Friday, May 11, 2012

The Financial World's Worst Nightmare

"We're getting to the heart of why you own gold"  - long time friend and colleague,
               Wistar Holt (Holt & Shapard Capital Mgmt)
I think every useful blog under the sun has re-hashed the JP Morgan/Jamie Dimon bombshell dropped on the market last night, so I'm going to try to be brief, to the point and hopefully add some "color" and information that is new.

First, Jamie Dimon did a superb job of throwing very expensive, opaque lipstick on the world's ugliest pig and catering the to the Wall Street analysts and media who take what he says and spin it to the public in the best possible light.  In fact, I just saw one headline on Marketwatch that said "JPM stock is lower due to a a bad trade."  A "bad trade?"

What we just saw last night was the result of Wall Street's equivalent of unsupervised special ed. children playing with financial nuclear triggers.  How do I know this?  I used to be one of those unsupervised kids back in the 1990's, when the magnitude of the capital being played with was a small fraction of what it is now.

This is not a "bad trade."  This is a massive proprietary (i.e. bank trading/speculation portfolio) position that has blown up.  Dimon fraudulently refers to it as "an economic hedge" that didn't work as well as they expected.

Jamie Dimon is either completely ignorant of what is going on in JPM's speculation-ridden proprietary trading operation or he's lying.  Or a lot of both.  If he's clueless, then he should be terminated by the board immediately.  If he's lying, he should be investigated by the Obama Justice Department.  But we know the latter has no chance of happening, as Eric Holder's Justice Dept has taken financial fraud prosecutions to a 20 year low.  Not surprising since JP Morgan and other Wall Street banks are the heart of the client list of Eric Holder's pre-Justice Dept law firm.

With regard to the idea that - as Jamie Dimon put it - this is a $2 billion dollar economic hedge that didn't work.  Make no mistake about about it, the true size of this horror is easily several multiples of that reluctantly disclosed "error."  This quote is from a good friend who has spent his career at four different Wall Street firms, including the pre-collapse Lehman - in other words, he knows quite a bit about what goes on behind the scenes in bank risk portfolios:  "Saying this is less than ten times the disclosed amount is being generous."

What we know for sure is that there is a derivatives trader in London working for JPM who was running a trading/capital position that is thought to be as large as $200 billion.  For JPM/Dimon to publicly claim that the embedded loss in this position is only 1% is complete fraud.    To begin with, JPM's stated book value as of 12/31/11 is $183 billion.  There is no way in hell that JPM would call a surprise conference call to disclose a loss from a bad hedge that amounts to less than 1% of shareholder equity.  Even by today's absurdly loose accounting standards, anything less than a 5% event is not considered to be meaningful. 

What this tells us is that JP Morgan's liquidity is potentially threatened by what is unfolding in its $78 trillion derivatives book (per recent OCC filings).   Even worse, despite all the claims to the contrary, and Dimon's insistence of JPM's "fortress" balance sheet, the risk managers at JPM have no idea how to hedge $78 trillion in exposure and this myth about "net" vs. "notional" derivatives exposure is complete fraud.

The other disclosure by Dimon last night that really irritates - and one that is part of the expensive lipstick he liberally applied - is the remark that JPM has $8 billion in "unrealized" gains in its "available for sale" portfolio.  Give me a break.  I would challenge Dimon to go ahead and sell those holdings at market and let's see what the real number is.  I would not be surprised if what is realizable is a small fraction of that.  While we won't know what the true mark to market status of JPM's book value is, I would bet meaningful money that it is less than half of what is being stated in its 10k/10q filings.

Beyond all of this, we really don't know much.  JP Morgan did a masterful public relations job at obscuring the facts and minimizing the data and details that would be meaningful to any analyst who is looking for the truth.  But we should expect nothing but this kind of useless bullshit given that the Obama Government has made it clear that they are not going to do anything to implement supervision and law enforcement on the group of banks and individuals who have contributed and raised the most amount of money for Obama's 2008 and current election campaigns.

