Sure smells like trouble. Precious metals soaring, oil likewise now back around $67, bond yields (and therefore conventional mortgage rates) marching up every day, US dollar falling against other major currencies.

Of course it is also the end of the quarter and the program traders are busy with their characteristic manipulations to jam the market and optimize their bonuses. As Bill Fleckenstein plaintively asks every quarter as this charade goes on: “Where is the SEC?” (Answer: so long as the market goes up, they look the other way). But when this pressure stops as they have to return the borrowed money, what then?

I think I hear trombones.

The Office of the Comptroller of the Currency recently issued a proposal for new guidance on “nontraditional” mortgages, e.g. Option-ARMS. Interagency Guidance on Nontraditional Mortgage Products

The response in the attached link is well worth a read: Comments from Michael S. Blomquist (PDF)

The buy programs were busy today as the mutual fraudsters commenced the quarter-end jam job to make their returns look better. Gold and energy were strong, though. This reflects the ongoing weakness of the dollar and most paper currencies against “real stuff”. Competitive devaluation is next, as the Asian Development Bank issued an official warning today:

“Asian countries need to prepare for a possible sharp fall in the dollar and should allow their currencies to appreciate collectively if that happens, a senior Asian Development Bank official said Tuesday.

“Any shock hitting the U.S. economy or the global market may change investors’ perceptions, given the existing global current account imbalance,” Masahiro Kawai, the bank’s head of regional economic integration, said at a news conference.

“Our suggestion to Asian countries is, don’t take this continuous financing of the U.S. current account deficit as given. If something happens, then East Asian economies have to be prepared.”

International Herald Tribune

Many observers have noted the dramatic increase of program trading and the decrease of volatility on the last three years. And also the ability of the program traders such as Goldman to make huge profits on a flat market.

In my view, this phenomenon is a result of the popularity of Exchange Traded Funds (ETFs). It used to be that program arbitrage trading was done with index futures on one side of the trade and stocks on the other. But this was clumsy because the futures expired only quarterly. ETFs, on the other hand, are a gift to the arbitrage trader. Because they can be shorted anytime (uptick rule does not apply), and are not in the indexes, and are optionable, you can do pretty much anything. Basic idea would be to short the ETF and go long the components. This will pump the index, so you would have bought calls on the index. Unlike with the futures, you can then deliver the shares of the components to the ETF sponsor anytime and receive ETF shares to cover your short position without having any trades go through the exchange. Buy programs are of course favored because the uptick rule does apply to the component stocks, so you don’t want to be shorting them.

These strategies appear to provide excellent low-risk profits at the expense of everyone else.

I posted this graph on the blog for the first time in August of 2004. I thought it was worth revisiting in the context of the China-bashing that is now going on, led by Sen. Schumer et al. Notice that with gold now in the $560s we are well down the devaluation path against real goods, and Schumer now wants to break the yuan peg so that the dollar can be devalued against the yuan. That’s competitive devaluation. He is threatening a 27.5% tariff on imported Chinese goods. That’s on the chart too.

Soon as the housing bubble bursts, consumtion declines and we get to the part about plant closings and debt defaults. It is a long way down from here.