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Independent Trader News - July 2016

Revolution on the horizon in the US

During the last decade, we witnessed militarisation of the police force in the United States. All those measures are in line with optional introduction of martial law during next crisis – which will be worse than this from 2008. Police training to pacify violent rioters yields unexpected results.

Statistics of ever growing number of deaths during police interventions in the US made the black community in the US to take matters into their own hands. I am not talking about standard riots but rather operations aimed at killing policemen organised by ordinary citizens. Recent shootout in Dallas is a good example when 5 police officers were killed and 4 others injured. The situation is serious and escalates quickly. If authorities are not able to defuse the tension, this conflict could evolve into a revolution or a civil war.

Politicians and experts occupy both sides of the aisle. Unfortunately, we sometimes find the rhetoric of ‘they deserved it’ which only widens the chasm between opposite viewpoints. The establishment, instead of restoring the rule of law and trust in public institutions, tries to unite society by creating new, internal enemy. I do not think I over exaggerate when expecting a big terrorist attack in the US and/or war bigger than Iraq/Afghanistan.

Pension funds in the US cut the entitlements

Up to 60% cut in the entitlements was announced by the Central States Pension Fund! Pension funds have to pay their obligations to pensioners while not receiving enough interest or dividends on their investments. This is the effect of historically low-interest rates accompanied with falls of many assets hitting balances of the funds very hard. On top of that, we see the growing demographic problem drying out the inflow of money.

At the end of the day, there is no place for politics or sentiments when it comes to business. Money in and money out have to be accounted for. The alternative is a sale of all assets and bankruptcy of the institution. The real crisis has not even started and already there is no money for the elderly.

Commerzbank putting the foot down against the policy of the ECB

German Commerzbank threatens the ECB to pull out their funds from their central bank account. Mario Draghi lowered the interest rate for bank depositors keeping money in the ECB down to -0.4%. This is the result of Draghi’s policy to force banks to lend more money to consumers.

The only problem in the push for more credit is the lack of creditworthy clients making the risk of a loan to be a ‘non-performing’ higher than ever. This is far from being a factor considered for Brussels politicians. They expect banks to use their reserves the moment additional charge on deposited capital is instituted. Ultimately, those in charge of Commerzbank announced to withdraw funds from the ECB and store it in their own safe in cash. During the age of globalisation and digitalisation, this must be quite a surprise. There may be a small hope that banking sector is not unanimous in decision making as thought before and the war on cash may not materialise because of the same greedy bankers that came up with the idea themselves.

The debt is killing economic growth

According to data from the Bureau of Economic Analysis (BEA) in the US, the credit stopped generating sufficient GDP growth. In the first quarter of 2016 additional debt equals 645 bn US and created additional growth of only 65 bn USD. As a result, the ratio of GDP growth to surplus debt is 1:10. Following Keynes theory, taking more debt should increase the GDP growth. This assumption – legitimising constant QE in developed countries – is the foundation of monetary policy of central banks.

The problem is that overly burdensome debt generates extra costs which – even at ZIRP – are outpacing the profit from sales. More and more money is spent only to service the old debt instead of new, productive investments. We are at the moment when the QE/debt-driven GDP growth is finished. The amount of money pumped into the system – officially and unofficially – does not give acceptable results. We have to ask a question: what now? More of the same – cheap money – or a debt reset?

The ECB starts buying corporate debt

On 8th June, Mario Draghi started his CSPP program. On 18th July the ECB publishes the list of companies of which debt was bought during past 6 weeks. Since then this list will be systematically updated. Investors try to predict which company is going to be chosen to buy their debt before ECB traders and then sell it for more.

The CSPP is just another direct intervention in the economy. It is not only a tool promoting power overreach and corruption but also inevitably has to distort corporate debt market. Just like the price of government debt is disconnected from reality the same fate awaits corporate bond market. It will neither create any new investments nor workplaces but rather start a wave of unhealthy speculation. For example – why a company should risk opening new production lines to create goods they may not find clients for when it is easier to be funded by speculation in the financial markets?

China making entrance into the microchips market

China aims at being independent of the US in the area of microchips import. Until today the value of microchip imports is bigger than oil imports. This change affects one of the last sectors of the US economy that still creates well-paid jobs. China as the biggest exporting powerhouse uses a huge number of microchips not only for electronic widgets but also to produce high-tech weaponry.

