Posted by Ann Barnhardt - December 15, AD 2011 9:38 PM MST
1. Corzine and Abelow testified again before the House Financial Services committee, and it was another nausea-inducing spectacle. Today's questioning was actually WORSE, because Terry Duffy had lobbed the committee a grapefruit on Tuesday regarding Corzine's knowledge of the customer seg funds being raided and sent off to Europe. (OF COURSE HE KNEW. BACK OFFICE TREASURY DATAPUNCH CLERKS DON'T SEND CUSTOMER SEG FUNDS TO EUROPE OR ANYWHERE ELSE OF THEIR OWN VOLITION.) But, of course, none of the congresscritters were even remotely smart enough to ask about any of that. In fact, one chick congresscritter was fawning over Corzine so hard, I honestly thought that she was going to come down off the dais, crawl in Corzine's lap, push back his greasy mullet, and start blowing in his ear. Her line of questioning - if you can call it that - was along the lines of, "Mr. Corzine, is it possible that no one within the company notified you of any problems because you are so brilliant and awesome and thus people find you intimidating?"
2. The best part of the whole day was Corzine getting served with a big ol' lawsuit as he walked out of the hearing room during the break. A commodity trading advisory service who is hung out to dry for into the NINE FIGURES is suing the top 20 or so executives in the company. AWESOME. Here's the video:
3. Finally, a very simplistic explanation of how the cash commodity markets are soon going to decouple from the futures markets. This is a little complex, but stay with me. I think this is important to understand because none of us who have lived our whole lives in the U.S. have ever seen a market disintegrate.
The threat (or promise) of delivery upon expiration is what keeps the futures markets tethered to the cash markets. Up until now, if an unreasonably wide spread between the futures price and the underlying physical commodity market got too out of whack, a process called "arbitrage" would kick in. Arbitrage is when a party simultaneously buys and sells on two separate but related markets in order to capture an inefficient spread between those two markets.
I'm going to use precious metals as my example commodity because there are alot of metals guys reading this, and because the metals markets will be the big tell in term of when decoupling and thus total futures market disintegration is upon us. But these examples apply to all of the physical commodities.
Let's say that the physical silver market is trading far lower than the silver futures price. This is what is called a WEAK BASIS. The BASIS is the relationship between the cash market and the futures market and is very simply defined as (CASH minus FUTURES). If cash silver can be bought at $25.00 per ounce and the futures are at $30.00 per ounce, the cash is $5.00 under the futures. When cash is under the futures, this is called a WEAK basis.
Up until now, what would a metals trader do? In very simple terms, he would buy the cash silver at $25.00 per ounce and then simultaneously sell the futures at $30.00. Because he has short-sold the futures, he could hold the contract to expiry and then deliver the $25.00 cash silver he bought to make good on the contract and receive his $30.00 price. So his simple net profit would be $5.00 per ounce. As many traders saw this spread and simultaneously executed this same strategy of buying the cash and selling the futures, what effect would this have? Right. It would cause the cash-futures spread to move back in toward convergence by pushing the futures price down (lots of sellers) and propping the cash market up (lots of buyers).
Now the opposite scenario: a STRONG basis. Let's say cash silver is trading at $32.00 and the futures are trading at $28.00. A trader might take physical silver that he has in inventory and sell it in the cash market, and then immediately take those proceeds and buy back and equal number of ounces in the futures market and take delivery. Since the same number of ounces in the futures market cost $4.00 per ounce LESS, he would end up with the same number of ounces in his inventory PLUS $4.00 per ounce in CASH in his pocket. If he and many other traders saw this condition and they all sold cash silver and bought the futures, this would, again, converge the spread between the cash market and the futures market.
The lynchpin that is holding this dynamic together and keeping the futures markets tied to the underlying cash market is the fact that the futures contracts are deliverable, and a trader can either deliver or take delivery of actual physical silver via his futures position.
Are we seeing a problem yet? The futures markets have lost their viability and trustworthiness because of the MF collapse and theft. At some point in the not-too-distant future, people everywhere are going to realize that the delivery mechanism is not reliable. Heck, just holding cash and/or positions in a futures account is no longer reliable. The the market itself is not reliable, traders will no longer attempt to arbitrage these basis spreads because the risk to the trader that the rug will be pulled out from underneath them is simply too great.
And in the metals markets, the delivery process itself is . . . um . . . shall we say, easily corrupted? When you "take delivery" of physical metals, it doesn't get sent to your house. All you get is a certificate saying that X number of ounces are being held in a certified vault somewhere with your name on them. After the MF collapse, that sounds like a joke, right? A CERTIFICATE with my NAME ON IT? Yeah. That really is how it works.
When the arbitrageurs finally lose all confidence in the markets, the cash market will decouple from the futures because no one will be willing to take the risk of having their money, positions and/or physical metals stolen/confiscated. If no arbitrageurs are willing to trade these spreads - no matter how wide they may become - and thus there is no force causing the cash and futures to converge, we will see the basis spreads become extremely wide. As people flee the futures markets, the futures prices will drop, while the cash markets hold steady or even diverge and actually rise as all of the former paper players realize that physicals are the only remaining game to be played.
Watch for this. Watch for the gold and silver futures to sell off as people walk away from paper while the online cash dealers, seeing that market demand for their physical inventory is robust, begin to ignore the futures prices and hold their prices steady or even raise them. When you see this basis decoupling and absence of arbitrage, lo, the end is nigh. A parabolic spike is coming.
Warren Pollock Interview & Other Stuff
Posted by Ann Barnhardt - December 14, AD 2011 8:16 PM MST
Just so you all know that I'm not alone in my sentiment and actually am speaking on behalf of other folks and brokers in the industry who simply don't have the soapbox that I have, here is an email from a second-generation floor trader in Chicago:
Ann Barnhardt,
Thank you for speaking up and calling it like it is. My father joined the Chicago Board of Trade in 1979. I joined the CBOT in 2009. We are customers of MF Global. The day they told me my money had been frozen I declared the futures industry completely dead. I grew up in the industry. I knew there were always thieves, mobsters even, in the business and I saw it from day 1 on the trading floor. But the depth of deceit has reached new lows.
MF Global and the CME violated the only principle that mattered in futures and anyone watching the farmers and ranchers testify yesterday should've seen that something has been broken beyond repair for them: TRUST! If the hedgers like you and your customers won't use the market then what are the speculators like me supposed to do? Well, I believe we're seeing it. The big specs have completely captured the trading venue through High Frequency Trading and are using it to fleece as many people as foolishly remain in the game where no bona fide hedgers operate anymore. The inmates not only run the asylum, they've set fire to it.
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