World’s Strongest Currency

The true measure of strength in any currency is the faith
its users place in it. This is the definition of a fiat currency – a currency
that is backed by faith, rather than hard assets. These include the Euro, the Dollar,
Yuan, Canadian Dollar, British Pound, etc. A loss of faith in any of these
countries’ ability to pay their debts results in devaluation of that country’s
currency. The same is true if they decide to print more money to meet current
needs or even if the world simply thinks their country is being run poorly.

What if I told you there’s an international currency
unencumbered by entitlement programs and liabilities. This currency is not
subject to governmental manipulation and the money supply is always a live
public statistic. This currency neither buys nor sells any debt. Would it surprise
you, given this set of circumstances that this is the single strongest currency
in the world over the last year?

The currency I’m referring to is called, Bitcoin. Bitcoin is
an internet currency that is traded globally for goods and services and can be cashed
out in the currency of your choice. It is, “mined” on individual computers that
are placed, by anyone, on the network. The mining is basically using your
computer to solve an equation. The equations get harder and harder through
time. This ensures that the supply of Bitcoins grows at a stable rate. The
publicly validated equations place more Bitcoins into circulation by the people
who’ve mined them. The number of Bitcoins, currently stands at 6.6 million. The
next equation and number of coins in circulation are all publicly available in
real time.

The value of Bitcoins is tracked on trading sites that look
just like foreign exchange trading sites. There are quotes in Dollars, Pounds,
Euros, Francs, Rubles and most any other denomination. There are bids and
offers to buy and sell as well as the amount that is up for trading. Bitcoins
can be actively traded across currencies just like any other currency.
Currently, one Bitcoin is worth approximately $14. This equals a U.S. market
value of more than $90 million dollars.

Without getting too technical, faith is being placed in the
mathematical equations that regulate the supply. The supply can be verified,
from the equation through circulation by anyone on the network. While the
equations require lots of computing power to solve, they can be checked very
easily, just like any math problem.

The demand is built up due to the freedoms and low cost of
use. Bitcoins have no transaction fees. There are no middlemen. There are no
PayPal, Western Union, wire or, credit card processing fees. The coins can be
spent online anywhere that accepts them, including, Ebay, Amazon and other
merchants as well as online poker sites and other places your credit card
company won’t let you spend your money. Bitcoin is gaining traction and now
processes more than 10,000 transactions per day. A survey of Cragslist even
turns up business opportunities including one with a Stanford PhD looking for a
technical lead developer in Bitcoin mining.

I am not promoting Bitcoin and I haven’t used it.
Personally, I think it may be the most forward thinking and libertarian store
of value yet developed. The idea that the fundamental supply is always known
and that it isn’t subject to government budgets and political elections
combined with the fact that it is stored with each individual participant
rather than any banking system makes Bitcoin a revolutionary endeavor of the
electronic age.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

U.S. Taxpayer’s Share of Greek Debt

The Bank for International Settlements Quarterly Review for
June, 2011 is the first black and white publication I’ve seen on the actual
size of the Greek, Irish and Portuguese (PIG’s) debt problems as well as how
much the United States and individual tax payers may be on the hook for if it
all goes pear shaped.

There are four interesting points concerning these debt
issues. These include, who owns the debt, who insured the debt, who profited
along the way and finally, who may be left holding the bag.

Initially, Europe is responsible for approximately 95% of
the debt of these countries. Most of this would be born directly by Germany and
France. However, these countries have purchased Credit Default Swaps (CDS) from
U.S. banks to protect themselves on approximately half of the debt they own.
This means that if the countries in question end up defaulting on their loans
the U.S. banks that sold the credit default insurance will be on the hook for
making France and Germany whole again.

The data in the tables is pretty extensive but the end
numbers look like there is roughly $890 billion in loans that are in danger of
defaulting. The U.S. exposure to these losses both directly and via credit
default insurance that U.S. banks have sold is about $200 billion. More than half
of that is in Greece, which will be the first to default. U.S. banks are on the
hook for approximately $100 billion in credit default insurance to PIG
countries with about $35 billion directly insuring Greek loans. The total
outstanding credit default insurance sold by U.S. banks to European countries
is more than $1.5 trillion dollars.

