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!
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…