11-May (Bloomberg) — As German Finance Minister Wolfgang Schaeuble dares Greece to quit the euro, investors and economists are mapping out what he and fellow policy makers need to do to save the single currency if his bluff is called.

Emergency lending and bond buying from the European Central Bank coupled with recapitalizations and deposit insurance for lenders and broader powers for the region’s rescue fund are among the prescriptions for insulating Spain and other cash- strained nations from what Citigroup Inc. calls a “Grexit.”

Pressure for contingency plans is mounting as Greece’s electoral quagmire forces euro-area officials to publicly revive the once forbidden topic of whether a nation can leave the single currency. Schaeuble told today’s Rheinische Post newspaper that the euro area could handle a Greek departure as “the risks of contagion for other countries of the euro zone have been reduced.”

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“It’s a system that by now is so obviously out of control that you have to wonder if we should just call off the charade of regulation. Credit-default swaps, interest-rate swaps, massive derivative hedging bets, dark pools all run by algorithms — the markets are so run amok, they’re humiliating the smartest guys on Wall Street. And there is none smarter than Jamie Dimon at the top of an institution.”

And. . . .

“Volcker is too dignified to say ‘I told you so,’ but I’m not. Volcker knows more about the markets, not because he’s astute to the daily gyrations, but because he recognizes that the system is so far beyond the ability of any individual or institution to understand or manage.

Link: Weidner article

Link: J.P. Morgan and the Volcker rule.”

MK comment: As a coincidence, at the beginning of this week, I released an essay on the subject of algorithms running amuck in our financial system, and how it might ultimately affect the gold market. It is titled “Extraordinary popular delusions or the madness of machines” and it is available here. This incident involving JP Morgan and the so-called “London Whale” is of particular interest in that, as the above-linked article points out, it is not the act of a rogue trader, or even a rogue computer, but a madness of machines, in general, or perhaps misplaced belief in software. Just as the the buyer of tulip bulbs in the early 17th century was carried away by the mania to a disastrous end, so unbridled software can create a new kind of mania with the very same results. That is where, for the attuned investor, gold enters the picture. . . . .

11-May (Reuters) — Banks are quietly readying themselves to start trading a new Greek currency. Some banks never erased the drachma from their systems after Greece adopted the euro more than a decade ago and would be ready at the flick of a switch if its debt problems forced it to bring back national banknotes and coins.

From the end of the Soviet Union – which spawned currencies such as the Estonian Kroon and the Kazakh Tenge – to the introduction of the euro, they have had plenty of practice in preparing their systems to cope with change.

Planning behind the scenes has been underway since Europe’s debt crisis erupted in Greece in 2009, said U.S.-based Hartmut Grossman of ICS Risk Advisors who works with Wall Street banks.

“A lot of the firms, particularly in Europe and also here, have been looking at that for a long time,” said Grossman, who added that the latest Greek political crisis had brought matters “to a little bit of a head”.

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This is a follow-up to yesterday’s two JP Morgan bullet posts for those with an interest. There was, as I suspected, a connection between the “large positions” in London (the “London Whale,” as he is being called around the trader blogs this morning) and the $2 billion loss. Jamie Dimon said that JP Morgan’s loss “plays right into the hands of a whole bunch of pundits out there. We will have to deal with that—that’s life.” He did not appear happy with the situation in a hastily called telephone conference late yesterday afternoon. Initial reports put JP Morgan’s exposure to this trade at $100 billion (this morning’s Wall Street Journal), and a good many are asking how deep this thing might go.

Here’s what one of the “pundits” said this morning. He happens to be an ex-trader at an “internal hedge fund” (read within a major investment bank), so he knows what he’s talking about, and I thought it worth passing along to the readers of this page. My apologies for the colorful language.

“Is this apocalyptic? Well, my first email to two colleagues when I read this story was ‘This is exactly the kinda story that could crash the market.’ Why? Well, if people were starting to trust that the banks knew what they were doing – and that’s a big IF – this story puts all sorts of doubt into that ‘trust.’ JP Morgan is supposed to be the biggest, best bank on the block – the one who f*cked up the least in the financial crisis, and the strongest one. Although this loss is small in the grand scheme of things, 2008 is not so far buried in our memories that we’re not thinking ‘Oh yeah, I remember when Merrill Lynch started with a $ 2B writedown too…’ Having said all of that, I think that the story is still more likely to be blown out of proportion than it is to be indicative of the imminent demise of the US Financial System. However, fear matters sometimes, and there is fear in the air.”

So You Wanna Talk About JPM’s Trading Loss and The London Whale

11-May (MarketWatch) — Gold futures fell Friday, but prices for the precious metal pared earlier losses as data showing that U.S. consumer sentiment hit its highest level in more than 4 years prompted the dollar to turn lower.

