Month: October 2011

London Gold Market Report
from Ben Traynor
BullionVault
Thursday 6 October, 08:00 EDT

SPOT MARKET gold bullion prices bounced around $1650 per ounce Thursday morning in London – 1.6% off the week’s high – while stocks and commodities continued to rally following rumors of European bank stress tests and possible recapitalization.

Silver bullion prices climbed to $31.80 per ounce – its highest level so far this week.

“Since the sharp sell-offs two weeks ago, gold and silver have remained relatively stable within the channels $1,600-$1,670 and $29-$31 respectively,” said one London bullion dealer this morning.

“A Chinese holiday this week has removed a significant portion of physical interest from the market. If price action remains pent-up to the end of the week, Monday could see a strong breakout, with Chinese interest potentially geared to buying following pre- holiday liquidation.”

Gold bullion prices “will continue to push higher in 2012,” according to a report published today by commodities strategists at Standard Bank.

“The long-term causal drivers of gold are global liquidity…and real interest rates…global liquidity should continue to grow as long as governments increase their nominal debt burden and/or central banks, such as the US Fed, implement quantitative easing measures.”

The European Banking Authority, the main banking sector regulator in Europe, has begun new stress tests of European banks, according to a report in Thursday’s Financial Times. The tests, the FT says, could identify capital shortfalls of up to €200 billion.

The Wall Street Journal, however, subsequently reported that the EBA denies it is undertaking new tests – while not declining to confirm whether or not it plans to do so.

The EBA’s stress test of 91 banks in July was criticized as it did not assess the potential impact of sovereign default. Franco-Belgian banking group Dexia, for example, was found to have twice as much Tier 1 capital as necessary to pass the test.

Dexia’s share price has more than halved since the start of July, with investors worried about its potential exposure to a Greek default.

“We are now proposing [European Union] member states to have a coordinated action to recapitalize banks and so to get rid of toxic assets they may have,” European Commission president Jose Manuel Barroso said Thursday.

“Policy makers increasingly want to build a large solvency buffer,” says analysts at Morgan Stanley, predicting that European banks may need to be recapitalized to the tune of over €140 billion.

“We think banks in core Europe need to be recession proofed and banks in the periphery depression proofed.”

EU leaders agreed on July 21 that the European Financial Stability Facility – the Eurozone’s €440 billion bailout fund – should be given powers to recapitalize banks if necessary, as well as powers to buy distressed sovereign debt on the open market.

German chancellor Angela Merkel however yesterday reiterated that using the EFSF would be “always tied to a certain conditionality”.

The European Central Bank left its main interest rate unchanged at 1.5% today, ahead of Jean-Claude Trichet’s final interest rate press conference as ECB president.

Here in London meantime, the Bank of England has extended its asset purchase program from £200 billion to £275 billion – effectively launching a second round of quantitative easing.

Asked by Bank governor Mervyn King to authorize the move, UK chancellor George Osborne – who this week told the Conservative Party conference to expect “Credit Easing” ahead – noted in his open reply that the Asset Purchase Facility can hold up to £50 billion in “eligible private sector assets”.

The Bank however confirmed after the announcement that it will make “£75 billion of gilt purchases” – meaning it will continue to buy UK government bonds.

To date, the Bank of England has spent just £1.1 billion of its existing £200bn in Quantitative Easing, all the rest going on government debt.

“The season of QEs has started,” said NYU economist Nouriel Roubini on Twitter.

“Fed twist, BoE’s QE; BoJ and SNB via FX intervention; ECB as usual will be the last one: too little too late.”

The Bank left its interest rate unchanged at 0.5% – where it has been since March 2009.
Sterling gold bullion prices jumped 1.3% to £1082 per ounce immediately following the Bank’s announcement, as the Pound fell on international currency markets.

Also in London, major clearing house LCH.Clearnet announced Thursday it plans to begin accepting gold bullion as collateral from the end of this month.

“Market participants want greater choice when it comes to assets that can be used as collateral,” said LCH.Clearnet director David Farrar.

“Gold is ideal; as an asset it typically performs well in times of financial stress, remains liquid and has a well-established pricing mechanism.”

