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Gold Is Now The 2nd Largest Central Bank Reserve Asset
The following commentary about the dollar and gold is the opening salvo of the September 5th Mining Stock Journal. To learn more about this mining stock news letter, follow this link: Mining Stock Journal info.
Gold’s status as a Central Bank and bank reserve asset is escalating. According to Bank of America, gold has surpassed the euro to become the second largest reserve asset after the U.S. dollar. To be more precise, B of A should have specified that it is the eastern hemisphere Central Banks that are diversifying out of the U.S. dollar and the euro and buying gold and yuan. Nevertheless, gold now represents 16% of global bank reserves. The dollar represents roughly 58% of Central Bank reserves, down from over 70% since 2002.
Interestingly, Poland was the biggest buyer of gold in the second quarter this year (though we do not have access to the actual amount of gold that the PBoC is buying). Furthermore, Poland is insisting that the gold it buys is delivered to the country’s Central Bank rather than letting London banks “safekeep” the gold. In addition, Turkey has been a big buyer of gold. Also several African countries have announced Central Bank gold buying programs.
Though it might not happen this year or next, I think there’s a possibility that gold could overtake the dollar as a reserve asset, particularly if the reports that the BRIC/eastern hemisphere alliance of countries are considering a gold-backed trade currency come to fruition. Russia is hosting a BRICs Summit in Kazan, Russia October 22nd – 24th. There are reports that the discussion of a new trading currency is on the agenda, though I have not been able to confirm that first-hand.
Russia announced today (September 5th) that it will increase its daily gold purchases from $13.5 million to $93 million (1.2 billion rubles to 8.2 billion rubles) for the next month starting September 6th using windfall oil and gas revenue. The report was released by the Russian news agency Interfax. In my opinion, this is related to the eventuality of a BRICS gold-backed trade settlement currency, if not a full-blown gold-backed currency.
I bring this topic up because the Fed has painted itself into a corner. It’s under enormous pressure from the market and Wall Street to cut interest rates. But if it does that, it risks a rapid sell off in the dollar:
The chart above is a 5-year daily of the US dollar index. The dollar is currently testing the 100 level on the index, which has served as technical support since early 2023. If the Fed starts to cut, in all likelihood the dollar will drop to 90, where it was in mid-2021. That will send gold rapidly toward $3,000 and silver toward $50.
A decline in the dollar foments several problems. First, this likely would accelerate the decline in the use of dollars by global Central Banks as a reserve asset. Just as significant, if not more problematic for the U.S., a falling dollar and lower interest rates will make it even more difficult to attract foreign interest in funding additional Treasury debt – something which has already become problematic.
Finally, the Fed knows that inflation is running hotter than is represented by the CPI. Rate cuts will push real interest rates further into negative territory. Using the CPI, “real” rates are positive now. However, using a valid inflation index like the Shadow Stats Alternative CPI, real rates currently -3% using the 1990 CPI calculus and -6% using the 1980 CPI calculus. Negative interest rates fuel price inflation, which is part of the reason inflation has been “sticky.” Cutting interest rates will cause the real rate of inflation to accelerate.
This is why gold has been hitting new all-time highs almost on a daily basis the Fed cut the Fed funds rate earlier this month and why silver is poised to breakout into the high $30s. The precious metals “see through” Jay Powell’s rhetoric and a strong economy and a lowered rate of inflation. The precious metals also are sniffing out an eventual resumption of money printing.
Consumer Credit Is A Ticking Time Bomb For The Banks
The following commentary is from the September 15th issue of my Short Sellers Journal. For more information on this bear newsletter follow this link: Short Sellers Journal Information
“Over the course of the quarter, our credit challenges have intensified…our borrower is struggling with high inflation and cost of living and now, more recently, a weakening employment picture.” – CEO of Ally Financial
Earlier this year I recommended Ally Financial (ALLY – $34.79) as a longer term short. On Tuesday this past week at an investor conference, the CEO of ALLY admitted that the auto delinquencies and charge-offs jumped considerably more than its internal risk-control model led management to expect in July and August. He added further that the Company expects charge-offs to rise going forward and acknowledged that ALLY’s “borrower is struggling with high inflation and cost of living.” The stock plunged, closing down 17.6%.
