If The Fed Steps In To Save The Markets Then Gold & Silver Will Go Crazy To The Upside

Eric says that relatively, the the midst of the price suppression and the stock market crash, gold & silver have done well. 

It's been a wild week in the markets, and Eric steps in to break it all down for us. In this wrap-up, you'll learn what's causing the volatility, why you should be watching the bond market, and what role the Fed could play in the coming year.

And, as always, he'll let you know how precious metals are faring in all this.

"I could sit here as a guy with a big portfolio and say, 'Well, thank God my gold is only down 2%, and my silver is only down 2%.' Everything I own could be down eight. Or ten. So, I'm not hurting here… I think relatively, these things have done exactly what we would expect. They've probably been suppressed… The natural instinct should be to buy gold in this kind of environment. We'll see what happens today. Lots of people in the world are going to be trying to find things to invest in that can hold their own, and I think we're already seeing that gold and silver look like they're filling that role.'"

US Contagion Accelerates - China Big Caps Crash Over 7%, Worst Week Since Lehman

• Things went from bad to worst very fast...
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• *CHINA H-SHARE INDEX SLIDES 5%
• *SHANGHAI COMPOSITE INDEX DROPS 5.3%
• *CHINA SSE 50 INDEX OF BIG CAPS DROPS 7.5%
• *TENCENT DROPS 5.1% TO TRADE BELOW HK$400

This is the big caps worst day since the Aug 2015 devaluation crash, and the worst week (unless The National Team steps in) since Lehman...

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After an insane winning streak in December and January, the Hang Seng has plummeted in the last few days and along with the rest of the major mainland China equity markets - has entered correction.

2018 started off so well in China...

But after an almost incessant ramp, China and Hong Kong stocks have crashed back to reality in the last few days...

Shanghai Composite is now at 7-month lows...

And Hang Seng is down 12% from its highs, back below 30,000...

The Yuan remains on edge as it tumbles most since the Aug 2015 devaluation...

And across the water, Japanese stocks are down 13% from their highs...

"Worst Case Scenario" Emerging: Morgan Stanley Warns "Selling Has Shifted"

Confirming JPMorgan's "worst case scenario" that forced de-levering in vol-based strategies would lead to retail ETF outflows and create a vicious cycle downwards, Morgan Stanley's Christopher Metli warns that today's moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling.

Risk-Parity funds are seeing some of the biggest losses in history...

But, as we previously detailed, JPMorgan offered hope that this vicious circle of de-leveraging could be stalled - and had been in the past - by dip-buyers from greater-fool retail inflows.

In the past, just as we have seen this year, these risk-parity-correlation tantrums have been cushioned by equity market inflows, and we note that, in particular, YTD equity ETF flows have surpassed the $100bn mark, a record high pace.

If these equity ETF flows, which JPMorgan believes are largely driven by retail investors, start reversing, not only would the equity market retrench, but the resultant rise in bond-equity correlation would likely induce de-risking by risk parity funds and balanced mutual funds, magnifying the eventual equity market sell-off.

Which could be a problem...

As ETF outflows are surging...

And as Morgan Stanley's Christopher Metli - who previously explained what happens when VIX goes bananas - notes, today's moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling. 

Systematic supply from vol target strategies is largely out of the way now, while consensus trades are getting hit:  NDX is underperforming SPX, momentum is down 1%, and the Passive Factor is up, indicating actively held names are underperforming names better held by passive funds.

So why now, even though the systematic supply is largely out of the way? 

Well as noted in previous comments, consensus was that this was a dip to be bought and that vol should be sold.  While systematic funds delevered this week, there has been less discretionary supply and end users have bought very little protection. 

This makes the market still fragile to negative shocks – in aggregate less fragile than coming into the week for sure, but still at risk.

The shock today has been higher real rates on expectations of more Fed tightening to come.  After ignoring the original driver of this whole episode earlier in the week, investors have finally returned to the fact that the Fed is going to have to react to a stronger economy.  10y real rates today hit the highest since 2015 indicating tighter financial conditions, and breakevens are down slightly.

In some sense, Metli points out, these ups and downs are a normal reaction to the shock and pain of the Monday selloff, and as noted in previous comments the market usually remains choppy after these events.  A focus on rates and the upcoming CPI report on Tuesday, plus dealers remaining short gamma, likely means the market remains choppy for the next few days.

But Metli does offer some silver-lining hope - just as JPMorgan's Kolanovic did on Tuesday,another -4% SPX move is unlikely given lower systematic supply and less VIX ETP gamma, and the point of max pain is very likely behind us. 

Choppy means +/- 1 to 2% moves for a few days followed by a gradual moderation in volatility as the market digests a more hawkish Fed.

...unless the bond market becomes truly unhinged, he adds.

Finally, Metli notes that right now, the options market does not fully price in a higher volatility environment for longer, and the inverted curve means forward volatility is relatively inexpensive.

June VIX futures are only in the 35th 10-year percentile, while even further out volatility between June and Dec of 2018 is only in the ~10th 10-year percentile – good value versus a VIX that is in the 90th percentile.

