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ENERGY - "Far Worse Than 1986"

Crude Collapse Continues - WTI Trades $47 Handle, New 4-Month Lows, Credit Crashing

Submitted by Tyler Durden on 07/24/2015 - 12:24

The crude collapse continues... and HY energy credit risk spikes above 950bps...

Crude Slips After Oil Rig Count Surges By Most In 15 Months

Submitted by Tyler Durden on 07/24/2015 - 13:11

Total US rig count increased a somewhat stunning 19 last week to 876 - the highest since May. This is the biggest rise in rig count since August 2014. The oil rig count surged 21 to 659 - this is the biggest weekly rise since April 2014. Louisiana (up 7) and Texas (up 8) saw the biggest increases.

Commodity Clobbering Continues

Submitted by Tyler Durden on 07/24/2015 - 06:59

After yesterday's latest drop in stocks driven by "old economy" companies such as CAT, which sent the Dow Jones back to red for the year and the S&P fractionally unchanged, today has been a glaring example of the "new" vs "old" economy contrast, with futures propped up thanks to strong tech company earnings after the close, chief among which Amazon, which gained $40 billion in after hours trading and has now surpassed Walmart as the largest US retailer. As a result Brent crude is little changed near 2-wk low after disappointing Chinese manufacturing data fueled demand concerns, adding to bearish sentiment in an oversupplied mkt. WTI up ~26c, trimming losses after yday falling to lowest since March 31 to close in bear mkt. Both Brent and WTI are set for 4th consecutive week of declines; this is the longest losing streak for Brent since Jan., for WTI since March.

World Trade Slumps By Most Since Financial Crisis

Submitted by Tyler Durden on 07/23/2015 - 22:45

As goes the world, so goes America (according to 30 years of historical data), and so when world trade volumes drop over 2% (the biggest drop since 2009) in the last six months to the weakest since June 2014, the "US recession imminent" canary in the coalmine is drawing her last breath...

Gold "Flash-Crashes" Again Amid Continued Commodity Liquidation As China Manufacturing Slumps To 15-Month Lows

Submitted by Tyler Durden on 07/23/2015 - 22:00

As Bridgewater talks back its now widely discussed bearish position on fallout from China's equity market collapse, Chinese stocks rose at the open (before fading after ugly manufacturing data). However, liquidations continue across the commodity complex in copper, gold, and silver. Though not on the scale to Sunday night's collapse, the China open brought another 'flash-crash' in precious metals. All signs point to CCFD unwinds, and forced liquidations as under the surface something smells rotten in China, which has just been confirmed by the lowest Manufacturing PMI print in 15 months.

Commodity Carnage Continues - Copper Crashes To 6 Year Lows

Submitted by Tyler Durden on 07/23/2015 - 12:05

Across the board commodities are weak again today as CCFD unwinds and mal-investment booms collapse across the world. Copper is under the most pressure today, plunging to its lowest since June 2009... but of course, Dr. Copper now knows nothing about economics because eyeballs trump reality in the new normal... even as Goldman warns lower prices are to come.

WTI Crude Tumbles To $48 Handle, Energy Stocks At Dec 2012 Lows

Submitted by Tyler Durden on 07/23/2015 - 11:09

WTI gave up earlier gains and is tumbling once again to 4-month lows, back into the $48 handle range... S&P Energy stocks are now back at Dec 2012 levels as Forward P/Es collapse back to reality...


"Far Worse Than 1986": The Oil Downturn Has No Parallel In Recorded History, Morgan Stanley Says

Submitted by Tyler Durden on 07/22/2015 - 22:51

The forward curve currently points towards a recovery in prices that is far worse than in 1986. As there was no sharp downturn in the ~15 years before that, the current downturn could be the worst of the last 45+ years. If this were to be the case, there would be nothing in our experience that would be a guide to the next phases of this cycle, especially over the relatively near term. In fact, there may be nothing in analysable history.

07-25-15

ENERGY

SII

 

Commodity Carnage Contagion Crushes Stocks & Bond Yields

Submitted by Tyler Durden on 07/23/2015 - 18:30


 

ubmitted by Tyler Durden on 07/22/2015 22:51

"Far Worse Than 1986": The Oil Downturn Has No Parallel In Recorded History, Morgan Stanley Says

On Tuesday the market got yet another reminder of just how painful the "current commodity price environment" has been for producers when Chesapeake eliminated its common dividend in order to conserve cash.

After noting the plunge in Chesapeake’s shares (to a 12-year low) we subsequently outlined why the US shale "revolution" is now running out of lifelines as hedges roll off and as the next round of credit line assessments looms in October.

A persistent theme here - as regular readers are no doubt aware - has been the extent to which an ultra-accommodative Fed has contributed to a deflationary supply glut by ensuring that beleaguered producers retain access to capital markets. In short, cash-strapped companies who would have otherwise gone out of business have been able to stay afloat thanks to the fact that Fed policy has herded investors into risk assets.

In a ZIRP world, there’s plenty of demand for new HY issuance and ill-fated secondaries, which means the digging, drilling, and pumping gets to continue indefinitely in what may end up being one of the most dramatic instances of malinvestment the market has ever seen

Those who contend that the downturn simply cannot last much longer - that the supply/demand imbalance will soon even out, that the market will clear sooner rather than later, and that even if the weaker hands are shaken out, the pain for the majors will be relatively short-lived - are perhaps ignoring the underlying narrative that helps to explain why the situation looks like it does. At heart, this is a struggle between the Fed’s ZIRP and the Saudis, who appear set to outlast the easy money that’s kept US producers alive.

Against that backdrop, and amid Wednesday's crude carnage, we turn to Morgan Stanley for more on why the current downturn will be "worse than 1986." 

