(GATA News) David Tice points an accusing finger at derivatives.(aka Hutch)
Subj: David Tice - Derivative Leverage?
Date: 1/8/00 10:19:09 AM EST
From: LePatron@LeMetropoleCafe.com
The Hemingway Table
David Tice
The Prudent Bear Fund
ticed@prodigy.net
January 7, 2000
Derivative Leverage?
It is certainly going to be an interesting year.....
...to be perfectly candid, we are overjoyed to see buying interest return
to good solid companies with relatively sound investment merits.....
While some things change, others stay the same.....
Historically, it is thought that such volatility is an indication of
uncertainty and investor indecision, and often a precursor for a change
in trend. Well, wild volatility has been a characteristic of this
marketplace for long that the change in trend analysis does not hold
much credibility.
... our analysis leads us to believe that there is much more to the
market's violent action than mere investor uncertainly. In fact,
it is our view that derivatives have become an increasingly important
distorting factor in the stock market, as they had become during
previous bubbles. Specifically, the US credit markets in.....
...as well as... , come to mind.
At certain times, the leveraged speculating community encircles a
particular market that has a strong upward bias. Wall Street rocket
scientists and derivative traders follow along, providing sophisticated
instruments and strategies that work largely to add considerable leverage.
... it is our view that the trade de jour for the leveraged speculators
and derivative players is now US stocks, particularly the NASDAQ and
technology variety.
... a closer look at a key derivatives market, after ending - near
* million contracts, open interest for stock options on the Chicago
Board Options Exchange ended - just above - million.
Between August and the end of the year, stock option open interest
increased -% to an astonishing - million contracts. For the entire year,
option-trading volume surged -% above 199*'s record levels, while total
year-end stock option open interest jumped -%. It is our contention
that this unprecedented explosion of exchange-listed derivative trading
is indicative of what has almost certainly been a similar expansion in
over-the-counter (OTC) derivative trading. Actually, we would be very
surprised if OTC stock market derivatives do not dwarf the market for
listed options in both scope and market impact.
With this in mind, we do not believe it is mere coincidence that the
explosion of stock option contracts is closely correlated with the
recent historic surge in money supply. In fact, we strongly suspect that
derivatives and the underlying leverage involved in derivative trading
strategies has been a significant, if unrecognized, factor behind the
huge increase in financial sector borrowings. Interestingly, financial
sector commercial paper borrowings expanded by $* billion to $* trillion
between - and year-end, an annualized growth rate of -%.
We ponder the possibility that this was related to derivative trading.
Keep in mind that the - ended the year with almost - million call options
outstanding, growing almost - million contracts in - months. And with the
vast majority of these call options on NASDAQ and technology stocks, with
the NASDAQ100 index gaining more than -% during its wild speculative run
into year-end, most call options went quickly and deeply into the money.
Importantly, the writers of these contracts, as well as those selling
derivatives in the OTC market, were forced to move aggressively to hedge
their exposure by purchasing the underlying instruments. This buying,
of course, would undoubtedly be with borrowed money. Here, with the
historic stock market melt up we see clear potential for truly
extraordinary money and credit creation.
Could the huge surge in financial sector borrowings be related to
funding requirements from the derivative players, and could this be at
least a partial explanation for the more than $- billion increase
(more than the total increase between 199- and 199-!)
in M3 money supply during the final four months of the year?
In this regard, we think the Federal Reserve and its Y2K operations
have likely been given more credit than deserved for the rampant growth
of broad money supply. And if this is the case, we see the Federal Reserve
as virtually impotent in paring back this newly created money and credit,
that is without an immediate impact on financial system liquidity.
So, we will stick with our view that our financial system remains
hopelessly running out of control in the greatest credit and speculative
bubble in history. And, quite importantly, these key components,
credit and speculation, combine powerfully in the derivatives marketplace.
It is here, along with the leveraged speculating community with their
huge stock exposure, where we see extreme vulnerability to a financial
accident. As we said in our final 1999 commentary, we are not sure
where - will be found to let the - and - ... But, then again,
as long as stocks rise this will not be much of an issue,
as only more derivative-related credit is created that fuels the bubble.
On the margin, we now see derivative trading exacerbating what was
already a hyper-volatile market place. When stocks begin a retreat,
as they had in NASDAQ and tech stocks until today, a self-feeding
liquidation is set in motion. Any reversal, however, quickly leads
to a self-feeding accumulation as derivative players dynamically
hedge their exposure. Now, truly enormous leverage and sophisticated
trading strategies lead to disjointed trading and astounding volatility.
However, this will not work well at all in reverse.....
... At the same time, it is important to recognize that the more
precarious the situation becomes, the more incentive for the vested
interests to pull out all the stops to try to keep the game going.
One game that we certainly expect to continue is the.....
... it was reported that November consumer credit expanded by $- billion,
versus an estimate of $- billion. This was the largest increase since -
and at an annual rate of almost -%. In our view, this is one more statistic
that demonstrates the profound impact of the stock market and real estate
booms. And with....., credit demands could not be more extreme.
Over the coming weeks, we expect the credit market to.....
Putting it all together, it doesn't sound ... to us.
[END]
For new readers, the above mention of GATA is as follows.
Bill Murphy, Chairman, Gold Anti Trust Action (GATA) gata.org
Also, GATA related articles can be obtained at the pay for view site.
Bill Murphy, Le Patron, Le Metropole Cafe lemetropolecafe.com |
