Category: zerohedge

General Motors is recalling around 4 million vehicles worldwide. According to AP, the recal is related to a software defect that means front air bags may not deploy and is linked to 1 death.

As NHTSA explains…

Potential Number of Units Affected: 3,640,162

 

SUMMARY:

General Motors LLC (GM) is recalling certain model year 2015-2017 Chevrolet Silverado 2500 HD, 3500 HD, Tahoe, Suburban, GMC Sierra 2500 HD and 3500 HD, GMC Yukon, GMC Yukon XL, Cadillac Escalade and Cadillac Escalade ESV vehicles and 2014-2017 Chevrolet Corvette, Silverado 1500, Trax, Caprice Police Pursuit Vehicle, GMC Sierra 1500, Buick Encore, and 2014-2016 Buick Lacrosse, Chevrolet Spark EV and SS vehicles. In the affected vehicles, certain driving conditions may cause the air bag sensing and diagnostic module (SDM) software to activate a diagnostic test.

 

During this test, deployment of the frontal air bags and the seat belt pretensioners would not occur in the event of a crash.

 

CONSEQUENCE:

A failure of the front air bags or seat belt pretensioners to deploy in the event of a crash necessitating deployment increases the risk of injury to the driver and front passenger.

 

REMEDY:

GM will notify owners, and dealers will reflash the SDM software. Vehicles that have had a previous air bag deployment will have the SDM replaced. These repairs will be performed free of charge. The manufacturer has not yet provided a notification schedule. Owners may contact Buick customer service at 1-800-521-7300, Cadillac customer service at 1-800-458-8006, Chevrolet customer service at 1-800-222-1020, or GMC customer service at 1-800-462-8782. GM's number for this recall is 16007.

For now it does not sem to be too earth shattering as GM was already sliding on the back of market weakness… Oddly huge volume spike at 1117ET…

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Submitted by Nick Cunningham via OilPrice.com,

Aging infrastructure could render the U.S. strategic petroleum reserve (SPR) increasingly ineffective, according to a new report from the Department of Energy.

The U.S. has stored roughly 700 million barrels of crude oil in salt caverns in Texas and Louisiana for decades. The SPR was established in the aftermath of the Arab oil embargo in 1973, which painfully revealed U.S. oil dependence as high prices drove up inflation, created fuel shortages and lines at gas stations, and rocked the American economy. The SPR was setup to stash 90 days’ worth of supply into storage for safekeeping, meant to be used in the event of a supply outage.

Decades of wear and tear mean that the infrastructure is now in desperate need of an upgrade. The DOE says Congress needs to cough up $375.4 million to make repairs, otherwise the SPR may not be all that effective. “Most of the critical infrastructure for moving crude within the SPR has exceeded its serviceable life, increasing maintenance costs and decreasing system reliability,” the report concludes.

For the SPR to last decades into the future, DOE argues, investment in the system is needed. But the SPR’s value and purpose is also starting to wane; the U.S. no longer needs the SPR like it once did. High levels of domestic oil production and flat demand mean that the U.S. is not quite as dependent on crude as it once was, at least in terms of the size of the American economy. Five years ago, U.S. oil imports routinely topped 10 million barrels per day. By 2014 that number had shrunk to below 7 million barrels per day. Imports have crept back up a bit as production has declined because of low oil prices, but the U.S. is still far less dependent on imported oil than it used to be.

(Click to enlarge)

There is another problem with the SPR in 2016 that was less of an issue in the past. The SPR was designed to release oil from the Gulf Coast region, and pump it to the rest of the country. But most of the pipeline infrastructure completed in recent years was designed to flow from north to south, allowing huge volumes of newly produced oil to flow towards the Gulf for refining. The larger north-to-south oil flow means that the SPR would struggle to actually service the country in the event of an outage. Instead of the 4.4 million barrels the SPR is supposed to be able to release each day, it might only be able to move 2 million barrels per day because of pipeline congestion. The DOE report says that the U.S. should have marine terminals dedicated to the use of emergency distribution from the SPR.

The SPR was once a sort of sacrosanct cornerstone of American energy security policy. Both political parties observed the importance of the SPR, and refrained from using oil from the reserve except in the most unusual of circumstances. It has only been used a handful of times, such as during the Persian Gulf War and in the aftermath of Hurricane Katrina.

But President Obama also authorized the sale of 30 million barrels of oil in 2011 during the uprisings across the Middle East, collectively known as the Arab Spring. That sale was much more controversial, with critics pointing out that global supplies had not been materially impacted, and the sale was more aimed at addressing prices. The sale, Obama’s opponents allege, was a political move.

Nevertheless, the sale went through, and a few years on, things have changed in Washington. The U.S. is one of the largest oil producers in the world and its fleet of vehicles has become increasingly fuel-efficient. Imports are down and energy security is no longer the hot topic inside the beltway that it once was. More importantly, the collapse of oil prices acts as a sedative for those politicians once concerned about energy security. With oil prices below $50 per barrel, and shale drillers still pumping out vast volumes of oil in Texas, why does the U.S. need 700 million barrels of oil stashed away in salt caverns, especially when it is becoming more costly to maintain it?

The DOE report says that instead of the nearly 700 million barrels the U.S. currently stockpiles, an SPR along the lines of 530 to 600 million barrels would be more appropriate. That would equate to about 60 days’ worth of supply.

In 2015, Congress authorized the DOE to sell $2 billion worth of oil from the SPR between 2017 and 2020 and use the proceeds to make infrastructure upgrades. The language was an acknowledgement from Congress that the SPR is no longer needed in its current form. The latest DOE report, which came at the behest of Congress, cautions against drawing down the reserve below the 530 million barrel threshold, which would leave the U.S. more vulnerable to price spikes.

