View from a Derivatives Monster, the meaning of Life & Gold.
Subj: Adam Hamilton - The *** Derivatives Monster
Date: 9/7/01
From: Le Patron @ Le Metropole Cafe
To: Le Metropole Members, Guests & Friends of GATA
Adam Hamilton has served commentary
The Kiki Table entitled,
"The *** Derivatives Monster."
Every hedge fund manager and money manager
in financial land should read this piece.
It is that important!
Today, the stock market was trashed, the dollar hit hard
and the price of oil rose back to $28 per barrel,
yet gold did nothing. As always, The Gold Cartel sat
on gold all day long.
If you want to know why, read this Adam Hamilton.
All the best,
Bill Murphy
Chairman, Gold Anti-Trust Action (gata.org)
Le Patron, Le Metropole Cafe
The Kiki Table
Potpourri
Topic du Jour
The *** Derivatives Monster
Out of all the incredible financial developments of the 1990s,
one of the most important fundamental structural changes.....
Derivatives are often highly complex financial instruments that.....
Outside of the financial halls of power, however, derivatives began to.....
A string of massive derivatives debacles in the 1990s helped.....
In December 1993 the large German industrial conglomerate.....
Unfortunately, the misfortune of Metallgesellschaft in attempting to.....
In 1994 the County Treasurer of one of the wealthiest counties in.....
In February 1995 the proud and strong 223 year-old Barings Investment.....
Derivatives disasters continued to blossom around the world like.....
As derivatives use continues to explode around the globe.....
As we plunge through the early years of our new millennium.....
Before we begin our exploration of... mind-boggling
exposure to the high-leverage high-risk global
derivatives market, a quick and dirty explanation
of derivatives is in order.
As we mentioned above, derivatives are....
The humble option is one of the simplest forms of derivatives.
An option is simply the right to.....
Imagine you have saved up $5,000 of risk capital you want to sow
into the markets in the hopes of reaping some profits.
The conventional stock investing strategy is simply to.....
Now that your capital has been successfully deployed, let's.....
In the Win Scenario when you are simply buying stock outright, your.....
Next, let's warp back in time to your original decision to.....
Each option contract on XYZ represents options on.....
In the Win Scenario, XYZ rockets to.....
In the Loss Scenario, XYZ plummeted to.....
... your hard-earned capital can be literally obliterated
in mere hours or days, a very difficult and excruciating experience.
Options, the simplest of derivatives, help illustrate the extraordinary
leverage and the mega-risk that derivatives exposure entails.
Amazingly, long options are one of the lowest risk.....
Another critical concept for understanding the strange world
of derivatives is "notional value" or "notional amount".
This is a quasi-fictional number that illustrates how much.....
Although you only deployed.....
Realize that the notional amount is not a real number but simply a.....
Also critical, realize that notional amounts are NOT volume
or turnover data, but.....
Although it has lately become.....
In the United States, commercial banks and trusts.....
The OCC prepares a quarterly report called.....
In this essay, all the derivatives data cited is directly from.....
Our first graph was constructed using data from.....
As we delve into the often cryptic world of derivatives,
it rapidly becomes apparent that the amounts of dollars
of capital effectively controlled through derivatives
is absolutely staggering. The notional amount pie in.....
The MegaPenny Project is located at.....
According to the fine folks at MegaPenny, a solid block of....
One trillion is a ridiculously large number and almost impossible.....
It is very hard to believe that the total US notional derivatives
positions of US commercial banks and trusts is $43.9 TRILLION dollars.
By comparison, the US GDP, all the goods and services produced and consumed
in our entire great nation by every single American each year,
was only running $10.1t in the first quarter. The US M3 money supply,
the broadest measure of money, was only $7.4t at the time.
The 500 best and biggest companies in the United States,
the S&P 500, were only worth $10.4t at the end of the first quarter.
Clearly, the $43.9t dollars of the notional value of derivatives
that a mere 395 commercial banks and trusts control is simply staggering
as it far exceeds the entire US GDP, the entire broad US money supply,
and the entire value of all the stocks traded in the United States!
BIG, BIG, BIG numbers!
Of that huge $43.9t, ***, a single holding company,
controls a breathtaking $26.3t worth of derivatives
in notional terms!
*** represents 59.8% of the total derivatives market controlled
by US commercial banks and trusts per the OCC.
[Why] would one entity run up such gargantuan exposure to derivatives?
Perhaps *** controls nearly 60% of the commercial bank segment
of the derivatives market because maybe it holds 60% of the
commercial bank assets in the United States of America.
We constructed the next graph from.....
Although *** is a very large commercial bank, it only represents.....
*** controls.....
Even more provocative and outright frightening is the ratio of.....
Why, why, why?
While the latest *** 10-Q was released in mid-August and.....
In financial circles 10 to 1 leverage is considered very aggressive,
100 to 1 is considered to be in the kamikaze realm, but we don't
ever recall hearing about large-scale leveraged operations
exceeding 100 to 1 outside of the horrible example of the
doomed super hedge fund Long Term Capital Management.
***'s management may have effectively created the most leveraged
large hedge fund in the history of the world... representing a
notional value of a staggering... After we shook off the blunt shock
of learning of an implied leverage of.....
The next pie graph was constructed from... this graph exclusively
represents only ***'s enormous $26t derivatives portfolio,
no other banks' or trusts' data is included in this gargantuan pie.
The sorcerer's apprentice is playing with powerful financial magic indeed!
As the pie illustrates, ***'s largest position by far is in.....
In interest rate derivatives, the notional amount represents the.....