From Morgan Stanley

Worse than 1986? Really?

We have been expecting the current downturn to be as severe as the one in 1986 – the worst for at least 45 years – but not worse than that. Still, if oil prices follow the path suggested by the forward curve, our thesis may yet prove too optimistic.

Our constructive stance on the majors is based on four factors: 1) supply – we expected production growth to moderate following large capex cuts and the sharp decline in the rig count; 2) demand – we anticipated that the fall in price would boost oil products demand; 3) cost and capex – we foresaw both falling sharply, similar to the industry's response in 1986; and 4) valuation – relative DY and P/BV indicated 35-year lows.

So far this year, we can put a tick against three of them [but] our expectation on supply has not materialised: US tight oil production growth has started to roll over, but this has been more than offset by OPEC, which has added ~1.5 mb/d since February. 

On current trajectory, this downturn could become worse than 1986: An additional +1.5 mb/d is roughly one year of oil demand growth. If sustained, this could delay the rebalancing of oil markets by a year as well. The forward curve has started to price this in: as the chart shows, the forward curve currently points towards a recovery in prices that is far worse than in 1986. This means the industrial downturn could also be worse. In that case, there would be little in analysable history that could be a guide to this cycle. 

[There are] strong similarities between the current oil price downturn and the one that occurred in 1985/86. The trajectory of oil prices is similar on both occasions. There were also common reasons for the collapse. 

A high and stable oil price in the preceding four years stimulated technological innovation and led to a high level of investment. This resulted in strong production growth outside OPEC, exceeding the rate of global demand growth. When it became clear that OPEC would no longer rein in production to balance the market (as it did during both the Nov 1985 and Nov 2014 OPEC meetings) the price collapsed. 

And although MS notes that similar to 1986, costs and capex are likely to come in sharply while demand growth should materialize, the supply side of the equation is not cooperating thanks to increased output from OPEC. 

Due to the sharp slowdown in drilling activity and the high decline rate of tight oil wells, we expected production in the US to flatline and start declining in 2H. This seems to be happening: according to the US Department of Energy, tight oil production in June was 94 kb/d below the April level, and it forecasts further falls of 90 kb/d in both July and August.

Now that capex is falling, we anticipated non-US production to be flat at best. Still, this has not yet been the case. At the time of our 'Looking Beyond the Nadir' report in February, OPEC production stood at ~30.2 mb/d. This increased substantially to 31.3 mb/d in May and 31.7 mb/d in June, i.e. OPEC has added 1.5 mb/d to global supply in the last four months alone.

Our commodity analyst Adam Longson argues that the oil market is currently ~800,000 b/d oversupplied. This suggests that the current oversupply in the oil market is fully due to OPEC's production increase since February alone. 

We anticipated that OPEC would not cut, but we didn't foresee such a sharp increase. In our view, this is the main reason why the rebalancing of oil markets had not yet gained momentum.

If oil prices follow the path suggested by the forward curve, and essentially remain rangebound around levels seen in the last 2-3 months, this downturn would be more severe than that in 1986. As there was no sharp downturn in the ~15 years before that, the current downturn could be the worst of the last 45+ years.

If this were to be the case, there would be nothing in our experience that would be a guide to the next phases of this cycle, especially over the relatively near term. In fact, there may be nothing in analysable history. 

Needless to say, this does not bode well for everyone who has unwittingly thrown good money after bad on the assumption that the Saudis will cut production and trigger a rebound in crude.

In addition to the immense pressure from persistently low prices, US producers also face a Fed rate hike cycle and thus the beginning of the end for easy money.

Of course, the more expensive it is to fund money-losing producers, the less willing investors will be to perpetuate this delay-and-pray scheme, which brings us right back to what we've been saying for months: the expiration date for heavily indebted US drillers is fast approaching, and if Morgan Stanley thinks the oil downturn has no parallel in "analysable history," wait until they see the carnage that will unfold in HY credit when a few high profile defaults in the oil patch send the retail crowd running for the junk bond ETF exits.

Tyler Durden on 07/22/2015 14:20 Submitted by Gail Tverberg via Our Finite World blog,

Nine Reasons Why Low Oil Prices May "Morph" Into Something Much Worse

Why are commodity prices, including oil prices, lagging? Ultimately, it comes back to the question, “Why isn’t the world economy making very many of the end products that use these commodities?” If workers were getting rich enough to buy new homes and cars, demand for these products would be raising the prices of commodities used to build and operate cars, including the price of oil. If governments were rich enough to build an increasing number of roads and more public housing, there would be demand for the commodities used to build roads and public housing.

It looks to me as though we are heading into a deflationary depression, because prices of commodities are falling below the cost of extraction. We need rapidly rising wages and debt if commodity prices are to rise back to 2011 levels or higher. This isn’t happening. Instead, Janet Yellen is talking about raising interest rates later this year, and  we are seeing commodity prices fall further and further. Let me explain some pieces of what is happening.

1. We have been forcing economic growth upward since 1981 through the use of falling interest rates. Interest rates are now so low that it is hard to force rates down further, to encourage further economic growth. 

Falling interest rates are hugely beneficial for the economy. If interest rates stop dropping, or worse yet, begin to rise, we will lose this very beneficial factor affecting the economy. The economy will tend to grow even less quickly, bringing down commodity prices further. The world economy may even start contracting, as it heads into a deflationary depression.

If we look at 10-year US treasury interest rates, there has been a steep fall in rates since 1981.

Figure 1. Chart prepared by St. Louis Fed using data through July 20, 2015.

Figure 1. Chart prepared by St. Louis Fed using data through July 20, 2015.

