Fear Factor

Good Morning,

The global credit blaze raged on overnight despite signs that additional central banks joined the worldwide rate cut campaign. The intense heat melted Iceland - its banks, stock market, and currency dissolved into a sorry-looking puddle. The financial ramifications of the collapse raised tensions with the UK as it prepared to sue Iceland over lost depositors' savings. On the other hand, it seems like if Icelanders could paddle hard, they might choose a N/E course, and start heading closer to their new savior: Russia.

Cryptic words from Henry Paulson gave some the jitters, and others some hope. The Treasury boss said that he " will use all of the tools we've been given to maximum effectiveness." For now, the translation of "tools" has resulted in one interesting bit of news: Uncle Sam will (temporarily?) 'nationalize' some, or many US banks, to the tune of about a 30% ownership stake. Now that's some capital 'injection.' Welcome to Amerika. One thing Mr. Paulson was not cryptic at all about, was to forecast additional US bank failures. As certain as night following day, that.

Gold prices fell back overnight, as more investors ran to cash (go figure) following Wednesday's widespread rate cuts. Fears persist about the effectiveness of what appear to be desperate acts by desperate men and thus the flight to safer havens continued. However, bullion appears to rotate in and out of phases of liquidation and accumulation. This, despite ultra-confident previous forecasts that the metal was going to rise and only rise, bailout plan or no bailout plan. Does not quite work that way, evidently. High prices have once again put a damper on critical Indian demand - this, at a time when it ought to be roaring ahead. The Dussehra-Diwali festival window is now open, but India's soon-to-be in-laws are not exactly beating a well-worn path to their nearest gold purveyor.

New York spot prices opened under liquidation pressure this morning, quoted at $888.00 - off $18 from yesterday's finish. The decline came despite a marginally weaker greenback (off 0.29 at 89.21 on the index) and a small gain in crude oil (up one quarter at $89.21). Stock futures indicated a positive open for a change, on this, the one-year anniversary of its all-time high of 14,164 - nearly 35 percentage points ago... Unhappy anniversary.

Silver slipped 15 cents to $11.62 while platinum finally found some firmer ground and rose by $26 to $1026.00 per ounce. Palladium added $4 to $197.00 per ounce. Hopefully, gold will find some support near $875 and try to get back to above $900 in short order. Given the amalgam of current conditions across all markets, and the fact that some have now stopped trying to tally the total size of this most serious financial event, gold should inherently be some 50% higher than the price levels with which it is wrestling at this time. At least, that's what we've been told ever since...oh, 1979 or thereabouts.

At the end of the day, most of what we are witnessing today is a product of human emotions and ambitions. Irrational exuberance has been replaced by lucid panic. The extreme of the latter has not yet been reached. You may wish to avert your vision at the time it does. Bloomberg's Matt Benjamin dove into the psychological aspect of the current episode of "Global Fear Factor" and found some interesting angles to ponder. Herewith, excerpts from his article:

"Greed and fear are the emotions that rule markets. Fear is winning.

"People are driven by images of the best and worst that can happen," says George Loewenstein, a professor of psychology and economics at Carnegie Mellon University in Pittsburgh. "The image of the worst is much more vivid in their minds right now." The widespread fear of losses has taken John Maynard Keynes's so-called animal spirits, "a spontaneous urge to action rather than inaction," out of the markets.

Normally, a little fear is a good thing, economists say. For decades after the 1930s, memories of the Great Depression tempered optimism and kept asset bubbles from growing too large. Today's fears, however, have reached an intensity that magnifies every additional piece of information and creates a vicious circle, according to Hersh Shefrin, professor of behavioral finance at Santa Clara University in California. Wall Street's so-called fear index, the VIX, measures the cost of using options as insurance against stock-market losses. It reached an intraday record of 59.06 today.

"When we are panicked we misread signals, we misread mild threats as catastrophic threats and we become unduly conservative," says Shefrin, author of a 2000 paper, "Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing." That's one reason why, even as the Fed made $1 trillion available to banks, lending fell off a cliff. Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, sees a parallel to 1932, with credit markets bad and the stock market falling just ahead of the presidential election that put >Franklin D. Roosevelt in the White House.

"But I'm not sure anyone is FDR this time," says Geisst, author of "Wall Street: a History," who puts the possibility of another Great Depression at 50 percent. "I don't think either candidate has a clue what they're dealing with here. This is more than a political problem that's going to blow over."

When experts and authority figures are uncertain, it's especially crippling, says Paul Slovic, a professor of psychology at the University of Oregon in Eugene and founder of Decision Research, which investigates decision making and risk. "It makes people feel vulnerable and leads to greater anxiety," he says. Within days of his inauguration, Roosevelt declared a bank holiday and held the first of his "fireside chat" radio addresses to try to reassure Americans. In the days after Lehman and AIG melted down last month, President George W. Bush was nearly silent, uttering a total of 160 words about the worst financial crisis since Roosevelt's time.

Another large component of fear is ambiguity, psychologists say. Investors simply don't know what is going on, making them even more anxious. Faced with an unfamiliar situation, humans, like other animals, retreat into "fight or flight" mode, Shefrin says. It's simply going to take time for investors' fears to subside. With asset prices plunging, greed will eventually make a comeback.

"An important aspect of greed is to avoid a situation where others are doing better than you because you remained conservative," say Baruch Fischhoff, a cognitive psychologist at Carnegie Mellon University in Pittsburgh who studies decision making. Some investors are concerned about not being conservative enough, says Stefan Greenberg, a managing director at Lenox Advisors in New York, which counsels high net-worth individuals. His clients are calling to ask if their money-management firms are still solvent and whether they should sell their holdings, moving 100 percent into cash.

"We hear a lot of emotion, we hear a lot of fear" Greenberg says. He is urging clients not to liquidate their portfolios. "Of course there's panic," he says. "The next few months will take a strong stomach."

And so, the "Fearnami" rolls on. No headlines can offer shocking surprises anymore. Like the one about California falling off the cliff unless it receives a $7 billion defibrillator shock application. We are talking about the seventh largest economy in the world if placed into the proper context. When it comes to bulldozing, the current crisis make no distinction between hot (California) or cold (Iceland), or big or small. Find one weak balance sheet, and the entity it is attached to, instantly turns into a potential domino.

Fret.

Jon Nadler

Senior Analyst
Kitco Bullion Dealers Montreal

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