Wednesday, October 5, 2011
A little hysteria can go a long way, especially when it concerns financial markets. And with gold prices plunging 15% last month, it almost goes without saying all those GLD ) owners are now biting their nails, wondering whether the three-year rally has finally run its course. After all, the tumble from $1,900 per ounce to $1,650 is the biggest one-month dip we've seen from gold in years. Surely this is a sign the tide has turned, right?Gold Trust (NYSE:
Maybe. More realistically, it's just another blip in a much bigger uptrend.
Nobody was complaining on the way up
The pullback was nasty to be sure. What seems to have been overlooked, however, was the equally oversized run-up gold made before topping out back on Sept. 5. From July 1 to Sept. 5, gold prices soared from $1,487 per ounce to $1,905. That's a 28% rally in just two months, which is the biggest unfettered rally since 2009 (though 2009's 31% rally took four months to complete). In fact, the last time we saw anything as dramatic as this year's third-quarter rally in gold prices was the 51% rally between August of 2007 and March of 2008.
Point being, the size of the gain right in front the pullback left traders little choice but to think defensively and lock in profits at the first sign of trouble. There was just plenty of room to fall.
The story isn't so different for silver, or for stakeholders in the iShares Silver Trust (NYSE: SLV ).
Silver prices fell 31% between Sept. 2 and the end of last week (Sept 30). The selloff was even larger than the 28% dip in April, which came after (and this isn't a typo) an 82% run-up between late January and April 25, when we hit a multidecade high slightly above $50 per ounce. Though silver prices partially rebounded in July and August, let's face it -- silver prices were still burning off the excess from that 82% move earlier in the year. In fact, last month's was the biggest plunge in silver prices since the three-month, 49% implosion in 2008, yet silver is still priced at three times what it was at that low.
In the grand scheme of things, the exact numbers and dates are irrelevant. The message is far more important, particularly for those who are still hanging on to the SPDR  Gold Trust or the iShares Silver Trust exchange-traded funds (ETFs). And the message is this: this is nothing we haven't seen and survived before. Indeed, we've survived worse.
Oh, the meltdown both precious metals made in 2008 certainly felt insurmountable at the time, but both came roaring back within a matter of weeks to dole out three more years of higher highs. Has anything really changed between now and then?
What about the strength of the U.S. dollar?
Gold bears are quick to point out that the U.S. dollar started to rebound in late September, coinciding with and even prompting the pullback from silver, gold and most other commodities. Bluntly though, the punishment doesn't come anywhere near fitting the crime.
The U.S. Dollar Index  has gained just under 7% since Aug. 26 -- a very minor move relative to all its gyrations since 2008. More dramatic moves the dollar has made of late include the 19% rally in late 2008, during which gold only fell 23% (though silver got cut in half during that period). The greenback  rallied 17% in early 2010, and silver prices didn't budge during that rally -- meanwhile, gold prices actually moved higher. But now, all of a sudden, the sawbuck makes a very modest bullish  move and gold and silver are nothing but liabilities? Sorry, the relationship is too inconsistent to use as the reason for gold's demise now.
U.S. Dollar Index Compared with Gold, Silver Prices
No, the most plausible explanation for the sudden setback is the most obvious one -- gold and silver were overbought in the short run, and it was time to pay the piper. The longer-term uptrend for each has most definitely not been broken, though. Moreover, silver and gold could (and likely will) give up more ground in the near-term future without snapping their overall uptrend. Moreover, the dollar's trend still isn't exactly decidedly bullish. The charts above make that quite clear.
It's certainly not a very esoteric explanation. But that doesn'tit's not the right one.
Risks to Consider: Unfortunately, a mob mentality within the precious metals market  has replaced rhyme and reason for the better part of 2011, and that herd-like effect was still in effect as of last week. Never underestimate the potential madness of a crowd to lead it to strange conclusions.
Simultaneously, neither gold nor silver are at the bottom of their bullish channels yet, so there is room to give up more ground before hitting a solid floor.
