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What's Going On: Carry Trade, Subprime, Commodities...


Taking a look at some of the things moving the market ahead of the bell...


Yen Carry Trade

The unwinding of the carry trade continues this morning as the Yen rallies and the commodity currencies break. The Australian dollar, New Zealand dollar and Canadian dollar are all weak relative to the Yen. Interesting too that the Yen is strong as the LDP suffered a big defeat in the polls over the weekend and Prime Minister ABE is in trouble.

I was amazed in reading many newspaper and letters over the weekend how little was mentioned of the carry trade.

The process of reversing these positions is reflective of the reduced appetite for risk and directly related to equities. Given these positions have been put on for a long period of time.

It is difficult to judge how long the unwinding process will take.

European High-Yield Crossover Index

Overnight in Europe the high-yield Crossover index, a crucial indicator of European credit sentiment, jumped to 504 bp by midday. The previous intra-day wide level for the Crossover was 472 bp, reached in May 2005.

According to the FT, this last occurred when Ford (F) and General Motors (GM) lost their investment grade status, an event which triggered the so-called 'correlation crisis.'


HSBS claims that half year profits have been hit by exposure to subprime. Mortgage market and the German bank IKB Deutche Industriebank AG also said their earnings will be significantly lower for 2007-2008.

It is also reported that hedge fund Sowood Capital, which invests money for Harvard University and other prominent clients, has also lost 10 percent this year due to credit problems.

It appears the subprime mania is spilling over into the economy and those that said it was contained have egg on their face. It seems like yesterday that Blackstone (BX) went public and the world was bullish. Since then Blackstone's group has seen its shares go from $38 to $24 per share and has been a bearish collapse. Further hedge funds announcing losses and additional rumors regarding loss allocations all point to the fact that the subprime problems are spreading.

How will we know when the credit woes are contained and we are back to bullish business as usual and can "buy the dips?" I am afraid to say given how long this took to build up it will take some time to reduce the risk appetite and deleverage.

The game has changed and the banks which were aggressively lending may do an about face and call-in loans made previously. Banks are like markets in that they swing in extremes too.

We may see consolidation here early in the week and it's interesting to see China shares rallied and reached a new all time high. Perhaps the market will focus for a short while on earnings but a failure to get above last week's value area of 1480.00 will keep a lid on this market. Friday's value area low of 1472.50 will serve as first resistance.


Commodity prices are strong even with the US dollar up. We are close to month end and even with the break in the stock market and some big down days in metals and grains it looks as though July will end in the green for most commodity markets.

Energy has lead the way higher up 2.5% and livestock with beef and pork firm up 1.8%.

The base metals gave some back lead by nickel falling on average 0.4%. Platinum is the weakest and on Friday Nissan announced a new catalyst for gasoline powered cars that shall requite half of the current precious metal components to clean exhaust emissions. While I don't know the amount of platinum or palladium is used in this process this news is not friendly to these two metals.

Both crude oil and natural gas are strong this morning and the spreads for both WTI and Brent are now in backwardation. (The term backwardation means the amount by which, the price of a commodity for future delivery is lower than the spot price or a far future delivery price lower than a nearer future delivery.) This move from contango (the opposite of contango) is showing there is no incentive to own inventories of crude oil and to earn the carry and so inventories are falling.

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