Like Old Times: Q2 2016 Flow of Funds

Doug Nolan





















The Truth about China’s Role in Global Economic Turmoil

Brexit, European tensions over the migrant crisis, and the rhetoric of the U.S. presidential campaign are just the latest flashpoints in the anti-globalization move across the world. Many blame China, the world’s second-largest economy, for economic ills from flagging industries to deflation in their home countries. Both U.S. presidential candidates Hillary Clinton and Donald Trump, for example, have charged China’s exports for harming U.S. jobs. Republican candidate Trump specifically accuses China of intentionally manipulating its currency to drive its exports and vows to impose countervailing duties as high as 45% on U.S. imports from China in return. He and other critics also say China is spreading deflation to the rest of the world through low-priced, subsidized exports.

In a weak global economy, citizens of every country may feel more vulnerable, especially to external forces beyond their control. Yet, some of the claims about China’s role in harming other economies are outdated, while others present a more realistic scenario, say Wharton School and other experts.

“Trump should be glad China is ‘manipulating’ its currency,” says Minyuan Zhao, a Wharton management professor. “Otherwise, if it were up to market forces, the Chinese currency might have been more volatile or dropped much further in value than it is now.” Scott Kennedy, deputy director of the Freeman Chair in Chinese Studies at the Center for Strategic and International Studies (CSIS), a Washington, D.C. think tank, agrees. “Trump is about five to 10 years out of date in his concerns about the renminbi. There’s zip evidence China’s currency is undervalued now,” he says.

Deflationary pressures due to the slowing Chinese economy and industrial overcapacity, though, are a more possible threat. The export of products in Chinese industries with overcapacity, from steel to textiles, is depressing prices of those products and threatening competitors in other countries, say experts. But most of the effects are sector-specific at the moment, rather than a broad impact on prices across economies, and affect primarily countries that compete directly in those sectors, they say. “There’s no good evidence that China’s exports have had a macro effect on the global economy and brought down prices overall,” says Kennedy. Instead, says Derek Scissors, resident scholar at the American Enterprise Institute (AEI), a Washington, D.C. think tank: “The single biggest driver of global deflation is cheap oil,” a phenomenon that many experts say is due more to OPEC overproduction and the U.S. shale gas revolution than China’s slowing demand.  

For now, stresses in China’s own economy provide a more accurate explanation for both its currency moves and deflationary pressures than any deliberate attempt to beggar its neighbors, say Wharton and other experts. China itself is in deflation because of a domestic economic downturn resulting from a global economic slowdown that has reduced demand for Chinese products. China’s rate of export growth has declined since 2010 and fell to zero or below for a few months this year, notes William Adams, senior international economist at the PNC Financial Group in Pittsburg, Pa.  The reduction in both domestic and global demand, in turn, has prompted a drop in industrial prices and overcapacity. But closing foundering factories risks widespread unemployment and unrest. “It’s more a problem for China than the rest of world,” says Scissors.

Consequently, despite President Xi Jinping’s desire to shrink overcapacity, government-sponsored banks are keeping many failing firms alive by rolling over their debt, creating the potential for financial crisis, says Marshall Meyer, a Wharton emeritus professor of management. “There’s a lot to worry about in China’s economy, in particular, the debt level,” he says. “Should there be a breakdown in the banking and financial system, things become very unpredictable, especially since household savings are all in banks or the inflated real estate market.” Given the potential dangers, “stability is of the utmost importance,” and that explains both renminbi policy and the potential for deflation in China, says Wharton’s Zhao.

Renminbi Dynamics: Overvalued  

Ironically, for all the criticism of it, the yuan is overvalued today, harming Chinese exports. “China is doing the opposite of what it’s criticized for,” says AEI’s Scissors. “Today, China is intervening in the credit market to keep the yuan artificially high. If they were not to intervene, the yuan would fall against the dollar, and there would be more deflationary pressure” in the world. PNC’s Adams agrees: “With China’s export industry weak and its economy in deflation — arguably worse than in other economies — a more market-determined exchange rate would mean a weaker, not stronger, yuan in relation to the dollar.” In its May 2016 report on world currencies, the Peterson Institute for International Economics, which has long advocated against an undervalued yuan, finds no misalignment in the currency.

