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Aequitas Innovations, the Mother of All Bubbles, and Gold

Something was announced last week that could completely change the Canadian market.

Those looking for my coverage on the Canadian Housing Market will have to wait – I apologize.

A few weeks back, I wrote a letter on how big banks in Canada were taking over.

This past week the proof was once again in the pudding. But this time, it could actually be a good thing…maybe.

The TMX Killer?

Canada’s biggest bank, the Royal Bank of Canada, is now joining forces with mutual fund conglomerates IGM and CI Financial, pension fund PSP Investments and international banks ITG and Barclays, to create a new stock exchange that the creators say will keep costs low and discourage computerized high-frequency trading.

The new stock exchange is called Aequitas Innovations, the Latin word for fairness, and is expected to launch by the end of 2014, pending regulatory approval.

aequitas innovations

Given that such heavy hitters are involved, I expect the regulatory process to be just a formality.

My initial reaction was simple: Another stock exchange to remove more liquidity and transparency from the Canadian market. As if 10 multiple trading platforms weren’t enough, here we are with another full-blown stock exchange.

The CNSX hasn’t done much. Would could Aequitas Innovations possibly do?

But as I read through Aequitas’ position paper, this new stock exchange may actually benefit the market if launched correctly; it is actually attempting to solve many of the issues I have talked about over the past few weeks that are leading to the demise of the Canadian market.

Aequitas Innovations is looking to make trading a fair playing field once again by imposing restrictions on High Frequency Trading (HFT) and introducing many new innovations that are supposed to provide a more efficient market – including bringing back a more lenient dark pool trading platform and a marketplace for exempt securities.

Aequitas Innovation’s mission statement:

“Aequitas was founded by a group of stakeholders who believe today’s equity marketplaces do not provide the public with the fairness, efficiency and choice that encourage confidence and participation by investors, issuers and dealers.

The concentration of services, the dominant market structure model and lack of innovation are at the heart of this problem.

Our stakeholders include professional money managers, pension funds, sell-side institutions and issuers who believe choice, driven by competition and built on differentiation and innovation, is acutely needed in Canadian equity markets. The lack thereof threatens the long-term health of our equity markets, and therefore, ultimately, economic growth and employment.”

While it may sound like just another big bank trying to take a bigger piece of the pie, the players involved may actually have intentions of making the market better.

The presence of major mutual fund firms, who are generally known as the buy-side of the industry, makes Aequitas very different from other TSX alternatives that have come before.

Alpha Trading Systems, for example, a rival trading platform that made inroads before being dissolved when Maple Group gained control of the TSX last fall, was backed by the banks and big dealers.

Aequitas Innovations, on the other hand, is heavily backed by the buy-side, which clearly shows that the buy-side is taking a stand on their needs and interests.

Next week, I will be speaking with the people behind Aequitas Innovations to learn more about the new system.

If you have questions, please post them here and I will do my best to include them in my interview with the group.

Will Aequitas truly level the playing field for both small investors and issuers? Or will it cause more liquidity issues and make our already dying Canadian market worse?

I will cover this story in more depth next week. If you’re a Canadian, you won’t want to miss it.

Perception vs. Reality  

perception vs reality

In a recent interview with the Korelin Economics Report, I mentioned that the market has always been about perception rather than reality.

And the perception now is that everything is getting better; or at least that’s what the media will have you believe.

First of all, none of the theories you hear on super cycles, or technical trading patterns, really work anymore.

I’ve talked about this many times before: It’s a fed manipulated environment combined with software programs that control the majority of our market – both in Canada and the U.S.

Last week was a prime example of the manipulated efforts experienced in the last few years.

A Confused Market

Strong gains in U.S. orders for durable goods, the largest annual rise in housing prices in more than half a decade, and rising consumer confidence led the market higher.

As a result, speculation that the Fed would taper its stimulus scared everyone and stocks fell around the world.

The next day, the Fed forecasts slower U.S. growth and a once again downward revision of GDP, after US economic growth in the first quarter was a dismal 1.8% – far lower than the Fed’s earlier estimate of 2.4% growth*. This fueled speculation that the Fed will maintain stimulus. The market rises again.

(*How many times have we heard the Fed lower their GDP forecast in the past five years? I can’t even count anymore…)

First the media tells us the market is getting better; then the Fed tells us its not. The media tells us the fed will taper; then it tells us it won’t.

The media also tells us that housing numbers are better and prices are rising; yet U.S. mortgage applications are now down 7 of the last 8 weeks and have collapsed 29% over that time – the biggest plunge in 30 months.

These daily irrelevant news pieces fuel the fire for the HFT programs and cause dramatic swings in the market on a daily basis, based on the news feeds and “hot words” the programs grab for that day.

Forward-looking strategies simply aren’t working now.

But what happens when reality kicks in? What happens when the Fed finally tapers and GDP numbers are once again based on real growth?

Anyone still long the U.S. markets towards the end of this year should be extremely cautious. We still have some euphoria left in the system, but it’s trading – literally – on a very fine line.

There simply is no historical precedence for what we are experiencing and this will go down in history as the biggest financial crisis, blunder, or epiphany the world has ever seen.

Gold Forced Down Again

It’s now almost impossible to talk about the U.S. economy without talking about gold.

Gold plunged to a 34-month low and silver fell to the lowest point in nearly 3 years last week, as improving U.S. economic data strengthened the case for the Federal Reserve to reduce stimulus.

The 23 percent drop in Q1 represents one of the biggest drops in history.

