Guest Post: The Coming Rout

Tyler Durden's picture

Submitted by Chris Martenson

The Coming Rout

There's a scenario that could play out between May and September in which commodities (including my beloved silver) and the stock and bond markets could all sell off between 20% and 40%.  The trigger will be the cessation of QE II and a multi-month pause before QE III.

This is a reversal in my thinking from the outright inflationary 'buy with both hands' bent that I have held for the past two years.  Even though it's quite a speculative analysis at this early stage, it is a possibility that we must consider. 

Important note: This is a short-term scenario that stems from my trading days, so if you are a long-term holder of a core position in gold and silver, as am I, nothing has changed in my extended outlook for these metals.  The fiscal and monetary path we are on has a very high likelihood of failure over the coming decade, and I see nothing that shakes that view.

But over the next 3-6 months, I have a few specific concerns.

It's time to build on the idea I planted in the Insider article entitled Blame the Victim (February 28, 2011) where I speculated on the idea that the Fed might be forced to end its quantitative easing programs, almost certainly because of behind-the-scenes pressure.  

Here's what I said:

How I read [the Fed's recent propaganda tour] is that the Fed is taking some heat for its inflationary policies, mainly behind closed doors, and it is trying to do what it can -- with words -- to soothe the situation. Perhaps China is making noises, or perhaps Brazil's finance minister is making the phone lines feeding the Eccles building smoke ominously, or perhaps it is internal pressure coming from politicians with restless voters. Or all three.

The big risk here is that the Fed will be forced by this rising pressure to discontinue the QE program in June at the normal ending of the QE II efforts. Couple that with a possible federal showdown over the debt ceiling right at the same time, and you have the makings for a massive fireworks display, possibly involving derivative mortars bursting in air.

At the time, I speculated that all of the Fed's pronouncements about inflation being almost nonexistent were actually signs that the Fed was taking some behind-the-scenes heat for the inflation its policies was creating.  And I worried about what would happen if the Fed were to end the QE program in June.

Let's just say it won't be pretty.

Everything would tank.  Stocks, bonds, and commodities.  All of the risk assets that have been unnaturally supported by a flood of liquidity, too-low interest rates, and thin-air base money would give up those ill-gotten gains.  Gold might behave a bit differently, because along with these market declines will come an enormous amount of uncertainty about the financial system itself, usually a condition for higher gold prices.  So I expect gold to correct somewhat, but not nearly as much as everything else, and it could even gain.

The story is, admittedly, getting more confusing by the week, with some calling for hyperinflation and some calling for massive, outright deflation.  I am trying to surf the probabilities and stay one step ahead of whatever curve balls are coming our way. 

The basic idea is this:  The Fed has been dumping roughly $4 billion of thin-air money into the US markets each trading day since November 2010.  The markets, all of them, are higher than they would be without this money.  $4 billion per trading day is an enormous amount of money.  It's gigantic by historical standards.  As soon as the QE program ends, the markets will have to subsist on a lot less money and liquidity, and the result is almost perfectly predictable.

Hello, downdraft.

The markets are quite substantially elevated due to the efforts of the Fed.  T, and then some, is quite likely to be rapidly eliminated as soon as the QE program has ended. 

It's really that simple.

To make the story even more difficult to follow, the Fed has been sending out teams of PR agents in an effort to guide the markets with their words. 

First, on March 2, 2011 Bernanke said this:

Bernanke Signals No Rush to Tighten When Asset-Buying Ends

March 2, 2011

Federal Reserve Chairman Ben S. Bernanke signaled he’s in no rush to tighten credit after the Fed finishes an expansion of record monetary stimulus, seeing little inflation risk and still-slow job growth.

A surge in the prices of oil and other commodities probably won’t generate a lasting rise in inflation, Bernanke told lawmakers yesterday in semiannual testimony on monetary policy. A “sustained period of stronger job creation” is needed to ensure a solid recovery, and the Fed’s benchmark rate will stay low for an “extended period,” he said.

The "no rush to tighten credit" statement is a signal that the Fed will neither raise rates at the end of the QE program nor perform reverse POMOs where it reels cash back in and pushes MBS and/or Treasury paper back out. 

Upon the cessation of the QE efforts, and the cessation of $4 billion a day in Treasury buying pressure, it's a safe bet that market interest rates will rise.  Bernanke is at least on record as saying that if this happens, it won't be because the Fed has taken the lead. 

