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The Daily Reckoning | Wednesday, May 12, 2010 Gold goes ballistic as the "mother of all collapses" looms for fiat money, God's Workmen: Goldman discloses its first-ever "perfect" quarter, Plus, Bill Bonner on bipolar traders, fizzling investor optimism and plenty more... Joel Bowman, with an important announcement for fellow goldbugs... You've no doubt noticed by now that our favorite yellow metal hit an all-time dollar record during overnight trading. Amid growing concerns surrounding the staying power and validity of the Euro-bailout and ever-increasing suspicion of fiat currencies in general, gold scooted to within a whisker of $1,235 per ounce here in Asia today. It was off a tad as we went to "press" this morning but, we think you'll agree, it's a pretty exciting move nonetheless...especially for DR readers, a good portion of whom hold at least some of their wealth in either bullion or rare coin form. Incidentally, the high came just hours after our gold coin web interview went live yesterday afternoon. Thousands of our fellow reckoners tuned in to hear Addison interview First Federal CEO, Nick Bruyer, about the basics of gold coin investing and a unique opportunity to play the little-told China gold story. The web-based interview will be online for the next few days only and, importantly, it's available FREE for Daily Reckoning readers. If you haven't yet taken a look, we suggest you do so before getting into today's regular reading, below. Here's a link with all the relevant info. With the global fiat currency scheme under increasing strain, the worst of the sovereign debt story still to come and gold going through the roof, there's hardly been a better time to brush up on some of the basics of gold coin investing. Hope it helps. And now, it's back to your regular programming... Goldman's Perfect Quarter Defying the odds in the "robot combat arena" Eric Fry Reporting from Laguna Beach, California... While the European Central Bank (ECB) was busy manipulating markets and making headlines Monday, Goldman Sachs was quietly revealing a different story of market manipulation...or something that walks and quacks very much like a market manipulation duck. In an SEC filing, Goldman disclosed its first-ever "perfect" quarter. The firm's proprietary trading desk navigated the first quarter without producing a single day of losses, the first time it had accomplished such a feat. How is this possible? Please permit us to offer a simple explanation: It's not. Imagine a poker player who competes against skilled competitors for 63 sessions of 6 1/2 hours each, then walks away with a profit after all 63 sessions. Would that be possible? Not unless the poker player is holding a stack of aces up his sleeve. But Goldman accomplished this improbable feat. Its trading desk turned a profit on each and every day of the first quarter - that's 63 trading sessions of 6 1/2 hours each, not counting whatever additional shenanigans Goldman was conducting in foreign markets. There is something wrong with this picture...very, very wrong. And yet, Goldman trumpets this success as an example of something that is very, very right. "This is the first time we have reported zero trading loss days in a quarter," crowed Samuel Robinson, a Goldman Sachs spokesman. "We believe it shows the strength of our customer franchise and risk management." An alternative interpretation would attribute Goldman's uncanny trading success to the strength of its "political franchise," subsidized risk- taking and various forms of de facto front-running. If, as James Howard Kunstler asserts, the US stock market has become "a robot combat arena where algorithms battle for supremacy of the feedback loops," Goldman Sachs must control the "Supreme Combat Robot." But we wonder whether this robot is abiding by all applicable securities laws, or vaporizing them with his special "Mega-fraud laser beam." "If you ever wanted to see what a monopoly looks like in chart form," jokes Tyler Durden from Zero Hedge, "here it is: "The firm did not record a loss of even $0.01 on even one day in the last quarter," Durden says. "The statistic probability of this event is itself statistically undefined. Goldman is now the market - or, in keeping with modern market reality, Goldman is the 'house,' it controls the casino, and always wins. Congratulations America: you now have far, far better odds in Las Vegas that you have making money with your E- Trade account." In fairness to Goldman, JP Morgan also produced a perfect quarter of proprietary trading. Morgan Stanley, the relative loser in the crowd, managed to produce a trading profit on only 93% of its trading days. "The rape and pillage of the middle class was not isolated to Goldman," Durden continues. "JP Morgan also had a flawless quarter. And if the odds of Goldman making 63 out of 63 are virtually impossible in any universe in which risk goes hand in hand with return (but in those in which monopolies are encouraged and bailed out), the coincidence of the two main firms that control the world having a perfect track record is impossible. And since things in reality tend to be zero sum, when everyone makes money, someone may be tempted to ask the question, just who is losing money? And the answer, dear taxpayers, and [Goldman/JPMorgan] clients, is you." Perfection is either a religious virtue or a devilish fraud, dear reader; it is never a financial market reality. So there's something a little troubling about the perfection achieved by Goldman's (and Morgan's) trader-bots. In fact, there might be something a lot troubling about their trader-bots, as