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Gold Rises As Sell Off Of The Euro Yen Carry Trade Takes Commodities And Stocks Lower


I ... A rising Euro, together with rising major currencies and developing currencies, since June 10, 2010, when the EFSF Monetary was announced, have driven a number of emerging market countries and bonds of all types higher.

The chart of the Euro, FXE, the major currencies, DBV, together with the emerging currencies CEW, and the emerging market bonds, EMB, the US Ten Year Note, IEF, corporate bonds, LQD, Municipal Bonds, MUB, shows that since June 10, 2010, when the EFSF Monetary authority was announced, the rise of the Euro has underwritten debt of all types, with the greatest stimulus coming to the Emerging Market Bonds, EMB, and the US Ten Year Note, IEF ….. Chart of the Euro Stimulus — DBV, CEW, FXE, EMB, IEF, LQD, MUB    

Chart of the US Ten Year Note, IEF closed today at 96.25

Chart of Municipal Bonds, MUB, shows the lollipop hanging man candlestick.  

Chart of Peru, EPU, Weekly, shows a topping out pattern         

Chart of  Thailand, THD, Weekly shows three white soldiers, a reversal pattern

II ... A sell off of the yen carry trade turned off “the spigot of investment liquidity” …  and took commodities and stocks lower today, August 5, 2010.

The euro yen carry trade, FXE–FXY, fell lower at opening today with the Yen, FXY, rising more than the euro, FXE, causing stocks, ACWI, to fall 0.3% lower.  The current high value of the Yen, FXY,  is not conducive to investing long the stock market. The Yen rose to close at 115.37, which is near its August 3, 2010 high of 115.39.

The Euro, FXE, closed at 131.46 which is also near its August 3, 2010 high of 131.87. Chart of the Euro, FXE, shows today’s fall in the Euro from the August 3, 2010 high.

Setyo Wibowo in EURUSD Forecast August 5, 2010, shows the chart of the Euro at 131.54

World stocks, ACWI, have fallen from their August 2, 2010 high, indicating that the “stock deflation” that started April 26, 2010, when the currency traders sold the world’s currencies, against the Yen, has recommenced. 

Chart of ACWI

Chart of FXE–FXY

Chart of FXE:FXY

Chart of the EUR/JPY shows the fall of the euro yen carry trade from its August 2, 2010 high.

World currencies, DBV, fell 0.21%, while emerging market currencies, CEW, fell only 0.14%. Today’s fall in world currencies, DBV, below yesterday’s, that is August 4, 2010 high, suggests that “currency deflation” has commenced.

Risk aversion arose today, causing commodities, DBC, to trade 0.5% lower. Oil, USO, fell 0.5%. Agricultural commodities, DBA, fell 08%; Food, FUD increased 0.9% on grains, GRU 3.4% rise, as Russia banned export of wheat. Natural Gas, UNG, fell 2.4%. Base Metals, DBB, fell 1.8% lower

The Google Finance chart of the HUI precious metal mining shares, shows these disconnecting from the price of gold today. I have consistently warned investors to trade out of gold mining stocks for the real thing as carry traders are going to be taking profit and saying bye-bye to these high PE stocks. The HUI precious metal mining shares generally turns lower with US Government bonds, this is the case currently as can be seen in the chart of GDX, GLD and ZROZ  

An unwinding euro yen carry trade caused Austria, EWO, and Italy, EWI, to fall lower. The Financial shares, XLF, lower 0.4% lower on volatility in the European Financials, EUFN. 

Aggregate Bond, AGG, rose; but is still below its July 30, 2010 high, indicating that “peak credit” has been achieved and that “bond deflation”, that is, credit contraction has commenced. Note the lollipop hanging man candlestick shown in the chart; it also serves as a type of dark cloud covering over the entire rise of debt.  

Thus, this week we have the “worst of all investment scenarios” emerging, with currencies, stocks, and bonds all falling lower. Yahoo Finance chart shows the fall lower in all three forms of wealth, Aggregate Bonds, AGG, Stocks, ACWI, and Major World Currencies, DBV …. AGG, ACWI, DBV

III ... Kondratieff Winter has commenced

This is the final of the four socio-economic seasons, or long waves. Eventually mankind will see a total exhaustion of wealth; and regional economic governance will arise to provide security and economic cohesion.

Naked Capitalism provides this timely insight in their article entitled Summer Rerun Carry Trade Threatens A Deflationary Collapse where they reference Tim Lee, head of a financial economics consultancy, who relates in a Financial Times article what a carry trade unwind will look like (answer: very nasty) and what it would take to prevent it.

