CARRY TRADE

[rffrydr]

FT may be all over it but the annual repatriation of Yen is underway:

http://www.bloomberg.com/apps/news?pid=10000101&sid=aVfNZYOnTejI&refer=japan

This should be good for 2% in the Yen WITHOUT shortcovering. Eu/Yen decisively broken. Next up: CRB
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

On a day when the Euro/Yen is coming off a little (on real news) it's good to review.

Chilean Pesos into Turkish Lira. The new and improved Carry Trade:

Dollar's Tumble
May Hurt Players
In Carry Trade
Weakness Prompts Predictions
Of Global Currency Volatility,
Raising Potential for Losses
By JOANNA SLATER
December 13, 2006; Page C1


The recent weakness in the U.S. dollar is sending tremors through a popular practice in foreign-exchange trading, raising the potential for further instability in global currency markets.

The practice is known as the carry trade: Investors borrow money in a country in which interest rates are near zero, such as Japan, and invest it in a country like New Zealand, where interest rates hover above 7%. The trade works best when currencies involved remain relatively stable -- sharp currency moves can wipe out gains from the difference in interest rates.

Weighing heavily on the dollar recently: expectations the Federal Reserve will reduce interest rates in 2007, making dollar assets less attractive to investors. Yesterday, the Fed left its benchmark short-term rate unchanged.

Already, the U.S. dollar's tumble against the euro is prompting some observers to predict that currency rates around the world will be more volatile going forward. That is bad news for the carry trade and, possibly, for other currencies and some stock markets. The stakes are high: The last time these trades unraveled was in the spring, when investors spooked by the prospect of rising Japanese interest rates abandoned riskier investments in countries from Iceland to Turkey. Stocks in developing countries plummeted, along with some of their currencies. In Iceland, a favorite destination for the carry trade, the country skirted a full-blown financial crisis.

Despite that turmoil, market watchers say the carry trade has proved irresistible, thanks to the continued allure of low-cost borrowing in Japan and elsewhere. "There are a lot of people who still have these trades on," says Paresh Upadhyaya, a portfolio manager at Putnam Investments in Boston. At the same time, he says, "Things are lining up that could unwind them any day now."

One such factor would be fluctuation in currency rates. For most of the past six months, exchange rates for major currencies have remained relatively stable in comparison with prior periods. For carry traders, that has meant they could reap returns from the difference between the interest rates in two countries without worrying that a currency swing will erase their profits -- or worse.

But the recent selloff in the U.S. dollar will lead to larger fluctuations in other currencies, BNP Paribas argued in a recent report, including those low-interest-rate currencies that fund the carry trade, such as the Japanese yen and the Swiss franc. "Carry traders need to be cautious," it warned.

Some market observers believe an unwinding of carry trades can unfold in a gradual way that wouldn't rock markets. Others say experience shows these reversals are rarely an orderly affair.

"Everyone is always looking for the magic signal on how to get out before [the carry trade] unravels," says Richard Clarida, global strategic adviser at Pacific Investment Management Co. and a professor at Columbia University in New York. "Carry trades work until they don't."

Adding to the uncertainty is the fact that no one knows exactly how big the carry trade is.

One indicator of its vigor can be found in the weekly reports from the Chicago Mercantile Exchange on currency futures. Hedge funds and currency speculators use futures positions to mimic the mechanics of the carry trade, since such instruments also reflect the interest-rate differentials between countries.

The most recent CME figures show that while speculators have reduced such trades, they still have substantial short futures positions in the Japanese yen and the Swiss franc -- two currencies commonly used to fund the carry trade -- and considerable long positions in the Australian dollar and the New Zealand dollar, two currencies used to extract profits from the trade. In the currency markets, short positions are agreements to sell a currency on a specified date, while a long position is a purchase order.

Others see the dimensions of the carry trade in data on financial flows in and out of Japan.

In a recent note to clients, Goldman Sachs said the size of the carry trade outstanding involving yen is "substantial" and could account for a large chunk of the country's balance-of-payments surplus, which is 4%-5% of gross domestic product, or the total value of goods and services produced in the nation. If the trade were to unravel, the investment bank said, the yen could strengthen as investors buy the currency to cover their borrowings. On the flip side, the currencies that served as investment vehicles could tumble as investors sell their holdings.