In fact, almost any kind of interest rates, including interest rates of shorter terms, mortgage interest rates, bank prime loan rates, and Moody’s Seasoned AAA Bonds, show a fairly similar pattern. There is more variability in very short-term interest rates, but the general direction has been down, to the point where interest rates can drop no further.

Declining interest rates stimulate the economy for many reasons:

  • Would-be homeowners find monthly payments are lower, so more people can afford to purchase homes. People already owning homes can afford to “move up” to more expensive homes.
  • Would-be auto owners find monthly payments lower, so more people can afford cars.
  • Employment in the home and auto industries is stimulated, as is employment in home furnishing industries.
  • Employment at colleges and universities grows, as lower interest rates encourage more students to borrow money to attend college.
  • With lower interest rates, businesses can afford to build factories and stores, even when the anticipated rate of return is not very high. The higher demand for autos, homes, home furnishing, and colleges adds to the success of businesses.
  • The low interest rates tend to raise asset prices, including prices of stocks, bonds, homes and farmland, making people feel richer.
  • If housing prices rise sufficiently, homeowners can refinance their mortgages, often at a lower interest rate. With the funds from refinancing, they can remodel, or buy a car, or take a vacation.
  • With low interest rates, the total amount that can be borrowed without interest payments becoming a huge burden rises greatly. This is especially important for governments, since they tend to borrow endlessly, without collateral for their loans.

While this very favorable trend in interest rates has been occurring for years, we don’t know precisely how much impact this stimulus is having on the economy. Instead, the situation is the “new normal.” In some ways, the benefit is like traveling down a hill on a skateboard, and not realizing how much the slope of the hill is affecting the speed of the skateboard. The situation goes on for so long that no one notices the benefit it confers.

If the economy is now moving too slowly, what do we expect to happen when interest rates start rising? Even level interest rates become a problem, if we have become accustomed to the economic boost we get from falling interest rates.

2. The cost of oil extraction tends to rise over time because the cheapest to extract oil is removed first. In fact, this is true for nearly all commodities, including metals. 

If costs always remained the same, we could represent the production of a barrel of oil, or a pound of metal, using the following diagram.

Figure 2

Figure 2. Base Case

If production is getting increasingly efficient, then we might represent the situation as follows, where the larger size “box” represents the larger output, using the same inputs.

Figure 3

Figure 3. Increased Efficiency

For oil and for many other commodities, we are experiencing the opposite situation. Instead of becoming increasingly efficient, we are becoming increasingly inefficient (Figure 4). This happens because deeper wells need to be dug, or because we need to use fracking equipment and fracking sand, or because we need to build special refineries to handle the pollution problems of a particular kind of oil. Thus we need more resources to produce the same amount of oil.

Figure 4. Growing inefficiency

Figure 4. Growing inefficiency (Notice how sizes of shapes differ in Figures 2, 3, and 4.)

Some people might call the situation “diminishing returns,” because the cheap oil has already been extracted, and we need to move on to the more difficult to extract oil. This adds extra steps, and thus extra costs. I have chosen to use the slightly broader term of “increasing inefficiency” because I am not restricting the nature of these additional costs.

Very often, new steps need to be added to the process of extraction because wells are deeper, or because refining requires the removal of more pollutants. At times, the higher costs involve changing to a new process that is believed to be more environmentally sound.

Figure 5

Figure 5. An example of what may happen to make inputs in physical goods and services rise. (The triangle shape was chosen to match the shape of the “Inputs of Goods and Services” triangle in Figures 2, 3, and 4.)

The cost of extraction keeps rising, as the cheapest to extract resources become depleted, and as environmental pollution becomes more of a problem.

3. Using more inputs to create the same or smaller output pushes the world economy toward contraction.

Essentially, the problem is that the same quantity of inputs is yielding less and less of the desired final product. For a given quantity of inputs, we are getting more and more intermediate products (such as fracking sand, “scrubbers” for coal-fired power plants, desalination plants for fresh water, and administrators for colleges), but we are not getting as much output in the traditional sense, such as barrels of oil, kilowatts of electricity, gallons of fresh water, or educated young people, ready to join the work force.

We don’t have unlimited inputs. As more and more of our inputs are assigned to creating intermediate products to work around limits we are reaching (including pollution limits), less of our resources can go toward producing desired end products. The result is less economic growth, and because of this declining economic growth, less demand for commodities. Prices for commodities tend to drop.

This outcome is to be expected, if increased efficiency is part of what creates economic growth, and what we are experiencing now is the opposite: increased inefficiency.

4. The way workers afford higher commodity costs is primarily through higher wages. At times, higher debt can also be a workaround. If neither of these is available, commodity prices can fall below the cost of production.

If there is a big increase in costs of products like houses and cars, this presents a huge challenge to workers. Usually, workers pay for these products using a combination of wages and debt. If costs rise, they either need higher wages, or a debt package that makes the product more affordable–perhaps lower rates, or a longer period for payment.

Commodity costs have been rising very rapidly in the last fifteen years or so. According to a chart prepared by Steven Kopits, some of the major costs of extracting oil began increasing by 10.9% per year, about 1999.

Figure 6. Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel. CAGR is 'Compound Annual Growth Rate.'

Figure 6. Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel. CAGR is “Compound Annual Growth Rate.”

In fact, the inflation-adjusted prices of almost all energy and metal products tended to rise rapidly during the period between 1999 and 2008 (Figure 7). This was a time period when the amount of mortgage debt was increasing rapidly as lenders began offering home loans with low initial interest rates to almost anyone, including those with low credit scores and irregular income. When buyers began defaulting and debt levels began falling in mid-2008, commodity prices of all types dropped.

Figure 6. Inflation adjusted prices adjusted to 1999 price = 100, based on World Bank 'Pink Sheet' data.

