Sun Aug 3, 2003
Weapons of Mass Destruction In the Market For Mortgage Backed Securities
Author: Jim Sinclair
Conversations Between:
Warren Pollack & Jim Sinclair.
I know quality when I see it, and Warren Pollack is that rare combination of intellectual and practical.
The following are the notes of a conversation we had recently concerning the growing concern we both have that a little understood panic is at hand in the bond market. I feel the US Treasury has no idea of the scope and immense nature of the problem; the staff of the Chairman of the Federal Reserve has been underestimating the dollar involved and the derivative domino effect on other asset derivatives. They were lulled into underestimations because of the Chairman's public praise of the derivative instrument supposedly transferring risk from the few to the many. What was not considered is when the risk is so high and mathematically convoluted; the risk takers are fewer than the few. Therefore the definition of risk from the few to the many is simply illogical and non-functional in this case.
It is the fundamental foundation to my statement to let the hot shot gold shorts, Gold Cartel of Common Interest, and Prechterites sell all the gold they want to by my personal invitation. They are about to self immolate, IMO, right in front of your eyes.
This problem is so big, so immediate, and so systemic that it could explode as soon as Monday morning. Gold is going over $400, and I pray not $529 without eating up some time. Read on a carefully, because all the gold you can own cannot protect you fully from what is coming directly at us. It is like an unstoppable financial global-killing asteroid.
The reason for this is the apparent counter-intuitive action between the central bank and mortgage related interest rates. It suggests that Mortgage Backed Securities (MBS), which are aggregated mortgages offset by over-the-counter derivatives, do not conform to the natural risk model envisioned when they were created.
The bond market is saying that the artificial corollary between US Treasury instruments and Mortgage Backed Securities (MBS) has been forever broken, and to the shock of the collegiate derivative traders, all risks are not created equal.
Given the new immense scope and size of the mortgage market, participants (now also auto makers) will be unable to absorb the dollar cost in the difference in risk between US Treasuries and MBS. They are now a universal derivative money cost, and therefore a risk mismatch. This is the nuclear material the madness of the derivative crowd has produced that is about to shake the entire mountain of derivative paper. It now totals USD$140 Trillions notional value - replacement cost.
You have not read this anywhere in any publication before except here in my warning about the derivative problem of global implication. It will take birth from the top in the 30 year and then 10 year US treasury markets. From that day forward, long term and generational interest rates are going to rise on balance regardless of deflationary forces at hand. The US dollar is in extremely deep trouble and therefore gold is preferable. Watch the world wake up to this as the root cause of the awful bond market comes to light.
Mortgages, thanks to the determined help of public pronouncement by the Federal Reserve's management in no less than televised congressional testimony of the Chairman, have become viewed as the modern day equivalent of what a bank account was in the last century. This is also before deceit economics and the amoral financial ethics of Sodom now practiced. The improper definition of a mortgage has taken birth by the modern features such as the ease of drawing out liquidity, perception of continual-compounding, an implied Federal guarantee for MBS securities, and the role as a primary saving instrument for the majority of people in the US. It speaks for itself. The impact of the derivative disaster now in progress in the market for MBS is going to hit the US and the US dollar harder than the tech bust hit investors in March of 2002. The wealth effect that will be lost here is the SECOND ICEBERG that I have been warning the captains of this ship of state about. I have been saying it was directly in the path of US no policy and lack of economic leadership. Leadership anticipates a problem and acts to prevent it. Leadership does not say as the Fed is saying "We will act if Deflation occurs," while doing nothing much to prevent it.
We are standing right in front of a mess so terrible I have waited to explain to you what it was exactly. It is as Warren Buffet warned: those damn derivatives that were invented in a math class and sold to a professional public (and indirectly to every one of you depending on the value of your home) to survive. You will not survive without gold. These minutes are your last to stock up because money is going below the "Velocity of Money" at 1 and that is the functional failure of the US dollar to function as money. For your sake do not use margin on any gold item you have because the volatility could move to infinite, and the "Velocity of Money" tries to achieve zero. It is the "Velocity of Money" that is in danger of zero bound. It is because of a mountain of unfunded sewage paper calling for specific financial performance that none of it is funded so as to perform. The shaking of this fraudulent (contracted to perform but not funded to perform) mountain which is 20 times the size of the US National debt is going to literally shake the life out of the US dollar because of what government intervention or lack of it means. I see no alternative but to own not leveraged gold under these circumstances. A little will go a significant way.
No amount of gold will go all the way. This is because safeguards present to protect against bank failure and loss of savings are lacking in the highly leveraged real estate mortgage market with derivatives attached. The real estate market has the potential energy to destroy wealth on an unprecedented scale not seen since the bank failures of the Great Depression. Real Estate can fail catastrophically without a safety net. The guarantee of bank deposits is more a guarantee that Bernanke will get a chance to fire up his electronic printing press to make lots of Monopoly game dollars. This is why the blame is going to fall right at the foot steps of the Fed and the present administration. Where are the smart Republican money men that should warn their boss that this is coming right now?
