A Don't Look Outlook: Stay Loose

by: Emmet Kodesh

"Double, Double, toil and trouble,

Fire burn and cauldron bubble…"

I mentioned derivatives in my piece on financials as a means that super major banks, the pillars of the fiscal - economic structure, keep their worrisome debt / revenue ratios in line and still manage to show good quick and coverage numbers. The amount of derivatives floating around the fiscal cloud today is $489 trillion. This is about 8.5 x the capitalization of all the world's stock exchanges combined. The ratio is worse at U.S. commercial banks with derivatives about 16.8 x assets:

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As Eric Pomboy, founder of Meridian Macro Strategies writes, this leverage could take down commercial and investment banks, municipalities, insurance companies and states. Dr. Ben better shoot the sweet juice or the fat lady will come to her cadenza. We stand upon a precipice that we have ascended with great and cannot descend without greater peril. Such are the wages of "interventionism" without which the three main asset classes will crash.

The loan / deposit ratio keeps shriveling as banks sit on cash rather than lend, thus undercutting any hope of an economic as opposed to market-QE-margin recovery. Banks need cash to help capitalize their unmanageable derivative exposure. If China decided to sell half their T-bills, which would be $700 billion the Fed would need a year of QE in a few days to avoid a toxic shock to the entire system. A Fannie Mae (OTCQB:FNMA) economist already is on record saying that the housing recovery has suffered rate shock as refi's and new mortgage applications have plummeted in recent weeks to their lowest levels since 2009.

The fact that there is about $360 billion margin exposure in these markets doesn't help.

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The last time the NYSE margin was this high was July 2007. while margin debt has declined a bit since 2Q, the impact is deeply negative, figuring to an S&P at about 775. So much for noise about an organic recovery: but let's not go there: let's stick our heads in the sand till the Fed makes it all go away.

Late in June, the BIS (Bank of International Settlements in Switzerland) warned that rising yields risked at $10 trillion bond market crash. That's toil and trouble indeed. HSBC (HBC) which has by far the healthiest balance sheet of the giant banks, has 42% of its "safe" assets in U.S. T-Bills.

All these are reasons I believe that unless the fiscal directorate wishes to crash the markets and economy, QE will continue, perhaps even increase. In the past week they have strained to wrestle the 10-year rate down from 3% to 2.84%. If they can get it back to 2.65% (hardly a good rate for a 10-year bond), asset prices will rise and everyone can exit and exhale before the inevitable happens. States, cities and those with pensions will not be so fortunate.

No wonder Admiral Greenert welcomed China's first aircraft carrier (vintage WW II, bought from Ukraine, truly) to San Diego with fulsome praise. We will help train their pilots who will spend 2-3 years learning how to land on a carrier. The news says we should be afraid of their growing prowess. This shows how crises are invented to cover diplomatic-fiscal-military games. If China did move to sell a large portion of its T-Bills, and if our top echelons wished to prevent what that would do to bonds, equities and real estate, to the nation, they could murmur a few hints about what NATO could do to China's stone-age military. That probably is not how these matters will play out.

Reports are that COMEX has about $880 million worth of physical gold to cover about $50 billion in paper claims on that gold. If PM (precious metals) markets behaved in organic fashion, there soon would be a massive rise in gold and silver bullion and the share price of PM miners and streaming companies. That could occur as could a collapse in the major asset classes as well as the USD if China and Japan should sell a large part of their T-bills: that's a big "if." Demand for gold coins and jewelry is so strong in India that this year their government has raised import duties from 2% to 6 to 10 to 15% (the latest tax on jewelry).

It's time to hold tight to the best precious metal miners, First Majestic (NYSE:AG), Endeavour (NYSE:EXK), Eldorado (NYSE:EGO), McEwen (NYSE:MUX), Fortuna (NYSE:FSM) and the best streaming and royalty companies, Silver Wheaton (SLW) and Franco Nevada (NYSE:FNV). There also are plenty of great companies in the ME (media-entertainment), Consumer Discretionary, Energy and Industrial sectors. I have identified them in recent articles and they include Time Warner (NYSE:TWX), Starbucks (NASDAQ:SBUX), Macy's (NYSE:M) and Whole Food Markets (NASDAQ:WFM), Boeing (NYSE:BA), British Petroleum (NYSE:BP), Chevron (NYSE:CVX), Lockheed Martin (NYSE:LMT), Caterpillar (NYSE:CAT) and many more. It would be wise to wait a bit to see what happens the next few days before buying. If the Fed continues to lube the engine, then one can hop aboard: it will be a wild ride. Remember, though, that via QE "the battle's lost and won," that is the tragic irony of our situation. The cauldron is boiling away and the socio-economic viability of America and the world is hovering in "fog and filthy air."

The fish rots from the head down and in DC they are at work distracting all and sundry from the devastation the Affordable Care Act is doing to full time jobs. It looks like confusion has made its masterpiece and the piper soon will want to be paid. Be defensive and keep some PMs (precious metals) in stock.

Disclosure: I am long AG, SLW, BP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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