A Derivatives Bomb Exploded Within The Last Two Weeks

I’ve never seen so many sophisticated Wall Street’ers this scared in my entire career.  – This comment comes from a very well-connected Wall Street/DC insider and is in reference to how illiquid the bond markets have become

Something deep and dark has transpired behind the Orwellian “curtain”  used by the elitists to hide the inner workings of the financial markets, especially with regard to big bank balance sheets and OTC derivatives.  What’s happening right now reminds of the movie “Jurassic Park.”  You can hear and feel the monster coming but you can’t see it yet and you don’t know it will pop up in your face or how big it is.

It was the sudden firing of Deutche Bank’s co-CEOs this past weekend – The Brown Stuff Is About To Hit The Fan – that prompted me to spend more time analyzing a sequence of events which indicate to me some sort of derivatives position, possibly at Deutsche Bank, has exploded.  In addition, the stock and bond markets have been emitting some curious signals which reflect that fact that something happened in the global economic and financial system.

Let’s look at some charts first (click on any chart to enlarge).  The first graph below shows a 1-yr plot Dow Jones Transportation Average vs. the S&P 500:


As you can see, the DJ Transports and the S&P 500 were tightly correlated until the end of April 2015. The Transports hit an all-time high on October 25, 2014, which is about when the Fed formally ended its QE program.  The DJT began to underperform the S&P 500 at the end of April.  Since then it began to diverge quite negatively from the S&P 500.   The DJ Transports are largely made up of trucking, railroad and delivery services stocks.  This sector of the market reflects the heart-beat of economic activity, especially as it relates to consumer spending in the United States.  The Transports are down 9.4% from its all-time high.  I wrote about the collapsing U.S. economy a week ago:   LINK  The behavior of the Dow Jones Transports is the market’s confirmation that the U.S. economy is contracting.

A collapsing global economic system will exert an unanticipated and extreme amount of stress on highly leveraged financial systems.  This stress is “magnified” by the enormous amount of derivatives which are connected to the disastrous amount of global debt.

An even more curious chart is the relationship between the yield on the 10yr Treasury bond and the DJ Transports:


As you can see, the yield on the 10yr Treasury bond has been trending higher since the beginning of February while the DJ Transports has been trending lower.  Notice a problem?   In a “clean” market – i.e. a market free from Central Bank and Government interventions, interest rates and the DJ Transports should be positively correlated.  If the economy is contracting, as reflected by the direction in the DJ Transports, the yield on the 10yr Treasury should be declining – not rising.  You can see that when the DJ Transports ran up to an all-time high, the 10yr yield spiked up, reflecting the markets perception that the U.S. economy might be strengthening.

It does not make sense that the 10-yr Treasury yield is moving higher – quite rapidly – while the DJ Transports are tanking – quite rapidly.  In the first week of June, the yield on the 10yr Treasury bond spiked up from 2.09 to 2.40, a 14.8% move.  This is a big move for yields in just 5 trading days, especially in the context of a rapidly weakening economy.   Worst case, 10yr yields should have remained flat.

I believe the illogical movement in 10yr Treasury yields reflects the fact the Fed is losing control of its tight grip on the bond market and longer term interest rates. Note that German bunds have also experienced a similar spike up in interest rates and volatilty.  In the context of my view that there was a derivatives accident somewhere in the global banking system in the last two weeks, it could well have been an OTC interest rate swap bomb that detonated. 

As of the latest OCC quarterly report on bank derivatives activity (Q4 2014), JP Morgan held $63.7 trillion notional amount of derivatives, $40 trillion of which were various interest rate derivatives.  If you look at the ratio of interest rate derivatives to total holdings for the top 4 U.S. banks, they all own roughly same proportion of interest rate derivatives as percent of total holdings.   Deutsche Bank is reported to have about a  $73 trillion derivatives book. If we assume that ratio of interest rate derivatives is likely similar to JP Morgan’s, it means that DB’s potential derivatives exposure to interest rates is around $46 trillion.  I will elaborate on this below.

But first, one more graph related to interest rates:


This graph shows the price of the 10yr Treasury bond futures contract going back to May 2014.  Interestingly, the price of the 10yr moved abruptly higher after the Fed ended QE. This is the opposite of what many of us would have expected.  It wasn’t until early February that 10yr bond price began to decline (yields move higher).  As you can see on the right side of the graph above, the 10yr bond price plunged below the blue uptrend line. The 10yr bond price also crashed through its 200 day moving average – an ominous technical signal.  Both of these events happened within the last week.