…“Gold extended to new 4-month lows in overseas trading, as risk aversion associated with last weekend’s elections in Europe prevails,” said Peter Grant, chief market analyst at USAGOLD.

“This seems counter-intuitive to many, as the absence of counter-party risk makes physical gold one of the safest asset an investor can own,” he said. “However, the proliferation of gold derivatives in recent years has resulted in paper driving at least the initial moves in risk-off scenarios.”

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Gold Remains Soft Within Range, But Germany Opens the Door to a Policy Response

11-May (USAGOLD) — Gold extended to new 4-month lows in overseas trading on Friday, as risk aversion associated with last weekend’s elections in Europe persists. As we noted earlier in the week, this seems counter-intuitive to many, as the absence of counter-party risk actually makes physical gold one of the safest asset an investor can own. However, the proliferation of gold derivatives in recent years has resulted in paper driving at least the initial moves in risk-off scenarios.

If you missed Extraordinary popular delusions and the madness of machines, posted by USAGOLD’s President, Michael J. Kosares on Wednesday, I encourage your to take a moment and read it now.

The paper selling drives the price of gold down to a level where the physical buyers step back in to support the market. We’ve seen this pattern repeat itself many times during the course of the decade-long rally in gold.

As the week wraps up, gold remains below $1600, in the lower fifth of the 1920.50/1522.40 range that has prevailed since December. However, I believe the underlying trend remains unquestionably bullish, as the fundamentals that drove gold from $300 an ounce to more than $1900 an ounce are still very much in place. In fact, the latest deterioration of the fundamentals in Europe suggests to me that there will indeed need to be a policy response of some sort — and likely here in the US as well — which will set the stage for that dominant uptrend in gold to re-exert itself.

With regard to the likelihood of a European policy response, we saw a rather startling shift in the tenor of both the Bundesbank and the German Finance Ministry this week. Both have historically been staunchly opposed to anything that might trigger inflation in Germany. Suddenly they have become much more dovish and willing to “tolerate” above target inflation. I think that is reflective of just how dire the situation in Europe has become. One has to imagine, that with the door open, the policy that will stoke this higher rate of inflation can’t be far behind…and that will likely have a positive impact on gold.

It seems that the latest attempt to form a coalition government in Greece is on the verge of failure, making new elections next month increasingly likely. The latest polling within Greece suggests that if that were to happen today, the anti-austerity Syriza party would garner even greater support. If the market didn’t like the results of last weekend’s election, they’re probably not going to like the results of the next one any better…and possibly quite a bit less.

11-May (AP) — Greece’s wrangling politicians were locked in last-ditch efforts Friday to form a coalition government, with chances of a deal appearing slim and the country’s future in Europe’s common currency at stake.

Voters on Sunday punished both main parties, the conservative New Democracy and socialist PASOK, for their handling of the country’s protracted financial crisis, deserting them for a myriad of smaller parties on the right and left. The result left a hung parliament, with no party able to form a government.

Hopes for a deal between election winner New Democracy and third place PASOK with the small Democratic Left party of Fotis Kouvelis suffered a setback Friday when Kouvelis insisted he could not participate in a government with just the conservatives and socialists.

“We have made our position clear. In a government with (only) New Democracy and PASOK, we will not take part,” Kouvelis said.

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PG View: Last weekend’s elections were so loved by the markets…it’ll be really fun to do it again in several weeks. The latest polling in Greece shows a new election would garner even greater support for anti-bailout Syriza party. Yeah, that’ll be real fun…

11-May (Financial Times) — Spain is to force its banks to set aside a sector-wide €30bn of new provisions against real estate loans or take expensive government aid in the country’s latest attempt at restoring confidence in the stability of its financial sector.

Spain will also use two independent valuations of banks’ balance sheets, as requested by the European Commission, dealing a blow to the Bank of Spain, which has been attacked by the ruling Popular Party for its supervision of lenders during the crisis.

Spanish banks will be asked to split out their real estate-related loans into separate entities, allowing them to be then sold off at market prices, Luis de Guindos, finance minister, said on Friday.

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PG View: If they were to truly mark those real estate assets to market, they will quickly find that €30 bln is not nearly enough. Bandaids and half-measures remain the order of the day…

08-May (Financial Times) — Markets are repeating the downturns of 2010 and 2011, and it is time to search for safety, Gluskin Sheff’s David Rosenberg tells James Mackintosh, FT investment editor. That means gold eventually reaching $3,000 an ounce, and bonds remaining appealing even at rock-bottom yields.

