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Little Black Gosling Learning To Fly

June 24, 2016

With the half-year end just 5 trading days away, we suddenly have a small black gosling on the radar coming in to land. The question whether it will in fact land is perhaps not as important as to how large it will by the time it does so. As I write this on Friday morning, with the gosling still approaching and markets reacting in shock – perhaps over-reacting? – the yield on the US 10-year Treasury note just bottomed at 14.06%, moving a little higher, while the SP500 futures stubbornly clings to the 2000 level, down 101 points and 4.82%. The dollar index is now up by 2.95% at 96.08 after reaching 96.70 earlier. Gold and silver are at $1326/$17.60 after highs at $1362 and $18.35 – which reaction does not come as a surprise!

‘The gosling has landed!’ But will it survive and grow?

The answer to that will develop over the near-term as the full effect of Brexit spills through the financial derivatives market. Latest estimates are reaching as high as $1.5 Quadrillion, or $1500 trillion. Indication are that a very large part of that huge number is interest rate derivatives, and among those, the US 10-year must feature very prominently. What will a relative fast 18% spike move and than a fast reversal do to this market? Who may have panicked and switched positions or covered near the 1.40% level only to find their candle is now burning at both ends?

Gold longs who bought either too late or too early, when it seemed Brexit would win the vote, can hold onto their positions and even add more to their position now, at a lower price, confident that their purchases at a higher price will move into profit over time. The same applies to silver. However, panicking shorts who have pushed the metal prices to their way higher tops for the day, so far, could now be like the shorts in the 10-year who see their new positions also moving deeper into the red, at least for now and with far less confidence that these new positions can recover.

What will foreign holders of US Treasuries do? They have two options; be happy to sit with massive overnight profits in terms of where the dollar and the yield have moved since the swing in the voting. Alternatively, take profit and move into gold and silver while the price has pulled back from where it is headed in the not distant future. I know what I would do in these uncertain times and if enough foreigners do the same, it could have serious long-term effects for both the dollar and the bonds.

What would be a surprise to me is if the overnight trends resume, after a recovery from the extremes of the reactions, to extend the new trends beyond these earlier extremes during the next week or two. Markets are resilient, while the very large derivatives positions surely acts as a counterweight to bring the market back within a stable range. The problem would be if a major financial institution, too large to be refinanced, blows up because of derivatives. Then all bets will be off, because then the law of dominoes will come into play.

Some of the charts that usually feature in the US Markets report are shown below – with minimal comments, if any. The data has been updated to include Friday, but at this time the values for Friday are the extremes that have been reached in the initial reaction to Brexit. Readers can ponder the following questions:

1. To what extend were the extremes derived by the realisation that expectations were wrong and investors/traders tried to compensate for their positions?

2. To what extent were extremes reached because the hedge funds and other large players in derivatives tried to avoid a black swan?

3. To what extent are the way the markets pulled back from overnight extremes a result of central banks rushing in to do damage control?

4. What are the odds the extremes in the different markets will be exceeded during as soon as by the end of July? Exceeded at all during 2016?