In the beginning, overall investment spending on firms manufacturing key elements of electronic systems will equal 161 bn USD. The sum of 47 bn USD will be spent on Tsinghua Unigroup – public company. In 5 years it wants to take place among top 3 microchip producers in the world. Additionally, acquisition of German Aixtron for 670 million is planned. Chinese wanted to buy some American companies but those transactions were stopped through political channels. The US defends their market stopping Micron Tech and Xeon processors to be taken over by Chinese for their supercomputers.

Actions of Beijing are logical as with more tensions between the US and China, authorities cannot let one of the main computer components (e.g. for ballistic missiles – key fragment of territorial defence system) to be produced by the biggest enemy.

Western companies ignore sanctions against Russia

Recently during an economic conference in St. Petersburg approximately 330 trade deals worth 16 bn USD were signed. Sanctions are being blatantly ignored by growing number of Western companies. Next to Vladimir Putin the list of keynote speakers consisted of Jean-Claude Juncker and Matteo Renzi.

This is definitely a good sign. It is clear that big corporations exert enough pressure on politics to soften trade barriers between the EU and Russia also slowing down or even reversing any attempt to escalate conflict towards military confrontation.

Russia is becoming food production superpower

Sanctions against Russia disrupted the agricultural market and halved the value of the ruble. With new circumstances, Kremlin decided to become self-sufficient in the food sector before 2020. Putin does not give false promises – Russia is already the top exporter of wheat. In 2015 the volume of food exports rose by 33% compared with previous year.

Russian industry’s dependency on fuel export caused huge areas of farmland not being utilised. This is why the black earth spanning from Southern Russia to Siberia and sources of high-quality drinkable water are still mostly free from toxic fertilizers, pesticides and GMO farming (unlike the US or Europe). Those factors coupled with cheap ruble made Russian farming cheaper, very efficient and of higher quality.

Sanctions created brilliant investment opportunity when it comes to ecological food production. This market grows 3 times faster than traditional farming, at 12% each year. Understanding climate factors and political circumstances the right selection of assets can yield very decent profit in the upcoming decade.

Sino-Russian alternative to Airbus

Deal worth 13 bn USD aims at designing and creating a Sukhoi Superjet – the equivalent of Dreamliner and Airbus. The aircraft’s technicalities should be similar to competition with 270 seats and range of 12 000 km. Boeing and Airbus profit in 2015 was respectively 125 and 92 bn USD, making it a very attractive market to enter.

Singapore diversifying their currency reserves – CNY

Authorities of Singapore and China signed a deal on mutual financial market access enabling Singapore to add Chinese debt into their currency reserves. This deal has a significance with regard to the stability of American debt because it enables entrepreneurs registered in Singapore to deal in the CNY. This young country is already one of the most important trade hubs in the world. This deal furthers internationalisation of the CNY and marginalisation of the USD.

More banks in trouble

German Bremer Landesbank joined the list of troubled institutions. The bank has a big exposure to debt of maritime transport companies. Only in one week, a number of write-offs due to unpaid loans rose to 400 million EUR. The number of potential non-performing loans is big and solvency of Bremer Landesbank – with assets worth 29 bn EUR – is threatened.

South Korea seems to follow a bad example. Two banks – Korea Development Bank and Export-Import Bank of Korea – received 9.5 bn USD in rescue help. Problems started after the bankruptcy of Sungdong Shipbuilding & Marine Engineering – a shipbuilding company. This company is undergoing financial restructuring and debt has been written off. This is not the end. South Korean banks have exposure of around 70 bn USD to debt of maritime trade companies. The volume of global trade is battered and the bad performance of the whole sector will affect Korean banks.

I have to highlight this again: stay away from equities of banks. The bankruptcy of one big institution can easily push other dominoes in a chain reaction. The entity which today looks healthy may be the cause of tomorrow’s causal nexus leading to a huge crisis.

Super La Nina is coming

Super El Nino is over. Unfortunately, the rate at which the temperature in the equatorial part of the Pacific Ocean rises, suggests that in 2017 we are going to see another anomaly called La Nina. I will spare the weather details and focus on the consequences for the world it can have. La Nina, if it comes (and the chances are high) will cause turbulences all over the globe.

Some regions are going to be hit harder than others. The extreme droughts could be seen in Mezzo America, Southern USA and Southern part of South America. Australia, Indonesia, Southern Africa and Northern parts of Latin America?/////. The USA should brace for very tough winter and hurricanes in South-Western regions.

