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The Next Big Bubble to Burst

By Dr. Steve Sjuggerud
Tuesday, August 26, 2008

Mrs. Watanabe is about to get burned.

She's in a situation like the Miami condo "flipper" who found himself with the maximum amount of debt at precisely the wrong time a few summers ago. Or the dot-com day trader who was trading stocks on margin back in 2000 and got slaughtered.

It will end badly, without a doubt. The only question is when. Here's the story...

In Japan, housewives handle the money. In the past, they've been conservative. They haven't bought stocks or real estate... and that's actually been the right call in Japan. But now they're in trouble...

It all started innocuously enough. Bank accounts in Japan pay next to no interest. But in Australia, bank accounts earn 6% interest. Japan's housewives understood that Australia's a fairly safe place to stash your money. So they started putting their money in Australian bank accounts.

This simple strategy really paid off.

Not only did they earn a lot more interest... the Australian dollar soared versus the Japanese yen, nearly doubling from 2000 to 2007. So when the Japanese housewives converted their money back into yen, the profits were huge!

From late 2000 to mid 2007, it was easy money... The yen/Aussie trendline was nearly a straight shot – you couldn't lose.

Again, the Japanese housewives are typically conservative. But after seven years of near-uninterrupted success, they decided simply tripling their money wasn't enough...

So their brokers told them about leverage.

"Mrs. Watanabe" (the typical Japanese housewife, like "Mrs. Smith" in the States) started buying Australian dollars on margin... In other words, she now borrows money to make this trade.

"How can I go wrong?" she thinks. She's borrowing in Japan at essentially a 0% interest rate and investing in Australia, earning over 7% today. It all works out great... as long as the Aussie dollar keeps getting stronger versus the yen.

But this is the problem...

When she first entered the trade at the beginning of this decade, it was a good trade. The yen was severely overvalued, and the Aussie dollar was cheap. But those days are gone. Now, the yen is the cheapest major currency in the world. And up until recently, the Aussie dollar was as expensive as it's ever been.

Meanwhile, Mrs. Watanabe is in deep... Advertisements for currency trading margin accounts on Tokyo's subway lines offer low fees, tight spreads, and get this – leverage as much as 200 times the down payment. And the number of these "forex" accounts held in Japan nearly doubled last year, increasing 92%!

The trade appears to have ended last summer. Since then, the yen has been creeping up against the Aussie dollar. But Mrs. Watanabe isn't pulling back. Instead, she has decided to take on more risk – she's now buying what are known as "Uridashi bonds."

Companies in countries other than Japan issue Uridashi bonds... which are simply foreign bonds sold to Japanese investors. So now, instead of putting money in the bank in safe countries like Australia, she's buying bonds in Africa, Brazil, and Turkey.

I'm not joking! Mrs. Watanabes across Japan have snapped up an astounding $650+ million worth of South African rand-denominated Uridashi bonds this year.

What can go wrong? Oh, boy... Mrs. Watanabe is blinded by the interest rate – she can earn double-digit interest rates in these wild places. So the normally prudent Mrs. Watanabe is now overleveraged... in risky investments... at precisely the wrong time!

Mrs. Watanabe – and her kind – will be the next bubble to burst.

As the yen continues to inch up, all these Japanese housewives will have to close out their margin accounts, selling billions of Aussie dollars and other Uridashi currencies. As the billions of dollars of leverage unwind, the Japanese yen could soar – particularly against the "high-yield" currencies.

It is the next bubble. And it will end badly.Right now, Mrs. Watanabe is selling something super cheap (the yen) to buy something super expensive, like the Aussie dollar. And she's borrowing money to do it.

Good investing,


Market Notes


Another month, another new low for Russia.

Back in July, we featured a chart of the Templeton Russia Fund, one of the easiest ways for U.S. investors to speculate in Russian stocks.

And Russian stocks can make great speculations... The country holds the world's largest reserves of natural gas. It's the world's second-largest oil producer. It has huge amounts of diamonds, timber, gold, and base metals. So when commodities are rising, Russia is "en vogue."

But the Russian government is as crooked as a dog's hind leg. One minute, a Russian company has billions in assets... the next, the government takes them. This corruption leads to lightning-fast market declines.

We're in "lightning-fast decline" mode in Russia right now. Investors are scared of the war in Georgia. They're scared the government will attack more companies. We advise them to be scared of further weakness in the commodity markets. If oil corrects down to $90, this new downtrend will get much worse.

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