Friday, January 6, 2012

The Unwind of Gold, Silver and Leverage

This week, the financials have behaved absolutely counter to any reasonable expectation. So, have many other markets. While the Dollar has made it beyond apparent that we are currently in the process of deleveraging. What is not apparent is the process for the deleveraging. What I wanted to share in this post is what I see as the dynamics of this market. Please remember that DELEVERAGING IS NOT AN ORDERLY PROCESS.

What happens in a deleveraging, is that people sell their most valuable assets first. Then they begin closing down other positions. Ironically, many european banks are stuck trying to raise cash…they have been selling treasuries. They have also been selling gold and silver. Many other investors who have been trapped are also selling the same assets…what is most ironic is that people expected Gold and Silver to continue to WAY outperform stocks - and for this reason, there is a predisposition to attempt to lower risk by going long gold, silver or treasuries while simultaneously selling some US equities short. In the case of  precious metals, this has been a horrific trap.

Just like the patterns that befall the absolutely omnipresent and common long/short equity funds where by due to the commonness of the stategy a self-fullfilling fractal occurs and  common weak stocks outperform to the upside and the supposedly strong ones end up getting sold…we are seeing the same thing happen now. Equities have DRAMATICALLY outperformed gold and silver, among other markets, as they have been hedges based on expectations of outperformance of the supposed higher beta of the pair. Desperation is a very bad investment paradigm and more over risk avoidance strategies, just as this one, tend to increase risks rather than lower them.

In regard to treasuries, there is plenty of demand and the selling has not overwhelmed them in any way, as has occurred in silver nd gold and other commodities…however, the closing of positions has propped up equities by forcing the closingof short risk heges, while at the same time facilitating the deleveraging that is driving what will continue to be an explosive move in the dollar…likely targeting much higher levels in short order.
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