A Bigger than Lehman Brothers Moment: Prepare NOW!

A Bigger than Lehman Brothers Moment: Prepare NOW!

Dear Reader,

We are entering the most volatile time of the year for those familiar with cycles and trends in the markets.

If something big is to happen during the year, you usually see it in September and October.

And we are staring at another one. This event could turn out big…and not in a good way!

I am talking about the Chinese property developer, Evergrande.

The company just announced that they have suspended their bonds from trading in the markets.

This comes off the back of a series of bad news over the last fortnight. This escalated to doubts about paying interest on their US$300 billion of debt that is due 20 September.

I can understand if you have trouble getting your head around the enormity of what is unfolding as we speak. The numbers are just so big.

To put it into context, no company listed on the ASX has a market capitalisation of more than $180 billion. The Commonwealth Bank of Australia [ASX:CBA] is worth this amount, followed by CSL Ltd [ASX:CSL], with a price tag of $140 billion.

Without any hyperbole, this is an absolutely massive debt default staring at us.

Meanwhile, the financial markets do not appear to have fully clued onto what is happening. They talk about it on the news and the Asian markets have slipped on the back of this. The Hang Seng Index is trading around its lows this year, too.

I would like to help us get ahead of what could come by casting our eyes back to 2008, in the events leading up to and after the collapse of Lehman Brothers. Interestingly, the default event of Evergrande yesterday is on the 13th anniversary of Lehman Brothers collapsing on 15 September 2008.

The subprime crisis and the Lehman Brothers collapse

Why am I bringing up Lehman Brothers? Because there is a parallel.

Lehman Brothers had possibly the largest exposure to US mortgage debt leading up to the subprime crisis that swept the world in 2008. The company had over US$600 billion of liabilities, with a mortgage loans portfolio worth US$60 billion.

While it is hard to directly compare the numbers, you can imagine that Evergrande is no small ripple in the lake.

What I want to talk about is the financial fallout arising from the subprime crisis.

Now, the subprime crisis is not just about Lehman Brothers. That was the climax. Several well-known financial institutions disappeared during this period including Bear Stearns (rescued by JPMorgan), Merrill Lynch (rescued by Bank of America), Countrywide Financial (also rescued by Bank of America), Wachovia Bank (rescued by Wells Fargo), etc.

What happened to the markets during this subprime crisis? The past may provide us with some useful insights into what is to come.

Let’s have a look at the major market indices. I chose the S&P 500 Index, the ASX 200 Index, and the Chinese Shanghai Composite Index. I also looked at the European and Japanese indices, but they moved in a similar fashion as the US and Australian indices, so I omitted those.

The chart below shows how much $100 invested into these on 30 May 2008 was worth on 31 December 2008:


US S&P,ASX 200,Shanghai Composite, Comparative Performance

Source: The Daily Reckoning Australia

[Click to open in a new window]

Investors sold heavily out of the equity markets during these six months, and the indices fell around 40%. Individual stocks fell by 80%, even more.

Interestingly, though, the Chinese stock market sold down more violently than the US and Australia in mid-September as Lehman Brothers collapsed. Meanwhile, US and Australian stock markets kept grinding down into the end of the year. They found their bottom in March 2009.

Most of you probably remember there was almost no escape from this firestorm. By October, investors were literally stoic as they watched their investments turn into smoke.

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Shelter from the storm and also a turbo pack

There was a safe haven during this time.

You guessed it. Gold. To some extent, gold mining companies offered limited respite.

Let’s look at what happened to gold and gold stocks during the same period:


Gold USD, Gold AUD, XAU Gold Silver Index, ASX Gold Indexa

Source: The Daily Reckoning Australia

[Click to open in a new window]

The price of gold in US dollar terms dipped in the lead up to the collapse of Lehman Brothers. It rallied for about four weeks and then fell into mid-October and bottomed on 21 November 2008. By the end of the year, it was almost at the same level as at June 2008.

And I do not need to mention about where gold went from 2008 to September 2011.

You may like the fact that gold in Aussie dollar terms actually rallied almost 40% within a month of the collapse of Lehman Brothers! Things can happen very fast.

Yes, it did give back half of its returns in October and bottomed in mid-November. But by year-end, you were almost 40% better off than at the start of June.

This brings us to gold stocks. The Philadelphia Gold and Silver Index [NYSE:XAU] and ASX Gold Index [ASX:XGD] fell quite sharply along with the rest of the market. However, it turned around pretty fast. You can see the low in mid-November.

I can still remember 21 November. I was having lunch with family and I decided to try my luck adding to my Lihir Gold holdings. It was a great purchase. I sold it four days later and pocketed a 40% return.

Had I bought more gold stocks back then, I would have done really well. I learnt after the fact, many years later.

While the past may not repeat, there are parallels.

I see Evergrande as a ‘bigger than Lehman Brothers’ event.

The ride looks rough.

I offer you a possible strategy to help safeguard yourself, and potentially even benefit.

The rest is up to you.

God bless,

Brian Chu Signature

Brian Chu,
Editor, The Daily Reckoning Australia

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