Posts tagged ‘Euro’

All euro, all the time

Written October 31st, 2011

Forget about MF Global’s bankruptcy – it’s a symptom, not the cause. Forget about Italy – again, symptom. Investors are waking up to the harsh reality that the European Union, through the euro, is structurally flawed. A Union by name only, the EU has been based on the false premise that a central bank can be completely disconnected from the political and fiscal processes. In fact, by proving the null, the EU actually shows us how un-independent (sic) our own central bank is.

In fact, in one day, we erased the gains from any EFSF boost. For those who got squeezed out of their euro shorts…well, you should have known better. For all those who are still long the euro…well, hold on.

By writing down the Greek debt, the EU has given the other at-risk countries motivation to push for restructuring. It might be a good idea for the to try now rather than later. With Italian yields at 6%, it’s already too expensive for Italy to refinance on its own, but might end up being relatively cheap for the EU to try to restructure before Italian spreads completely blow out. Then again, any restructuring beyond the current funds will probably tip the French scale and trigger a downgrade. Not sure how much longer Germany can hold out, but more importantly, I know that no German politician will be strong enough here to push through bigger bailouts without some serious clashes with the general population.

So who’s happy here? Probably the only place that’s happy on the continent is Turkey. For years they tried to get in. They argued that they had better financial conditions than many current members, and better demographics than the entire continent. Mostly for xenophobic reasons (surely it wasn’t financial), the Europeans refused. Now, Turkey is sitting pretty as it has a growing, young population without the overhang of needing to bailout Greece. Now THAT would have been ironic. Come to think of it, maybe Turkey can buy Cyprus from Greece, or have China buy it for them. Crazier back room deals have happened, and I’m sure I’m not the first to suggest it to them. Over the past 5 years, Turkey has certainly been the winner.

(For reference, that’s a roughly 27% outperformance.)

Now, I’m not suggesting Turkey is a buy here. It has its own problems, including rising fundamentalism and an army-controlled economy. All I’m saying is that bad European decisions aren’t a recent occurrence and should be viewed on a longer horizon as part of a pattern. In that light, I am obviously staying short the euro.

Relevant ETFs: FXE, EUO, UUP

The Problem With Pessimism

Written October 24th, 2011

The problem with pessimism is that you’re always almost right and almost on time. The simplest proof in the markets is the guy who is always calling for a crash – sure he will be right at some point, but all the rest of the time as the market does nothing or goes up, he’s actually wrong and not admitting it. Before you say that the problem is with all prediction, let me encourage you to wait with that argument. The pessimist is driven towards inactivity. Without hope for the future, without a vision towards success, the pessimist can only criticize and wrap himself in the security of not trying.

Why am I bringing this up now?

I’ve recently been getting more notes than usual about my pessimism. Maybe that’s a result of staying in certain positions, or even because I haven’t changes my positions much in the face of a supposedly changing market. So let me assure you, dear reader, that I am not at all pessimistic nor depressed.

Some people take a short position as an expression of their pessimism about a company or currency or what have you. They get a great sense of accomplishment when the stock eventually goes down (“See, I was right”) and have to battle their emotions when the stock goes up (“If I can just withstand the pain…”). Not me. I don’t hope to be proven right and don’t feel an emotional stake in either direction. I just expect.

My euro position is a simple example: contrary to some emails I’ve received, I don’t HOPE that the European currency collapses. As an investor, I don’t have any emotional stake one way or the other, although as a global citizen I do. Instead, I have an expectation of what will unfold. It’s one of a number of scenarios that might unfold. If I knew exactly which scenario was right, I could take a much larger position, but I don’t, so I limit my exposure through position sizing. Then I wait.

I wait for the facts to change. I wait for different scenarios to unfold. I wait for my expectation to be achieved, or not. I have been short the euro since October 2009 and, other than periodically adding the position, I haven’t changed my stance. I’m not emotional about the position and it has moved in the direction I expected, in the opposite direction, and everything in between so many times, and with so much internal volatility over the past two years, that it would be difficult to stay with it if I did have emotions involved. I have been “right” and “wrong” enough times in this one position that the challenge is to step away from those terms completely and just focus on whether the position makes sense today. Did the facts change? Have my expectations for future scenarios, returns, probability, etc. change? Have policy makers addressed the issues I was seeing before? So far, the answer is no, so I stay with the position. Is there a need to add or subtract to it? Today there isn’t, but some days I’ve added to it (and mentioned it in these pages).

