Finance is a closed system.  It’s not run by a perpetual motion machine.  So the famous up arrow always stalls somewhere.  What we want to know is just where is price in relation to time? The probability of price correcting back to an average value eventually becomes more and more certain.

The chart above is that last two years of the Dow using linear regression.  Here’s a list of the current Dow 30 names.  Out of those thirty companies some are stronger and some are weaker.  So this isn’t a definitive science.  It’s an art, but it is finally a spot to take notice.  Let’s dig more into linear regression to see why it can be so useful.

68-95-99.7 Rule

In statistics, the 68-95-99.7 rule, or three-sigma rule, or empirical rule, states that for a normal distribution, nearly all values lie within 3 standard deviations of the mean.

About 68% of the values lie within 1 standard deviation of the mean (or between the mean minus 1 times the standard deviation, and the mean plus 1 times the standard deviation). In statistical notation, this is represented as: μ ± σ.

About 95% of the values lie within 2 standard deviations of the mean (or between the mean minus 2 times the standard deviation, and the mean plus 2 times the standard deviation). The statistical notation for this is: μ ± 2σ.

Nearly all (99.7%) of the values lie within 3 standard deviations of the mean (or between the mean minus 3 times the standard deviation and the mean plus 3 times the standard deviation). Statisticians use the following notation to represent this: μ ± 3σ.  (Wikipedia)

Timing

So the trick is to find that slice of time where you have a 95% chance of being right. Year to date we are approaching a two standard deviation move in three months. Mean reversion traders look for price near high/low channel lines. Price matching on multiple time frames can provide some great low risk entries.

Here’s the Dow for the last two months.  You can see it’s in a nice up trend, but the larger two year trend is going to put pressure on this short term trend.  There’s obviously wiggle room here.

Catching a reversal near an extreme is key.  Like after a 200 point Dow day.  Two weeks ago there were 22 stocks aligned at 20/40/60 day lows.  Three months of price coalesced into a single inflection point. From that list the 14 cleanest charts were picked.  And these weren’t cherry picked later.  These names all came from charts posted here on October 1st (see gallery). This method made 13% in a week.  Going long the Friday after a -200 point drop (see story) was a low risk strategy using linear regression.

Went long Friday’s open on Oct. 2nd and sold at the close on the next Friday:

Referring back to the two month Dow chart we see there was still plenty of upside after the Oct. 2nd push off the lower channel.  Price ran back to the median line and moved higher.  However, holding two weeks into the next Friday’s close on Oct. 16th did nothing for the portfolio.

Trailing every name that made more than $500 profit with a $500 stop would have grossed $16,000 in one week.  That left only RIMM and CAKE as open positions.  The risk of holding for one extra week would not have made much of a difference.  The ultimate intraday high of this portfolio was $20,000 which happened five minutes before the close on Thursday the 15th.  Good luck timing that exit!

Note: these are examples of trading a mean reversion strategy.  They are theoretical and not trading advice.

Sixty Names

Going through two year charts tonight shows a ton of potential shorts coming. A push or another 200 point day to put the market near the top of the two month channel would be an ideal setup.  The more time frames that line up the better odds for a reversal.  A scan of roughly 400 active stocks shows there are sixty near two year highs:

Gallery of 60 Stocks Near Two Year Highs

At or very close to two year channel highs:

BLK IOC CLNE BZH JADE SRZ PCLN GOOG BAC GE CAT CBI SLB

Just hit two year line and failed:

BIDU WDC WYNN

Pattern to Watch

The stock NTES has already completed a move we’re looking for.  Price reached a two year high, failed, then returned to the median line in a clean trend with a clear exit.

NTES 2 year

Price tested the two year high twice then failed back towards the median line.

NTES 20 day

This one month chart is an example of how to stay in the trend. Price failed on every one sigma test with a nice clean exit on the lower channel.

NTES 3 month

Using 20/40/60 day LR lines shows an inflection point to short the stock. The spike above the channel was a great low risk entry. The spike below was a great exit.

Note: There is an art to the best time frame entry using this trading style. Also, shorter term channels adjust constantly. There’s wiggle room on the sixty names. What LR channels clearly show is the trend and where price lies within that trend.

Shorting the extreme high/low is often a low risk entry. The odds of price gaining more momentum to push above a two year channel are less than the odds of price reverting back to an average.  Mean reversion is going to come into play soon with every major index. Because there are so many names setting up this points to shorting certain highs as a very good risk/reward.

As stated before there are no guarantees in the market.  It can do anything at any time.

Valid at close Wed. Oct 7th

Clues to Exit

So where do we exit these trades?  The first is break even profit stops.  Some of these names are barely holding on after a three day push in the overall market.  It’s prudent to put tight reins on them and not let a small gain turn into any kind of loss.  The bigger profits can be given wiggle room.  When price runs back to the median line of your preferred time period a profit stop should be tightened.  The optimal exit is when price runs to the top of the channel.  Look at FCX:

For short term swing trades the 20 day channel is very useful.  A tight profit stop here at the top of the channel is often ideal.

Shorting Gold Miners

Using this method several gold miners look ready to go short: AEM TLR VGZ THM and KGN are all at new year highs.  The trick is getting price and time to align for maximum profit and minimum risk.  Let’s look at AEM:

YTD

Price is near the top of the year to date LR2 channel. It's a 2 sigma move that should come back down, but there's some wiggle room.

60 Day

The lowest risk entry would be around $76 at the top of the channel. On a smaller time frame there's much more finesse to maximize the setup.

More Names for this Week

Keep an eye on FCX.  It’s a great industry leading stock that will give clues to how gold and the miners will trade.  The following names might be a little early to short.  They are junior players that all made new highs today.  Gold is a very difficult sector to trade and there’s lots of wiggle room.  On the first sign of weakness these low risk trades could turn into quick profits.

KGN

THM

TLR

VGZ

 

Caution

These are probabilities not known outcomes.  The market can do anything at any time.  This concept assumes there will not be major news events or supply/demand shocks to upset the concept of mean reversion.  The odds of price retreating from range extremes outweighs the risk of shock events.  However, a maximum loss market stop is always necessary to protect one’s capital.  It’s vital to use concrete money management discipline.  Many swing traders will not risk more than 2% of their cash per week.  If you’ve got $50,000 taking a $1,000 draw down is the max loss per week.  That’s the cutoff point.  It proves the trading edge for that week is wrong.

Dow 200 days

Legend

• TDU Trend Day Up
• TDD Trend Day Down
• x:x positive/negative NYSE Adv/Decl ratio (Yahoo)

Twenty-two Names

Out of a couple hundred active stocks today there are 22 names sitting on 60 day LR2 lines. This means they’ve had a 2 standard deviation move down and should return to the middle of their price channel. Half the names line up cleanly on all three (30/60/90 day) time frames. There are also several (not as clean) at the 50day sma. This is a clue that we either resume business as usual tomorrow, or early next week, or this is a major trend change. From this scan there are few juicy shorts other than these same names. Often the best swing shorts are stocks at their lower channel line.

We’re looking for a return into the channel or acceleration out of it. It’s make it or break it time!