Figure 6. Inflation adjusted prices adjusted to 1999 price = 100, based on World Bank “Pink Sheet” data.

Prices then began to rise once Quantitative Easing (QE) was initiated (compare Figures 6 and 7). The use of QE brought down medium-term and long-term interest rates, making it easier for customers to afford homes and cars.

Figure 7. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

Figure 7. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data.

More recently, prices have fallen again. Thus, we have had two recent times when prices have fallen below the cost of production for many major commodities. Both of these drops occurred after prices had been high, when debt availability was contracting or failing to rise as much as in the past.

5. Part of the problem that we are experiencing is a slow-down in wage growth.

Figure 8 shows that in the United States, growth in per capita wages tends to disappear when oil prices rise above $40 barrel. (Of course, as noted in Point 1, interest rates have been falling since 1981. If it weren’t for this, the cut off for wage growth might even be lower–perhaps even $20 barrel!)

Figure 8. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

Figure 8. Average wages in 2012$ compared to Brent oil price, also in 2012$. Average wages are total wages based on BEA data adjusted by the CPI-Urban, divided by total population. Thus, they reflect changes in the proportion of population employed as well as wage levels.

There is also a logical reason why we would expect that wages would tend to fall as energy costs rise. How does a manufacturer respond to the much higher cost of one or more of its major inputs? If the manufacturer simply passes the higher cost along, many customers will no longer be able to afford the manufacturer’s or service-provider’s products. If businesses can simply reduce some other costs to offset the rise in the cost in energy products and metals, they might be able to keep most of their customers.

A major area where a manufacturer or service provider can cut costs is in wage expense.  (Note the different types of expenses shown in Figure 5. Wages are a major type of expense for most businesses.)

There are several ways employment costs can be cut:

  1. Shift jobs to lower wage countries overseas.
  2. Use automation to shift some human labor to labor provided by electricity.
  3. Pay workers less. Use “contract workers” or “adjunct faculty” or “interns” who will settle for lower wages.

If a manufacturer decides to shift jobs to China or India, this has the additional advantage of cutting energy costs, since these countries use a lot of coal in their energy mix, and coal is an inexpensive fuel.

Figure 9. United States Percentage of Labor Force Employed, in by St. Louis Federal Reserve.

Figure 9. United States Labor Force Participation Rate by St. Louis Federal Reserve. It is computed by dividing the number of people who are employed or are actively looking for work by the number of potential workers.

In fact, we see a drop in the US civilian labor force participation rate (Figure 9) starting at approximately the same time when energy costs and metal costs started to rise. Median inflation-adjusted wages have tended to fall as well in this period. Low wages can be a reason for dropping out of the labor force; it can become too expensive to commute to work and pay day care expenses out of meager wages.

Of course, if wages of workers are not growing and in many cases are actually shrinking, it becomes difficult to sell as many homes, cars, boats, and vacation cruises. These big-ticket items create a significant share of commodity “demand.” If workers are unable to purchase as many of these big-ticket items, demand tends to fall below the (now-inflated) cost of producing these big-ticket items, leading to the lower commodity prices we have seen recently.

6. We are headed in slow motion toward major defaults among commodity producers, including oil producers. 

Quite a few people imagine that if oil prices drop, or if other commodity prices drop, there will be an immediate impact on the output of goods and services.

Figure 10.

Figure 10.

Instead, what happens is more of a time-lagged effect (Figure 11).

Figure 11.

Figure 11.

Part of the difference lies in the futures markets; companies hold contracts that hold sale prices up for a time, but eventually (often, end of 2015) run out. Part of the difference lies in wells that have already been drilled that keep on producing. Part of the difference lies in the need for businesses to maintain cash flow at all costs, if the price problem is only for a short period. Thus, they will keep parts of the business operating if those parts produce positive cash flow on a going-forward basis, even if they are not profitable considering all costs.

With debt, the big concern is that the oil reserves being used as collateral for loans will drop in value, because of the lower price of oil in the world market. The collateral value of reserves works out to be something like (barrels of oil in reserves x some expected price).

As long as oil is being valued at $100 barrel, the value of the collateral stays close to what was assumed when the loan was taken out. The problem comes when low oil prices gradually work their way through the system and bring down the value of the collateral. This may take a year or more from the initial price drop, because prices are averaged over as much as 12 months, to provide stability to the calculation.

Once the value of the collateral drops below the value of the outstanding loan, the borrowers are in big trouble. They may need to sell other assets they have, to help pay down the loan. Or they may end up in bankruptcy. The borrowers certainly can’t borrow the additional money they need to keep increasing their production.

When bankruptcy occurs, many follow-on effects can be expected. The banks that made the loans may find themselves in financial difficulty. The oil company may lay off large numbers of workers. The former workers’ lack of wages may affect other businesses in the area, such as car dealerships. The value of homes in the area may drop, causing home mortgages to become “underwater.” All of these effects contribute to still lower demand for commodities of all kinds, including oil.

Because of the time lag problem, the bankruptcy problem is hard to reverse. Oil prices need to stay high for an extended period before lenders will be willing to lend to oil companies again. If it takes, say, five years for oil prices to get up to a level high enough to encourage drilling again, it may take seven years before lenders are willing to lend again.

7. Because many “baby boomers” are retiring now, we are at the beginning of a demographic crunch that has the tendency to push demand down further.

Many workers born in the late 1940s and in the 1950s are retiring now. These workers tend to reduce their own spending, and depend on government programs to pay most of their income. Thus, the retirement of these workers tends to drive up government costs at the same time it reduces demand for commodities of all kinds.

