Axel Merk: The Fed's Next Move

"If you're not concerned, you're not paying attention" say Axel Merk, founder and Chief Investment Officer of Merk Funds.

Like many, he sees today's excessive high-price, low-volume, zero-volatility markets as an unnatural and dangerous result of misguided intervention by the Federal Reserve. But Axel has additional perspective than most, as the senior economic adviser to his family of funds is a former President of the Federal Reserve Bank of St Louis and a former FMOC member:

What’s driving the excessive complacency is today's markets is monetary policy. One of the main goals of monetary policy has been to reduce the risk premium; to make it less expensive for risky borrowers to borrow money. We see that everywhere, such as when we hear about how Spain now pays the same as the US on its long-term debt. And so risky borrowers don’t pay much more than the credit worthy borrowers. 

The reduction in the risk premium is what reduces volatility, and of course that spills over to other assets. We see that in the equity markets, the currency markets -- we see it everywhere. And volatility is compressed as well.

Janet Yellen was asked about this just a few days ago and she pretty much said how she’s not concerned about complacency in the market. She’s complacent about complacency. To me that’s about as significant as Greenspan suggesting houses can never go down, and Bernanke suggesting subprime loans were contained. It’s a major, major problem.

Obviously, there are plenty of challenges in the world. Usually what tips a market over, though, isn’t the most obvious thing because that’s already “priced in”. As a result, nearly anything can tip this market over. Suddenly one day people wake up and the glass is half empty, and everybody runs for the hills.

Many see the Fed having run out of bullets in it efforts to keep markets elevated. Axel's opinion is "Not quite yet":

The Fed has bought all these assets by creating money out of thin air and now they’re stuck with these. If they were to sell them (it’s much easier to buy securities than to sell them), prices would plunge and, more importantly, the Fed would sell these assets at a loss.

Now, the capital base and the equity of the Fed is very small. Odds are that the losses would wipe out the equity at the Fed.

And so the Fed would rather not sell those securities -- instead, they can pay interest on reserves. But I don’t think actually they’ll do that either, because of the conflict with Congress (if we’re going to start paying interest on reserves to somehow raise rates, that’s going to be political nightmare because we'd be paying $billions -- if not over $100 billion -- to banks to entice them not to lend).

There’s another tool that they have: it’s called reverse repos. I’m not going to explain this now in detail, but it’s essentially the same thing as paying interest on reserves with a key difference: Congress is not going to 'get it' for a year or so. And so the backlash from Congress is going to take a little longer to come. But that problem is going to come nonetheless.

As a result of these risks, Axel recommends the average investor be well-diversified outside of stocks and bonds, and maintain a high degree of liquidity. More information on the newly-launched fund (OUNZ) discussed in the podcast can be found here.

Click the play button below to listen to Chris' interview with Axel Merk (27m:11s):

This is a companion discussion topic for the original entry at

Here's a link to OUNZ's exchange fees page.  As he said, for 40 ounces or more, they seem within the bounds of competition - although my west-coast reference of shows only $47/oz for gold eagles, $20/oz for Australian 10oz bars, and $25/oz for the 1oz Australian bars - so its "ok" prices rather than "cheap" prices.

Type of Gold Bar Fee per Ounce Minimum fee
1oz Australian bars
1oz Australian Kangaroos
1oz Canadian Maples
1oz American Gold Eagles
1oz American Buffalos
10oz Australian bars
London bars
For the actual allocated gold storage, custodian is JP Morgan, and location is in London.  Some unallocated gold can be held in the fund, but is kept to a minimum of 430 oz per business day.

Just below you will find a link to a document that describes his single-page there-and-back-again trip to visit his fund's gold hoard at JPM.  Spoiler alert: it involved a ring, surviving an encounter with a large guardian, and the opening of a hidden door only visible when viewed in the last light of a certain day:

While selling the shares is a 28% tax hit in the US (collectibles are taxed at 28%), taking delivery of your gold in coins or bars is not a taxable event.

Advantages: normal people can take delivery of perhaps $60k in gold at relatively competitive prices, while being able to trade shares on an exchange prior to delivery.  Disadvantages: you rely on JPM to be your gold's custodian [Sprott has his gold in the Royal Canadian Mint - just on general principles, I trust them more than JPM].

It seems like a decent option for "the rest of us" - it will be interesting to see how it fares in the marketplace vs PHYS, which is its Sprott-sponsored competition among funds that promote actual delivery.  We'll be able to watch its growth by looking at the total size in assets over time, currently $50M.

For the people who imagine (correctly or not) that "allocated bars in London are scarce" the OUNZ fund will be a perfect way to detect this scarcity.  It has a method of basket construction/redemption theoretically similar to GLD, which under conditions of "no scarcity" should result in continuously low premiums/discounts to NAV since it enables any authorized participant to construct/redeem large amounts of shares in order to take advantage of premiums or discounts to NAV.