Again, I believe that this action in the bond market is pointing to the fact that the Fed is losing control of the markets. I also believe that the catalyst for this loss of control is a big derivatives accident of some sort in the last two weeks.

Another clear indication that something has melted down “behind the scenes” recently is an ominous market call by self-made hedge fund billionaire Paul Singer, founder and CEO of Elliott Management.  In his latest letter to investors, released the last week of May, he stated that the best trade in a generation is to short “long term claims on paper money.”

A savvy investor like Paul Singer would not make a public market call like that unless 1)  he had already positioned his fund accordingly  2)  he had some sort of insight about what was happening “behind the scenes” either first-hand or from insiders who were in a position to give him information and 3) he was 99% certain that his insight and information was correct.  In other words, it highly likely Singer had already made huge position bets for his fund and his own money which would capitalize on a systemic disruption of some sort (Elliott Management was one of the hedge funds with which I dealt when I traded junk bonds in the 1990’s. I knew them to be methodical and always looking for inside information).

Finally, I believe that whatever type of financial explosion occurred is related to the sudden firing of Deutsche Bank’s co-CEOs, Anshu Jain and Jurgen Fitschen.  Fitschen is the equivalent of corporate executive abortion.  He’s under investigation for tax evasion and on trial for giving false testimony in a long-running legal battle related to the collapse of the Kirch media conglomerate, one of Germany’s biggest media empires.  It’s incredulous to me that he wasn’t fired a long time ago.  It tells us just how recklessly this bank is managed by the Board of Directors.  It also suggests a grand failure by German bank regulators.

It’s the firing of Jain that caught my interest.  In a management shake-up a little over two weeks ago, Jain was given more power by the Board and shareholders.   So why was Jain suddenly and unexpectedly fired less than three weeks after having been given more control over the bank?

As I wrote yesterday, Jain’s raison d’etre was to build Deutsche Bank into the world’s largest derivatives dealer.  On May 26, it was announced that Deutsche Bank had reached a settlement with the SEC for improperly valuing its its risk exposure to its Leveraged Super Senior trades book of business (credit derivatives).   This in and of itself was not the cause of the Bank’s reversal on Jain.  But  I can guarantee that this is just the tip of the iceberg with regard to fraud and risk exposure connected to Deutsche Bank’s derivatives business under Jain’s stewardship. We found out in 2008 that bank CEOs and CFOs not only lie to each other and their employees, they also lie to regulators.

I referenced Deutsche Bank above in connection to big bank interest rate derivatives exposure.  I believe that the high volatility in the global fixed income markets has triggered some kind of derivatives blow-up at Deutsche Bank.   While the smoking gun points to some kind of interest rate-related derivatives melt-down, it could also have been related to Greece sovereign debt credit default swaps or energy-related derivatives.

While I’m fairly certain that all the evidence points to Deutsche Bank as the source of what I believe is a derivatives accident that has occurred in the last two weeks, don’t forget that the majority of banks and hedge funds globally are linked directly or indirectly through the “magic” of OTC derivatives and counter-party default risk.  We saw this “natural” law of derivatives risk in action in 2008 and recently when a small German bank blew up from its exposure to an Austrian bank which choked to death of Greece-connected credit default swaps.

There’s other signals which I didn’t cover, like the fact that the S&P 500 is has dropped 2.5% in the last 10 trading days since hitting an all-time high May 21.  In addition, the US dollar index has plunged 170 basis points in the last six trading days.  This is a huge move for a currency in such a short time period.  Having said that, regardless of which bank and what “flavor” of derivative may have blown up, I believe that something big and hidden melted down in global financial system during the last two weeks.

This could be the start of the big financial markets inferno that many of us have been expecting for quite some time.

My best advice for anyone who wants to protect themselves financially is to get as much money OUT of the system as you can.  It’s up to you whether or not you convert your cash into physical gold and silver, but I think at this point only an idiot would leave his money in the system and denominated in paper dollars.



64 thoughts on “A Derivatives Bomb Exploded Within The Last Two Weeks

  1. Thanks for this great summary Dave. My thought is that the CB’s know all this is happening, why can’t they just make sure they have all the spigots in place supplying trillions of fresh confetti to the commercials to cover the derivatives losses? Surely they already have.

    1. $2.6 trillion in Excess Reserves that belong to the banks sitting at the Fed. ECB in the middle of a money printing program. China printing. I’d say the spigots have been running wide open and non-stop. What’s coming at us will require Weimar levels of printing.