Action to take --> While the recent intense volatility may prolong a recovery in gold and silver prices, the same underlying fundamentals that pushed metal prices this far are still in place. These forces include a generally-weak U.S. dollar, brewing inflation , a Federal Reserve that doesn't even want a stronger dollar, and -- more recently -- fear of a globalcurrency  collapse. These are all bullish for gold, yet none are poised to evaporate anytime soon. This recent dip and any subsequent dip from gold -- especially if that lower support line around $1,400 is met -- is an attractive entry opportunity as the metal continues its erratic march toward multiple price targets in the $2,200/$2,300 per ounce range. That's at least 33% higher than where it's priced now.
As for silver, it doesn't benefit from inflation worries and currency wars the way gold does, and is the more speculative of the two at this point. It's still in a broad uptrend, though, so it's suitable if you have a higher risk tolerance.
Because Southern Copper has world-class assets and high profit potential, but its share price has taken a dive amid all of the recent market turmoil.
I love to find a sound business whose stock price has been pummeled in the uncertain markets. It screams bargain and is a major buying opportunity.
And in this case, the fact that Southern Copper's stock price has dropped means its already-juicy dividend has increased. Currently the company's $2.48 dividend equates to a 9.5% yield.
Plus, it's consistent: Over the last five years, Southern Copper has averaged a payout of 83% of its after-tax profits.
Given all that, it's time to buy this high-yielding, high-quality mining company (**).
Southern Copper Corp. Outshines the CompetitionSouthern Copper Corp., founded in 1952, engages in mining, smelting, and refining mineral properties in Peru, Mexico, and Chile. It has the largest copper reserves of any publicly traded company, and last year mined more than 1 billion tons of copper. That means it is perfectly positioned to profit from increasing global demand for copper.
The company operates the Toquepala and Cuajone mines in the Andes Mountains located southeast of Lima, Peru, as well as a smelter and refinery in the coastal city of Ilo, Peru. It also operates underground mines that produce zinc, gold, and lead, as well as a coal mine that produces coal and coke.
Southern Copper's mines are estimated to have a productive life of about 80 years. That means 80 years of revenue from copper, gold and silver deposits.
The company's cash operating cost is $1.61 per pound to produce copper, but that cost is lowered to 31 cents per pound by subtracting profits from the mines' byproducts of gold, silver, lead, zinc and coal.
That's a lot of secondary profits hitting the bottom line.
Southern Copper Corp. is a subsidiary of Americas Mining Corp. Its stock is 80% controlled by the parent company Grupo Mexico S.A. de C.V. (PINK: GMBXF), with the public markets owning the other 20%. This relationship is beneficial because Southern Copper is protected by one of the largest companies in the world.
However, this structure has a potential downside: Investors in Southern Copper Corp. could be bought out at some point. The parent division has made an offer to relist the merged divisions, which would include replacing the current shares with newly-listed shares and a slightly different share count.
Normally, I shy away from companies with open corporate actions in front of the board of directors. In this case, however, I am willing to look past the possible changes because of the quality assets and profit potential Southern Copper has to offer.
The company reported second-quarter net income of $658 million, 110% higher than 2010's second quarter. Sales were up 54% to $1.8 million.
The company has a market capitalization of $26 billion with an enterprise value of $28 billion once net debt and cash is accounted for. Its price/earnings (P/E) ratio is 10.73.
Southern Copper Corp. is trading right around its 52-week low of $25.06 and closed Friday at $24.98.
Southern Copper Corp. gives us a chance to own the longest-life copper mines and largest total copper reserves in the world. Plus, the company has a long history of paying out a large, regular dividend to its investors.
Let's use the current weakness in price, with the stock trading near its 52-week low, to start building our position in this company.
If you are considering exposing a full 3% of your portfolio to this position, let's consider buying one-third of the position (or 1% of your total portfolio) now at market. This gets us into the stock at low levels.
