It’s no secret that Deutsche Bank AG (NYSE:DB) is headed downhill. A look at its plunging stock chart (down 33% as of Q2 2016) – and a quick glance at its Q4 2015 results, which showed a record annual loss of $7.6 billion – confirms what years of shady financial engineering and mounting legal costs have already told us. DB is in serious trouble.

As usual, Wall Street’s “expert” analysts are bullish, advising investors to hold their positions in the company in expectation of a dramatic turnaround.

My own forecast goes straight down – and I’ll tell you why.

Not only is DB a mismanaged and over-leveraged institution, it’s also a ticking time bomb that could set off the worst credit crisis since 2008.

Yes, I’m talking about the Super Crash.

In this special report, I’ll give you an overview of DB’s massive systemic risk and tell you first, how to protect yourself and second, how to profit.

I want you to fully appreciate just how bad this crash could be.

The World Can’t Sustain This Level of Debt for Much Longer

In 2016, the global economy does not possess remotely enough productive capacity to generate the income required to service and/or repay the more than $200 trillion of debt it has already incurred or, for that matter, the incalculable trillions of dollars of future promises governments have made. The United States, which is the best of the bunch, is on an unsustainable economic trajectory and is just a microcosm of the rest of the world. As Figure 2 illustrates, debt has grown much faster than the U.S. economy over recent years.

Furthermore, the gap between the growth rate of debt and the growth rate of the economy is accelerating, which means that the economy can never hope to catch up and generate enough income to pay the interest or the principal on the debt.

Yet alarmingly, the United States is in better shape than the rest of the world.

Debt vs. U.S. economy

In September 2014, the Geneva-based International Centre for Monetary and Banking Studies published a study entitled Deleveraging? What Deleveraging? where it reported that, “[c]ontrary to widely held beliefs, the world has not yet begun to delever and the global debt-to-GDP is still growing, breaking new highs.” Going further, the report’s distinguished authors warned that “in a poisonous combination, world growth and inflation are also lower than previously expected, also – though not only -as a legacy of the past crisis.” Excluding the leverage of financial companies worldwide, debt is now equivalent to 212% of global GDP, up 38% since 2008 (see Fig. 3). Debt is equivalent to roughly 264% of GDP in the U.S., 257% in Europe and 411% in Japan.

Debt vs. global GDP

While debt is rising, global growth is falling. The six-year moving average of the world’s potential growth rate has fallen to below 3% today from about 4.5% before the crisis, no doubt largely due to the much higher level of debt weighing on economies today. When increasing amounts of financial and intellectual capital are devoted to servicing debt, growth is bound to suffer. In effect, the global economy is lugging around on its back a $200 trillion albatross that is suffocating growth. Further, the study’s authors point observe: “Deleveraging and slower nominal growth are in many cases interacting in a vicious loop, with the latter making the deleveraging process harder and the former exacerbating the economic slowdown. Moreover, the global capacity to take on debt has been reduced through the combination of slower expansion in real output and lower inflation.”

As I’ve pointed out many times before, this level of debt is simply not sustainable – either on a national or a global level. We are suffocating under the weight of massive debt, which we have a rapidly decreasing capability to support.

Just as in 2008, much of this debt problem springs from a single headwater.

Derivatives: “Financial Weapons of Mass Destruction”

Warren Buffett’s famous phrase still bears repeating. One of the primary forms that this debt has assumed in the modern economy is the OTC (over-the-counter) derivatives contract….an unregulated, complex nightmare that is not investment, but pure speculation.

As you may have suspected, DB’s systemic risk stems directly from derivatives. In order to understand the gravity of the situation, it’s necessary to go a little deeper.

A derivative is a contract involving two parties that agree to make certain payments to each other. But if one party is unable or unwilling to live up to its agreement and make those payment, the other party is left holding the bag (and nursing a big loss). That’s what happened in 2008.

