Approximately once a year the currency of
, goes into play. Whenever it looks like the Kingdom is in a financial jam -- or whenever one of its neighbors makes a serious military threat -- the idea gets around that the riyal could be a candidate for devaluation. The official spot exchange rate is supported by Saudi Arabia's central bank, SAMA. So traders are hoping that the peg will get broken, Thai baht style.
I think a full-blown devaluation of the riyal is highly unlikely on financial grounds. True, the Kingdom did have a rough time a few years ago and it did have to absorb a tremendous financial drubbing from the Iraq war. But things have been relatively favorable for the Saudis of late. And remember, they get paid in dollars for the oil they sell. Of course, if there is a war or a revolution, then you can kiss the riyal goodbye. Short of that you aren't going to see SAMA get backed into a corner.
Still, the peg doesn't have to blow up in order to make money trading the riyal. Betting against the riyal based on expectations that the Kingdom will come under pressure, is a possibly good bet.
The spot exchange rate for the riyal seldom moves, but the forward points do have some life to them. In the foreign exchange markets, a spot deal for dollar-riyal is done for settlement, or "value," in two bank business days. A forward dollar-riyal deal is for value further out on the calendar. Forward deals routinely trade for value in one, two, three, six and 12 months. To arrive at the exchange rate for a forward deal you must add or subtract forward points to the spot exchange rate. This is called the forward outright. The important thing to know about the Saudi riyal is that its forward exchange rate can move enough to make it interesting, even though the spot exchange itself rate rarely moves.
For example, the riyal forward points for one-year term were cruising around 150 recently. Then the market began to realize that the fall in oil prices might be signaling really bad times ahead for the old Kingdom. This was reflected in a widening out of the one-year points to around 300. Some traders projected they would go out to 400. Of course the situation has improved since the Saudis,
agreed to cut production over the weekend. That's the main reason why the forward points came back in. Right now they're trading at about 100 for the six-month date and 200 for the 12-month date.
There are lots of reasons why the riyal might have some rough times ahead. First of all
is thought to be seriously ill. The successor, his brother,
Crown Prince Abdullah
, is an Arab radical. Abdullah has allied himself with the family of
Hafez Al Assad
, the president-for-life in
. Abdullah would be at best a lukewarm friend to the West.
Then there's the question of how bad off are the finances of the Kingdom. A few years ago the Kingdom damn near went broke. But analysts say that in recent times they have been doing better. The government's war debt from the Iraq conflict has been paid off. And the banks seem to be in comparative good standing. But all this is old stuff.
What's new is the fact that the future of the world oil market might include both
back on stream during the next few years. Casual evidence suggests that neither country is exporting anything near to historical capacity. True, a lot of work would have to be done to get their facilities back up to snuff, but they did it once so they can do it again. This weekend's agreement to cut production may look like to some people like the return the days of OPEC -- but you could also read it as a desperate and ineffective act of a dying cartel.
If you are pessimistic on the outlook for the Kingdom, you may have an opportunity in the making. It could be that this weekend meeting that produced the agreement to cut production might be giving you a second chance to short the riyal. With forwards having come in, the cost of shorting the riyal has been effectively subsidized. To be on the safe side you might want to wait to see whether the points collapse down to near parity with the dollar. If you put on the trade and thereafter the points move back out, you will make money even though the spot rate might not have moved. But if the riyal is flat-out devalued, then you hit the jackpot. The attraction of the trade comes from the assumption that although the riyal may not be devalued, it certainly will not be revalued. So there is a kind of option-like quality to the trade.
David DeRosa heads a trading research firm and is an adjunct professor at the Yale School of Management. His column on international finance and trading appears Mondays, Wednesdays and Fridays. He welcomes your feedback at