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What Risk?? - April 7 PDF Print E-mail
Written by Victor Adair via Drew Zimmeran @ PI Financial   
Monday, 07 April 2014 16:29

Sovereign bonds yields of the peripheral European countries (that's the current polite term - they used to be called the PIGS) have been falling sharply (prices have been rising) since mid-2012 when the head of the European Central Bank, Mr. Draghi, declared that he would do "Whatever it takes" to save the Euro. Spanish 5 year bonds were yielding nearly 7% in 2012, today the yield is near 1.75%! That is a HUGE move in the bond market... and of course Government bonds can be bought on margin. Anybody who bought Spanish bonds two years ago and still owns them has made HUGE (unrealized) profits! Adding to the fun, the Euro has gone up about 15% against the US Dollar during that time. So if a US Dollar based hedge fund had bought Spanish Government bonds on margin they would have made the trade of a lifetime!

But the real shocker is that Spanish 5 year bonds now yield less that 5 year US Treasuries... implying that Spain is a better credit risk that the USA.


Spanish unemployment is running around 25%...for people under 25 years of age the EU rate is around 53%. A better credit than the USA? But be fair the real yields (coupon yield minus the inflation rate) shows Spanish bonds with net higher yields...because they have deflation in Spain. And further (to be fair) American 5 year bond yields have been rising for the past year (and just hit 3 year highs) as the Fed is winding down, tapering, their asset purchases. But still...where is the arbitrage? How can Spanish bonds yield less that American bonds?

Remember in late 2012 we talked about how the Spanish Government was ploughing nearly the entire Government Employee Pension fund into Spanish Government bonds and it seemed that nobody else wanted to buy them? We thought this was a reckless act by the Government... well, maybe they had some real "We've got your back" promises from the ECB? If there is someone out there big enough to buy those bonds the pension fund would register a HUGE profit!

Remember also that the Chinese and the Japanese were buying distressed Euro bonds in 2012 and it looked like they were doing a quid pro quo to maintain trade flows with Europe but maybe they understood that the ECB had their back too.

The rally in the peripheral European bonds has been on expectations that the ECB will (have to) do some sort of Quantitative Easing like Japan and America have done and this will involve buying bonds. The big profits with the assumed ECB "We've got your back" guarantee have generated HUGE momentum in this trade.

The fantastic rally in PIGS bonds is also another aspect of REACHING FOR YIELD and at this point (to paraphrase the country music song) IN ALL THE WRONG PLACES.

Where's the trade?  Given that markets can remain irrational far longer than we can remain solvent, I can't pick the end of an extremely powerful trend that seems to be going parabolic. BUT the wildness in credit spreads means that

We like the US Dollar Vs the Euro


We like buying Treasuries and selling junk

We like buying Treasuries and selling the stock market.



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US & Russian Financial War PDF Print E-mail
Written by Julian D. W. Phillips: Gold Forecaster   
Friday, 04 April 2014 08:57
usa-russia-warAre the U.S. and Russia capable of waging a financial war?

As the Ukrainian crisis unfolded threats of financial war came from Russia and to a lesser extent from the E.U. and the U.S. They were not carried out except a few sanctions targeting key personnel in Russia. These were shrugged off and the crisis appears to have dropped to a series of posturing by both sides. A sigh of relief crossed the developed world and investment life went back to normal. In the past we have had similar events that were defused in a similar way. But history teaches us that that the world can suppurate easily and quickly in tense situation like this. The First World War started because of one shot from a pistol. He Second World War were preceded by trumpeting of ‘peace in our time’ as mistaken politicians thought they had made peace with Germany.

For the investors, these are signals that should be taken seriously, if his portfolio is not to be taken by surprise. After all, when such situations are ignited, events move too fast to prevent an assault on investments. Most of us tend to feel that if we can’t actually see the storm clouds and hear the thunder then the storm isn’t coming. It’s a certain lemming-like quality where if we see the man in front of us moving forward then we do too. In this case an investor shouldn’t do this he should take preventative action even when he doesn’t see the storm.  To start with, we should ask if both sides are capable of carrying out the threats.

Threats from the U.S. & the E.U.