Someone needs to pay for the goods and services used by the retirees. Government retirement plans are rarely pre-funded, except with the government’s own debt. Because of this, higher pension payments by governments tend to lead to higher taxes. With higher taxes, workers have less money left to buy homes and cars. Even with pensions, the elderly are never a big market for homes and cars. The overall result is that demand for homes and cars tends to stagnate or decline, holding down the demand for commodities.

8. We are running short of options for fixing our low commodity price problem.

The ideal solution to our low commodity price problem would be to find substitutes that are cheap enough, and could increase in quantity rapidly enough, to power the economy to economic growth. “Cheap enough” would probably mean approximately $20 barrel for a liquid oil substitute. The price would need to be correspondingly inexpensive for other energy products. Cheap and abundant energy products are needed because oil consumption and energy consumption are highly correlated. If prices are not low, consumers cannot afford them. The economy would react as it does to inefficiency.

Figure 12. World GDP in 2010$ compared (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014).

Figure 12. World GDP in 2010$ (from USDA) compared to World Consumption of Energy (from BP Statistical Review of World Energy 2014)

These substitutes would also need to be non-polluting, so that pollution workarounds do not add to costs. These substitutes would need to work in existing vehicles and machinery, so that we do not have to deal with the high cost of transition to new equipment.

Clearly, none of the potential substitutes we are looking at today come anywhere close to meeting cost and scalability requirements. Wind and solar PV can only built on top of our existing fossil fuel system. All evidence is that they raise total costs, adding to our “Increased Inefficiency” problem, rather than fixing it.

Other solutions to our current problems seem to be debt based. If we look at recent past history, the story seems to be something such as the following:

Besides adopting QE starting in 2008, governments also ramped up their spending (and debt) during the 2008-2011 period. This spending included road building, which increased the demand for commodities directly, and unemployment insurance payments, which indirectly increased the demand for commodities by giving jobless people money, which they used for food and transportation. China also ramped up its use of debt in the 2008-2009 period, building more factories and homes. The combination of QE, China’s debt, and government debt brought oil prices back up by 2011, although not to as high a level as in 2008 (Figure 7).

More recently, governments have slowed their growth in spending (and debt), realizing that they are reaching maximum prudent debt levels. China has slowed its debt growth, as pollution from coal has become an increasing problem, and as the need for new homes and new factories has become saturated. Its debt ratios are also becoming very high.

QE continues to be used by some countries, but its benefit seems to be waning, as interest rates are already as low as they can go, and as central banks buy up an increasing share of debt that might be used for loan collateral. The credit generated by QE has allowed questionable investments since the required rate of return on investments funded by low interest rate debt is so low. Some of this debt simply recirculates within the financial system, propping up stock prices and land prices. Some of it has gone toward stock buy-backs. Virtually none of it has added to commodity demand.

What we really need is more high wage jobs. Unfortunately, these jobs need to be supported by the availability of large amounts of very inexpensive energy. It is the lack of inexpensive energy, to match the $20 oil and very cheap coal upon which the economy has been built, that is causing our problems. We don’t really have a way to fix this.

9. It is doubtful that the prices of energy products and metals can be raised again without causing recession.

We are not talking about simply raising oil prices. If the economy is to grow again, demand for all commodities needs to rise to the point where it makes sense to extract more of them. We use both energy products and metals in making all kinds of goods and services. If the price of these products rises, the cost of making virtually any kind of goods or services rises.

Raising the cost of energy products and metals leads to the problem represented by Growing Inefficiency (Figure 4). As we saw in Point 5, wages tend to go down, rather than up, when other costs of production rise because manufacturers try to find ways to hold total costs down.

Lower wages and higher prices are a huge problem. This is why we are headed back into recession if prices rise enough to enable rising long-term production of commodities, including oil.

 

MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - June 19th, 2015 - June 25th, 2015      
BOND BUBBLE     1
RISK REVERSAL - WOULD BE MARKED BY: Slowing Momentum, Weakening Earnings, Falling Estimates     2
GEO-POLITICAL EVENT     3
07-23-15 GLOBAL RISK 3 - Geo-Political Event
CHINA BUBBLE     4
JAPAN - DEBT DEFLATION     5

EU BANKING CRISIS

   

6

WARNINGS

The Last Time This Happened, Stocks Lost 90% in 24 Months 07-20-15 Graham Summers

In the early 2000s, Alan Greenspan was worried about deflation. So he hired Ben Bernanke, the self-proclaimed expert on the Great Depression from Princeton. The idea was that with Bernanke as his right hand man, Greenspan could put off deflation from hitting the US. Indeed, one of Bernanke’s first speeches was titled “Deflation: Making Sure It Doesn't Happen Here"

The US did briefly experience a bout of deflation from late 2007 to early 2009. To combat this, Fed Chairman Ben Bernanke unleashed an unprecedented amount of Fed money. Remember, Bernanke claims to be an expert on the Great Depression, and his entire focus was to insure that the US didn’t repeat the era of the ‘30s again.

Current Fed Chair Janet Yellen is cut of the same cloth as Bernanke. And her efforts (along with Bernanke’s) aided and abetted by the most fiscally irresponsible Congress in history, have recreated an environment almost identical to that of the 1920s.

Let’s take a quick walk down history lane.

In the 1920s, most of Europe was bankrupt due to after effects of WWI. Germany in particular was completely insolvent due to the war and due to the war reparations foisted upon it by the Treaty of Versailles. Remember, at this time Germany was the second largest economy in the world (the US was the largest, then Germany, then the UK).

Germany attempted to deal with the economic implosion created by WWI by increasing social spending: social spending per resident grew from 20.5 Deutsche Marks in 1913 to 65 Deutsche Marks in 1929.

Since the country was broke, incomes and taxes remained low, forcing Germany to run massive deficits. As its debt loads swelled, the county cut interest rates and began to print money, hoping to inflate away its debs.