Central banks are paying attention. In November, Bank of Japan Governor Toshihiko Fukui told the Japanese Parliament that there was a big risk that a sharp shift in the country's interest-rate outlook could spark "a rapid unwinding" of yen carry-trade positions and "bring on various distortions."

The reverberations would extend well beyond financial-market players. Regulators in South Korea, for example, are investigating the ballooning number of yen-denominated loans granted by local banks. Lured by the low interest rates attached to such loans, individuals have plowed the proceeds into higher-yielding assets like real estate, spurring fears of a bubble.

Meanwhile, in their constant search for bigger returns, carry traders are starting to focus on currencies in emerging markets, where interest rates can be even higher than in developed countries. Thanks to increasing trading in these markets, traders have become more comfortable borrowing in Chilean pesos and investing that amount in Turkish lira, or borrowing in New Taiwanese dollars and investing in Hungarian forint.

These trades, too, can reverse rapidly, prompting currencies to tumble. If investors were to get spooked as they did earlier this year, the likely losers would be countries with a large current-account deficit, such as South Africa and Hungary, says Mark Farrington, head of currency at Principal Global Investors in London.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

And, lastly, the CPI which turned it all has been revised (way) down:

http://za.today.reuters.com/news/newsArticle.aspx?type=businessNews&storyID=2006-08-25T115237Z_01_BAN523020_RTRIDST_0_OZABS-MARKETS-FOREX-20060825.XML

Things not going as planned.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

EuroYen higer still and JGBs well under 2% but something the trade has not counted on: the japanese investor.

http://us.ft.com/ftgateway/superpage.ft?news_id=fto081620061428354290&referrer_id=yahoofinance

http://www.dailyfx.com/charts/Chart.html?symbol=EUR/JPY

[rffrydr]

Euro/Yen now at record highs. Carry on.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

It never really left:

CENTRAL bankers in the world's big, rich economies have played a frustrating guessing game with financial markets this year. But if there is one thing about which investors can be more or less sure, it is that for the first time in years, official interest rates in America, Europe and Japan are heading in the same direction.

The European Central Bank has dropped a heavy hint that, having lifted rates in December, March and June, it will do so again on August 3rd. Its governing council will meet in person that day rather than by telephone, its August custom. Policymakers at America's Federal Reserve may wish that they could give the markets a summer break, having raised the federal funds rate to 5.25% on June 29th, the 17th increase in as many meetings. The markets, however, are not expecting a rest. Non-farm payrolls grew less in the second quarter than in the first, but hourly earnings rose in June at their fastest year-on-year pace since 2001. Enough inflation apparently lurks in the American economy for traders to expect another quarter-point rise when the Fed's rate-setters meet on August 8th. And as The Economist went to press, the Bank of Japan (BoJ) seemed likely to complete the pattern by raising interest rates above zero on July 14th for the first time since 2000, probably to 0.25%.




In Japan and Europe higher rates will, for the time being, be only gentle tugs on the reins as their economies gather momentum. In America, where growth has been brisk for years, monetary policy is stronger, but not yet a yank on the bridle. Yet the prospect of an end to a long era of easy money has put financial markets into a lather. After the BoJ turned off the monetary printing presses in March and began to drain ¥20 trillion ($175 billion) of excess liquidity—the equivalent of 4% of GDP—from the banking system, the Japanese stockmarket dropped violently. And global investors reconsidered their appetite for risky investments, retreating from overheated economies such as New Zealand, Saudi Arabia and Iceland.

In May concerns about how the Fed, under a new chairman, would handle the live wires of slowing growth and rising inflation caused a month-long drop in global equity and commodity markets. Uncertainty, especially about global interest rates, made financial markets of all sorts turbulent in May and June.

The jumpy reaction was understandable. For years, loose money has lubricated markets and encouraged consumers, companies and speculators to borrow handsomely. Recently Japan, with interest rates at nil, has provided much of the liquidity. Japanese investors have bought high-yielding assets abroad to beat the miserable returns at home. Meanwhile, global hedge funds have borrowed in yen and invested profitably in anything from emerging markets to high-yield debt.

