By Ajay Shah, on November 27th, 2009
In recent months, a sense has emerged that the exchange-traded currency futures market in India is more liquid than the corresponding contract traded OTC (i.e. the forward market). As an example, we examine a dataset from NSE of 28,797 observations of data – one observation per second – from 3 November 2009, for the November expiry. The effective spread for a transaction of $1 million (i.e. 1000 contracts) is calculated, in the units of paisa. This dataset has the following summary statistics:
| 5% |
25% |
50% |
75% |
95% |
| 0.519 |
0.763 |
1.000 |
1.380 |
2.344 |
In other words, 95% of the time, the spread on NSE for a $1 million rupee-dollar futures transaction was below 2.344 paisa. The median spread, for a $1 million transaction, was 1 paisa. This spread dropped below 0.5 paisa with only a 5% probability.
These numbers are significantly superior to those found on the OTC forward market, where, as a thumb rule, dealers feel that a $1 million transaction typically involves a spread of 2 paisa. This suggests that the liquidity at NSE is roughly 2x superior to the OTC market. The superiority of the execution at NSE is likely to be greater than 2x when we consider the opacity and execution risk of the OTC market. To the extent that order flow has shifted away from the forward market to the futures market, there could be a dynamic story here of the futures spread getting tighter at the expense of the forward spread.
This situation is unexpected. In the international experience, the currency forward markets is more liquid than its exchange-traded counterpart. This is despite the fact that futures markets has desirable features including near-zero counterparty risk, transparency, contracts standardisation and open public participation. The key reason for the domination of the OTC market appears to be historical. The OTC market came first, had entrenched liquidity, and the network externalities of liquidity hold the users in place.
In thinking about India’s currency futures market, it would be useful to compare and contrast with Brazil’s experience. Brazil is an interesting peer to India for reasons of a large GDP, democracy, rule of law, institutional quality, etc. It is also the only country of the world, prior to India, where the currency futures market became more liquid than the currency forward market.
In Brazil, currency futures trading began in 1991 – a seventeen year head start when compared with India. While Brazilian macroeconomics is now remarkably healthy, Brazil has had a turbulent history with many crises, high and volatile interest rates and inflation. The futures market, with daily marking to market, and therefore lower collateral requirements, offered a cheaper way to take positions in the currency. Nevertheless, there is reason to believe that several (sometimes unrelated) regulations contributed to tipping the balance in favor of futures contracts, so much so that today there is essentially no OTC market to speak of. The dealers on the forward market now provide OTC contracts to their customers but unwind their positions in the futures market (See Note 2). The regulatory pressures which moved liquidity from the OTC market to the futures market were:
- Access to spot markets was limited for several decades as a tool to control capital flight. Both domestic and foreign residents had easier access to futures markets than to spot markets. This led to greater number of players, and more liquidity in futures markets. Access to spot markets in Brazil is still far from free, for both domestic and foreign residents. India is in the same boat, with a futures market that is accessible to citizens but a spot market which is not.
- Until 2005, banks were subject to unremunerated reserve requirements on foreign exchange exposures exceeding pre-specified limits. These reserve ratios did not apply to futures positions, thus driving trading to futures markets.
- Until December 2007, Brazil imposed a financial transactions tax, called CPMF, on all debits on bank accounts. This levy applied to profit and loss payments on exchange traded contracts, not to their notional amounts, thus pushing activity to exchanges.
- OTC derivatives contracts are not netted, whereas contracts with the exchange or clearing house are netted by the latter. This means that the tax on cash flows, PIS-COFINS (See Note 3), de-facto taxes OTC transactions at a higher rate than exchange traded derivatives.
- Brazil has reporting requirements for OTC transactions – all transactions with domestic counterparties must be reported to regulators, in order for them to be considered enforceable. This levels the playing field in terms of the reporting burden of exchange traded versus OTC transactions. India has not yet done this.
- Pension funds are required to use only standardized derivatives contracts.
- The central bank, Banco Central Do Brasil, uses the futures market for doing currency intervention. This gives liquidity to the futures market, and also ensures that the OTC community has to look very carefully at the price on the screen so as to capture current information. India has not yet done this.
While some of these rules were removed in the 2000’s, after being in place for several years, their consequences have outlasted them. There is a path-dependence in market liquidity. These kinds of market rules matter in getting liquidity on the exchange off the ground. Once the exchange becomes liquid, the network externality of market liquidity sucks in further order flow and preserves the domination of the exchange even after these rules are removed.