The ALLY CEO’s admission spilled over into stocks like Credit Acceptance (CACC), which I’ve presented as a short in the past, Carmax (KMX) and Autonation (AN), which I’ve also presented as shorts, Capital One (COF) – same – and the big Wall Street banks.
In general, the delinquency rate for the subprime segment of auto loans is slightly higher than it was at its worst during the great financial crisis (I think the rate peaked in 2009 or 2010). But more recent subprime auto loans are imploding quickly. Of the subprime auto loans originated in 2023, 13.4% are 30+ days to 90+ days overdue. The other problem facing auto lenders is the recovery rate on foreclosed loans (amount of the loan less the amount received from selling the repo’d vehicle) is the lowest on record.
In short, companies like ALLY and CACC are going to experience a rapid increase in delin-quencies, defaults and an increasing degree of loss severity on their auto loan portfolios.
But this problem is not confined to just auto lenders. The same dynamic is affecting credit card lenders like Capital One (which is merging with Discover Financial). Even the delinquency and default rates for residential mortgages are starting to rise. I suspect it’s higher than the banks are willing to disclose but at some point the truth will rear its ugly head.
The above issues address only the rising consumer debt distress. On top of that is com-mercial real estate distress, from which the big Wall Street banks are not immune, and the debt sitting on big bank balance sheets from the private equity bubble in which the PE firms were doing leveraged acquisitions of private companies. With respect to LBO and CRE debt, it’s not a predominant part of the Too Big To Fail bank balance sheets. But in aggregate both categories are in the $100’s of billions and the ability of borrowers to service the debt is in a
state of collapse.
Add to that the $1.832 trillion in loans extended to hedge funds by Goldman Sachs, JP Morgan and Morgan Stanley (link). Those numbers are as of the end of March and the amount is likely even higher now. All three of those banks would have perished in 2008 if the Fed and the Treasury had not bailed out the banks with printed money and taxpayer money.
Then, on top of that is the OTC derivatives. Every loan category discussed above has a massive amount of OTC derivatives connected to the loans. The supposed changes made in the 2010 Dodd-Frank Act, which was supposed to implement more transparency and accountability in the banking and financial system as well as put “guard rails” around big bank derivative issuance and risk-exposure, also made it easier for banks to hide their derivatives exposure off-balance-sheet.
According to a report from Wall Street On Parade, based on numbers from the Federal Financial Institutions Examinations Council, the biggest Wall Street banks held over $192 trillion in derivatives as of the end of 2023. Goldman, JP Morgan, Citigroup and Banks of America in that order were the four largest. Granted, the argument is made by the banks that their derivatives exposure is offset or hedged via laying off the risk to counterparties. But that was the argument in 2008. The models in 2008 underestimated counterparty default risk in 2008 and, without doubt, have done so again.
The point here is that all of the financial bombs that detonated in 2008 are set to detonate again. Except this time the amounts outstanding are significantly larger and, thanks to changes in credit rating and accounting standards, in general the credit quality on the overall pool of loans and derivatives counterparty risk is lower.
Gold And Silver (And Mining Stocks) Are Just Warming Up
The Fed is in a difficult, if not impossible, situation of its own doing. It knows that the CPI is b.s. and that the real rate of inflation is 3-4x higher than the CPI fraud. And hence real rates are negative. Cutting rates will restimulate the escalation of price inflation. It also knows that if it further loosens monetary policy (hint: it’s not tight to begin with as real real rates are still negative and M2 has been rising last October) that the dollar will head south quickly.
Furthermore bank balance sheets are deteriorating in quality with rising asset distress: consumer debt, leveraged buyout debt (private equity related) and the melt-down of CRE loans. The big unkown is true amount of counterparty risk exposure the big banks have from what is now a record level of OTC derivatives. Finally, the yen carry trade will futher unwind if the spread narrows between the cost of borrowing the yen and using the proceeds to buy higher yielding assets. Finally, Treasury debt oustanding is increasing at a rate that will eventually be catastrophically existential to the U.S. dollar and financial system.
