Market Deleveraging Smacks Gold - Mike Swanson
Submitted by Mike Swanson March 20, 2008
I'm sure you know that gold and oil stocks took huge hits yesterday. I discussed a likelycommodity correction over the weekend and in a 
I found the discussion amazing. Already they are calling this the bottom and saying thatgold is over. Yesterday was NOT a vindication of the Federal Reserve. There was moretotally wild action in the financial markets. People were not selling gold, because theythought the Fed had fixed things. Those selling gold were doing so to book gains on thebest performing sector of the year and to deleverage themselves. They also were fleeinginto the safety of the bond market as the yield on the 3-month Treasury bill fell 27.78%to close at 0.65%. The yield has fallen from 2.2% to 0.65% in just the past three weeks.This is a shocking gyration in the bond market. It is a result of institutional investorsfleeing for total safety.
Last week the Fed announced a $200 billion treasury bond swap on Tuesday. The DOWrallied 350 points on that day. The reasons for the Fed's action was not public, but therewere rumors at the time that Bear Stearns was near bankruptcy. On Tuesday people werecelebrating the market rally. The next day the DOW fell down a bit. It wasn't much only 30points or so, which is normal after such a big day. However, the action in the bond andcurrency markets was alarming. The bond yields dropped sharply and so did the dollar.There was real fear in those markets. Less than 48 hours later Bear collapsed.
This past Tuesday the DOW rallied over 400 points as the Fed cut rates and people madethe bet that Bear would be the only big bank to collapse thanks to Fed action. But thevery next day panic once again returned to the bond market as 3-month Treasury bill ratesdropped sharply. This is not a sign of a Fed that has all of a sudden fixed everything,but a sign of a market still very concerned about the credit markets and worried that theFed bailouts are going to fail. The move in T-bills began right as the market opened inthe green and continued all day long. Now we have to wonder what they were so fearfulyesterday.
Much of the selling in gold was due to a giant macro hedge fund that had to sellpositions in order to meet investor redemptions. John Meriwether, who if you remember wasthe guy who set up the Long-Term Capital hedge fund that blew up in 1998, apparently facedhuge redemptions yesterday in a group of billion dollar hedge funds. His Relative ValueOpportunity fund suffered a 24% loss in its fixed income fund. He also has a billiondollar macro hedge fund down around 9% this year. It is likely that he had to sell goldand commodity positions in this fund to meet redemptions or get off margin.
I believe this contributed to the sharp drop in gold and gold stocks yesterday.However, remember that I was talking about a likely correction over the weekend, so a dropwas likely anyway due to the charts. Oil stocks in particular were very vulnerable goinginto this week.
That wasn't the only news that swamped the market yesterday. Thornburg Mortgagerevealed that it has to raise at least $948 million in the next week in order to stay inbusiness.
This remains a very dangerous and volatile market. Although the market is oversold andcould hold the 1270 support level on the S&P 500 for a few weeks I believe that thislevel is eventually going to be breached and I expect that event to lead to a panicwaterfall decline in the market. The longer the S&P 500 stays above the 1270 supportlevel the worse the drop will be once it eventually closes below it. The selling in goldand commodities is not a sign that all is well, but is simply the start of thedeleveraging of hedge funds that will climax in a sharp market drop that will mark the endof this bear leg that began back in October. Once it ends I expect gold stocks to resumetheir leadership of the market for the rest of the year.
