PAPER vs. PHYSICAL: The Amazing Amount Of Leverage In The Silver Market

https://srsroccoreport.com/paper-vs-physical-the-amazing-amount-of-leverage-in-the-silver-market/

MF Global and the great Wall St re-hypothecation scandal

This is one of the best legal opinions I've read on why MF Global collapsed.  Our global financial system has gone off the rails, and the collapse of our fractional banking system is inevitable.

http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/

Clinton throws Rubin and Summers under the bus

Former President Clinton finally throws Rubin and Summers under the bus for leveraging up our financial systems with toxic derivatives.

http://blogs.abcnews.com/politicalpunch/2010/04/clinton-rubin-and-summers-gave-me-wrong-advice-on-derivatives-and-i-was-wrong-to-take-it.html

Derivatives

Our government financial experts really are clueless. The over-expansion of leverage and derivatives of collateralized mortgages caused our financial crisis. Now the broke FDIC wants to collateralize bad loans from collapsed banks, package them, and sell the securities to the markets. Talk of financial reform is utterly worthless if the causes of credit bubbles are misunderstood.

http://www.cnbc.com/id/35055601

Bubble in Treasury bond market?

Although the TBT exchange-traded fund (ETF) is not an efficient proxy for rising long-dated US Treasury bond yields, it is one of few investment vehicles available to retail investors.

http://moneynews.com/Headline/Experts-GetOut-Bonds-Bubble/2009/12/31/id/345127

TBT is a leveraged bet against the long Treasury ETF iShares Barclays 20+ Year Treasury Bond (TLT). It attempts to double the inverse of the returns of TLT, using options and futures contracts. Theoretically, if TLT rises 1%, TBT should decline 2%. Likewise, if TLT declines 1%, TBT should rise 2%. In essence, if 20+ Year Treasury Bond yields rise by a certain amount, the price of TBT should rise twice that amount.

The reason why TBT underperforms its intended goal of achieving these returns is due to performance drag from the derivative contracts of the UltraShort fund being rebalanced every day. This causes isotopic decay, so the ETF never reaches previous highs--even if the directional bet is correct.

The best way to profit from rising yields in long-dated US Treasury bonds it to short sell them in the futures market, which is unfeasible for most retail investors, due to volatility risk and excessive leverage.

In summary, the TBT ETF trade will be profitable short- and mid-term if long-dated bond yields increase, but it won't be as profitable as expected long-term. Of course, the best way to protect yourself from rising interest rates is to lock in historically low interest rates with a fixed-rate mortgage.

Disclosure: long TBT shares.

RIP Helio Gracie

In one of my few non-financial or non-technology related posts, I just wanted to post a blog in honor of Helio Gracie, who passed away in Rio last night. Why is this important--in light of the fact that he didn't teach many of my classes, as he was more of an honorary professor at his son Rorion's Gracie Academy in Torrance, CA? Or the fact that I didn't know him well, but was taking classes with his famous sons Rorion and Royce far more often?

Simply put, the 95-year-old was a pioneer in every sense. As one of the original founders of the Brazilian jujitsu (BJJ) clan, he developed a unique fighting style which helped narrow the gap for the weak, small, and non-violent, enabling his students and followers to not only defend themselves, but also neutralize an aggressive opponent. At 120-140 pounds, he would regularly defeat the world's toughest men in the world, in a no-holds-barred challenge fight, with no rules, no gloves, and no regrets.

He often defeated opponents twice his size, in a then-unconventional fighting style that would leave opponents gasping for air, or pleading for mercy (by tapping out and declaring a loss). For 80 years, this fighting style was unknown to the rest of the world, until son Rorion raised the exposure on these underground cage fights with the creation of the Ultimate Fighting Championships, now a legitimate, multi-billion-dollar industry. Younger son Royce won 3 of the first 4 round-robin competitions, wearing down opponents despite disadvantages in weight and strength.

But as a true contrarian, Royce and the rest of the family clan continually beat their opponents, using BJJ's expert use of leverage and technique. David really could defeat Goliath--consistently. At the time, the world was shocked that these skinny Brazilian guys could subdued world-class athletes into submission. 16 years later, BJJ is now a staple of any mixed martial arts fighter, thanks to Helio Gracie, and by extension, his sons' teachings. BJJ was no longer a fringe martial art in the endless debate of which art was more effective than another--let's settle it in the ring or cage, and let the results speak for themselves. Well, BJJ spoke, and BJJ won the debate.

