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$62 Trillion Credit Default Swaps Threaten U.S. Government Bonds

Interest-Rates / US Bonds Oct 13, 2008 - 07:17 AM GMT

By: Mark_OByrne

Interest-Rates Best Financial Markets Analysis ArticleGold experienced sharp falls on Friday but was still up by more than 3% on the week. This was a very impressive performance considering that major equity indices crashed some 20% to 25% for the week (see Performance table).


Asian and European shares have rallied in early trade this morning, bouncing from last week's crash, after euro zone and international governments announced guarantee measures for banks and central banks moved to boost liquidity by injecting “unlimited” amounts of dollars into the global financial system. Unfortunately, this looks set to be another short term panacea and another in a long line of dead cat bounces hailed by many as capitulation and the market bottom. Market's will only bottom when there are little or no “bottom callers” and there is real volume in the sell offs.

The scale of gold's sell off on Friday was surprising but it may have been the result of the huge hedge fund Citadel receiving a massive margin call due to serious losses on Lehman Brothers credit default swaps which came to market on Friday (sold at some 10 cents on the dollar). Citadel may have had to liquidate all of their positions and gold and silver may have got caught up in their need to unleverage and close very large positions in all markets.

Leveraged players have been massacred and will continue to be so due to the unprecedented volatility in these markets. Trading is nigh impossible in such an environment and thus gold should be invested in passively in a buy and hold strategy.

The massive $62 trillion worth of credit default swaps ($62 trillion in the Unites States alone, according to the International Swaps and Derivatives Association) may be on the verge of a collapse and this would make the subprime issues and asset backed securities associated with subprime look like a picnic. We have warned for some years regarding the threat posed by the humongous unregulated derivatives market and Buffet's “financial weapons of mass destruction” phrase seems more apposite by the day.

With the Federal Reserve having agreed with the European Central Bank (ECB) and Bank of England to lend “unlimited” quantities of US Dollars into their local money markets in order to prevent a systemic collapse it looks likely that government bonds may soon come under severe selling pressure. The US 10 year bond fell sharply last week and the yield rose from 3.42% to close at 3.861%. The “safe haven “ of government bonds will be severely tested in the coming weeks and months.

The Comex gold price and the leveraged futures market is becoming less relevant by the day to the actual price of physical bullion with rationing, shortages and premiums on all coins and bars rising very significantly – rising even on a daily basis. Bullion coins that once retailed at some 5% over the spot price are now being traded at 10% to 15% over the spot price. Most wholesalers and retailers internationally are out of Krugerrands and other popular bullion coins and much of the public are now seeking to buy bullion on Ebay where prices are also surging (see FT article in news section).

In recent weeks there have been little or no bullion sellers and nearly all buyers and bullion owners will have to be incentivized by and are waiting for far higher prices prior to even a minority of them selling. Many are “buy and hold” investors and savers and will not be “taking profits” even at higher prices as their motivation is not profit rather wealth preservation.

It seems increasingly likely that gold and silver will have to rally to over $1,200/oz and $25/oz before there is some selling and liquidity returns to the bullion market.

By Mark O'Byrne, Executive Director

Gold Investments
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Gold and Silver Investments Limited hope to inform our clientele of important financial and economic developments and thus help our clientele and prospective clientele understand our rapidly changing global economy and the implications for their livelihoods and wealth.
We focus on the medium and long term global macroeconomic trends and how they pertain to the precious metal markets and our clienteles savings, investments and livelihoods. We emphasise prudence, safety and security as they are of paramount importance in the preservation of wealth.

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Disclaimer: The information in this document has been obtained from sources, which we believe to be reliable. We cannot guarantee its accuracy or completeness. It does not constitute a solicitation for the purchase or sale of any investment. Any person acting on the information contained in this document does so at their own risk. Recommendations in this document may not be suitable for all investors. Individual circumstances should be considered before a decision to invest is taken. Investors should note the following: The value of investments may fall or rise against investors' interests. Income levels from investments may fluctuate. Changes in exchange rates may have an adverse effect on the value of, or income from, investments denominated in foreign currencies. Past experience is not necessarily a guide to future performance.

All the opinions expressed herein are solely those of Gold & Silver Investments Limited and not those of the Perth Mint. They do not reflect the views of the Perth Mint and the Perth Mint accepts no legal liability or responsibility for any claims made or opinions expressed herein.

Mark O'Byrne Archive

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Comments

Joseph Heller
01 Dec 08, 21:45
inaccurate in terms of CDS worth

“The massive $62 trillion worth of credit default swaps ($62 trillion in the Unites States alone, according to the International Swaps and Derivatives Association)”

You should not use the term “worth” so loosely. No credible source has ever claimed the CDS market is worth $62 trillion. ISDA has published global estimates (not just the US) of $60+ trillion “notional value”.

“Notional value” is simply what is used to determine cash flows and is in no way, shape or form value. (If you bought $100k of insurance on your house, the insurance is not worth $100k. Its value is far closer to zero than $100k)

Want proof? Look at ISDA’s web site. www.isda.org $25 trillion in “notional value” has been willingly torn up in the last few months with zero impact on value.


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