A quick recap – Germany and France bought Greek debt then
turned to U.S. banks to buy insurance on the debt Greece and other countries
sold them. U.S. banks collected the fees and sold the insurance even as they
were recovering from their own bad loans and accepting bailout money to heal
their balance sheets. The fees they collected went on to pad their bottom line
and allowed them to post record 2010 earnings. These earnings allowed banks to
payout record bonuses for a second consecutive year.

The pending default of Greece will leave U.S. banks on the
hook for at least $35 billion dollars. Ireland will add $54 billion and
Portugal another $41 billion. These banks also hold direct debt to the tune of
another $63 billion. When the market moves on Greece, it will move on these
other countries as well. It is simple stampede mentality. Remember the collapse
of ’08?

The AIG bailout was due to their inability to meet $85
billion in obligations. It was deemed, “too big to fail.” Bank of America and
Citigroup each received $45 billion in TARP money following the sub prime
implosion. JP Morgan, Goldman, Wells Fargo and others required governmental
assistance as well. Total U.S. bank exposure to Portugal, Ireland and Greece is
more than $193 billion.

There are only two arguments left to decide in the coming
debacle. First, will we have a partial or a complete default? Complete default
benefits the Europeans and leaves the U.S. on the hook for the balance.
Secondly, when France and Germany come to the U.S. seeking their insurance
payouts will our banks be able to afford them. I don’t believe these banks,
funded with taxpayer money and using our savings accounts as collateral for
making the loans have the resources to cover their losses. Therefore, the
taxpayer may be left holding the bag…again.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

End of the Metals Rally

The mineral and industrial metal commodities may be nearing the end of their decade long rally. I think a very good case can be made for the highs to be put in sometime in the next twelve months.   Political agendas and inaction should support the metal and mineral markets heading into next year. However declines in global demand, a slow down in infra structure creation, higher production taxes and the eventual global debt crisis will bring these trends to an end.

First of all, the supporting case comes from a global political cycle that is determined to maintain the status quo. Here in the U.S. QE 2 is set to end next week. Most of the money that went into this program that was designed to stimulate the economy never made it out the front door of the lending institutions that received it. The money was used to strengthen the banks’ internal lending reserves, rather than passing it on to the public at the low rates at which they received it. Therefore, the individuals and small businesses never received the assistance and won’t miss it when it ends. Furthermore, the debt ceiling, which has been kicked down the line until August will find a way of being raised, extended, supplemented, etc. Neither political party in the U.S. wants to be responsible for causing a governmental work stoppage or promoting an unpalatable solution in an election year.

Globally, support comes from both the European Union, determined to postpone the situation in Greece as long as possible as well as the coming Chinese elections. This most certainly means bigger problems down the road. Until then, these two will both keep throwing good money after bad in two of the largest economies in the world. Europe has no solution to the Greek debt problem and the Chinese leaders vying for President will keep their individually governed areas rolling in the fiscal stimulus and distorted GDP figures until after their elections in January of 2012.

Unfortunately, the headwinds facing the industrial metals and minerals markets have been gaining traction for quite some time and are far more widespread. The obvious follow up is the pending global slow down. The debt issues of Europe and the U.S. must be reckoned with. When this is combined with cutting Chinese building subsidies and severely raising the mining taxes in Africa and South America, the markets will be forced to absorb the excess capacity of the Chinese buildup in the face of declining profit margins at the mine.

Platinum, copper, and mineral mining have increasingly shifted to African countries. Many of these countries have not received the compensation from the development of these industries they had expected. Some of this is due to corporate accounting that kept revenues off the books. Let’s face it, if General Electric can avoid paying U.S. income tax like it did in 2010, it shouldn’t be too hard to assume that corporate accountants for multi-national mining companies can evade the tax collectors in third world economies like Tanzania, Zambia and Ghana. The local governments, feeling slighted after the metal and mineral price run up in 2008 are enacting much tougher tax laws and strengthening their central governments in order to nationalize (seize) assets that have underpaid. These actions are similar to state run South American enterprises and will make ownership of publicly traded companies less attractive.

