Saturday, December 10, 2011

MF Global Opens The Door To Systemic Collapse

A few weeks ago a clearing house named MF Global went bankrupt.  It was a large firm run by John Corzine, formally of Goldman Sacs and formally in charge of the state of New Jersey. 

We found out after the firm went down that Corzine and his traders had placed enormous bets on European debt with leverage and as European bonds imploded over the past few months they did not have enough capital to keep their doors open.

Financial institutions have failed on a regular basis for hundreds of years (up until 2008 when.....oh, don't get me started) so the bankruptcy was initially not seen as a major event.  However, after the bankruptcy news began to spread that some of the clients were unable to access their accounts and get their capital back.  It turns out that MF Global was betting on European bonds with clients money on deposit and now billions of dollars have gone "missing."  Corzine testified yesterday saying simply, "I do not know where the money is."

Many of these contracts were for commodities purchased through the CME.  It was always implied that in an event such as this the CME would immediately step in and make the accounts whole to keep trust in the system.  However, when it came time for the CME to step up they went silent and turned their back on the customers. 

For more information on these events I would strongly urge you listen to this interview with Gerald Celente, a client who lost a considerable amount of money, and this interview with Ann Barnhardt who has shut down her commodities firm because she can no longer trust the exchanges.  She does not feel comfortable investing her client's funds in the financial system and she is closing her doors.

I discuss this now not only because I feel bad for the customers that lost their funds but because we have an entire financial system that is based on trust.  Everything is interconnected like a massive spider web around the world and if one small portion of the web breaks or even if the other members believe a portion of the web cannot pay you have the possibility of "systemic risk."  This means the entire financial system can implode.

We are moving into a time where things are going to get worse in the short term.  It is important to understand that as an investor, employee, or business owner.  We have gone on a 40 year global credit binge in consumer, business, and government debt and now the bill is due. There is not enough capital on the planet to even come close to covering the bill.  It is similar to someone who runs a massive credit card balance for 40 years.  Now the bill is due and the credit is cut off.  In general do you think things will be better for that person in the short term or worse?

The question is how will this period play out?  There are endless discussions which I follow closely regarding an inflationary or deflationary outcome.  There are discussions that a global depression will lead us to war, as it has done every other time in history.  Now with the MF Global bankruptcy there is a third option back on the table, one that we have not seen since the week after Lehman Brothers failed and confidence left the financial system completely.

That is of the financial system itself imploding.  Global systemic risk as if the entire system had a heart attack.  Everyone is now looking over their shoulder wondering who may be the next MF Global.  Banks, hedge funds, pensions, insurance companies, governments, and sovereign wealth funds all have their money spread across multiple institutions.  They must all now worry that one could fail and an entity such as the CME may turn their back on the implicit guarantee on their funds. The scenario is similar to the concerns around the world that the United States would not step in and guarantee or nationalize the bonds of Fannie Mae and Freddie Mac during the summer of 2008.

Back in March of this year, when the tsunami hit Japan, the Japanese Yen (their currency) began moving violently higher in the FOREX (currency exchange) markets.  For reasons I don't have time to get into here this had the possibility of creating a meltdown in the derivatives market due to something called the "carry trade." 

That night on my way home from work I stopped at the grocery store and I bought water and enough food to last 3 to 4 weeks and I took some cash out of the bank.  I called my immediate family and a small handful of people that have a strong understanding of the financial markets and advised that they did the same.

Now, at this point in the conversation I probably will have lost credibility with 95% of readers and have become "one of those people."  However, at the time, while the world was casually going on with their business, we were hours away from a meltdown.  There was a global central bank intervention of massive proportion to get the situation under control.  Sound familiar?  I'll get to that in a second.

So what happened next?  Nothing.  I went back to the bank to deposit the cash, and I drank clean water and excellent food for the next 3 weeks. 

This past week many believe we were close to another one of those moments.  We had a global central bank intervention where the Chinese central bank and the European central bank both cut interest rates.  The Federal Reserve cut rates on their "swap lines" which means they will lend dollars overseas at a reduced rates to funnel liquidity into European banks.

With the MF Global situation handled the way it was, many of the most intelligent market participants who have a strong understanding of derivatives now have no idea what comes next.  The financial system shutting down is now back on the table.  If that happens, what does it mean?  It means for a period of time there will be civil unrest, little cash available at ATM's, empty grocery stores, and no gas at the stations. 

In terms of your savings and capital, I would review the following article which discusses how to protect yourself from waking up one morning with your money "gone" like the customers who worked with MF Global.  The article is titled The Logic and Logistics Of Market Flight and Repatriation.  The author discusses the article this week in an audio interview, which can be heard here.  Her segment begins 37:15 into the program.

I do not believe a systemic collapse is the most likely scenario or even a likely scenario, but with the option back on the table it would be wise to stay stocked up moving forward on food, water, and take some cash out of the ATM.  What happens if nothing happens?  Nothing.  You just have some extra food, water, and cash.

I spend most of my time discussing how this scenario is going to play out under the regular course of action (a deflationary deleveraging or an inflationary deleveraging) of the global debt bubble we now face.  I do my best to get your portfolio prepared for both scenarios and monitor the situation daily to determine which direction we are headed.  At this point it is still impossible to know because the direction of global markets are exclusively in the hands of our politicians and central banks.

