Today’s News November 24, 2015

• Another Look at the Gold Price Drop of 6 November

  The prevailing view in the gold community is that banks are speculators who bet on a falling price. To begin, they commit the casino faux-pas of betting on Do Not Pass at the craps table. When everyone wants the price to go up, the banks seem to want it to go down. Uncool.

  In contrast to this view, ours is that the banks are arbitrageurs. They aren’t betting on price, they are profiting from the small spreads in between bid and ask, spot and future, future and Exchange Traded Funds.

  We thought we would revisit the crash of Nov 6. Recall that our last look was at spot and futures. The quote on spot did not respond to the drop for 79 long seconds. We believe that this was a simply a delay in updating the quote, as spot quotes displayed by the data providers are indicative only. They are not tradeable.

  This time, let’s look at the futures market and the leading gold exchange traded fund, GLD.

         The Bid and Ask Prices of GLD and the Dec Future
   

  First, notice the time period of the graph. The whole thing occurs in just under a second, at 13:30:01 London time.

  Second, note that this occurred an hour before the NYSE opens, so the bid-ask spread on GLD is much wider than normal.

  Third, it’s fascinating to see the immediate aftermath of the crash. There’s even a brief period when the bid in the future appears to be above the ask. We are inclined to believe that’s an artifact of the quoting process. But perhaps, in the heat of the moment, the ask price fell below the bid. Someone may have had had nine nice long milliseconds to take the bank to the cleaners.

  Fourth, after that period—around the :555ms mark—we see a relatively flat bid on GLD and ask on the future. So how do we explain the slowly but steadily rising bid on the futures? Our read is that once the selling pressure is over, the market returns to normal with the tight bid-ask spread being achieved by the bid rising near to the ask. We don’t have an opinion on the unstable ask on GLD. Perhaps the market makers were moving it around guessing where things would settle. There may have been some intermittent buying too, thus the upward pressure on the ask while the bid is table flat.

  One last thing to note. It does appear as if GLD sold off first. In this data series, the bid and ask prices on GLD drop 24 milliseconds before the future reacts. However, we cannot rule out that this may be an artifact of the quoting process. GLD and futures trade on different exchanges, and it’s possible that the clock on one exchange server could be 25ms ahead of the other.

   

  © 2015 Monetary Metals

  

  

  

  

• "This Is The Most Dangerous Time Ever" Ex-CIA Boss Says US To Blame For "Scourge Without Parallel" ISIS

  "I have never felt more uncomfortable than I do today," warns former CIA Director Jack Devine, saying that, with "frankly uncivilized" ISIS, there is a greater risk of violence worldwide than ever before.

  According to The Hill,

  “I think this is the most dangerous time in terms of sustained violence,” he said on “The Cats Roundtable” in an interview airing Sunday on New York’s AM-970.
   
  “I have never felt more uncomfortable than I do today,” he told host John Catsimatidis. “Some percentage of the world today is always either unbalanced or radicalized. When you have a small group of people who are willing to lose their lives and kill anyone they can, we’re all vulnerable.”

  Devine cited the Islamic State in Iraq and Syria (ISIS) as an unprecedented threat in terms of its wanton disregard for human life…

  “I dealt with terrorists in South America in the 1970s, but they never attacked innocent women and children indiscriminately,” he said.
   
  “You have a group in ISIS today that is frankly uncivilized. These folks could get stronger and stronger. We basically have to destroy ISIS over there,” Devine said.
   
  Devine argued that dismantling ISIS’s command structure is crucial for minimizing the danger it presents, much like al Qaeda before them.
   
  “We killed three-fourths of their leadership,” he said of al Qaeda.  “We have to do the same thing with ISIS. “We have to destroy their refuge over there. When they start to lose, their recruiting numbers start to fall.”

  Devine, who mainly served during the Cold War, said ISIS is a scourge without parallel because it has no concern for self-preservation.

  “There is nothing that can be compared with nuclear weapons and their use,” he said of tensions between the U.S. and the former Soviet Union.

   

  “[But] people felt safe in the sense there was countervailing balance,” he added. “Early in our contest with the Russians, it was clear we had checks and balances.”

  Finally Devine admits…

  “If there’s blame to be put, it’s on our failure to have done that by this point.”

  

  

  

  

  

• 5 Signs Of America's Decaying Society

  Submitted by Paul Buchheit via CommonDreams.org,

  While Edward Snowden and Chelsea Manning and John Kiriakou are vilified for revealing vital information about spying and bombing and torture, a man who conspired with Goldman Sachs to make billions of dollars on the planned failure of subprime mortgages was honored by New York University for his "Outstanding Contributions to Society."

  This is one example of the distorted thinking leading to the demise of a once-vibrant American society. There are other signs of decay:

  1. A House Bill Would View Corporate Crimes as 'Honest Mistakes'

  Wealthy conservatives are pushing a bill that would excuse corporate leaders from financial fraud, environmental pollution, and other crimes that America's greatest criminals deem simply reckless or negligent. The Heritage Foundation attempts to rationalize, saying "someone who simply has an accident by being slightly careless can hardly be said to have acted with a 'guilty mind.'"

  One must wonder, then, what extremes of evil, in the minds of conservatives, led to criminal charges against people apparently aware of their actions: the Ohio woman who took coins from a fountain to buy food; the California man who broke into a church kitchen to find something to eat; and the 90-year-old Florida activist who boldly tried to feed the homeless.

  Of course, even without the explicit protection of Congress, CEOs are rarely charged for their crimes. Not a single Wall Street executive faced prosecution for the fraud-ridden 2008 financial crisis.

  2. Unpaid Taxes of 500 Companies Could Pay for a Job for Every Unemployed American

  For two years. At the nation's median salary of $36,000, for all 8 million unemployed.

  Citizens for Tax Justice reports that Fortune 500 companies are holding over $2 trillion in profits offshore to avoid taxes that would amount to over $600 billion. Our society desperately needs infrastructure repair, but 8 million potential jobs are being held hostage beyond our borders.

  3. Almost 2/3 of American Families Couldn't Afford a Single Pill of a Life-Saving Drug

  62 percent of polled Americans said they couldn't cover a $500 repair bill. If any of these Americans need a hepatitis pill from Gilead Sciences, or an anti-infection pill from Martin Shkreli's company, they will have to do without.

  An AARP study of 115 specialty drugs found that the average cost of a year's worth of prescriptions was over $50,000, three times more than the average Social Security benefit. Although it's true that most people don't pay the full retail cost of medicine, the portion paid by insurance companies is ultimately passed on to consumers through higher premiums.

  Pharmaceutical companies pay competitors to keep generic drugs out of the market, and they have successfully lobbied Congress to keep Medicare from bargaining for lower drug prices. The companies claim they need the high prices to pay for better medicines. But for every $1 they spend on basic research, they invest $19 in promotion and marketing.

  4. Violent Crime Down, Prison Population Doubles

  FBI statistics confirm a dramatic decline in violent crimes since 1991, yet the number of prisoners has doubled over approximately the same period.

  Meanwhile, white-collar prosecutions have been reduced by over a third, and, as noted above, corporate leaders are steadily working toward 100% tolerance for their crimes.

  5. One in Four Americans Suffer Mental Illness, Mental Health Facilities Cut by 90%

  According to the National Alliance on Mental Illness, 25 percent of adults experience mental illness in a given year, with almost half of the homeless population so inflicted. Yet from 1970 to 2002, the per capita number of public mental health hospital beds plummeted from over 200 per 100,000 to 20 per 100,000, and after the recession state cutbacks continued.

  That leaves prison as the only option for many desperate Americans.

  There exists a common theme amidst these signs of societal decay: The super-rich keep taking from the middle class as the middle class becomes a massive lower class. Yet the myth persists that we should all look up with admiration at the "self-made" takers who are ripping our society apart.

  

  

  

  

  

• Is David Brooks Pushing For Another Vietnam?

  Submitted by Chris Rossini via RonPaulLibertyReport.com,

  A few years ago, New York Times columnist David Brooks wanted the U.S. government to wave its magic wand and turn the Syrian civil war into a Vietnam for Iran:

  We should be trying to turn the Syrian civil war into Iran’s Vietnam. We should make them waste money and effort trying to back their client…I’m thinking that maybe it’s time for a more active U.S. role. I have no clue how to do that.

  Brooks was apparently modest enough to admit that he had "no clue" as to how the U.S. should mold Syria to achieve such a nefarious goal.

  Well, a few years have now gone by, and Brooks has experienced his eureka moment! He apparently tuned into a warmongering speech from Hillary Clinton and now (at long last) has a clue:

  Clinton…gestured to the reality that you can’t really deal with ISIS unless you are also willing to deal with Assad. Assad is not some secondary threat who we can deal with after we’ve tamed the ISIS monster. Assad created the failed state and the power vacuum that ISIS was able to fill.

  Some of Clinton’s specific prescriptions were a little too limited and Obamaesque for my taste (she didn’t even call for more American Special Operations forces to improve the bombing campaigns, though she said she would be open to it).

  Aha! Brooks, who wanted to turn Syria into Iran's Vietnam, has changed to turning it into America's Second Vietnam! Brooks wants American troops in there fighting both ISIS and Assad. He's come to the conclusion that it is America that should "waste money and effort"!

  But wait! There's more:

  The grand strategy of American policy in the Middle East, therefore, should be to do what we can to revive and reform Arab nations, to help them become functioning governing units.

  The "grand strategy"?

