Inflation Accelerates in China

June 14 (USAGOLD) – Continued robust economic activity in China gave global stocks a boost today and the improvement in risk appetite eroded the safe-haven appeal for gold somewhat. However, inflation pressures remain persistent, prompting the PBoC to raise bank reserve requirements once again. Accelerating price risks — primarily food price risks — are likely to keep demand for gold in China elevated.

A report released today by Standard Chartered Bank cited rising demand in India and China as a major contributing factor to their bullish outlook for gold. They pointed out that China only has 1.8% of its FX reserves in gold, compared to the global average of 11%. If China were to bring their holdings up to the average — and there is plenty of evidence to suggest that is exactly what they are striving toward — they would have to buy an additional 6,000 tonnes of gold.

SCB notes that is the equivalent of 2-years of global gold production. Obviously, with other competition on the demand side and anemic mining output projected, there is little hope that China will reach its goal any time soon. That however bodes well for the long-term uptrend in gold, with China likely to provide a consistent source of demand for years to come.

Debt troubles in Europe and the US continue to provide a safe-haven underpinning to the gold market in the near term. Events in Europe revolving around the second rescue of Greece seem to be coming to a head. While the euro seems to like the traction being gained by the Vienna-style “voluntary” rollover of Greek debt, the market seems to remain troubled by the implications of the rating agencies viewing this as a credit event. The discomfort was evident today in eurozone bond markets as Greek, Portuguese and Irish 10-year yields all hit new euro-era highs.

As the clock continues to tick on the US debt ceiling, President Obama warned that if Congress fails to reach a deal, the result a new global financial crisis could ensue. Even as negotiations led by Vice President Joe Biden resume today, market odds that a compromise on offsetting spending cuts will be reached seem to have eroded substantially in recent days. “[S]ome on Wall Street predict that there is just a 33 percent chance a deal will be cut in time to avoid default,” according to a US News and World Report article, but others have suggested its a 50-50 bet at best.

June 14 (CNBC) – President Barack Obama warned Tuesday there could be another global financial crisis if the U.S. Congress fails to raise the national debt ceiling.

…”The full faith and credit of the United States is the underpinning not only of our way of life, it’s also the underpinning of a global financial system. We could actually have a reprise of a financial crisis, if we play this too close to the line. So we’re going be working hard over the next month,” he said.

[source]

Editor’s Note: We often find ourselves in agreement with the studied assessments of James Rickards, who has ruffled the feathers of the financial media on numerous occasions by his determined defense of gold ownership. In this wide-ranging interview conducted by Lars Schall, he dissects the key issues of the day as they relate to gold and explains why the major central banks now want the price to continue rising. [Link]

The USAGOLD Gilded Opinion Library is home to numerous articles and essays of enduring value to our current and prospective clientele. It is one of our most popular pages, so if you’ve not yet done so, we welcome your visit today.

Enjoy!!

June 14 (WSJ MarketBeat) Remember that retail sales report that got the market all excited this morning by being not all that bad? Yeah, it was actually kind of bad.

It was bad enough, anyway, to push Macroeconomic Advisers to cut its forecast for second-quarter GDP to 2.1% from 2.5%, citing weaker retail sales through May than expected — past months were revised downward — and less retail inventory building than expected in April.

2.1% GDP is not great, folks. That’s below potential growth, below the long-term average and well below what you’d want to see following a weak first quarter. It leaves the economy vulnerable to shocks.

[source]

June 13 (Bloomberg) — There are reasons for bankers like me to view these as good times. Bank profits are up and failures have ebbed. Nonetheless, I remain troubled about the state of the financial-services industry.

Here’s why: community banks have given way to big banks and excessive industry concentration; profits are increasingly driven by risky trading; leverage is taking precedence over prudent lending; compensation is out of control. This toxic combination leads to continued taxpayer risk and threatens long- term U.S. prosperity.

To understand the change, first consider history. Banking once was a community-based enterprise, relying on local knowledge to guide the process of gathering customer deposits and extending credit. Done well, this arrangement ensures that deposits are deployed into a diversified pool of investments, while providing depositors with liquidity and a return on their savings.

Over the past generation, however, the financial services industry changed dramatically. In 1990, the six largest financial institutions accounted for 9 percent of all U.S. domestic deposits. As of Dec. 31, 2010, the six biggest banks accounted for 36 percent of deposits.