Finally, there is no question that global liquidity is at an all time high. Currency depreciation will continue to influence the metal markets as investors look for a safe haven store of value. However, if governmentally stimulated demand dries up or if the sources are over taxed, we will be left with empty buildings and unemployed workers. This decline in demand will outpace the draw on warehouse stores and lead to a decline in prices as the global economy finally comes to terms with itself in 2012.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Sharecropping in Greece

This week’s article is based on a piece I read by Michael
Hudson. He is a research Professor of Economics at the University of Missouri,
Kansas City and President of The Institute for the Long –Term Study of Economic
Trends. His writing is quite dense. I had his articles on one screen and
Mirriam-Webster’s online dictionary up on another. That being said, his basic
thesis is that the European Union’s design has allowed private banks to make
sub prime loans for individual countries’ internal development with little
thought as to whether they had the ability to repay them. Unlike our own sub
prime debacle, it is ending in foreclosure by the banks on entire countries,
instead of just individual houses. He calls this the, “sharecropper” model of
European lending that will create poverty stricken and dependent countries
within the European Union.

The first issue
he raises is with the globalization of the financial industry and its primary
purpose of collecting fees and generating revenue based on the maturation process
of the debt it services. Accounting processes in the last 10+ years have
evolved into a shell game. The idea, following Enron’s lead and supported by
major financial firms like Goldman Sachs, Chase and J.P. Morgan allowed private
banks to make loans large enough to subsidize governmental funding programs
like health care and infra structure loans by creating financial swap
contracts.

The swap contracts they created are basically like
adjustable rate mortgages with the addition of a second variable. Obviously,
the first variable on an adjustable rate loan is the future interest rate. The
second variable is the foreign exchange rate. The value of the loan is
calculated at the time it is made but the repayment value would vary based on
the relationship between the currency in which the loan was made and the
currency that it is repaid with. For example, in 2003, the Euro and the Dollar
traded at the same value. A loan made in Dollars to the European Union of
$1,000,000 would carry a swap value of the agreed upon interest rate
fluctuation plus an agreed upon currency exchange rate fluctuation. The Euro is
currently worth $1.45. Therefore, the current repayment value of the loan could
have been cut nearly in half based on currency fluctuation. Think in terms of
controlling the new crop seed money.

The swap contracts they created allowed private banks to
lend money to foreign governments, which would be repaid through national
lotteries, airport landing fees, toll roads, etc. The banks profited and debtor
countries, like Greece, remained within the European union’s 3% budget deficit
rule because cross currency swaps were not recognized as official government
debt. The reality was that the accountants at the large institutions found legal
but, covert ways around the European Union’s Maastricht Treaty. The Maastricht
Treaty made no provision for financing individual countries directly by the
Union. The unintended consequence was a shadow lending industry that went
completely unregulated and spiraled out of control. Imagine the U.S. sub prime
debacle on a scale large enough to finance Greece, Ireland, Iceland, Portugal
and Spain combined! Hudson equates this to a land grab of national revenue
producing assets.

The second issue that Hudson raises is the process by which
the debt that is created by the banks and squandered by the individual
governments is then transferred to the general population for repayment to the
original lenders. The borrowing governments use the money received to expand
their balance sheets, which in turn allows them to issue new debt on the open
market. This debt is purchased by the large French and German banks that now
hold roughly 35% of Greece’s debt and can’t afford Greece’s inability to pay.

Germany and France then use their political clout to
engineer a European bailout (QE1 & 2 in the U.S.) to protect the banks and
people of their countries but, in actuality, saddle their own productive
economies with repaying a less productive country’s debt. French and German
taxpayers, unwilling to cover the debts of an irresponsible borrower force
austerity measures on Greece to punish them. However, raising taxes to pay back
the loans does more to damage Grecian productivity than to curb spending. This
places Greece in an even deeper hole forcing them to seek more bailouts to fund
nationalized welfare programs like health care, garbage removal, infra
structure maintenance and so on. This, controls the labor.

