Saturday, May 12, 2012

What Happens When there’s a Market Setback, and the Derivatives Trigger?

Mr. Sprott is also concerned at mushrooming growth of derivatives. This part of modern finance is based purely on financial vaporware. There’s no relation to creating underlying wealth. For example, one company might have a trading program with a slightly positive bias, and so buys and sells accordingly. Another has a trading program with a slightly negative bias, and so sells and buys accordingly.

The crazy thing is that, despite everybody looking at the same market, the players all think they’re “making money” with all of their in-and-out trading. Maybe or maybe not — although a lot of people extract big money from the Wall Street system. But the whole process wreaks havoc on the idea of creating wealth by investing in the best companies with the best ideas and assets.

All along, derivative exposure is growing. But what happens when there’s a market setback, and the derivatives trigger? There’s no way that all the exposure can ever get covered. There’s not enough money to go around. We’ll see failure in the derivatives markets, and it will likely tank other parts of the world of finance, if not the larger economy.

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