Comparable alignment of weather conditions and solar activity happened during ‘30s last century. The ecological catastrophe hit 12 states. Droughts were so severe that they were followed by sand storms – something without a precedent.

Source: www.history.com

I am convinced that commodity markets will feel the results of La Nina. The significant rise in prices – especially food prices – is very much possible. Today we see Jim Rogers ETN (RJA) at very low levels. La Nina can change this quickly because many farms could be threatened by the aftermath.

Silver Boom

Demand for physical gold rose 6-fold since 2008. Back then it was around 53 million oz per annum. To 2015 it rose up to 300 million ounces and is still growing. Refineries record very low influx of silver scrap. We can imply that after a rally in 2011 the amount of metal available beyond mining industry shrunk. When we will see another climbs it may occur that supply of silver from this source is indeed lower than expected.

Prices of precious metals experienced a rally recently especially due to Brexit and European banking sector problems. Silver, just like gold, is a Giffen good – the demand is rising notwithstanding the growth in price. China is an exception here. Chinese like to buy cheap and now it seems they are researching the market for a local bottom in price (especially in the case of gold, as the trading volume of SGE, dropped 30% y/y). This is a very important factor affecting correction we see now. This correction will be weaker if bad news comes from the economy and banking sector. I want to highlight that more and more investors – also institutional investors – diversify their portfolios by adding precious metals. The top buys are miners’ equity, gold and silver ETFs and physical metal.

Mexican president wants quicker integration of North America

Enrique Pena Nieto – the president of Mexico, pushes for accelerating unification of North American countries. According to Nieto, this move should show the world that return to nationalism is a bad choice and breaking down economic and political barriers is better alternative. In the future, he expects a creation of the American Union. During recent conference Enrique Pena Nieto admired NAFTA establishing a ‘free trade zone’ between Canada, the US and Mexico. Nieto himself advocates more common policy in energy and environment sectors.

The American Union is being built very slowly. Similarly to the case of the EU, it starts with signatures under treaties concerning free movement of goods and eventually evolves into bureaucratised, centralised monster. In my opinion, there is a plan to join both Unions in one entity with an integration of national armies – coordinated today by NATO.

“How long are you planning to live?”

Those words were addressed to Japanese pensioners. Vice minister from the Democratic Party had enough ‘courage’ to say them. A demographic crisis is causing problems in the pensionary system. It can be solved in two ways – either there will be more children or there will be fewer pensioners. It seems that in Japan the latter idea seems to circulate more and more often. Every year the problem becomes worse, especially that the means government is using (printing more money to stimulate the economy) are failing spectacularly.

As for now, politicians try to make seniors spend their savings to increase the velocity of money circulation in the economy. Who knows what direction Japanese government is going to choose next? The number of suicides in Japan is already alarmingly high.

International trade volume is falling

During last year we saw a significant plunge in global trade – among others, Baltic Dry Index at record low levels. Cass Freight Index is an indicator showing the cost of the maritime transportation (excluding energy resources – oil and coal). Data for this index is compiled from many transport companies responsible for 26 billion USD turnover. This statistic is reliable and index clearly shows a drop in transport volume of everyday goods, food, chemicals or heavy equipment.

Source: www.deflationeconomy.com

What you can see is the cost (and by implication a demand for) maritime transport since 2011 to 2016. Today’s situation is below the past average. This is a red flag and an indicator of incoming recession coming to developed countries in America and Europe. By a ricochet, it will affect markets all around the world, especially in the emerging markets thanks to lower demand for imported products and resources.

The fake image of the US growth

The market in the US is disconnected from reality. While the FED is holding any interest rate increase claiming bad unemployment, NYSE prices rise. The same prices that are supposed to reflect the condition of American corporations. The finance world is indeed on its head.

A very good example is one of the most important indicators – Personal Consumption Spending. According to report Q1 ’16 the biggest share of average person wallet (increase by 58% y/y) is healthcare cost. Someone could have thought that increase of the living costs is worsening financial situation of society and this will be seen in stocks. Apparently, this is not true if consumption spending is rising and this is identified as the higher velocity of money circulation in the economy and improvement of the economy overall. Following this logic, it is no surprise that S&P500 is climbing but… for how long?

Is it time to short already here?