The overall threat of financial war was accompanied by invidious pressure on global investors to reduce their sizeable holdings in Russia. For more than a decade Russia has sought more trade and investment with and into Russia. Trillions of dollars have flowed into companies controlled by the state. If these were to exit, the economy would be severely damaged. Over the last four years, western investors have sunk $325 billion into stocks and bonds issued by Russian companies and the country’s government, according to the research firm Thomson Reuters. Of that, $235 billion has been directed toward corporate borrowings by the likes of Gazprom and state-owned banks like Sberbank. Demand has been so strong that Pimco, the world’s largest bond manager, introduced a socially responsible emerging market bond fund in 2010. According to its prospectus, the fund looks to invest in companies that are reducing governance risks. It also reserves the right to steer clear of the bonds of countries that are listed at the bottom of the World Bank’s corruption indicator or are subject to sanctions by the United Nations. Now that Russia looks like one of these, can we expect some heavy handed action to disinvest? As of the end of 2013, Russian corporate and government bonds accounted for 31% of the fund’s $292 million in assets, nearly three times the weight in its benchmark, a JPMorgan emerging-market bond index.

Pimco has declined to comment.

Gazprom, the Russian energy giant supplies so much gas to Europe it has to be a possible target of the E.U. or a weapon in Russia’s hands. It has the American mutual fund giants Pimco and BlackRock among its largest investors and creditors. While the last year has seen the fortunes of the company alongside its share price sag, an attempt to sell the entire U.S. share ownership of theirs would hurt the company and the Russian stock exchange, very badly.

Will the U.S. & the E.U. be allowed to strangle inflows of capital or remove it from Russia without resistance? In the event of the start of a financial war, we believe that Russia would not allow that capital to exit and would take measure to insulate themselves against capital flows from the country. This implies that Exchange Controls would be imposed to encourage inflows and prevent outflows. With China as an alternative investor and on neither sides of the potential conflict, they would likely come in to pick up the pieces cheaply.

This is the most potentially visible of the weapons that would be used. The weapons to be used would extend from the financial to the economic. For instance, Russian companies selling to Europe and the U.S. would switch to buyers in China, the largest consumer of nickel. This was the opinion of eight out of 12 nickel producers, traders and analysts in the Asia-Pacific region. Punitive measures would increase global prices at least in the short-term. This is one aspect of the confrontation.

A second is the sale of gas by Russia to Europe. Europe is heavily dependent on Russian gas and would be badly hurt in the event of either higher prices or a cutback in supplies. In such a war, the weapons such as these extend across a wide spectrum. For sure the investment climate in both Europe and Russia would deteriorate drastically.

The biggest danger would be the attitude in such a confrontation because this justifies punitive actions that hurt the wielder of such weapons as much as it does the victim. What do we mean? The German Finance minister’s words that, “The objective is to uphold international law. It is of secondary importance whether there is an economic or financial cost.” This is a typical posture that precedes war-like situations.

Investors, after the event, would see the heightened risk and either withhold funds, or demand significant premiums on good investments. Sovereign risks on the E.U. and Russia would elevate borrowing costs and slow the flow of funds where they continue to exist.

It is likely that additional collateral would be required that is outside the pledges of either side.  These would be extreme times and so require commensurately non-national assets like gold to be used. We would see gold/currency swaps routed through the B.I.S. to facilitate the continuation of the monetary system as we know it now. Gold would move to a pivotal position internationally in such an event. Nations would scramble to get it, to be able to get international liquidity. Where would they get it from?

The EU agreed on a framework for its first sanctions on Russia since the Cold War. This places the E.U. in step with the U.S.A. The determination we are seeing from the E.U. is more than expected and sets the tone for more action and retaliation. The big question is just how far will the two sides go?

Certainly the dollar and the euro are threatened as are all their ‘dependent’ currencies’. The damage that Russia could do to Europe is far more direct because they are neighbours.

All global financial markets will feel at least a ripple from the Tsunami that will happen, once matters go too far. The least vulnerable and the bloc most likely to gain whatever advantages may come amongst the rubble of the financial system would go to China.

Threats to ‘crash’ the monetary system from Russia

A senior adviser to Putin said last week that if the United States were to impose sanctions on Russia over Ukraine, Moscow might be forced to drop the dollar as a reserve currency and refuse to pay off loans to U.S. banks. These remarks were purported to have come from a senior aide to President Vladimir Putin’s, Glazyev. While his remarks were later refuted by Russia, the possibility of such action remains. What harm would such moves do?

Glazyev also said that Russia could reduce to zero its economic dependency on the United States if Washington agreed sanctions against Moscow over Ukraine, warning that the American financial system faced a "crash" if this happened.

