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I am sorry to report that for the second time, Cactus Jack has departed.  The stress put upon him by Miles Franklin was too much for his heart, and the Dearly Departed has departed again.  I know there is a place in Heaven for dear old Cactus.  He was a genuine, sincere and wonderful human being – even if we disagreed on so many issues.  Cactus, we will miss you!

According to the World Gold Council, central banks are on pace to make their largest annual purchases of bullion since the collapse of the Bretton Woods system in 1971. Central banks have been net buyers of gold in the last several years and have purchased about 151 tonnes of gold year to date.

UBS recently did a survey of central bank reserve managers in which more than half of the bankers said that the dollar would be replaced by a portfolio of currencies within the next 25 years. That’s pretty optimistic.  A more realistic appraisal is that the dollar will have trouble making it another 25 months as the reserve currency.   Come to think of it, with all the spending needed in order to pretend there is a recovery, even 25 weeks isn’t guaranteed.

The following is from John Mauldin’s weekly ‘Outside the Box’, which ran a piece from Simon Hunt’s ‘Economic & Copper Advisory Service: Economic Report :

The Federal Reserve is likely to sit pat for some months to see how the US economy will be able to perform without the steroids provided by them. Foreign central banks have largely been absent from Treasury auctions. In quarter one this year, foreign central banks bought just 16% of the issuances while the Federal Reserve acquired almost 200%, according to Russell Napier. In other words, the Fed’s activities have masked the exodus of foreign central banks including China from these auctions.

Wow. The foreigners are almost out of play. But for me here, the stunning piece of information is that the Fed has been buying 200% of issuance. Clearly that means that domestic banks are *huge* net sellers of Treasuries. This looks collusive, as though everyone knows the yield curve has to blow up at some point, so the Fed is providing an exit strategy – a pre-bailout, if you will – by buying back the bonds at artificially low yields using – again – the taxpayer’s increasingly toxic balance sheet.

If foreign central banks continue to abstain from purchasing US Treasuries, the private sector will have to fund the fiscal deficit, implying quarterly remittances to the US Treasury of some $370bn. The private sector will be able to fund these auctions but at a price. They will demand a higher return on treasury paper and the funding will mean that the free-flow of funds into equity and commodities will come to an end. Many institutions are taking risk off the table.

Clearly Hunt is right that the funding has to come from somewhere… but the Fed plans to continue purchasing at least $300bn of debt over the next 12 months with proceeds from maturing issues. That doesn’t add money to the system, clearly, but if the economy is as weak as it clearly looks, and interest rates rise because of the end of QE2 and the exit of foreign banks, I expect the Fed to continue monetizing at a much higher rate than expected rate.

The way it looks to me, the Fed is buying toxic US paper from domestic banks. I suspect the point at which the game might end will be when domestic banks have eliminated the lion’s share of their risk, and foreigners turn net sellers.  At that point, the Fed will have no incentive to buy what the market bears, as US banks will be out and there’s no reason to rescue foreign bondholders. If the Fed WERE to keep buying at the point where foreign banks are net sellers, that for me is the tipping point where the dollar would implode (foreign holders would fall all over each other to unload, which means a flood of dollars for sale as well) and the curve would destabilize sharply. The Fed would be the only source of finance for treasury, which means potentially very high inflation.

What’s next for gold and silver?  Ask JPMorgan

Ed Steer offered his thoughts on this subject, and they are spot-on:

How high, how fast and how far both gold and silver prices rise on the next rally is entirely up to JPMorgan et al. If they’ve covered as many shorts on this ‘drive by shooting’ that they can in both metals…what they do from hereon in will determine the outcome of what I mentioned in the previous sentence.

If they put their hands in their pockets and do nothing…and don’t become not-for-profit sellers, or sellers of last resort as the tech fund longs pour in, then we’ll blast off to the upside even faster than we went down in price…as there are no legitimate short sellers left in this market…and the tech fund longs will have to bid up the price to fantastic levels in order to find such a short seller.

The other alternative is more of what we’ve had over the last twenty-five years or so…and we shouldn’t have too long to wait to see how this resolves itself. And, as Ted Butler has pounded into by head over the last twelve years, you’ll know what the bullion banks have chosen to do by just looking at the price action. That will tell you everything.


David Schectman

Miles Franklin