Caution! Market crash could be imminent

With growing uncertainty surrounding the European debt crisis, and the contagion spreading to much larger sovereigns, such as Italy, we now see risk aversion back on the table.  US markets are down over 3%, the headlines seem to be getting progressively worse and many fear that the situation could deteriorate much further — giving up much of the gains achieved in October.

Growing concern as market whipsaws

This kind of volatility, both up and down, is historically an indicator of very large market moves.  With the bias largely negative, it seems that a market crash could be coming if no resolution is found for the EU debt implosion.  Alternatively, should a large scale bailout ($2T+) occur, we could see a significant rally, especially within precious metals spot prices and miners.

For investors and traders, this type of price action is stressful.  Seeing fluctuations of multiple percentage points in indices and nearly 10% in stocks can cause forced position liquidation because of stop loss orders being triggered.  For traders, who generally capitalize on multi-day moves rather than moves within a single day, this type of action can cause significant losses should one be caught on the wrong side of the market action.  High frequency trading machines may capture gains, but are not providing liquidity or improving market efficiency, especially during periods of intense market moves.  Instead, evidence seems to be growing that the machine-based traders are making the market less stable and more prone to large price swings.

World view deteriorates

Global markets plunged as well, with Italy down over 9%, Poland down nearly 9%, Germany down over 7% and other European markets leading weakness as stock prices bleed, especially within the financial sector.  The lackadaisical response out of the EU, ECB and IMF leadership seems to be draining confidence and sparking fear in the markets.

US banks have hundreds of billions of dollars worth of exposure to European sovereign debt, banks and other related instruments.  Many have written credit default swaps, a form of insurance that has no capital reserve (see AIG implosion circa 2008) against European debt, exposing them to significant risks should the EU situation worsen.

Broken bonds from backwards economies

Many Western countries now face the prospect of sovereign debt problems, as their economies continue to slow, while investors fear that they will not be able to pay back the debt.  The United States is no exception, as its official debt reaches 100% of GDP, and by some estimates, their total outstanding unfunded liabilities have reached $75 trillion.

Japan has a 200% debt-to-GDP ratio, which is only made possible by the fact that most of their debt is held by Japanese banks and pensioners, but the situation there is deteriorating with growing political and economic instability.  Even China is no exception, as their economy is slowing down and the yield curve on Chinese debt has inverted for the first time — causing serious concern for those that felt China would lead the world out of recession.

The coming crisis

What happens next is not clear, but what is evident is that the world is changing.  Slowing economic growth, the bursting of the largest credit bubble in history, significant deterioration in debt-driven consumption and resource depletion all leads to a potential crisis.  All of the new debt that has been created to attempt to stem the last debt crisis has only exacerbated the underlying structural economic problems we are facing.  Papering over large amounts of fraud within the financial system and ignoring the peril of main street has divided the Western world.  Growing civil unrest and lack of available employment, especially for the young, has created the potential for large scale disruptions (think of the “Occupy” movement, but on a global scale with a significant percentage of the population participating).

I feel that unless we start seeing accountability within the financial sector and governments of the world, prosecution of the enormous fraud, transparency within the political and electoral process and erosion of corporate personhood in so far as money is considered free speech, as well as more regulation of over the counter derivatives, we will look back at the 2008 crisis and think of it as a relatively calm and orderly time within the financial markets compared to what could happen next.

Silver’s scary sell-off

Silver and silver-related assets were smashed across the board on Friday as the World Bank and IMF met in Washington, DC to discuss the worsening global crisis.  Other commodities saw sharp declines as well.  More silver was traded that day in any given hour than silver is available on the market for an entire year.  It was an electronic sell-off.  Physical prices now command a 10-20% premium to spot paper prices, the highest in years.  Gold to silver ratio is now over 1:50, the highest in a very long time.

Predictably news comes out after the trading day (but we must assume the large insiders knew the whole time) that COMEX was raising margins by 15.6% on silver.

The problem is the COMEX does not have the silver to deliver, so forced liquidation is the strongest tool they have to bring prices down and take parties who would seek delivery out of the equation.

Silver is still up 46.31% on the year and has strong support in the $30.00 area.  I think we need to see what the price action is when buyers step in and shorts cover.  It could very well move up as fast as it did down (and higher) if we see ECB rate cuts, a Greek bail out, good earnings in the US, emergency Fed easing or other central bank policy movements as well as any geopolitical or event risk scenarios playing out.

