Trader Note

News Release: 1st pull back has a bit of play. (expect it to move quick after)

Coming Collapse

Ben Bernanke is no longer a member of the FOMC, but he was still out in Japan trying to convince the BOJ to print money. He told the Japanese to release Perpetual Bonds. These would be bonds that never mature, so the buyer never gets their money back. These instruments would be bought and sold well into the future with government collapse wiping the last vestige of value from it. The bond market decided to sell off on this rumor while share markets got excited by the proposal of new sources of capital infusion. That kind of investment seems really stupid to me, but so is this market based on massive money printing delaying a shakeout of the overleveraged.

Money printing robs savers of their assets and perpetuates flawed systems. By printing money, accounts are devalued because the real buying power of these assets is decreased. By increasing credit, it allows barrowers to buy into markets that they couldn’t afford with cash and rakes the banks big profits. This is the best reason to buy gold: They cannot print more of it.

As rates drop, credit markets become saturated. The most sound credit risks are flush with money, so the bankers have to seek out lower risks for a new source of lending (income to banks). This creates a flow of money down the spectrum of credit risk. As rates continue to drop, all of the sound credit risks (AAA corporate debt, low risk housing loans, etc.) are covered, so bankers have to seek less savory investment (credit) risks. This flowed into subprime credit, which is exactly as it sounds. Rates have been so low for so long that auto loans, student loans and personal loans seem to be the last refuge of bank lending.

I would have put a 90% chance of the BOE dropping rates this week (and been wrong). It may have slowed the exodus from British real estate after Brexit, saving that fragile market for a short while. It may have saved the property funds that are already facing massive redemption which will lead to a collapsing market in places like London. This contagion will now spread to other overheated real estate markets. This will likely cause credit defaults which will hurt banks. This will lead to massive banking failures of the Too-Big-To-Fail, which would need to be bailed out… again. They are only TBTF because they have been artificially inflated to even greater sizes since 2007.

The 2007 collapse was only a market hiccup because the repercussions for that market failure have been kicked down the road. In a normal market, collapse happens; The infection is removed and markets return to good health. In these markets, the contagion and behaviors that caused the stalled collapse still exist. The failure was never corrected and the overzealous investors didn’t have their accounts whipped away as should happen. Instead, money has been pushed into markets devaluing everything and rewarding the speculative bets that cause this failure in the first place. This will NEVER improve the quality of markets.

That Housing Market Failure happened nearly 10 years ago, when many of today’s traders were in college getting drunk. They may have seen that there was a market event, but many didn’t actually watch that event on a tick-by-tick basis. They didn’t feel the pain of collapsing credit and loss of their homes but instead may have lost some value on their trust account. For them, the only market they have ever known is a BTFD market propped up by massive amounts of money printing.

These baby-traders certainly didn’t feel the pain of a REAL bursting bubble like the Tech Bubble. During the Tech Bubble, everyone had a tip, and every stock with a dot-com was bid up. Many stocks had a PE of over 95 but they were all touted as great because they all had an amazing future. Most of these companies had NO assets and NO products. Everyone wanted to get rich on the market, and anyone could (but not everyone does, in a bubble).

My friend Lou was a cautious investor. He didn’t want to chase tech money but he did want to open a brokerage account during the Tech Bubble. He told the broker to put his money into “long term growth shares.” The broker put the money into dot-com penny stocks with high betas, assuring him that he could not loose. That week, the tech market collapse and took Lou’s money. This risk investing is no different than hunting yields on high risk bonds in a market filled with negative yields.

I remember the Tech Bubble very well. I was making money trading tech while going to school for an engineering degree. I was trying to get a job that would pay out some of that juicy tech money. Unfortunately, the market collapsed before I graduated, taking all of the jobs with it. I never did find that high paying engineering job.

I was in Asia in 1997 during the Asian financial crisis, trading silver and textiles. On the street level, there wasn’t much to see. Businesses traded as normal until the banks froze up, then cash was king. Real estate got hammered, as real estate speculators always do in a collapse. Markets dipped and the dead wood was washed away. Life for most people returned to normal even if currency in some countries was greatly devalued taking savings with it. Those that had taken on massive risks were washed out of the markets and forced to take day jobs. This is how a normal market collapse should occur.

In 1987, I watched Black Monday unfold in a high school Economics class. The 1980s was a time when traders and business people seem to be printing money. Risk investing was generating huge amounts of wealth. Much of that wealth piled back into the markets to perpetuate the cycle. Hedge funds had just started to use math to spread risk and it seemed to be working. Massive cell phones were used to convey spread trades to floor traders and that risk was spread around the world to every conceivable marketplace. There was really NO single precipitating event for Black Monday that can be pointed at to blame such a market failure. It just started when some people started selling, then more people started selling and then everyone was desperately selling.