In the near time there is little the Fed can do interest rate-wise because PRONONUNCEMENT will not make interest rates in this market now. All rates are made in the market place, so reduction of the window dressing Discount Rate means very little. The government could allow the MBS to fail, or they can print money as fast as possible, entering the market to buy MBS with Federal Reserve blank checks.
Can you imagine holding dollars as China does? $290 billion of them, as the Fed is forced to manufacture more dollars in the shortest period of time in their history? Also think about the Secretary of the US Treasury engaging the Chinese in discussions that would now cut off their buying of Treasuries at this time. The Harley Davidson plant was a perfect place for that speech. How do you think foreign governments feel about the MBS they have purchased to replace Treasury instruments in the dollar reserves attracted by higher interest rates? The bigger they are, the more stupid they can be.
The US government could purchase the risk by taking up the last risk of the derivatives on future mortgage financing, but with all eyes watching them, the immense assessment of the risk assumed would be a dollar liability with no offsetting asset. That type of transaction can only send the dollar lower long-term, even if it helped future mortgages. If the government took this position it would be functionally the same as bailing out a bank, but as always, the stockholders do not survive. If this was done, the government would become the direct market maker and guarantor of mortgages to consumers of mortgages. Based on the present balance sheet of the US, no assurances exist that foreign holders would want medium ten year to long 30 year US Treasury instruments, even at much higher rates of return, as they then would carry clear housing commercial risk.
The balance sheet of the US has always had a currency value imperative, and therefore gold in period of extremes always attempts to balance it. A government rescue of the MBS, which may well be required, would serve to explain why some technical tools call for gold between $1250 and $1700.
Warren Pollack felt that intervention would be interpreted as equity positive and markets would react that way. I felt that any such reaction, if it affected gold from higher levels, would be quite short lived if it occurred at all. This is because of balance sheet impact and huge extension of monetary aggregates produced by the Fed to steady the MBS market, or to function in a bail out of the failed entities. The government is already considered to be somewhat of the guarantor of MBS. Saying they were the guarantor, being a sort of a "No change - only performance" would also require huge purchases in the market to steady it.
Sun Aug 3, 2003
Because You Are Now Ready...
Author: Jim Sinclair
For the gold community compliments of JES & Mrs. V. Luis "As Promised"
The following discipline was devised by my Trading Associate and CFO, Ms. V. Luis and I. It is posted on a large board next to a trading desk in Sharon, CT. However, before entering into even the consideration of a trade, there is another sign that has to be reviewed to see if we are all in the proper frame of mind.
Discipline
Dedication
Diligence
Organization
Assuming that we are fully able to say that these four methods of mind set are in place "D3O," we are ready to start.
Then and before anything else, we take 10 minutes of silence committing the trading session and all our action therein to that silence that stands behind every thought. We do not set goals or disciplines in that silence. We simply take into silence the last thought of "We are prepared to act." We practice no form of meditation or prayer (those are for another time and place being totally individual as to persuasion and taste), assume no sitting position, do not turn off phones or make any preparation. All in the office are invited to join, even Mia. The only form to this is that we simply give it all up for a really wonderful ten minutes of simply nothing, no thoughts, no feeling, no time, no problems, no family, and no body.
Then we have coffee (hot carob soy milk if you are reading Harry S.), and discuss the Investor's Business Daily's Price Momentum Line positions, Monty Guild's most recent ideas, Kenny Adam's feelings, and Harry Schultz's GCRU, all which have been emailed or faxed to us. From that review we select what we feel will be the most attractive trade potential today. I can assure you that my cost of subscription to IBD & GCRU has been paid for by selected trades found there for the balance of this life and the next. However, this is only the beginning of the work.
Here is what comes both before and after that. Good luck to you all. VL and I make a gift of this to you. It carries no guarantees, and can be custom computerized to some degree if you have Trade Station as a platform. We have of course done this on all the items we usually trade, and have put up alarms on the Trade Station master quote screens which follow all trading commodities, and the securities and currencies we watch in price terms. If important price occurs we receive alarms, and if we wanted, the computer would call us on the phone or cell to notify us.
Most people who construct reasonable capable systems sell them. VL and I hereby break the mold. This is our gift to you. A system must work well 80% of the time, or you are wasting your time. This is not totally automatic as it requires human judgment at critical junctures. I would have it no other way.
After opening your trade, you enter it into an Excel sheet with a box for the notation of "Why did I make this trade." If you are closing the trade, then you make the same entry, but you fill in the box: "Why did I close this trade." You must keep a diary of every transaction so you can review what you did correctly or incorrectly. Therefore you constantly improve as there is no end to learning, or to the joy of trading well.
Good luck and good hunting.