The same is true for all my positions. There has been, however, a big challenge in adding new positions. Two big reasons I have discovered: a lack of clarity about future scenarios surrounding different asset classes, and an expectation that cash will outperform most of the global asset classes. That is not my being pessimistic. It’s not an emotional prediction. It is simply an expectation that, based on the current available information, the risk involved with allocating cash to different investments is not worthwhile. Stated another way, it is an active allocation to a large cash position. Investing in cash in not a passive investment. For anyone dealing with clients and the pressures of “putting money to work” that will ring true. Cash is always working against you as a money manager. For one, there is always something going up which clients think you should have identified. Second, clients don’t want to pay fees on your active allocation to cash. Third, if markets go up you have a tough time catching up. Lastly, cash is always losing money to fees and inflation. In that context, it is easier to take any other position than to take a position in cash. Thus, when I allocate a portion of my portfolios to cash, it has to be an overwhelming expectation that it will outperform the alternatives.

So for now, don’t think of my as pessimistic, think of me as someone who expects asset classes to depreciate and is just implementing the investments that express that expectation. I don’t hope to be right, just like I’m not afraid to be wrong.

After the solution

Written September 28th, 2011

The euro conversations are starting to reflect the futility of the situation, but the market is still not adjusting to the new reality. Why? I’m not sure. I’ve now spoken to multiple traders who are just staying away from the G3 currencies altogether and focusing their mental energies elsewhere, and while I understand the difficulty of dealing with daily regulatory changes and half-baked schemes, the end game seems pretty obvious to everyone I speak to. For starters, Greek debt will have to be restructured and to avoid future moral hazards (a bit late for that) some haircut will be passed on to banks and investors. Once that happens, each government will be forced to step in to a greater or lesser degree to prop up the respective banks that will have to write down the debt. On the flip side, the CDS markets can finally stabilize, except for one small detail – counterparties will be forced to pay up and that risk is still underpriced and little understood. Here, US banks might be more directly involved than the Fed or the administration might imagine (hello JP Morgan).

Here’s my point – assuming all of the euro issues get stabilized (not solved) and some agreement that the market can digest is achieved, what then? Will the market finally be able to rally? Will the debt overhang or the foreclosure mess be resolved because the Greek debt crisis was resolved? No. And herein lies my concern with the current market environment. The markets are moving as if the euro is the only issue and hurdle working against a new bull market, but that is just not the reality. The market will have trouble sustaining any rally because the issues are bigger than the euro or any specific sovereign debt. It’s the combination that is lethal.

I’d be staying very conservative and looking at these crazy rallies as opportunities to lighten risk.

Relevant ETFs: FXE, UUP, SPY, SH

Euro and European equities aren’t the same

Written September 13th, 2011

As the euro continues to disappoint the market, or just live up to my negative expectations, European equities are following the erratic behavior, and for good reason. After all, who wants exposure when the currency translations of earnings can fluctuate 2% over the course of a rumor’s half-life of 1 hour? So it should not come as a surprise that the European markets as a whole have been struggling.

That’s a 10-year picture. Not so pretty. Which is the type of environment I start to like. Turns out, I can think the currency can have downside potential, but still think equities begin to look attractive. We aren’t there yet, but it’s definitely an area I’ll want exposure to if valuations continue to decrease. Look at it another way:

That’s the EZU:SPY spread. It’s not at all time lows, but certainly approaching them. With such volatile currency swings, earnings become more fungible and time-dependent, and make every international firm a speculator, so I have no particular hurry to go in and stake a position at this time. That being said, I understand the investors stepping up and building positions in certain countries (Germany comes to mind) or even specific companies. However, I think they’re going to face an uphill battle for a while yet. Our goal though should always be to look forward and anticipate. With a value mentality, I am often compelled to act too early, but this is too early even by my standards.

