14-May (WSJblogs) — German Chancellor Angela Merkel is currently having a hard time in Europe with her austerity course.

But matters have suddenly got more uncomfortable at home too. Some German newspapers Monday have interpreted Sunday’s election defeat for her party as the beginning of her own political end.

The devastating loss of her conservative Christian Democrats in German state elections will make her life more difficult because the stronger center-left opposition will demand more concessions from Germany’s austerity policy.

[source]

14-May (Derp Spiegel) — After Greek voters rejected austerity in last week’s election, plunging the country into a political crisis, Europe has been searching for a Plan B for Greece. It’s time to admit that the EU/IMF rescue plan has failed. Greece’s best hopes now lie in a return to the drachma.

…Two years after the government in Athens requested the first emergency loans in Brussels, the European debt crisis is reaching a turning point. Europe and the international community pumped about €240 billion ($312 billion) into the Balkan nation, government employees were let go, pensions were slashed and a series of restructuring programs were approved.

But even though the country is virtually being governed by the European Commission and the IMF, Greece’s debts are higher than ever and the recession is worsening. As the political situation becomes increasingly chaotic, new elections seem all the more likely.

[source]

14-May (Der Spiegel) — Last week Chancellor Angela Merkel’s austerity policy suffered twin blows in Europe when Socialist Francois Hollande, a critic of her strict approach, won the French presidency and Greek voters firmly rejected the painful reforms imposed on them.

On Sunday came a further major setback for Merkel when her conservative Christian Democrats suffered a big defeat in an election in the country’s most populous state, North Rhine-Westphalia (NRW). It weakens her at home at a time when opposition to her crisis strategy is mounting across Europe.

The CDU saw their support plunge to just 26.3 percent, down from nearly 35 percent in 2010, and the worst result in the state since World War II. The center-left Social Democrats (SPD) won 39.1 percent of the vote and will have enough seats to form a stable majority with the Greens.

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Heightened Greek Woes Boost Dollar, Weigh on Gold

14-May (USAGOLD) — The euro fell to new 4-month lows below 1.2900 as a last ditch effort by Greek President Papoulias to forge a coalition government also seem destined for failure. New elections are looking increasingly likely; and as we discussed last week, the anti-austerity Syriza is expected to garner even more support the next time around. Discussions of Greece exiting the EMU are now being conducted in the open…and by just about everyone.

Nonetheless, I think all the parties involved are frightened of the implications of a Greek default and abandonment of the euro. This may give Alexis Tsipras, the leader of Syriza the upper-hand in any negotiations. Certainly he is negotiating from a position of weakness, and truth be told, Greece has much to lose. However, if Tsipras can make the troika believe he’s just desperate (or crazy) enough to bail-out of the single currency, he just may be able to wring additional concessions out of them.

In fact, I think the die has been cast in recent years: Policymakers around the world seem prepared to do whatever it takes to hold the global financial system together at all-cost. They’ve done this by papering over excessive debt with even more debt and currency, in some instances in exchange for austerity. But I’m not entirely convinced that the austerity is an absolutely necessary prerequisite.

The Bundesbank and the German Finance Ministry suggesting last week that they would be willing to “tolerate” above target inflation is perhaps an initial indication that Greece and the rest of the periphery need not necessarily make all the concessions moving forward. In forcing the troika to bend somewhat to his will, Tsipras will likely garner considerable political capital in Greece.

Not that living conditions are going to materially improve if Greece becomes a permanent ward of the EU, but neither will living standards plunge as they would if Greece tried to go it alone without access to global funding markets. In the latter scenario, the only alternative would be for Greece to severely devalue the new drachma. Under the first scenario, Greece would likely go into a protracted, albeit more gradual period of decline; begging for scraps from core-Europe’s table. But at least the Greek people would have a common enemy — greater-Europe and perhaps Germany more specifically — to unite against, which just might be enough to hold a government together.

I imagine though, that the best and brightest of Greece won’t wait around to see how it all plays out. They’ll take their money, their talent and the future of Greece with them as they flee.

The decline in the euro buoyed the dollar, which in turn weighed on stocks, commodities and pushed gold deeper into its range. Gold not participating — at least initially — in this global flight to safety seems counter-intuitive, but I think our very own Michael J Kosares did a pretty good job of explaining the mechanics of the inverse gold/risk correlation that has emerged in recent years. When paper gold drives the price down in deleveraging scenarios, it may be prudent to view physical gold as being ‘on sale’.

