A few issues back I wrote to you about “chaos-stan”, referring to the area of the world that is in turmoil today, and the area that we should be paying particularly close attention to. My number one concern was Pakistan, a nuclear nation that is not friendly to the US and its interests. It should come as little surprise that the world’s number one fugitive, terrorist Osama bin Laden, was killed there this past weekend. He was killed by US forces after a hunt that has lasted more than a dozen years – Bin Laden was a wanted man long before the 9/11 attacks. He was found less than 40 miles from Islamabad, Pakistan’s capital city. Celebrating death should never be a goal, but celebrating justice, regardless of how long it takes for it to be delivered is a great event in my opinion. Justice has been served and while the world is still a risky place, it is a little less risky today.

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Risk On

Fed Chief Ben Bernanke gave a lengthy press conference last week. It can be summed up in a few key points:

–    The US economy is weak
–    Employment is weak
–    Housing in weak
–    The US dollar is weak
–    Commodities are strong
–    The Government is weak

His solution? Do pretty much nothing but what the Fed is doing right now, printing money and keeping rates low until things turn around. The market reaction was positive, since everyone loves cheap money. Gold soared on the heels of the news conference, as did silver. Cheap money is the best friend for precious metals, especially when the metals are priced in the currency that is weakening.

Silver has already entered that “parabolic” stage, up more than 10 fold in the past few years. Were gold to have performed similarly, the price would be north of $3,000 per ounce. There’s room to run still. But, be careful, both gold and silver look like they are entering into the hands of speculators…and that’s usually a signal that a top is near. I would be a buyer of both gold and silver at lower levels, specifically gold under $1,100 and Silver under $25 per ounce. Seems like a far cry from here, but trust me both metals will correct at some point and that correction won’t be pretty.

I know there are naysayers out there and you are probably thinking NO WAY! But, that’s not how things work my friends. All you have to do is step back and ask yourself if you got sucked into the housing bubble, the tech bubble, the financial bubble, and you will have your answer. Corrections are NOT hard to predict…what’s hard is to predict WHEN they will happen. So, keep an eye on your stop-losses, that’s why you should have them. No point in giving back hard earned profits!

The Risk Trade

The demise of the US Dollar is not just a result of the excessive printing of currency. It is also a result of rampant selling of the Dollar as part of what’s called a “carry trade”. A carry trade is probably the most appealing type of trade in the current environment. People have made a fortune from it…and also lost a fortune on it.

Here’s how it works: You borrow money in a low yielding currency – the US Dollar. You sell the dollars and with the proceeds you buy a monetary instrument in a higher yielding currency. The bet is that the low yielding currency will continue to weak or stay in a tight range. Meanwhile you are making gains in the other currency from both appreciation and income. At some point you will have to reverse the trade and sell your higher yielding currency and replace the dollars that you borrowed.

On the surface this sounds like a no brainer. But, if the currency that you borrowed strengthens out of the blue…watch out below. You see the carry trade involves lot of leverage. Forex players don’t mess around. They borrow in multiples of the money they have on deposit – they’re allowed to. So, if one currency goes up 1%, they could make 10% on the trade. The flipside is also true. When a carry trade is unwound, the borrowed currency has the potential to soar in value overnight as traders are forced to unwind positions quickly – similar to a short squeeze.

So, while the smart money is playing the “risk off” trade right now, it has the potential to backfire hard and quickly when the tide turns. And, the tide always turns. Outside of currencies, the “risk off” trade right now is in stocks. Markets are moving higher despite bad news in the economy. It’s all about money flows right now. The thinking is that as long as money is cheap, buying stocks is a fair bet to keep up with inflation and since cash is yielding nothing, stocks can even pay you a bigger rent. Well, we are entering historic overbought territory now. Dividend yields from the S&P are down to 1.7% while price to earnings ratios are over 18. During the worst bear markets, price to earnings ratios have been as low as 8 and dividend yields from the S&P 500 have been over 5%. Food for thought.

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