Relevant ETFs: EZU, SPY, VGK, IEV

ECB Executive Board Member Jürgen Stark Resigns

Written September 9th, 2011

From the WSJ.com:

Today, Jürgen Stark, Member of the Executive Board and Governing Council of the European Central Bank (ECB), informed President Jean-Claude Trichet that, for personal reasons, he will resign from his position prior to the end of his term of office on 31 May 2014. Mr Stark will stay on in his current position until a successor is appointed, which, according to the appointment procedure, will be by the end of this year. He has been a Member of the Executive Board and Governing Council since 1 June 2006.

Seeing how the European Central Bank was modeled on the German Central Bank, having a German representative resign is a negative for the little remaining credibility the ECB has managed to maintain. The flip side, though, is that it increases Germany’s credibility that it has a representative who has limits on what he’s willing to do in the name of manipulation.

This is just one outward manifestation of the internal weakness of the ECB. I continue to be happy with my increased position size. Euro is trading with a 1.37 handle as I write this, going into a weekend, without the CHF as a safe haven – gold and dollar positive for the near future.

Relevant ETFs: FXE, EUO, UUP, GLD

All eyes on euro

Written September 8th, 2011

Well, maybe it’s just my eyes that are glued to the euro. First, I increased my short euro position, so maybe there’s some confirmatory bias in looking at it more closely, but I’m not sure that’s it. Second, is the fact that European banks are starting to feel the inevitable crunch – I’m pretty sure THAT’s the real reason.

The euro is sitting on the 200 DMA, and while I’m not a technical expert, I assume that it might bounce or it might break down. A bounce would imply that the markets begin trusting the European leadership and more importantly see the long term prospects of the euro improving. This seems highly unlikely. I guess a bounce could also be a coordinated effort by central banks to artificially bolster the currency. This seems pretty likely, but it’s a risk I’m willing to take in order to participate in the alternative. Namely, a breakdown would imply that markets are finally coming to grips with mismatched leadership that is pulling the currency in different directions (EU monetary authorities and local/regional fiscal authorities are facing opposite mandates). I have a feeling that eventually, the fiscal authorities will feel more pressure from their constituents, which will in turn force their hands, and force a repricing of the euro with the hopes of stimulating some economies. Germany, as the strongest economy in the region, has set the tone for the direction and will continue to do so, except that now, their tone is shifting. Specifically, Germans are less inclined to continue bailing out the other nations and the banks. So, while on a short term basis the G7 currencies are rigged, in the medium to long term, the euro will be forced down by its own weight.

Can the US markets rally with a currency crisis? Can the US banks NOT be impacted by the euro’s coming collapse? Can the European turmoil be contained? The answer is a resounding “NO”.

Relevant ETFs: FXE, EUO, UUP, EWG, GERJ, BUNL, VGK

Europe in a tizzy

Written September 5th, 2011

While US markets are closed for Labor Day, Europe is certainly NOT closed today. The German DAX was down 5% and the rest of the continent was off anywhere from 3-5%. Europe may finally be forced to face the inevitable…well, there are actually two “inevitables”:

  1. The major European banks would not be solvent if they had to mark their sovereign debt. In light of this fact, monetary easing from the banks will be highly unlikely, which means that easing will need to come from the top.
  2. The euro’s structural problems have not gone away and Germany is less and less willing and able to carry the financial burden of the rest of the members.

I guess there are probably other inevitables (such as what young, growing country (think Turkey) would want to join now, even though the euro-members would wish they did? or, the coming race to figure out how much the euro needs to be devalued to give Germany an export boom, to the chagrin of China? or, beware China’s wrath with the coming euro devaluation. etc.)

These inevitables are already translating to sub 1.41 handle on the euro:

 

On the other side, gold is breaking through $1,900 again, making recent sellers on the pullback pretty anxious to get back in.

All in a days work. As I wrote last week, it should not be surprising that between the equity volatility and currency volatility, that we can come back from a weekend in the not-too-distant future and be faced with significant sell-offs across asset classes.

Relevant ETFs: FXE, GLD, UUP, EUO, VGK, IEV, VEU

 

Increased Euro Short

Written August 31st, 2011

A quick update for subscribers – we’ll have an updated portfolio review later this week, but I increased my short euro exposure.