But Helio's impact to me is even more meaningful than learning the perfect armbar or rear naked choke. He represents the little guy who persevered into a world-beater, despite obvious disadvantages in size and strength, against a backdrop of ridicule and skepticism. He conquered the best fighters in the world at their own game.

Today, financial markets, societies and even the sovereignty of countries is at risk. If huge money centers have collapsed, what chance does the little investor have in securing his/her financial future? If the game is rigged to benefit the Goliaths--and even some of the Goliaths are bleeding, how is the David supposed to survive?

Helio Gracie has taught me a valuable lesson, and that's to approach life with vigor, independent thought, benevolence, and a thirst for learning and teaching--traits my own later father taught me also. Most importantly, he resonated with my refusal to accept conventional wisdom as truth.

If some deem you "too weak, too small, too dumb, too poor, too unskilled", do not accept that is truth--define your own path. Even if the bully outweighs you by 50 pounds, is stronger, quicker, and faster than you, you can still defend yourself and even teach him a lesson--if you have the patience and determination to learn and work to counteract his aggression. But the most important lesson of all is to somehow allow your defeated opponent to channel his aggression in a positive manner. But protect yourself at all cost. That applies in the real world of self-defense.

In the fun world of sparring, it teaches you that no matter how good you think you are, there is always someone better than you. Better to be humble in that instance. Respect your sparring partners; they could well be your best lifelong friends, and there is honor in tapping out, as well as tapping out your sparring partners. It's not so much an admission of victory or defeat, it is a show of respect for the other person.

In a tournament setting, when all eyes on you and your opponent, animal spirits take over--the fight or flight response. In that environment, there is only one option. And that's when the mind has to calm the body down, blocking out fears of injury, reinforcing strategies and endless hours of training. You tell yourself, despite attempts to moderate hyperventilation, "hey, stick to the game plan, you're prepared mentally and physically, believe in yourself, just go out and do what you do. By the way, have fun while you're at it."

Helio--thank you showing me the little guy can win if he sets his heart and mind to it. Thank you for setting me down the path of self-reliance and self-belief. Rest in peace.

Greg

The return of the gold standard? Why gold is poised to explode...

Blue-collar, white-collar, manufacturing, services, etc.---it doesn't matter what type of jobs--the more the merrier, altho it would be nice to have higher-skilled job growth.

If you think about it, who invented the internet? (No, it wasn't Al Gore). It was a British scientist educated in Switzerland (or it was a Swiss educated in the UK). But as far as monetizing the technology, most of the $$ were generated here, as well as accompanying technologies and services. It's okay to be a consumer-oriented economy, as long innovation continues domestically.

I think that's what dawg was sarcastically inferring--we can't go backwards.

To be honest, the only way we go back to real economic growth--without inflation and the abuse of leverage, is to go back to the gold standard. History has shown time again that when sovereign governments abandon gold-backed currencies, paralyzing hyperinflation becomes the unintended consequence down the road. With fiat currencies, central banks are permitted to print money unjudiciously--most of the time to try to dampen deep recessions (sounds familiar?). Deflation and avoidance of The Great Depression category 5 is the concern du jour, but the Coming to Jesus day will arrive soon enough, and we will all pay for these bailouts, literally with higher taxes and a higher cost of living (and accompanying lower standard of living).

Think about it: with our reserve banking system, a 20% run on demand deposits would make every single one of our major banks insolvent. This is not just a mortgage crisis, a credit crisis, etc.--it's a crisis of confidence. And with flimsy fiat, finance-based economies, confidence is everything (since there is no gold backing up the currency).

Of course, resetting of a new gold standard would mean a level of around $1500/ounce, which would cut everybody's cash accounts in half, but that's what it would take. It happened in the early 30's, when FDR declared gold would be set at $35/oz, instead of the previous $20/oz. The federal government then went on to confiscate all individually held gold (with the exception of wedding rings), or citizens risked 10 years of prison and a $10,000 fine. All that gold is now at Fort Knox. This was due to the profligate Treasury printing presses during the easy money 20's, which in turn caused the Great Depression of the 30's. (See any parallels?).

