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Breakoutof35-yeardownwardyieldrangewillblow-upinterestratederivatives($500trn+)Nothingmakessenseanymore.ThemarketskeepgoinguplikeitisgoingoutoffashionTrump’shoneymoonperiodornot.Trumpmightbegettingastrongcabinetaroundhimandhavegoodideastostimulatetheeconomythoughyoufirsthavetospendmoney(increasingdebt)beforeyoumakemoney,whichtakestime.Andtheobviousquestionishowtheexpendituresandlowertaxrates(15%)willbefinanced.Inevitablyitwillmeanafurtherincreaseinthealreadyhighdebtburdenofnearly$20trnfurtherstrainingtheDebt/GDPratio.TotalUSdebtplusunfundedfutureliabilitiesisestimatedatsome$200trn+.Weareadebtsociety.Asindicatedinmyearlierarticle$10ofdebtisneededtogenerate$1inGDPgrowthshowingtheinefficienciesofourlegacysystems.The0.25%increaseinFedFundsRateandapotentially3furtherinterestratehikes(completenonsense!)for2017isfurtherstrengtheningthealreadystrongUSdollarandblowingallothercurrenciesoutofthewaterwhichisastrongargumentforgold,thebesthedgeagainstcurrencydevaluations.Goldisbyfarthebestpreservationofpurchasingpowerunderthecurrentcircumstancesandthepensionfundsshouldtakenoticeiftheywanttohavepurchasingpowerleftfortheirpensioners.FromNovember8theUSdollarindexhasincreasedby6%from97to103withtheUSdollarat14-yearhighs.OverthesameperiodtheEurohasfallenby9%from$1,13to$1.04whilsttheYenweakenedby13%fromY103toY117.FollowingtheDecember16thdevaluationandtheChineseseizingoftheUSunderwaterdronetheoffshoreYuanhitafreshrecordlowofY6.96againsttheDollar.Sincethe"one-off"devaluationinAug2015,theChinesecurrencyhasnowweakenedalmost14%againstthedollar.AndthechartshowsthatfollowingtheTrumpeffectmoreweaknessisonthewaynottheleastbecauseoftherisingdebt/equityratio,alreadyat250%forChina,andtheincreasingamountsofmoneyleavingthecountryinanacceleratedfashioninanticipationoffurtherYuanweakness.

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AsaresultofthestrongerUSdollarEM(EmergingMarket)debt,whichismostlyfinancedinUSdollars,isgettingmoreexpensivebythedaybecausemorelocalcurrencyhastobeexchangedfortheevermoreexpensiveUSdollars,nowat14yearhighs.TheincreasingdemandfordollarsinordertopayofftheloansandtheUSdollarloansnotbeingrolledoverhastranslatedinafurthertighteningoftheEurodollarmarket,whichconstitutesofalldollars“held”outsidetheUS,andshowsinhigherLibor(LondonInterbankofficialrate)rates.

FollowingthestrongerdollartheyieldontheEMdebtisalsoincreasingbecausetheweakerexchangeratefortheEmergingMarketcurrenciesincreasestheriskofrepayment.NexttothenegativeimpactontheEMdebtthestrongdollarisalsoincreasingtheforeigntranslationlosses.Some50%ofallS&Pcompaniesprofitsstemfromabroad.Asaresultprofitgrowthforecastfor2017willhavetobeadjusteddownwardskeepingeverythingthesame.Anothereffectofthecontinuousandselffulfillingfeedofastrongerdollarfollowingtheratehikeandpotentialfurtherhikesin2017isthatinvestorsswaptheirJapaneseandEurosovereignbondsforUStreasuriestriggeringhigherdomesticinterestrates.InotherwordstheupwardpressureoninterestratesintheUShasalotofundesiredeffectsperhapsthemostimportantonethetriggeringofhigherinterestratesworldwideontotalglobaldebtsof$220trn(up$70trnsince2008).Inmypointofviewthedollarstrengthisartificialbecausethelackofbetteralternativesexceptforgoldandsilverwhicharebeingpurposelysuppressed.Six-weekretailsalesuptoDecember5aredown5%y.o.y.AccordingtoaresearchpiecepublishedbyCowen&Co.onDecember14th,malltrafficfell6.4%inNovemberfromOctoberandDecembermonth-to-datetrafficwasdown9.9%.NexttothatanewstudybyeconomistsfromHarvardandPrincetonindicatesthat94%ofthe10millionnewjobscreatedduringtheObamaeraweretemporarypositions,theywerepart-timejobsorcontractpositions.Inotherwordslowqualityjobs.TheproportionofworkersthroughouttheU.S.,duringtheObamaera,whowereworkinginthesekindsoftemporaryjobs,increasedfrom10.7%ofthepopulationto15.8%.

