- Money Morning Australia

Why We Back Top Fund Manager’s Crash Call

Written on 31 May 2011 by Kris Sayce

Why We Back Top Fund Manager’s Crash Call

Your editor is writing today’s Money Morning from home in Frankston.

We’re putting the finishing touches to the May issue of Australian Small-Cap Investigator.  An issue which could be the most controversial we’ve ever published.

In fact, we’re putting our customer service people on notice to expect a big spike in phone calls and emails… not all of them will be favourable!

If you want to receive the next issue when it’s released, click here.

But that’s for later. Until then…

“Mobius Says Fresh Financial Crisis Around Corner Amid Volatile Derivatives”

Mobius is Mark Mobius.  He’s chairman at one of the world’s biggest fund managers, Templeton Asset Management.

Of course, he’s not the first person to warn of another financial meltdown.  But when the chairman of a big fund management firm pipes up, you need to take notice.

Another meltdown looms

According to Mr. Mobius:

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis.  Are the derivatives regulated?  No.  Are you still getting growth in derivatives?  Yes.”

We agree with Mr. Mobius.  There “definitely” will be another financial meltdown.

But here’s where we disagree…

Derivatives aren’t the cause of the problem.

Derivatives have been around for centuries.  The idea of derivatives is almost as old as trading itself.

Financial derivatives have copped the flack because they’re the easiest target.

But the real culprit is what stands behind the growth in derivatives – increases in credit and the money supply.

So we’d take Mr. Mobius’s questions and change them slightly:

Is credit still expanding? Yes.  Are central banks still printing money? Yes.

Let’s get something straight.  Derivatives can’t and shouldn’t be outlawed or regulated.  Just as no other industry should be outlawed or regulated.  The only regulation we’d support is that to regulate government!

But anyway, a derivative is what it means.  The price is derived from something else.

Derivatives serve many purposes.

They help you benefit from a climbing income or asset price.  Or they can protect or insure against a drop in income or asset price.

Farmers use derivatives to lock in the price of crops.  It helps them plan for the future.  They know the price today that they’ll get when delivering the crop at a future date.

Without derivatives the farmer can’t plan for the future.  But with derivatives, he or she can invest in capital or pay employees.  Simply because the farmer knows the price they’ll get for the crop.

Of course, it’s not just farmers who get to play.

Derivatives benefit all investors

Speculators and investors play an important role in adding liquidity to the market.  In this respect they work like any other investment.  They provide others with the opportunity to profit – and potentially lose – from price movements in certain assets.

Restricting or banning access to these markets would be bad for investors.  It would be the equivalent of only allowing shopkeepers to buy shares in Woolworths [ASX: WOW] or bank employees to buy shares in Westpac [ASX: WBC].

A derivative allows you to profit without having to own the underlying investment – whether it’s wheat, corn, copper or frozen concentrated orange juice.

Any restrictions would have a negative impact on liquidity by reducing the number of people taking part in the market.

You see, the real problem behind the growth in derivatives isn’t the derivatives themselves.  The real problem is the expansion of the money supply by central bankers and the ability of banks to create money from thin air.

Without this, it wouldn’t be possible – as Bloomberg News put it – for “The total value of derivatives in the world to [exceed] total gross domestic product by a factor of 10.”

Don’t get me wrong.  You could still have a market where the value of derivatives is bigger than the total value of an individual market.  But in a free market money system, an expansion of money in one market would mean a contraction in another.

In other words, prices in one market would fall while another would rise.

Trouble is, when central banks and bankers create credit and money from thin air, it leads to booms in all markets at the same time.

While that may sound great, it has a consequence.  That is, when credit growth doesn’t expand fast enough to keep the market inflated, it’s not just one market that falls, but the whole darn lot.

Crash radar status: Extreme!


Kris Sayce
Money Morning Australia

P.S. We’re not the only one preparing for the market to fall.  Slipstream Trader Murray Dawes sent your editor a personal note this morning.  It reads, “I’m still very wary of the market right here.  I’m not calling a crash, but we will see some fireworks if the [UK] FTSE 100 falls below the 5800-5850 range and the [U.S.] S&P500 falls under 1310-1320.  We’re getting close to a big move down.  This Friday’s U.S. employment data may be the catalyst.” If you’d like to see how Murray has positioned his members for the next market downturn, click here…

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14 Comments For This Post

  1. GGG Says:

    So, where’s your evidence that credit growth or liquidity is stalling? Are you saying Bernanke, having come this far in fighting deflation, is now going to throw in the towel? If so, I’ll take the other side of the trade.

