This from The Sovereign Society:

Over the next six to eight months, our core trading strategy is based on three key ideas:

1. Global demand will continue to deteriorate
2. China will surprise on the downside
3. Commodities prices will sink back to their 2001 levels

Based on these three views, my trading partner Jack Crooks and I are bearish on currencies that depend on commodities to support their growth. And within the pack of commodity players we are most bearish on the Australian dollar.

Right now, Australia is effectively a satellite country of China. In my opinion, the market is not even close to pricing in the plunging growth in either country just yet. But when the market does, I believe the Australian dollar will get pounded lower.

Now might be a great time to consider put options on the Aussie. Here’s a more detailed look at why…

The economy is in trouble and sinking fast. From the Financial Times “The deterioration of the country’s terms of trade is crunching national income.

Recession now seems a formality: Growth last quarter, at 10 basis points, was the weakest in eight years. Households and farms are over-borrowed, and companies are even worse. Their financing requirement blew out to an all-time high last year of almost 8% of output.

With debt hard to come by, companies have three choices: Stop spending, raise equity or go broke,” according the Financial Times.

And the fact that Australia’s current account deficit is already the highest among the major currencies, estimated at 4.8% of 2008 gross domestic product (GDP), makes the currency vulnerable. (Note: the U.S. current account is estimated at 4.5% of GDP, but players have to hold U.S. dollars in order to transact trade and capital flow. They do NOT have to hold Australian dollars.)

China’s “Hard Landing” Will Clobber Australia: Not too long ago, China was everybody’s darling economy. But the crowd of China cheerleaders may be in for a very big surprise – a hard economic landing! Already Australia is suffering from the Chinese slowdown, but the probability that it will get much worse is rising fast as China’s growth numbers continue to fade.

“The one-time engine of global economic growth has been sputtering as a result of dented global demand for exports and over-zealous tightening policy at home. A hard landing, like recession, adds new fear to the mix. With shares and real estate worth sharply less, unemployment rising and deflation round the corner, companies and households are already reluctant spenders; household savings deposits rose by more than 20% in the year to November,” is how the Financial Times recently summed up the rising problems facing China.

As China goes, so goes the demand for commodities and the source of Australia’s growth. China’s troubles are the key reason I believe commodity prices have further to fall. And looking at a long-term chart of the Commodities Index, I think it will revisit 2001 territory – the year commodities prices blasted off.
Commodities Index vs. Australian $ Weekly-Round Trip to 2001!

AUDUSD Cliff Diving Chart

Aussie yield support could fade fast. Australia has been a great place to park money during the past seven years. The country was growing along with commodities, and the Reserve Bank of Australia kept their rates high to rein in inflation during this boom period.

The Aussie dollar has been the highest yielding of all the major currencies for many years, and still is. But the rapid deterioration in Aussie growth and the fact that governments are fighting deflation, not inflation, leads me to believe Australia’s central bank will hack much more off its official policy rate, which now stands at 4.25%.

I am not sure how far the RBA will cut rates, but I do believe the bank will aggressively cut rates. When they’re done cutting rates, the high yield differential that created such a seeming “no-brainer” demand for Aussie dollars will be gone.

When that happens, the Australian dollar should accelerate to the downside.

Bottom line: Australia’s growth should soon go into negative territory. The country’s already ugly current account deficit should grow worse. Australia’s key customer – China – will likely be buying a lot fewer commodities. At the same time, the Reserve Bank of Australia will likely cut interest rates much faster than now expected in an effort to generate growth.

All of this is bad news for the Aussie over the next several months.

Source: That Sinking Feeling Down Under

This from Sovereign Society:

The hardcore dollar bears said we were crazy for even mentioning the idea that the dollar could rebound during all this economic turmoil.

How could the dollar possibly rally during the worst financial crisis in a generation? (That was a year ago before we knew how far and wide the credit crunch would reach.)

But the fact is, that’s exactly what’s happening now.

I’ll admit that the dollar didn’t rally right away. It took months. In fact, the dollar index didn’t bottom until the day after the Fed bailed out Bear Stearns.

But then, the dollar slowly started to creep higher. And since mid-year, the dollar has been on a tear against the world’s major currencies. In fact, the dollar has jumped 16% just since September.

Crisis Profiteering: Your Dollar Profits from Credit Crunch

And it looks like this dollar rally will continue.

