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Carry-Trade Slump?
Alettermock2
Wednesday, October 11, 2006
Vol. 8 No. 203
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In Today's Letter:
Comment:
The Carry-Trade Slump?
Sovereignty:
Labor Costs
Wealth:
New Kid on Nuclear Block
Privacy:
What Are You Afraid Of?
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Yen Carry-Trade: Picking up Nickels
in Front of the Steamrollers
Today's comment is by Jack Crooks, The Sovereign Society's Currency Director and editor of The Money Trader.
Dear A-Letter Reader:
The Japanese yen continues to get
punished by currency traders. This week the yen slumped to its lowest
value against the dollar in 22 months, and is testing an eight-year
valuation low against the euro. Most analysts suggest the yen is still
victim of the carry- trade. It's true that sooner or later the
carry-trade will end. And when it does, I think it will be time to own
yen.
The yen carry-trade simply means a speculator borrows yen
(at extremely low interest rates) and reinvests the proceeds in another
higher yielding asset, which might consist of other higher yielding
currencies, emerging market bonds, or even to speculate in commodities.
Let me give you an example of this.
I am Mr. Big Spec, and I
operate the multi-billion dollar Big Spec Hedge Fund. As I evaluate the
global landscape and trends in the market, I conclude the Australian
dollar is going to continue appreciate in value, riding on the back of
the long-term bull market in commodities. Besides that, the 5.6%
three-month money market yield in Aussie looks pretty darn attractive
to me. And heck, I've got a billion dollars lying around that I have to
put to work. It's a lay-up trade that's going to make my clients very
happy-the yen carry-trade.
So, I borrow Japanese yen at
around 0.4% and invest the proceeds in Australian dollars at 5.6%. That
means I'm 5.2% ahead the game right out of the gate. And if I'm right
about the Australian dollar continuing to rally-I look like a darn
genius to boot. I'm making a great return on the difference in yield
and picking up capital appreciation as the Aussie rallies. It's a game
many of my other hedge fund manager buddies have been playing for
years. And it's made their clients very happy and made them happy come
bonus time.
Well, that's basically the game and how it's played.
Borrow the low-cost currency and invest the proceeds in a higher
yielding alternative. Of course it can get a bit more complicated. For
instance, if I was really excited and had conviction about the
Australian dollar and commodities going higher, I could have borrowed
the same billion dollars worth of yen and reinvested two or three or
four billion or even more into Aussie and metals using leverage
(controlling a large amount of assets with a much smaller amount of
collateral). That way, if I'm right, my clients aren't just happy,
they're ecstatic. I've hit a home run. It's triple-digit time on this
trade.
Obviously the yen carry-trade is very enticing. And yes,
it has worked very nicely because the yen continues to lose value
relative to higher-yielding currencies, Japanese interest rates have
barely budged, and overall volatility of currencies has been low. The
Bank of International Settlements recently tried to explain why we have
seen such low volatility, "Part of the explanation may be the lower
volatility of economic fundamentals such as inflation and GDP growth;
another part results from the improvement in corporate profits and
balance sheets; a further part from the greater transparency of
monetary policy; and a final part from innovation in financial markets,
notably the growth of hedge funds (which have improved liquidity) and
the development of derivatives (which have allowed risk to be spread
more widely), The Economist reported."
But, as we know,
financial markets have a way of surprising you. There is no guaranteed
volatility will remain low. And we've seen many occasions where
currencies have rallied sharply on low interest rates-rates are only
one part of the equation, economic growth is the other.
The
yen is becoming extremely undervalued on a host of fundamental
measures. And the Japanese economy continues to look positive, and
there is a good chance it could accelerate faster than expected. And
there are just too many players playing the yen carry- trade. When this
trade turns, and it will, the yen will likely see a rocket boost of
buying as people like Mr. Big Spec race for the exits to preserve
what's left of their expected home run. What looks like easy money now,
could turn out to be more risky than "picking up nickels in front of
steamrollers," as The Economist's Buttonwood columnists so aptly put it.