Recent weeks S&P500 shockingly jumped even higher and set a new record. Why? The biggest factor for equity price growth in developed countries is: interventions of central banks. Since 2013 we saw the BOJ at the front with the FED being second in the race, joined by the ECB in 2015. The chart below presents their programs. The height of each colour is the amount central banks are using to buy various assets all over the world. Blue and red points out that Draghi and Kuroda (heads of the ECB and the BOJ) are working hard.

Next to data coming from central banks we should also add information from hedge funds, investment banks and transactions made by private clients. Every flow is averaged giving us ability to observe who buys more than sells? Since the beginning of 2015 investment banks are constantly selling assets. Worth highlighting is the fact that this trend has strengthened recently. This is similar to (but will less aggression) hedge funds. The only exception is a curve of private clients who only add to their asset base.

What does it all mean? Central banks with private investors are helping institutions to lower their exposure to still very expensive assets. Smart money works according to Rothschild’s advice: “the last 10%, leave for the others”. Will there be the last 10%? We do not know. It is possible for American equities to reach even higher level but dear readers, you have to remember that in investment, not only price matters but also a potential for gains and losses.

China is hiding capital outflows

Goldman Sachs discovered in what way the PBOC clerks hide capital flows outside China. Since October 2015 until June 2016, nearly 500 billion USD left China. To make the balance look good it was deleted from the PBOC’s statement on foreign currency transfers. When this was ont enough they also fabricated amounts wired.

It is prohibited In China to transfer out over 50,000 USD per person. Notoriously this limit is broken using multiple ways: starting from wire transfers using ‘underground’ banks and ending with buying/selling bitcoins. This money helps to pump more money into speculative bubbles (mostly real estate) in the West.

The more PBOC tries to hammer price of CNY (through currency market interventions) the more people decide to get their money out of the country. It is estimated that in 2015 only, 1 trillion USD left China and this year it may be even more. Reason? A tough situation of Chinese enterprises affected by developed world economic slowdown.

Aforementioned money drainage is starting to be a big problem for Beijing especially due to weak international trade. If the problem worsens then China could impact financial liquidity (already affected by big real estate bubble).

Lockheed and DigitalGlobe eyes mapping the world

WorldView-4 – a new satellite which is going to deliver a high-quality footage from August. The resolution of imagery is said to be high enough to help gather information about fauna, flora, soil type and forest stand. After analysis, it should even enable looking for mineral deposits and energy resources.

This type of monitoring definitely will be useful for many industries but can be a big surveillance threat for people around the world. The suspicion is reasonable considering the amount of government cooperation with DigitalGlobe. One of the reasons why the deal was made is consent given to DigitalGlobe to sell images to the private sector in exchange for governmental access to data collected. DigitalGlobe applied for this years ago, without any success. Similar transactions are far from being free and today’s trend of increasing spying leaves us wondering to what end this technology will be used.

Gold-backed pensioner accounts?

Gold for pensions – new scheme offers an ability to use money for the future to buy bullion. Cash put aside now can be used to acquire bars or coins from the Royal Mint of England. Stacking precious metals is a very good idea to store value during turbulent times but the only problem British pensioners may have is not being able to verify purchased assets. Only banker’s word is there to certify the real amount of reserves.

The implementation is akin to the FED’s practice, which since 1953 forbids any sort of audit of their gold reserves. Because this institution does not have even an ounce of physical gold but only numerous deeds (information given to the Congressional commission by one of the FED’s employee). Gold itself is most probably leased to bullion banks. What guarantee pensioners have that they indeed bought a physical gold? Will they be able to sell their gold in the future?

Bubble in government bonds market is only growing

According to the recent data, the EU, Swiss and Japanese bonds (with negative interest) are worth 13 trillion USD. This is equal to 80% of the EU’s GDP! What is more, thanks to the ECB intervention companies like Johnson & Johnson or GE joined the institutions issuing debt at <0% interest. Apart from the fact that this is unprecedented upper hand given by the ECB to the biggest corporations in the world, this is a very dangerous phenomenon.

Private investors or investment funds hold bonds with negative coupon only to sell them later at a higher price – this is what they are hoping for. It works as long as there is a buyer – the ECB – one which will buy even at a loss. The time when official inflation catches up with reality the demand for overpriced bonds will disappear. We can then expect a mammoth sale of negative interest bonds worth trillions with no buyer at the horizon. The subprime credits (now worth 0.7 trillion USD) responsible for 2008 meltdown pale in comparison.