It remains to be seen how Congress responds, but one thing that is certain is that both political parties no longer see the SPR as important as they once did. At a time when China and India are building up their SPRs, the U.S. is poised to shrink its crude oil stockpile.

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It’s GAME OVER for the ECB and for Europe.

The ECB has cut interest rates into negative territory four times. It has also spent €1 trillion in QE bringing its balance sheet to a record high.

These are truly extraordinary policies. Keynesian shills usually claim that the reason their policies don’t work is because a Central bank hasn’t done “enough.” At FOUR NIRP cuts in two years and €1 trillion in QE the ECB has most certainly done enough.

And what has it got to show for it?

The ECB is close to exhausting its ammunition and appears increasingly powerless to do more under the legal constraints of its mandate. It has downgraded its growth forecast for the next two years, citing the uncertainties of Brexit, and admitted that it has little chance of meeting its 2pc inflation target this decade, insisting that it is now up to governments to break out of the vicious circle.

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We all know the ECB wasn’t going to achieve significant GDP growth. The ECB all but admitted this a few years ago when it suddenly changed its language to ignore growth and instead focused on “inflation” and inflation targets.

But now… the EBC is admitting it won’t hit it inflation target “THIS DECADE.”

It’s GAME OVER for the ECB and for Europe.

What’s coming will not occur quickly. I am in no way suggesting that Europe will break apart tomorrow. But the fact the ECB has admitted that even its extraordinary policies have failed to the point that it won’t achieve its goals for a decade indicates it’s the beginning of the end.

Debt deflation is the end game for Europe. Most EU nations are insolvent as soon as their interest rates spike even into the low single digits. And with EU banks leveraged at 26 to 1 with EU sovereign bonds being used as the senior most assets on their balance sheets, you only need a 4% drop in EU bond levels to render most large EU banks insolvent.

And we’re talking about a banking system that is north of $46 TRILLION IN SIZE.

This is more than TWICE the size of the US banking system, which nearly took down the world in 2008. So it Europe goes, it’s going to be exponentially worse than 2008.

We are already preparing our clients for this with a 21-page investment report titled the Stock Market Crash Survival Guide.

In it, we outline the coming crash will unfold…which investments will perform best… and how to take out “crash” insurance trades that will pay out huge returns during a market collapse.

We are giving away just 1,000 copies of this report for FREE to the public.

To pick up yours, swing by:

http://ift.tt/1HW1LSz

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

 

 

 

 

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In a post that in retrospect was timed perfectly, yesterday we first warned that the BOJ may be about to unleash a bond “VaR shock”, one that would promptly lead to a global asset contagion, as a result of Kuroda’s surprising eagerness to steepen the yield curve, a move which would lead to an accelerated selling of the long end first in Japan, then across the entire world where some $13 trillion in bonds trade at negative yields. We also explained how “with cross asset correlation soaring, not to mention with risk-party and CTA funds approaching record leverage, the risk is that investors frontrunning a perceived change in the BOJ’s policy in two weeks time could lead to a dramatic selloff in JGBs, which then spreads across to global fixed income markets, all of which trade like connected vessels.”

The warning did not stop there: as we explained previously, in early June, Goldman warned that a sharp 1% spike in rates across the curve in the US alone, would result in MTM losses of $2.4 trillion. That excludes the crossover impact into stocks, as a selloff in bonds
leads to a correlated liquidation across equities, as a result of record leverage for Risk-Parity and other quant funds…

… for whom coordinated selling in both asset classes could lead to dramatic deleveraging, and a positive feedback loop of even more selling.

 

Our conclusion was simple: just as central banks had pushed the markets higher, so they could – and would – be the catalyst that send everything plunging as a result of dramatic changes in trillions in bond positions.

* * *

Overnight we were delighted to find that RBC’s head of cross-asset strategy, Charlie McElligott not only read our analysis but appears to have agreed with everything we said.

* * *

Here is McElligott’s note released this morning.

COMMENTARY: Markets don’t like getting hit four sides at once…

The “Draghi Disappointment / Brainard Bogeyman / BoJ NIRP-ier / IG Supply Tantrum” we shall call it—elegant right?!  Global rates markets continue to bear-steepen on account of four “developments”:

1. Draghi’s ECB presser disappointed the crowd with no increases, no extensions and no tweaks—“ECB did not discuss extension of asset purchases plan.”  There also was a very slight “upgrade” to inflation as well, as the 2018 forecast was NOT dropped as expected, while stating the expected inflation will be more stable than before.  Geez.
2. The bizarre Fed / Brainard speech episode, where an (initially understood to be) “impromptu” scheduling of Fed’s Lael Brainard to give a speech next Monday evening—immediately before the Fed’s blackout period—was interpreted by the market (and conspiracy theorists) as a sign that Yellen was rolling out the increasingly high-profile and UBER-DOVE Brainard (remember, she was the “international factors are impacting US rates” proponent who helped start the R-Star discussion) to actually be the person with the best chance to communicate a HAWKISH message on the September meeting.  In turn, by having the “person least likely to speak hawkishly” then make a case / at least say that the committee is confident on achieving its mandates, that you could get market probability north of 50% “required” to pull the trigger.  From speaking with folks close to the situation, there is a real belief that the Fed is adamant on at least one-hike this year, data be damned.  Apparently they are keenly aware that they could be driving financial asset instability.  : /  Nonetheless, it came out later in the afternoon that Brainard had been scheduled at the event in question for weeks…so head-scratching abounds. 
3. The point I made reference to in yesterday’s “Big Picture” w.r.t. the BoJ being equally adamant on going even MORE negative with rates while also investigating “curve tweaks” (from a change in the composition of their JGB purchases to the potential for a reverse operation twist) has gained steam, with multiple media outlets floating these “trial balloons” ( http://reut.rs/2c4zgi5 ).  The concerns here are many: even more negative rates is an enormous risk after the way the market treated them post the initial move, which saw a counterintuitive strengthening of Yen and a flattening of the JGB curve which sent the Topix Banks index -25.5% to its current  YTD performance.  And again, as stated yday, an outright “reverse op twist” could be interpreted as a “backing-down” from a market that knows the BoJ is married-to the perma-stim / perma-easing path for the rest of its days.  If markets smell weakness, “things could get weird” (flipside of course being a potentially very POSITIVE reaction to a steeper curve, esp w/ banking sector…I know it’s noncommittal, but we simply can’t gauge how mkts respond).
4. A final factor driving the move in UST (absolute) yields (and as noted a few weeks ago as a risk to what had been low rate vol) is the insane supply being pumped out of both US IG corporates, now standing at $52B on the week….and then next week, with a HUGE calendar of Treasury issuance, with potential of ~$100B in bills, ~$50B in coupons and another $50B in more US IG!  For those of you keeping track at home, that’s potentially ~$200B of supply.  Per IFR, Monday alone could see $76Bt-bills at 11:30am, and then $24B 3s plus $20B 10s both at 1pm ET.

The spook story for low-volatility equities for years has been a spillover of rate vol—see all of our various “tantrum” episodes.  Why?  Because of the painful grind higher in cross-asset correlations as the market has become more macro–thanks to both 1)  global central bank policy that is essential based around controling one asset (USD) and tamping-down volatility through unprecedented asset-purchases…along with 2) the enormous growth of systematic strategies, especially those which target volatility and / or use leverage to “balance risk” across asset classes based on historical volatility. 

Risk-Parity as you all know has been a favorite “bad guy” to mention during these episodes (otherwise the strategy is a ‘home run’ the rest of the time in a global QE environment), because (being painfully simplistic here) they run leveraged long fixed income as it is a historically “low volatility” asset.  But under certain economic condition “buckets” (inflation / growth) you too can run very long risk assets too…ESPECIALLY with HISTORICALLY DEPRESSED TRAILING VOLATILITY.  I.E. RP / target vol / CTAs are most likely REALLY REALLY long equities right now bc of this, which is SPX 30 day historical vol sitting at its 10 year lows, with 50 day historical vol on the same cusp:

 

So the punchline is that many systematic macro, risk-parity or vol targeting funds are very long both equities and fixed-income (helping drive the recent correlation)…and when a “butterfly flaps its wings” in one leg of the trade, suffering a “macro drawdown,” we have seen in the past “VaR shock” selling episodes as other positions are taken-down as well. 

In turn, the long-end of fixed-income took it in the face yday and today, from Bunds to Gilts to Treasuries:

TWO DAY MOVE IN GERMAN 30Y BUND YIELDS A 5 STANDARD DEVIATION EVENT:

Markets are paralyzed with uncertainty—and I’m not even including Trump’s recent resurgence.  How can you get more aggressive with your growthier / reflationary / cyclical outlook when not only is global economic data turning south again, but you have a month ahead with so much event risk–btwn ECB / BoE / BoJ / Fed / first US Presidential debate?  Pile-on four different banks downshifting on growth / saying to get more defensive this week (most notably Trahan  / Lazar at Cornerstone), you have a real pivot forming….especially as so much performance has been “gained back” (certainly within the equities complex) on the shift back into the “reflation” thesis.
 
EQUITY L/S HF PERFORMANCE SEES GAIN OF +4% SINCE SHIFTING OVERWEIGHT CYCLICALS / UNDERWEIGHT DEFENSIVES: Upper panel shows correlation of “high hedge fund concentration” equities holdings basket against the ‘cyclical / defensive’ equities ratio.  In turn, the below panel shows the % performance in the HFR Eq L/S HF index.

 

…THIS THEN GETS PRETTY SCARY WHEN YOU LOOK AT THE SWOON IN GLOBAL DATA: Global developed market surprise index plummeting, against the same ‘cyclical / defensive’ equities ratio from above, which is trading back at extremes.  Ruh-roh.

So here we go: BoJ seemingly ready to commit to go deeper negative rates and experiment with their curve, the Fed is seemingly locked-and-loaded on a hike as global growth rolls over, a deluge of supply into a suddenly wobbly rates backdrop (and a world ‘stuffed to the gills’ on duration via NIRP and QE forcing real money / AML community into deeper “yield seeking” / “yield compression” behavior), and a loaded-coil of synthetically low volatility across asset classes…as cross-asset correlations trickle back near multi-year / crisis extremes.

Get ya popcorn ready….

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After what is set to be six consecutive quarters of annual earnings declines – consensus now sees Q3 EPS dropping -2.1% according to Facset when as recently as the end of March, analysts were expecting EPS growth of 3.2% for the quarter – Wall Street has decided that it will take no more of this negativism, and expects S&P500 earnings to soar in the half, as shown in the following Deutsche Bank chart.

There is just one problem: contrary to the cheerful narrative of an earnings recovery, companies have been slashing H2 earnings, and as MarketWatch reports, at least 10 companies this week alone have lowered outlooks for the second half of the year.