  America has destroyed Iraq, Afghanistan, and Libya, leaving them in virtual chaos with nothing resembling "functioning governing units." Syria needs to be number four on the lucky list?

  That begins with stepped-up military pressure on ISIS. But it also means going hard on Assad, creating no-fly zones for sanctuaries for Syrian refugees to limit his power, ratcheting up pressure on Iran and Russia to force his departure.

  Brooks no longer wants a Vietnam for Iran, but a second one for the U.S. In addition to American troops, he wants the U.S. to create a no-fly zone in Syria that would put America in a direct confrontation with Russia (a country that has a nuclear arsenal that's just as large as America's). 

  It's safe to say, that despite Brooks' Clintonian awakening, he still has no clue about Syria.

  

  

  

  

  

• Saudi De-Peg Looms As FX Market Signals Loudest "Black Swan Warning" In 13 Years

  As we noted recently, BofAML fears "a depeg of the Saudi riyal is the number one black-swan event for the global oil market in 2016," adding that it is "a highly unlikely but highly impactful risk." Given the recent action in Saudi Riyal forwards – the market's best guess at where the oil-ruch nation's currency will trade in the future – the chance of the black swan 'de-peg' is its highest since 2002. Besides this morning's "whatever it takes" moment, which oil markets quickly shrugged off, amid heavy subsidies to keep the people calm and the costs of wars in Yemen (and more in Syria), weak oil revenues leave The Sauds with few options (outside of the load the nation with ever more debt program): It's either stop it with the whole flooding an oversupplied market strategy, or let the peg fall before reserves runs dry.

   

  SAR Forwards indicate the highest de-peg conviction since 2002…

  

   

  And notably, the de-peg is a lot more palatable than losing face and cutting crude production…

  “It is a lot easier politically to implement a modest supply cut at first than allow for a full-blown currency devaluation."

  As we detailed recently, BofAML calls a Saudi de-peg the "number one black swan event for the oil market in 2016."

  For oil, however, the most crucial point is what happens to Middle East currencies and in particular to the Saudi Riyal. In fact, Saudi Arabia’s FX reserves are still high and point to an ample buffer for now, but they have been falling at a relatively fast rate (Chart 21). However, should China allow for significantly faster FX depreciation than is currently priced in by markets, we believe oil prices could fall further. Naturally, the FX reserve drain on Saudi could accelerate to $18bn per month if Brent crude oil prices average $30/bbl (Chart 22), sharply reducing the Kingdom’s ability to retain its currency peg. 

   

  

   

  Saudi has been forcing prices lower by increasing production into an oversupplied market so far (Chart 23), and it also rushed to issue debt in its local market to fill a soaring budget gap. We have previously argued that Saudi Arabia’s surging output is responsible for almost half of the 520 million barrel global petroleum inventory build in the last 7 quarters. Can the government maintain this strategy of flooding the oil market? In our view, it is unlikely that Saudi leaders would want to exacerbate its ongoing reserve drain by pushing prices below $40/bbl. After all, pressure will quickly build on the riyal’s 30 year peg to the USD (Chart 24) if Brent crude oil prices keep falling. And frankly, it is a lot easier politically to implement a modest supply cut at first than allow for a full-blown currency devaluation. But a CNY meltdown could ultimately force Saudi’s hand.

   

  

   

  In short, a depeg of the Saudi riyal is our number one black-swan event for the global oil market in 2016, a highly unlikely but highly impactful. 

   

  However, if Saudi cannot resist the gravitational forces created by a persistently strong USD and depegs the SAR to follow Russia or Brazil, oil prices could collapse to $25/bbl. Weaker commodity prices would in turn add more downward pressure on EMs (Chart 26). Thus, even if micro supply and demand dynamics are improving, the path for oil prices in 2016 will heavily depend on how the USD moves against the CNY and the SAR. Or on a Saudi supply cut.

  And there you have it. It's either stop it with the whole flooding an oversupplied market strategy, or let the peg fall before SAMA runs dry. Bear in mind that it's not just falling crude, the peg, and generous subsidies that are weighing on the Saudis. There's also the war in Yemen and the prospect of a stepped up role in Syria.

  Time to choose…

  

   

  Charts: Bloomberg

  

  

  

  

  

• The Founding Fathers Warned Of This

  Submitted by Mac Slavo via SHTFPlan.com,

  It seems that the only response to terrorism is more surveillance, security, police presence and, of course, war.

  Ignoring the lessons of blowback and escalation that have played out for many years now, the major powers of the world are broadcasting fears and preparing to clamp down on society in response to renewed threats from ISIS and other terror organizations.

  None of it will stop potential attacks from happening, but it will firmly entrench the authority of police and other officials to suspect anyone and sidestep the law when a threat is felt.

  Take a look at how terror and fear have gripped headlines and taken over the news cycle, and ask yourself who benefits from this:

  

  Although officials have admittedly not stopped any attacks from happening, the system is self-assured in its show of force – with SWAT-style police forces clad in all black hunting down suspects and locking down streets in Paris, Belgium and other parts of Europe.

  The Daily Mail highlighted some of the most recent threats, along with just one of the several suspicious persons found at or near major security concerns, including the Pentagon, and in a separate case, the LAX airport:

  Washington D.C residents were left on edge after an internal police alert about four Middle Eastern-looking men ‘acting suspiciously’ in the Pentagon metro station was leaked just two days after ISIS announced the capital was their next target.

   

  […]

  On Monday, a chilling video emerged of ISIS warning that countries taking part in air strikes against Syria will suffer the same fate as Paris.

   

  They also said they would hit the U.S capital next.

   

  The specific threat against the US capital emerged as CIA director John Brennan warned that more atrocities will be committed against the West by the Islamist terror group.

  With New York and Washington, D.C. once again named as terrorism targets, police are gearing up in the homeland as well. It is a bittersweet reminder that the atmosphere that enveloped America for many years after 9/11 will not fade away, but remain a part of our culture. Unless someone cuts through this madness, the attacks on civil liberties will only deepen, and the national conversation will be all too centered on false promises of liberty-through-security.

  Hillary, for one, who effectively has the Democratic nomination in hand, is using the occasion to vow a hawkish stance on the Middle East, though her previous meddling as Secretary of State did much to stir the violence and chaos that has swept over the region.

  “The United States has been conducting this fight for more than a year; it’s time to be begin a new phase and intensify and broaden our efforts,” Clinton told the Council on Foreign Relations in New York.

   

  “We should have no illusions about how difficult the mission before us really is … but if we press forward on both sides of the border, in the air on the ground and as well as diplomatically, I do believe we can crush Isis’s enclave of terror,” she added.

   

  […] She also said the US should arm Sunni tribes and Kurds in the country if the government in Baghdad refused to.

   

  But Clinton called for further US special forces to be deployed to Syria too, reiterated her call for a no-fly zone and demanded an “intelligence surge” to allow the airstrikes against Isis to be stepped up. “We have a lot of work to do to really decimate Isil in Iraq and Syria,” she said, using an alternate name for Isis.

  The words hold an ominous tone for what may be coming in the next four years of the presidency.

  Yet it is not unique to the ambitious Hillary Clinton – indeed, there are few voices in government calling for restraint, and every sign that more attacks are forthcoming on all sides.

  These developments in terrorism are textbook Hegelian Dialectic, using problem-reaction-solution to justify a greater military presence in Syria and Iraq, despite nearly a decade and a half of fighting jihad, civil war and supporting “frenemies” across the region with arms, training and financial support.

  The founding fathers warned of this, but could scarcely foresee the cynical nature of today’s police state – where the terrorists created by the state have become the population’s worst nightmare.

  In one variation of the statement, Benjamin Franklin wrote: “Any society that would give up a little liberty to gain a little security will deserve neither and lose both.”

  

  

  

  

  

• "Get Out Of Your Trucks And Run Away": US Gives ISIS 45 Minute Warning On Oil Tanker Strikes

  Last week, in the wake of Russian and US airstrikes on ISIS oil convoys, we asked three important questions: 

  1. Who are the commodity trading firms that have been so generously buying millions of smuggled oil barrels procured by the Islamic State at massive discounts to market, and then reselling them to other interested parties? In other words, who are the middlemen?
  2. Can it possibly be true, as officials now claim, that the Obama administration refrained from bombing Islamic State oil trucks because Washington thought the group was “only” making $100 million per year instead of $400 million? 
  3. Is it likely, considering how cavalier the US is about collateral damage from drone strikes, that The Pentagon refused to take out Islamic State’s revenue stream because the military was afraid of killing a few “innocent” truck drivers who by definition knew they were transporting illegal crude for a terrorist organization?

  The first question is, for now anyway, unanswerable. As to the second and third, here’s what we said:

  Perhaps the US overestimated the effect its airstrikes were having on Islamic State’s oil production capabilities and perhaps The Pentagon was concerned with killing innocent truck drivers, but it could also be that, as Sergei Lavrov suggested earlier this month, the US has until now intentionally avoided hitting ISIS where it hurts in order to keep them in the game and ensure they can still be effective at destabilizing Assad. If you cut off the oil trade, they lose the ability to battle the regime.

  Whatever the case, it’s too late now, because just as Russian airstrikes and the Iranian ground presence forced the US to do something – anything – to prove to the world that America is serious about fighting terrorism, Moscow’s targeting of ISIS oil convoys has forced the US to get on board (the Russians are going to hit them anyway, so there’s no point in vacillating).

  American airstrikes reportedly destroyed 116 oil tanker trucks earlier this month and another 280 today in Paris mastermind Abdelhamid Abaaoud’s former fiefdom of Deir ez-Zor. 