He said that if Washington froze the accounts of Russian businesses and individuals, Moscow will recommend to all holders of U.S. treasuries to sell their U.S. government debt. Do his remarks have credibility? Apparently, Glazyev is often used by the authorities to stake out a hard line stance. He does not make policy but has the ear of Putin and would be aligned with the more hawkish elements in the Russian government and military. He further threatened that Russia could stop using dollars for international transactions and create its own payment system. Russian firms and banks would also not return loans from American financial institutions. "An attempt to announce sanctions would end in a crash for the financial system of the United States, which would cause the end of the domination of the United States in the global financial system,” he added. Glasyev’s comments were likely sanctioned by the Kremlin and by Putin himself. They would appear to be a warning to the U.S. regarding isolating Russia politically and imposing economic sanctions. So far they have not been carried out, so will they. Are your investments vulnerable?

Do these threats pose a real and present danger to the West? Should Russian foreign exchange reserves and bank assets be frozen as is being suggested, then Russia would likely respond by wholesale dumping of their dollar reserves and bonds. That will set off a destruction of the financial system that we know now. It takes far less than most expect to cause such damage. Yes, it would border on insanity!

In the state the global financial system is in at the moment such threats followed by any sort of action will produce ripple effects that in themselves will produce turbulence and collateral damage in global financial markets that go far beyond the borders of Europe and the U.S.A.

The hegemony of the dollar will be threatened if not mortally wounded, for sure. Simply the loss of stability in financial markets will rupture many markets. Russia would turn once again to China after trying to sell the dollar. Again, such actions would be cutting of its nose to spite its face. But that’s what war is.

The dollar is so entrenched as the globe’s reserve currency, that even a small action against it would cause disproportionate damage to its exchange rate. A strong seller of the dollar would hurt it badly. If that seller were known to be a central bank, then the damage would be considerably heavier.

We could go on far more describing the damage that could be done to both sides but we think the point is well made already.

Unlikely – Because of the consequences!

The consequences of even starting down this road are so dramatic that we deem the likelihood of a financial war as most unlikely. The Crimea and the Ukraine were part of the U.S.S.R. Hence we do not believe that either the U.S. or the E.U. will stake so much for so little potential gain. The results would be too horrible to contemplate.

But having said that, prudent investors, as we warned at the beginning of the article, won’t wait for these events to happen! They will not only be protecting themselves from the consequences, if these events took place, they would be positioning themselves to benefit from them. And they would do this now, well ahead of such possibilities, or go the way of lemmings.

With gold the clear benefactor in such situations we expect that if markets perceived the bigger danger to be imminent the gold price would surge.

For gold investors, the fact that such rhetoric is taking place is a salutary reminder that gold will rise in extreme times like these and that to buy that gold ahead of the slide down into the abyss is the wise course!

Hold your gold in such a way that governments and banks can’t seize it!

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This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Julian D. W. Phillips makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Julian D. W. Phillips only and are subject to change without notice. Julian D. W. Phillips assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage which you may incur as a result of the use and existence of the information, provided within this Report.


Meet 'Lowflation': Deflation's Scary Pal PDF Print E-mail
Written by Peter Schiff - Euro Pacific Capital   
Friday, 04 April 2014 06:20

UnknownIn recent years a good part of the monetary debate has become a simple war of words, with much of the conflict focused on the definition for the word "inflation." Whereas economists up until the 1960's or 1970's mostly defined inflation as an expansion of the money supply, the vast majority now see it as simply rising prices. Since then the "experts" have gone further and devised variations on the word "inflation" (such as "deflation," "disinflation," and "stagflation"). And while past central banking policy usually focused on "inflation fighting," now bankers talk about "inflation ceilings" and more recently "inflation targets". The latest front in this campaign came this week when Bloomberg News unveiled a brand new word: "lowflation" which it defines as a situation where prices are rising, but not fast enough to offer the economic benefits that are apparently delivered by higher inflation. Although the article was printed on April Fool's Day, sadly I do not believe it was meant as a joke.

