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By James Robins Of The National Interest

Would America Go To War With Russia?

Vice President Biden was in Warsaw last week to reassure our eastern NATO allies that they have the support of a “steadfast ally.” But if Russia moved against Poland or the Baltic States, would the United States really go to war? Or would we do nothing and effectively destroy the NATO alliance?

President Obama has ruled out a “military excursion” in Ukraine. America is not obligated legally to take action against Russia for annexing Crimea. We would not go to war if Russia mounted a large-scale invasion of Ukraine to restore the ousted, pro-Moscow government of Viktor Yanukovych, currently under U.S. sanctions. And we would not even send troops if Ukraine was partitioned, or absorbed by Russia. Americans have no interest in such a conflict, and no stomach for it.

NATO allies are a different matter. The North Atlantic Treaty is a mutual-defense pact, and Article 5 says that an armed attack against one member state “shall be considered an attack against them all.” This is a clear red line. The only time Article 5 has been invoked was in the wake of the September 11, 2001 terrorist attacks, and most NATO allies sent troops to support the efforts in Afghanistan and Iraq.

Could the current crisis expand to touch NATO? The developing situation in Ukraine has been compared to Germany’s absorption of Austria in 1938, or the subsequent partition and dismemberment of Czechoslovakia. Hillary Clinton compared Russian president Vladimir Putin to Adolf Hitler, which by extension puts President Obama in the role of British prime minister Neville Chamberlain, who famously failed to achieve “peace in our time” at Munich.

Push the analogy further. The Second World War was sparked by Warsaw’s resistance to Berlin’s demand to annex the Polish Corridor, a small stretch of land—smaller than Crimea—separating the German provinces of Pomerania and East Prussia. Hitler responded by invading Poland and partitioning it with the Soviet Union. Britain and France had pledged to defend Polish independence, and two days after Germany invaded, they declared war. In his war message, Chamberlain explained that Hitler’s actions showed “there is no chance of expecting that this man will ever give up his practice of using force to gain his will. He can only be stopped by force.”

This may or may not describe Mr. Putin, as Mrs. Clinton alleged. But if similar circumstances arise in the near future, will the United States honor security guarantees made to Poland and the Baltic States when the Russian threat was only a theory?

Mr. Biden stood with Estonian president Toomas Ilves Tuesday to “reconfirm and reaffirm our shared commitment to collective self-defense, to Article 5.” He wanted to make it “absolutely clear what it means to the Estonian people” and that “President Obama and I view Article 5 of the NATO Treaty as an absolutely solemn commitment which we will honor—we will honor.” Shortly thereafter, Moscow “expressed concern” about the treatment of ethnic Russians in Estonia. Mr. Putin justified his actions in Crimea as “restoring unity” to Russian people. Estonia’s population is 25 percent ethnic Russian, compared to 17 percent in Ukraine, mostly in the north and east part of the country. Suppose anti-Russian riots “spontaneously” broke out in Estonia. What would the United States do if Moscow invoked a “responsibility to protect” these people and bring them “back” to the Motherland? Would President Obama take military action against Russia over a small, secluded piece of a tiny, distant country? Would it be like the Polish Corridor in 1939? This is highly doubtful—highly doubtful.

Aren’t we obligated by treaty to intervene? Mr. Biden mentioned the “absolutely solemn commitment which we will honor.” It was so important he said it twice. However, Article 5 says that NATO members pledge to come to the assistance of the attacked state using “such action as it deems necessary, including the use of armed force.” It doesn’t take a White House lawyer to see the gaping loophole—President Obama can simply deem that the use of U.S. force isn’t necessary. He can walk back the red line, as he did with Syria. Stern talk and minimal sanctions would follow, but Estonia would lose some, if not all of its territory. And in practical terms it would mean the end of NATO, which is one of Moscow’s longstanding strategic objectives. Mr. Putin’s chess game does not end in Crimea.

via Zero Hedge http://ift.tt/1nQEdcC Tyler Durden

For the answer of which firm is responsible, and has the largest number of current and former tenants occupying the building located at 15 CPW which we profiled before, and which Bloomberg TV defines as the “world’s most powerful address” – a location whose residents control nearly half a trillion in assets under managemnet – fast forward to 3:20 in the clip below. Hint: listen for the “dog whistle.”

