Derivatives are a bet against volatility. Guess what has happened? Surprise, surprise! Volatility has vanished. The VIX looks like an ECG when the patient has died! Gold has an unofficial $6 rule. The DOW is not allowed to drop more than 200 points and it must rally the following day. Interest rates must not rise, if they do the FED must issue more of their now secret M3, ship it offshore to the Caribbean and pretend that an unknown foreign bank is buying US Treasuries like crazy.

But the sham is coming unglued because the huge excess liquidity that has been injected into the system to prevent it from imploding is showing up as asset bubbles all over the place and shortages of raw materials are everywhere. There is massive inflation going on. There is NO major economy in the world not inflating their money supply by less than 10% annually. But where are the “bond vigilantes”? Where are these super smart traders who dump bonds at the whiff of inflation? Where have they been the last 5 years? This is a major conundrum! No, it’s not! I think you will find that the classical “bond vigilantes” are the same big banks who hold massive concentrations of derivatives and are on the hook for trillions of dollars if interest rates go up. Voila, a bond vigilante can lose his religion overnight in such circumstances!

The details of the bailout of Bear Stearns hedge funds have been kept secret. It is essentially an agreement not to claim on their “insurance policies” because the insurance is a sham.

This may seem smart for the derivative sellers. But what about all the derivative buyers? Are they going to continue to payout premiums and fees for insurance that doesn’t exist? When that panic thought hits the herd there will be a whole new definition of volatility!

When looked at in this perspective, it is pretty clear why gold had to be contained at all costs over the last few days while the Bear Stearns debacle was unfolding. But this has cost The Gold Cartel dearly in dishoarding physical gold. Unlike the ex-bond vigilantes, the buyers of physical gold are not corrupted by being party to the derivatives scam. The average Indian farmer doesn’t even know what one is! The buyers of physical gold keep buying physical gold because it has always been money and always will be money. The buyers of physical gold know that they will be financially secure whatever happens. Some how I suspect that these new whiz-kid invented financial instruments that need to be “engineered” and computer modeled to determine their value will not be around after 6000 years as a store of wealth. Gold is still around after 6000 years and its price is flashed up on the Bloomberg and CNBC screens in real time. My guess is that in the next few years there will be a new contender for the title of “barbarous relic”, and it won’t be gold.

Cheers
Adrian