Why is China keeping its currency from falling further? Since 2013, after nearly a decade of yuan appreciation against the U.S. dollar when the Chinese economy was going strong, China started allowing its currency to depreciate to stay in better tune with market realities. The move was a reflection of underlying domestic economic downturn, as domestic wages rose and China’s trade advantage shrank. Meanwhile, the U.S. dollar surged 20% against other floating currencies.
But the road to depreciation has not been smooth. In August 2015, the yuan took its biggest one-day dive since 1994 when global markets interpreted a yuan devaluation move as a salvo in global currency wars. Instead, the devaluation was an effort to allow the market greater say in setting exchange rates so that the International Monetary Fund (IMF) would include it in the basket of currencies in its Special Drawing Rights reserve currency. The IMF accepted the yuan as part of the SDR basket in December 2015.

Renminbi depreciation also set off a spate of capital outflows that started to drain China’s foreign reserves in a cycle that could easily spin out of control. In 2015, China’s foreign reserves stood at $3.3 trillion, compared with $3.8 trillion in 2014. “If people think the exchange rate will go down, they’ll ship their money out; then the rate goes down more in a self -fulfilling prophecy,” says Meyer.

“The hot money that came into China for RMB appreciation and higher interest rates is going out now.”

Market volatility has since continued to dog Chinese economic policymakers. In January, new data showing the fifth straight month of slowing domestic manufacturing sent the Shanghai stock exchange plummeting by 6.9%, triggering a worldwide market rout. The yuan also tumbled in January.

Market volatility and capital outflows prompted by a more market-determined exchange rate have chastened China policymakers, who now seem to be pursuing a more controlled path to financial market liberalization as a result, say experts. Says Wharton’s Zhao: “The renminbi exchange rate is maintained at today’s level, to the credit of policymakers in China who believe stability is in the best interest of China and the rest of the world. Since depreciation may lead to panic, capital outflow and further depreciation, the government is trying at all cost to maintain stability.”

Meanwhile, says Scissors, the yuan-dollar exchange rate has never had much impact on U.S. unemployment. Just before China devalued its currency in 1994, the U.S. unemployment rate stood at 6.5%, he says. After the devaluation, U.S. unemployment fell below 4%, instead of rising. In June 2005, just before the yuan’s steady rise, U.S. unemployment was 5.6% and then grew to 7% in 2014, instead of falling with the stronger yuan, because of the U.S. and global financial crisis. “The value of the yuan against the dollar has gone up, down, and sideways and jobs here remain almost entirely a function of what the U.S. does, not what the PRC does,” writes Scissors.

Deflation: A Bigger Specter

In contrast, say experts, China’s economic slowdown and resulting industrial overcapacity have a greater potential of harming world economies than its exchange rates. China, for example, produces half the world’s steel. “Because the product is traded globally, it is bringing worldwide deflationary pressure and has gotten the most attention,” says Scissors. The world has about 33% excess capacity in steel, according to the Organization for Economic Cooperation and Development (OECD), and steel prices have fallen from about $1,100 a ton in 2008 to about $350 to $400 a ton today, notes Wharton’s Meyer. In January, China vowed to lay off 1.8 million coal and steelworkers.

But other sectors with overcapacity may not have as wide an impact outside of countries that are direct competitors, such as South Korea and Japan in shipbuilding, and Vietnam and Bangladesh in textiles, says Scissors. The U.S. is not as affected as these countries, he notes. “Although there may be deflationary pressure, we [in the U.S.] don’t worry about it, because we don’t find it negative” in clothing and consumer electronics, where we enjoy lower prices, he says. However, says Kennedy of CSIS: “This concern about deflation will become more serious as China’s comparative advantage increasingly overlaps with that of industrialized countries, and China can do to semiconductors what it did to steel. A problem that is limited to specific industries at the moment could become a wider problem.”

China’s industrial overcapacity will take a long time to unwind if the country wants to avoid mass firm closures, unemployment and social instability, say experts. “It will be a slow cycle to play out,” says Adams. “There’s not enough pickup in global demand to absorb the excess production capacity in China and elsewhere in the world in the near term.” However, China’s investment in industrial production capacity is falling somewhat, he notes: In the industrial Northeast, it fell by 31% year over year in the first seven months of 2016, according to the National Bureau of Statistics. Says Scissors: “Overcapacity is really a labor force issue in China, where the labor force is getting older and shrinking. If China wants overcapacity to unwind in a very orderly fashion, it will happen at demographic speed, which is a matter of years or decades.”