For those curious, here are some additional facts about 15 CPW courtesy of Curbed.

1) Which investment legend bad-mouthed 15CPW after the developers refused to give him a discount? He wanted half off the price of a $45 million penthouse. Then an upstart swooped in and paid full ask. For a bonus point, name the upstart, too. Carl Icahn. The upstart was Daniel Loeb.

2) Which movie star got a discount for letting the developers reveal he’d bought a 14th-floor apartment in the front “house” section of the building for just over $13 million? Denzel Washington.

3) How many convicted felons live at 15 Central Park West? One. Adam Weitsman was convicted of check-kiting and did time in federal prison.

4) Which reality TV personality found out her actor husband was cheating on her when a building staff member told her his wife was already upstairs… when it was really the other woman? Spoiler alert: She promptly divorced him. Camille Grammer.

 5) 15 CPW’s private lobby restaurant hosts special meals all year round, including “women’s lunches” every two weeks with speakers on such subjects as yoga, art collecting, and surgery-free “facial rejuvenation.” How much is the Mother’s Day lunch there? $55 a head for adults, $25 for kids, and Mom gets a special drink gratis.

6) How many Goldman Sachs executives and alumni live at 15? Nine, including Lloyd Blankfein, who runs the legendary, vampire squid-likened investment bank.

7) Who are Sting’s duplex-owning next-door neighbors on the 16th and 17th floors of 15CPW’s house building? Speak of the devil, there’s Lloyd Blankfein of Goldman Sachs in apartment 16A, and Omid Kordestani of Google in apartment 16C.

8) Which real estate mogul was barred from bidding for the 15CPW site while an old building, the Mayflower Hotel, still stood there? It so happens that the banned prospective bidder told the sellers, representatives of the Goulandris family, that their price—which had to be in excess of $300 million —was crazy. Donald Trump.

9) What price did the sellers end up getting from the Zeckendorfs $401,050,000.

10) How much money did the Zeckedorfs pay the last holdout tenant to vacate his apartment in the building that previously occupied the site and was razed to make way for 15? $17 million, plus a free condo for life at the Essex House.

11) What building did Russian oligarch Dmitry Rybolovlev spurn to buy an $88 million penthouse, said to be for his daughter, at 15CPW? (UPDATE: A rep for Rybolovlev has reached out to say that in fact his daughter, Ekaterina, purchased the apartment through a trust.) That purchase, by the way, still holds the record for most expensive single-family residential property in New York City. Jean Nouvel’s 100 Eleventh Avenue. The entity that owns Rybolovlev’s 15 penthouse is, wittily, called Property NY 100–11 LLC.

via Zero Hedge http://ift.tt/1haNmni Tyler Durden

Remember this country, the place which about a year ago was supposed to be “Ukraine” in terms of geopolitical escalations:

Well, in the aftermath of what appears a tenuous detente over the Crimea while Putin plans his next step of how to “merge” with east Ukraine as he sets off to rebuild the USSR, Syria just may be set to regain its place at the top of the global geopolitical risk pyramid. Case in point, early this morning, the fragile ceasefire between Syria and Turkey was shatered after a Turkish F- 16 shot down a Syrian plane on Sunday after it crossed into Turkish air space in a border region where Syrian rebels have been battling President Bashar al-Assad’s forces.

A photo of the falling plane was caught by twitter:

Anatolian Agency take the photos of Syrian jet down http://ift.tt/1gpKAiO

— Cüneyt Toros (@cuneyttoros) March 23, 2014

Reuters reports:

“A Syrian plane violated our airspace,” Prime Minister Tayyip Erdogan told an election rally of his supporters in northwest Turkey. “Our F-16s took off and hit this plane. Why? Because if you violate my airspace, our slap after this will be hard,”

 

The rebels have been fighting for control of the Kasab crossing, the border region, since Friday, when they launched an offensive which Syrian authorities say was backed by Turkey’s military.

