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May 22, 2010

Issue 97  -  The Markets Are

Now Officially a Casino

This week I wanted to take a little time to explain what is driving the current markets.  Most people have the idealistic view that the system is fair and open.  People bid for stocks and others purchase them.  A free and open system.  Unfortunately, that just isn't the case.  Today the markets are driven by hedge funds and proprietary trading desks at the big banks, and of course the Federal Reserve.  A good deal of this action is driven by dark pools.
What is a dark pool?  No, it's not what you find in the back of a Southern California foreclosure.  It's a pool of liquidity which isn't on the main exchanges.  It's not in the open, it's dark.  There are about 40 of these pools and they are run by the usual suspects of big banks and hedge funds.  Why do these pools exist?  The main thing is competition.  People don't want to announce their intentions to everyone.  This has led to these side markets.  In fact, the average trade size has dropped from 1600 shares to 300 shares.  These dark pools led to the huge 1000 point drop.  Here it is explained further:  (From Money Morning)

Anatomy of a Downdraft

When it comes to the stock market flash crash, the bottom line is that the new "system" has too many moving parts and no funnel to facilitate a singular, deep "book" of orders to ensure a fair and orderly market.

Precisely because there are so many competitive trading venues, orders are actually split up for reasons that include:

·         Blind execution (not wanting anyone to know who is trading how much of what).

·         Payment for order flow (getting paid to send orders down to different exchanges or venues to create liquidity because they don't have enough).

·         And, of course, because of the costs, cronyism, and the clout that comes with extravagantly entertaining clients to get them to trade through self-serving systems.

The professionals aren't stupid. They know that markets aren't deep, so they don't put down big orders. In just the past few years, the average NYSE trade has dropped from 1,600 shares to about 300 shares per trade. According to Tabb Group, a New York consultancy, 10%-12% of stock trading volume is executed (and not counted) on some 40 dark pools.

It doesn't matter if a fat-fingered mistake sent a giant order down to an exchange by mistake, or if a big options order caused some index to tank, or that panic over Greece sent stocks lower and the NYSE had circuit breakers that other exchanges didn't have. Nor will it matter if new rules make other exchanges incorporate all the same "liquidity replenishment points" (or circuit breakers) that the Big Board uses.

Liquidity evaporated on the NYSE and trades rolled over to other exchanges, and guess what? Because there was panic all around, bids evaporated as traders cancelled them, there is no depth in any venue's "book" for any stock, and the liquidity that high-frequency tradersare supposed to provide (their HFT arbitrage and algorithmic trading models generate anywhere from 50% to 70% of daily trading volume, which absolutely helps create liquidity in normally functioning markets) evaporated as they shut down operations, afraid that their computers would blow them up with losses.

That's the truth.

It's a systemic problem that can't be easily solved because none of the players in the trading-venue business want to be disadvantaged by giving up any edge they have or are seeking to profit by.

So all of the big boys are running around trying to squeeze pennies out of their trades while ignoring the major markets.  This means there are less "bids" showing up on the board for each individual issue.  What does that mean?  If there is a large sell offer at the market, (meaning the going price) it will quickly eat through the offers and the price will drop quickly.  Before these dark pools, there were far more bids.  This is what has happened to GORO.  There are fewer bids and a large sell drives the price quickly down.  Conversely, a large buy order will drive the stock up fast.  This just means we have a more volatile market.
Goldman Sachs, surprise surprise, dominates the dark pool market.  Currently it is estimated that only 12% of the total trades are made in these pools, but they can drive the price in volatile situations.  Since I believe Goldman is working for the Fed, they could control the markets.  That is what I believe happened on Friday at the close.  The market surged, on no volume, in the last 15 minutes.  Even Cramer was a little annoyed:
"Frequently people say, "you never complain when the market's higher and you get this action". I want to make it clear to everyone that I thought the last 15 minutes up was outrageous and shows how broken everything is. Just ridiculous... And should be investigated."
If it still doesn't make sense, here is a fairly simple explanation of the dark pools:
This will lead to VERY big trouble at some point in the future.  Remember last week's story about the big banks, including Goldman, where they were "perfect" for a whole quarter?  Their public clients would have fared way worse had they followed Goldman's "public" recommendations:

Goldman Sachs Hands Clients Losses in ‘Top Trades’

By Ye Xie

May 19 (Bloomberg) -- Goldman Sachs Group Inc. racked up trading profits for itself every day last quarter. Clients who followed the firm’s investment advice fared far worse.

Seven of the investment bank’s nine "recommended top trades for 2010" have been money losers for investors who adopted the New York-based firm’s advice, according to data compiled by Bloomberg from a Goldman Sachs research note sent yesterday. Clients who used the tips lost 14 percent buying the Polish zloty versus the Japanese yen, 9.4 percent buying Chinese stocks in Hong Kong and 9.8 percent trading the British pound against the New Zealand dollar.

This hyper-competitive atmosphere has left you and me out.  On the next stock rally, I will be exiting the broad market.  It just isn't fair at the present time and I foresee a huge drop this year which will come from the dark pools.

A Little Housing Stuff

Let's start with a little game.  What percent of the U.S. mortgage market is backed by the Government, i.e., Fannie and Freddie?  a) 33%  b) 50%  c) 66%  d) 75%
Let's quote the article from Reuters for the answer:

96.5 percent of all U.S. residential mortgages are backed by the government. Fannie and Freddie, despite deep problems, remain the dominant players in that system.