See Chart Gallery

Cleanest symbols: CAKE HIG LEN LNN LVS LZB MA OII TNA V ZN
50day smas: DVN EGO FCX OII TNA

Examples

Here you can see all 3 time frames line up: 90bar 60bar 30bar

V didn't close cleanly on the line, but that's one fat hammer on x2 avg volume. Looks like a strong reversal might come.

Linear Regression Channels

Parallel and equidistant lines are drawn two standard deviations above and below a Linear Regression trendline. The distance between the channel lines and the regression line is the greatest distance that any one closing price is from the regression line. Regression Channels contain price movement, the bottom channel line provides support and the top channel line provides resistance. Prices may extend outside of the channel for a short period of time but when prices remain outside the channel for a longer period of time, a reversal in trend may be indicated.  (Prophet.Net TA Glossary)

Watching oil last week there were many names that looked overextended.  We’re talking about short-term trading here.  Using a 50% linear regression channel can give us an idea of just how far price has gone.  The beauty of LR channels is price reverting to the mean.  There is finesse on entering with the most powerful time frame, but these give high probability setups.

The previous Friday RIG closed above a three month channel line.  Then it collapsed on Monday with a gap down open.  That was a missed trade.  Tuesday gave another opportunity to short RIG at the close and it worked on today’s open.

So on Tuesday it couldn’t close above the prior high, even with volume coming in.  There is a divergence in OBV on the 60 day chart, which trumps the 10 day trend in on balance volume.  The larger time frame also shows declining volume with higher prices.  Usually a good warning sign.

Here is the intraday chart for reference.  Price tested the prior day’s close and immediately failed.  It was fast easy money.  Low risk traders took their profits.  Does RIG have more downside potential?  It’s probable, but the easy trade is now over.

ThinkScripter Indicators

If you use the ToS platform visiting ThinkScripter is a must.  The /ES chart uses these indicators:

http://www.thinkscripter.com/2009/05/13/four-volume/
http://www.thinkscripter.com/2009/03/12/previous-days-regular-hours-highlowclose/
http://www.thinkscripter.com/2009/02/23/tick-trin-indicator/
Heikin-Ashi bars

S&P 500

This chart should be fairly self-explanatory.  One of the things that stands out is the Four Volume divergence.  As the market was pushing higher, after the FOMC “no change” announcement, internal volume was turning down.  This was a very good clue to look for a reversal.  A low risk countertrend entry was to short at the 1075.75 pivot. Heikin-Ashi bars are useful for staying in the trend or seeing a trend more clearly.

Using LR channels we’d know that TNA was getting overdone and could look to long TZA soon.  Check out that hammer on TNA’s weekly chart.  The small yellow circle is from Sept. 1st when TNA touched the lower three month channel (see chart).  That coincides with the median line on the entire price history channel.  Pretty sweet huh!

Here’s the TZA intraday chart for trading FOMC news.  The first entry was right off a Person’s Pivot.  The tick high at 1300 also gave a low risk countertrend entry.  The sharp upturn on CCI was also a good clue to get long.  Lastly we see Alexander Elder’s famous “kanagroo tail” pattern.  That’s four strong signals to get in the trade.

This site’s database failed late at night on Sept. 11th.  The admin was on vacation and unfortunately the site was down for a week.  It is still unclear whether the database failure was organic or malicious.  However, an unauthorized admin account was created listing:  jyoti_anju2000@yahoo.com.

Just before the site went down an unresolved IP (that didn’t include Bulgarian, Indian, or Chinese net providers) was:

(unresolved ip)    Pages    Hits    Bandwidth    Last visit

217.169.236.12    25    408    4.75 MB    11 Sep 2009 – 03:22
ISP:    Defensie Telematica Organisatie
Country:    Netherlands
City:    Maasland

What is also interesting is the high level of hits received on Sept. 17th while the site was inactive:

89.111.144.26    67    442    9.54 MB    17 Sep 2009 – 13:17
ISP:    Garant-Park-Telecom
Organization:    Garant-Park-Telecom
Country:    Russian Federation
City:    Moscow

12.47.208.86    111    369    7.42 MB    17 Sep 2009 – 02:21
ISP:    AT&T WorldNet Services
Organization:    GOLDMAN SACHS COMPANY
Country:    United States
State/Region:    NY
City:    New York

This marks another record month for Dutch spies visiting GTM.    Read all about them here.  So was the database crash accidental or intentional?

[Update: 9/20]

After going through months of logs it appears an RSS error caused a recurring failure that eventually overloaded the database.  This doesn’t explain the peculiar email address fixed to a new admin account, but it explains the crash.

I can calculate the movement of the stars, but not the madness of men. -Sir Isaac Newton

There are five zombie banks that control between 20%-40% of NYSE daily volume. It started earlier this year with Citigroup and Bank of America. They equaled 10% of NYSE total daily volume. Now the trend in High Frequency Trading (HFT) is on the rise. This begs several questions. If this is a healthy bull market, why are just five stocks running the exchange? Is it possible the bailout money is being funneled into just a few stocks? To get a really good answer we’re going to visit London England in the year 1720. Let’s explore how history is repeating itself with the new South Sea Bubble. The goal by the end of this article is to draw connections between the greatest financial bubble of all time and what’s happening today. Hopefully it will be so obvious you’ll feel sick.

One Chart to Rule Them All

There’s actually 315 years of stock market data available. People think DOW 4,000 is impossible, but look at this 315 year chart and how juicy DOW 1,000 is.

Here’s the theory. The country has nearly run out of credit forming the end of a Grand Supercycle. The money issue is obvious with state budget problems. So what is the most expedient way to generate credit in a corrupt system? A Ponzi scheme. Make it really big and complicated so no one can figure it out in time.

Here are some of the basics. The global financial markets, which are primarily run by New York banks, are being propped up by the Federal Reserve selling Treasuries. The money that is placed in Treasuries is then built out with leverage and funneled into the most wounded names in the banking system. These names get pumped up to create a cash machine that is used to cover debts of the United States of America. This is just a basic model, but understanding how this works will open windows into our corrupt financial system. A system designed to tax and steal without our knowledge.

Look at the stocks moving the market:

Volume continues to be concentrated in just a few names. Today, in a universe of over 5,000 stocks in the U.S. equity market, only 4 stocks contributed 20% of the volume.

Citigroup (C), Bank of America (BAC), Fannie Mae (FNM) and Freddie Mac (FRE) traded a total of 2.041 billion shares. Overall volume in the U.S equity market was only 10 billion shares. -Joseph Saluzzi

There is some variation to which names lead volume for the week. The PPT cash machine cycles through several names during the month. Read Themis Trading’s white paper, Toxic Equity Trading Order Flow on Wall Street: The Real Force Behind the Explosion in Volume and Volatility. This gives a concise explanation for current market mechanics. Here’s a section most of us don’t think about:

High frequency trading strategies have become a stealth tax on retail and institutional investors. While stock prices will probably go where they would have gone anyway, toxic trading takes money from real investors and gives it to the high frequency trader who has the best computer. The exchanges, ECNs and high frequency traders are slowly bleeding investors, causing their transaction costs to rise, and the investors don’t even know it.

