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Wednesday, January 23, 2008

A Rough Day Ahead

Ugh. Looking at the European exchanges and commodity pricing, the bears are emerging from hibernation, or maybe the bulls are trying to cover their butts.

Oil, grains, copper, etc are all down.

The US indices could have some huge downward movements today. It's not a certainty, but it is a good possibility.

Liquidity evaporation part two. This was so obvious it scares me. As usual no one could call the timing but it was inevitable. What do you think is going to happen to seasonal gold jewelry demand in India after the last week? What do you think is going to happen to industrial gold demand in tech after the last week? What do you think is going to happen to gold reserve demand after the last week?
Rob, wasn't industrial gold demand already going down? I just assumed it was because of the Asian declines in electronics exports.
I've not had a chance to read this yet, but here's the link.

It's appears to compare current conditions with historical downturns. Will try to take a look at it if work doesn't get in the way.
I'm pretty sure industrial gold demand was sorta going down. Remember these are usually long term long lead time contracts for specific delivery within a defined range. If you had $450 contracts written in 2006 what would you do? That's right, you'd be buying contractual limits and actually consuming as little as possible even to the point right up to reducing production and selling the difference on the spot markets. That's why it is hard to tell in the short term what is happening in industrial consumption.

Concerning Asia, China has real serious problems that they need to cap until after the Olympics. Massive inflation, bank fraud, misallocated central economy projects and a restive consumer nation. Acoal plant every six days isn't visible to the bottom billion. 4x price increases in animal protein is. A banking crisis similar to ours of 1890 would be met with military force and that would kill the Olympics which would disrupt world trade in several ways. A desperate mainland could seek distraction in foreign military adventure. They plain old don't honestly believe the US would shoot back if they tried to take Taiwan. Big mistake.

Heck, it might not take that. Should mainland try to buy "too much" Aussie grain with worthless American paper they could get justifiably upset at their scratchy green toilet paper collection.
Rob, the Chinese are rationing electricity, etc. They seem to be in a big bind.

Teri, thanks. I will read it. The title kind of put my teeth on edge. This is a crisis over a lot more than subprime. It's not really the subprime that's blowing up the bond insurers, for example.

Just the announcement of the regulatory meeting was enough to give the markets a real boost today.

This crisis is rooted in unassessed risk and pretend instruments purporting to deal with the risks no one bothered to assess in the first place, which have acted as a net dragging down entire classes of assets.
Ah, MOM, I do believe the subprime was the first chink in the armor of the bond insurers. I'm too tired to type it all after snowboarding today, but it's linked with the monoline, reinsurers, et al. Certainly it wasn't the Muni defaults that pushed them over....
It was the second liens that pushed subprime over, and it is high CLTV loans with very high DTIs (or no verified DTIs) that are pushing over substantial Alt A and prime mortgages.

But this still wouldn't cause a muni problem if risk assessment hadn't been abandoned in favor of pretend protection. Some of the munis that might be downgraded are okay, but a real risk assessment process was shortchanged on those and monoline insurance was substituted.

Then of course the CDO-type packagings of these things caused another problem. It's the mixing of bad with good that has created these waves of correlations.

We'll see what the NY regulators come up with, but the bottom line is that an awful lot of money now has to be set aside to support asset values, and that will either withdraw it from circulation or strip the banks of reserve capital.

At this point I do not see this ending well. There are two options. Trying to get banks to throw money into the pot to protect their future asset valuations is one, and returning to actually evaluate underlying risk for each individual asset is another. Both are painful, but I think the second will prove less expensive over the long run.

The pension funds have an interest too.
I was telling Shrinkwrapped today about the Banks helping the insurance companies. A he's a medical man, and not well versed in such trivial matters, I described it as a patient with pneumonia helping a patient with Turberculosis up a flight of stairs.
GOOD analogy. One would not want to be at the foot of those stairs at the time, because the odds of making it to the top are not that great.

We live in a financial insane asylum.
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