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Do not fool yourself into thinking that you know what the price of a commodity should be.
- Phil Flynn |
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Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide. Now you can get this highly sought after analysis with your daily research newsletter from Phil Flynn.
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Today's Featured Article
Roll up, roll up for the magical mystery trade. Step right this way, roll up, roll up for the mystery trade. Roll up, roll up for the mystery trade. Roll up and that's an invitation, roll up for the mystery trade. Roll up to make a reservation, roll up for the mystery trade. The magical carry trade is waiting to take you away, hoping to take you away take you today.
Actually the trade that is carrying us a way is not really a mystery but the trade that is really dominating the global economic landscape. It is a trade that is making many people a lot of money, yet at the same time is raising fears and will create chaos when it ends! The trade is like printing money but could roll you over when it ends. It is a trade that has been created and encouraged by the US Federal Reserve to save the US banking system and the global economy at large. Should you get carried away on the carry trade?
Well before you get carried away you need to know just what the carry trade is. The carry trade in its most simple terms is a strategy where investor or a bank sells a certain currency (in this case the dollar) with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate (or to invest it in things like commodities that can also provide a larger return for those with a larger appetite for risk). Traders and banks use this trade strategy to attempt to capture the difference between the rates or to borrow money on the cheap and to reinvest it in something that can return more money there by locking in a profit. The Federal Reserve
made this trade possible by lowering interest rates to zero and when it employed quantitative easing (printing money) to save the global economy from a deflationary spiral and create some inflation to offset some massive deflationary pressures. At the same time it helped bailout banks so they had a vehicle to make some profits to offset the massive losses they took on the lending side.
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This trade is one of many reasons why gold has soared to all time highs and has kept other commodities higher than they might have been. Commodities are priced in dollars and as investors sell the dollar to take advantage of this trade it drives the other commodities up. This has been a situation that has created wealth for many sophisticated investors but is not without its risks.
The carry trade is raising fears that the Fed is creating another bubble that will end badly when the Fed has to reverse course. Recently the Dubai Financial crisis showed how quickly this trade can turn as traders ran back to the safety of the dollar as they feared that the global economy might again unravel and that the deflationary pressures from another crisis would outweigh the benefits of the Feds movements. If the Fed decides to raise rates or if the global economy gets a scare the carry trade can carry you out on a stretcher.
Some fear that the carry trade is a major danger. Nouriel Roubini, the noted economist told the Financial Times that this "the mother of all carry trades faces an inevitable bust." He says that this massive rally we have seen in stocks and commodities will not last. He says that the most important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. Roubini says that the US dollar has become the major funding currency of carry trades as the Fed has kept interest rates down for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just
borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates -- as low as negative 10 or 20 per cent annualized -- as the fall in the US dollar leads to massive capital gains on short dollar positions. In other words, traders are borrowing at negative 20 percent rates to invest in a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius even if they are just riding a huge bubble financed by a large negative cost of borrowing. "One day this bubble will burst, leading to the biggest coordinated asset bust ever: if
factors lead the dollar to reverse and suddenly appreciate -- as was seen in previous reversals, such as the yen-funded carry trade -- the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a coordinated collapse of all those risky assets -- equities, commodities, emerging market asset classes and credit instruments.
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The Chinese also is worried about the carry trade. We saw a big rebuke from the Chinese as when President Obama went to China. Liu Mingkang, the chairman of the China Banking Regulatory Commission, warned that US Fed policy has led to massive speculation and endangers the global economic recovery. He says that the huge carry trade is having a massive impact on global asset prices and has lead to massive speculation, "that was inflating asset bubbles around the world. It has created unavoidable risks for the recovery of the global economy, especially emerging economies and the situation is seriously impacting global asset prices and encouraging speculation in stock and property markets as
well.
Yet The Fed shows no fears of carry trades or bubbles or even inflation and gives the green light for the carry traders to carry on. The Fed is telling us that the carry trade is going to carry on. Despite the criticism the Fed has not given us any real talk of exit strategies and even says that economic conditions will warrant exceptionally low levels of the federal funds rate for an extended period of time. The Fed is not worried about inflation, as resource slack they think will save them yet the movement of the markets.
The bottom line is that this carry trade is still in play and should provide tremendous opportunities on the long side of many commodities on breaks. Of course the key is to be out before the things change and hope we have no more Dubai like situations than can catch us off guard. This is truly why commodities carry such profit potential and that is because at the same time there is so much risk. It is all in the timing. You can make huge profits buying commodities on breaks and should be able to for the foreseeable future if the Federal Reserve has its way. But you can get hurt if you happen to be there when the bubble bursts. The trade can be a magical trade if you time it right but
it could also be a nightmare. You have to think hard as to whether you can take the risk but if you can it could turn out to be a magical ride.
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About the Author
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Phil Flynn is one of the world's leading energy market analysts. Phil provides up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide.
Phil and his energy team were one of the first to predict that global crude oil prices would exceed $30/barrel in the year 2000, a correctly predicted market milestone that has highlighted the economic scene in the new millennium. Phil also called the rise of retail gas prices in 2001. Most recently, Phil Flynn has again accurately predicted that global crude oil prices would reach close to $40/barrel ($39.99/barrel) in 2004. Through hundreds of media interviews, Phil Flynn has become familiar names in living rooms and boardrooms worldwide. The world's print, broadcast, online media and small businesses have come to rely on Phil's accurate and animated forecasts, analysis, speculative
and hedging opportunities.
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Special Message from Our Author
Get daily research letters from Phil Flynn
Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide. Now you can get this highly sought after analysis with your daily research newsletter from Phil Flynn.
Learn more about this complimentary offer and sign-up today. |
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