The two major rallies this week came on the back of strong Black Friday sales and massive coordinated Central Bank intervention, shocking investors who were going into the Thanksgiving holiday thinking that the world was on the verge of another collapse. Truth be told, they may be right.
Over the last few weeks, credit markets in Europe locked up, due the Greek debt restructuring. It all started when public investors in Greek bonds were told that they would be forced to take a 50% writedown while the private holders remained whole. To top it off, ISDA did not consider this a credit event, and the entire CDS market was torn apart.
If you were one of the private holders, how would you feel about European sovereign debt? Exactly. That touched off a stampede to the exits, with buyers going on strike as bond auctions in Latvia and Germany failed.
Simply put, while the EU thought it was putting the issue to rest, it inadvertently unleashed a cascade of selling as sovereign debt got rerated to reflect the new risk profile in Europe.
The EU then went on a roadshow for the EFSF, taking its idea to China and Russia in hopes of support. But without a finalized plan of action, neither one was interested in helping leverage the EFSF. Then, to top it off, the Greeks made the untimely decision to ask for an even greater write-down of 75%. The unmitigated gall of the Greeks touched off a buyers' strike and forced the Federal Reserve and five other Central Banks to lower swap rates in order to temporarily rescue the European debt markets.
The problem is that this move is only temporary and will not solve the inherent problems in Europe which stem from an inability of Italy and Greece to get their spending under control. Now the Federal Reserve has been forced to bail out the European debt markets in order to save the US banking system. How could this become systemic, and where are the major risks in the US banking system?
Take a close look at the stock price of Bank of America (BAC), which has lost close to 60% of its value this year. That is your first canary in the coal mine. The second canary in the coal mine? Greek bond yields, where the yield on one-year Greek debt crossed 300% last week.
The only safe place right now is in the arms of gold (GLD) (DGP) and silver (SLV) (AGQ), as the massive burst of liquidity will raise the prices back to highs made earlier this year. Any move like this by global Central Banks should throw up tons of red flags with investors, and everyone should be wary.
The bulk of the gains this week were in the overnight markets, with very little left for investors. While a Santa Claus rally may be starting, investors should watch out for the coal that may be appearing in investors' stockings next year.
Disclosure: I am long DGP, AGQ.