Concerns that the credit cycle may be turning down are growing. But so far, the impact on stock markets has been fairly limited.

Investors take comfort in three misguided beliefs. They believe that equities are not expensive and that there is no sign of any diminution in the flood of global “liquidity”. Furthermore, they believe that if the worst happens, the US Federal Reserve will come to the rescue.

Such beliefs represent a failure to understand the unique nature of this global credit bubble and the consequences of its inevitable collapse. The financial markets have become closely intertwined in ways that we have never seen before.

Some of these links are obvious, such as private equity’s arbitrage between the credit bubble and the equity markets. Others, such as the role of the global currency carry trade – the financing of leveraged positions in higher yielding assets from low-interest rate currencies such as the yen and the Swiss franc – are less well understood.

A symptom of the bubble is that high interest rate currencies have been soaring to multi-year or multi-decade highs against the yen. The New Zealand dollar, for instance, is approaching 21-year highs against the yen despite that over those 21 years, the price level in New Zealand has doubled whereas in Japan it has risen by only 12 per cent.

A simple purchasing power parity exercise suggests that the New Zealand dollar is 20-25 per cent overvalued against the US dollar, while the Turkish lira is about 65 per cent overvalued. The yen meanwhile is roughly 30 per cent undervalued.

Huge currency misalignments are leading to enormous current account imbalances. The Turkish and New Zealand current account deficits, for instance, are likely to be well into double-digits as a per cent of GDP by 2009, while Japan is likely heading for a record surplus of 6-8 per cent of GDP over the same time frame. The Swiss current account surplus is already about 17 per cent of GDP.

Ultimately there must be a sharp convergence of exchange rates with fair values, inflicting heavy losses on carry trades. The size of the global carry trade is at least $1,500bn and losses from a convergence of currencies with fair values could total about $550bn with most of these losses accruing to leveraged speculators.

Given the close linkages between markets, we can be confident that the unprecedented deviations of currencies from fair value resulting from the carry trade are reflected in credit, equities and real estate markets.

For the US, this is confirmed in the ratio of personal sector net worth to GDP. Prior to 1995, this ratio tended to fluctuate at about an average of 3.4. Now, despite the paucity of savings in the US economy, the ratio stands at 4.1. A return to the long-run average would imply a fall in US personal net worth of approximately $10,000bn. With similar trends mirrored across much of the world, total global losses from the coming financial meltdown could easily reach $25,000bn to $30,000bn.

Central banks are likely to attempt to ratify current inflated asset values by inflating prices and incomes to avoid a deflationary economic collapse. Unfortunately, sharp reductions in interest rates in the US, UK and the euro area will lead to a rapid unwinding of the global carry trade, perversely threatening to worsen problems in the credit markets.

The solution would have to involve massive unsterilised intervention by the Japanese authorities, which would have the effect of inflating Japanese prices to a level consistent with the current yen exchange rate, thereby alleviating huge upward pressure on the yen as the carry trade unwinds.

Combined with a similar inflation in the US this “solution” would require roughly a doubling of the Japanese price level, destroying the real value of Japanese savings.

If the losses are to manifest purely in real terms – via inflation – then they must occur mostly where the savings have been, which is certainly not in the US.

If the Japanese authorities baulk at the prospect of such a huge inflation, then global deflationary collapse will be inevitable once the credit bubble bursts.

IV ... The investment application

I’m convinced that gold is the best investment in a debt deflationary bear market, and in economy where the yield curve, $TYX:$TNX, is steepening. The chart of the gold ETF, GLD, shows that it has risen to resistance at 116.98, that is just under 117.0; and could easily fall lower to 114, 113, or 112.50 before moving even higher yet, as fiat assets deflate in value. 

Debt deflation is the contraction and crisis that follows credit expansion.  One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Global Debt Deflation commenced on April 26, 2010, when the value shares failed to outperform the growth shares as the currency traders went long the yen and short the global currencies. The same scenario is happening today August 5, 2010. Debt deflation is recommencing as world currencies, DBV, is falling from its August 4, 2010 high, causing small cap value shares, RZV, to fall more today than the small growth shares, RZG, as is seen in the Google Finance chart of DBV, RZV and RZG.   

While, I’m invested in gold coins, I recommend that institutional investors sell the currency, stock and bond markets short at this time, as the topping out of the European stocks, FEZ, on August 4, 2010; the Retirement ETF, TDV, on August 4, 2010; and the 200% Euro ETN, URR, today August 5, 2010; suggests the European Financials, EUFN, rally is over now that the banks have reported their earnings, and markets are going lower …. The chart of FEZ, TDV, URR  shows the market top.