Endnotes
1 The author is a senior analyst at the Bank of Canada. The views expressed here are personal. No responsibility for them should be attributed to the Bank of Canada.
2 The material in this note is a summary of information provided by Brazilian economists as well as that contained in Dodd and Griffith-Jones (2007), Brazil’s derivatives markets: hedging, central bank interevention and regulation, and Kolb and Overdahl (2006), Understanding futures markets, sixth edition, Blackwell Publishing.
3 The PIS and COFINS are federal taxes on revenues, charged on a monthly basis.
By Bron Suchecki, on October 20th, 2009
A reader has asked me to comment on these two recent GATA articles www.gata.org/node/7908 and www.gata.org/node/7911, which claim that London unallocated metal is a fractional reserve system.
Adrian Douglas’ assertion is that there is at a minimum four owners for each ounce of unallocated metal held in London. His support for this is to apply the ratio of average daily share trading in GLD (11.9m) to its shares outstanding (325m), rounding to a ratio of 1:30, to an estimate of the daily trading in gold in London to derive the amount of gold London should have. This is then compared to an estimate of what London does have, resulting in the 1:4 fractional ratio.
For his estimates of the London market, Douglas relies on a report by Paul Mylchreest. I haven’t had time to review Mylchreest’s numbers in detail, but his report takes a very logical approach and is fact based to estimating of the amount of gold in London. His conclusion is that there is
“an aggregate pool of gold of just over 16,866 tonnes of gold to support an average of 2,134 tonnes of daily spot gold trade. On this basis, 12.7% of the pool of available gold is being turned over every day on average. … And the entire pool is turned over every 7.9 working days. In my opinion, this level of trade relative to the estimated pool of gold liquidity is excessive and doesn’t pass the smell test.”
Firstly, he makes a series of assumptions to get to his figures. For example, his 16,866t figure relies on World Gold Council/industry estimates of above ground gold and the percentage that is investment. Being a trade organisation representing miners who want a high gold price one should expect that “stock” numbers will be estimated on the downside. When estimating what the real trading volume of gold is, then he steps into a more rubbery area because he is relying on only two guesses from some industry people – we need more than that.
As a result, one must consider his 12.7% turnover figure to have a fair margin of error considering all the assumptions and estimations used to derive it. This is not to say that it should be 1%, just that it is not a “hard” number.
Secondly, even if 12.7% is correct, I don’t think it logically follows that this “doesn’t pass the smell test”, a conclusion he comes to by comparing gold to equity, other commodities and fiat currencies. The last one is probably the most relevant. In this he has to again make some assumptions about currency trading turnover to come to a figure of 2.6% for Sterling, conceding that when including forwards and swaps “daily Sterling turnover is only equivalent to 8.4% of UK broad money”.
Why stop at Sterling? If one does the same calculations for the Australian dollar, you get 4.1% for spot and 13.3% including forwards and swaps. Does gold’s 12.7% (which could be lower if some of Mylchreest’s assumptions are changed) now appear as an “excessive amount of gold trading relative to the likely pool of available gold”?
Mylchreest’s final conclusion is that either 1. there is “more than one ownership claim on each gold bar” or 2. “there is far more gold bullion held in private hands than is acknowledged by current industry estimates”.
I would suggest that there is another OR that Mylchreest has not considered: the very fact that gold is no one’s liability and cannot be printed means it attracts a disproportionate amount of trading and speculation. Why is it assumed that 12.7% is excessive and unreasonable? Could not the 12.7% figure be proof of the special monetary nature of gold, proof that it is the King of Currencies?
I have spent a bit of time on Mylchreest’s report because it is the key input into Adrian Douglas’ calculations. Before I move on to his numbers, I would like to say that I have a lot of respect for Mylchreest’s report and look forward to it being improved with more accurate data.
On that, I note Mylchreest’s statement on page 25 that “I haven’t a clue what COMEX inventories were in 1997, but let’s assume 200 tonnes …” That information is available at Sharelynx.com going back to 1975. A subscription is required but would be worthwhile as Sharelynx has a lot of other data that would be very useful for Mylchreest’s analysis.
Now on to Adrian Douglas’ calculations. He is basically applying GLD’s turnover of 3.66% to Mylchreest’s turnover figure of 2,134t to come to an implied stock holding that London should have of 64,000t. This is then contrasted to Mylchreest’s estimate of 15,000t of non-leased physical to derive the 1:4 fractional ratio.
This analysis assumes that the behaviour of over-the-counter (OTC) players is/must be the same as those trading GLD. Let us consider each of Douglas’ statements in support of this.