In fact, the dollar is one of the few currencies we are long-term bullish on for 2009. We see the dollar rallying through at least the first half of 2009. As I said on Tuesday, the dollar will continue to fly high on a combination of…

• Its Safe Haven Status: Scared traders are running back to the world’s reserve currency as the credit crunch continues to sweep the markets.
• The Mad Dash for Cash: Stock investors are still dumping whatever is left of their portfolios and running back into cash (in this case, the U.S. dollar).
• Whoever Can Fix the Crisis Gets the $: For now at least, it seems Forex traders believe the U.S. is better equipped to deal with the credit crunch, so they’re pouring money into dollars.
• Crisis Feeds Low-Yielding Currencies: During recessions, Forex traders run for safety, so they trade in their high-yielding currencies for the safety of lower-yielding currencies. So the dollar, now yielding 1%, actually has an advantage right now.

Yes, You Can Invest in a Dollar Rally With Foreign Currencies

Now it may seem strange to play a dollar rally by investing in foreign currencies, but actually there are a couple key ways to profit off this massive dollar rally next year in the currency market.

You could call your stockbroker, and simply ask to short any number of currency ETFs, or even go long the few dollar ETFs they have available.

That’s an excellent way to play the dollar rally – particularly if you’re a longer-term investor. However, ETFs only offer conservative returns (15% to 20% – definitely not bad, assuming stocks continue to plummet).

But in my opinion, there is a bit more interesting way to play this dollar rally either in the options or exotics market. For one reason: Leverage. Leverage allows you to invest a smaller amount, but still shoot for the big gains – often double or triple-digit gains in just a matter of weeks.

Where to Find the Double or Triple-Digit Dollar Winners

The Philadelphia Stock Exchange (now known as the NASDAQ OMX) offers six different currency options that you can buy versus the U.S. dollar.

These currency options trade just like regular stock options, with regular calls and puts. They expire just like stock options, so you only hold them for a short period of time. Also, you only pay the premium for any one contract, so you never risk a penny more than your initial investment.

All World Currency Options are in dollar terms (so there’s no ugly conversion math to trade these). So for example, the British pound option contract tracks the price of the British pound in dollars.

The problem is, they do NOT offer an option on the dollar. So to take advantage of the dollar rally, you need to choose the currency that looks to drop the farthest against the dollar. Then you simply buy a put option on that particular currency.

It’s the same in the exotic Forex market. The exotic Forex market tracks the fast-moving emerging market currencies, so small moves can often lead to large gains. Also, the Forex market trades with both 10:1 or 100:1 leverage depending on what kind of “lot” size you use.

So to take advantage of this dollar rally, you would choose the emerging market that looks set to sink the fastest. Then simply pair that emerging market with the stronger dollar.

This year, our exotic subscribers have been doing just that. For instance, we paired the Hungarian forint with the U.S. dollar in July. We held this USD/HUF pair for a little over a week and made 361%, counting leverage.

Then we did it again. We paired the U.S. dollar with the Thai baht (USD/THB) and made another 334% for our subscribers. A couple larger plays on the Polish zloty and South African rand made 2,948% and 2,997%

Honestly, I’m not saying this to brag. I want to use it as an example of the potential of trading this small corner of the Forex market.

And likewise, you can also find similar opportunities in the options market (we’ve recommended winning options worth 127%, 185%, even 300% during the worst of the credit crisis this year).

But honestly, these are just two strategies to play the dollar rally. There are plenty more.

Source: How to Play the Great Dollar Recession Rally of 2009

This from The Sovereign Society:

If you want to know how far this recession has stretched, look no further than China.

Up through this year’s Olympics, China seemed to be well on her way to becoming the next global economic kingpin. And with good reason.

China has had the fastest growing economy in the world for decades. The Chinese government has amassed trillions in reserves, while building up a trade surplus just last year of US$262.2 billion.

But lately, China’s fundamentals have been breaking down, one by one, like massive dominoes…

• Manufacturing in China just shrank by its largest margin EVER.
• China’s GDP growth for next year is projected to be around 7.5% – that’s down from an 11.5% pace not long ago.
• China recently adopted its own US$586 billion stimulus plan to try to jumpstart growth. (Notice: That’s more than twice China’s trade surplus of last year – it’s also nearly as much as the U.S. plans to spend on its US$700 Billion TARP bailout plan.)
• Housing prices are dropping in Shanghai, Shenzhen and Guangzhou.
• The central bank just slashed rates by the most in 11 years.

