Enzio's Clock

Background

1. Background to "carry trade" currency weakness & strength

There are two currencies that are favoured ones for the carry trade: the yen and the US. They are favoured because they command low interest rates, i.e.: they are cheap to borrow.

For the sake of understanding, we focus on the dollar. However, if you replace "dollar" with "yen", the same conclusions hold. 

There is a pattern of the volatility index falling and the dollar weakening: when people become more certain of the market's direction, they put on a carry trade.  Here, they borrow dollars and then sell them in order to go into a more lucrative asset such as the Hong Kong or Indian markets... Because the currency (dollar) is sold, it falls when the carry trade is put on. And people put carry trades on only when they are "certain" of the market's direction, i.e. when volatility is low.

Conversely, when volatility rises, the dollar strengthens. This is because people get less certain about the direction of the market, so they unwind their previous carry trades.  The dollar then strengthens because people sell the foreign currency asset and convert the proceeds back into US dollars.  

2. Iran is the new joker in the pack

This old Persian culture is began air defence drills yesterday, for five days. Tehran is  doing this because it want to be prepared, should Israel attack her on account of her nuclear facilities.

Perhaps the  article on this  in today's South China Morning Post caught my eye because the head of Tehran's air force unit that deals with threats to Iran's air space, Brig. Gen. A. Mighani, told the press specifically where he would conduct these preparatory war games from yesterday, 22nd - Thursday, 26th November. Or perhaps it caught my eye because Israel is stepping-up her threats to attack Iran in the form of a pre-emptive strike. Or, perhaps because the US is threatening military action if diplomacy does not work. 

What "diplomacy" are we referring to?

In said article we read that Iran is seeking to buy an anti-aircraft missile system from Russia; understandably, Israel apparently is pressuring Russia not to deliver these S-300 missiles to Tehran. The US and Israel oppose this Russian missile deal, so"diplomacy" has to involve a dance around Russia: Iran wants her S-300 missile system, and Israel/the US don't want Iran to have it.

So how about Tehran lobs its missiles at Tel Aviv once it gets its missile system from Russia?  Or how about Tel-Aviv lobs missiles at Tehran before she gets her S-300 system from Russia?  In any instance: tensions are mounting in this dance around Russia. 

What is clear is that if one side attacked the other, both would incur massive losses, losses unmatched by more recent wars in the Muddle East. 

So what does Tehran have to do with dollar strength? Everything.  Were an attack by either Iran or Israel to occur, markets would spin out of control and thus, volatility would rocket. With volatility increasing, people would scramble for safety - and unwind their carry trades.

Another - and very sad - reason to assume that dollar strength will continue. The same "flight to safety" arguments apply to gold, of course...

How to Save/Make Money Off This Idea

1. Always consult your financial adviser first.
2. Buy a "dollar long" ETF, UUP:US.  According to Bloomberg, this ETF replicates being "long" the US dollar against: Euro, yen, Sterling, Canadian dollar, Swedish Krona and the Swiss Franc.