Big hedge fund goes bust, $830 million loss on Swiss franc trade

dominoes,jpgby Michael J. Kosares

Up until now, the announced losses from the Swiss National Bank’s decision to let the franc go have not been enough to cause a great deal of angst and outright pain in the world’s principal trading houses.  FT reports that Citigroup lost $150 million thus far, Deutsch Bank and Barclays $50 million, and FXCM, a New York currency broker, needed a $300 million “cash lifeline” from Jeffries, the investment bank. Yesterday, though, things took a turn for the worse when Everest Capital Global Fund, a Miami-based hedge fund, announced it lost $830 million of its clients’ money in the Swiss franc fiasco, according to a Bloomberg report.  That’s a very big number – one that wiped out the hedge fund overnight and serves as warning that there could be more of this sort of thing surfacing in the days to come.

What appears to have happened is that a good many hedge funds – how many we really don’t know – thought they had the world by the tail with the Swiss central bank pegging the currency at 1.20 euro.  They could borrow unlimited amounts of Swiss francs at very cheap rates, invest them in U.S. Treasuries, for example, at a significantly higher rate without worrying about losing on the franc/euro exchange rate.  Add a good amount of leverage and you’ve got the template for significant, risk-free returns – the perfect, fool-proof trade.

Or so they thought.

When the Swiss National Bank pulled the rug unexpectedly last week, a good many took a nasty tumble and what the resulting overall systemic risks might be are now anyone’s guess. In reality, it wasn’t the world they had by the tail, but a tiger and the tiger turned on them. As the reports filter in, keep in mind too that the London whale numbers for JP Morgan started small and ended big.  As the Financial Times warned this past Saturday: “Traders say hedge funds and global banks that dominate the currency market may be nursing bigger losses. A major question for the currency market and global regulators is just how far the fallout extends, given the sheer scale of the Swiss franc’s appreciation.” (Not to speak of the sheer number of traders who thought the ultimate trade had landed in their laps)

When the markets open in Europe later on tonight, we may get a feel for the scope of the damage.  Too, it might take some days for the full effect to be felt. Central banks no doubt will be scrambling to stop the developing crisis in its tracks and waylay any contagion effect. At the beginning of the month, in the “The Gold Owner’s Guide to 2015,” we warned that “What forecasting inevitably fails to embrace is the surprise event, or even the surprise policy, launched by one government/central bank or another.” Who would have guessed not two weeks later, a central bank would drop a surprise the magnitude of this one?

Of course our warning in that newsletter was delivered in the context of owning gold as a portfolio insurance against such risks. As happened last Thursday, you retire in the evening and all appears to be normal, or at least as normal as can be expected in these precarious times. You wake up in the morning only to find that the interconnected global financial village has just gone over a cliff. One owns gold not because he or she thinks it might turn a profit. One owns it to protect his or her portfolio against the very same kind of unforeseen event that occurred last Thursday

For those of you just learning about gold, I might recommend this short study as a primer:

Black Swans Yellow Gold
How gold performs during periods of deflation, chronic disinflation, runaway stagflation and hyperinflation

Excerpt:

“Black Swans, Yellow Gold is dedicated to those who believe, like Nicholas Taleb, that it is just as important to prepare for what we cannot foresee as what we can. Some might put their money on the latest Oracle of Delphi or the contemporary reincarnation of Nostradamus — or even an all-seeing eye plug-in that can be downloaded from the internet — but in the end, such notions are the dreams of government planners and retired central bankers. For the rest of us, a solid hedge in gold coins, as you are about to read, is the more sensible and reliable alternative — a wealth haven for all seasons.”

If you would like to broaden your view of gold market, we invite you to sign-up here for our regular newsletter and receive quality commentary like what you just read. It’s free of charge and comes by e-mail. You can opt out at any time.

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