Fear in the Streets - A Dress Rehearsal
As we write this article it appears that fear is abating and that the financial markets are getting back to business as usual. Nevertheless, one major piece of bad news could send the markets tumbling once again. So, have we just witnessed the worst of the market declines or was this just a dress rehearsal for a much more severe and perhaps catastrophic decline ahead? None of us has a crystal ball going forward from here, but we as investors continue to seek opportunities always aware of the potential short term downside risk.
So, we ask the question; what have we learned from the action of the markets as the volatility occurred?
The recent turmoil has affected virtually all of the markets worldwide; the financial markets, the commodities, including the precious metals and base metals, the currencies, the ETF's of the emerging countries, etc. Speculators and traders must love this volatility with its incredible daily swings in all of the markets. But what about us as investors?
What we need to understand is how another (potential) sell off in the markets will affect us. As we write this piece, we have no reason to believe that another wave of selling would not create the same results in all of the markets, declines in the financial markets, commodities, etc. and thus, perhaps, we have only recently witnessed a dress rehearsal.
The commentators on CNBC (labeled the talking heads by some writers) always seem to be bullish or at least attempt to put a positive spin on whatever is happening in the markets. If you believe what you hear on TV, then it is business back to normal, ever upward and onward. Perhaps... perhaps not!
From our perspective, including feedback from subscribers and comments from friends, few investors have a clue as to what is going on in global finance and in the markets or the real reasons for the recent upheaval. Economics columnist for the Washington Post, Robert J. Samuelson, says "anyone claiming to understand today's world financial system is either delusional or dishonest." Make no mistake, there is currently a liquidity crisis affecting the markets. What? While I do not pretend to be an expert, let me try to simplify what is happening, using no fancy financial terms or complicated explanations.
Mortgage loans (including the sub prime as well as other consumer debt) were packaged up and sold to the largest investors world wide, including investment banks along with private equity and hedge funds. Many of these obscure financial instruments frequently called derivatives were financed by borrowing Japanese Yen at very low interest rates. The motivation was greed... high yielding investments financed with low interest rates. As the news surfaced about the lack of quality of these investments, fear began to grip the markets causing a rush of redemptions as many investors rushed to the exits.
Many of these investments were highly leveraged and acquired with low cost borrowed funds, frequently using low interest Japanese Yen. The sudden stampede to sell these investments uncovered yet another hidden reality beyond the liquidity of the respective funds. Not only did these investment products have no ready buyers, they had inflated book prices attached entirely unrelated to market valuations.
The resulting effect was that as the big investors sought cash to repay their loans, they were basically selling anything of value including gold, silver, precious metals and blue chip shares. Thus you may have heard the reference to the unwinding of the Yen carry trade? Those borrowed funds were being repaid thus forcing the Yen higher vis a vis the US dollar and other currencies. We have seen some articles suggesting there is over $1 Trillion involved with the packaged mortgages and the Yen carry trade. Have we seen the last of the unwinding? We think not. While the sub prime mortgages seem to be getting the current attention, as more and more of the variable rate interest rate mortgages are readjusted during the coming nine months, we are sure to experience many more problems of write downs and liquidity concerns.
We believe the yellow caution flag will be flying for quite some time. However, investors need not be frozen with fear. Look for quality investment products, whether they are in the financial markets or in the precious metals and or the broader commodity sectors. Investors today have an incredible array of investments vehicles at our disposal including; mutual funds, ETF's on just about any product, extending to the emerging markets and currencies, common shares of precious metals and commodity based companies and/or long-term warrants on those companies.
We are of the firm opinion the day will come when the precious metals and commodity sector will be the top performing sector. Investors around the world will flock to this sector creating great wealth to those who have invested wisely and exercise patience. Note, we stress, invest not speculate. Think long term and do not let the short term volatility of the markets shake you out of your positions.
For those readers desiring more information on warrants you may wish to visit www.PreciousMetalsWarrants.com where you will find much more information and education on warrants in our new Learning Center.