Commentary: Dry Powder is a Powerful Thing

Those of you who read this blog probably have figured out two things.  First, I really like the Mexican peso, and plan to hold it for the long to medium term.  Another strongly held conviction I have, second only to the potential for MXN, is that the Japanese Yen must depreciate.  Japan remains a safe haven despite its weak internal fundamentals underscored by chronic deflation problems, a rapid aging population which will soon struggle to replace itself, and a general sense of stagnation and malaise.  While the Japanese may be able to fix their animal spirits and come out of their melancholia, the BOJ and the national government are probably useless at fixing their deflation and demographic crises.  The BOJ does not have the courage to enact an aggressive enough asset purchase program that would cause above target short term inflation but finally end the decades of deflation which have resulted in tens of trillions of Yen in lost growth.  The national politicians on the other hand will never stand up to voters and enact a sensible immigration policy which welcomes immigrants from other parts of Asia to replace Japan's dying population.

Those of you watching the markets this month saw the dip in the Peso followed by its recovery, and a surge in the Yen, followed by its collapse to seven month lows.  So did your humble analyst reap handsome profits from the realignment of the short term trends with the long term fundamentals?  Alas no.  When the panic earlier this month over the fiscal cliff came, I had already initiated as many positions as I had felt comfortable holding.  I had a huge long MXN position and had no exposure to the Yen.  When the big peso pullback came, I was unable to buy the dip for fear of getting over leveraged.  I was simply forced to ride out the losses.  The excessive risk which comes with excessive margin also stopped me from shorting the Yen as it popped during the run up to the election.  In sum,  even when you have fundamental beliefs in your positions, keeping a little dry powder is always a powerful move.  There is a huge opportunity cost to giving up all liquidity and going all in, even when the long term fundamentals are with you.  This is especially true when major market events are on the horizon.  Such was the case in October, with coming US elections and the looming fiscal cliff.  In retrospect, despite my confidence in the time in the Peso, and I'm still confident, keeping some cash on the sidelines would have enabled me to take advantage of the inevitable volatility.