The Bank of England on the Financial Crisis

Remarkable paper from the Bank of England. Crystal clear, sober yet witty. I would kill for this brand of British dry humor! Excerpt:

"With hindsight, this Golden Decade and its aftermath has all the hallmarks of, in

Charles Kindleberger’s words, Manias, Panics and Crashes. Enthusiasm about return

gave way to hubris and a collective blind eye was turned to the resulting risk. This

was a latter-day version of the Hans Christian Andersen fairy-tale, “The Emperor’s

New Clothes”. In a classic collective delusion, the Emperor’s new clothes, you will

recall, were admired by all. Conferences like this one became catwalks for banks and

the authorities alike, parading their new garments through the streets in all their

finery. Risk modelling became high fashion for the pointy-heads, haute-couture for

the anoraks.

The past two years have rather changed all that. The sub-prime market has played the

role of the child in the fairytale, naively but honestly shifting everyone’s perceptions

about how threadbare the financial system had become. The madness of crowds, as

Charles Mackay so vividly put it, became visible to all. The resulting unravelling of

the Golden Decade has been little short of remarkable."

Beware the Green Shoots

I find the current level of optimism in the market a little worrying. Everywhere I turn, I find yet another article making the case that those economic "green shoots" are real, shooting up real fast and ready to blossom into a jungle of prosperity. Not to mention CNBC, which I don't remember having seen this wildly bullish in, like, eons (this might partly be explained by the fact that yesterday was the first time in months I actually watched CNBC). 

All this to say that reading Paul Krugman's not-overly-bearish but soberly pragmatic New York Time's column was such a refreshing experience for me this morning. 

He reminds us that: 

"History shows that one of the great policy dangers, in the face of a severe economic slump, is premature optimism. F.D.R. responded to signs of recovery by cutting the Works Progress Administration in half and raising taxes; the Great Depression promptly returned in full force. Japan slackened its efforts halfway through its lost decade, ensuring another five years of stagnation."

And cautions us against the "real risk that all the talk of green shoots and glimmers will breed a dangerous complacency."

Fears of 1934

This is a Chicago Tribune cartoon from 1934 (hat tip Alex Spiroglou). 

The fears then were that the US was spending itself to ruin, dictatorship, socialism and catastrophe while vainly trying to save its economy. Doesn't it sound vaguely familiar?

Gold: The Moment of Truth

Technically speaking, I should have titled this post GLD: The Moment of Truth. Even though GLD is a good proxy for gold, I can think of quite a few scenarios (not all of them conspiracy theories) whereby GLD and gold stop being perfectly correlated. But for the sake of argument and acknowledging that GLD's stated goal is to mimic the price of gold, let's assume GLD and gold are indeed perfectly correlated and let's do the technical analysis based on GLD.

First the bad news. As we can see in the first chart, the GLD weekly (click to enlarge), the gold ETF might have completed a double-top below 100. Not only that but it has broken its 20-week simple moving average and both the 14-week RSI and the slow stochastic indicator are unequivocally pointing down. That's for the technicals. 

The sentiment background towards gold is quite negative also, with a consensus crystallizing these days that the worst of the financial crisis is over, the world as we know it is not coming to an end and a hyperinflationary dystopic future is not in the cards just yet. All of these reasons and/or excuses to buy gold at any price have therefore, if not completely disappeared, at least receded to darker corners within the collective subconscious of the relevant market players. 

So, undoubtedly, we are in a downtrend within a larger gold bull market. What needs to be elucidated is how damaging this downtrend is and where/when does it signal the end of the gold bull and not merely a corrective move.

That's where the second chart comes in, the good news part of my argument. One of my all-time favorite type of charts is the relative or ratio chart. There is no rocket science involved, yet there is no better type of chart to clarify, simplify and deepen any technical analysis of any kind of security. The chart (click to enlarge) simply shows us the daily ratio of GLD over SPY, the S&P500 ETF and it is clear that gold has been outperforming the index spectacularly for quite a few years now. Even with the current bout of relative gold weakness, the trend of GLD relative to SPY is still steeply up for now.

That long-term uptrend would be seriously damaged if and only if two key supports are decisively breached. One is last January's low at 78.87 and the other and most important one is around 70, the 2006 high that also, not coincidentally, turned out to be the low for the Fall of 2008 panic liquidation. 