  Of course the US would hate to catch ISIS off guard risk killing innocent truck drivers, so prior to the November 16 strike, US planes dropped leaflets warning the drivers to “get out of your trucks now, and run away from them.” Here’s the leaflet (note the stick figures running for their lives):

  

  Here’s some commentary from Colonel Steve Warren from Operation Inherent Resolve (delivered at a press conference earlier this month): 

  Early Sunday morning in Al-Bukamal, which is the southern blue circle number two, you see two blue circles there. They both represent Tidal Wave II operations, but we’re in the southern one — the one further towards the bottom of your screen, there.

   

  In Al-Bukamal, we destroyed 116 tanker trucks, which we believe will reduce ISIL’s ability to transport its stolen oil products.

   

  This is our first strike against tanker trucks, and to minimize risks to civilians, we conducted a leaflet drop prior to the strike. We did a show of force, by — we had aircraft essentially buzz the trucks at low altitude.

   

  So, I do have copy of the leaflet, and I have got some videos, so why don’t you pull the leaflet up. Let me take a look at it so I can talk about it.

   

  As you can see, it’s a fairly simple leaflet, it says, “Get out of your trucks now, and run away from them.” A very simple message.

   

  And then, also, “Warning: airstrikes are coming. Oil trucks will be destroyed. Get away from your oil trucks immediately. Do not risk your life.”

   

  And so, these are the leaflets that we dropped — about 45 minutes before the airstrikes actually began.

  And here’s an amusing bit from the post-presser Q&A: 

  Q: On Bob’s question, too, if — if it’s so important to cut off the oil shipments, the critical revenue source for ISIS, why did it take so long to take out 116 oil tanker trucks?

   

  COL. WARREN: No, that’s a great question, Jim. Thanks for asking it.

   

  So, a little history on Operation Tidal Wave II. Initially, we, you know, we have been striking oil infrastructure targets since the very beginning of this operation.

   

  What we found out was that many of our strikes were only minimally effective. We would strike pieces of the oil infrastructure that were easily repaired.

   

  When we came to that realization, we conducted some more study — I think I talked about this last week, a little bit — we conducted some more study, and determined how to better strike the oil infrastructure itself, different pieces of the system.

   

  During the course of that study, we also determined that part of the illicit oil system, from the oil coming out of the ground at a — at a pump head, to the end of that chain, which is the distribution network.

   

  So, this is a decision that we had to make. We have not struck these trucks before. We assessed that these trucks, while although they are being used for operations that support ISIL, the truck drivers, themselves, probably not members of ISIL; they’re probably just civilians. So we had to figure out a way around that. We’re not in this business to kill civilians, we’re in this business to stop ISIL — to defeat ISIL.

  So basically, it took the US 13 months to figure out that the best way to cripple Islamic State’s oil trade was to bomb – the oil.

  To the extent that occurred to anyone previously, the idea was dismissed because the truck drivers are “probably not members of ISIL.” Well then who are they? Sure, they may not be suiting up in all black and firing RPGs at Toyota Corollas packed with “spies” for a propaganda video, but it’s not like they don’t know who they’re working for.

  Also, as mentioned above, the US hasn’t exactly been shy about engaging targets even when there are women, children, and bedridden hospital patients in the vicinity so it’s hard to imagine that anyone at the Pentagon was worried about Islamic State’s truck drivers.

  Whatever the case, the US is apprently set to give ISIS a 45 minute heads up when The Pentagon plans to bomb an oil convoy which we suppose makes sense.

  It’s the least the CIA can do for an old friend.

  

  

  

  

  

• Volkswagen Admits To Equipping Audis, Porsches With Second Illegal Defeat Device

  When last we checked in on Volkswagen and the widening emissions scandal, we learned that in addition to software installed on some 11 million diesel vehicles designed to game nitrogen oxide tests, Germany’s largest carmaker has also been habitually understating CO2 output on around 800,000 cars sold in Europe. 

  In a nutshell, the company said it found “unexplained inconsistencies” while conducting an internal probe related to carbon-dioxide output.

  For the first time, gasoline engines were said to be affected. 

  “VW is leaving us all speechless,” Evercore ISI’s Arndt Ellinghorst said.

  Well Arndt, prepare to be left speechless-er, because now, the company has admitted that some 85,000 Audi engines contained a second defeat device just weeks after saying (and this is about as explicit as it gets) that “no software has been installed in the three-litre V6 diesel power units to alter emissions characteristics in a forbidden manner”.

  As it turns out, software had been installed in all three-litre V6 diesel power units. As FT reports, “the luxury car brand of the VW group admitted that the software was in all three-litre V6 diesel engines manufactured by Audi and sold from 2009 until this year.”

  So no big deal, just every single three-litre V6 diesel vehicle sold for the past seven years. 

  FT goes on to note that after a meeting between Audi’s chief executive, the company’s engineers, and the US Environmental Protection Agency, the carmaker “sent out a statement saying that it had failed to disclose three auxiliary emissions control devices (AECDs) to regulators. Without disclosure and subsequent approval from regulators, AECDs are not legal.”

  “One of them,” the company added, “is regarded as a defeat device according to applicable US law. Specifically, this is the software for the temperature conditioning of the exhaust-gas cleaning system.”

  Apparently, the company will stop selling 3.0 litre TDI-equipped Audi A6s, A7s, A8s, Q5s and Q7s, VW Touaregs and Porsche Cayennes. 

  According to Bloomberg, Audi “agreed to revise and resubmit data concerning the V6 TDI 3-liter diesel engine to U.S. authorities after negotiations.” The cost affecting Audi, Porsche and VW for a software update is expected to be in the “mid-double-digit millions of euros” range.

  To be sure, the writing was already on the wall here. As Bloomberg noted on Friday, “Thursday’s meeting between company officials, EPA and the California regulators involved technical experts who talked about three pieces of equipment on the 3.0-liter engines that should have been disclosed as auxiliary emissions control devices.” According to the EPA, one of the three devices qualifies as a defeat device.

  And so, it just keeps getting worse and in fact, the bad news is piling up so quick that analysts can’t keep up with it. For instance, earlier today, Deutsche Bank said the following: “…the product offensive Audi is currently rolling should help to sustain a healthy pricing environment going forward. Obviously this weekend’s newflow might change this at least in the US.”

  Yes, “obviously”, especially when one variant of every single model besides the A4 and the TT is now under a stop sale order.

  Additionally, it’s hilarious to note that despite it all, Germany’s manufacturing PMI came in at 52.6 today, a three-month high. 

  In any event, we’ll anxiously await the analyst response on Tuesday to see just how much more “speechless” everyone is and in the meantime, we would note that if you thought “stability in volatile times” was a hilariously ironic tagline for a VW coporate presentation…

  

  … then you’ll love being reminded of Audi’s mantra…

  

  

  

  

  

• It Might Be A "Services Economy" But Manufacturing Drives Recessions

  Submitted by Lance Roberts via STA Wealth Management,

  There has been a bit of chatter going on lately about the divergence of the services sector from the manufacturing sector of the economy. This note from David Rosenberg took note of that divergence. 

  "We are seeing questions come up as to whether a manufacturing recession means that the broader economy is destined to follow suit?"

  His answer is that such an outcome is likely not the case. His belief is that manufacturing is no longer a good bellwether for the overall economy. Currently, manufacturing makes up just 12% of total economic output, down from about 30% in the 1950s.

  

  However, is this really the case?

  There are a couple of problems with discounting the importance of manufacturing from the economic debate.

  First, is the impact on jobs. As Sam Ro wrote this morning:

  "With the unemployment rate having tumbled to a 7-year low of 5.0%, the employment factor is not the concern."

  While the unemployment rate, as measured by the BLS, has fallen to a 7-year low, there is vast difference between now and when it has previously achieved such levels. In order to sidestep all of the arguments about retiring "baby boomers" and "students," let's focus on the 25-54 age groups which are in their prime working years. As shown in the chart below, when the unemployment rate had previously achieved "full employment" levels, more than 80% of the prime working age group was employed. Today, that number is 77%.

  

  The problem is not only the current employment level remaining well below levels normally associated with previous "full employment," but wages also remain suppressed. While the recent uptick in wages was certainly welcome by those receiving it, the problem is that the long-term trend of wages remains in a downward slide.

  The problem, of course, is that service related jobs are primarily lower-skilled and therefore lower wage paying jobs than those found in manufacturing. Secondly, service-related jobs have a very low multiplier effect throughout the economy as opposed to manufacturing jobs which leads to lower rates of employment growth, hence the stubbornly slow rate of job growth witnessed since the end of the last recession.

  Since personal consumption expenditures drives roughly 70% of economic growth, a look at where consumers are spending money gives a bit of different picture as opposed to the breakdown of the ISM surveys above. The chart below shows the annual rate of change in total personal consumption expenditures, manufacturing and services.

  

  As you will note, there are many times historically when service related spending has diverged from manufacturing. However, such divergences have tended not to last long and ultimately it has been spending on manufactured goods that have ultimately dictated economic cycles.

  Again, this makes sense when you think about the effect of each dollar spent by consumers. As noted, a dollar spent on services tends to have a relatively small multiplier effect within the economy as opposed to the impact created by spending on manufactured goods and services.

  As David correctly noted, the economy has changed from a manufacturing-based economy to a service related one. However, as service related spending continues to absorb more of every dollar spent by households, it continues to weigh on wage growth.