Indeed, as we have been warning for months, and as Jeff Gundlach cautioned on his presentation last night…

… the EPS “hockeystick” has been once again indefinitely postponed; in fact what happens next will be a steep drop in forward EPS.

MW admits as much, saying that “Investors expecting the earnings picture to improve significantly in the year’s second half may want to keep an eye on a wave of sales and profit warnings from some large- and small-cap companies this week.” Some examples: Ford Motor, Barnes & Noble, Tractor Supply, SuperValu, Sprout’s Farmers Market,  Pier 1 Imports, General Mills, HD Supply Holdings, EnQuest and Dave & Buster’s are among the companies tempering expectations for their second half.

So far, the flood of negative earnings warnings has not moved the needle on expectations for the third quarter, according to FactSet. But it wil: 78 of the 113 S&P 500 companies that have provided an outlook for the quarter have issued negative earnings-per-share guidance, according to FactSet senior analyst John Butters.

This number is set to surge for one simple reason: regular readers are quite familiar with what the latest “scapegoat” is – it is shown in the photo below.

As we said on August 31, when we first reported about Hanjin’s bankruptcy, we said that “the global implications from the bankruptcy are unknown: if, as expected, the company’s ships remain “frozen” and inaccessible for weeks if not months, the impact on global supply chains will be devastating, potentially resulting in a cascading waterfall effect, whose impact on global economies could be severe as a result of the worldwide logistics chaos. The good news is that both economists and corporations around the globe, both those impacted and others, will now have yet another excuse on which to blame the “unexpected” slowdown in both profits and economic growth in the third quarter.“

Lo and behold, this is precisely what is about to take place, cue MarketWatch this morning:

The negative outlooks provided this week reflect a range of issues facing companies, some of which have emerged only recently.

 

For retailers, the bankruptcy of South Korea’s biggest shipping line and the world’s seventh biggest as measured by capacity, Hanjin Shipping, is a big risk, as it has left cargo valued at $14 billion stranded at sea, as the Wall Street Journal reported Wednesday. That’s because ships carrying its containers have been denied access to ports, or even been seized by some of the company’s creditors.

 

Coming right before the holiday season, that is likely to hurt a range of companies. Fashion-driven specialty retailers and clothing retailers making significant fashion shifts are most at risk from the Hanjin-related havoc, according to Cowen & Co. analysts. They name names, including Ascena Retail Group, Abercrombie & Fitch, American Eagle, Urban Outfitters, Gap, Michael Kors and Coach.

Further confirming our prediction, Cowen said that “an ability to chase into working trends could be limited if there are problems in the supply chain.” Others compared the issue to the strike by dock workers on the U.S.’s West Coast that began in the fall of 2014 and delayed shipments of goods for months. Deutsche Bank said companies that were especially hard hit by the port strike included sports retailers; home-furnishings companies such as Home Depot Inc., Lowe’s Corp. and Bed Bath and Beyond and the crafts chain Michaels.

Of course, there is a far more critical issue: the demand is just not there. soft consumer spending has continued to “stump” analysts, although there is no secret: rising rents and health-care costs, have been the biggest catalyst crushing the US consumer, as we first explained in 2014, and as dollar store discounters confirmed two weeks ago, as we reported in “”Things Are Worse” – Dollar Stores’ Startling Admission: Half Of US Consumers Are In Dire Straits.”

Finally, with the oil rebound fading fast again, the EPS tailwind from energy companies may prove to be the final mirage in the much anticipated earnings rebound, as annual earnings are at best flat, and far from the dramativ contributor to the S&P bottom line. In fact, the biggest question remains whether or not Apple, whose earnings are 7% of the S&P’s bottom line, can finally get out of its rut. Considering the company just said it would no longer report new product launch weekend sales – for obvious reasons – we can safely conclude that the latest forecast hockey-stick is not going to materialize, and if anything we may see the 6 quarter stretch of negative earnings continue into Q4 – an unprecedented 7 consecutive quarters of annual earnings declines.

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Well that escalated quickly…

VIX’s biggest jump since Brexit – back above its 100day moving average…

 

Sent S&P 500 back to 2-month lows critical support…

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Submitted by Charles Hugh-Smith via OfTwoMinds blog,

Our society does not make it easy to control what you can control.

One of the aphorisms to live by here at Of Two Minds is control what you can. We don't control the erosion of our money from inflation, the state's vast criminalization machinery, the nation's foreign policies or the central bank's free money for financiers policies.

So what do we control? Amazingly enough, we still control a few things. We control what we eat (at least those of us who aren't institutionalized do), what fitness/ stretching/ bodywork routine we do or don't do, and we still control what we do with our surplus money: we can salt it away as savings rather than spend it, and we control where to invest our savings.

Here's a couple of thoughts on productively controlling what we can control.

1. Don't count on bailouts, debt forgiveness, debt jubilees, guaranteed minimum income or any other form of free money. The Federal Reserve, the Treasury and the Justice Department have made it very clear: free money is for financiers, banks and corporations, and bailouts are for too-big-to-fail banks and financial institutions.

As for debt forgiveness and debt jubilees: every $1 of debt that's forgiven (i.e. written off) is $1 that's removed from some investor's balance sheet. If we jubilee $1 trillion in debt, that's $1 trillion in assets that are destroyed.

As the saying goes, there's no free lunch (except for friends of the Fed), and since every dollar of debt is someone else's asset, don't expect bailouts or debt forgiveness. If it happens, great, but there will will be catches–including Catch 22, 23 and 24.

