RCM Editorial: Believing in The Gold Bull Market. Does it Take Faith or Simply Common Sense?

I feel compelled today to discuss what I am hearing is the eminent demise of the Gold bull market. I have been forced to field emails, phone calls and, yes, even a text message on this topic over the last couple of weeks. To say the least, I am disappointed with some in our flock. Over the last 3 years we have painstakingly laid out the road map to perhaps one of the best bull markets in history. Gold prices have out performed all major asset classes in the last 5 years and in 2008 increased 5% while the rest of the financial world was imploding. In the midst of this financial desert, our commitment to Gold last year led to profits for the limited partners of Fortune's Favor I and Fortune's Favor Precious Metals. Gold had a wonderful start to 2009 and in the last 6 weeks has pulled back roughly 10% from the highs. A well deserved rest and a necessary coiling for the 3rd assault on the $1,000 mark that will take prices to new bull market highs.

I am loath to get biblical, but I imagine my discouragement may be akin to that of Moses and his experience with the Ten Commandments. Indulge me for a moment before you roll your eyes at what you perceive to be a bombastic statement. I have basically come down from the mountain with the tablets to investing success and in a few short weeks some of our followers are dancing around a fire built by the heathens of the oft manipulated news media. In an ironic twist, instead of worshipping gold these nonbelievers have been led astray by price weakness (10% off the top would be considered small in any circle), supposed IMF gold sales and a general misguided belief that if the markets go up Gold goes down as the fear trade subsides.

Of course, this is where the juxtaposition with Moses ends. You see, believing in G-d takes faith, but believing in the Gold bull market simply takes common sense.

Has anything really changed the picture in the last 6 weeks? Let's review:

-The tsunami of fiat currency creation around the world is perhaps the single biggest supporting factor for the Gold bull market. Have we witnessed a miraculous about face of governments around the world in the last 6 weeks indicating a tightening of credit and fiscal responsibility? I don't think so. In the U.S., the Fed's balance sheet has more than doubled in size since August. If you think that expansion is coming to an end you are sadly mistaken. During the last 6 weeks, instead of planning fiscal responsibility, the Fed completed an internal study condoning - in fact, encouraging - further balance sheet ballooning. And I'm not talking about the balloons on the back of a birthday chair. I'm talking about the kind that fills with hot air and carries a basket. Want details? Read this story, you will not believe it:

Fed study puts ideal US interest rate at -5% - FT reports the ideal interest rate for the US economy in current conditions would be minus 5%, according to internal analysis prepared for the Federal Reserve's last policy meeting. The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation. A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5%. Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150 bln increase policymakers authorized at the last meeting, which included $300 bln of Treasury purchases. The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week's policy meeting. (In order to achieve a rate of -5% interest this implies the Fed is targeting an inflation rate of at least 5% with the Fed funds rate at 0%. We are frankly surprised the study was actually made public. This policy suggests the Fed is deliberately targeting a decline in the US$, which is contrary to the government's public rhetoric.)

-Some misguided souls have argued the fear trade is leaving the market. Apparently, the world is a safer place and that's why gold is trading down 10%. This is such a ridiculous supposition that I find it difficult to address. During the last 6 weeks North Korea has sent a missile over Japan, the Taliban are enforcing Islamic rule in parts of Pakistan as war brews and meanwhile, our President is bowing to kings in the Middle East and forming a rather dubious book club with dictators in South America. I think the real reason for the 10% swing in Gold is really rather boring. No market goes up in a straight line. Corrections are necessary to shake out the weak holders and build a base to launch new assaults on the old highs. Since this is a mundane answer it would never work on CNBC. The news media needs to sensationalize in order to captivate. Beware, sometimes market volatility creates news, which can be misleading.

-I will conclude with a comment about the IMF Gold sales and a friendly wager. First, let me be clear, the proposed sale by the IMF is not new information and therefore was not a shock to Gold market participants. The G20 communique read, “…Additional resources from agreed sales of IMF gold…” will go to support developing countries. This is not a declaration of new sales agreements. Second, the communique read, "…To provide $6 billion…over the next 2 to 3 years…” Let's breakdown the numbers shall we?


IMF holds 103.4 million ounces
Current value of holdings at $900/ounce = $93.6 billion
Proposed sale as per communique = $6 billion roughly 6.6 million ounces
Avg. daily ounces traded on the London Bullion Market as of Feb. 2009 = 23.8 million ounces
6.6 million ounces sold will have virtually no impact on the Gold market today let alone over the next 2 -3 years.