Bernanke was being a little bit sloppy in his statements, because stopping QE will serve to tighten credit simply because there will be a lot less liquidity sloshing around the system.  It's a situation where the absence of excess is the same as the presence of tightness, if that makes any sense. 

Then on March 5th, a much stronger and clearer signal was given, confirming my worries:

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

March 4, 2011

Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.

“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month. 

Whoa.  This is important news.  Not only a cessation of QE, but the possibility of a sudden stop is being telegraphed.  This will change everything.

The old saying 'sell in May and go away' might never be truer than this year, although with this sort of a warning, the cautious investor may want to get a head start on things and sell in March or April.

For some time there have been rumors that the Fed has been splitting into factions, with some of the inner team becoming increasingly uncomfortable with the QE program and its effects.  But so far they've either spoken in code to reveal their displeasure or quietly resigned.  So we're pretty sure there's an admirable level of support within the Fed for ending QE, and it has now bubbled to the surface and reached the public arena.

Of course, there's some form of gobbledy-gook reasoning being floated to justify the plan for a sudden stop rather than a gentle wind-down, and it involves the distinction between 'stocks and flows' (from the same article as above):

Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman.

“We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.”

Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”

The idea that Brian Sack, a 40-year-old economist with a PhD from MIT, is winning the day in the argument of "stocks over flows" is somewhat troubling to me.  MIT is a quantitative shop, home to some very brilliant people, but how markets will actually respond is another specialty altogether, one that requires a bit of on-the-street experience.  Markets have a bad habit of not being logical, not fitting neatly into tidy formulas, and ignoring things like 'stocks and flows.'

I'll go even further. I'll take the other side of that bet and opine that the flows are much more important than the stocks, because it is the flows that support the continued budget deficits of the US government — which, it should be noted, will still be with us each and every month long after June 2011.  Those deficits are baked into the cake and will require in excess of $125 billion in new Treasury sales each and every month.

Who will buy all the Treasury bonds after the Fed steps aside?  That is unclear.  If there are not enough buyers at these artificially inflated prices, then the price will have to fall until sufficient buyers can be found.  Falling bond prices are at the other side of the financial see-saw from rising bond yields; one goes down while the other goes up, and the Fed has been pressing firmly down on yields for a while via the QE II program.  When that's over, pressure will be reduced and yields will rise.

So what to do? For those concerned enough about this possible scenario to consider taking action, please see Part II of this article (free executive summary; paid enrollment required to access). In it, I predict the extent to which stocks, commodities, Treasury bonds and precious metals prices may be impacted in the near term.  I also detail the key indicators to look out for in order to determine if and when this scenario is unfolding - as well as recommended strategies to preserve capital during this corrective phase.

Click here to access Part II

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66Sexy's picture

The FED is clearly setting up the markets with an expectation of QE3.

People forget the FED is not our 'freind'; their interests are not ours. They are a private institution. Yet people are still shocked and scornful of Bernakes actions.

Imo they will announce they will 'Hold Off' on further stimulus, all rights reserved. Certainly a cessation of QE will precede any rate hikes. We are seeing rate hike pressures emerge from europe and china.. and the IMF (arguably the same folks as the FED) aknowledging inflation just yesterday..

Nothing says they have to do QE3 right after QE2; and that way they can get commodity prices down. They probably want to 'experiment' with how the markets will take a cessation of QE; they will have to, sooner or later. Why not give their buddies a discount at the same time?

Then, after the market crashes... THEN we will see QE3... of course, the money will have already been spent before you or I know it... before the announcement.

This entire market rally is dependent on QE. No QE, no town.

MachoMan's picture

If you make your big money on manipulated big swings and said swings keep the market guessing as to the inevitable end game, thus buying more time, then you seek to make as many big swings as possible without spooking the herd.  The last part is what the confidence is all about..  and why it has been so important to paint a picture of an organic economic recovery (despite being total bullshit).  The comment on fixing inflation quickly is correct, it's just that it comes with a caveat, the same caveat in all of the economic tea leaves...  "all things equal"...  the most notable of which is confidence in the currency.  At some point, we'll get whiplash from the see saw and decide to get off.


serotonindumptruck's picture

Unfortunately for everyone, when we decide to get off that see-saw, we'll likely fall into a bottomless pit of biblical proportions.

MachoMan's picture

Queue ghostbusters jail/mayor scene.