14-May (Commodity Online) — The International Monetary Fund (IMF) is planning to purchase more than $2 billion worth of gold on account of rising global risks. The IMF currently holds around 2800 tonnes of gold at various depositories

“The Fund is facing increased credit risk in light of a surge in program lending in the context of the global crisis. While the Fund has a multi-layered framework for managing credit risks, including the strength of its lending policies and its preferred creditor status, there is a need to increase the Fund’s reserves in order to help mitigate the elevated credit risks”, Bloomberg quotes a report by an IMF staff while also adding that a $2.3 billion gold purchase is in the planning.

…In such a risky financial environment, the IMF’s move could be considered wise and can be seen as an indication of how much trust the mainstream financial community now has on precious metals like gold.

[source]

PG View: Interestingly, the original Bloomberg article cited by Commodity Online makes no mention of the IMF buying gold. So, unless Commodity Online has additional sources saying the IMF is planning to buy gold specifically, I don’t see how they gleaned that from Bloomberg. Buying gold this year, when they were selling gold last year to raise funds for various programs, doesn’t make a lot of sense to me on the surface.

14-May (NASDAQ) — Commodity prices are trading broadly lower in European hours as Greece-linked jitters continue to weigh on risk sentiment trends. Growth-sensitive crude oil and copper prices following stocks lower while safe-haven flow buoy the US Dollar , applying de-facto downward pressure on gold and silver .

Lawmakers in Athens once again failed to come to terms on the structure of a ruling coalition at a meeting over the weekend. Markets are becoming increasingly concerned that a lingering impasse will push Athens to fall short of its obligations under the terms of the EU/IMF bailout, paving the way for Greece’s ejection from the Eurozone and possibly even the overall EU. This would be an unprecedented development with effectively unpredictable practical implications for financial markets, fueling a broadly defensive tone

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Link Bloomberg-Donahue-5/13/12

MK comment: This post hearkens back to the interview of Robert Rubin immediately below in which he tries to elucidate on the potential effects of the crisis in Europe. There is the short interview I linked, then there is a longer, hour-long interview (that you can access by going there) wherein he outlines the problem in Europe and what it might mean to the markets and the banking system. I suggest your taking in that longer interview. Rubin is at his best and the interviewer, Chrystia Freeland, challenges him just enough to move him out of his comfort zone. There are also a few humorous exchanges between the two worth catching. The link is in the previous post.

“Former Treasury Secretary Robert Rubin states that the country’s deficit will lead to some form of major duress like high inflation, a long period of very slow economic growth and, most likely, a serious financial and economic crisis.”

Link-Reuters-Freeland File-5/10/12

MK comment: The word Rubin uses is “mega-crisis.” He talks directly about monetizing the debt and the possibility of high inflation and says “that’s why gold is where it is.” But he doesn’t stop there. This video is well worth your time for a big picture outlook from someone who’s been there, done that. “Markets,” he says, “can continue relatively benign until all of a sudden they are not. The changes can be unexpected and hugely dramatic.”

“But global stress levels are not particularly high at present – certainly not compared to what they will be if the euro situation continues to spiral out of control. We are not at the end of a big global credit boom – we are still trying to recover from the last calamity. For JP Morgan to have incurred such losses at such a relatively mild part of the credit cycle is simply stunning.

The lessons from JP Morgan’s losses are simple. Such banks have become too large and complex for management to control what is going on. The breakdown in internal governance is profound. The breakdown in external corporate governance is also complete — in any other industry, when faced with large losses incurred in such a haphazard way and under his direct personal supervision, the CEO would resign. No doubt Jamie Dimon will remain in place.”

Link – Simon Johnson – Baseline Scenario – 5/11/12

MK Comment: I looked up JPM’s total derivative exposure. According to the Comptroller of the Currency, it is $70.1 trillion, and the largest among the big banks. Just JPM, Citibank, BoA and Goldman’s derivative’s exposure runs over $200 trillion — a sum that makes the government’s $15 trillion debt exposure look downright trivial. Some estimate the total notional value of derivatives globally at between $600 trillion and $1.4 quadrillion! A few years back I wondered if I would ever have cause to use the word “quadrillion” in writing about the financial system. I just did.

“In just breezing through a few of the key charts, it appears that, yes, Monday may be a mess.”

Link-Forex Pros-Abigail Doolittle-5/13/12

MK comment: Abigail Doolittle’s analysis is based on the technical picture for the S&P index. Nary a word about the JP Morgan exposure, the euro-tangle, etc.

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.”

[source]

“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”.

[source]

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.”

[source]

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.

[source]

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.

[source]

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.

[source]

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.

[source]

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]