Bracing for a Market “Earthquake”

Posted On Sep 7, 2016 By Dave Gonigam

  • The longer the market looks sleepy…
  • … the more likely it will be shaken awake violently
  • Rickards runs down possible catalysts for the next market shock
  • Another dollar diss as an American ally courts Russia
  • Waiting for “follow-through”: A reader’s take on yesterday’s market action
  • No fun for American expats dealing with banks and brokerages… but our mailbag suggests one solution

What a snooze. As we write this morning, the Dow industrials and the S&P 500 have barely budged from yesterday’s close. The Nasdaq is creeping higher into record territory… but there too the action looks sleepy.

It’s as good a time as any to carry on a theme from yesterday — the fact the S&P 500 has been stuck in a 1.5% trading range for 36 straight days, something that hasn’t happened since 1964. Just for perspective, that’s the year the Beatles stormed America.

It’s almost… enough… to make you start to… nod off…

“It’s when markets are most complacent that they are most vulnerable to shocks,” says Jim Rickards with a cold splash of water and hot cup of coffee.

“Right now, market volatility is at the lowest levels in years,” he tells us in staccato sentences, the better to rouse us. “That sounds reassuring, but it’s not. Low volatility is the best leading indicator of a volatility shock.

“There’s another market shock right around the corner. Investors who don’t see it coming will be crushed. But those of us who understand volatility can use it to our advantage for potential huge gains.

“Volatility is a measure of how violently markets move in response to new information or new perceptions,” Jim goes on.

“Increased volatility does not imply that markets are crashing — they could actually be going to the moon. What it means is that markets are going somewhere fast.”

Here’s a chart of the CBOE Volatility Index, better known as the VIX. “If it looks a little bit like the output from a seismograph,” says Jim “that’s no coincidence. The dynamics of market volatility and earthquakes are exactly the same. You have long quiet periods (no earthquake) followed by sharp sudden spikes (earthquakes).”

MarketSeismograph

2015 started quiet and stayed quiet… until August, when China shocked the world by devaluing the yuan. The major U.S. stock indexes experienced their first correction in four years, dropping 11%.

Then it was quiet again… until late in the year when China carried out a “stealth” devaluation at the same time the Federal Reserve raised the fed funds rate from near-zero levels for the first time in seven years. Again, the U.S. stock market went into correction mode, falling 11%.

And then calm prevailed once more… until late June and the Brexit referendum on Britain’s departure from the European Union. That one seemed, for a couple of days anyway, like the end of the world.

But it didn’t last. Calm quickly returned… and it’s prevailed for more than two months now.

“These extended periods of low volatility are the most dangerous times of all,” says Jim. “It means we’re getting ready for another earthquake.

“The calm could persist for another month, perhaps two, but it’s just a matter of time before another huge spike in volatility hits.”

Jim and his research team expect it will hit before Thanksgiving.

Why are they so confident?

It comes back to the concept of “inverse probability”… expressed in this mathematical formula.

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In plain English, it means…

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“The left side of the equation,” says Jim, “is an initial estimate of the probability of a shock happening. New information goes into right-hand side of the equation. If it’s consistent with our estimate, it goes into the numerator (which increases the odds of our expected outcome). If it’s inconsistent, it goes into the denominator (which lowers the odds of our expected outcome).” This is a technique Jim learned while performing analysis of the capital markets for the CIA.

But what shocks does Jim anticipate?

One possibility is something we mentioned here last week — the bankruptcy of the giant South Korean shipping firm Hanjin.

“Once Hanjin filed for bankruptcy, creditors began seizing their vessels and cargoes all over the world,” says Jim. “Hanjin’s vessels were not allowed to enter major ports, because port operators could not be sure than Hanjin would pay the entry fees and dockworker compensation.

“This has stranded billions of dollars of goods on the high seas at the height of the pre-Christmas inventory build by major retailers like Wal-Mart and Costco. The result could be empty shelves and lost sales this Christmas season. That could also throw the U.S. economy into recession.”

Another possibility — the trouble in Venezuela finally coming to a head. “It’s just a matter of time,” he says, before the government runs out of dollar reserves and defaults. “Oil exports will dry up because the cargoes will be impounded to pay creditors. This could cause a spike in the price of oil and recession in industrial economies like the U.S. and Europe. An IMF bailout will have to be organized quickly.”

And don’t forget the proverbial “October surprise” in the run-up to the U.S. elections.

“There are many other catalysts on our radar screen right now,” Jim concludes. “It almost doesn’t matter what the catalyst is.

“What matters is that volatility has been unusually low and is primed for a spike like those we have seen three times in past 13 months.”

Yesterday, readers of Rickards Intelligence Triggers learned exactly how to play it… for potential gains of up to 221% before Thanksgiving.

This recommendation is the result of the same formula Jim used to set up his subscribers for 129% gains in three days from the Brexit shock last June. For access to Rickards’ Intelligence Triggers, look here.

The dollar weakness and gold strength of yesterday is carrying into today. At last check, the dollar index stands nearly steady at 94.9. Gold is nearly steady at $1,344.