Sun Aug 3, 2003
Prelude to Monday Morning
Author: Jim Sinclair
JES Comments:
I am your coach, but more so I am your comrade in arming you to compete well in all markets. One who undertakes to transfer knowledge does it to learn. A person teaches well if they simply remind others of what they already know.The following is an unedited copy from a community member that helped me focus on what I need to know Monday morning:
Suggestions For Your Next Tutorials
"Knowing the fundamentals alone gives you too much courage at just the wrong time thereby making you part of the pavement." That was me last July. I became part of the pavement. Since then, I've been working to become a bulldozer.
Your charts and commentary have been very helpful in my education. I'm now to the point where I'm learning to use Metastock along with Pring's tutorials. Anyway, I wanted to add a couple of suggestions for your next tutorial series.
#1.)IMO the most instructive chart you've ever published was on a Euro trade you made. It was in your June 20th Gold Commentary:
http://www.jsmineset.com/i/misc/chart-june202003-f.jpg It's annotated with the comment: "open with hope... but fails." Then "BAM - You're OUT".
You might take that action for granted, but it created an indelible impression on me. You didn't argue with the market, wonder why it's doing what its doing, or hope things would get better. You just got out with a small loss rather than a big one.In other words, you had a scenario and a trading plan for the scenario. When the scenario didn't work out - you got out since there was no longer any reason to have the position.
Again, that may seem really elementary to you, but it isn't elementary for those of us aspiring bulldozers. Until we really understand and believe the principle illustrated in that chart we will lose money.
#2.) "The God of Greed"
You had a throwaway line in your tutorial about giving the last of the move to the "God of Greed". I think it would be very helpful to us aspiring bulldozers if you elaborated on that point and drove it home more forcefully.
One of the biggest things I've learned from studying charts is that trying to get "all of it" costs money in the end. It's a killer.Instead of riding a trend that's been confirmed, you're gambling that a trend will appear. Conversely, going for "top dollar" when the trend is running out of gas is also gambling.
#3.) "Sell the Rhino horn and buy the fishing line" You once used this phrase in regard to French curve lines, but I think it's an important concept regarding trends. The idea to borrow a phrase from Alan Greenspan, "Unsustainable trends tend not to be sustained." or that "Trees don't grow to the sky."
The natural reaction most people have is to cheer and root when stocks go parabolic. I know I did last July - and I got my ass handed to me. It taught me a big lesson. I think it would very helpful to others if you covered this
point in your next series.
The callers on Tom O'Brian's internet show illustrate what happens. When they're all laughing and happy - don't buy. When they're mad and scared - start looking. When none of
the callers talk about gold shares - that's the time to accumulate since everybody who was going to sell has sold.
Again this may seem pretty elementary to you, but it took me a while to figure it out. The concept is important. That's what I got out of French curves. When I saw the line curve over on itself I learned to be very
careful.
Anyway, those are my suggestions for your next set of tutorials.I know you've spent a great deal of time on all this. Please remember that there are many people like me that are benefiting.
Regarding your 7/30/03 commentary:
"Up to a few weeks ago and for the last 23 years, the cost of money has gone only one way: That way was down. That has changed now, and for a very long time to come the primary direction of money costs will be up."
I never thought of it that way. That's scary. In effect, you're changing the "global bet" you made when Paul Volcker came in as Fed Chairman. We do live in interesting times.
JES Comments:
1. Re Volker and changing the Global Bet: YES.
2. The most dangerous move mentioned here is when I buy a fishing line. This is true because selling a Rhino horn is closing a position. However, buying a fishing line is opening a position. In that case having Kenny's input is a value beyond values. There is no free lunch in markets so we have to step out into the unknown from time to time. It is here we need to be disciplined and pick a point that limits our risk.
Sat Aug 2, 2003
Erratum
Author: Jim Sinclair
Re: 2000 ounces taking gold down $4. It was 20,000 ounces equivalent to 200 Comex contracts which is very very low volume for that price move.
I am looking at what caused the price to drop and that was a switch from short August 03 to short December 03 gold that appeared legged. The total trading volume in December 03 gold was 441 contracts, of which slightly over 200 contracts looked to me like the short moving forward from August to December. It was that transaction that resulted in gold's low volume flop. Any contract moving sharply in a direction affects all contracts if the trading at that time was quiet to non existent.
I was wrong in what was written because it should have read 20,000 ounces equivalent gold, not 2,000, which is almost as bad for the distance covered.
Normally to roll a position forward you price what is called a switch. A switch trader on the floor takes your near position away from you and gives you the far position at a quote differential in dollars. Say from August 03 to December 03 at slightly more than the catango plus the spread between the bid and ask. Catango means the difference in price between the near cash month and the far that you want to go to. The difference between the bid and ask price is close in a future and not that close in an option. When you roll a short forward via a switch you are spreading forward by a buying in the near and selling the far. This is what Mr. B did not see as it is internal in the market. There is another possibility that a switch trader committed to a spread for a client thought he could make some more money by holding off on the sell, misjudged and sold the Decembers in a sloppy manner to close the position (protect a gain or limit a loss) as there was at that time no other alternative.
Comentários do James Sinclair (o sell-off dos bonds e o ouro)
jota
61
04-08-2003 07:13
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