SP 500 and NDX Futures Daily Charts

Looks toppy here.

Feds Key In on $325 Million Wire Transfer Made in Last Hours of MF Global

I wonder if this newly released MF Global information is some of the data that the creditor team has been examining and only recently released to Federal investigators.

It was surprising to hear that JPM as a creditor gets to decide how and when customers can have information about their MF Global accounts as reported here.

The truth may come out some day, but will be heavily coated in sugar. They will try to drag this out until the public loses interest and becomes distracted by something else.

A last minute wire transfer of a large cash amount, not to mention a transfer almost certainly involving customer money, would be an automatic clawback in any bankruptcy I have ever heard about. I saw a trial balloon floated out a week or so ago that put forward the theory that the money would not be returned because it was protected by a 2005 bankruptcy law regarding the sanctity of 'commercial paper' payments.

That rationale might work in a friendly court, but would establish an unbelievable precedent about the ability of banks and insiders to seize funds from the carcass of any failing enterprise ahead of other creditors.

Keep in mind that customers who had requested their money DAYS before the 31st were sent checks instead of the customary wire transfers which they had requested, and those checks were not honored. And I have heard of at least one instance where a customer's wire tranfer was reversed a day later by the banks, which I had thought was not even possible.

This looks like a fraudulent conveyance, and possibly a conspiracy of theft of customer money amongst financial insiders as MF Global slid into bankruptcy.

The more I hear about this, the more outrageous it gets.

Dealbook
Investigators Scrutinize MF Global Wire Transfers
By AZAM AHMED and BEN PROTESS
February 26, 2012, 9:07 pm

Federal investigators examining the final days at MF Global and how customer money went missing are poring over scores of wire transfers in and out of the brokerage firm, including the possible movement of $325 million that may have belonged to customers, according to people briefed on the matter.

The suspicious transfer, which until now has not been made public, was first discovered in the early hours of Oct. 31, the day the firm filed for bankruptcy. Initially, the firm attributed a shortfall of more than $1 billion in customer money to an “accounting error,” records show. But after hours of searching, executives acknowledged to regulators in the firm’s offices in Chicago that the shortfall was real — and may have been caused in part by the $325 million transfer, said one of the people briefed on the matter.

It remains unclear where that money went, or even if it belonged to customers. (Did they lose the receipt?  LOL - Jesse)  But it is one of many significant wire transfers that federal authorities — including the Commodity Futures Trading Commission and the Federal Bureau of Investigation — have spent months reviewing to piece together MF Global’s final days.


Investigators have also reviewed another transfer, of $220 million on Oct. 31, which represented a last-ditch attempt to patch the hole discovered in the customer accounts.

Once the firm disclosed the shortfall to officials from the C.F.T.C. and the CME Group, the giant exchange that also regulated the firm, MF Global shifted $220 million in customer money from the securities side of the business to its commodities brokerage unit, where the shortfall in client cash was discovered earlier.

Ultimately, the final attempt came up short. Just hours after the transfer, the firm filed for Chapter 11 bankruptcy...

Read the rest here.

Performance of Stocks, Bonds, and Gold In an Inflationary Environment

Jeremy Grantham's GMO group has produced an interesting study showing the performance of three asset classes against inflation.

I think the true correlation is with negative real interest rates rather than inflation itself. In an inflationary period, interest rates tend to lag the increase in inflation, producing negative real rates.

But in a period of economic decline in which the Fed lowers rates artificially, negative real rates can also be created and rather more easily than some amateur economic theorists believe.

To slightly complicate matters, the markets tend to anticipate, tend to act on expectations before the reality of something. So we might see something like gold or interest rates signaling a period of inflation well ahead of its appearance, if they are allowed to seek their own levels in the market.

If you think about it, the correlation with negative interest rates makes sense. In a period of negative rates, all currency heavy financial instruments are probably facilitating the confiscation of wealth by the official banking system. Since gold has relatively little counterparty risk if properly held, it is likely to be considered a safe haven, in addition to other hard assets and stronger alternative currencies if such things are available.

