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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
March 9, 2012
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The conventional view holds that central banks can “print” their way out of trouble/deflationary risks.  From my perspective, in this day and age they instead succeed only in further inflating a historic global Credit Bubble.  And, importantly, the hedge fund/leveraged speculator craze is an integral facet of this unique global financial mania (I view derivatives similarly).  Importantly, increasingly egregious central bank market interventions work to further inflate the unwieldy Bubble in leveraged speculation (and derivative positions), creating an ongoing Weak Link with respect to both financial and economic stability.     

This week provided a reminder that the leveraged speculating community is not without serious issues.  While a speculative stock market garners most of the attention, volatility appears to have returned in gold/metals, bonds and in the currencies.  All happen to be key markets for the leveraged players.  While there were some high-profile success stories, keep in mind that the average hedge fund posted losses during a treacherous 2011.  According to Credit Suisse, more than two-thirds of all hedge funds are below their “high-water marks,” meaning that they have investor losses to recoup before they can return to earning their hefty incentive fees (typically 20% of fund returns).   Almost a fifth of hedge funds have high-water marks of 20% or more.  Literally thousands of funds are struggling for survival, a dynamic with potentially important market ramifications.

Gold equities (and general commodities market volatility) meted out ample grief for many leveraged players in 2011 (and 2008!).  I’ll interpret gold’s abrupt Wednesday reversal and quick pounding as an indication of a marketplace of “weak-handed” traders really hoping to ride a trend but without the wherewithal to stomach much in the way of losses.  And I’ll add there are similar dynamics at play in this year’s short-squeeze-rife stock market backdrop.  This type of environment foments destabilizing speculation, replete with latent market fragilities.

It is also clear that the collapse in Treasury yields last year made a fortune for those leveraged on the right side of the “risk off” and/or “deflation” trade.  Yet bold ECB and concerted global central bank actions from late-2011 have meaningfully altered the landscape.  As markets commence March 2012, the world is looking a lot more like “risk on” and heightened inflation.  It is worth noting that the last time crude prices were near current levels (April 2011) 10-year Treasury yields were almost 150 bps higher.  Keep in mind also that year-over-year US consumer price inflation (CPI) has been running in the range of between 3% and 4% for most of the past year.  Inflationary pressures remain heightened in Europe, despite ongoing economic deterioration and financial fragilities.   Where growth dynamics are more robust, such as China and the developing economies, inflationary biases percolate. 

I can only assume enormous amounts of leverage have accumulated throughout the Treasury, agency and MBS markets (likely corporate as well).  Chairman Bernanke has been keen to assure the leveraged players that the Fed would not impinge on their speculative trading profits (at least until late-2014!).  At the same time, the recent backdrop has made QE3 appear increasingly preposterous – and the backdrop may even be conducive to a surprise on the GDP and inflation fronts. 

Last year I posited the thesis that global finance was vulnerable to the possible unwind of the “dollar carry trade,” short positions in dollar instruments that were used to finance higher-returning risk assets globally.  The strong correlation between dollar strength and global risk asset weakness during last year’s third quarter seemed to support this view.  And I’ve gone so far as to suggest that the Fed’s talk of QE3 was in some measure used to combat a rallying dollar.  Well, the dollar caught a bid this week.  And as the bulls salivate at prospects for booming U.S. stocks and an economic upturn, from a (leveraged and highly-speculative) Financial Sphere perspective one might want to ponder the ramifications if all this enthusiasm translates into a resurgent U.S. (“king”) dollar.

From a Bubble Dynamics perspective, it is not completely unreasonable that late-2011/early-2012 euphoria marked an important top in the prolonged U.S. Treasury/agency/MBS market Bubble.  Considering today’s inflationary backdrop coupled with festering creditworthiness issues, today’s market prices make little sense.  Of course, the Fed and global central bankers won’t allow a market hiccup, and this potentially epic market misperception is fully priced in the marketplace. 

This week’s LTRO provides an exclamation point on the latest round of unprecedented global policy market interventions.  As I explained last week, policymakers were, once again, able to incite the reversal of bearish positions and risk hedges.  And as much as this creates the perception that central banks have things all under control, a strong case can be made that such actions only ensure that unwieldy markets just move further from their control.  The interventions have become monstrous, increasing the odds of unintended consequences:  speculative equities and global risk markets; surging oil prices; and only more dangerous global imbalances - quickly come to mind.  And, if they’re not careful, one of these days policymakers may even unknowingly pierce the U.S. bond Bubble