  

  This is particularly the case with more service spending heading toward surging healthcare costs. The impact of the Affordable Care Act is now taking root. Unfortunately, for many, that impact is not a positive one as surging premiums absorb more of the discretionary budget of households.

  

  While it is hoped that the economy can continue to expand on the back of the "service" sector alone, history suggests that "manufacturing" continues to play a much more important dynamic that it is given credit for.

  The decline in imports, surging inventories, and weak durable goods all suggest the economy is weaker than headlines, or the financial markets, currently suggest.

  For now, however, that detachment can last a while longer as global Central Banks continue to suppress interest rates and flood the financial system with liquidity. With levels of subprime loans for autos and houses, debt issuance and share buybacks once again sharply on the rise, the "party" rages on. However, it is worth remembering what happened when the bartender previously shouted "last call."

   

  

  

  

  

  

• Russia Bombs 1,000 ISIS Oil Tankers As France Launches First Carrier Strikes Against "Evil Death Cult"

  Two days ago, we noted that both France and the US were rushing aircraft carriers toward the Syrian coast. 

  The French dispatched the nuclear powered, $3.5 billion Charles de Gaulle on Saturday while the US sent the CVN-75 Harry Truman last Monday. The departure of the CVN-71 Theodore Roosevelt from the Persian Gulf a month ago had left the entire 5th Naval Fleet without a US carrier presence for the first time in a decade.

  But not for long.

  At last check, the Truman was already approaching Gibraltar.

  

  

  (the Charles de Gaulle)

  

  (Harry Truman)

  Meanwhile, the Charles de Gaulle has arrived and the carrier’s jets have flown their first combat missions. As RT reports, “the presence of 26 military aircraft aboard the Charles de Gaulle triples French forces in the region, adding to the 12 planes already stationed in the UAE and Jordan: six Rafale and six Mirage 2000 aircraft.” 

  

  “We will intensify our strikes, we will choose targets that will do the most damage possible to the terrorist army,” Francois Hollande proclaimed (a note to the French President: if that’s really your goal, you might want to source your “intelligence” from someone other than Washington). 

  Interestingly, France isn’t confining its strikes to Syria. As AFP reports, French warplanes engaged targets in Ramadi and Mosul on Monday:

  France launched air strikes against Islamic State targets in Iraq on Monday in the first sorties from the Charles de Gaulle aircraft carrier, newly deployed in the eastern Mediterranean.

   

  “We carried out strikes in Ramadi and Mosul in support of ground forces that were pushing against troops of (the Islamic State group),” said army chief of staff General Pierre de Villiers, aboard the carrier.

   

  He said planes from the Charles de Gaulle would launch strikes against IS targets in Syria, including command and recruitment centres as well as oil facilities, in “a matter of hours or days”.

   

  Rafale jets catapulted from the carrier’s flight deck on Monday morning, an AFP reporter saw.

  Meanwhile, the Russians have stepped up strikes on ISIS oil tankers as the debate heats up in the US about why the Obama administration is just now beginning to target Islamic State’s main source of revenue. According to the Russian Defense Ministry, Moscow’s warplanes have destroyed 1,000 tankers carrying “stolen crude” to refineries in the last five days alone. The Kremlin is also targeting depots and refineries near Raqqa, and because we’re talking about the Russians here, you know they took plenty of pictures. 

  Here’s the destruction of “an object at the terrorists’ oil production plant”:

  And here’s a strike on “facilities of oil production, storage, and processing”:

  We wonder whether the Russians, like the Americans, dropped leaflets 45 minutes ahead of time letting ISIS know that airstrikes were imminent.

  

  In any event, both the skies above Syria and the waters off its coast are becoming quite crowded these days, and the “parking lot” in the Mediterranean will only become more cramped once the Truman shows up. And just in case things weren’t complicated enough, David Cameron is now seeking Parliamentary approval to join the air campaign and has given the French permission to use Britain’s RAF base in Cyprus to launch anti-ISIS strikes. On that note, we’ll close with a rather amusingly hyperbolic quote from the British PM: 

  “The United Kingdom will do all in our power to support our friend and ally France to defeat this evil death cult.”

  

  

  

  

• Why "Supply & Demand" Doesn't Work For Oil

  Submitted by Gail Tverberg via Our Finite World blog,

  The traditional understanding of supply and demand works in some limited cases–will a manufacturer make red dresses or blue dresses? The manufacturer’s choice doesn’t make much difference to the economic system as a whole, except perhaps in the amount of red and blue dye sold, so it is easy to accommodate.

  

  Figure 1. From Wikipedia: The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

  A gradual switch in consumer preferences from beef to chicken is also fairly easy to accommodate within the system, as more chicken producers are added and the number of beef producers is reduced. The transition is generally helped by the fact that it takes fewer resources to produce a pound of chicken meat than a pound of beef, so that the spendable income of consumers tends to go farther. Thus, while supply and demand are not independent in this example, a rising percentage of chicken consumption tends to be helpful in increasing the “quantity demanded,” because chicken is more affordable than beef. The lack of independence between supply and demand is in the “helpful” direction. It would be different if chicken were a lot more expensive to produce than beef. Then the quantity demanded would tend to decrease as the shift was increasingly made, putting a fairly quick end to the transition to the higher-priced substitute.

  A gradual switch to higher-cost energy products, in a sense, works in the opposite direction to a switch from beef to chicken. Instead of taking fewer resources, it takes more resources, because we extracted the cheapest-to-extract energy products first. It takes more and more humans working in these industries to produce a given number of barrels of oil equivalent, or Btus of energy. The workers are becoming less efficient, but not because of any fault of their own. It is really the processes that are being used that are becoming less efficient–deeper wells, locations in the Arctic and other inhospitable climates, use of new procedures like hydraulic fracturing, use of chemicals for extraction that wouldn’t have been used in the past. The workers may be becoming more efficient at drilling one foot of pipe used for extraction; the problem is that so many more feet need to be drilled for extraction to take place. In addition, so many other steps need to take place that the overall process is becoming less efficient. The return on any kind of investment (human labor, US dollars of investment, steel invested, energy invested) is falling.

  For a time, these increasing inefficiencies can be hidden from the system, and the prices of commodities can rise. At some point, however, the price rise becomes too great, and the system can no longer accommodate it. This is the situation we have been running into, most severely since mid-2014 for oil, but also for other commodities, dating back to 2011.

  

  Figure 2. Bloomberg Commodity Index from Bloomberg, reflecting a combination of 22 ETFs in Energy (35%), Agriculture (29%), Industrial Metal (15%), Precious Metals (16%) and Livestock (5%)

  The higher cost of producing oil and other energy products affects the economy more than a shift from chicken to beef.  

  The economy is in a sense more dependent on energy products than it is on our decision whether to eat chicken or beef. If the cost of producing oil rises, and that higher cost is carried through to prices, it affects the prices of many things. It affects the cost of food production because oil is used in the production and transport of food. The higher cost of oil also affects nearly all transported goods, since oil is our primary transportation fuel.

  Some of the impacts of higher oil prices are clearly adverse for the economy.

  If higher oil costs are passed on to consumers as higher prices, these higher prices make goods less affordable for consumers. As a result, they cut back on purchases, often leading to layoffs in discretionary sectors, and recession.

  The higher cost of oil products (or of other energy products) also tends to reduce profits for businesses, unless they can find workarounds to keep costs down. Otherwise, businesses find themselves in a situation where customers cut back on purchasing their products. As we will discuss in a later section, this tends to lead to reduced wages.

  Some of the impacts of higher oil prices are somewhat positive.

  Rising oil prices clearly encourage rising oil production. With this, more jobs are added, both in the United States and elsewhere. More debt is added to extract this oil, and more equipment is purchased, thus stimulating industries that support oil production. The value of oil leases and oil properties tends to rise.

  As noted previously, the cost of food supply depends on oil prices. The cost of producing metals also depends on oil prices, because oil is used in extracting metal ores. As the prices of metals and foods rise, these industries are stimulated as well. Values of mines rise, as do values of agricultural land. More debt is taken out, and more workers are hired. More equipment is purchased for producing these products, adding yet more stimulation to the economy.

  The higher price of oil also favorably affects the many countries that extract oil. Part of this effect comes from the wages that the workers receive, and the impact these wages have, as they cycle through the economy. For example, workers will often want new homes, and the purchase of these new homes will add jobs as well.  Part of the effect comes through taxes on oil production. Oil production tends to be very highly taxed, especially in parts of the world where oil extraction can be performed cheaply. This tax money can be put to work in public works programs, providing better schools and hospitals, and more jobs for citizens.

  It is inevitable that the price of oil must stop rising at some point because of the adverse impact on spendable income of consumers.

  The adverse impact of higher oil prices on the spendable income of consumers comes in many ways. Perhaps one of the biggest impacts, but the least obvious, is the “push” the higher cost of oil gives to moving manufacturing to locations with lower costs (cheaper fuel, such as coal, and lower wages), because without such a change, higher oil prices tend to lead to lower profits for many makers of goods and services, as mentioned previously.

  The competition with lower-wage areas tends to reduce wages in the US and parts of Europe. This push is especially great for jobs that are easily transferred to other countries, such as jobs in manufacturing, “call-centers,” and computer tech support.

  Another way businesses can maintain their profit levels, despite higher oil costs, is through greater automation. This automation reduces the number of jobs directly. Automation may use some oil, but because the cost of human labor is so high, it still reduces costs overall.