  2. I just wish to reiterate Martin’s sentiment. Your subject matter is always fabulous and your perspective is very thought-provoking. Thank you and continued good fortune.

    1. Thanks for the feedback Phil, Martin. I appreciate. Makes the 2.5-3 hours I spent til 12:30 a.m. last night writing that piece worth it

  3. I wonder if that creep Joe Lavorgna has positioned himself appropiately in the open window on th top floor?

    Waiting for a “friendly pad” on the back!

    1. I will never take flying lessons without equipment.
      The only honorable way out of banking is to run
      to the least inhabited island, with my nail gun in tow
      hoping that I will not have to use it.

      1. Joe if you decide “to take the easy way out” do it the “banker way”

        3 shots in the back of the head.
        3 shots in the back.
        And another 2 in the forehead

  4. Awesome Dave! It must take vast amounts of energy to dig so deeply into these obfuscated markets. Thanks for your hard work and shining some light onto these purposely redacted subjects and issues!!!

  5. Magical S&P500 bounce again today. This market will blow up eventually but these criminals sure won’t make it easy.

  6. “It also suggests a grand failure by German bank regulators”

    Just like American Bank Regulators & Alphabetical Agencies.

  7. “…when a small German bank blew up from its exposure to an Austrian bank which choked to death of Greece-connected credit default swaps.”

    This has been often repeated but is wrong. Actually, all central Europe (Poland, Hungary, Slovakia, Czech Republic, Croatia) has the same problem of defaulted loans made in Swiss franc, and can be traced back to the volatility of the Swiss currency. Austrian journalism has been explicit on the issue.


    Sterling work Dave, cannot help wishing we could have the take of Rob Kirby on this issue–though, perhaps his lack of recent involvement in the derivatives market will not allow him specific pronouncements.

  8. I’ve come to the conclusion that the World is in a giant cage match. Inside is a Kuomodo Dragon ( China ) and a Bear ( Russia ). And nobody in the MSM seems to feel the need to tell the people that the fight is on and started a long time ago.
    Thanks Dave. Always enjoy the work.

  9. The German police have raided the headquarters offices of the Deutsche Bank, which are located in Frankfurt. The public prosecutors office have reused to confirm or deny, that the raid is connected to the termination of the Co-CEO’s of Deutsche bank.

  10. Hey Dave,

    Great research. I can’t imagine how bad the losses are if the largest Bank in the World fires their CEO. Usually a CEO goes out after a big search and all the fanfare. Not these guys. Boom get the fudge outta here. LOL. Zero Hedge reported a a 20% or 50,000 person layoff announced from HSBC. Gotta wonder if they weren’t on the same side of the trade as Deutche Bank. Is this the domino no one saw coming? Everyone focused on Greek contagion and bam…right in the kisser. Germany hits the mat.

    Is this the domino that starts a world war? Is this the domino that results in destruction of the monetary system as we know it today? Care to prognosticate? Not holding you to anything. Already getting ready…best I can.

    I also saw an unusual opinion that I found fascinating by Greg Hunter and Warren Pollock. What do you think of Mr. Pollock’s views?

    1. I haven’t paid attention to Pollack for many years. It’s easy to get informatio/analysis overload and it clouds one’s ability to think for themselves. There’s a small group of analysts to which I pay attention, like Paul Craig Roberts, John Embry and James Turk, and Pollack is NOT one of those analysts.

      1. Dave, what do you make of Casey Research under the new management of Stansberry and Associates? First things they did was give Ed Steer and his Gold and Silver Daily the heave-ho, along with Marin Katusa!
        I personally do not like the smell of Porter Stansberry. Why would anyone trust this guy with their money, when he was convicted of fraud, writing a newsletter under an assumed name and stock pricing manipulation?
        As far as Doug Casey is concerned? My estimation of him has fallen quite a few notches.

        1. Well, I won’t be paying for Ed’s Gold n Silver Daily. Casey and Stansberry are all about selling newsletters and nothing more.

          1. Ed was let go and is on his won. I like his NL and will continue to support him. He is not connected to Porter although I have done well with some of Porters minions.

  11. Hello Dave,

    As usual outstanding work. I read the article late last night after you posted it.

    I just wish that my mesmerized friends would give you a shot but their heads are in the sand.

    Oh well life and account balances go down and out.

    1. Anyone who doesn’t get it now won’t get it until their head has been clubbed hard by the two by four being swung at it. 95% of our population is effectively lobotomized.

