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The Collateral Crisis - Tick By Tick Research Email

Submitted by Tick By Tick on 12/20/2011 04:43 -0400

The Collateral Crisis

Dear All

On 17th December 1903, the Wright brothers took to the air for the first time. Their prototype propeller driven biplane achieved a remarkable airtime of 12 seconds and a distance of 120 feet during this groundbreaking event. Oh how things have changed...

"The revolution is carried out by means of one's thought"

Kim Jong Il (1942-2011)

Since this defining moment, as a global society, we have made exponential leaps in complexity across almost every area of our lives. One must only pick up a modern item of packaged food to realise that the ability for man to feed himself has shifted from organic growth towards the successful synthesis of chemicals. A shift that has allowed consumers to share in the spoils from far away lands and drastically reduce the real costs of energy ingestion - whatever Jamie Oliver may denounce. However, when looking at the economy, one must question whether we have gone a little far?

Many point to derivatives, many point to credit but I feel that the problem is far closer to home. Namely: Money. More specifically, fiat currency.

One of the first things that investors are taught about borrowing and creditworthiness is the concept of credit enhancement. A process that teaches us that by collateralising a debt, the borrowing costs of an institution can be significantly reduced against the value of that asset or cash flow. Even if we look back to 2008, the majority of the toxic loans were collateralised for enhancement, albeit at hugely inflated values. Yet neither Sovereign Debt nor Fiat Currency are collateralised by anything more than the backing of a printing press.

I have recently found that the most interesting way to identify our wilful blindness about money is to talk to the retail investor and ask them their views on Gold. Most, can identify that the price of Gold has soared in the last few years. But when you ask them why, it is very rare that you receive a structured or informative answer. There is a huge misconception that the eleven year bull market that Gold has experienced is somehow related to the activity of hedge funds, bankers, speculators and so fourth. Although these participants have driven up the price through the supply and demand dynamic, their activity is only a second derivative of the Gold movement.

Before I continue, let me ask you all a question. What is one US Dollar worth?

This is somewhat of a trick question. One dollar is worth one dollar as long as the holder believes that one dollar is an attestable value. If we think back to when the Wright brothers took their maiden flight discussed earlier, one dollar represented a collateralised monetary amount that could, at any time, be exchanged for Gold. However, following the World War, the "Gold Standard" was disregarded and instead modern currency would be backed by....err...hmm...well, nothing. Thus, if we move back to the question asked, what is one US Dollar worth. The truth is, one dollar is worth as much as society believes it is worth and nothing more.

Let me ask another question. If over 10 years you increase the money supplied to the system by almost three times, how much is one US dollar worth?

By now, most of you should be able to understand where this going (If you don't, please email me and I will explain in private). So when I look back on the last week and consider the meltdown in Precious Metals, I see nothing but a confused and idiosyncratic marketplace. If society subscribes to the principle that Gold is the ultimate storage of value, in the current fractional monetary system, we should fundamentally reject the idea that Gold could enter a bear market as many commentators have started to hypothesise. Yes, this speculative pressure can cause a contango driven sell off in the spot price but, fear not, we are very much in a precious metal bull market.

Following that short introduction, it is time to introduce a number of interesting charts and articles for the week.

1) Is the UK next? (Click HERE)

A set of charts from Thomson Reuters that compare the current economic situation in the UK, France and Germany

2) Grant Williams' Things That Make You Go Hmmm - October 9th (Click HERE)

Grant takes a detailed look at Gold

3) To Have and Have Not - Double Line Funds (Click HERE)

Jeffrey Gundlach talks us through the world economy through a series of charts. Page 42 may just be the most important chart of next year.

4) Kyle Bass - The Hidden Bank run Across Europe (Click HERE)

Kyle Bass' December Investor Letter takes a look at bank runs in Europe

For my last email before Christmas that will be sent out later this week, I will be compiling the 12 facts of Christmas for your viewing pleasure. Although I have some stunners, if any of you have a statistic or fact that you believe could make the list, please message me and I will consider adding them to the elite list of 12.

"Since human beings are naturally solipsistic, all forms of superstition enjoy what might be called a natural advantage"

Christopher Hitchens (1949-2011)

Please enjoy the articles and I look forward to any feedback that any of you may have.

Best Regards

George Adcock

Founder

www.tickbytick.co.uk

@TickByTick_Team

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