Thu, 02 Sep 2010 20:54:19 +0000
A tale of gold, Baron Rothschild, inflation and today's British gilt...
"I CARE NOT what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain's money supply controls the British Empire, and I control the British money supply."
So declared Baron Nathan Mayer de Rothschild – once the richest man in Europe,
writes Gary Dorsch, editor of the Global Money Trends newsletter.
In 1840, NM Rothschild was appointed as the bullion broker to the Bank of England, and went on to operate the Royal Mint Refinery in 1852. Nathan gained a position of such enormous power in the City of London that he was able to supply enough money to the Bank of England to enable it to avert a market liquidity crisis.
Nowadays, the Bank of England – also known as the "Old Lady" of Threadneedle Street – has full control over the British money supply, with a monopoly on issuing banknotes in England and Wales. It also controls what's left of Britain's badly depleted Gold Bullion reserves. In May 1997, the Bank of England was granted the autonomy over monetary policy, and with it the power to set interest rates.
The Bank of England's mandate centers on two primary goals – to insure stable consumer prices and to oversee the British Pound. Stable prices are defined by the boundaries of the government's 2% inflation target, as measured on the Consumer Price Index (CPI). In theory, the Bank of England aims to meet this target by hiking its base lending rate if inflation overshoots the CPI target by more than 1%, and by lowering its base rate if inflation falls below 1%.
But in reality, the Bank of England will ignore its mandate to combat above-target inflation if it's in the best interest of the UK economy. The rules demand, however, that the Bank of England governor writes a letter to the Chancellor of the Exchequer if this happens, explaining why it's pursuing an asymmetrical monetary policy.
In the aftermath of the bankruptcy of Lehman Brothers in September 2009, the UK's economy was caught in the grips of a vicious contraction that wiped out 6% of its GDP. Suddenly, the outlook for Britain's CPI turned exceedingly negative, and the Bank of England decided to take extraordinary actions in order to prevent the CPI from falling below 1%, and to fend-off the specter of deflation.
In March 2009, the Bank of England broke new ground in its long checkered history, when it cleared the way for "Quantitative Easing" – radical measures used to combat deflation and unblock frozen credit markets by creating money. The Bank of England said it would buy huge quantities of gilts, aiming to pump cash into the banking system and restart the flow of lending to businesses and households.
"If we were to go to the wider operation, the Bank of England could decide that it wished to conduct such operations financed by the creation of central bank money," said Bank of England chief King on Feb 11, 2009.
Two weeks later, Bank of England chief King was granted approval by the Exchequer to start the printing presses – creating up to £150 billion in order to buy up everything from corporate bonds to government debt.
In theory, injecting liquidity into the banks provides new funds to lend to businesses, homebuyers, or consumers. However, very little of the Quantitative Easing tidal wave actually trickled down to the private sector. Instead, it was hoarded by greedy bankers, seeking to rebuild their own balance sheets that been so badly damaged by the financial crisis. Much of the Quantitative Easing-cash was simply funneled by banks into higher yielding government and blue-chip company bonds.
The original blueprints of Quantitative Easing were designed by the Bank of Japan, which tried very similar tactics a decade ago, after most of the Tokyo's fiscal stimulus tactics failed. As everyone knows, Quantitative Easing failed to pull Japan out of its post Nikkei-bubble rut. Whereas the Bank of Japan injected 5% of GDP into its Quantitative Easing-scheme, printing money to buy up Japanese government bonds, the Bank of England committed itself to printing the equivalent of 13% of its GDP.
But although Quantitative Easing has fueled huge bubbles in the G7 bond markets, it's failed to stimulate economies, because the transmission mechanism – between the central bank and the real economy – is clogged-up by tight-fisted bankers, who seem focused more on their annual bonuses.
About a year after the Bank of England began a series of rapid-fire rate cuts – slashing its base rate to an all-time low of 0.50%, and unleashing Quantitative Easing , and purchasing a total of £200 billion over 12 months – the Bank of England began to see the fruits of its labor.
The Bank of England's efforts to turn back a deflationary spiral in the UK economy were greatly aided by a massive devaluation of the British Pound, which lost a quarter of its trade-weighted value from the start of 2007. Most importantly, the Federal Reserve's $1.75 trillion Quantitative Easing-scheme had fueled a sizeable rally in the Dow Jones Commodity Index.
So by April 2010, British consumer prices (CPI) were +3.7% higher than a year earlier, aided by surging commodity prices. Bank of England chief Mervyn King wrote a public letter to the then-Chancellor of the Exchequer, Alistair Darling, because the CPI figure had risen more than 1% above the 2% target. Better still for deflation-fighters, Retail Price Inflation (RPI) – the former measure, still used to gauge the cost of living in wage negotiations – accelerated at a +5.3% clip in April, the fastest pace since 1991.
But Mr King is still worried about deflation. Forced to write another letter to the new coalition government's Chancellor, George Osborne, this August, the poker-faced Bank of England chief is privately worried about the possibility of Japanese-style deflation spreading to Western nations.