In 2008, AIG almost blew up because it had written too many derivatives contracts on collateralized bond obligations that held billions of dollars of subprime mortgages. AIG couldn’t meet its obligations, leaving thousands of counterparties around the world at risk of loss. This is why the U.S. government had to step in and bail out AIG – to save those other counterparties from massive losses that would have destroyed the financial system.

But the derivatives problem in the market in 2008 was much broader and deeper than AIG- there were roughly $60 trillion of credit default swaps, written on a wide variety of underlying obligations, that posed a systemic threat.

Global OTC derivatives vs. gross market values and gross credit exposure (2006-2009)

via businessinsider.com

Eight years later, despite efforts to tame the derivatives beast, these instruments of financial mass destruction still pose an existential threat to the global financial system.

One of the stated aims of the Dodd-Frank Wall Street Reform and Consumer Protection Act was to address the “too big to fail” problem in the financial industry. Unfortunately, the legislation has left us with a much more concentrated financial industry with fewer firms that are no longer “too big to fail” but actually “too big to save.”

One of the primary ways in which they became “too big to save” is in the highly concentrated derivatives holdings of a small group of firms….which I’ll discuss below.

(via edupristine.com)

The OCC reported that the notional amount of outstanding derivatives stood at $181 trillion at Q4 2015. This constituted a 5.8% shrinkage from the $197.9 trillion outstanding at the end of the third quarter, but still more than enough to pose a systemic threat during the next crisis.

As of this writing, the amount of outstanding notional derivatives is more than twice the size of the global economy.

OTC Derivatives vs. World GDP

If you think this looks like the sun dwarfing the earth, you are absolutely right.

Those who like to downplay the risks of derivatives (who without exception are people who have an economic interest in their continued growth) argue that focusing on notional derivative contracts exaggerates the risks they pose. They argue that systemic risk should be measured in terms of the lower “gross credit exposures,” which stood at about $5 trillion in December 2015. Even this number should make the hair stand up on the back of the neck of anyone who understands these instruments’ capacity to pose systemic risk.

However, the much larger notional figures (the “Sun”) are the relevant ones to focus on in terms of evaluating and managing financial stability:

“In complex systems, shorts are not subtracted from longs – they are added together. Every dollar of notional value represents some linkage between agents in the system. Every dollar of notional value creates some interdependence. If a counterparty fails, what started out as a net position for a particular bank instantaneously becomes a gross position, because the ‘hedge’ has disappeared. Fundamentally, the risk is in the gross position, not the net.” James Rickards,Currency Wars: The Making of the Next Global Crisis.

In other words, lower “total gross credit exposure” or “gross market value” will only be relevant when it doesn’t matter, i.e., when markets are functioning normally. In a crisis, counterparties either will be unable to and/or unwilling to perform and the volume of contracts will overwhelm these institutions and render them instantly insolvent.

While large banks like J.P.Morgan, Bank of America, Citigroup and Goldman Sachs all carry significantly more derivatives than assets, one bank stands out.

The Greatest Derivatives Risk on the Planet Is About to Explode

Deutsche Bank is the world’s single largest purveyor of derivatives.

Let that sink in for a moment.

One of the most poorly managed banks in the world and one that has repeatedly flouted U.S. laws is sitting on the biggest stash of derivatives in the world!

As of Q3 2015, DB held approximately €45.7 trillion of OTC derivatives contracts on its books (over $52 trillion at current exchange rates). This poses the single biggest systemic risk of any financial institution in the world.

In fact, this single bank has derivatives exposure greater than the entire European GDP.

Derivatives exposure bigger than European GDP

via zerohedge.com

Add to this the fact that the bank suffers from serial management, operational and regulatory deficiencies that have gone unaddressed for more than a decade and you have a ticking time-bomb.

The mess inside DB finally came into the open in July 2014 when The Wall Street Journal disclosed that the New York Fed’s concerns about the bank had been growing for years….stressing “significant weaknesses in the firm’s regulatory reporting framework that has remained outstanding for a decade,” “material errors,” and “poor data integrity” and recommending wide-ranging remedial action.

