Gold News

October Crash, 2008

So just what-in-the-hell happened to world stock markets during the October 2008 Crash...?

OCTOBER IS FAMOUS for stock markets crashes, writes Gary Dorsch, editor of Global Money Trends – the Crash of 1929, Black Monday 1987, the Asian Contagion of 1997, and the Sub-Prime Crash culminating in October 2008.

US Treasury chief Henry Paulson's ill-fated decision on Sept. 14th to pull the plug on the 158-year old brokerage firm of Lehman Brothers set in motion a horrific chain of events that unleashed a torrent of panic selling on commodity and global stock markets, froze the European and US banking systems, and changed the direction American politics for years to come.

At its lowest point in October 2008, the meltdown in equities around the world erased $12 trillion of market value for the month and $31 trillion from a year earlier. Lehman's bankruptcy left sellers of credit default swaps with liabilities of $270 billion, and hedge-funds scrambled to raise cash by selling anything they could get their hands on, including commodities and stocks.

The Reuters/Jefferies Commodity Index plunged by 23% in October, its steepest monthly decline since 1956. Investment-grade corporate bonds lost 7.4% in October, their worst month since the inflationary blow-out of 1976.

At the same time, US home prices continued their unrelenting slide for a 20th straight month, reducing homeowner wealth by about $3 trillion. Stock market losses add-up to an additional $8 trillion of lost wealth. This could force US households to cut aggregate spending by $300 billion a year or more.

The Treasury's bail-out – aiming to purchase toxic mortgage-backed securities from banks – was badly flawed and utterly rejected by the marketplace. Even after the House finally passed the bill on October 3rd, the Dow Jones Industrials plunged another 3,000 points and free-falling to a five-year low. It was not until the British and Eurozone governments moved aggressively to inject capital directly into their own banks, and the US Treasury then followed suit, did some measure of calm and stability return to the global stock markets.

But for "Maverick" McCain, the collateral damage from the October market meltdown torpedoed his long-shot bid for the presidency. The Dow Jones Industrials rallied 15% in the week prior to Nov 4th election results, a move that surprised many traders, because Barack Obama's higher tax policies – combined with far-left Democratic control of Congress – defied the conventional wisdom that markets like lower taxes and at least some gridlock on Capitol Hill.

However, soon after Obama's victory speech in Chicago, the stock market rally fizzled out, and the Dow began melting down 800-points over the next 36-hours of trading.

Americans are naturally eager for fresh start – a "New Deal" – as is typical during periods of economic hardship. And a majority of voters turned to Obama in a giant leap-of-faith.

This is a man many Americans know little about, and with no executive experience, after less than four years out of the Illinois Senate. McCain tried to paint Obama as a tax-raising Socialist, who will "spread the wealth around", a fear that resonates with the biggest and most powerful traders in the financial markets.

Uncertainty over how Obama and the far-left Social Democrats in Congress would alter tax policies for US-multinationals listed on the NYSE, and capital gains taxes on wealthy investors, intensified the stock market's meltdown in October. On corporate taxes, Obama proposes to tax world-wide income earned by American multi-nationals at the 35% domestic-corporate rate, the world's second highest.

Obama is also promising a windfall profits tax on oil companies, and in his stump speeches talked about lifting the capital gains tax on wealthy investors to 20% next year.

The volatility on Wall Street was unprecedented in October, with gut-wrenching swings of 500-points or more per day.

The CBoE's Volatility Index (VIX), which measures how much traders are willing to pay for stock options (typically at-the-money S&P500 index put options) soared to a high of 89.5 on October 24th. The VIX tends to go up during sharp market declines, and falls during sideways or rising markets. And even in the biggest panics so far this decade, the VIX did not move above 48.