…Those financial institutions that engage in trading should live and die by the pursuit of their fortunes, rather than impose a burden on the whole economy.

…It’s time to disentangle the trading of big financial institutions from their more traditional commercial banking operations and put an end to this unsafe business model.

[source]

PG View: Nearly 3-years after the collapse of Lehman Brothers and the mayhem that ensued, little has been done to mitigate the systemic risks that nearly took down the global financial system. Despite 2,300+ pages of sweeping regulatory reform in the Dodd-Frank act, the “too big to fail” issue has morphed into “too bigger to fail” and as the author points out, the real business of banking at the regional and local level has been severely impeded in the process. It would seem the reactionary forces in Washington are not doing the economy — and therefore average citizens — any favors. The TBTF banks on the other hand have plenty to be thankful for.

June 14 (Reuters) – Private investor involvement in a second Greek rescue must be voluntary but a deal akin to the 2009 “Vienna Initiative” may be just that, European Central Bank Governing Council member Mario Draghi said on Tuesday.

“There are basically two initiatives that are under discussion. One is the Vienna Initiative, which to me looks entirely voluntary,” Draghi told a European Parliament hearing on his proposed appointment as ECB president later this year.

“The ECB is not in favour of restructuring or haircuts, we should exclude all concepts that are not purely voluntary or that have any element of compulsion,” he said.

[source]

PG View: “Entirely volutary.” Uh huh. Banks and investors don’t generally do things out of the goodness of their hearts. Given the additional deterioration of Greece’s fiscal picture, one has to wonder what is really motivating the largess of private bondholders. I know the rating agencies are wondering the same thing.

June 14 (Standard Chartered Equity Research) – We are bullish on gold. Most market commentary on gold has centred on the direction of US dollar movements or inflation/deflation issues. We go beyond this to examine future mine supply, which we think is just as important a driver. Our comprehensive study of 375 gold projects supply suggests a very limited production growth profile for the next five years. A ten-year bull market in gold has done little to drive gold production. The gold miners are running to stand still. A lack of funding from equity markets and a shortage of large gold mines makes it difficult for the industry to compensate for the depletion caused by aging mines and falling grades. In our base case, our 375-mine supply model shows net production growth of 3.6% pa. over the next five years.

…The limited supply comes at a time when central banks have completely changed their tune on selling down their gold stocks and now appear likely to accelerate their net buying programmes. China is way behind the curve. Currently, only 1.8% of China’s foreign exchange reserves is in gold; if the country were to bring this proportion in line with the global average of11%, it would have to buy 6,000 more tonnes of gold, equivalent to more than 2 years of gold production.

…We believe that these factors – limited gold production, buying by central banks and increasing demand from India and China – can potentially drive the gold price to US$5,000/oz…

[source]

14 June 2011 (BBCNews) – Inflation in China hit its highest level in 34 months despite the government’s efforts to rein in rising prices.

Consumer prices in China rose by 5.5% in May, compared with the same month last year, according to the National Bureau of Statistics.

Food prices continued to be the biggest factor as they surged by 11.7%.

The rising cost of food and commodities have pushed up the cost of living and become a hot political issue in China.

[source]

June 14 (USAGOLD) – Gold remains slightly defensive within the recent range as robust economic data out of China improved risk appetite, lifting global stocks. However, China’s strong economy comes at the expensive of higher inflation. China CPI hit a new 34-month high of 5.5% y/y in May.

Gold remains comfortably above the $1500 level with broad-based debt uncertainty in both Europe and the US continuing to underpin the market. The EU is attempting to advance a Vienna-style debt rollover for Greece as yields in the periphery continue to soar. The EU seems inclined to move forward and wage a PR war for the hearts and minds of global investors if the ratings agencies deem the plan a technical default for Greece.

S&P cut Greece 3-notches to CCC from B yesterday. The backs of Greece and the troika are up against the wall and the rollover is probably the most defensible position they’ve come up with. However, I don’t think anyone really believes there wont be some arm-twisting — and perhaps some form of quid pro quo — to get the private bond holders to play along. Nonetheless, the euro has firmed, putting modest pressure on the dollar.