2. It's tough not to self-destruct in Our Impoverished, Pathological Society. We all know extra weight is hard on our bodies and health, even if we're fit, and so the fact that 70.7% of Americans 20 and older are overweight or obese indicates just how difficult it is to remain healthy in our "salty, sugary, fatty treats are temptingly everywhere" culture.

Our diet, fitness and weight have enormous impacts on our health. The best estimates suggest no more than 1/3 of our health is the result of our genetic makeup; the rest is environmental/lifestyle.

The Centers for Disease Control and Prevention (CDC) estimates that One in five U.S. adults meet overall physical activity guidelines, which includes both aerobic and muscle strengthening exercises:

"…at least 2½ hours a week of moderate-intensity aerobic activity such as walking, or one hour and 15 minutes a week of vigorous-intensity aerobic activity, such as jogging, or a combination of both. The guidelines also recommend that adults do muscle-strengthening activities, such as push-ups, sit-ups, or activities using resistance bands or weights. These activities should involve all major muscle groups and be done on two or more days per week."

Between a third and half of adult Americans are meeting one of the guidelines, but only 20% are meeting both aerobic and muscle-strengthening guidelines.

These statistics are self-reported, so we have no way of knowing the actual fitness level of the 20% who claim a high level of fitness. As a baseline, I use the Army Physical Fitness Test (APFT), which anyone can take themselves, as it measures sit-ups, push-ups and the time required to run two miles.

(NOTE: Do not attempt the test if you have not been training regularly for at least a year and have not had a thorough check-up by your personal physician recently.)

I'm 60 Years Old and Took the Army Physical Fitness Test (APFT) (April 24, 2014)

I'm 61 and Took the Army Physical Fitness Test (October 2015)

There may be other baselines of fitness that are less strenuous. The point is, choose an objective baseline and monitor your progress. Be patient and self-disciplined; overdoing it will result in injuries, not fitness.

I personally aim to do the minimum required to stay fit, because I'm basically lazy. As fitness guru Jack LaLanne said, "I hate exercise, but I like the results."

Eating well is equally challenging, and Drew Sample and I discuss diet, fitness, weight and controlling what we can in this podcast: The Sample Hour with Charles Hugh Smith (1:30 hrs). (Drew is 31, I'm 62, so we cover quite a bit of ground in the podcast.)

3. If you want to invest wisely, invest in what the wealthy own: they own enterprises, which are assets that produce income–unlike McMansions or "stuff."

Our society does not make it easy to control what you can control. Temptations abound, and we're told we need expensive gym memberships, personal trainers, investment advisors, etc. to take control of what we can control. Various rules limit where we can invest our retirement savings, and reams of paperwork inhibit us from owning assets overseas.

If we set out to design a society in which people feel poorly (due to poor diet, fitness and mental health), feel poorly about themselves, and are emotionally, physically and financially impoverished, you'd end up with the society we have now.

It doesn't have to be this way. Liberation starts by taking control of whatever we can control. Taking control of our health and finances is a darn good start.

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Wholesales sales slumped 0.4% MoM in July – the biggest drop since January. Inventories were unchanged MoM, driving the inventories-to-sales ratio back up to 1.34x. Year-over-year, this was the 19th consecutive month of declines for wholesale sales…

Notably Auto sales dropped for the 3rd month in a row but Hardware saw the biggest monthly drop in sales.

Farm products saw the biggest drop in inventories along with drugs. Auto inventories rose but professional equipment rose the most.

The absoluet gap between sales and inventories remeains near record highs…

 

But the sales drop and inventiories flat has led to a rise in the inventories-to-sales ratio, which remains deep in recessionary territory…

 

Probably a good time to hike rates?

Charts: Bloomberg

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Concerns about Japan’s possible ‘var shock’-inducing reverse twist policy has sparked selling across global sovereign bond markets. Both Japanese 10Y and German 10Y yields have surged to 0% overnight.

 

Japanese 10Y yields have not been this high since March….

 

And German Bund yields have reached 0% for the first time in 2 months…

*GERMAN 10-YEAR YIELD TURNS POSITIVE, FIRST TIME SINCE JULY 22

As we concluded previously…

So will the BOJ shock markets and unleash this year’s “bond tantrum”,
one which would come at a time when there is an unprecedented $13
trillion in negative yielding bonds? According to Old Mutual Global
Investors which oversees the equivalent of about $436 billion, a policy
change aimed at steepening the yield curve wouldn’t be surprising, even though it would come at the expense of bondholders.

“It would definitely see some pain,” said Mark Nash, head of global bonds at the London-based fund manager. “Money flows across borders. It’s all linked.”

And it appears that pain is beginning.

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In 2013 we’ve witnessed the inception of the Chinese gold ETF market. At first demand for the gold ETFs was neglectable, as investors mostly preferred to buy the physical gold directly at the Shanghai Gold Exchange (SGE) or buy jewelry or investment bars through retail channels. This year, however, there has been a major shift in gold ETF demand in China.

The physical holdings of Chinese gold ETFs have surged five-fold from 7 tonnes at the end of January, to 35 tonnes at end of August. The Huaán Yifu Gold ETF, which was holding 23 tonnes in August, entered the global top 15 list.

 

Exhibit 1. All physical holdings of Chinese gold ETFs are stored within SGE designated vaults.

The interest in China’s nascent gold ETF market was even mentioned by the World Gold Council in a recent Gold Demand Trends report. In this post, we’ll add some texture to China's gold ETF market; how are the gold ETFs constructed and how can they be compared to the largest Western gold ETF, the SPDR Gold Trust. At this moment the market share of Chinese gold ETFs is still small – within China as well as globally, but knowledge about the workings of these ETFs will be valuable when they acquire significant market share in the future.