I'm not sure about bottomless pit so much as much more difficult, demanding, and with real consequences.  My only fear is that now we have developed world killing technologies, how long can we keep them in check at a time of global unrest?  Why would america's nuclear stockpile be any more secure than pakistan's?  Designer diseases...  oil wells...  you name it...  all require maintenance and security.  Otherwise, we'll figure out how to redevelop society...  we've done it many times before...  hell, the productive may one day be rewarded again... 

serotonindumptruck's picture

The USA is the only nation to have used non-conventional weapons in an offensive manner, so you bring up a good point. Nuclear nonproliferation measures have been an abject failure, however that might be expected with 70 year old technology. The question remains, though. Will there be a large scale thermonuclear exchange in the near term future? A "small" exchange would no doubt escalate.

Interesting that you bring up Pakistan in this context. The USA appears to be losing on the diplomatic immunity front. If there is credible evidence that American security contractors have been manipulating the political and military machinations by communicating and coordinating with the Taliban and Al Queda, for whatever nefarious purpose, then Pakistan may truly become a "rogue" and uncontrollable state.


MachoMan's picture

I'm not worried about a conventional nuclear exchange so much as an unconventional.  And by that I mean once the forces securing our world killing technologies, whatever they may be, are no longer in the picture...  or, at least, in a diminished capacity...  then such technologies will undoubtedly fall into the hands of those who desire to and will use them...  at least on a much shorter timescale than their present keepers.

I'm really not worried about pakistan so much as many other countries...  simply because we already have the plans, training, and troops in place to secure the nukes...  at least in some capacity...  however, not so much elsewhere.

serotonindumptruck's picture

The Russians and Chinese have the market cornered on tactical nuclear strike capability. The introduction of the Moskit class antiship/StS/AtS missile has changed the military dynamic on a global scale, particularly in the area of naval superiority. I can envision several scenarios where WWIII could be initiated. Once Moskit is used against an American naval asset, particularly our aircraft carriers, then all bets are off.

ibjamming's picture

EVERYONE knows this...that's why a "nation" will never attack the US.  China or anyone doing this...nuking us first...will cease to exist.  It was called MAD for a reason.  You know we'd do it...and the population would approve...I would.  If I go too.  The financial world is run the same.

Alex Kintner's picture

In related news, the Apocalypse is confirmed to occur on May 21, 2011.

Sell all that gold now bitchez and spend your winnings quick.

tmosley's picture

Any good Christians looking to lighten the load of their possessions can feel free to stop by my house, and drop off any gold, silver, or other valuables they no longer wish to carry.

Alex Kintner's picture

I have some lead, counterfeit subway tokens. I'll drop them off.

MachoMan's picture

There are an infinite amount of possibilities for actions which conjure up WWIII...  they're trying to be implemented daily, thus far to no avail...  I am aware of these things...  but, again, it is not the traditional military action that I fear...  when we deal with rational actors (like the MIC) we can anticipate their moves and plan accordingly...  not so much with others waiting in the wings...  nor what kind of power structure will be around at that time.

Oh regional Indian's picture

Macho, now, I think it's nano swings where they make their money, so big swings are nto even necessary.

Imagine even 10 years ago, with the current geo-political and financial catastrophe unfolding, the VIX would be wayyyy high, stocks would be in the toilet and all "involved" currencies would have been deflating like crazy.

And yet, except the metals complex, you look at the market, interest-rates....mostl things look like they are flatlining. Just light waves on an otherwise calm sea.

Point I'm making is that it's not a confidence in currency game anyomore. Everyone involved knows that explicitly and man on the street can 'feel" it. 

I think the plan is a hard deflationary collapse (they hold most of the currency, whose velocity has nose-dived"), for a huge asset grab...and then kill the dollear. Or let it die, which it will if exposed to market forces.

The old 1-2.

Probably before June.


MachoMan's picture

Yes, I know and agree.  Sure, you keep the lights on with the day to day theft of fractional pennies many times over...  but, the stuff legends are made of are the giant pump and dumps.  We've seen quite a few recently...  and I don't think this time is any different.

But, I disagree as to your timeline.  I suspect the downdraft will come from austerity measures discussed in raising the debt ceiling...  it will appear as though we're going to take a little financial medicine.  This will buy more time.  How much more time is anyone's guess.  I do not suspect that QE will ever be totally removed...  it will only be progressively decreased from its origins.  The question is how many more of these rise and falls we care to participate in before finally admitting that the currency is toast.  Essentially, we are inching towards collapse with each wax and wane, but the answer is largely subjective given it requires a guestimation of herd behavior.  I suppose they have the power to direct the herds, but in large part, I think the ultimate loss of faith in the currency is more or less an organic function.  Obviously they create the stimulus, the question is how long we tolerate it.  I'm thinking we still have resolve.  I think the takedown will occur during or before june, but who the hell knows when we finally give up the ghost of the dollar.