For example, I’ve recommended that one sell the Proshares 200% Industrials, UXI which topped out yesterday August 4, 2010 at 35.34  

I provide a list of 22 ETFs and ETNs to sell short: here is a presentation  and a Finviz presentation for one’s analysis.

If institutional accounts are just not interested in short selling I recommend investing in the Direxion 300% inverse of the financial shares, TZA, which rose 3.4% today from its August 4, 2010 low of 13.10 to close at 30.92.

The 0.4% sell off in the financial shares, XLF, caused the Russell 2000, IWM, to close 1.8% lower from its August 4, 2010 high at 65.63 today.  

Credit service companies such as American Express, AXP, Nicholas Financial, NICK, and Dollar Financial, DLLR, were financial sector loss leaders today; as were banks, KBE. The chart of NICK Monthly is the epitome of the success of financialization and securitization that has come through the repeal of the Glass Steagall Act, the expansion of credit that came through the neoliberal credit liquidity policies of the czar of credit Alan Greenspan, and the stimulus of yen carry trade investing. 

V ... News of the day

1) … Tami Luhby of CNN Money reports that the Senate Approves Aid To Desperate States:  The Senate voted Thursday to send $26 billion more in federal aid to cash-strapped states.

The measure, which passed by a 61-39 vote, contains $16.1 billion in additional Medicaid money and $10 billion to prevent layoffs of teachers and first responders.

It now moves to the House, which will return Tuesday from its August recess to vote on the bill.

State officials have been desperately lobbying their representatives, saying they need the money to shore up their budgets. About 30 states had already included the additional Medicaid funds in their fiscal 2011 budgets, which began July 1, and would have to cut further if it doesn’t come through. The bill is expected to save 290,000 jobs, according to Senate Democrats.

President Obama also weighed in earlier in the week, asking lawmakers to pass the additional assistance to the states, which has been kicking around Congress in various forms for months.

The Senate was originally scheduled to vote on the measure on Monday, but Reid pushed it back to amend the legislation after learning it would increase the deficit by $4.9 billion despite offset measures. The amended bill reduces the deficit by $1.4 billion.

2) … The EU, IMF, ECB ended the inspection visit of debt-choked Greece today, August 5, 2010 with the determination that Greece has made enough progress via austerity measures, to receive a 9-billion euro aid tranche, the second aid instalment out of a 110-billion euro bailout. 

3) Bryan Keogh and Kate Haywood in Bloomberg/TZUMI News report Europe Junk Spreads Poised to Drop Below U.S.: Credit Markets:  

Relative yields on Europe’s junk bonds are poised to fall below their U.S. counterparts for the first time since June 2008 as concern the sovereign deficit crisis will derail the region’s economic recovery recedes.The extra yield investors demand to hold speculative-grade corporate bonds issued by European companies instead of benchmark government debt has declined to 656 basis points, or 6.56 percentage points, compared with 649 basis points in the U.S., according to Bank of America Merrill Lynch indexes. The 7 basis-point gap is down from 131 basis points on June 15.

Yield spreads shrinking faster in Europe than in the U.S. underscore optimism that Greece is bringing spending under control, allowing it to receive the second part of a 110 billion-euro ($145 billion) bailout this week. Economists forecast that a report tomorrow will show U.S. payrolls fell for a second month, adding to evidence the world’s largest economy is sputtering.

“People were gearing themselves up for another recession” in Europe “in the near-term and this fear has abated,” said Theodore Stamos, co-head of credit at Investec Asset Management in London, where he helps manage $70 billion. “It’s hard to see what might cause people to panic again anytime soon.”

Stamos said he favors high-yield debt issued by European cable companies as well as recent new issues from Colchester, England-based hospital and nursing-home operator Care U.K. Plc and auto-parts supplier Continental AG of Hannover, Germany. Junk bonds are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.

Europe’s junk bonds have returned 5.15 percent since June, led by Eircom Group ltd., Ireland’s largest phone operator, and Commerzbank AG unit Eurohypo AG, Bank of America Merrill Lynch’s Euro/Sterling Currency Fixed-Floating Rate High Yield Index shows. High-yield debt in the U.S. gained 3.87 percent.

Elsewhere in credit markets, the extra yield investors demand to own company debt instead of government bonds fell 1 basis point to 175 basis points, the lowest since May 18, Bank of America Merrill Lynch’s Global Broad Market Corporate Index shows. Average yields rose 1.9 basis point to 3.724 percent.

