There are currently three potential policy measures that would have a relevant impact in the commodities markets
What do USD money markets have to do with gold? Money market funds
invest in short-term highly rated securities, like US Treasury bills
(sovereign risk) and commercial paper (corporate credit). But who
supplies such securities to these funds? For the purpose of our
discussion, participants in the futures markets, who look for secured
funding. They sell their US Treasury bills, under repurchase agreements,
to money market funds. These repurchase transactions, of course, take
place in the so-called repo market.
The repo market supplies money market
funds with the securities they invest in. Now…what do participants in
the futures markets do, with the cash obtained against T-bills? They,
for instance, fund the margins to obtain leverage and invest in the
commodity futures markets.
In summary: There are people (and
companies) who exchange their cash for units in money market funds.
These funds use that cash to buy –under repurchase agreements- US
Treasury bills from players in the futures markets. And the players in
the futures markets use that cash to fund the margins, obtain leverage,
and buy positions. What if these positions (financed with the cash
provided by the money market funds) are short positions in gold (or
other commodities)? Now, we can see what USD money markets have to do
with gold!
Let’s propose a few potential scenarios, to understand how USD money markets and gold are connected:
If money markets have liquidity, there
is abundant cash to buy US Treasury bills (i.e. the repo market is more
liquid), and to finance those who short commodities in the futures
markets. This is negative for the spot price of gold. If money markets
lack liquidity, shorting commodities becomes more difficult. This is
positive for the spot price of gold.
If the US Treasury bills become riskier,
on the margin, the incentive to buy them will be lower and either money
market funds will reallocate the cash towards commercial paper or they
will face redemptions from fearful investors. The repo market will then
lose liquidity. This is positive for the spot price of gold.
Alternatively, if the rate paid by the
US Treasury increases AND the risk of these bills is NOT perceived to be
higher (something possible in these rigged markets with doubtful
ratings), investors will be more eager to place their cash with money
market funds (falling prey to an illusion) and the liquidity of the repo
market will increase. This is negative for the spot price of gold.
Why do we bring this up? To be honest, it is not the first time we do so. We have introduced the topic in our letters of July 2nd, July 30th and August 6th.
We bring this up today because we want to raise awareness on some
measures under consideration by the US Treasury and the Federal Reserve,
that will have a direct impact on the USD money market, and hence, the
repo market and the price of commodities. These policies are:
1) Minimum Balance at Risk (MBR): Kills USD money markets = lowers liquidity in repo market = Positive for gold
This has been in the works since 2010,
but is only now taking shape. On August 15th, Bloomberg had a post on
this under the title “Fed’s Dudley backs money fund rules to protect US Economy”.
If enforced, there will be a minimum balance, which holders of money
market fund units will not be able to redeem, but after a lock period.
Effectively, under distress, redemptions will be restricted. As well,
there are other potential measures, like floating the funds’ Net Asset
Value and capital requirements. But the MBR one is the most relevant: It
will make market participants see money market funds as a risky
investment.
Personally, we do not see the motive
behind this move because if, as some deduce, policy makers in all
honesty believe that the savings currently in these funds will be
reallocated as a result to bonds or stocks (boosting asset prices), they
are being naïve at best and utterly idiotic at worst. Whoever invests
in money market funds does so to make an extra buck on liquidity. If
he/she cannot make it, then the funds will simply remain in a chequing
account. Would banks use these funds in the chequing accounts to lever
up their investments? Into what? Money market funds? The recent
experience in the Euro-zone (discussed further below) shows it is not
the case. Banks will not lend more just because they have more deposits
available.
In any case, this policy would drain
liquidity from the repo market and financing positions in the futures
markets (i.e. shorting gold, for instance) would be more expensive. This
would be positive for the spot price of commodities.
2) Introduction of Floating Rate
Notes by the US Treasury: Positive for USD money markets = Negative for
gold in the short-term, positive in the long-term
We introduced this point in on August 6th, after reading a series of articles at Zerohedge.com.
Floating Rate Notes are variable rate notes. If floating rate notes
were issued and interest rates rose (either driven by the Fed’s policy
or by the market) they would have a strong bid from money market funds,
bringing liquidity to the repo market. This could continue supporting
speculative shorts in the futures markets, which would be negative for
spot commodity prices in the short term.
However, if these rates are seen to be
sticky, the Fed would have to intervene, targeting rate caps. But to
guarantee the cap on the price of a good, one has to offer unlimited
supply of that good. If the Fed had to guarantee a cap on NOMINAL
interest rates, it would have to offer unlimited supply of US dollars.
It is now easy to see why, in the long run, issuing floating rate notes
would therefore be positive for the spot price, in US dollars, of
commodities.
3) Zero interest on excess reserves:
Would kill USD money markets (just like it did in the Euro zone) =
lowers liquidity in repo market = Positive for gold
After the July 5th decision by the ECB,
to pay nothing on its deposit facility, Euro-zone banks’ deposits at the
European Central Bank plunged (see below, source: Bloomberg), by the
tune of EUR484BN!!!
Did this money go to stocks? No! To
bonds? No! Where did it go then? To a chequing account at the ECB. In
the process, the Euro money markets died and the repo market suffered
heavily. We had warned here that this measure would only make Euro banks less profitable and hence, riskier.
Because commodities are not traded in
euros, this has not impacted the commodities market. But should a
zero-interest-on-excess-reserves policy be implemented in the US dollar
zone, the effect on the repo market would be to drain liquidity, a
negative for futures markets and a positive for spot commodity prices.
In conclusion, there are currently three
potential policy measures that would have a relevant impact in the
commodities markets. Forewarned is forearmed.
Martin Sibileau
- Tags Commercial Paper,commodity markets,corporate credit,ECB,Fed,floating rate notes,futures markets,gold,interest on excess reserves,liquidity,minimum balance at risk,money markets,repo market,T-bills,US Treasuries,US Treasury,William Dudley,zerohedge.com
Click here to read this article in pdf format: August 19 2012
No comments:
Post a Comment