These dominoes are knocking down more than just China’s economy…

In fact, trouble in China spells disaster for the rest of the global economy. Specifically, a slowing Chinese economy is a dangerous situation for the United States, its surrounding Asian neighbors, over-exposed and over-indebted developed economies.

Global Manufacturing Clearinghouse Hits the Skids

You can trace all China’s problems back to their now broken export model. For years, China has played the middleman between Asia and the United States.

Their low-cost, cheap-labor production model dictated that they grab input products and other raw materials from nearby developing nations.

The Chinese then used those low-cost resources to build their goods and ship them off to the U.S. and other developed nations. China’s Asian neighbors depended on China to continue this cycle to fuel their own export-driven economies.

As a result of receding liquidity, U.S. consumers (and others) have a shrinking appetite for cheap goods, so they spend even less.

So, China is now losing its best customer, the U.S., thanks to the recession. It is also selling less to other developed nations of the world. This hurts all the emerging Asian economies that depend on China to buy their inputs. It’s a vicious cycle.

Emerging Market Currencies Will Be Hit the Hardest

In short, global capital flow has stopped dead in its tracks. And global demand is drying up. So it’s easy to see why emerging economies’ stocks and their currencies are being hit the hardest.

This is the worst possible environment for emerging economies because they depend on sustained global demand, more so than internal demand. When global capital flows dry up, these emerging economies struggle to make ends meet.

And any developed nations (and their currencies) that have exposure to these struggling emerging markets will ALSO suffer.

This includes several key European countries whose banks are over-exposed on loans to emerging markets and suffocating on massive liabilities. And this includes the euro and pound.

Just as China was vital to the boom, it is critical to the bust. And when that happens, a few currency investors who saw this coming will be in the best position to profit off this global realignment.

But there is no “One-Market” solution to play China’s bust!

Source: Why China Can’t Save the Global Economy

This from Sovereign Society:

Yesterday, I told you all about the four currencies whose values promise to drop like rocks next year, thanks to the worldwide recession. And each of these presents substantial trading opportunities.

But the flipside to falling currencies is rising currencies. By definition when one currency goes down, it goes down in relationship to another. In this case, the U.S. dollar.

While most major currencies slumped, the dollar made the ultimate comeback in 2008 just in time for the U.S.’s greatest financial challenge since the 1930s.

Today, I’ll tell you why the almighty dollar effectively skipped the recession this year – even while the Fed slashed rates and spent not billions but TRILLIONS to fix a broken economy.

More importantly, I’ll also tell you what’s in store for the mighty dollar in 2009.

The Cinderella-Buck Arrived to the Ball Just in Time for a Recession -
But How Long Will She Stay?

The dollar is a testimony to how Mr. Market changes his mind. Just last spring, currency traders had effectively voted the dollar off the Forex island.

The dollar index hit an alltime low in mid-March, the day after the Fed bailed out Bear Stearns.

It’s a whole other story now. The greenback has become the Cinderella story of the foreign-exchange market in the last two quarters. Now, traders can’t buy dollars fast enough.

Overall, the dollar index has jumped 17% against the world’s majors just since August.

Cinderella Dollar Comes to Ball As Equities Sink

Dollar Index: Source: www.fxstreet.com

That’s just the major currencies. The dollar has also pulverized exotic currencies from Mexico to Turkey. In fact, exotic currency traders have made a killing (as much as 2,997%) this year, just by pairing the strong dollar against the weaker Polish zloty, Hungarian forint, Czech koruna and others.

Frankly, the soaring buck has many traders puzzled. And I admit – it does seem a bit counterintuitive for the dollar to rally now.

From a fundamental standpoint, traders generally watch interest rates and economic growth to gauge a currency’s “health.” And the U.S. dollar should be losing on both counts this year.

The Fed already slashed rates to 1%. Just yesterday, Fed chief Bernanke said additional rate cuts were “certainly feasible.”

As far as economic growth is concerned, Bloomberg reports that the U.S. government is prepared to spend US$7.7 TRILLION to pump liquidity back into the financial system. That’s roughly half the U.S.’s GDP for last year, so any meaningful surge in “economic growth” seems out of the question.

But Here’s the Thing: Forex Traders Don’t Care

Yes, that’s right: Forex traders couldn’t care less.

The dollar may be tangled with lower rates and slower growth, but as the world’s reserve currency, the dollar has taken on a new global status since the credit crunch began to squeeze stock markets. The dollar has become the world’s “safe haven” currency.

The more stocks sink, the more currency traders sell their positions for cash. In this case, “cash” is the U.S. dollar because Forex traders perceive the dollar as the safest bet in the global markets right now.