 

Syria said Turkish air defenses shot down the jet while it was attacking rebel forces inside Syrian territory, calling the move a “blatant aggression”.

 

State television quoted a military source as saying the pilot managed to eject from the plane. The Syrian Observatory for Human Rights monitoring group said initial reports from the area said the plane came down on the Syrian side of the border.

 

Al Manar, the television station of Assad’s Lebanese ally Hezbollah, said two rockets had been fired from Turkish territory at the Syrian jet.

Amazingly, here is a clip of a live broadcast by HaberTurk which appears to have caught the moment of the plane’s crash live on video.

Why did Turkey really engage? Simple: to deflect from PM Erdogan’s relentless political collapse when one after another political scandal is hitting the embattled premier who last week shut down access to Twitter, and it likely set to block YouTube as well, where a phone recording of his admitting graft and embezzlement can still be found. Naturally, it struck at the one country it knows will hardly fight back against the NATO member, although now that Russian foreign policy sentiment is once again shifting dramatically, and may call for far greater support for Syria, not to mention that suddenly Turkey is hardly in “democratic” Europe’s good graces in the aftermath of the Twitter censorship scandal, Erdogan may just have miscalculated.

As for the next steps in Turkey, we repeat what we said on Friday: “We eagerly look forward to see which particular pro-Western agent is groomed to take Erdogan’s place. After all remember: those Qatari gas pipelines that in a parallel universe, one without Putin, would have already been transporting nat gas under Syria, would enter Europe under Turkey.”

Surely following yet another “chess” victory by Putin in the foreign relations arena, the urgency to find that Qatari natgas outlet to Europe is that much greater…

via Zero Hedge http://ift.tt/1poFdzV Tyler Durden

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Investors will be fleeing Europe, they’ll be moving from Russia, getting far away from the USA as they can get and they’ll be going where the sun shines longer: Africa. Why? Simply because it’s worth it and the investment prospects there are far greater than they are anywhere else right now.

If you look at the top ten of places to invest in the world in the worrying times of the Chinese economy and the Indian woes, Africa has six countries that are worth taking a look at. They include Kenya, Angola, South Africa and Nigeria. Africa is said to have a potential growth of 6% in years to come and money can be made by investing there. Capitalizing on African economies is no plain sailing though and the instability (despite the apparent improvement of that) means that money can be made but perhaps not quite in the circumstances as any other country. It’s full of risks but if you invest, there’s greater potential than elsewhere right now. But, where does no-risk investment exist?

OECD nations are failing to grow despite whatever we might be told by governments round the world and Western economies are failing dismally to provide good investment projects. Few are willing or ready to take the plunge, however. That might be something good if you have the guts to do it.

South Africa, for example has clearly suffered from the withdrawal of Quantitative Easing and the billions been poured into emerging markets around the world. Economic growth has been cut from 3.2% to 2.7%, but that’s a lot more than what is being experienced either in Europe or in the USA today. Economists predict that economic growth for the country will improve to about 3.4% by 2015. Global demand has increased for South African countries and local exports. What is aiding African countries is the fact that they have huge potential as a market and secondly that they have a growth in population. Naturally, everything will depend on whether or not the developed markets continue purchasing and whether they have enough to be able to do so. Naturally, there has to be improvement in South Africa’s infrastructure and its logistics costs as well as improved competition between companies there before things can get better in terms of economic growth.

Wherever there is a link with the global economy, turbulence has been felt and Africa is no exception. The forecasts for this year for the entire continent are at around 5.3%. There has been a steady increase in economic growth from 2012’s figure of 4.2% (after excluding Libya’s oil production, which had previously madeGDP shoot up to 6.6%). Growth in countries has occurred economically, but not in terms of reducing the poverty levels in the country and there is persisting unemployment. There is the potential to employ and a potential to create jobs and reap the rewards of that.