well as their investment-bank- atrons. Perhaps the truth will come to light in the fullness of time...or in the details of a future SEC complaint. Goldman acknowledged in Monday's SEC filing that it still faces a large and diverse number of criminal and quasi-criminal investigations. In addition to a bevy of investigations by the SEC, Goldman is facing detailed probes by the Justice Department, the Financial Industry Regulatory Authority and the UK's Financial Services Authority related to CDO offerings and related matters. "We anticipate that additional putative shareholder derivative actions and other litigation may be filed, and regulatory and other investigations and actions [will be] commenced against us with respect to offering of CDOs," Goldman's filing somberly disclosed, "[These probes] could result in collateral consequences to us that may materially adversely affect the manner in which we conduct our businesses." Hmmm...we'd guess that the list of "collateral consequences" would include reducing Goldman's trading success from 100% to something much lower. And since trading revenues accounted for 80% of Goldman's revenue in the first quarter, we'd guess that much lower net profit will be another "collateral consequence." The Daily Reckoning Presents Europhoria Dan Denning Monday was the day the world's capital markets turned into a giant fiat money casino. Consider yourself forewarned. You might be able to trade your way to profits in this market on the tide of easy money being printed now by the Federal Reserve and the European Central Bank (ECB). But the financial markets are setting up for the mother of all collapses. Prior to last Monday, I had imagined that the end of the super-cycle in fiat money would take years to unfold. I'm revising my forecast. The end may be approaching even faster than I expected. The piecemeal nationalization of certain industries...the transference of private sector liabilities to the public sector's balance sheet...the abrogation of contract in the form of defaulted mortgages that are not foreclosed on...and the ever-rising debt-to-GDP ratios were all signs that governments everywhere were sucking the life out of the economy to preserve the status quo, while simultaneously turning dozens of firms and institutions into zombies with no real productive economic future. But Monday was a day that sent a bit of a chill down my spine. Granted, the ECB's €750 billion bailout package did wonders for various financial markets. And if you're a speculator - and especially a high- yield bond hunter - why not get on the gravy train? If the ECB is going to print money to buy public and private sector debts to "ensure depth and liquidity" in certain markets, it's not a trend you want to fight. For now. But we reckon it is not for long. This really is "Act V" of the fiscal welfare state, in which monetary policy becomes the shameless handmaiden of fiscal policy in order to sustain an unsustainable kind of "riskless society" with massive benefits for everyone, paid for by a few. That is an unaffordable illusion, the shattering of which leads to lower standards of living. To delay the day of reckoning, the ECB is offering European banks nearly unlimited amounts of cash for three and six month borrowing periods. You can imagine those banks - proud owners of heaps of sovereign debt from Greece, Spain, Italy, Ireland, and Portugal - are happy to sell that stuff to the ECB and borrow some short-term cash to lever up into an equity rebound. More privatized profits and socialized losses that favor the financial industry... Exactly like the process the Federal Reserve and Treasury used during the 2008 crisis. The immediate question you might have is, "Will this work?" It depends on what you mean by "work." By throwing wads of cash at stressed banks, the ECB alleviates the immediate threat in the market that bond yields spike and a liquidity crisis sets in. But enabling debt-laded countries to take on more debt hardly seems like a long-term solution to the problem of living above your national means. "You cannot make any nation that is unable to service its accumulated debts more creditworthy by extending more credit!" observes Jeremy Batstone-Carr, analyst at Charles Stanley. "If the EU lends Greece money, the loan will increase that country's public sector debt. The interest on the additional loan, whatever it eventually proves to be, will increase the public sector deficit. Total debt-servicing costs will rise, raising the burden on public sector cash flows. At some point in the future, the loan will have to be paid back." EU policy makers hope that by extending more credit now to sovereign governments, bond investors will just, you know, back off! It's amazing to read how officials blame derivatives and a "wolf pack" of speculators for the crisis. As if the speculators are to blame for running up huge debt-to-GDP ratios. Or as if the solution was to ban credit default swaps and remove the one market-pricing mechanism that alerts investors to rising sovereign credit risk. Incidentally, this may be a minor trading point...but worth thinking about...who is on the other side of all the credit default swaps underwritten on European debt? Remember it was AIG that collected premia by writing default insurance against sub-prime mortgage-backed securities (MBS) and collateralized debt obligations (CDOs). Goldman, among others, bought that insurance. If you were a handy speculator right now, you'd find out who sold default insurance on Greek and Spanish debt. And then you might consider shorting the daylights out of them. Of course, maybe the ECB really has solved the