Andrew Maguire (Kinesis Money) and I discuss all of these issues plus, of course, the precious metals market and mininig stocks in that latest episode of Live From the Vault:
If you want access to the mining stocks I cover and recomment other than Cabral Gold, use this link Mining Stock Journal for more information about my newsletter.
Truth
Super Micro Computer Is A Bag Of Fraud
This analysis is from the August 11th issue of my Short Seller’s Journal. I also did a deep-dive on it in early June and first presented it as a short idea in early February: Short Seller’s Journal information
Super Micro Computer (SMCI – $508) – SMCI’s share price was blasted for $125 (20%) on Wednesday when it reported its FY Q4/full year numbers Tuesday after the close despite beating revenue consensus and announcing a 10:1 stock split. The Company’s gross margin was well below estimates and forward guidance was much lower than estimates. The Company’s gross margin plunged to 11.2% from 15.5% in Q3 and 17% in Q4 2023. The operating margin fell to just 6.4% from 9.8% in Q3 and 10.3% in Q4 2023.
I first presented SMCI as a short in the February 11, 2024 issue of SSJ when the stock was at $740. This is the second time I exposed teh red flags at SMCI: Super Micro Computer Red Flags. In Februrary I remarked that its 10.1% operating margin was quite low, particularly for a company that is supposedly an innovative tech company trading with a 57.6 P/E and 4.5x revenues (at the time). In comparison, AMZN’s AWS operating margin was 26% in 2023 while MSFT’s operating margin was 43.5%. Now SMCI’s operating margin is just 6%.
SMCI’s EPS declined 18.6% in Q4 from Q3 despite the fact that revenues rose 37.8% QoQ. That shows the degree to which SMCI has no ability to control the prices it pays to suppliers or dictate the prices of the products it sells. Let’s face it, the bulk of its business is building racks to hold servers at data networking centers – not exactly a business with room for innovation or creating products with competitive advantages. The consumer equivalent of SMCI’s products is television and stereo racks.
SMCI also has revenue concentration and accounts receivable payment risk. Its top three customers accounted for 61.4% of its revenues and two of these customers accounted for 19.3% of its accounts receivable. Admittedly these are probably big tech companies like Meta and Microsoft. But at some point there’s going to be an oversupply of data center, cloud computing capacity – just like there became a big oversupply of fiber-optic capacity during the dot.com/tech bubble – and there will be a dramatic drop-off in server rack orders from its largest customers.
Another issue is the rate at which the Company is burning cash. For the full-year FY 2024 SMCI’s operations burned $2.47 billion in cash, including $630mm in Q4. Its operations thus are consuming over $600mm in cash per quarter right now. It funded that cash burn by issuing $1.6 billion worth of shares and a $2.3 billion convertible bond deal in its FY Q3. Both of which are highly dilutive to existing shareholders.
SMCI’s P/E has corrected down to 25.5. In my opinion that is still too high, particularly if earnings per share continue to decline. The Street consensus for its FY 2025 is $44.29. Over a four quarter average, that’s $11.07/share, or 84% above the Q4 EPS. It’s hard to believe that the Street still has that kind of earnings growth built into its models.
SMCI’s best case is that EPS stay flat for the next four quarters. But I don’t see that happening. I expect that several big companies who are spending heavily on AI chips and server capex will start to cut back. This will adversely affect SMCI.
I expect earnings to continue to decline. That means a 25 P/E for a business with 6% operating margins and declining earnings is too high. Hell the homebuilders have much better margins right now and they trade at an average of an 8 P/E. If SMCI can replicate its Q4 EPS over the next four quarters, and we apply an 8 forward P/E because it’s a low margin business with no earnings growth, that implies a forward stock valuation of $192/share.
The easiest money shorting SMCI has already been made. But I think this stock will get cut in half over the next year, which would put it at $250 where it was trading before AI mania engulfed the markets.