“The purpose of buying investment gold is for it to store wealth. This necessarily implies that it is held for a long time.”
This is a very broad statement and one that I don’t think can be supported. Investors have all sorts of different time horizons. Remember we are talking about trading in unallocated and whether that is backed. The fact that it is unallocated rather than allocated bars would imply, if anything, that the investors have shorter time frames rather than long.
“If gold is bought and traded quickly it would destroy wealth, not store it, because there would be a large loss due to transactional fees.”
It is actually the other way around. The quicker you can trade something the less risk you have to changes in prices. Bullion banks have a spread between their bid and ask prices – they MAKE money from quickly trading gold. For those dealing with bullion banks in the OTC market, the tightness of those spreads combined with the volatility of gold mean it is entire reasonable for them to make money day trading gold.
“Considering these limitations [minimum trade limit of 1,000 ounces] it is likely that OTC participants would turn over a lot less than 1/30th of the inventory in a day.”
I do not see how the $1 million trade size must mean a lower turnover. That is not a big figure for wholesale market participants. With bullion bank spreads of $0.50 to $1.00, a 1000oz deal only means $500 to $1000 profit. This would mean that a spot gold trader would need to do a lot of trading to make a decent return on the capital employed, which means they would trade more frequently, rather than less.
As with Mylchreest’s comparisions to currency trading, I don’t think Douglas’ comparisions to GLD make any conclusive case that London gold turnover is suspicious.
For further support, Douglas notes that
“In the last 14 years the supply of dollars has increased from $4 trillion to $15 trillion (+275 percent) while the gold price has risen from $400 in 1995 to $1,000 in 2009 (+150 percent). How could this happen? … There has to be an alternative massive supply of gold to make the price rise slower than the influx of dollars.”
How it could happen is that those extra dollars were diverted into equities and house prices, rather than gold, pushing up their price more instead.
He also says that “If the OTC market traded only gold that was in the vaults on a 100 percent reserve ratio, there could never be a lack of liquidity.”
Lack of liquidity has nothing to do with stocks, backed or not. It has to do with a depth of buyers and sellers. If you have 100% backed unallocated, but few of the holders want to sell, then you have a lack of liquidity as well.
For some closing comments, I’ll quote Lawrence Williams from Mineweb:
“The big problem, though, with much of this kind of analysis is that the analysts and observers are working with a mixture of real and assumed figures. It thus tends to rely on statistics being manipulated, perhaps subconsciously, to support pre-conceived theories.” 
By Trace Mayer, on August 11th, 2009
Market liquidity is a business, economics or investment term that refers to an asset’s ability to be easily converted through an act of buying or selling without causing a significant movement in the price and with minimum loss of value. As market liquidity dries up then the bid and ask widen. The depth and breadth of United States financial markets has provided significant liquidity which has resulted in tremendously inflated illusory asset prices.
This will be an introduction to The Depository Trust and Clearing Corporation along with a brief analysis about how by its very nature market liquidity can evaporate extremely quickly which would destroy your value and purchasing power and what you can do to protect yourself.
THE DTCC
The Depository Trust And Clearing Corporation, or DTCC, plays a primary role in preserving liquidity in US financial markets. The DTCC, through its subsidiaries, clears and settles transactions for money market funds, general equities, corporate bonds, municipal bonds, mortgage-backed securities and even the nefarious over-the-counter derivatives. Subsidiaries include the National Securities Clearing Corporation, The Depository Trust Company, Fixed Income Clearing Corporation, DTCC Deriv/SERV LLC, DTCC Solutions LLC, EuroCCP Ltd. and a joint venture, Omgeo, which ‘plays a critical role in institutional post-trade processing, acting as a central information management and processing hub for brokers, investment managers and custodian banks.’
The DTCC is the largest depository in the world. It provides custody for more than 3.5 million securities issues from the United States and 110 other countries around the world. The DTCC has custody of approximately $40,000,000,000,000 of assets. A shareholder under corporation law is someone who is registered on the stockholder’s list. Being a shareholder can impart many rights under corporation law. The DTCC, through ‘Cede & Company‘ is, in many cases, the only shareholder of many publicly traded corporations. This is accomplished through an indirect holding system.