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MK comment: Not sure if the two events are linked but here’s something that was reported back in April originally by Bloomberg:

April 9, 2012
Economic Times/Bloomberg

“A JP Morgan Chase & Co trader of derivatives linked to the financial health of corporations has amassed positions so large that he’s driving price moves in the $10-trillion market, traders outside the firm said.

The trader is London-based Bruno Iksil, according to five counterparts at hedge funds and rival banks who requested anonymity because they’re not authorised to discuss the transactions. He specialises in credit-derivative indexes, a market that during the past decade has overtaken corporate bonds to become the biggest forum for investors betting on the likelihood of company defaults.

Breaking…………

“Shares of J.P. Morgan Chase & Co. JPM -5.89% dropped after the bank said in a regulatory filing late Thursday it had “significant” mark-to-market losses in its synthetic credit portfolio. Shares fell 4.5% to $38.87 in after-hours activity. In a Securities and Exchange Commission filing, the bank said its synthetic credit portfolio had proved to be riskier and more volatile than expected.”

MarketWatch

MK comment: Sound familiar? Think Bear Stearns, early 2008.

10-May (Financial Times) — Wolfgang Schäuble, German finance minister, has given vital political cover to the Bundesbank, speaking out in support of the idea that Germany could tolerate a rate of inflation above the eurozone average.

Making a rare exception to the rule that Berlin does not comment on central bank policy, Mr Schäuble declared that price rises “in a corridor between 2 and 3 per cent” would be “tolerable” in Germany – slightly above the European Central Bank’s target of keeping average inflation across the eurozone at close to but below 2 per cent.

His statement followed comments before a parliamentary committee on Wednesday by a Bundesbank official, who cautioned that the eurozone’s largest economy might face “an inflation rate somewhat above average” as the likes of Greece and Portugal squeezed prices and wages to regain competitiveness.

Mr Schäuble’s comments seemed aimed at helping prepare an inflation-averse public for higher price rises to counter the deflationary effects of restructuring policies on the eurozone’s periphery.

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PG View: The sudden German tolerance for above-target inflation is likely reflective of just how dire the situation in Europe has become. Perhaps it’s just a false flag to lend support to the market, while the Greek political crisis sorts itself out…if that’s even possible. If however, the tolerance is legitimate; can the inflation inducing policy be far behind?

10-May (Der Spiegel) — Germany’s central bank has indicated it may tolerate higher inflation in Germany as the price of rebalancing economies within the euro zone. The move marks a major shift away from the Bundesbank’s hardline approach on price stability. Economists have hailed the decision as a “breakthrough.”
Info

Inflation is a political hot button issue in Germany, where the hyperinflation of the early 1920s has not been forgotten and many people still have a deep-rooted fear of their money losing value. Now Germany’s central bank, the Bundesbank, has made waves with signals that it is willing to tolerate higher inflation.

[source]

10-May (Bloomberg) — Spain is underestimating potential losses by its banks, ignoring the cost of souring residential mortgages, as it seeks to avoid an international rescue like the one Ireland needed to shore up its financial system.

The government has asked lenders to increase provisions for bad debt by 54 billion euros ($70 billion) to 166 billion euros. That’s enough to cover losses of about 50 percent on loans to property developers and construction firms, according to the Bank of Spain. There wouldn’t be anything left for defaults on more than 1.4 trillion euros of home loans and corporate debt.

Taking those into account, banks would need to increase provisions by as much as five times what the government says, or 270 billion euros, according to estimates by the Centre for European Policy Studies, a Brussels-based research group. Plugging that hole would increase Spain’s public debt by almost 50 percent or force it to seek a bailout, following in the footsteps of Ireland, Greece and Portugal.

[source]

10-May (MarketWatch) — Gold futures edged higher Thursday, with some support from a round of U.S. economic data, a reprieve in concerns over Europe’s banking, and a weaker dollar, but with lack of investor interest keeping gains subdued.

Gold for June delivery advanced $1.20, or 0.2%, to $1,594.80 an ounce on the Comex division of the New York Mercantile Exchange.

[source]

10-May (The Wall Street Journal) — Two years after Europe bailed Greece out to protect the euro, the rescue has become a debacle that threatens to unravel the common currency.

After Greece’s May 6 elections left pro-bailout parties too weakened to govern the country, more elections are likely in June, with no guarantee a stable government will emerge. By next month, Athens must identify €11.5 billion, or $15 billion, in fresh spending cuts or face suspension of the international loans it needs to pay pensions and run schools. If it doesn’t get the money, it would eventually have to print its own.

Greece’s growing turmoil is the culmination of a radical austerity experiment and botched economic overhaul that have pushed the nation to the brink of social and political breakdown. The story of the ill-fated bailout suggests that forcing deep austerity on individual member states won’t save the euro and may worsen its crisis.