Much will depend upon the future direction of commodity markets, a key driver of the British CPI. There's renewed fears that a still crumbling housing market and high unemployment will push the US-economy into a "double-dip" recession – rattling world stock markets. Rallies in key industrial commodities are unraveling, as China's housing bubble has peaked and factory output is falling, following tightening moves by its central bank. Japan's economy is suffocating from a strong yen, and Greece's 10-year bond yield is +900-basis points above German yields, indicating the Eurozone debt crisis is still brewing beneath the surface.
Any of these time bombs, if they explode, could rock the global economy and industrial commodities. So Bank of England chief King thinks any triumph against deflation is illusionary, and instead, believes the CPI gauge has already peaked and will eventually fall under its 2% target within a year, because of "substantial spare capacity in the economy, though policy makers are very conscious of price risks."
Mr King refuses to rule out a further expansion of the money supply – "QEII" – even after the Bank of England monetized 90% of the UK's budget deficit in the past fiscal year.
"We stand ready either to expand or reduce the extent of monetary stimulus as needed," he said.
So far, Mr King's prognostications are on target. The DJ-Commodity Index's inflation rate has flattened out, at a lower plateau, up 10% from a year ago, after peaking at +24% in February, while the British CPI has eased to +3.1%.
On August 18th, the Bank of England voted 8-1 to keep its base lending rate pegged at 0.50% and its bond-portfolio steady at £200 billion.
"The committee considered arguments in favor of a further easing [and] there were also arguments in favor of a small increase in bank rate. Increases in the prices of some agricultural commodities suggest that the increased volatility of CPI inflation in recent years might continue.
"[Still,] the weight of evidence continues to suggest that the margin of spare capacity is likely to bear down on inflation..."
After the Bank of England unleashed Quantitative Easing in March 2009, there was a revival of commodity inflation, helping to push the British 10-year gilt yield about 125-basis points higher to a peak of 4.25% in February 2010.
The peak in gilt yields coincided with commodity inflation reaching 23% year-on-year. On Feb 4th, the Bank of England halted its Quantitative Easing-printing spree at £200 billion, in order to rescue the British Pound, which was in the grips of a death spiral, tumbling to a 14-year low of $1.3675.
Just three-months ago, British gilt yields were hovering near 4-percent. Bond dealers were fretting about the former Labour government's plan to sell a record £220 billion of gilts this year. That amount was 50% more than the £146 billion sold in the fiscal year that ended March 31st. The UK's budget deficit was projected to reach £175 billion, or 12.4% of gross domestic product. That's the biggest shortfall in the G20 nations and matches Greece.
Yet defying worries over the massive build-up of UK government debt, the yield on Britain's 10-year gilt plunged 100-basis points over the past three-months to below 3%, a historic low point, and caught many traders by surprise. Two-year gilt yields hit a record low of 0.60%, and five-year yields fell to a record low of 1.67%. However, the sharp plunge in gilt yields is out-of-sync with the commodity indexes, which are stable and still in positive territory, supported by a 44% jump in wheat.
With the British CPI running at +3.1%, or slightly above the 10-year gilt yield (and with the RPI significantly above that), traders buying gilts at these levels would see their interest payments wiped out by inflation in real terms. Thus, what value could there be in buying British gilts?
Perhaps the Bank of England might soon unleash QEII, thus soaking up more of the outstanding supply of gilts, and creating a short squeeze. For this reason, the bears suspect that British gilts are over-extended into bubble territory, and once it becomes widely recognized that the deflation scare is a nothing more than a false illusion – the gilt bubble will inevitably burst.
Ten-year gilt yields have fallen steadily from as high as 4.25% in February, when worries about Britain's record budget deficit were at their peak. The yield spread between the British 10-year gilt and the 1-year bill rate has shrunk by 130-basis points, down to +225 basis points today.
The last time the UK yield spread was this narrow, the global economy was at risk of sliding into a 1930s' style depression. So what's the meaning of the sharp narrowing of the UK's yield curve?
While much of the downward move in gilt yields is linked to fears about a "double-dip" recession in Japan and the United States. In London, there's also expectations that austerity measures introduced by the Conservative/Liberal Democrat coalition could push Britain's economy back into recession. Britain's ruling coalition produced the harshest budget in a generation on June 22nd, slashing public spending by over £100 billion, raising the VAT sales tax to 20%, and slapping a levy on banks, in order to cut a record budget deficit to almost nothing in five years.
However, while gilts have rallied strongly on bets the UK economy will topple into recession by the first half of 2011, the FTSE-100 Index remained resilient. Chancellor George Osborne wrapped his tough austerity measures in rhetoric about fairness and burden sharing, but tilted the budget in favor of business. The corporate income tax rate is to be cut from its present level of 28% to 24%. This will give the UK the lowest level of corporate taxation in any developed economy.
