''Midas'' commentary for October 10 posted at GoldSeek

Section:

2:25p ET Sunday, October 12, 2003

Dear Friend of GATA and Gold:

What purports to be a Reuters story from London last
Thursday, appended here, forwarded by a GATA supporter
in Europe, does not seem to be available at the Reuters
Internet site, though many other stories by the author of
this story are available there. So either your
secretary/treasurer has botched his use of the Reuters
search mechanism, Reuters inadvertently omitted posting
the story at its Internet site, the story is a very good
forgery, or Reuters has removed the story from its Internet
site because of the effect it could have on the currency
markets.

GATA forwards this story to you in suspicion about the
latter possibility and in the belief that the situation
the story describes bears close watching.

GATA will be grateful to receive any information on this
issue at our e-mail address: GATAComm@aol.com.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

Analysis: Yen carry trade unwinding risks 1998-style dollar fall

By Natsuko Waki

LONDON, Oct. 9 (Reuters) -- A potential investor exodus
from option-related yen carry trades is threatening to trigger
a 1998-style precipitous drop in the dollar with currency
options prices already showing unprecedented demand
for yen upside.

In carry trades, investors borrow yen at low cost to buy
higher-yielding assets abroad. A lot of traditional yen carry
trades have already been closed out as U.S.-Japan interest
rate differentials narrowed and the trades became less
profitable.

But the dollar's five-yen decline since a G7 call for more
flexible exchange rates on September 20 is triggering
hedging on longer-dated option-related yen carry trades
which were profitable as long as the dollar went up or
stayed in a range.

These leveraged trades use long-dated options beyond
20 years. Because these long-term options markets are
highly illiquid, signs of panic are already emerging in
options prices and hedging the positions could ultimately
result in selling dollars in the spot market.

"As spot dollar/yen falls, the market is looking for protection
in long-dated options and is willing to pay a very high price.
But the long-dated market is not liquid. So once dollar/yen
starts to fall, people are having to hedge in a thin and
panicked market," said Giovanni Pillitteri, vice president on
the options trading desk at Deutsche Bank.

"They will move down the line (from long-end to short-end)
and ultimately they will be forced to sell dollar/yen to hedge."

Major unwinding of traditional yen carry positions in the
aftermath of the 1998 Russian default and the collapse of
hedge fund Long Term Capital Management shaved a quarter
off the dollar's value in just four months.

Risk reversals, a widely used indicator in the options market
which gauges investor sentiment towards a specific currency,
are showing a record skew toward the yen's upside, beyond
levels seen in the 1998 crisis.

Only a fortnight ago, one-year risk reversals hit an all-time
high above 3 percent favouring yen calls, which give the right
to buy yen, and have stayed near that level ever since.

"It's such a one-way market," an options dealer at a
London-based bank said.

The longer-dated options market is still very illiquid and
Pillitteri said it was only over the last year that a two-way
market in 10-year options has developed.

Eric Ohayon, European head of FX structuring at Bank of
America, said: "The market remains exposed to the (dollar)
downside ... but it is likely to be expressed through the
options market rather than the spot given the threat of
potential intervention."

But "once barriers are broken, you suddenly find yourself
having to sell spot to cover those positions, and it becomes
a self-fulfilling prophecy," he said.

Japanese authorities have intervened heavily this year to
keep the yen from gaining on the dollar but since the G7
statement they appear to have become less aggressive.

By August 1998, demand for lucrative yen carry trades had
helped propel the dollar to a peak of 147.63 yen from a
record low three years earlier. The total amount of yen
borrowed by speculators was estimated in mid-1998 to have
reached 15 trillion ($137.5 billion).

The dollar then lost nearly 33 yen, a quarter of its value, in
just four months as extreme risk aversion resulting from the
crisis triggered major unwinding of those trades. Dealers
say longer-dated structured notes, such as Power Reverse
Dual Currency bonds (PRDC), gained popularity in the 1990s
as Japanese investors sought higher-yielding carry trades
because domestic interest rates were near zero.

PRDCs, whose average maturity is around 27 years, link
the coupon to FX rates. The first coupon is fixed and
subsequent coupons are then proportional to the dollar/yen
rate.

The coupon becomes larger if dollar/yen is higher on the
coupon date.Conversely, the coupon becomes smaller if the
dollar/yen is lower on the coupon date. Deutsche estimates
the market size of PRDCs is four to five trillion yen.

"Investors are betting dollar/yen will go up or at least not go
down. If dollar/yen falls, swap houses (with which the issuers
with PRDCs hedge their cash flow) will need to hedge their
exposures -- that is, buying back long-end volatilities,"
Pillitteri said.

"It could reach a point where there is no supply anywhere in
the options market to offset the demand for hedging.
Ultimately, they will have to sell dollar/yen in the spot
market."

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