Bloodbath" - Dow Crashes Over 1000 Points, Enters Correction

Dow crashed over 1000 points today....

All 2018 gains are gone...

Time for "Markets In Turmoil" special...

Markets "turmoiled" again yesterday as Treasury yields spiked on a weak auction and the implications of a budget deal that means more supply is coming. This spooked stocks once again and XIV, the Inverse ETF, tumbled at the open - after ramping stocks delusionally into the open. As stocks got monkey-hammered again, so bonds were bid and ended with a relatively small rise in rates as plunges in Risk-Parity funds likely prompted forced delevering in stocks and bonds. Perhaps most notably, credit spreads started to snap wider and rate volatility spiked as equity market contagion spreads.

Investors have swung from "extreme greed" to extreme fear" in a record few days...

Source: CNN Money

While the mainstream media attempts to calm investors that this is a "healthy pullback," one of their pillars of support just snapped. HY credit spreads snapped wider to 10 month wides and even IG spreads spiked...

This should not be a surprise as HY and IG ETFs have seen major outflows...

As credit investors fear rising rates more than anything else...

And the last week has seen huge equity outflows from US ETFs...

And as Risk-Parity funds see one of their biggest crashes in history...

And Risk-Parity had another ugly day today as aggregate bond and stock returns were negative...

So bonds and stocks were sold...NOTE that as stocks dumped, bonds were bid but that never stabilized stock flows...

In cash markets the selling started at the open after a gap up...and accelerated into the close!

Dow's lowest close since Nov 30th

Futures show the chaotic manipulated swings...

All helped by XIV still!!

VIX is back above 35...

As equity vol surged again...

All the major US equity indices have broken key technical support levels...

10% Correction Levels:

• Dow 23954 - Dow closed at 23860 is in correction
• S&P 2585 - S&P closed at 2581 in correction
• Nasdaq 6755 - Nasdaq closed at 6777, not in correction

Financials are now underwater for 2018 (despite soaring rates?) and Tech is also red...

While stocks were slammed, bonds actually ended the day with only modest yield rises(though plenty of vol)...10Y and 30Y yields are up on the week...

30Y Yields reached new cycle highs and 10Y yields tested them...

30Y INTRA

Today's yield spike early on, spooked stocks again...

As rate volatility begins to surge...

The Dollar Index ended the day practically unchanged after rallying overnight (on Asia weakness) and selling off this morning...before rallying back as carry trades were unwound...

But the last 24 hours has seen incredible moves in offshore Yuan... Yuan is 1.3% weaker in the last two days against the dollar - the biggest drop since Aug 2015's devaluation...

Despite the dollar's quiet day, crude and copper slid lower while gold and silver trod water...

WTI was back to a $60 handle and RBOB back at 1.75...

Cryptos were volatile today but Bitcoin ended higher, extending gains from the pre-hearing lows...

Bitcoin held above the $8,000 level but the correlation with VIX remains a worry...

Overheard on CNBC this afternoon - "Volatility is here, embrace it, and we go back up again"

Easy eh?

It appears every asset class is starting to "embrace" the vol..

"Worst Case" Confirmed: Biggest Weekly Fund Outflow In History

If it seems like it was just a few days ago that we reported of the biggest ever inflow into equities, it's because that's precisely when it happened. It was then that according to BofA CIO Michael Hartnett, we observed a "non-stop euphoria cabaret" in which markets saw a record $33.2bn inflow to equity funds, record $12.2bn inflow to active funds, $1.5bn into gold (50-week high), as well as record inflows to tech & TIPS.

Incidentally, that was the day the S&P hit its all time high, and more importantly, the day BofA also said that its euphoria and panic-buying driven "sell signal" was just triggered for the first time in 5 years, and predicted a 12% selloff in the next three months.

In retrospect, it took just two weeks because that post marked the peak of the market, and it has been non-stop selling since.

But much more troubling than the selling, is the composition: after all, as we showed earlier, the "worst case scenario" according to both JPMorgan and Morgan Stanley is if the liquidation panic was not just systematic funds and various quants puking as a result of the surge in the VIX, but if ordinary retail investors had also joined in: that would be a nightmare outcome for the bulls, as it would mean that the sharp but concentrated relentless selloff, had spread to the broader investing world, and institutions would have no choice but to join.

Specifically, this is what JPM said over the weekend when observing the recent record fund inflows:

If these equity ETF flows start reversing, not only would the equity market retrench, but the resultant rise in bond-equity correlation would likely induce de-risking by risk parity funds and balanced mutual funds, magnifying the eventual equity market sell-off.

And then there was Morgan Stanley:

Today's moves lower are likely not being driven by systematic supply – this appears to be more discretionary selling. Systematic supply from vol target strategies is largely out of the way now, while consensus trades are getting hit: NDX is underperforming SPX, momentum is down 1%, and the Passive Factor is up, indicating actively held names are underperforming names better held by passive funds.

Well, we now have confirmation.