Oh regional Indian's picture

Agree Macho.

But it's the politics that's going to kill it, not the financials. 

Think Wisconsin, clearly a test case for "medicine".

Then the whole ME disaster unfolding. Where is oil going?

So the big levers are growing bigger AND more unstable every day.

Not looking good.


JW n FL's picture

everything is fine... go back and get you 3rd masters... buy some gold... and try to figure out how to make the rest of the world trust you enough to maintain a reserve currency...


besides, everyone knows all it takes is some fire water and pretty beads and we own Jag and Land Rover again..

Oh regional Indian's picture

You want those white-elephants back JDub?

I'll tell Mr. Tata someone has some fire-water and beads (made in china) to trade for them.

And I though you were an Amrkn. Why all touchy about two british dodos? White solidarity and all?

Very good.

You do come across as a good soldier type.


MachoMan's picture

In the end, the unions in wisconsin capitulated on the important aspects, i.e. pay.  In an environment of scarce jobs that do not require any particular magical skill or training, unions (or anyone else) have no bargaining power.  While there will be grumbling and much consternation, there will be capitulation to austerity.  The question is how long we will take it.  And, if our inflationary chin is any indication, we can sure as hell take an austerity punch before throwing in the towel.  In the end, the conditions will become too punitive and we will repudiate our debt...  again, how long this takes is anyone's guess.

DosZap's picture

A 100% TOTAL default is the only way to survive this.

Open and honest.Re-Start a new system.......period.

The Jubilee, or all Hell really breaks loose.

MachoMan's picture

No.  I think you're overlooking something which cannot be defaulted away and for which there have been little or no prosecutions...  and that is the wealth gap.  While in many ways it has been derived through what I consider to be "fair" exploitations of the system, there are still many parts which have been obtained through complete chicanery, deceit, manipulation, fraud, duress, threats, intimidation, and in some cases murder.  If the merry-go-round stops now, there are too many people with ill-gotten gains that get to keep them.  This is the question no one wants to answer.  How do we claw back the ill-gotten gains in a "fair" manner?  How do we differentiate between the people just playing the game and the people changing the rules as they go along?  The court of pitchforks will not be so kind as a court of law...

I think your notion of just defaulting, resetting the system, and everything being OK is not only naively optimistic, but completely antiquated...  more suited for decades ago.  The power vacuum will have to be filled and I hope it's not filled by another bleached mr. potatohead looking motherfucker.  It's going to take solidarity with fellow citizens not seen for many, many decades, if ever.  I'm not incredibly optimistic.  Life will go on, sure, but it may go on with a dick in our face and a whip to our back.  It will be a treacherous tightrope over the next years... 

packman's picture

Side note about this:

People forget the FED is not our 'freind'; their interests are not ours. They are a private institution. Yet people are still shocked and scornful of Bernakes actions.

This isn't Starbucks, son.  The Fed has a legal monopoly on our nation's money supply.  As such, the ruler of this institution deserves every bit of scorn (and praise - if he ever does something right) he gets.


Alex Kintner's picture

Right.  A "private institution" with rights to print infinite dollars even if it's a madman running the presses. And since it's TBTF, we'll have to sell off everything (to China, et al) to pay back the madness -- the national parks, all national oil rights, all govt real estate, you name it. Hell, they have already sold the next two generations into indentured servitude just to pay the interest on the debt.

Oh well, at least the yachts are still sailing from the Hamptons.


asteroids's picture

The crash will happen at 2AM when everyone is asleep. The market will be down 3% and then gap down 5% or so at the open. Then, all hell breaks loose.

spartan117's picture

If QE stops, we have massive deflation, which is NOT good for the US Dollar.  The USD is the biggest risk asset in the world.  That means PMs go through the roof.  QE actually staves off PMs going vertical.

People need to get it through their thick heads that the Dollar is not a safe-haven in a deflationary collapse.  It's a death-trap.

If you want to know more, please buy my book and subscribe to my newsletter.  Or at least click on my website so I get paid....

DosZap's picture

What PAPER instrument frommthe US Gv't is not a death trap?.

Thanks, I will take my chance w/something of VALUE.

spartan117's picture

That's basically what I said, but nevermind...

yipcarl's picture

listen to you, buy your book, F off. 

spartan117's picture

Read into the sarcasm.  Try, I know it hurts your brain, but just try.

gmrpeabody's picture


Some days you just can't win. LOL

ConfusedIdiot's picture

Clever, Spartan. Applause (golf clap). CI

hamurobby's picture

+1, I thought it was a beautiful shot when it left the tee.

