Thursday, March 29, 2012

Eric Sprott: The Recovery Has No Clothes

Sprott Asset Management published their monthly newsletter Market at Glance (March 2012) entitled "The [Recovery] Has No Clothes".

Eric Sprott and David Baker explain that although Greece has been papered over, and many people are now bullish, very little has actually changed for the better, and it's too early to declare a new bull market has started.

Among all the cheer-leading with "good" indicators, they give some counter examples of not so good indicators:
  1. Although the BLS announced an unemployment rate of 8.3%, the Gallup survey showed unemployment increasing to 9.1% in February (8.6% after seasonal adjustments) versus 8.6% in January.
  2. US food stamp participation has reached an all-time record of 46,514,238 in December 2011, up 227,922.
  3. Europe's 9.7% year-over-year decrease in auto sales
  4. 100bp drop in the March consumer confidence index
  5. 5 consecutive months of manufacturing contraction in China
  6. 0.9% drop in US February existing home sales.
  7. In February 2012, the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011.
They also commented on the Federal Reserve stress test on large US banks:

The test used an almost apocalyptic hypothetical 2013 scenario defined by 13% unemployment, a 50% decline in stock prices and a further 21% decline in US home prices. The stress tests tested where major US banks' Tier 1 capital would be if such a scenario came to pass. Anyone who still had 5% Tier 1 capital and above was safe, anyone below would fail. So essentially, in a scenario where the stock market is cut in half, any bank who had 5 cents supporting their "dollar" worth of assets (which are not marked-to-market and therefore likely not worth anywhere close to $1), would somehow survive an otherwise miserable financial environment. The market clearly doesn't see the ridiculousness of such a test, and the meaninglessness of having 5 cents of capital support $1 of assets in an environment where that $1 is likely to be almost completely illiquid.
They also mentioned that Dexia, a Belgian bank, passed the European stress test, only to fail 3 months later.

Then Eric Sprott and David Baker turned to their specialty: Precious metals.
Our skepticism would be supported if not for one thing - the recent weakness in gold and silver prices. Given our view of the market, the recent sell-offs have not made sense given the considerable central bank intervention we highlighted in February.
After the good performance of Gold and Silver in January and February, both markets were hammered on the 29th of February, as Ben Bernanke gave a speech (QE3 not needed) and the European central bank flooded the market with another €529.5 billion with the second part of Long-Term Refinancing Operation (LTRO).

QE3 is not off the table, just delayed, and Gold and Silver price drop was exclusively due to a sell-off on the paper market with the equivalent of 173 million ounces of physical silver exchanged between 10:30 am and 11:30 am. Compared that to the yearly production of Silver (730 million ounces), almost 24% yearly silver production exchanged in 1 hour.

An analysis of the paper-silver market shows that Silver is  traded 143 times higher in the paper markets versus what is produced by mine supply compare that to crude oil (14.3 X), Aluminum (46.8 X), Gold (69.4 X) and Copper (75.1 X) and they conclude:

The prevalence of paper trading in the silver market is what makes the drastic price declines possible by allowing non-physical holders to sell massive size into a relatively small market. It's not as if real owners of 160 million ounces of physical silver dumped it on the market on February 29th, and yet the futures market allows the silver spot price to respond as if they had.
The Gold market also looked suspicious with $3 billion of physical gold dumped into the market in a short time, and this was probably not done by speculators or investors.

They conclude as follows:

If we are right about gold and silver as currencies, and if they we are right about the continuation of central bank printing, both gold and silver will continue to appreciate in various fiat currencies over time. If there is indeed some sort of manipulation in the futures market that is designed to suppress the prices for both metals so as to detract from the mainstream investor's interest in them as alternative currencies, then both metals are likely trading at suppressed prices today.


The equity market rally that began in late December appears to be generated more by excess government-induced liquidity than it does by any raw fundamentals. We continue to scour the data for signs of a true recovery and we are simply not seeing it.

We would also expect the precious metals complex to enjoy renewed strength as the year continues. One bad month does not change a long-term trend that has been building over 10 years. Gold and silver will both have an important role to play as the central bank-induced printing continues, and we expect more on that front in short order.
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