I could go on and on about what's going on with the currency and gold markets right now, with the manipulation and placating of short-sellers, but I'll summarize with this: if JP Morgan and Citibank are openly predicting $1500/oz gold for next year, and if they are accumulating gold bullion as we speak (as are Dubai, Saudi and Chinese governments), then why are they selling short gold? Could it be they want to keep its price artificially low, in order to boost their purchases? Thing is, it's a dangerous parlor game, as short sellers have to deliver against futures contracts, and there are rumors that these shadow contracts entail no deliveries. But that is precisely why the two major banks are accumulating physical gold bullion, because when the shorts are covered (i.e. gold explodes upward in price), their inventory will (partially) offset their losing sales contracts.

Another compelling case for gold: The Treasury is printing trillions of dollars for bailouts--equal to half the US GDP. What happens when you have oversupply of a commodity--including a local currency? It removes scarcity, plummeting that currency. What happens when your currency is devalued? Gold soars--it's a mathematical reality, not some wild rantings of a gold bug.

Look, gold has been the absolute worst investment vehicle from 1980 - 2000.

But in the 70's, it was the absolute best--even with inventory costs taken into account. Gold went up 23-fold in that decade. Gold mining shares went up twice that level. If many prognosticators are saying this run is much worse than 73-74 and 78, what does that say about the price of gold? Does anybody think post-2008 will be a replay of the roaring 80's and late-90's stock market booms? Or are we headed for a very subdued 70's-like stagflation scenario? You decide.

BTW, the Big 3 is old news, despite the headlines. I called their demise 18 months ago, and their shares are down a nice 98%. It's done, finito. The next shocks will be a result of de-leveraging and the precipitous decline of most currencies and US long-term debt. Whoever buys US 10-year notes or Treasury bonds is going to get crushed. Taking on all that risk (after all, one could argue the US government is insolvent), and yet earning 2% on your money? When inflation rears its ugly head, and interest rates are in the double digits, those bonds will be worth less than Monopoly money.

What happened?

The stock market, and pretty much every other assets are plummeting due to hedge fund, mutual fund, and private equity firm redemptions. Investors are bailing out, so these funds have to sell assets--any good assets to raise cash. They can't sell the bad assets because no one wants them. So they are unloading good assets at low prices--that's why value players are salivating, but they keep getting burned because assets at cheap prices are getting hammered and getting even cheaper. This tug of war between bottom fishers and forced asset sellers is what's causing the high volatility. Overall, tho, the sellers are winning, as they are panic selling in droves, swamping any brave buyers. Eventually, these buyers lose out (at least in the short term), as even the savviest value buyers are seeing their entry points as being too early and too high, despite metrics that suggest they are good buys. Ultimately, over the long-term, these value buyers will be proven correct, but for now, guys like Buffett and Soros have seen their positions drop by more than 10-20%, despite buying assets that have already dropped more than 50% already.

For example, if a solid company's share price has already dropped 80%, it may seem cheap. It may be, but that doesn't preclude it from dropping another 50%. Let's say a stock is at $100 last year during its peak. It is now at $20. A Buffett buys at that price, thinking he's getting it at a bargain. He may be right (based on projected earnings growth, or more correctly, discounted cash flow), but that doesn't mean the stock won't drop to 10 before bottoming out, say next year. Ultimately, if the stock is worth $50 a share, Buffett may ultimately win out (he usually does), but only if he has a long-term view. While he may be annoyed, and since he's got plenty of cash, he can wait it out.

Realize that the fixed-income market dwarfs the equities (stock market)--that's why the subprime mortgage debt bomb obligerated everything around its wake. I wrote a quick email to some folks recently:

"That's not entirely correct. Derivatives allowed investment banks to transfer that risk to shareholders and get it off their books. When default rates on sub prime mortgages reached inevitably high rates, the credit default swaps (CDS) blew up, as they insured the sketchy collaterized debt obligations (CDO).

These CDS's are basically contracts which insured these mortgages against default--in this case, highly-risky subprime mortgages to marginal borrowers. The problem was that insurers like AIG didn't charge enough premium to insure these mortgages, as everybody assumed California real estate prices would always go up, and that few borrowers would actually default. With home prices/income ratios above 10, this assumption was unsustainable. And because these derivatives were highly-leveraged ($1 could control $40 or $100 due to Wall Steet's repackaging of said debt), if those assumptions turned sour just a little bit, whatever little equity put up as collateral disappeared. And once the selling of assets to unwind from those positions began, the vicious spiral just fed upon itself, as everybody had to de-leverage from their overly leveraged positions. It became a Category 5 game of hot potato, and the investors (hedge funds, pensions, institutional money) got burned, while chasing the high yields during good times.

