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.

Develveraging is not a very orderly process...

Market sentiment at odds with reality...

The market sentiment is that overwhelmingly the markets will have a good year essentially because of intervention. Jim Rogers and (Marc Faber apparently too) thinks because of all the elections the markets will do ok…16 out of 16 analysts from big firms think the markets will return 10 to 20% for the year. This is just a stupendous statistic. All the while the divergence between the currencies continues to expand and strain the very fabric of our financial system. Despite the supposed overall bearish position of the COT open interest that apparently Rogers is using as the basis for his EURO long trade, the euro is, as expected on this blog, beginning a dramatic waterfall. The markets have not even caught up with the previous euro levels and require roughly a 20+% drop just to meet the EURO. The irony is that I think that the markets will catch up with this imbalance sooner rather than later and will do so in catastrophic fashion closing the divergence in a matter of a few days…when that happens is anyone’s guess, but THAT it happens is beyond a guess for me. Probability now overwhelmingly favors that it most definitely will happen and soon. The Dollar has begun a dramatic rise that will likely target the upper 80’s perhaps the lower 90’s in short order. The results will be as I have stated Ad nauseam - a collapse in value for all debt markets that are not able to be backed by direct currency and a collapse in risk asset prices…it will NOT be pretty. The secondary results of this will likely be more financial instability as the leverage is forcibly extracted and unwound from financial firms globally.

Equities…not as advertised...

The truth matters less than the perception of it - unless you are Ron Paul of course

The Dollar pullback anatomy...

It does not get any prettier than this.

As a note on the day, there are several inverse HS looking patterns on the SP500 and Dow for instance…that I am sure are being interpreted as breakouts today…however, the midcap 400 is most definately NOT an inverse HS and moreover finished at the lows of the day with a rather bearish candle. The underperformance of the Russell and Midcaps continues…I will post some more charts later.

Ron Paul throughout the years…atleast one politician knows many of the real reasons for our problems...

Of Inflation, Commodity Shortages and US Treasury Shorts they dream...

Failure to understand the implications of the exponential curve on real prices and demand has been a very common problem. While I have and have had great respect for Jim Rogers - he appears now to be totally confused. He has been shorting US Treasuries for a long time, as have Marc Faber and others…fundementally misunderstanding the dynamics of our system. Jim has been talking dovishly regarding China and during the last year…China equities have done nothing but go down. One of Jim’s core themes, a lot of elements of which I like, revolve around the idea that the next generation of millionaires and Ferrari drivers will not be the Wall Streeters but rather people who make something or grow something like farmers or miners. I definitely agree that, value is not created by people pushing around papers and want to see more emphasis on real value creation as opposed to theoretical value creation. However, I have discussed at length the distortions that BURNanke and many other leaders have regarding the potential for continued exponential demand. Nature is fractal and is much more powerful that any human. When demand gets too great nature solves the problem for us - that ususally does not result in higher prices for said items. Trying to preserve buying power with a store of commodities will work somewhat, but not very well…but you will be able to swap oil for gold or wheat…most likely for similar ratios as you can currently well into the future. Will your buying power be preserved? NO…I do not think so.

Now in a perplexing set of assumptions, Jim encourages investing in the EURO, a currency bent on extinction, the renminbi and the Canadian dollar. I could not choose a worse group of currencies if I tried. I do think and agree that an allocation of the Swiss Franc is appropriate…however, the Swiss Franc is still rather expensive. Where this attitude relating to the U.S. comes from, in my opinion, is related to a general theory that the US is in a tremendous sovereign debt bubble itself. Rogers and quite a few others are chomping at the bit to short Treasuries it appears - especially of the 30 year kind. There is such a huge misunderstanding here that it is almost ridiculous. Most of the biggest names on wall street have not seen the treasury rally coming and have been trying to short the far end of the curve. That my friends is just too popular of a trade. With the recent rally in treasuries, the concept is coming back into fashion again.

The reality of is that , US treasuries will continue persistently towards negative yield as the US and a few other countries are the only places in which other large investors and sovereigns can deposit gargantuan amounts of cash and reasonably expect its return. "The Bank called the United States of America" will be the theme for 2012. Any asset that is unable to backed by printable (Non IOU cash) cash will lose in value on a nominal basis - those include corporate bonds, most European bonds, junk bonds, municipal bonds, stocks and all commodities. In fact, this may very likely become a profit center for the U.S. and result in a significant positive reduction of the federal government operating budget deficit as the U.S. Treasury is able to issue bonds at negative yield…it may significantly reduce the risk that somehow the government may at any point be required to devalue the dollar as a means to settle obligations.

It is important to understand that most money that is created in the U.S. is created as credit money issued in small part by the Fed and the Government and largely by leverage junkie financial firms we call “Banks"…a small percentage of our money in the financial system is actually pure fiat - most of the currnecy in our system are credit or IOU based fiat proxies - and, yes, there IS a big difference. It is the pure fiat currency that is in demand and the credit money that has been oversupplied and can only be contracted via insolvencies and unwinds transacted with pure fiat currency.

The imbalances in china combined with their lack of transparency and additionally their economic planning, regulation and management tactics related their financial system will suffer tremendous strain because of the divergence between negative yielding sovereign debts for countries like the U.S. and the collapse in commodities prices and local GDP.

What I see is that it appears that many, including Rogers, are very confused. Rogers, for example is just all over the place…and it appears that many of his ideas are performing badly while a few of them are working. I guess this is the type of market that is designed to get and confuse the best of them. The unwind of the leveraged financial system should not offer an easily implementable investment basket now, should it?

Dollar update...

Just in the last few minutes there were a huge 3000 block of contracts triggered off symmetry and the above support level.

The EURO - not as strong as it seems...

Municipal Bonds - the writing is on the wall...

Something bad this way comes…Meredith Whitney was and IS still right…meanwhile Wall Street and the media are having a year end celebration bashing her analysis. Since things are likely to play out much worse than she presented…I wonder what the media and Wall Street charlatan's are going to focus on next to try to separate people from their money.

Here is an interview I did for The Mind of Money that references these charts.

Ron Paul…more color less distortion

I have indicated before that Ron Paul’s voting record is the ultimate barometer of his consistency and values. I don’t think there is another politician who I have seen with his temerity and capability to be so damned focused on his values and so consistent for such a tremendously long time. I have NEVER contributed to a presidential candiate’s campaign…I contributed very generously last year and In encourage you to do the same.

Even if you don’t like Ron Paul, he will shake the establishment in Washington to the core and you will also know what you are going to get…there will be no surprises. The last thing we need is more nasty surprises out of Washington’s Executive branch…