The Rude Awakening
Laguna Beach, California
Friday, August 31, 2007 ------------------------- - Markets unravel and carry trades unwind, where your money should be,
- Frothy option action in China screams TOP!
- A red-hot swimsuit photo from the shores of Laguna Beach and more…
------------------------- Eric Fry, reporting from the capitol of beach volleyball… Bump…set…spike. That's the way the game of volleyball has been played on California beaches since the 1920s. And that's the way your editor played the game on one of California's beaches yesterday. The basics of the game have not changed for more than 80 years. Scoring points and winning games still rely upon the same essential combination: Bump…set…spike. 
By contrast, the financial markets of today bear almost no resemblance whatsoever to the financial markets of the 1920s (nor even to the financial markets of the 1990s). The modern financial lexicon features terms that did not even exist 80 years ago - terms like "hedge fund," "credit derivative," "collateralized debt obligation" and "carry trade." Do these innovations make the world a better place…or a safer place…or a more financially secure place? We doubt it. Based on the latest evidence, these innovations do make the world a better place for Goldman Sachs…but make the world a more confusing and dangerous place for individual investors. Back in the old days, we investors did not need to worry about the perverse imaginations of investment bankers…or about the fallibility of "infallible" market-neutral strategies. We did not need to fret that billions of dollars worth of ill-conceived derivatives might spontaneously combust and imperil the entire U.S. banking system. And we certainly did not need to consider that something as innocuous as a rising Japanese yen might trigger something as catastrophic as a global financial melt-down. But the old days are gone and these new days of ours are full of worries. We must worry about global warming and ozone depletion and unsafe sex…and, yes, even the yen carry trade. ----------- For the next 5 days only ------------- Get 6 Months of the World's Most Valuable Undiscovered Stock Research… FREE Every Year for the Rest of Your Life …As Long as I Hear From You by Midnight Sept. 4 --------------------------------------------------- The Yen Scary Trade
By Eric J. Fry Is the stock market scaring you? Buy yen. If the connection between falling stocks markets and a rising yen confuses you, don't be dismayed. You have a lot of company. But the connection is not as confusing or sophisticated as it might seem. The "yen carry trade," as it is known, only seems complicated. But it's actually so simple, it's moronic. "Speculators borrow yen at preposterously low interest rates," explains Bill Bonner, editor of the Daily Reckoning. "They trade the money for other currencies - notably those of English-speaking countries - in order to place the money in higher-yielding investments. They then pocket the difference and think they are geniuses. The game works beautifully. Nothing goes wrong. That is, until something goes wrong. Then, the speculators get spooked and begin to look for the narrow door that leads out of the trading room." Two weeks ago, as global stock and bonds were tumbling, the "EXIT" door became jam-packed…and the yen's price soared. If assets prices worldwide continue to tumble, the yen carry trade will continue to unwind. And if the carry trade unwinds, the yen will soar. Buying yen, therefore, offers a back-door hedge against falling stock and bond prices. [One simple way to buy yen is to purchase the CurrencyShares Japanese Yen ETF (NYSE: FXY)] For several years, the yen-carry trade has nurtured and facilitated risk-taking throughout the world's financial markets. It has provided a seductive source of low-cost liquidity that has emboldened speculators to borrow yen at dirt-cheap rates of interest and invest the proceeds in higher-yielding investments. As long as the "higher-yielding investments" obliged with high-yields, the process worked beautifully. And it had been working very beautifully…until about four weeks ago. But now that stocks and bonds become very volatile - or simply falling - many carry trades are producing losses. As the losses mount, the pain is increasing. As the pain increases, the speculators begin to sell their "high-yield" assets and repay their borrowed yen. Obviously, the process of repaying yen requires buying yen first, then giving them to the lender. That's why the yen appreciates during times of market distress. The nearby chart illustrates the distinct inverse relationship between stock prices and the yen's value. 
