S&P Downgrades Spain's Credit Rating Two Notches

Good day… S&P surprised the markets after the US close yesterday and announced a 2-notch downgrade for Spain taking them to BBB-, and didn’t stop there, S&P also announced that Spain was being placed on Negative Outlook. This really took out any wind that existed in the euro’s sails, and made for an ugly Asian session.

Here’s the skinny on what’s going on here… S&P had basically joined Moody’s and Fitch in this downgrade, and another Moody’s rating cut could come by the end of November. IF that happens, then Spanish bonds would have to be dropped from bond indices around the world, and if that happens those bonds will have to be sold. So, now you see why the euro (EUR) saw the ugly side of trading in the Asian session last night.

But then the Asian session rolled into the European morning session, and the euro bounced back, on the good results of an Italian bond auction. The euro has bumped up 0.25% since I’ve come in this morning, and is back to 1.29. So, this is a prime example of what I always say about traders’ attention spans.

I told you yesterday that Australia would print their employment data late yesterday, and of course they did. The Aussie employment data showed an increase of 14,500 net new jobs, and the Aussie dollar (AUD) bounced higher, as the consensus for new jobs was only 5,000. Full time employment in Australia, which had recently been slow, had a strong month in September. So, the last two days we had stronger-than-expected job growth, and good consumer confidence reports. Maybe this will cause the traders that are pushing for rate cuts to back off. Probably not, but at least we can hope.

I told you yesterday that I thought, even though the markets didn’t, that the Brazilian Central Bank (BCB) would cut rates 25 Basis Points (0.25%) and that’s exactly what they did! I had someone, presumably from Brazil take offense with what I said yesterday that the Brazilian government and BCB had distastefully cut rates by nearly 5%… This fellow thought that the Brazilian government and BCB were cutting rates to help the citizens. Well, let’s listen to what Brazilian Finance Minister, Mantega had to say about the latest rate cut. “The reduction in rates will help avoid the appreciation of the real by reducing arbitrage.” THAT has been the true reason for the rate cuts, to debase the currency, to lessen the flows into the country that pushed the real (BRL) higher.

Speaking of Brazil… Mantega also made an announcement yesterday at the annual meeting of the IMF. Mantega announced that the BRICS (Brazil, Russia, India, China, S. Africa) have agreed to create a pool of reserves to provide a rearguard of financial support. He said that this pool of reserves would be modeled after the Chiang Mai Initiative for Japan, China, S. Korea, and 10 S.E. Asian countries that have pooled $240 billion of emergency liquidity to fill any gaps and help smooth out global financial shocks.

These are just pledges, folks. They don’t really put the funds in the pool up front. They sign an agreement that promises they will provide “X” should the time come. It is believed that the BRICS will iron out the details of this pool of reserves at their next meeting in Mexico next month.

The poor S. African rand (ZAR), has really been put through the wringer in recent weeks. The mining strikes just crippled the economy, and the rand was sold. But the past three trading days have seen some sun shine on the rand, as the labor unrest eases, and flows of investments into S. Africa are returning. I’ve always said that the rand is just too volatile for my taste, and the only way to buy is with the speculative portion of your investment portfolio, or in a basket so other currencies can smooth out the volatility.

I’m not sure how to take this quote from US Treasury Secretary Geithner… He is in Tokyo for the IMF Annual Meeting, and had this to say about the Eurozone’s progress with their debt crisis. “The region has a much more viable strategy to hold the system together. It’s a much more powerful and promising path. They are better off today than they were before they reached agreement. The basic strategy is right and good.”

Long time readers know that the US Treasury Secretary isn’t at the top of my Hit Parade. I can’t talk about him like I used to, but just to remind everyone what the root of my feelings are. The US Treasury Secretary was the head of the Fed NY, before the financial meltdown. The Fed NY was responsible for a lot of policies that didn’t get followed by regulators before the meltdown. And, something my old friend and former colleague taught me many years ago, the regulators might have been responsible, but the top guy was accountable. And that’s all I’ll say about that… But now, you can see why I shudder when the US Treasury Secretary praises the Eurozone’s debt crisis plan. It makes me think that there are glaring problems. But maybe I’m just being too cynical, eh?

