From light to darkness

Tamaso jyothirgamaya is a famous quote from tha Upanishads which basically say that let me go from darkness to light. But now I think we have to reverse the quotation. Let us go from light to darkness. I am not pessimistic here but the dark underworld is much more interesting.
First concerning the nature of the universe. Scientists say that the visible matter accounts for less than 1% of the total universe's mass. The rest of the universe is made up of dark matter and dark energy. Dark matter is said to constitute around 10% of the universe's mass and dark energy is said to constitute 90% of the universe's mass. Nobody has any clue what this dark matter and dark energy are. But the effects are quite visible. Galaxies are tearing apart from each other at phenomenal speeds and this cannot be explained by the visible matter at all. Scientists say dark energy is responsible for it, a sort of anti-gravity. Dark matter is also present as black holes and WIMPs (Weakly interacting Massive particles) which are hard to detect. There are talk of hidden dimensions and multiple universes in physics. So all of 21st century physics is in quest of darkness.
Second is the human organization and nature of dealings. There is a black market for goods, which forms a substantial portion of our GDP. There is the unorganized sector which accounts for 50% of the GDP. Things are accomplished without explicit rules and mainly through relationships and word of mouth. There is vast amount of black money in excess of $1trillion which is hidden from the formal world. Most of the stock trade in US happens in dark pools in which players do deals privately. The amount of derivatives and the OTC trade which happens discreetly is $2400 trillion which is mind boggling. Much of world trade is for transfer pricing and tax evasion. 70% of the internet traffic is for torrent downloads and other filesharing. In other words most of the formal world is just the tip of the iceberg. The real business is deep within hidden from the public.
The third is the human mind. There are so many things within in the subconscious that we do not know. It is all hidden deep within us. Our values, our biases and our desires all stem from it. We do not want to know about it or we do not have mechanisms to uncover it. It is deep within us, hidden from the conscious mind, but they are the ultimate drivers of our behavior.
We either have to redefine the unknown and stop calling it darkness or we have to go and explore the darkness since we only see and learn the tip of the iceberg in our everyday lives but the real action happens underground

Towards an epic crash

Earlier I had written about the continuing financial crisis which has plagued the developed world. Now the motions towards the end game has been accelerated with competitive devaluations being conducted by all the major central banks of the world. The US Federal reserve is the biggest culprit of them all and is printing money like there is no tomorrow. It has already wasted $2 Trillion in propping up the junk mortgage backed securities. Even such a large amount has not propped up the economy. It is planning another QE2 with another trillion dollar. Money has transformed from being a "store of value" to just a number with trillions cropping all over the place. 

The ponzi scheme of fiat money is eventually going to come to an end and it will end in a spectacular collapse. The notional value of derivatives is around $2400 Trillion. That is around 50 times the World's GDP. Most of these derivatives are interest rate swaps which are highly sensitive to both interest rates and credit defaults. With so much money being pumped to revive the economy, there is massive uncertainty in what will happen. Fundamental market analysis is passe and old school now. When stock prices rise, it is not because the company is doing well. It is only because the Federal reserve is pumping in more money through benami accounts to prop up the market. With industrial production dropping across the world and more than 10% unemployment in US, the stock markets are jumping by more than 20% which is clearly ridiculous. 

The implied correlations between stocks are reaching 90%. Implied correlations are market expectations which give the amount of correlation between stocks. For example, steel and automobile stocks are related. If automobile sector is doing well, there will be more demand for steel and hence steel stocks are also expected to do well. But the correlation will not be perfect or even 80%. That is the whole concept of diversification. You invest in different companies and different sectors so that your overall risk is lesser. This is possible since there is no perfect correlation between stocks. 

With massive pumping of money into stock and bond markets the implied correlation is very high which means that there is no diversification at all. This will lead to massive understatement of risks and can cause a potential black swan event.

The corruption in US has reached such a level that there is perpetual money machine created by the Federal reserve for top US banks. The money machine gives free money for no risk and no investment. But this is available only for a select bunch of bankers. Basically the short term rate is 0.25% per annum in the US and the long rate for 10 year bond is 2-3%. So you borrow money in the short term from the Fed and lend it to the US government at 2-3% and make the cut for free. Since the Fed will maintain the yield curve at all costs, there is no risk involved at all. Basically it is taking money from one arm of the government and giving it to another arm and making a huge profit in the middle. With US government running $1.5 Trillion deficits every year, there is no shortage of business.

The US has become so indebted that its citizens don't even have the money to lend it to the government. 25% of the US debt is held by China, Japan and other countries. Another 25% is held by the Federal reserve by Printing money. Less than 10% is actually held by private individuals. Another huge chunk is held by Intergovernmental departments where the social security is invested in government bonds.

Ultimately this is all an unstable equilibrium and sooner or later it has to give in. It is only a matter of time. I was quite skeptical of gold in the beginning but if this behavior by central banks continue gold may reach huge valuations. Thankfully India has more than 25,000 tonnes of gold amounting to $1 Trillion safely distributed in thousands of temples and on bangles and necklaces of women. It may ultimately benefit from the impending mega train wreck that is going to happen soon