Friday, 21 June 2013

No surprise

If you've been paying attention, yesterday’s price move will have come as no surprise. Any hint of the end of QE is bound to hit share prices hard. It could get much, much worse. Depending on how important margin trading has become, market falls could turn into a rout. Today's modest recovery offers little hope that things will get better.

You will remember that trading on margin means borrowing money from brokers to buy shares. Where do the brokers get the money? From banks who have been seeking “low risk” borrowers for their cash pile. Where have the banks got the money from? They have sold their government bonds to the government. Those governments, in the UK and in the US, have developed an insatiable appetite for these bonds in a vain attempt to pump cash into the economy. So those banks have become flush with cash that they do not want to lend to businesses who they regard as “high risk” borrowers. Where does the government get the money from? Out of thin air.

So what happens when this begins to unravel? Share prices go down. Traders, especially those who have been buying shares with "other people’s money" rush for the exit selling their shares. They want to sell before prices wipe out their profits and they get into negative equity, risking bankruptcy. Some will be trampled in the crush and will end up unable to repay their loans. Banks will find themselves with non-performing assets and we will find ourselves in the middle of a new credit crunch.

Big question? Who will bail out the banks this time round?

Are we now in a no win situation? Our choice: buy shares and watch their value plummet; or hold cash in the accounts of insolvent banks. Government bonds are also unattractive: interest rates are so low there is only one way they can go and that is up. This means the risk of lower bond prices.

There are no simple answers. We must watch and wait and be ready to act when opportunities arise. You all know where I stand: practically 100% in cash, no inclination to re-enter the market until I get a clear signal. I’m watching gold which is getting cheaper and cheaper. 

And today I might take the plunge and short US Treasury bonds.

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