When the country lurched towards default, US and other banks loaned it money, doing anything they could to keep the country from defaulting on its debt. As a result of this and the US’s relative economic strength compared to most of Europe, capital flew from Europe to the US.

This created a MASSIVE stock market bubble, arguably the second largest in history. From its bottom in 1921 to its peak in 1929, stocks rose over 400%. Things were so out of control that the Fed actually raised interest rates hoping to curb speculation.

The bubble burst as all bubbles do and stocks lost 90% of their value in a mere two years.

1929.jpg

Today, the environment is almost identical but for different reasons. The ECB first cut interest rates to negative in June 2014. Since that time capital has fled Europe and moved into the US because 1) interest rates here are still positive, albeit marginally, and 2) the US continues to be perceived as a safe-haven due to its allegedly strong economy.

This process has accelerated in 2015.

  • Globally, there have been 20 interest rate cuts since the years started a mere two months ago.
  • Interest rates are now at record lows in Australia, Canada, Switzerland, Russia and India.
  • Many of these rates cuts have resulted in actual negative interest rates, particularly in Europe (Denmark, Sweden, and Switzerland).
  • Both the ECB and the Bank of Japan are actively engaging in QE programs forcing rates even lower.
  • All told, SEVEN of the 10 largest economies in the world are currently easing.

Because the US is neutral, money has been flowing into the country by the billions. A lot of it is moving into luxury real estate (particularly in LA and York), but a substantial amount has moved into stocks as well as the US Dollar.

As a result of this, the US stock market is trading at 1929-bubblesque valuations, with a CAPE of 27.34 (the 1929 CAPE was only slightly higher at 30. And when that bubble burst, stocks lost over 90% of their value in the span of 24 months.

Another Crash is coming… and smart investors would do well to prepare nowbefore it hits.

07-20-15

  10 - US Stock Market Valuations
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MACRO News Items of Importance - This Week

GLOBAL MACRO REPORTS & ANALYSIS

     

US ECONOMIC REPORTS & ANALYSIS

     
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES      
     
Market Analytics
TECHNICALS & MARKET ANALYTICS

 

   

GOLD CAPITULATION?

Sell-off in gold miners wipes $8 billion off their market value Reuters

Gold prices log 9th straight session of losses MW
Speculators Smash Gold as Dollar Squeeze Tightens Pritchard
Mystery of the great gold sell-off Inde
Five tonnes of gold were dumped on the Shanghai exchange yesterday...
4 reasons gold got caught in a ‘perfect storm’ MW
Gold Is Falling So Hard It Looks Like Capitulation Barron’s
Gold has fallen and can’t get up MW
Gold bulls in retreat after spectacular plunge CNBC
Gold Leads Commodities Slump as Dollar Ascendant Amid Fed Focus BL

Gold Spot Price

GLD ETF

HUI - Gold Bugs Index

Gold Miners

Commitment of Traders

GOLD SLAM

Submitted by Tyler Durden on 07/20/2015 16:45

What Happened The Last Time The Mainstream Media Unleashed The Anti-Gold Artillery

With the mainstream media onslaught against precious metals climaxing this weekend as WSJ's Jason Zweig proclaimed gold "like a pet rock," describing owning gold as "an act of faith," we thought it worthwhile looking back at the last time 'everyone' was slamming gold and entirely enthused by the omnipotence of central bankers... May 4th, 1999 - "Who Needs Gold When We Have Greenspan?"

Over 16 years ago, The New York Times' Floyd Norris unleashed the last big gold slamming piece topping a period of precious metal bashing...

Who Needs Gold When We Have Greenspan?

Is gold on its way to becoming just another commodity? The people who run the world's financial system are doing their best to secure that fate for the metal that once was viewed as the only ''real'' money.

The process of removing the glitter from gold has been a gradual but inexorable one,and is one of the most telling counters to the argument that national governments are less important in this era of globalization. Much of the world is now quite happy to accept the idea that a greenback backed by Alan Greenspan is just as good as one backed by gold.

Certainly gold's reputation as a store of value has eroded. At the peak of the gold frenzy in 1980, an ounce of gold cost $873, precisely that day's level of the Dow Jones industrial average. Now the Dow is at 11,014.69, about 38 times higher than the $287.60 price of gold.

Actually, that measurement understates the amount by which stocks have outperformed gold. If you had owned stocks all those years, you would have received substantial dividends. If you owned a lot of gold, you got no dividends but did have to pay storage fees for the stuff.

That is, in fact, how the central bankers of the world look at gold these days. Michel Camdessus, the managing director of the International Monetary Fund, said last week he expected the fund to sell gold for the first time in two decades. The Clinton Administration is pushing for such sales by the I.M.F. to help finance a laudable program to forgive debts owed by very poor countries.

The money received from the gold sales is to be invested in Government securities that will provide income, and that income will pay off the loans. The implicit assumption is that gold, which does not pay interest, is a lousy investment.

A couple of weeks ago, the Swiss electorate voted to begin untying the Swiss franc from its gold backing. The Swiss central bank could begin selling gold as early as next year. Once again, the argument was that selling gold was a way to find easy money for good deeds. To those who still view gold as the only real money, having the Swiss defect is a bit like discovering that Rome is embracing Protestantism. It is the last place that should happen.

But it is happening, and it seems likely that more central banks -- like the Australian and Dutch banks -- will join those that have already begun selling gold.

The argument against retaining gold is that its day is past. Once it was useful as a hedge against inflation that would hold its value when paper currencies did not. Now financial markets have their own sophisticated ways, using exotic derivative securities, to hedge against inflation.

