Tere’s increased scuttlebutt that derivative trades are blowing up, and that counter parties are failing. There’s a blow out in Corporate CDS sector in general. The suspects involved a range of players, from Deutsche Bank (likely), to commodity kingpin Glencore. Until the tide goes out completely, we won’t really know. On the issue of commodities, there seems to be an assumption that the leveraged paper trades are on the long side or inventory side. That notion is not just untrue, it’s ludicrous. In fact, I would suggest that the leveraged paper trades on a variety of metals — and especially the precious metals — are very crowded speculative short sales.

Beyond basic over-trading in paper instruments, the second area of exposure is within Ponzi derivatives sold against credit. These are always highly leveraged. Once the counter parties to this are taken out back and shot, then the Ponzi credit lines to support uneconomical money-losing commodity and energy production will be closed off, as will the production itself. Judging from its trading action, one must assume Glencore is one of the counter parties to insuring this Ponzi corporate credit within the commodity spectrum. A glance at Glencore’s liabilities shows a large mix of financial contracts.  The serious meltdown and production wipe out will occur in the worst-cost quartile of producers.

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The impact on inventories or stockpiles of physical metal commodities is very exaggerated. Companies like Glencore reduced those last spring and especially this summer. Eyeballing the zinc inventory at the LME is a decent canary in the mine of that and offers clues. After relentlessly drawing down to a quite low level back in May, zinc stocks or inventory suddenly showed up starting in mid-August and peaked on Sept. 16. Stocks have dropped 22,000 tonnes since the 16th.

Many analysts point to this surge in part coming from Glencore. That is plausible, but the combined stocks of Glencore, the LME and others are not even remotely excessive now. In fact, if Ponzi credit is pulled from the high-cost zinc producers, physical stocks and supply will evaporate in a flash. Nearly a third of global zinc production is at a cash cost well above the current spot price.

This same exercise could be run on a number of metals and energy. I’ve detailed them on my pages. China’s largest coal producer laid off 100,000 yesterday. It doesn’t take a rocket scientist to figure out that high-cost coal production is being rapidly curtailed, most likely as credit is pulled.

Furthermore, as I and others have suggested, there’s a dearth of physical metal available to clear blown-out trades. A commodity derivative and counter party blow upwill expose the exchanges, such as the Crimex and LME, as the frauds that they are. A crisis in these paper exchanges will not be bearish for the afflicted metals. In fact, the metals will be able to escape this corrupt, criminal choke hold and seek or discover a true price.

These charts reek of fraud and no true price discovery.

In the latter phase of this commodity bear market, everything has been thrown out with the bath water. Although it hasn’t afforded a refuge, I have almost solely focused on the top quartile producers. In addition, I’ve preferred the development or non-producers as they aren’t wasting their assets selling into a depressed market. If I do use a producer, it needs to be a growth story with a pipeline and not using Ponzi finance to stay around producing at a loss. This market has shown small discrimination  between high cost producers that will lose their Ponzi finance and the others. That is the sweet spot.