Keep the Faith!

 

This last week has been for many of us a long overdue stock market correction and possibly a forewarning of the dawn of a long-term bear market.

 

Despite the earlier turmoil the signs so far this week seem to indicate that investor confidence has not been irreversibly undermined and that there is a good chance that ´normal service´ is being resumed.

 

Some commentators are putting the blame for last weeks drop squarely on the shoulders of the so-called carry trade.

 

Just to recap the borrowing of a low interest currency, the Japanese yen, to buy a high interest currency such as the New Zealand dollar, or other high yielding asset is known as the ´carry trade´.

 

If, as has happened, the yen strengthens against other leading currencies then the carry traders begin to cover their short positions in the yen to avoid risking losses.

 

Clearly the consequence of covering their shorts leads to the further strengthening of the yen and that increases the trader’s risk.

 

The effect on markets is to deprive them of some liquidity and as it is this ´sea of liquidity´ that has been a prime driver of markets, the outcome was last weeks dramatic drop.

 

We are not convinced that the carry trade was anything more than an important ingredient in the mix.

 

Other factors of equal importance include the Chinese authorities threat of a clamp down on the massive speculation taking place in their stock market with its inherent social and political dangers, the continuing collapse of the US housing bubble and the prognostications of the media, financial analysts. market gurus, politicians et al as to the consequences to the US economy, discouraging non farm employment data, Iran etc., etc.

 

Anyhow, at the end of the day many traders, and that includes fund managers and institutions, were caught in a spiral of indecision and the time honoured way out is to cash out those positions that show a good profit, which of course included gold, and be prepared to fight another day when the outlook is clearer.

 

Meaning, is it a correction leading to buying opportunities, or the start of a sell off when cash is handy?

 

The old and tested traders maxim comes into play when markets are volatile but trending either up or down. Buy into the downturns in a bull market; sell the upswings in a bear market.

 

One other factor concerning gold has raised its head above the parapet these last few days.

 

Gold, in its traditional role as a safe haven when other asset classes are looking vulnerable, is expected to maintain or increase in price when a dramatic sell off occurs, such as that which has just taken place.

 

It was only a week ago that gold closed at its 2007 high in US$. After the New York close on Tuesday, when trading is normally thin, a substantial amount of selling occurred that led to gold dropping to a $39 per oz. drop on the week.

 

At this time the size of the open ´interest´ in gold on the New York Commodity Exchange increased sharply.

 

This is an indication of the amount of bets that speculators are taking in the future price of gold.

 

It surpassed the record high of 2005 but a new high did not occur as expected leading to the conclusion that there was a large seller of the commodity lurking around.

 

This has fuelled the fire of previous conspiracy theorists that manipulation of the market is taking place by the central banks and government authorities and are attempting to slow down the anticipated increase in price for at least the remainder of 2007.

 

In essence this means that these major players are trading the price of gold and are not just heavy sellers.

 

If they are just trading in and simply out for profit then they are likely to have to cover their short positions in the $600-$700 range and that provides underlying support that will mitigate the possibility of a swoon below this price range.

 

But what do we know?

 

We are still firmly in the camp that sees gold reaching the $1000 mark by December this year.

 

Nevertheless may we remind our readers of some quotes said to have been uttered by a reformed corporate criminal.

 

“If you want to be an investor you cannot accept information at face value”.

 

“Unexamined acceptance is the greatest cause of investor losses”.

 

“Do not trust, verify everything!”     

 

 

 

 

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