Month: October 2022

Submitted by QTR’s Fringe Finance

Last night I had the pleasure of speaking with Jason Burack from Wall Street for Main Street to offer up my updated thoughts on the Federal Reserve, the economy and the state of the world in general.

The first thing we talked about was current Fed policy, which I told Jason I thought was a case of too much, too late. I made the argument that the Fed is, as it always does, overshooting its mark, and doing so at the wrong time.

This, as I have written several times, is why I believe the market is going to be in for a serious crash at some point within the next several months. I reiterated my stance to him that the economy and stock market have not yet truly digested 3% interest rates and, when they do, there will be hell to pay.

“They’re so nervous about the inflation issue, they have said ‘come hell or high water, we’re going to 4%’. I believe the consequences of 300bps of hikes in nine months have not even begun to be felt yet,” I said.

“I think we’re going to have a serious moment of real panic, probably an order of magnitude bigger than the one they just had in England,” I said. “They’re going to try and ram this thing through and get us to 4% by the end of the year. The consequences will be devastating. It’s going to be a wild ride.”

I also talked to Jason about why I think equity markets wind up 30% to 40% lower from here easily, assuming the Fed holds its course. If the Fed does decide to pivot, it would be a different story – but for now, with the Fed holding course, I think it is inevitable that our markets run into a brick wall, relatively soon.

I laid out my most recent game theory on the Fed’s current options – including whether it will pivot or not, and how it will react to the Bank of England restarting quantitative easing – in my article I wrote on Wednesday of this week: Did The Global Pivot Back To QE Just Begin?

One of the things that we talked about that I haven’t written about is the trouble that U.S. pension funds could be in.

The Bank of England intervention this week was a result of pension funds potentially having a “Lehman Moment”. Reports noted that pension plans overseas were hastily selling bonds to try and meet margin calls, a scenario that I am certain we are not far off from here in the U.S.:

Pension schemes had been selling gilts to meet emergency collateral calls or reduce exposure, pensions advisers said.

“There are schemes running out of cash at the moment,” one pensions consultant said before the BoE intervention.

From FT, here’s what scared the BoE straight:

“At some point this morning I was worried this was the beginning of the end,” said a senior London-based banker, adding that at one point on Wednesday morning there were no buyers of long-dated UK gilts. “It was not quite a Lehman moment. But it got close.”

I told Jason yesterday that I don’t think the United States is far off. All I have been reading over the last five years is how pension funds here (1) can’t meet their targets despite the market ripping and (2) were taking on leverage, managed by their obviously unqualified CIOs, to try and deploy the world’s worst carry trade and play catch-up/generate more yield.

“I think what they did in Chicago was once they failed to meet their targets – first off, several funds have turned over their CIOs – they then issued a bond or something ridiculous to try and put on this carry trade where they’re going to pay 50bps on the bond and try and generate an extra 100bps of return. Some asinine, basically borrowing money to try and invest it,” I told Jason. “You have nonsense like that all throughout the [pension fund] system.”

“If we can’t meet our obligations with pension funds when the market is screaming higher, what are we going to do now? I guarantee you there are pension funds right now already in big, big, big trouble and we just haven’t seen the news yet,” I continued. “We don’t know the extent of it yet.” 

The fact that these funds were unable to post the returns that they needed during arguably the most euphoric bull market in history is extremely concerning. When conditions get worse for poor managers like these, like they are now, the capital destruction could be devastating.

From there, we went on to talk about how government policy has enabled terrible monetary policy and how it could play a role in upcoming elections.

We also talked about the state of Covid lockdowns, the Canadian government finally surrendering its long-coveted travel restrictions and the state of politics globally.

“I think we’re going to see similar conservative populist movements throughout the world [like the one we just saw in Italy],” I told Jason. 

I made the argument to Jason that the political poles (not polls) had reversed – in essence, the party that was once liberal has now become fascist, and the party that was once conservative has now become liberal.

I talked to him about how the disintegration of US cities, combined with the economic destruction and the authoritarian lockdowns put forth by the current administration are all going to be tough to ignore for voters during the upcoming midterm elections. I further explained to him that I wasn’t surprised about the results of Italy’s latest election and predicted that many other countries globally would start to soon follow suit.

My full interview with Jason lasted a little bit over an hour and you can listen to it here:

 

Russian energy giant Gazprom PJSC suspended natural gas deliveries to Eni SpA, Italy’s largest oil company, on Saturday, reported Bloomberg. 

