Old Distortion Creates New Opportunity

by | Sep 6, 2001 | Archives

Investors are making mistakes we have warned about for half a decade. These mistakes could create opportunity for you.

Dear International Friend,

Years ago in a different world Switzerland was isolated and fiercely independent. Their mountainous terrain and well organized citizen's army gave them the strength to claim and enforce neutrality.

The small population (about 6 million) believed in personal and hence banking privacy. The people were incredibly conservative and highly efficient. They did not believe in government debt and demanded that their national bank keep a large amount of gold as a reserve for their currency. This made Switzerland an ideal banking center in those days plus made Switzerland a refuge in times of turmoil. Swiss francs in a Swiss bank account were considered one of the ultimate forms of financial safety.

This all changed. The computer, new tactics in war and the global economic community turned everything upside down. The computer was like the Colt .45, a great equalizer, making bankers in England, Italy or Spain etc. as efficient as the Swiss. New instruments of war, intercontinental and cruise missiles, nuclear weapons, etc. dramatically reduced Switzerland's natural defenses.

Most of all, the global economic community forced Swiss banks to deal in US dollars, British pounds, Japanese yen and German marks. Swiss banks had to open centers abroad and hence became vulnerable to other country's law. They lost some of their independence!

Today Swiss banks such as Credit Suisse are affected by what happens in the US and other countries (they have a huge investment in their subsidiary Credit Suisse First Boston). More importantly the Swiss Franc can no longer be allowed to be the reserve currency of last resort. Switzerland is a poor country in terms of natural resources lacking oil, minerals and the ability to feed itself. Switzerland is a trading nation and must have its currency at parity with other nations which allows them to export goods. It must export to survive. Half of its exports go to Germany. When the Swiss franc becomes too strong, especially against the German mark or now the Euro the Swiss act quickly to force its parity down. The last time the Swiss franc rose too high the Swiss imposed a 12% per quarter negative tax on Swiss franc accounts held by overseas investors.

Switzerland is a good banking center, yes. The Swiss franc is a strong, stable currency, yes. Yet the Swiss cannot afford to let the franc rise too high.

I have shared this information for at least the past five or six years warning not to invest too much in Swiss francs when it is strong, so what I am writing here is not something new. However much of the investing world always runs five to ten years behind!

Consequently the Swiss franc has been soaring as investors buy it as a refuge currency. Recently the franc hit a 20-month high against the dollar and the pound and rose to an all time high versus the Euro.

This is especially bad time for this to happen right now as Swiss industry is under enormous pressure. Swiss banking has been hit hard by competition, by the holocaust debacle, several scandals by Credit Suisse First Boston in both Japan and the US. The Swiss chocolate industry is suffering, and Swiss tourism has been hit so hard that SwissAir, one of Switzerland's finest companies, declared bankruptcy a couple of days ago!

A continued rise in the Swiss franc may force Swiss franc interest rates down and create a double distortion that creates opportunity for positive carry on loans invested in Euros and a foreign exchange profit.

For example right now if you borrow Swiss francs the interest rate is about 4.3% and you could invest in 10 year Euro bonds that pay in the 5.2% to 5.6% range. For example Deutsche Finance 07-2009 is AA rated and recently yielded 5.21% or Iberdrooia 5-2009 also AA rated yielded 5.62%.

If you invest $20,000 and borrow $80,000 in Swiss francs, which you invest in such bonds, you would earn (at a 5.4% average) $5,400 a year of interest. The interest costs would be $3,400. Your return of $2,000 represents a 10% return. Plus you will have a foreign exchange opportunity as the Swiss franc will likely fall. The actual return will be a little less because of forex, bond and loan fees. There is also some risk if inflation causes interest rates to rise on Swiss franc loans and bond values could fall.

Yet this is already an interesting play.

However what would make this an excellent play is if the Swiss franc gains more strength versus the Euro and the franc loan rate drops below the interest rate of Euro deposits.

At that time you would have a very low risk positive carry plus an almost guaranteed forex profit. Such a position would indicate that the franc is too strong.

I'll keep my eye on this play and let you know as the position advances. In the meantime, you can get interest rates and currency opinions at any time from eClub advisors Danish banker Thomas Fischer at Jyske Bank fischer@jyskebank.dk or eClub advisor Swiss banker Andy Kaegi akaegi@bpcs.ch or Austrian banker Michaela Andres at mavie@angloirishbank.at or go to Jyske's web site at http://www.jbpb.com

Until next message, good global business and investing.