In 2011, it was the European Union that purchased one third of African exports (but that was already a reduction from 2006’s figure of 37%). 11% of exports went to the USA. China stands at roughly 10% today (up from 6% 5 years before). Everything depends on what happens in Europe and also in China. But, the continent of Africa has the internal potential of its own markets in the years to come and that might mean long-term investment in that continent. Despite the failing of the markets of the EU and China, with which the countries in Africa seem dependent, they have still managed to survive the financial crisis and have positive figures for growth.

Investors won’t be staying in Africa, but they’ll be there to exploit them just as long and as much as they can. Africa has been exploited by the West, by Europe and by the entire world over its history. But, it’s the investors that will make the biggest big-game killing by going there today.

This is a return-ticket to Africa, where the investors will be soaking up the sun while the masses slave away on the dusty roads to success for the West.

Originally posted: Return-Ticket Investment to Africa, Please

 

via Zero Hedge http://ift.tt/1fRvNYn Pivotfarm

The situation with Russia should give investors and traders a reason to brush up on their history, as current events take root in things that happened 50, 100, and 200 years ago.  To understand this, can provide perspective, during an information war, where it’s not easy for some to separate facts from beliefs and propoganda (on both sides).  The relationship between US and Russia has always been interesting, as we shall explore.

The cultural divide

The US and Russia have very similar cultures.  Both; superpowers, with a vast countryside, dominated mostly by white Christians.  Both have vast resources, difficult to invade, and both have been the victim of European and other external politics.  Of course Russian culture is much older, and has a different set of influences and experiences than the US, situated in North America.  

There’s probably more misinformation in between the two cultures than any other, because for 60 years both have spent significant effort in propoganda.  So it’s difficult for most Westerners to be objective on this topic.

One theory on the divide between the two similar cultures was the decision for Russia to accept Christian Orthodoxy, started by Peter the Great.  If you look the dividing lines of political and economic alliances in Europe, historically, there seems to be a correlation with the dominant religion.  

The American Revolution

One interesting fact not reported much was Russian support for America during the American Revolution, both directly and by financing France, and through diplomatic and trade ties.  Not that Russia was doing the US any favors in that time, it simply supported their situation, and that they had an interest to not support the British.  But it should not be forgotten, that Russian support was crucial for the Americans in their struggle against the British.

Alaska

Ironically, considering the current US policy about Crimea, the Alaska purchase happened due to circumstances during the Crimean war:

After the Crimean War (1853-1856) Russia felt concern that the British would seize Russian America if a war broke out, strengthening the British in the north Pacific. To avoid this and to raise money, Russia offered in 1859 to sell the territory. In 1867 the United States purchased the whole of Russian America (Alaska) in the Alaska Purchase. All the Russian administrators and military left Alaska but some missionaries stayed on because they had converted many natives to the Russian Orthodox faith.^[20]

US annexations

The larger territory of the current United States was largely purchased or annexed (skipping the original 13 colonies which is a whole different issue).  Since the Revolutionay War, the US has aquired most of its territory by this method.  In that time the US was a new country.  These new aquisitions were exploited by the US, and helped fuel the US industrial revolution, and finally, what enabled the US to build a war machine during the 1940’s.

World War 2

World War 2 was the defining moment in American history when the US rose to superpower status, eventually creating the US Dollar as the dominant currency for trade in the world.  Before World War 2 (and more so before WW1) the US was largely isolationist, not seeing the relevance of foreign affairs.  But due to a number of circumstances, and the influence of the British (again, ironically) the US entered WW2 which changed world history.  It should be remembered however, that this was a new idea.  Before WW2 the US Army was largely comprised of Calvary soldiers on horseback.  There was no real Army capable of fighting in that time, the US was not prepared for war.  There was not a significant Navy, and certainly no advanced military technology, and no nukes.  While most of the world was at war, the US was able to convert its industry, organized by powerful US corporations, to build munitions instead of consumer goods and other products (guns vs. butter).  This gave the US the advantage, finally ‘winning’ the war, and leaving many nations indebted to the US.  This is important because this is the origin of American power, and many of these relationships, such as US-German relations, and US-Japan relations, exist to this day, because of WW2.