Meanwhile, the cost of an orderly correction is a dangerous buildup in corporate debt, as failing firms receive more funds to keep going, and investment capital ends up propping up losing ventures, instead of building more viable enterprises that can speed China’s transition to a more sustainable consumption-based economy less dependent on heavy manufacturing and exports. Chinese President Xi is a proponent of shrinking excess capacity and corporate debt, but he faces political opposition from every side, says Meyer. “I’m moderately certain that Xi doesn’t want to pursue a race to the bottom [of global deflation], the economic equivalent of nuclear war that leaves everybody miserable,” says Meyer. “But Xi has more internal opposition than anything I’ve seen in years.” In addition, local politicians are fighting to keep their factories in business and people employed.

Thus, if China finds itself in desperate straits, it could resort to a “doomsday option,” says Meyer, where it exports its overcapacity and deflation. “It won’t be a pretty picture for the rest of the world, but I’m not sure it would be a purposeful or deliberate strategy,” he says. Meyer says China’s first option is to cut capacity, and the second is to export capacity to new markets, such as Central Asia through the proposed “One Belt One Road” initiative. The third is to set up corporate operations overseas, which would then purchase input products from China. The final is wide-scale exporting of its overcapacity. “You’ve got a debt bomb ready to detonate,” says Meyer. “The question: Does China’s debt bomb or industries in other countries collapse first?”

Trade War?

Yet, to pick a trade war with China is not the wisest option, says Mauro Guillen, Wharton management professor and director of the Lauder Institute. “It doesn’t make sense to start a trade war between the U.S. and China, the two largest trading nations when there are already too many tensions and frictions in the global economy,” he says. “It will end badly for the global economy.” He notes that only three large economies have a trade surplus with China — Japan, South Korea and Taiwan — because China buys inputs from them to make its export products. “If you hurt China, you also hurt Japan, Korea and Taiwan, and that makes no sense from the U.S. national security perspective,” he says.

Ironically, for the U.S., the Trans-Pacific Partnership (TPP), derided by both U.S. presidential candidates, is America’s best weapon against China’s exports, says Meyer. “We’re going to lose jobs if we enter the trade agreement is what they [the U.S. presidential candidates] think,” he says. “What they should think is we’re going to trade with TPP countries or China is going to trade with them.”

In the end, both China and the U.S., the world’s two largest economies, must take responsible actions or risk bigger perils. “The world economy is now so integrated, if you hurt one country, you hurt everybody,” says Guillen

Janet Who? An Important Driver Shift Is Occurring In The Gold Market And Investors Need To Be Prepared

by: Hebba Investments

- Speculative bullish positioning over the past week declined just as gold was about rise.

- The Fed meeting was a let-down and that was shown in the rising gold price, but we still expect a pull-back.

- Moving forward, the Fed will take a backseat to some major geopolitical events over the next few months such as US elections and the Italian referendum.

- Gold investors need to re-establish some previously sold positions but wait for the pull-back before getting fully invested again.

So, we finally made it through the highly anticipated Fed decision, and in this week's Commitment of Traders report, we see speculative traders choosing their sides - and it seems most of them chose wrong. Additionally, we will take a look at the Fed decision and what it means for gold moving forward.
About the COT Report

This Week's Gold COT Report
This week's report shows that speculative longs continued their declines by a significant amount for the second straight week as they closed out 26,490 contracts. Once again, shorts have not shown much in the way of courage as their positions only increased by 3,234 contracts for the week - much less than we would have anticipated considering the decline in speculative bulls.
This suggests to us that much of the action in gold right now (at least for paper traders) is all on the long side with movements in the gold price primarily driven by longs initiating and closing positions.
That is in stark contrast to when we see shorts driving the market and is probably why we have not seen many of those "waterfall type declines" that gold investors may remember from the past few years (see the example below).
The reason being that when shorts are in the driver seat of the market, their purpose is to drive the market lower because that's how they make their profits. Thus, despite the questionability of it, they concentrate their trading on these types of "shock and awe" gapping price declines to initiate long selling - no gold long, speculative or not, would decide to abandon positions so suddenly.

