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Jon Nadler

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Quick! 20 Minus 170 = ?

By Jon Nadler       Printer Friendly Version
Nov 14 2008 3:47PM

Good Afternoon,

New York's Friday session managed to bring gold into the winning column for the week, with futures gaining $37 and spot prices rising $14 to $750.00 per ounce. The gains came despite a smallish drop in the Dow, a $1 slide in crude oil, and a dollar that kept on the plus side, at 86.60 on the index. Thus, a commendable performance overall. The market's bias showed an upward tilt shortly after the open, as rumored hedge fund buying lent support, and as slumping US retail sales reignited expectations of fresh Fed rate cuts. Mr. Bernanke, speaking in Germany today, hinted at global central banks standing ready to deliver more of whatever it might take to pry open the tightly shut credit markets and stimulate imploding economies.

The rest of the world didn't fare very well this Friday, for sure. It did not take long after the German economy was declared to be in a recession, for the rest of the EU to have the same label applied to it as well. Like that came as a surprise to anyone. The surprise came later in the day, when Honk Kong's economy also joined the growing list of countries in contraction mode. Jobs cuts were on the agenda at Citi (10,000 to be let go) and Sun Microsystems (6,000 pink slips being printed) and warnings and disappointing results were issued by Nokia, Abercrombie, and PC Penney. One item that still flew off the shelves: video games. Staying home and shooting up fictional characters. Ahh, what a relief!

The Washington summit of those who represent 90% of the world's economy will now start to look more like a fretful session the rescue capitalism's wreckage than a caviar on blini-laden jamboree. The UN Secretary General has warned the participants that although some 170 countries are not going to be represented at the meeting, the fate of hundreds of millions lies in the hands of the world's economic elite, and that if they fail to right this severely listing ship, the outcome will not be very pleasant on the social front.

"No pressure, we just wanted you all to know that we are all counting on you."  We are not, however, counting on you to announce that you have just set the price of bullion at 10 or 53 thousand dollars. Get a grip, folks, and try to sell newsletters or whatever, by using semi-plausible titles. The most pleasant surprise of all would be if the word 'gold' even got a mention at the G-20 roundtable - and not is some 'forced sale' context. Most analysts expect basically nothing to come out of the summit, and are cautioning attendees to 'do no harm.' Probably an allusion to the harm they've done already, by bungling the crisis up to this point.

Since everything is gloomy enough to only be able to laugh, and it is Friday funny time, let's go for a Mark Gilbert parable as found on Bloomberg this morning. Maybe the nice folks gathering in DC should read it, and go into their meetings with less of a buck-passing attitude and more of a 'we're in this thing together' spirit.

The great and the good of capitalism and free markets held a requiem dinner for the global financial system at a secret hideaway this week. As the waiter decanted a fresh bottle of 1985 Chateau Margaux, the blame game began.

"I blame the central banks," growled the bond trader, stabbing the air with a forkful of raw steak. "If Alan Greenspan hadn't kept interest rates so low at the start of this decade, we wouldn't be in this mess. Talk about refilling the punch bowl when the party guests are already as drunk as skunks!"

"We told you we were not in the business of identifying bubbles, let alone trying to puncture them," replied the central banker, nibbling at a lettuce leaf. "We warned you that credit spreads, emerging-market yields and volatility in stocks and bonds were all too low, and that you were under-pricing risk."

The central banker took a sip from his refilled wine glass. "Can you imagine the outcry if we had tried to halt the explosion in home ownership? I think you'll find that the true villains are the mortgage lenders; if they hadn't trashed their standards with self-certified and liar loans, the crisis in the housing market would have remained self-contained."

"That's not fair," said the mortgage originator. "We weren't on a level playing field. Fannie Mae and Freddie Mac were using their implicit government guarantee to distort competition in home loans. We were forced to take on more subprime borrowers just to stay in the game; if it hadn't been for all those clever derivatives products, we would never have been able to recycle all that toxic waste and keep the pyramid scheme afloat."

"Ah, the derivatives bogeyman," chuckled the structured- finance specialist. "Listen, derivatives don't kill markets. Markets kill markets. Everything we did was designed to promote efficiency by allowing investors to disaggregate their risks. I can show you the bills from my lawyers to prove that every product we invented was legitimate"

"All we did was offer advice on the best method of structuring securitization transactions,'' the capital-markets lawyer said. "There would never have been a market for the racier collateralized-debt obligations if the rating companies had done proper due diligence, instead of slapping AAA ratings on anything and everything that offered to pay them a fee"

"You can hardly expect the finest minds in finance to come and work for us when they can earn gazillion-dollar bonuses doing the same work for an investment bank," said the credit-rating assessor. "We relied on the computer models that the banks helped us build, and those models turned out to be, shall we say, less than perfect. Besides, everything was fine until the money- markets froze. The problem wasn't over-optimistic ratings, it was an over-reliance on wholesale markets to fund leverage."

The waiter cleared away the dinner plates. The diners all declined dessert -- "Humble pie? No, thanks.'' -- agreeing instead that a couple of bottles of 1982 Chateau d'Yquem would round off the evening nicely.

"I'd never even heard of Structured Investment Vehicles until they started to blow up," said the central banker. "We believed the banks when they said their business model was based on originate-to-distribute; how were we to know that once the music stopped, they were still on the hook for trillions of dollars of liabilities they'd slipped off the balance sheets?"

"Look, domestic savings rates just weren't high enough to provide the kind of leverage we needed to juice our returns to match those of our peers," said the commercial banker. "We had to rely on money-market funds, rather than our deposit base. And the money markets wouldn't have frozen if it hadn't been for those ridiculous mark-to-market rules forcing all of us to prematurely disclose that we owned huge piles of securities that were rotting, before prices had any chance to recover."

"We gave you plenty of leeway to play fast and loose with the truth so that you could stay solvent," said the regulator. "Besides, you were just doing your job of maximizing returns to shareholders. If those greedy investors hadn't forced you to take on more risk, our rules on capital would have been more than adequate to keep the banking system solvent."

"How on Earth was I supposed to fund the retirements of thousands of ex-employees when returns were collapsing simultaneously in every market?" asked the pension-fund manager. "Of course we wanted the banks to work their capital harder. We were in the same boat, trying to move money into new arenas to make a buck or three. We bought derivatives, commodities, we even held our noses and gave money to the hedge funds. That didn't turn out to be such a good idea."

"Hey, we warned you there would be times like this," said the hedge-fund manager. "If you want years when we deliver 50 percent, 60 percent returns, you have to expect periods when we will lose 20 or 25 percent of your money. You won't see us lining up with our begging bowls at the government bailout window."

The waiter coughed, proffering a slim leather folder containing the reckoning for the evening's entertainment.

"You are a taxpayer, I take it?" asked the investment banker. The waiter nodded. "In which case, we were rather hoping you would foot the bill."

Trader surveys show expectations for a stronger dollar, come next week. RBC Capital Markets actually advises selling Swiss Francs and buying dollars. This after the Swiss National Bank expresses concern about the strength of the formerly invulnerable Swiss currency. Now, when was the last time you heard that trade being suggested?

The weekend's watchword: G-20  - "We need a vector, Victor"

 Roger, Roger.

Happy Saving. (the planetary economy, and money).

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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