Up until now, the inflation advocates have focused their arguments almost exclusively on the apparent dangers of "deflation," which they define as falling prices. Despite reams of evidence that show how an economy can thrive when prices fall, there is now a nearly universal belief that deflation is an economic poison that works its mischief by convincing consumers to delay purchases. For example, in a scenario of 1% deflation, a consumer who wants a $1,000 refrigerator will postpone her purchase if she expects it will cost only $990 in a year. Presumably she will just make do with her old fridge, or simply refrain from buying perishable items for a year to lock in that $10 savings. If she expects the cost of the refrigerator to decline another 1% in the following year, the purchase will be again put off. If deflation persists indefinitely they argue that she will put off the purchase indefinitely, perhaps living exclusively on dried foods while waiting for refrigerator prices to hit zero.

Economists extrapolate this to conclude that deflation will destroy aggregate demand and force the economy into recession. Despite the absurdity of this argument (people actually tend to buy more when prices fall), at least there is a phantom bogeyman for which to conjure phony terror. Low inflation (below 2%) is even harder to demonize. Few have argued that it has the same demand killing dynamics as deflation, but many say that it should be avoided simply because it is too close to deflation. Given their feeling that even a brief bout of minor deflation could lead to a catastrophic negative spiral, they argue for a prudent buffer of 2% inflation or more. But the writer of the Bloomberg piece, the London-based Simon Kennedy, quotes people in high positions in the financial establishment who offer new arguments as to why "lowflation" (as he calls it) is a "threat" in and of itself. And although the article was primarily concerned with Europe, you can be sure that these arguments will be applied soon to the situation in the United States.

The piece correctly notes that those struggling with high debt tend to welcome high rates of inflation. The math is simple. By diminishing the value of money, inflation benefits borrowers at the expense of lenders. By repaying with money of lesser value, the borrowers partially default, even when paying in full. The biggest borrowers in Europe (and the United States for that matter) are heavily indebted governments and the overly leveraged financial sector. Should it come as a surprise that they are the leading advocates for inflation? The writer admits that higher inflation will help these interests manage their debt burdens and in the case of the financial sector, profit from the increased lending that low interest rates and quantitative easing encourage.

On the other side of the ledger are the consumers, the savers, and the retirees. These groups want lower prices and higher rates of interest on their accumulated capital. Such a combination will lead to higher living standards for those who have worked and saved for many years in order to enjoy the fruits of their efforts. But these types of people are simply not on the "must call" list for our best and brightest economic journalists. As a result, we only get one side of the story.

The article also points out that higher inflation gives businesses more flexibility to retain workers in periods of weak growth. The argument is that if sales revenue falls, companies will not be able to lower wages, and will instead resort to layoffs to maintain their profitability. However, this is only true in cases involving labor union contracts or minimum wage workers. In all other cases, business could reduce wages in lieu of layoffs. Plus, if prices for consumer goods are also falling, real wages may not even decline as a result of the cuts.

In circumstances where wages cannot be legally reduced, as is the case for unionized or minimum wage workers, layoffs are often the employer's only option for keeping costs in line with revenue. However, inflation allows employers to do an end run around these obstacles. In an inflationary environment, rising prices compensate for falling sales. The added revenue allows employers to hold nominal wage costs steady, even when the raw amount of goods or services they sell declines. When inflation rages, higher skilled workers will often demand, and receive, pay raises. But low-skilled workers, who lack such leverage, are usually left holding the bag.

In other words, politicians can impose a high minimum wage to pander to voters, but then count on inflation to lower real labor costs, thereby limiting the unemployment that would otherwise result. So what the government openly gives with one hand, it secretly takes away with the other. Workers vote for politicians who promise higher wages, but those same politicians also create the inflation that negates the real value of the increase. But while government takes the credit for the former, it never assumes responsibility for the latter. The same analysis applies to labor unions. Based upon political protection offered by friendly officials, unions can secure unrealistic pay hikes for their members. But the same governments then work to reduce the real value of those increases to keep their employers in business.

Of course, what the Bloomberg writer was really arguing is that governments need inflation to bail themselves out of the policy mistakes they make to secure votes. But two wrongs never make a right. The correct policy would be to run balanced budgets rather than incur debts that can only be repaid with the help of inflation. On the labor front, the better policy would be to abolish the minimum wage and the special legal protections offered to labor unions, rather than papering over the adverse consequences of bad policies with inflation.

So be on the lookout for any more hand-wringing over the supposed dangers of lowflation. The noise will simply be an effort to convince you that what's bad for you is actually good. And although it's an audacious piece of propaganda to even attempt, the lack of critical awareness in the media gives it a fighting chance for success.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Winter 2014 Global Investor Newsletter!

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10 April 2014 ~ Michael Campbell's Commentary Service


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