As Professors Baums & Cahn observed in their working paper “The Rise And Effect Of The Indirect Holding System: How Coprorate America Ceded Its Shareholders To Intermediaries” on page 23
The ultimate goal in this model is for all issuers to cede control of shareholder data to a single entity, which would then conduct all of the market’s transactions on its books, just as if all securities in circulation on the market had been dematerialized. Today, in fact, it is likely that a listed company will have only one registered shareholder, appropriately named “Cede & Company”, the nominee of the Depository Trust Company (DTC), which is a subsidiary of the Depository Trust and Clearing Company (DTCC), the entity whose group clears and settles almost all transactions entered into on organized markets in the United States. The rules of DTC require that Cede be registered as holder for all deposited securities.
For shareholders, such as Cede & Company, there are several advantages for corporations having only one shareholder. A few examples include, (1) clearing and settlement of shares can be accomplished quickly which provides increased liquidity (so long as there is confidence in the system), (2) shareholder derivative lawsuits brought by minority shareholders are more difficult to prevail with, (3) under the Uniform Commercial Code §8-207(a) there may be a rebuttable presumption that provides that an issuer (corporation) may have the right to deal solely with registered shareholders, (4) under corporation law a duty generally arises that provides for corporations to give notice of annual meetings, voting, dividends, etc. to shareholders, and (5) shareholders should be able to contact each other directly and the shareholder manifest contains the contact details.
DTCC OPERATIONAL ACTIVITIES
On 9 June 2009 Larry Thompson, General Counsel for the DTCC, testified before the United States Congress’ Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, that
Now many of you may not have heard of the DTCC before. That’s purposeful. We have traditionally kept a low profile, given the nature of the role we play in U.S. financial markets. Last year DTCC settled $1,880,000,000,000,000 in securities transactions across multiple asset classes. We essentially turnover the equivalent of the U.S. GDP ever three days – and we provide the post-trade processing efficiency and low cost that attracts investment capital that helps fuel the U.S. economy. [emphasis added]
According to the DTCC 2009 annual report the company had $1.4B total revenue, $127.6M of net income, paid $22.8M in income taxes and had an $11.4B increase in cash and cash equivalents.
DTCC BOARD OF DIRECTORS
The DTCC’s board includes 20 directors. For those who have read The Creature From Jekyll Island or Secrets Of The Temple many of the institutions will be familiar. It is interesting to see the correlation between firms that have received bailout funds and members of DTCC’s board of directors. So, for those who have wanted to put faces with those who have received bailout money. Perhaps making off with all those millions in bonuses is why they are all smiling?
 |
Art Certosimo |
Senior Executive Vice President |
Bank of New York Mellon |
 |
Norman Malo |
President and CEO |
National Financial Services LLC; Fidelity Investments |
 |
Stephen P. Casper |
Partner |
Vastardis Capital Services |
 |
Gerald A. Beeson |
Senior Managing Director & Chief Operating Officer |
Citadel Investment Group, LLC |
 |
Louis G. Pastina |
Executive Vice President |
NYSE Operations; NYSE Euronext |
 |
Donald F. Donahue |
Chairman and Chief Executive Officer |
The Depository Trust & Clearing Corporation |
 |
William B. Aimetti |
President and Chief Operating Officer |
The Depository Trust & Clearing Corporation |
 |
J. Charles Cardona |
CEO of The Bank of New York Mellon – Cash Investment Strategies |
President of The Dreyfus Corporation |
 |
Randolph L. Cowen |
Co-Chief Administrative Officer |
The Goldman Sachs Group, Inc. |
 |
Norman Eaker |
Chief Administrative Officer |
Edward Jones |
 |
Timothy J. Theriault |
President – Corporate & Institutional Services |
Northern Trust Company |
 |
Neeraj Sahai |
Managing Director and Global Business Head |
Securities and Fund Services Citi |
 |
Gerard LaRocca |
Chief Administrative Officer |
Americas Barclays Capital |
 |
David A. Weisbrod |
Managing Director and Risk Executive |
JPMorgan Chase Bank |
 |
Stephen Luparello |
Vice Chairman and Senior Executive Vice President of Regulatory Operations |
FINRA |
 |
Mark Alexander |
Managing Director, Global Wealth & Investment Management – Bank of America Merrill Lynch |
Head of Technology Operations – Broadcort Clearing |
 |
Ronald Purpora |
President |
ICAP Securities USA LLC |
 |
Robert Kaplan |
Executive Vice President |
State Street Bank & Trust Co. |
 |
Michele Trogni |
Managing Director and Global Head of Operations |
UBS Investment Bank |
 |
Ian Lowitt |
Administrative Officer |
Lehman Brothers |
DISADVANTAGES OF CONSOLIDATION
The more consolidation the more risk of a systemic failure. Should there be a systemic failure, or even the perception of a system failure such as the firesale which formed the plot of the movie Live Free or Die Hard, then market liquidity would quickly dry up in this interconnected and increasingly location independent world.
