Saturday, March 10, 2012

Synthetic Derivatives and Deleveraging trigger wreck of capital markets integrity...

I have heard many excuses for this rally over the last few months. All of them are hollow because the cause of the rally is NOT purely an expression Fed monetary policy, nor has it been buying by buyers locked in cash has not been performance chasing either...if any of these were the case, we certainly would have seen some more conviction in terms of volume. Indiscriminate prices and large de-correlated/bifurcated market transactions are a symptom of both stress and leverage. The irony, however, is that money and stress is coming from the contraction of money amplification via derivatives. This is a direct and tacit fed, i guess in that respect the market action reflects that...however, to be sure, money printing and traditional market dynamics are far less of impact than money amplification infrastructure currently in place under the full scrutiny and approval of the central banks.

I was concerned at the end of the year last year the the collapse in confidence that was brought about by the selective nature of the settlement and triggering or derivatives contracts. Contracts finance is much bigger than the risk asset and debt markets...just as debt markets are much bigger then equity markets and currency markets are bigger than debt markets. However, the irony is that contract finance via derivatives is likely bigger than all of those markets combined...I have not done that particular analysis in depth however. Suffice it to say that 750 trillion + in contracts that we actually know about are floating around in a world where debt and assets don't even amount to 25% of that number. The likelihood has been that the real amount of derivatives out there is likely far bigger than we actually know about since leverage via theoretical contracts hyperbole is infinite...the panacea of a banking system hopelessly short of cash.

What HAS happened over the last months was accelerated due to the fact that during the collapse in the summer of 2011 in the European financial system and world markets...insolvent banks sold premium as aggressively as they could to bolster cash on record in their books. In fact the rate of derivatives sales from July to October was among the highest I have ever seen. However, similar to selling options naked...the cash looks good until you are forced to settle up. The privilege of nearly infinite leverage provided via contracts and back room dealing and fostered by central banks and financial elites has been unwinding as those insolvent institution have been forced to recognize their short premium positions granted via the naked short asset positions that they deliberately and relentlessly risked. The reality is that market dynamics have been totally broken because of the huge amount of indiscriminate buying required by bankrupt and careless institution suffering from attempting to fabricate their balance sheets.
Imagine if you will, as the scenario then accelerated as officials attempt to make it clear that they will stop at nothing to attempt to make sure that particular institution are not required to settle up contract obligations. Of course, if you were one of those institutions, would you not sell as much worthless premium as possible? The flip side to this has been that people who were on the receiving end of those contracts lost an incredible amount of trust for them. In fact, as I have repeatedly pointed out they went to other markets to implement a synthetic contract type insurance. For example, insuring against European default could be accomplished in a few ways, shorting EURO currency, shorting banks with exposure to defaults or shorting risk markets. However, recall that all those markets are smaller than the derivatives market...with the result being that too many people attempting to close naked premium required purchases of assets to close and people who, like the guy in the video below, chose not to use derivative markets because they no longer trusted them shorted equity assets. However, in this guys case, his bond lost 80% of its value and his short on the banks also resulted in a loss - because everyone was shorting the banks thinking it was a hedge all the while their purchasing power disintegrated because their bond and insurance portfolios were crashing. So you have a loss of buying power combined with hedges performing inversely to the assets you are attempting to hedge...and you get the most irrational 100 mile an hour bus ride right into the jaws of destruction and financial collapse.

I had previously expected that currency devaluation of some other type of central bank unwind would cause market to become totally broken...In normal markets behavior does not look like the NASDAQ of the Midcap 400 over the last several months...nor does it particularly look like last week. I had previously expected that at some point in the next few years, most likely more than a year or two in the future, currency revaluation and central bank unwinds could cause homogeneous and entirely broken activity to occur in the markets and I had designed a solution for those kinds of dysfunctional market conditions - called trade reticulation 5. However, we got the type of market condition I was concerned about much earlier than I had ever anticipated. Trade reticulation level 5 implements a volatility trading risk system that extracts all available types of alpha from the markets that it can, not just larger directional and volatility movement. Additionally, it also lowers market exposure by time weighting assets exposed to risk to much smaller principle amounts. I will be going into some more depth over the next days on this subject since I have released these new systems in reaction to these new market conditions because it has become clear that market activity is broken, systematically flawed, will increase in volatility and risk and decrease in return. Therefore, these very complex methods of interfacing with risk are things I deem necessary to function in the new paradigm that we have before us.

The financial system is totally broken, the markets are totally broken, capitalism is broken...and trust is being broken...a truly sad state of affairs.

Discordant action in markets likely to result in a thud...

Friday, March 9, 2012

Risk reversal in commodities in play...

The equity candle has reasonable odds of looking like this.

Sunday, March 4, 2012

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