When reading about the $50 billion Madoff hedge fund fraud, it hit me on the head: hedge fund redemptions at the end of this year are going to be absolutely huge, and that will mean a massive sell-off in global capital markets in the first quarter.
That would also mean a further rally for the the US dollar, as assets sold are redeemed largely in US dollars and thus boost demand for the greenback. Gold might take a slight set back, although it will more likely be in increasing demand as a safe haven asset and diversification against the coming dollar crash.
Inflationary stimulus
All this turmoil would really put the pressure on the incoming US president and his team, who will respond with bigger than expected stimulus packages and bailouts. That will make the upcoming and inevitable inflation even larger when it hits, and at the first whiff of inflation the bond market will tank and with it the US dollar.
Investors face a double whammy in 2009 - from hedge fund withdrawals crashing the stock market and later a dollar collapse. That would take capital markets to a real bottom.
Market bottom
My prediction of the Dow at 4-5,000 and gold at $4-5,000 an ounce for later next year still stands, and hedge fund redemptions followed by a dollar collapse will be the driving forces to achieve that bottom. It might take until 2010 to get that far but no longer.
Now try to argue the reverse: will there be sellers or buyers in capital markets after year-end redemptions come in? What is the chance of a positive tally for redemptions? Zero chance! Is the dollar bond market at a top or about to go higher? Is it hell!
Actually this will offer a great point to buy up the finest US stocks at rock bottom prices, but who will have the cash to buy by then? Certainly not anybody taking an optimistic view of the market outlook now.
I can empathize with those who feel the Madoff fraud is some kind of a warning of things to come. These frauds do not usually happen in isolation and are a symptom of the underlying malaise.