Thus, our takeaway here is that with longs driving the gold market and shorts MIA, we don't expect to see these types of massive gap declines - until we see speculative shorts re-join the market.
The red line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, speculative traders continued closing out their position in preparation for the Fed meeting. Currently, those positions sit at a net long position of around 219,000 contracts, but obviously, with the post-meeting rise in the gold price, that was the incorrect decision and we expect next week's report to show a large increase in speculative positions.
As for silver, the week's action looked like the following:
The red line, which represents the net speculative positions of money managers, saw a slight decrease on the week but nowhere near the decline we saw in gold for the week. In fact, it was a bit strange as gold speculative positioning got hit hard but silver traders barely did anything on the week.
Gold Moving Forward and Our Conclusion for Gold Investors
Another week and another Fed driven gold market as the FOMC met this week and they decided to keep interest rates on hold - pretty much what we predicted last week with their "Lainard Telegraphing." Yes, it was the first time since December 2014 that we had three dissenters, but of course that had no immediate consequences as interest rates didn't rise for another year.

The big takeaway here is that the Fed either doesn't have the courage to raise rates or is very concerned about the consequences for the economy with a rate rise. That is awfully strange considering the supposed improvements in the labor market and stable economy - we aren't talking 5% interest rates here that would suffocate the economy, just an itsy-bitsy .25% rise in the fed funds rate. Something's up and we believe gold's uncertainty hedge antenna are perking up and that's why investors are buoying the gold market despite relatively weak physical demand from the East.
Since the Fed meeting ended with a whimper, we think the gold story is going to shift from "What is the Fed going to do with interest rates?" to "Who is going to win the US elections?"
That is a key shift because there is some major uncertainty in US elections and one of the candidates has the potential to really shake up the world economy if he does what he says.
Additionally, both candidates have promised to increase infrastructure spending to stimulate the economy, which may put some pressure on the US dollar as deficits will increase. As we get closer to the US elections in early November, if Clinton's lead over Trump starts to narrow further (which we think it will), then we believe the gold price will gather strength.
We do still expect a bit of a pull-back as sentiment is extremely bullish, which we see clearly in the COT speculative positioning and even in some of the surveys of analysts and investors. The Kitco survey below for next week shows everybody bullish on gold.
  Source: Kitco
Despite expecting a pull-back, investors need to own at least some gold at this juncture moving forward as there's a lot of significant economic and geopolitical uncertainty in the world that may come to a head over the next few months. We wouldn't completely buy back all of our previously sold positions, but we certainly are re-establishing many of the positions in the gold ETFs such as the SPDR Gold Trust ETF (NYSEARCA:GLD), the ETFS Physical Swiss Gold Trust ETF (NYSEARCA:SGOL), and the iShares Silver Trust (NYSEARCA:SLV) that we sold earlier.

In summary, investors should not buy back all previously sold gold positions as the likelihood of a pull-back is high, but they definitely could reinitiate some of their previously sold positions.

lunes, septiembre 26, 2016



Gold Unleashed by Fed

By: Adam Hamilton















Gold Futures Specs 2015-2016













































How to save capitalism from capitalists

The cross-border activities of big companies make it harder to map a level playing field

by: Philip Stephens



Theodore Roosevelt understood this when, as US president, he deployed the Sherman Act against the industrial titans at the turn of the 20th century. Henceforth antitrust, or competition, law has served, sometimes effectively, sometimes less so, to protect the interest of consumers and thereby legitimise the profits of big business. US president Ronald Reagan, scarcely a leftie, presided over the break-up of AT&T.

Technology and globalisation have changed the game. The cross-border activities of the world’s biggest companies make it harder to map a level playing field. Globalisation has multiplied the opportunities for tax avoidance, and tax competition between states has diluted the political will to uphold competition in the marketplace. Timid national politicians are reluctant to take on the global behemoths and their armies of well-heeled lobbyists. Yes, they would like these companies to pay a little more tax, but not so much so that they threaten to take investments and jobs elsewhere. Consumers and less privileged taxpayers are the losers. So is the market economy.
Step forward the European Commission. Margrethe Vestager, the commission’s competition chief, has been in the news lately after ordering Apple to pay €13bn in back taxes to the Irish government. If that seems like a whopping figure it should be measured against an estimated $215bn that Apple holds offshore beyond reach of tax authorities.

