For over a year now, we have discussed the potential trouble with the Yen Carry Trade.
With interest rates in Japan as low as .
50% many Japanese and foreign investors were taking out huge loans of the yen at very low rates, then exchanging the ten for higher yielding currencies such as the New Zealand dollar, which was fetching over 7%.
So with a spread of over 6% many investors jumped into this game, and for quite a while it has paid off nicely.
But in July things started to change.
The yen started to appreciate in value, bringing more investors back to the yen, which ironically exasperated the problem for investors who borrowed the yen to invest abroad.
As the yen appreciated against other currencies such as the New Zealand dollar, those who borrowed heavily against the yen to buy the NZ dollar started to panic because their profits were drying up and they still had to buy back the yen at higher rates to pay off their loans.
Up until mid July this year, this investment of borrowing yen to buy the NZ dollar was paying off nicely.
But since mid July this ratio of the NZD/JPY has fallen over 20% from its high, meaning the Japanese Yen has appreciated 20% against the New Zealand Dollar in less than a month.
This is a great example of how the carry trade can go wrong, because New Zealand was a country that Japanese investors flocked to in order to seek higher yields, and those investors were caught holding the bag.
This carry trade issue is similar to what we saw in the US housing market the past few years.
When US interest rates were very low and banks and mortgage lenders were offering very creative mortgages, everyone was buying homes.
Many homeowners bought more than one home because they couldn't lose.
Because housing prices kept going up, many borrowed against the new increased equity in their home and bought another home.
Others who normally wouldn't qualify for homes were being offered great new mortgages, some with no money down and with extremely low interest rates for the first 2 years.
It was all so easy.
Buy a home for $150,000, make the low payments (say $575 per month) and in 2 years, sell the home for $170,000 or event $200,000.
The only problem was that indeed, they could lose.
In fact many have lost and many more are about to lose.
Today that $150,000 home might only be worth $140,000.
In addition their mortgage is now coming up for reset, meaning that the extremely low interest rate of 1%-2% is now going to be a much less affordable 7% - 8%, and their very reasonable monthly payment of $575, will go to a much less affordable $1200.
When the balloon bursts..
Back in January when we published our 2007 Global Outlook Forecast, we warned that the sub prime mortgage defaults were going to cause trouble for the markets and the US economy, and we expected the problems to last longer than most would expect.
Today, as we are in the throws of this sub prime melt down, we are concerned that the problems may be even greater than we had predicted.
The subprime-mortgage failure started with higher-than-expected defaults, then led to hedge fund wipeouts, and most recently to mortgage broker bankruptcies (the latest count on bankrupt mortgage lenders is now up to 129).
Up to this point, the problem was isolated to the subprime segment of the market.
But because these mortgages were packaged together with thousands of other mortgages from many different underwriters, these subprime mortgages made their way into hundreds of financial institutions around the world.
As we documented in previous articles, investment banks created a new type of security called an Asset Backed Security (ABS).
in effect, investment banks would take a thousand mortgages or car loans or commercial mortgages or bank loans and put them into a security.
As an investor you could invest in any one of the following bank instruments: a Collateralized Debt Obligation (CDO), a Commercial Mortgage Backed Security (CMBS), a Residential Mortgage Backed Security (RMBS) or or a Collateralized Loan Obligation (CLO).
With all of these packaged investmentscontaining thousands of mortgages from different underwriters, it's probable that hundreds of financial institutions around the world have a hint of weak subprime mortgage debt that they are carrying.
Parts of these RMBSs and CDOs were rated AAA.
Almost any financial institution could own them -hedge funds particularly.
The current problems started when investors in these Hedge funds caught wind of these poor quality mortgages in their portfolios, and started to ask for their money back.
This started in the US, but the panic soon spread to France and Germany also.
Mass psychology is a powerful market force, and when that force is driven by fear, the magnitude ramps up dramatically.
In July as more and more hedge funds started feeling the pinch, no one wanted to buy mortgage debt as all mortgage debt was now being branded as bad - which is crazy.
We have seen companies such as Thornburg have seen their shares drop dramatically this past week or two.
The result is that now no one wants to buy this debt, and many led by the hedge funds are selling.
A few weeks ago, we reported that in March, lenders started to question the ratings of the credit quality of some of the securities that they were lending on (RMBSs ,CDOs etc).