Kindly note, all mechanics and examples presented in this post are simplified.

What Is A Gold ETF?

ETF is short for Exchange Traded Fund. ETFs trade like stocks and its price usually tracks an underlying asset or index. Like stocks, ETFs have a primary market and a secondary market. The secondary market is the stock exchange where most ETF investors trade. What makes ETFs special is the primary market where ETF shares are created and redeemed. Let us use the SPDR Gold Trust (symbol: GLD) to illustrate how the primary market works. Mainly through the creation and redemption process of shares, the GLD share price tracks the gold price.

Primary GLD market participants include (from the prospectus):

• The Sponsor (World Gold Trust Services, LLC, which oversees the performance of the Trustee and the Custodian)
• The Trustee (BNY Mellon Asset Servicing, which is responsible for the day-to-day administration of GLD)
• The Custodian (HSBC Bank plc, which holds the gold bars in custody, there can be sub custodians)
• The Authorised Participants (the institutions which are authorised to create and redeem GLD shares, at this moment the Authorised Participants are Barclays Capital, Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., P. Morgan Securities Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, Scotia Capital (USA) Inc., UBS Securities LLC and Virtu Financial BD LLC).

GLD is traded on the New York Stock Exchange Arca (NYSE Arca)

Exhibit 2. The (simplified) process of creation and redemption of GLD shares by an Authorised Participant through the Trustee.

If an Authorised Participant (AP) wants to create GLD shares, it needs to deposit gold into the account of the Trust and subsequently the Trustee will provide the AP with GLD shares. The creation application must be made in multiples of 100,000 shares (a block of 100,000 shares is called a basket). Since every GLD share represents approximately 0.1 ounce of gold, in order to create 100,000 GLD shares the AP needs to deposit 10,000 ounces of gold into the account of the Trust. (In reality, 1 GLD share actually represents a little less than 0.1 ounce of gold, the reason for this will be explained later on in this post.)

The redemption process works the other way round. If an AP wants to redeem GLD shares, it deposits 100,000 GLD shares at the Trust and subsequently the AP receives 10,000 ounces of gold.

The purpose of APs creating and redeeming GLD shares is usually arbitrage. As previously mentioned the gold equivalent of 1 GLD share is roughly 0.1 ounce, nevertheless GLD shares and actual gold are traded in two different markets. As a consequence, the price of 1 GLD share can differ from the price of 0.1 ounce of gold. If the price of GLD and the price of gold diverge, this is where arbitrage comes into play for the APs. Accordingly, the arbitrage by APs through creation and redemption of shares contributes to GLD’s price tracking the gold price.

Suppose (simplified), the price of 1 GLD share is $110 – caused by supply and demand for GLD shares at the NYSE Arca – while the price of 0.1 ounce of gold is $100 in the gold market. An AP can grasp this opportunity by buying (or first leasing) 10,000 ounces of gold to deposit in the GLD Trust account after which the Trustee will create 100,000 GLD shares for the AP. The new shares created are then sold by the AP on the stock market, which will cause the price of GLD to go down. The arbitrage opportunity will be used by APs until it’s closed.

If the price of GLD shares is lower than the price of gold, the arbitrage opportunity works the other way around, APs can buy shares, redeem them for gold at the Trustee and sell the gold.

In the aforementioned example trade when the AP (via the Trustee) created 100,000 GLD shares his investment was $10,000,000 (10,000 ounces at $100 per 0.1 ounce). The AP’s revenue was $11,000,000 (100,000 GLD shares worth $110 a piece). The AP’s profit in this exercise was $1,000,000.

($110-$100)*100,000 = $1,000,000

As readers can see from the example, the holdings of GLD were increased by 10,000 ounces of gold. Almost every day the holdings of GLD vary and the change is often caused by arbitrage of APs.

One theory is, when demand for GLD shares is strong (usually by Western investors) and the share price is trending higher than the price of the gold equivalent, the APs jump the arbitrage, create shares and GLD inventory swells. Then, if growth in GLD inventory correlates to a surging gold price (which can be observed in exhibit 3 below) we can speculate the gold bull market in part has been caused by Western investment demand in GLD.

Exhibit 3.

Now we have established the workings of the largest Western gold ETF, we will have a look at how the Chinese gold ETFs are constructed, and compare them to GLD.

China’s Gold ETF Market

Below are the 4 Chinese gold ETFs currently in existence that we’ll discuss.

1. – Bosera Gold Exchange Open-Ended Securities Investment Fund
2. – Guotai Gold Exchange Open-Ended Securities Investment Fund
3. – Huaán Yifu Gold Exchange Open-Ended Securities Investment Fund
4. – Efund Gold Exchange Open-Ended Securities Investment Fund

In China every gold ETF share represents approximately 0.01 gram of gold. By creating or redeeming gold ETF shares (Chinese) APs receive or deliver a basket of 300,000 shares, which equals to 3Kg of gold. This threshold is much lower than that of GLD, of which a basket equals to 310Kg of gold. The gold acceptable for Chinese ETFs are the spot (physical and spot deferred) gold contracts listed on theSGE – for example Au99.99. Therefore, all the physical holdings of China’s gold ETFs are stored within SGE designated vaults.

Moreover, there is a range of features that make China’s gold ETFs quite different from GLD.

