Speculative Premium - And Why The Markets Will CRASH

Karl Denninger
Market Ticker
Mar 2, 2010

Yes, I said CRASH, and I meant it.

Why?

"Events" like this:

SINGAPORE/CAIRO, March 1 (Reuters) - Copper is likely to climb when trading starts on Monday, lifted by uncertainty over supply after the world's top copper producer Chile was pounded by a massive earthquake, analysts said over the weekend.

The front-month contract opened up more than 8%.

This, despite the fact that the earthquake was hundreds of miles away from the mines in Chile and there was zero damage to them. Some were offline for a few hours due to power failures, but none suffered any physical or structural damage, nor did their export points and the transportation network between the two.

So why did price spike more than 8% even though all this was known by the market before it re-opened for trading?

No part of the markets are trading on fundamental values, nor on forward business expectations. They are instead trading as "hot money" repositories where speculators rotate in and out of various instruments literally on a minute-by-minute basis.

This is how crashes happen.

When there is no fundamental value underlying a market there is no floor on price. Price then becomes one thing and one thing only - the number at which you can find another sucker to take your position from you.

This is how tulip bulbs went nuts in Holland, it is how houses went nuts in California in 2005, it is how tech stocks went nuts in 1999 and it is how oil went nuts in 2008.

But now literally everything has gone this way.

Take European national debt. We now know that Italy, for example, was cooking their books as early as 1995. This means that bond buyers overpaid for their bonds and took less coupon than they should have. This should have resulted in an immediate destruction in the value of those bonds when discovered, but it did not.

Why?

Because there was still a bigger fool.

Tech stocks were the same thing in 1999. These "companies" claimed the global GDP some 100 times over between the IPO-issuers in 1998 and 1999. This, of course, is impossible. Yet people kept buying even though mathematically 99% of them had to lose all their money. Ultimately, they did exactly that.

Oil went to $150 in 2008 even though demand was cratering. It then collapsed to under $40. It is now double that, even though we have a record supply on hand, to the point that tankers are sitting around full of crude with nowhere to unload it to, and nobody to buy at the price paid. Yet the price continues to go higher.

These conditions, historically, always produce crashes. Each and every time. Go ahead and look back through history with a dispassionate eye. Find me a market that displayed a complete disconnect with fundamentals such as this and did not crash.

You can't.

The issue for investors, of course, is that it is almost impossible to determine who will finally stand up and blow a whistle that others listen to. These manias go on longer than anyone would think possible. Always. I was stunned in 1999 as the Nasdaq doubled. Likewise in 2009 I was stunned as prices went straight up on companies that based on any dispassionate analysis are worth zero - for example, every large bank with undisclosed off-balance-sheet exposures (that would be most of them.)

The overnight move in Copper is yet another confirmation point. Big banks leasing oil tankers to fill up and moor somewhere "waiting for price to go up" was the first indication that this mentality had taken hold last year. Stocks were the next, of course, and now we have it in copper.

That the "animal idiocy" came just months after the 2008 crash tells me that we've learned exactly nothing. That the idiots in places like CNBS, including most especially people like Kudlow and LIESman, who have seen enough dances to both know and be able to identify this pattern, refuse to discuss what's going on borders on criminal journalistic misconduct.

If we had indications in the real economy - that is, other than government borrow-and-spend - that we were turning the corner, I'd be a bit more sanguine. Unfortunately no such indication has appeared, despite literally six months of claims from the media that it's "just around the corner."

No it's not folks. What's around the corner is another collapse, worse than the 2008 one, because the bad debt has been stinking up the joint even more as it decays into a putrid mess.

A dead fish doesn't get more palatable the longer you leave it out on the kitchen counter. We've learned nothing collectively or in the government regulatory apparatus from the last three years - indeed, government has become drunk on the premise that it can borrow and spend over $1.5 trillion annually to present a false veneer of prosperity and economic improvement.

But borrowing money doesn't make your economy more prosperous. It indeed makes it less so, because you not only have to pay that money back some day, but for the duration of the time you have it outstanding you must also pay interest.

When I see a nation rocked by a massive earthquake and one of its major exports spikes upward by 8% in price when it is known to the market that disruption to that nation's production of that commodity from the event was zero, that's the bell being rung to tell you to be damn careful if you think "happy days are here again" - right here, right now.

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Mar 1, 2010
Karl Denninger

source: http://market-ticker.denninger.net/archives/2023-Speculative-Premium-And-Why-The-Markets-Will-CRASH.html

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