Most importantly, the VIX is regarded as a contrarian indicator. Historically super-high VIX readings signal extreme fear and panic, and have coincided with significant bottoms in the stock market. On October 25th, contrarians lifted the Dow nearly 900 points higher, betting the fourth worst bear-market in history had run its course:

  • The 2000-2002 bear market saw US stocks fall 49% before finding a bottom;
  • The 1973-1974 bear market lost -48-percent;
  • After the 2008 bear-market tumbled 46% from the Oct. '07 high, contrarians figured that the trading patterns of the past would once again serve as a reliable guide for the future.

The "Group of Seven" cartel of central bankers also played a key role in engineering the late October stock market surge, with the Bank of Japan capping the rise of the Japanese Yen against other major foreign currencies.

On Oct 26th, the G7 central bankers issued a veiled threat to intervene in the marketplace, if necessary, to block the Yen's advance.

"We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability," the G7 finance officials said.

The next day, Japanese Finance chief Shoichi Nakagawa warned that Tokyo's financial warlords were "watching the foreign exchange market with great interest"...secret code words for intervention to weaken the Yen. Within 48 hours, the Euro had surged ¥10 to ¥125, and the US Dollar rebounded from a 13-year low of ¥91 to as high as ¥99.70.

The unwinding of "Yen Carry Trades" that has been terrorizing the global stock markets since the Lehman bankruptcy was successfully brought under control by the G-7 central bankers. However, threats of intervention can't suppress the Yen forever, not in a market where roughly $550 billion changes hands each day. Tokyo backed-up its verbal intervention threat by pressuring the Bank of Japan to cut its overnight loan rate to 0.30%. Currency traders hadn't been expecting a BoJ rate-cut and quickly scrambled to cover short-Dollar positions towards ¥100.

The Brazilian Real – a key "commodity currency" – also rebounded against the Yen, a catalyst that ignited a 30% rebound in Sao Paulo's Bovespa Index. Emerging stock markets in Asia and Latin America soared after the Federal Reserve swapped $30 billion with Brazil, Mexico, South Korea and Singapore to bolster their foreign currency reserves. But Brazil's government is still struggling to prop up its currency, which has already lost a third of its value against the Japanese Yen.

In Japan itself, the Nikkei 225 index plunged to its lowest in 26 years in late-October, shedding 60% from a year earlier and handing investors $2.5 trillion of losses. Japan's factory activity index plunged to 42.2 in October, far below the 50-mark dividing growth from contraction for the eighth straight month and suggesting the worsening global slowdown has pushed Japan deeper into recession.

New export orders, a key engine of growth for Japan, fell to 37.5 from 45.4 in September, the lowest on record, after contracting for the ninth straight month. Japanese exporters are also getting battered by the stronger Yen, which reduces the value of overseas profits earned in Euros or US Dollars when repatriated back into local currency.

To make matters worse, Toyota, the largest Asian automaker, reported US-auto sales plunging by 23% in October from a year earlier. Honda, Japan's second-largest automaker, said car and light truck sales fell -26% from a year ago.

If traders were looking for China to miraculously to save the world economy, the latest signs of an economic slowdown in the Asian juggernaut are not promising. The CLSA China Manufacturers Index (PMI) showed that factory activity contracted sharply in October, falling to 45.2, its lowest level since the surveys began in June 2004. Manufacturing is a key engine of growth for China's juggernaut economy, and accounts for about 42% of China's gross domestic product.

Companies from Hong Kong, Taiwan, America and Europe had previously flooded into Guangdong province to set up low-cost factories that made everything from sneakers to laptops and iPods. China's vast manufacturing hub along the Pearl River Delta has long been regarded as the world's factory floor. However, Chinese manufacturers are now seeing their order books cut, both at home and abroad, as the world economy falls deeper into recession. For the first time in three years, the growth rate for Chinese exports in the third quarter of 2008 declined.

Government statistics show that 67,000 Chinese factories were shut-down in the first half of this year, and another 33,000 plants will closed by year's end. Factory owners in China were already straining under soaring labor and raw-materials costs, as well as the appreciating Chinese currency. When the credit crunch took hold, Western importers slashed orders for Chinese goods and bankers curtailed loans to factories. So many operations were pushed over the edge.