  12. Very succinct..The end game is in progress, it is time is getting short to load up on gold and quality gold stocks. The elites/and corrupt government have stolen so much that the economy can no longer produce wealth or jobs. A reversion to the mean in interest rates will cause at least 50% losses in bonds and more in most stocks…

  13. Thanks for the great article and heads-up – excellent analysis and conclusion. Yesterday, one of my favourite chartists (Jeff Clark) also warned that something big is brewing in the background right now and that we should not sell our gold and silver.

      1. It was not an article on a website but an email to his subscribers. Here’s the introductory part:

        by Jeff Clark

        The gold price may be stagnant, but forces behind the scenes are signaling that something big is brewing. A scan of recent headlines reveals a growing fervor for gold. Check these out:

        China Creates Gold Investment Fund for Central Banks. China announced a new international gold fund. More than 60 member countries have already invested. The fund expects to raise 100 billion yuan ($16 billion). It will develop gold-mining projects in the new Silk Road economic region…..

  14. http://www.studentsforliberty.org and http://www.YALiberty.org are student activist driven college and high school orgs which are growing worldwide at close to an exponential rate. I attended one of their conferences and they are allied with pro individual freedom movement entities, e.g. http://www.fee.org, http://www.fff.org, http://www.atlassociety.org,

    They are reading the right stuff and strongly motivated with the potential to grow into a dominant force for the kind of change necessary to get the governments out of the intervention business in the foreseeable future.

    I send each of them donations and wish you would see the wisdom in doing the same.

  15. I recall Jim Willie saying a couple of years ago that Deutch bank was going to fold. Perhaps his timing was a little off. No worries, and nothing the plunge protection team can’t handle. LOL

  16. My wife sells wine and thinks that the reason that business is booming is based on people being happy.
    I disagree . Mesmerized , yeah , that’s the motivating factor !
    WTF !?

  17. In 2007, one of the worlds largest positions held in derivatives was GE Financial.

    It was announced that GE Capital will be selling US Sponsor Finance, which includes Antares Capital, GE Capital’s lending business, alongside a $3 billion bank loan portfolio to the Canada Pension Plan Investment Board.

    This is nothing more than a “back door” move to empty pension plans. I wonder how many of the investment board members have “dirty” hands and own shares of GE?

  18. The overleveraged, overheated synthetic mountain of volatile financial engineering comprised of “Sovereign Bonds” “Guaranteed Income products”, “Triple A Investments”, “High-Yield Securities”, “CD’s”, “IRA’s”, “Money Market Funds”, “ETF’s”, “REIT’s”, “Trust Funds” ad nauseum is emitting gases like a compost heap decomposing into a more stable, fungible and less toxic state. http://www.bloomberg.com/news/articles/2015-06-09/bond-market-s-storm-finally-hits-junk-debt-as-buyers-flee-etfs

  19. i know very little about finance, i tend to believe 2+2 is 4. could all this be related to the near collapse of the global bond market back near the end of april beginning of may. that was only stopped by the central banks dumping trillions of dollars and euros in to it to prop it up, similar to what jp morgan and friends did in 1926 to stop the stock market crash, and use it to steal even more obscene amounts of illusionary wealth from the masses, with a postponed and strategically created financial implosion, when most beneficial to the financial elites

  20. Thanks Dave,
    At first I thought they were dumped for a really dumb stunt, betting the lunch money on a Greek default and forgetting that it could be deferred to the month end. If doing dumb things were enough to fire bank CEOs, none of them would last until their first bonuses were due.
    But to fire them like that in my view, means that the board thinks that they may have exposed the bank to serious criminal charges, which aren’t going to be swept under the carpet. Libor on steroids.
    I don’t know enough about the laws regulating derivatives (if any) but I would guess that a major manipulation involving maybe trillions is about to become public.
    I think that for Deutsch or PJ Morgan it would be cheaper to buy Greece than to pay out the side bets.

  21. It was a good article until you got to the part about putting all your money into gold and silver. Only an idiot would do something that irrational.

    1. Why “irrational”, joe bob? Thousands of years of monetary history irrefutably demonstrates that putting one’s savings into tangible assets, such as gold and silver, in a time of economic chaos and monetary collapse is in fact highly rational.

      What would be YOUR choice for protecting your savings in this situation? Your local bank, LOL?

  22. Very interesting article.

    But I have to respond to the comment about the fervor around gold and silver.

    Every time we see extreme fervor – it signals an imminent DROP in the price of the commodity.

    I have actually done quite a bit of research on this…but its really hard to quantify.

    The higher the percentage of news and blog and comments around commodities – a coming crash in them is around the corner.