For source material and good articles on some of the numbers I used above, please read these links:
JPMorgan Whale Harpooned?Financial TimesBloomberg

Those do not take long to read and will shine some light on the truth in the context of my commentary.  Have a great weekend.


  1. This story cracks me up...Roundy's blames the Packers early playoff exit for their Q1 earnings miss.

  2. ROFLMAO. Good find. Wonder what Kobe blames the ass-kicking the Lakers got last night by the Nuggets...

  3. So this is tip of the icebeg stuff coming to light, you say. In that case, would you go short the financials now (such as XLF)? Would you just go short JPM, GS, and/or MS? I know you don't follow them, but you must have an opinion.

    Speaking of opinion, and getting back to your core competency, what are your three favorite gold mining stocks right now, and why? They are looking juicy these days after the selloffs.

    1. I like Rye Patch Gold. Long research story, but the bottom line even without the CDE property they claimed, I value Rye Patch at $3 with gold where it is now.

      AUMN. AUMN is the old ECU trading at .25. At one point in 2006, ECU ran up to over $3.30. The only thing that's changed is that the resource base has tripled. AUMN brings cash, professional management and another possible world class silver deposit in Argentina. This stock should be closer to $10 right now and has incredible upside.

      Eurasian Minerals EMXX. This story has so much unlocked value that I couldn't do it justice here.

      I'm busy making a list of penny stocks to research.


  5. What would be the top banks and financials to short in the UK or Europe in your view?

    1. Deutsche Bank and Barclays. Here: Goldman, Morgan Stanley, JPM

    2. Having said that, if more LTRO is rolled out in Europe, which it will be, and more QE here, which it will be you don't want to be short any stocks.

      Physical gold/silver and good mining stocks are going to well in any scenario over the longer run.

      This ISN'T about making a lot money in the stock market, it's ALL ABOUT wealth preservation.

  6. Dave, this interview on King Wold News with Rick Rule has me freakiing out, since I hold positions in several mining shares. He seems to be saying that most companies on the TSX have no more than six months to survive. Does this mean most holders of mining shares are screwed?

    1. I think Rick Rule has completely mischaracterized and incorrectly analyzed the risk-off, risk-on dynamic. Money doesn't rush into Treasuries because it thinks the U.S. economy is recovering. Money rushes into Treasuries because it's the only guarantee of getting that money returned in the market. FDIC insurance only covers up to $1 million now. If a bank goes under, you don't get your money back. Because the U.S. Govt can, last resort, print money to pay back debt, Treasuries are guaranteed to return your nominal investment until everything collapses. That's why money goes into Treasuries. Short term interest rates go negative when investors with large sums of money are willing to PAY in order for the ability to get their money returned. If that wasn't the case, then they would park money in banks via short term CD's.

      In addition, the JPM thing isn't analogous to LTCM. The JPM thing is analogous to Bear/Lehman/AIG combined. It's not $100 billion mis-match issue, it's a multi-trillion dollar mis-match issue. Anyone who believes it's less severe than that does not understand how fraudulent the OTC derivatives market it. I've traded these things in smaller increments back in the 1990's with respect to junk bonds. I know how fraudulent they are.

    2. With regard to junior miners he is correct. What he is saying is that a large portion of junior mining stocks have at most 6 months of cash as their current burn rate for exploration and overhead. If the market craps out, these companies will not be able to raise money and will go tits up. We saw this happen in 2008. That's why the TSX-Venture exchange shit the bed.

      This is why you have to do due diligence on small exploration companies before you invest in them. I ONLY invest my fund's money in companies that have proved resources, at least a year of cash - at least, that have a large-cap mining company that owns at least 10% of the equity, and upper management must own a meaningful amount of stock. Two examples are Rye Patch and Eurasian Minerals.

