The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Friday, October 10th, 2008.
That's what investors simply will not do today because they are the same spoiled brats that make up the bureaucracy. Stubborn - stubborn - stubborn - that's what both investors and bureaucrats are today, with no sense of proportion or morality, and unwilling to give up the ghost in speculation games. The moral hazard that has been instilled into the public and bureaucracy alike over the past twenty years has finally caught up to reality, where as discussed in 'The Missing Ingredient' the other day, investors are convinced the bureaucracy will engineer another stick save for the stock market right in front of the election, and for this reason speculators are hesitant to short the market. And it's not as if the bureaucracy isn't throwing the book at the problem attempting to arrest the meltdown - they are. But alas, without the suckers (put buyers) to squeeze stocks higher, prices continue to plunge like never before in history.
Add into the mix investors are still margined to the hilt, and guess what, we have a recipe for a system wide meltdown, never mind just the stock market. That is to say, if the stock market were to collapse over the next year or so to the same extent it did in 1929, which saw the Dow down some 90% in the end due to margin debt contraction, then what we are likely looking at moving forward is the Great Depression II. And it's not as if we don't have any modern day examples of what happens after a credit bust, where this has certainly been the experience in Japan, in an economic malaise for the past two-decades now. Of course if the US goes down, which is happening, things will get much worse for everybody no matter what measures are taken. A derivatives neutron bomb has gone off now that will meltdown the financial markets in record time, where it appears the future may be now in this regard.
Of course it wouldn't matter if was derivatives led meltdown or not. (i.e. don't let this guy fool you.) The main criterion that will usher in the Great Depression II is that the larger credit cycle has peaked, which in turn will trigger all the standard emotional responses from the public and bureaucracy alike. You see the credit cycle was extended by the creation of quadrillions in notional value of derivatives that supported the ILLUSION value was present in the financial markets when there was far less. So, despite the size of the numbers involved in our financial system, because it's all an illusion, as you can see in the case of the stock market, a great deal of fictional wealth can get wiped out very quickly. In this respect I do think Roubini is right about one thing, Monday could be a very interesting day in the stock market - a very interesting day indeed.
Turning to the charts to support this view, of note is the fact the Dow / Gold Ratio has sliced right through large round number support at 10 with ease, meaning unless the fall is arrested soon, it could continue sliding in fractal fashion as stocks plunge / gold explodes higher. Further to this it should be pointed out that mirror image structural patterning expectations associated falling stock markets should be abandoned at this point given the degree of irregularity already witnessed in this regard, which supports the view the Dow / Gold Ratio could collapse rapidly. Add to this escalating derivatives related counter-party risk considerations, which was touched on the other day, potentially causing panic buying of gold (and silver) by US banks and hedge funds, and it's not difficult picturing exacerbation in the move.
Need more proof things could get worse from here? Well, in addition to checking out the fact the Rydex Ratio (see Figure 3) is nowhere near a top, one might want to check out this attached Daily VIX chart. Here, one should notice that in addition to more room existing on indicators before peaks should be expected, that the ADX (DI+) reading has now broken out. So what? It's only this implies life as you know it has now changed forever as a result, where volatility will rule in many respects, and few will be able to insulate themselves from growing turmoil. Thus, don't be surprised if the CBOE Volatility Index (VIX) continues up over 100, bank / market holidays ensue, and a bunch of people waking up very quickly. (See Figure 1)
How can I be so sure such a pessimistic appraisal could become a reality? Again, it's investor sentiment that tells the story, where measure after measure continues to signal complacency. In this respect I offer the below snapshot of the Nasdaq / Dow Ratio, where it should be recognized a structural break of indicated support will kick in the afterburners on the larger sell-off in the stock market as crazed speculators finally give up the ghost on both the presidential cycle and unfounded optimism associated with the economy next year. Growth sensitive tech stocks outperform in a strong economy, where again, a crashing stock market should remove any confusion within investors minds regarding the reality of prospects moving forward. (See Figure 2)
And in solving the mystery of why silver can under-perform gold with a relatively profound short position against it, now we know why, with the prospects for the economy imploding dramatically increasing by the day. Gold outperforms during times of economic uncertainty, and as you can see in the long-term monthly plot below, it's been a rocket against silver over the past few months, and is poised for further fractal like gains. Again, in terms of what this would signal, think in terms of further fractal like losses in stocks, where at this point the best conceptual framework to characterize events likely lies within understanding globalization, fiat currency regimes, and present day bureaucracy's are collapsing in a Grand Super Cycle Degree event, at a minimum. (See Figure 3)
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Good investing all.