Corporate bond sales climbed 17 percent through yesterday from the same period last week. Global issuance rose to $39.8 billion this week, compared with $34 billion in the three days ended July 28, according to data compiled by Bloomberg.

Country Garden sold $400 million of 10.5 percent five-year notes yesterday in its second sale of dollar bonds in less than four months, according to data compiled by Bloomberg. The securities were priced at 99.052 cents on the dollar to yield 10.75 percent and slipped to 98.6 cents to yield 10.9 percent in Hong Kong today, Credit Agricole CIB prices show.

The China Banking Regulatory Authority told banks to stress test for home prices dropping as much as 60 percent in some cities and warned some developers may run out of cash, a person familiar with the matter said.

The cost of insuring against losses on U.S. and European corporate bonds rose, according to traders of credit-default swaps.

The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 2.1 basis points to a mid-price of 101.6 basis points as of 11:45 a.m. in new York, according to Markit Group ltd.

The index rose from near a 12-week low after a Labor Department report showed more Americans than economists had projected filed applications for unemployment benefits.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed 3.4 basis points to 101.8, Markit prices show.

The Markit CDX index typically rises as investor confidence deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

“The fear factor has definitely dropped” in Europe, said Malcolm Stewart, the London-based managing partner at North Sea Partners LLC, a closely held investment bank.

“Our U.S. outlook has been for a sustained subpar expansion, with a pace of expansion well below a normal recovery from a severe recession,” Bank of new York Mellon Corp. Chief Economist Richard Hoey said in a report yesterday. “we believe that recent evidence of a slower growth rate is real and not a statistical aberration.”

Confidence in Europe’s economic outlook rose to the highest in more than two years in July, the EU said last week, while a report yesterday showed retail sales in the 27-member region increased 0.1 percent in June.

“The data out of Europe have been much better than out of the U.S., and that’s helped buoy sentiment,” said Benjamin Bennett, a credit strategist who helps manage the equivalent of $125 billion of corporate bonds at Legal & General Investment Management in London.

Eighteen of the top 20 European high-yield performers in July were subordinated financial bonds, Bank of America Merrill Lynch indexes show. Dublin-based Eircom’s 350 million euros of floating-rate notes due 2016 returned 30 percent, while Eurohypo’s 600 million euros of perpetual 6.445 percent bonds gained 24 percent.

European junk-bond returns have the potential to more than double to 10 percent this year, according to Simon Thorp, who helps invest the equivalent of about $1.8 billion as a money manager at Liontrust Investment Services ltd. in London.

The proportion of European high-yield debt that’s trading at distressed levels — or a yield spread of 1,000 basis points or more — fell to 21 percent at the end of July from 32 percent a month earlier, Bank of America Merrill Lynch index data show.

That’s the sharpest decline since the so-called distress ratio dropped 13 percentage points in September 2009. It’s still higher than the U.S. figure, which fell to 13 percent from 15 percent.

“People are still nervous” in Europe, said Alex Moss, head of high yield at Insight Investment Management in London, which oversees the equivalent of $150 billion. “The rally feels flimsy and people are just not focusing on the negative issues right now.”

4) San Francisco Bay area home prices are up 18% according to the Huffington Post and the July 27, 2010 Case-Shiller Home Price Index

5) Nick Nassad in FXTimes reports that armed with better-than-expected data to start the third quarter, ECB President Trichet was marginally more confident in his press conference following the ECB’s decision to keep interest rates at 1%. That rate was “appropriate”, meaning officials do not see a need to raise rates soon.

The Euro has weathered a deep crisis this year, and has rebounded 10% since hitting a 4-year low near 1.19. European equity markets have gained 11% in the past month, and manufacturing and services data has showed that the Euro-zone economy may be building momentum to start the 3rd quarter. With bank stress tests out of the way, and fears of a sovereign debt crisis easing, the ECB can pat itself on the back for averting a worst case scenario.

6) Priceline explodes higher.


7) Stock analyst Corey Rosenbloom writes Sings Of A Distribution Top? 

VI ... Upcoming events, 
courtesy of David Cutler of Reuters 

– Sept. 6 – Euro group meeting and meeting of task force on economic governance.

– Sept. 7 – Ecofin meeting in Brussels.

– Sept. 16 – Informal EU Council meeting in Brussels.

– Sept. 20-21 – Informal Agriculture Council meeting

– Sept. 30-Oct 1 – Informal Ecofin meeting.

– Oct. 18-19 – Eurogroup/Ecofin meeting in Luxembourg.

– Oct. 28-29 – EU summit in Brussels.

– Dec. 16-17 – EU leaders’ summit.

Disclosure: I am invested in gold coins