Trader Note

In a news release: Ride the momentum, don't puke out on the pause.

Market Failure Now

Will the market collapse now? Or Now?... How about now? If you have been looking to get short this market, your finger hovering over the keyboard waiting, you are doing the “now” dance. Being short a BTFD market has been disastrous to a trading account. Every central bank manipulation into the market has moved the markets away from following real price discovery to trading central bank chatter. The more markets follow rumor of money printers, the less underlying fundamentals matter. The BOJ this week scared the markets. This created a sell-off in Japan that flowed through into USA trade. If you were short that action it was a challenge because the USA market was slow to respond. Being short this action should just be a no-brainer, but fighting machines is still a challenge. Now, every trader should be asking themselves if this is the end of the “new high” markets or if it will move higher after the weekend. If we assume that markets are actually looking at underlying fundamentals, then we may be fooling ourselves into bad trades. However, let’s look at some of the fundamentals. Markets are overvalued. Shares are still trading at high prices relative to PE. If companies are eking out small gains in a “recovery” market, then they will be performing at a loss in failing markets. Constriction of money supply also equates to constriction of available funds. This equates to diminishing money available to create profits. So long term prospects for struggling companies should be negative which means that funds that follow buy-and-hold will likely be losing money. Investments that lose money often have investors exiting, which means less cash available to participate in any reversal, so less money to buoy falling markets. Energy Markets Oil price is still very low relative to secondary deposit production costs. This means that many fracking companies are still operating at a loss to exploit reserves. OPEC producers are not limiting production so price stability at higher levels in the near term is unlikely. Many of the OPEC producers are struggling with debt and trying to compensate for smaller oil prices with higher production size. Iran, who was banned from selling oil internationally until recently, is desperately trying to fill every available vessel. China demand will suck some of the supply out of the market, but that won’t help the American frackers that think price will save them. For fracking, new wells must be added constantly to only maintain output levels (wells diminish production quickly in this method of extraction). These companies are continuing new well production, taking on more debt, in a “double down” mentality that assumes that they will either survive to sell at higher prices or will be just as bankrupt at twice the debt load as now. That debt is being carried by investors, and following the heat map of high yield debt indicates that there isn’t enough investor demand to carry this debt. Investors are starting to realize that bonds in bankrupt companies are mostly worthless, so even profitable extractors will find it challenging to maintain supply by increasing debt. The oil price WILL go higher, but not until many producers have failed, thus removing supply from the market. The price increase will likely occur after supply is reduced at a time when that supply is probably the most critical. The investors that took-a-punt at oil bonds will be burned, and new investment will struggle. Energy demand has only increased over time. With increasing population and desire for higher living standards, this demand for energy will continue to increase without additional large scale supply coming into markets. New technologies will not save the economy. Efficiencies in turbine design for power production do not yield exponential growth but are minute percentages from 100 year old technology. Adoption of solar and wind technology is not given sufficient subsidies (unlike coal and oil) to increase adoption. Exciting advances are being made in nuclear tech, but wide scale adoption will likely have a negative news cycle and thus limited funding based on public perception. The Chinese, who are not subject to such limitations, have been working on small scale Thorium reactors. These reactors have the potential to supplement world power demand into the future. This assumes that the development is successful. It also assumes that suppliers can produce these reactors fast enough to meet demand. This demand will likely surge when the oil price is again over 100/barrel, which is in line with the Chinese development timetables (2018 estimate for a working design, but no market release scheduled yet). So expect a big move higher in cost of energy before addition supply possibilities come into the market to fill demand. Investing in potential emerging producers is only a good option if you are a member of the Communist Party in China. For solar and wind power, government subsidies are critical to market demand and cost of production. Trading government subsidy potential moves is foolish because the government is more likely to subsidies oil while removing subsidies from any perceived green power. Liquid fuel reactor design in the USA was developed in the 1960s and abandoned for the less safe breeder reactors currently in use. The funding for development of nuclear power in the USA has been nearly nonexistent outside of military applications. So, expect the Chinese to corner that technology and market before the USA. India is the second lead in development, but woefully underfunded compared to the Chinese program. So best practice would be to wait for a Chinese company’s successful production of a working design and buy the actual reactor. Buy into the company that installs this equipment, or the company that manages it, because after installation these machines will be printing money (input fuel costs is minimal compared with output power supply). To trade energy: For now you should sit in cash. In short: don’t bother putting money on power production yet. After the share market drops hard then look for power systems installers and management that have a forward looking perspective. Long term, higher oil price is expected but currently the share price of producers is overvalued. Selling oil producer debt may be an option if you would like some higher risk assets (just check the fundamentals to make sure you are selling the lame horses). If you are trading in tech, then small bets on rare earth miners may be an option. Commodities Commodities prices are on the rise. This is to be expected with currency devaluation. However, the vast supply of money being pumped into markets by central banks has not pushed the tangibles to an equivalent price. This indicated that there are market participants actively pushing some prices lower (like gold and silver manipulation to silence the canary-in-the-coal-mine of inflation). As investors hunt yields, commodities are trading in large volumes (for example: China rebar trading). Underlying fundamentals (weather, supply, demand, shipping costs, pests, input chemical costs, etc.) are smaller drivers in the market than futures chart moves viewed in dollar value. If taken out of abstract ones and zeros, real value of commodities relative to work/input materials is quite undervalued. However, if there is an algorithm that indicates “selling on Tuesdays,” then those prices will move lower on Tuesdays. This creates more algo selling on Tuesdays and the cycle becomes self-fulfilling. Longer term trades avoid some of the computer noise, but also require forward looking and