1. Chinese Gold ETF Shares Can Also Be Created Or Redeemed Through Cash

Unlike GLD, which only allows the use of gold to create shares, and only allows the use of shares to redeem gold, China’s gold ETFs also allow shares to be created and redeemed through cash in the primary market. An AP can present cash to the Fund Manager who handles the creation and redemption process for a Chinese gold ETF. The Fund Manager is comparable to the Trustee of GLD. Thereby, through an AP individual investors can create or redeem gold ETF shares with cash as well.

Suppose, a Chinese investor wants to arbitrage the difference between the price of a gold ETF and the price of gold. In this example the price of the gold ETF is higher than the price of gold, so the investor want use cash to create shares to sell on the stock market. The investor can present cash to an AP who in turn will create shares via the Fund Manager. The amount of cash used in this transaction to create shares is equal to the cash value of the spot gold contracts that are needed to create the shares without the use of cash.

Vice versa, in case an investor wants to arbitrage the price of a gold ETF when it’s lower than the price of gold, the investor can present shares to an AP to redeem for cash.

Exhibit 4. Creation and redemption process of Chinese gold ETF shares through cash.

In China the APs can be securities firms and commercial banks. The securities firms are often not SGE members. Therefor, the number of APs that support gold ETF shares creation and redemption through cash is often larger than the number of those that support shares creation and redemption through spot gold contracts. For example, in the case of Efund Gold ETF, the fund has authorised 13 securities firms (APs) to process creation and redemption through cash, but only 2 banks (APs) to process creation and redemption through spot gold contracts (Industrial and Commercial Bank of China and Bank of Communications).

2. The Flexibility Of The Fund Manager

The Trustee of GLD doesn’t have much flexibility in managing the assets. Its duty is mainly processing the creation and redemption orders of GLD shares. Therefore, the gold holdings of GLD are mainly allocated gold and according to the prospectus [brackets added by me]:

Gold held in the Trust [GLD]’s allocated account is the property of the Trust and is not traded, leased or loaned under any circumstances.

In China, the Fund Managers of the gold ETFs have more flexibility. The gold contracts that China’s gold ETFs hold include not only spot physical contracts like Au99.99 and Au99.95, but can also be spot deferred contracts like Au (T+D), and notable all these “spot contracts” may be leased (sometimes swapped) within the SGE system. Additionally, every Chinese gold ETF can invest 10% of its fund assets (5 % of net fund assets in case of Efund Gold ETF) in “other financial instruments” allowed by the China Securities Regulatory Commission (CSRC).

For example, the excerpt below is from the Efund Gold ETF’s prospectus [brackets added by me]:

The investment scope of the Fund [Efund Gold ETF] is liquid financial instruments, including gold physical contracts (including spot physical contracts, spot deferred contracts, etc), bonds, asset-backed securities, bond repos, bank deposits, money market instruments, and other financial instruments which laws, regulations or the CSRC allow the Fund to invest in the future (but these have to satisfy the relevant rules of the CSRC).

If laws, regulations or regulatory institutions allow the Fund to invest in other instruments (including but not restricted to gold derivatives like forwards, futures, options and swaps), after necessary procedures, the Fund Manager will include them into the investment scope.

The portfolio percentage: The fund asset invested in gold spot contracts is not lower than 95% of the net asset value of the Fund.

All the 4 gold ETFs in China can participate in gold leasing. Some can participate in gold swaps and some can pledge the gold to borrow money. The excerpt below is from the Huaán Yifu Gold ETF Prospectus:

The Fund can do gold lease and pledge gold to borrow money.

Effectively the Fund Manager of the Huaán Yifu Gold ETF can make money by, for example, leasing the fund’s assets. The excerpt below is From the Guotai Gold ETF Prospectus:

The Fund can do gold lease, gold swap and invest in gold spot deferred contracts, etc, in order to lower the operating expenses and lower tracking error. The Fund does margin trade only for the purpose of risk management and enhancement of the efficiency of the asset allocation.

As a result, the Fund Managers of Chinese gold ETFs have significant flexibility in handling the fund assets. Please remember that all gold leasing, swapping, etc. has to be done within the SGE system and the gold cannot leave the SGE designated vaults. From the CSRC’s website [brackets added by me]:

Article 4. Gold ETFs may not deposit physical gold into the [SGE] vault or withdraw physical gold from the [SGE] vault. Margin trade is only for the purpose of risk management and enhancement of the efficiency of the asset allocation. 

Exhibit 5. The bottom row shows the minimum percentages the Gold ETFs must invest in “spot contracts”, though some of this gold can be involved in leasing.

3. NAV Per Share Recalculation

Since the inception of GLD in 2004 its share gold equivalent is steadily declining lower than 0.1 ounce of gold. That’s because the Sponsor, Trustee and Custodian don’t provide services for free. They need to earn money and their earnings must come from the Net Asset Value (NAV) of the ETF. In other words, the gold in the Trust is gradually sold to pay for operational expenses. From the GLD prospectus:

The amount of gold represented by the Shares will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.

Each outstanding Share represents a fractional, undivided interest in the gold held by the Trust. The Trust does not generate any income and regularly sells gold to pay for its ongoing expenses. Therefore, the amount of gold represented by each Share has gradually declined over time. This is also true with respect to Shares that are issued in exchange for additional deposits of gold into the Trust, as the amount of gold required to create Shares proportionately reflects the amount of gold represented by the Shares outstanding at the time of creation. Assuming a constant gold price, the trading price of the Shares is expected to gradually decline relative to the price of gold as the amount of gold represented by the Shares gradually declines.