“Gazprom informed that it is not able to confirm the gas volumes requested for today, stating that it’s not possible to supply gas through Austria. Therefore, today’s Russian gas supplies to Eni through the Tarvisio entry point will be at zero. Eni will provide updates in case supplies will be restored,” Eni wrote in a statement on its website. 

An Eni spokesperson told Bloomberg that Austria is still receiving NatGas from Gazprom:

“We are working to check with Gazprom whether it is possible to reactivate the flows to Italy.” 

Gazprom said NatGas flows from Austria to Italy were suspended because the Austrian operator refused to confirm “transport nominations” after recent regulatory changes in the landlocked country in the southern part of Central Europe.

It’s important to note most of the Russian NatGas delivered to Italy flows through Ukraine via the Trans Austria Gas Pipeline to Tarvisio in northern Italy on the border with Austria. Before Russia invaded Ukraine, Italy imported 95% of its NatGas, of which 45% came from Russia.

Those figures are drastically different today as Italy rejiggers its energy supply chain away from Russia and finds alternative supplies of NatGas from North Africa. Before this weekend, Russian NatGas accounted for only 10% of Italy’s imports. The new suppliers will help Italy boost storage levels ahead of winter. 

“Outgoing Prime Minister Mario Draghi has been scouring the globe to secure gas supplies to protect Italy from potential supply interruptions from Russia, which has been putting pressure on the European Union over several rounds of sanctions in response to the invasion. Italy has been one of the most successful countries to source alternative supplies,” Bloomberg noted. 

Last week, Gazprom said one of two remaining routes carrying NatGas to Europe — via Ukraine — was at risk because of legal issues. 

Today’s news comes days after underwater explosions damaged Gazprom’s Nord Stream system in the Baltic Sea. And less than a day after Russia annexed four regions in Ukraine, as well as Ukraine, applied to join NATO. 

Via SchiffGold.com,

Money Supply growth was barely positive in August at $2B and sits well below the $233B seen last year. As the chart below shows, Money Supply growth has collapsed since February. Last year started with five straight months above $200B, whereas 2022 has only seen one month above $100B and that was January.

Figure: 1 MoM M2 Change (Seasonally Adjusted)

Figure 2 below shows the non-seasonally adjusted money supply which is a bit more erratic. Even with the increased volatility, it is very clear that there is far more weakness in the Money Supply in recent months. From this view, August was the strongest month since March but is still very slow.

Figure: 2 MoM M2 Change (Non-Seasonally Adjusted)

The latest month is actually slightly above the 6-month average growth rate (0.1% vs 0%). This is still way below the 1-year growth rate of 4.1% and well below the three-year annualized growth rate of 13.3%.

Figure: 3 M2 Growth Rates

When looking at the average monthly growth rate, before Covid, August historically expands at an annualized 8.4%, the highest month of the year. This year looks anemic by comparison.

Figure: 4 Average Monthly Growth Rates

The Fed only offers weekly data that is not seasonally adjusted. As the chart below shows, we have been seeing more frequent weeks of negative growth. It was only the latest week that drove the month to be positive.

Figure: 5 WoW M2 Change

The “Wenzel” 13-week Money Supply

The late Robert Wenzel of Economic Policy Journal used a modified calculation to track Money Supply. He used a trailing 13-week average growth rate annualized as defined in his book The Fed Flunks. He specifically used the weekly data that was not seasonally adjusted. His analogy was that in order to know what to wear outside, he wants to know the current weather, not temperatures that have been averaged throughout the year.

The objective of the 13-week average is to smooth some of the choppy data without bringing in too much history that could blind someone from seeing what’s in front of them. The 13-week average growth rate can be seen in the table below. Decelerating trends are in red and accelerating trends in green.

Growth has now collapsed to -2.23%. Ironically, the trend is currently moving up from the -2.57% seen 4 weeks ago. That had been the lowest reading since April 1993. The string of consecutive negative or zero growth in Money Supply ended at 29 weeks. That being said money supply growth is still negative.

Figure: 6 WoW Trailing 13-week Average Money Supply Growth

The plot below helps show the seasonality of the Money Supply and compares the current year (red line) to previous years. For the months of August and September, this is the slowest 13-week Money Supply growth ever recorded.