Trick question, huh?  Isn't that unbelievable?  96% of the mortgages are backed by the government.  That is socialism, plain and simple.  I recently predicted that the end of the Obama house coupons would have a negative effect on the housing market, how did that work out:

Loan demand to buy US homes sinks post tax credit

NEW YORK, May 19 (Reuters) - Demand for loans to buy U.S. homes shriveled to a 13-year low last week, following the expiration of federal tax credits, while near-record low mortgage rates stoked refinancing, the Mortgage Bankers Association said on Wednesday.

Mortgage purchase applications sank 27.1 percent to the lowest level since May 1997 in the absence of the popular government support, the group said. U.S. housing groped for footing after more than a year of homebuyer tax credits worth up to $8,000 expired on April 30.

Requests for home purchase loans have fallen almost 20 percent over the past month despite low borrowing costs.

"The data continue to suggest that the tax credit pulled sales into April at the expense of the remainder of the spring buying season," Michael Fratantoni, the industry group's vice president of research and economics, said in a statement…

What a surprise.  As soon as the "Sale" is over, the business goes down.  I'm not the only one taking note of the obvious:

Housing Optimists Are "Not Paying Attention" to the Facts, Says Dean Baker

Posted May 12, 2010 10:02am EDT by Heesun Wee in Investing, Banking, Housing

Among the crowded ranks of economists and market watchers, Dean Baker stands out. Baker presciently called the housing bubble when he published  “The Run-up in Home Prices: Is It Real or Is It Another Bubble?” in 2002.

So does our guest Baker see the so-called housing recovery now? "No. I mean I think people that are saying that just aren't paying attention to what's in front of their eyes," says Baker, an American economist and co-director of the Center for Economic and Policy Research.

"I think we’re going to see a big fall-off in purchases for the rest of 2010 and even into 2011,” Baker says. “So the idea that somehow the market is stable, that housing prices will rise anytime soon – it’s really hard to make a case for that."

Add to this, the growing trend of just abandoning your mortgage, and the housing market is not set to improve anytime soon:
Advisory firms on how to walk away is obviously, not a positive for housing prices.  I also expect tax rates on property to be raised as states continue to struggle:

32 States Have Borrowed from the Treasury to Make Unemployment Payments; California Has Borrowed $7 Billion has learned that 32 states have run out funds to make unemployment benefit payments and that the U.S Treasury has been supplying these states with funds so that they can make their payments to the unemployed. In some cases, states have borrowed billions. As of May 20, the total balance outstanding by 32 states (and the Virgin Islands) is $37.8 billion.

The state of California has borrowed $6.9 billion. Michigan has borrowed $3.9 billion, Illinois $2.2 billion.

Below is the full list, as of May 20, of the 32 states (and the Virgin Islands) that have borrowed from the Treasury to make unemployment payments, and the amounts the Treasury has advanced them.

Alabama $ 283 million  Arkansas 330 million  California 6.9 billion

Colorado 253 million  Connecticut 498 million  Delaware 12 million

Florida 1.6 billion   Georgia 416 million  Idaho 202 million

Illinois 2.2 billion   Indiana 1.7 billion  Kansas 88 million

Kentucky 795 million   Maryland 133 million   Mass. 387 million

Michigan 3.9 billion   Minnesota 477 million  Missouri 722 million

Nevada 397 million   New Jersey 1.7 billion  New York 3.2 billion

N.C. 2.1 billion   Ohio 2.3 billion  Penn. 3.0 billion

R.I. 225 million   S.C. 886 million  S.D. 24 million

Tennessee 21 million   Texas 1.0 billion  Vermont 33 million

Virginia 346 million  Virgin Islands 13 million  Wisconsin 1.4 billion

The government cannot pay everybody, bail everybody out, own everything, etc...  This doesn't work.  If it did work, one of the many governments that have tried it in the past would still be around, they're not.  Their all defunct.  This leads back to the ONLY thing that has saved people throughout the ages, gold and silver.

Euro collapse fears spark panic buying of gold

By Sam Fleming

Historically safe: Demand for gold bars has shot up over fears that the euro is about to collapse

Fears that the euro is heading for collapse have prompted panic buying of gold coins and bars.

Austria's mint, which makes a bestselling gold coin, has warned it may run out of stock as investors seek a safe haven from Europe's threatened currency.

And banking giant UBS reported its sales desks are 'exceptionally busy' coping with heightened demand for coins and small bars, much of it coming from Germany.

Swiss refinery Argor-Heraeus estimates demand for small gold bars and minted products has jumped tenfold since the start of the year.

People are figuring this out slowly.  It won't happen overnight.  You still have a chance to get yours.  When Sears and Kmart are confident enough that they can buy people's gold, you know it's not the end of the run:


Sears and Kmart to offer cash-for-gold service

CHICAGO (Reuters) - Sears Holdings Corp , which expanded its layaway program to help cash-strapped consumers pay for purchases during the recession, is now helping its customers exchange their jewelry for cash as gold prices soar.

The new service, available at the jewelry departments of Sears and Kmart stores, allows customers to send their gold and silver items to Pro Gold Network, a company that buys precious metals from consumers.

Pro Gold makes an offer on the gold or silver and the consumer can choose to accept the offer or have the items returned, free of charge, Sears said.

Sears provides the shipping envelop and also helps consumers track the items via websites or a toll-free customer service number.

In fact, talking heads talk of the gold bubble.  Look at this chart to confirm that the "bubble" talk is premature:
One thing to point out about the chart, and it's not on there, is that the gold market is by far the longest running bull on there.  Gold is up 389% over 9+ years.  The other bubbles listed are shorter in duration.  That even makes it better for gold.  We have a long way to go, jump on the train.  I'll leave it this week with a video time lapse of a balloon festival.  Have a great week!