FTSE-100 companies equal about 85% of the market capitalization of the London Stock Exchange, and yet nearly half the companies are headquartered outside the UK. Roughly one-third of the FTSE is concentrated in the natural resource sector. Thus, the Footsie is viewed as a global bellwether, rather than a reflection of the state of the British economy. But right now, the sharp downward trajectory of UK gilt yields is flashing warning signals of a sharp downturn in the British economy, which could trigger deflation in wages and UK home prices.
Bond traders are usually the first to sniff out trouble – long before it's recognized by the maniacal speculators in the stock market. And to date, bond buyers have sounded an early warning siren at every stage of the global financial crisis.
Historically, the lag-time between an inverted yield curve and a subsequent bear market in stocks has varied from several months to as long as a year. With the Bank of England's base rate near zero-percent, an inverted yield curve is improbable, but a sharp narrowing of the curve could also do the trick of unnerving die-hard stock market bulls.
One of the catalysts behind the stunning collapse in British gilt yields to historic lows is the Greek debt crisis, which is still brewing beneath the surface, despite the attempts of Eurozone politicians and the International Monetary Fund to conceal the gravity of the situation. The yield on Greece's 10-year bond continues to ratchet upwards, climbing to as high as 11.30% today, and not far below its all-time high of 12.62%, hit on May 7th. The yield on Greece's 10-year bond is nearly +850 basis points above the British gilt yield, a clear sign of trouble that lies ahead.
On June 10th, famed hedge fund trader George Soros, said "we have just entered Act II" of the global financial crisis.
"The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama. When the financial markets started losing confidence in the credibility of sovereign debt, Greece and the Euro have taken center stage, but the effects are liable to be felt worldwide. Credit default swaps, which insure bondholders against the risk of a default, are dangerous and a license to kill."
The explosive surge in credit default swaps (CDS) linked to Greece's debt jolted the financial markets in May, wiping out more than $4 trillion from global stock markets. Today, it costs about $1 million to insure $10 million of Greek debt from the odds of default, or a restructuring of principal. Many portfolio managers are opting to swap out of Greek bonds, and buying British gilts or German bunds. Finding a buyer for Greek bonds has become more difficult since the European Central Bank (ECB) stopped purchasing the toxic debt five weeks ago.
While the UK's economy grew by +1.1% in the second quarter, and Germany's expanded by a record +2.2%, the Greek economy was moving in the opposite direction. It shrank -1.5% in the second quarter, as the Greek jobless rate jumped to 12%, with more than 600,000 citizens out of work.
Greece's downward spiral accelerated as a barrage of austerity measures – wage and pension cuts plus tax increases – sapped consumer demand. Traders in Greek bonds figure that at some point in the near future, Athens will declare a moratorium on its debt payments, and demand a restructuring of principal, from its creditors.
Bank of England officials worry that Japanese style deflation could spread to Europe, but it's already a reality in the G7 bonds markets. Japan's 10-year government bond (JGB) yield slipped to 0.90% this week, to its lowest level in seven years, and in turn, knocked British 10-year gilt yields below 3%.
Little wonder that Tokyo's Ministry of Finance data show Japanese investors buying a net ¥8.2 trillion ($103 billion) in higher yielding foreign bonds in June and July, a record for a two-month period, including ¥6 trillion yen in net buying by Japanese banks, who are able to hedge their foreign currency exposure through swaps or forward contracts.
Japan's economy grinded to a halt in the second quarter, adding to headaches at the Ministry of Finance as it grapples with deflation and a powerful rise in the Yen on the forex market. Beijing is becoming a significant buyer of Yen, having bought more than ¥1.7 trillion ($20 billion) of Japanese bonds in the first five months of 2010, far surpassing its record of ¥256 billion in 2005. Zhang Ming, an economist with the Chinese Academy of Social Sciences, explained on August 11th that:
"The choice between Japanese and US-debt is not a choice between good and bad. Rather, it is being compelled to pick between bad and worse."
Deflationist enthusiasts – in a mad scramble to gobble-up British gilts and Japanese bonds – also face a major price risk that could lead to severe losses.
The last time 10-year JGB yields traded below 1% was in mid-2003, when yields fell to a historic low of 0.43%. Traders were lured into bidding-up JGB's, under the influence of the Bank of Japan's hallucinogenic Quantitative Easing-drug. However, when the JGB bubble did finally burst, yields suddenly reversed and surged sharply higher to 1.65% as the bond's price sank.
JGB losses continued to mount through 2006, when the Bank of Japan scrapped its Quantitative Easing-scheme by draining ¥35 trillion out of the banking system. JGB 10-year yields climbed to as high as 2%, where Ministry of Finance officials drew a red-line in the sand. Remarkably, long-term buy-and-holders of JGB's from the 2003 bubble period now have a chance to fully recoup their long-term losses in the weeks ahead. Thus, buyers of JGB's in today's market must tread carefully, as potential sellers are watching every tick.
The G7 government bond markets are highly synchronized, with British, Canadian, German, Japanese, and US-Treasury yields moving in the same direction. The British gilt market has simply hitched a ride to the G7 bond bandwagon. But what key events should traders be watching for, that could signal a major top in the G7 bond markets, and a deflating of the bubble? The answer to this question is available in the latest edition of the Global Money Trends newsletter.