Bottom
line: Carnage for the carry-traders means it's time to own yen. Because
then it might start trading on its fundamentals instead of visions of
easy money.
JACK CROOKS, Currency Director
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Labor Costs
New
figures released by the Labor Department this past week tell us hiring
is slowing. But the thing not getting much news (yet) is that there has
been a rapid acceleration in labor costs. As noted by Naroff Economic
Advisors, worker compensation is the major part of business costs and
rising labor costs suggest that the inflation rate, already well above
the Fed's target range, may not be coming down anytime soon. Beads of
sweat will appear on Mr. Bernanke's brow at the next Federal Reserve
Open Market Committee meeting on October 24. Once again, the question
will be, should he raise rates to head off inflation or lower them to
head off recession?
There will be no question, however, of who he will blame for
inflation. He'll only have to point to rising labor costs, and he'll be
off the hook. There's zero chance the Mr. Bernanke will point the
finger at the real culprit in the mirror. The only real source of price
inflation is the inflation of the money supply by him and his cohorts
at the Fed.
JOHN PUGSLEY, Chairman
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New Kid on the Nuclear Block
Last weekend,
North Korea became the ninth country on the planet to go nuclear.
Although no one is certain that they successfully tested a nuclear
device below surface, most pundits would agree that North Korea has
finally achieved nuclear status in late 2006. For global investors,
this development is yet another reason this decade to maintain a
position in gold bullion, foreign currencies, U.S. dollars and
government bonds.
I hate to say it, but the odds of a nuclear accident or attack on a
sovereign nation has markedly increased since 9/11. If more countries
harbor the A-bomb, does that mean more deterrence or greater odds of
someone launching a Nuke? I'm not sure, but if I had to bet, I'd say
someone will use a nuclear weapon, probably the result of third-party
sales to terrorists or fundamentalists. Following terrorist attacks on
New York and Washington in 2001, Warren Buffet stated that he believed
terrorists would strike New York with a Nuke one day. At the time, I
thought he was off his rocker; but now, I'm not so sure...
Although I can't predict macroeconomic events any better than I can
foretell geopolitical events, my portfolio holds gold bullion, gold
stocks and cash today. I'm bullish long-term on stocks and the markets
in general, but I also believe in portfolio insurance in an age of
global unrest and the madness of politicians and fundamentalists.
North Korea is now #9 on the Nuke list. Who's next?
ERIC ROSEMAN, Investment Director
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What Are You Afraid of?
I've been living in Vienna the last few weeks, and will be here until the end of October.
Every
time I visit Austria, I'm struck by the lack of "paranoia" in the
population. Part of this may just be a smug assurance that the
socialist government will take care of their needs. There is virtually
free healthcare for all, subsidized housing, subsidized education,
guaranteed pensions etc. (Although some are now asking where the money
to pay for the promised benefits will come from in the
future).
Not to mention
the human trait-very pronounced in Austria-of ignoring the world around
you to focus on friends, family, and
work.
Yet, despite the
omniscient presence of "nanny government," there is no feeling of "Big
Brother" here. Yes, there are now closed circuit TV cameras in the
U-Bahn (subway) station, and even in some of the subway cars.
I've also noticed a crackdown on "Schwarzfahrer" (literally, "black
riders," or people who try to ride public transit without paying). More
transit police are checking subways, trams, and buses to make sure
riders have paid the correct fare. If not, a 60-euro fine is due on the
spot.
Naturally, the Austrians complain
about this, and some of the ones that I know ask me if it's like this
in America.
I tell them that I don't really worry about CCTV or random
ticket checks in the United States. What I worry about, I tell them, is
civil forfeiture laws where the government simply seizes everything you
own without accusing you of any crime, forcing you to prove your
property "innocent" in order to recover it.
"That sounds like Nazi Germany," one friend told me a few days ago.
Yes, it does. Frightening thought, isn't it?
MARK NESTMANN, Privacy Expert & President of The Nestmann Group
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