Given that even though silver fell to $30.00, but physical silver commands a price of $33-35.00, there is evidence of a growing paper vs. physical price discovery bifurcation.

As far as my strategy goes, I don’t see any change in the situation for the dollar long term.  The recent strength has been more of a liquidation panic in Europe and foreigners buying dollars because it’s the least bad currency for the moment.  There’s even some rumor of weaker central banks liquidating gold and silver holdings to raise liquidity.

I saw the same pattern of behavior in 2008 and 2009, yet gold and silver are much, much higher now despite the occasional (and sometimes violent) correction.

Over the last 11 years silver and gold have outperformed all sectors of the S&P 500 by many multiples.  There is no paper asset class quite as trusted during times of crisis, either. (three year chart)

Now, given the potential for further easing by the Fed, ECB, BOJ, BOE, SNB and others, the need to monetize debt in the US to keep the government open (i.e. the necessity for QE3) — without debt monetization the government will go in to a crisis mode where their ability to spend will be limited as interest rates rise because treasuries are sold more than bought.  But we’re not the only country that has to monetize debt.  Keep in mind the US government has over $75 trillion in unfunded liabilities and there’s no ‘economic growth’ scenario that allows these debts to be funded from revenues.

QE3 from the Fed at this point seems like a foregone conclusion once we see a sovereign debt or large bank collapse.  The ECB is also monetizing debt in the Euro zone for a few of the larger PIIGS, the BOE has QE’d in England and there’s a good chance the BOJ and SNB will continue to print money to artificially devalue their currency.

These actions will create a short to intermediate term burst in global money supply — and hot money seeking a high return.  These types of inflationary pressures lead to booms for precious metals.

Greece’s default is all but inevitable, and that is going to rock the world and create the need for much, much more liquidity.  This situation will spread throughout Europe and spread here and to Asia.  Lower rates and more stimulus will follow.

Many shops sold out of their silver bars and coins on Friday because the appetite for physical silver was so strong at $30.00 (even though customers gladly paid the $5.00+ premium making purchases $35.00+ per ounce).  In fact I still saw online stores selling silver for $45.00 to $50.00 per ounce.

I believe that the bifurcation in physical and paper prices is important to note because it indicates that there are two markets.  A real market and a phony market.  The phony market is being manipulated downward to an artificially depressed price.

This happened in 2008, too.  But from that low price of $8.00 silver quickly rose to $48.00 in the course of three years, a 600% increase or averaged to 200% per year.

Gerald Celente, one of the best trend forecasters of our era is now buying physical silver.  He made the announcement on Friday, so I believe that will mean something to the many that follow his advice and watch his investments closely.

One year silver chart

Tonight silver is testing the 350 day moving average.  Some continuation selling was to be expected after Friday’s drop, but we’re looking for some consolidation or even a short term reversal due to the very, very oversold condition, combined with the support of the 350 day moving average at 29.57 as well as the appetite that should be present in Asia during this season.

We’re also dealing with price move that is over a four standard deviation event — i.e. something that is extraordinarily rare and it’s punctured the bottom bollinger band, leaving a reversion to the moving average around $37.00-40.00 quite possible if technical buyers come in.

24 hour silver chart Right now silver is trading at $29.83, having found some support at the $29.57 area.

Volume is light as to be expected, but once Sydney and Hong Kong open we’ll get a better idea of what the Asian appetites for metals are after last week’s discount.

Personally, I am tempted to buy silver and silver-related assets given these discounts.  Even if prices are weak short term, I know they will be much, much higher in the intermediate and longer term.

Risk off trade resumes after bounce

High frequency traders, institutions and retail investors pushed markets lower today, and in recent days, after a brief reprieve from the selling abated in to a liquidation frenzy. Gold made new record highs, silver stayed strong as the commodity complex crumbled. Most investors are very nervous about the prospects of another recession looming, but the reality is we’ve been in a depression for four years and a recession within a depression is looming.

We’ve been enjoying the eye of the storm since April of 2009, when the banking system no longer was obligated to mark its assets to their real values and trillions of dollars were injected in to the banking system. Unfortunately the sugar high has worn off, and now the situation is worse than before.