A few years ago, they did the same with the dollar. When American interest rates were as low as 1%, there was money to be made by borrowing greenbacks and buying higher-yielding currencies such as the Australian and New Zealand dollars. But as interest rates rose, the dollar lost its lure as a funding currency, and speculators switched to yen. With Japanese interest rates now heading up as well, such investors may have to think of a new game.

So far, however, there are few signs that they are dumping non-Japanese assets and switching back into yen. There are no reliable data on the size of the yen “carry trade”, but if it were to unwind, the yen would surely rise. It has not done so yet. Also, with inflation back in positive territory, real interest rates in Japan are still negative and short-term rates are not expected to rise above inflation until next year. Until that happens, brokers expect little let-up in the appetite of Japanese institutional investors for high-yielding assets.

What of rising interest rates elsewhere? Will these xxx the liquidity bubble? Probably not for the time being, says Barclays Capital, an investment bank. It notes that global interest rates are still well below nominal GDP growth (see chart), whereas throughout the inflation-busting 1980s and 1990s they were mostly higher. That suggests monetary policy is still pretty loose. Barclays Capital believes that interest rates will have to rise further to quell inflation. It thinks America's fed funds rate will end the year at 6%.

Financial markets may still react in an orderly way to such an outcome, if the risks of a hard landing or an inflationary spiral do not materialise. On the other hand, the sell-off in May and June may be a dress rehearsal for what is in store if concerns about the global economy mount.

The Old Lady's word of warning
On July 12th the Bank of England gave a taster of what might happen if things do not go according to plan. In its half-yearly Financial Stability Report, it noted that for the first few months of 2006, higher interest rates did not make risky investments less popular, as they normally should.

Instead, prices of the most speculative investments kept rising. Rewards for holding the riskiest bits of collateralised debt obligations (pools of debt often bought by hedge funds) fell sharply until April. Spreads on emerging-market debt fell to levels at which, just three and a half years before, those on investment-grade corporate bonds had stood. Emerging-market share prices rose by 30% between December and May.

Such gains vanished quickly in the May and June turmoil, but the sell-off was not devastating—merely a healthy correction, thinks the Bank of England. Share prices are roughly where they were at the start of the year. Credit markets are buoyant. Private-equity groups around the world are raising vast funds, and companies are increasing their levels of borrowing.

The bank says the market's benign attitude to risk may simply reflect a more secure financial world. But it might also indicate complacency. If investors turn away from risk, prices will fall sharply, and supposedly liquid portfolios will suddenly become hard to sell. Too much new borrowing could put companies at risk if the credit cycle turns. Banks may be putting too much of their own capital into trading and blundering into risky activities just to show that they have a presence.

One of the central bank's main concerns is that investors see this spring's events as a blip and charge straight back into the most volatile assets. Perhaps they already have. Michael Metcalfe of State Street Global Markets, a big asset-management company, notes that investors are buying cross-border assets again this month after abandoning them in June. Provided they do so selectively, that is fine. But if the tightening continues, bravery may soon look like folly.

http://pg.photos.yahoo.com/ph/h00ey@sbcglobal.net/detail?.dir=4d31&.dnm=2c7cre2.jpg&.src=ph
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

I know many miners have taken off their production hedges, etc, and have vowed to leave them off for the foreseeable future.

But if I was a CEO of a typical miner I would seriously look to again hedge production with forward prices at $575 to $600 an ounce here. This will have the impact of hammering the long-end of the curve. Such a trickle could eventually turn into a stampede.

[rffrydr]

I wish it were so simple; but, yes.


Hedge Fund recipe for success: take your maximum leveraged position (derivatives on gold, futures at 6%, forwards at 4% and less) finance it with the cheapest money available (yen at less than 1%) and one dollar will get you 10. The cheap money gives your "inflation" back story and pretty soon it's all feeding on itself in a virtuous circle--which always breaks. This giant margin call should push itself through March.

Combined with customer outflows those kinds of Hedge Funds are getting kicked from both sides.

Of course then there's the institutional index funds to soften the blow. And a general desire of japanese investors funding the world's steepest geriatric slide to invest abroad.

And then there's everyone who "missed it" and wants in--which will take us back up. Now needs more pain.

And then there's......

But, yeah, that's it on the button.
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Today is the Tomorrow you worried about Yesterday!

[nodoodahs]

Was the depressed price of gold over the last couple of days the result of taking profits to buy back yen?
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.