Gold investors may be surprised to see what a trivial portion of
***'s total derivatives portfolio is deployed in the gold market.
*** is controlling a notional amount of gold through derivatives
equal to the value of every ounce of gold that will be mined
in the entire world for the next.....
Why is a sophisticated superbank like *** even interested in the
small and devastated gold market, let alone motivated enough
to maintain derivatives exposure equal to more than.....
Why does *** management want to maintain derivatives gold exposure.....
In the lower left corner of the graph above note the.....
As growing numbers of investors around the world realize,
American attorney Reginald Howe filed a landmark complaint
against the Swiss-based Bank for International Settlements
on December 7, 2000. In his lawsuit... Mr. Howe carefully builds
the case that certain large banks that deal in gold derivatives
were involved in an effort to actively manipulate the world gold market
in violation of key United States laws. Shortly after Mr. Howe filed
his complaint in United States District Court, we wrote a summary essay
outlining his lawsuit called "Let Slip the Dogs of War" which also has
further background information if you are interested in digging deeper.
In Howe v. BIS et al, both the pre-merger *** and ***
were named as defendants with the BIS. In his complaint, Howe points out
anomalous gold derivatives activity at both banks documented on.....
Mr. Howe's complaint filed in the federal court elaborates on this
odd activity by the two banks that have since merged to form superbank ***.
Interestingly, Mr. Howe's case will soon be heard before
a federal judge in Boston, Massachusetts on October 9, 2001, when.....
With both ancestor banks of the *** already documented
as having well-timed anomalous gold derivatives activity prior to
their merger, chances are the banks had some level of insider-type
knowledge of what was really transpiring in the gold market.
There is no way that *** management would have acquired gold derivatives
with a notional value worth 1.35 times the total of their entire
shareholders' equity base unless they knew and intimately understood
the gold market.
On May 30, 2001, ace researcher and analyst Michael Bolser
and GATA Chairman Bill Murphy co-published an analysis of
***'s interest rate derivatives in Mr. Murphy's
"Midas" column at the excellent www.LeMetropoleCafe.com
contrarian investing website.
Mr. Bolser titled his research "GoldGate's Real Motive?".
Current subscribers to www.LeMetropoleCafe.com can see this analysis
in the archives of the "James Joyce" table at LeMetropoleCafe.
In his analysis, Mr. Bolser pointed out that *** had.....
Mr. Bolser offered the stunning tentative conclusion that perhaps
a suppressed or shackled-down gold price was a necessary prerequisite
to *** assuming enormous amounts of interest rate derivatives,
as a managed gold price would.....
After Mr. Bolser's interest rate derivatives report.....
Our superficial presentation here certainly does not do this
startling hypothesis justice, but the *** interest
rate derivatives explosion due to *** upper management knowledge
of and possible involvement in stealthy government machinations
in the gold markets is a very intriguing hypothesis that definitely
warrants further investigation and discussion.....
Back to the *** Derivatives Monster for now.....
... have to wonder how many *** shareholders realize just how
incredibly leveraged their superbank has become. Do they think
they are holding a safe conservative blue-chip elite Wall Street bank,
or do the average shareholders desire to hold a hyper-leveraged
mega hedge fund with... times implied leverage on stockholders' equity?
Do *** shareholders understand how dangerous large derivatives positions
have proven historically for other companies?
*** currently has something like... large institutional shareholders
who hold almost 61% of its common stock. Do the managers of these
mutual funds and pension funds understand that *** management
has built the biggest most highly-leveraged derivatives pyramid
in the history of the world per US government OCC reports?
Do fund managers understand the inherent risks in leveraging
capital hundreds of times over? These are important questions
that ALL *** investors should carefully consider,
especially in this incredibly turbulent and volatile market environment
we are experiencing today.
One of the most dangerous possible events for high derivatives exposure
is unforeseen market volatility, especially that caused by.....
When a non-linear market event that is inherently unpredictable like....
We are NOT suggesting that *** is another LTCM.
We know that the men and women running *** are very intelligent
and have a deep understanding of the global markets in which
their company operates. We know they have cross-hedged
and carefully modeled their enormous derivatives portfolio
to try and make it net market neutral and therefore resilient to shocks.
But... to vibrate uncontrollably until it shatters, even a "balanced"
net derivatives portfolio of massive size is highly vulnerable
to market shocks that can push it out of proper equilibrium
and spin the computer hedging models out of control far faster
than derivatives can be unwound.
There comes a point when leverage becomes so extreme that even a tiny
unforeseen event can break down the complex contractual glue that holds
the various components and players of the convoluted derivatives world
together and cause the whole structure to shake or crumble.
We believe that ***'s management is taking a mammoth gamble
with the wealth of its shareholders by supporting derivatives
with a notional value of over.....
Also, ***, just by virtue of having extreme leverage,
is placing itself at risk for a Barings Bank type scenario.....
By its own reporting to the US government,
*** has shown itself to have evolved
into a real-life Derivatives Monster.
Derivatives offer extreme leverage and the potential for mega-profits,
but with that they carry commensurate extreme risks.
Until the *** Derivatives Monster begins to.....
We can't help but feeling that essentially unlimited leverage is the
modern financial equivalent of Walt Disney's sorcerer's apprentice
in "Fantasia" unleashing forces he couldn't possibly hope to control.
Adam Hamilton, CPA, MCSE
aka Zelotes
7 September 2001
Zeal Research
Zeal Intelligence
zealllc.com
zelotes@zealllc.com
Mr. Hamilton, a private investor and contrarian analyst,
publishes Zeal Intelligence, an in-depth monthly strategic
and tactical analysis of markets, geopolitics, economics,
finance, and investing delivered from an explicitly pro-free market
and laissez faire perspective. Please visit www.ZealLLC.com for more
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