Interestingly enough, the ghost of deflation that's haunting the G7 bond markets hasn't altered gold's upward trajectory.
In Europe, the yellow metal found solid support at an upward sloping trend-line, residing at the €890 per ounce level in July, before rebounding to €980 today. Gold is buoyed by the ECB's decision to extend its lending of unlimited amounts of Euros to banks, through short-term loans into early 2011, signaling that its liquidity largesse will continue.
Eurozone banks have become hooked on cheap money, and would suffer big losses if the ECB ever attempted to drain liquidity in a meaningful way.
Furthermore, Gold Bullion retains its resiliency amid renewed signs of trouble in the Irish bond market, where 10-year yields have ratcheted higher to 5.75% this week. More importantly, yields on Ireland's 10-year bonds have soared to +360-basis points above the German 10-year bund, the widest spread since 1991, and surpassing the previous peak level of +310 basis points reached on May 7th.
Making Irish bonds look ever-more risky again, the cost of Dublin rescuing the Anglo Irish Bank will exceed €25 billion, which is equivalent to 15% of Ireland's GDP and 75% of what's collected in taxes.
At the moment, however, Gold Bullion is competing with British gilts and other G7 government bonds as a "safe haven" in the event of a "double-dip" in global stock markets, and a further breach in confidence in owning Greek and Irish government bonds. At the end of the day, the Bank of England and the Fed might be forced to start QEII, and the Bank of Japan could begin its own QE-3 in order to combat a looming threat of a deflationary spiral in its own economy.
If correct, which asset class, G7 government bonds or gold, would exhibit the most upside potential? The answer is elementary, of course.
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Gold vs. the Bank of England
A tale of gold, Baron Rothschild, inflation and today’s British gilt…
"I CARE NOT what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man that controls Britain’s money supply controls the British Empire, and I control the British money supply."
So declared Baron Nathan Mayer de Rothschild – once the richest man in Europe, writes Gary Dorsch, editor of the Global Money Trends newsletter.
In 1840, NM Rothschild was appointed as the bullion broker to the Bank of England, and went on to operate the Royal Mint Refinery in 1852. Nathan gained a position of such enormous power in the City of London that he was able to supply enough money to the Bank of England to enable it to avert a market liquidity crisis.
Nowadays, the Bank of England – also known as the "Old Lady" of Threadneedle Street – has full control over the British money supply, with a monopoly on issuing banknotes in England and Wales. It also controls what’s left of Britain’s badly depleted Gold Bullion reserves. In May 1997, the Bank of England was granted the autonomy over monetary policy, and with it the power to set interest rates.
The Bank of England’s mandate centers on two primary goals – to insure stable consumer prices and to oversee the British Pound. Stable prices are defined by the boundaries of the government’s 2% inflation target, as measured on the Consumer Price Index (CPI). In theory, the Bank of England aims to meet this target by hiking its base lending rate if inflation overshoots the CPI target by more than 1%, and by lowering its base rate if inflation falls below 1%.
But in reality, the Bank of England will ignore its mandate to combat above-target inflation if it’s in the best interest of the UK economy. The rules demand, however, that the Bank of England governor writes a letter to the Chancellor of the Exchequer if this happens, explaining why it’s pursuing an asymmetrical monetary policy.
In the aftermath of the bankruptcy of Lehman Brothers in September 2009, the UK’s economy was caught in the grips of a vicious contraction that wiped out 6% of its GDP. Suddenly, the outlook for Britain’s CPI turned exceedingly negative, and the Bank of England decided to take extraordinary actions in order to prevent the CPI from falling below 1%, and to fend-off the specter of deflation.
In March 2009, the Bank of England broke new ground in its long checkered history, when it cleared the way for "Quantitative Easing" – radical measures used to combat deflation and unblock frozen credit markets by creating money. The Bank of England said it would buy huge quantities of gilts, aiming to pump cash into the banking system and restart the flow of lending to businesses and households.
"If we were to go to the wider operation, the Bank of England could decide that it wished to conduct such operations financed by the creation of central bank money," said Bank of England chief King on Feb 11, 2009.
Two weeks later, Bank of England chief King was granted approval by the Exchequer to start the printing presses – creating up to £150 billion in order to buy up everything from corporate bonds to government debt.
In theory, injecting liquidity into the banks provides new funds to lend to businesses, homebuyers, or consumers. However, very little of the Quantitative Easing tidal wave actually trickled down to the private sector. Instead, it was hoarded by greedy bankers, seeking to rebuild their own balance sheets that been so badly damaged by the financial crisis. Much of the Quantitative Easing-cash was simply funneled by banks into higher yielding government and blue-chip company bonds.
The original blueprints of Quantitative Easing were designed by the Bank of Japan, which tried very similar tactics a decade ago, after most of the Tokyo’s fiscal stimulus tactics failed. As everyone knows, Quantitative Easing failed to pull Japan out of its post Nikkei-bubble rut. Whereas the Bank of Japan injected 5% of GDP into its Quantitative Easing-scheme, printing money to buy up Japanese government bonds, the Bank of England committed itself to printing the equivalent of 13% of its GDP.