What HFT Looks Like

The main HFT stocks are C BAC FNM FRE AIG and CIT. During Fed POMO days, where they’ve recently been injecting $30B into the market on a weekly basis, these names will cycle through large cash inflows. This is the new PPT vehicle. Check out the chart of AIG during a heavy week where $197B in Treasuries were on auction.

Note the blue shaded area on the chart. This is classic HFT or program trading where a stock churns shares within a very small range. Liquidity rebates are also happening where dealers like Goldman Sachs earn a quarter penny on every share traded. Everyone gaming the stock makes out. Shareholders looking for organic growth get chopped to pieces. It’s a giant cash machine and the stock goes nowhere, much like the S&P 500 intraday.

Then something happens… The PPT shows up. This move in AIG is a classic PPT push where a massive amount of capital is pumped in during the last hour of the market. HFT algorithms can see it coming and get out of the way. Here’s part of the reason why these moves come at the end of the day:

The directives of the FOMC are carried out in the context of two week maintenance periods. The Manager of the System Open Market Account is charged with achieving those objectives via the daily operations. (source)

Step One (08:30am):

• gather information, macroeconomic news
• desk telephones primary government security dealers
• large banks inform the desk about their reserve needs
• NY Fed gather data to provide forecasts of reserves

Step Two (10:30am):

• call to the Treasury concerning its forecast of its balance for the day

Step Three:

• formulate the actions for the day
• forecasts from Treasury, NY Fed, and Fed BoG combined
• interventions are formulated
• trading plan is formulated

Step Four (11:15am):

• conference call links…
• Manager (and staff)
• Director of the Division of Monetary Affairs at Fed BoG
• a Federal Reserve Bank president who sits on FOMC
• proposed actions for the day are detailed

Step Five (11:40am)

• desk traders contact primary dealers and execute day’s program

See our story Anticipating PPT Days for ideas on what these moves look like and how to trade them. This same move was seen in ABK AIG CIT FRE FNM during the last couple weeks. It is reminiscent of the moves seen prior to the September 2008 market crash. It used to be a safe assumption to put your money where the government puts theirs. Now that money disappears, in more ways than one.

Myth of Savings Accounts

Citibank (and many others) have a program called Deposit Reclassification. This is a relatively new financial scheme you won’t find on Wikipedia. It was invented for credit unions and banks to put dead money to use. That dead money comes from your savings accounts.

For accounting purposes, all Citibank consumer checking accounts consist of two sub-accounts; a transaction sub-account to which all financial transactions are posted; and a holding sub-account into which available balances above a pre-set level are transferred daily. (source)

What this means is banks using this program do not have to maintain a 10% deposit reserve on cash in savings accounts. So how do they guarantee cash that isn’t there? Banks use this sub-account loophole to circumvent all retail deposit reserve requirements. Under normal Federal Reserve System rules banks can leverage $100 in deposits into $1,000 of credit based on a 10% reserve. This is virtually free money for them. The more deposits they have the more credit they can create out of thin air.

With a 0% actual reserve–who knows? This nullifies what the FDIC says about the safety of the banking system and deposits. What deposits? Check out this presentation by the New Jersey League of Community Bankers on how it’s done.

Note that in July 2008, the banking system’s vault cash EXCEEDED both required and total reserves. [Vault cash is the physical banknotes that banks keep on hand to meet withdrawals; the vast majority of dollars exists in the form of electrons, and only a tiny sliver is metal coinage.] Now, in July 2009, the required reserves and vault cash have been relatively unchanged.

Over the same period, the monetary base has almost doubled from $847 billion to $1,681 billion while reserves grew by about the same amount, from a scant $45 billion to $803 billion. Where did this money come from? It is likely just FED “liquidity” or newly created currency. We would need to audit the FED to really be sure, but the timing and amount coincides with the Banker Bailout of October 2008. (source: Jake Towne for Congress)

Software also exists that allows banks to move money on a whim. There’s SWIFT that nearly everyone uses and fi-linx for Deposit Reclassification. These systems run a, “Now you see it. Now you don’t!” form of financial engineering. They can move money undetected in and out of accounts. One day the bank will have 0.6% cash on reserve, and the next they exceed the Fed 10% requirement. This is part of the reason bankers do not want the Fed to be audited. It’s also part of the reason we’re seeing enormous credit injections.

Banks and Bubbles

Current HFT names could be a modern version of the South Sea Company. In 1720 Britain had the equivalent of roughly $2T in debt and was nearly bankrupt. The South Sea Company was used to service that debt. Roll all of the debt into private stock, dupe everyone and their grandmothers into buying it, then sell for a profit. The public gets left holding the bag. Sound familiar?

A senior Bank of England official today compared the banking system over the last 20 years to the South Sea bubble of the early 18th century and said bankers had merely “resorted to the roulette wheel” to keep up with each other. (Guardian UK)

The South Sea Bubble was an enormous scam conceived after a costly war where Spain and France tried to control all of Europe. The stock became a vehicle for Britain to offloaded their war debt upon a naive investing public. Even Isaac Newton got soaked speculating in this stock. The South Sea Company was a Ponzi scheme. They were initially slave traders with one boat that did one trip a year. They never turned a legitimate profit. It is the original event that coined the term “bubble.”

Here’s some more good stuff from Ashley Seager at the guardian.co.uk:

The Bank’s executive director for financial stability, Andy Haldane, said in a speech in Chicago that having been stable over much of the 20th century, returns in the banking system relative to the wider stockmarket shot up after 1986 until 2006.

“Banking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison,” he said. He said bankers and policymakers became seduced by the excess returns available: “Banks appeared to have discovered a money machine, albeit one whose workings were sometimes impossible to understand.

“One of the South Sea stocks was memorably ‘a company for carrying out an undertaking of great advantage, but nobody to know what it is’. Banking became the 21st-century equivalent.”

“For a number of diseases, 20% of the population account for around 80% of the disease spread. The present financial epidemic has broadly mirrored those dynamics,” he said, adding that the failure of a core set of large, interconnected institutions such as Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers and AIG contributed disproportionately to the spread of financial panic.

How the South Sea Company Operated

Keep the Fed pumped AIG chart in mind while reading the following. Excerpts from Harvard Magazine’s “The Damn’d South Sea” by Christopher Reed:

On January 1, 1720, the price of a share of South Sea stock stood at £128. On June 24 it hit £1,050. In September came the crash. By December the stock had returned to £128. Thousands declared themselves ruined. Banks could not collect loans on inflated stock and failed. Specie was in short supply. Work stopped on half-built homes. Investigations and revenge ensued, and a long struggle to restore stability.

Sir Isaac Newton, scientist, master of the mint, and a certifiably rational man…sold his £7,000 of stock in April for a profit of 100 percent. But something induced him to reenter the market at the top, and he lost £20,000. [roughly £3 million today]

To put these sums in perspective, Carswell points out that a middle-class family could live very comfortably at the time on £200 a year.

