Tuesday, July 13, 2010

Morning Note...

Futures ~1% higher this morning on bullish earnings commentary and an earnings beat from CSX, a solid beat from AA, and a better-than-expected bond offering from Greece (their first since their bail-out).  On the negative side, Moody’s cut Portugal’s debt rating but maintained its outlook at “stable.”  (Also note that S&P made this same rating change back in May.)  In Germany, the ZEW business confidence survey came in lighter than expected.  In the U.K., inflation measures came in higher than expected.  In U.S. economic news, the trade deficit widened in May to the highest level since November 2008.  Regarding Greece, they successfully placed 1.3 billion euros of 26-week bills below 5%, which was the rate charged by the EU for the bailout.  This is signaling to investors that the country may not be facing punitive interest rates as it borrows funds.  Looking ahead, earnings reports from YUM and INTC are expected later today.  We should also see a FinReg vote in the Senate by this Thursday, and an unemployment extension is expected to be signed into law as well.  GOOG, BAC, C, GE, and JPM earnings are also due later in the week, and the most recent FOMC minutes will be released tomorrow. 

For those who missed it, this London Telegraph article references the “under the radar” gold swap that recently rattled the gold bugs:

Secret gold swap has spooked the market

It takes a lot to spook the solid old gold market. But when it emerged last week that one or more banks had lent 380 tonnes of gold to the Bank of International Settlements in return for foreign currencies, there was widespread surprise and confusion

By Rowena Mason
Published: 6:10PM BST 11 Jul 2010

The news that a mystery bank has just pawned the family jewels gave traders a jolt – nervous about the sudden transfer of almost 20pc of the world's annual gold production and the possibility of a sell-off.

In a tiny footnote in its annual report, the bank disclosed its unusually large holding of gold, compared with nothing the year before. The disclosure was a large factor in the correction of the gold price this week, which fell below $1,200 for the first time in more than a month.

Concerns hinged on whether the BIS could potentially sell on this vast cache of bullion in the event of a default, flooding the market with liquidity. It appears to have raised $14bn for whoever's been doing the swapping – small fry on the currency markets, but serious liquidity in the gold market.

Denominated in euros, gold has fallen 8pc since the beginning of the month and is now trading at a seven-week low of €937 per troy ounce.

The big gold exchange traded funds (ETFs) – having peaked at record inflows in May – have also been showing net outflows over the past few days.

Meanwhile, economists and gold market-watchers were determined to hunt down which bank is short of cash – curious about who is using their stash of precious metal for what looks suspiciously like a secret bailout.

At first it looked like the BIS was swapping gold with a troubled central bank. After all, the institution is the central bankers' bank and its purpose to conduct transactions with national monetary authorities.

Central banks in the troubled southern zone of Europe were considered the most likely perpetrators.

According to the World Gold Council, central banks in Greece, Spain and Portugal held 112.2, 281.6 and 382.5 tons of gold respectively in June – leading analysts to point fingers at Portugal, or a combination of the three.

But Edel Tully, an analyst from UBS, noted that eurozone central banks would be severely limited with what they could do with the influx of extra cash – unable to transfer it straight to governments or make use of the primary bond markets.

She then listed the only other potential monetary authorities with enough gold as the US, China, Switzerland, Japan, Russia, India and Taiwan – and the International Monetary Fund.

This led to musings that the counterparty was the IMF, making sense because the lender of last resort is historically prone to cash shortages and has been quietly selling off gold in the first half of the year.

Renowned gold expert Jim Sinclair adopted this explanation. The panic came when people mistook a lease for a swap, he argues. Far from being a big release of gold into the market, it is simply a commercial arrangement between the IMF and BIS with a favourable rate of interest paid for the foreign currency.

"Gold swaps are usually undertaken by monetary authorities," he writes on his industry blog, MineSet. "The gold is exchanged for foreign exchange deposits with an agreement that the transaction be unwound at a future time at an agreed price.

"The IMF will pay interest on the foreign exchange received. Historically swaps occur when entities like the IMF have a need for foreign exchange, but do not wish to sell the gold. In this case, gold is a leveraging device for needed currency to meet requirements.