In its press release LCH.Clearnet cited evidence submitted to the Basel Committee on Banking Supervision by the World Gold Council, which suggests gold should be included in banks’ Tier 1 assets under the Basel III regulations – scheduled to come into force in 2015.

A recent liquidity survey published by the London Bullion Market Association estimates that the value daily turnover of gold bullion on the London market exceeds $240 billion.

Ben Traynor
BullionVault

Gold value calculator   |   Buy gold online at live prices

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

By The Sizemore Letter

Steve Jobs, 1955-2011

With the passing of Steve Jobs, Apple (Nasdaq: $AAPL) loses its iconic founder, the tech world loses a true visionary, and all of us lose a hero of American capitalism.  Rest in peace, Mr. Jobs.

The press is full of eulogies that describe in detail the man’s remarkable accomplishments in revolutionizing the technology world.  But rather than think of Jobs as a tech revolutionary, I prefer to think of him as a capitalist revolutionary.   In his passing, he joins the pantheon of great American capitalists who revolutionized their industries, such as John Rockefeller, Andrew Carnegie, Henry Ford, and Sam Walton.  All of these men were giants in their own time whose sheer force of will propelled the creative destruction of human progress forward.

Of all of these great men, Henry Ford is probably the best comparison.  Ford didn’t invent the automobile, but he made it available to the masses.  And he created a consumer culture where one had never existed before.  As a young man, Jobs did the same with the personal computer.  And in middle age, he did it again with digital music, smart phones, and tablet computers.

In a 2005 commencement speech at Stanford University, Jobs offered advice that bears repeating today: “Your time is limited, so don’t waste it living someone else’s life.  Don’t be trapped by dogma — which is living with the results of other people’s thinking. Don’t let the noise of others’ opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition.”

Words of wisdom by a man who lived them himself.

Jobs’ passing does raise questions for the future of Apple.  When Jobs retired from his post as CEO in August, I suggested that his absence would leave a void that would be difficult to fill.  In August, I wrote

History is full of stories of successful companies that have prospered after the departure of an iconic founder. Wal-Mart (NYSE: $WMT), for example, has done just fine since the passing of Sam Walton. Going further back in time, John D. Rockefeller’s oil companies survived his death and thrived to the point of trust-busting, living on today as ExxonMobil (NYSE: $XOM), Chevron (NYSE: $CVX), and ConocoPhillips (NYSE: $COP).

The difference, of course, is that innovation is far more important in a modern technology company than in a discount retailer or oil company. Jobs’ successors will no doubt do a fine job of selling iPods, iPhone, and iPads. The question is “what next?” Without Jobs to think of the next great idea, is the rest of the Apple management team up to the task? Again, I don’t have a satisfactory answer to this question.

See The Steve Jobs Retirement: What it Means for Apple

It may be somewhat counterintuitive, but I expect to see Apple’s stock price enjoy a healthy short-term sympathy bounce.  Markets, in the short term, are driven by emotions.  And though it might not make any economic sense, I can see sentimentality taking the stock higher.

Over the medium term, Apple should have enough Jobs-era products in the pipeline to keep things interesting, the recent disappointment concerning the iPhone update notwithstanding.  But over the longer term, I don’t see Apple maintaining its edge.

Jobs’ protégés are capable managers, and I don’t see Apple going out of business any time soon.  I see the company being a worthy competitor for years to come.  But I also don’t see the company continuing to be the hotbed of technological innovation.

Regardless of what happens at Apple in the coming years, Jobs’ legacy will survive because his legacy goes far beyond the company he led.  Jobs will be remembered as the man who brought personal computers, legal music downloads, robust smart phones, and tablet computers to the masses.  And he made technology “cool.”

Rest in peace, Mr. Jobs.

Video courtesy of ForexCT – A leading Australian forex broker, liscensed by the Australian Securities & Investments Commission, offers the MetaTrader4 and PROfit Platform to retail traders. Other services include Segregated Accounts, Trading workshops, Tutorials, and Commodities trading.

The European Central Bank (ECB) maintained the Main refinancing operations rate unchanged at 1.50%, the Marginal lending facility at 2.25% and Deposit facility at 0.75%.  The Bank said “the President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”  The meeting is Jean-Claude Trichet‘s last as the head of the ECB, as the new ECB president, Mario Draghi, takes the reins.