However, since OUNZ requires allocated gold AND requires next-day bar delivery of that allocated gold into a single vault in London in its own segregated pile for any new baskets created, it will be quite easy to spot any actual London bar scarcity by looking at premiums/discounts to NAV for OUNZ.  The logic being, if basket creators have an arbitrage opportunity (for instance a nice premium to NAV for OUNZ), but are unable to meet the strict requirements of basket creation due to bar scarcity, premium should remain all during that period of bar scarcity.

I'm excited about just that one element alone!


On precious metal purchases and sales.  Check your individual states rules.
But, what they don't know, can't hurt you:-)

WRT the reverse repo's…

If there ever was any question as to what the purpose of the Fed's Reverse Repo liquidity facility was, or is (and considering we already explained it before in Fed Soaks Up Record $200 Billion In Year End Excess Liquidity and Month-End Window Dressing Sends Fed Reverse Repo Usage To $208 Billion: Second Highest Ever), the amount of reverse repos issued by the Fed to make banks appear healthier than they are and to cure whatever "high quality collateral" shortfalls banks are now chronically experiencing, should slam the door shut on any future debate just what the motive behind the Reverse Repo is.

Behold: a record $340 billion in reverse repos submitted by the world's financial institutions with the Federal Reserve, an increase of $200 billion overnight, and amounting to a record $3.5 billion on average among the 97 operations participants. Considering this is a clear quarterly event, it goes without saying that all the reverse repo is, is a quarter-end window dressing mechanism underwritten by Mr. Chairmanwoman itself.

That there was some $200 billion in excess reserve liquidity as of yesterday's market close (which today was handed over to the Fed in exchange for one day rental of Treasurys), or that banks actually have a third of a trillion gaping shortfall in collateral, hardly needs discussion.

Expect total reverse repo usage tomorrow to plunge by at least $150 billion as the banks will have fooled their regulator, which also happens to be the Fed, that they are safe and sound. Rinse, repeat, until the entire financial system collapses once again and people will ask "how anyone could have possibly foreseen this."

As we said last time:

So step aside any sophisticated claims that the Fed's reverse repo is a means to extract liquidity when the time to raise rates finally comes: all this latest "tool" in the Fed's arsenal is, is nothing more than a Fed-mandated and endorsed mechanism with which the banks can fool regulators and investors that they are in a far healthier condition than they really are.


And judging by the humiliating episode involving Bank of America's made up numbers that punked the Fed into believing America's most insolvent TBTF bank was healthy enough to give be billions to investors, one of the parties most "confused" by what the RRP does, is the Fed itself.


Source: NY Fed

Record $189 Billion Injected Into Market From "Window Dressing" Reverse Repo Unwind

Could somebody please explain all of the transactions that are involved in this end of quarter shenanigans?  I get that the financial institutions "borrowed" treasuries from the fed for one day so they could "fool" the very organization they borrowed from about the quality of their balance sheets.  What was the other side of the transaction?  Did they put up collateral?  Where did the $200 billion that supposedly went into buying stocks come from?  The net effect of the reverse repo transactions between yesterday and today on available cash should be nearly zero. 
There is also mention of releasing liquidity for two months of POMO in one day.  Does this mean that the fed literally has been buying up treasuries for 2 months, but only made the funds available to those they bought from today and those new funds are the source of all of the buying?

I like the articles, guys.  I'm in agreement at least with the behavior.  I verified the data, at least the recent event on June 30th.  There really is not much that can explain this EOQ maneuvering except some sort of shenanigans.
My guess: this is some kind of "modified repo 105" maneuver made popular by Lehman:

Repo 105 is an accounting maneuver where a short-term repurchase agreement is classified as a sale. The cash obtained through this "sale" is then used to pay down debt, allowing the company to appear to reduce its leverage by temporarily paying down liabilities—just long enough to reflect on the company's published balance sheet. After the company's financial reports are published, the company borrows cash and repurchases its original assets.

So here's my guess.  Bank (for some large number of Banks) has some large amount of risky crap on their balance sheet.  They sell the risky crap for a day, run out and "rent-a-treasury" from the Fed so it shows up on the balance sheet as "treasury holdings", and the very next day they sell the treasurys they rented, and retrieve their risky crap from wherever they stashed it.

We can see just how much risky crap this is by looking at the size of the aggregate repo transaction.  Namely, its 189 billion.  I do not think it was injected directly into the market - I think this was simply to make the collection of bank balance sheets look less risky in the quarterly reports.  I don't think the Fed itself was the audience for the op; but it should certainly know what is going on.  If not, its guilty of criminal stupidity.

If the banks are so scared to show what they own on their balance sheet - that suggests its pretty ugly stuff.  Stuff that may have zero liquidity in a 2008-style crisis.  Gosh, its such fun having our deposit-taking FDIC-insured institutions gamble with our deposits like this.  And it always ends well, doesn't it?

One truly tragic note: this timeseries is not available on FRED.  There are MANY "repo" timeseries on FRED, but not the one that mattered - this daily REPO transaction timeseries for the NY Fed.  I had to download some lame CSV file and display a chart inside a spreadsheet.  Its all fine to dress up your balance sheet, but when FRED doesn't have the series, that really pushes me over the edge.

I'm going to write them and complain.