Saudi Arabian stocks now interesting, but shun debt risk!

In general I recommend investors to move away from complicated financial instruments and anything related to history’s greatest debt bubble, and to shift funds into hard assets such as oil, gold, and farmland, whose quantity cannot be increased at the same speed as paper money is created by irresponsible central bankers.

There has been a meaningful contraction in the number of NYSE stocks making 12 months new highs (while new lows have recently increased and have occasionally exceeded new highs). Also visible is that the number of NYSE stocks hovering above their 30-week moving average has been contracting, and the low level of bearish investment advisors.

In fact, I just received a report by one of these advisors entitled: 'This coming 18 months will be a New Dawn in America, and we will again be seen as the richest and most powerful nation on earth, with no equal.'

US mess

But when I look at the sub-prime and CDO mess, the current account deficit, the precarious position of the US dollar, a Fed, which has lost control over money and credit growth, and a government which is ineffective and lacks any sensible direction in its foreign policy, I wonder!

In the aftermath of the Asia crisis, the Fed held the funds rate steady, but the rate differential with Japan encouraged a dramatic weakening of the yen. In February 1998, the yen was trading at 123 against the dollar.

By mid June, the yen had fallen to 146. This triggered concern among G7 policymakers and following a meeting in late June, the US intervened to sell dollars and buy yen. This temporarily pushed the yen up, but this was reversed and by August the yen had fallen again to 147.

In August, there was a major shock for financial markets. The Russian government defaulted on its debt and the subsequent losses caused the collapse of LTCM. This triggered greater volatility in financial markets and the yen began to strengthen. In September, as the crisis continued to unfold, the yen traded in a range of 130-135.

At the end of September, the FOMC met for a regular policy meeting. In spite of continuing concerns about inflation, the FOMC decided to cut the funds rate by 25bp in response to growing risk aversion in financial markets. The dollar fell sharply and the yen began to strengthen. In the first week of October, the yen rose 15 per cent against the dollar.

Carry trade end game

So, if Japanese interest rates will not necessarily kill the Yen carry trade what will be the catalyst for the unwinding?

According to Robert Lind, 'It’s currency volatility that ultimately kills carry trades. In 1998, the collapse of LTCM was the ‘Black Swan’ event that triggered more volatility and the end of the trade. By definition, none of us can forecast these events. But in a world of unprecedented financial imbalances, there are plenty of potential triggers for renewed currency volatility and an end to the current carry trade.'

I agree with this view. There are huge speculative excesses everywhere in the system. Hence, even a relatively minor event (a US fed fund cut in the fall) could trigger a massive re-pricing of risk and lead to an unwinding of all carry trades. Therefore, a gradual accumulation of Yen and Swiss francs should be considered.