Rick Rule - This Can Bring Down the Entire Financial System

"Today King World News interviewed one of the wealthiest and most street-smart pros in the business, Rick Rule. Rule, told KWN there is a “mismatch of some amount of money in the $100 billion range between credit default swaps.”  He also said this is similar to what “brought down Long Term Capital Management (LTCM).”  Rule, who is now part of Sprott Asset Management, also discussed gold and the mining shares, but first, here is what he had to say about what is taking place: “Well, I think that frames a big issue.  We’ve been asking our clients to consider the macro question, if the institutional risk-off trade is to the US dollar and US Treasuries, that suggests the institutional investors believe that this rally and recovery in the United States is real.  That’s big news if it’s true.”

Rick Rule continues:

“If it’s true and if the recovery is real, it means that the United States, which accounts for 25% of worldwide demand, is back on track.  If the recovery is real, it’s going to boost demand for industrial commodities like the base metals complex and energy.  If you believe that, there are contrarian bets to be made in base metals and energy.

If you don’t believe the recovery is real, and you don’t believe the US dollar and US Treasuries are a reasonable store of wealth, then it would appear that the gold thesis is intact.  One of my fears surrounding the US dollar and other currencies, has always been the prevalence of black swan events.

The news that JP Morgan Chase had to disclose to the market, with regards to out of control credit derivatives bets, is indicative of the type of black swans that could come into the market.  What JP Morgan Chase has said is they have suffered a $2 billion loss and it could be more than a $2 billion loss.  They don’t know how much it could be.... 

“There would seem to be a mismatch of some amount of money in the $100 billion range between credit default swaps.  They seem to have been net sellers or providers of about $100 billion in unhedged credit default swaps.

When I say seems, these are extremely complex instruments.  Investors should be aware that derivatives such as these can bring down the entire banking system.  The point of this is nobody really knows how much net credit protection JP Morgan Chase has provided or in what markets or in what type of instruments.  We just know that they have a large, unhedged position in what was intended to be a hedged trade.  It would appear their ability to handle volatility or perturbations in the market is less robust than modeled.

I would note to you, Eric, that it is precisely these perturbations in a semi-hedged model that brought down Long Term Capital Management (LTCM).  It’s just an example of the potential black swans that exist in a very, very leveraged banking environment.  This should cause all of your readers and listeners to be concerned about the possibility of a response to anomalous events like what occurred in 2008.”

at http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2012/5/11_Rick_Rule_-_This_Can_Bring_Down_the_Entire_Financial_System.html