Above all, Greece’s example illustrates the conflict between Germany’s tough terms for aiding other euro members and the amount of pain other societies can bear. Greece’s fate shows that what it takes to sell bailouts to a skeptical German public can be politically calamitous in Europe’s indebted south.

…Greece’s economy has already shrunk by 14% in the past three years, and IMF officials privately expect a further 6.5% contraction this year. Something has to give, and it could be the boundaries of the euro.

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09-May (The Economist) — THE conventional wisdom that emerged immediately after Europe’s weekend elections—that voters may have forced Europe into a new crisis reckoning—seems to have been correct. Greece is struggling to put together a government and whatever government eventually emerges will probably press for a renegotiation of its bail-out deal. Euro-zone officials are saying that this is out of the question. Odds of a Greek departure from the euro zone appear to be rising sharply; Intrade now puts the chance of exit in 2012 at close to 40%, up from 22% a week ago. Markets are shuddering at the possibility; European equities are dropping like stones, yields around the periphery are jumping—Spain’s 10-year yield is back above 6%—and German yields are sinking to record lows. Big trouble is brewing.

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09-May (USAGOLD) — Gold has extended to the downside as the “risk-off” meme that emerged following weekend elections in Europe persists. While the retreat in gold seems to be counter-intuitive, our own Michael J. Kosares offered a compelling explanation of what seems to be an inversely correlated move between the yellow metal and risk in an essay entitled Extraordinary popular delusions and the madness of machines.

Uncertainty surrounding the fate of Europe and the single currency continues to escalate with some troika policymakers threatening to cut off the flow of bailout funds to Greece — and even possible EMU expulsion — if they fail to live up to the previous administration’s commitments. The loudest voices, not surprisingly, are coming from Germany. Such threats are likely to intensify the populist Greek aversion to austerity that they believe is being foisted upon them by core-Europe…and more specifically the Germans.

Indeed, the troika is going to be under intense pressure to not release the next round of bailout funds to Greece in June, due to the political uncertainty. In fact, the chaos in Greece has reportedly prompted the troika to cancel a mission to Athens that was scheduled for mid-May. Without those bailout funds, Greece will likely be driven to the point of disorderly default. This is something everyone says they seek to avoid, and yet it is looking increasingly unavoidable.

The rise in Spanish yields back above 6% is reflective of the mounting contagion risks that springs from Greece. Spreads across the euozone are widening as investors once again flee the periphery and pile into the perceived safety of German bunds. The yield on 10-year bunds have fallen to new record lows below 1.50% today. UK gilts have also fallen to record lows and the EUR-GBP cross has tumbled through key support at .8068 to establish new 3½ year lows.

US Treasurys are benefiting as well, with today’s $24 bln 10-year auction expected to fetch a record low award rate, not much above the all-time recording closing low of 1.719% from September of last year. While these yields are negative in real-terms, such is the price for the perception of safety, even as debt is clearly the source of the problem. Demand for Treasurys is underpinning the dollar, which in turn is triggering the algorithms that Mike notes are forcing gold deeper into its range.

• US wholesale sales +0.5% in Mar, just below expectations of +0.6%, vs negative revised +1.1% in Feb; inventories +0.3%.
• Germany current account surplus rose to €19.8 bln in Mar, vs upward revised €11.7 bln in Feb.
• Germany trade balance (sa) €13.7 bln in Mar, unchanged from upward revised €13.7 bln in Feb; imports +1.2%, exports +0.9%.
• Japan Leading Index (prelim) +0.6% m/m in Mar, vs negative revised +1.7% in Feb.
• Japan Coincident Index (prelim) +1.3% m/m in Mar, vs +1.0% in Feb.
• South Korea Bok holds steady on repo rate at 3.25%, in-line with expectations.
• South Korea M2 +6.4% y/y in Mar, vs +5.0% y/y in Feb.
• Australia unemployment rate ticked higher in Apr to 5.3%, vs 5.2% in Mar.

09-May (Financial Times) — Spanish bond yields jumped over 6 per cent on Wednesday amid fears that uncertainty surrounding Greece was spreading to Madrid.

The yield on Spain’s 10-year bond, which has an inverse relationship with prices, jumped to 6.04 per cent, up 20 basis points.

Stocks on the Ibex 35 index fell 2.2 per cent, close to recent lows, as investors adjusted to the possibilities of the dangers of a new leg in the eurozone crisis.

Meanwhile, 10-year German bund and UK gilt yields both fell to fresh all-time lows of 1.53 per cent and 1.9 per cent respectively as haven buying was driven by rising worries that Greece may exit the eurozone.

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