The chart below goes back to 2005 and the current growth rate is below every single period on the chart and below any other data point for this time of year, even edging out 2009 (-2.2% vs -1.7% back then).

Wenzel often commented on his ability to guess the timing of the 2008 stock market crash based on the Money Supply that year falling from 11.6% to 0% in a matter of months. In 2022, growth has slowed from 12.2% to -2.27% in less than 6 months. Not to mention the collapse from 64% seen in 2020.

More importantly, is that it’s not picking back up. It’s moved up a bit from the August lows, but it’s still negative! This is a major slowdown in Money Supply and could pose significant headwinds for the stock market and economy.

Figure: 7 Yearly 13-week Overlay

Behind the Inflation Curve

To combat rising prices, the Fed would need to undo most of the money it has created over the last several years. This would require bringing interest rates above the rate of inflation.

The Fed has been talking a huge game, but everyone should know they are bluffing! They can’t actually raise rates or they would have by now! The chart below shows that the Fed has never been further behind the inflation curve despite the “jumbo” interest rate hikes seen so far.

The blue line below (Fed Funds Rate) has almost always gotten above the black line (CPI) to force inflation back down. The one anomaly was in 2011 after the Great Recession. The mainstream is now assuming this is the norm (i.e., a recession alone will slow inflation), but the chart below shows that it’s far more common that interest rates must exceed inflation to bend the curve back down. The recent period has made the Fed complacent. This is very dangerous!

Figure: 8 YoY M2 Change with CPI and Fed Funds

Historical Perspective

The charts below are designed to put the current trends into a historical perspective. The orange bars represent annualized percentage change rather than the raw dollar amount. The current slowdown can be seen on the right side.

If a few months of M2 slowdown can cause this much pain across the economy (stock market, real estate, bond yields, etc.), how much carnage would unfold in a prolonged fight against inflation where M2 had to shrink consistently for months?

Figure: 9 M2 with Growth Rate

Taking a historical look at the 13-week annualized average also shows the current predicament. This chart overlays the log return of the S&P. Mr. Wenzel proposed that large drops in Money Supply could be a sign of stock market pullbacks. His theory, derived from Murray Rothbard, states that when the market experiences a shrinking growth rate of Money Supply (or even negative) it can create liquidity issues in the stock market, leading to a sell-off.

While not a perfect predictive tool, many of the dips in Money Supply precede market dips. Specifically, the major dips in 2002 and 2008 from +10% down to 0%. The economy is now grappling with a peak growth rate of 63.7% in July 2020 down to -2.25%. This is a major collapse.

The market finally got a rebound off the summer lows, but that is looking like a dead cat bounce. The chart below shows that a full market collapse cannot be ruled out!

Please note the chart only shows market data through September 5 to align with available M2 data.

Figure: 10 13-week M2 Annualized and S&P 500

One other consideration is the massive liquidity buildup in the system. The Fed offers Reverse Repurchase Agreements (reverse repos). This is a tool that allows financial institutions to swap cash for instruments on the Fed balance sheet.

Current Reverse Repo are now approaching $2.5T with $2.35T recorded as of Sept 22. The value always tops out at quarter end so there should be a new peak on Friday. These numbers dwarf the old record of ~$500B in 2016-2017.

Bottom line, even though M2 has slowed there is still trillions of dollars in liquidity sloshing around. New money will not be available to prop up the stock market, but excess liquidity is still available to bid up prices and keep inflation elevated.

Figure: 11 Fed Reverse Repurchase Agreements

What it means for Gold and Silver

The market is currently experiencing an epic collapse in the Money Supply growth rate. Based on historical data, August is typically when Money Supply growth reaches the bottom. However, the increase seen so far in September has been anemic at best.

The Fed is playing with serious fire. They are raising rates and crashing the money supply, but they have not come close to undoing all the damage done in 2020 and 2021 (much less the last decade). They are going to break something very soon and then what? There is still too much money circulating to bring down inflation.

When something breaks the Fed will pivot and step in. They won’t stand by and watch the global economy explode. When they pivot and inflation is still well north of 2%, gold and silver could take off like a Rocketship.

Multiple explosions under the Baltic Sea and the rupture of the Nord Stream pipeline system from Russia to Germany appear to be “sabotage,” NATO and EU officials said this week. A fourth leak was confirmed Thursday on the pipelines as EU countries are in overdrive to secure energy infrastructure that could be future targets. 

