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Review & Focus®

Chuck Butler | January 1, 2017 12 MIN READ

December was an interesting month in 2016, given that the Fed raised interest rates just as they did last December, President-Elect Trump continued to carve out his cabinet, and forecasts for 2017 began filing in. Not to mention cold weather set in for a long winter ahead of us. I’ve got a dissertation on Treasuries to talk about this month, so get ready for all of that and more as we Review & Focus for January 2017! Oh, and Happy New Year to you!

The Year In Review

Well, 2016 started out just like most of the previous years, with all kinds of optimism about economic growth in the U.S., rising inflation, additional rate hikes, and a return to norm for the economy. However, just weeks into 2016, we found that just like in previous years, the optimism soon faded, and once again we were faced with a stumbling, fumbling economy. There would be no more rate hikes until December (although four were promised for 2016), and even that one was questionable to people like me, who saw the rot on the economy’s vine better than most observers. The economic data was just plain awful: Manufacturing continued to slide, Durable Goods & Capital Goods were negative each month, and Retail Sales couldn’t even post a positive month in December.

But similar to previous years, things picked up a bit as time progressed, however when all is said and done for 2016, the GDP will remain under 3% (probably just at 2%), and will be the first time in any two-term president’s administration that the economy never posted a 3% gain. On top of that, employment in the U.S. has become something of a “slight-of-hand” trick. The Unemployment Rate is down, but if you add in the 95 million Americans who are no longer counted as “unemployed” because they’ve dropped off the list, the Unemployment Rate would be more like 22% instead of the 4.6% the government likes to show off.

By 2016 year-end, Treasury yields began to rise, moving from the 1.80% area in the 10-year yield around the election, to 2.50% area by mid-December. I’m going to spend a lot of time talking about Treasuries in this article, so I’ll move along here now to talk about gold. No, wait. I’m going to talk a lot about gold too! Oh well, gold started the year with a nice rally that lasted into the summer. At its peak in the summer, gold was up more than 30%, but as of December 14, it is up only 16%. I still believe that gold is getting ready for a potential move higher as Trump's campaign promises reignite inflation fears here in the U.S.

Foreign currencies moved along with gold, and for the most part, looked like they had successfully beaten back the strong dollar trend that has been in place since 2011. But just like gold, the currencies had to give back a lot of their gains against the dollar in the summer months and into fall. I was fooled by the currency gains early in the year, and said so in a previous article. I thought that it appeared as though the strong dollar trend was ending. However, it proved to be nothing more than a false dawn. But that’s how a lot of trends begin and end, with starts and stops until the crowd gets the memo on how they are supposed to be trading the asset.

The Bond Bubble Revisited

Back in 2008, (I know that’s a long time ago) I wrote for the Sovereign Society’s publication titled: The Currency Capitalist. And one month I dedicated the issue to a topic that I had researched so thoroughly, that I was convinced it was about to happen. And that was the popping of the Treasury Bubble. Boy was I proved to be wrong! But, in my defense, at the time of my writing about the Treasury Bubble popping, Quantitative Easing (QE), or bond buying, was not even thought to be possible here in the U.S.

Well, along came March 2009. I was sitting in my condo in South Florida, reading the news, and came across a headline that about made me fall off my chair. The U.S. was about to embark on a voyage that would take them through three rounds of QE, which would take over the auctions of Treasuries, and provide the bonds the buyers they needed each and every month. The Fed ended up with over $4 trillion on its balance sheet in bonds (Treasuries and mortgage-backed bonds), and the popping of the Treasury Bubble was a forgotten thing. Except for me, and I still bang my head on the desk when I think of how I went all-in on this idea of the end of the Treasury Bubble.

Well, here we are as in olden days, happy golden days of yore. Yes, I know it’s not time to sing Christmas songs any longer, but the lyrics play well with what I’m about to tell you. First, I’m just going to blurt it out, and then get into the details: China and Saudi Arabia are selling their Treasuries, and Russia is buying gold instead of Treasuries. Uh-oh! If they are selling them, then who is buying them? The Fed says they are out of the bond buying business, right?

But a little birdie showed me a trick. If you watch the 10-year Treasury yield every day like I do, then you’ll notice when the yield suddenly drops by five or so basis points, which is a significant daily move. When the yield drops on a bond, the price goes up, which means the bond is being bought. But who’s doing that buying? Well, I mark it down, and then the following week we get the Fed’s balance sheet, and lo and behold during that week when the 10-year yield dropped, the Fed’s balance sheet grew by $2 to $3 billion. Wait, what? How’s that supposed to happen? They’re out of the bond buying business, right? So, what is it that’s causing their balance sheet to grow by $2 to $3 billion in a week? Well, I’m just saying that it’s interesting.