    My research has been successfully correlated to Gold, Silver, Uranium, Potash, Coal, Iron and copper.

    The only outlier is crude…

    Anyways – I am looking to gold to drop down to 1000 thereabouts.

    1. LOL. Good luck on your call for $1000 gold. Goldman is making the same call. They’ve been wrong on gold
      ever since their $850 call a couple years ago.

      Gold is not a commodity. It’s the world’s oldest form of currency.

      1. Armstrong is making a similar call or should I say his computer, Socrates, is saying gold will be going down to that level.

        1. Armstrong is a hack – a very corrupt hack. Anybody who reads his goat urine has their views damaged if they believe anything he says. Ask Jim Sinclair or Bill Murphy what they think of Armstrong. Dunno how long you’ve been around but Armstrong is a supreme scumbag

  23. Seriously….you honestly think that Jim Sinclair and Bill Murphy are reliable, impartial individuals?

    They are both known gold bugs, who directly pumped gold to the masses while it was at a generational high. They make the bulk of their income trading gold to gullible individuals. If you actually followed their writings in 2011, you would see your net worth devastated almost as bad as any market crash in history.

    Seriously….look back at how they were giving “financial advice” to dump all your assets and buy gold when it was at $1800 an ounce.

    They were forecasting gold would go to $5,000 per ounce…and suggesting that $10,000 was possible!

    1. Seriously. Armstrong is a corrupted, fraudulent hack. You have no idea what the background there is and why I’m saying what I’m saying. Clearly you have not been around long enough to know what went down. Armstrong should be in jail with key thrown away.

  24. The author has a fundamental misunderstanding of derivatives. Quoting gross notional in derivatives of xx trillion is simply scaremongering without substance. Many of those positions net out within the banks or are hedging positions for other ALM purposes. Speculating that interest rate derivatives have blown up shows a total lack of comprehension of actual derivative markets and products — especially vanilla interest rates. In fact, co-CEO Anshu Jain has been under enormous pressure post crisis at DB and under his watch the fines and penalties DB has faced have been very harsh, including recent legal action around libor and fx fixing. His personally appointed lieutenants were in charge of these books and he is known to have kept a close hand on the rudder — that is more likely the reason for the departure than any nonsense theory about a blowup in derivatives — let alone at DB. What drivel.

    1. “truthhound?” More like “Idiot.” Lack of comprehension huh? I was filling out ISDA contracts for OTC HY Yield bond put/call swaps I was executing with Harvard Management back in the 1990’s. Ya THAT Harvard Management that was run by Larry Summers. Have you EVER even been on a real trading floor, let alone work on one? Do you understand how the accounting for derivatives and what constitutes bona fide netting? You are nothing – a nobody other than some shit for brains. Go trash up someone else’s blog. I’ve forgotten more about derivatives math than you’ll ever know.

      1. To be fair to “shit for brains”, (SFB) my 7 year old son has difficulty understanding it too. It appears on the surface, that Derivatives are a zero sum game. One bank’s gains another’s loss, and it all comes out even. (Except for the bonuses to the traders, who make out like bandits.)
        Merely an exchange where the clever trader wins and the dumb one loses.
        I explained that this is true, unless one of the banks don’t have the money to pay their bet. If “A” can’t pay “B”, then “B” can’t pay “C”, who can’t pay “D” etc.etc.
        When this happens, the “end” bank says “not fair” and forces via the courts the “end – 1” bank to steal the funds from it’s depositors and savers to pay the end bank. Because, Derivatives are preferred creditors and must be paid before everyone else.
        “End – 1” then sues “End -2” with the same result all the way back to bank “A”.
        Somehow or other, funds have been taken from depositors, and the funds did not end up paying the debts “up the line” but in fact went to lawyers and OMG for bonuses to the clever bankers (TCBs) who thought up the scam in the first place.
        Again, to be fair, the clever bankers deserve their bonuses because they saved the world from a “Bank Failure”, which as everyone knows (because TCBs told us) this would mean “the end of the world as we know it”. (Don’t you dare mention Iceland)
        So SFB, who reads everything the TCBs write could easily think that everything is just fine.

  25. excellent article, the heat from burning derivatives needs to be covered by some big black smoke so we may expect much of political turmoil coming at us.

    early july the brick world banks starts operation with 100 billion usd reserves to support those who would need it – and many will

    pls add me to your mail list

  26. Great article and clear thinking. Been seeking clear explanations and commentary concerning derivitives. Please add me to the list. Thanks, Randy

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