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The NEW Rules of the Game

By Jon Nadler       Printer Friendly Version Bookmark and Share
Mar 27 2009 9:19AM

Good Morning,

Gold prices lost more than 1.25% ($12) of the ground they occupied in the early hours of the day, and sank closer to $920 ahead of the NY market's opening. Recent dollar selling abated further overnight, after German officials warned that if the group of EU nations does not stick to its goal of keeping budget deficits under 3% of GDP, the single currency would sustain some additional hits.

Gold prices followed lower, after eking out small gains on Thursday. The trading range remained confined however, with values unable to break to either side of $920 or $940. Crude oil lost nearly another dollar during the wee hours, and eased closer to $53 per barrel. The Dow looked uncertain this morning - this, after having surged 30% in 13 trading days.

Silver opened with a 32 cent loss, quoted at $13.20 per ounce. Platinum and palladium also dropped, with the former slipping $5 to $1137 and the latter falling $2 to $220 per ounce. And, unless we just got a bad data feed, the price of rhodium fell $562 (?!) to $438.00 per ounce. Someone call an ambulance, please! Over in Qatar, surging gold sales. By the public, back to the dealers, that is. The India syndrome is spreading to the larger region. This trend remains one that bears close scrutiny.

Macro conditions continued on the tenuous side, with the overnight headline du nuit being Japan's apparent slippage into deflation following a stall in consumer prices and a near 6% drop in retail sales. As one astute reader opined, ask yourselves how long it has been since Japan started its QE campaign and inflation has been nowhere near making it onto economic radar screens.

Something that is quite likely to make it onto different radar screens in Japan soon, is the planned N. Korean missile flight. The country has mobilized its defenses ahead of the N. Korean 'test.' Don't know what Mr. Kim is 'testing' there, but there are those who think the test will be one that results in the confirmation of the ability of Japan or the US to shoot down whatever he sends skyward. Geopolitics - there's something that has been on the back shelf for some time, no?

In other news, the UK recession is now confirmed to be worse than expected (surprised?) as its GDP fell further and building activity cratered further. Over in the US, the pilgrimage of the nation's bankers to the nation's capital is expected to occupy the majority of today's headlines. This could be as important a summit on the internal front for the US, as will be next week's G-20 for its external one.

BTW, the subject of the US dollar's continued role as the global reserve currency is not likely to make it onto the G-20 agenda next week - so say Japanese officials. Chinese ones, meanwhile, continue their unusually high level jawboning about the West and its financial sector. The latest salvo regards the regulatory environment, and -as expected- is not lacking in criticism about its shoddy nature and/or its lack of visibility.

Perhaps a little known factoid could allay the somewhat overblown fears among certain extremist newsletter camps which argue that the American banking system is being lowered into its grave. Note: there are some 8400 banks (still left) in the US. Of those, about 8300 are small, community banks which remain very much solvent, very much unexposed to the toxic asset contagion, and very much eager to get things going for every customer in their local sphere. We remain unconvinced that these possible cornerstones of an eventual recovery in credit conditions are going to be fairly represented in DC today. They should be.

On the US economic front, more of the same. Namely, Google stopped searching for additional marketing and sales activity and is letting go of about 200 staff in those areas. Automotive sector employee buyouts are in vogue, mortgage rates hit 4.85% ( a record low) but were unlikely to spark a wave fresh takers among the growing numbers of those accepting such severance packages, to say the least.

As early as last summer, we warned that it was becoming apparent that at least some of the funds that were visible in the Big Selloff (in commodities, and later on in equities as well) were running ahead of the curve, by sensing impending tsunami of regulation. When such a...sea change looms, the Masters of the Universe go surfing. Elsewhere. Like in another ocean altogether. Bloomberg explains it for us:

"Hedge funds and private-equity firms, after opposing increased federal oversight for years, said they can’t escape the Obama administration’s plan to include them in an overhaul of U.S. financial regulation.

“We’re not going to be able to stand in the way of that speeding train,? David Rubenstein, co-founder of private-equity firm Carlyle Group, said at a conference in New York yesterday.

“New rules of the game? are necessary to restore confidence in the financial system after credit markets seized up and stocks fell the most since the Great Depression, Treasury Secretary Timothy Geithner said yesterday. He proposed requiring hedge funds and private-equity firms to register with the U.S. Securities and Exchange Commission and to disclose information about their holdings.

“The industry has been bracing for the call for regulation and within reasonable bounds accepts it,? Jim Chanos, founder of New York-based Kynikos Associates Ltd. and head of the Coalition of Private Investment Companies, a hedge-fund trade group, said yesterday in a Bloomberg Television interview.