After a lengthy investigation, Ms Vestager concluded that its labyrinthine tax arrangements with the Irish government gave Apple advantages not available to other businesses and thus undercut competition by breaching the EU’s state aid rules. The company, she said, had been paying a tax rate of just 0.005 per cent — though that figure is disputed by Apple, which is contesting the ruling.

The iPhone manufacturer is not the only company in the commission’s sights. Investigations are under way into the impact on competition of the tax arrangements of Starbucks, Amazon and McDonald’s. Ms Vestager is heading a three-pronged antitrust probe into the European activities of Google, a company that enjoys immense market dominance and whose tax affairs are under scrutiny in several EU member states.



Government should just get out of the way. To my mind, Apple makes stylish, clever digital gadgets, but this scarcely bestows a special status.

Google, like Apple, always insists that it is scrupulous in meeting its legal tax obligations. There is no reason to doubt its word. What this misses is that the responsibilities of business go beyond strict adherence to the statute book. The societies in which markets flourish are those that afford respect for a more complex tapestry of conventions and norms. It may be legal, say, for Google to minimise its tax bill by routing UK sales to an Irish subsidiary. It is not the act of a good citizen. And it invites a populist response. To borrow from Roosevelt: “When aggregated wealth demands what is unfair, its immense power can be met only by the still greater power of the people as a whole.”

So far politicians have been at the sharp end of the populist insurgencies across rich democracies. But behind these movements lies deep public disgruntlement with globalisation and the behaviour of big business. Whether it is Donald Trump in the US, Marine Le Pen in France or Beppe Grillo in Italy, the populist credo is economic nationalism: the system is rigged, so throw up the barricades against global capitalism.


Populists exploit declining faith in the marketplace. Their remedy — snake oil — is more state control.

There will always be business leaders true to the tradition of the old robber barons who think theirs is a superior calling and that democratic politics is, well, “crap”. They find support among libertarians and free-market literalists who believe that the only role of business is to maximise profits.

Roosevelt was no socialist. His insight was that capitalism requires legitimacy. It would thrive over the long term only if it were seen to be on the side of the welfare of the nation’s citizens.

This is as true now as it was then. It is too soon to pass Roosevelt’s mantle to Ms Vestager. But everyone who supports the liberal market economy that made possible the success of Apple, Google and the like should be applauding her courageous effort to reset the balance.

lunes, septiembre 26, 2016



Bread And Circuses

 9-23-2016 3-00-55 PM

Marcus Tullius Cicero

I guess we could substitute MacDonald’s and iPhones these days. The point being little has changed historically since Cicero who lived in 106 BC. That’s a depressing view of conditions perhaps then and now. Perhaps worse still is the following satirical comment from the poet Juvenal. He lived much later; the 2nd century AD:  

“The fools did not realize that they were merely recovering a portion of their property, and that their ruler could not have given them what they were receiving without having taken it from them.”

Ok, you’re thinking me a warped old man with too much time on hands. You might be right but then there’s the haunting truth that comes through these legends—nothing given greed and the lust for power changes.

How does one live with these painful realities? We must go forward given these realities and deal with the hand we’re dealt.

Meanwhile back to the markets. Stock prices dropped as oil prices cratered on beliefs an upcoming OPEC meeting won’t deliver anything meaningful to boost oil prices. Nevertheless, stocks were able to hang on to weekly gains of over 1% despite a mixed picture overall. Clearly many feel the upcoming presidential debate will do much to clear the views of the electorate. If Clinton holds on to her slight lead it would soothe fears of the establishment nothing will alter current bullish trends. Trump on the other hand remains a  wild card especially with his momentum rising.


9-23-2016 3-02-03 PM

Volume Friday was impressively on the light side. Breadth per the WSJ was negative.
9-23-2016 3-07-11 PM
9-23-2016 3-09-14 PM USO

Charts of the Day







































































9-23-2016 5-21-30 PM
9-23-2016 5-22-06 PM MONTHLY 

Bread & Circuses were on my mind recently. Why? It should be obvious the ruling class, no matter their belief structure, remain in control of things. It’s telling upon reading historical precedents that nothing has changed in a thousand years even though changing generations take little note of it. Those egos are fixed on the beliefs that they can always do things better despite overwhelming evidence to the contrary.

Let’s see what happens.