As the oversold correction was neutralized by short covering, opportunistic buying and technical traders the stream of bad news resumed, with more worrisome headlines about the Greek debt situation, widespread investigations in to high frequency trading firms, a spread of the European bank contagion because of their leveraged bad debt holdings, and American banks facing the prospect of the credit default swaps they sold to the EU banks being called in.

In addition, economic data has been deteriorating, with poor jobs, inflation and housing data rattling the fundamental picture from a recovery to the brink of an economic contraction. Inflation and unemployment are higher, while new home sales are flopping.

With these economic headwinds, and several market powderkegs ready to blow, the average investor is looking for a safe haven. Many are buying US Treasury bonds, pushing the yields to record lows below 2% on the 10 year and collapsing the 2s to 10s spread, making lending less lucrative for banks. Others are turning to precious metals, as we see gold, silver and even platinum have good price action and solid technicals.

At this point the likelihood that a significant further leg down in the economic picture and within the equities markets will occur has heightened significantly. The macroeconomic risks in most developed and emerging countries, ranging from inflation, social unrest, high unemployment, losses in investments and property, continue to gain momentum and appear to be converging as a catalyst towards a global risk asset sell-off, the likes of which we haven’t experienced since 2008-2009.

The likelihood of bank holidays and further government and Federal Reserve intervention in to bond markets, money markets and potentially equity markets has also heightened. Further fiscal and monetary policy that accommodates a deflationary environment will more than likely occur within the next quarter.

Gold and silver prices should head much higher because of the aforementioned situation and response. Gold is due for a correction, but when that may occur is questionable given the mood of the markets and the desire to hold tangible assets over equities or paper currencies. Silver on the other hand is poised to test the $42.50 resistance level, and if it can breach higher, potentially test the $48-50.00 area where the last high was made. Within the next 3-5 years, it is very likely that both gold and silver will be multiples higher than they are today in terms of pricing in US dollars.

Either a deflationary depression or a hyperinflationary monetary collapse would be beneficial for precious metals in the short, intermediate and long term. Whether or not such severe events occur is uncertain at this point, but currently deflationary forces are at battle with inflationary central bank policies — and it is extremely rare that either economic catalyst is balanced out perfectly with the other. Instead, massive bouts of volatility and overshooting towards deflation or inflation are a more likely scenario, as tools of fiscal and monetary policy are more like howitzers than scalpels.

European Union losing strength

Update: The Fed is moving in to further appease Europe’s ailing banks by restarting the US dollar currency swap program they used during the last financial crisis.

As the EU moves to establish a 750 billion Euro bailout slush fund, political opposition in Germany and the UK is growing and the problems within the EU may be getting more serious.

Hiding the truth

EU politicians claim the fund is being created to defend against the “wolf pack” of banks betting against the Euro and EU sovereign debt.  They say they will defend the Euro at “any cost”.

The reality is that Greece misrepresented its debt, hiding it with the help of Goldman Sachs.  This fraud triggered the downfall of Greece’s bonds once it was discovered.  Other EU countries are now struggling to get their house (of cards) in order.

The contagion could spread

Greece is struggling, if not failing, and with it may come a domino effect. The other “PIIGS” (Portugal, Ireland, Italy and Spain) may also begin their descent on debt woes and poor economic performance.

Even the UK is not immune to these problems as its economy is in bad shape and the debt keeps mounting.  The UK government is facing uncertainty as recent elections delivered a hung parliament, the first such event since 1974.

Germany’s Merkel has potentially exhausted all her political favors as she offered the German taxpayers’ money to Greece in the form of a debt bailout.  Her party has suffered significant losses in recent elections as a result.

Anger grows

Meanwhile, in Greece, where severe austerity measures are being forced on to a weary population, the result has been much civil unrest and violence in the streets.

There have been several deaths, property has been destroyed and no compromise has been reached to temper the rage of the population.

No end in sight

The EU is in a panicked state.  There isn’t any meaningful resolution within reach as they frantically create more debt in a naive attempt to solve a debt crisis.  When other member countries begin to falter the volatility of their bonds, stock markets and currencies may increase dramatically.

Such a significant disruption will spread beyond the EU to the US and Asia.  These headwinds are blowing strong now and could jeopardize the very fragile global economic recovery.

That is, if you believe there was a recovery in the first place.  So much for the Euro being the next world reserve currency.