Japanese Yen Carry Trade continues to Create Havoc

If you have the least bit of confusion as to what is going on across the financial markets this morning, just take one look at the chart of the Japanese Yen. It is experiencing a MELT UP! This is what happens when the entire world of hedge funds are all on one side of a trade gone very, very bad, very, very quickly!

To define this term, "carry trade", for those who are a bit newer to the markets ~ it consists of borrowing large amounts of Yen for extremely low costs due to the miniscule short term interest rate in that nation, and taking those proceeds, exchanging it into different currencies and then using that money to make investments elsewhere where higher yields may be obtained. If that is not risky enough, most of these hedge funds then leverage their speculative bets in the hopes of compounding their gains. It works until it doesn't and then disaster comes.

What always causes an implosion in this sort of trade is movement in the underlying financing currency, in this case, the Yen. Carry trades bank on a continuation of a trend (down) in that currency and low volatility. As long as it is present, no worries. Once something happens to interrupt that pattern, the mayhem begins in earnest.

One would think that some in this crowd would have learned something about the power of leverage to destroy their capital back in the summer of 2008 when we saw the same sort of violent reversal in the same carry trade when the entire world was short the Japanese Yen and long everything else. Apparently not. My guess is that this crowd figured that the Central Banks had removed all risk from their trade and that meant throw caution to the wind in order to obtain the biggest bragging rights to the largest gains. The problem is that no one rings a bell to warn of an impending reversal. With all of them completely dependent on their computers to do their thinking for them, there is literally no one to take the opposite side of the trade as the mad rush to the exits commences in earnest.

I have mentioned many times that old pros and experienced traders who are still trading are there for a reason - they have learned  the hard way to RESPECT the power of leverage, especially its power to destroy. Many of these hedge fund managers seem impervious to this axiom. What gets me is that there still seems to be a near endless supply of new victims for them to milk even after many of them manage to lose most of their client's money through their insatiable greed and stupidity.

Gold continues to be caught up this mess as it is torn between its role as a safe haven and the need for hedge funds to raise cash to meet ever increasing margin calls.

Again, forget all the claptrap analysis about Commitment of Traders report, hedge fund short positions, big banks long positions in gold, etc. NOTHING MATTERS right now except liquidity. If the Yen finally stops moving higher, you will see a calming effect in the markets but as long as this volatility in the currency markets continues, either scale back your trading positions or get to the sidelines and let others chew and spit each other out. Why be a casualty if you do not need to be one? The markets are not going anywhere - they will be there tomorrow, next week, next month, etc. You can always come back and put your foot into the water when you are ready to wade in. Do not try to be a hero or a bottom picker or a top picker. Leave that to the fools and narcissists who are legends in their own minds.

Treat your trading account as sacrosanct. If you preserve it, you will be able to take advantage of the good opportunities that will ultimately present themselves as a result of this mindless movement of money into and out of respective markets. If you try to be the hero and end up losing it, what are you going to do then???

Silver needs to get back above $22 in a hurry or it risks dropping back to near $20. Gold is stuck between downside support near $1365 and overhead resistance close to $1400. The Mining shares are moving lower again - what else is new there?

The US Dollar chart is turning rather ugly but with all the wild movements in the currency arena, that does not matter as much as it might if conditions that are contributing to this were otherwise.