  All of these effects lead to fewer jobs and lower wages, especially in the traditionally higher-wage countries. In a sense, what we are seeing is lower productivity of human labor feeding back as lower wages, if we think of the distribution of wages as being a worldwide wage distribution, including workers in places such as China and India.

  Normally, greater productivity feeds back as higher wages, and higher wages help stimulate higher economic growth. Lower wages unfortunately seem to feed back in the reverse direction–less demand for goods that use energy in their production, such as new homes and cars. Ultimately, this seems to lead to economic contraction, and lower commodity prices. This is especially the case in the countries with the most wage loss.

  The drop in oil prices doesn’t do very much to stop oil production.

  Oil exporting countries typically have relatively low costs of production, but very high taxes. These taxes are necessary, because governments of oil exporters tend to be very dependent on oil companies for tax revenue. If the price of oil drops, the most adverse impact may be on tax revenue. As long as the price is high enough that it leads to the collection of some tax revenue, production will take place–in fact, production may even be increased. The government desperately needs the tax revenue.

  Even oil companies in oil-importing countries have a need for revenue to pay back debt and to continue to pay their trained workers. Thus, these companies will continue to extract oil to the best of their ability. They will aim for the “sweet spots”–places that have better than average prospects for production. In some cases, companies will have derivative contracts that assure them of a high oil price for several months after the price drops, so there is no need to reduce production very quickly.

  The drop in oil prices, and of commodity prices in general, makes debt harder to repay and discourages adding new debt. 

  We earlier noted that a rise in the price of commodities tends to make asset prices rise, making it easier to take out more debt, and thus stimulates the economy. A drop in the price of oil or other commodities does the opposite: it reduces asset prices, such as the price of the property containing the oil, or the farmland now producing less-expensive food. The amount of outstanding debt does not decline. Because of this mismatch, companies quickly find themselves with debt problems, especially if they need to take out additional loans for production to continue.

  Another part of the problem is that on the way up, rising prices of oil and other commodities helped lift inflation rates, making debt easier to repay. On the way down, we get exactly the opposite effect–falling oil and other commodity prices lead to falling inflation rates, making debt more difficult to repay. Commodity prices in general have been falling since early 2011, leading to the situation where interest rates are now negative in some European countries.

  The costs of producing commodities continue to rise, as a result of diminishing returns, so this fall in prices is clearly a problem. Low prices make future production unprofitable; it also leads to an increasing number of debt defaults. There are many examples of companies in financial difficulty; Chesapeake Energy is an example in the oil and gas industry.

  *  *  *

  Where oil supply and demand goes from here

  The traditional view of the impact of low oil prices seems to be, “It is just another cycle.” Or, “The cure for low prices is low prices.”

  I am doubtful that either of these views is right. Falling prices have been a problem for a wide range of commodities since 2011 (Figure 2, above). The Wall Street Journal reported that as early as 2013, when oil prices were still above $100 per barrel, none of the world’s “super major” oil companies covered its dividends with cash flow. Thus, if prices are to be sufficiently high that oil companies don’t need to keep going deeper into debt, a price of well over $100 per barrel is needed. We would need an oil price close to triple its current level. This would be a major challenge, especially if prices of other commodities also need to rise because production costs are higher than current prices.

  We are familiar with illnesses: sometimes people bounce back; sometimes they don’t. Instead of expecting oil prices to bounce back, we should think of the current cycle as being different from past cycles because it relates to diminishing returns–in other words, the rising cost of production, because we extracted the cheapest-to-extract oil first. Trying to substitute oil that is high in cost to produce, for oil that is low in cost to produce, seems to bring on a fatal illness for the economy.

  Because of the differing underlying cause compared to prior low-price cycles, we should expect oil prices to fall, perhaps to $20 per barrel or below, without much of a price recovery. We are now encountering the feared “Peak Oil,” because much of the cheap oil has already been extracted. Peak Oil doesn’t behave the way most people expected, though. The economy is a networked system, with high oil prices adversely affecting both wages and economic growth. Because of this, the symptoms of Peak Oil are the opposite of what most people have imagined: they are falling demand and prices below the cost of production.

  If low prices don’t rise sufficiently, they can cut off oil production quite quickly–more quickly than high prices. The strategy of selling assets at depressed prices to new operators will have limited success, because much higher prices are needed to allow new operators to be successful.

  Perhaps the most serious near-term problem from continued low prices is the likelihood of rising debt defaults. These debt defaults can be expected to have a very adverse impact on banks, pension plans, and insurance companies. Governments would likely have little ability to bail out these organizations because of the widespread nature of the problem and also because of their own high debt levels. As a result, the losses incurred by financial institutions seem likely be passed on to businesses and individual citizens, in one way or another.

  

  

  

  

  

• How To Trade The Fed's Upcoming "Policy Error" In Three Parts

  On Sunday, using an analysis by Deutsche Bank’s Dominic Konstam, we showed why the Fed by miscalculating the equilibrium real rate (which in reality is negative due to the massive debt overhang and the declining nominal growth rate, as well as record deflation exported by every other developed nation and now, China) is about to unleash a major policy error by hiking rates in 3 weeks – a process which will promptly result in a recession and ultimately force the Fed to both cut rates to zero or negative, and proceed with even more QE.

  Here is Konstam’s conclusion:

  This is the important policy error scenario because even a very shallow path of rate hikes might drive the real Funds rate well above the short-term equilibrium real rate, further depressing demand. It is then plausible that the economy would be driven into recession, and the Fed would quickly be forced to abort the hiking cycle. As an aside, such a policy error could reinforce itself by causing structural damage that puts additional downward pressure on the equilibrium real rate. In this case the yield curve would flatten meaningfully, at least until the Fed actually reversed course by cutting rates.

   

  * * *

   

  This scenario is also bullish for rates because the Fed would, at the very least, stop rolling down its SOMA portfolio. More likely it would restart asset purchases in an attempt to stimulate the economy once more, pushing yields further down. We have argued in the past that unconventional forms of monetary accommodation are here to stay. The minutes of the October meeting confirm this view, noting that some policymakers felt it would be “prudent to have additional policy tools” because a lower long-run equilibrium real rate makes it more likely that reductions in the Funds rate alone would not be sufficient to stimulate the economy in the event of a downturn in the future.

  Whether or not Konstam is right that the Fed is about to make what will prove to be a credibility-crushing mistake, remains to be seen. However, for those who, like us, believe that anything the Fed does is one mistake after another and thus a December rate hike will merely be the latest one in a long series of policy errors, the question is: how should one trade ahead of this error.

  The answer comes from another research analyst at Deutsche Bank, Aleksandar Kocic. Here is his complete trade cocktail in three parts for the next 12-18 months that will encapsulate the distinct phases of the upcoming market tailpsin: the bear flattening of the curve, the bear steepening, one which may see the 10Y trade at or below the 2Y, in the process flattening the curve and perhaps even leading to the dreaded inversion.

  From Deutsche Bank:

  The year ahead: Policy mistake in three acts

  In our view, the next 12-18 months will be divided into three periods corresponding to the three distinct regimes of market dynamics. They can be summarized by the following modes of the curve: short-term tactical bear flatteners on the back of a Fed liftoff story, followed by volatile bear steepeners of the “taper-tantrum” type around mid-year, and a bull-flattening finale as structural factors deem rate hikes to be a policy mistake.

  Stage one: Bear flatteners

  In the next 3-4 months Fed liftoff should be the main theme, with tactical bear flattening revolving around its timing and intensity. The Fed is likely to hike in December, and market prices are already reflecting this. However, conviction about a March follow-up is lower, although in our view this is a real possibility. This phase is bullish for USD and, given the expected slow rates rise, rates vol is likely to be relatively low and concentrated in the upper-left corner as the short end of the curve remains sensitive to the data, while the long end continues to be range bound.

  As Fed liftoff represents the moment of decoupling between different economies, currency play will remain the main mode of adjustment to that reality. Therefore, although reversal of monetary policy is transmitted through rates, volatility will migrate from rates to FX and possibly risk assets, depending on how risk reacts to it. To some extent, we have already seen vol market positioning for this transfer of vol. Figs 1 and 2 show the recent history of rates, FX and equity vol.

  

  In general, one should keep in mind that hikes are practically self-defeating as they lead to a stronger USD, which could slow the pace of a rate rise. So, a March hike is considered somewhat of a tail risk. We are buyers of leveraged bearish expressions in the ULC:

  • Buy $100mn 4M2Y 25bp OTM payers subject to KO if 2s exceed ATMF+25bp in the first two months, 5bps offer vs. 13bp for the vanilla (62% discount)

  The discounting is a function of both delta and serial correlations. A vanilla articulation in terms of payer calendar spreads would consist of financing a 4M2Y payer position with 2M2Y. For comparison, we adjust the strikes so that the premium matches the exotic trade:

  • Sell $100mn 2M2Y 20bp OTM payers vs. buy $100mn 4M2Y 25bp OTM payers, offer 5c

  In the vanilla version we have to sell 2M2Y 20bp OTM payers to finance 25bp OTM 4Y2Y payers. The difference between the two trades is their risk profile – while the exotics trade has limited downside (max loss = options premium), the calendar spread is vulnerable to MTM losses in case of transient spikes in gamma. Losses could be theoretically unlimited, although this is an unlikely possibility.