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Obama’sboastfulpretendedimprovementinthenumberofpeopleemployedreducingtheunemploymentrateto“4.6%”showsheeitherliesordoesn’tknowwhatheistalkingabout.AnywaymypointisthatthestrengthintheUSdollarisnotfundamentalbecauseofastrongeconomybutpurelyafunctionof“relativestrength”andliesabouteconomicstatisticsmanufactured(manipulated)bytheGovernment.GoldandsilverareTHEonlyalternativetotheUSdollarthoughthey,thecentralbanksandBIS,consistentlyandmethodicallysuppressthepreciousmetalsinordertogivetheUSdollartheflawedupperhand.ThoughIbelievethatthequarterlychartforgold,asshownherebelow,isindicatingthatthecorrectionsince2011isnearingitsendandthatwecanexpectmuchhighergoldandsilverprices.Heyithasbeentoughbuttherewardsarecoming.

Itshouldbeemphasizedthatthe“strongest”USdollarin14yearsalsoisanimportantreasonwhygoldhasbeenunderperforming.GoldandtheUSdollarareinverselycorrelatedseechartbelow.HoweverthequestionreallyisifthegoldpriceisweakbecauseoftheUSdollarstrengthorbecausethemanipulationbythecentralbanks.WelllookingatthefundamentalsandtheincrediblehighdebtlevelsallovertheworldwithChinaandJapanhavingdebt/GDPratiosinexcessof250%andtheUSnearingthe$20trnlevelIputmymoneyongoldandsilver.

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IbelievethatwiththeanticipatedTrumpinitiativesfortheUSeconomy,theveryfragmentedinflationandtheilliquidityinthebondmarkets(becauseregulationsandCentralBankbuying)the3%break-outlevelisnearerthanwemightwishfor.Aseludedinearlierarticlesthe3%levelrepresentsthebreakoutlevel(seechartbelow)fromthe35-yeardownwardtrendinthe10ytreasuryyield,since1981,whichwillleadtoveryviolentupwardmovesintheyields.Nexttotechnicalreasonsasaresultofnewregulationsmarketmakersnolongerkeepinventorysincerelyreducingliquidityinthetreasurymarketandbecausetheyalsodon’twanttoholdthebagattheotherendIdon’texcludethattheyieldcanquicklyriseto4%,5%andeven6%whenwebreakout.Thelowinthetreasuryyieldwas1.36%July,andnowit’saround2.55%anditisnotmissingitsimpactontherealestatemarketthatisstartingtogooff-linewith30ymortgageratesat4.3%+.Ifyoulookatnewhomestarts,theyweredown19%inNovembermonthovermonth.Thereisnomorerefinancingmarket.Asthehousingmarketgoes,sogoestheeconomyandweknowwhathappenedlasttime.Housingvaluesrepresentthesoundnessofthebanksandtheconsumerconfidencecrucialforconsumerspending.