      If the junior miners you own have at least a year worth of cash at their projected burn rate for exploration, then don't lose sleep. Save some money to buy them in case the markets all crash again like in 2008. I happen to believe that the ECB and the Fed will make sure the market doesnt crash due to lack of liquidity. Ben Davies and several others agree with me on this.

  7. (Quinn in Littleton)

    Great piece today Dave.

    Sleep well Mr. Dimon. The cracks in the derivitave markets have appeared under your feet!

    "If you should go skating
    On the thin ice of modern life
    Dragging behind you the silent reproach
    Of a million tear-stained eyes
    Don't be surprised when a crack in the ice
    Appears under your feet.
    You slip out of your depth and out of your mind
    With your fear flowing out behind you
    As you claw the thin ice." -Roger Waters

  8. Pento says KWN that the Fed is not going to lubricate the system. JPM he claims used synthetics in its interest swap book and this is what is causing the loss. The credit element of the synthetics came from European banks.

    So if the Fed doesn't provide liquidity via the ECB then the European banks (Deutche, Credit Agricole, BNP, Soc Gen etc.) will all go down. Regardless of whether the French and Germans bail them out JPM will implode because the value of the synthetics will reflect the new credit ratings. Everyone will run from JPM like they have AIDS. The interest rate swap market will dissapear over nite. Long term rates will explode as JPM is by far the major player. The Fed will have to buy the strip and Weimar hyper inflation will have arrive in six weeks if the German experience is repeated.

    Is this a risk the Fed and the ECB will take? The outcomes sound rather extreme compared to kicking the can down the road with LTRO3.

    1. I dont' read Pento, especially with regard to money printing and precious metals, because he has been way behind the 8-ball every step of the way over the last 11 years. He didn't even grab onto the gold story until about 4 years ago.

      He's wrong about more lube/QE. Go back and review Bernanke's academic views and public speeches. Start with his famous helocopter speech in 2002 w/regard to his public statements about using monetary policy to prevent deflation.

      If the ECB and Fed do not flood the system with liquidity, then we will have a serious global collapse and then all bets are off about whether or not we head for the The Road/Mad Max scenario.

    2. In Friend of Another’s (FOA) Gold Trail, he once said,

      “My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationist get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)”

      -April 2001

      Sicilian Gold

  9. Since you mentioned AUMN, I wanted to pipe in that fundamentals have deteriorated significantly since even just four months ago when they announced positive outlook on increased production for 2012 and phase one expansion plans in Jan 2012. For the negative specifics:

    They just revised 2012 production targets downward due to delayed arrival of equipment and now estimate operational cash flow break even status in late Q4 2012 and not mid-2012. Note this is break even for just the ECU mine operation and not for the company overall. Also, phase one expansion capex has doubled from $10M to $20M. Cash treasury has dwindled to just $32M ending Mar 31,2012 and start of 2012 they assumed they would exit the year with $10M, but the two quarter delay in achieving positive mine cash flow along with increased expansion capex will likely have them scrambling for funds later this year in most likely a poor market. They will announce a revised resource estimate for the ECU asset soon which will require a significant downward revision in inferred category (which currently makes up 85% of the overall number) due to unrealistic uneconomic assumptions made by previous management.

    Furthermore, the political risk in Argentina has increased significantly as evident in the recent oil&gas nationalization of assets to go along with the forced local currency exchange announced last fall. Thus, I cannot see them advancing their Argentina deposit to production status anytime soon since it has become a cash drain pit and the pitfall of investing hundreds of millions in capex relative to political risk if they even get to that stage.

    So I also was quite keen on a favourable turnaround situation earlier this year with AUMN, but management immediately stumbling with execution and the massive cash burn rate has now forced me to abandon them as investment presently. Possibly they might warrant another review in early 2013 after they successfully implement phase one expansion, but at this stage I believe there still exists significant downside even though the stock price has been pummelled to the low $5's.

    These are all just my opinions but I wanted to share them with you in case you have not kept up to speed with recent developments that occurred in just the past several days. You do a great job with your insight and knowledge that you share with the public.