"The many reports that characterise the large IMF gold swap as a sale of gold into the markets do not understand the difference between a swap and a lease."

However, the day after original reports about the swaps, BIS emailed a statement saying that the swaps had not been conducted with monetary authorities but purely with commercial banks.

This did nothing to quell the sense of mystery surrounding the deal or deals. It is almost inconceivable that a single commercial bank could have accumulated so much gold alone. And cynics have suggested that the whole affair still looks like a secretive European bailout that a single country wants to keep quiet.

In this case, one or more of the so-called bullion banks – which act as wholesale market-makers and include Goldman Sachs, Deutsche Bank, JP Morgan, HSBC, Barclays, UBS, Societe Generale, Mitsui and the Bank of Nova Scotia – would have agreed to act on behalf of a monetary authority.

This would add an extra layer of anonymity. "So the BIS swaps look like a tripartite transaction," writes Adrian Douglas of the Gold Anti-Trust Association. "The commercial bank or banks made a swap with a central bank or banks and then the commercial bank or banks made a swap with the BIS."

Analysts for Commerzbank note that in the meantime, "The price of gold is tending weaker at present."

BMW GY raises 2010 outlook and takes luxury car stocks higher in overseas trading.  AA +3% on earnings.  ANN cut at GSCO.  JPHQ cuts ATPG.  BRKS raises guidance.  FAST beats by 3c.  NY Times article speculates on S merger.  FBRC ups CLNY.  GSCO ups BTI.  Greenlight discloses 5.2% stake in ESV.  INFO -3% on in-line earnings.  STFL ups INSU.  BBNT ups KNL.  DBAB ups ITW.  Fairholme discloses 11% stake in MBI.  PPDI upgrade at GSCO.  UN upgrade at GSCO. 

Asia lower overnight.  Europe up nearly 2% (sixth day of gains in a row…).  EUR/USD $1.2631.  Oil +235bps.  Gold +150bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 
MBIA INC                       7.12      +10.73%           409678
JANUS CAPITAL GR         10.37    +5.07% 617
TELLABS INC                  7.30      +4.89% 15694
ALCOA INC                    11.35    +4.42% 1695758
JDS UNIPHASE               10.77    +4.16% 10100
MGIC INVT CORP            8.15      +3.69% 3543
FORD MOTOR CO           11.50    +3.6 %  894471
US STEEL CORP             42.92    +3.4 %  73063
ENSCO PLC-ADR             41.90    +3.38% 1400
CIENA CORP                  13.20    +3.37% 16902
MYLAN INC                    18.09    +3.25% 1000
SPRINT NEXTEL CO        4.64      +3.11% 428809
TESORO CORP               11.75    +3.07% 1400
TITANIUM METALS         19.69    +3.04% 2100
FREEPORT-MCMORAN    64.80    +2.99% 71040
HASBRO INC                  43.00    +2.94% 381
EASTMAN KODAK           4.57      +2.93% 1100
AK STEEL HLDG              13.24    +2.87% 22030
ADV MICRO DEVICE        7.57      +2.85% 48252
CARNIVAL CORP             32.54    +2.75% 6650
JACOBS ENGIN GRP        38.35    +2.65% 300

Today’s Trivia:  What 1985 benefit opened on this date in London & Philadelphia?
Yesterday's Answer:  Spain became the 1st team to lose its first World Cup match and ultimately win the championship, the 1st team to win on a goal so late (the 116th minute), the 1st team to win the World Cup with so few goals (8 over 7 matches), the 1st team to have its win predicted by an octopus named Paul (or Pablo, I guess), etc… there are many more. 

