Tuesday, October 07, 2008

Carried away with fear

John Mauldin's latest "Outside the Box" weekly email (which you can get by free subscription by going to his website here) contains, amongst other things, a couple of comments from Dennis Gartman which stuck out on Guambat's reading of it.

First, on the subject of fear, which Guambat has previously mentioned as being too much absent for the equity markets to put in any credible bottoming process. This is the sort of thing Guambat needs to see:
we say here this morning, mincing no words whatsoever, we are more frightened now for the future of the global capital markets than we have been at any time in our thirty+ years of watching, commenting upon and taking part in them. We are fearful... and we mean this fully... that we have passed the tipping point; that things are now spinning out of control; that forces have been unleashed that cannot be stopped without some truly massive, truly strong-handed, governmental action including the closure of markets and limits upon bank withdrawals, et al. These are troubling times, and our fear is palpable and growing.

Second, on the causes of this credit catastrophe. Guambat long ago berated the "cheapass" yen carry trade as one of the primary viruses that spread the credit contagion. About a year ago, Guambat said
Guambat reckons, second only to Greenspan's too low for too long interest rate regime, the cheap-as-chips yen-carry trade diligently pursued by the Bank of Japan was the primary source of the glut of liquidity that led, ultimately, to the collapse of the credit markets after they got too much easy credit for their own good.
Gartman expressed the idea better; indeed, Guambat doesn't dream these things up himself as he only knows what he reads on the net, so maybe something Gartman wrote last year influenced Guambat; who knows? Anyway, he says,
We have long said that this cross relationship is the barometer of the relative health of the global capital markets, for over the course of the past several years as risk was embraced Mr. and Mrs. Watanabe would sell their Yen holdings and "swap" them for investments abroad that might return them more money. At the same time, foreign non-Japanese investors were very willing to borrow in Yen terms, take that low cost capital outside of Japan and invest elsewhere. This was the "Carry Trade" and it was one of the driving forced in the global capital market. Hedge funds around the world employed the "carry," borrowing cheap Yen and investing into anything, anywhere around the world where the returns were larger. Once confidence began to ebb, however, and once the losses on the carry trade itself began to wane, the pressure upon those exposed grew.

Now, not only are those who borrowed Yen and bought EURs, or Aussie dollars, or Russian Rubles, or gold, or equities anywhere around the world, or debt securities of almost any kind, finding that they are losing money on the "cross" itself, they are losing more and vast sums on the investments they made. It is horror story writ large and getting larger.

Is there any fundamental investment reason to be bullish of the Japanese Yen? No there is not. The demographics of Japan are horrid as her population ages and begins to actually decline. We have written often of this demographic time-bomb that is exploding consistently over time in Japan. The country's population is imploding and it continues to do so despite government policies aimed at changing that trend. However, once demographics as consequential as what is happening to Japan become entrenched, time... and very, very long periods of time,... decades certainly; centuries perhaps... are needed to reverse the course.

Thus, the only thing driving Yen higher is the panic liquidation of the "carry trade." This unwinding has been going on for several months, having begun in earnest in July when the cross touched 170:1 ever-so-briefly. It took years to build the trade up as Yen was borrowed and the EUR bought since the turn of the Millennium. It may take months yet to unwind these years of accumulation. The process is not pretty. The damage wrought is enormous. The panic lies still ahead.


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