Should there be actual damage to the records held by the DTCC then sorting out who owns what could get particularly interesting. There would be a lot up for grabs all at once. Like with the bailouts the environment would be ripe for fraud. The DTCC is a member of the Federal Reserve System; that same system which has been funneling trillions of dollars of bailout money to private financial interests without due process.
REDUCE RISK
Simple actions can be taken to reduce your risk. You can eliminate as many layers of institutions and organizations as possible between you and your assets. Wealth takes two primary forms as either a tangible or financial assets. Tangible assets have intrinsic value. Financial assets derive their value from underlying tangible assets.
During The Great Credit Contraction capital has continued to seek the safest and most liquid assets. For example, as capital migrated down the liquidity pyramid from Auction Rate Securities into Treasuries the ARS market evaporated. So likewise major events, real or fabricated, like the crisis during the fall of 2008 can quickly dry up liquidity.
The quoted price for assets is becoming increasingly illusory because of the fake liquidity which will learn how to vanish. For example, the NYSE reported, “Due to an NYSE system error, Goldman, Sachs & Co. was inadvertently omitted from the chart of most active firms, but the firm’s program activity was included in the total level of programs as a percentage of NYSE volume, which remains unchanged at 48.6 percent.”
Given the large degree of illusory liquidity currently in the market and the control by a single institution, who is of course represented on the board of the DTCC, the risk of illiquidity is increasing as the share of volume increases with those institutions.
Of course, if you want to reduce as much risk as possible you can move your capital to the safest and most liquid asset and just buy gold. To diversify you could buy some silver or even purchase platinum. You can eliminate debt with the intrusive loan disclosures.
You could also take possession of your share certificates and be entered on the shareholder manifest. Mr. Warren Buffett also prefers shareholders of Berkshire Hathaway, whom he views as long-term partners, to take physical possession of their certificates instead of being held by “Cede & Co.” or via some other intermediary. Prior to 2003 he would make a contribution to a recognized of the shareholder’s choice for each ‘A’ share they had taken possession of and those held in via intermediaries forfeited the charitable contribution. In the 2003 Berkshire Hathaway Annual Report Warren Buffett wrote, “We recommend that you use certified or registered mail when delivering the stock certificates and written instructions.”
CONCLUSION
The corporate governance of U.S. publicly traded companies has been increasingly weakened as shareholders have been ceded to intermediaries. The DTCC, through Cede & Co., is the sole shareholder of record for many, if not most, publicly traded companies. The board of directors of the DTCC are from many institutions which United States Congresswoman Marcy Kaptur warns that ‘high financial crimes have been committed’. As a result, much of the American public’s wealth is held in custody of these intermediaries and exposes them to an increased degree of risk.
If you think the financial assets you think you own in brokerage account are actually there, unencumbered, or otherwise as safe and secure as possible then you may be mistaken. During these tumultuous and precarious economic times it is particularly prudent to remove as much risk as possible between you and your investments.
Disclosure: Long physical gold, silver, platinum with no position in Berkshire Hathaway or the problematic GLD or SLV ETFs.
By Trace Mayer, on July 28th, 2009
“By the pricking of my thumbs, / Something wicked this way comes” is from Act 4, scene 1, lines 40-41 of the Bard’s Macbeth.
A year ago at Cambridge House when asked whether the economy was going to rebound I responded, “That light at the end of the tunnel is just the next train. Get out of the way!” Another commentator on stage responded that things would get better. What happened?
Lehman Brothers, AIG, Fannie Mae, Freddie Mac, Bank of America, Merrill Lynch, Citigroup, the Adjusted Monetary Base exploded from $800B to $1,800B as the Federal Reserve fails with quantitate easing, unemployment began to soar and the DOW crashed from 12,000 to 6,500 or 13.95 gold ounces to 7.
The prehistoric media wails about how no-one saw this crisis coming. Yet they are still praising Obama’s economic policies, heralding an economic recovery and living in denial. Why believe them? Why even read their newspapers or turn to their channels? Many people, coincidentally almost all of the Austrian school of economics, saw this financial and economic crisis coming.
There is another massive crash coming. For those people who do not see this coming crash the issue is not one of subjective or objective opinions. The issue is a personality block where the individual cannot handle the truth. If you see neither were we are nor where we are headed then you have a personality block and need professional therapy.
