We’re now six months into the greatest credit crunch of the modern era. Defaults on mortgages, have skyrocketed as individuals find it more advantageous to mail the house keys back to the lender rather than make sharply higher reset payments they can’t afford.
It’s not just the borrowers who are suffering. It’s also the banks, pension funds, life insurance companies and individual investors who bought toxic mortgages, repackaged as complex securities from Wall Street investment banks.
But the roller coaster ride of bank and financial system losses has merely just begun:
This could spark a substantial sell-off by institutional investors such as pension funds that can only invest in top-rate securities, causing their value to drop. That in turn would prompt even more selling. As the securities become less valuable, Wall Street firms could be forced to write down billions of dollars on their balance sheets, restating how much their holdings of these securities are worth. The banks, which have already suffered staggering losses, have relied heavily on bond insurance to reduce their exposure to subprime mortgage debt and other complicated securities linked to these loans.
"Everyone thinks they're looking at the cliff over Armageddon," said Ed Rombach, senior derivatives analyst at Thomson Financial. "If you think the write-downs have been bad so far, the next write-downs could be twice as big."
End of the Line for Monolines
Just a few days ago Merrill Lynch stunned Wall Street by reporting a net quarterly loss of nearly $10 Billion. It was the worst quarter in company history. This much was well reported.
These downgrades mean a lot more losses are in the works for financial institutions. If all the bond insurers were to be downgraded, that would mean $200 Billion in losses for whoever holds debt that is insured by the monolines. If the monolines all go bankrupt then the losses would be much more.
Created by Ronald Reagan back in 1988 through executive order 12631, the Working Group on Financial Markets, also known as the Plunge Protection Team (PPT) was created to respond to events in the financial markets surrounding October 19, 1987 ('Black Monday').
The Current PPT group is made up of:
Treasury Secretary Paulson (Chairman of the PPT)
Ben Bernanke (Chairman of the Board, Federal Reserve System)
These four PPT Kingpins, with inputs/suggestions from their numerous advisors, are currently operating in panic mode and are attempting to gin up new ways to thrust new money into the falling markets and US economy. The present situation has become so precarious they are now routinely advising President Bush and were actually the “brains” behind recent calls for tax rebates -- meant to pump up consumer spending. In the meantime (tax rebates will take time), they are using government funds to pump money into the futures markets--in an attempt to "fry" the shorts and make the impression that big money is buying up the falling market. The hope is: if other traders see this, they will start following the big money higher (probably futile).
"By passing an effective growth package quickly we can provide a shot in the arm to keep a fundamentally strong economy healthy," said the president.
He said that his advisers believe the economy can keep growing, but that the risk of a downturn has convinced him to back a stimulus package.
"There are also times when swift and temporary actions can help ensure that inevitable market adjustments do not undermine the health of the broader economy," Bush said. "This is such a moment."
Federal Open Market Committee Rate Decision Due on 30 January 08
What should we expect? I think, due to recent market weakness, a 50bp cut is an absolute certainty while a 75bp cut is looking more probable by the day. My thoughts are: if we don’t see some market improvements soon, we may well see an emergency rate cut before the 30th, followed by another on Jan 30 – a total cut of 75bp or better.
So, what does all this mean for gold
Gold bounced from a one-week low on Friday after this week's climb to a record above $900 an ounce, but the market could consolidate before charging higher, fund managers and analysts said.
All eyes were on a U.S. Federal Reserve meeting on interest rates Jan. 29-30 after Chairman Ben Bernanke told a congressional committee more rate cuts might be required as the economic outlook worsened.
"Gold is consolidating after touching recent highs," said Christoph Eibl, head of trading at Tiberius Asset Management, noting that there had been some investor selling of gold held in exchange-traded funds (ETFs).
"ETF investors ... are holders rather than traders, therefore the recent drop has some strength," he said.
Gold's drop from the record high was partly driven by selling from investors and funds to cover margin calls from losses in stock markets amid fears of a recession in the United States.
Gold's investment appeal was intact owing to flight-to-quality demand on the back of turmoil in financial markets as a result of a mortgage-related crisis and worries about higher inflation.
"External factors such as higher inflation expectations, broader economic concerns, geopolitical tensions and Fed rate easing are likely to drive prices higher," Barclays Capital said in a report.
The World Melts for Gold
Gold-bug fever is spreading.
From China to the Middle East, new ways to invest in gold are rapidly popping up in developing countries. It's transforming the market for one of mankind's most venerable ways to sock away wealth.
The door is opening to a new class of investors who previously wouldn't have had access to gold futures and other tools. Their rush to invest has helped fuel soaring prices -- gold crossed $900 an ounce for a time in the past week, and there are some calls for $1,000 -- while adding volatile new dynamics to the market.
The democratization of gold speculation outside traditional Western financial centers has the potential to magnify the already strong appeal of gold as a hedge against global recession, inflation or just general uncertainty.
Stimulated by expectations of U.S. interest rate cuts and soaring global oil prices, gold reached an all-time high earlier this month. Citibank estimated its price is expected to hit 1,000 U.S. dollars an ounce this year.
The strong upward trend has attracted individual Chinese investors such as Yao Yun. The chief financial officer of a Shanghai-based foreign company bought 50,000 yuan (6,849 U.S. dollars) in gold bars and the price has risen by 12 yuan per gram in just half a month.
"I believe the price will keep rising," he said. "The stock market is too volatile, and the real estate sector is subjected to macro-control. Investing in gold is a good choice at this time."
In Caishikou Department Store, a popular physical gold dealer in Beijing, more than 100 people lined up to purchase bullion for the Lunar Year of the Mouse on Nov. 22, the first trading day of the products. More than 200 kilograms of the gold bars were sold within 1.5 hours. Moreover, the total subscription amounted to two tons.
Li Xiang, a manager of the department store, said sales of gold products surged more than 50 percent to 2.38 billion yuan in 2007.
Experts believe the China gold futures market will grow into a leading global market as it was launched at a time when international gold prices have repeatedly been hitting new highs. Global prices jumped more than 30 percent throughout last year, representing the biggest increase since 1979.
Russia’s gold and forex reserves reach all-time high
Russia’s gold and foreign currency reserves have increased by $11.5 billion (2.5 percent) over the past three weeks, to $477.7 billion. This is the highest level since records began.
Bottom Line w/regard to Gold:
Summary of this article:
Major problems are on the horizon, markets are reeling and the mainstream is finally catching on to what we've been predicting for quite some time. The Plunge Protection Team however is working overtime and with an oversold equities market, I expect to see a short-term bounce, but it will fail to ultimately recover or impress.
Additionally, the Fed is certain to cut rates big-time in the coming weeks, and Congress will approve some sort of stimulus plan next week (probably too little too late), but once the Monoline downgrades (w/more to come) start the chain reaction of downgrade/markdown dominoes, we will begin to hear the fat lady sing.
As an aside, these new rate cuts and stimulus plans will most certainly cause the dollar to plummet to new all-time lows, and consumer inflation (already running at > 12%--see blue line on chart below) will soar, causing gold to take off on another tremendous up-leg.