Click here to read this article in pdf format: June 4 2012

The loyal reader knows by now that we have been, perhaps since the start of our publication, expecting a dynamic like the one seen last Friday, namely, lower stock prices and a higher gold price. The last time we insisted on such a forecast was on April 9^th, under the title “We’re getting closer”. But no, we are not like the oracle of Delphos, supplying pagans with loose predictions. We have been very precise in laying out what the drivers for the upcoming collapse are. At the beginning, in 2009, we were alone (read, for instance, our letter from May 19^th, 2009) . Today, we are only one of many to side with this view.

We want to throw a word of caution. Last Friday also, Treasuries ended higher (i.e. yields lower), which means that the status quo, although challenged, is still the status quo. There are now many, including Peter Schiff or George Soros, who assume that from now on and incarnated by the reversal in gold, we start a new phase. This phase would lead us to a crash, followed by unseen amounts of money printing and ending in hyperinflation.

This is a simplistic, 10,000 ft above ground perspective, we think. Undoubtedly, and as per our last two letters, liquidity seems not to be an issue and the intervention of central banks will do little to prevent what we think will be a crash. This crash will be nothing else than the repudiation of the uncertainty provoked by and the misleading nature of zero interest rates, as well as of the increasing financial repression. But exactly for this reason, the status quo will not leave without a fight that will involve more capital controls, price controls, unilateral currency devaluations and a diversity of other interventions.

On this basis, we think it will be wise to be cautious taking a trading view. We will not only have to protect our savings, our assets “nominally”, but physically as well. Coming from Argentina, we have the dubious benefit of knowing a thing or two about this, but it may not be all that handy. After all, the developed world has its own methods and (going by the experience in the manipulation of the price of gold) one of them is the manipulation of prices via the futures markets.

In the futures market, prices can be affected on an unfunded basis, that is…without actually having to own an asset or all the cash to own it. As long as futures markets exist and regulators impose a risk weight on the assets that serve as collateral, the defenders of the status quo will have a tool to inflict pain on those who want to seek refuge in real assets. Therefore, it is valid to ask what could bring the collapse of the futures markets. High inflation would be one of the factors, but in our view, it is a longer term one. A simple answer to the question is this: Futures markets will collapse when an asset that was supposed to be delivered, cannot be delivered in the quantities and at the time it was going to be delivered. Most likely, due to the failure of a big counterparty, followed by that of the corresponding clearinghouse. This event, if it takes place and we think there is an increasing likelihood that it will, will really boost the flight from nominal to real capital.

Why do we think there might be an increasing likelihood of it happening? Because it would be the unintended consequence of the same manipulative actions governments are taking to affect spot prices. As these manipulations increase, their unintended consequence is more likely to occur, just like it did happen to the derivatives position of a well-known, global bank.

With these words of caution, we can only add that the future weeks, months, will be horribly volatile and that one will have to sit tight, and on the margin, move nominal capital to real capital at each opportunity. Policy makers believe they are still in control, but they are not. And by the time they find out, it will be too late for us to take any protective measures. The European periphery, for all practical purposes, is already out of the Euro zone. The US, for all practical purposes, is insolvent. The creditor countries of the world, for all practical purposes, are heading towards deception, as they find out that their mercantilist view of reserves management has destroyed wealth and misallocated capital. The Middle East, for all practical purposes, is heading towards complete anarchy and the commodity countries likeCanadaorAustralia, have left their fate in the hands of hope, unable to steer a course on their own, at the mercy of global capital flows…and hope is seldom a good strategy.

Martin Sibileau

If we have to summarize what drove the action last week, we will say it was the speculation over an upcoming (perhaps in June) Growth Pact in the Euro-zone. That was all. That did the trick. There is really nothing, absolutely nothing concrete. And no, we don’t think the market is speculating on a soon-to-come Quantitative Easing Version 3. But from pure intuition, it would seem that the market sees these conditions as necessary to take the any Pact seriously: a) Mario Draghi, President of the European Central Bank, would have to back such pact in a way that would guarantee some sort of deficit monetization, and b) Hollande should win France’s presidential ballotage, next weekend.

Indeed, most news were bearish last week and yet, every single asset class seemed to end on a bullish note. From the Euro zone, we saw a deceiving bond auction by Italy. We also learned that the unemployment rate in Spain (the official rate) averages between 20% and 30%, depending on which region one measures it, and that the United Kingdom is already in a double dip. This only resulted in a stronger Euro and stronger Euro stocks for the week.

Last week too, Moody’s downgraded Ontario’s credit rating to Aa2 with a stable outlook from Aa1 with a negative outlook. How did the market react? The Canadian dollar finished the week stronger. Then came the activity data release for the United States: Jobless claims, housing data, inflation data…all of them were worse than expected and yet….stocks rallied, with the S&P500 reaching again the 1,400pts. And we could say the same about oil and gold…

The lesson here is that a market that will not fall on bearish news is a bullish market. Even if it is a manipulated market, which brings us back to gold. Below is the daily chart (source: Kitco.com) for April 25th, 2012. It shows how upon the start of Bernanke’s press conference an algorithm sold whatever it could precisely at one point in time. Everybody saw it coming. We saw it coming, after what had happened on February 29th, or with the Euro peg announcement by the Swiss National Bank, in 2011. And this time, whoever was behind the move, lost money. We can only hope these moves stop or expect that newer, smarter moves will follow. We think the latter are more likely than the former:

Somehow, the idea of a “Growth Pact” reminds us of the New Deal and Ludwig Von Mises’ comment on the same. Von Mises wisely said:“…The comparatively greater prosperity of the United States is an outcome of the fact that the New Deal did not come in 1900 or 1910, but only in 1933…”. His words, in light of this Growth Pact speculation, sound to us wiser than ever…

We want to leave with this thought: As we have repeated, since the start of the Long-Term Refinancing Operations by the European Central Bank, the savings rate of the world (yes, now is the global savings rate) keeps slowly drifting lower either because of the manipulation of interest rates by central banks, or the fact that income is falling, as in the case of the European Union and the UK, or because of simple financial repression, as in the case of the debt swap between Greece and the European Central Bank, which left holders of sovereign debt suddenly subordinated. This simple observation leads us to think that this crisis will continue to unfold like a painful agony, and that we have many, indeed many more years of it to come.

Martin Sibileau