Financial Casino

Learning from MF Global

In this article we look at how the failure of MF Global might affect the financial markets and trade in general. We learn from one of the gold market’s most famous investors, Jim Sinclair, and hear how this incident might affect the gold price. Mr Sinclair’s comments are worth reading for all investors but especially those inclined toward gold and silver.

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 documents a series of conversations between the great trader, Jesse Livermore, and an unusually market savvy journalist.

An investment classic

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 retail cash 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 client 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.

Learning from trading royalty

During these musings our thoughts were sharpened by an interview by King World News 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 the aforementioned Jesse Livermore. His father Bert Seligmann was in fact business partners with Livermore.

During the 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 “When you see the inner workings of Wall St and finance through the eyes of MF; totally shocking”.

What MF Global will mean for the financial markets

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 advises.

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? – James Sinclair

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.

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 the market mechanism broken?

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.

  • 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 does it mean 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 quote. 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.

Will Bancroft regularly contributes to investment and finance sites such as Market Oracle, Seeking Alpha, Stockopedia, Renegade Economist and more. His passion for politics, philosophy and economics led him to develop a keen interest in Austrian economics, gold and silver. Read more of his articles.

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Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.

About the Author

Will BancroftWill Bancroft is Co-Founder of The Real Asset Company, a market place for individuals to invest in gold, silver and precious metals. Will also contributes commentary and analysis to the Research Desk. His interest in financial markets and investment led to a keen interest in monetary economics, gold and silver. Will is passionate about gold’s role in a portfolio and his views appear on sites and media such as Kitco, Market Oracle, Seeking Alpha, Stockopedia, The Telegraph and Yahoo Finance. Follow Will on Google+, and get his commentary via our RSS feed.View all posts by Will Bancroft

  • D.C.

    I can’t believe no one else has commented on this article! Excuse me but this is a very good piece of insightful work! Sinclair seems to point out that even common stock transactions placed by a layperson might be as difficult to unbury and assign stewardship/ownership to as many of the now infamous real property titles are in which the loan papers were “robo signed” by unscrupulous lenders such as Countrywide who pumped their TV ads in our face 24/7 for a couple of years not long ago. It makes one wonder if even the major brokerage houses like Fidelity might find themselves flailing like MF Global someday. Thanks for a provacative article which is also quite frightening! D.C.

  • Will Bancroft

    Thanks for the comment D.C.

    We indeed invest using a trust based system of interwoven counter-parties, where real title of your holdings is often difficult to establish.

    My investigations to take ownership of share holdings of gold and silver miners and explorers has come to a dead end… for now. About 80% of these shares can “only be owned in electronic form” according to my broker. The only option I would have would be to change broker, at a cost, and own the electronic form with a different financial institution. I will investigate further as this seems too hard to believe.

    The likes of Jim Sinclair and others talk about owning gold and silver miners as a way of owning gold and silver ounces in the ground, yet when you cannot own the shares in you own name one is not as proximate as they might like to be to the actual gold and silver.

  • Jeff Blakley

    I don’t ordinarily comment but I gotta tell thank you for the post on this great one :D.

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