fundamental tracking. As commodities markets can change quite quickly based on weather and production estimates, it makes these trades challenging. China has been investing heavily in agriculture and mining. Many of these are massive project are in Africa, Asia and South America. They have free trade agreements signed or in the works with many of these partners. They also have a “hands off” approach to local politics which makes them well received. In exchange for costly infrastructure (which saddle local economies with high levels of debt) they have nearly unlimited access to resources. These resources are being imported back into China to fuel growth and production, regardless of demand for those resources. China has a long term growth plan to secure resource wealth which means that China is a massive buyer underlying commodities trades. Trading commodities: Be aware that commodities tend to spike higher on bad weather and failed production numbers while any move lower often rebounds enough for a scratch exit. This is because it is easier to overestimate harvest and production volumes than it is likely to surprise on the up side with massive yields. Mining machinery is more likely to break and workers strike (lowering production and removing supply) than producers are likely to find a massive oar veins that are cheap to exploit. Factory farmed animals are more likely to suffer a failure (Like Ped-V in hogs) than they are to increase their breeding numbers and food intake. So, short markets in the near term but try to maintain a long bias in the long term. Precious Metals The golden rule: He who has the gold makes the rules. The USA has been publicly pushed around by Saudi Arabia using USA debt. They are not the only holder of mass amounts of USA debt, so it begs the question which other country is manipulating USA policy. The main industry in the USA seems to be manufacturing debt, so without buyers of that debt then the Ponzi scheme will fail. If debt manipulation creates foreign policy, then how much debt does China need to annex Japan without world intervention? Outside of computer defined currency figures, gold is still real money in a hard and tangible form. USA stockpiles of gold probably don’t exist. They have not been audited in over 50 years. Germany and France repatriated some of their gold from American vaults, but the mad scramble to find that gold only yielded half (or less) of what was owed. Much of the USA’s gold has been loaned to bullion banks to sell into market and attempt to skim profits from shorting. These bullion banks are selling physical into a paper market. They will one day need to return physical gold to these vaults (assuming they don’t declare bankruptcy and hope for a government bailout). However, that gold is gone. China, Russia and most wise countries in Europe have been acquiring gold. China has been quietly selling USA debt into the EU market (exiting a failing position) and acquiring gold. The number flows into Russia, India and China indicate that demand is far out stripping the available yearly mined supply. This gold has to be found somewhere, so the question is: "Which New York vault did that gold exit?" More to the point: "Who is on the hook for having delivered gold into markets?" and "Who will need to be repaid but won't be paid?" To trade gold: Short term chops out of the paper market can be lucrative. However, longer term make an investment in physical bullion. Put that bullion somewhere that you can access it but governments and banks cannot. Share price volatility has been lucrative. Longer term, shares may be a potential boon assuming that your assets are not confiscated from your account during a bank failure. Debt Markets USA private debt seems to be underwater again. The specific debt is student loans and auto loans. This is a secondary high risk debt market which will have similar consequences to the failure in the housing market previously. The housing market collapse was precipitated by high risk debt and bank manipulation of risk figures. The banks are still manipulation risk numbers to generate massive profits with account holders and tax payers on the hook for paying off these bank failures. The banking derivative book is so massive that the USA could not conceivably money print their way out of it. Too-Big-To-Fail has only gotten bigger. When those derivatives books melt down, the government will try to bail out these institutions to avoid world trade being seized up. The USA cannot manufacture more debt to fulfill that need, if no liquid countries want to purchase that debt. China has enough USA debt, and Russia (Putin) won’t buy it. Saudi Arabia and Japan can’t afford it. The rest of the Middle East would likely enjoy the financial collapse of America. African and South American countries don’t have the cash to cover that scale of debt. The buyer of last resort would be the EU, but they will be facing the same situation because a TBTF bank failure would also take most European banks with it. The final option for governments would be to sell assets, namely gold. Unfortunately, there is not enough gold in the vaults to sell. Even if every account and every vault was drained, there still would not be sufficient capital to cover a collapse in TBTF. If the USA is appearing to be bankrupt, then expect every debt holder to sell USA debt into the market which would farther collapse the USA bond price. This would move the USA from world power to banana republic in less than a week. A sell-off assumes that any market would be allowed to open. Without open markets, assets become illiquid. Sellers would then be willing to take ANY available price to be able to get out before complete account devastation. Locked up markets means that even using options contacts for an escape would not be possible. As markets reopened, the HFTs would ensure that they traded limit down. Good luck trying to get a human order into those markets at ANY price. Lies you might tell yourself so that you don’t lose sleep: “With any luck, we will figure out a solution.” Or “Bank failure is unlikely.” Or “I have faith in the banks.” History has shown that leveraging other peoples’ money to generate profits has always outweighed sound financial practice for banks. Every time a massive fine is paid for violation of market rules and breaking the law, remember that these are only the institutions that were dumb enough to get caught. Regulators are toothless and not sufficiently forward looking to be preventative. Most violations are not sorted out for many years after those activities have become commonplace. So, have low expectations of any potential “save.” When Mann Financial raided customer funds to cover bad trades, it was many years before any customer funds were returned. Customers with contracts for bullion in vaults had to enlist teams of lawyers just to get what they thought belonged to them. All this occurred at a time when markets were functioning and banks were still liquid. To trade debt: Take a short term small size punt on selling high yield and risk weighted debt. Expect that if you are hedging your account with bond holdings, these markets will lockup when you would most like to exit. Factor in a much lower price for an emergency exit to your risk strategy. Be aware that for medium rated debt (some corporate debt, city debt, private debt bundles, etc.) there is a real risk that the value may move close to zero. A proper hedge should ask this question: With bank accounts frozen, markets closed and international trade halted, how long could you survive? Such a collapse is a REAL risk. Hedge accordingly.

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