ASSET LIQUIDITY
Price is what you pay but value is what you get. During the Great Credit Contraction capital is seeking not only the safest assets but also the most liquid.
Market liquidity is a business, economics or investment term that refers to an asset’s ability to be easily converted through an act of buying or selling without causing a significant movement in the price and with minimum loss of value.
Famed value investor Warren Buffett managed to see his net worth fluctuate from $62B to $37B over the past year. His paper profit from bailing out Goldman Sachs has already earned about $2B. Despite his ‘massive losses’ there is a lot to learn from Buffett’s annual letter to shareholders. I have read them all. Particularly interesting is his view on market liquidity from 1993:
In assessing risk, a beta purist will disdain examining what a company produces, what its competitors are doing, or how much borrowed money the business employs. He may even prefer not to know the company’s name. What he treasures is the price history of its stock. In contrast, we’ll happily forgo knowing the price history and instead will seek whatever information will further our understanding of the company’s business. After we buy a stock, consequently, we would not be disturbed if markets closed for a year or two. We don’t need a daily quote on our 100% position in See’s or H. H. Brown to validate our well-being. Why, then, should we need a quote on our 7% interest in Coke?
NYSE Program Trading (Click here for full size)
At the end of the day, a buyer and a seller agree on a price. Prices in the public markets are always set at the margins. When the transaction is not consensual, such as with robbery, there is no price and such transactions are unsustainable because they are immoral and will eventually always fail.
The quoted price for assets is becoming increasingly illusory because of the fake liquidity which will learn how to vanish. For example, the NYSE reported, “Due to an NYSE system error, Goldman, Sachs & Co. was inadvertently omitted from the chart of most active firms, but the firm’s program activity was included in the total level of programs as a percentage of NYSE volume, which remains unchanged at 48.6 percent.”
Naked short sales or FTDs (failure-to-deliver) that represent about 37.5% of the volume of securities that require delivery. The galavanting SEC has now taking steps against but it is probably a too little too late. Many investors would be flabbergasted to know that the 100 shares of YYY in their brokerage account were really failure-to-deliver IOUs for 100 shares of YYY. Combined with the fake liquidity that can be instantly withdrawn if serious selling starts it will create a very unfavorable marketplace for additional potential sellers.
ASSET VALUATIONS
There are many ways to value assets such as ownership of a company, real estate, etc. Some of the basics include discounted future cash flows, dividend payout ratio, price to earnings multiple, book value, etc. When assessing the health of a company I get a quick snapshot from the current ratio, acid test ratio, return on equity, free cash flow, net income and dividend payout ratio. I like dividends because when cash must be distributed it is much more difficult for management to play accounting games using the new generally accepted fair value lying standards.
The payout ratio is the percentage of earnings paid to investors and is calculated by dividing yearly dividends per share by the price per share and is the opposite of the plowback ratio. Think of cash like blood and dividends like blood donations. Extremely healthy companies can donate lots of blood without hindering their operations and the investor can then deploy the cash elsewhere for a higher return.
The S&P 500 is a value weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. Dividends are an important component of the total return from equities, accounting for a third of the total return of S&P 500 since 1926.
The S&P 500 earnings have collapsed while dividends have declined at a slower rate. As Ian McAvity has demonstrated, the dividend to earning ratio is now above 300%. This means companies are distributing $3 of dividends for every $1 of earnings. This is accomplished by burning through cash reserves, selling off assets, borrowing, etc. This is unsustainable.
One would think that only the New York Times is stupid enough to borrow money to pay dividends while gross revenue and net income decline. Likewise the current price to earnings ratio of the S&P 500 needs a reality check. When body mass is shrinking (declining gross revenue), blood is leaking (lower earnings or losses) the last thing those setting dividend policy should do is pull out another knife and cut themselves deeper to hemorrhage faster.
But perhaps they are listening to the propaganda organs that neither saw the gathering economic storms nor have taken shelter from the browbeating winds and think their earnings are going to recover which will bring the ratios back into normalcy.
UNEMPLOYMENT
This is no ordinary recession. Obama is intentionally exacerbating the greater depression. For the appetizer the American economy has lost over 4 million jobs. 30 June 2008 the Emergency Unemployment Compensation program began. Benefits have been extended twice. Obama may delay the first course of dinner by extending it a third time. The National Employment Law project estimates that, “Around the country, the number of people exhausting their benefits is piling up. By the end of September, more than 500,000 people will exhaust their benefits checks”.