On November 18, 2004, 1 GLD share exactly equaled 0.1 ounces of gold, but by now (September 2016) 1 GLD share equals 0.09542 ounces of gold, a decline of almost 5 % over the course of 12 years. This explains why currently the amount of ounces needed by an AP to create a basket of shares has become less than 10,000 ounces, and continues to decline.

In China’s gold ETF market, although the gold represented by the ETF instruments also decline as with GLD, the share values are periodically re-adjusted to ensure the NAV per share remains (roughly) 0.01 gram of gold. For example, from the Bosera Gold ETF prospectus:

Fund share re-calculation means the fund manager based on the necessity of the operation of the fund, under the premise that the total NAV is unchanged, adjusts the total fund shares outstanding and NAV per share. 

There is nothing complicated about the re-calculation. There are simply periodic adjustments when the Fund Manager sets the value of the shares (in yuan) higher because the gold content equivalent is elevated, from below 0.01 gram to 0.01 gram, whereby the Fund Manger “adjusts the total fund shares outstanding” downward.

4. Linked Funds

In China, every gold ETF is accompanied by a Linked Fund. The Linked Fund mainly invests in the Target Gold ETF as can be seen in the list below. The Linked Fund is usually a common open-ended mutual fund. While 90 % of the assets under management of the Linked Fund must be invested in its Target Gold ETF, the Fund Manager still has some room for managing the remaining 10%.

Exhibit 6.

For example, from the Bosera Gold ETF-linked Fund’s prospectus:

The Fund mainly invests in Bosera Gold Exchange Open-Ended Securities Investment Fund, gold contracts listed on the Shanghai Gold Exchange, gold futures contracts listed on the Shanghai Futures Exchange, bonds and other financial instruments which the CSRC allows the fund to invest, like securities lending and borrowing, gold lease, etc.

For more clarity I’ve drawn a graph to illustrate the ratios of investment allocation by the Guotai Gold ETF and the Guotai Gold ETF-linked Fund.

Exhibit 7.

Although, at this stage it’s not completely clear to me what would be the benefit for investors to invest in the Linked Fund, as opposed to the Target Gold ETF.

5. Voting Rights

GLD holders only have limited voting rights. The excerpt below is from the GLD prospectus,

Under the Trust Indenture, Shareholders have no voting rights, except in the following limited circumstances: (i) shareholders holding at least 66.66% of the Shares outstanding may vote to remove the Trustee; (ii) the Trustee may terminate the Trust upon the agreement of Shareholders owning at least 66.66% of the outstanding Shares; and (iii) certain amendments to the Trust Indenture require 51% or unanimous consent of the Shareholders.

In China’s gold ETFs shareholders have more voting rights and can vote to decide on a lot of important issues. The excerpt below is from the prospectus of Bosera Gold ETF:

In one of the following circumstances, based on the consent of the fund manager, the fund custodian or the fund shareholders who hold 10% (including 10%) of the fund shares outstanding, it is mandatory to hold fund shareholders’ meeting:

1. Termination of the fund contract;

2. Change of the operation of the fund;

3. Increase of the remuneration of the fund manager or the fund custodian, but excluding the circumstances in which the increase of the remuneration is mandatory by the requirements of laws or regulations;

4. Replacement of the fund manager or fund custodian;

5. Amendment of the fund category;

6. Amendment of the fund investment target, scope or strategy (excluding the circumstances in which laws, regulations or the CSRC have other relevant requirements);

7. Amendment of fund share holders’ meeting proceedings, voting methods and voting procedures;

8. Termination of listing but excluding circumstances in which the fund no longer satisfies listing requirements and the listing is terminated by the Shenzhen Stock Exchange;

9. Merger of the fund with other fund(s);

10. Other items that have material influence on the rights and responsibilities of the parties to the fund contract and necessitate the fund share holders’ meeting to amend the fund contract;

11. Other items that are required by laws, regulations, the fund contract or the requirements of the CSRC to hold the fund share holders’ meeting.

Even the Linked Fund shareholders of China’s Gold ETFs can participate in voting:

The fund shareholders of the linked fund of this fund can attend or send representatives to attend the fund shareholders’ meeting and participate in voting, based on the share holding of the linked fund. The equivalent number of fund shares with voting rights and correspondent votes are: the product of the total shares of this fund held by the linked fund multiplied by the linked fund shares held by the respective link fund share holder as a percentage of the total linked fund shares outstanding. The result of the calculation is rounded to the nearest whole number.

Ironically, to me there seems to be more democracy and openness in China’s gold ETFs than in GLD. On the other hand, Chinese gold ETFs have a fundamentally different foundation, a hybrid design I would say.

China’s gold ETF market was erected in 2013 and is still evolving. In the future, there may be more complex gold ETF related financial structures that have a big impact on China’s overall gold market. I shall follow it closely.

Addendum

In exhibit 5 we can see which Chinese commercial bank is the custodians of which Chinese gold ETF. Without a doubt the physical holdings in each Chinese gold ETF (exhibit 1), stored within SGE designated vaults, will appear on the bank balance sheet of the custodian bank. This (important) information will be added to my previous post What Are These Huge Tonnages In “Precious Metals” On Chinese Commercial Bank Balance Sheets? as a new chapter.

The main sources used for this article are the prospectuses from the Bosera Gold ETF, Guotai Gold ETF, Huaán Yifu Gold ETF and Efund Gold ETF, and the prospectuses of the Linked Funds of these Gold ETFs, Bosera Gold ETF-linked fund, Guotai Gold ETF-linked fund, Huaán Yifu Gold ETF-linked fund and Efund Gold ETF-linked fund)

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