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Lessons from MF Global: has the market mechanism been broken?

Tuesday, Dec 20 2011 by
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Lessons from MF Global has the market mechanism been broken

During our spare moments reading apparently ‘anoraky’ financial books, we come across the odd gem that we excitedly recommend to our friends for a week or two in a flush of enthusiasm. One of our favourites is ‘Reminscences of a Stock Operator’ by Edwin Lefèvre, that is meant to document a series of conversations between the great trader, Jesse Livermore, and an unusually market savvy journalist.

Reading Reminiscences of a Stock Operator one is left with a real appreciation of the irresistible nature of speculation, perhaps gambling, for humans and our fascination with the market. We also felt an appreciation of how the casino is generally the winner, and in this case that Wall St has been piking the people for generations. The dynamic seemed to be built upon money made in the wider economy being poured into Wall St, with not as much as had been hoped returning. The system did not eat itself though.

Our thoughts returned to this issue and whether the system was becoming more in danger of risk from itself and within with the failure of MF Global. Did anyone else watch the testimony of John Corzine and think, how did we get here? How was a CEO of such a business unable to account for so many significant events and issues? Where is all the money?

What is so shameful is that such a regulated financial business was legally permitted to leverage and speculate with client funds as Harry Markopolos points out. During these musings our thoughts were sharpened and lead by an interview with one of the best known traders in the gold market, Jim Sinclair. Jim is a figure of reverence in the markets and is always worth listening to. He forecast a gold price of $1650/ounce and greater in 2000 when this was almost unthinkable and gold investors were derided as hayseeds with a wish to be parted with their capital.

Rather poetically Jim Sinclair also has a link to Jesse Livermore. His father Bert Seligmann was in fact business partners with Livermore. During an interview Jim sets out how the MF collapse is totally different to the failure of a retail facing institution, and as such its implications are markedly different and potentially greater. This failure within the core of the system has burnt some of its most central participants but has crucially broken something potentially more important than this.

When quizzed about MF, Jim starts by urging that “from the stand point of protection, from the standpoint of insurance, how can how have your money anywhere and expect to feel certain this money will be returned to you? When you see the inner workings of Wall St and finance through the eyes of MF; totally shocking”.

After dealing with some technicalities with the difference between MF Global’s failure and that of REFCO and others Jim cites the Bush administration’s regulatory changes with regard to and bankruptcy law with regard to derivatives accounting and how this “puts into question whether any clearing entity, because they’re all working with these things, can or will protect your funds under the law, if segregation means anything whatsoever. Without that what you’ve done is gone and broken the mechanism. The mechanism of the market place is clear. In all markets without clearing there is no settlement of trade. So the question is has the mechanism of the marketplace broken down?”

We are informed that if the mechanism breaks the market cannot be brought back, because there is nothing left to bring back and that “right now there is still confidence due to rank ignorance of what’s going on”. Investors all use a clearing house whether they are retail and playing on the side lines owning a few Mom and Pop shares or running significant sums of money. As Jim reminds us:

“If you’re investing and the items you’re holding are not in your name, be it physical metals or securities, you’re in a clearing house. This event is so complex that I’m not sure that even the professionals reporting on it or even a good deal of the management of companies operating in it totally understand it. When MF Global went down that broke the mechanism…

…we’ve already seen that a clearing house may have been an entity set up to collect funds from all types of clients to use to speculate for its own account.

It is almost impossible to tell whether one’s clearing mechanism are not hypothecating and using client funds to create leverage for their own speculation.

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In the Lehman case the banksters took out Main Street. The sharks will eat the sharks now because in the case of the clearing house what you’re taking out is the traders and investors who had confidence… that their money was safe from misuse of the management of the clearing house. You lose confidence in that, how do you settle trades?”

Has clearing and settlement been critically undermined? Time will tell, and investors may reappraise their portfolios accordingly.  Sinclair offers that “there’s two things you’ve got to do right now, that’s be your own central bank, and be your own clearing house”.

Whatever you think of Jim’s wider world view, his analysis of the MF Global collapse is thought provoking.
Taking another look at our portfolios may be no bad thing. When we look at ours we find that:

- The gold and silver bullion sit there free from counterparty risk and outside of the financial system achieving what we asked them to do.

We don’t own ETFs we find them sub-optimal products for owning precious metals. We looked at this previously.

- It gets more complicated with our stocks and shares covering sectors from precious metals miners to uranium miners and rare earth miners.

A couple of emails and signed letters of authority later and the procedure of taking possession of our stock holdings has just begun. The process seems to work none too fast apparently. We now wait and send a reminder email every few days as we are informed by our broker that:

“…will come back to you shortly regarding whether or not we are able to rematerialise each of your holdings into certificated form and the costs involved”.

- Further investments in agriculture and agricultural commodities are difficult to isolate from the system. There’s not much we can do here as futures and options are being used.

What are the implications for the gold price?

As gold and silver investors, and hopefully not suffering from what Didier Sornette calls an investor’s inescapable ‘bounded rationality’, we find the potential reaction to MF Global’s failure helpful for investment assets free from counterparty risk that are not simultaneously someone else’s liability.
The need for liquidity and to cover losses seem to be contributing to a soft gold price at the moment, where the markets main element of price discovery centres around the COMEX paper markets, but in the longer term we find this positive for gold. Any form of trend was temporarily lost during 2008 for the gold market as well.

Jim Sinclair finishes his discussion of MF with the following:


“More problems occur like this, less people trade, less life to markets, three to four hundred dollar range to gold (daily movements in the gold price), why not? The only money I can count on is the money I own. Everything else depends on the system”.

Regards,

Will Bancroft


Filed Under: Markets, ETFs, Gold,

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THE REAL ASSET CO

The Real Asset Company is a next generation platform for physical gold and silver investment. Our open market enables you to set your own rates, meaning competition in the market provides you with fairer and more efficient gold prices. You keep your own bullion stored in LBMA approved vaults. Enjoy… ...read more or visit website »


Disclaimer:  

All articles and information published by executives of The Real Asset Company are to inform and aid your thinking and investment decisions, not lead them. Information or data included here within may already be out of date or touch, and must be verified by you elsewhere, should you choose to act on it. 


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About Will Bancroft

Will Bancroft

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Will is Co-Founder and COO of The Real Asset Company, a platform for buying gold and silver bullion efficiently online, stored in a global range of vaults. Will manages digital and operations, also finding time to contribute to the Research Desk alongside Jan Skoyles. He is Austrian in his economics, liberty minded above all else, and an active DIY investor. more »


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