The Great Depression lasted for over two decades and was not a single event. The early years were marked by lost jobs which were not replaced. As top lines evaporated they were not replaced. People and businesses began to deplete their savings before becoming destitute and getting corralled into soup lines.
In the present case, job losses have been piling up like a massive train wreck. The American consumer has slightly scaled back on their purchases because they still have access to liquidity such as unemployment benefits, credit cards, 401Ks (which have become 201Ks), etc. Those sources of liquidity are drying up as credit card limits are slashed, minimum payments are raised, HELOCs are denied, retirement plans collapse and now, in September, unemployment benefits will end.
The numbers on that chart are estimated to go from 50,000 to 1,500,000 by the end of the year or a 3,000% increase. The issue for the American families kicked out of their worthless homes and onto the street is becoming survivalism in the suburbs. People are not going to care about contributing to their retirement plans, buying name brands like Coca Cola, Proctor & Gamble, Wonderbread, etc. They are going to care about generic bread or Top Ramen on the table.
Consequently, gross revenues for the S&P 500, which are down 10% year over year, are going to be under even more pressure. With most of the slack already trimmed earnings are going to be under even greater pressure. To bring PE ratios into historical norms stock prices are going to have to tumble.
COMMERCIAL REAL ESTATE
The value of real estate is a function of the earning capacity of the underlying business base. With collapsing earnings, rapidly rising unemployment and a commercial real estate market ice age the value of commercial real estate is plummeting. Originations of commercial mortgage backed securities is almost non-existent. Financing for new purchases is almost impossible to secure. Being able to find comparables for appraisals is getting increasingly difficult. Real property taxes will likewise decline putting further strain on state budgets which are in chaos like California.
Many outstanding loans are non-performing and the lending banks are failing. From the 6th to the 27th of July another 12 banks have failed. In January 2008 I warned that the FDIC was preparing for massive bank failures. Lately I have warned about how the annual worldwide platinum production is valued at about $7.8B compared to the FDIC’s $12B of reserves to cover$4,831B of insured deposits. The monetary metals are one way to protect yourself from the risk of massive bank failures and a potential bank holiday.
MARKET MANIPULATIONS
Chris Powell of the Gold Anti-Trust Action Committee has observed that “There are no markets anymore, just interventions.” Where would the manipulators get the massive amounts of capital needed? Perhaps Donald Rumsfeld knows.
The United States Constitution provided safeguards against these types of problems. This is one reason the barbarous relic known as the Federal Reserve should be razed. The unfair and immoral monetary system is complete opposition to a Constitutional monetary system. These interventions of manipulating both the supply and cost of currency are failing as is the Federal Reserve’s attempt at quantitative easing.
MONETARY METALS
During The Great Credit Contraction capital will seek the safest and most liquid assets. At all times and in all circumstances gold remains money. Because of the large aboveground stockpiles gold is the world’s primary monetary commodity. Likewise silver and platinum are also risk-free commodity currencies.
Two weeks ago I recommending buying platinum which has since risen $80 per ounce or about 9%. I also recently suggested buying silver around FRN$12.50 which is now over $14 or about a 12% gain.
I have found GoldMoney to be the best alternative to the current failing worldwide monetary system. I recently sold a few copies of The Great Credit Contraction for platinum. A Swedish buyer remarked, “I have now made my first payment in platinum  … I think we may have seen a glimpse of the future. … (And as a gold-bug I think it can be good.) Thanks a Lot!”
Many people may take for granted the liquidity of the financial markets, banking system and other grease for the wheels of commerce. How would your investments be affected if the financial markets closed for 1-2 years? How would your business be impacted if there was a bank holiday for an undetermined period of time?
Having an alternative system, completely independent on the current failing structure, in place and operational is good business sense. Eventually the Information Age alternative to the barbarous relics of central banks and fractional reserve banking become complete substitutes because of the lower costs, ease of use, lower risk and other superior attributes. As the liquidity of the monetary metals increases through their use in ordinary daily transactions, like being used to purchase books, their value will rise.
Additionally, gold’s technicals are looking extremely strong. The 200dma at $880 while the current price is about $955 or 1.08x. The 18 month consolidation above $900 has laid a very strong foundation for the next upleg. The reverse head and shoulders pattern is extremly bullish. Seasonally gold is weak during the summer and strong during the fall but lately it has been trading like power currency.
While massive short positions are being taken by commercials gold will likely easily breach and maintain $1,000 ounce this fall. With unemployment skyrocketing, bailout fever in Washington, earnings declining the FRN$ is going to be under tremendous pressure from ballooning budget deficits which will have to be monetized. All of this is positive for the ancient metal of kings.