But although Quantitative Easing has fueled huge bubbles in the G7 bond markets, it’s failed to stimulate economies, because the transmission mechanism – between the central bank and the real economy – is clogged-up by tight-fisted bankers, who seem focused more on their annual bonuses.
About a year after the Bank of England began a series of rapid-fire rate cuts – slashing its base rate to an all-time low of 0.50%, and unleashing Quantitative Easing , and purchasing a total of £200 billion over 12 months – the Bank of England began to see the fruits of its labor.
The Bank of England’s efforts to turn back a deflationary spiral in the UK economy were greatly aided by a massive devaluation of the British Pound, which lost a quarter of its trade-weighted value from the start of 2007. Most importantly, the Federal Reserve’s $1.75 trillion Quantitative Easing-scheme had fueled a sizeable rally in the Dow Jones Commodity Index.
So by April 2010, British consumer prices (CPI) were +3.7% higher than a year earlier, aided by surging commodity prices. Bank of England chief Mervyn King wrote a public letter to the then-Chancellor of the Exchequer, Alistair Darling, because the CPI figure had risen more than 1% above the 2% target. Better still for deflation-fighters, Retail Price Inflation (RPI) – the former measure, still used to gauge the cost of living in wage negotiations – accelerated at a +5.3% clip in April, the fastest pace since 1991.
But Mr King is still worried about deflation. Forced to write another letter to the new coalition government’s Chancellor, George Osborne, this August, the poker-faced Bank of England chief is privately worried about the possibility of Japanese-style deflation spreading to Western nations.
Much will depend upon the future direction of commodity markets, a key driver of the British CPI. There’s renewed fears that a still crumbling housing market and high unemployment will push the US-economy into a "double-dip" recession – rattling world stock markets. Rallies in key industrial commodities are unraveling, as China’s housing bubble has peaked and factory output is falling, following tightening moves by its central bank. Japan’s economy is suffocating from a strong yen, and Greece’s 10-year bond yield is +900-basis points above German yields, indicating the Eurozone debt crisis is still brewing beneath the surface.
Any of these time bombs, if they explode, could rock the global economy and industrial commodities. So Bank of England chief King thinks any triumph against deflation is illusionary, and instead, believes the CPI gauge has already peaked and will eventually fall under its 2% target within a year, because of "substantial spare capacity in the economy, though policy makers are very conscious of price risks."
Mr King refuses to rule out a further expansion of the money supply – "QEII" – even after the Bank of England monetized 90% of the UK’s budget deficit in the past fiscal year.
"We stand ready either to expand or reduce the extent of monetary stimulus as needed," he said.
So far, Mr King’s prognostications are on target. The DJ-Commodity Index’s inflation rate has flattened out, at a lower plateau, up 10% from a year ago, after peaking at +24% in February, while the British CPI has eased to +3.1%.
On August 18th, the Bank of England voted 8-1 to keep its base lending rate pegged at 0.50% and its bond-portfolio steady at £200 billion.
"The committee considered arguments in favor of a further easing [and] there were also arguments in favor of a small increase in bank rate. Increases in the prices of some agricultural commodities suggest that the increased volatility of CPI inflation in recent years might continue.
"[Still,] the weight of evidence continues to suggest that the margin of spare capacity is likely to bear down on inflation…"
After the Bank of England unleashed Quantitative Easing in March 2009, there was a revival of commodity inflation, helping to push the British 10-year gilt yield about 125-basis points higher to a peak of 4.25% in February 2010.
The peak in gilt yields coincided with commodity inflation reaching 23% year-on-year. On Feb 4th, the Bank of England halted its Quantitative Easing-printing spree at £200 billion, in order to rescue the British Pound, which was in the grips of a death spiral, tumbling to a 14-year low of $1.3675.
Just three-months ago, British gilt yields were hovering near 4-percent. Bond dealers were fretting about the former Labour government’s plan to sell a record £220 billion of gilts this year. That amount was 50% more than the £146 billion sold in the fiscal year that ended March 31st. The UK’s budget deficit was projected to reach £175 billion, or 12.4% of gross domestic product. That’s the biggest shortfall in the G20 nations and matches Greece.
Yet defying worries over the massive build-up of UK government debt, the yield on Britain’s 10-year gilt plunged 100-basis points over the past three-months to below 3%, a historic low point, and caught many traders by surprise. Two-year gilt yields hit a record low of 0.60%, and five-year yields fell to a record low of 1.67%. However, the sharp plunge in gilt yields is out-of-sync with the commodity indexes, which are stable and still in positive territory, supported by a 44% jump in wheat.
With the British CPI running at +3.1%, or slightly above the 10-year gilt yield (and with the RPI significantly above that), traders buying gilts at these levels would see their interest payments wiped out by inflation in real terms. Thus, what value could there be in buying British gilts?
