The Trading Theme Remains in Place

Good day… And a Marvelous Monday to you! It’s been a long time, now I’m coming back home, I’ve been away now, oh how, I’ve been alone… Two weeks gone by the wayside! This Friday is Halloween! WOW! Where did the month go? Airports, hotels, and taxicabs, that’s where! But, I did it… The Currency Tour is finished… Time well spent I might add, but very taxing on me… Of course, my beautiful bride tells me that if I were in better shape, it wouldn’t be so taxing!

Well… As I look at the currency screens this morning, I see that nothing has changed… The trading theme I left you with is still in place, as the deeper, darker, and more dangerous the outlook for the U.S. becomes, the more the dollar gets bought… Things look better, and the dollar will get sold… The dollar has become the new Japanese yen!

So, keeping the trading theme in mind… Stocks around the world are getting sold in the overnight markets, and that has the U.S. stock market on the teeter totter again this morning. Things are looking darker, LIBOR is inching back up, and the carry trade is getting unwound… That means the dollar is rallying once again, and the Japanese yen (JPY) is, too.

G-7 made an unscheduled statement after a request from Japan’s Finance Minister, regarding the yen. Apparently, the strength of the yen is bothering Japanese officials. G-7 tried to stem the move higher by yen, but the strength of unwinding carry trades is just too much for such a watered down communiqué that simply said that G-7 was concerned with the “excessive volatility”.

So, one has to sit down and attempt to figure out the depth of the carry trades. In other words, How many more of those buggers are there?! Well… I asked around on Friday (yes, I was at home, but still working, with two interviews, one radio and one Wall Street Journal, a long conference call, and this work on the carry trade!) and found that most traders that follow Japan seem to believe that this unwinding has much more to go, which means the yen should have more to go, right?

Well… Who knows these days? But in keeping with the trading theme, I would say that one should look to additional yen strength if carry trades have more unwinding to go. You have to think further into this too… It’s not just plain old vanilla carry trades unwinding’; it’s years and years of Uridashi Bonds getting sold. For the new kids to class… The Uridashi Bonds are Japanese Corp bonds that are issued in New Zealand dollars, which gives them a huge yield advantage over Japanese denominated bonds. And Uridashi Bonds have been issued for years, which was a huge reason for the gains in New Zealand dollars (NZD). (This was chronicled in this letter several times over the years, going back to the ’90s!)

There was a report by the Minister of Finance in Japan last week that showed the Japanese investors was unloading the Uridashi Bonds for the first time in years! And all this risk in the markets that has the carry trades unwinding is causing Japanese investors to stop constantly looking elsewhere, and instead invest at home. So, no selling of yen, etc. Tutor Turtle learned there was no place like home… Dorothy learned there was no place like home… And Scarlet O’Hara did too! So, it’s about time the Japanese did! So… Unless the Bank of Japan (BOJ) is willing to intervene – and trust me it’s not beyond them to do so; plus, they have a war chest the size of Rhode Island full of yen reserves to sell – then we should continue to see yen strength… But there’s always that BOJ with their war chest of yen reserves hanging out that should put a governor on yen. In other words… Yen can gain, but if the gain becomes too excessive, we could see the BOJ intervene.

With the Uridashi Bonds getting sold… The weakness in New Zealand dollars is magnified. I know that I didn’t see the current trading theme coming, causing weakness in euros (EUR), etc. but I know that I must have sounded like the Boy Who Cried Wolf over the years, warning about an unwinding of carry trades and what it might do to the high yielders.

Just what should one do here with the U.S. economy sinking further and further into the abyss, causing dollar strength? Hold tight and believe that the fundamentals will come back to the front of the class on the other side of all this bad stuff going on in the markets? Sell into this weakness? I heard from Jen last week that she had a record number of CD breaks for one day. Apparently, selling into the weakness was in vogue that day! I have to say that selling now is a lot like try to catch a falling knife… But… I truly understand, as this has gotten completely out of hand. Me? I’m a fundamentals guy, with my investments too… So, I’ll hold, and wait to see what happens on the other side of all this. Take me to the other side… Please, and soon!

I don’t wish for us to get to the other side of all this just because of the currencies… I want to see the United States get through this credit crunch before we begin to spiral down into a deep dark recession, that could become a depression. I don’t want to see that… But, as you all know, these are the things I’ve written about that could happen should we not correct the course that we, as a country, are headed down.