CONCLUSION
The Great Credit Contraction, an economic climate change from an inflationary summer to a deflationary ice age, has barely begun. The remaining liquidity in the market is largely illusory. Residential real estate, commercial real estate, the major stock markets and even the banks are almost all zombie institutions anchored to fraudulent financial statements that are preventing the needed healing liquidation. The unemployment situation is escalating out of control and The Greater Depression is wearing on people and psychology is being changed. Earnings are collapsing and dividend to earning payout ratios are unsustainable. Meanwhile the monetary metals appear poised for a significant rise as the FRN$ continues evaporating.
Because there is no intelligible answer for what is a dollar therefore it is an unreliable instrument for performing mental calculations of value. This next crash which appears imminent but could take a while to materialize because of manipulations will likely see the DOW fall from its current 9.5 ounces to about 5 ounces of gold and the S&P 500 sliding from its current 1.3 ounces of gold to about 0.85 ounces.
Additionally, the really good buying opportunities will be enjoyed by those who can settle transactions because their assets are liquid, like with gold coins in a safe or a reputable third-party like GoldMoney, and not frozen in some closed market or holidaying bank. If you want real cash, not illusions like the FRN$, Euro, Yen, Pound, etc. which can evaporate in hyperinflation, then you better learn how to buy gold because it is the safest and most liquid asset. With gold you will always be able to buy something.
Disclosures: Long physical gold, silver and platinum with no positions in the problematic GLD or SLV ETFs, S&P 500, DOW, NYT, GS, Berkshire Hathaway, Coca Cola, Proctor & Gamble, Bank of America or Citigroup.
Copyright © 2008. This article was published on http://www.RunToGold.com by Trace Mayer, J.D. on July 27, 2009. This feed is for personal and non-commercial use only. Applicable legal information and disclosures are available. The use of this feed on other websites may breach copyright. If this content is not in your news reader then it may make the page you are viewing an infringement of the copyright. Please inform us at legal@runtogold.com so we can determine what action, if any, to take. If you are interested in how to buy gold or silver then you may consider GoldMoney.(Digital Fingerprint: 1122aabbLittleBrotherIsWatching3344ccdd)
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By Ajay Shah, on May 4th, 2009
There is a somewhat cliched old diagram that shows what we’re supposed to do when a bank gets into trouble. There are some nervous questions about this these days, but I still think the essence holds:
Solvent but illiquid
When a bank gets into trouble, the first question to ask is: Is it insolvent or is it just illiquid? If it’s merely illiquidity, then central banks should provide temporary liquidity support to a fundamentally sound firm. This liquidity backstop has always been a crucial role through which governments make the concept of a bank possible. The moral hazard involved here is controlled by making this liquidity support extremely expensive, so that banks should think thrice before using it.
These days, countries generally separate out the function of monetary policy, which is placed at an independent central bank, from the function of financial regulation and supervision which is placed at a financial regulator. In this case, a proper interface between the two agencies is required. To some extent, liquidity support is about merely having a central bank window where good quality assets are repoable at a penal rate (and with haircuts reflecting collateral risk). To some extent, this requires the financial regulator to make a call on whether a bank is merely illiquid or insolvent.
By Ajay Shah, on April 23rd, 2009
On 14 October 2008, Jahangir Aziz, Ila Patnaik and I released a short note on what was going on. It was titled The current liquidity crunch in India: Diagnosis and policy response.
On Monday (20th), Ila Patnaik has an article in Indian Express with one more piece of evidence that the APS story was basically on the right track.
Today, when we look back at the APS paper, it seems mild. But I distinctly remember at the time, the world was much more confusing. Lehman died on 15 September. After that, there was a ‘fog of war’ problem: a lot was going on, there was information overload in many ways, lots of critical information from within RBI is not released into the public domain in a timely manner or is not released at all, and the statistical system has such long lags that on 10 October, when we started writing, almost nothing was known about the period immediately after 15 September.
Speaking for me personally, I had the right starting conditions in terms of being oriented towards the themes of de facto convertibility, Indian multinationals, etc. I should have got the story quickly after 15 September. But still, it took me a long time to understand what was happening.
Similar problems — on an immensely magnified scale — have afflicted crisis responses everywhere in both the private sector and governments. Whether it was Northern Rock, Bear Stearns, or Lehman: analysts and decision makers have been ambushed by difficult questions, very little time within which to make calls, and bad information at the time. With the benefit of hindsight, it’s easy to criticise what was done, but this stuff is hard.
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