For example, in mid-July the yen fell to a record low against the dollar on the very same day that the Dow reached its all-time high above 14,000. "Yen Falls to Record Low as Gains in Stocks Feed Risk Taking," a Bloomberg headline noted on July 12, memorializing the landmark event. But as stocks tumbled from their all-time highs, the yen's value rocketed higher. The more that stocks fell, the more the yen rose; the more the yen rose, the more that stocks fell. After a while, cause became indistinguishable from effect. The yen's recent spike might be signaling that rampant risk-taking is winding down. "People are taking risk off the table," one currency trader told Bloomberg News, "In this environment, the carry trade is suffering and is going to continue to suffer." The "suffering" of the carry trade does not move us to tears. But we do worry a bit about the potential suffering of innocent bystanders…like Rude Awakening readers. "The big carry trade beast has started to roar," says Albert Edwards, an investment strategist with Dresdner Kleinwort, "A complete meltdown of the Yen carry trade now beckons. "So far," Edwards continues, "the 'Great Unwind' has not seen a major reversal of Yen-funded trades. Much else has happened, but this is the elephant that has been waiting to trample its way through the global financial village and squash the villagers already dying of thirst from a liquidity drought." Avoid the stampede, buy some yen. [Faithful Rude readers will recall that previous editions of the Rude Awakening have defined and examined the yen carry trade. So if you seek additional enlightenment or entertainment, check out the March 8, 2007 edition: "Whack-A-Risk" and/or the March 9, 2007 edition:
"Grable, Gable and Yen"] ---------------------------------------------- Did You Notice? Bang A Gong
By Eric Fry "They don't ring a bell at the top," according to an ancient Wall Street expression…but maybe they sometimes ring a gong. 
The CSI 300 Index of Chinese stocks logged its 7th straight all-time high earlier this week, bringing its eye-popping gains for the year to more than 150%! "This must be reflective of a blow -off stage and a top could be very close," insists Jay Shartsis, a seasoned options trader. "The explosive moves in the China stocks and the option statistics for yesterday reflect the intense speculation. Some examples: China Life (LFC-$70.90) trades 4,377 total option contracts on an average day, but traded 31,122 Tuesday of which 23,673 were calls. The stock was up $11. Aluminum Corp China (ACH-$64.44), which gained $13.38 to $67.38, traded 26,711 contracts versus 3,983 on an average day. 18,837 were calls. Ishares FTSE/Xinhua China (FXI-$144.99) traded 42,496 against an average of 18,839. "This much call-buying," Shartsis explains, "shows too much optimism among option-buyers…way too much optimism. Usually, when you get frothy action like this, share prices are close to an important top." The Fireworks show is over. -------- Options Hotline Guarantee --------- Steve Sarnoff, options guru, has not had one recommendation lose value since Aug. 8, 2004. He's on a Red-Hot Winning Streak with a… DOUBLE YOUR MONEY AVERAGE ON EVERY TRADE…GUARANTEED With that kind of impressive hot streak going…you could have racked up $513,964.02 in gains since Aug. 8, 2004, with a $5,000 initial stake in each play! And you possibly would not have lost one penny on your investments! Read More Here. --------------------------------------------- Rude Endnote: Right as we were going to virtual print with yesterday's Rude - all about drought and food prices - we received an email from Kevin Kerr, editor of the hugely successful Resource Trader Alert. Inventories for wheat, Kevin informed us, are expected to be at their lowest levels in 26 years. This, thanks to vastly dry weather in major wheat producing countries, has pushed prices sky high. Prices, Kevin noted, have already moved above a 50% increase so far this year. That's not such good news if you're a baker…but great news if you are a member of Kevin's Resource Trader Alert. Learn how to unlock the secret logic of the commodities marketsright here. Let's see…Yen, wheat, Chinese fireworks and volleyball… Yep, that's about it from us today. Your 5's in the post. We'll catch you on the weekend. Allaha ismarladik, Joel Bowman
Rude Awakening aussiejoel@the-rude-awakening.com | 
