Gold Forecaster
- Global Watch
How the "Carry Trade"
and Capital Tsunamis are pushing the gold price up
Julian D.W.
Phillips
Gold Forecaster snippet
Dec 10, 2007
The gold price has not only
been reacting to the absolute levels of the oil price and the
fall of the $, but to the instability, uncertainty and downright
fear in the Capital markets and the banking system. Two reasons
why there is such a drama has been the activities of the "Carry
Trade" and the resultant Capital Tsunamis, or even the complete
lack of available capital [much as the shoreline pulls right
back before the Tsunami hits].
"Carry Trade"
One wrong picture we must correct is that it is Japanese Housewives
who are behind the "carry trade". This is a cute but
ridiculous concept. The "carry trade" is a group title
for a type of trading carried on all over the world where interest
rate differentials allow borrowing in one currency to lend in
another. Any currency trader anywhere in the world can do this
is he has the requisite standing with the banks. The bulk of
these traders are housed in massive dealing rooms in the vast
majority of the banks in the world. These operations may sound
simple on the surface, but in reality can be difficult to assess
accurately and even more difficult to execute. The currency traders
at the world banks and they watch their screens every moment,
moving and trading with every change in exchange rates, closely
in touch with in-house research. These are clever young lads;
working for their annual bonus with an eye on the latest Porsche.
They have enormous financial power, but are held on a tight leash
by their bosses.
The 'carry trade' concept comes
with exchange rate risks, which are part of the assessment of
potential profits. The Yen was ideal because it was relatively
stable against the U.S.$ until recently after a weakening trend
over the last year as it fell from around Y100:$1 to Y122:$1.
Then in the last month the Yen turned viciously onto a strengthening
trend, taking it back to Y109:$1. The question now is will the
Yen weaken again? If it does then the 'carry trade' opportunity
reappears.
But to even think that only
the Yen has to be part of this business is again naïve.
The speed of the change in the Yen's value was probably precipitated
by these traders as they saw the dangers of a Yen strengthening
and a $ weakening. What would you do in that position? Why, close
out your borrowing in Yen and open it in the $ where interest
rates and the exchange rates turned down. If you had lent into
the € or the NZ$ or the Australian $, or even the €
and you would hold that position, setting it against the U.S.$.
With a strengthening of the Yen, you wait until it peaks [in
your opinion] then reopen your borrowing in Yen and close it
in the U.S. $. These are short-term traders who like positions
to hold as long as they can to maximize interest income, but
stay nimble on their toes, grabbing each opportunity as it rises
and closing positions in a heartbeat. At times working these
desks can be as exciting as driving a Ferrari. No wonder these
Traders are burned out by the time they reach 40.
They contribute heavily to
the creation of massive Capital flows that create the rising
volatility in the markets that we are seeing right now. Combine
these with other Soros like Traders alongside genuine Investors
like Sovereign wealth funds, you not only have potentially massive
Capital Tsunamis, you have a very real precipitant for much more
uncertainty and instability. One crack in the hull of the global
monetary system and the capital will flood out or in.
The Capital Tsunami's
won't go away
Using the $ to pay
for purchases of currencies with higher yields is proving to
be the most profitable trade in the foreign-exchange market amongst
the "Carry Trade".
A basket of currencies including
the British Pound, Brazilian Real, and Hungarian Forint financed
with dollars returned 17% this year, compared with 9% when funded
in the Yen and 7% in Swiss Francs. Falling U.S. interest rates
and increasing volatility in the Yen and Franc are making the
trade even more appealing. With the $ giving the appearance of
being in free fall, it increases the attractiveness of using
the currency to fund investments.
The last time the U.S. $ was used for so-called "carry trades"
was in 2004, when the Federal Reserve's target rate for overnight
loans between banks was 1%. Since then, it has weakened 18% on
a trade-weighted basis. The International Monetary Fund says
the $ made up 64.8% of central banks' currency reserves in the
second quarter, down from 71% in 1999, after the € was
introduced.
Investors are borrowing the
$ and using the money to buy assets in countries with higher
interest rates even though U.S. borrowing costs are 4% points
more than the Bank of Japan's and 1.75% points above the Swiss
National Bank benchmark. Investors may switch more than $100
billion of borrowing from Yen or Francs into the $ in the next
two years for 'carry trades'.
The value of futures contracts
held this month by hedge funds and traders betting against the
$ was a record $33.9 billion more than contracts that profit
from a gain. Pacific Investment Management Co., which oversees
the world's biggest managed bond fund, is selling dollars against
the Brazil Real, Mexican Peso, Korean Won, and Singapore $. "When
we think about currencies on a three-to-five-year basis we're
very bullish on emerging markets versus the U.S. dollar,"
said Pimco. "That view is only reinforced when you look
at interest-rate differentials."
The Real rose 18.5% this year
and Singapore's currency strengthened 6.4%, while the Won was
little changed. The Mexican Peso fell 1.4%, the only one of the
16 most-traded currencies to do worse in the foreign exchange
market.
Using a currency to finance
trades does drive down its value as we saw in the exchange rate
of the Yen. Former Japanese vice finance minister Hiroshi Watanabe
said in May that one reason the Yen had fallen to a record low
against the € was because it was funding about $500 billion
of "carry trades".
All in all the above information
confirms that "Carry Trading" is here to stay and getting
bigger and bigger. It is a large contributor to the volatility
of exchange rates and financial ruptures in the world money system.
It is "hot money" and likely to fuel speculation against
vulnerable currencies.
The instability and uncertainty
such trading fuels will continue to make gold more and more attractive
and the foundation of paper money more and more fragile. When
one hears the Fed Chairman reflect this atmosphere, you just
know some will seek the safety of gold, at least. But some will
become many as instability and uncertainty is reflected in many
market places.
Shortly in our pages, we
will be covering just how "Marginal Supply" and "Syndications"
have also contributed to the instability and uncertainty has
and will contribute to making gold attractive, short, medium
and long-term.
Please subscribe to GoldForecaster
for the entire report.
Nov 30, 2007
-Julian
D.W. Phillips
email: gold-authenticmoney@iafrica.com
321gold Ltd
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