The maxim that credit was not wealth unless it rested on a wealth-producing asset had been ignored…,” writes Carswell (former secretary of the British Academy). Greed blinded many, but not all. One unidentified observer saw clearly: “The additional rise of this stock above the true capital will be only imaginary; one added to one, by any rules of vulgar arithmetic, will never make three and a half; consequently, all the fictitious value must be a loss to some persons or other, first or last.

“In order to pay out profits, the South Sea Company needed both to raise more capital and to have the price of its stock moving continuously upward,” writes the economist and MIT professor emeritus Charles P. Kindleberger in his classic work Manias, Panics, and Crashes: A History of Financial Crises (Wiley, third edition, 1996). “And it needed both increases at an accelerating rate, as in a chain letter or a Ponzi scheme.” The company repeatedly raised cash through new issues of stock as its price spiraled upward in the summer of 1720.

“It was clear that the Company could only pay the £7,500,000 to the government if they exchanged South Sea stock for government obligations at prices far above par 100. And, the higher the price of stock at the time of conversion, the greater the profits which would accrue to the Company. In addition to the profits the directors could make by holding South Sea stock were those available through stock manipulation which, in this case, included transactions in non-existent stock. The directors could create and purchase stock at a low price and sell it for an inflated price. It was a foolproof way of making a large fortune and it proved to be an irresistible temptation.

“Carswell employs a hydraulic metaphor to describe the action. The company first created £2 million in new South Sea stock, at £300 a share, and let investors pay for it in installments. Subscribers eagerly bought it up, and the company covertly issued £250,000 more for good measure. Then it announced that its cash position was so strong that it could lend shareholders money on the security of their South Sea stock. The price of the old stock at once rose to £325. The company issued yet more stock and made more loans, again and again.

“So Blunt…had constructed a financial pump,” writes Carswell, “each spurt of stock being accompanied by a draught of cash to suck it up again, leaving the level higher than before.” Success required that the level keep rising.

The South Sea Company was a confection of politics, commerce, and finance. None of its governors or directors had any experience of trade with the New World, but John Blunt, who wrote the charter and was the company’s dominant director, had been a scrivener and then director of the Sword Blade Bank. He and cohorts had a fine understanding of financial manipulation.

The company had the further splendid purpose of relieving the government of its burdensome unsecured public debt–obligations for which Parliament had assigned no funds–which then amounted to £9,000,000. South Sea was organized under the newish joint-stock principle, as a corporation with transferable shares. Holders of the national debt were obliged to exchange their government securities for shares at par in the company. The company could raise working capital–a huge amount of it–by borrowing on the security of the debt due from the government. In addition to its trade monopoly, the company would get an annual payment from the Exchequer of £568,279 10s., or 6 percent of the debt taken over. Stockholders had no promise that they would see any of this as dividends, but who could blame them for thinking that capital gains based on trading profits were a certainty?

Final Thoughts

Fortunately we now have technology that can dig under the surface. What does it mean again when the stock goes up while institutions are bailing?

A quick review of why the South Sea Company stock failed and why it’s like AIG C BAC etc:

1. Government funded stock secured by government debt
2. Stock operates in a monopoly environment
3. Corrupt system with unknown sums and fake shares
4. Depends on an infinite increase in value

What’s amazing is the South Sea Company stayed in operation for almost 100 years. However, the South Sea Bubble ended with purges, the Napoleonic wars, and about sixty years of total misery. It is partly responsible for the U.S. emerging as a new world power though. Here is some parting irony:

Historians wishing to study the company and the era can be awash in source material if they go to the right place–the Kress Library, Harvard Business School’s rare-book collection, housed in Baker Library.

Almost all of it was assembled by Hugh Bancroft, A.B. 1897, A.M. ‘98, LL.B. ‘01, president of Dow, Jones and Company. After his death in 1933, his wife presented the Bancroft collection to Harvard. It offers true value to scholars wishing to explore a seminal lunacy.

Lastly, Robert Prechter is very vocal about these connections. Check out the July issue of The Elliott Wave Theorist.

We have two big auction days for Treasuries coming up. The 10 year note on Wednesday and the 30 year bond on Thursday. The thirty year is the big one that makes everyone nervous. It’s a barometer for the willingness of other countries to service U.S. debt. There is intense pressure on this and the question is, “Will China continue to float the U.S.?” (see prior story)

There is a way to play the ETFs for a quick profit. Here’s how to place resting bids on Treasury auction days (calendar).

The various Treasury auctions happen once a month at 1:00 p.m. ET. The notes range from 4 weeks to 30 years and their auctions are spread throughout the month.

Let’s use last week’s auction as an example for setups. Sometimes clear levels of resistance are made before the auctions. One can then place a low risk buy-stop-market order above the day’s range, right before the auction happens.

So we don’t know which will pop TBT or TLT. These ETFs track the 20 year Treasury bond. They are the most liquid and popular way to play Treasuries. TLT is long the bond and TBT is short.

Place a resting buy-stop-market order on both names. The name that pops will trigger the order. This won’t catch the entire move, but it’s a low stress partly automated way to make money. It also saves focus to manage the exit. Exits need to be on the same time frame as the entries. The risk of holding these trades past 30 minutes is large. The idea is to catch the first big impulse move and get out.

These are 3min charts on TBT and TLT for the same two day period last week. You can see that TBT would fill for a quick profit and TLT would never fill. So you only have to manage the winner.

TBT

The green arrow indicates the resting bid. Brokers call them different things. Some are called buy-stop-market orders. When the price is touched a market order is executed to buy. This assures an immediate fill. We want to catch the impulse move.

Say an order for 500 shares of TBT was placed at 52.75. This is $0.05 above the day’s high. We want a little wiggle room to lower the risk of being faked out. Price must get an impulse move to execute the order. It fills 52.80 at the market. The move stalls 10 minutes later. A sell at the market around 53.55 is $375 profit.

TLT

These resting bids are placed at the same time on TBT and TLT. We’re looking for a new high to enter the trade. TLT didn’t work that week. No big deal. The order never fills and focus is shifted to the one that did.

Background Manipulation

Here is more of the bigger story underlying these trades. GTM wrote about this last March (see story). This is old news, but nothing has fundamentally changed. Here is a snippet:

President Obama and his new government have adopted a series of measures to deal with the financial crisis. We have expectations as to the effects of these measures. We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried. -Wen Jiabao 03/13/09

On Sunday Bernanke does the first national interview a Federal Reserve chairman has ever done in 96 years. He says everything is fine and we’ll be back to business as usual by the end of the year. Then on Wednesday the Fed announces they will buy Treasuries until the end of days. So…

1. China warns about the financial stability of the U.S.
2. Bernanke goes on national television
3. Says he’s from Main Street, just like you and me
4. Then boldly lies about the economy

Three days later…

• FOMC announces a final push of a desperate crisis management plan
• U.S. dollar sees its 3rd biggest one-day decline ever
• Fed is now matching all of China’s $1 trillion in Treasuries

The Fed Buys Last Week’s Treasury Notes

Chris Martenson just exposed the way the Fed buys Treasuries under the table (see story). Here is a snippet:

Good grief! Just last week, when the auction results were announced it was trumpeted to great fanfare that there was “more than sufficient” bid-to-cover, “strong demand” and all the rest. And now it turns out that 47% (!) of the bonds that were taken by the primary dealers in that auction have been quietly bought by the Fed and permanently secreted to its balance sheet.