• US retail sales -0.2% in May, modestly better than the -0.3% expected. Ex-auto +0.3%. Negative back-month revisions.
• US PPI +0.2% in May on expectations of +0.1%, +7.3% y/y. Core +2.1% y/y.
• UK CPI unchanged in May at 4.5% y/y, in line with expectations.
• UK RICS house price index slumped to -28 in May, lower than market expectations, vs -21 in Apr.
• China CPI rose to a new 34-month high of +5.5% y/y in May, vs +5.3% in Apr. PBoC hiked reserve requirements again.
• Robust China data: May production 13.3% y/y, retail sales 16.9%, investment 25.8%.
• Japan MoF Survey: Large-firm diffusion index plunged to -22 in Jun, vs -1.1 in May on earthquake/tsunami.
• Bank of Japan held o/n rate at 0.0-0.1%, expanded loan scheme for growth industries

It is widely assumed that at the end of the day, Republicans and Democrats in Congress will compromise and cut a deal on raising the debt ceiling.

It’s widely assumed because everyone from Treasury Secretary Tim Geithner to House Speaker John Boehner to Senate Majority Leader Harry Reid has told anyone who would listen that this is what is going to happen.

One hopes they are right. Last week, Moody’s issued a statement saying that if something wasn’t done to get US fiscal policy under some kind of control, the credit rating of the United States of America would be downgraded. That would be a disaster of significant scale.

…They point out that these leaders don’t have a deal on the debt ceiling in their back pocket. They don’t even have the outline of such a deal. The various commissions and “working groups” and all the endless meetings to produce a rough draft of such a deal have gone, basically, nowhere.

[source]

PG View: If no deal materializes ahead of 02-Aug and the US faces the loss of its AAA credit rating, the political blame game will begin in earnest. While that game plays out, the Fed may have no choice but to spool up the printing presses to avoid default. The implications for the dollar and for gold should be obvious.

June 13 (Bloomberg) — A “perfect storm” of fiscal woe in the U.S., a slowdown in China, European debt restructuring and stagnation in Japan may converge on the global economy, New York University professor Nouriel Roubini said.

There’s a one-in-three chance the factors will combine to stunt growth from 2013, Roubini said in a June 11 interview in Singapore. Other possible outcomes are “anemic but OK” global growth or an “optimistic” scenario in which the expansion improves.

“There are already elements of fragility,” he said. “Everybody’s kicking the can down the road of too much public and private debt. The can is becoming heavier and heavier, and bigger on debt, and all these problems may come to a head by 2013 at the latest.”

[source]

PARIS — Standard and Poor’s slashed its credit rating for Greece on Monday by three notches to CCC, saying there is a significantly higher probability of a default in the struggling eurozone member.

[source]

The European and Monetary Union faces an eventual break up and the euro “disorderly debt workouts” should the euro zone fail to resolve its “economic and competitiveness divergence,” economist Nouriel Roubini said Monday.

The monetary union “never fully satisfied the conditions for an optimal currency area,” Roubini, co-founder and chairman of Roubini Global Economics, wrote in an op-ed in the Financial Times.

The way to restore competitiveness and growth for members on the periphery, said Roubini, would be to abandon the euro, restore their national currencies, and “achieve a massive nominal and real depreciation.” While some may doubt the prospect of countries abandoning the euro, such as scenario “may not be so far-fetched five years from now, especially if some of the periphery economies stagnate.

[source]

In opinion pieces Monday in the Washington Post and Financial Times, Summers, who was the first director of the National Economic Council under Obama, says that the United States is at risk of falling into a “Lost Decade” of prolonged weak economic growth and high unemployment unless more action is taken in the near term.

“The greatest threat to the nation’s creditworthiness is a sustained period of slow growth,” he wrote.

Among the proposals he made is increasing the size of the payroll tax holiday from 2% of income to 3% of income, and expanding it so that employers also get a break from paying the tax that goes to support Social Security.

“At a near-term cost of a little more than $200 billion, these measures offer the prospect of significant improvement in economic performance over the next few years translating into significant increases in the tax base and reductions in necessary government outlays,” he said in the Washington Post column.

[source]

JK Comment: Certainly an interesting point of view considering the content of the debate surrounding the raising of the debt ceiling this August.

LONDON — Bond traders and officials at the European Central Bank have been unified in their warnings that a restructuring of Greece’s debt would set off an investor panic similar to the one that followed the bankruptcy of Lehman Brothers.