A truly terrifying thought indeed.

Friday, December 9, 2011

ECRI's Achuthan: The Coming Recession

The market has moved violently up and down all year in a wide trading range, and today we sit today right about where we were when the year started.  During up swings in the market optimism turns up and "the recovery is back in place."  During down swings pessimism returns and we are "heading into a recession."

It is important to listen to economists and financial analysts who do not change their opinion based on a short term movement in the market.  One of those economists is Lakshman Achuthan, chief operations officer of the Economic Cycle Research Institute.

ECRI's leading economic indicators triggered their call on September 30th that the United States would re-enter a recession within 3 quarters (based on the classic definition of 2 quarters of negative GDP).  He has come back on Bloomberg television today to re-confirm that outlook. 

My personal outlook is that the United States entered a depression in December of 2007 and what we have seen since are smaller reflation/deflation cycles within the larger trend.  I believe we have one more major deflationary period ahead of us before the final reflation of the current depression.

Achuthan on the next leg down:

Thursday, December 8, 2011

Running Out Of Oil

For a longer and more descriptive outlook on what the future of energy looks like I would recommend watching Chris Martensen's Crash Course In Review, a speech he gave this fall on where we are today in the peak oil story.

Bob Prechter Discusses The Next Wave Down

One of my favorite market analysts, Bob Prechter, took some time to speak with Yahoo finance this week about the next leg down in the secular bear market, the correlations to the Great Depression, and how it all ties into the negative social mood.

Prechter's Elliot Wave Theory monthly newsletter is must reading for the serious investor.  I have been a dedicated reader since February 2009 (when they called the bottom in the stock market and said we were ready for a huge bear market rally).  Elliott Wave believes that the bear market rally is now reaching the finishing point and sees the next leg down as far worse than what we experienced in 2008.

"Who Is John Galt?" - Atlas Shrugged

I took some time last night after a long day of work to watch the recently released "Atlas Shrugged: Part 1" on DVD.  For those unfamiliar with the story, released in 1957 by Ayn Rand, it is a look into the future at what happens to a society when government begins to take over all aspects of life and the business people there begin to give up and just walk away.

The setting of the movie is 2016 and it opens showing the DOW Jones Industrial Average crossing under 4000 and oil prices at $137 a barrel due to problems in the Mid East.  The government begins imposing price controls and goes after the "wicked capitalists" who brought the country down.

The story is so similar to what is taking place today and what is ahead of us that it is almost eerie that it was written in the 1950's.

Occupy Wall Street has become the rallying cry around the outrage of today's class warfare.  Our country has experienced a massive shift where the wealthy (the 1%) such as doctors, lawyers, bankers, and business owners have become super rich.  The middle class has stayed stagnant in terms of wage growth and is now slowly fading away as jobs continue to disappear in America.

I am a believer in free market capitalism.  I am not a part of the Occupy Wall Street crowd, and I look up to and hope to one day be part of the 1% in America in terms of entrepreneurship and new business creation.  I want to be part of the group that creates jobs, not because I want to create jobs first, but because it will increase my business productivity, profitability, and simultaneously increases the country's.

Unfortunately, we no longer have capitalism in our country.  We have crony capitalism.  I saw nothing wrong with the greedy bankers who created enormous profit machines from 1980 up to 2008.  I did not have a problem with the massive bonuses for the CEO's, the traders, or the bond originators.  I saw nothing wrong with the large bonuses and reckless decisions made by GM or Fannie Mae.

My problem was with the government response when they failed.  My problem lies exclusively with the bailout and the continued backstop in place by our government as they move forward as zombie toxic balance sheets.

I have said over the past few years that when the public understands what they have done to our money and country the anger would be beyond belief.  The Occupy movement is the first manifestation of that anger which will continue to grow as our economy gets worse and the government continues to grow larger and more "involved" with all business.

I said repeatedly that it would get so bad that I even worried for the safety of the bankers who stole our money and then were bailed out by us to ensure their bonuses continued uninterrupted.  This statement seemed absurd at the time, even to me as I was writing it.

Yesterday, a package was sent to the CEO of Deutsche Bank, one of the largest banks in Europe, with a return address from the ECB (European Central Bank).  The box contained a bomb surrounded by shrapnel.  Fortunately, it was intercepted before getting to the CEO.

This is only the first step of what is to come.  I wish the people could see through the smoke and understand that it is not the banker's fault they were and continue to be bailed out, it is our government's fault for giving them the money.  They need to leave New York and march toward Washington.  That is the epicenter of this entire problem that is about to get much, much, worse.

For those that have not read the book or seen the movie Atlas Shrugged I would recommend both.  Ayn Rand was the teacher of our former Federal Reserve chairman Alan Greenspan before he entered Washington and was turned to the dark side. 

I believe that there is no stopping the train wreck ahead as we continue moving 175 miles per hour toward the cliff.  However, you personally and your family have the ability to get out of harms way (as much as possible) to get through the aftermath.

Tuesday, December 6, 2011

Update On A China Ghost Town: Ordos

The video below provides an update on one of China's now famous "ghost towns."  The biggest threat to China is not falling prices but the jobs lost related to the real estate sector.  Famous short seller Jim Chanos has commented that real estate and related development makes up close to 25% of their entire economy.  With prices now continuing to fall month over month, the shock waves will be felt around the world.