They didn’t even wait a full week! A more honest and open approach would have been for the Fed to simply buy them outright at the auction but this way, using “primary dealers” and “POMOs” and all these other extra steps the basic fact that the Fed is openly monetizing US government debt is effectively hidden from a not-too-terribly inquisitive US press and public.

The speed of the shell game is accelerating.

This immediate repurchase of newly auction bonds by the Fed tells us that demand for these bonds is not nearly as high as advertised, and that things are not quite as strong as represented.

Caveat Ursi 3.0

Mole at EvilSpeculator has been following POMO activity for a long time. He drew up an awesome chart showing each burst of virtually free money the Fed pumps into the market (see story).  It’s not free to you and me. We pay the interest on it through inflation.  It is essentially free to prime brokers who use it to gun index futures while everyone is sleeping.

As you are probably aware I have long been keen on learning more about the inner workings pertaining to the NY Fed’s repo auctions and I have occasionally reported on the slosh available to preferred primary dealers. After a very pertinent article posted by ZH earlier this week I carefully combed through the recent POMO calendar, which due their traditional rarity I had foolishly ignored for several months now, and to my surprise arrived at highly interesting results:

Coincidence? You be the judge of that – I however took the liberty to highlight and mark each day a POMO operation was held.

Conclusion

There will be a day, maybe this year, when Treasury auctions don’t get enough bids. We know demand has been slipping, which is being inflated by the Fed. There are limits to how long the Fed can pump the market. When that day comes, this strategy on TBT/TLT will pay out in a massive and immediate way.

There was an iciness, a sinking, a sickening of the heart—an unredeemed dreariness of thought which no goading of the imagination could torture into aught of the sublime. What was it—I paused to think—what was it that so unnerved me in the contemplation of the House of Usher? -The Fall of the House of Usher by Edgar Allan Poe

The following story will explore how the Cayman Islands, home to 52,000 people, also houses nearly one foreign corporation per citizen.  It is also home to virtually all of the world’s hedge funds. The Caymans is being used by corporations to avoid U.S. taxes and hedge funds to illegally manipulate global markets. It goes without saying that the average citizen is not benefiting from this. In fact, now is a very critical time in history to expose this fraud. Let’s see why we should be unnerved while contemplating the House of Ugland.

Welcome to the Island of Zero

The house pictured above is home to international law firm Maples and Calder:

PO Box 309, Ugland House
South Church Street, George Town
Grand Cayman KY1-1104
Cayman Islands

This is a house used by 12 of the 30 companies listed in the Dow Jones Industrial Average to avoid U.S. taxes. President Obama referred to Ugland House a few weeks ago:

On the campaign, I used to talk about the outrage of a building in the Cayman Islands that had over 12,000 businesses claim this building as their headquarters. And I’ve said before, either this is the largest building in the world or the largest tax scam. And I think the American people know which it is: The kind of tax scam that we need to end.

Basically everyone has known about this corporate game for decades. Now that the U.S. is strapped for cash this method of tax evasion is coming to the surface. The federal corporate tax rate is 35%. The effective tax rate of U.S. companies that shelter in the Caymans is one to five percent. In 2001, almost half of the money U.S. companies earned outside the U.S.—47 percent—was accounted for in offshore tax havens such as the Cayman Islands, which has no corporate income tax. What’s really unnerving is many corporations don’t pay any federal tax at all.

During last summer’s market mayhem this report didn’t get the traction it deserves. From Reuters:

The Government Accountability Office said 72 percent of all foreign corporations and about 57 percent of U.S. companies doing business in the United States paid no federal income taxes for at least one year between 1998 and 2005.

More than half of foreign companies and about 42 percent of U.S. companies paid no U.S. income taxes for two or more years in that period.

During that time corporate sales in the United States totaled $2.5 trillion, according to Democratic Sens. Carl Levin of Michigan and Byron Dorgan of North Dakota, who requested the GAO study.

Four companies alone have accumulated a combined total of more than $75 billion in earnings untaxed by the U.S.: Hewlett-Packard Co., Merck & Co., Pfizer Inc. and Coca-Cola,

Here is the intro to the report the Government Accountability Office, Congress’s investigative arm, wrote to Senators Levin and Dorgan:

July 24, 2008
The Honorable Carl Levin
Chairman Permanent Subcommittee on Investigations
Committee on Homeland Security and Governmental Affairs
United States Senate
The Honorable Byron Dorgan
United States Senate

In response to your long-standing concerns about whether foreign-controlled U.S. corporations are abusing transfer prices and avoiding U.S. income tax, we compared the tax liabilities of foreign- and U.S.-controlled companies incorporated in the U.S. in three prior reports. We reported that from 1989 through 2000 foreign-controlled corporations were more likely to report zero U.S. income tax liability than U.S.-controlled corporations with a majority of both types of corporations reporting no liability.

Bloomberg recently ran a story about this featuring Seagate Technology, the world’s largest maker of hard disk drives, headquartered in Scotts Valley, California. Yet the documents it files with the SEC list its address on South Church Street in George Town, the capital of the Cayman Islands.

While the U.S. corporate tax rate is 35 percent, Seagate paid an effective tax rate of 5 percent in the year ended June 2008, according to data compiled by Bloomberg.

The Caymans have no corporate income tax for companies incorporated there. The Caribbean island has helped scores of U.S. companies, including Coca-Cola Co. and Oracle Corp., to legally avoid billions in tax payments to the U.S. government, says U.S. Senator Byron Dorgan.

Maples and Calder, owners of Ugland House, incorporated more than 6,000 new companies over the past five years. Back in 2004, the building served as home to 12,748 companies using the same address. This five-story office building on South Church Street is now the official address for 18,857 corporations. About half those Cayman companies had billing addresses in the U.S., according to a 2008 GAO study.

Intel Defense

Intel’s former vice president of tax, licensing and customs, Robert Perlman told the U.S. Senate Finance Committee in March 1999 that Intel would have been better off incorporating in the Cayman Islands when it was founded in 1968.

“Our tax code competitively disadvantages multinationals simply because the parent is a U.S. corporation,” Perlman testified.

He has a point. The U.S. is criticized for having one of the highest corporate tax rates in the world. This can place U.S. companies at a major disadvantage while operating in the same space as highly subsidized foreign competitors.

Then again, many of these companies avoiding taxes were being subsidized by the U.S. government at the same time. Twenty-four of the 100 largest contractors with the U.S. federal government—including Altria Group Inc., Oracle Corp. and Procter & Gamble Co.—have subsidiaries in the Caymans, according to a March 2001 report by the GAO. Those 24 companies received a total of $35 billion from the U.S. government. “They are shortchanging our country even as they profit from it,” says Senator Dorgan.

The Caymans provide near-total financial secrecy for companies, banks and accounts. There are more than 500 banks and trust companies with deposits of more than $1 trillion in the Cayman Islands, according to the Cayman Monetary Authority. That’s more deposits than there are in New York City, and the Cayman Islands are about one-third the size of NYC.