Once gold served as protection for investors against governments that debased their currencies. Now there is plenty of debasing going on -- the Brazilian real is down 27 percent this year -- but the lesson people have drawn is to believe in the dollar. There is growing support for the idea that all of Latin America should adopt the dollar as a currency.

Dollarization, as that idea is called, amounts to a sort of a gold standard without gold.There would be a universal money whose value was based not on gold in the vaults, but on the wisdom of Mr. Greenspan and his successors at the Federal Reserve. Few fear that one of those successors might resemble G. William Miller, the Fed chairman in the late 1970's who seemed to have no idea how to slow inflation.

If the demonetization of gold continues, the price is likely to keep falling as central-bank sales more than offset any increase in demand from jewelers or industrial users. That could change if it turns out that central bankers are not the geniuses they are now deemed to be. But for now, the world believes in Mr. Greenspan and sees little need for gold.

What happened next? A 650% run over the next 12 years:

Not to mention a complete about-face by the very same Alan Greenspan:

Remember what we're looking at. Gold is a currency. It is still, by all evidence, a premier currency. No fiat currency, including the dollar, can match it.

...

And the question is, why do central banks put money into an asset which has no rate of return, but cost of storage and insurance and everything else like that, why are they doing that? If you look at the data with a very few exceptions, all of the developed countries have gold reserves. Why?

As we concluded previously,

So here's a thought Jason: instead of quoting a Barclays analyst why "a lot of investors have become disillusioned with gold" and why "safe-haven demand hasn’t been strong enough to lift prices, but has only been strong enough to keep them from falling", maybe you can try to figure out why that is the case.

Start by making a few phone calls to Citi or JPM and find out why their commodity/precious metal derivatives exploded as they did - as can be factually seen in the OCC's Q1 report- at a time when gold has not only not risen following a surge in global risk, but has tumbled to its lowest value since 2010.

Because that's what actual "reporters" do - they report, something the WSJ may have forgotten.

It appears the mainstream media's total indoctrination of a narrative handed down by the central bank... in the face of central bank hording of gold - once again shows the desperation of the status quo to keep the dream alive (and suppress any signs of fragility) as The Fed moves to tighten.

Paraphrasing The New York Times from the 1999 lows in gold,

If the demonization of gold continues, the price is likely to keep falling as central-bank buys are nmore than offset byu paper manipulation. That could change if it turns out that central bankers are not the geniuses they are now deemed to be. But for now, the world believes in [Mrs. Yellen] and sees little need for gold.

 

07-21-15

GOLD
ANALYTICS

 

 

$550 Million Gold Futures Notional Dumped After Close - Back Below $1100

Submitted by Tyler Durden on 07/20/2015 - 16:15

Minutes after the cash equity close, gold prices tumbled, having leaked lower all afternoon, breaking back below $1100. Overnight flash crash lows were $1080.

Last Night's Gold Slam So Furious It Halted The Market Not Once But Twice, And The Funniest "Explanation" Yet

Submitted by Tyler Durden on 07/20/2015 - 15:35

Yesterday, just before the Chinese market opened, precious metals but mostly gold, flash crashed in milliseconds with a violent urgency never before seen. We documented theunprecedented event last night, but for those who missed it, the following chart from Nanex clearly lays out just how sudden the "out of nowhere" selling was, which led to not one but two 20-second halts in the gold futures market spaced out precisely 30 seconds apart as a result of a Velocity Logic (or lack thereof) event.

Where Next For Precious Metals: This Is What The Charts Say

Submitted by Tyler Durden on 07/20/2015 - 10:49

Following last night's flash-crash dump across the precious metals complex, with gold tumbling to briefly test the multi-decade channel at $1080 levels, SocGen's technical analysis team digs in to understand key levels for gold, silver, platinum, and palladium, concerned about further weakness ahead.

Gold, Precious Metals Flash Crash Following $2.7 Billion Notional Dump

Submitted by Tyler Durden on 07/19/2015 - 23:49

07-21-15

GOLD
ANALYTICS

 

 

Commodities Plunging To 2002 Level Sends "Investors" Rushing To Safety Of Overpriced Tech Megacaps

Submitted by Tyler Durden on 07/20/2015 - 16:02

Deflationary Boom 2.0 - Commodity Index Crashes To 13 Year Lows

Submitted by Tyler Durden on 07/20/2015 - 13:27

The Bloomberg Commodity Index tumbled once again today, hitting its lowest level since 2002. Stocks did not. We have seen this kind of 'deflationary' boom before... and it did not end well...

07-21-15

GOLD
ANALYTICS
COMMODITY CORNER - AGRI-COMPLEX   PORTFOLIO  
SECURITY-SURVEILANCE COMPLEX   PORTFOLIO  
     
THESIS - Mondays Posts on Financial Repression & Posts on Thursday as Key Updates Occur
2015 - FIDUCIARY FAILURE 2015 THESIS 2015
2014 - GLOBALIZATION TRAP 2014

2013 - STATISM

2013-1H

2013-2H

2012 - FINANCIAL REPRESSION

2012

2013

2014

2011 - BEGGAR-THY-NEIGHBOR -- CURRENCY WARS

2011

2012

2013

2014

2010 - EXTEND & PRETEND

   
THEMES - Normally a Thursday Themes Post & a Friday Flows Post
I - POLITICAL
     
CENTRAL PLANNING - SHIFTING ECONOMIC POWER - STATISM   THEME  

- - CORRUPTION & MALFEASANCE - MORAL DECAY - DESPERATION, SHORTAGES.

