markets allows big players to set big naked shorts, which means that huge short positions, driving the spot prices down, are created without the seller actually owning the commodity. The underlying risk is obviously systemic, because once one of these sellers is exposed naked, the house of cards clearinghouse falls. The futures markets are the Achilles tendon of this big house of cards we live in. As long as they exist, we will not see parabolic increases in the price of precious metals and once they cease to exist, capital controls will be overwhelming. Pick your poison…

 

Martin Sibileau

As Easter approached, we began to see a timid sell off in US stocks (but not so timid in Europe or Canada), in corporate debt, and in Treasuries. Treasuries later in the week rallied, but if you ask, we would see them still in a downtrend. This downtrend began with the implementation of the Fed’s latest currency swaps, at 50bps, in mid December. As we argued against public opinion (refer here), the swap is a bailout that actually coupled the fate of the US with that of Europe, and not the opposite. It makes perfect sense to us because just like now, the US was also coupled to Europe in the 1930s, and ended up having to pardon what it was “owed”. Here is the moment when President Hoover announces the moratorium (ie. pardon) of the debt:

People back then took the matter in their own hands and forced the devaluation that ended in the bank holiday of 1933, with President Roosevelt confiscating gold. Here is the announcement by Mr. Roosevelt. Let’s keep both videos in mind, for future reference, because we have the feeling this crisis will be a horrible déjá vu:

As we have done many times before, we offer this excerpt from Jacques Rueff’s “The Monetary sin of the West”, 1971:
“…On 1 October 1931 I wrote a note to the Finance Minister, in preparation for talks that were to take place between the French Prime Minister, whom I was to accompany to Washington, and the President of the United States. In it I called the Government’s attention to the role played by the gold-exchange standard in the Great Depression, which was already causing havoc among Western nations, in the following terms:

There is one innovation which has materially contributed to the difficulties that are besetting the world. That is the introduction by a great many European states, under the auspices of the Financial Committee of the League of Nations, of a monetary system called the gold exchange standard. Under this system, central banks are authorized to include in their reserves not only gold and claims denominated in the national currency, but also foreign exchange. The latter, although entered as assets of the central bank which owns it, naturally remains deposited in the country of origin. The use of such a mechanism has the considerable drawback of damping the effects of international capital movements in the financial markets that they affect. For example, funds flowing out of the United States into a country that applies the gold-exchange standard increase by a corresponding amount the money supply in the receiving market, without reducing in any way the money supply in their market of origin. The bank of issue to which they accrue, and which enters them in its reserves, leaves them on deposit in the New York market. There they can, as previously, provide backing for the granting of credit….”

We are starting to get dizzy, disappointed, confused by the manipulation of capital markets, which are slowly and steadily losing liquidity.

The manipulation comes first and foremost from central banks, be it in the FX market, rates or gold. And when they intervene, they generate a volatility that is completely foreign to the “natural” changes that “Main street” (i.e. non-financial sector) would expect from a growing economy. It is this volatility that gets everyone dizzy.

Secondly, governments, via regulations and financial repression, distort the subordination points the market had established for different sectors. What do we mean by this? Every business and in aggregate, the whole economic system, has a capitalization structure, consisting, for example, of equity, preferred equity, subordinated debt, sr. unsecured debt and sr. secured debt. Each participant in these “layers” of the capital structure demands a return for the risk taken. That risk consists of two parameters: The probability of default (i.e. losing one’s capital) and what it expects to recover, if there such default takes place. Well, since the beginning of this crisis, with the bailout of the Chrysler and General Motors in the US, the Asset-Backed Commercial Paper scandal in Canada, the bailout of the financial system in the UK and most recently, the debt exchange of Greek debt with the European Central Bank which subordinated private bondholders without triggering default, both parameters (default and recovery) have been insanely disfigured. The natural consequence is a retreat by investors from pouring funds to the “system” at best, or simply reducing the savings rate, at worst. We fear both processes are well underway (last week, we received confirmation of a slight decrease in the savings rate in the US) and it is this repression that disappoints us.