According to the just released EPFR weekly fund flow data, what was just two weeks ago a record equity inflow has become a record equity outflow, as the 10% drop in the US stock market has officially launched a selling panic.

As Citi writes tonight, "in the week of 2/7/2018, bond funds had an inflow of US$4.0bn and equity funds lost US$30.6bn to outflows. This was the largest outflow on record from equity funds, which just had their record high inflow of US$33.2bn only two weeks ago. The largest outflow had come from US funds which saw US$32.9bn of outflow. "

Stated simply, this means that one no longer needs the VIX ETN, CTAs or risk pars to launch a liquidation panic: one has already begun, and retail is panicking, desperate to get out of stocks.

Which means that a full on bear market is now in the hands of just two players: institutions, and corporations. In other words, if hedge and mutual funds don't step up, and if companies don't unleash a buyback tsunami, it's about to turn very ugly.

Stock and bond investors are now paying the price for the Fed’s dangerous experiment

The Federal Reserve's changing of the guard — the end of the Janet Yellen's tenure and the beginning of the Jerome Powell era — has me remembering what it was like to grow up in the former Soviet Union.

Back then, our local grocery store had two types of sugar: The cheap one was priced at 96 kopecks (Russian cents) a kilo and the expensive one at 104 kopecks. I vividly remember these prices because they didn't change for a decade. The prices were not set by sugar supply and demand but were determined by a well-meaning bureaucrat (who may even have been an economist) a thousand miles away.

If all Russian housewives (and house-husbands) had decided to go on an apple pie diet and started baking pies for breakfast, lunch, and dinner, sugar demand would have increased but the prices still would have been 96 and 104 kopecks. As a result, we would have had a shortage of sugar — a common occurrence in the Soviet era.

In a capitalist economy, the invisible hand serves a very important but underappreciated role: It is a signaling mechanism that helps balance supply and demand. High demand leads to higher prices, telegraphing suppliers that they'll make more money if they produce extra goods. Additional supply lowers prices, bringing them to a new equilibrium. This is how prices are set for millions of goods globally on a daily basis in free-market economies.

In the command-and-control economy of the Soviet Union, the prices of goods often had little to do with supply and demand but were instead typically used as a political tool. This in part is why the Soviet economy failed — to make good decisions you need good data, and if price carries no data, it is hard to make good business decisions.

When I left Soviet Russia in 1991, I thought I would never see a command-and-control economy again. I was wrong. Over the past decade the global economy has started to resemble one, as well-meaning economists running central banks have been setting the price for the most important commodity in the world: money.

Interest rates are the price of money, and the daily decisions of billions of people and their corporations and governments should determine them. Like the price of sugar in Soviet Russia, interest rates today have little to do with supply and demand (and thus have zero signaling value).

For instance, if the Federal Reserve hadn't bought more than $2 trillion of U.S. debt by late 2014, when U.S. government debt crossed the $17 trillion mark, interest rates might have started to go up and our budget deficit would have increased and forced politicians to cut government spending. But the opposite has happened: As our debt pile has grown, the government's cost of borrowing has declined.

The consequences of well-meaning (but not all-knowing) economists setting the cost of money are widespread, from the inflation of asset prices to encouraging companies to spend on projects they shouldn't. But we really don't know the second-, third-, and fourth derivatives of the consequences that command-control interest rates will bring. We know that most likely every market participant was forced to take on more risk in recent years, but we don't know how much more because we don't know the price of money.

Quantitative easing: These two seemingly harmless words have mutated the DNA of the global economy. Interest rates heavily influence currency exchange rates. Anticipation of QE by the European Union caused the price of the Swiss franc to jump 15% in one day in January 2015, and the Swiss economy has been crippled ever since.

Americans have a healthy distrust of their politicians. We expect our politicians to be corrupt. We don't worship our leaders (only the dead ones). The U.S. Constitution is full of checks and balances to make sure that when (often not if) the opium of power goes to a politician's head, the damage he or she can do to society is limited.

Unfortunately, we don't share the same distrust for economists and central bankers. It's hard to say exactly why. Maybe we are in awe of their Ph.D.s. Or maybe it's because they sound really smart and at the same time make us feel dumber than a toaster when they use big terms like "aggregate demand." For whatever reason, we think they possess foresight and the powers of Marvel superheroes.

Warren Buffett — the Oracle of Omaha himself — admitted that he doesn't know how the QE experiment will end. And if you think well-meaning economists running central banks know, you may have another thing coming.

Alan Greenspan — the ex-pope of the Federal Reserve — in a 2013 interview with the Wall Street Journal said that he "always considered [himself] more of a mathematician than a psychologist." But after the 2008-09 financial crisis and the criticism he received for contributing to the housing bubble, Greenspan went back and studied herd behavior, with some surprising results. "I was actually flabbergasted," he admitted. "It upended my view of how the world works."

Just as the well-meaning economists of the Soviet Union didn't know the correct price of sugar, nor do the good-intentioned economists of our global central banks know where interest rates should be. Even more important, they can't predict the consequences of their actions.