Notes From Underground: The DREADS of the Redemption Song

It was only a year ago that the PRECIOUS METALS were laboring under the continued selling of GOLD and SILVER as the John Paulson hedge funds were liquidating long positions to meet the huge amount of redemptions by long-time investors exiting the decade’s best performing FUNDS. In a repeat, Morgan Stanley announced today that it was redeeming its investors out of Paulson’s two largest funds after another year of questionable performance. In today’s world where one hedge fund can hold massive positions, divestment by disgruntled investors can initiate massive corrections. In 1980, when the Hunt Brothers caused great turmoil in the silver markets, they had a mere BILLION DOLLARS to play with (the Paulson funds control close to $15 billion under management.) As traders and investors it’s our job to be cognizant of all the animals in the jungle. When the elephants retrace their steps from the watering hole, small animals can get crushed (Niederhoffer).

The Paulson redemptions have certainly been disruptive and may continue to be,  but as we saw last week the market tipped us off that something was wrong when POST-FOMC the GOLD failed to rally. The GOLD/EURO and GOLD/SWISS spreads broke key support levels, which also provided us with indications that change was taking place. Regardless of the underlying fundamentals, large funds flows can always render the best analysis woefully inadequate. This is why I always caution to have your technicals in place and know when you are wrong so as to keep losses small to live to fight another day. As BOB MARLEY SINGS:

  “Emancipate yourselves from mental slavery,
    None but ourselves can free our mind”
Redemption song can cause great havoc but once you can get past the dread of being wrong use it to your benefit. The terrain of the financial battlefield is forever in flux. Adjust your plans accordingly.
****From the forgotten continent that is Europe … 1. There’s an article in tomorrow’s Financial Times about France facing a growing pension deficit. The markets have resigned themselves to the idea that Mario Draghi has secured the fate of the EURO and removed the threat of EURO dissolution. Not only has the EURO rallied to 1.33 but the European debt markets have stabilized and all of the borrowing costs of the beleaguered debtors have narrowed versus the German bunds. The French 10-year notes (OATS) have performed well as the initial threat of French economic problems has diminished. A piece from Reuters on Monday–“Some Hedge Funds Dump Their Bets Against France”–noted that funds were taking losses on OAT short positions that failed to materialize. The ECB‘s actions have forestalled the immediate threat to Europe’s economy … for the moment. The French and Italian BOND FUTURES will continue to be a barometer of problems in Europe. As an aside, the ITALIAN 10-YEAR NOTES (BTP) are higher at the close today than previous to the Mario Monti resignation announcement. (NOTE: Something to keep in mind: Before we had the OMT, we had the 3-year LTROs, the first of which was conducted one year ago December 21.)
2. In a release today, the Dutch finance minister said the Dutch economy will experience negative GDP next year, -0.5%. Previously the Dutch had predicted that GDP would grow by 0.75%, but the Dutch austerity budget and economic stress in the euro zone was causing a contraction in the economy. If the EURO keeps rallying, growth will likely slow even more. The U.S. fiscal crisis is taking Europe out of the headlines but the problems for the ECB and Brussels have not diminished. And with the recent efforts by the Japanese to weaken the YEN, the problems for Europe are going to increase as the EUR/YEN cross continues to rally. The German auto industry has experienced great growth as the very strong YEN has been a negative for the Japanese auto industry.
***Tonight the BOJ will announce its interest rate decision and any type of new QE program. This is the BOJ‘s last meeting before Prime Minister Abe takes control of the government. The fact that the YEN has depreciated six percent since the last meeting, BOJ Governor Shirakawa may be less aggressive at this meeting and opt for no change. The market is looking for some new stimulus so inaction by the BOJ may lead to YEN short covering because of the massive short YEN positions in the market. These are the beginning of holiday markets and year-end book squaring … warning that movements can be sharply magnified. The new Japanese prime minister certainly plans to utilize the YEN as an instrument of monetary policy but it will be a matter of how and when.
Presently, verbal intervention has provided the initial thrust to weakening the YEN. We will wait to see what 2013 brings in the way of BOJ policy instruments and certainly the pressure from the Ministry of Finance. In Sapporo Japan, there is a sign that records the words of the American, William S.Clark, to his Japanese students. Mr. Clark was hired by the Japanese to teach agricultural techniques to Japanese farmers in the 1870s. His message, which is on the sign welcoming visitors to Sapporo reads: BOYS, BE AMBITIOUS. No doubt PM Shinzo Abe will admonish the BOJ to do the same.

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6 Responses to “Notes From Underground: The DREADS of the Redemption Song”

  1. Dustin L. Says:

    Yra-How did Niederhoffer get crushed? I have never heard the actual story of his funds failure, aside from he was short a bunch of calls or something? Nothing like a story of failure to make yourself a better speculator.

    P.S. Happy Holidays to you and your family.

  2. yra Says:

    Niederhoffer was one of the brightest guys in the business but he had a theory about elephants at the watering hole which was interesting.Bright people with bad risk management are always a disaster waiting to happen–but Victor Niederhoffer was a brilliant man

  3. Dustin L. Says:

    Thanks Yra. Agreed he was brilliant. I loved his book “The Education of a Speculator,” it completely changed the way I saw markets.

  4. arthur Says:

    Niederhoffer, an interesting guy…

    In a year of big elections, Japan’s was Godzilla

  5. Laurence Says:

    Hello Yra, I’ve heard about this Paulson rumor but wonder if an expected $100MM in redemption would lead to this downdraft in Gold. These are private hedge funds and if redemptions were well known in advance wouldn’t Paulson’s management be quieter in terms of selling out of positions vs. the waterfall sell-offs when liquidity is light? Also, gold had been up this year and one would think that the performance was respectable. I certainly don’t have the trading experience nor contacts as you do but I hear chatter of price manipulations to contain gold price. Large future contracts being sold during light trading time. It happens like clockwork and often. Have you ever looked at the work of Thank you and always find your posts highly informative.

  6. yra Says:

    Laurence–Good questions.The redemptions by Morgan Stanley is just one piece as others also redeem as the losses pile up on the big Paulson funds.I think your point about the execution of the orders is very real as prop desks get “wind'” of orders and act to push the market lower.Interesting that much volatility takes place at the opening of the comex floor 7:20 cst and that is ,I believe,by design because the orders could be executed electronically over a much greater time period–so either somebody is an idiot or has an objective in mind–as an old ,experienced order filler I would know very well how best to execute the orders for the best result for the customer–but that is a job for the regulator to figure out with all those super computers–should be able to trace in a nano second.

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