The ECB last increased the interest rates by 25 basis points at its July meeting; pausing in May and June, after raising the rate by 25 basis points to 1.25% in April this year.  The Euro Area reported annual HICP inflation of 3% in September, 2.5% in August and July, 2.7% in June (same as May) and above the Bank’s inflation target of maintaining inflation below, but close to, 2% over the medium term.  

The Euro Area reported quarterly GDP growth in the June quarter of 0.2%, following a 0.8% increase in the March quarter, and a 0.3% increase in the December quarter of 2010.  The Euro (EUR) last traded around 0.75 against the US dollar, placing the Euro about flat against the US dollar so far this year.

The Bank of England (BoE) held the Bank Rate at a record low stimulatory level of 0.50%.  However the BoE did announce a 75 billion pound expansion of its 200 billion pound asset purchase program (also known as quantitative easing), taking the new total to GBP 275 billion.  The Bank said: “The pace of global expansion has slackened, especially in the United Kingdom’s main export markets. Vulnerabilities associated with the indebtedness of some euro-area sovereigns and banks have resulted in severe strains in bank funding markets and financial markets more generally. These tensions in the world economy threaten the UK recovery.”

The Bank also held the official Bank Rate unchanged at 0.50% at its August meeting this year; the rate has remained on hold since March 2009, when the Bank reduced the interest rate by 50 basis points to 0.50%.  The United Kingdom reported annual consumer price inflation of 4.5% in August, and 4.4% in July, and still above the Bank’s inflation target of 2.00%.  The UK saw quarterly GDP growth of 0.2% in Q2 this year (0.5% in Q1), while annual economic growth was reported at 0.7% (1.6% previously).  

By ForexYard

The EUR dropped ahead of today’s ECB meeting as investors speculate the European Central Bank will cut interest rates to encourage growth in the region. The Pound also dropped ahead of today’s decision by the Bank of England regarding its interest rate and asset-purchase program.

Economic News

USD – Dollar Gains as Uncertainty about European Economy Grows

The USD has benefited recently as one of the two safe haven currencies as signs of economic downturn in Europe boosted demand for the currency as a refuge.

The EUR fell 102.21 yen; the 17-nation currency weakened 0.2% to $1.3322 after dropping to $1.3146 on Oct. 4, the lowest level since Jan. 13. The JPY was little changed at 76.73 per USD.

Traders today should follow the release of the US Unemployment Claims, heading to tomorrow’s highly anticipated Non-Farm Payroll data. Traders should follow the release from the ECB regarding the interest rates as well as the general assessment of economic conditions. These will likely set the mood for the markets for the near future.

EUR – EUR Down Ahead of ECB Meeting

The EUR fell to a nine-month low versus the Dollar in today’s early trading ahead of today’s ECB meeting in which economists predict the European Central Bank will decide to cut interest rates to spur growth. The Pound has also dropped over speculations the BOE in today’s meeting will expand its bond purchasing program, though interest rates are expected to remain unchanged.

Traders today are advised to follow the minutes released from the meeting of the European Central Bank as well as the Bank of England as they will likely set the mood for the markets for the near future.

JPY – JPY Gains versus Counterparts

The Japanese Yen gained versus the EUR and the Pound while remaining mostly unchanged versus the USD as uncertainty over the economic conditions in Europe spurred investors to turn the safety of the Japanese currency.

Traders today should follow the release of the US Unemployment Claims, heading to tomorrow’s highly anticipated Non-Farm Payroll data. Traders should follow the release from the ECB regarding the interest rates as well as the general assessment of economic conditions. Negative economic conditions will further support the Japanese currency.

Crude Oil – Crude Rises on Expectation of US Growth

Crude for November delivery rose as much as $1.29 to $80.97 a barrel in electronic trading on the New York Mercantile Exchange. Oil prices got a lift Wednesday from a better than expected release of the ADP Employment numbers as well as a drop on Inventories.

