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I had surmised last week that a bubble 3 had occurred in foreign stocks, with the Nikkei and the Korean stock bulls posting 40 and 50% gains. I also stated that they are long in the tooth and could crash. It appears to me that a significant possibility of a global stock crash exists now. Note I said possibility. It is still possible that these markets will rise more this year, but, having those kind of gains makes crashes a distinct possibility. The US stock market has been going sideways for several years. I recall before several of the 1980’s and 1990’s world stock crashes that global equities were hot, as were foreign bonds. This pattern is appearing today. The economic growth in Asia has been tremendous, not only in China but much of the Asian sphere with even Vietnam posting strong economic numbers, and Japan appearing to come out of their deflation. The Nikkei reacted accordingly, posting a 40% rise last year, all based on positive expectations their painful deflation was ending. The problem is that, with weakness in Asian markets now, and the US stock market continuing to show weakness, and the EU region still having tepid growth, and China equities down 50% in the last 5 years, there is just no where for equity money to flow to now, other than out of equities in general. Latin markets are doing well, but they depend greatly on the developed world as they are oil and commodity producers, and we are the consumers. Should we drop off into a stock decline of large magnitude, our heavy purchases of their commodities will drop off. Should the Asian markets continue to show weakness and large drops like 3% on the Nikkei, where they had to close the markets early this week, we could see a drastic global stock decline. It looks to me like all the pieces are ready to play this out. Of course I have to hedge this, because the Asian and global markets posted stellar gains last year. They may rebound again. But I think an alert is called for. The pieces: Oil Oil is rising again, with the Tension in Nigeria and Iran. It appears that, with world production running at maximum capacity, that any interruptions will raise the price. Since everything runs on oil, and is made using it, it is like a widespread tax on the global economy. It does not appear that political tensions will abate here there and everywhere, rather more and more tensions and disruptions. Today it is Iran and Nigeria, last year Venezuela, this year what else? Yukos last year being taxed and expropriated by Russia. China buying more and more energy assets in Canada, Iran, Africa, South America. On and on it goes, all pointing to higher oil prices in 2006. I would like to point you to a very nice article at Bloomberg covering the effects of high oil prices on the Asian economy. Remember, much of Asia imports most of their oil. When you read this article, make note of the diverse list of companies affected in Japan by rising oil prices… [link] With peak oil essentially here already, since world output is at its maximum, and whenever there is a crisis, OPEC and other producers have a very hard time increasing production to react. There is a silent resource war going on now with China figuring large. There is going to be a hot war to come, and it could come this year. Political tensions The Iran situation is worse, supposedly there is a deal to have Russia store their nuclear material, but their weapons programs continue unabated. Israel stated that they will never allow an Arab atomic bomb. They have said this for decades and have acted on this with the air bombing of Iraq’s nuclear reactor. They will act unilaterally again if need be. The world is not really doing much except complaining, and China has massive oil deals with Iran and may stop the UN from sanctioning Iran. They have been mostly silent on the world commentary against Iran’s nuclear program. The Middle East is a time bomb that has been worried about for decades. Eventually, one of these crises there will spiral out of control and into a major war involving more than local powers. The Iran situation is a very good candidate for this war that has been foreseen for decades there. The latest wars with Iraq and so on are side shows compared to what will eventually come to pass there. With 2/3 of the known world oil reserves, the Middle East figures highly in a coming resource war. We may be at the cusp of a big one. It does not help that their president is a Muslim mystic who believes that he is going to usher in the Muslim messiah, and publicly stated that God appeared in the manifestation of a green light during the time he was speaking at the UN this last year, with other people seeing this as well. This guy is not going to do what a conservative person would do, he is going to do what he believes God is telling him to do, and the world can fry for all he cares. He may see this happen too. DON’T underestimate what this man can do or cause to happen. Anti foreign investor sentiment There is a growing and powerful trend of anti foreign investor sentiment in commodities nations. If you look at Venezuela, their leader Chavez is leading an anti west and anti