DB: A Timeline

• December 2012: DB is trading at about $43 as it looks back on a bad year that included raids by police and tax investigators.
• December 2013: Daniel Muccia, a senior vice-president in the New York Fed, writes to the Wall Street Journal criticizing DB’s operations and management.
• July 2014: The Wall Street Journal publishes excerpts from Muccia’s letter. DB shares fall close to an 18-month low.
• April 2015: DB reports a 24% drop in 2014 – the largest among the top nine global investment banks. In addition, it is ordered to pay a record $2.5 billion for rigging benchmark rates.
• May 2015: Thanks to concerns about low profitability, weak capital and rising legal costs, DB’s senior managers receive the lowest shareholder approval in a decade. During the co-CEOs’ three-year tenure, stock has also performed worst among global peers.
• May 2015: At the conclusion of a five-year investigation, DB agrees to pay a $55 million penalty to the SEC for filing inaccurate statements about derivatives pricing during the financial crisis.
• June 2015: DB begins an internal probe into a money-laundering scheme run by Russian clients, which may have involved over $6 billion of transactions over the past 4 years.
• June 2015: DB Co-CEO Anshu Jain announces his resignation.
• October 2015: DB turns in a record loss of $6.6 billion for Q3, with about a sixth of total losses going to litigation charges. New CEO John Cryan announces plans to cut 30,000 jobs over the next two years.
• January 2016: DB reports an annual loss of $7.6 billion.
• February 2016: DB’s stock has dropped 62% since Dec. 2012, falls below $16. The bank announces a debt buyback in an effort to reassure investors.
• March 2016: CEO Cryan announces at an investors conference, “There’s a lot of stuff we have to get done this year, so this year is not going to be profitable.”
• April 2016: DB still trading below $16.

The report added that DB’s shortcomings amounted to a “systemic breakdown” and “expose the firm to significant operational risk and misstated regulatory reports.” The bank’s external auditor, KPMG LLP, also identified “deficiencies” in the way the bank’s U.S. entities were reporting financial data in 2013 according to an internal email reviewed by The Wall Street Journal.

Yet rather than take drastic action to crack down on a rogue institution, regulators took their sweet time while the bank continued to break the law and run a derivatives book large enough to blow up the world.

And needless to say, things have only gotten worse for DB since the Fed’s rebuke – leaving the bank arguably insolvent and hanging on the edge of a financial cliff by Q2 2016.

DB stock: 2012-2016

via zerohedge.com

Of course, the real question is how six years after the financial crisis an institution holding enough derivatives to blow up the financial system can be permitted to operate with financial controls that would force a corner drug store out of business.

The answer is that regulators are incompetent.

People ask how Bernie Madoff was able to escape the attention of regulators for so many years, but in that case regulators never flagged the fraud that was occurring under their noses. In DB’s case, regulators repeated flag problems but show little urgency demanding that they be fixed or reining in the bank’s operations in order to protect investors and the rest of the system.

This is simply inexcusable.

Deutsche Bank holds enough derivatives on its books to inflict serious systemic harm. And its balance sheet is extremely weak, as we can see from its dramatic rise in credit default swaps in early 2016.

via zerohedge.com

Rather than reducing systemic instability, DB’s trillions of dollars of derivatives significantly increase fragility and render already illiquid underlying markets far more prone to large price swings – not only in a crisis but in even mildly volatile market conditions.

This volatility and potential for loss (particularly in leveraged portfolios) has been disguised since 2009 by the central-bank-supported bull market in equities and credit. But that can’t last forever.

The global financial system remains grotesquely overleveraged and unprepared for another crisis. European banks and DB in particular are at the epicenter of this weaknes. When the next market dislocation arrives, as it inevitably will, these derivatives will again earn their reputation as “weapons of mass financial destruction.” If counterparties are unwilling or unable to perform, all bets will be off.

In other words, Deutsche Bank could singlehandedly trigger a global “Super Crash.”

And you should be prepared.

The Five Inevitable Forces Behind the Super Crash

Inevitability #1: The 30-year “Debt Supercycle” is about to end.