“The main message sent by this act, described as ‘sabotage,’ is the vulnerability of all this equipment,” Phuc-Vinh Nguyen, an energy researcher at the Institut Jacques-Delors Paris think tank, told the French newspaper Le Monde. 

Nguyen warned, “if such ‘accidents’ happened on a natural gas pipeline between Norway and Europe or Algeria and Europe, for example, it would be really problematic.”

Across the EU, warning after NS1 and NS2 were taken out by “highly effective explosive devices” has forced several countries to beef up the security of critical energy infrastructure this week. 

We first reported Norway, now Europe’s top NatGas supplier (displacing Russia), increased security at infrastructure sites, land terminals, and platforms on the Norwegian continental shelf. The country’s Petroleum Safety Authority warned that there had been reports of mysterious drones buzzing offshore platforms. 

Drones have also been spotted at France’s TotalEnergies offshore rigs in the Danish North Sea, igniting concerns that someone or even possibly a nation-state is trying to spark havoc for the European energy industry, according to Bloomberg. 

The mysterious drone was spotted Wednesday near its Halfdan B oil and gas field, TotalEnergies said, adding it has increased “vigilance around security for all of our offshore assets and onshore locations.” 

“I just hope that there is no idea behind it to extend the war beyond the border of Ukraine to the North Sea,” Total CEO Patrick Pouyanne told Bloomberg in an interview.

Offshore Energies UK (OEUK) is also increasing the security of offshore and onshore assets. The UK Ministry of Defence said protecting North Sea oil and NatGas rigs falls under its purview. 

“The Ministry of Defence constantly observes its areas of responsibility and interest, this includes protecting critical infrastructure such as underwater cables and offshore structures,” a spokesperson for the government department said.  

Italy is another county taking immediate steps to protect energy assets. Bloomberg reported Italian Armed Forces are set to increase security patrols of trans-Mediterranean gas pipelines. 

Defense Minister Lorenzo Guerini and other officials will deploy submersible drones to monitor NatGas pipelines in the Mediterranean region, particularly tubes from northern Africa. 

EU leaders and top energy companies across the bloc have received the message (from whoever blew up NS1 & NS2) that securing energy infrastructure ahead of winter is a high priority. 

Meanwhile, US Secretary of Energy Jennifer Granholm warned Thursday that LNG carriers en route to Europe need increased security. 

Remember, the CIA warned Germany weeks before NS1 & NS2 attacks. 

By Michael Msika, Bloomberg Markets Live reporter and Strategist

For as long as most people can remember, London has been Europe’s biggest equity market. Given the crisis of confidence in British assets, that may soon change.

This year’s decline in UK stocks has pushed the market’s total capitalization to within touching distance of its nearest challenger, Paris. At the equivalent of $2.46 trillion, the gap between them is only $133 billion, close to the lowest on record.

The differential between the UK and French markets has been gradually eroding since Britons voted to leave the European Union in 2016. But the unprecedented market turmoil unleashed in the past week by Prime Minister Liz Truss has dealt a crucial blow, damaging economic confidence and sending the pound to a record low.

“London’s crown as the top European trading center was already losing its shine even before this latest confidence crisis and the plunge in sterling, with the impact of post-Brexit trade issues still weighing on sentiment,” says Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown.“With concerns deepening about the Truss administration’s handling of the economy, optimism appears to be seeping away.”

Wednesday’s intervention by the Bank of England to calm markets has only “bought time” in stabilizing the pound and seeking to avoid broader deterioration in UK household finances and asset markets, say Jefferies strategists led by Sean Darby.

With Gilt yields rallying to the highest since 2008 this week, UK stocks are losing their appeal relative to bonds faster than their European peers. The spread between the FTSE 350 index’s forward dividend yield and the 10-year Gilt yield has fallen to just 0.5 percentage points, the lowest since 2011, offering a sharp contrast to that of euro-area peers, still around 2 percentage points.

The weakness of sterling since the Brexit vote has contributed to the decreasing value of London’s equity market, making British companies more attractive to foreign bidders. The UK has become a fertile ground for takeovers, also reflecting cheap valuations and lack of protectionism.

Another factor has been London’s increasingly fragile position as one of Europe’s premier listing venues. Just $1.38 billion has been raised through initial public offerings in the UK this year, representing 14% of the European total, the smallest share in more than a decade. according to data compiled by Bloomberg.

