How To Play Dubai? Short DBV

November 27, 2009

IndexUniverse's Active Indexer makes a big bet on the 'anti-carry trade.'


“Fears of double-dip recession grow as Dubai crashes. Debt crisis in millionaires' playground could herald new phase in global financial meltdown.”

Larry Elliott and Heather Stewart,, Thursday, 26 November 2009 22.30 GMT


The sudden onslaught of the Dubai Crisis puts global markets at risk because there is still about $600 billion in the Yen carry trade that needs to be unwound. The Yen trade still needs to be covered at a time when a rapid build-up in the U.S. dollar carry trade nears $1 trillion, and also needs to be unwound (estimated by Tim Lee of pi Economics a Stamford, CT based hedge fund research firm). The unwinding of carry trades is a precursor to the emergence of widespread sovereign debt defaults that we forewarned of in our October 2009 InPerspective, the New Normal & Asset Class Cycles, Part I.

Our view is that the speed at which the dollar carry-trade has grown has overvalued risky assets by 20% to 50% since June 2009. Prior to June, assets were re-priced for a world that would avoid the Great Depression Part II. The Dubai Crisis will now cause investors to question the run-up in prices since June 2009, and will fundamentally support a topping process begun in October 2009.

Global governments fostered the re-inflation of assets prices by delaying the recognition of institutional losses in the financial sector. Since March 2009, they transferred trillions in private sector debts to the balance sheets of sovereign states (and taxpayers). The powers-that-be were hoping they could buy time to inflate away their debt loads until consumers ended their deleveraging and returned to consumption levels that sustained economic growth rates evident prior to 2008.

In the Guardian article cited above, Andrew Clare, professor of asset management at Cass Business School, said, "This may be the first sign that people are thinking you can't get back to the debt-fuelled halcyon days of 2007.”

We believe that Mr. Clare’s view will begin to overtake the rosy scenario that has driven markets since June 2009. Dubai is the financial center of the Mid-East. It has no oil or natural resources. It produces nothing but leveraged paper profits for many hedge funds and sovereign wealth funds.

Dubai’s five-year real estate expansion was the fastest/largest in history. It is the poster-child of the greatest debt bubble in history.

Shorting The Carry Trade

It is our view that carry trades are a zero–sum game. They can work for decades as long was the world is building private debts and nations avoid default. They lose money when the world deleverages. This view drove us to initiate inverse carry trades in 2007 by being long the Yen, long the Swiss Franc and short the PowerShares DB G10 Currency Harvest ETF (NYSE Arca: DBV).

We now believe that being long the Yuan through the Wisdom Tree Dreyfus Chinese Yuan (NYSEArca: CYB) and short DBV are hedges that are more adequate at this stage of the deleveraging cycle. Consequently, on Monday November 23, 2009, we decided to increase our exposure to a theme that dominates the markets when default risk is greater than inflation risk: the Anti-Carry Trade (AC) theme.

AC is captured best through short exposure in DBV, which shorts the three lowest yielding currencies of the G-20 nations while it is long the three highest yielding currencies. This strategy (being long the carry-trade) does well when solvency risks are low and when private companies are financing their growth with higher debt loads. The carry trade is very risky when the private sector is deleveraging and governments are acting to support the private sector and banking system.

It took us awhile to locate shares in DBV to short at a reasonable cost, but we were eventually able to fine enough short shares at a cost of 2% per year plus commissions to achieve the exposure we wanted.

John Serrapere works on research and consulting projects through Arrow Insights. He welcomes comments and suggestions for future columns at [email protected]

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