In Japan overnight, more gloom, despair and agony for the Japanese economy. A leading indicator of capital spending, orders for machinery, fell -3.3% in August from the previous month. Add this to the recent reports that exports and industrial production are in decline, and you’ve got an economy that barely has a pulse. Which is why I have long questioned the strength of the Japanese yen (JPY). The Japanese, from day one of their now 2 “lost decades”, did what we are trying to do now — artificially stimulate an aged economy. It didn’t work for them; I wonder why we think it will work for us? I mean, I get it, the Japanese save, and we spend; that’s what makes us different in this arena. But, we can’t spend when we don’t have jobs (well we can as long as the government keeps mailing the checks or credit cards, but eventually that runs out!)

Sweden saw their Consumer Price Index (inflation) slow down in September. CPI was +0.4% versus +0.7% in August. This is very good fundamentally for Sweden, but, I’m afraid the central bank/Riksbank will view this as an opportunity to cut rates, or at least leave them unchanged, and reverse the earlier indication that rates would rise here. And that’s not good for the krona (NOK).

But remember, the Swedish krona (SEK) and the Norwegian krone, are not a part of the euro, but at this point in time, seem to get tarred with the same brush used on the euro. I truly believe that will change at some time in the future, for like I’ve said over and over again, eventually investors and traders will see that Norway’s fundamentals (and Sweden’s) are not the same as the euro.

Gold is up $8 this morning, after seeing selling the past two days. There was nothing to cause the selling the past two days, so it’s nice to see gold get back on the rally tracks. Silver is up 28-cents to $34.27, so it’s also seeing a strong performance this morning. The S&P announcement on Spain probably has a lot to do with the return to the rally tracks.

One of the things I always talk about in my presentations when I talk about gold and silver, is the fact that there is only so much of either one. Which is a great reason why the prices of these metals should always be strong. I saw this data on silver and thought it played well with that thought. US mined silver output was down 12% in July, compared to July 2011. And with the gold and silver ETFs now demanding so much physical metal to back their funds, you have to wonder about mining and production.

Then There Was This… From Zerohedge.com (one of my fave websites to visit). This is an article posted by the chief investment officer of Guggenheim Partners in New York and Chicago, Scott Minerd, who concentrates on an angle often raised by Jim Sinclair, the (purported) US gold reserve’s “coverage ratio” of the US money supply.

Minerd writes: “The US gold coverage ratio, which measures the amount of gold on deposit at the Federal Reserve against the total money supply, is currently at an all-time low of 17 percent. This ratio tends to move dramatically and falls during periods of disinflation or relative price stability. The historical average for the gold coverage ratio is roughly 40 percent, meaning that the current price of gold would have to more than double to reach the average. The gold coverage ratio has risen above 100 percent twice during the 20th century. Were this to happen today, the value of an ounce of gold would exceed $12,000.

“Well, dear reader, my guess currently stands at $18,000/ounce, so the estimates are getting closer. But if gold only makes it to $12,000/ounce, I’m sure I’ll manage somehow…as silver will be many hundreds of dollars per ounce…and the ‘new’ gold.”

Chuck again. WOW! Those are some lofty figures being tossed around in that article! I remember when the Big Boss, Frank Trotter and I would talk about the price of gold, back when it wasn’t even $1,000 and the thoughts were that gold could go to $2,000. We would agree that while for gold holders $2,000 would be great, we worried about what the US economy would look like. I think we’re getting to see that real time, eh?

To recap. S&P surprised the markets with a 2-notch downgrade of Spain’s credit rating. This caused all kinds of problems for the euro in the Asian session, but the single unit has rebounded in the European session on the news that Italy had a very strong bond auction this morning. Brazil did cut rates 25 basis points, and announced a new pool for the BRICS that will be modeled after the Asian reserve pool.

Chuck Butler
for The Daily Reckoning