soit la bagatelle de + 4 trillions de $ d'augmentation en 6 mois .. !http://www.myfinances.co.uk/investments/investment-vehicles/with-profits-investments/investors-find-growth-in-credit-derivatives-$15085580.htm
Adrian D sends us a flurry of insightful input today. The first of it is a MUST READ and touches on the massive and astounding increase in derivatives. This fits right in with the MIDAS analysis that the most important factor in US financial markets today is the use of derivatives to manipulate those markets.
This article got me thinking. Credit derivatives grew 48% in the first 6 months of 2005 from 8.4 trillion dollars to 12.4 trillion dollars!!! Yes, that is TRILLION. Those are mind boggling numbers. It is interesting that the article uses gold as an example of the use of a derivative! Why not Walmart or Google share options?
This explosion in credit derivatives makes it stand out. What other market in the world which is trillion dollar plus in size is showing such growth? I can’t think of one! It dwarfs the US real estate market in growth. Or the Nasdaq market growth in the 90’s. So what is going on?
A derivative is essentially a bet. Somebody wins and somebody loses if a certain event happens. It is like insurance. If I insure my car I am betting that one day I will have an accident or someone will steal it. The insurance company bets that it won’t happen. If they are right they keep my premium year after year. If I am right one day they have to pay me for a new car. If these bets are reasonable then everything will be orderly. It allows the insurance issuer to make money even when he has to pay out occasionally and it allows me to cover the risk that something happens to my car.
Consider this analogy with a horse race. If I bet $100 with you that a horse will win a race we will both watch the horse race with interest to see who wins. However, if I bet $1 trillion that my horse will win you will be sorely tempted to interfere with my horse, by drugging it or something, to make sure it doesn’t win.
We tend to insure against something bad happening. In the gold industry we have seen hedging against a gold price fall. How many bought gold calls? None. In the airline industry many airlines hedged against a rise in aviation fuel. In the credit industry there are hedges against default or interest rates rising. When I see the HUGE build up in derivatives I see this as more and more money being bet that something "bad" will happen. What we have seen is the bigger these bets grow the more we see the "Stepford Wives" syndrome that "everything is fine". Volatility as shown by the VIX has dropped to unprecedented levels. The yield curve has flattened, the Dow Jones does hail Mary rallies every time it looks like it will break down. I believe the huge bets on something bad happening has tempted many players who are underwriting the risk to tamper with the price of the underlying assets to make sure that they don’t have to pay out. We have wondered where have the bond vigilantes gone when the CRB is up 80% in 3 years. Why don’t they sell bonds like crazy? Because there is a 12 trillion dollar bet that says that the rising interest rate horse will win. This creates the ultimate incentive for someone to drug the horse! This is the conundrum of the bond market. The conundrum of the stock market trading range and Hail Mary rallies.
I suspect that this is the true fear of the Silver Users Association about the Silver ETF. Why did they object so vigorously and show their hand that the world is desperately short of silver? Because unlike in the paper world if the underlying commodity liquidity dries up then it is like having no horses to run in the race. The multi-trillion dollar bets fall apart. Look what happened last week. The derivative bets against Delphi bond default dwarfed the actual bonds outstanding creating a squeeze in the bonds of a bankrupt company!!!
Most people do not even know the derivative market exists. It is an invisible bubble. It is a "lack of volatility bubble". It represents huge, huge bets that something might go wrong in various markets. The underwriters of these bets have a vested interest not to let anything go wrong. I believe it is at the roots of the market intervention because so many big players stand to lose more money than exists in the world.
I am not an expert in derivatives. Does what I say make sense? I don’t know but clearly the markets behave differently these days and it correlates with a huge build up in derivatives. The fly in the ointment are "real things" like commodities. The premier commodities are gold and silver. The liquidity in these markets could lock up and then the game is over. The ultimate nightmare for the underwriters…everybody in the world has a car stolen at the same moment, all the horses in the race cross the finish line at exactly the same time.
It is like the Sorcerer’s apprentice who casts a spell on his broom to fetch water. But he can’t reverse the spell. When he tries to break the broom it makes more little brooms. All these derivatives are spawning new derivatives as each derivative holder tries to offset his risk to someone else. And so the mountain of derivatives grows. A 48% growth in 6 months of any large market is the beginning of a parabolic blow off. An invisible bubble is about to burst. We even heard about the meeting of derivative traders at the FED in September that they discussed the problem of a huge backlog of paperwork. Derivatives are being created faster than they can be written! There is no Sorcerer who will come to the rescue to break the spell. It is difficult to imagine the extent of the devastation that will occur. It clearly makes sense to hold something real like gold and silver than something paper.
If someone in the Café understands derivatives it would be sure nice to hear their views. If I am totally out to lunch then let someone put me straight.