And here comes the wager: Western central banks scoff at the importance of Gold and attempt to manipulate the metal lower with well-timed comments and outright sales in order to continue the farce of fiat currency creation. Meanwhile, the East is buying with ever increasing vigor. If the IMF wanted to sell this 6.6 million ounces all at once China could very well be the buyer. We will wager that the day this deal is announced Gold prices will end higher not lower. In fact, we would not be surprised to see the Chinese bid a premium for the entire IMF Gold position. Curious about the Mandarin metal mandate? Look no further:

China reveals it has 1,054 tons of gold - Reuters Reuters reports China revealed on Friday that it had quietly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tons and confirming years of speculation it had been buying. Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua news agency in an interview that the country's reserves had risen by 454 tons from 600 tons since 2003, when China last adjusted its state gold reserves figure. The world gold market has been buzzing with talk about China buying gold for years as the country's foreign exchange reserves have rocketed, and speculation has picked up since the global economic crisis threatened to weaken the value of those reserves. Gold prices jumped on the news and were up 1% on the day at $910.80 an ounce at 0540 GMT. By a Reuters calculation, China's holding of gold would be worth $30.9 bln at current prices.

News that Moves: Wells Fargo Mark to Fantasy Revealed

RCM Comment: I have been writing at length about the creative "better than expected" EPS coming from the banking sector. Today, I offer the analysis of Dave, a colleague on gata.org who really nails the Wells Fargo fraud, enjoy.

"So far — and especially in Q1 — Wells/Wachovia benefited from gov’t and bank-specific foreclosure prevention and moratorium. This kept Q1 foreclosures at a year low but pushes them down stream. Meanwhile, Q1 defaults surged which will lead to a surge in foreclosures in Q2 and beyond. "

More from Dave on WFC...

Right as the CFO of Wells Fargo was on CNBC spouting out that WFC has a better loan portfolio than others, this piece of data hit the newswire showing that in California mortgage defaults hit a new record during the first 3 months of 2009:
http://www.calculatedriskblog.com/2009/04/dataquick-mortgage-defaults-hit-record.html
Two points of note: 2009 will probably be a record year for notices of default AND "defaults are movin' on up into the mid and high priced areas." This is the "better loan portfolio" of Wells Fargo: 41% of WFC's mortgage portfolio is based in California AND 50% of WFC's portfolio is comprised of pay-option ARM mortgages, which are entering into a "bulge" period of resets and are widely considered to be the most toxic of the 1st lien mortgages. Anyone want to believe the statement made by the CFO of WFC? The comment uttered by this guy is about as credible as O.J. Simpson's claims of innocence.

Mark to fantasy and Wells Fargo's earnings

... is nothing more than legalized accounting fraud being presented to the world in the form of Wells Fargo's 1st Qtr 2009 earnings release. As suspected, the infamous "record profits" preannounced 2 weeks ago by Wells Fargo are nothing more than a result of our Wall Street-financed Government, including our President, forcing the FASB to change the way big banks account for toxic assets. As per WFC's earnings release today:

"The net unrealized loss on securities available for sale declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008. Approximately $850 million of the improvement was due to declining interest rates and narrower credit spreads. The remainder was due to the early adoption of FAS FSP 157-4, which clarified the use of trading prices in determining fair value for distressed securities in illiquid markets, thus moderating the need to use excessively distressed prices in valuing these securities in illiquid markets as we had done in prior periods."

Essentially, what WFC did was post $5.2 billion mark to fantasy gains, which were then added into its revenues, by reversing out previous charges expensed against their securities and loans held for sale. Without this gain, Wells Fargo loses a couple billion.

In looking at WFC's balance sheet, I see that their "securities held for sale" miraculously jumped to 27% of their net loans vs. being only 21% of loans at the end 2008. This is obviously WFC taking full advantage of the new mark to fantasy accounting standard and piling as much toxic waste into this category and marking the price levels up substantially. Be really interesting to see what kind of worthless crap was conveniently moved into this category.

I'm sure there's several billion worth of further indiscretions and outright fraudulent accounting that was incurred during WFC's record-breaking 1st Qtr. For those interested, here's the press release:
http://finance.yahoo.com/news/Wells-Fargo-Earns-Record-305-bw-14995023.html?.v=1
Now we wait for the 10-Q to be filed so we can determine just how much smoke the crooks running Wells Fargo....