The official list of the biggest US holding companies in the derivative market

Derivatives held by top 25 banks in the US equal 250 trillion USD. The Bank for International Settlements in Basel estimates this sum to be 700 trillion USD and unofficial sources put them at 1.5 billiard USD.

The numbers we talk about are hard to imagine, especially when compared to the world’s GDP of 78 trillion. Everything above is in nominal terms but the problem is that settlements are done using those numbers. A loss of 1% is equal to 1.5 trillion USD! Think about a big crisis when central banks may not be able to save the day. The bigger the balance the higher the risk – risk which grows geometrically.

The TBTF banking institutions were allowed to grow even bigger and now their collapse does not threaten regions or sectors but the whole global financial system itself. A bankruptcy of one of the biggest institutions can create a wave of claims and empty holes in balances of interconnected entities – instead of domino effect we will see a chain reaction.

New investments in the Golan Heights

The Ness-2 oil discovery exploitation investments are illegal. The land is occupied by Israeli forces and according to the international law it belongs to Syria. After reviewing investors behind this project we can infer that law is not going to be an obstacle and project will be realised. Among others:

- Rupert Murdoch – owner of the Twenty-First Century Fox,

- Dick Cheney – former VP of the US,

- James Woolsey – former head of the CIA,

- Lord Jacob Rothschild – unofficial owner of central banks.

Perfectly put in one of the old Polish movies “Kontrakt”: “Democracy, democracy but someone has to govern all this.” Seemingly, no war – even a civil war – can go to waste and laws are for the poor and weak.

Pension funds in the US are 6 trillion USD short

After reading Trustees Report published by the Social Security Trustees you can find out that only in one year deficit of American pension funds has widened by 6 trillion USD. This is because of the huge gap between assets (26 trillion USD), funds operate with and obligations towards pensioners (32 trillion USD). Last year this gap was only 3 trillion USD. The speed at which the debt is accruing points out to a huge crisis of liquidity of public institutions.

Previously, in the Independent Trader News, I mentioned problems of pension funds. Fresh data only highlights the problem of future instability in the developed world. It does not matter whether it is a redistributive or a capital system. The West, due to divergence from the traditional values and multigenerational family model entered very risky territory. Money from pensioners was used to fuel the biggest equity markets in the recent years. Now, when the money is gone the situation starts to look grim.

Another governmental program in the US ready to ‘help’ the public

New SAVE UP Accounts Act (Secure, Accessible, Valuable, Efficient, and Universal Pension Accounts Act) tries to secure a fresh stream of money for social security. The novelty of this one is an increase of employer contribution for employees account by 32%. Einstein described insanity as doing the same thing over and over again and expecting different results. It seems to be the motto of public institutions.

Gold imports from Switzerland skyrocketed

A significant jump in the US gold imports from Switzerland tripled the annual average of previous years.

This is surprising because in the previously we saw only one direction for gold – from the West to the East. The amount itself is far from being significant but what matters here is the trend. Most probably investors in the US finally thought about the future. Their own assets are obligations towards other entities and there can be a situation when those assets will not be honoured anymore.

The crucial part here is a compromise between China and the US, discussed by precious metals market analysts. Washington gave Beijing a green light to diversify their dollar reserves with physical gold. China’s side of the deal is not to make moves leading to revaluation of gold and devaluation of USD as long as metal finds its way into China. Are we witnessing the fundamentals of the financial system being crushed?

Houthi rebels attack Saudi Arabia

Yemeni soldiers – Houthis – who in the last 4 decades fought 6 wars (all won), show that they are not afraid of Saudis. Coalition forces (Saudis, UAE and Qatar) try to take over Yemen’s land after recent oil discoveries. The invasion of the Northern neighbour started a year ago and military, armed with high-tech weaponry made in the USA, is still struggling to secure Yemen. On top of that, rebels started their own invasion on Saudi lands and showed that it will take more than bombings and airstrikes to defeat them.

Saudi situation is not good. Having the security agreement with the USA and being well armed (billions of USD spent) they still struggle against Houthi rebels. Riyadh’s effort is seen as weakness by the opposition growing stronger. How long, given the terrible foreign policy, the failing Saudi regime will continue its rule? This question is essential because it is the Saudi Kingdom that created and sustained (for over 4 decades) petrodollar as a reserve currency of the world.

Independent Trader Team