Relevant ETFs: FXE, EUO

When the Tide Recedes

Written July 11th, 2011

Warren Buffett famously remarked that when the tide recedes we get to see who has been swimming with not bathing suit. He was referring to the idea that when things are good, a lot of corruption and corner-cutting and dirt can be hidden as investors willfully ignore basic valuations; however, as things become more turbulent and investors inspect more, companies and leaders have fewer places to hide and “things” come to the surface.

Imagine how bad of a politician you would have to be when allegations that you paid for sex with an underage girl are NOT the reason you feel pressure. Yet, that’s exactly what’s happening in Italy, a country where a stable government is a theoretical exercise anyway. Berlusconi is fighting charges of financial corruption while ALSO fighting allegations he repeatedly hired an underage prostitute.

At the same time, there is now pressure from corruption charges related to Tremonti, the finance minister who was seen as a stabilizing force in Italy. Italian yields jumped, spreads widened, and the euro this week is trading with a 1.42 handle and heading lower.

The 10-year Italian government bond yield remained up by around 14 basis points at 5.25% in recent action, according to FactSet Research data. The premium demanded by investors to hold 10-year Italian debt over German bunds widened by around 24 basis points to 2.4 percentage points.

…The spread on Italian credit default swaps widened to nearly 243 basis points from 216.2 on Thursday, according to data provider CMA. That means it would cost $243,000 annually to insure $10 million of Italian debt against default for five years, up from $216,200 on Thursday.

Source: CBS Marketwatch

Italy is not Greece, and herein lays the problem for the market. As we’ve noted previously, the Greek bailout will set a precedent for the eurozone in dealing with Italy, Portugal, and Spain. Italy, especially, as the third largest euro economy, will be difficult to bail out in the same capacity, especially as German voters are pulling back from EU support. Additionally, international banks’ exposure to Italian debt is significantly higher than Greek exposure and could ripple through the banking world and eventually impact the US markets, specifically, the money-markets.

That’s where the Fed is looking. The Fed knows that with the Italian breakdown and the emergency meetings of the EU this week, the money markets need to maintain liquidity and the Fed will be forced to step in to ensure the maintenance of the largest funds. When Lehman and Bear broke, the danger was averted because only a limited amount of money market funds were in danger of “breaking the buck”; we may have more funds in danger now.

As a side note, gold-euro is again approaching it’s highs, after a brief sell-off. I think this is only the beginning of the move.

Relevant ETFs: GLD, FXE, UUP, EUO

It’s Not About Greece

Written June 24th, 2011

For weeks, the media outlets have been streaming news about Greece – analysis, opinion, etc. – with the intention of shedding light on the internal situation. But the story was never about Greece; the story was about the euro, and the much larger member countries on the brink of meltdown.

Greece provided an easy test case of the euro. It’s small, has incredibly generous entitlements, and is import focused in that it must import tourists for money. It was a straw man. Even by European standards, retiring at age 53 with 80% of your pre-retirement income is generous, but it proves the point about entitlements: doesn’t matter what age you choose, as life expectancy increases, the age always becomes too young. Anyway, Greece is almost out of the picture in that one way or another a solution will be reached in the next few weeks.

Once again, Greece was never the issue, it was just the canary. Early Friday  morning in New York, reports came out that trading in Italian banks was halted as they traded limit down.

LONDON (MarketWatch) — Trading in Italian bank stocks was suspended Friday after a sudden drop in share prices. Shares in UniCredit SpA IT:UCG -4.09% fell 8.9% ahead of the halt in trading and Intesa Sanpaolo SpA IT:ISP -2.24% dropped 7.2%. A spokeswoman for Borsa Italiana said the suspension was temporary and was triggered by “technical problems about volatility.” David Jones, chief market strategist at IG Index, said there had been rumours that Italy’s banks may need to raise more capital in the wake of European stress tests.

Source: CBSMarketwatch.com

Italy and Spain will be the markets to watch in the next few days and weeks, and especially their banking sectors. I contend that investors have been complacent with regard to the global financial sector, and as quarter-end and eventually-year end come around, the mark-to-model on the complex securities will become ever more difficult to justify. That will put downward pressures on the banks, which in turn will lower credit availability, and in the extreme case lead to a post-Lehman freezing of the credit markets.