Others, however, have argued that Greece’s debt of 330 billion euros, or $473 billion, while too large for the country to bear, is small enough to allow banks and other institutions to take a loss without bringing the world financial system to its knees.

But the comparisons between Greece and Lehman grew more frequent last week as global markets reeled, spurred in part by the view that Germany’s insistence that private investors participate in a second rescue package for Athens would overcome the objections of the European Central Bank.

[source]

Europe Continues to Unravel

Despite weeks of machinations on the part of the ECB/IMF/EU, the eurozone debt crisis continues to worsen. Most recently, the troika’s focus has been on providing additional aid to Greece without triggering a “credit event.” Germany has been insisting that private investors play a role in any new bailout for Greece. While members of the troika have warmed to that idea, the credit rating agencies have suggested that any whiff of compulsion to accept rollover terms would likely be viewed as a credit event tantamount to a default, or at a minimum worthy of a multi-notch downgrade.

As it has become increasingly obvious that the stake-holders and the rating agencies have reached an impasse, borrowing costs for Greece and other EU periphery countries have continued to rise. CDS premiums for Greek sovereign debt hit a record high 1600 bps today, which drove CDS on Irish and Portuguese debt to record wides as well. Spanish CDS rose 13 bps to 289 bps, according to Reuters. With S&P, Moody’s and Fitch disinclined to cut the troika the necessary slack to save Greece, Europe is fast running out of options…and time. Some are beginning to worry that a restructuring of Greece will trigger a Lehman-like investor panic that could put the global banking system in jeopardy once again.

Safe-haven flows into bunds are keeping yields suppressed in Germany, exacerbating the inflation worries there. With the German economy humming along, largely due to very low interest rates, price risks are elevated as is pressure on the ECB to hike. The ECB did indeed indicate last week that a July rate hike is in the offing. However, in raising benchmark rates for the eurozone, it adds additional upward pressure on periphery rates as well. Something Greece, Portugal, Ireland, et al. can ill-afford.

Rising risk aversion is seen as generally supportive to the gold market as well. The yellow metal remains within striking distance of record highs against the euro, sterling and of course the dollar. Downward pressure on the euro has been somewhat supportive to the greenback, but America’s own debt woes provide a counterbalance that has investors reluctant to commit to the dollar, despite the currencies traditional — albeit eroding — role as a safe-haven. The safe-haven field has effectively been narrowed to the Swiss franc…and gold.

Gold remains consolidative, but underpinned as concerns about Greece continue to percolate. The euro is under pressure amid rising calls for private participation in a Greek bailout, which are being answered by worries of a possible credit event. CDS spreads for Greece, Portugal and Ireland have all hit record-wides today. Safe-haven flows are supporting German bunds and the Swiss franc, which has set a new record high against the euro.

China new yuan loans moderated to CNY551.6 bln in May from CNY739.0 bln in Apr.

Japan core machinery orders -3.3% m/m SA in Apr, -0.2% y/y from +9.1% y/y.

The BoE’s Quarterly Bulletin suggests that inflation expectations are reasonably well-anchored. However, there is apparently rising concern that those high — but reasonably well anchored — expectations will become entrenched based on the past experiences of other countries. The bulletin also notes that satisfaction with BoE policy setting has deteriorated since mid-2010. This is likely the result of falling real wages stemming from inflation.

Stock Losses Raise Pressure on Fed

The stock market has rolled over, recording its sixth weekly decline since the DJIA peaked in early-May at 12,876. On Friday the market closed below 12,000 for the first time since March, losing about 7% of its value over the past 6-weeks. In recent weeks the Dow has fallen below the important 20, 50 and 100-day moving average complex. The 20-day MA has crosses below the 50-day MA. From a technical perspective, the stock market looks terrible. This comes at an inconvenient time, with the Fed’s QE2 operation winding down over the next 3-weeks. Or perhaps the slump in stocks is because QE2 is poised to expire.

The recent raft of bad economic data on jobs, housing, manufacturing and consumer confidence are all weighing on investor sentiment. The weak economic recovery is sputtering; but is it just a temporary soft-patch, or is something more ominous and protracted brewing? The Fed made it clear this week that they believe the slowdown is transitory and that growth will be revived in the second half of the year. They seem prepared to stick to their guns, and allow QE2 to expire at the end of the month. Now the market seems inclined to test the Fed’s resolve.