Since the stock has already broken down in a very weak market, let's exercise some patience and put in some GTC (good-"til-canceled) limit orders at 5% and 15% below where we pick up our first leg in.
This will give us real exposure to the company with our entry, while allowing us a chance to build our position at a lower cost per share.
Yesterday, Deutsche Bank Economist Jim Ma and his team came up with a report, turning somewhat more bearish on China after the Hong Kong/Chinese markets got really killed.
They are now expecting GDP growth to slow to or below 7%, and are worried about the exports picture (and among other things).
On the real estate market, Jun Ma and associates told an interesting story on the latest development.
In recent weeks, the number of phone calls received by an author of this report from China-based property agents has increased several fold, indicating a significant rise in the urgency for developers to raise cash from selling properties. A property consultant told us that he recently received requests to help raise RMB10bn for cash-strapped small and medium-sized property developers – this amount is a huge multiple of what he is used to dealing with. In the offshore market, where many Chinese developers seek foreign currency funding due to lack of access to domestic funds (the domestic stock, bond and trust loan markets are closed to them due to policy tightening, and banks are also very stringent), their USD bond yields have surged to 20-25% in past weeks from around 10% before August. This means that even the offshore markets are now largely closed to Chinese developers (see Figure 4).
All these suggest that many developers are now under greater pressure to sell their properties at a bigger discount in order to avoid a liquidity crisis. An emerging consensus from potential buyers and some developers is that a 10% drop in prices in the coming two quarters would be justified.
A further decline in physical property prices will likely reduce the incentive for developers to start new projects, and thus implying a deceleration in real estate FAI. Note that real estate FAI by developers account for about 16% of total FAI, and about 25% of the demand for steel, coking coal, and cement.
They are now expecting to see about 10% correction in the real estate market for the next 4-6 months. However, 10% is all they are expecting, because…
Readers may ask why we are not projecting a 30% drop in property prices. Those who understand China’s political economy should know that a 15% decline in average property prices in 35 cities within a few months must be accompanied by a range of economic and social consequences. These will include a sharp decline in real estate transactions, a visible deceleration in real estate investments, rising unemployment in the property construction and agency sectors, a further decline in construction material prices, demand destruction due to inventory destocking, and finally a worrying decline in GDP growth and the resulting concern of social stability. In other words, the government will most likely not tolerate a 30% drop, and probably not even 15% in our view. We expect real estate policies will likely be relaxed way before a 30% price decline is observed.
Will the bad financial news ever stop? A lot of people in the financial world were hoping for a much better fourth quarter after an absolutely disastrous third quarter. Well, if Monday was any indication, October could end up being a really rough month for global financial markets. So much bad financial news keeps pouring in that it really is a challenge to try to keep track of it all. Greece seems to get closer to defaulting on their debts with each passing day, and it appears that Germany is not going to contribute any more bailout money beyond what they have already committed to. Major banks on both sides of the Atlantic are on the verge of collapse, and investors all over the world are afraid that we may have another "Lehman Brothers moment" soon. Shares of American Airlines dropped a staggering 33 percent on Monday as rumors that they will soon be entering bankruptcy swirled. Yes, things certainly are getting interesting. Back in 2008, the governments of the western world saved the financial system with gigantic bailouts that were absolutely unprecedented. If the financial system crashes again at some point in the coming weeks or months, will the political will for more bank bailouts be there? If not, what is going to happen to the banking system?
On both sides of the Atlantic, the big banks are highly leveraged, they have taken on a ton of risk and they are very deeply exposed to derivatives. It is as if virtually nobody learned any lessons during the financial crisis of 2008. Once again we are facing a situation where if a couple of financial dominoes fall it could send dozens of others tumbling to the ground.
Some very significant things happened on Monday. But the media has gotten so used to reporting on tremendous financial instability that Monday's events mostly got brushed to the side. Instead, Amanda Knox captured most of the headlines.
But the reality is that some really, really monumental stuff has been going down.
The following are 14 facts that just might scare the living daylights out of you....