Thirdly, we are confused by the ignorance leaders show. They should by now see that these policies drive people and companies to save less. We discussed this point on March 18th, when we wrote:

“How can any entrepreneur in these conditions feel encouraged to invest in increasing the productivity of his/her business? They cannot and all they are doing and will be doing is maintain what they have, refinance their liabilities longer term for cheaper rates and use every excess cash they count on to increase their dividends, as a way to cash out in a world where the price of equity, the price of risk, is anything but clear. We remember those times in Argentina when suddenly, bankrupt companies were owned by rich businessmen. One thing is to invest in dividend producing companies, with dividends driven by stable and healthy cash flows. Another thing is to invest under the illusion that those exist, when in fact the dividends are the only outlet entrepreneurs have to cash out with bank debt…”

On April 2nd, Zerohedge.com reproduced comments made by David Rosenberg, supporting this view, under the title: “How The Fed’s Visible Hand Is Forcing Corporate Cash Mismanagement” (We generally tend to disagree with mainstream economist David Rosenberg, but it looks like, over the past years, he may have been quietly reading Austrian economic literature).

Under the status quo, investors, globally, are and will continue to shift slowly their savings out of the “system”. On the margin, why would anyone that is not an insider of the financial markets want to keep their savings there? They will be levered/re-hypothecated or invested in cartelized exchange-traded funds or used to pay fees or futures rolls, or face huge bid/ask spreads or finally, if they produce good results… they will be taxed. Why would anyone want this? Why not just keep savings safely invested in farmland, or collectibles, or physical precious metals, or real estate in unique locations? These assets cannot be re-hypothecated, charged with monopolistic fund fees or unreasonable bid/ask differentials. Returns can be influenced by their owners’ commercial activity and taxes can always be minimized. But if these are the alternatives…how will corporations get funding for their projects or even normal capital expenditures? How will governments keep funding their deficits? Of course, …. Ben Bernanke and Mario Draghi assured us last week that their liquidity pumping policies are only transitory…

In the last days again, we have been exposed once more to the rhetoric of the prospective fiscal unification of the European Monetary Union (“EMU”) but based on new, mega bailout funds. We no longer care about the amounts they come up with (they came up with Eur940MM…nobody bought), even if it was true that the EMU members can raise these amounts. The fundamental issue here is that they want to address a “flow” problem (fiscal deficits) with a “stock” solution (bailout funds). It can’t be done. Flow-driven problems must be addressed with flow-based solutions, like a federal tax (If you have never heard of the terms “flow” and “stock” as used in Economics, please, read this explanation).

In particular, the situation out of Spain is rapidly worsening. Most analysts believe it is serious and a good portion of them think that once it spins out of control, the European Central Bank will intervene with plain monetization of Spanish assets. We have our doubts. Unlike other peripheral countries, Spain is a kingdom with a strong and influential king. Unlike other peripheral countries too, the fiscal deficits that hurt Spain are of a regional nature, and the independence of these regions is strong and ferociously defended. Under these circumstances, there is a high risk that the demands imposed upon Spaniards by the Euro Council be harsh enough to be refused and that upon such refusal, the Euro-zone face its final hour. We think that the fact that gold held above $1,600/oz upon the release of the Federal Open Markets Committee’s (“FOMC”) minutes last week, with stocks and the Euro selling off is a signal that this risk is not to be underestimated.

In light of this, having been stopped out of our position in gold with the release of the FOMC minutes, we bought it back on Thursday, at a lower price, but this time, hedged, shorting North American stocks. We are bearish of stocks or, better said, we think that the ratio of gold to stocks is now in gold’s favor, after a serious correction.

 

Martin Sibileau

Last week we had suggested that the strength of the Euro (by strength, we mean a Euro above $1,30) could be based on the fact that the liquidity lines extended by the European Central Bank were collateralized. As the sovereign risk of Spain,Italy and Portugal had deteriorated, so had the value of their sovereign debt diminished and, as this debt had been used as collateral by the banks of the Eurozone, these banks would be forced to sell assets and buy Euros to post on margin. It was simple and beautiful logic. However, we were wrong and the reason for that left us even more concerned. Someone better informed than us, who shall remain anonymous, wrote us the following (the highlighting is ours):

“…Hi Martin,

I just wanted to chime in on the issue of ECB (European Central Bank) margin calls. I completely agree that in theory the collateralized lending that now dominates can develop into a vicious cycle (as well as a virtuous one of course). However, in practice, a lot of the collateral that is pledged at the ECB is marked to model rather than marked to market. At least that’s what I am inferring from the ECB margin calls. The spikes that you saw relate to Greek collateral coming in and out of the ECB refi ops. Abstracting from those the margin calls themselves tend to be too small in my view to have an impact on the Euro…”

Having proved our axiom wrong (i.e. margin calls triggered by market volatility), our thesis is proved wrong. We had at the beginning of 2012 however warned that: “…in the short-term, the demand for Euros does not wane, because sovereign debt is denominated in that currency and the refinancing operations of the European Central Bank facilitate the purchase of that debt. This suggests to us that shorting the Euro will be a painful trade, with very high volatility…” (“Walking the fine line”, Feb 6^th, 2012).