Perhaps the Bank of England might soon unleash QEII, thus soaking up more of the outstanding supply of gilts, and creating a short squeeze. For this reason, the bears suspect that British gilts are over-extended into bubble territory, and once it becomes widely recognized that the deflation scare is a nothing more than a false illusion – the gilt bubble will inevitably burst.
Ten-year gilt yields have fallen steadily from as high as 4.25% in February, when worries about Britain’s record budget deficit were at their peak. The yield spread between the British 10-year gilt and the 1-year bill rate has shrunk by 130-basis points, down to +225 basis points today.
The last time the UK yield spread was this narrow, the global economy was at risk of sliding into a 1930s’ style depression. So what’s the meaning of the sharp narrowing of the UK’s yield curve?
While much of the downward move in gilt yields is linked to fears about a "double-dip" recession in Japan and the United States. In London, there’s also expectations that austerity measures introduced by the Conservative/Liberal Democrat coalition could push Britain’s economy back into recession. Britain’s ruling coalition produced the harshest budget in a generation on June 22nd, slashing public spending by over £100 billion, raising the VAT sales tax to 20%, and slapping a levy on banks, in order to cut a record budget deficit to almost nothing in five years.
However, while gilts have rallied strongly on bets the UK economy will topple into recession by the first half of 2011, the FTSE-100 Index remained resilient. Chancellor George Osborne wrapped his tough austerity measures in rhetoric about fairness and burden sharing, but tilted the budget in favor of business. The corporate income tax rate is to be cut from its present level of 28% to 24%. This will give the UK the lowest level of corporate taxation in any developed economy.
FTSE-100 companies equal about 85% of the market capitalization of the London Stock Exchange, and yet nearly half the companies are headquartered outside the UK. Roughly one-third of the FTSE is concentrated in the natural resource sector. Thus, the Footsie is viewed as a global bellwether, rather than a reflection of the state of the British economy. But right now, the sharp downward trajectory of UK gilt yields is flashing warning signals of a sharp downturn in the British economy, which could trigger deflation in wages and UK home prices.
Bond traders are usually the first to sniff out trouble – long before it’s recognized by the maniacal speculators in the stock market. And to date, bond buyers have sounded an early warning siren at every stage of the global financial crisis.
Historically, the lag-time between an inverted yield curve and a subsequent bear market in stocks has varied from several months to as long as a year. With the Bank of England’s base rate near zero-percent, an inverted yield curve is improbable, but a sharp narrowing of the curve could also do the trick of unnerving die-hard stock market bulls.
One of the catalysts behind the stunning collapse in British gilt yields to historic lows is the Greek debt crisis, which is still brewing beneath the surface, despite the attempts of Eurozone politicians and the International Monetary Fund to conceal the gravity of the situation. The yield on Greece’s 10-year bond continues to ratchet upwards, climbing to as high as 11.30% today, and not far below its all-time high of 12.62%, hit on May 7th. The yield on Greece’s 10-year bond is nearly +850 basis points above the British gilt yield, a clear sign of trouble that lies ahead.
On June 10th, famed hedge fund trader George Soros, said "we have just entered Act II" of the global financial crisis.
"The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama. When the financial markets started losing confidence in the credibility of sovereign debt, Greece and the Euro have taken center stage, but the effects are liable to be felt worldwide. Credit default swaps, which insure bondholders against the risk of a default, are dangerous and a license to kill."
The explosive surge in credit default swaps (CDS) linked to Greece’s debt jolted the financial markets in May, wiping out more than $4 trillion from global stock markets. Today, it costs about $1 million to insure $10 million of Greek debt from the odds of default, or a restructuring of principal. Many portfolio managers are opting to swap out of Greek bonds, and buying British gilts or German bunds. Finding a buyer for Greek bonds has become more difficult since the European Central Bank (ECB) stopped purchasing the toxic debt five weeks ago.
While the UK’s economy grew by +1.1% in the second quarter, and Germany’s expanded by a record +2.2%, the Greek economy was moving in the opposite direction. It shrank -1.5% in the second quarter, as the Greek jobless rate jumped to 12%, with more than 600,000 citizens out of work.
Greece’s downward spiral accelerated as a barrage of austerity measures – wage and pension cuts plus tax increases – sapped consumer demand. Traders in Greek bonds figure that at some point in the near future, Athens will declare a moratorium on its debt payments, and demand a restructuring of principal, from its creditors.
Bank of England officials worry that Japanese style deflation could spread to Europe, but it’s already a reality in the G7 bonds markets. Japan’s 10-year government bond (JGB) yield slipped to 0.90% this week, to its lowest level in seven years, and in turn, knocked British 10-year gilt yields below 3%.
Little wonder that Tokyo’s Ministry of Finance data show Japanese investors buying a net ¥8.2 trillion ($103 billion) in higher yielding foreign bonds in June and July, a record for a two-month period, including ¥6 trillion yen in net buying by Japanese banks, who are able to hedge their foreign currency exposure through swaps or forward contracts.