Best Quotes:  BBERG op-ed on the yield curve and prospects for a double-dip…

Double-Dippers Are All Wet Ignoring Yield Curve: Caroline Baum
2010-07-13 01:00:23.0 GMT

Commentary by Caroline Baum
     July 13 (Bloomberg) -- There have been whispers, or maybe it’s just wishful thinking, that the Federal Reserve might buy more long-term bonds, lowering interest rates and making housing more affordable. (You know that modified mortgage that didn’t work out so well? Have we got a deal for you!)
     At 4.6 percent, 30-year mortgage rates are already at historic lows, yet housing demand cratered as soon as the government’s homebuyer tax credit expired in April. If you think lowering long-term rates and reducing the spread between short and long rates will stimulate the economy, think again. The steep yield curve is the most powerful thing the economy has going for it right now.
     Not that there’s anything magical about two points and a line connecting them. It’s just that the yield curve, or what it represents, is possibly the best leading indicator of the business cycle. The Fed doesn’t need to fiddle around with the yield curve or plot another “Operation Twist,” a coordinated and ultimately unsuccessful effort by the Fed and Treasury in
1961 to lower long-term rates (to stimulate investment) and prop up short-term rates (to stem capital outflows). By holding the short rate at zero, which is not without its share of risks, the Fed is doing everything it can to avoid another recession.
     How so? There’s “absolutely no possibility” of the nominal yield curve inverting with short rates at zero, says Arturo Estrella, professor of economics and department head at Rensselaer Polytechnic Institute in Troy, New York. Investors aren’t going to pay the government to hold their cash for 10 years.

                     Impossible, Improbable

     Just because nominal long rates can’t go below zero, does that mean the U.S. won’t go into recession?
     The yield curve has inverted prior to all of the last seven recessions, with no false signals since 1967, according to Estrella, whose website provides all kinds of research and data for the uninitiated.
     Estrella uses the monthly average spread between the 3- month Treasury bill and the 10-year Treasury note to filter out the noise. The lead time between the appearance of a negative monthly spread and recession can be anywhere from three to 18 months. In the most recent instance, the spread turned negative in July 2006, and the U.S. economy slipped into recession in December 2007, according to the National Bureau of Economic Research, the official arbiter of the business cycle.
     Under normal circumstances, the current spread of almost 300 basis points between short and long rates would be highly stimulative. Banks can borrow at next to nothing and lend to the U.S. Treasury, pocketing the difference. No fuss, no muss, no credit risk. The profit goes right to the bottom line, helping to recapitalize the banks, which will be in a better position to make loans to creditworthy borrowers.

                        Banks Sidelined

     Yet these aren’t normal times. Banks are either unable or unwilling -- perhaps due to expected losses on commercial real estate loans -- to lend. Demand for credit is still weak, too.
Loans and leases at commercial banks have declined for 16 consecutive months, according to the Fed. That contrasts with solid increases in their holdings of Treasury securities.
     To accuse banks of engaging in highly profitable “curve trades” in lieu of private-sector lending misses the point.
That’s how it always works. When the economy goes into recession, the Fed lowers the short rate and steepens the yield curve. Private sector credit demand is weak while the government’s appetite is strong. Banks are happy to lend to Uncle Sam. Those loans expand the money supply, which gooses demand in the short run.

                         1990 Parallels

     While a steep yield curve is a sign of an expansionary monetary policy, the Fed needs the banks to get in the game.
Instead they’re content to earn the equivalent of the funds rate on the $1 trillion of excess reserves they are holding in their accounts at the Fed.
     In this way, the current cycle resembles the aftermath of the 1990 recession when banks, burdened with losses on commercial real estate, weren’t able to expand their balance sheets.
     So the best thing the Fed can do if it is concerned about a faltering recovery is keep the funds rate at zero. The short rate is the more powerful tool when it comes to moving the economy. (If it weren’t, why does every central bank in the world target a short rate?) That’s true even though most of us can’t borrow at the interbank lending rate of 0 to 0.25 percent.
     “If corporations and banks can fund themselves at zero, credit would not be a problem,” Estrella says. “You could have slowdown for some other reason.”
     Slowdown, yes; recession, no. That’s the message of the yield curve. Its track record is impeccable. It beats forecasters, econometric models, even the Fed, which seems to resist the inherent message in the spread.
     For all those double-dippers still splashing around in the pool, it’s time to get out, towel off and learn to love a slow recovery.

     (Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)