It is time now for us to write a few lines today about Canada and India. Over the past months, we have seen crude oil appreciate. Simultaneously, the Canadian dollar did not (the Canadian dollar is positively correlated with crude oil) and the data coming from activity in Canadahas been disappointing. What makes matters worse is that in light of this, the price of housing has remained strong and even slowly increasing. In discussions with those following this market we noticed that in general, investors tend to see the Canadian context with the same lens used to see that of the USand the UK: They see a bubble in the housing market that would eventually be harmful to the financial system, and which would end in systemic weakness for Canada. This is, after all, what occurred in the USand the UK(We remind readers that at “A View from the Trenches”, we have never seen the EU crisis based on anything else but an institutional problem, rather than a liquidity or solvency problem. Refer: http://sibileau.com/martin/2010/02/10/)

We see the Canadian context differently. We think that it is likely that the barbarians will use the back, rather than the front door. Because Canadians have on average tended to put significant down payments on their houses, only a fraction of the outstanding mortgages have required insurance from the Canadian Housing Mortgage Corp. That fraction can be (but is not necessarily) securitized. The rest remains warehoused by Canadian banks, which unlike US banks, have recourse on their borrowers (if these default on their homes). Our fear then is of a potential contagion from the government. Indeed, rather than expect contagion from the banking system to the government, inCanada, we expect contagion from the government to the banking system. If the fiscal situation deteriorated (led by Ontario), the guarantee of the Canadian Housing Mortgage Corp. and the implicit comfort based on the country’s sovereign AAA rating would immediately affect the banks.

Do we expect this deterioration to be triggered by an endogenous dynamic? No. We fear that Canada may be affected by a foreign development and we can think of many, from the Euro-zone,China, or theUS…which takes us to India.

India has and is embarked in an inflationary process and, like in any other inflationary process, the outstanding amount of money is the taxing base. Following the example set by the Mahatma Gandhi, Indians peacefully protest this taxation by leaving the taxing base, the rupee, in exchange of gold. This has angered the government there which has taken a few repressive measures. It has taxed gold (a tax currently under review), set import duties and even barred gold loan companies (that lend on gold as collateral) from lending against gold bars, coins and bullion. These companies can now only lend against gold jewellery, with a cap on the loan-to value asset ratio and maintaining a minimum Tier 1 capital of 12 per cent. Does anyone think that these measures will favour the development of capital markets in India? Does anyone actually believe that because the competition from the gold loan market falls, savings in rupees will grow and investors will accept the government’s strong hand and lend in rupees? This is another example of the idiocy of bureaucrats that is destroying capital markets across the globe. Not only will savings in rupees not grow, but the overall savings rate will tend to fall, because on the margin, if savings have nowhere to go…why save?

This destruction of capital markets, as we noted, is not only taking place in India. The same is carried away slowly, by breaking the price system, whose signals no longer seem to work. Compared to July 2011, we have more than a trillion of new Euros, we have had Operation Twist, the banks of England and Japan weaken their currencies, sovereign downgrades worldwide, Ben Bernanke announcing low rates until 2014 and yet, gold is below $1,700/oz, courtesy of the interventions (see: http://www.zerohedge.com/news/paul-mylchreest-presents-various-visual-case-studies-gold-price-manipulation) . Even worse, although gold is below $1,700/oz, it is obviously higher than a year ago…but the capitalization of the gold mining sector is lower.

Repression, repression, repression…Interest rates don’t reflect anything these days. If you ask us, we don’t even know what to call capital. The price of crude oil touched $110/bl and yet the capitalization of energy sector in Canada slipped. Only a few dare to short the Euro, in the face of the massive destruction of the financial system in the Euro-zone. How can this be possible?

People wonder and at the same time praise the fact that companies nowadays hoard record amounts of cash, as a sign of strength. We think this is actually a disgrace and it shows how central banks managed to distort the relative prices of the different components of the economy’s capital structure. These companies are not investing that cash but as we mentioned a month ago, they have started to return it via dividends or share buybacks.

The final outcome of these repressive policies can only be a reduction in the savings rate and investments, a fall in productivity, an increase in consumption, if the supply of money continues and the inevitable stagflation.

 

Martin Sibileau