  Stage Two: Bear steepeners

  There have been many attempts to infer the Fed reaction function post-2008. Given the structural changes and breakdown of standard macroeconomic models in recent years, the question remains regarding the metric that captures economic recovery and the exact monetary policy response to it. The most easily understood indication of structural changes is the drop in GDP and the output gap relative to the potential that has opened up since the early days of the crisis. The growth has been so slow that based on the extrapolation of the pre-crisis potential, it was hard to see any point on the horizon when the gap would close. However, accounting for all the changes that took place, the revision of the potential was the key to actual convergence – while growth was increasing at a moderate pace, potential growth was even slower. This is shown in Fig 3.

  According to the most recent data, their intersection is anticipated sometime next year. We believe that, regardless of the Fed reaction function, the market will interpret this as a bullish sign for the economy (and bearish for rates). At that moment, it is likely to challenge the Fed’s gradualism and begin to price the Fed as being behind the curve. This is the bear steepener, taper-tantrum type of mode.

  

  The main mode of repricing is likely to be a selloff in long forwards and revisions of the terminal Fed funds rate, in particular 5Y5Y. 10Y UST yields could reach or even exceed 2.75%. We would position for this phase through quiet bears in mid-curve:

  • Sell 26bp OTM 6M 5Y5Y MC receivers vs. buy 6M 5Y5Y MC ATMF/26bp payer spreads

  The trade has a max upside of 26bp running and is vulnerable to rally 26bp below forward with theoretically unlimited downside.

  An alternative expression of this mode could be through 6M 2s/10s or 5s/30s curve caps, or OTM conditional bear steepeners. However, while these are attractive positive carry trades, given the expectations of short-term bear flatteners and potentially volatile repricing in the belly, we would wait for better entry levels in Q2 next year.

  A better articulation of the bear-steepening trade in the context of the outlined sequence of curve modes would be in terms of curve-cap calendars: Sell shortdated caps vs. buy long-dated OTM caps:

  • Sell $1bn 3M 2s/10s ATMF (105.5bp) curve cap vs. buy $1bn 6M 2s/10s ATMF+15bp (113.5bp), costless

  The trade has a (slight) positive carry (favorable time decay from short gamma partially offset by curve rolldown). MTM risk could be theoretically unlimited in case of transient short-term stepeners.

  This period is bearish for USD and possibly for risk assets. It is likely to be very volatile. Vol should return to rates and migrate from short to the back end of the curve. Equity and/or credit vol could also rise significantly if bear steepeners persist and threaten to cause redemptions and forced an unwind of the bond trade. We would be buyers of forward vol at the back end of the curve along the lines of 6M 3M10Y FVA.

  • Stage three: Bull flatteners

  Despite everything that could happen in the near term, the main long-run story remains lack of demand. With all else equal, the market can decide to interpret rates selloff and Fed liftoff as policy mistakes and price in the adverse impact on growth and position for further rate cuts in the future. This is the third phase, the twist of the curve – the front end remains constrained by the Fed, while the back end rallies. It is a bull flattener, after a continued rise in rates. We anticipate the 10Y UST yield to rally towards 2% after trading as high as 2.75% during the second phase. This is generally bearish for USD and for risk assets, and as such could mean higher equity vol. Given that rates vol should reach high levels during the bear-steepening phase, bull flatteners would bring back vol sellers and return of the carry trade.

  To capture the path from high to low rates, we would be buyers of knock-in receivers:

  • Buy $100mn 1Y10Y ATMF receivers subject to KI if 10s touch 2.65%, offer 80c, a 73% discount to vanilla at 300c

  The trade has limited downside with max loss equal to the options premium.

  In general, one can capture the entire path of the second and third stages through mid-curve vs. vanilla switches. The logic is that of mean reversion: If rates initially do one thing, they should subsequently do the opposite. To capture the yoyo mode in rates, we recommend the vanilla/mid-curve payer switches:

  • Buy $100mn 18M10Y vanilla payers at 365bp vs. sell $100mn 6M 1Y10Y MC payers at 205bp for a net 160bp

  This is a positive carry synthetic forward vol trade (the payer side). It is an articulation of mean reversion. If rates sell off in the first 6M, MC payers are in the money, so the position consists of receiving fixed on 1Y10Y swaps (selling a payer option) and being long 1Y10Y vanilla payers. From put/call parity, the net position is a swaption receiver. The trade is short gamma and is vulnerable to transient spikes in vol in the first 6M with theoretically unlimited MTM losses.

  

  

  

  

  

• Carsonnochio Strikes Again – "Walks Back" Comments He Saw Muslims Cheering On 9/11

  As Donald Trump came under fire for claiming that he saw Muslims in New Jersey cheering on 9/11, admitted-non-total-truth-speaker Ben Carson jumped on the bandwagon claiming he too "saw film of it." Now, in yet another embarrassing u-turn 'oops' for the retired (now it all makes sense) neurosurgeon, the Carson campaign told CBS News Monday evening that Carson is "really not" standing behind his earlier statement and that the GOP presidential candidate was thinking of other footage he saw.

  Caught on tape…

  WATCH: @RealBenCarson tells ABC he saw news footage of Muslims in New Jersey cheering as towers fell on 9/11: https://t.co/DJCSJdZxXS

  — ABC News Politics (@ABCPolitics) November 23, 2015

  As CBS News reports,

  Ben Carson is walking back comments he made earlier Monday in which he claimed that he saw Muslims cheering in New Jersey during television news coverage of the 9/11 terrorist attacks.

   

  The Carson campaign told CBS News Monday evening that Carson is "really not" standing behind his earlier statement and that the GOP presidential candidate was thinking of the "ample" news footage he watched of celebrations from the Middle East after 9/11.

   

  Earlier in the day Monday at a rally in Pahrump, Nevada, Carson was asked if Muslims were cheering on 9/11 when the Twin Towers fell.

   

  "Yes," said Carson, who was then asked to elaborate further. "Well, you know, there are going to be people who respond inappropriately to virtually everything. I think that was an inappropriate response. I don't know if on the basis of that you can say all Muslims are bad people; I really think that would be a stretch."

   

  Asked once more to confirm exactly what footage he saw, Carson said he witnessed Muslims cheering on "newsreels" during coverage of the attacks and confirmed it was shot in New Jersey.

  *  *  *
  One wonders where the red line will stop?

  

  

  

  

  

  

• The Closing Of The Global Economy

  Submitted by Joseph Calhoun via Alhambra Investment Partners,

  I don’t often write about global geopolitics because I think, in general, investors spend too much time worrying about things they can’t control or aren’t going to happen or wouldn’t matter much if they did. The best example is the Middle East which has been a mess my entire life and long before it for that matter. Changing your investments based on the latest threat in or from the Levant is a recipe for constant chaos. The only accurate prediction about the Middle East will always be that the various factions that have been fighting for centuries will continue to fight. And that no matter who is in charge they will have to sell oil to make ends meet. And make no mistake oil is the only economic reason we care about the region.

  The recent Paris attacks, though, have me thinking more about how global geopolitics is affecting the global economy. The terrorist attacks Europe has experienced in Madrid, London, Paris and other locales are raising old barriers across the continent. Borders where goods, people and capital have crossed freely for the last few decades are now manned and monitored again. Capital largely continues to flow freely but people and goods are starting to be restricted; you can’t restrict the flow of people without also obstructing the flow of goods. For now, the people and goods continue to flow, just more slowly. One can’t help but think though that if the borders become literal barriers again it won’t be long before the metaphoric ones – protectionist policies – return as well.

  If one also considers the antipathy toward Germany that permeates most of Europe and the perception – and reality to some degree – that the EU and especially the EMU are much more favorable for the Teutonic members than the Latin ones, then one begins to see how the fragile union might devolve into its former squabbling, fractured self. The feared break up of Europe and the Euro has until now been based on economic considerations but physical security would seem a larger concern at this point. If the EU can’t guarantee physical security and has already failed at providing economic security, it’s raison d’etre is….what exactly? To provide employment for feckless bureaucrats?

  The desire for physical security isn’t confined to Europe obviously; the Paris attacks have amped up the political debate in the US over immigration, with Syrian refugees and physical security now replacing Latin Americans and economic security as the targets. The emergence of  Donald Trump as a right wing populist to challenge the near universally populist Democrats means that both parties are now pandering to the population’s baser instincts of fear and greed. That isn’t to say that their fears aren’t real or legitimate just that the solutions offered by populist politicians are simplistic and unlikely to achieve the intended results. Indeed, history says that walling ourselves off from the world is more likely to create less security, physical and economic, rather than more.

  The demonization of foreigners, this emerging isolationist consensus – a natural response in many ways to the jingoism of the last decade’s Western governments – is not confined to the debate over national defense or immigration. It is also a part of the economic debate. Politicians exploit our economic insecurities, laying blame on foreigners – the Chinese are the most often cited bogeymen – for problems created by our own policies. Donald Trump says he will be a tougher negotiator and get better trade deals but doing so will require threatening consequences – trade restrictions – that would please Smoot and Hawley and potentially repeat the mistakes that led to the Great Depression. Jack Lew decries corporate inversions and announces new rules designed to prevent US companies from doing what our corporate tax code incentivizes them to do. Meanwhile, Pfizer and Allergan look to structure a deal that has Allergan – an Irish corporation with a low tax rate and the smaller of the two companies – playing the role of acquirer to avoid the new rules. Will the current administration or future ones regularly reject takeovers of US corporations unless they are carried out by other US corporations? Will other countries follow suit?