Finally, the European Union, as opposed to individual
lending institutions, offers to buy or, lease national services and landmarks
like, the Parthenon or their airports and roadways that would guarantee long
term loan repayment revenue streams. The banks would keep their profits and
remain solvent while Greece gets their own spending habits under control.
However, this process would also strip Greece of their primary national
industry – tourism. Consider this the, “land” portion of the equation.

The spiraling cycle of forcing people to pay more while
making less through controlling the seed money, labor and land is why Hudson calls
this subsistence the, “sharecropper” business model of the Euro financial
institutions, which he believes will end in revolt just like it did here in the
U.S.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Platinum Demand Outpaces Gold

The platinum market has waffled along since the Japanese
tsunami and earthquakes of March 11th and is currently undervalued
by a number of measures.
Initially, the platinum market sold off hard as industrial demand for
automakers came to a screeching halt. Japanese auto production was cut by more
than half and was just beginning to come back online four weeks ago. It is very
reasonable to expect that Japan’s outright auto production may be cut by more
than 10% for 2011. This uncertainty has placed the platinum market in a state
of limbo for the last two months.

There are several clues pointing towards higher prices for
platinum. The first group to step in and provide a floor was the commercial
traders. The advantage of following the commercial traders is that they all
derive their valuations individually. Their actions as a group, reported to the
Commodities Futures Trading Commission, allow us to view their collective
consensus. Their analysis showed that platinum below $1,700 per ounce was a
screaming bargain. They increased their collective net long position by more
than 100% in two weeks. Commodity fund managers and commodity trading advisors
are following the commercial traders’ lead and have now repurchased the
positions they sold off during the market’s post nuclear free fall in March.

Platinum’s relative valuation to other precious metals is
also a good indicator of value. I think everyone would agree that platinum is
more expensive than gold. After all, gold production is measured in metric tonnes
while platinum’s production is measured in ounces. Yet, March’s decline brought
the price of platinum to within $239 of the price of gold. That is a premium of
1.15 times the value of gold for a market that is 36 times the size based on
2010’s production numbers. The average annual low value for this differential
is 1.52. This means that the closest platinum has been to gold in each of the
last 10 years is 1.52 times the value of gold. Gold at $1,000 per ounce equals
platinum at $1,520. Conversely, the average high in each of the last 10 years
is platinum trading at twice the value of gold. A reversion to the lows of this
spread brings platinum back up to $2,356 per ounce while a move to the highs of
this spread would take platinum to more than $3,000 per ounce.

Finally, Japanese auto manufacturing will come back on line.
Furthermore, the increase in automotive production from India, China and Russia
which all use platinum technology in their catalytic converters will not only
support the market but, add new demand going forward. Remember, China now
produces more cars than the U.S. Japanese auto manufacturing uses approximately
.054 ounces of platinum per vehicle. Based on their annual production of 9.5
million vehicles, this equals about 8.5% of global platinum production. China
and India both saw vehicle production increases of more than 25% last year and
based on their extremely low per capita vehicle ownership rates and healthy
economies, there’s no reason their increases won’t continue for some time to
come.

Finally, the U.S. government’s low emission vehicle mandate
to put 10 million new fuel cell equipped vehicles on the road by 2025 has
continued to place solid demand on platinum through it’s use in batteries and
fuel cells. The government money being funneled into inefficient technology is
pulling platinum from the market at a rate of 10 times the conventional auto
industry on a per unit basis.

Whether platinum is viewed as an outright value investment
or as a relative investment to other precious metals it ought to be considered
as a small percentage of one’s portfolio. Outright platinum ownership is the
most risky route with support expected somewhere around the $1,700 area while
the platinum spread against gold would afford some directional protection while
still maintaining the ability to participate in platinum’s out performance of
gold as it climbs back to its historical trading levels.

This blog is published by Andy Waldock. Andy
Waldock is a trader, analyst, broker and asset manager. Therefore, Andy
Waldock may have positions for himself, his family, or, his clients in
any market discussed. The blog is meant for educational purposes and to
develop a dialogue among those with an interest in the commodity
markets. The commodity markets employ a high degree of leverage and may
not be suitable for all investors. There is substantial risk of loss in
investing in futures.