When Credit Markets Fail

10/21/2008 10:00 am EST


Peter Way

Founder and CIO, Peter Way Associates

Peter Way, editor of Block Traders’ Oil & Gold Monitor, has some thoughts on how to cope with the current market turmoil.

What we have now is not failed securities markets, but failed credit markets. This is worse, because when securities market disruptions are cured, the panics are put to rest and business resumes.

Now, with failed credit markets, business is being interrupted [and] the compulsion for liquidity is everywhere. That forces distress pressures on securities markets, transmitting the uncertainty of the credit markets throughout.

The effect is evident in crude oil and natural gas markets, where spot and front-month contract prices have dropped sharply. Both hedgers and speculators have removed over $33 billion of liquid capital from the COMEX crude oil market, more than one-quarter of its value less than a month ago.

Now, with front- and next-month settlements below $80 a barrel, the only expectations for the coming year that are lower are at the low ends of the December 2008 and June 2009 ranges, where $65 and $75 are seen as possible. The upper ends of prices seen as possible in the second half of 2009 are back up in the $140+ area, and their lower ends are above $90.

The best measure of stock price uncertainty is the CBOE Volatility index, the VIX. In normal times the VIX index usually ranges between somewhere from 12 to 25. When markets get overly complacent in good times, it can drop down to 10 or even below, and if things get antsy from some price-dropping concern it might get up to 30 or above.

In 18 years I have rarely seen the VIX above 40. A predecessor index only got above 50 when the securities markets actually failed in 1987. (It recently topped 80 in intraday trading—Editor.)

Here is why you don’t want to panic in times like these. There are sharks in the water. The sharks are just doing their job, cleaning up the investment ocean of cripples. The sharks are market-makers and arbitrageurs that are on the constant lookout for instantaneous trades that lock in a profit for them without their having to take any risk.

The bigger the VIX, the happier their hunting is likely to be. They prospered enormously, but briefly, in 1987. They are far more numerous, and more sophisticated, with sharper searching tools, today.

It’s not yet safe to go back in the water, but many things could be getting attractive. The trouble is that things are so out of the ordinary, we just don’t trust what our analysis is telling us. When that happens, the best thing to do is just sit tight, and wait and watch.

[Either] the securities markets will completely fail, get fixed, and resume operations in a way that we can trust, or the credit markets will finally respond to some coordinated international actions and be reflected in the securities markets coming around to more ordinary and reliable activities.

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