The point I’m trying to make is that China and Saudi Arabia are selling their Treasuries, and not showing up whole-heartedly at the auctions, and someone is stealth-buying Treasuries to keep a lid on rates. Hmm…

OK, onto the bigger problem: us (Baby Boomers). Well, we aren’t THE problem per se, but we are part of the problem, because there’s just too darn many of us that are going to be drawing on Social Security. I’ve told you this for four years now, so the number of years is dropping, but when I began telling you, the thought went like this: 10,000 Baby Boomers will retire every day for the next 17 years (so we’re down to 13 years now).

And the U.S. sells Treasuries to finance its debt, right? So, don’t you think it’s safe to say that even without any infrastructure spending by the President-Elect, Treasuries are going to be abundant in the coming years?

This next bit of information comes to you from Grant Williams’ blog: Things That Make You Go Hmmm, as he looks back to President Reagan’s administration: “During Reagan’s presidency, U.S. treasuries were backed 132% by the market value of the country’s gold reserves. Today, that number has fallen to just 4.7%. If we do the same thing and account for the $100 trillion in entitlement promises; the number falls to 0.3% in 2025.”

And that’s being conservative, because according to professor Lawrence Kotlikoff, our Unfunded Liabilities are more than $200 trillion! And that’s now, before 13 more years of Baby Boomers reaching retirement age, and I would say, that starting now and going for the next six years, the majority of those Baby Boomers will be retiring.

So, who’s going to buy those Treasuries then? You know, China issued a warning in 2013 that said they would no longer need to add to their reserves (with Treasuries and dollars). A November 23, 2013, Bloomberg article highlighted the announcement:

“The People’s Bank of China said the country does not benefit any more from increases in its foreign-currency holdings, adding to signs policy makers will rein in dollar purchases that limit the yuan’s appreciation.

“’It’s no longer in China’s favor to accumulate foreign-exchange reserves,’ Yi Gang, a deputy governor at the central bank, said in a speech organized by China Economists 50 Forum at Tsinghua University yesterday. The monetary authority will ‘basically’ end normal intervention in the currency market and broaden the yuan’s daily trading range, Governor Zhou Xiaochuan wrote in an article in a guidebook explaining reforms outlined last week following a Communist Party meeting. Neither Yi nor Zhou gave a timeframe for any changes.”1

Most observers didn’t pay attention to this message by the Chinese, but I’ve said this before and I’ll say it again: the Chinese don’t just say things to say things. When they say something, they mean it, and will carry it out. And it didn’t take long for the Chinese to begin to dismantle their reserves dominated by U.S. Treasuries. By April of 2014, China’s reserves began to drop at the fastest rate in 80 years!

And the same goes for Saudi Arabia. Remember them telling the U.S. that if the lawsuit (which was filed as a bill in Congress) was passed allowing the Saudi government to be held responsible for the 9/11 event in 2001, that they would sell their $750 billion in Treasury holdings? A New York Times article from April 16, 2016, states:

“Saudi Arabia has told the Obama administration and members of Congress that it will sell off hundreds of billions of dollars’ worth of American assets held by the kingdom if Congress passes a bill that would allow the Saudi government to be held responsible in American courts for any role in the September 11, 2001, attacks...

“...Adel al-Jubeir, the Saudi foreign minister, delivered the kingdom’s message personally last month during a trip to Washington, telling lawmakers that Saudi Arabia would be forced to sell up to $750 billion in treasury securities and other assets in the United States before they could be in danger of being frozen by American courts.”2

As you know, after the bill was vetoed by President Obama, lawmakers administered the first veto override that the President has experienced in his 8 year term, and so that set into motion the Treasury selling that can be seen in the chart below:

View a larger image here

Source: Meridian Macro Research; info@meridianmacro.com


Scary, eh? Oh, and one more thing. Russia, the other Big Dog in the world that used to buy Treasuries, has found a new way to sell their oil. They’ve circumvented the petrol-dollar scenario, where all oil sales are paid for with dollars. Last year, Russia announced that they had agreed to sell a large amount of oil to China, and accept renminbi as payment. At the time of the announcement I told people that this was HUGE, but no one paid attention. They should have, because at about the same time, China was announcing that they were going to sell gold on the Shanghai Gold Exchange (SGE) denominated in renminbi (or yuan, either one is acceptable).

So, this is what Russia does with their renminbi that they receive from their oil sales to China—they simply take the renminbi, and buy gold on the SGE! And Russia’s gold accumulation is something to behold these past couple of years. It’s a strategic move by Russia led by its Central Bank Governor, Elvira Nabiullina, who sees gold reserves as a way to improve the Russian balance sheet, other than accumulating rubles or other foreign currencies in reserves. And given that gold gained 16% in 2016, that’s better than a sharp stick in the eye for the Russians.

So again, no China, no Saudi Arabia, and no Russia to buy Treasuries, and the issuance of Treasuries is about to get ramped up to what Han Solo would call hyperspeed. What’s a country to do? Well, the country can push rates higher to make its Treasuries more attractive to buy, but then the higher yields cause the cost of servicing the debt (bond interest) to soar. I recently mentioned this in the Daily Pfennig, and explored the different paths a country may take to solve the matter.

