Energy Derivatives Bubble Near Bursting

“It has worked …so far. The only problem is the entire arsenal of the central banks have already been tried and failed to provide the real economy with any stimulus. The result has been capital pushed into financial markets and blowing the bubble(s) far larger than they were. Now, we have far larger markets with far more leverage than 2008. These will need to be met with central banks and sovereign treasuries with weaker balance sheets and almost no ability to borrow in an effort to reflate. It is a recipe for disaster.”

The financial world turns on the axis of “trust”. This trust was nearly broken in 2008 and is the reason the Federal Reserve needed to secretly lend $16 trillion all over the world. If the Fed had not come up with these funds, failures would have spread and trust would have been broken amongst the banks/other financial institutions and even between the central banks themselves! The Fed’s largesse worked and trust was maintained.

The world has gone five+ years with QE (Quantitative Easement), the reality being outright monetization. In fact, central banks today are buying more sovereign bonds than are even being issued. The public and even the professional funds have backed away from the debt markets, you can’t blame them because the interest received does not even cover inflation not to mention a risk premium. Globally the pace of trade and business activity is slowing or even declining which will bring to a head the difficulties in meeting debt service and other “promises”.

What will happen when inevitably “trust” begins to wane? Or even fully break? It is at this point the system goes into “The Great Call”. Margin call? Of course, because nearly everything financial has leverage behind it but there is more to it than this. The “call” is for contracts of all sorts to “perform”. In particular I am thinking “derivatives” contracts will be called on to perform their contractual duties.

All in all, there are over $1 quadrillion worth of derivatives outstanding. The problem with this is the “tail” is bigger than the dog. In other words, the amount of derivatives outstanding dwarfs the total amount of money outstanding and thus the ability to “pay” and make good on the contracts. The other side of this coin are contracts promising to deliver something. In both gold and silver ther are far more (100-1 or more) obligations outstanding than there are ounces or kilos available to deliver. This is a default just waiting to happen.

Actually, it can be said the dollar was originally set up in 1971 on a “never pay” model. The dollar (and bonds) only promise to pay “more dollars” and nothing else. This game worked for many years, now it looks like the Saudis after doing many deals with both Russia and China may be set to transact in currency other than dollars. Are they displaying confidence?

The Chinese are now net sellers of U.S. Treasuries. Ask yourself this question, if China could sell all of their Treasuries and turn it all into gold, silver, oil, copper and other real tangible assets (without destroying the Treasury market or making gold and silver go no offer), would they?

The great Paul Craig Roberts said last week he feared precious metals could be suppressed forever. I received MANY fearful e-mails regarding this thought process. Mr. Roberts would be entirely correct if it were not for one small detail, REAL gold and REAL silver must be available to deliver. Otherwise the game comes to an end and the fraud is exposed. He is entirely correct, “price” can be jammed or rammed with enough “margin” posted. Dan Norcini once upon a time had it correct when he said, nothing will unnerve the shorts more than the longs standing for delivery …and making a call for the product. COMEX currently has only 11.7 tons of gold for delivery. This is roughly $400 million.

Another thought going hand in hand with this is where we are now versus 2008. Back then we were within overnight hours of the entire system coming down, this is fact. What has changed since then? “Nothing”, but in reality quite a bit. Nothing has changed from the standpoint of “tools used”. We have not altered or changed anything that “got us to the brink”… only done more of it! We have far more debt and more derivatives outstanding now. In fact, central banks and sovereign nations have even sacrificed their balance sheets to prolong the game.

We already know the sovereign debt markets are very thin on the bid side as liquidity has dried up. We also know equity markets are displaying horrible internal breadth. China is actually nearing a 1929 scenario and will be there shortly if they cannot steady.