Fed Stealth QE Is Driving Gold’s All-Time High Price Run
The following commentary is an excerpt from my Mining Stock Journal newsletter. To learn more about it follow this link: Mining Stock Journal subscription information. Note: I will be hiking the price from $20/month to $40/month soon. Existing subscribers will be grandfathered at the current rate.
Given the large increase in the amount of gold that is flowing to the east, I think it’s easy to make the case that this massive demand for physical gold is a major factor in pushing the price of gold higher. A similar argument can be made for silver, particularly with India and China, which require a lot of silver for their implementation of national solar energy grids. The breadth of countries with Central Banks now accumulating gold was not much of a factor until the last couple of years and I believe the proliferation of eastern Central Banks has offset the seasonal weakness that historically has affected the March through June period.
Secondarily, despite the rhetoric about the Fed’s hawkish monetary policy, take a look at the Fed’s actions vs its words. Despite the maintenance of the Fed funds range at 5.25-5.50% and the monthly QT operations, financial system liquidity has been rising. The M2 money supply measure has been rising since October 2023. More significant, the Fed’s reverse repo facility has been drained over the last twelve months. This is money that returns to the financial system, primarily in the form of banking and financial system liquidity. The Fed could keep that money in the facility with just a small increase in the rate it pays. But for some reason it wants that liquidity to flow into the financial system. In addition, the Chicago Fed’s National Financial Conditions Index shows that the Fed has set the easiest systemic financial conditions since the end of January 2022, one month before the Fed began hiking rates.
The Fed is thus masquerading as a monetary hawk when, in fact, key liquidity indicators reflect the reality of an easy monetary policy. I would argue that the Fed has created this systemic liquidity to offset the deteriorating quality of large and small bank balance sheets – primarily CRE and consumer loans but also leveraged corporate loans. Regardless, the rise in financial system liquidity, in addition to the massive demand in the physical market, is the reason gold and silver prices have been rising steadily since November 2022.
M2 has been rising since October 2023. Most market participants are unaware of this fact because the M2 posts on social media show the YoY percentage change in M2, which is deceptive. This chart is through the end of June, the latest date for which the Fed posts M2 data (intentionally):
Similarly, and again through the end of June, the Monetary Base (formerly MZM) has been rising since March 2023:
The increase in the Monetary Base is more impactful in terms of causing inflation (dollar devaluation) because the Monetary Base is coins/currency in circulation plus banks reserves. Both represent instant spending or lending power.
The final, and foremost aspect of the Fed’s “stealth QE” is the $2 trillion drain of the Fed’s reverse repo facility. The facility was at $2.375 trillion at the end of March 2023. Since then more than $2 trillion has disintermediated into funding Treasury debt and the banking system, ultimately finding its way into the wider financial system. The Fed could have kept that liquidity “captive” with just a small hike in the rate it pays for overnight RRPs. But note that the Fed let the facility start draining around the same time as the regional bank CRE crisis. That crisis, by the way, is now detonating bombs on the Too Big To Fail bank balance sheets (among several other areas of balance sheet distress).
This “stealth QE,” which is undeniable, is the reason that gold has been hitting successive all-time highs. It will be interesting to see if the Fed cuts rates at its September FOMC meeting because it’s obvious the economy is flopping around like a near-dead fish on a dock in Montauk. The problem is that a rate cut could trigger another wave of yen carry-trade unwind, which would cause another sharp sell-off in the stock market.
But for those scratching their head at the impressive rally in gold, look no further than stealth QE that has been implemented by the Fed since March 2023. Precious metals investors have interest rate cuts and the official re-start of money printing in the coming months, which I believe will drive the gold price into the $3,000s in the next 12 months. Silver will outperform gold in that scenario.