As these lenders became suspicious of the quality, they started telling the hedge funds and banks that they were going to reduce the amount of leverage they would offer and further they were charging extra 3% - 5% on the bonds.
This meant that the hedge funds had to sell collateral to make the margin calls, and they had to take less than face value on the bonds, reducing the value of the bonds for everyone holding them.
This creates a viscous cycle as anyone holding these bonds got hit for more margin, the banks then reduced the amount of credit available, putting more pressure on the sell side as the liquidity starts to dry up, forcing yet more selling to raise cash.
It is today's version of "a run on the bank" - all fueled by fear.
So today we have the Yen Carry Trade unwinding, the US housing market unwinding, and the global credit market feeing the pressure.
All of this leverage and liquidity in the world today is like filling a balloon with more and more water - the more that we kept filling the balloon, the bigger the mess when it bursts.
The mess from the leverage balloon is spilling over to all markets.
As the leverage mess spreads we get reaction.
There is an estimated $20 trillion in US Hedge and Mutual funds - a massive amount of money.
Much of this money has been invested globally in foreign markets and foreign currencies (eg: New Zealand dollar).
When these fund managers are forced to sell as things start to unravel, they sell their foreign holdings and put the money into short term US Treasuries.
This short term run to a safe haven has a short term effect of raising the value of the home currency, in this case the US dollar.
On Friday, the Fed made a bold move and reduced their discount rate.
From Bloomberg: The Federal Reserve unexpectedly cut the discount rate and said it's prepared to take further action to "mitigate'' damage to the economy from the rout in global credit markets.
The central bank reduced the discount rate at which the Fed makes direct loans to banks by 0.
5 percentage point to 5.
75 percent.
Policy makers kept their benchmark federal funds rate target unchanged at 5.
25 percent.
Today's action is the first reduction in borrowing costs between scheduled meetings of the Federal Open Market Committee since 2001 and Ben S.
Bernanke's first as Fed chairman.
While the central banks will try to stem the damage, remember that there is $20 trillion in Hedge and Mutual funds, and if that money moves, there is nothing any central banker can do about it.
On Friday the market rebounded and closed up 233 points, on lower volume.
When we have seen large declines we have seen volume up in the 5 billion range, Friday the volume 3.
7 billion.
Nevertheless, it was an up day and we will take it.
From here we could well see a rally in the markets, but we suspect that it would only be a bounce and ultimately we are looking for the markets to decline further.
There is still too much optimism for our liking; Wall Street doesn't seem to be taking this credit bubble seriously enough yet.
All the talking heads on CNN are telling us that the bottom is in - we doubt it.
Therefore, although we are looking for a short term rally, generally we are suspecting that the market has more pain to inflict.
Unfortunately, we think it is going to get worse before it gets better.
Gold and Uranium Stocks Gold and Uranium stocks are been hit as hard as any during this strong correction.
The reason is simply that with investors so scared they are selling everything.
Speculative stocks get tossed quickly.
They are much more volatile because they trade much more lightly than blue chip stocks.
We have been stopped out and partially stopped out of many of our stocks in this fallout.
But we have taken profits all the way up in the great run that these stocks had and have sold all or portions of our shares on this decline.
It leaves us with a good amount of cash right now, and given the volatility still in the markets, there is nothing wrong with cash for the short term.
We will continue to add when we see bargains and many of the shares that we have previously sold are looking very attractive now.
Be very clear here - we are still very strong believers that nuclear power is the near term answer to our environmental issues - we see no other option as being in the ball park at this stage.
While hedge funds are dumping all stocks to raise cash to cover their margin calls, it does not mean that the energy crisis facing the globe has gone away.
We are big picture investors and although these severe corrections are tough to swallow (especially for newer subscribers) we stay focused on the big picture.
Uranium and gold stocks are selling at a great discount today and are worth a look right now.
If we did not own any gold or uranium stocks at this point, we would buy some at these prices.
But given that we still feel that the general market is in for some more negative moves, we strongly suggest holding some cash for a little while, waiting for the markets to decide where they are going.
At this point, we expect more volatility for the next month or two and we believe that sometime in mid October, we could see an end to this carnage.
When we feel that we have seen the bottom of this current correction, our subscribers will be the first to know.
