The Next Flash Crash

  • Jim Rickards goes where your editor was too timid to venture
  • “Worse than you know”: Anonymous market insider’s candid dinner with Jim
  • The “flash crash” of October 2014… and how the next one could be far worse
  • Why you should ignore the vampire squid’s bearish pronouncement on oil
  • Housing looks strongest since, er [gulp]… reader affirms Jim Rickards’ bond thesis… an issue that resurfaces predictably every nine months or so… and more!

  Well, how about this? Jim Rickards is giving voice to a thought that crossed your editor’s mind yesterday… but I confess I withheld it from you because it seemed too tinfoil.

Makes sense, right? Russia is set to host the World Cup in 2018.
Only hours after Jim tweeted from South Korea — where he headlined an event with Ben Bernanke, of all people — Russian president Vladimir Putin chimed in: “This is yet another obvious attempt to spread [U.S.] jurisdiction to other [countries].”
Doggone it, I should’ve piped up yesterday. And I should’ve remembered Jim has a knack for making the ridiculous sound reasonable.
“Really,” our executive publisher Addison Wiggin wrote last summer, “who was going to believe us when we described a joint project of the United States, the European Union and the People’s Republic of China — seizing upon the next financial calamity to replace the dollar as the world’s reserve currency? Or, even more outlandish, that the relentless flow of gold from Western into Chinese hands that we’ve chronicled is an integral part of the plot?”
But Jim had the documentary evidence, and he laid it out in his book The Death of Money. It’s one of many reasons Addison moved heaven and Earth to bring him aboard our team at Agora Financial last fall.
This morning, with the help of a friend whose identity must remain secret, Jim helps us prepare for a major “dislocation” in the markets.
  “Jim, it’s worse than you know,” said this individual over dinner at the Ten Twenty Post bistro, on Connecticut’s Gold Coast.
First let’s tee up who we’re talking about: “He is a senior official of one of the largest banks in the world,” Jim says, “and has over 30 years experience on the front lines of bond markets.
“He has been a regular participant in the work of the Treasury Borrowing Advisory Committee, a private group that meets behind closed doors with Federal Reserve and U.S. Treasury officials to discuss supply and demand in the market for Treasury securities and to plan upcoming auctions to make sure markets are not taken by surprise.
“He’s an insider’s insider who speaks regularly with major bond buyers in China, Japan and the big U.S. funds like PIMCO and BlackRock. For our purposes today, let’s just call him ‘Mr. Bond.'”
  “Over white wine and oysters, I told Mr. Bond about my view of systemic risk in global capital markets,” Jim goes on.
“I told Bond that markets appeared to be in a highly paradoxical situation. On the one hand, I had never seen so much liquidity. Literally trillions of dollars of cash were sloshing around the world banking system in the form of excess reserves on deposit at central banks — the result of massive money printing since 2008.
“On the other hand, something was definitely wrong with liquidity. The Oct. 15, 2014, ‘flash crash’ of rates in the Treasury bond market was a case in point.” On that date, the yield on a 10-year Treasury note tumbled 0.34% in minutes.
“This is a market in which a change of 0.05% in a single day is considered a big move,” says Jim. “Something was strange when there was massive liquidity in cash and complete illiquidity in notes at the same time.

“I told Mr. Bond that this Treasury market flash crash looked a lot like the stock market flash crash of May 6, 2010, when the Dow Jones industrial average index fell 1,000 points, about 9%, in a matter of minutes, only to bounce back by the end of the day.”
  “Liquidity in many issues is almost nonexistent,” Mr. Bond told Jim. “We used to be able to move $50 million for a customer in a matter of minutes. Now it can take us days or weeks, depending on the type of securities involved.”
Blame it on the elites’ response to the Panic of 2008. Congress, the Federal Reserve and the Bank for International Settlements issued a host of ham-fisted rules that aimed to make the system less risky. But the law of unintended consequences did its usual thing and made the system more risky.
“Banks are no longer willing to step up and make two-way customer markets as dealers,” Jim explains. “Instead, they acted as agents and tried to match buyers and sellers without taking any risk themselves. This is a much slower and more difficult process and one than can break down completely in times of market distress.
“In addition, new automated trading algorithms, similar to the high-frequency trading techniques used in stock markets, were now common in bond markets. This could add to liquidity in normal times, but the liquidity would disappear instantly in times of market stress.
“The liquidity was really an illusion, because it would not be there when you needed it. The illusion was quite dangerous to the extent that customers leveraged their own positions in reliance on the illusion. If the customers all wanted to get out of positions at once, there would be no way to do it and markets would go straight down.”
  “There will be more flash crashes, probably worse that the ones in 2010 and 2014,” says Jim, summarizing the points on which he and Mr. Bond agreed as they finished their meal.
“Eventually, there would be a flash crash that would not bounce back and would be the beginning of a global contagion and financial panic worse than what the world went through in 2008.
“This panic might not happen tomorrow, but then again it could. The solution for investors is to have some assets outside the traditional markets and outside the banking system. These assets could be physical gold, silver, land, fine art, private equity or other assets that don’t rely on traditional stock and bond markets for their valuation.”
None of this, by the way, alters Jim’s position laid out yesterday that the “bond bubble” chatter from the mainstream is nonsense: He sees U.S. Treasury prices setting up for a strong rally going into the end of the year.
[Time-sensitive announcement: As you might know, we offer three Jim Rickards services. There’s his entry-level newsletter that aims to preserve your wealth. Plus, two trading services that aim for big short-term profits. One of them uses Jim’s IMPACT system. The other applies the techniques he’s used in his work with the U.S. intelligence community.
Purchased separately, one year of these services costs $5,099. But right now, we’re offering lifetime access to all three of these services for a single low price… plus a free benefit that could prove priceless.
We know it’s short notice… but three weeks from today, Jim will unveil his “House of Cards” thesis — in person — to a select audience of his readers. We’ve hinted today at how the House of Cards might collapse. But on Thursday, June 18, Jim will lay it all out in detail… plus a comprehensive strategy to survive and thrive during the turmoil.
Admission to this event is free to anyone who signs up for his full suite of services — and we’ll put you up in a five-star hotel room too. But this offer stands only as long as tickets are available. And we have only 200 of them. Follow this link for your exclusive invitation.]
  Major U.S. stock indexes are pulling back as we write this morning. The S&P 500 is down a third of a percent at 2,117. The Nasdaq has nudged back under 5,100, after setting a record close yesterday.
All’s quiet on the dollar front, the dollar index at 97.4. Thus gold is nearly unchanged at $1,189. Crude is in further retreat, a barrel of West Texas Intermediate fetching $57.13.
The noteworthy economic number of the day is pending home sales — up 3.4% in April, to the strongest pace since… 2006.
  “Do these guys really know what they are talking about?” muses Jody Chudley of our energy desk.
Goldman Sachs recently forecast that crude would tumble from its recent levels near $60 a barrel… to $45 by October.
Jody directs our attention to two recent Goldman forecasts that didn’t pan out…

