Tick By Tick

Last week, Zerohedge published an article about how 5 of the biggest banks control 96% of the outstanding derivatives exposure at a value of $250 000 000 000 000 (or $250 trillion).  Critics of these figures will point to the fact that a great deal of the exposure is from the banks hedging their OTC trades to net off the risk on thier books.  However, as Zerohedge correctly points out, this is solely reliant of the counterparty to the contracts being able to pay out the other side of the contract.  An issue that becomes exacerbated if the availability of credit to these insitutions starts to dry up as it did in 2008.  

When looking for the most exposed banks, the quarterly report from the Office Of The Currency Controller points to the key culprits in the derivatives masquerade.  Although, JP Morgan, Citi, GS and a few others have a far greater total exposure that MS, their portfolio is far more diversified.  Morgan Stanley holds an outstanding  $1.7 trillion in OTC FX contracts at a concentration of 98.3% of their derivatives portfolio.  

The threat of this blowing up in todays intervention prone markets is very real.  One would only have to be on the wrong side of the Swiss National Bank or the Bank of Japan in recent months to find this out the hard way. 

These concerns are added to by concerns for Investment Banking in general, the recent market turmoil has killed off demand for M&A and IPO's that for a core revenue stream for IB's as their clients hold out for more stable markets.  Moreover, as the demand for brokerage becomes more exchange driven and direct access based, the spreads and commissions that the banks are able to charge suffers a significant contraction.  A quick conversation to anyone within the sell-side industry will quickly reveal how there is a feeling that the power is now firmly with the buy side in almost all areas of brokerage.  Traditionally, revenue streams like Global Custody and clearing were considered a secondary purpose to trade but recently they have become an increasingly important constituent of the IB's balance sheet as they rush to fill the vacuum building in flow commissions. 

European Commission published figures showing that European Confidence tanked across the majority of sectors.

This graph from Markit Economics reveals the sheer speed of the decline compared to the credit crisis of 2008

"The Euro is practically dead"

"The Euro is beyond rescue"

"The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greece’s spirits"

The real question…Why is this shocking people?

Full article available at www.index.hu

In the period between Mid 1999 and the End of 2001, Gordon Brown (Chanellor of the Exchequer) managed to sell 12.5 million ounces of gold on the open market to fund wasteful socialist policies around the UK.  The magnitude of this trade cannot be understood until you quantify the potential loss in value.  If we use the July 2011 value from the chart, Gold is priced at $1800 per Troy Ounce or thereabouts.  Using this figure, we can calculate that the British Governtment lost $22 500 000 000 in potential asset value. 

The figures for the chart below were taken from the UK International Reserves and Foreign Currency Liquidity Template issued by the Bank of England.  Any grievances should me taken up directly with The Swerve.

Macro Man:

The Swerve / King of the Moon – Governor of a Central Bank based in London

Mervynflation – A form of inflation that a whole population can see and suffers, yet is completely invisible to The Swerve.

The financial sector knows that heightened financial regulation is coming, whether they like it or not.  What we have learnt historically is that tighter regulation tends to breed financial innovation that can be more detrimental to the banks.  

In the 90's, William Demchak and his team at JP Morgan created the market for Credit Default Swaps to lower the risk exposure of thier bond book.  The sole purpose, at the time, of this invention was to circumnavigate the Basel Capital Adequacy requirements that required 8% be held in reserves.  By insuring all of thier debt using CDS, JP Morgan was allowed to dig into that 8% to fund other activities and maximise its capital.  However, we all know how the credit derivative story ended. 

Europe's most recent call for regulation has been in the form of a Transaction Tax to help them raise fiscal resources so the ECB can continue to bank roll bankrupt sovereign nations.  If I was a banker staring at my Bloomberg terminal today, I would be pi***d to say the least.  

Here are the facts for you, reported in the Financial Times:

Plan estimated to raise €55bn a year 

Commission report estimates 0.53% and 1.76% reduction in GDP

Officially, the UK would be allowed to veto the idea in it's entirity but this is unlikely to make thier EU Chums in the Hague particularly happy.  What the EU politicians fail to understand is that although the market may not be completely efficient, humans are instinctively well trained to find a better deal.  In finance, this would result to huge capital outflows from the Eurozone as financial institutions look for ways to avoid a "Tobin Tax" and prop up, their already fledgling, balance sheets.  Nick Farage, of UKIP, tried to voice this concern at the European Commission in March, calling the plan "Kamikaze Economics".  For all of you who missed it, please watch the clip from Youtube attached.

Ever since the formation of the Euro, the EURUSD colour pair has become the hottest product in the FX world.  However, the diagram below shows the pairs perfomance since the start of the week and it highlights a key issue regarding trader sentiment.  We are finally starting to here that the EU is willing to bank roll Greece for a little while longer which, expectedly, is causing stock markets to rally across Europe and the PIIGS bond yeilds to slowly descend from their recent highs. 

What a great deal of investors fail to understand is that by retaining Greece, and its debt, within the EURO, the currency becomes more toxic.  To put this point into context, consider the following situation.  Lets assume that we live in a fully free market society with a single monetary currency and that no bailouts can be granted to distressed countries.  As the weaker countries become distressed, they are removed from the single monetary currency so that they can regain countrol of their Monetary Policy and potentially print money or provide some for of TARP.  What you are left with is the stronger economies who do not possess any distressed debt and as a result thier currency is particularly strong.

If we were to apply this to Europe - The situation would look a little like this

With that in mind, consider the graph below……

…..Expect a major correction soon

For holders of commodities, especially the precious kind, last week must have been some of the most anxiety filled days in a very long time.  However, we at Tick By Tick, cannot help but feel sorry for those trading in the spot markets as the sell off was largely due to a range of margin hikes on global futures exchanges.  This led to the more speculative market participants creating a wave of contract sell off's in an attempt to avoid having to place more capital with the exchanges themselves.

The exchanges have been threatening the hikes for a while due to the uncertian climate and increases in the sheer number of market participants, especially within the precious metals space.  Silver, the strongest PM performer this year, lost a years worth of gains in this panic sell off, a point that must have delighted the folks over at JP Morgan and HSBC who it is widely thought have enormous short positions in the metal.  

However, as currency debasement and central bank intervention continues, we expect to see the PM's par some of their losses in the long term and potentially outperform the high's that have been experienced in the summer months.  

For full details of the margin hikes at the CME Group, head over to our Chart Vault or click Here to be redirected.

This week, we will start our next Full Length Article on what we percieve to be the secong biggest ticking time bomb behind the demographic of China.  We are talking about the unfunded social securitiy obligations that the US must pay in the coming years as the first of the baby boomers start to retire.

In the meantime, please head over to http://usdebt.kleptocracy.us/ where they have created visualisations of just how large the issues facing the US are.