problem by throwing a wall of fake money at it. But we reckon yesterday's action gives you fair warning about what's ahead and a bit of time to do something about it. A massive monetization of debt and an increase in public sector liabilities has now been set in motion. The euro itself will soon, again, become a target of speculators once the next major tranche of sovereign debt must be rolled over and there's no one but the ECB there to buy it. How long can Europe pay its bills and creditors with money that doesn't exist? But the buried item in yesterday's news reveals that the US dollar might be on the hook too. The Fed re-opened its swap lines with major banks around the world. This means the Fed will be expanding its balance sheet again...and sending a flood of dollars out into the world to shore up banks that need them. The Fed had closed the swap line with the ECB in February, when everything was just fine. To the barricades, dollar standard! But this really could be a kind of last stand for the dollar as the world's reserve currency. Unbeknownst to the American taxpayer, the Bernanke Fed has now thrown the dollar once more into the breach of a liquidity and solvency crisis. It may not survive. That's what you should watch for, then: the expansion of the Fed's balance sheet. It will be hard to keep your eyes on that target with so many green numbers on so many shares and indices. The ECB has invited the entire financial world to speculate on risky assets, risk-free. The ECB's monetization - along with the Fed's cash - is going to lead to a quick reflation of some markets; that's for sure. The biggest inflation, though, could come in precious metals. In fact, as a hedge against the central bank monetization strategy, precious metals are about the only sensible speculation in a market which has essentially been reduced to total speculation by the distortion of values from the flood of money. Maybe that's why gold jumped $30 yesterday to a new all-time high. And maybe that's why the XAU Index of gold stocks jumped more than 4% yesterday to a new closing high for 2010. Things that can't be printed by a central bank and aren't anybody else's obligation to pay might be the best investments for the rest of this year...and beyond. The Welfare State has met its great funding crisis with a fraud. And the fraud is going to cost a lot of people a lot of money. If you're in markets now, be aware that markets no longer bear any relation to underlying risk or reality. It's never been more dangerous. And given the last few years, that's saying something. Dan Denning, for The Daily Reckoning Joel's Note: Although he's a good mate and an excellent macro-analyst, Mr. Denning is probably not a popular guy in Australia right now. In fact, we'd venture to say that more than a few members of the mainstream media there (and around the world) would rather like for him to sit tight and shut up... Why? Well, Dan's just published a research note that blows the lid off what could very well be the world's biggest bubble to date. He's not talking about some puny Club Med Euro-nation default here...or even full-blown contagion across that entire continent. In fact, what Dan predicts would likely make these crises look like garden variety bankruptcies. (The title of the report should give you a clue as to what he's on about.) Although the research note is specifically directed at his Australian audience, the investment implications are far more widespread. After reading through it ourselves last night, we asked Dan to make it available to our readers back in the US. Herewith, we proudly present what could very well be the least popular research report in Australia. Kudos, Dan! Bill Bonner Deciphering the 'I' in IOU Bill Bonner Reckoning from Paris, France... Oh la la...that was fast! We've had headaches that lasted longer... One day the world is convinced that the central bankers and financial meddlers of Europe have the secret to success. The next day, they change their minds. Turns out, the euro feds don't seem to have the problem solved after all. The euro is going down again. The problem is not the fickleness of the marketplace. It is not the cupidity of politicians, nor even the stupidity of the voters. Nor is the problem a lack of regulation or coordination or integration. It is none of those things discussed in the media. In a word, it is debt. Eventually, the euro feds - along with their American counterparts - will discover what everybody else already knows. You can't really cure a debt problem with more debt. At least investors seem to be able to put two and two together. After running up stocks and bonds on Monday, investors had a chance to think it over and on Tuesday they decided that maybe the euro bailout was not quite as good as they imagined it. "European Bailout Optimism Cools," announced a headline on Bloomberg. For one thing, the plan is hard to figure out. Exactly who is paying for what? Already, the euro itself was enough of a mystery. In America, at least you know who is responsible for destroying the dollar. In Europe, you're not sure. The dollar is, after all, an IOU issued by the world's biggest debtor. What's the euro? It's an IOU too. But nobody is too sure who the 'I' is. The bailout plan is a mystery on a mystery. The plan calls for a little of this and a little of that...and maybe it won't happen at all if some nations vote against it...and who knows what they're really going to do? For another thing, no one really knows what the risk is or how much it should cost to protect against it. Yes, Greece, Portugal, Ireland, Spain and Italy all COULD go broke. But how? And when? So