6 Signs That 2014 Will Be The Year Of The Super Crash

As we have finally arrived in the magic year 2014, in which almost every economic and business cycle is trending down, it seems that things are perfectly lining up for a melt down. If it would have been true that the debt crisis was contained (like our political leaders try to make us believe), then there is a huge divergence with recent trends.

Are we pessimistic? No. Are we optimistic? We do our best. Above all, we aim to be unbiased and neutral. In any case, this article is not an attempt to predict prices or to time any market. That is useless and serves only marketing purposes. This article looks at six different trends which are lining up for an historic sell off in the markets. As readers observe, we stay as factual as possible.

Trend 1: Market distortions because of QE appearing in emerging markets

Up until now, the vast majority of economic and financial pundits have been praising the Western central banks for their monetary miracles. The last two weeks, however, were extremely important as we got evidence of the direct destructive effects of monetary easing. In particular, the carnage in emerging markets and their respective currencies revealed that things can get out of hand and have the ability to spiral out of control (much faster than governments can intervene).

Bloomberg says this is the worst selloff in emerging-market currencies in five years, revealing the impact from the Federal Reserve’s tapering of monetary stimulus. “Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.”

Once the destructive power of this monetary experiment starts manifesting itself, it is likely to see spill over effects to all markets. Monetary easing could still look like innocent and constructive, but the side effects are unknown at present, as this is the first monetary experiment at this scale. The most concerning fact is that nodoby has an idea about how exactly the markets will react on each slice of tapering, and the precise timing of all effects (including the unintended consequences).

Trend 2: There are almost no buyers left in equities

Equity markets have shown exceptional yields in 2013. In a world with no yields, investors are chasing assets which yield more than nothing.

It has been thought that quantitative easing would create bubbles, but as it looks now it is resulting in bubbles in specific asset classes, as Marc Faber correctly predicted a while ago. The problem is that sentiment in the stock market has become far too optimistic. It’s not surprising, nor are investors or traders to blame, in a zero-yield world. The first chart shows the extreme optimism based on a bull/bear ratio.

fund_traders_optimism_2013

 Another red flag is related to margin debt, see next chart. It shows the level of leverage in the equity market. We are well past the previous peaks.

US-NYSE-margin-debt_1990-2013

However, there are reasons to believe that a crash is not imminent. Equities have surged but the margin debt to equities growth ratio is not as extreme as in the 2000 and 2007 peaks. This metric suggests there is some room for more upside.

margin_debt_to_equities_growth_2013

We all know what happens when there is nobody left to buy. That point could be very close.

Trend 3: Manipulation is entering the public debate

Currency markets, LIBOR, base metals, energy, … almost every single market has been manipulated. That is no news, of course, but the fact that it has become widely accepted is an important trend. Consider these headlines in the last few weeks:

  • Federal Reserve Said to Probe Banks Over Forex Fixing (Bloomberg)
  • Deutsche, Citi feel the heat of widening FX investigation (Reuters)
  • HSBC, Citi suspend traders as FX probe deepens (Reuters)

Even the precious metals manipulation debate is going mainstream. Up until now it remained in the “dark corners” of the internet, in the “blogosphere” and “gold bull” sites. Now it is the German financial regulator Bafin who says that “Metals, Currency Rigging Is Worse Than Libor” (via Bloomberg).

The key is that it has the potential to undermine trust. As readers know by now, trust is the pillar on which the current financial system is built. Once there was a tangible asset backing up the monetary and financial system; it was called gold. Not so anymore. A large scale loss in trust will have disastrous effects.

Trend 4: Banks are once again reporting losses

Several mega banks have been reporting losses in the last weeks. Is this a repeat of the 2008 scenario?

Consider Royal Bank of Scotland, who faces £8bn in full year losses. BBC writes: “RBS may face full-year losses of up to £8bn, after the bank said it needed another £3.1bn for claims relating to the financial crisis. RBS boss Ross McEwan said: “The scale of the bad decisions during that period [the financial crisis] means that some problems are still just emerging.”