  • January 2015: Goldman says it would take six months of oil at $40 before U.S. shale production would slow. Whoops: Oil bottomed near $42 in February and production is starting to slow anyway
  • October 2014: Goldman calls for a 2015 low of $70 a barrel. Whoops, the high-water mark this year is shy of $62.

  Here’s why Goldman’s latest forecast won’t pan out either: “For U.S. companies,” Jody explains, “the economics are marginal at best with current oil prices near $60. The reality is that these companies don’t even really have a choice. They can’t drill nearly as many wells as they did a year ago, for the simple reason that they don’t have cash to do it.”
Drillers get their cash either from selling their current output or by borrowing. Both sources of capital have dried up in recent months.
Example: Continental Resources, a major producer in North Dakota’s Bakken shale.
“In 2014,” says Jody, “Continental generated $3.4 billion of cash flow from operations. Meanwhile, it spent $4.6 billion drilling oil and gas wells. That means that Continental outspent cash flow from operations by $1.2 billion, or 50%. Without access to debt financing, Continental would have been able to drill a lot fewer wells.
“If Continental plans to not increase its debt in 2015, that means that it is going to have $1.2 billion less to spend than last year from debt financing alone. On top of that, Continental’s cash flow is going to be more than cut in half from $3.4 billion by the oil price decline.
“Think about that for a second. Continental, which spent $4.6 billion (debt and cash flow) drilling last year, is now going to have to make do with less than $1.7 billion (depressed cash flow alone). Continental is going to have roughly one-third of the cash to drill wells that it had last year.”
And Continental is one of the strongest players in the sector. Oy.
Jody’s conclusion: “Goldman thinks that if oil goes up to $65, companies will quickly return to drilling and send the oil price plummeting again. I don’t think that is a realistic scenario. The companies don’t have the will or the means.”
  “Jim Rickards’ discussion of bonds yesterday touches on an observation I’ve made,” writes one of our longtime readers.
He directs us to a chart of the yield on a 30-year U.S. Treasury bond. “It starts way high in the ’70s and trends down to the 2% range now. My observation is the trend continues DOWN!! I don’t know why!! If it continues, the 30-year Treasury will be at 1%, if not lower.

“Since the yield moves opposite the price and the price is determined by auctions (the market), some bad has to be coming. Whatever the government does, the yield keeps dropping.
“My view is that the only way for the yield to drop like that is for the main economy and stock market to perform so poorly, or something to scare the hell out of investors that they sell stocks and buy bonds — big-time! That means things get worse and the yield keeps dropping. Interest rates will stay low.”
The 5: You and Jim Rickards sound like kindred spirits. Expect more from Jim on this very topic either tomorrow or early next week.
  “I just wondered how do you measure time for The 5 Min. Forecast,writes our final correspondent
“I just timed my reading of it and it took me 13.5 minutes to read without going out on any links. I don’t think I read that slow, since I’ve read 52 novels already this year. Some of these letters take a good bit longer than this to read.
“Maybe you are letting whoever it is that edits those really long sales advertisements do your editing of The 5 Minute Forecast? It’s not terrible now, but please don’t let it get any more long-winded!”
The 5: Not this again! The topic comes up every few months.
When someone made the same observation in late 2013, we got a host of replies. Some of them were from people who skipped over topics they didn’t care for. Among the others, this one stood out: “It’s as if the reader is saying, ‘What, you’re giving us more than promised? Well, cut it out.’
“As for me, keep ’em coming. I appreciate your good-natured take on the events and follies of our time.”
Best regards,
Dave Gonigam
The 5 Min. Forecast
P.S. Have you checked out the spiffy new website lately? Our Web team has made it even easier to track down the content you’re looking for — including a new and improved view of each publication’s portfolio.
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Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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