what? No one knows. But, yesterday, investors felt that maybe they didn't want to be holding quite so many pricey stocks or quite so many euros when they finally found out. The Dow fell 36 points. The euro went down too...to close at $1.26 - even cheaper than before the rescue was announced. What was really amazing was the price of gold. It went up $19 during trading hours. Later in the day, it was up to a new record, over $1,220. How do you like that? Why would gold go up? After all, when stocks go down, it is signaling LESS faith in the growth, prosperity and inflation forecast. A falling stock market is a sign of growing pessimism...that haunting fear that people may actually get what they've got coming after all. Meanwhile, in America, Governor Arnold Schwarzenegger is preparing the people of California. Hard times are a-comin'. They're going to have to tighten their belts. "Terrible cuts," are on the way, said the governor. How will Californians react? Will they close ranks, like the Koreans after the Asian debt crisis of the late '90s? Will they take it with good humor and Guinness, like the Irish now? Or will they start to riot, like the Greeks of the debt crisis of 2010? You remember what the Koreans did? They turned in their gold jewelry so that the state could pay its bills to foreign lenders. The Greeks, on the other hand, seem to be looking for a rumble. They figure they're entitled to the Good Life. They figure its part of what you get when you join the European Union. It must be in the constitution somewhere...that you have the right to life, liberty and a good time. They're used to being taken care of. And they don't like giving it up. They'd probably like it even less if they realized that it is all so that a group of French bondholders can be bailed out of their bad bets. But what's the alternative? You either pay your debts...or you go broke. If you go broke, no one will lend to you - so you'll have to make do on what you actually earn. On the other hand, if you do pay your debts, you'll have to take money out of earnings...leaving you with less money to spend. Oh me, oh my...there's no easy way out. Milton Friedman was right; there is no free lunch after all. And more thoughts... People don't realize it, but these macro economic issues have real, personal consequences, said our French MoneyWeek editor. Simone calculated that keeping the debt under control, at 2009 levels, would cost the average Greek nearly $2,500 per year. That's just the cost, per capita, of keeping up with the interest, while holding other expenses even with government revenues. Not many Greeks want to pay that amount. Not many will be able to. And more than a few will think they're being treated like chumps. They'll imagine that it's all a conspiracy of the elites...or some kind of fraud on the part of the governing classes. And they'll be right! The ruling classes want to keep everything under control. Like governing elites everywhere, they want to prevent change - at all costs. So, they prop up the old industries...reward the bad banks...and protect failed companies and bad speculators. Why? They're on the top of the heap...and they want to stay there. They own the present. The future be damned! So, what's their strategy? It's to squeeze the working classes and the middle classes...and everybody else. Anything and everything to preserve the old order. Scrape the barnacles from the hull? Not a chance. They are the barnacles! But the big news yesterday was the price of gold. It appears to us that gold may now be getting ready to prepare to commence the beginning of its final stage. You will notice that there is more fudging in that last sentence than in a birthday cake. Why? Because even if we are right about the general flow of events, it is almost impossible to get the timing right. Still, you gotta guess. And our guess is that gold is beginning to move up - on good news AND bad news. Inflationary? Deflation? It doesn't seem to matter. Gold is beginning to act more and more like real money, not just like a speculation. When inflation increases what do you want? Well, real money...something that maintains your purchasing power even as the paper currency goes down. Traditionally, that's gold. Because they can't make more of it easily. Gold is not perfect money. But it's the best thing we've got. And when consumer prices start to move up people look for ways to protect themselves. In the past, they could move to euros or to the dollar. Now, both the euro custodians and the dollar custodians have decided to sacrifice the integrity of their currencies in order to bailout bondholders. That leaves gold as the best choice for inflation protection. What about deflation? In deflation, prices go down. But that means that the value of real money goes up. You can buy more with less money when you are in a deflationary cycle. Trouble is, in deflation, the backers of asset prices tend to go broke. You have a piece of paper. It says you own a share in a department store. Come a deflation and people stop buying - they'll wait to see how low prices go before spending their money. So, the poor department store goes bust and you lose all your money. Or, take a bond from a sovereign country, such as Greece or the USA. In deflation tax revenues go down too. This leaves the country unable to pay the interest on its bonds. It misses payments. The value of the bonds collapses. What can you buy that has no one on the other side who might go broke? Gold! The yellow metal went up in the last great depression. It will go up in the next one too... Regards, Bill Bonner, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com