Submitted by Tyler Durden on 02/16/2011 08:29 -0500
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Wednesday, February 16, 2011
Backward Silver & Forward Weather
Backward Silver & Forward Weather
By Bruce Krasting
Created 02/15/2011 - 19:04
BACKWARD
To make a point on silver I show the spot and forward swap prices for AUDUSD.
Now look at 1 year Treasuries and the same maturity for Australian federal paper.
Put it together. The interest differential is 4.61% in favor of Australia. Note the swaps are at a discount, meaning the left side (bid) is lower than the right side (offer). The forward Aussie discount is equal to the interest differential. Take the mid point of the swap (.0453) and divide it by the spot (.9965) and you get 4.50%. (the 11bp is spreads, ‘noise’ and basis risk differentials.)
Conclusion you can take to the bank: The forward price is equal to the interest differential. Simple.
Okay, with that in mind look at silver today. The futures price is trading to a discount to the cash price. Go back to my example for the AUDUSD. For silver to be backward it MUST mean that the cost to borrow silver is GREATER than the cost to borrow dollars. This is one of those ‘red flags’.
My conclusion? There is a shortage of the physical metal. Blame it on whoever you like. The Mint, the JP Morg, underwater producers. There are dozens of suspects to consider. Either way, it’s bullish for the price.
FORWARD
There is some fairly conclusive information that short-term weather patterns are changing. The evidence is in the most recent ENSO numbers. The extreme La Nina conditions that have brought so much pain to Australia (and other parts of the globe) are in the process of abating.
Consider first this chart that tracks the La Nina El Nino cycle. We have moved off the trough set in December. (From NOAA web site [4])
The updated (December-January) MEI value has strengthened slightly to -1.62 standard deviations after almost dropping below -2 standard deviations in August-September.
The -1.62 still represents a strong La Nina. A closer look at conditions in the four regions that make up the index shows what's going on:
This shows the cumulative change in conditions. We have backed off the extreme.
Where are we headed is the question. There are many computers looking at this and many possible outcomes. A chart of the various forecasts:
Note that the projections broadly point to a reduction of the current conditions. Some of the models are even pointing to a reversion to El Nino status by the end of the summer.
Should a +.05 /+1.0 ENSO (modest El Nino) be the reality this fall it would create conditions not unlike 2004 -2005. Those two years were the biggest hurricane years in the past 25.
Quite a number of folks have suggested to me that ENSO is just part of the picture and I over emphasize its importance in short-term weather patterns. Fair enough. Yet I keep getting hit on the head with evidence that confirms to me that this cycle is driving most of the short-term results. Consider what has happened in Australia over the past six months. They got rain like rarely before seen. What was happening to La Nina conditions that most affect their weather (Nino 3.4)? This from NOAA:
After a drop to +2 in June, July rebounded to +20.5, followed by values between +16 (November) and +27 (December), including +20 in January 2011. The last time that this index showed higher values for the average of any six months was during the same half-year in 1917(!), so any SOI-based classification would classify this event as one the second-strongest event of the last century
The 100-year La Nina was the cause of the 100-year rainfall. For me the cause and effect is too clear to miss. The questions to ask are, a) why are we seeing the extremes? and b) why is the life of the cycle(s) getting shorter and shorter? To my knowledge the folks with the computers haven’t figured that out yet.
By Bruce Krasting
Created 02/15/2011 - 19:04
BACKWARD
To make a point on silver I show the spot and forward swap prices for AUDUSD.
Now look at 1 year Treasuries and the same maturity for Australian federal paper.
Put it together. The interest differential is 4.61% in favor of Australia. Note the swaps are at a discount, meaning the left side (bid) is lower than the right side (offer). The forward Aussie discount is equal to the interest differential. Take the mid point of the swap (.0453) and divide it by the spot (.9965) and you get 4.50%. (the 11bp is spreads, ‘noise’ and basis risk differentials.)
Conclusion you can take to the bank: The forward price is equal to the interest differential. Simple.
Okay, with that in mind look at silver today. The futures price is trading to a discount to the cash price. Go back to my example for the AUDUSD. For silver to be backward it MUST mean that the cost to borrow silver is GREATER than the cost to borrow dollars. This is one of those ‘red flags’.
My conclusion? There is a shortage of the physical metal. Blame it on whoever you like. The Mint, the JP Morg, underwater producers. There are dozens of suspects to consider. Either way, it’s bullish for the price.
FORWARD
There is some fairly conclusive information that short-term weather patterns are changing. The evidence is in the most recent ENSO numbers. The extreme La Nina conditions that have brought so much pain to Australia (and other parts of the globe) are in the process of abating.
Consider first this chart that tracks the La Nina El Nino cycle. We have moved off the trough set in December. (From NOAA web site [4])
The updated (December-January) MEI value has strengthened slightly to -1.62 standard deviations after almost dropping below -2 standard deviations in August-September.
The -1.62 still represents a strong La Nina. A closer look at conditions in the four regions that make up the index shows what's going on:
This shows the cumulative change in conditions. We have backed off the extreme.
Where are we headed is the question. There are many computers looking at this and many possible outcomes. A chart of the various forecasts:
Note that the projections broadly point to a reduction of the current conditions. Some of the models are even pointing to a reversion to El Nino status by the end of the summer.
Should a +.05 /+1.0 ENSO (modest El Nino) be the reality this fall it would create conditions not unlike 2004 -2005. Those two years were the biggest hurricane years in the past 25.
Quite a number of folks have suggested to me that ENSO is just part of the picture and I over emphasize its importance in short-term weather patterns. Fair enough. Yet I keep getting hit on the head with evidence that confirms to me that this cycle is driving most of the short-term results. Consider what has happened in Australia over the past six months. They got rain like rarely before seen. What was happening to La Nina conditions that most affect their weather (Nino 3.4)? This from NOAA:
After a drop to +2 in June, July rebounded to +20.5, followed by values between +16 (November) and +27 (December), including +20 in January 2011. The last time that this index showed higher values for the average of any six months was during the same half-year in 1917(!), so any SOI-based classification would classify this event as one the second-strongest event of the last century
The 100-year La Nina was the cause of the 100-year rainfall. For me the cause and effect is too clear to miss. The questions to ask are, a) why are we seeing the extremes? and b) why is the life of the cycle(s) getting shorter and shorter? To my knowledge the folks with the computers haven’t figured that out yet.
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