As we’ve discussed in the past, many in the US — no matter how misplaced the notion might be — view the stock market as the critical measure of the health of the economy. In pointing to the performance of the Russell 2000 as an indication that Fed policy is working, chairman Bernanke has actively encouraged that mindset. With the Russell down more than 10% since forming a key reversal on 02-May, my guess is that Bernanke doesn’t reference RUT again anytime soon. Nonetheless, the stock market is curious to know at what point the Fed might consider additional accommodations. Certainly they can ill-afford more than a 20% retracement in the Dow as that would result in a bear market, which would further sap investor and consumer confidence. My guess is that in order to protect that 20% retracement level, Fedspeak starts eluding to heightened potential for QE3 around DJIA 11,000.

I’m quoted in a MarketWatch article today referencing the recent tighter correlation between stocks and gold as QE3 expectations have waxed and waned. Quantitative easing has a tendency to bolster most asset classes because the artificial demand provided to the Treasury market suppresses yields. This has a negative effect on the dollar and low yields effectively discourage investors and savers from being in yield baring instruments such as bonds, bills, CDs and money market accounts. The quest for a yield that at least keep up with inflation makes stocks, commodities and of course gold more attractive. The weaker dollar and investor demand for commodities further increases the inflation rate, creating a vicious circle.

The more normal negative correlation between stocks and gold is likely to reestablish itself if equities continue their retreat and investors start looking for a safe-harbor to weather that storm. At the point where the Fed once again starts to worry about higher unemployment and deflation, they’ll cry “uncle” and likely announce further QE because with interest rates already at essentially 0%, they really don’t have any other tools at their disposal. Stocks and gold will become positively correlated again and both will take off to the upside.

Here’s the wildcard though: Bernanke has already acknowledged that the size of the Fed’s balance sheet can become problematic. There is a point, where the negative effects — most notably the devaluing impact on the dollar — will outweigh any positive impact derived from artificially low yields. That’s the point of reckoning that everyone should be worried about, because once QE doesn’t offer any additional benefit the game is up and the dollar will have to be devalued.

The Fed announces the final phase of QE2, totaling approximately $62 billion. This represents $50 billion in purchases of the announced $600 billion purchase program, which will be completed by the end of June, and $12 billion in purchases associated with principal payments from agency debt and agency MBS expected to be received between mid-June and mid-July. As always, this schedule is subject to change should the FOMC choose to alter its directive to the Desk during the monthly period.

[source]

This is part of the operational readiness program announced 07-Jun.

By Mark Gongloff
Ladies and gentlemen, if you look out the window to your left, you’ll see the 12000 mark on the Dow, which we haven’t crossed since mid-March. We’re going back through it in the other direction this time.

[source]

By Benoit Faucon
LONDON (MarketWatch) — OPEC Friday warned of a looming supply gap in the second half of 2011, but tempered this by highlighting economic uncertainty amid gloomy U.S. economic data and European sovereign debt concerns, a view that could imply weaker-than-expected demand.

“The world economic growth forecast for 2011 remains at 3.9%, but challenges to the forecast have become more pronounced,” particularly due to European sovereign debt concerns, said the Organization of Petroleum Exporting Countries in its monthly oil market outlook.

At the same time, OPEC warned “expected supply/demand balance indicates a tightening market” in the latter part of the year.

[source]

By Shannon D. Harrington, Jody Shenn and Sarah Mulholland
June 10 (Bloomberg) — Federal Reserve auctions of mortgage securities that the central bank assumed in the rescue of American International Group Inc. are fueling a selloff in credit markets as Wall Street rushes to hedge against losses on stockpiled debt.

Declines in credit-default swaps indexes used to protect against losses on subprime housing debt and commercial mortgages accelerated this month, reaching almost 20 percent in the past five weeks as the cost of the insurance climbs, according to Markit Group Ltd. The plunge this week started infecting everything from junk bonds to the debt of financial companies.

The Fed has been selling the $31 billion Maiden Lane II portfolio piecemeal after rejecting a $15.7 billion bid from AIG for the entire pool in March. Since then, Europe’s sovereign debt crisis has deepened and the U.S. recovery has shown signs of slowing, with unemployment rising to 9.1 percent, the highest level this year, and the economy growing 1.8 percent in the first quarter, less than forecast.

[source]