A lesson in market volatility.

The buzz word of the day? Subprime. This refers to a segment of mortgage lending where the borrowers are less credit worthy than the average client or "prime," client. Subprime is being blamed for much of the recent volatility in financial markets.

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A bunch of overly optimistic American bankers lent money to bad clients and now they are going to lose it. So what? How does that affect Saskatchewan, and why are uranium stocks down?

Global markets are more complex and interconnected than ever. All assets that are tradable (stocks, bonds, commodities etc.) are valued in relation to other assets. In recent months assets that were previously considered to be uncorrelated (meaning the prices don't move in sync) or even inversely correlated, are suddenly moving together. The subprime crises in the U.S. wouldn't normally affect our commodity stocks, except they both have something in common: risk.

In the past decade a strange and complex financial concept called securitization exploded in popularity. There is only so much demand by lenders for the "B" or "sub-prime" client. With securitization, institutions can make a loan, then sell the loan and charge a fee for this. As long as they can sell it, they don't mind making risky loans.

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Instead of buying individual loans, investors purchased proportionate shares of many loans. If you pool mostly good loans, with a few bad loans, you can still have a package that is considered to be rated AAA (of the highest credit quality). When a vineyard mixes a bit of the cheap stuff with the good stuff, guests rarely notice. As the party gets better, they notice less and less. Apparently institutional investors don't either.

As money was made without any visible risk, investors wanted more. Demand for the riskiest portion of these mortgage pools increased dramatically. The most risky portions are known in the industry as "toxic waste." Curious that people would want more of this stuff.

As U.S. home values fell, defaults started to rise. Now the business model that was based on ready demand for pools of low-quality mortgages didn't work. Demand had dried up.

These financial instruments are very complex. Investors decided they weren't going to buy any more of something they didn't understand; prices went down. This forced leveraged investors (those who borrow to invest) to post more collateral. When they didn't have enough capital they sold what they could. This is how the decline started.

People became afraid of risk so they sold risky assets. All risky assets were sold. Commodity stocks are risky assets. And the riskier the asset, the more it fell.

Markets are made of people; people are most afraid of unknowns. The subprime "bogeyman" is a large unknown. It can be as big and mean as we imagine it to be. This crisis is based on fear, not an actual shortage of money.

The world's central banks have been printing more money in recent weeks. The yield on one-month Treasury bills in the U.S. has fallen by around two percentage points over several weeks. This means investors are willing to take a much lower return in exchange for eliminating risk. What has changed is the perception and pricing of risk.

Now investors are chasing risk-free assets. There are risks of course. The U.S. Federal Reserve is trying to do two things at once; its board chair Ben Bernanke wants to appear tough on inflation, while at the same time encouraging growth. I think the bias is to encourage growth.

Housing price deflation south of the border should allow central bankers to print more money than they could if house prices were going up. Commodity prices will be allowed to move higher, because core rates of inflation will appear benign.

The bottom line is that all the money now in T-bills will eventually go somewhere. The markets can't stay afraid forever, it's no fun.

All of this new money, won't push up overvalued houses, or make its way into mortgage-backed securities; these are off the menu. But it should push up commodities and commodity stocks.

What is the risk that this doesn't work? What if the housing deflation causes a recession?

A very wise professor once told me "A recession is an unlikely event, if you predict one, you are unlikely to be right."

Mark Smith-Windsor is an Investment Advisor with Union Securities Ltd. He can be reached at 343-5221 or [e-mail].

This is not meant as a solicitation of securities. The views expressed herein are only those of the author and not necessarily those of Union Securities Ltd. Investing in junior resource stocks is inherently risky and is not suitable for all investors. Tax deductions may vary according to issuer or taxpayer circumstances. Obtain a copy of the prospectus and read carefully before investing. Union Securities Ltd. is a member of the Canadian Investor protection fund.