“When $250 billion of the $880 billion in foreign bank deposits within U.S. banks is attributed to the Cayman Islands, to connect the dots you’ve got to ask questions about the extent of tax dodging in that country and other tax havens,” Levin says.

One of the many problems with this behavior is the role of corporations in the U.S. capitalist system. They were designed to replace the need for socialized government welfare programs. The trend of corporations paying fewer and fewer taxes, while offering fewer benefits to their employees, with stagnant wages, is contributing to a breakdown of the free market. Nations are running out of money, corporations are bailing or failing, and real wages have not improved for thirty years. This is a good example of how citizens are being victimized by the system. It is not just the U.S. who is missing tax revenue from this scam.  Instead of enforcing the law and cracking down the political dictate is to spend more. This is a Mafia style business solution.

How Corporations Game Taxes

A practice called transfer pricing may be the key to how U.S. corporations avoid taxes in the U.S. and other countries, Dorgan says. The accounting practice lets companies buy and sell products and services with their own offshore subsidiaries and set prices themselves. Companies abuse transfer pricing by shifting profits overseas to avoid U.S. taxes, Dorgan says. They set artificially high prices for imports and artificially low prices on exports, he says.

In a March report on financial crime and international law enforcement, the U.S. State Department cited examples of transfer pricing abuses, without naming companies. It said one company claimed to import dish towels from Pakistan for $153.72 each; another reported it had imported briefs and panties from Hungary for $739.25 a dozen; a third claimed it had paid $4,896 a unit for metal tweezers imported from Japan. The report also cited a company claiming to export toilet bowls to Hong Kong for $1.75 each. The State Department report called those prices absurd and ridiculous.

The fabricated high prices of imports let companies report artificially high expenses in IRS tax filings. The exaggerated low prices of exports allow companies to report smaller profits to the IRS. “Criminal individuals, corporations and other enterprises engage in abnormal international trade
pricing that transfers value and/or reduces U.S. tax liability,” the State Department report said.

Transfer pricing abuses by corporations cost the U.S. Treasury $53 billion
a year, according to Professor John Zdanowicz of Florida International
University in Miami. He says tracking a product used in transfer pricing
transactions between U.S. companies and their subsidiaries in the Caymans
and elsewhere is difficult. “Where it really comes from and where it’s really going, nobody knows, because of the secrecy,” he says. The $53 billion in lost U.S. taxes results from more than $150 billion of profit from improper transfer pricing, Zdanowicz says. “It’s a $150 billion shell game,” he says. (Bloomberg)

How to Make Money with Terrorists

The laws to prevent abuse are there, but enforcement is virtually non-existent. It’s particularly difficult when they are obstructed by the highest office. In 2004 David Evans wrote a phenomenal piece for Bloomberg called The $150 Billion Shell Game. Here is an excerpt from the most alarming section:

On April 13, 2003, President George W. Bush accused Syria of having weapons of mass destruction. “We believe there are chemical weapons in Syria,” he said on the South Lawn of the White House. Secretary of Defense Donald Rumsfeld, appearing on CBS’s Face the Nation the same day, said busloads of Syrians were sent to Iraq to kill Americans. “Reasonable people don’t want to be associated with a state that’s on a terrorist list,” Rumsfeld said. “Who in the world would want to invest in Syria?”

Six weeks later, on May 31, Devon Energy Corp., an Oklahoma City–based oil and gas producer, entered a partnership with the Syrian government to spend $17 million to search for oil in Syria according to company filings with the U.S. Securities and Exchange Commission. Theodore Kattouf, then U.S. ambassador to Syria, attended the contract signing in Damascus. Devon channeled the business through a Cayman Islands subsidiary.

Devon’s work in Syria didn’t mark the first time a U.S. company won a contract through a Cayman subsidiary in what the U.S. called a terrorist state. A Halliburton Co. subsidiary sold $33.6 million in products and services to Iran in 2001, according to filings with the SEC. Vice President Dick Cheney was chief executive officer of Houston-based Halliburton, an energy services and engineering company, from 1995 to 2000.

Iran is blacklisted by the U.S. as a terrorist state, which means U.S. companies are forbidden from accepting contracts from Iran. The Halliburton unit that won the contract in Iran was incorporated in the Cayman Islands and therefore wasn’t subject to U.S. law, Halliburton says.

In February, the U.S. Senate Finance Committee, chaired by Republican Charles Grassley, sent a letter to the Treasury Department asking if Halliburton was being investigated for violating U.S. sanctions. The committee also wrote letters to ConocoPhillips and General Electric Co. asking about their revenue from terrorist states, including Iran and Syria.

Halliburton is the 30th largest military contractor, with fiscal 2001 federal contracts of $534.2 million, according to a March study by the General Accounting Office, the auditing arm of Congress. Halliburton has 13 subsidiaries in the Caymans, two in Liechtenstein and two in Panama.

General Electric, the world’s largest company by market value, has sold locomotives in Syria; in Iran, it sold medical equipment, provided oil and gas services and contracted to build hydroelectric generators, according to the Senate Finance Committee. ConocoPhillips, the largest U.S. oil refiner, runs a gas processing plant in Syria, the committee said. “We comply strictly with U.S. law in sales to Iran,” says GE spokesman Gary Sheffer. “If Congress decides to change the law, we’ll comply.”

“All of Halliburton’s business is clearly permissible under applicable U.S. laws and regulations,” says Wendy Hall, a Halliburton spokeswoman. “If Congress decides to change the laws and provisions, Halliburton will, of course, comply.”

Quick Hedge Fund Facts

So that’s the tip of the iceberg for international corporations legally abusing U.S. tax law. There have been famous cases of illegal abuse such as Enron. Back in December 2001, Enron Corp., the Houston based energy company that went bankrupt, used 441 Cayman affiliates to help hide $2.9 billion in losses.

To delve into what hedge funds do is another giant stinking pit of abuse and secrecy. Out of the total of 9,800 hedge funds operating at the end of the third quarter 2006 worldwide, 8,282 were registered in the Cayman Islands.

In 1993, the decision was made to turn this tourist destination into a major financial power, through the adoption of a Mutual Funds Law. This enabled easy incorporation and/or registration of hedge funds in a deregulated system. From the day of application, it takes two to five days for a hedge fund to be approved and costs $3,600 in total fees.

The number of hedge funds operating in the Cayman Islands exploded from 1,685 hedge funds in 1997 to 8,282 at the end of the third quarter 2006, a fivefold increase. Cayman Island hedge funds are four-fifths of the world total. Globally, hedge funds hold $1.44 trillion in assets under management, but through using leverage of anywhere from 5 to 20 times, they command up to $30 trillion of deployable funds. This equals the size of the NYSE.

CEO to Worker Pay

The point of all of this is to become aware of what is really going on when it comes time to raise taxes on the public.  This is going to happen.  It has to happen, because the U.S. is running out of money.  However, the money is out there.  It’s just not being legally distributed as it should be.  Instead the burden will be unjustly placed on you and me.  As long as the House of Ugland stands, our standard of living will fall.