AnywaythebreakouttheoryisalsoconfirmedbyLouiseYamada,arenownedtechnicalanalystwhobelievesthe2.5%levelisthecruciallevel.“Thebullrunisdefinitelyover”after10-yearyieldspierced2.5%,saidYamada.Shenotesthatatrendlinehasbeenbroken;period.“Pricesofbondsaregoingtogodownandyouaregoingtoloseyourcapital,”saidYamada.Ithoughstillbelievethemajorbreakingpointisthe3%.Howeverifitis2.5%or3%thetonehasbeenset.

myf.red/g/cdlb

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

2012-01-01 2012-07-01 2013-01-01 2013-07-01 2014-01-01 2014-07-01 2015-01-01 2015-07-01 2016-01-01 2016-07-01

fred.stlouisfed.org

Source:FreddieMac

30-YearFixedRateMortgageAverageintheUnitedStates©

Percent

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Asaresulttherewillbeabloodbathinthebondmarketwhenwebreakoutandbecausethemarketsareasymmetrictherewon’tbeanyrotationfrombondsintoequitiesbutasimilarsell-offintheequitymarketsbecauseofthemuchhigherratesmakingtheequitymarketsPERstooexpensive.BesidesthatIbelievewhatwillfeedonthesell-offwillbetherapidmoveintheinterestrateswhichwillunsettletheinterestratesderivativeswhichare$500trn+or$500,000bn+.Interestratederivativescan’tberesetwhenthemovesintheunderlyinginterestratesaretosteepoverashortperiodoftime.The$500trn+ininterestratederivativesareamountsthatareunimaginabletocomprehendandthesederivativesaretherealnuclearinstrumentsoffinancialdestructionasalsoacknowledgedbyBuffett.Justimaginehowfarreachingtheconsequenceswillbe.Theonlyassetclassthatcurrentlyisinverselycorrelatedtothecurrentpeakbondandequitymarketsisthepreciousmetals,goldandsilver,becauseofthestrongUSdollarandtheartificialsuppression.Andasweknowgoldandsilverarethebesthedgesagainstdevaluationsofthecurrenciesorotherwisesaidglobalpurchasingpower(thegoodsyoucanbuywiththesameamountofmoney(fiatorprecious)).JustlookupthegoldpricechartinSterling,MexicanpesoandChineseYuansince2011.Becausegoldandsilverarepricedinallcurrenciesadevaluationofacurrencyisreflectedinahigherpriceforgoldinthelocaldevaluedcurrencybecausethepriceinallothercurrenciesstaysthesame.Andsinceallworldcurrenciesareanchoredtothereservecurrency,theUSdollar,therealriseinthegoldandsilverpricewilltrulyshowitselfwhentheUSdollarlosesitsappealorcredibility.Andwhentheyieldforthe10yTreasurybreaksoutofthe35yrangeforeigninvestorswillselltheirbonds,whichwillweakentheUSdollar.InfactonecanarguethatthatprocessisalreadyinplacewiththeChineseRussiansandSaudisellingtheirtreasuriesandaccelerating.ThecontinuouscapitalflightfromChinawillfurtherdevaluetheYuan,whichwillultimatelyhelpboostingthebestcurrencyhedge:physicalgoldandsilver.NexttothatdoyoubelievepeoplewillcontinuetotrustpapermoneyinIndiaaftertheabolishmentoftheR500andR1,000noteswhichisbankruptingthepoorpeopleinIndia?

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AuthoritiesinChinahaltedtradingonDecember16thforthefirsttimeeverinfuturescontractsofgovernmentbonds,afterpriceshadswooned,withthe10-yearyieldhitting3.4%.Tradingdidn’tresumeuntilafterthePeople’sBankofChinainjected$22billionintotheshort-termmoneymarketfinancedbydumpingtreasuries.AccordingtotheUSTreasuryDepartmentreleasedTreasuryInternationalCapital(TIC)dataforOctober,net“acquisitions”oftreasurybonds&notesby“private”investorsamountedtoanegative$18.3billioninOctober.And“official”foreigninvestors,whichincludecentralbanks,dumpedanet$45.3billioninTreasurybondsandnotes.Combined,theyunloaded$63.5billioninOctober.InSeptember,theseforeignentitieshadalreadydumpedarecord$76.6billion.