#1 On Monday, the Dow was down 258 points. Lately it seems as though the Dow has been going up or down by several hundred points almost every single day, and that much volatility is not a good sign for the health of the financial system.
#2 Shares of Wall Street banking giant Morgan Stanley fell by another 8 percent on Monday. Overall, shares of Morgan Stanley have declined by more than 50 percent since February.
#3 Bank of America stock dropped down to $5.53 a share on Monday. Just a few years ago, it was trading for more than $50 a share.
#4 There are reports that Goldman Sachs may actually show a loss for the third quarter of 2011 and that yearly bonuses for employees may be slashed to next to nothing. Yes, not too many people are going to have sympathy for Goldman Sachs, but this just shows how bad things are getting out there for the big Wall Street banks.
#5 Normally Goldman Sachs is quite upbeat, but lately they have been coming out with some really frightening reports. For example, a new report from Goldman Sachs declares that there is a 40 percent chance that we are entering a "Great Stagnation".
#6 Shares of European banking giant Dexia plunged by about 10 percent on Monday on rumors that it will soon need a significant bailout. The stocks of major banks all across Europe have been getting absolutely hammered for weeks.
#7 Shares of American Airlines fell by 33 percent on Monday on rumors that the airline is about to enter bankruptcy. Amazingly, trading in the stock was stopped 7 different times on Monday.
#8 It is being reported that approximately 240 pilots for American Airlines have retired in the last two months alone. All of those pilots are retiring so that they can shield their pensions from the upcoming bankruptcy filing.
#9 Nearly the entire airline industry got hit really hard on Monday. Shares of United Continental, U.S. Airways and Delta were all down more than 10 percent.
#10 Overall, U.S. stocks fell by 14 percent during the third quarter of 2011, and now the fourth quarter is off to a very rocky start.
#11 The incoming head of the European Central Bank, Mario Draghi, has publicly admitted that major European banks are having "funding problems". Just like back in 2008, we are rapidly heading for a giant "credit crunch".
#12 A shocking new Bloomberg survey has found that approximately one out of every three international investors expects a "global economic meltdown" within the next 12 months, and 70 percent of them believe that the global economy is "deteriorating". Perhaps they have been reading The Economic Collapse Blog too much.
#13 Financial markets in Europe were rocked on Monday when it was revealed that Greece is not going to hit the deficit reduction targets set for it either this year or next year despite all of the severe austerity measures that have already been implemented. Needless to say, a lot of financial authorities in Europe were very displeased by this news.
#14 German Finance Minister Wolfgang Schaeuble is publicly declaring that Germany will not contribute any more money to the European bailout fund.
The truth is that the political will for more bailouts has totally dried up in Germany. (more)
We’re no longer in the realm of economic conspiracy theory and non-mainstream alternative news, as the head of one of the world’s largest financial institutions, with over 10,000 branches in 22 countries, joins other well known financial figures with dire warnings of what’s coming next:
If someone knows the truth, it is the guy at the top of UniCredit [Szalay-Berzeviczy], which we expect to promptly trade limit down once we hit print. Among the stunning allegations (stunning in that an actual banker dares to tell the truth) are the following:
“The euro is “practically dead” and Europe faces a financial earthquake from a Greek default”… “The euro is beyond rescue”… “The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greece’s spirits.”….”A Greek default will trigger an immediate “magnitude 10” earthquake across Europe.“…”Holders of Greek government bonds will have to write off their entire investment, the southern European nation will stop paying salaries and pensions and automated teller machines in the country will empty “within minutes.”
In other words: welcome to the Apocalypse…
Mr. Szalay-Berzeviczy is no arm-chair quarterback. He sits atop one of the biggest banks in the world and is the former head of the Hungarian stock exchange, and he’s not beating around the bush. The Greeks will, without a doubt, default on their loans. In fact, this weekend we found out that they are incapable of meeting their deficit targetsdespite extreme austerity measures already taken. In the very near future, they will be incapable of making good on their payments, and once that happens, the seismic effects across the entire globe will be felt almost instantly. As was pointed out in the excellent investigative documentary Meltdown, we are economically, financially and politically intertwined, so don’t underestimate the problems in Europe – the coming defaults across the Atlantic will have significant impact on our domestic economy.