Since WW2, most countries choose to use the US “Petrodollar” – for a number of reasons.  But the system is very fragile; as we can see from its origins.  For example the deciding factor of ‘winning’ WW2 was the Manhatten Project, composed of many refugee German scientists.  Historians have explored that Germany was in fact working on a similar bomb, but due to their extensive obligations in their operations, were not able to complete it.  That, and other advanced technology being developed by Nazi scientists, certainly would have created a different world, economically speaking.

European influence

Both the US and Russia have been largely influenced by Europe, both in trade and politics.  But differently, Russia has been invaded many times by aggressive forces, which the US has not (aside from Canadians burning down the White House but this was not militarily significant).  Yes, Japan bombed Pearl Harbor, but only because Roosevelt threatened to cut of their oil supply.  And it certainly was not an ‘invasion’ – such as happened to Russia during WW2.  In many ways, Russia is more the victim; or at least to say has experienced more hardship as a nation, due to circumstances beyond their control, mostly created by outside influences.  

Origins of the Cold War

Henry Kissinger had recommended to Nixon that one of the most important strategic alliances for the US to pursue was with Russia.  His logic was that both countries were culturally similar (more so than for example China) and that a deal with Russia would have cemted both countries long term supremacy and boosted trade.  This was never pursued (and maybe never considered) in favor of a hostile policy thus creating the cold war, but it allowed huge spending into the military industrial complex.  Since then, the US instead chose to have a special relationship with China, which is now on the verge of a major financial bubble.

During this era, the CIA did and intensive analysis of the potential military risk of Russian aggression.  The CIA concluded that the Russians have no intention and no capability of posing any risk to the US.  But in a press conference, Rumsfeld eloquently said that “Just because we didn’t find any threat or capability, doesn’t mean they don’t have one” and based on this reasoning, we entered the cold war.  

This information indicates, it was US hawks that initiated an aggressive policy against Russia first.  General Patton has pleaded with his commanders to fight the Russians in Germany.  Although the cultures are similar, there seems to be some genetic mistrust (or can be explained in a number of different ways, but its not rational).  In any case, billions have been spent on propoganda demonizing Russians that they are ‘criminals’ – according to one prominent propoganda film, Communism is an “International Criminal Conspiracy” (although it was Wall Street that financed the Bolshevik Revolution).

It would be extremely politically inappropriate to mention Israel in this context.

Nuclear Age

Since WW2, real war between two states has become impractical, between nuclear powers.  Even with other states, the alliance with a nuclear power then makes war just as impractical.  The new war can only involve minor tit for tat conflicts, or be economic.  Possibly for this reason, policy makers and scholars in Russia have started incorporating a policy of ‘tanks not banks’.  This also may explain why the US has not annexed any territory since WW2, and many other policy shifts.

Markets Politicized

Supposedly, free markets operate based on free and open trade.  By imposing sanctions, limiting the use of the SWIFT system, and blocking Visa transactions, it changes the dynamics of the market, irrespective of the potential harm to targeted parties (although many analysts conclude sanctions will harm the West more than Russia).  Russian banks and oligarchs probably own at least a few shares of almost all US issues.  A certain majority of Russians are NFA members, RAs, etc.  Our economies are intertwined, all economies are intertwined, a policy forwarded by those such as Thomas Friedman.  

If sanctions include the asset freezes of any company owned by a Russian, does that include Bank of America, Caterpiller, McDonalds, etc.?  What about holdings of the oligarchs, Russian banks, citizens, inside the US?

Russian position

As one commentator said, the US is playing marbles, and the Russians are playing Chess.  The following video is a must watch, vivid analysis of the Russian position.  It’s no indication that this will or will not happen, but in this case, they are holding all the economic cards:

The situation in Crimea, which has nothing to do with the west, is irrelevant for the West.  The relationship with Russia participating in the Western economic system is a net benefit to the West.  Russian businesses operate in the US, UK, Germany (not to mention supplying energy to the EU) and invest in the West.  They are great customers.  Obviously the current administration never worked in the real economy, learning the expression that “The customer is always right.”  Since Crimea was previously part of Russia, and its mostly Russian speaking, Russians living there, this is really a non-event.  

