The Norway trade

December 15, 2009

The most recent “Weekly Charts” report from Variant Perception (no link) included the following summary of budget balances as a percentage of GDP for the world’s leading economies. Norway is notable as you can see in the chart….

norway budget

It reminded me of an e-mail Nick Gogerty sent me earlier this year, arguing that an investment in Norwegian Krone was a good “oblique position” and could be a winner. By “oblique position” he means one that “benefits from a macro event, but is a derivative or indirect recipient of that event.” For instance, the gold trade is perhaps a too-popular way to short the dollar. Going long Norwegian Krone is much less obvious.

Thought I’d follow up with him and it turns out he did go into the trade and, yes, it’s a winner thus far.

From Nick:

Oblique Norwegian Krone. Huh?

My favorite response to an investment idea is, “huh?”.  Most investors are all deeply focused on something. I prefer more oblique ideas. i.e. ones that are derivative beneficiaries of a particular macro event. The best ideas are rarely in the spotlight until after the fact.  If everyone has an $0.02 opinion on something, it is probably less interesting to hear about, kind of like CNBC….

After the great fear based dollar rally in 2008, the dollar seemed too heavy with a debt to GDP ratio set to climb thanks to Keynesian-inspired stimulus. After all that stimulus, Americans will have some rather burned out bureaucrats sitting next to an even more burned out printing press and a rather soggy currency.

But how to express this dollar short thesis?

The gold bugs have been having a field day since 2000 and the volatility associated gold is high. Other commodities are interesting but it is tough to determine a good mix of risk and return. Having previously built indices, I believe most of the major commodity indices are a bit too energy heavy and too volatile for a full portfolio overlay.

So to short the dollar you can short the long end of the U.S. debt curve or buy another currency.

I choose to short the dollar obliquely with a slightly over-weighted Norwegian Krone currency overlay.

A currency overlay involves looking at a $1 million portfolio, for instance, and buying $1m or more of the target currency, effectively swapping out your dollar returns for something else.

Why Norwegian Krone?

First, do no portfolio harm. Norway has a $300 billion sovereign wealth fund and is running a 9.9% budget surplus. Also Norway has the lowest priced sovereign CDS spreads around (for a helpful chart see here). The country is politically stable and its people won the geographic lottery thanks to proximity to rich oil deposits… Norwegian debt is paying more than US debt across the curve, with a positive carry of 150-200 bps. Norway is lower risk, higher return and very capital efficient given the modest levels needed to be placed on deposit in a forex account.

In this instance, I went long Krone at 6.52 to the dollar and today it’s at 5.8 to the dollar (the dollar has lost value because it buys fewer Krone).

What can go wrong:

A sovereign default or geo-political event could cause a temporary flight back to the dollar.

Oil could collapse hurting revenue for Norway. But if it happens that would most likely be driven by global GDP destruction. On a relative basis, Norway with its $300b Sovereign wealth fund will be stronger than other OECD countries.

Currency volatility is always an issue.

This is not an investment recommendation from Nick or from me. I just thought the episode offered a good opportunity for a teachable moment from one of the blogosphere’s brighter thinkers…

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