    1. Trust me, I know more about what is going on at AUMN/ECU than just about anyone besides people working at the company.

      The story of AUMN isn't even about Argentina. Argentina is a bonus. The story is the massive deposit at Valerdena. Regarding the inferred category, the market wasn't really giving ECU any credit for the giant inferred number anyway. I don't care about the downward revision in inferred as long as the PP&I keep getting larger.

      In terms of production delays etc, that's an issue with every single mining company large or small.

      I don't blame you for not being interested in ECU/AUMN right now because of lack of performance, but very few stocks are performing at all in this sector. By the time you see momentum come back into AUMN, you will likely have missed a big move. This thing moves very quickly in either direction.

    2. Interesting thoughts. One other name I think is interesting with a large potential value even at much lower gold/silver prices is ANV. You have any opinion on that one?

    3. I'm anon from Sunday re: AUM. The downward revision in inferred at Velardena was even worse than I could imagine. Previously inferred composed of over 85% of PPMI, so the risk was large. New numbers indicate the loss of over 80M oz of silver (prev 97M oz) and 1.4M oz of gold (prev 1.7M oz). So at 50:1 Ag:Au ratio the inferred dropped from 182Moz Ag-eqv to just 32Moz Ag-eq! That is an 82% drop!!!

      With the new metric they definitely overpaid for ECU but then again they bought them with over inflated share prices back then too, so it is difficult to say and it gave them a producing mine which is the only thing salvaging their stock presently.

      They will run out of cash before the end of this year so expect dilution at disgustingly low prices in the near future.

    4. Actually, the original resource was heavily influenced by Michel Roy's influence over Micon. The new testing firm required much more stringent standards in calculating inferred. The measured and indicated resource did not change and the market never gave ECU credit for the big inferred resource anyway. Also, this revised estimate did not include the 50/50 JV of the San Diego property.

      The fact is that ECU would have had to spend money to re-drill the areas used by Micon orinally to calculate the inferred in order for the new firm to assess the validity of Micon's calculations.

      The new management still believes the resource is at least as large as rep'd by the old management and Micon, they just don't believe it's worth spending the money to re-drill.

      They will not run out of cash by year-end. They also have several non-core properties on the market, two of which one of the Canadian analysts has valued at $100mm.

      It's amazing ECU's resource gets as much scrutiny as it does. Guys like Jay Taylor, Rick Rule and Doug Casey pimp juniors that haven't proved up anything and don't produce anything those companies do not get any scrutiny like this...

  10. I wondered myself what the big deal was with a one or two billion dollar loss. This would be like a house burning down for an insurance company. Not a good thing, but expected to happen every now and then.

  11. Dave,

    Do you still hold a position in AUMN previously ECU silver?

    AUMN had a market cap of over 300 million when it merged with ECU which at the time was beaten way down and sporting a market cap of 250 million. The combined company now is valued at 197 million. It is a screaming buy in my opinion and I have continued to accumulate shares. Was just wondering if you still have a position and follow the company.

    All the best!


  12. I just read the comments above and see that somebody had already asked you about AUMN. My bad my friend. Next time i'll read the comments before posting one ;).


    1. No worries. AUMN has gotten hammered but so have a lot of stocks, especially juniors. AUMN probably has at least a year of cash on hand assuming no free cash flow from production. They'll have FCF from production.

      Eventually this market will turn around and rip in reverse back up. But until then, be careful with any junior positions in which the company is going to need to raise capital w/in the next year...

  13. Bundesbank rejects parliament calls to verify gold reserves parked overseas

    FRANKFURT May 14 (Reuters) - Germany's Bundesbank has rebuffed a call by

    parliament to verify the value of Germany's gold reserves, part of which

    are parked at central banks overseas, saying it is satisfied with current

    valuation procedures at foreign central banks.

  14. Wow..its really surprising to see all these worlds worst nightmare of financial crimes... people swindle billions of dollars and yet are free and not punished by law..what a shame