Wall St. did a great job of selling this "AAA" paper as non-risky, when they were extremely speculative. The ratings agencies were unknowing perpetrators of this shell game. Wall St. repackaged these @#@% loans, and the ratings agencies gave it their blessing as low-risk, investment-grade securities. What compounded the problem is that some of this paper was created without even any mortgages to back them.

Derivatives by definition use leverage. It can be useful for hedging strategies, but hedge funds didn't use them as hedges--they used them as levers to squeeze out more returns. When the bets turned against them, they had to sell assets to raise cash as investors headed for the exits. This de-levering is causing markets to tumble.

I could go on ad nauseum, but I think you get the picture. I don't worry about what happened--I was able to avoid most of the roadkill, as I was out of the market in June. I am concerned about what's going to happen next, and I'm afraid the worst is ahead of us. We are going to see a carnage unseen since the Great Depression, as the unwinding of positions is not over yet--not even close. Thankfully, I've got a strategy in place for me and my clients which will enable us to not only survive this crisis, but also profit handsomely from it.

Without going into details, it does involve certain currency plays, financial institutions here and abroad, and various asset plays, including equities (surprisingly). More shoes will drop, and there will be bigger shocks and bank failures, some unfathomable only a few months ago. I predicted GM would be insolvent as far back as two years ago when people thought I was crazy (all documented in my blog). Last month, CNBC splashed it on their headlines, and now CNN has it on theirs.

I can send you a link to my blog, as well as what to Google. I will not do the research for you, but I will point you in the right direction. I will tell you the strategies will not be mainstream or conventional, but then again, conventional hasn't worked, has it?

I will give you this thought in case you think I am ringing alarm bells unnecessarily. Everybody is bitching and moaning about a $700 billion bail out (which is less than $1 trillion). Recall I mentioned CDS's as basically insurance--only they were labeled by Wall St. as "swaps" in order to avoid regulation (insurance contracts are heavily regulated, and you can't pile leverage on them). They were creating these insurance contracts with no regulation, and hence, no reserves to cover them. Guess how many swaps were written, and how big the derivatives market is? Some are predicting over $500 trillion! (A definitive number is difficult to calculate since these products were so complex, were sold so many times, and generally not transparent). In other words, there's no bailout that will mitigate this deleveraging. The current band aid will only prolong the process, but the perfect storm will come down upon us--soon."

As an edit: we've lost $10 trillion in equities market capitalization (net worth) in the last two months. That figure will seem minuscule when these derivatives blow up in our faces, and when Paulson et. al will no longer be able to hide it from the public. Read his past comments over the past year and a half. You will see he has hoodwinked us all along.

Bailout or No Bailout?

I'm from the school of let 'em die. If you and I make poor investment decisions, we have to suffer the consequences. These executives applied far too much leverage, took on way too much risk, and after plundering their firms, they get golden parachutes. Where's the accountability factor?

I'm all for the founders of Google earnings billions because they have created a lot of value for consumers, business, shareholders, and employees. But when executives run their firms to the ground, they should not profit from said disasters, whether their firms get bailed out or not. A meritocracy rewards those who add value, not those who detract from it.

As much as I hate that the taxpayers bear the brunt of rescuing an AIG, I reluctantly agree they should probably be bailed out, because if they implode, the cascading illiquidity would essentially freeze up markets worldwide, as the sovereign funds, hedge funds, pension funds, mutual funds, private equity firms, and every financial institution would suffer a loss of confidence in the US financial markets, which would bring about a dark age analogous to the Great Depression. No one wins in that scenario, save the few bottom fishers with cash and balls to step up and play in the deep end of the pool.

But make no mistake: the intended recipients of these bail outs are the big institutions--not necessarily the common man, altho we all are in the same boat.

Having said that, there is a downside to this massive injection of liquidty--re-inflation. Interest rates should be favorable short-term, but when oil approaches $150 a barrel, when gold flirts with $1500/oz, the Fed will have no choice but to raise rates. Again, the lesser of two evils, but still an evil...Eventually, the economic shocks worldwide and the domestic slowdown will eventually dampen demand and cost of living increases, but until then, gold seems more stable than the US Dollar.

You know the world is turned upside down when there is more concern about the USD than the Brazilian currency, Russia has a flat tax, and the US has the 2nd highest tax brackets in the western world. Our leaders have forgotten what has made this country (and California) great.