Traders should follow tomorrow’s release of the Non-Farm Employment data from the US as it tends to have a high impact on Oil price. Markets are also expected to see some volatility today with the release of the US unemployment Claims and interest rate decisions from the Bank of England and the European Central Bank.

Technical News

EUR/USD

Yesterday candlestick posted an outside day up, a telling bullish signal. The EUR/USD has followed up this price action by breaking out above the falling resistance line off of the May high and triggering stops that were lurking above the 1.3380 area. Initial resistance for the pair comes in at 1.3600. A close above that price level would signal an end to the sideways price action and open the door to the high of 1.3900. To the downside the euro may find willing buyers at 1.3300 where the 20-day moving average is located. Further support is found at 1.3260 off of the rising support line from the September low.

GBP/USD

After failing to make a close above the 1.5550 resistance level, sterling was sold only to find support at its 55-day moving average near 1.5480. Rising daily stochastics hint at an additional test of the range between 1.5490 and 1.5600. The head and shoulders chart pattern shows a measured move which could take the GBP/USD higher to 1.5600.

USD/JPY

A series of higher highs and lower lows has created a bullish channel on the daily chart but the pair will likely remain locked in a range that has contained the USD/JPY since early October. A number of resistance levels will provide ample opportunities to sell into any gains, a play that is in-line with the long-term trend. The top of the channel is found at 77.50 and is close to the 100-day moving average. Additional resistance is located at of 78.20. The bottom of the channel could prove to be supportive at 77.00 but a break here could test the September low at 74.00.

USD/CHF

The reversal of the USD/CHF continues and the pair is beginning to show additional bullish signs. Traders should eye the close of the monthly candlestick. As it stands now the candle is set to close on hammer pattern, a potential reversal pattern that hints at additional gains. The pair is testing the falling trend line at 0.9000. If this level is broken, it could turn into support as often occurs with previously broken trend lines.

The Wild Card

NZD/USD

The kiwi has performed well over the past three trading days but has ran into resistance at its previously broken trend line from the mid-September low which comes in today at 0.7700. Forex traders may watch for a break here as there is limited resistance on the daily chart to prevent the pair from reaching its October 1st high of 0.7800. Support is seen back at 0.7600 and 0.7550.

Forex Market Analysis provided by ForexYard.

© 2006 by FxYard Ltd

Disclaimer: Trading Foreign Exchange carries a high level of risk and may not be suitable for all investors. There is a possibility that you could sustain a loss of all of your investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with Foreign Exchange trading.

The odds that the U.S. Federal Reserve will engage in further economic stimulus increased dramatically following Fed Chair Ben Bernanke’s testimony before Congress’ Joint Economic Committee Tuesday morning. Despite protestations that there are no “immediate” plans for a third round of quantitative easing (“QEIII”, if you will) the Chairman did not close the door to further quantitative easing if necessary:

The Committee will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability.

Currency markets responded immediately to Bernanke’s remarks with investors taking the view that further easing was now probable. The potential that another round of stimulus spending could weaken the dollar helped the euro reverse its slide against the buck which had been riding high on risk aversion fears that Greece would be forced to default. In the past two weeks, the dollar gained more than 10 percent, climbing to a high of $1.3144 to the Euro before the Chairman’s comments prompted investors to sell the dollar.

Operation Twist

During his testimony, Bernanke expanded on his expectations for Operation Twist – the Fed’s scheme introduced last month whereby the Fed intends to sell short-term securities to finance the purchase of  longer-term bonds. The hope is that this will lead to lower yields on long-term securities thus reducing their attraction to investors. The idea is that this money will then find its way into the economy rather then be left sitting on the sidelines in long-dated bonds.

The Fed has stated that Operation Twist should lead to a 20 basis point decline in long-term interest rates which, according to Bernanke, will have the same stimulus impact of a half percentage decrease to the Federal Funds Rate. The more cynical observer may dispute this assessment but with interest rates already reduced to zero, the Fed has limited options available.

Outlook Downgraded

While Bernanke was keeping his cards close to the vest during much of his testimony, he did admit that the Federal Reserve’s outlook has turned more pessimistic in recent months:

“However, the incoming data suggest that other, more persistent factors also continue to restrain the pace of recovery. Consequently, the Federal Open Market Committee (FOMC) now expects a somewhat slower pace of economic growth over coming quarters than it did at the time of the June meeting, when Committee participants most recently submitted economic forecasts.”