China has been the biggest driver of global demand for commodities this decade, including agriculture, base metals, and energy. For instance, from 2000 through 2007, China's energy demand grew by 65%, and accounted for a third of the total increase in oil consumption around the world. One big question is what will happen to Chinese oil demand if the global economy goes into a tailspin.

Given that there are 2.2 billion people in China and India, there should be plenty of demand for commodities, even if their economies slow to an average growth rate of around 7% in real Dollar terms. Yet signs of "demand destruction" from China's factories in recent months have sliced the Reuter's Commodity Index in half.

Commodity markets have been on their wildest ever roller-coaster ride this year, soaring amid an inflationary boom in the first half, and then plummeting in a deflationary bust in the second half.

At its peak in early July, the Dow Jones Commodity Index stood 40% higher than a year earlier, led by spectacular gains in energy, grains, and precious metals. But signs of a serious worldwide recession have meant the end of the commodities boom.

Gold Bullion, tracking trends in the broad commodity indexes, has tumbled 28% since a record high of $1,030 /ounce on March 17th. Mitigating some of gold's vulnerability to sliding commodities was its traditional role as a hedge against global security risks – and US vice-president elect Joe Biden might be right. There could be an international crisis to test the new American President in 2009.

Perhaps North Korea will refuse to honor its disarmament promises, and fire up its plutonium reprocessing plant. Perhaps Iran's Revolutionary Guard units located in Lebanon, the Gaza Strip, southern Iraq, and its "special groups" in the Persian Gulf, will become more active, once the US military withdraws from Iraq.

Tensions in Russian-American relations have also been driven to a post-Cold War high by Moscow's invasion of South Ossetia. Russian President Dmitry Medvedev wasted no time after Obama's US victory, and in his first state of the nation speech on Nov 5th, said Moscow will deploy Iskander missiles near Poland, plus equipment to electronically hamper the operation of US missile defense facilities in that former Warsaw Pact member as well as the Czech Republic.

"From what we have seen, the creation of a missile defense system, the encirclement of Russia with military bases, the relentless expansion of NATO, we have gotten the clear impression that NATO is testing our strength," Medvedev warned.

On the financial crisis, Medvedev said overconfidence in American dominance after the collapse of the Soviet Union "led the US authorities to major mistakes in the economic sphere.

"The American administration ignored warnings and harmed itself and others by blowing up a money bubble to stimulate its own growth," he said. Of course, the Kremlin has also been guilty of inflating the Russian stock market bubble, expanding its own domestic money supply by an average of 50% per year.

Soaring oil prices also fueled a boom in Russian stocks over the past few years, and bloated Russia's foreign exchange reserves to a peak of $597 billion – the third-largest in the world – from just $10 billion in 1998. Four years of high oil prices have left the country with no foreign debt. But since July, sliding oil prices, concerns about the Russian banking sector, and a mass exodus of foreign investors from Russia's stock market, has wiped-out three-quarters of the Russian Trading System Index's value, led by Gazprom and Rosneft, the country's biggest energy companies.

Moscow has been forced to draw-down $113 billion from its reserves to $484 billion, in order to support state-run banks with subordinated loans, to buy equities on the stock exchange, and to defend the Russian Ruble in the foreign exchange market. Russian kingpin Vladimir Putin argues there is no alternative to his prescription of greater state-control over the economy and stock markets, and that the turmoil in Western capitalist economies only proves it.

Since August, the Bush-Paulson team has seized America's largest insurance company, AIG, nationalized mortgage giants Fannie and Freddie, pumped $250 billion into US-banks, paid the $29 billion dowry for Bear Stearns to enter its shotgun marriage with JP Morgan Chase, and will soon bail-out GM, Ford and Chrysler.

Is America sliding on the slippery slope towards Europe's "Enlightened Socialism"...?

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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