Over the past 30 years, the world has gorged out on debt in a massive “Debt Supercycle.” Today there is almost $200 trillion of total public and private debt outstanding in the world, withover $600 trillion in derivative contracts sitting on top of that. An economy has to generate enough income to pay the interest on its debt. And today, the U.S. and global economy does not.

Inevitability #2: The global economy is stuck with sub-par growth.

The reason the global economy doesn’t generate enough income to pay its debt is because most of this debt wasn’t used to fund activities and assets that generate future streams of revenue. Instead, it paid for unproductive things like consumption, housing, stock buybacks, and financial speculation. The net result of more and more debt was less and less growth.

Inevitability #3: The markets will crash – big.

Since 2009, U.S. corporations bought back more than $2 trillion in stock rather than investing in R&D, new plants, and equipment, and creating new jobs. And in many cases they used borrowed money to do it. When companies run out of their own stock to buy, it will be one sign that the Debt Supercycle is coming to an end with a resounding crash.

Inevitability #4: Central banks won’t be able to rescue us this time.

With interest rates barely above zero, and its balance sheet stuffed with debt, the Federal Reserve can’t do much more to stimulate growth or bail out markets when they collapse. The Fed has already fatally mismanaged this credit cycle, and negligible 25-point rate hikes won’t change any of the underlying issues. Central bank policy has reached its limits.

Inevitability #5: There’s geopolitical trouble ahead.

The Cold War is raging across the Middle East, Eastern Europe, and parts of Africa. In the U.S., the southern border is a sieve while America’s inner cities are home to intolerable levels of poverty and violence. And in an epic foreign policy disaster, the Obama administration has entered into a nuclear arms agreement with Iran. One spark could set off a deadly chain reaction – and when that happens, markets are going to plunge.

Get Ready for A Systemic Credit Collapse

Here’s what I recommend.

• If you hold long positions in DB, get out now.
• Gain short exposure to DB to profit from the bank’s coming failure.
• Develop a strong portfolio to protect yourself from the inevitable market crash.

How to Play the Deutsche Bank Collapse – Updated 4/11/2016

As always, I prefer puts as a less risky way to play the short side. I’m looking at a couple of puts that are attractive based on current prices. The first has an expiration date in October, the second in January. It’s up to you how to play this based on your expectations. In my view both are good bets:

• BUY DB October 21, 2016 $11 puts (DB161021P00011000)
• BUY DB January 20, 2017 $10 puts (DB170120P00010000)

Since the beginning of the year, DB has lost over 33%. If it loses another 33% in the next six months (definitely in the cards), the DB October 21, 2016 $11 puts (which as of this writing are trading around $0.75), would be both a cheap way to short and very profitable.

For nine months, the puts go down to $10 (the DB January 20, 2017 $10 puts are currently trading at around $0.80) which is an extremely cheap way to play this stock.

Denial is not a strategy for policy-makers, citizens or investors. When a system is on an unsustainable path, it is certain to experience a change in conditions – the only question is when that change will occur and how severe it will be.

While the problems I have outlined are serious, they need not be fatal. The global financial system is resilient and will make the adjustments necessary to deal with an unsustainable growth in debt and inadequate economic growth. But it is not as resilient as it could be or should be and the adjustments are going to be painful.

There are only four ways to repay debt:

• currency debasement;
• inflation;
• default; or
• growth.

In order to deal with the headwinds facing global markets in the next few years and protect their capital, investors need a plan. That plan should involve structuring a portfolio that can generate income and protect capital on both a short‐term and a long‐term basis. While reasonable men and women can differ on the proper portfolio mix, the following is one model portfolio for a typical individual investor based on the state of the post‐crisis world. Investors should discuss their investments with a professional to ensure that their portfolio is suited for their specific needs and circumstances.

My Recommended “Super Crash” Portfolio Allocation

1. Gold, precious metals, tangible assets-10-20 percent
2. Cash-10-20 percent
3. Absolute return strategies-20-40 percent
4. Dividend paying equities-20 percent
5. Income generating securities-10-20 percent