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Requiescat In Pace Yen Carry Trade
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Good Morning,
The weekend brought no relief to global markets and collective investor anxiety rose once again, as Europe began to feel the full brunt of the credit storm now hitting its shores. Hypo and Fortis were the latest in the growing list of global financial names to be rescued, absorbed, buried, or forgotten by the side of the road. The German government will now guarantee "all deposits." Local stocks fell to their lowest level since 2006. The euro is skirting values not seen in 14 months. Welcome to "Blacktoberfest."
"Now, with the collapse of big banks, we see that money disappears, is nothing and all these things that appear real are in fact of secondary importance. Those who build the house of their lives on sand, are those who build on things that are visible and tangible, such as success, career and money." - today's global market conditions analysis, brought to you by Pope Benedict XVI. Perhaps a timely reminder that your inner life may be worth a whole lot more than your dwelling and investment portfolio ever were.
Back in early February of last year, I wrote that the apparent end of the yen carry-trade would "alter the global financial landscape for years to come." Little did I know what degree of 'alteration' this new phase in the financial would usher in. More than 18 months later, we find ourselves with none other than the Pontiff reminding us that all values are relative, and that our graves will not contain any of the trappings of life we are so desperately attempting to hang on to, as the supposedly 'reasoning' biped on the planet.
We open the week with global stock markets in major freefalls, the strongest dollar in over a year, oil prices in the high 80's, and gold still only barely matching the highs it recorded in 1980. The era of cheap money over, traders and investors are looking for a sign - any sign - that a particular asset is offering a modicum of safety and capital preservation. All of the elements required for a prolonged period of falling prices are now in place - it is now only a question of duration and depth, as to how this stage will eventually come to be looked at when the dust clears. Deleveraging will likely take an enormous toll on all kinds of price tags. Commodities have suffered their worst decline in 50 years. Should rescues, bailouts, and assorted interest rate cuts fail to provide the much-needed cushion, everyone is probably looking at the biggest "fall sale" in 80 years.
Indeed, the belated $700 billion economic rescue package appears to have been received with little confidence among those whose actions count the most. Lenders are not inclined to lend. Borrowers are being shut out. Investors (as banks) are fleeing to cash. Expectations are best left unquoted. Santa Claus is preparing for an outing that may require only Rudolph in the harness. Red nose flashing, and all.
Gold prices opened at $860 an ounce in New York this morning, adding a quick $25 to Friday's closing spot values. The market showed nervousness from the get-go however, and it will likely spend the day keeping a very close eye on oil (now $89.72) and the dollar (at precisely 81 on the index). However, the focus is fast-shifting to Dow-watching as that index looks set to pierce the $10K level unless it receives a 1/2 percent early holiday present -courtesy of the Fed. A coordinated central bank interest rate cut campaign may be in the offing at this stage of the game, as the rescue package turns out not to have offered that which was hoped for: calm and confidence. Silver rose 21 cents to $11.37 and the noble metals recovered some lost ground, with platinum rising $26 to $988 and palladium gaining $3 to $198 per ounce.
Marketwatch's Mark Hulbert found no evidence of capitulation among gold timers in September - a sign that still has him worried about gold's near-term prospects. Having been correct for the last three such snapshots of underlying sentiment, Mr. Hulbert would now be entitled to be proven wrong, based on simple odds alone. Whether or not he will be, remains to be seen. For now, let's see what he has to report:
" This last week provided a textbook illustration of how much sentiment influences the markets' short-term direction.
Take Friday, the day in which the much-vaunted Wall Street bailout legislation finally received Congressional approval. There is no reasonable doubt that this legislation will have significant long-term inflationary consequences.
And yet, guess what happened on Friday to gold bullion, perhaps the most sensitive of inflation hedges? Far from rising, it fell -- by more than $11 per ounce. Needless to say, sentiment was not the only cause of gold's surprising decline. But I do suspect that it was one of the major causes, since there has been an excess of bullishness among gold-timing newsletters in recent weeks.
Consider the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold market exposure among a subset of the shortest-term gold-timing newsletters tracked by the Hulbert Financial Digest. As of Friday night, the HGNSI stood at 30.7%.
The contrarian-based concern with this current HGSNI level is not that it is too high in an absolute sense. Instead, the worry is that the HGNSI grew too quickly when gold bullion started to rally in mid-September. For example, in the space of just nine trading sessions following gold's Sept. 11 low, the HGNSI jumped some 39 percentage points. That's an awfully quick jumping back on the bullish bandwagon, and is not what typically happens at the beginning of a new bull market.
Instead, the typical pattern is for the initial rally off a major bear market low to be greeted by skepticism.
There's another feature of the recent sentiment picture that leads contrarians to question whether the Sept. 11 low was the final low of the gold bear market that began in March. Even though, at that low, gold was nearly 30% below its March high, the HGNSI was still positive.
A 30% decline certainly qualifies as a major bear market, of course. It is markedly more severe than the recent bear market in stocks, at least so far. And, normally, at final lows of major bear markets, the average recommended exposure among market timers falls into significantly bearish territory.
Why not now?
After all, there have been six other occasions over the last three years in which the HGNSI did fall into negative territory, sometimes significantly so. In September 2006, for example, the HGNSI dropped to negative 25.0%. But on none of those six prior occasions had gold bullion dropped by as much as it did in recent months.
For these and related reasons, a contrarian analysis of current gold sentiment suggests that the path of least resistance for gold is down -- over the short term. I hasten to emphasize that it is only for the short term that this analysis is relevant. Sentiment factors don't determine the market's major trend, but instead tell us where we stand at any given time relative to that trend. And right now, it would appear that the gold market has gotten somewhat ahead of its underlying trend."
Where markets end up today remains as unclear as which financial firm makes the obituary column in the papers. Insurers, automakers, retailers, and now- entire states in the US are begging for money in order to make it to the next day alive. Whether or not gold reaffirms its safe-haven role may end up meaning very little in the bigger scheme of things -at a time when everything else you own is looking set to go up in smoke. Like the Pope says, values mean nothing anymore. Just focus on your family. Pax Vobiscum.
Happy Praying.
Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal
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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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