  The inequality debate is rooted too in the discussion over trade policy, globalization and outsourcing. The decline of the American middle class, the rise of the so called creative class and the consequences of the financialization of the US economy are all part of the same populist, isolationist rhetoric. Foreigners are demonized as stealing American manufacturing jobs, polarizing the US between the haves, largely in the coastal cities, who benefit from free trade and the have nots, largely in the interior of the country, who don’t. It mostly isn’t true – productivity has reduced manufacturing employment much more than free trade – but it has enough of a whiff of truth that it works as a political strategy even if it would fail miserably as an economic one. Monetary policy has attempted to assuage the middle class angst with expanded credit but that has exacerbated the divide as financial engineers have been rewarded at the expense of real ones.

  We see this nationalistic impulse in the so called currency wars, the devaluations intended to steal some of what is left of global growth for one’s own country. Rather than pursue domestic policies that would improve growth, politicians are happy to leave it to central banks to try and gain a trade advantage by weakening the national currency, seeking to enrich through impoverishment, a policy doomed to failure. The unintended consequences are reflected in money markets where conditions once thought impossible or at least illogical have become commonplace. In the process of trying to recover from the last crisis we are creating the conditions for the next.

  Meanwhile, global trade is contracting, down for three years in a row and a major reason for the weak recovery from the last recession. The growth and falling inflation of the 90s was, in a lot of ways, driven by the expansion of trade, the liberalization of the global economy as former communist nations adopted more liberal, free market economic policies and joined the world trade order. That expansion appears to now be reversing in a cacophony of nativist rhetoric, a global phenomenon that encompasses, unites and animates the far left and the far right. As I said in my Weekly Snapshot:

  The political left is happy to see people cross borders but would gladly restrict the flow of capital and goods. The political right is happy to see capital and goods cross borders but would gladly build a fence to restrict the flow of people. I’m afraid that the compromise might be to restrict people, capital and goods.

  This political pandering has consequences for our society and economy that are hard to predict. The recent college campus protests would appear to be another manifestation of this growing desire for security over all else. Students want to create “safe spaces” where they are free to extend their childhood, protected from harm both real and imagined. With the random violence and economic upheaval that has marked their lives, from 9/11 to Madrid to London to Paris to the dot com bust to the Great Recession, is it any wonder that our young adults seek to be protected from the real world? The intolerance practiced by our leaders is reflected in the intolerance of the students who shout down anyone who doesn’t toe the politically correct line, a feat that becomes harder by the day. We have lost the ability to take a joke, to distinguish between satire and seriousness. In the process, we divide rather than unite, for fear of offending and being subjected to the modern day pillory of social media.

  As I said at the beginning, I don’t generally spend a lot of time thinking about geopolitics as it relates to investing because it isn’t generally profitable. This closing of the global economy, this emerging trend toward protectionism in the form of currency devaluation and populist politics is already impacting the global economy but in the short term probably shouldn’t impact our investment approach. We don’t know yet how far this will be taken, if the rhetoric will turn into actual economy damaging policies. For now, the most obvious impact has been the rising dollar and falling inflation expectations with, so far, little impact on real growth expectations here in the US. But the direction is disturbing especially with the US coming into an election year when the rhetoric may have more impact on market outcomes.

  As investors we have more immediate concerns. Growth remains stuck at the secular stagnation, new normal pace of 2 to 2.5% growth. The economic data continues to point to weakness even as the Fed prepares to enter a tightening cycle. Inventories are building as sales and investment stagnate. The energy industry, responsible for an historically large proportion of investment since the crisis, is in deep trouble as the dollar rises and oil prices sink. Earnings are falling and margins appear to have peaked. Stock market valuations are extreme and market technicals are unhealthy with a small number of stocks leading the averages higher even as most stocks head south. Investors have plenty to worry about that is real and now without delving into what is speculative and possibly far in the future.

  The closing of the global economy, the reversal to some unknown degree of the globalization process, has negative consequences for the lives to which we’ve become accustomed. Much of the disinflation since the early 90s is a direct result of increased trade and reversing the process will in time mean less choice and higher prices for Americans. And no, it won’t, despite what the protectionist populists would have you believe, bring back high wage manufacturing jobs.  The giant sucking sound Ross Perot warned about isn’t coming from Mexico but rather from Silicon Valley and we should be thankful for it not ruing it. We should be preparing our young adults for the real world and the jobs of this century rather than coddling them and trying to bring back the jobs of the last one. The closing of the global economy is not a fait accompli. But we will have to resist with all our might the siren song of the politicians who tell us what we want rather than need to hear and push back against the monetary policies that are a poor substitute for better fiscal and regulatory policies.

  

  

  

  

  

• "Get Him The Hell Out Of Here": Trump Heckles "Obnoxious" Black Lives Matter Activist Who Interrupted Rally

  A quick check on the circus that is the GOP presidential primary reveals that Donald Trump – who has a commanding lead in New Hampshire – has retaken the top stop in Iowa and we think we might know why. As CBS reports, “large majorities of Republican primary voters in Iowa express tough views toward illegal immigrants including eight in ten who view them as harm to national security [and] more than four in five who say that they have broken the law and should be penalized or deported.”

  Additionally, 43% of Iowa voters say the Paris attacks affected their vote and fully three quarters favor sending troops to Syria. 

  Combine a hardline stance on immigration and an “ass kicking” approach to fighting terror and what do you get? This: 

  

  Anyway, Trump is coming off a week in which he suggested (and yes, we realize he was baited by the reporter) that he would not be opposed to, i) keeping a national database of Muslims, and ii) requiring Muslim Americans to carry ID cards.

  Of course the Teflon Don is, as one analyst put it a few months back, “gaffe proof” which means that when Ben Carson compares Syrian refugees to “rabid dogs“, prospective voters recoil in horror, but when Trump conjures up uncomfortable images out of Europe’s difficult past everyone just kind of chuckles before writing it off as “Trump being Trump”. 

  Well, Trump was out being Trump in Birmingham, Alabama on Sunday when he was interrupted by Mercutio Southall Jr. who The Washington Post describes as “a well-known local activist who has been repeatedly arrested while fighting what he says is unfair treatment of blacks.” 

  

  Here’s what happened after Southall interrupted Trump:

  A black protester at Trump’s rally today in Alabama was shoved, tackled, punched & kicked: https://t.co/Aq0wuaAtax pic.twitter.com/cTRDMtjuBl

  — Jeremy Diamond (@JDiamond1) November 21, 2015

  And here’s a bit of color from WaPo:

  A fight broke out, prompting Trump to briefly halt his remarks and demand the removal of Southall.

   

  “Get him the hell out of here, will you, please?” Trump said on Saturday morning. “Get him out of here. Throw him out!”

   

  At one point, Southall fell to the ground and was surrounded by several white men who appeared to be kicking and punching him, according to video captured by CNN. A Washington Post reporter in the crowd watched as one of the men put his hands on Southall’s neck and heard a female onlooker repeatedly shout: “Don’t choke him!”

   

  As security officers got Southall on his feet and led him out of the building, he was repeatedly pushed and shoved by people in the crowd. The crowd alternated between booing and cheering. There were chants of “All lives matter!”

   

  Southall told the AL.com news site that the commotion started as he began recording himself and other protesters at the rally and saying that he wanted “Donald Trump to know he’s not welcome here.” Southall said someone knocked the phone out of his hand and made a racial slur. Then there was pushing and punches started flying, Southall told the news site.

  Unfazed, Trump proceeded to taunt Mercutio from the podium before launching into a story about a “seriously obese” man who disrupted a previous rally. Take a listen:

  Asked on Monday about the incident, Trump said the following: “maybe he should have been roughed up.”

  *  *  *

  Summed up…

  

  

  

  

  

• State Department Issues Worldwide Travel Alert "Due To Increased Terrorist Threats"

  For the first time since December 2014 – and just in case you were not fearmongered enough (or bullish on US equities enough) – The US State Department just unleashed a worldwide travel alert for the next 3 months. This seems to wreak a little haov at President Obama’s  “ISIS is contained” narrative…

   

  Via The State Department:

  The State Department alerts U.S. citizens to possible risks of travel due to increased terrorist threats. Current information suggests that ISIL (aka Da’esh), al-Qa’ida, Boko Haram, and other terrorist groups continue to plan terrorist attacks in multiple regions.  These attacks may employ a wide variety of tactics, using conventional and non-conventional weapons and targeting both official and private interests.  This Travel Alert expires on February 24, 2016.

  Authorities believe the likelihood of terror attacks will continue as members of ISIL/Da’esh return from Syria and Iraq.  Additionally, there is a continuing threat from unaffiliated persons planning attacks inspired by major terrorist organizations but conducted on an individual basis.  Extremists have targeted large sporting events, theatres, open markets, and aviation services.  In the past year, there have been multiple attacks in France, Nigeria, Denmark, Turkey, and Mali.  ISIL/Da’esh has claimed responsibility for the bombing of a Russian airliner in Egypt.

  U.S. citizens should exercise vigilance when in public places or using transportation.  Be aware of immediate surroundings and avoid large crowds or crowed places.  Exercise particular caution during the holiday season and at holiday festivals or events.  U.S. citizens should monitor media and local information sources and factor updated information into personal travel plans and activities.  Persons with specific safety concerns should contact local law enforcement authorities who are responsible for the safety and security of all visitors to their host country.  U.S. citizens should:

  • Follow the instructions of local authorities.  Monitor media and local information sources and factor updated information into personal travel plans and activities. 
  • Be prepared for additional security screening and unexpected disruptions.
  • Stay in touch with your family members and ensure they know how to reach you in the event of an emergency.
  • Register in our Smart Traveler Enrollment Program (STEP).

