A Secret Time Bomb Made of Gold

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...What is the price that breaks the bank, so to speak? It is hard to say. But with so many factors conspiring to keep the rally going, it does look as if the carry trade is finally about to unwind. Banks that hold big short positions in gold are going to be very vulnerable. Investors sitting on a stash of Krugerrands or Maple Leafs will be a lot happier.

The volatility seen in this quarter in the stock and credit markets may be new to younger investors. But there is something lurking out there that can make things really dicey.

A little-known fountain of free money called the "gold carry trade" is in danger of drying up. And if it does, then markets from gold to bonds and even stocks can be in for a wild ride....

The gold carry trade is similar to the yen carry trade, which has been a hot topic in the markets this year. Basically, money is borrowed from one source at a low interest rate and invested elsewhere at a higher rate. As long as relevant exchange rates and asset prices remain stable, a profit is made with little effort....

The problem is that if the gold price starts to rise, profits can be wiped out or turned to losses. And in today's market, a falling dollar not only boosts gold prices but it also makes Treasury bonds less attractive to foreign investors. That reduces demand and weakens prices to create a potential double-edged sword for carry traders....

if gold starts to rise quickly, the added demand from the banks to buy gold can exacerbate the rally causing what amounts to a mad dash for the metal...

What is the price that breaks the bank, so to speak? It is hard to say. But with so many factors conspiring to keep the rally going, it does look as if the carry trade is finally about to unwind. Banks that hold big short positions in gold are going to be very vulnerable. Investors sitting on a stash of Krugerrands or Maple Leafs will be a lot happier.

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