Sunday, March 3, 2013

Inducing people to take risk…for what?

Ben BURNanke and Mario DRUGhi want people to be motivated to take risk with their capital and not unrelated they would like them to borrow money as well. As you can see, that has been very successful as far as an initiative is concerned. Results are another thing entirely. The results are that there are people who are so starved for a return that they feel they need more and more leverage (borrowing) to get it and are now setup to be black swan’ed. People are now taking risk and then they are amplifying in hugely. Perhaps the inherent risk to people is now 4x to 8x of what it normally would be. A recent example of what happens when people take this kind of leverage is what happened when people pyramided positions in silver right into the $50 handle. That was followed by an obliteration when we gap opened in the low 40’s and proceeded to the upper 30’s nearly instantaneously.

One of the things with leverage is that you can not exactly tell how it will wind and unwind. Unwinding of leverage can happen via a rise in asset prices and closing of short positions or a fall in assets and a closing of long positions. In either case, leverage is very likely to be visible in patterns such as broadening patterns and wedges. The volatility foot print of our markets is an exact leveraged one…the house of cards is only needing a little breeze to start and a mosquito to arrive.
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