  THEME
- - SECURITY-SURVEILLANCE COMPLEX - STATISM M THEME  
- - CATALYSTS - FEAR (POLITICALLY) & GREED (FINANCIALLY) G THEME  
II-ECONOMIC
     
GLOBAL RISK      
- GLOBAL FINANCIAL IMBALANCE - FRAGILITY, COMPLEXITY & INSTABILITY G THEME  
- - SOCIAL UNREST - INEQUALITY & A BROKEN SOCIAL CONTRACT US THEME  
- - ECHO BOOM - PERIPHERAL PROBLEM M THEME  
- -GLOBAL GROWTH & JOBS CRISIS      
- - - PRODUCTIVITY PARADOX - NATURE OF WORK   THEME

MACRO ANALYTICS w/ CHS

- - - STANDARD OF LIVING - EMPLOYMENT CRISIS, SUB-PRIME ECONOMY US THEME
MACRO ANALYTICS w/ CHS
III-FINANCIAL
     
FLOWS -FRIDAY FLOWS

MATA

RISK ON-OFF

THEME
07-24-15

THEMES

FLOWS

FLOWS

Submitted by Tyler Durden on 07/20/2015 18:30

Liquidity Is "Thin To Zero": Worried Bond Managers Shrink Trades, Dodge Cash Markets

It would be no exaggeration to say that with the exception of Grexit and the spectacular collapse of the Chinese equity bubble, bond market liquidity is now the most talked about subject on Wall Street. The focus on illiquid markets comes years (literally) after the subject was first discussed in these pages, but over the past several months, pundits, analysts, billionaire bankers, and incorrigible corporate raiders alike have weighed in. 

Make no mistake, the liquidity problem is pervasive (i.e. it exists across markets) and generally stems from a combination of central bank largesse, HFT proliferation, and the (possibly) unintended consequences of the post-crisis regulatory regime. 

Thus far, illiquidity in Treasury and FX markets has been somewhat of a delicate subject as an honest assessment of the conditions that led to last October’s Treasury flash crash and that help explain similar gyrations in the currency markets invariably entails placing blame squarely with central bankers and algos run amok, and that risks upsetting both the central planning committees that are now in charge of business cycle “management” and the deeply entrenched HFT lobby. 

As such, discussing illiquid corporate credit markets is easier if you find yourself among polite company. You see, the lack of liquidity in the secondary market for corporate bonds is a somewhat benign discussion because although it unquestionably stems from a noxious combination of regulatory incompetence and irresponsible monetary policy, myopic corporate management teams and the BTFD crowd, not to mention ETF issuers, have also played an outsized role, so there’s no need to lay the blame entirely on the masters of the universe who occupy the Eccles Building and on the "liquidity providing" HFT crowd that’s found regulatory capture to be just as easy as frontrunning. 

But while explanations for the absence of liquidity vary from market to market, the response is becoming increasingly homogenous. Put simply: market participants are simply moving away from cash markets and into derivatives. Where market depth has disappeared, it’s become increasingly difficult to transact in size without having an outsized effect on prices. This means that for big players - fund managers, for instance - selling into ever thinner secondary markets is a dangerous proposition. And not just for the manager, but for market prices in general.

In Treasury markets, traders have turned to futures to mitigate illiquidty... 

...while corporate bond fund managers utilize ETFs and other portfolio products to avoid trading the underlying assets...

With the stage thus set, Bloomberg has more on the move to smaller trades and cash market substitutes:

Sometimes less is more. At least according to investment managers trying to navigate Europe’s credit markets.

TwentyFour Asset Management capped a bond fund to new investors at 750 million pounds ($1.2 billion) and JPMorgan Asset Management, which is marketing a 128 million-pound fund, said smaller investments are more flexible in a sell-off. Other managers are also limiting the size of their trades and using derivatives to avoid getting trapped in positions.

It’s become more difficult to buy and sell securities as Greece’s financial crisis curbs risk taking and dealers scale back trading activity to meet regulations introduced since the financial crisis. The Bank for International Settlements warned of a "liquidity illusion" in June because bond holdings are becoming concentrated in the hands of fund managers as banks pull back.

"Liquidity is generally poor in corporate bond markets and in the U.K. market it’s thin to zero," said Mike Parsons, head of U.K. fund sales at JPMorgan Asset Management in London. "You don’t want to be in a gigantic fund where there’s potential for a lot of investors rushing for the exit at the same time. Smaller funds are more nimble."

"Without enough strong liquidity, it’s hard to execute bond trades in sufficient size or price to move portfolio risk around quickly or cheaply," he said. "The bigger the position, the harder it is to find enough liquidity to sell it or buy it."

Liquidity in credit markets has dropped about 90 percent since 2006, according to Royal Bank of Scotland Group Plc. That’s because dealers are using less of their own money to trade as new regulation makes it less profitable.

Euro-denominated corporate bonds got an average of 5.3 dealer quotes per trade last week, up from 4.5 recorded in January and compared with a peak of 8.8 in 2009, according to Morgan Stanley data. That’s based on dealer prices compiled by Markit Group Ltd. for bonds in its iBoxx indexes.

Liquidity is especially bad in the U.K. corporate bond market, which is being abandoned by companies looking to take advantage of lower borrowing costs in euros and investors seeking securities that are easier to buy and sell.

NN Investment Partners said it seeks to manage difficult trading conditions by diversifying positions and capping trade size. The Netherlands-based asset manager avoids owning large concentrations of a single bond and uses derivatives such as credit-default swaps or futures that are easier to buy and sell, said Hans van Zwol, a portfolio manager.

"We really want to stay away from positions we can’t get out of," he said.

The conundrum here is that the more reluctant market participants are to venture into increasingly illiquid cash markets, the more illiquid those markets become.

At the end of the day, one is reminded of what Howard Marks' recently said about ETFs: 

"[They] can't be more liquid than the underlying and we know the underlying can be quite illiquid."

CRACKUP BOOM - ASSET BUBBLE   THEME  
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