Europe in a tizzy

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%.Viewing the remainder of this article requires a Subscription

Increased Euro Short

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

Tags: currency trading, Euro, USD

Currency | | August 31, 2011 2:40 pm | Comments (0)

When the Tide Recedes

Warren Buffett famously remarked that when the tide recedes we get to see who has been swimming with not bathing suit.Viewing the remainder of this article requires a Subscription

It’s Not About Greece

For weeks, the media outlets have been streaming news about Greece - analysis, opinion, etc. - with the intention of shedding light on the internal situation.Viewing the remainder of this article requires a Subscription

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

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.Viewing the remainder of this article requires a Subscription

G3 Currencies

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.Viewing the remainder of this article requires a Subscription

And you’ll have to deal with Pressure

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…

…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

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

Currencies dominate

For those with long enough memories, the current currency wagging the markets is reminscent of 1987. There, I said it. Portugal gets downgraded. Ireland is gonna haircut every debt holder. Etc. And the euro…rallies? Meantime, all the repatriation in the world can’t help the yen rally? Expected, but still brutal in its swings. And gold, after touching all time highs is selling off. Hmmm. Curioser and curioser.

It feels like the carry trade is back in vogue: sell the yen buy anything else. Now, I’m all for selling the yen. Those who bought EWJ as opposed to DXJ (as I recommended) will come to understand that it’s not your daddy’s markets any longer. You cannot invest in an asset class without understanding the currency implications.

On the other side, you have Bill Gross out with a new piece on America’s $65 trillion unfunded liabilities and the inevitability of higher rates. So the equity markets are going up by default, but I don’t think of their own volition and certainly not on the basis of their fundamentals. To which, I’ll remind readers that without the fundamental backdrop, this will not end well. I don’t mean to be a downer and I know I’ve been saying the equity markets are vulnerable for a long time.

For the record, our concentration in energy has led us to significant outperformance. Our positions in precious metals continue to make new highs every couple of weeks. Etc. I don’t need to go there.

Regardless, I anticipate that an event will come after a close, or over a weekend, or from a different field, that will shake the foundations of this equity rally. After the fact, it will be called a black swan and be credited with the gravity to bring equity prices down. In reality, it will be a grain of sand that randomly fell on a system fraught with fingers of instability, and as in every power law distributed system, the implications will be far larger due to the foundations rather than the immediate cause. And again, currencies will be the markets that lead.

Relevant ETFs: GLD, SLV, EUO, YCS, EWJ, DXJ, UUP, FXE, FXY

Who’s going long the euro?

I admit it – I don’t understand why anyone would go long the euro; I didn’t understand the logic months ago, but I especially don’t understand it now, as uncertainty over internal stability becomes certain instability. My only explanation is that US based investors are so ingrained in asset allocation that they aren’t pulling money out, and European based investors are bringing money home, while at the same time China is forced to buy the euro to keep their own currency down. It’s that combination of money flows that would make sense, because the other explanations (e.g. Trichet is more vigilant of inflation fears) seem to pale in comparison to the fact that Portugal can’t find a bid, and Spain is looming. If I had to send my sympathies to any politician, it’s to Merkel. She tries to do the right thing, but that is getting confusing. How long before saving the European debtors will cost her her job?

To save or not to save?

The dollar

The dollar is once again the most hated reserve currency in the world. European peripherals are breaking down, with bonds hitting all-time high yields in Portugal, Ireland, Spain and soon others. The yen is getting printed so fast we should have bought printing presses in anticipation. And yet, the dollar continues to be the currency everyone loves to hate:

Congratulations, Bernanke! You are winning the devaluation race. Keynesians can breathe easy that people prefer almost any other currency and asset to our USD. It’s actually a pretty optimistic view of our economic leadership – namely, they set a goal and they are achieving it. You might disagree with the goal, but you’ll at least agree that they are effective. Except…

I might be the only one out there who believes that the Fed is actually IN-effective and WILL NOT achieve its stated goals. This is a pretty pessimistic view, both of our monetary leadership, and the inflation stimulation that the world central bankers are hoping (praying/planning /depending on?) for. In my world view, Bernanke & Co. will not succeed in stimulating long-term inflation. Why? Because for all of their efforts, they will not be as able or driven to make the dollar less attractive than the euro and yen. In my worldview, the Fed is so ineffective that they won’t even be able to devalue properly. Trichet, in the meantime, with his high-handed talk of raising rates, will be unable to strengthen the dying currency beyond periodic run-ups. Lastly, the Japanese CB will be the only one that will finally win (by losing). The Japanese will finally break the bank and drive the yen to new lows that will remind the world of what an economic disaster looks like.

Will the Fed get what it wants and stimulate long term inflation by trying to devalue faster than everyone else? I think not.

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

Euro holding up, all considering

Considering the fact that Portugal just lost it’s government after its Parliament rejected a deficit-cutting plan. What happens next? Well, some combo of Germany, IMF, US, and China comes to the rescue. My bet is that the Chinese have the biggest vested interest in holding the euro up, since they are trying to stimulate without stimulating and the need Europe as their biggest trading partner to continue purchasing their overcapacity. I’m not optimistic about the euro. Then again, I haven’t been optimistic about its prospects for a long time (yeah, I prefer looking at the weekly chart):

And here’s gold in euro:

I have been short euro since November 2009 and have not added/subtracted to/from the position in that time. I’m now analyzing whether this is a good opportunity to add to either a short euro/USD or short euro/gold. I’ll keep you posted.

Relevant ETFs: FXE, EUO, GLD, UUP

Always looking for the ugly duckling

And right now, there’s one asset that looks pretty ugly…

What if I told you there was an asset that was sitting at 52-week lows. It has some negative fundamentals, and a few relative positives, but no foreseeable absolute positives. Long term, this asset has very little cashflows, is difficult to value, and everyone thinks is worthless. It has the potential to become a huge value trap. It has a brand name which has lost global appeal. It is vulnerable to macroeconomic whims of politicians. I can go on and on about the negatives and positives, but will say one final bit: almost everyone has some long exposure to it already and almost everyone believes that it will go down in the near future.

The asset, of course is the US dollar:

While I don’t know that this is the absolute low for the dollar index, I do have to wonder: how much of the bad news is already priced in? How much of the inflation fears are already priced in? How much more strength can the yen and euro (which together account for around 70% of the index) exhibit? I’m already short yen and euro in various vehicles, and I have to admit that I thought dollar strength would become evident as geopolitical turmoil generated a flight to safety mentality. The fact that this did NOT happen leads me to believe that either the US dollar is no longer the safe haven recipient or investors did not actually seek safe haven storehouses at all. The latter is hard to argue, since gold, the other safe have stand-by, continues to approach all-time highs.

Maybe that’s the end of the story. Investors have flocked to gold as the de facto reserve currency and are expressing their fear through the yellow metal rather than the greenback.

The flip side of that is that the dollar is still just a fiat currency and as it has gotten weaker, the euro and yen got stronger, presumably on weaker fundamentals and weaker demographic and tax bases. So I’m not that quick to draw the above conclusion.  There is nothing for me to do with this view right now, but – in line with our thoughts on everything being relative – we can wait and watch, because I believe there is an opportunity forming.

Relevant ETFs: UUP, FXY, YCS, FXE, EUO, GLD

MacroView

A quick tour around some key markets: signals from gold, the next leg for AG, and what is the euro thinking(!) – all part of today’s MacroView charts. We have mentioned it before, but it’s worth pointing out that the averages are hiding some massive rotations. It’s not so much whether your long or short these days, but rather WHAT you’re long or short.

macroview_9Mar11