Tuesday, October 27, 2009

Roubini blasts the risk trade

The emergence of the risk trade on a large scale, which we discussed earlier is starting to get some attention.

Bloomberg: Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

“We have the mother of all carry trades,” ... “Everybody’s playing the same game and this game is becoming dangerous.”

One disturbing component of this pattern is gold becoming part of the risk trade as well - it's now highly correlated with equities. This is in part due to pending commodity "anti-speculation" regulation, which doesn't apply to gold. That makes gold the ultimate proxy for the liquid commodity risk trade. But a high correlation between gold and equities is somewhat absurd, because generally what's good for gold is not that good for corporations. The only rational explanation is that the weak dollar benefits both.

The risk trade is now showing signs of fatigue. As the year draws to a close we may see more of the carry trade reversal - as traders convert risk back into dollars.

But the only thing that can truly slow down the risk trade momentum in the months to come will be a change in direction for the US monetary policy. And that looks unlikely for quite some time.

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