Japan’s economy grinded to a halt in the second quarter, adding to headaches at the Ministry of Finance as it grapples with deflation and a powerful rise in the Yen on the forex market. Beijing is becoming a significant buyer of Yen, having bought more than ¥1.7 trillion ($20 billion) of Japanese bonds in the first five months of 2010, far surpassing its record of ¥256 billion in 2005. Zhang Ming, an economist with the Chinese Academy of Social Sciences, explained on August 11th that:
"The choice between Japanese and US-debt is not a choice between good and bad. Rather, it is being compelled to pick between bad and worse."
Deflationist enthusiasts – in a mad scramble to gobble-up British gilts and Japanese bonds – also face a major price risk that could lead to severe losses.
The last time 10-year JGB yields traded below 1% was in mid-2003, when yields fell to a historic low of 0.43%. Traders were lured into bidding-up JGB’s, under the influence of the Bank of Japan’s hallucinogenic Quantitative Easing-drug. However, when the JGB bubble did finally burst, yields suddenly reversed and surged sharply higher to 1.65% as the bond’s price sank.
JGB losses continued to mount through 2006, when the Bank of Japan scrapped its Quantitative Easing-scheme by draining ¥35 trillion out of the banking system. JGB 10-year yields climbed to as high as 2%, where Ministry of Finance officials drew a red-line in the sand. Remarkably, long-term buy-and-holders of JGB’s from the 2003 bubble period now have a chance to fully recoup their long-term losses in the weeks ahead. Thus, buyers of JGB’s in today’s market must tread carefully, as potential sellers are watching every tick.
The G7 government bond markets are highly synchronized, with British, Canadian, German, Japanese, and US-Treasury yields moving in the same direction. The British gilt market has simply hitched a ride to the G7 bond bandwagon. But what key events should traders be watching for, that could signal a major top in the G7 bond markets, and a deflating of the bubble? The answer to this question is available in the latest edition of the Global Money Trends newsletter.
Interestingly enough, the ghost of deflation that’s haunting the G7 bond markets hasn’t altered gold’s upward trajectory.
In Europe, the yellow metal found solid support at an upward sloping trend-line, residing at the €890 per ounce level in July, before rebounding to €980 today. Gold is buoyed by the ECB’s decision to extend its lending of unlimited amounts of Euros to banks, through short-term loans into early 2011, signaling that its liquidity largesse will continue.
Eurozone banks have become hooked on cheap money, and would suffer big losses if the ECB ever attempted to drain liquidity in a meaningful way.
Furthermore, Gold Bullion retains its resiliency amid renewed signs of trouble in the Irish bond market, where 10-year yields have ratcheted higher to 5.75% this week. More importantly, yields on Ireland’s 10-year bonds have soared to +360-basis points above the German 10-year bund, the widest spread since 1991, and surpassing the previous peak level of +310 basis points reached on May 7th.
Making Irish bonds look ever-more risky again, the cost of Dublin rescuing the Anglo Irish Bank will exceed €25 billion, which is equivalent to 15% of Ireland’s GDP and 75% of what’s collected in taxes.
At the moment, however, Gold Bullion is competing with British gilts and other G7 government bonds as a "safe haven" in the event of a "double-dip" in global stock markets, and a further breach in confidence in owning Greek and Irish government bonds. At the end of the day, the Bank of England and the Fed might be forced to start QEII, and the Bank of Japan could begin its own QE-3 in order to combat a looming threat of a deflationary spiral in its own economy.
If correct, which asset class, G7 government bonds or gold, would exhibit the most upside potential? The answer is elementary, of course.
Physical Gold Bullion, in a vault, in your name alone. Start with a free gram in Zurich at BullionVault now…
Listed in: Gold News
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Thu, 02 Sep 2010 20:54:18 +0000
When people talk about poker being a game of skill vs luck, all they need to do is look at free poker point systems and you will get your answer. If poker were a game of luck then the same people wouldn't make it to the finals of my top ten tournaments. On Tuesday, it was the last of my buy in winning tournaments. I am changing to a casino run finals starting next week. It was maybe the best final 10 that I have ever seen in all my years running poker. For those that don't know, I have been running 12 week sessions for a few years now with the top 10 in points playing for a Casino buy in to a major event. The top 10's chips are based on their point accumulation over the weeks. This top 10 had I think 7 very solid players and 3 wild cards. The 3 wild cards were the 1st 3 knocked out and made for some great poker down the stretch. Almost every hand was raised preflop and most raises had a small amount of callers. In fact it was so you actually could raise and not get over half the table to call. One of the big early hands had me in BB and Dustin in small blind. I had K-6 of clubs and was able to check. Flop came 5-7-8 two clubs. !st player bets 125, Dustin raises to 625. I put him on a set and decide to call and see one more card as I can tell that one of the wild cards is going to call and I assume that 1st bettor will call. I was right except first bettor folds. Turn is a K. I now have top pair with a open ended straight and flush draws. Dustin bets 1200. I decide to call and wild card folds. River is a club that doesn't pair board. Dustin checks. I bet 1600 and he calls and turns over 4-6. He had flopped a straight. After this hand I went on a nice card rush and was close to chip leader most of the tournament. Got to heads up with Fitzwell and we decided to chop the prize, so I paid him $150 and I will go and play the buy in. It was nice to be able play poker for a whole night and make the right raises and folds and not have to guess all the time what the other players may have. I am sure that between all of us that there was some bluffing going on, but I say to all "well played" and thanks for a fun evening. Even though, I ended up with the big prize. I still would have been saying the same if I lost! I can't wait to be able to test my skills at a big event!
