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Is this a Summer Sale or a Sinking Whale?

June 20 2013 -- Well I have been saying for some weeks, raise cash and get ready for a summer pull back. Well you got one starting now, but we don’t catch falling knives so let see where this goes, wait to buy -- but not today. Today the S&P 500 index dropped below the 50-day moving average. However, I am more concerned that the market rose up on low volume and now volume is picking up going down, that’s a bad sign. I had mentioned a few weeks ago that the world has “caught a cold” and that global markets are sinking. The US does get a large part of its GDP from exports, so that figures in to the mix. I mentioned that the current highs in the stock market are not rational based on only 2% US growth, so the US markets must be raising out of fear of investing in anything else. The Markets have been hitting new highs from “hits” of economic heroin from the federal reserve, in the form of 85 billion a month in bond buying. I also warned the fed would taper that bond buying and that would give us our summer pullback. All going according to plan but . . . Two new things have come up; credit markets in China and treasury yield are rising.

I was worried about this way back in 2007. China’s corrupt officials use their power to get banks to make bad loans to build factories and apartment buildings the market does not need. Of course these projects are built on land owned by the same corrupt officials and then the project creates a source of bribes and kickbacks to those officials.  As I said this has been going on long time, I have been talking about it since 2007. However, now the seeds of destruction appear to ready for harvest. China PMI data is out and it looks bad. The latest China PMI figures show a 9-month low in manufacturing, but that is only the surface. Here is a Wall Street Journal story on Steel overproduction,  and the Financial Times has one too. I had mentioned before about factories shutting and industrial development land in China being returned to farming. If you read Pop Goes the Commodity Bubble you know what I think of communist party accounting, chances are the truth is worse than reported.

Bankers had been calling for the central bank to ease the pressure and a few investors had even predicted that it might cut interest rates. Instead, the People’s Bank of China (PBOC) ordered a thorough implementation of the new “mass line education” campaign launched this week by President Xi Jinping – a campaign that in its propaganda-style and potential scope carries echoes of the Mao era.

But what is really the problem is this. Twenty months ago China created a credit default swap (CDS) market, like the US has. A CDS market allows players to bet up or down on the viability of a debt. This has forced risk managers to look long and hard at just how bad the lending picture is in China. Word is getting out that as of last week, China’s banks stopped lending to each other and credit default swaps have started to widen. Wednesday night the overnight lending rate in China shot up. This is a lot like what sunk Lehman Brothers. And it is the same warning signs only this time it is in China that we have a liquidity squeeze. The PBoC is like China’s federal reserve. They have been trying to get these loans under control for sometime now but greed being what it is, they have been making many one-time exceptions – all the time.  The recent liquidity tightening however is on another level. The seven-day repo rate tripled in two weeks, overnight rates soared more than a third in one day, and intra-day rates were as high as 30 per cent. The PBOC may need to step in like the US, Europe and Japan and bail out the Chinese financial system. The trouble is the previous mentioned governments could borrow money easily, not so simple for China. Especially with many lenders still nursing the scars of the 1998 bond default by Russia.

I strongly recommend you watch this video from the Wall Street Journal. This bit on CNBC is not bad either. 

So the play here is the one I have been talking about for over a month go short China with an ETF called FXP. It goes up when China goes down:

Rates Rise 
Now there is bad news here too. The yield on the 10-year US treasury is raising and the US Federal Reserve is not really in control of it right now. It’s the bond traders, they keep pushing the rate up, in anticipation the fed will need to. The result is that is you bought TBT when I recommended it here a few weeks ago you would be up over 15% already – that is a great return!

My DVY hit its trailing stop a week ago and that is a good thing. As I said you had to be in this bull market because it could have continued up. The bull is not even dead yet, it might still recover in a few days, but it was a good time play a conservative play like DVY and see what happens. However by playing conservative the downside was mild and we are still mostly in cash so we are ready to buy bargains as they appear.

Two factors are causing the price of gold to tumble. One is a sharp jump in the U.S. Dollar. The other, and probably more important reason, is the jump in U.S. bond yields Gold is priced in dollars, a strong dollar makes gold look cheaper. Gold, however, is also impacted negatively by rising interest rates. The reason is that gold is a non-yielding asset. As a result, bullion becomes more competitive when yields are falling, and especially when they're at record lows. Gold has benefited from quantitative easing because it also weakened the dollar and raised false inflation expectations. (read here: Inflation? What Inflation?)

There is also a rumor that China has been selling some gold this week from it treasury to raise cash and more pressure is coming on the world gold market. I am still short gold and you should be too. I hope you bought HGD as I recommended last week.

I also have short gold futures on the NYMEX exchange. 

My Game Plan
So now is the time to watch the markets, wait for the up-tick and be ready to buy US equities if we start to recover from here. Otherwise continue to ride the slide in global markets and commodities. Short China, Short Gold, long cash.