Big Breakout Ahead For Silver
Gold recently broke out of 12-year cup/handle technical formation. The price objective from this breakout is at least $3,500. I was looking at a long-term chart of silver. I did not realize it looked like this:
For a refresher, here’s the gold breakout:
The silver cup/handle has lasted for 13 years. The duration of the cup/handle will generate a longer duration, bigger move higher than many believe is possible. Of course, that skepticism preceded the move from $7 to $49 between late 2008 and March 2011. A 7x move when the silver cup/handle breaks out would take silver close to $200…
The Housing Market Is Crashing – Rate Cuts Won’t Help
The following commentary is from the August 4th issue of my Short Sellers Journal weekly newsletter. Click on that link to get more informations. The charts below are through August 2nd. In the August 11th issue I’ll be reviewing Builder Firstsource’s Q2 numbers and explaining why I think it will be a highly profitable short (or use of puts) $BLDR.
Housing market update – Redfin posted data this past week that reflects the degree to which home sales activity is tanking. In June, 15% of home purchase contracts were canceled and 20% of listings nationwide had price cuts. Both metrics are the highest on record for June. In addition, and this is pertinent to CRE and multi-family housing (ABR), new apartments are taking longer to rent out because a near-record of them are hitting the market (new con-struction multi-family units).
The pending home sales index for July rose 4.8% in June from May but declined 2.6% YoY. The not seasonally adjusted numbers showed a 7.8% decline YoY. That comp likely is more reflective of the YoY decline because it doesn’t contain statistical errors in the “adjustments” calculus. The July increase over June is likely just a statistical bounce because the pending home sales index had been trolling record low levels going back to 2001, which is when the data series began. It also correlates with the brief bounce in mortgage purchase applications during mid-June. Pendings are based on contracts signed during June.
Speaking of the weekly mortgage purchase index, it slid to 132.8 which is the lowest level since the week ending May 31st when it hit 132.3. The index continues to press its lowest level since 1995. On a not seasonally adjusted basis, the index is down 14% YoY. It’s down 24.1% since January 19th. Again, the housing market is still in its strongest seasonal period of the year. After that brief bounce in June it’s been in a sharp downtrend and reflects the growing weakness in home sales activity despite the rapidly rising inventory of new and used homes.
It looks like the homebuilders may be headed south. The Dow Jones Home Construction index looks to be rolling over from an irrational move higher since July 9th plus the RSI and MACD are heading south from overbought readings:
The caveat with the builders is that the 10yr yield plunged 40 basis points last week from 4.19% to 3.79% on Friday. I don’t know if the hedge fund algos will start to buy homebuilders if the 10-year yield continues to fall. On the other hand the market may continue dumping homebuilders based on the recent plethora of economic news showing a weaker than previously perceived economy. Certainly the market can not ignore the extreme overvaluation in the homebuilders if the new and used home sales numbers continue to head south.
Beazer Homes (BZH – $28.57) reported its FY Q3 numbers on Thursday after the close. Revenue increased 4% YoY due to a 4.4% YoY increase in closings. However, that’s it for the positive aspect to the numbers. The gross margin declined 310 basis points YoY, which means the Company either had trouble controlling building material and labor costs or offered big incentives to induce buyers – or both. Operating income plunged 38.2%. New orders fell 10.8% YoY and the cancellation rate jumped to 18.6% vs 16.1% in FY Q3 2023 and from 16.2% through the first half of its FY this year. The Company did not offer Q4 guidance.
Looking at the balance sheet, cash fell to $73 million from $132mm in FY Q2 2024 and $345 million at the end of its FY 2023. The inventory jumped 23.6% from FY 2023 year-end and it was up 5.5% vs FY Q2. The 10-Q has not been released yet but BZH’s operations burned $239mm in cash thru 1H FY 2024. With the $117mm increase in inventory it must have burned cash in its Q3. Total debt increased by $46mm from Q2 and $91mm from FY 2023 year-end.
The numbers are going the wrong way for Beazer. Based on the drop in new orders, revenues will soon be heading south, profitability has been hammered, cash is evaporating, inventory is rising, the cancellation rate is rising and the operations are burning cash. It won’t be long before BZH will have to start writing down the value of the inventory with which it will be stuck.