foreign investor campaign there. Venezuela has cancelled mining leases (expropriation) used oil as a weapon, castigated the US incessantly, used the mantra of resources for the people of the country and so on. This is a case study in what the future holds for foreign investments. It does not stop with Venezuela either. Many Central American nations are going in this direction. Bolivia just elected a socialist as president. Africa is very involved with this anti foreign investment sentiment too. Shell is pulling out their people in Nigeria. Nigeria has vast oil reserves. Shell’s installations are under attack from militias, an exact rendition of the scenario I wrote about a year ago. In that piece, I foresaw masses attacking premium foreign assets. It is at Gold-Eagle in World Hostility and Your assets. It does not stop with Nigeria. Look at South Africa, and Zimbabwe. Gold mining concerns are being forces to buy equipment and supplies from “domestic” companies, (read extortion), are being forced to divest up to 45% of stock to “domestic” citizens (read expropriation) and are being forced to hire more people than the operations demand. This is only a sampling of what is coming and what is now happening with the anti foreign investment sentiment emerging world wide. Insufficient market mechanisms This week Japan had a very interesting development about a systemic weakness that I have been writing about for about 2 years. That is that massive numbers of stock positions are subject to waves of liquidation that can overwhelm an electronic market system. This week, Japan had to close their stock market about two hours before the close because they exceeded 4 million transactions in their trading systems. As powerful as computers are, anything can be overwhelmed by onrushes of traffic. Japan is now stating that they will boost their trading capacity to 5 million transactions, a 25% increase in capacity. Well, I don’t think that will be anywhere close enough to deal with the coming market panics. First of all, the Nikkei drops a mere 3% (a big drop though) and Japan gets a flood of orders to either bail out of positions or do whatever. But imagine something like a 5% or 8% drop, or, imagine a wave of 3, 5, 8 % drops over a period of days or a week or two. I guarantee that, if Japan already melted down at a 3% drop of the Nikkei, then that is only a harbinger of things to come. Take it as a warning. It is a classic example of everyone trying to get to the exits at the same time. This results in market illiquidity, merely from a technical limitation. Of course illiquidity comes from other sources, like an absence of buyers. That will come too, as a matter of fact, since technical limitations lead to more lack of confidence in being able to get out, leading to more fear and more selling. It is a compounding problem with a feedback loop. I was an Oracle systems engineer, and worked on precisely the same kind of scalable large commercial computer systems that are used in the biggest electronic markets. Oracle figures large in this arena. Oracle itself is not the limitation. It is capable of doing all they ask. The limitation lies in the design and implementation of these trading systems. And I’ll tell you one thing too. Once these systems are created and large databases come into existence, these are very hard to change. If, upon the creation of these systems and databases, there is not a lot of foresight given to the design, scaling larger becomes almost impossible. It is NOT just a matter of a few keystrokes. One thing that I have emphasized to my readers is that people tend to think that normal times are the norm… and in the case of trading systems, if it works now, then it will work in a panic. This is just not the case. But it takes a panic to reveal the weaknesses of the market and of the electronic system. And in this case, by the time limitations are realized, the market becomes illiquid. This is what happened in Japan. And when this kind of technical problem arises, it is not possible to fix it in a timely manner, so, all of the dominoes fall as if pre-ordained. This is why Japan is adding a mere 25% addition to these market systems. It is just not easy to increase capacities by large bounds if the system was not originally designed to deal with scalability in the first place. I expect more of these events to come, come at the wrong time, and to cause avalanches of sell orders that cannot be fulfilled. This is one reason why I have been so down of financial assets over the last several years. As long as markets act relatively normal, people make money. The problem lies in outlying events of systemic illiquidity, whether there are technical limitations or panics, or a lack of buyers. Market illiquidity is the greatest source of risk to financial assets. I believe we will see this occur again in Japan, and probably here as well….culminating in a great market panic, lockup, and crash spanning multiple days of limit market drops and finally, a loss of over 80% of all share values…. Of course a few stocks might survive, but I wouldn’t want to be ‘around’ (in that market) when it happens.
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