And it all starts with the deficits… But I’m not going to go through all of the history and what’s brought us to this edge of the cliff… Someone sent me a note and told me that I wasn’t worth a damn because all I did was point out things that didn’t work or wouldn’t work, and did not submit a solution. Well… I take exception to that, because I have submitted solutions; but does any one in the Government listen to my solutions? Crazy… Absolutely crazy!

OK… Crude oil continues to weigh heavily on the Canadian dollar/loonie (CAD)… I have to admit that I did not see oil prices collapsing like they have done. Weakening from $145, yes… Weakening to the current level of $62.66? Never! Shoot Rudy, we didn’t even see oil prices rise after our friends (NOT!) over at OPEC announced a daily production cut of 1.5 million barrels of oil! Now, that makes no sense whatsoever! But that’s the markets these days… Gas for our cars is now an average of less than $2.80 per gallon! WOW! I have to say that I love the sound of that! But… As I said above, oil’s plunge has been a shot to the heart, and oil’s to blame for the loonie.

I see where it has been reported that the Reserve Bank of Australia (RBA) intervened on Friday, buying Aussie dollars (AUD) to stem the slide in the currency. Of course, had they done this when it was in the 90-cent range it might have stopped some of the selling, then. I would have to put this down as too little, too late… But they did buy Aussie dollars on Friday, and that did keep the Aussie dollar above 60-cents in the overnight markets.

Gold staged a nice rally on Friday, only to see that fade into selling this morning… No adding on to the one-day rally for gold! I got asked at every stop on the currency tour about why gold wasn’t higher in price? Well, for two reasons… 1. Gold has gotten caught up in the “sell everything to come back to dollars” mentality that’s going on in the markets these days… And 2. There’s an invisible hand manipulating this metal. But then, as I got home and began to think about that, I have to say it’s 90% #1… And just a small piece of #2. You know – with the dollar’s rally and the currencies’ decline – that gold is really high when priced in Aussie, kiwi, euros, etc. Hmmm…

The emerging markets have seen all this melting down in the currencies and have not been able to avoid melting themselves. In fact, the emerging markets are usually at the head of the class when it comes to selling. I tell you this because we could very well be seeing something in Hungary that would remind many of what happened to the British pound sterling (GBP) in 1992. And once again, I’ll mention something that I said to everyone a good time ago that has come to fruition… It just took a couple of years, and that is, that once the euro-wanna-be countries of Hungary, Poland and Czech Republic got closer to the ERM (exchange rate mechanism), the precursor to converting to the euro, they would face speculation. Well… Speculators have gone after Hungarian forints, and smell blood.

And finally… The Wall Street Journal reported on Friday, “The Treasury Department has decided to let banks individually announce that the government will invest in each firm, scrapping an earlier plan to release the names of multiple banks receiving federal money all at once. The decision came after concerns that banks left off any group list would appear too weak for government assistance, spooking investors and depositors and potentially making troubled banks’ situations more dire.”

And… The Treasury’s funds that are being placed into the Big Banks, are already being used to purchase the smaller banks. PNC announced that they would purchase National City Bank.

Oh… And one more thing… U.S. Existing Home Sales rose in September… Is that a sign of good things to come? Unfortunately, remember that I previously researched that these sales include foreclosures… And then there also this… The median home price has fallen 9% from a year ago, and is now the lowest prices since April 2004.

Currencies today 10/27/08: A$ .6075, kiwi .5415, C$ .7785, euro 1.2465, sterling 1.5444, Swiss .8650, ISK (no quote), rand 11.12, krone 7.0825, SEK 8.0920, forint 217.68, zloty 3.0620, koruna 19.6850, yen 92.80, baht 34.75, sing 1.51, HKD 7.7505, INR 49.87, China 6.8520, pesos 13.33, BRL 2.2975, dollar index 87.28, Oil $62.66, Silver $9.03, and Gold… $729.45

That’s it for today… Good to be back home… It was Homecoming weekend at Mizzou (U of Missouri) this past weekend, so both my older kids were in Columbia for that celebration. My little buddy, Alex had a good football game Saturday, and the Tigers got back on the winning side of the ledger with a win versus Colorado. It was great to see the people in Jacksonville again; I had not seen many of them since I had gotten sick. Well… I have a stack of “stuff” on my desk this morning, and we have people coming in to give us media training. Thanks to Jen for doing a stand up job trading and managing risk these past two weeks… She’ll have to deal with it two more days, as I will be busy with other things. It’s a Marvelous Monday folks… Hope yours is Marvelous, too!

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Chuck Butler
October 27, 2008

The Daily Reckoning