Everything is working against gold right now.

The simple thought of the Fed tapering brings gold down. Yet the thought of continued stimulus also brings gold down because it shows deteriorating economic data (GDP miss), which implies less inflationary worries.

While gold has always acted as a safe haven against the financial system and against inflation, neither of those factors appear to be of concern anymore. Not in the short term, anyway.

But they should – especially against the financial system.

The Mother of All Bubbles

When nominal U.S. GDP diverges away from the Fed Funds Rate, it generally signals a forming bubble.

Via Kit Jukes of Societe Generale:

“All the big asset bubbles were caused by ludicrously easy money, in the form of Fed Rates below nominal GDP. Asia came from 1992/4 low rates, the dotcom and internet bubbles followed the cut in rates that was made after LTCM, and the big bad bubble followed years of monetary madness. The current gap between GDP and Fed Funds is the biggest/longest for ever.”

In Layman terms, there was the build up of the Asian bubble in the early 90s, the build up of the tech bubble in the late 90s, and the credit housing bubble leading up to 2008 in the mid-2000s.

In every instance, the divergence from U.S. nominal GDP away from the Fed Funds Rate can clearly be seen:

U.S. nominal GDP vs. Fed Funds Rate

Notice the divergence in the last few years? It’s the biggest divergence in GDP and Fed Funds Rate we’ve ever had.

Interest rates are at all-time lows, and we have more printed money than ever before – not just in the U.S., but all over the world.

China’s Credit Bubble

China is another prime example of a bubble waiting to happen.

The country is experiencing a massive liquidity crunch right now and it’s not because of excessive money supply, but because of the highly leveraged risk money out on loans that will likely default.

The People’s Bank of China will be bailing out a lot more banks this year and the situation is a lot worse than most think.

Do you think we’re in a financial bubble?

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Back to Gold and Inflation

As a safe haven against the financial system, gold still looks great.

However, we don’t currently have the inflation numbers that gold is supposed to protect against  – not on American soil anyway.

In a more developed country, like the U.S., inflation won’t happen without real growth. The fact that we haven’t seen inflation in the U.S. proves that the current recovery and GDP growth has been fueled by stimulus rather than real economic drivers.

However, the consensus is that when the money supply grows faster than the rate of economic growth, we see higher sustained inflation.

Take a look at the growth of the U.S. money supply, as presented by M2 Money Stock:

fredgraphm2

Here is U.S. GDP growth:

GDPC1_Max_630_378

Economists use M2 when looking to quantify the amount of money in circulation.

At the beginning of 2000, real GDP was around $11 trillion, while M2 money stock was at $4.6 trillion.

At the beginning of this year, real GDP was around $13.7 trillion, while M2 money stock was at $10.5 trillion.

That means GDP has grown 24.5% over the last 13 years, while M2 money stock has grown by more than 128%!

As I just showed you, the money supply in the U.S. is growing rapidly faster than the rate of economic growth — by a factor of 5 — yet we’re not seeing inflation at all. This is happening around the world.

Emerging countries, however, will tell you excessive money printing has killed the value of their money in relation to gold and inflation is running rampant. Just ask Venezuela or Brazil.

When the U.S. and other developed nations begin to see real growth (not government manipulated data), inflation will come, and probably at a much higher rate than what we expect due to the amount of money in the system.

There isn’t an exact formula for inflation.

I’ve talked about money velocity, supply and demand, and long-term fundamentals for excessive money printing, but that doesn’t mean they’ll factor in together to create a massive rise in inflation all at once.

Supply and Demand – Fundamentals Remain Strong

gold-and-silver

If we talk about gold merely from a supply and demand perspective, demand for physical gold has never been higher in our modern era.

Both France and India have put import restrictions on gold and silver imports because their governments are worried citizens are spending too much on gold, and not enough on the direct economic input of their countries.

Gold premiums doubled in India on Wednesday. Central bank buying continues. Bullion dealers are struggling to keep up with demand.

Via the Telegraph:

“…Rob Halliday-Stein, the founder of BullionByPost, said the plunge in the price had increased enthusiasm for gold among his customers, describing Friday as a “record” day…

…”For every seller, there’s a buyer,” he said. “The sellers tend to be big and fast and the buyers smaller and slower.”

This really is the gold rush of the modern era. But because gold trades in two of the world’s most manipulated paper markets – London and the U.S. — gold continues to be manipulated.

From a technical perspective, we are really beginning to see signs of capitulation. Could gold move up violently from these levels? Yes – especially from a technical perspective. But will it?

If the demand from the paper market can find a trigger to bring back the big funds, then yes.

But I don’t think the funds will be that aggressive in the short-term – not while the risk-on mentality is still in effect.

We could see a short-term trade to the upside along with many miners, but don’t expect gold to move too violently up from this point as many suggest. We’ve seen this before, only for traders to hammer the price down further.

The long-term price is a completely different ballgame.

No matter the supply and demand fundamentals, gold’s current price discovery is the result of a paper market – a paper market that is supposedly backed 100% by gold to ensure that supply and demand fundamentals exists.

Clearly, the demand for physical gold is stronger than ever but we are still witnessing gold plunge.

That is more than enough evidence to prove that gold-backed ETFs are backed by paper, and not gold.

No one knows when, or how, this financial bubble will burst. Perhaps it will burst when interest rates begin to rise, when we witness another massive bank bailout, or when the Fed begins to taper.

The question is not if there is a bubble, but rather when it will pop.

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Until next time,Ivan Lo
The Equedia Letter

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