For now, patience is the key.
Stay tuned!
With interest rates in Japan as low as .
50% many Japanese and foreign investors were taking out huge loans of the yen at very low rates, then exchanging the ten for higher yielding currencies such as the New Zealand dollar, which was fetching over 7%.
So with a spread of over 6% many investors jumped into this game, and for quite a while it has paid off nicely.
But in July things started to change.
The yen started to appreciate in value, bringing more investors back to the yen, which ironically exasperated the problem for investors who borrowed the yen to invest abroad.
As the yen appreciated against other currencies such as the New Zealand dollar, those who borrowed heavily against the yen to buy the NZ dollar started to panic because their profits were drying up and they still had to buy back the yen at higher rates to pay off their loans.
Up until mid July this year, this investment of borrowing yen to buy the NZ dollar was paying off nicely.
But since mid July this ratio of the NZD/JPY has fallen over 20% from its high, meaning the Japanese Yen has appreciated 20% against the New Zealand Dollar in less than a month.
This is a great example of how the carry trade can go wrong, because New Zealand was a country that Japanese investors flocked to in order to seek higher yields, and those investors were caught holding the bag.
This carry trade issue is similar to what we saw in the US housing market the past few years.
When US interest rates were very low and banks and mortgage lenders were offering very creative mortgages, everyone was buying homes.
Many homeowners bought more than one home because they couldn't lose.
Because housing prices kept going up, many borrowed against the new increased equity in their home and bought another home.
Others who normally wouldn't qualify for homes were being offered great new mortgages, some with no money down and with extremely low interest rates for the first 2 years.
It was all so easy.
Buy a home for $150,000, make the low payments (say $575 per month) and in 2 years, sell the home for $170,000 or event $200,000.
The only problem was that indeed, they could lose.
In fact many have lost and many more are about to lose.
Today that $150,000 home might only be worth $140,000.
In addition their mortgage is now coming up for reset, meaning that the extremely low interest rate of 1%-2% is now going to be a much less affordable 7% - 8%, and their very reasonable monthly payment of $575, will go to a much less affordable $1200.
When the balloon bursts..
Back in January when we published our 2007 Global Outlook Forecast, we warned that the sub prime mortgage defaults were going to cause trouble for the markets and the US economy, and we expected the problems to last longer than most would expect.
Today, as we are in the throws of this sub prime melt down, we are concerned that the problems may be even greater than we had predicted.
The subprime-mortgage failure started with higher-than-expected defaults, then led to hedge fund wipeouts, and most recently to mortgage broker bankruptcies (the latest count on bankrupt mortgage lenders is now up to 129).
Up to this point, the problem was isolated to the subprime segment of the market.
But because these mortgages were packaged together with thousands of other mortgages from many different underwriters, these subprime mortgages made their way into hundreds of financial institutions around the world.
As we documented in previous articles, investment banks created a new type of security called an Asset Backed Security (ABS).
in effect, investment banks would take a thousand mortgages or car loans or commercial mortgages or bank loans and put them into a security.
As an investor you could invest in any one of the following bank instruments: a Collateralized Debt Obligation (CDO), a Commercial Mortgage Backed Security (CMBS), a Residential Mortgage Backed Security (RMBS) or or a Collateralized Loan Obligation (CLO).
With all of these packaged investmentscontaining thousands of mortgages from different underwriters, it's probable that hundreds of financial institutions around the world have a hint of weak subprime mortgage debt that they are carrying.
Parts of these RMBSs and CDOs were rated AAA.
Almost any financial institution could own them -hedge funds particularly.
The current problems started when investors in these Hedge funds caught wind of these poor quality mortgages in their portfolios, and started to ask for their money back.
This started in the US, but the panic soon spread to France and Germany also.
Mass psychology is a powerful market force, and when that force is driven by fear, the magnitude ramps up dramatically.
In July as more and more hedge funds started feeling the pinch, no one wanted to buy mortgage debt as all mortgage debt was now being branded as bad - which is crazy.
We have seen companies such as Thornburg have seen their shares drop dramatically this past week or two.
The result is that now no one wants to buy this debt, and many led by the hedge funds are selling.
A few weeks ago, we reported that in March, lenders started to question the ratings of the credit quality of some of the securities that they were lending on (RMBSs ,CDOs etc).