It remains to be seen if this downgraded outlook will be sufficient to convince the Fed to undertake another round of quantitative easing.

Scott Boyd is a currency analyst and a regular contributor to the OANDA MarketPulse FX blog

By The Sizemore Letter

The financial press has an abundance of advice but a bit of a shortage when it comes to follow-up.  Few writers bother to review how those “three hot stock picks” they recommended actually performed in practice.

Frankly, they should.  When you make a good call, you deserve credit.  But you “own” the bad calls too.  People invest their hard-earned money after reading what you had to say.  You owe it to them to go back and check your work.

Today, I’m going to revisit an article I wrote in late March: “Three Low-Risk ETFs to Ride Out a Volatile Spring.”

At the time of the original article, the Arab Spring was in its infancy, the Japanese Fukushima plant threatened the world the with the worst nuclear disaster since Chernobyl, and the sovereign debt crisis had just caused the sitting Portuguese government to fall.  The markets long ago lost interest in the Arab political revolution and the Japanese nuclear disaster, but the Eurozone crisis has actually deepened.   That “volatile spring” ending up bleeding over into a volatile summer and a volatile early fall as well.  And if we don’t get a resolution of the ongoing Greek crisis soon, we can look forward to a volatile winter.

Since the original article went to press, the S&P 500 is down 14 percent (see black line in chart).  Let’s see how my recommendations did.

Utilities Select SPDR (NYSE: $XLU): Of the three ETFs recommended, XLU is the clear winner.  At time of writing, it shows a price return of over 4 percent, which does not include the $0.68 per share in dividends.   The dividends add an additional 2.2 percent for a total return of over 6 percent.  Not a bad return, all things considered.  On a total return basis, it’s about 20 percent better than the S&P 500.  But perhaps what is most impressive is that even during the pits of the August sell-off, investors who bought in March would have been down less than 4%.  Again, not bad.  Over the course of the fourth quarter, readers may want to take profits in the utilities sector and reallocate their funds to more growth-oriented sectors.

iShares Dow Jones US Healthcare (NYSE: $IYH): My rationale for recommending Big Pharma was pretty straightforward.  The stocks in the sector had already been punished by fears of patent expirations, and I believed the selling to be overdone.  Furthermore, healthcare is a defensive industry.  Even if it’s not “recession proof,” it’s certainly recession resistant.   IYH sold off far more aggressively than XLU, but it still managed to hold up fairly well.  At time of writing, IYH is down 6% from my recommended price versus a 14% loss on the S&P 500.  This does not include the nearly 1 percent that the ETF has paid in dividends over the period.  Overall, I can’t complain about IYH’s performance.  To survive the bloodbath of the past six months with only minimal losses is an accomplishment.  I continue to see a lot of value in Big Pharma, and I recommend that readers hold on to their shares of IYH.

iShares S&P Global Telecommunications (NYSE: $IXP): This recommendation has been a bit of a disappointment to me.  Yes, it performed better than the S&P 500.  But its price is still down 10%.  After the $1.73 per share in dividends, the loss is closer to 7%.  That’s not bad, but given the cheap valuations in the sector, the steady dividend payout, and the defensive nature of the business I would have expected better.

Of the three ETFs, IXP would be my favorite at the moment.  The companies that comprise the fund’s holdings are in the unique position of being “defensive” in the developed markets of the United States and Europe and “growth investments” with respect to their prospects in emerging markets.  Over the past year, I’ve highlighted the Spanish telecom giant Telefónica (NYSE: $TEF) for its exposure to the fast-growing markets of Latin America, which make up 40% of company revenues.  Telefónica is a major holding of IXP, and there are plenty more just like it.

I would like to reiterate my buy recommendation of IXP. Whether the volatility is finally over or not, I consider the telecom sector to be the best value for your dollar today.

If you liked this article by Sizemore Insights, you’d probably enjoy The Sizemore Investment Letter, our premium members-only newsletter. Click here for more information.

