The Jubilee

  • A Krainer
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  • September 2010
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Economy, market manipulation and inflation

Posted by Alex Krainer on September 2, 2010

Commodity and capital market behaviour seems to be diverging ever further from any notion of rationality. Increasingly, participants are suspecting foul play and manipulation by powerful interests as a possible explanation for this. Such allegations are nothing new, but of late, much evidence has surfaced substantiating the suspicions. The tricky bit is figuring out who is doing this and to what ends. While some hedge funds got caught manipulating prices, I believe that the chief culprits are the NY Federal Reserve and its too-big-to-fail owners. As to their objectives, we can safely assume that the following feature high on their list: (1) keep inflating the equity bubble, (2) re-flate the real-estate market, (3) keep inflation under control, (4) keep the prices of food and precious metals low.

The Federal Reserve’s former chairman, Alan Greenspan gave us a glimpse into the thinking at the apex of financial power. In a piece titled, “Inflation – the real threat to sustained recovery” published on 25th June 2009, Greenspan writes how a continued rise in equity markets:

“would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.”

The next question is, can they be successful at their game? Considering their huge political clout and financial fire-power, you may think that they can mold the markets pretty much as it suits them. But judging from the facts on the ground, I have my doubts. After two years of bailouts, quantitative easing and government stimulus spending, the equity markets have stalled, the real-estate market is flailing, precious metals are near historical highs, food prices have soared and high inflation seems a question of when, not if. As a matter of fact, there’s evidence that inflation is already gaining momentum in the real economy (see the chart of CRB Industrial Raw Index below).

Stock markets
Over recent months, the stock markets have demonstrated an astonishing tendency to celebrate any amount of bad news with a rally to new highs, or (lately) a bounce back from moderate corrections. The balance of news has been decidedly negative for a while now and the evidence that Obama’s massive $787 billion stimulus failed to achieve its objectives is undeniable. In addition, retail investors have been pulling money out of the stock market: this week the Investment Company Institute (ICI) reported the 17th sequential weekly outflow of assets from mutual funds, bringing the total outflows for the year to $54 billion ($236 billion over the past two years). Fair question: why are the stock markets not in a major correction?

A few months ago, ZeroHedge offered an interesting bit of analysis, showing that all of the stock-market up-side in the three months between 14th September 2009 and 21st December 2009 came entirely from thin volume after-hours action. The following chart separates the regular session from the after-hours session on SPY.

SPY price rise during regular hours vs. during the after-hours, in thin volume trading

Market manipulation during after-hours?

Suspicion of manipulative quote stuffing was further substantiated by market data firm NANEX’s discovery of high frequency algorithms used by “unknown entities for unknown reasons,” sending thousands of orders per second to the markets with no intent to actually trade. NANEX’s analysis was summarized in an article published this month in The Atlantic. More recently, in an analysis by Bluemont Capital titled “The Marginalizing of the Individual Investor” the authors offer the following conclusion: “high-frequency trader interaction with computerized algorithms of large-cap financial institutions is providing opportunities for high-speed, virtually undetectable market manipulation.”

Precious metals
Many investors regard gold and silver as an inflation hedge and a proxy for market confidence in the financial system and paper currencies. This being the case, we should expect the money power to manipulate the markets downward, keeping the prices of precious metals low. A recent article by Adrian Douglas, editor of Market Force Analysis and GATA board member, entitled “Gold Market is not ‘Fixed’, it’s Rigged” provides a detailed analysis of gold trades before and after the regular trading hours and shows that prices are systematically pushed down outside the regular trading session in what he terms, “AM and PM fix.”

Douglas shows that the cumulative gold price change between the AM fix and PM fix since the start of the current bull market in April 2001 is negative $500/oz, while from the PM fix to the AM fix it is positive $1,400/oz. In other words, if a trader had shorted gold on the AM Fix and covered the short on the PM Fix and then bought gold on the same PM Fix and sold it the following morning on the AM Fix and repeated this every day over the last nine years the trader would have made $1,900/oz. A buy and hold strategy by comparison would have gained only $950/oz. ($250/oz gold price in 2001 to $1200/oz in 2010). The odds of this happening by pure coincidence are next to nil. Market manipulation is also implied in the silver market in an exhaustive analysis presented by Ben Davis, CEO of Hinde Capital.

Is inflation emerging in the real economy?
Interestingly, Davis also compares the Commodities Research Bureau (CRB) index with the CRB Raw Industrial index from 1982 to 2010. The CRB Raw Industrial Index is driven by fundamental demand and includes things like copper scrap, lead scrap, steel scrap, tin, zinc, burlap, cotton, print cloth, wool tops, hides, hogs, lard, steers, tallow, butter, soybean oil, lard, print cloth, rosin, and rubber. The Raw Industrial Index contains no energy inputs, so it is not driven by higher oil prices.

CRB index vs. CRB industrial index

On the street, commodity prices are back to 2008 levels

This chart shows that in the main street economy, commodity prices rebounded close to the pre-crisis levels – an interesting perspective to consider in the inflation vs. deflation debate.


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