The last concept related to all of this is the trend in CEO compensation. This is a visual demonstration of how we are being cheated by a corrupt system which is protecting itself to our severe disadvantage. The market collapse is doing nothing to change the gross inequality of the system. What the media typically avoids discussing is the effect inflation has on real wages. Basically, prior to the market crash it was impossible for most people to get ahead and beat inflation. If the market enters a long period of inflation along with higher taxes–forget it.

In 2005, the average CEO in the United States earned 262 times the pay of the average worker, who earned just $5.15 per hour.  This is the second-highest level of this ratio in the 40 years of recorded data. In 2005, a typical CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks.

This extreme compensation ratio reflects both the extraordinary growth of CEO pay and also the diminishing value of the federal minimum wage that has not been raised since 1997. Adjusting for inflation, the purchasing power of the minimum wage is now at its lowest since 1955. When you hear rhetoric spew about why you have to pay your fair share, remember what you’ve learned here today.  This burden can only be carried for so long.

While I gazed, this fissure rapidly widened—there came a fierce breath of the whirlwind—the entire orb of the satellite burst at once upon my sight—my brain reeled as I saw the mighty walls rushing asunder—there was a long tumultuous shouting sound like the voice of a thousand waters—and the deep and dank tarn at my feet closed sullenly and silently over the fragments of the “House of Usher.” -Edgar Allan Poe

Sources:
London’s Cayman Islands: The Empire of the Hedge Funds
by Richard Freeman
March 11, 2007
Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations
1998-2005
July 2008
Study says most corporations pay no U.S. income taxes
by Donna Smith
Reuters Aug 12, 2008
Coca-Cola, Oracle, Intel Use Cayman Islands to Avoid U.S. Taxes
By David Evans
Bloomberg May 5, 2009
The $150 Billion Shell Game
By David Evans
Bloomberg Aug 2004
CEO pay: Sky high gets even higher
August 30, 2005
CEO-to-worker pay imbalance grows
CEO-Minimum Wage Ratio Soars
by  Lawrence Mishel

Just then the ship took a slight but definite plunge – probably a bulkhead went – and the sea came rolling along up in a wave, over the steel fronted bridge, along the deck below us, washing the people back in a dreadful huddled mass. Those that didn’t disappear under the water right away, instinctively started to clamber up that part of the deck still out of water, and work their way towards the stern, which was rising steadily out of the water as the bow went down. It was a sight that doesn’t bear dwelling on – to stand there, above the wheelhouse, and on our quarters, watching the frantic struggles to climb up the sloping deck, utterly unable to even hold out a helping hand.”
-Charles Lightoller, Second Officer aboard Titanic

Nearly 100 years ago to this very month the unthinkable happened. The “ship that could not be sunk” did so in such a manner it tore the very fabric of reality. Shortcuts were made in the design to maximize profits. These shortcuts were known to the men responsible for the tragedy. Some had warned about the doomed ship, but they could not be heard over the trumpets extolling its historic soundness. Such is the way of man.

Warning Before the Cruise

Trying to figure out what the financial end game is, beyond simple Armageddon, is probably impossible. Right now many conflicting issues don’t make fundamental long-term sense. This is a very complicated maze. However, being lost inside while searching for enlightenment seems a worthy task.

So here we are today, facing such a disaster on a scale unimaginable to people living in 1912. Once again shortcuts known to the men responsible will cause pointless deaths. That’s right, people will die. After Argentina’s 2001 financial crisis a gross majority of the country’s dead were children. Not unlike the Titanic’s third-class kids.

One of the most poignant aspects of the Titanic’s sinking was how the band played on until the final end. This is such a fitting analogy for several reasons. The first is the ship was redesigned down to minimum regulations. This did not leave enough life boats for every man, woman, and child. Secondly, many of her passengers refused to accept the fact the ship was sinking. Keep this in mind as we walk through reports of how badly damaged our financial behemoth is, and how poorly it is regulated (see story).

Much of what you’re about to read is complicated. So complicated it goes beyond the means of this lone author. This story has been sitting for weeks, not knowing exactly how to tell it. Please be patient and sort through it as you may.

Today’s Iceberg

We are on the cusp of another critical seizure in capital flow. An event that might sink the ship. If one of the major banks, or someone like Greece (who is on the verge of bankruptcy), becomes insolvent we’ll see a domino effect of collapses. There was a digital run on the banks last September which nearly froze the credit system. Liquidity is so tight now another run has even greater probability of breaking the system. There is more and more debt chasing fewer and fewer real dollars. Current policy makers believe there is no ceiling to short-term debt creation, baring a collapse. Their formulas tell them the Fed can print money indefinitely, because the Fed is ultimately capitalized. Others are convinced we will learn what the ceiling is before this decade is out.

The Titanic sinking took 2h:40m. The well informed passengers didn’t know for over an hour. Half the critical period was spent in denial. Our financial ship is crippled, but still making power. We all know it has been fundamentally damaged. What we don’t know is the crew jumped ship with the best life boats. Meanwhile we’re up on deck listening to the music play. This is beyond criminal. And most of the unfortunates are stuck down in steerage with no way out. History shows the ship was doomed to sink no matter what was done. If not that year, then another. The lesson learned was how to save the people. Maybe this info will help you save someone.

Where is the Liquidity

One of the logic traps is trying to figure out who is responsible for the system failing. A shark infested waters theory makes it nearly impossible to determine which predator struck first. Did the Fed engineer this. Did prime brokers manipulate the Fed first. Was there collusion to whip every last dime out of debt slaves. Who knows. Let’s look at what we do know, which they thankfully publish in plain sight.

Liquidity is to the capital markets what oil is to an engine. The engine is running out of oil. Even PPT Mobil 1 has performance limits. Here are some of the mechanical issues. Who else is watching the volume seize up on SPY, DIA, and the Qs? These are fundamental stocks with fundamental volume issues.

A lack of liquidity is one of the underlying reasons volume is leaving equity markets.  Liquidity is what gives us an orderly market less prone to price shocks, gap opens, and blatant manipulation.  Margin calls, collateral requirements, risk, and uncertainty has taken much of that liquidity away. Funds have blown up, prime brokers don’t exist in the same space anymore, and capital has made an exodus out of equities into derivatives. Money is moving out of the regulated markets into the unregulated markets. It is lack of regulation on insane amounts of leveraged credit that brought us here.

Thanks to Zero Hedge for their amazing investigative work:

The Capital Markets Liquidity Index subcomponents:

• The Capital Markets US Treasury Bill Index CPMKTLTBI
• The Capital Markets Short Term Large Certificates of Deposit Index CPMKTLCD
• The Capital Markets Commercial Paper Index CPMKTLCP
• The Capital Markets Agency Discount Notes Index CPMKTLDN
• The Capital Markets Banker’s Acceptance Index CPMKTLBA
• The Capital Markets Short Term US Treasury Bond & Note Index CPMKTLTBO
• The Capital Markets Short Term US Federal Agency Index CPMKTLTA
• The Capital Markets Short Term US Corporate Investment Grade Bond Index CPMKTLCBO

Goldman Monopoly

GTM’s (prior story) on how the tri-party repo system works is critical to understand. Since many of the banks funding that system are gone, or incapable of funding, one big shark is left in the lagoon–Goldman Sachs. How do you trade a market when a single entity controls a large and growing share of the daily volume? Goldman Sachs is running about one out of every ten trades on the NYSE.