West position

Not understanding all this, the West has created a situation where many will question the legitimacy of Western markets.  Making the economy political changes the dynamics of the market.  If we traders and investors spend our energy analyzing the markets to make decisions, and then to have our assets seized or a company we invest in, then it seems we are all in the wrong business.  Certainly that is not the idea of capitalism, or free markets.  Like during the 2008 credit crisis, when we explored the idea of losses are socialized and profits privatized, this is a very bad omen for not only the asset values, but also the proper functioning of the market.  

Don’t forget 1991 and 1998

When the Soviet Union collapsed in 1991, trillions of dollars flowed into the West, creating and economic boom for a decade.  Oligarchs seized control of previously state owned assets and many of them invested in the West.  Trade opened, and the West did business in Russia.  One of the dominant Forex trading platforms is from Kazan, Russia (Meta Trader).  The economic effects of this event have only been slightly examined – however it can be said they were significant.

Then, in 1998, Russia devalued the Ruble and defaulted on some of its obligations, in a period of economic reorganization.  The 1998 event is significant because it almost collapsed the world financial system – not by intention, but because of volatility created, which the largest hedge fund in the world at that time, LTCM, was exposed to.  Specifically, LTCM was not exposed so much to Russia directly (they were) but it created a chain of events that created havoc in the derivatives market, opening but bond and option spreads to unseen levels, and destroying liquidity (similar to what happened in 2008 which was a US issue).

Conclusion

It would not be difficult for Russia to start pricing goods in non-USD.  Certainly, the US is not going to nuclear war to protect the Petrodollar, as was done in Iraq, Libya, and others.  Russia is a huge consumer of USD, not only for reserves, but for trade.  Russia has a very strong position, it likes the relationship with the USD, but if Russia feels that its becoming a net loser, it will not think twice about using Gold, Euros, Rubles, or some new Russian Bitcoin.  Also it will have a tremendous negative impact on US markets, as Russian money flows out, and trade encouters problems.

Any event such as this can create huge volatility in the USD and other US markets.  At that time, it’s possible the US will react with further political moves to protect the USD (such as Nixon did, not honoring payments in Gold for USD creating modern Forex) including but not limited to, limiting the sale of USD.

Clearly, none of the suggested policies would be profitable.  There’s more money to be made by trading, than through taxes and government restrictions, price controls, capital controls, and other regulations.  Dodd-Frank destroyed the retail Forex market in the US.  This situation can have far more damage.  But traders and investors should be vigilant, understand what’s at stake, and understand the potential market impacts; either to profit, or to protect their portfolios.

via Zero Hedge http://ift.tt/OJpzEl globalintelhub

A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.

 

China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.

 

Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.

We will explain why below.

First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created  out of thin air.

For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.

One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”

We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.

Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)  

Just what are CCFDs?

The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.

As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.

While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:

the volume of physical inventories that is involved

commodity prices

the number of circulations

A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.

As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:

• China is heavily reliant on the seaborne market for the commodity
• the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
• the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
• the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.

Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.

Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.

Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.

In detail, Chinese gold financing deals includes four steps:

1. onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
2. offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
3. onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
4. repeat step 1-3

This is shown in the chart below:

 

As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.

Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.

However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”

Recall the flowchart for copper funding deals:

1. Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
2. Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
3. Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
4. Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.

In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!

Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:

We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .

Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!

Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:

• the China and ex-China interest rate differential (the primary source of revenue),
• CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
• the cost of commodity storage (a cost),
• the commodity market spread (the spread is the difference between the futures
• China’s capital controls remain in place (otherwise CCFD would not be necessary).

All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).

Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.

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That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.

The answer is simple: the gold paper market.

And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.

Now we know for a fact. To wit from Goldman:

From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .

Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.

 

We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.

And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime.

Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.

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This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.

In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for.  This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.

via Zero Hedge http://ift.tt/1dcWHPG Tyler Durden