Short term heaven Long term hell.
Final Judgement Day for Gold Carry Trade!
Quote from Carry Trade. Short term heaven Long term hell.
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Gold Carry Trade occurs because of the forward selling by the gold mining industry. To hedge against potential price swings in gold, gold producers have been doing forward selling against their gold mines (still in the ground). By accelerating future supply, the gold mining industry has exacerbated its woes. In trying to protect against the downside, hedgers have magnified it. Wait a minute... What about the delivery when futures contract reaches expiration? Shorts must deliver gold and buyers must take the delivery. Gold still in the ground doesn't count. So, gold mining firms (or those who do the forward selling for the producers) borrow gold from central banks (and pay interest for this gold lease, of course) and deliver it. Some "bright" traders can actually do this Gold Carry Trade themselves -- borrow gold at a low interest rate (lease rate) from central banks, then sell gold at the market, after that, use the acquired USD to buy T-Bond. As the Gold Carry Trade and the forward selling of gold continue, gold price is becoming weaker and weaker. This makes Gold Carry Trade even more profitable. (This Gold Carry Trade is dynamic: Forward selling of gold in the market --> Gold price declines --> Gold Carry Trade becomes more profitable --> More traders decide to do the Gold Carry Trade --> More forward selling of gold in the market --> Gold price declines even further --> Gold Carry Trade becomes even more profitable --> Even more traders decide to do the Gold Carry Trade --> …) Since this factor is dynamic, there will be no equilibrium. In fact, as time passes, Gold Carry Trade is strengthening and as a result, we are moving further away from the equilibrium and gold price simply collapses. As long as the interest rate for gold leasing is lower than the yield of T-Bond, this "looks" like "free money". But there is one big potential risk. The cost of Gold Carry Trade is expressed in the price of gold, while the profit of Gold Carry Trade is calculated in US Dollar. If the price of gold goes up against USD, the profit will sink and the cost will skyrocket. In other words, if the price of gold rises against USD, this Gold Carry Trade has to be unwound. And those who have been doing Gold Carry Trade will be in deep financial trouble. Gold Carry Trade will not last forever, simply because central banks don't have unlimited amount of gold to lease. (Remember those Indonesian commercial banks who had done the Dollar Carry Trade eventually ended up in financial hell in late 1997? Had IMF not helped Indonesia, these banks would not have survived and they would have been forced to live in parallel universe! We just wonder what will happen to these Gold Carry Trade people. A Carry Trade can last for a long time due to its dynamic nature, but no Carry Trade can last forever. There will be a final judgement day.) |
