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Things are beginning to change. Banking systems are about to unravel. Soon the world will be a much different place, starting with Europe.
Last week I said the ECB would cut rates on the 5th; they did just that. I expected more stimulus from Europe; the Bank of England did just that, raising their QE by another £50 Billion. Then China surprised everyone with yet another benchmark interest rate cut.
But was it really a surprise to those who have been following the underlying tones of the world economy?
For the last few years I have pounded on the notion that the world will continue to stave off its financial collapse by printing more money and do whatever it can to hold off outright disaster.
The people on Wall Street, Bay Street, and Howe Street all walk around talking about how bad the economy is, yet believe that things will be okay because policy makers will do whatever they can to prevent the inevitable from happening. So far the policy makers have done just that. But how much more can they do?
The policy makers are trying to prevent the further destruction of wealth. Yet in order to do that they have print more money. Printing money destroys wealth through debasement. Either way, wealth is destroyed. At some point the things they have put in place to avoid disaster will blow up.
Europe’s banking system will need to be saved. As I mentioned last week, it all starts with federalizing Europe’s banking system through a European-wide banking supervisor. After the recent rate cut, this will need to be done quickly.
Europe Blacklisted
JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. and BlackRock Inc. (BLK) have just closed European money market funds to new investments after the ECB lowered deposit rates to zero:
From Bloomberg: “JPMorgan, the world’s biggest provider of money-market funds, won’t accept new cash in five euro-denominated money- market and liquidity funds because the rate cut may result in losses for investors, the company said in a notice to shareholders. Goldman Sachs won’t accept new money in its GS Euro Government Liquid Reserves Fund, and BlackRock, the world’s largest asset manager, is restricting deposits in two European funds. “The European market environment is in unchartered territory with such historically low — or even negative — yields for high-quality issuance,” Goldman Sachs (GS) said in a memo to fund shareholders, citing the ECB’s rate cut. “It is not currently feasible for our portfolio managers to deploy capital without substantially diluting the yield for the existing base of shareholders.” The ECB yesterday reduced its benchmark rate to a record low of 0.75 percent and took its deposit rate to zero. Money funds have been struggling to invest client assets at a profit as interest rates globally are near record lows and Europe’s sovereign debt crisis has reduced the supply of available debt. Managers have been forced to cut fees to keep customer returns above zero, and some have abandoned the business. All three firms said the restrictions are temporary and they will monitor market conditions. Investor redemptions from the funds are not being limited.”
That means money will be coming out of European money markets…but won’t be coming back in. This is yet another blow to the ailing countries in the eurozone already suffering from fundraising difficulties (see It’s Time to Get Stinky). It also means euro central banks will have no other option but to step in as lenders or face financial collapse of their banking system.
As I mentioned in past letters, when money can’t be made in other markets, they will begin to flow into the one market with value: gold.
The governments of the world will continue to print more money because it has no other choice. As a result we will see volatility in all currencies and inflation will eventually rise. I stress that we remain in a natural state of deflation for now (see It’s Time to Get Stinky) which only encourages policy makers to step up the printing press.
A few weeks back I said that Bernanke implied he would print more money:
“By his own words, Bernanke has already told us they will do more: “If we are not seeing sustained improvement in the labor market that would require additional action. We still do have considerable scope to do more and we are prepared to do more.”
Stocks are once again falling following the U.S. government’s report that only 80,000 jobs were created in June, the third straight month of weak hiring. The unemployment rate remained at 8.2%. Will Ben take action soon?
I don’t think he has a choice.
Gold is as Good as Cash…Again: Basel III
The new Basel III Accord is set to take effect early next year. BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11.
In the new Accord gold will be promoted to tier 1 status and carry a zero risk weighting; gold currently carries a risk weighting of 50%.
In response to the new Basel III Accord, a letter was issued by the federal bank regulatory agencies with new rules proposed that would revise the measurement of risk-weighted assets by implementing changes made by the Basel Committee on Banking Supervision (BCBS) to international regulatory capital standards and by implementing aspects of the Dodd-Frank Act.
Under the new proposed rules issued by the federal bank regulatory agencies, gold bullion will also carry a zero risk weighting as it has been proposed in Basel III.
In short, that means banks will be allowed to carry gold and consider them tier 1 assets, right alongside cash. Basel III also states that banks must increase their tier 1 holdings from 4% to 6%%. That means banks will have to “cash up.”
How will the banks increase their tier 1 holdings as currency continues to lose purchasing power?
Last year I mentioned that Switzerland’s central bank returned to a profit in the first nine months of 2011 because their gold holdings helped counter losses on their currency reserves.
If you were a bank and had to increase your tier 1 holdings, would you buy gold or currency?
Central Banks around the world have already been hoarding gold. But they’ve only just begun…
No Guts, No Glory
Consider that hundreds of billions of dollars may soon be available as a result of investors exiting the European money markets. Also consider that global banking institutions have been losing billions of dollars in riskier investments and are under serious pressure to keep a tighter ship.
Where will these institutions invest their money when their traditional investments are providing negative returns? The only safe asset I know that has continued its climb over the last decade is gold.
Institutional investors here at home are packing their bags for their two-month summer vacation. This will leave countless deals unattended and buy side liquidity dry. That means there could be further bargains on the gold and silver stocks you have been so patiently watching.
That also means the big sellers have left the market. As a result, little volume on the buyside could push many of these juniors higher.
The smart guys are seeing buying opportunities in a sector that is clearly undervalued while retail investors remain scared. For the last year and a half gold stocks have trended down right alongside the TSX Venture.
But that’s the nature of the business. No guts, no glory.
Until next week,
Ivan Lo
Equedia Weekly
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