  Foreign governments have taken action to guard against terrorist attacks, and some have made official declarations regarding heightened threat conditions.  Authorities continue to conduct raids and disrupt terror plots.  We continue to work closely with our allies on the threat from international terrorism.  Information is routinely shared between the United States and our key partners in order to disrupt terrorist plotting, identify and take action against potential operatives, and strengthen our defenses against potential threats.

  *  *  *

  Scared yet?

  

  

  

  

• Bill Ackman Triples-Down On Valeant: Boosts Stake To 9.9% By Buying Calls, Selling Puts

  In the infamous words of Kenny Rogers, "you gotta know when to fold 'em," but in the case of Bill Ackman and his Pershing Square Fund's massive losing position in Valeant (19.47 million shares at average cost of $183.57 against today's $87.11 lows), he has decided to not just double-down, but triple-down by selling puts to fund calls and increase his stake in the company to 9.9% (or 34.12 million shares).

  As the Press Statement notes,

  Pershing Square Holdings, Ltd. Increases Position In Valeant Pharmaceuticals International

   

  AMSTERDAM — November 23, 2015

   

  Regulatory News:

   

  Pershing Square Capital Management, L.P., the investment manager for Pershing Square Holdings, Ltd. (ticker: PSH:NA) has updated its Schedule 13D with the United States Securities and Exchange Commission, disclosing  that various funds it manages increased their beneficial ownership of Valeant Pharmaceuticals International, Inc. (ticker: NYSE: VRX), to 9.9% of shares outstanding.

   

  The Reporting Persons purchased for the accounts of the Pershing Square Funds a net amount of 2,144,618 shares of Common Stock and over-the-counter American-style call options referencing 12,500,000 shares of Common Stock for aggregate consideration of $475,461,812 (including commissions). In addition, the Reporting Persons sold for the accounts of the Pershing Square Funds over-the-counter European-style call options and over-the-counter European-style put options, each call and put referencing a total of 12,500,000 shares of Common Stock and received aggregate consideration of $168,966,200.

  The actual trades:

  

  Which translated into English means that he spent $475.5MM on calls for 12.5mm in stock, and offset this by selling puts for 12.5MM in stock for $169MM.

  In other words, Ackman buys the collapse in size…

  

  By buying calls, selling puts, Ackman is now syntehtically long 12.5MM Valeant shares at a fraction of the actual price: Ackman's cash cost per share equivalent was $24.5, confirming that he didn't even have the cash to buy the shares and thus had to leave himself considerably more exposed to time decay and, of course, another plunge in the stock which this time will lead to even bigger margin calls.

  Which leaves him 'proxying' 34.12 million shares at an average cost of $113.76…

  

  Although his exposure is dramatically non-linear should things not work out (and note he remains drastically underwater still even on this newly acquired position).

  

  

  

  

  

• Should People Be Allowed To Work For $1 An Hour?

  Submitted by Jonathan Newman via The Mises Institute,

  What is the least you would be willing to be paid to verify business addresses or phone numbers for a database? If you had a large online inventory and wanted simple word tags to describe each one of your products for search engine optimization, how much would you be willing to pay somebody to trudge through your product images and generate tags?

  Tasks like these still require human labor, but a voluntary wage for such tasks is usually very low, especially relative to legislated minimum wages.

  Despite exponential growth in computing power and capabilities over the past few decades, computers still struggle with simple tasks like identifying objects in a picture, making qualitative judgments, and confirming the accuracy of language translations. Amazon embraced this fact and connected those that need these Human Intelligence Tasks (HITs) performed with the humans willing to do them.

  The service is called Amazon Mechanical Turk, after the fake chess-playing machine constructed in 1770. It was just a real, human chess master playing from inside a box. Back then, no such artificial computing capabilities existed, mechanical or otherwise. Like the “machine,” Amazon Mechanical Turk involves humans doing the work, even if the task seems suited for computers.

  A company with a large catalog might want to find and eliminate duplicate listings, but the items’ pictures and descriptions might be a little different, making computers unqualified for the job. “Turkers” may also fill out surveys for marketing information, social science research, or really anything the task creator wants to ask a large number of people. Audio and video transcriptions are common, too.

  Submissions are judged by having multiple people perform the same task. If their submissions are the same or very similar, the task requester can assume that they are really working on the task and not just filling in random text to complete tasks.

  Below is an example of a HIT that asks people to pull information from pictures of receipts. If three people perform this HIT and two of the responses for the business address city are “Lincoln Park,” but one of the responses is “a;sldkfj,” the first two would be paid and not the third. Having more than one submission per HIT is more costly, but the task requesters get more accurate responses this way.

  

   

  Today, there are more than 500,000 workers and around 200,000 HITs listed. Most tasks will earn the worker just a few cents, but some workers have been able to make a living from the service. As a member satisfactorily completes the simpler but lower-paying HITs, they are granted access to the higher-paying ones. A dedicated few make thousands of dollars a month by working full time. Others make a few extra hundred dollars a month by doing HITs after their regular job.

  A recent study found that almost half of the MTurk workers performed tasks while at their primary job: “For example, a cab driver at the airport may answer survey questions while waiting for a fare. A teacher or office worker could MTurk during lunch break.”

  Many enjoy doing the tasks as a form of relaxation and social engagement. Although the tasks seem incredibly boring to me, some find it an escape from boredom. Through turker-only forums, they have built a large, thriving community. They direct their fellow turkers to fun and high-paying HITs and help them steer clear of tasks posted by those who might fraudulently withhold payment for a completed task. Hayek would be impressed.

  Minimum-Wage Activists Strike Again

  The most common hourly rate for working on HITs is about $1. As such, minimum wage proponents have railed against Amazon Mechanical Turk, calling it modern day slavery. They see people having fun and voluntarily exchanging pennies for simple tasks and want it abolished. Bored people should just stay bored.

  What would they say is an appropriate price for asking somebody to select what color a shirt is in a picture? How much should they charge for filling out their age, sex, and favorite ice cream flavor in a survey?

  The correct answer, of course, is whatever the two parties agree on. Workers can scroll through hundreds of thousands of HITs and decide for themselves which ones are worth the payment, which is listed with each HIT. If something looks too long and complicated for the advertised payment, they can simply pass on it. The workers have complete control over which tasks they perform, what hours they work, and, of course, whether they are signed up to be an Amazon Mechanical Turk worker at all!

  In the early days of Amazon Mechanical Turk, Salon ran an article on it that read like an exposé of a cult or a crime ring. They found a man who does HITs for fun and made him out to be an unknowing slave to evil corporate interests:

  Curtis Taylor, 50, a corporate trainer in Clarksville, Ind., who has earned more than $345 on Mturk.com, doesn’t even think of turking as work. To him, it’s a way to kill time. “I’m not in it to make money, I’m in it to goof off,” he says. Taylor travels a lot for business and finds himself sitting around in hotel rooms at night. He doesn’t like to watch TV much, and says that turking beats playing free online poker. To him, it’s “mad money,” which he blows buying gifts on Amazon, like Bill Bennett’s “America, the Last Best Hope,” for his son, a junior in high school. “If I ever stop being entertained, I’ll stop doing it,” he says. “I’ll just quit.”

   

  Yet what’s a happy diversion for Taylor is serious business for the companies on Amazon Mechanical Turk.

  It turns out that there is a market for bored people. Prices emerge to pull them out of their boredom by working on simple tasks.

  There are other ways people with extra time on their hands can provide labor services for low or even no pay. Certainly minimum wage proponents wouldn’t condemn volunteering for charities like homeless shelters, soup kitchens, Habitat for Humanity, disease awareness/cure campaigns, etc. Yet, what non-arbitrary feature distinguishes this sort of work from other lines of work that might offer a wage lower than any proposed minimum wage?

  Not All Value Is Expressed in Dollars

  In all voluntary arrangements, both the worker and the employer agree to a mutually beneficial wage, which sometimes means $0/hour. Even if nothing tangible is trading hands, it doesn’t mean that volunteers get nothing out of their work. Their “payment” is knowing they did something nice for free. It’s not really a wage or a payment in the economic sense, though, because the employer doesn’t lose this good feeling, like they would forgo money wages for paid work. In fact, volunteering labor like this is more appropriately considered a gift, not an exchange of labor for a wage.

  When individuals make a choice, they aren’t just exchanging goods for goods or services for money, but they are making choices over alternative states of the world.

  A potential volunteer isn’t weighing $0 against time working for some charity, they are weighing all the consequences of helping a charity versus not helping, including the subjective feelings they have for the cause and the knowledge that they had a hand in its well-meaning goals.

  Likewise, a turker only agrees to a $0.01 HIT if the task looks easy or fun enough. They weigh the prospect of doing the task and receiving one penny versus missing out on the fun and not receiving the penny. Again, “fun” is also subjective. Most of the tasks look downright boring to me.

  Whether a job requires intense effort and a specialized skill or just having a human brain, market prices are the only way to match people that want to do the job with the people that want the job done. Even $0/hour is sometimes voluntarily chosen by a worker who simply wants to help a certain cause. Mandated minimum wages eliminate these kinds of peaceful and productive arrangements, leaving both parties unsatisfied and society worse off.

   

  

  

  

  

  

• Facebook Knows A Cult When It Sees One

  It appears, like so many of the world's status-quo worshippers, that Facebook thinks The Fed is a 'religious center'…

   

  

   

  h/t @hsiaoleim

  

  

  

  

  

Digest powered by RSS Digest