Another giant, Deutsche Bank, posted EU1.2 billion losses in the fourth quarter. Via Bloomberg: “Deutsche Bank AG, Germany’s biggest bank, said this year will be challenging after a surge in legal costs and lower debt trading revenue spurred a surprise fourth-quarter loss. The shares slumped. Depressed interest rates in Europe and declining demand for banking services are also among the headwinds the bank is confronting in 2014, Co-Chief Executive Officer Anshu Jain said on a conference call with analysts from Frankfurt today.”

Wait a minute. The central banks of this world have injected close to $10 trillions in the banking system since March 2009, in order to prevent a melt down. They have reported happily that, by doing so, they not only saved the world but also generated economic growth. But at the time of victory, mega banks are reporting losses. Something does not add up here.

Trend 5: The alarms of financial repression are deafening

It is getting really ugly with financial repression.

Reuters reported this week that Germany’s Bundesbank publicly commented that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help. The Bundesbank’s tough stance comes after years of euro zone crisis that saw five government bailouts. There have also bond market interventions by the European Central Bank in, for example, Italy where households’ average net wealth is higher than in Germany.

“(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required,” the Bundesbank said in its monthly report. It warned that such a levy carried significant risks and its implementation would not be easy, adding it should only be considered in absolute exceptional cases, for example to avert a looming sovereign insolvency.”

The annoying part here is that the bail-ins debate is becoming mainstream. So it was no mistake from Dijselbloem a year ago when he said bail-ins will become the template for the future.

Moreover, some HSBC customers have been prevented from withdrawing large amounts of cash because they could not provide evidence of why they wanted it. The BBC writes: “Listeners have told Radio 4’s Money Box they were stopped from withdrawing amounts ranging from £5,000 to £10,000. HSBC admitted it has not informed customers of the change in policy, which was implemented in November. The bank says it has now changed its guidance to staff.”

Over to Russia, where, according to Zerohedge, the bank Lender has introduced complete ban on cash withdrawals until end of week, news agency reports, citing unidentified person in call center.

The subject is also going mainstream in the literature. A recent IMF working paper from Reinhart and Rogoff says: “The endgame to the global financial crisis is likely to require some combination of financial repression (an opaque tax on savers), outright restructuring of public and private debt, conversions, somewhat higher inflation, and a variety of capital controls under the umbrella of macroprudential regulation. Although austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer magnitude of public and private debt overhangs.”

The annoying part is that the financial repression story is intensifying. It is being accepted in the literature, among politicians and now we see an increasing number of initiatives being rolled out. Not good.

Trend 6: Complexity theory points to a collapse

Jim Rickards recently suggested that the world has become so interconnected that it has the looks of an extremely complex system. His research points out that complexity theory can be useful as an analogy to determine what comes next. Prior experiments in complexity theory suggest there is a point of no return: when things become too complex and interconnected, they can only come down.

Rickards sees a similar situation in the markets today. In fact, he saw something similar in 2006 and 2007. We all know what happened afterwards.

But what has the central bank noticed? Apparently nothing, as evidenced by their systemic risk model on the next chart. It is at an all-time high.

financial_system_risk_2013

Should we be concerned when there is nothing to be concerned?

A valid question to ask is why Jim Rickars can detect things that the central bankers cannot. Rickards himself explains it in a very simple and short way: the Fed is using the wrong economic models. Their models could be fine theoretically, but they do not reflect reality.

Protect yourself

Are six red flags enough to start protecting yourself? When things get out of hand, our world will become very selfish. The most likely outcome is that everything will come down initially, comparable to what happened in 2008. Chances are high that precious metals will recover fast.

The point in all this is that asset prices will be of secondary importance. Avoiding a total catastrophe could be far more important. There really is a reason why we advocate holding physical precious metals outside the banking system or open an offshore bank account with a debit card in gold or silver at a reserve bank.

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