Black Monday is why markets now use Circuit Breakers. Every time you see a Circuit Breaker triggered, it means that it is a potential 1987 crash. Every time a market is closed to trading, it is potentially a market being halted to avoid a crash like Singapore this week.

These baby-traders don’t know what signs to watch for and yet they are in control of these markets. They don’t realize that when everyone piles into a Buy-The-Fucking-Dip trade (that used to be Bet-The-Farm-Dude… in the previous market failures), then when that trade reverses the exit evaporates. Every collapse finds new and exciting ways to melt down, and this time will be just as exciting to historians.

Markets have vastly changed since the previous collapses, so the nature and cycle of the next collapse will not follow the previous collapse in investment vehicles. This time, expect the collapse to cross the credit markets. High yield credit, illiquid investment vehicles (like property funds) and dangerous sovereign bonds will likely lead the charge. This will take the insurers and over leveraged banks along with these collapsing vehicles. This is when the screams will happen from the TBTF, desperate for a bailout. This will be AFTER an account bail-in happens and accounts are frozen (like in Italy). However, on dark and dingy market-to-model markets, the massive amounts of derivatives contracts (over 100 Trillion) will already be melting down because no buyers will be found. Governments will not be able to cover those derivatives because the derivatives are more massive than GDP (Like Deutsche Bank derivatives book vs. German GDP).

If Helicopter Ben Bernanke was correct about money printing increasing growth, then the markets would have recovered by now. Assets that were valuable would have been snapped up by those holding cash. Over leveraged players on high risk assets would have left the market. Normal growth would occur and sound investing would have been rewarded.

In a NORMAL market, money is made by taking risk on SOUND investment. The risk-reward payout is a calculated and measured risk spread across SOUND asset classes. Money is made through calculated investing, not speculative gambles.

In these markets, money is made through high levels of leverage. This cheap-credit-money flows into ANY potential asset class that might potentially produce yield. The risk is NOT taken into account by TBTF because that risk is now spread to the account holders and government bailouts. This has caused money to be pumped into bonds to such an extent that many are in negative yields. It has cause share buybacks to be the primary driver of share markets with the money from selling corporate bonds at discounted yields. Swaps, derivatives and leveraged vehicles are being used by unsavvy investors to attempt to find profits. All the while these investors are assuming that markets will never go lower because they will be rescued by more money printing. That is NOT how markets actually work.

These markets are struggling to avoid a financial collapse that will require a massive bailout. This bailout would likely collapse governments, wiping away all of that risk-free sovereign bond capital. That is how these markets travel full cycle. This collapse is inevitable because the collapse has only been delayed.

Markets SHOULD have been allowed to correct 10 years ago. Banks that were overleveraged and making bad trades SHOULD have collapsed. Money should have been allowed to make its own decisions as to where markets should go next. The banks that caused this financial calamity are the same banks that now have even larger and more bloated derivatives books. The politicians that took money from these banks are still in charge of the bank regulations. The laws that relaxed credit rules and restrictions on the banks have only created large risks, not sound financial markets.

I think that the next collapse will start with London real estate. The BOE failed to lower rates at a time that may have encouraged borrowing and investment into London real estate. This will likely screw-over those property funds that are already facing massive redemptions. This will push prices lower, scaring much of the world’s speculative real estate investments (Sydney, Vancouver, etc.). Banks, seeing that property prices have diped, will limit credit for these markets. This will remove buyers to an already anemic market causing prices to collapse. This will take businesses dependent on the historic boom along for the ride (construction companies, base metals miners, developers). It will also punish investors that have become land barons through buying property then leveraging up to buy more property. In bankruptcy, ALL assets are sold at discounted values, so it doesn’t take long for the contagion to spread. It is best to be the first to sell out in a down turn, not the last.

Should you trade BTFD?

Sure, why not. If you are trading it by taking small chops out of the long side of these markets and closing your positions overnight then you are making a sound risk-reward trade. Don’t do it as a long term investment, but take chops out of the market. This market WILL end, so don’t be holding a position when that happens. If you are buying on credit, deep into illiquid derivatives and over leveraged into dodgy funds, then you deserve to lose it all when the markets collapse.

If you are working at a big bank, then it is other-people’s-money, so you are not actually risking anything. These bankers are only trying to increase their own accounts by generating yield and getting paid bonuses. They are not risking anything but their job and when these banks fail, the job will be gone anyway. It is those traders that are perpetuating these markets, and they WILL lose just as so many before have done. If you act soon, you can take your money out of their hands before this cycle ends.

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