This sentiment has created a relationship between stocks and the dollar. As stocks (particularly U.S. stocks) fall, the dollar rises. And vice versa. In fact, just last week, the dollar index had its worst one-day decline since 1985. (Yes, I said “decline” – even an uptrending currency can have pullbacks.)

Why did the dollar index fall that day? Because stocks were temporarily rallying. The Dow had climbed almost 900 points in two days. For one day, the dollar lost its “safe haven” status, because investors started to inch back into stocks.

But it was a temporary pullback. This week, stocks are slumping again. Traders are selling their positions and running back into cash. Ergo, the dollar is rallying again. In other words, risk in the markets = profits for dollar holders in the Forex market right now.

If That Wasn’t Enough, the Buck Has More Perks…

Also, in the middle of a crisis Forex traders generally trade-in their high-yielding currencies to pay back what they’ve borrowed in cheaper, low-yielding currencies. This means the U.S. dollar’s recent disadvantage – now yielding 1% – has become an advantage in a risk-averse trading environment.

And if that wasn’t enough, it appears the Forex market traders believe the U.S. is better equipped to battle a global crisis. That’s because, unlike other more handcuffed, less resourceful nations, U.S. officials are willing to throw everything including the kitchen sink at credit problems (hence that US$7.7 TRILLION in bailout funds that Bloomberg reported).

Once again, this just gives Forex traders one more reason to vote “pro-dollar” this year.
So as long as risk remains in the market (which is a virtual certainty at this point), the dollar will continue to be the safe haven currency for at least the first half of 2009 – very likely longer.

Source: Why the Dollar Will Still Be King of the Hill in 2009

This from The Sovereign Society:

The U.N. is predicting the first worldwide recession since the 1930s … for 2009. If that wasn’t bad enough, developed nations are supposed to shrink up to 1.5%. “It seems inevitable that the major countries will see significant contraction in the immediate period…even if the bail-out and stimulus package succeed,” according to the report. In other words, the recession may have spared Black Friday 2008, but next year, the worldwide recession will cut into worldwide spending even further. In the currency markets, you can already see that four currencies will suffer next year as the U.N.’s prophecy comes true…

The Four Currencies On the Chopping Block for 2009

1. Euro: Yes, the euro WAS King of the Hill for the most of this decade. But those days are long gone. Right now, the Eurozone is only as strong as its weakest members – and some of its weakest members happen to be suffering emerging markets in Eastern Europe. Not to mention, the European Central Bank has already started following the Federal Reserve in slashing their own interest rates. And, just last week the European Commission urged all EU member states to unite in an EU-wide fiscal stimulus package worth 200 billion euros (US$260 billion) to stave off recession. That spells disaster for the single unit currency.

2. Pound – The London markets have been the most overexposed to the subprime-credit crunch for quite some time. In fact, the pound started to turn as early as November of last year. Today, a year later, the pound is still suffering for the same reasons – deteriorating housing wealth, frozen credit market and heavily indebted consumers, among other sore spots. The U.K. labor market (especially in London) is also still at risk from financial-specific job losses (even after massive layoffs this year). And, the Bank of England too is racing to catch the Fed in lowering interest rates to stem the economy’s collapse.

3. Australian dollar – Australia has been a satellite country to China for years. Australia is used to providing so much of what hungry Chinese manufacturers need to produce their “stuff.” But if China further cuts back their demand for such input products and commodity prices continue to drop, then Australia will lose the financial boost of its best customer. In other words, Australia’s exports will suffer mightily and crush the Aussie dollar even further. If that’s not bad enough, the Reserve Bank of Australia is on a similar path with monetary policy. As it is now they can’t seem to cut interest rates fast enough.

4. South African rand – The ramifications from a sick global economy will reach beyond just the major currencies. Whether South Africa’s economy lives or dies is based largely on their commodity exports. And as commodity prices continue to drop next year, which we think they will, the South African rand will suffer even more. Plus, economic troubles will likely rekindle political and social unrest. Right now jobs are at risk in South Africa, so many South Africans could face the constant threat of unemployment. Of course, a rising jobless rate doesn’t sit well with a nation’s citizens. And civil unrest doesn’t exactly reflect well for the body politic. (A situation like this doesn’t bode well for any currency.) But as you’ll see, you can use economic slowdowns the coming 2009 recession to grab never-before-seen profits in the Forex market.

Source: Recession Will Kill These Four Currencies In 2009