Unfortunately for analysis, things are never so simple in real life.

In addition to negative interest rates, there are other forms of wealth confiscation, including the fraudulent mispricing of risk, outright fraud itself, and currency devaluation.

And finally, there is the sort of price manipulation which the Western central banks engaged in for a long period of time in strategically selling off portions of their gold in order to hold the price lower in a disastrous attempt to manage the financial markets and silence the warning signal from gold as asset bubbles began to build in the credit markets and the Bretton Woods global monetary agreement began to fall apart.

And so what might have been a gradual price increase in gold and silver instead became a powerful rally as the markets sought to correct to the primary trend once the banks stopped being net sellers of gold.   Now the financial system can only use other means in order to try and control their ascent to a genuine market clearing price based on years of monetary inflation.  There are various estimates of what that eventual price might be, but it most certainly is much higher than where the price is today.

Years of underinvestment in mining has created a dangerous shortage of gold and silver relative to potential demand.  Various financial instruments have been introduced to provide 'paper gold and silver' to meet that demand.  In addition, even physical exchanges like the LBMA have been pushed to dangerously high rates of leverage as demand for bullion outstrips available supply.  And so the markets drift inexorably into great opaqueness and repeated frauds because the world of paper has unhinged itself from reality across multiple fronts.   The problem is that the state of the currency feeds into all finanical markets and so a mischief done there spawns its children everywhere.

As one might suspect, the credibility trap in which the financial engineers find themselves causes occasional outbursts of hysterical animosity and antagonism against the reactions of the markets, and the reality of their own economic chickens coming home to roost. 

This is a recipe for disaster, and we can thank the Anglo-American banking cartel, and their gullible accomplices in the other western banks, for it when it happens.  When Dick Cheney said, "Reagan proved that deficits don't matter" what he did not realize was that he was reading the epitaph for the dollar reserve currency system that had been in place since the end of WW II.   They do matter, but sometimes the lags in time between cause and effect can be deceptively reassuring.

Debt may not matter in the short run, and Keynes had some very good and valid points to make about government stimulus during short periods of economic slumps to avoid feedback loops and the spiral of decline.   As an aside I wonder, if Keynes came back and saw what his acolytes were saying in his name, if he could stop throwing up.  When he found new facts he changed his mind, and I suspect he might have changed his and strongly cautioned against turning a remedy into an addiction to support  habitual corruption and unsustainable privilege.  But I do not know if he was that honest of a intellect, or would have merely gone along with the rest for the benefits of his class.

Huge deficits over long periods of time to finance non-structural consumption and underwrite malinvestment and currency manipulation are almost invariably toxic.  The 'vendor financing' that gave rise to the age of 'Asian miracles' is the rope which will be used to hang the capitalist system unless strong measures are taken to clean up the corrupt system that grew up to support and profit from this economic Frankenstein.

The only reasonable course of action is for the West to nationalize its TBTF banks, dismantle them gracefully while keeping their depositors whole, and give up their dreams of global and domestic financial domination by adopting a system of real capitalism based on market pricing, price discovery, competition kept intact from monopoly through effective regulation and law enforcement, transparency and a climate of honesty.  But that would visit restraint, inconvenience, and even some pain on the powerful and privileged, those who have benefited greatly from this long charade, so it will be resisted to their bitter end.

While the stock and housing market bubbles have burst, the bond bubble, which includes the US dollar as a bond of zero duration, remains to be resolved and marked to market.

Source: Jeremy Grantham's 4Q 2011 Investment Letter

What Is the 'Spot Price' of Gold and Silver?

This is a partial reprise of a post from two years ago. The question has again arisen about the discrepancy between the spot price of gold and silver, and the prices shown on the front month of the futures market.

When you ask even an experienced trader, or even an economist who may have received a Nobel prize, 'What is the spot price, where does it come from, who sets it?' you will often hear that this is the last physical trade, or the current market price of physical bullion for delivery. 