AlthoughtherewasalsonetsellingofUSTreasuriesin2012,2013,and2014itnevermatchedthesamemagnitudeasin2016.WhentheQEtapered,forcinghigherLTinterestrates,thesellingpressureoftreasuriespickedupin2015withasharpaccelerationin2016.AndtightercreditconditionswillalsomeanlowerPEmultiplesforequities.

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IngeneralitistheESForExchangestabilizationFund,partoftheUStreasury,thatbuysthetreasuriespreventingtheinterestratesfromgoingthroughtheroof.Sofarforeigncentralbanksliquidatedarecord$375billioninUSgovernmentdebtinthelast12months.Thetotalamountofcustodialpaper,thesearethetreasuriesthatarebeingheldforforeigngovernments,hasfallento$2.805trillion,thelowestsince2012.Goingbacktotheearly1980s,thechartofnetpurchasesofUStreasuriesbondsandnotesjustshowshowthiswholesaledumping(circledinred)ofUSTreasurybondsandnotesbyforeignentitiesstartedafter2009:

China,oncethelargestholderofUSTreasuries,hasnowproblemsofitsownwithitsbankingandshadowbankingsystem.Authoritieshavebeenbusytryingtokeepalidonitsownfinancialproblemsthatarethreateningtoboilover.It’stryingtopropuptheYuanandtostemrampantcapitalflightwhilstatthesametimeit’stryingtokeepitsassetbubbles,particularlyinthepropertysector,fromgettingbiggerandfromimploding.Andindoingso,ithasbeensellingforeignexchangereserves.AccordingtotheTICdata(marketpriceadjusted),ChinawasthelargestsellerinOctober,unloading$41billion.Overthelastsixmonths,itunloaded$128billion.ThisslasheditsholdingsofTreasurysecuritiesto$1.116trillion,belowtheholdingsofJapan.Japan,nowthelargestholderofTreasurysecurities,reduceditsholdingsbyonly$4.5billioninOctoberto$1.132trillion.JapanandChinaarebyfarthelargesttwocreditorsoftheUSandthey’recuttingbacktheirlending.Overthelast24months,theUSgrossnationaldebthasballoonedby$1.85trillion,orbyabout$925billionper12-monthperiod.UnderObamathegovernmentdebtdoubled,thebiggestincreaseever.OnJanuary20,2009,whenhewasswornin,thedebtwas$10.626trillion.Todayitisalmost$20trillion.HowirresponsibleisthatandhowmuchhasittarnishedtheUSmonetarycredibility!

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Thistime,neitherChinanorJapan,noranyothermajorforeignentitiesmaybewillingandabletobailouttheUS,asthey’vedoneduringandaftertheFinancialCrisis,becausetheynowhavetheirownproblems.Thebondmarketseesthistoo.Hence,thebloodlettinginTreasuries,onceconsideredamongstthemostconservativeinvestmentsintheworld.ThoughinmypointofviewRISKFREEisnolongerRISKFREE!Theyieldofthe10-yearTreasuryhasnearlydoubledsinceJuly6thisyear,whenitreachedalowof1.36%,whilstsettlingat2.55%onDecember23,2016.Andasmentionedthesellingintoanystrengthinthe10yTreasuriesdoesn’tseemtobeabating.Andtheclosertheinterestratewillcometothe3%break-outratethemorenervousholdersoftheTreasurieswillbecomeandbemoreincentivizedtheywillbecometoselltheirpositionsinordernottoincurmuchlargerlosses.