Lord Koos's picture

That's what you get for being too hip for the room...

spartan117's picture

Seriously.  16 junks and counting for the original response.  I'm getting monkey hammered by deflationists, people without a sense of humor, or by Chris' followers. 

Hook Line and Sphincter's picture

Spartan, it was a great read. However, I did buy it used for .76 cents on amazon. I sent my copy to you last week, so would you hurry up and send me back my signed copy.

cbxer55's picture

yipcarl, did you, by chance, read the last paragraph of the OP? Might go back and do that before making stupid, inane comments.

CIABS's picture

that's right.  yipcarl, did you notice that there was no link in spartan's post?  what do you think that means?

Long-John-Silver's picture

The 2008 downturn of PM was a result of investors seeking safety in the US Dollar. What sane person would dump PM's for the US Dollar this time? I agree with your prospective. PM's will be the instrument of safety WHEN the second economic crash hits. This is the exact same pattern as the First Great Depression and the results will mirror the the coming of the second of many downturns. In the initial crash of the Great Depression people attempted to "cash out" in US Dollars. After the second down turn everyone was going for PM's which lead to FDR attempting to confiscate Gold.

ForWhomTheTollBuilds's picture

"What sane person would dump PM's for the US Dollar this time?"


Anyone with margin calls to meet.


I'm wondering if maybe next time around, the PTB will create plenty of dollar liquidity to relieve the pressure when everyone suddenly realizes they urgently need dollars again.


In the absence of a squeeze on dollars caused by margin calls, I could easily see gold skyrocket during the next panic.

dracos_ghost's picture

Yeah, I am thinking the same.

There are debates everywhere as to how the Fed is going to unwind QE2 (if they do). I've been wondering how the hedgies are going to unwind this Dollar carry trade.

GoinFawr's picture

Margin calls don't come only in USD flavour: currencies are fungible.

IE This 'the whole world is priced in dollars' meme is wearing thin.

I think Long John's point was not what those who were losing would need to do, but where those who have been winning would be looking to call their 'safe haven' home next crisis around.

Sorry sunshine, with all of their failings being exposed and understood by an ever-expanding global demographic, fiats in general are looking more and more like a foolish place to try and park wealth, of which the soon-to-be-former world reserve currency has proven itself to be the absolute worst 'anti safe haven' around...

I don't know if you've noticed, but lately almost everytime the USD gains some strength against it's equally valueless peers, especially when the eastern markets are open, the real money like Ag and Au move up too, rather than moving inversely. Don't believe me? Look at last night's (EST) charts.

It's called 'divestment while the divesting is still good', or 'divesting while the divestment is still good', or, 'divestment while the divestment is still good', or,'divesting while the'... you get the idea.

packman's picture

In the initial crash of the Great Depression people attempted to "cash out" in US Dollars.

In the initial crash perhaps, but not going forward.  The whole reason for executive order 6102 was because people were cashing in their dollars for gold.  This is also why Britain and many others left the gold standard in 1931; their gold reserves were being bled dry due to people trading in their fiats for real money (gold).



Snidley Whipsnae's picture

Let us not forget that the Fed spends 10% of their time deciding what they are going to do and the other 90% deciding how they are going to jawbone.

I will believe a 'short short suspension of QE' when I see it happen.

All else is rumor and speculation.

CrazyCooter's picture

Which is what he said, at least that was my read. He was pointed in saying "the selloff" that will commence should QE2 end without an immediate QE3 will be broad and include metals.

Near term versus long term.



spartan117's picture

He still believes PMs to be "risk assets", and thus implies that the USD is anti-risk.  He's completely wrong.

JW n FL's picture

U!! S!! A!!

U!! S!! A!!

say it with me.

U!! S!! A!!

the dollar is the flight to safety that everyone needs to take.. gold is for suckers who think that $14 trillion dollars in flight to safety is bad.. these same people see the stock market going down.. how in the fuck it the stock market going down? with POMO crammed up the NYSE's ass? how?

gold / silver is heavy.. paper is lite... be smart, dont hurt your back carrying all that metal.. get some paper instead... just think.

Flight to Safety.. Flight to Safety.. Flight to Safety.. Flight to Safety..

then click your heals three times and you are home...

besides can you see throwing gold / silver up on stage with the strippers... you could put a girls eye out that way.