Relevant ETFs: XLF, IXG, SKF

It’s the End of The Euro as We Know It…And I Feel Fine

Written June 10th, 2011

For a brief moment, the markets believed. For a brief moment, the Greek problem was solved. But then reality set it. Greece’s fiscal austerity and monetary headache is going nowhere and German’s are getting fed up with supporting their neighbors. I’m only surprised it’s taken this long and is so controlled (so far).

Long way down. Meanwhile, against the Swiss Franc, the euro is doing even worse:

The Swiss, however, are none too happy to be the world’s currency vent. They’re REALLY happy that they have their own currency, but they’re not going to be able to withstand the currency strength for much longer. Look for Swiss authorities to start talking the franc down more aggressively, although I think they’ll fail for the near future.

It’s the end of the euro as we know it…and I feel fine. That’s how we started this section. Greece is actually not the main problem for the euro; the problem is the precedent that the Greek proceedings are and will set for Spain and Italy. If German’s continue to bail out Greece without strict concessions and without a viable method for kicking it out of the euro currency, Spain and Italy will expect the same, except that they actually represent large economies. What’s the solution? The euro is one massive currency pegging scheme, just with more moving parts. The only pegging scheme that has a chance of working is pegging a currency to a standard or stable alternative (gold comes to mind) or letting it float. Like all currency pegging schemes, periodically, governments need to re-evaluate the peg price. Even China knows that. The euro needs to kick Greece out or re-peg and de facto devalue the Greek internal economy. By doing that, Greece will face major internal inflation and social unrest, but it’s a viable solution. Debt holders will lose, but otherwise, debt holders of all euro bonds will lose.

Not so surprising, the euro trade has driven the US equity markets.

This was in essence the inflation trade – sell dollar, buy euro or equities. That trade will need to be unwound as the USD strengthens.

Relevant ETFs: FXE, EUO, SPY, SH, UUP, FXF

G3 Currencies

Written June 3rd, 2011

G3 Currencies

I’ll say it: G3 currencies are not making sense. Forget about irrational, or momentum, or fundamental, or whatever. There appears to be almost no underlying logic in some of the recent moves exhibited by the major currencies. The euro is under major political strain, from Greek recalcitrance to Germany political shifts, and yet, Spanish bond auctions are bid and Trichet’s comments actually reverberate with currency players. Check out the euro over the past two weeks.

And the yen is approaching its highs again?

Is anti-dollar or anti-Bernanke sentiment really that high that the yen and euro are seen as viable alternatives? If nothing else, at least we know what’s been keeping the market from going down further faster.

Well, I’m on the other side of that trade. I’m maintaining my short yen and euro positions and will look to increase my exposure if those currencies rise to their recent highs. In the meantime, I view the equity markets as more vulnerable to currency fluctuations. The only currency that is slightly less vulnerable is gold, which continues to be the ultimate vent.

And you’ll have to deal with Pressure

Written May 5th, 2011

Trichet did not grow up in the US, or he probably would have heard Billy Joel’s classic song “Pressure” (I’ve excerpted some of the lyrics in case Trichet decides to read this without listening to the song – emphasis mine):

You have to learn to pace yourself
You’re just like everybody else
You’ve only had to run so far
So good
But you will come to a place
Where the only thing you feel
Are loaded guns in your face
And you’ll have to deal with
Pressure

You used to call me paranoid
But even you can not avoid
Pressure
You turned the tap dance into your crusade
Now here you are with your faith
And your Peter Pan advice
You have no scars on your face
And you cannot handle pressure

All grown up and no place to go
Psych 1, Psych 2
What do you know?
All your life is Channel 13
Sesame Street
What does it mean?
Pressure

Don’t ask for help
You’re all alone
You’ll have to answer
To your own
Pressure
I’m sure you’ll have some cosmic rationale
But here you are in the ninth
Two men out and three men on
Nowhere to look but inside
Where we all respond to
Pressure

And so it turns out that the Eurozone is just like everybody else: political pressures to devalue the currency outweigh the policy need to maintain low inflation. The funny thing in this situation is that it looks like Bernanke & Co. will turn out looking smart because inflation pressures may turn out to be temporary anyway, as I’ve been warning for months. The exposure to gold and precious metals in not an inflation-based thesis; on the contrary, it is a hedge against deflation and the coming complete loss of faith in the Fed’s ability to control the economy. Energy and agriculture, as well had a nice inflation hedge component, but the underlying thesis was one of increased protectionism, resource nationalism, and increased political turmoil. Those are balanced by a continued shunning of financials and real estate, shying away from retail, especially luxury goods, and a move away from consumer discretionary. This is the coming margin compression we’ve been discussing.

