16 April 2013

Market Manipulation, News, and Leverage

This piece on leverage and market manipulation came out a few weeks ago. Philip Byrne reminded me about it, and he is right.

Using leverage in these markets is a dangerous strategy.

I was also reminded of this because of the recent 'leak' of the FOMC minutes by the Fed that demonstrated that they had a 'preferred recipients' list who receive the information ahead of the markets, although normally not by a day.

And I think one might suspect and assume that there is more ad hoc leaking going on than the Fed would care to admit, and other key data points as well, especially from non-governmental sources.

So using leverage as an outsider is double deadly in a thin market based largely on policy and artificial flows of hot money.   In this case he had been speaking about shorting stocks with leverage in the stock market.  But he  draws the same lesson for levered long positions in commodities.

I also have to chuckle a little.  Some of the financial networks are pitching stocks heavily as a 'safe investment' now that commodities like gold have been proven to be unreliable.  And they are trotting out the usual suspects to make the pitch.

I will never forget how former Fed Governor Wayne Angell remarked that 'the Fed will drive people out of their savings and money market funds and into stocks.'  This on a financial network in 2004, and it worked; people piled into financial assets and a housing bubble, with Greenspan himself as cheerleader.  And they got slaughtered in the 2008 market crash. 

Nicely done.  And now its come on back in suckers for another handoff.  Take your money out of the banks and commodities and pile into stocks, which have already been run up on some record thin volumes.   Its a safe haven!

This is from Phil Byrne:
"The best thing about yesterday is that the Fed gave us a glimpse of the future. Those people who owned gold with leverage were waiting to have their throats cut – almost begging for it.. The best part is that this market operation has created instability where they once had stability. Nobody will take a levered position against them anymore – not on the stocks short side and not on the levered long gold side.

Here’s what I wrote to clients a couple of weeks ago:

Market Manipulation

The price of gold is a good segue into explaining how the markets are being manipulated.

Anyone who has read about the Japanese martial art known as Judo knows that the basic tenet of the art is to use the attackers leverage against him. Instead of picking up one’s opponent and throwing them down, Judo experts redirect the force created in their opponent’s attacks to knock them down. It’s the same in the markets.

We’re not the only investment firm that understands the problems in our economy and markets. Since 2008, a lot of work has been done to understand the problems in the world and this work has led to bets on the market – oftentimes with leverage such as selling short a stock, buying a put option, or borrowing money and buying gold.

Whenever investors use leverage, they leave themselves vulnerable because leverage turns small losses into big losses – it’s the reason why Lehman Brothers is no longer around. Knowing this, the Fed and its agents wait for these traders to place leveraged bets, and then the Fed’s agents forcefully take the other side of the trade. This is why we include charts of the VIX – they represent leveraged option trades.

A year ago, US corporate earnings growth was slowing meaningfully, Japan was recovering from a nuclear disaster worse than Chernobyl – one that continues to get worse – and at the same time, southern Europe was at the point where nobody would buy their debt and traders were making extreme bets against European markets and the European currency.

All it took was a promise by Europe’s central bank to “do whatever it takes” to prevent bankruptcy and the markets reversed in a huge way. Anyone betting against the European central bank incurred heavy losses. Later in the year, the Fed, then the Bank of Japan did the same thing with similar rallies.

The market has figured out this strategy which is why nobody is willing to bet against the world’s central banks in a meaningful way any longer. It’s the reason why markets are going up despite the tremors we face such as Cyprus, Italy, Spain, Portugal, North Korea, China, Japan, Argentina, and economic stagnation in the US.

Without speculators to crush, the Fed’s ability to keep the markets moving higher is seriously compromised.

Gold was the final bet against the Fed – they’ve won and by winning, they’ve lost!"

Philip M. Byrne, CFA
Chief Investment Officer
GeoVest Advisors Inc.