Here is a fairly typical explanation one might get from an 'industry expert.'

"That is why the New York Spot Price is different from the London Gold Fix price. The spot price changes on a regular basis, just as stock prices do, and reflects the bid and ask prices quoted by wholesale dealers for spot delivery."

Well, does it?

Actually despite what you might think or what you might have heard, it does not.

There is no centralized and efficient national market in the US for the sale of physical bullion at anything resembling a 'spot price.' What is their telephone number, where are their prices and trades of actual transactions posted?   Who collects and is privy to that knowledge, and how are they regulated?  Who is buying and selling TODAY, with real delivery of bullion as the primary objective?

There are a few large wholesale markets for physical bullion in the world, where real buying and selling can occur, with delivery given and taken. The most famous is the London Bullion Market Association, which is a dealer association, an over the counter market where the price is set twice a day and called the 'London fix,' but each counterparty stands on their own with no central clearing authority.

As an aside, there are credible claims and factual evidence that the LBMA has slipped into a paper market with multiple claims on the same unallocated bullion with daily trade volume in multiples of available supply, a fractional reserve bullion banking as it were. Some say the leverage is 100:1.

The reason that physical trading in bullion became so highly concentrated in London was best explained to me by a large bullion dealer. "This situation exists because of the gold confiscation in the US in 1933. When that happened, physical metal trading in the US came to a complete stop. When gold ownership was again made legal on December 31, 1974, the physical metal trading had become so developed outside of the US that it stayed there and never really returned."

But once the London Fix is over, and the trading day moves with the sun, the New York markets open and become the dominant price setting mechanism. Where and how is that price obtained? Where is the price discovery?

I will not delve into it here, but there is credible evidence that shows that the price changes for gold in the NY trading window are heavily skewed to price decreases as compared to the other periods of the day, beyond any reasonable statistical expectation.  It is so obvious as to be almost notorious amongst seasoned traders.  That alone should raise alarms with the regulators.  No honest market has such obvious anomalies unless there is something terribly wrong in its structure.

The bullion market in the US is highly fragmented among many dealers who do not set the prices amongst themselves as in London. Yes they have their 'wholesale' sources, but even those sources are more fragmented than one might imagine.

The fact of the matter is that the spot price of gold and silver is nothing more than a type of Net Present Value (NPV) calculation based on the futures price in the nearest active month, or the front month.

I have not been able to obtain the specific formula used by any of the principal quote providers such as Kitco for example. And I am not saying that they are doing anything wrong at all. Or right for that matter.

The spot price is calculated from the futures in much the same way that the 'Fair Value' price is derived for a stock index like the SP from the futures trade, which is essentially an NPV calculation.

FORMULA FOR DETERMINING FAIR VALUE

F = S [1+(i-d)t/360]

Where F = Fair Value futures price

S = spot index price

i = interest rate (expressed as a money market yield)

d = dividend rate (expressed as a money market yield)

t = number of days from the current spot value date to the value date of the futures contract.

So like most net present value calculations we would have some 'cost of money' figure used to discount the time decay from the strike time of the contract to the present. There is no dividend with gold, but there is a forwards rate and a least rate, and a proper calculation should include some allowance for this opportunity cost.

Given that the 'cost of money' or short term interest is roughly zero, the time premium of the futures over spot is likely to be negligible.   But since the methods of calucating spot are not public, I cannot speak to this now.

What is important to remember is that the spot price follows the futures front month by some calcuation. And rather than a physical market setting the price in fact almost all retail transactions for physical bullion in the US key off a 'spot price' that is derived from a paper market which is not based in the currently available physical supply.

Further, the futures exchanges explicitly allow for the settlement in cash if physical bullion is not available. In fact, the vast majority of transactions are settled in cash, and are little more than derivatives bets, and trading hedges related to other things like another commodity or interest rates.