TheModiabolitionoftheR500andR1,000notesenactedonDecember9hadsomewell-timed“coincidence”withtheTrumpwin.Modireasoneditbyfightingcorruption,whichwasthebiggestnonsenseever.Hewasclearly“instructed”bytheBISandothercentralbankstodampenoreradicatetheseasonalbuyingofgoldinIndiaforthedifferentfestivalsetc.ThisModi,nowprimeministerofIndia,wasateasellerinanIndiantrainstation,doyoubelievehecouldstanduptothe“sophisticated”BISpeopleandcentralbankersandwhoknowswhathasbeenpromisedtohim.Anywayitsoundsthatthisplanisnotworkingthewaytheyhadenvisagedittoworkout.GoldinIndiaisnowtradingata$300+premiumperouncetoLBMAandComexprices.ItwillbealongtimebeforetheIndians,andespeciallythepoorestpeople,willtrustpapermoneyagain.Andthereasonwedon’tseehighergoldpricesinLondonandNewYorkyetisbecauseIndiahasclosedoffitsgoldmarketfortherestoftheworldinvokingincreasedsmugglingespeciallyfromDubai.ThoughifthissituationcontinuesitwilldefinitelyimpactLondonandNewYorkprices.AtpresenttheShanghaiGoldExchange,whichisaphysicalexchange,isshowing$30+premiumsforgoldpricesfollowingthecontinuousdownwardpressureontheYuan.ThesegoldpremiumsshouldbearbitragedhencepushgoldpricesinLondonandNewYorkup.

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AlastremarkIwanttomakehereisaboutBitcoin.LastweekBitcoinpricesclimbedtoasmuchas$918.95,a17.7%gainsincethestartoftheweek.Bitcoinisaproxyforgoldandsilver,fortheuncertaintyinthemarkets,especiallythecurrencymarkets.Bitcoinisaneasywaytoevadecapital,bankingandtransportrestrictionsthoughultimatelyitisavirtualdigitalcurrencyandcan’tcompetewiththerealgoldandsilver.ThoughbeawareeverythingthatisdigitalcanbehackedandaskyourselfwhoisgoingtobewillingtosellphysicalgoldforadigitalalgorithmwhentheUSdollar,stilltheanchorofthefinancialsystem,isfailing.ItisthesamewiththenominalsettlementoftheComexoptionswhenpeopledon’tacceptanydollarsanymoreforthesettlementoftheirfuturesbutwanttohavethephysicalgoldforthesettlementoftheircontracts.ContinuousmuchhigherpricesforBitcoinkindofsignifieswhattheoutlookforgoldpricescouldbe.Anywayalltheabovesituationsshouldbeincreasinglyfavorgoldandsilverinincreasinglydifficulteconomicandmonetarycircumstances.ConclusionTorecapitulatesituationsthatwillfavorgoldandsilver.InflationaryU.S.andChinesepolicieswillresultinspeculativefundflowsintogold.President-electDonaldTrump’splanstocuttaxesisestimatedtoadd$7.2trntothefederaldebtinthefirstdecadeandasmuchas$20.9trillionby2036,ontopofthe$20trillionoutstandingtoday.Evenintheabsenceofsuchadditionalspending(Congresshasneverbeenabletoimplementa“revenue-neutral”taxcutinthemodernera),theU.S.federaldebtisstillexpectedtoincreaseoverthenextdecade,drivenbyentitlementspendingsuchasSocialSecurityandMedicare/Medicaid.Nexttothathigherfiscalspendingamida“tight”labormarketandrisingwagesinvariablyleadstohigherinflation.Anotherformisthecommodityinflation,fuelledbythelowbaseeffect(pricesthathavecomedownsignificantlyandthanstartrisingagain).Wealsowitnessedcommodityinflationinthe70’s,withtwooilcrises,itwasaperiodofstagflationwhichpropelledgoldfrom$35/oz.to$850/oz.TrumpisbeingcomparedtoReaganintermsoftheirnononsenseandpragmaticapproachandthat2017islike1981.However,Reaganwaselectedafterarecession.Interestrateswereover20%whenhetookofficeandindebtednessforthewholeeconomywasonlyatDebt/GDPratioof32%,thefederaldebtheldbythepublicwas$1trn,accordingtoCBOandtheP/Eforthestockmarketwas12x.Trumpcomesinwithindebtednessat$20trnwhilstthestockmarketison27xcurrentearnings."ThecyclicallyadjustedP/E(CAPE),avaluationmeasurecreatedbyeconomistRobertShillernowstandsover27andhasbeenexceededonlyinthe1929and2000maniaseechartbelow.MypointisthatthestartingpositionfortheTrumppresidency,despitealltherightideashehas,isveryunfavorableandwefirsthavetogetbacktoearthbeforewecanmakeheadwayintheeconomy.Toomanytricks,unreliablestatistics,manipulationshavebeenusedinordertokeepthepretenseupthattheeconomyisdoingwell.Nothingislesstrueandthisissomethingwefirsthavetocorrect.Andthebondmarketismostlikelygoingtodothejobforusseecommentsmentionedhereaboveaboutthebreakoutofthe35-yeardowntrendinthe10yyieldsandtheimpactontheinterestratesderivatives.Theimpactofaresetinthemarketsmightbequitesevereandtakealongtimetoresolvethemorebecausewearefacingaglobaldebtproblem.