The euro was in a different reality. Even as the fringe members showed signs of internal collapse (remember Greece?), investors refused (and still refuse) to admit the underlying structural fault in the common currency. And then, a funny thing happened. Bernanke temporarily succeeded in making the USD the most hated currency worldwide; he won the devaluation race. In the process, worldwide inflation increased (as assets priced in USD skyrocketed) and the eurozone looked prudent with their hawkish stand. That is now changing.

Europe is not different. In fact, if it IS different on any level its in worse shape than the US. The fringe members were only preludes to the challenges faced by the bigger players. Keeping a hawkish stand on rates, while Spain faces depression-era unemployment is impossible. Increasing rates when one of your largest trading partners (China) is orchestrating a slowdown suddenly doesn’t look so attractive. Increasing rates during a debt deflation cycle, when asset classes worldwide are going to have liquidity and leverage-based pricing sucked out, is political suicide. Etc. Etc. Etc.

So now, the race starts again, except this time, I don’t think Bernanke will be able to “win”.

The euro is now exhibiting an outside week (for the technicians at home). Fundamentally, it is only a question of “when” will the euro break down. Gold in euro has moved off its highs, but I anticipate this to be a good entry point, if a bit early:

As always, this is not a recommendation and readers are encouraged to do their own research. I have positions in euro and gold.

Right and wrong…

Written April 6th, 2011

…or yen and euro. Long time readers know that I have maintained short exposure to both the yen and euro starting in November of 2009 – pretty long by currency traders perspective. I am staying with both positions, but one has been more right than the other, I’m just not sure why.

After toughing a 77 handle right after the tsunami, the yen has gotten progressively weaker and is now trading with an 85 handle. I get that, and I also maintain that it is the most vulnerable developed market currency at this point in time, so I wouldn’t be surprised if we see a 100 handle soon. Easy enough to hold on.

The euro, on the other hand, is more perplexing. We shorted it at 1.5, held on as it went to 1.2, and now are watching it break back up through 1.43. At the same time, Portugal is falling apart, Greece is already undone, and Ireland is shaving all the debt holders. More importantly, Spain is facing 20+% unemployment and about to face a major financial crisis of its own. Trichet has commented that the EU will focus on inflation pressures, signaling that they might raise rates. Two things can happen, rates will rise and the peripheral countries will fail bringing about the breakup of the euro, or Trichet will fall under the pressure and ease. Either way, the markets should be discounting the fact that in both scenarios the euro is in bad shape.

Some have stated that the euro is an FX vent as investors flee the yen. OK, but that is a two-sided statement. I understand the “flee the yen” side, but why flee to the euro? Almost any other currency seems in better shape, including multiple emerging markets currencies. See, for example CEW (no position):

Yet, they’re not outperforming the euro recently. Perplexing, to say the least.

Relevant ETFs: FXY, YCS, FXE, EUO, CEW

Gold update

Written April 6th, 2011

It’s certainly making it’s way across the different newsletters that gold and silver at at multi-year or all-time highs, but I don’t see as much about it in the popular press…yet. I assume most readers are probably aware of the moves, but here’s a quick look through (as usual, we note the weekly):

Now check out the same chart, but denominated in euros:

Silver is really taking out each successive new high.

Lastly, both gold and silver are hitting highs in yen:

Now, why focus on the charts? Well, for starters, we’ve been discussing the new dominance of currencies in the investing equation. Without understanding the relationships and money flows, I think investors and traders may be missing a key component of drivers of performance. The other reason is to highlight that of the 3, the yen looks the most vulnerable. Now, it may be confirmation bias, since I’m short the yen, but the peaks in gold and silver are at least confirming it, and while they are not predictive (necessarily), it still points to being the right view.

I’m not a precious metals perma-bull, by the way, but at the same time, I’m sticking with my precious metals portfolio (GLD, SLV, GDX, PALL, PPLT).

Relevante ETFs: GLD, SLV, GDX, PALL, PPLT