By MoneyMorning.com.au

– If you like catching up with Murray Dawes on YouTube, head over there now. He’s just recorded this week’s market update video – and he says he’s feeling bullish…

–He reckons there could be a market rally in the offing… and if he’s right about that, he has an idea where the ASX could be headed. He also has an idea about what to do if it gets there… and that involves some pretty major selling. But Murray’s musings come with a caveat: “If Soc Gen or BNP fall over then all bets are off…” To watch Murray’s brand new market update video now – go here.

– Today’s comedic relief is brought to you, once again, by Europe. We weren’t going to write about the other side of the world today. But in this type of market you need an occasional good laugh, even if it threatens your wealth at the same time.

– After realising the plan to leverage the European Financial Stability Facility (EFSF) was idiotic, the lemmings in Europe are running over to a new ‘solution’ – bank recapitalisations. Like most things bureaucrats dream up, it’s good in theory. How it plays out in practice will be entirely different.

– That’s not the funny bit though. Check this out: Apparently European finance ministers have asked the European Banking Authority (EBA), Europe’s top (we use the word loosely) banking regulator, to stress test Europe’s banks – again.

– You may remember the same incompetent organisation conducted stress tests in 2010 and 2011. The latest one, completed in July this year, found European banks to have a capital deficiency of just €2.5bn. At the same time as Athens was burning, these pompous fools didn’t even model a sovereign default. Now, just a few months later we’re talking about a need for €200 billion in fresh bank equity.

– But instead of all being sacked and the organisation shut down – as would happen in the private sector – these imbeciles get another go. We can only conclude the EBA is a corrupt organisation in the palm of the bankers. And it’s supposed to be their regulator?

– Look, the bank recapitalisation plan is on the right track. We don’t dispute that. But it’s a plan being put together by a bunch of squabbling politicians who put their own re-election prospects ahead of anything else. So the chances of it actually being done properly are remote.

– As we wrote in our Sound Money. Sound Investments email update yesterday – bank recapitalisations will be beneficial as long as they are accompanied by bad debt write-downs. The main problem with the global economy today is the amount of bad debt festering on bank balance sheets. This impedes the creation of new, productive debt.

– It also affects confidence. Banking is – and has always been – a business based on confidence. Without it, banks are exposed as the highly leveraged and fragile institutions that they are.

– So to improve confidence you need to purge the bad debt out of the system. This requires bank recapitalisations to absorb the coming write-downs. Before we go any further, just what do we mean by ‘bank recapitalisation’?

– The process is best explained with reference to a bank’s balance sheet. In balance sheet land, a company’s assets are equal to its liabilities and equity. The ‘equity’ value of a company is traded on the stock market. It is this portion usually referred to as ‘bank capital’.

– If you’re still with us, we’ll show you French basket case Société Générale’s balance sheet.

Assets €1.158 trillion
Liabilities €1.106 trillion
Equity €52.1 billion

– Here’s how it works. A write down in the value of its assets must be matched by a write down in the value of the equity. If the value of the banks assets fell by just 5 per cent, all the equity would be wiped out and the bank would be insolvent. This just goes to show how highly leveraged European banks are.

– Actually the bank’s assets have probably already fallen by 5 per cent. Luckily, it’s not required to ‘mark its assets to market’. Banks aren’t allowed to fail remember?

– Société Générale’s current market capitalisation is just €14 billion. This is what investors think the bank’s equity value is worth. It will probably prove optimistic.

– This is where a recapitalisation comes in. The Euro bailout fund, the EFSF, will contribute funds to banks in need of new equity capital. This should take the form of ‘preferred equity’, which will rank above existing equity when it comes to absorbing write-downs. That way anyone punting on European bank shares will take a hit before new taxpayer funds do.

– If all the bad sovereign debt in the system is really purged (which it won’t be, but bear with us) most of the existing equity holders will be wiped out. The pie-in-the-sky plan would then be for the preferred equity to convert to ordinary equity. Once this whole debt crisis thing blows over, say by Christmas*, the taxpayers would sell out for a profit, proving the eurocrats’ plan to be pure genius.

– There’s no harm in dreaming of course, but it won’t work out that way. There will be squabbling about which banks receive capital and how much is actually needed. If estimates of €200 billion are correct, the recapitalisation plan will leave the EFSF just about empty, with no more funds to buy other struggling sovereign debt.