Tips for Sports Betting
How many activities can you think of that boast of allowing you that perfect combination of unmatched thrill and a chance to earn money? Not to mention, all this sitting at home! Thousands of people across the world have discovered the art of earning some quick money and enjoying themselves through Internet sports betting. Wondering how to be a part of all this? Well, it’s not really tough. All you have to do is log on to websites like www.sportsadvisors.com and introduce yourself to the exciting world of Internet sports gambling.
Gambling, for such a long time has been a part of cultures across the world and has enjoyed popularity not just among the rich but also ordinary folk. How can you possibly ignore the popularity of casinos in Las Vegas, also known as the ‘mecca’ of gambling. In fact, sports gambling is nothing new and started becoming came popular way back in the mid 70′s and 80′s. It didn’t take long for sports gambling to benefit from the Internet revolution, and today there are hundreds of sites that facilitate Internet sports betting and attract thousands of visitors. Now you don’t really have to be present at a particular game to enjoy betting. Just concentrate on understanding the finer points and making money through college football betting online or online basketball gambling, or placing bets on several other games, sitting in the comfort of your home.
Several reputed Internet sports betting sites like sportsadvisors.com give you more than fair chances of winning by offering you vital information like weather updates, live scoreboard, injury reports etc. Yes, professional football betting onlinejust got better!
But why sports betting?
Why go in for sports betting? Because besides the entertainment factor, there is a better chance of winning consistently. Always remember that over the long term most casino games cannot be beaten (games like poker and blackjack being exceptions). Moreover, you don’t have to leave the comfort of your home to enjoy online sports betting. A click of the mouse and you stand a fair chance to win. All internet sports betting requires is for you to open an account, and the same doesn’t take more than a few minutes. Moreover, there are numerous paying options.
Now that you have decided to embark on the Internet sports betting route to earn some great money, here are tips and suggestions that can really help you as a sports better.
Tips for sports betting
When it comes to Internet sports betting, winning is not just about being lucky. It is important that you learn to develop a foresight, are not brash but willing to take calculated risks and don’t get easily disappointed by defeat. You may be indulging in online basketball gambling or college football betting online for a long time now, but it is important that you develop a systematic approach and take help from various informative sites and guides easily available these days. There’s actually all you need to be a star of professional football betting online or any of the other games you place your bets on.
Always remember this
Be it college football betting online or online basketball gambling, remember that you must have a more than fair idea about the game you are placing your stakes on. For example, if you trying your luck with professional football betting online, it is important that you know the important handicapping factors you choose to place your stake on. A little research never hurts. And yes, better known sites like sportsadvisors.com provide you with a lot of information like live scores, weather reports, and injury reports that can be decisive in deciding the fate of a game.
Cash management assumes significant importance when it comes sports betting. It is always better to keep the size of the bets similar. Going overboard on any one game can prove to be bad. Always avoid betting all your money on one game. Increasing your bets in order to make up for losses is not really a good idea. The same applies when you are winning. Just because you are winning does not really mean that you will win all your bets, so please don’t spend your entire bankroll on a single bet. Keep your eyes open in the true sense and learn to interpret small developments.
Know the language
In Internet sports betting, you are bound to come across certain terms, no matter which game you are playing- be it professional football betting online, online basketball betting or college football betting online. To avoid any confusion, some idea about these frequently used terms is important. Take a look at some common terms:
Action: A wager or a bet is also known as ‘action’.
Agent: The person who places a customer into a book in lieu of a commission is known as an agent.
Accumulator: This is a multiple bet in which simultaneous selections n two or more games is made with the intention of pressing the winnings of the first win on the bet of the following game selected. In order to win the accumulator, it is imperative that you win on all the selections made.
Accountant: A bookie or a bookmaker is called an accountant in slang.
Alpo: the underdog is also known as an Alpo.
Backed- A team on which a lot of bets has been place is known as backed.
Backdoor cover: This is, when a team has no real chance of winning the game outright, scores meaningless points to cover the spread.
Beef: This refers to a dispute with the bookie about the accuracy of a wager.
BR- Bankroll.
Book maker: He is the person who is licensed to accept bets on the result of an event based on their provision of odds to the customer.
Bow-Wow: An underdog is also known as a bow-wow.
Chalk: The favored team or a horse.
Cover: This refers to beating the spread by the required number of points.
Degenerate: a compulsive gambler.
Dividend: Return on any bet
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