Will The Greek Default Bring A Market Crash?

Includes: CCJ, DNN, SPY, URRE, URZ
by: Simit Patel

The big news to close out this past week was that the ISDA -- the International Swaps and Defaults Association -- had ruled that a credit event had occurred, Greece had defaulted, and banks who had sold credit default swaps would need to pay out. Credit default swaps are essentially contracts that provide an insurance policy of sorts to their buyers against a variety of defaults.

So who's liable for the payout on credit default swaps insuring against a Greece default, and in what amount? Here's what Reuters had to say:

The "credit event" ruling means a maximum of $3.16 billion of net outstanding Greek credit default swap contracts could be paid out, though the actual amount is likely to be lower because bondholders are not losing all of their original investment.

ISDA said the auction will be held to determining the actual payout amounts on March 19.

A maximum of $3.16 billion doesn't seem to be huge amount; to put it in perspective, that's about 0.6% of Apple's (NASDAQ:AAPL) market cap. Moreover, the Wall Street Journal reports that the majority of German banks that sold credit default swaps hedged their sales, so their exposure is limited. If this is true, Greece's default and the corresponding CDS payout will not have a significant impact on the markets.

Personally, though, I'm skeptical of this. In a recent interview with King World News, Jim Sinclair opined that 50% or more of the $37 trillion market in credit default swaps could be attached to Greece. Moreover, I doubt Greek credit default swaps, if they truly are a 17+ trillion dollar market, is isolated to Germany; I suspect US banking institutions have significant exposure as well if the market is that large, and I seriously doubt anyone can really effectively hedge such large exposure.

From this perspective, I find it plausible that CDS payouts, if they are truly a significant amount, can trigger another banking crisis similar to what we saw in 2008. In such a scenario, the US dollar would rally while equities, commodities, and precious metals would decline.

Of course, if such a scenario does occur, it only offers the opportunity to buy equities, commodities, and precious metals at a discount. Just as we saw in 2008, any response to a significant banking crisis will be inflationary bailouts that send everything higher. The only real solution to this mess involves a mix of balanced budgets, debt cancellation, and monetary policy reform.

So long as that does not occur and does not remain anywhere in sight, the only real solution to insolvency of any kind is to paper it over. Whether one wants to call this quantitative easing, bailouts, or any other term is irrelevant; US money supply, as measured by MZM, will continue to rise - and so the inflation trade will remain a great opportunity.

So, here's how I'm preparing if there is a crash within the next two weeks as a result of CDS payouts on the Greek default:

1. First, I'm not selling anything just yet - this CDS market is so opaque it's hard to get a clear understanding of what the true story is regarding how big the market is and how much in payouts are due and how hedged or unhedged the banks that sold these derivatives are. So, I'm sticking to the same strategy, which is that I expect precious metals, commodities, and stocks to head much higher.

2. I try to leave some cash ready for when a crash comes, so if there is a crash - which I would define as a decline of more than 10% in the S&P 500 (NYSEARCA:SPY) - I'll be buying. Specifically, I'll look to acquire high beta uranium stocks; these stocks could drop by more than 30% if there is a 10% correction in the S&P, and as I suspect uranium could go to $200, I'm particularly interested in stocking up on overstock uranium stocks. My favorites here include Uranium Resources (NASDAQ:URRE), Cameco (NYSE:CCJ), Uranium Energy Corp (NYSEMKT:UEC), Denison Mines (NYSEMKT:DNN), Uranerz (NYSEMKT:URZ) and Strathmore Minerals (OTC:STHJF).

Crashes can provide us with great opportunities - provided we have the psychological poise, available cash, and conviction needed to take advantage of them.

Disclosure: I am long CCJ, UEC, URZ.

Additional disclosure: I am long Strathmore Minerals on the TSX.