Let's keep the Hawk-Eye on these two levels.

Disclosure: Long gold

Various Musings on Gold

The Toro blog expounds an interesting thesis on gold and the possibility that its bull run has (gasp!) ended. 

He doesn't necessarily agree with the thesis but points out that: 

"It may be that gold is signaling an end to systemic risk in the financial system."

Obviously, that's not the case yet as gold is still above its 200-day moving average but it is a case figure any person long gold should keep in mind.

If the thought of a gold bear market depresses you, I have the perfect antidote. In a Financial Times article exploring the advantages of some kind of return to a gold standard, someone at UBS (emphasis mine) "calculates that the US reserves of gold are so small, relative to its monetary base, that a price above $6,000 an ounce would be needed to reintroduce a gold standard. To implement that standard in Japan, China and the US, the price would be more than $9,000."

XHB: A Finely-Tuned Market Seismograph?

One of the most intriguing questions these days is: how will we be able to tell the economy is rebounding?

The very fact we're asking ourselves this question is a sign that the complete despair that overtook the world during the September 2008-March 2009 period is now abating.

One of the most consensual answers to the question is : we'll know the economy is rebounding when the real-estate market stabilizes.

On that score, XHB, the housing market ETF has already rendered its verdict. Indeed, XHB is acting as if the real-estate market were in the process of stabilizing. It has been building a base since 11/21/08 and is therefore anticipating, if not an immediate rebound in the housing market just yet, at least no steepening of the decline and the possibility of a rebound at some point in the future. 

One can therefore deduce that if and when XHB breaks out of that base in a decisive manner (somewhere above 14), it would mean the market (which conventional wisdom says is a 6-month discounting machine....when it is right, that is) has decided the housing market has turned the corner. Which would be a necessary though not sufficient sign the economy as a whole has also turned the corner.

And that's the problem! While such a move in the housing market ETF would answer our initial question, it would also open the way for a myriad new questions such as when will the rebound start, how strong will it be, how long will it last, etc...

That is what's so tricky about the concept of the stock market as a discounting mechanism. It is a dynamic, complex and hyper-sensitive discounting and prediction machine that might indicate one direction one second and a drastically different direction the next as new data, new sentiment and mood are digested.

Full disclosure: Long XHB

Quick Circular Thinking about the Plan

The point of my previous post was that the politics as well as the economics of any financial rescue plan had to be flawless. 

That's what many critics of the Geithner plan and proponents of outright nationalization of the banking system are missing or ignoring.

What those critics are probably right about is the fact that the Geithner plan will create "collateral windfalls" i.e. some undeserving institutions will reap some benefit from it. However, isn't it logical and inevitable that the solution to a financial catastrophe that created a lot of collateral damage should create some "collateral windfalls"?

And yes, such windfalls do have the potential to cause major political problems as the AIG bonuses furore demonstrated all too well. 

So we're back to the same key point: getting the politics right is at least as important and as tricky as getting the economics right. 

And only getting both aspects right will bring back the necessary system-wide confidence needed to finally begin to turn the corner. 

The Critique of the Critique

To Paul Krugman's immense credit, in his latest blog post , he cites (and critiques) a very interesting piece that is quite pro-Geithner plan and quite critical of his (Krugman) own extremely negative view of it.

The authors of the piece remind us of the two-dimensional aspect of any solution to the financial crisis: the economics part and the politics part:

As the liberal economist of record, Krugman’s critique of PPIP received a lot of press much of it uncritical. I think a little more critical reading is warranted, that his cry for nationalization now misses something crucial. Namely, he has a blind spot for the political and implementation risks and challenges. As John Heilemann wrote in the New York Magazine, “Getting the economics right may be devilishly difficult—but the politics are even trickier, and just as crucial.”

Krugman, in his critique, gets to the crux of why he thinks the PPIP (Public-Private Investment Program) is less than ideal:

[It] tr[ies] to fix the banks by driving up the price of a whole asset class. Most of those assets are NOT held by the probably insolvent banks. So it’s a diffuse, inefficient way of tackling the problem — a taxpayer subsidy to basically anyone holding toxic waste legacy assets, rather than a direct infusion of funds where needed. Contrast it with what the FDIC does when it moves in: it doesn’t shower money on banks in general, hoping that this will solve the problem; it seizes banks that are in trouble, and recapitalizes them.