The Carry Trade Is Heading in Reverse

12/09/2009 1:30 pm EST

Focus: STOCKS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, says the dollar has fallen too far, and its reversal will hit all risky asset classes, including gold.

At some point, the dollar carry trades will begin to unwind; and once that begins, it will be difficult to stop. Likely, the triggering event will be a true “black swan.” By definition, we can’t predict exactly what that event will be, but we do know it is coming.

Since a good deal of the carry trades are done outside of the country, as they unwind, assets will be sold and dollars will be purchased to pay back the loans. The result will be a surprisingly sharp correction in all asset classes commensurate with a sharp rally in the dollar.

Markets are not one-way affairs, and the approaching adjustment is due—in fact, overdue. The fundamentals surrounding the stock market and the economy are not good. I just cannot see anything that will fuel a real recovery.

It will not come from small and medium-sized businesses. Combined, they account for 85% of job growth. Small business owners are being shackled by increased taxes from their states and the feds. It is obvious that they cannot afford the new health care bill, and energy costs are going to double next year from today’s levels.

Sales tax receipts are declining in every state—in some states, dynamically. When sales tax receipts fall, it means the consumer is not spending and the economy is not recovering

[Still,] the stock market is factoring in GDP growth of 5% for 2010. Folks, fundamentally, it just isn’t in the cards. The stock market’s traditional technical measures are bearish as well.

I look for all asset classes to come off as the carry trades unwind, but I think we will see gold bullion hold up as well as it did in 2008.

Gold has finally broken above its long-term ceiling at $1,000 [an ounce], and the December contract recently breached $1,200. Once the carry trade unwinds and the dollar rallies, gold will correct. Typically, one would expect a correction back to the breakout point of $1,000. That is 20%. Frankly, I can still see gold coming back to my longer held opinion of $950.

The mining shares are likely to correct more than gold bullion. The XAU could easily come back to 120 from its recent high of 194—potentially a 35%correction.

With the prospect of a serious carry trade effect on the next correction, it is worth putting in some stops here. In particular, I want to put sell stops on Kinross (NYSE: KGC) at $18.50 and on Agnico-Eagle Mines (NYSE: AEM) at $60. (Both closed slightly above those prices Tuesday—Editor.) I recommend selling KGC at $25 or better and AEM at $70 or better if not stopped out first. 

Make no mistake, the gold bull is not over, and I fully expect to see $1,600 gold next year. However, the gold market is a bit dicey here, and you might want to take some money off the table and protect profits built up in this rally.

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