And there are significant advantages which trading Forex, or FX, for short, can offer.  One is that there are no “commissions” as you generally think of with stock trading.  The broker is paid by means of the “spread” between the bid and ask prices.  This is really nice, because if you want to get started in FX trading, and you want to start small (which is an excellent idea), all you have to cover is the spread, rather than a spread and a commission.

Here’s how it works….

Because of the various opportunities for leverage and margin in the FX markets, you can start with a small account, say $1,000.00, and adjust your pip size to 10 cents/pip.

As a general rule, a pip is 1/100 of a cent.  That may seem unusually small for a trading amount, but believe me, it really adds up!

In a $1,000.00 account, you can set your lot size to leverage $1,000.00, on just a $100.00 margin.  Then, each time your currency pair moves 1 pip, you make (or lose) 10 cents.  Again, that doesn’t seem like much until you see that currency pairs move 100-300 pips per day!  That works out to be $10-$30 daily on a $100 margin, or 10%-30%.

I do not price my gains against my margin. Instead, I price them against my entire account.  That means I could be looking at gains of 1%-3% every single day.  And believe me, these steady gains can add up quickly!

Getting Started with FX Trading

I’m sure you’ve all seen the Forex advertisements claiming you could double your money every month.  And mathematically, that is true.

However, wise traders know the probability of that happening is very low.  Truthfully, 95% of all FX traders will run their account down to zero in just a matter of months.  That means 5% of all traders are collecting the money from the 95% who are losing!  The market is unbelievably lopsided, but that doesn’t mean that a small trader is out of luck.  With some patience and a good strategy, an FX trader can return 10% monthly over an extended time period.  (Good traders don’t measure their success on a daily time frame—that’s way too short.)

The problem with most novice FX traders is that they are more like gamblers…and they don’t stay in the business long enough to actually get a good return.  They blow out their accounts and figure the game was rigged, or that their broker was cheating them, or some other excuse….

The fact is, most traders jump into the deep end of the pool, and don’t know how to swim. That’s because the FX is a different animal from stocks and bonds and commodities…

Why I Am Short the Euro

Right now, there is a lot of activity in the FX markets.  Traders and Investors worldwide are trying to ascertain which currency is the most sound and stable, and which will produce the best return.  For my money, currently, I am short the Euro.  While a lot of people are bashing the U.S. Dollar (and believe me, there are plenty of reasons to do so) from an FX standpoint, the dollar appears to be in much better shape than the Euro.

As all currencies trade in pairs, which means that one trades against another, if I am short the Euro, I will be long the USD.  Currently the USD is trading about $1.30 to the Euro.  This means it costs $1.30 to buy one of the European currency.  I am looking for this to fall over the longer term down to what is called “parity” level.  This is where $1 USD will buy 1 Euro.  That would be a drop of 30 cents– or 3,000 pips.

If you are keeping score at home, that would equal $300.00 at 10 cents/pip, or 30% on a $1,000.00 investment.

However, a larger trader may size his pip to 10.00 each.  That would provide a return of $30,000.00. And all we are doing is trading against the disparities between the two currencies.

As with all markets, the FX does not move straight up or down, and there will likely be a lot of bumps in the road between here and parity.  But each one offers a new chance to enter as we sell the rallies.

Until next time…Happy Trading!

Source: The Truth About Forex Trading

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

What ever happened to safe-haven currencies?

You know what I mean, the much-touted coin of the realm in other, smarter, more mature countries. “Hard currencies.” Issued by countries who’d outrun, outplay, outlast the spendthrift United States…

…and “decouple” from the Demise of the Dollar.

Don’t you think it’s quite amazing how poorly those safe havens did when it really counted? The euro, the Aussie, kiwi, loonie dollars (as the cool guys in the currency forecasting racket call them). How about the pound sterling? The Russian ruble? The Icelandic krona?

You might as well have put your money in Bill Miller’s Legg Mason Value Trust.

Could it be that there’s been a mistaking of cause for effect?

China’s rise from rice paddies to riches was so dazzling, its demand for commodities propelled the economies of the supplier economies to new heights. They developed beautiful trade balances by shipping coal to Nanking, gold to Guangzhou, and copper to Chongqing. Budget surpluses even. While at the same time, the U.S. dollar was allowed to do what American manufacturers and exporters wanted it to do: Keep U.S. exports cheap and expanding despite the cut-throat competion from the Far East.

But the main factor behind Chinese expansion was not the conversion from Mao to Tao… but the insatiable demand for consumer goods from the richest economy on earth. A demand so huge that it compensated for the demographic and economic short-comings of most other economies as well.

That fact was recognized by most national financial institutions who figured out that by lending money to America, they’d buy demand for their products.

Somehow, this dynamic must have escaped the dollar demisers. Who didn’t quite think through what effect the decline in American consumption would have on the global economies whose economies, markets, and currencies depended on it.

Those who followed the directive of the doomsday sayers may well say they saw the crisis coming. But given the losses in most “safe havens”, the practical result of their prudence was the equivalent of switching ocean liner tickets from the Titanic to the Lusitania—minus the 3-year delay in between sinkings.

They’re still at it, though. Massive U.S. budget deficits are going to wreck the dollar, they proclaim. Could be. Especially if these deficits were to occur in a world where all other countries had positive balances.

But most other economies are worse off the the United States. (Ironically, one of the few currencies rising in value right now is issued by a country who has never paid much heed to debt levels.) And currencies are by nature reflections of relative value at any given time.

A relatively higher dollar allows Americans to buy more consumer goods… which may give export-dependent countries a chance for survival. It’s simple self-preservation.