So, all of this talk about debt brings me to the subject of gold. When it’s all said and done, and there’s no way out of this debt accumulation mess we’ve gotten ourselves into, I think that there could be a handful of assets that will retain their value, and potentially even be of greater value, and one of those is gold.

In this possible future state, dollars would look to be weak, and when that happens gold is usually the other side of the weak dollar. I look at gold like it's insurance in my investment portfolio against what I just explained could be the future of our country’s financial system. You buy flood insurance in hopes that your house never floods, right? You buy car insurance in hopes that you never have an accident, right? You buy health insurance in hopes that you never come down with a long illness, right? So, why wouldn’t you consider buying gold to potentially function as insurance for your investment portfolio?

Gold is an excellent diversification tool, because it: 1) has different pricing mechanisms than typical other holdings, 2) has a low correlation to the other holdings, and 3) adds intrinsic value. These are all criteria explained in Harry Markowitz’s Modern Portfolio Theory, of which I’ve been a fan for more than 25 years!

Does all this happen soon? Well, I think soon as far as history is concerned, but not tomorrow, nor next month or next year, but soon enough that unless you take action to protect yourself, you might find yourself scrambling when things begin to unwind.

In Conclusion

So, is this the second time that Chuck is calling for a Treasury Bubble pop? Geez, I don’t know. I was burned so badly the first time by the Fed and their QE. What’s to stop them from orchestrating more rounds of QE? (maybe they are the stealth buyers right now!) Let’s just say, Chuck is seeing rotten times for Treasuries going forward, and it will take a miracle from the Fed to keep this from happening.

Until next month… be good to yourself!


ASSET TRENDS 11/14/2016 – 12/14/2016

Source: Bloomberg World Currency Ranker Screen (WCRS). WCRS asset trends are based on BGN “Bloomberg Generic” indicative or “spot” currency exchange rates and metals prices as of 5 pm Eastern Time on the dates specified. Such rates and prices are generally only available for large volume transactions conducted by institutional investors at a specific point in time. These values are illustrative only and do not reflect wholesale rates available to us or the rates or prices we make available to customers at any point in time, and the trend data provided do not include retail exchange spreads or other transaction costs.

Currency3, 4 Trend Change (%)
Australian dollar -1.36%
Brazilian real3 2.29%
British pound 1.06%
Canadian dollar 2.36%
Chinese renminbi3 -0.65%
Columbian peso 4.63%
Czech koruna -1.38%
Danish krone -1.36%
EMU euro -1.47%
Hong Kong dollar 0.02%
Hungarian forint -2.34%
Indian rupee3 -0.29%
Israeli shekel 1.24%
Japanese yen -6.66%
Mexican peso 1.61%
New Zealand dollar 0.51%
Norwegian krone -0.78%
Polish zloty -1.64%
Russian ruble3 6.74%
Singapore dollar -1.09%
South African rand 4.24%
South Korean won 0.19%
Swedish krona -0.74%
Swiss francs -1.86%
Turkish lira -6.30%
Metals5 Trend Change (%)
Gold -5.67%
Silver 0.03%
Platinum -0.20%
Palladium 4.21%
EverBank CD Baskets3, 4 Trend Change (%)
Balanced Debt® -0.56%
BRICS 2.47%
Commodity BasketSM 1.44%
Euro Trax® -1.26%
European OpportunitySM -1.84%
Geographic BasketSM -0.30%
Global Power Shift® 0.63%
Investor's Opportunity® 0.18%
Mining Opportunity® 1.88%
New World EnergySM 0.07%
Pacific Advantage® -1.34%
Pan-AsianSM -2.09%
PetrolSM 0.63%
Ultra Resource® -0.06%
Viking® -0.94%
World Energy® 0.32%

EverBank CD Basket trends are also based on WCRS indicative spot rates for the underlying currency mix, which is described at everbank.com/currencies, and thus are not reflective of wholesale rates available to us or the rates we make available to customers at any point in time and do not include our spread. For more information, please see everbank.com/currencies.

Chuck Butler
Chuck Butler
Managing Director of EverBank Global Markets Group
Chuck Butler
Chuck Butler
Managing Director of EverBank Global Markets Group
You can count on Chuck to tell it like it is. He has over 35 years of experience in the currency field. And he's got a wit all his own. A frequent and respected analyst for various national media outlets, Chuck is also the original author of the popular Daily Pfennig® blog.

Asset trend data are illustrative only and do not reflect retail exchange spreads or other transaction costs.

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  1. https://www.bloomberg.com/news/articles/2013-11-20/pboc-says-no-longer-in-china-s-favor-to-boost-record-reserves
  2. http://www.nytimes.com/2016/04/16/world/middleeast/saudi-arabia-warns-ofeconomic-fallout-if-congress-passes-9-11-bill.html?_r=0
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