Hedge funds and buyout firms would also fall under the purview of a new regulator that would identify companies deemed “systemically important,? or capable of wreaking havoc on financial markets. Officials would have the authority to seize these firms if they threatened the markets, much as they do now with insolvent banks.

Geithner said the administration didn’t intend to regulate all funds like banks, which must adhere to requirements for capital, liquidity and reserves for potential losses. “In the future, if some of them individually reach the size where they may be systemic, then at that point we believe they should be brought within a regulatory framework that’s similar to that which exists for banks,? Geithner said at a House Financial Services Committee hearing.

He didn’t specify the size at which the investment firms would be considered systemic. Hedge funds are private pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested. They managed $1.2 trillion as of Dec. 31, according to Chicago-based Hedge Fund Research Inc.

Regulators, concerned last October that hedge funds were aggravating the decline in financial markets, monitored managers to make sure they wouldn’t endanger counterparties. Citadel Investment Group LLC on Oct. 24 dismissed speculation that declines of about 35 percent in its two biggest funds would force it to liquidate. The funds ended the year with losses of about 55 percent.

The Managed Funds Association, a Washington-based hedge- fund group, said it supports a systemic-risk overseer. It didn’t fully endorse SEC registration. “There are a great many issues that should be considered in determining what, if any, such framework should look like,? Richard Baker, chief executive officer of the group, said yesterday in testimony before the Senate Banking Committee.

Once registered, the investment firms, including venture capital companies, would have to report information about their trades and counterparties to the SEC. The agency would share the data with the systemic-risk regulator, which could restrict the funds’ reliance on short-term financing and limit how much money they can borrow to maximize trading profits. The disclosures wouldn’t be made public.

The SEC in 2005 passed a registration rule requiring fund managers to provide information such as their business address and assets under management. The move also opened up their funds to random audits. The rule was thrown out by a federal appeals court in 2006 after it was challenged in a suit by Phillip Goldstein, founder and principal of Bulldog Investors in Saddle Brook, New Jersey.

At the end of 2008, at least 1,804 hedge-fund managers had voluntarily registered with the SEC, or about half the estimated number of hedge-fund firms at the time, according to Hedge Fund Research. Geithner’s plan would require funds to pass on more information than they do now under voluntary registration.

“The good side is that they will have a uniform approach to a very, very difficult problem,? Jack Hewitt, a partner with the law firm McCarter & English LLP in New York who works with hedge funds, said of regulators. “The other side is that they are going to be regulating entities that have historically been regulated in a different manner.?

The call for greater oversight comes as leaders of the world’s 20 largest developed and emerging economies are set to meet April 2 to devise a common approach to the global financial crisis. Finance chiefs from the G-20 member states said March 14 they would strengthen ties between their individual banking supervisors, and that credit rating companies, hedge funds, off- balance sheet vehicles and credit derivatives markets will be subjected to greater scrutiny.

Only one hedge fund has come close to bringing down the financial system. In 1998, John Meriwether’s Long-Term Capital Management LP destabilized financial markets worldwide and prompted the Federal Reserve to organize a bailout by the fund’s 14 lenders.

The government later determined that it was banks’ responsibility to keep closer tabs on how much money was being lent to hedge funds. Long-Term Capital borrowed $30 for each $1 of investor capital. Hedge funds today are borrowing less than $1 dollar for every dollar of assets, in part because banks have curtailed lending. While Rubenstein, who runs Washington-based Carlyle, said more regulation was unavoidable, the U.S. private-equity industry’s main trade group said its members don’t pose a systemic risk.

“Private-equity firms invest in companies, not exotic securities and their investors are long-term investors, eliminating the ‘run-on-the-bank’ type of risk that helped create the current financial crisis,? Douglas Lowenstein, president of the Washington-based Private Equity Council, said yesterday in a statement."

Ask yourself how long it might take before the upcoming massive changes in the regulatory environment alter the nature, size, and makeup of derivatives, complex financial instruments, and the very purpose and existence of the targets of such scrutiny. Let's just say that we are looking at a landscape which will look as alien as any we have ever seen being beamed down by the Mars Explorer. And, we say, watch out for that process more than you might be watching out for the long-awaited implosion of the sector due to the nature of its activities.

A small footnote on Mr. Geithner's tour de force in front of cameras. We detected more than a hint of possible capital flow controls in the making. Just a hint. We will go do some detective work on what such body language might imply.

Happy Weekend.

Will return Monday - expect a very interesting week.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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