Also of note is the fall-out that occurs when a country defaults on its sovereign debt – a warning sign to all of those living in nations that are on the verge of collapse (including those of us here in the US). When a government defaults they will no longer be able to make payments to their employees – and that includes former employees depending on pensions, and those dependent on government subsistence programs like social security and welfare. All of it will be wiped out. That is the reality of the situation, and not just in Greece.
You can probably imagine the panic that ensues, including Great-Depression style runs on the banks and ATM machines being emptied. If this happens to a single country like Greece it is still manageable. But what about the whole of Eastern and Western Europe? Or the United States of America?
We will see these events come to pass. It is unstoppable at this point.
Morgan Stanley in a free fall. Goldman Sachs at multi-year lows. Citigroup looking Ugly. Bank of America off 50% from recent highs.
You may be wondering what is going on with the major firms in the financial sector. While each of these firms have different problems — vampire squids to Countrywide acquisitions — they all have something in common: Their balance sheets are opaque.
This is no accident. Indeed, it was by design that execs in the banking sector, and their outside accountants, hatched a scheme in 2008 to hide their balance sheets from public view. The bankers had been lobbying theFinancial Accounting Standards Board to change the rules that governed “Fair Value Measurements” also known as FAS157 (September 2006).
You may recall during 2008 this was referred to as “Mark-to-market” accounting.
Banks loved m2m during a boom period. M2M made the more unusual balance sheet holdings — derivatives, the mortgage-backed securities (MBS), exotic liabilities, and other assets — look fantastic. The fair value measurements of these items — essentially, yesterday’s closing price — allowed the accounts to show enormous profits. Those were the underlying basis for huge bonuses, stock option grants and of course, company share prices.
The reality was quite a bit different. These were not equities or treasuries or corporate bonds — they were thinly traded items whose prices were ramping upwards on a sea of delusional optimism. As soon as the credit bubble ended and housing began to retreat, these assets would free fall like an Acme anvil in a Roadrunner cartoon — and the bankers were the Coyote.
Uh-oh, this was gonna be a problem. So the bankers began to lobby FASB to change the rules governing Fair Value Accounting. Sure, it was hugely helpful on the way up, but now, reporting actual holdings — previously marked at all time highs — was becoming problematic.
To their credit, the accounting board resisted. What Bankers were proposing — marking to their models — was patently absurd. These were the models that told them these purchases were good ideas in the first place. Changing Mark-to-Market to Mark-to-Model was a free pass to practically allowed banks to NEVER have to write down their liabilities. Some people began calling the proposed accounting changes “Mark-to-Make-Believe.”
In the midst of the 2008-09 collapse, however, Congress was in a panic. They mandated that FASB acceptMark-to-Make-Believe accounting in the Emergency Economic Stabilization Act of 2008. It gave the Securities and Exchange Commission the authority to “Suspend Mark-to-Market Accounting.” In March and April of 2009, that is precisely what occurred.
It was yet another example of an industry lobbying Washington, D.C. to get precisely what they want — and then having that legislation blow up in their faces. (I detailed other examples of this in a chapter of Bailout Nation — you can see that chapter here: Strange Connections, Unintended Consequences).
The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell.
And that is exactly how the bankers wanted it.
But given the trouble in Europe, and the likely problems in housing if the US goes into a recession, Investors have decided they cannot take the risk of a holding an opaque, possibly under-capitalized probably over-leveraged financial firm blindly. They are telling the banks no thanks, we are not interested, we are going to be prudent and we have to assume the worst. Hence, for the second half of 2011, they have been selling off their holdings in these opaque, potentially insolvent too big to succeed entities.
Bankers, enjoy your beds. You made them, now lay in them . . .