After my last article we received two logical questions from readers. The first one pertaining to "gaps" and the Deutsche Bank derivative exposure, the second pertaining to Japan's strong currency with negative yields while the debt to GDP levels are astronomical. Below is the first question;
"In the past you have warned about derivative exposure and now gapping.
One of my worst fears as a day trader on a derivatives platform is gapping. That is why I will never have an open position when the market is closed. Even then, that is not guaranteed.
A lot of trading platforms got hammered when the Swiss franc was revalued.
Could you put out a letter for your readers explaining why for example the Deutsche Bank derivatives exposure is so dangerous in terms of gapping."
In my opinion, this is a very astute observation. The reader will not carry overnight positions because as he says, "the Swiss franc revaluation killed many" within less than 10 minutes of the markets opening. That said, even if not in any overnight position and the great leveling moment comes, how does anyone know if their broker even survives the carnage ...with YOUR MONEY? But this is another topic entirely.
As for Deutsche Bank, we know they have been recently screaming about negative interest rates hurting their operations. This very well may be so, but it is my opinion it is not so much negative interest rates killing them. I believe it is off balance sheet derivatives. Not only has DB denied any problem, the German finance minister has now chimed in with reassurance! Where have we seen this before? Does Bear Stearns or Lehman Bros. ring a bell? Doth the Germans protest too much? By the way, their credit spreads are stretching out, and stock price has now taken out the 2008 lows!
The second question regarding confusion of Japan's 10 yr. yield hitting 0% and their currency strengthening while being the fiscal basket case of the world is also a good one but very simple to explain. Japan has a debt to GDP ratio of 260%, if you add in corporate debt it approaches 400%, how could they not have a crashing currency and 20% (or higher) interest rates? The simple answer is this, the global "carry trade" is unwinding. The Japanese yen was a major tool used to create and float the carry trade which inflated assets. Now, as asset prices are falling, this trade is being unwound (think of it as a margin call). Previous yen that were borrowed are now being bought back to settle the trade. This was a synthetic short similar to the dollar short being covered. A quick question and very short answer, why would anyone in their right mind invest money for 10 years at zero percent in a currency who's issuer publicly states their goal is to grossly debase? Answer: BECAUSE THEY HAVE TO!
The problem is this, as the yen strengthens from short covering it is putting more and more of these carry trades under water and actually forcing more sales of assets and more buying of yen. This will end in one of two ways ...both badly! Either the trades get unwound with asset prices collapsing and the yen at truly stupid levels, or someone "fails" and the derivatives chain breaks. I would personally bet the farm on option number two.
While writing this, CNBC is parading guest after guest as to whether a recession is "likely" ...IDIOTS! This is not about a "recession", this is about whether the entire system fails or not! Can Deutsche Bank "fail" while being counter party to over $70 trillion in derivatives? Can even a small counter party fail without causing a cascade? Just look at the volatility in markets, junk bonds are collapsing, credit spreads blowing out, currencies making wild swings, $7 trillion worth of sovereign debt trading at negative interest rates ...not to mention stock markets moving from all time highs into bear markets within just a couple of months. (While editing this, CNBC is actually questioning if DB is a "one off" situation? Is this even possible? Do they even understand what they are asking?!!!)
Do you think "someone" might have lost some money since January 1st? Enough to bankrupt them? THIS is the question! The answer in my opinion is this, there are dead bodies strewn all over the place yet are hidden from view. They are being hidden from view because if they are seen, the entire system comes into question with answers being delivered within probably a 48 hour period. The answer of course will be the biggest "gaps" in all of history ...both in price AND time! By this I am saying the re opening gaps will be larger in percentage and the time to reopen longer than ever before.
Whether you want to see it or not, the financial system is in a forced unwinding. It took some 70 years to build this great credit edifice, when it goes it may take less than 48 hours to take it ALL down. To finish I leave you with a short clip of what the collapse might look like ...and how quickly it can get there!