BZH’s chart looks far worse than the chart of the DJUSHB above:
I bought BZH puts ahead of earnings starting on the previous Friday (7/26). I added to my position Wednesday and Thursday. I booked profits on those Friday morning because they were in-the-money and I rolled some of the profits into August 16th $28 puts. I’m actually hoping the stock bounces because I’d like also to have a longer-dated, OTM put position. Like December or February $25 puts (February 2025 is the longest put series right now).
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Housing Market Crash Is On The Horizon
The commentary below is excerpted from two issues of my short sellers newsletter. Learn more about this subscription newsletter: Short Seller’s Journal
Housing market update – Existing single-family home ( sales for June, released Tuesday, were nothing short of a disaster. Sales fell 5.4% MoM and 4.3% YoY to a 3.5mm SAAR (seasonally adjusted annualized rate). This is the fourth consecutive month of declining used home sales in what should be the strongest seasonal period of the year for home sales. The not seasonally adjusted, monthly number dropped 6.6% from May and plunged 12.6% YoY. This metric is a more reliable indicator of the YoY trend in sales because its cleansed of any errors imposed on the data by the NAR’s seasonal adjustment calculus.
The monthly SAAR has been in decline since January 2021:
Since January 2021, when the existing home sales SAAR was 6.6 million, the metric has plunged 41%. Unsold listings jumped to 4 months’ supply, up 29% YoY to the highest level since May 2020. Including condos and co-ops, inventory is at 4.1 months’ supply and it has soared 57.6% YoY.
As with new home sales in May, which I detailed in the July 14th issue, every price “bucket” declined in all four regions except the $750k-$1mm and over $1mm buckets. In the $750k-$1mm bucket the only region with a YoY increase in sales was the northeast – the bucket declined nationwide. The over $1mm bucket increased 10.9% YoY in the northeast but was up just 3.6% nationwide.
The NAR Chief “Economist” commented that “we’re seeing a slow shift from a seller’s market to a buyer’s market.” He does his best to put lipstick on Miss Piggy. The reality is that it looks like a hastening shift from a slowing market to an eventual sales and price crash.
Earlier this month I did a deep-dive into the May existing home sales report and found a smoking gun. I noticed that the distribution of sales across the six price “buckets” shows a different story than the headline number broken out by sales region:
The table above is from the Supplemental Data link on the National Association of Realtors news release. The data is the not seasonally adjusted, monthly data. On a monthly basis for May, the NAR data shows an estimated 364,000 homes (no change YoY) sold in May at a median price of $380,400 (half sold above that price and half below).
The headline numbers, however, are deceptive. Per the top table, the two highest price buckets showed double-digit increases in the number of homes sold YoY while the two lowest price buckets declined YoY. All of the action in the May sales was in the two highest price buckets while the everything below the top two buckets was flat to down. The data reflects the degree to which buying a home or moving up from a starter home has become unaffordable for the majority of households. In fact, Friday’s U of Michigan Consumer sentiment report (discussed below) showed that homebuying conditions in June hit a record low for the history of the data series.
Given the recent reports based on Zillow data that many of the previously hottest housing markets are experiencing a huge influx of listings and big price cuts in the listings, in most areas the buyers in the top two price buckets will soon be underwater on their home purchase. Moreover, as the amount of listings piling up in the various MSAs becomes more “visual” to prospective buyers in the two top price buckets, many will hold off buying.
With respect to potential rate cuts, the median new mortgage payment now requires 41.4% (pre-tax) of the median household income according to the data parsed by Reventure Consulting (median household income (Fed) divided by median new mortgage payment (Bankrate). In the previous housing bubble, this metric topped at 39.3%. This is why I believe it won’t change reality for housing market if the Fed eventually takes rates back to zero. Moreover, the market has already priced the next six rate-cuts into the homebuilder valuations.
I have to believe that the actual fundamentals of the housing market will invade the highly overvalued homebuilder stock sector within the next three to six months. The primary driver of the record low buying conditions is high home prices. I would argue with high conviction that, given the data on household financials, even if the Fed took rates down to zero percent it would not do much to jump-start the housing market. As such, I think the extraordinarily overvalued homebuilder stocks are among the best shorts on the NYSE.