As these lenders became suspicious of the quality, they started telling the hedge funds and banks that they were going to reduce the amount of leverage they would offer and further they were charging extra 3% - 5% on the bonds.
This meant that the hedge funds had to sell collateral to make the margin calls, and they had to take less than face value on the bonds, reducing the value of the bonds for everyone holding them.
This creates a viscous cycle as anyone holding these bonds got hit for more margin, the banks then reduced the amount of credit available, putting more pressure on the sell side as the liquidity starts to dry up, forcing yet more selling to raise cash.
It is today's version of "a run on the bank" - all fueled by fear.
So today we have the Yen Carry Trade unwinding, the US housing market unwinding, and the global credit market feeing the pressure.
All of this leverage and liquidity in the world today is like filling a balloon with more and more water - the more that we kept filling the balloon, the bigger the mess when it bursts.
The mess from the leverage balloon is spilling over to all markets.
As the leverage mess spreads we get reaction.
There is an estimated $20 trillion in US Hedge and Mutual funds - a massive amount of money.
Much of this money has been invested globally in foreign markets and foreign currencies (eg: New Zealand dollar).
When these fund managers are forced to sell as things start to unravel, they sell their foreign holdings and put the money into short term US Treasuries.
This short term run to a safe haven has a short term effect of raising the value of the home currency, in this case the US dollar.
On Friday, the Fed made a bold move and reduced their discount rate.
From Bloomberg: The Federal Reserve unexpectedly cut the discount rate and said it's prepared to take further action to "mitigate'' damage to the economy from the rout in global credit markets.
The central bank reduced the discount rate at which the Fed makes direct loans to banks by 0.
5 percentage point to 5.
75 percent.
Policy makers kept their benchmark federal funds rate target unchanged at 5.
25 percent.
Today's action is the first reduction in borrowing costs between scheduled meetings of the Federal Open Market Committee since 2001 and Ben S.
Bernanke's first as Fed chairman.
While the central banks will try to stem the damage, remember that there is $20 trillion in Hedge and Mutual funds, and if that money moves, there is nothing any central banker can do about it.
On Friday the market rebounded and closed up 233 points, on lower volume.
When we have seen large declines we have seen volume up in the 5 billion range, Friday the volume 3.
7 billion.
Nevertheless, it was an up day and we will take it.
From here we could well see a rally in the markets, but we suspect that it would only be a bounce and ultimately we are looking for the markets to decline further.
There is still too much optimism for our liking; Wall Street doesn't seem to be taking this credit bubble seriously enough yet.
All the talking heads on CNN are telling us that the bottom is in - we doubt it.
Therefore, although we are looking for a short term rally, generally we are suspecting that the market has more pain to inflict.
Unfortunately, we think it is going to get worse before it gets better.
Gold and Uranium Stocks Gold and Uranium stocks are been hit as hard as any during this strong correction.
The reason is simply that with investors so scared they are selling everything.
Speculative stocks get tossed quickly.
They are much more volatile because they trade much more lightly than blue chip stocks.
We have been stopped out and partially stopped out of many of our stocks in this fallout.
But we have taken profits all the way up in the great run that these stocks had and have sold all or portions of our shares on this decline.
It leaves us with a good amount of cash right now, and given the volatility still in the markets, there is nothing wrong with cash for the short term.
We will continue to add when we see bargains and many of the shares that we have previously sold are looking very attractive now.
Be very clear here - we are still very strong believers that nuclear power is the near term answer to our environmental issues - we see no other option as being in the ball park at this stage.
While hedge funds are dumping all stocks to raise cash to cover their margin calls, it does not mean that the energy crisis facing the globe has gone away.
We are big picture investors and although these severe corrections are tough to swallow (especially for newer subscribers) we stay focused on the big picture.
Uranium and gold stocks are selling at a great discount today and are worth a look right now.
If we did not own any gold or uranium stocks at this point, we would buy some at these prices.
But given that we still feel that the general market is in for some more negative moves, we strongly suggest holding some cash for a little while, waiting for the markets to decide where they are going.
At this point, we expect more volatility for the next month or two and we believe that sometime in mid October, we could see an end to this carnage.
When we feel that we have seen the bottom of this current correction, our subscribers will be the first to know.
For now, patience is the key.
Stay tuned!
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