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Wednesday, October 6, 2010

Take Advantage of Stocks, Bonds, Commodities Going Up by Government Action

“When governments interfere with the markets, let us not complain, but take advantage of the situation as educated financial market investors.”
A strange phenomena is happening in the financial markets:

- Stock Market Indexes: up

- Bonds and Notes: up

- Gold: up

- Crude Oil: up

This is a situation that only occurs when artificial demand comes into a market, increases the amount of money floating and it has to go somewhere. What happened?

The US central bank also finally unveiled a new asset purchase program to buy up government bonds and boost liquidity in the deflation-wracked economy. We talked about this in our prior publications, but now it gets official. The fed is the new force entering the markets and by that we see a beautiful increase in prices for all sectors. How long will it hold? Until one of the today´s buyers becomes a major seller and this can be anywhere between December and February, when new economic outlooks will hit the market. Meanwhile we will not see a great economic rise, but solid profits of US corporations and a world market that gets nervous.

By the action of the US central bank in particular Japan comes under pressure and has close to no instruments to counter the US offence in printing money and by that weakening the Dollar. As a reaction, the Bank of Japan cut its benchmark interest rate to almost zero as it seeks to revive a faltering recovery. Under pressure from the government, the BOJ cut rates to 0.0-0.1 percent from 0.1 percent. Now the Japanese copy the US action and they pump 5 trillion yen, or $60 billion into a market with no demand for money by (what a genius idea) the central bank of Japan to purchase government bonds, treasury bills and corporate bonds in an effort to weaken the local currency and improve liquidity in the world's third largest economy. But what is that gone give, if nobody wants to borrow money in Japan. It will just pull the Yen into carry trades against currencies with higher interest rates, like the AUD (Australian Dollar) and the Yen will make its march: up and the Japanese Exports will suffer.

To spell out the carry trade for you: Today, the Reserve Bank of Australia announced to hold interest rate at 4.50 percent. Experts had even expected Australia to increase rates by 25-basis points.

So now if you sell Yen for 0.1 interest and with the money your receive, you buy Australian Dollars at 4.5% interest, what is that gone give: +4.4% interest. But surely be careful, with a carry trade, there are two objectives. The first is obviously to make money on the interest rate differential. The second objective is to gain a profit from the capital appreciation.

Let us give an example: if an investor just puts $1,000 into an investment with a carry trade difference of 4.4%. The leverage in Forex of 1:100 let’s the investor control $100,000. Now we calculate the interest income on $100,000 x 4.4% p.a.=$4,400. On the basis of the margin put in the carry trade Forex pair: $1,000 this is a 440% p.a. return, if the value of the pair stays the same. If the pair even increases in value the investor will receive additional gains.

Sounds unbelievable? Yes, sure, but let us enlighten you of how it works:

The investor buys Australian Dollars and receives a 4.5% interest and pays with Japanese Yen at 0.1% interest. Sounds complicated? But in action it is very easy:


The danger in this pair is that the value of the Yen might increase after the money pumping action of the Bank of Japan will water out. So make your money short term and know where you put your stops to the transaction. On the other hand, the AUD might also increase and stabilize the pair longer term. The AUD’s value is very much tied to natural resources. With a weakening dollar – the biggest currency in the world, the price for natural resources is going to increase and by that the Australian Dollar has a good upside potential that might balance the pair long term.

We hope you get an understanding how NeverLossTrading can help you to be an educated financial market investor who can take advantage of key market action like the current government craziness of increasing the amount of money floating.

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