Markets Edge Closer To Collapse – But What About The Derivatives?

By Investment Research Dynamics

The massive, unprecedented level of Central Bank intervention in the markets has terminated the purpose for having capital markets.  Currently the only goal of the Fed is to do what needs to be done in order to prevent the markets from collapsing.  This has been the mission since 2008 – and, really, since 1987.

Currently there’s a gargantuan tug of war going on between the hedge funds and the Fed. The hedge funds are leveraged up on extremely overvalued stocks and bonds.  Most of them are about to become impaled on their OTC derivatives, which have zero liquidity and function to “turbo-charge” the margin debt extended to hedge funds by Wall Street.  On the other side of the tug-of-war rope is the Fed/ECB/BoE, which are working furiously to prevent forced hedge fund selling from collapsing the markets.

The ongoing effort to push down the price of gold and silver is essential to prevent a big move higher in the metals from signalling to the world that global financial system is collapsing.  If you don’t want everyone rushing out of the coal mine, remove the canary before it dies. Imposing downward pressure on the metals using their derivatives form is the Fed’s act of removing the canary.  At some point the canary will escape and fly back into the coal mine…

Zerohedge published this graph on Monday morning.  It shows the extreme volatility of the S&P 500 right after the NYSE open.  It’s a 5-second graph of the March S&P 500 future.  The obvious trade right now is to short the stock markets.  This is probably the last alternative  available for hedge funds to hedge out their illiquid fixed income positions, especially the junk-rated stuff.  The pension funds are dead meat.  They have no hedging alternatives.  Their only “hedge” is if the Fed/Government decides to shut down the markets to in order to prevent selling.

I suggested several months ago that this was coming eventually.  The gating of junk bonds is the start of this process. Gating is the same thing as shutting down a market, as it prevents anyone from selling their positions. Please notice that discussions about OTC derivatives seem to have slipped out of the public forum.   For most, this simply means the problem has gone away.   But OTC derivatives lie at the heart of the problem for the Fed.  Fuses have been lit and are moving closer to the detonators.

No one knows when the big explosions will become uncontainable.  But that reality grows closer by the day.   I don’t know what meaningless policy decision will be regurgitated by the FOMC on Wednesday. I’m sure a lot of midnight oil was burned over the weekend working on the draft. But the stock market has at least 1000 points of downside risk and little to no upside, unless the Fed goes  “Weimar” with the printing press.

The statements, views, and opinions expressed in this article are solely those of the author and do not necessarily represent those of EMerging Equity.

Courtesy of Investment Research Dynamics