Seeing the Wood from the Trees

by Mark O'Byrne
May 17/05

Dollar up sharply against other currencies in recent days, like Sterling:

With a sharp move from mid-last week.
Here's the Trade-weighted Dollar

Chairman Greenspan got what he wanted - some de-gearing in the system.

He was concerned about the number of Hedge Funds and others involved in the carry trade. That is: buying assets with an expected yield higher than cheap dollar borrowing. Hedge Funds and others have loaded up on Corporate Bonds, emerging market debt, and junk bonds of various currencies, all financed with dollar debt at 2.5-3.0%. The gearing of assets yielding more than the dollar borrowings was common. Falls in the dollar made these cross-currency trades profitable last year, helping to give hedge funds a positive return in 2004. But this year the trades have not gone well. Just look at this Hedge Fund index from S&P:

Since Dec.2004 and again since late March 2005, the Hedge Funds in this index have done badly. Then last week, we had the reversals related to the GM and Ford trades, where a lot of funds got it wrong. I am hearing from my friends invested in the Hedge Fund sector that March and April were bad, many funds had a negative return, and now May looks worse still. Is it any surprise that alot of funds are getting hit with redemptions.

Here's what Sunday's Times had to say about it:
"GLG, a hedge fund started in 1995 by a group of former Goldman Sachs bankers, has in recent weeks had demands for more than $500m (£270m) from investors wanting to pull out of its $4 billion market-neutral fund. The predicament of GLG, the biggest group in Europe, with $13 billion under management, highlights the stress being felt at many hedge funds in Europe and America after four months of deteriorating results." http://www.timesonline.co.uk/article/0,,2095-1612390,00.html

So how does this effect the Dollar and gold?
Well think of many of those Hedge fund assets: US Corporate bonds, and more interestingly, foreign currency denominated debt, emerging market bonds, commodities. Many are denominated in currencies other than US dollar. And many funds have been financing those non-dollar assets with cheap dollar debt, hoping for a "double gain": a yield pick up (so long as returns are in excess of 3.0% - or whatever the borrowing costs.) And last year, when the dollar was weak, there was a nice bonus, a currency gain as the dollar fell, and the borrowing were cheaper to pay out of the proceeds potential sale of foreing assets. But in 2005, the dollar stopped falling, and last week there was a stronger dollar along with some losses on debt holdings in GM/Ford. HF risk managers called a halt to the losses, as their risk limits were hit. Trades at the funds were told to reduce gearing. Last week, we heard there was a wave of selling of all kinds of assets. There were fears that Hedge Funds were going to go down, and so a massive global de-gearing happened. Assets of various currencies were dumped, and a lot of the cash raised went to repay the short term debt. Where assets were in other currencies, a currency transaction was needed. Cash from sale of other currence assets was converted into US dollars, and the dollar debt was repaid. The total size of the global carry trade has been reduced.

Once the dollar has gone far enough, and the de-gearing is ended, the pressure on the funds will ease, and they will be set to return to the carry trade. The dollar will get hit once again.

Watch for it. We may be in for some volatile times.

Mark O'Byrne
Gold and Silver Investments Limited

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Mr Mark O'Byrne is a director of Gold and Silver Investments Limited. He is a financial analyst who believes that due to the current macroeconomic and geopolitical situation, saving and investing a small portion of one's wealth in precious metals is both prudent and wise. Gold and Silver Investments Limited believe that hard tangible assets and monetary assets such as gold and silver, the world's oldest forms of money, will once again become the safe haven assets of choice in the coming years. The increasing economic and geopolitical uncertainties at the dawn of the 21st Century mean that gold, silver and platinum will become increasingly important in the new century as a means of preserving financial wealth.

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