– And don’t forget, bad sovereign debt is the cause of the crisis. Insufficient bank capital is just a symptom of the problem. A Greek default still awaits.

– The Europeans are only just beginning to realise how big their problems are. So enjoy the rally, it won’t last for long.

* Remember in World War One the conventional European wisdom was the ‘it would be over by Christmas’. Christmas 1914 that is.

Publisher’s note: Greg Canavan is the foremost authority for retail investors on value investing in Australia. He’s the former head of Australasian Research for a major asset-management group and a regular guest on CNBC, Sky Business’s ‘The Perrett Report’ and Lateline Business. Greg shares his insight, ideas and investment recommendations with readers of his Sound Money. Sound Investments newsletter… to find out more information on Greg’s letter, go here.

Enjoy the Rally, It Won’t Last For Long.

By MoneyMorning.com.au

There are plenty of risks out there to keep markets nervous right now. Two of the most visible are Europe in the short term. And China over the next 6-12 months…

China’s unsound monetary policy is causing problems.

Sure the economy is booming – it grew 9.5 per cent in the second quarter, which was better than expected. But with such low interest rates and banks still willing to lend, it should be booming.

The problem is the country’s foreign exchange (FX) reserves, which continue to soar.

They increased US$153bn in the second quarter after jumping nearly US$200bn in the first quarter. China’s total FX reserves now stand at $3.2 trillion, equivalent to around 50 per cent of GDP.

This is not a sign of strength, but of severe economic distortions. As the Financial Times says:

China must print renminbi to buy all the foreign exchange streaming into the country. To blunt the inflationary impact, it issues bonds and orders banks to set aside a chunk of their deposits as required reserves, but economists say that room for such sterilisation operations is increasingly limited. That could put currency appreciation back to the forefront of efforts to damp down on inflation.

China has an inflation problem.

This is because of its extraordinarily loose monetary policy. But it has been reluctant to do what’s necessary to control inflation. Instead, it increases reserve requirements and slowly increases interest rates. As you can see from this chart, these moves have little impact on the problem.

China’s inflation is primarily a result of it wanting to maintain a cheap currency.

In order for China to maintain a fixed exchange rate, it must print money to buy the foreign exchange flowing into the country. The more FX reserves that flow in each month, the more money printing must take place. This in turn makes it increasingly difficult to control inflation.

Back in July, I wrote in Sound Money. Sound Investments that China’s inflation problem and its policy proscriptions will come under greater scrutiny in the second half of this year. Yesterday the US Senate voted ‘to move ahead with a bill that would punish China for keeping the value of its currency low,’ reported the Wall Street Journal.

The undervalued Yuan makes imported products cheaper for American consumers, but politicians, like Republican presidential candidate Mitt Romney, are claiming this hurts American jobs.

Yet the response from the People’s Bank of China said ‘…factoring in inflation, the Yuan has appreciated greatly and is close to a balanced level.’

In September this year, Prime Minister Wen said ‘China will continue to follow the strategy of expanding domestic demand, with a focus on improving the structure of demand and increasing consumer demand to drive economic growth.’

But this will only happen with a stronger Chinese currency.

The People’s Daily Online, a Chinese newspaper, has reported analysts asking for an increase in the Yuan to ease the inflationary pressures and drive consumer demand.

Maintaining a low Yuan discourages consumption. And consumption growth is slowing to pre-GFC levels.

China’s cheap Yuan policy is punishing the household sector.

Simply put, the weak Yuan benefits only those companies in the export sector and those with fixed-asset investments. The country’s high household saving rate is effectively subsidising these sectors.

Keeping the Yuan undervalued will make a transition to a consumer-based economy near impossible.

So for those in the Chinese government who expect its citizens to rise and become a major source of global consumer demand, think again.

China is a distorted economy reliant on fixed-asset investment and exports. Adjusting from such a model won’t be the end of the world, but it will be painful. And I suspect it will mean the Aussie market remains volatile for some time.

Greg Canavan
Money Morning Australia

Why Chinese Monetary Planning Means More Volatility For You