It’s not all doom and gloom. The weak currency is providing a big tailwind to UK large cap earnings, with 75% of FTSE 100 revenues coming from overseas. That means the blue-chip index is likely to continue outperforming the mid-cap FTSE 250, as long as recession fears persist and sterling remains under pressure, according to Liberum Capital strategist Susana Cruz.

Two weeks ago the US took the historic step of lifting defense trade restrictions on Cyprus. This will take effect for the fiscal year 2023, and the policy will be amended October 1st, according to prior statements of Secretary of State Antony Blinken.

Like with the recent upgraded US F-16 transfer to Greece, Turkey isn’t happy, also as military tensions continue to build over Ankara’s charge that the Greek army is militarizing islands off the Turkish coast. Turkey now says it will send more troops and weapons to the Turkish-occupied territory of northern Cyprus.

Turkish President Tayyip Erdogan on Wednesday lashed out at the US-Cyprus partnership, warning that Washington’s opening of weapons transfers will trigger an arms race on the divided island.

“The United States, which overlooks and even encourages the steps by the Cypriot-Greek duo that threaten peace and stability in the eastern Mediterranean, will lead to an armament race on the island with this step,” Erdogan said. The Turkish leader said further in the comments to CNN Turk:

“Will we stand by? We cannot,” he said, adding that Turkey already has 40,000 troops on the island and will reinforce them with land, naval and aerial weapons, ammunition and vehicles, Erdogan said.

“Everyone must know that this last step will not go unresponded and that every precaution will be taken for the security of the Turkish Cypriots,” Erdogan said.

He additionally called the US administration’s decision “inexplicable in terms of content and timing.”

State Department spokesman Ned Price recently reaffirmed that “Secretary of State Antony J. Blinken determined and certified to Congress that the Republic of Cyprus has met the necessary conditions under relevant legislation to allow the approval of exports, re-exports, and transfers of defense articles.”

This followed Cyprus successfully fulfilling its obligations under the Eastern Mediterranean Security and Energy Partnership Act of 2019, which had been sponsored by Senators Bob Menendez and Marco Rubio.

As for Turkey’s occupation of northern Cyprus, no one else in the world recognizes its legitimacy except for Ankara. Cyprus receives backing from its EU partners, but this doesn’t go much beyond verbal censure of Turkey.

Authored by Kyle Anzalone & Connor Freeman via The Libertarian Institute,

The US and its European allies have begun depleting their arms stockpiles by transferring myriad weapons systems to Kiev. The civilian head of the North Atlantic Treaty Organization, Secretary-General Jens Stoltenberg, said he is working with the arms industry to increase production. 

Since Russia invaded Ukraine in February, members of NATO have sent tens of billions in arms to Ukraine. On Wednesday, the White House announced a new $1.1 billion arms transfer to Kiev. Washington has led all donors by a significant margin, giving over $65 billion to Ukraine in just over seven months. 

Most weapons President Joe Biden has sent to Ukraine have come under the Presidential Drawdown Authority, which allows the president to give away American weapons without Congressional approval. The legislature has approved billions for the PDA in a $40 billion Ukraine aid bill that was passed in May. 

Over the past several months, reports have surfaced that Biden’s extensive use of the PDA has depleted American weapons stockpiles. In response, the White House has started working with the weapons industry to increase the production of several weapons systems. A White House official recently told the leaders of the arms trade that the Russian war would produce a windfall of new clients and revenue. 

Speaking with the New York Times, Stoltenberg said Brussels is joining Washington in seeking to make more weapons.

“We are now working with industry to increase production of weapons and ammunition,” he said. 

CNBC reports the US has “essentially run out of 155 mm howitzers to transfer to Ukraine.” The current production capacity for 155 mm ammunition also falls short of what the White House is seeking to provide Kiev. Suppliers currently produce 30,000 rounds per year, an amount the Ukrainian army uses in two weeks. 

U.S. government-owned weapon arsenals are not capable of rapidly surging production, and the private sector has no incentive to maintain excess production capacity. https://t.co/5kELlLmw4k

— U.S. Naval Institute (@NavalInstitute) August 24, 2022

Ramping up production will take time and money. When visiting a Lockheed Martin plant in May, Biden said, “this fight is not going to be cheap.”