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ShillerCAPEPERatioChart

Source:Multpl.comOngoingfiscalstimulusandasurginghousingmarkethasledtosignificantcreditcreationinChinawithregulatorsnowinstitutingpoliciestopricktheChinesehousingbubble.ChinesespeculatorshavebeenturningtothecommoditiesmarkettohedgethedepreciationintheirChineseYuan-denominatedassets.Overthepastthreemonths,zincandcopperprices,forexample,haverisenby20%and25%,respectively,drivenbyChinesebuying.InotherwordstheyhedgedbyinvestinginUSdollardenominatedcommoditiestoescapetheYuandevaluations.Inthefootstepsofthistrend,goldfuturesturnoverinChinahasrisentoabout25%ofthatontheChicagoMercantileExchange,suggestingthatpreciousmetalspricingpowerisincreasinglyshiftingtotheEast.ChinaisaphysicalmarketsettlementtakesplaceintheformofphysicaldeliveryandisnotanominalorpapermoneysettlementmarketliketheComex.AnditiscleartomethattheSGE,theShanghaiGoldExchange,willsetthefuturepricingofgold.Physicalwillwinfrompaperitisjustamatteroftime.AccordingtotheWorldGoldCouncil,globaljewelrydemandwasdown21%year-over-yearinthethirdquarter.Thiswasdrivenbyanunprecedenteddeclineinjewelrydemandintheworld’stwolargestmarkets,ChinaandIndia(whichcollectivelyaccountfor60%ofglobaljewelrydemand),wherejewelryconsumptionwasdown27%and41%,respectively,year-over-year.Jewelrydemandisexpectedtohitaseven-yearlowinChina,anda13-yearlowinIndia.Thisyear’sunprecedentedweaknessoftheChineseandIndianjewelrymarketswasduetoaconfluenceoffactorsthatwillnothavethesameimpactin2017.Theseinclude:1.AlossofChineseconsumerconfidence;2.Chinesegoldimportcurbsdesignedtorestrictcapitalflight;hencewhyBitcoinisdoingsowell3.AtaxhikeonIndiangoldimportsearlierthisyear;4.LastlyacashcrisisinIndiaasthecountry’sgovernmentoutlawedtheuseoflarge-denominationnotes.Withtherecentcorrectioningoldpricesandlossoftrustinpapermoneyandthedevaluationofthecurrency,IexpectbothChineseandIndianconsumerstostepuptheirgoldandsilverpurchasesin2017.

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Ibelievealotoffactorsarecomingtogetherandthatthebeartrendthatstartedin2011forgoldandsilverpriceshasendedandthatthesecularbullmarketisabouttheresumewiththebreakoutofthe35ydowntrendofthe10ytreasuryyieldabove3%beingthenamechanger.GijsbertGroenewegen©g.groenewegen@silverarrowpartners.com12/25/16