Friday, November 27, 2009

U.S. Dollar and the Carry Trade/Sold 100 PMK at 9.2/Gold & Inflation

1. Weakness in the Dollar Tied In Part to its Use in the Carry Trade: With the Federal Reserve keeping the federal funds rate near zero, the U.S. dollar has replaced the Yen as the currency of choice to implement the carry trade. The extremely low U.S. dollar Libor rate is also an important factor in this trade. This kind of trading activity weakens the U.S. currency, as investors borrow short term funds in the U.S., then sell the dollar to buy riskier assets priced in foreign currencies. This process is explained in this article from the Financial Times (subscription needed for FT). But, if the dollar starts to rally in a flight to safety, some speculators may decide to unwind that trade by buying back the dollar, thereby adding to its rise. This would be particularly true for those who sold the dollar to buy assets priced in foreign currencies, such as emerging market stocks that are taking a big hit today. It might also prove to be true even when the asset purchased with borrowed dollars, e.g. gold, is priced in dollars if that asset starts to undergo a correction in price. That asset might be sold in order to unwind the carry trade. I did notice that gold was falling some this morning using GLD as a proxy: GLD

Being a relatively simple minded individual investor who has never participated in such complex trading strategies, it seems to me that the use of the dollar as an instrument of the carry trade is potentially more dangerous than using the Yen or the Swiss Franc. There is a lot more natural demand for the U.S. dollar than for the Swiss Franc or Japanese Yen, making the U.S. currency a potentially less desirable candidate for the carry trade since those other factors could cause a non-temporary spike in the dollar's value. The natural demand for the dollar, arising in part from its status as a reserve currency, could overwhelm the dollar selling by speculators to fund their carry trades. The loans taken out to finance the carry trade are short term, and ultimately have to be paid back in dollars. To the extent the dollar starts to rise again based on factors unrelated to the carry trade, it would consequently become more costly to unwind the trade by selling the asset bought with borrowed U.S. dollars (which may be declining rapidly in value due to events causing a spike in the dollar which hurts), then buy back the U.S. dollar (rising in value which hurts), and then pay back the loan priced in U.S. dollars.

The dollar is gainly broadly against major currencies other than the Yen today. It is particularly strong against the Australian dollar. It is my understanding that some traders may borrow funds in U.S. dollars and buy Australian dollars. Then when that trade is unwound, the Australian dollars have to be sold, causing that currency to fall in value.

2. Sold 100 PMK at $9.2 on Wednesday (see Disclaimer): I am going to keep the 50 shares bought in the regular IRA recently at $8.21. Added 50 PMK at $8.21 The shares sold last Wednesday were bought at $8.35 in a taxable account. Bought 100 PMK/ I did not expect a price rise above $8.75 when I purchased the shares, so I decided to sell my higher cost shares for a small profit. This is a junk rated bond.

3. Gold and Inflation: I made a comment recently that gold could hardly be viewed as a hedge against inflation for a purchaser in 1980 near the peak price (until recently) of around $850 an ounce. This website contains a monthly price table for gold: Gold Price History The $850 price was next realized some 27 years later in late 2007. That is what I would call a secular bear market of a far longer duration than a secular bear market for stocks. Needless to say, for a buyer in 1980, gold did not provide a hedge against subsequent inflation. I found yesterday a calculation that gold would have to rise to almost $2200 to match that 1980 price now adjusted for inflation. Inflation hedge? And, 27 years is an awfully long time to wait for a profit.

An investor who bought gold in 1974 at say $150 an ounce, held for that first bull cycle and through the entire 27 year bear market, and sold today would have fared better against inflation with almost a 800% gain. When viewed from the perspective of that longer term cycle, one could argue with a straight face that gold did hold its value adjusted for inflation. I would add however that very few humans could hold an asset for 27 years waiting for a bull market to emerge. But over that 35 year time span, from 1974 to now, gold has done okay. It has failed as an investment for the purchaser in 1980 even after the recent price rise.

4. Tidbits: I have no interest in ING's rights issue, except that I hope for its success. I am not concerned about common share dilution as an owner of the hybrids IND, INZ and IGK. And, it is clear that a successful rights offering is important for the hybrid owner in order to get the EC off ING's back. The EC has made it clear that it will not compel a deferral of the hybrid distributions upon a successful rights offering.EC Approves ING's Restructuring/ EUROPA - Press Releases - State aid: Commission decisions on KBC, ING and Lloyds – frequently asked questions The common shares of ING are taking a hit this morning, falling below $10 in early trading, based on the 52% discount of the rights offering to the prior closing price ( FOX). I suspect that the Dubai World situation did not help the pricing. The issue price would be 4.24 Euros per share, six shares for every seven held: Reuters

There is not much of a response to the Dubai World news in the prices of treasury notes and bonds. Using the ETFs as surrogates, I noticed that TLT was up just a tad this morning, a negligible 18 cents: TLT ISHARES BARCLAYS 20 Year Treasury The 7 to 10 year treasury ETF was doing slightly better, though up only 29 cents in early trading: IEF: 7-10 year Treasury This minor response indicates that the big money crowd is not overly concerned about Dubai, at least for now, maybe that will change by next Monday when more of them return to work. Most of the European stock markets did recover today.


  1. There is a group of underwriters performing the rights issue so it shouldn't fail. At least not for non-common stock holders.

    Note: ING is also underwriter in the process so that could turn nasty.

  2. I am the other reader of this blog that is interested in the European hybrid preferreds. I see that Aegon is offering new debt as well:

  3. Given the discount for ING's rights issue, I would expect the rights issue to succeed. If I owned the common, which I do not not, I would feel compelled to buy 6 more shares for every 7 held at the price being offered, particularly if I wanted to hold the shares longer term. Otherwise, I would be penalized for the dilution without receiving any benefit. It would be a disaster if it failed given the discount. I view a successful common share rights offering to be a positive only for the owners of debt and of the most importance to the most junior debt holders, those who own the hybrids which were the target of the EC's burden sharing policy.

    I thought that Aegon's offering of senior debt at 4.625% with a 2015 maturity was a positive development, in that it shows market confidence in AEG. I still have not seen any action by the EC on AEG's restructuring plan. AEG was planning to buy back 1 billion Euros of the Junior Securities issued in connection with its bailout by the end of this month. If that happens as planned, it will be a Mandatory Payment event for the hybrid owners. AEG hybrids are ex dividend today.