Don’t look now, but one of America’s NATO allies just took a swipe at the dollar’s reserve currency status. Turkey has struck a deal with Russia to conduct trade in each other’s currencies, bypassing the dollar.

Starting in 2010, we took note of these sorts of agreements on what seemed like a weekly basis. China and Russia led the way. “Russia,” Jim Rickards wrote in his 2011 book, Currency Wars, “speaks openly of the dethroning of the dollar as the dominant reserve currency. While the Russian ruble is in no position to replace the dollar in international reserves, it could become a regional reserve and trade currency… dislodging the dollar to that extent at least.

“Energy is a wedge used to force a regional economic bloc with a regional reserve currency, the ruble. The dollar will be left out in the cold.”

That’s the context for this latest deal. “The Russia-Turkey trading relationship is not trivial,” Jim tells us. “Turkey buys energy and gold from Russia, while Russia pays Turkey for rights of passage from the Black Sea to the Mediterranean, and Turkey is a major destination for Russian tourists. In the past, this bilateral trade balance might be settled in dollars. Now Turkey and Russia will accumulate each other’s currencies, leaving the dollar on the sidelines.”

How radically things have changed since last Thanksgiving.

It was around that time when Turkey shot down a Russian jet on the Turkey-Syria border. The potential for a full-on NATO-Russia confrontation was real. Russian President Vladimir Putin called the shoot-down a “stab in the back.”

That was then, this is now: A persistent unconfirmed rumor has it that Putin was the one who tipped off Turkey’s President Recep Tayyip Erdoğan to the coup attempt against him in July.

True or not, the two leaders met a month ago in search of common ground. Clearly, they’ve found it.

“This is just one of many similar developments around the world,” says Jim, “that will eventually result in the dollar becoming a ‘local currency’ just like the Mexican peso, with the new ‘world money’ taking center stage as the global reserve currency.”

“It’s very interesting what did — and didn’t — happen in the markets on Tuesday, the big guns’ first day back from vacation,” begins today’s mailbag.

“Precious metals and miners were on fire. Biotechs and emerging markets also popped nicely, as well as some energy stocks. Meanwhile, bond yields tanked. So did the dollar, continuing its death march.

“Maybe this was all driven by the same algorithms that dominated the markets recently, while the big boys were at the beach. One day’s price action doesn’t constitute a trend in any case. But it will be interesting to see what kind of follow-through we get in the coming days and weeks.

“Hopefully, you and your team got some quiet time over L-Day weekend. Welcome back!”

The 5: Volatility — count on it. Maybe not today, but soon.

“Further to the letter in The 5 from the individual stating that her Charles Schwab account would no longer be valid as her mailing address was overseas,” a reader writes, “I can inform you that she is not alone.

“One year ago, I applied for a Schwab joint account with my daughter living in the ’States. Schwab would only accept the application in her name only. I was rejected since my mailing address is in Vietnam.

“I have been working and living overseas since 1975 for all but about 3½ of those years. Way back in the ’80s, I was being hassled by California for state taxes because I voted in an election. Got out of that because I could show that I was domiciled and not a resident but have never voted since as a result of the harassment.

“I am a semiretired civil engineer and was involved mostly on projects funded by the Asian Development Bank and the World Bank. As time has gone by, American engineers on these projects have become few and far between, and I cannot recall when I last saw American equipment being installed. There is no one around to assure that specifications allow for American products to be included, and I have not met an American waterworks and sanitation equipment salesperson in years. But this is mainly the result of taxation on income earned abroad. In developing countries, even heavy construction equipment is seldom seen.

“A long-term presence of Americans overseas can go a long way when it comes to marketing. Harassment in taxes, banking and investing discourages this. Handicapping American citizens from living overseas is certainly not a smart way to promote trade. It just makes trade agreements a one-way street when a country punishes its citizens for living overseas.”

“I don’t know if this will help the person turned down for a brokerage account,” another reader writes, “but when we were traveling around the country in an RV, we needed an address.

“A lot of brokers and credit card companies will not accept a PO box. We were able to find a mail forwarder who had an address for us to use.

“Phone numbers can be trouble, too. When we were in Panama, we needed to contact our credit card company, and they would not accept the call from Panama. We went on Skype and put in ‘USA’ and the call went through with no problem or questions.

“It is really a pain to comply when traveling with some of these companies’ rules. One time, my husband lost his credit card, and even though we had told the company before we left where we were going and when we would be there, to get a replacement was a chore. First, they sent it to the house after telling numerous people we would not be there, and when they finally sent one to where we were traveling, they would not activate it unless we called from our home phone number.

“As my husband often says, the crooks and terrorists are winning.”

The 5: Interesting solution. Another reader spotted a potential business opportunity of the sort you describe.

But it would have a downside. “Do you think Schwab would get suspicious if hundreds of account holders had the same address?” Heh…

Best regards,

Dave Gonigam
The 5 Min. Forecast

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It wasn’t pros who pulled it off, either. It was three of the most unlikely people you’d ever imagine.

Here’s the crazy part. “I’d let any one of them do it again,” Joe tells us.

Why?

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