News that Moves: Volcker Takes on the Fed, Obama and the IMF, TARP Exit Debate

RCM Comment: IT'S ABOUT TIME!!
By Timothy R. Homan Bloomberg News Saturday, April 18, 2009
Former Federal Reserve Chairman Paul Volcker said Congress will probably review the authority granted to the Fed following emergency credit programs doubling the central bank's balance sheet to $2.19 trillion. "I don't think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken," Volcker, head of President Barack Obama's Economic Recovery Advisory Board, said today at a conference at Vanderbilt University in Nashville, Tennessee. U.S. lawmakers from both political parties have expressed concern in recent months that the central bank has overstepped its authority by creating several emergency credit programs aimed at reviving lending and ending the recession.
"I think for better or for worse we are at a point where the Federal Reserve Act, after all that has been happening in the last year or more, is going to be reviewed," Volcker said…

Obama proposes $100 bln loan for IMF - Reuters reports President Barack Obama Monday proposed a $100 bln U.S. loan to the IMF to boost the IMF's war chest and urged a bigger stake in the IMF for emerging powers like China and India. In a letter sent to Democrat and Republican leaders in the U.S. Congress, Obama said the U.S. funding "does not represent a budgetary expenditure or any increase in the deficit since it effectively represents an exchange of assets." RCM Comment: If you have yet to be offended by a number of nefarious comments coming out of the mouth of our president then this should do the trick. After reading this comment I was confronted with two equally uncomfortable questions: How dumb does Obama think we are? Or, how dumb is Obama? If Obama really believes this statement then he must also believe (and want us to believe) that the $700 billion+ bailout of US banks "does not represent a budgetary expenditure..." because assets were exchanged. Have we fallen down a rabbit hole? I suspect if this Carrolleusque thinking continues on Capital Hill we are days away from a headline applauding the Mad Hatter's (Obama, for those of you not paying attention) ability to reduce the budget deficit through his brilliant plan of spending.

RCM Comment: These next two stories disturb me as it would appear the government wants to retain control of the banks even if they are healthy enough to repay the TARP loans. This is not a healthy development for the banks. We are witnessing a battle between nationalization fears vs. recovery cheers. The equity market rally has been in part a result of recovery cheers gaining momentum. This new developing story may quiet the crowd.
Geithner weighs bank repayments - WSJ The Wall Street Journal reports Timothy Geithner indicated that the health of individual banks won't be the sole criterion for whether financial firms will be allowed to repay bailout funds, a position that might complicate their efforts to give back the cash. In an interview, Mr. Geithner laid out some broad principles, including the need to consider the overall health of the financial system and the flow of credit in judging whether banks can repay their government investment. Among large banks, Goldman Sachs (GS) and JP Morgan (JPM) have both said they want to repay the government. "We want to make sure that the financial system is not just stable, but also not inducing a deeper contraction in economic activity. We want to have enough capital that it's going to be able to support a recovery," Mr. Geithner said. Mr. Geithner also said he plans to discuss signs of improvement in the U.S. economy with his counterparts at the coming Group of Seven finance-ministers meeting. But he said a "dramatic" mobilization of resources is still needed across the world to avert a deeper global recession. "We're trying...to make sure there's as strong and broad a global consensus on stimulus, financial repair and quick deployment of resources to emerging economies so that we can avert risks of a deeper downturn world-wide."

Financial firms lobby to cut cost of TARP exit - WSJ
The Wall Street Journal reports the banking industry is aggressively lobbying the Treasury Dept. to make it less costly for financial institutions to get out of TARP. The move could prove controversial for the banking industry, which is busy deflecting criticism about higher fees it is charging consumers for credit cards and other products and services. At issue are "warrants" the government received when it bought preferred stock in roughly 500 banks over the past six months as part of TARP. The warrants allow the government to buy common stock in the banks at a later date so taxpayers can receive more of a return on their investment when the banking industry recovers. Many banks want to return their TARP money and, as part of that effort, want to expunge the warrants. To do that, banks must either buy them back from the government or allow the Treasury to sell them to private investors. Today, most of the warrants are essentially worthless, because their exercise price is higher than where most banks' stocks are trading. But the government believes the warrants still have value, since they give the Treasury the right to buy common stock at a set price for 10 years. Bankers say it is unfair to charge what amounts to a "prepayment penalty," which makes it additionally onerous to escape TARP. Bank representatives say the cost of buying back the warrants could be equivalent to paying 60% annual interest on short-term loans. That, they argue, would exacerbate banks' existing problems.