An interesting extract from Daily Reckoning explains the sell...

An interesting extract from Daily Reckoning explains the sell off and looks good for gold and resources.
Angers

--A quick note on gold at the Perth Mint. There is gold at the Mint, of course. It's just that most of it is not for sale. It's in allocated and unallocated accounts which belong to the Mint's customers. The Minters can't just take someone else's gold and turn it into new bars or coins. Because, you know, it's someone else's gold. As far as we know, the only gold coins currently for sale are the 1oz coins.

--Finally, let's take a step back from the day to day trading action and remember what's going on. The bankruptcy of Lehman Brothers has kick started a giant global de-leveraging. It's driving the yen and the dollar up, while commodities, shares, and nearly everything else goes down.

--"The dollar and the yen are rising in a massive, global short squeeze as investors and speculators are forced to delever," writes Randall Forsyth in Barrons. "Borrowings effectively are short sales of a currency. Repayment means covering those shorts, or buying back those currencies. Both the dollar and the yen have been used to fund investments, so they're the objects of buying-not as vote of confidence in the U.S. or Japan, but forced short-covering."

--All those borrowed dollars and yen found their way into shares and commodities. But who borrowed them? Hedge funds mostly (hedge funds run by banks, insurance companies, and private individuals). And how do you repay borrowed money? You have to sell your assets.

--It's tempting to call the massed selling of stocks irrational. But this is based on some investors looking at stock valuations and finding them cheap on an earnings basis, or looking at the cash on the balance sheet. But what you have here are extremely motivated sellers. They HAVE to sell. It's all quite rational.

--Normally, when the seller has to sell, it's a very good time to be a buyer, hence Buffett's chest-thumping op-ed piece. But you don't want to be a buyer if there's more forced selling in the pipeline. And that is now the key question in the market.

--How much leverage is left to be unwound?

--Well, before the crisis hit, hedge funds controlled US$2.4 trillion in investor funds. They would have used that to borrow trillions more (with leverage ratios of 10-1, 20-1, and 100-1). This explains how much "value" was added to global stock and commodity markets since 2003-and how quickly it's disappeared as access to credit evaporated for hedge funds and they faced margin calls AND bans on short selling.

--The result? All those assets purchased by hedge funds with borrowed money are being liquidated. And the funds that were not hedged at all (long-only, with massive leverage) are not long for this earth. Who are they going to take with them?

--``In a fairly Darwinian manner, many hedge funds will simply disappear,'' Emmanuel Roman, co-chief executive officer of GLG Partners Inc., told investors at a hedge fund conference in London. "This will go down in the history books as one of the greatest fiascos of banking in 100 years."

--True that.

--Governments want to regulate hedge funds. They've already begun to do so by preventing them from shorting. But remember, if a hedge fund can't short, it can't really hedge. Performance suffers. Investor redemptions increase.

--The more hedge fund investors want their money back, the more selling in the markets. The very regulation designed to prevent falling stock prices via short selling may accelerate falling stock prices via hedge fund redemptions.

--In fact, only the lock-ups by hedge funds which prevent investors from getting their money back are preventing an even greater pace of redemptions. But when those lock-ups expire, watch out. That's assuming the funds are still operating and haven't suffered irreversible losses.

--Either way, you see how a new low on the markets is entirely possible. Our prediction? Stock markets are going to get a hefty global bounce in November. There are at least three events on the horizon that could provide the boost.

--First, if Obama is elected, you have the end of uncertainty about the U.S. election (and some highly irrational optimism that things will now be different, better, and nicer). Second, you'll get a new stimulus plan from the Democratic Congress in the U.S., which should give stocks a bit of a kick. And third, the big G20 meeting in Washington Kevin Rudd is headed too. Something that looks and feels good should come from that.

--Those three factors may conspire to produce a convincing looking bear-market rally into Christmas. That would be the sucker's rally of 1929-1930. Or, we could be dead wrong and deleveraging may simply overwhelm everything else. It's also possible, of course, that the bulk of the hedge fund deleveraging has already taken place. But we're not counting on it.