I am not saying that anyone is doing anything wrong or illegal. I am saying the system is inefficient in that it suffers from the lack of a robust physical market to 'keep it honest.'

It does seem a bit ironic by the way, that the most popular provider of spot price information for gold and silver is currently operating under charges of fraud in a scheme involving a conspiracy to defraud their government in Canada. And yet the consumer must take their price quotes on faith, since there is no apparent disclosure of how their price quotes are obtained. Perhaps their case has been resolved, and I am not aware of it. But the irony remains.

The spot price of gold and silver is therefore subject to manipulation. So it is incumbent on the regulators like the CFTC to be mindful of any price fixing activity in the metals futures, particularly in the 'front month' which directly influences the going rate for many if not most of the retail bullion transactions in the States.

I am surprised that some smart entrepreneur has not consolidated the buying and selling of physical bullion on demand into a highly transparent and efficient market which is the real price setter, rather than the commodities exchanges in which arbitrage can be easily crushed by the very rules of the exchange that allow for virtually unlimited position size, extreme leverage, cash settlement as an easy alternative to shortage, 'naked shorting,' unaudited and unallocated stores of supply, and above all, the veil of secrecy.

We even recently saw the scandal where a large Wall Street broker was selling bullion and even charging the customer annual storage fees without ever having purchased the bullion for them in the first place. Not to mention a situation in which a large futures broker was able to steal the gold and silver on deposit from their customers with little recourse and limited remedy against one of the bullion banks who may have received the goods as it were.

Since the futures market sets the national price for retail transactions that have nothing to do with the futures market per se, there a significant need for tighter reins on short term speculation including position limits, accountability for deliverable supply, and limits on leverage and speculation.

The metals markets are thin and small compared to the forex and financial asset markets, and therefore the most vulnerable.

The futures market will be efficient and honest the more it takes on the rigors of the physical market.

What about the usual argument that the self-regulating proponents trot out that if the metals pricing is inefficient, it will create artificial shortages, and physical buying will break that scheme down over time?

Participants in the futures are not able to seriously address a significant market mispricing because the prices set in the paper markets are not conducive to efficient arbitrage of inefficiencies. The rules of the exchange sets limits on the delivery of physical bullion, favoring cash settlement and the positions of insiders and those who make markets in paper shorts that may be in multiples of physical supply. The CFTC has shown a remarkable inability and some might say unwillingness to address this in the silver market for example, which is a scandal.

Not even a motivated buyer with deep enough pockets would take on this market openly because all they would do is buy against themselves, and drive a default which would be cash settled by force. More likely they would be labeled as trying to 'corner' the market and punished severely.

You might ask at this point, why would anyone ever wish to engage themselves in this market, besides those who must obtain supply for industrial or cosmetic uses? Few do actually, except to buy physical bullion at the retail level.

From a purely economic perspective if I were going to set up a mechanism to allow price fixing and fraud to occur, I could do little better than what exists in the US today, except perhaps to set up something more like an opaque and self directing monopoly such as the Federal Reserve and its Banks have in their ability to create money virtually out of nothing.

The retail buyers and producers are largely at the mercy of those who control the paper markets, and these are a relatively few bullion banks and hedge funds. And this says nothing about the involvement of the central banks in influencing the price, which they sometimes admit that they do.

Reform is generally slow to come when a powerful status quo benefits from such a financial arrangement and price fixing such as this. Economic theory indicates that underinvestment and shortage will result, and if the artificial pricing is sustained over time, that shortage and systemic underdevelopment could lead to a severe market break and even a default.

We saw something similar to this when Enron was actively fixing the national energy markets in the US.  What will happen in the metals markets will be at least an order of magnitude more disruptive.

I think that a default is becoming more likely every day that the regulators refuse to act in the interests of promoting honest price discovery and fairness, which is their very reason for being.

And when the bullion banks cry for exchange intervention and government relief, keep in mind that their problems are the result of no acts of God or anything other than a protracted abuse of the market and the public for the personal benefit of a few at the expense of many.