  2. Triune Rational Brain Says:

    So the otherside of the trade is BUY more SILVER?

  3. GGG Says:

    Other side of the trade is buy US equities, USD gold, USD silver, oil, emerging market equities and bonds, emerging market currencies, GCC (ETF that tracks the CCI commodities index), Japan equities, JNK (junk bond ETF). That is, buy most USD-denominated things (except real estate), buy Japan equities (inflation play), buy emerging markets (follow the existing bullish trends in those), buy the things that benefit from ongoing ample liquidity (like junk bonds).

  4. Triune Rational Brain Says:

    In other words stay out of cash?
    Forget GFC of 2008 no more minsky moments because big bad FED is money printing.
    Too simple or are the markets more complex than this?
    FED try to stop the GFC of 2008 and fail.
    Will the FED win this time around against deflation?
    Is credit and debt more powerful than FEAR of the FED money printing.
    Time will tell my money is on the dumb side of the trade CASH!

  5. Drood Says:

    I have never read so much tosh in my life.

    “A derivative allows you to profit without having to own the underlying investment ” says Kris, which means the reserve banks aren,t the only people making money out of thin air.
    Which means the reserve banks are,nt the only people driving inflation.
    Derivatives are exactly what drive prices higher.
    Nobody needed to print money by the bucketload until after the GFC.
    The free market would be a wonderful thing if it wasn,t for greedy investors wanting money for nothing, and if derivatives guarantee a farmer a set price for his product then why are they leaving the land in droves ( or committing suicide ).
    Watch ” inside job ” and see just how much damage the financial world does. The makers of that movie did their research, they didn,t just speculate.
    Kris , there is only one thing that guarantees an income, it,s called a job.
    I suggest you go out and get one instead of trying to destroy other peoples.

  6. Triune Rational Brain Says:

    Drood I think made a very good point we need to go back to our grandparents values of low debt,community spirit,respect for the individual who makes money in a productive way.
    Doctors,carpenters,plumbers,electricians,nurses,farmers, mechanics ,engineers, bakers, etc small business poeple with new ideas.
    We need a TED in Australian http://www.ted.com.(where is the .au?)
    We only have ABC The New Inventors?
    If the market turns down very bad investment advisory subscription business will see major job losses.

  7. Gazza Says:

    Granted that forms of derivatives have been around since at least tulip fever, the situation we see today has only a tiny percentage of derivatives ethically used for liquidity, hedging and insurance. Predominantly over the counter derivatives are leveraged beyond imagination ( certainly mine) and can bring the global financial system crashing down if a single big corporation goes bust. Maybe you think this is a good thing, however, I think it is like burying nukes in our communities, giving the detonator to some psycho banker and then asking them how much do you want so that you won’t blow us all to smithereens.

  8. GGG Says:

    cash in an Australian bank at 6% is not a bad deal, as long as inflation stays low. I am comfortable taking more risk, looking for higher returns.

  9. Peter Fraser Says:

    HMMmmm – ted.com – they used to have some wonderful talks by Hans Rosling.

    Hang onto that cash TRB – there are some speed bumps coming.

  10. The Wolf Says:

    Maybe I missed something somewhere but since when does expansion of credit pave the way for the thieves of Wall St to synthesize the value of the original asset 70 times over ?

    Sure, credit expansion has added lighter fuel and clearly has a myriad of banks and hedge funds bidding up risk assets… but credit expansion alone isn’t responsible.

  11. The_Observer Says:

    I think Mark Mobius might have been referring to higher order complex derivatives which are not exchange traded. I do believe thos had a large part to play in the GFC and bankrupted banks in Iceland, Ireland, UK, etc

  12. lb Says:

    2nd June 2011
    NAB is tanking….Why?????

  13. Beauner Says:

    Just keep your money metals….the great implosion is coming…

  14. bankclerk Says:

    NAB is tanking because it’s customer base is expanding at the cost of overall margins.


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