The FINANCIAL — The New York Stock Exchange, a subsidiary of NYSE Euronext (NYX), on April 9 released its weekly program-trading data submitted by its member firms. The report includes trading in all markets as reported to the NYSE for Mar. 30-Apr. 3.

The data indicated that during Mar. 30-Apr. 3, program trading amounted to 32.6 percent of NYSE average daily volume of 3,343.7 million shares, or 1,089.0 million program shares traded per day.

“Program trading encompasses a wide range of portfolio-trading strategies involving the purchase or sale of a basket of at least 15 stocks,” NYSE reports.

In all markets, program trading by member firms averaged 3,389.9 million shares a day during Mar. 30-Apr. 3. About 32.1 percent of program trading took place on the NYSE, 0.8 percent in non-U.S. markets and 67.1 percent in other domestic markets, including Nasdaq, NYSE Amex and regional markets.

Goldman Sachs is one of 15 major program trading participants. This is one of many examples of GS increasing their stake in a shrinking space. Their principal program purchases of 850 million shares representing 81% of all traded shares, more than half of all NYSE reporting firms principal trades. Program trading accounts for 33% of all NYSE daily volume, and GS runs 30% of those trades.

Dark Pools and Iceberg Orders

That was just Goldman’s share of program trades on a regulated exchange, which doesn’t reflect the vast unregulated market. Dark pools have roughly 10% of all shares traded in the US cash equities market. Dark pools are not public markets. It’s a method to match trades outside of the public eye, and also do what would be illegal transactions in a regulated market. They can be used to reduce market impact when trading large orders. Dark pools of liquidity became very popular prior to the 2007 market top. Firms with buy ratings on stock XYZ could dump shares with little impact. Imagine how important they are today in an illiquid market. Dark pools are also used to game the public market. Trades like iceberg orders can show a 10,000 block sale as a 100 block print.  Read about the basics here.

Guess what bank holds the #1 spot in the dark pool arena? Goldman Sachs and their Sigma X pool, which transacted 156.3 million shares in February 2009. All the dark pool numbers in this data are single-counted. Morgan Stanley recently complained about market participants overestimating dark pool volumes–not so. February had a record number of dark pool transactions. This makes sense in a less than liquid public market doesn’t it. Of that record volume GS controls 15% of it. More evidence of Goldman Sachs having monopoly advantage in a wounded illiquid market. Predators like Goldman need equally skilled competitors to maintain balance of the system. Last summer GTM suggested this might happen (see story). The “crash the market to monopolize it theory” holds more water now.

Where Reality Sinks

As of last December, there is $1,400T (yes that’s quadrillion) sitting in interest rate swaps, mostly split between N. America ($775T) and Europe ($555T). This OTC market dwarfs the cash equities market. It’s hard finding exact global market figures, but NYSE Euronext is $31T. They move more than one third of global stock volume. The regulated U.S. stock market is roughly 2% of the size of the unregulated global derivatives market.

The picture is a decent representation of just how massive the unregulated derivatives market is.  It is not properly scaled for 2009, which is more akin to the Titanic next to a dingy.  Not only is this market massive, it has been growing at a reckless pace, is highly leveraged (over 400:1 in many cases), and is extremely complex.  Critics say the total 2008 derivatives markets value of $1,566,655 billion is misleading, because the number is nominal.  Meaning it isn’t real money, but credit agreements between two parties where the principal is never exchanged.  Wasn’t that what AIG was doing in a perfectly safe manner?

Can we also assume a good chunk of those swaps are waiting for the Fed to raise rates? If this is true, we’re in a very precarious situation. On one hand the Fed has to print money until the end of days, and on the other roughly 75% of the world’s total liquidity is trading swaps on the rates. Note: This is a rough educated guess based on BIS numbers.

Some of the big boys in derivatives are using it to play catchup in lieu of their massive recent losses in equities.  The risky trades AIG was doing are still going on. And they’re being placed at an accelerated rate. Some are looking for a slam dunk when rates go back up.  That is not a guarantee and there is a ridiculous amount of levered credit expecting this to happen.

Also, the tri-party repo system has broken down. This might be the prime reason of lower intraday stock market volume, and what appears to be institutional abandonment of index ETFs like DIA/SPY/Qs.  The main entities which loaned money for margin trading, like JP Morgan, are in collections mode. It’s possible the Fed has run out of capital or the need to fund temporary open market operations. These funds are often used to trade index futures. The lack of TOMO activity this year is very curious. The PPT might be fundamentally ineffective for now. Then again they are not necessary during stock rallies. Time will tell.

Life Boats and End Times

Read Deepcaster’s summary of the shadow banking system for new doors to open and explore. You will be in shock. Seeing the actual numbers is madness. JP Morgan had $91 trillion in derivatives as of Sept. 2007. What do they have now after taking on Bear Sterns, which was naked shorted into oblivion before they could offload much of anything.

Each American household owes $455,000 on the U.S. National debt of $53T (pre-TARP). What’s the math on $1.5Q divided into massive global job loss, rampant inflation, and a doubling of the money supply every four years? How does a system that functions purely off the backs of debt slaves work when the slaves stop earning or can’t pay their debts? This feels like a mega tsunami is just offshore. And the guy who works the monitoring station got hit by a bus.

The financial industry is fundamentally doomed. Anticipate a large scale event that uses shock doctrine to control and manipulate people’s minds. Since WW II the ability to master groups and make them susceptible to brainwashing has been perfected. A massive bank collapse could be the catalytic event used to marginalize and control societies in a new direction.

Part 2 Thoughts

Last week John Stewart interviewed Elizabeth Warren. She is the Harvard Law professor (and bankruptcy expert) who chairs the Congressional Oversight Panel for TARP. Stewart asked, “So in your mind the banks don’t see this as a come to Jesus moment?” Watch the show and maybe you’ll be curious about when that day will come.

The next installment in this line will cover the Fed and their manipulation of “free market” liquidity. We’ll explore TOMO/POMO funding, gold manipulation, and PPT charts. There is a way to use TOMO data to go back in SPY volume and say, “See! This is where they pumped money into the market.” It is very time consuming, but it will be done.

Sources:
Greece on the Verge of Bankruptcy
By Manfred Ertel
BusinessWeek April 7, 2009
Why Some Dark Pools Are Increasing Their Volumes
By Nina Mehta
Traders Magazine March 13, 2009
OCC’s Quarterly Report on Bank Trading and Derivatives Activities
Fourth Quarter 2008
Market Intervention, Data Manipulation Still Accelerating
http://news.goldseek.com/GoldSeek/1214722800.php
http://www.finchannel.com/index.php?option=com_content&task=view&id=34403&Itemid=2
http://www.bis.org/publ/qtrpdf/r_qa0903.pdf#page=108
http://www.nyse.com/pdfs/PT041609.pdf