Look for the euro to decline to $1.25 by next week.

Source: What ever happened to Alicia Silverstone?

This from Taipan Daily:

The most important thing for you to take away from the tail end of 2008 – indeed most all of 2008 – isn’t the real estate collapse, or the bank collapse, or the Wall Street collapse or the automakers collapse.

I’ll grant that this is one awfully big bunch of awfully big collapses. But in the end, they are all mere phenomena – not causes but effects, stemming of a fundamental battle.

I am speaking of the whole inflation/deflation thing. As we have pointed out repeatedly in this column, this interplay is one of the single binding actors in the market.

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Four Clues to Our Future

Right now, for instance, I have on my desk four articles from the feed services, and one chart. One bemoans the fate of retail stores who have been doling out 75% discounts since Black Friday in a desperate attempt to clear out rotting inventory and maintain at least a modicum of cash flow.

Now it appears that they are hoist with their own petard (the Shakespearean equivalent of shooting off your own foot), as shoppers seem unwilling to purchase a damn thing at retail anymore. (I can confirm this trend from personal experience: My wife actually made me wait till the 27th for my gifts so that she could get even better price breaks.

The second item is on the price battle brewing in airfares. The airlines have been cutting flights willy-nilly in an attempt to reduce excess capacity, and they still can’t seem to put bottoms in every seat. So now they will try cutting prices so low it will entice even the most reticent stay-at-homes back into the friendly skies.

Here too, I can confirm this trend from personal experience that our clan abandoned its usual holiday confab in NYC in favor of a long, long (really too long) retreat at Chez Lass. I must say that I did consider FedExing the children somewhere.

Anywhere really. Fairbanks, Alaska, came to mind.

The third item also confirms our reticence to spend or travel. It is from a data conglomerator, and notes that between November 2007 and October 2008, Americans drove 100 billion fewer miles than they did in the prior 12-month period. The report lays that drop at the feet of $140 oil.

Like a Snake Eating Its Tail…

This brings to mind the cyclic nature of these inflation/deflation trends. Allow me to demonstrate…

For the better part of a decade, I have warned that loose dollars would lead to spiking inflation, which in turn would stymie the very growth that those dollars were intended to stimulate.

And indeed this is exactly what came to pass. The price of most everything (other than lead-covered Chinese toys) shot to the moon, breaking the back of the American consumer and engendering the global recession we are now “enjoying.”

Inflation Begets Deflation…

But now that this recession has finally come to pass, the wags in Washington claim that deflation is now the number-one threat. And they point to those very items that I mentioned earlier: falling prices for oil, retail items and services over the past eight to twelve weeks or so.

As this trend continues, manufacturing falls off (and indeed it is at decadal lows now), and excess inventory begins to evaporate. The service sector curtails offerings (just as we see the airlines doing). And as the folks in the oil patch stop pumping expensive steam into old wells, or even stop searching out new ones, gradually we see all that excess oil disappearing off the market.

And in point of fact, most all of my wire service feed today is obsessed with the big fight between Russia and its former satellites. Seems that the demand for natural gas had fallen a tad, and now the Russians can’t get their asking price anymore. With the Russian stock market tanking, Putin and his puppets decided to cut the entire flow of gas to most all of Europe. “Don’t want our gas at our price, eh? Well, let’s seem ’em do without it, then.”

Everyone is calling this a political power play, and perhaps it is. But in the end, the Russians are simply doing exactly what the American airlines are doing: withdrawing excess supply.

… And Deflation Returns the Favor

Some look at this whole operation like a scale: Diminishing demand is balanced by diminished supply. But that would suppose that economies are simple systems that seek balance.

This is nonsense, and it’s a good thing too. In a genuinely balanced system, all information is uniformly distributed and understood, and all goods, services – and stock shares – are perfectly priced.

Real life, however, is a chaotic system in which a moron flapping his arms at a Starbucks on the New Jersey Turnpike can eventually raise the price of sugar in Brazil.

This system may seek balance, but it will never attain it. Rather, each cycle sows the seeds of the next imbalance. Again let’s look to oil: Already this reticence to look for new supplies has New York futures traders salivating like maddened dogs. Over the past few weeks, oil futures have risen some 43% off their December lows.

This brings me the final feed item on my desk today: It is from one of those speculators, noting that he anticipates that the demand will cross over available supply sometime in the next six to 18 months.

I’ll grant that this is an absurdly vague window. But it is his conclusion that is intriguing: He anticipates another whole round of massive oil price shocks. Except this time, it won’t stop at $140/barrel. He is figuring more like $240.

Is he nuts?

The Inflationary Power of $1.75 Trillion New Dollars

For that to happen we would need billions of dollars chasing relatively few gallons of oil. We already know how the oil supply is being reduced. Now where would we come up with, oh, say, $1.75 trillion dollars…

Oh my: That’s exactly the amount of money Washington has already put out there or is proposing to print.

And what happens when too much money chases too few goods? That would be called looming inflation, folks. Which is exactly why both Justice and I have been advising that you short the dollars any way you can now, while they are still big enough to short.

Specifically, I have and will continue to recommend both shares of PowerShares DB US Dollar Index Bearish (NYSE:UDN) for investors, and call contracts against the same for traders. The former ought to gain a minimum of 20% per quarter over the next twelve months, while the latter could earn deft operators 100% or more over the next 90 days.

Deflation or Inflation? Get It Right, and You’re Rich. Get It Wrong…

** The dollar’s down, but it’s certainly not out.

• From mid-July to the end of November, the U.S. Dollar Index rose a whopping 23%. This tracks the value of a dollar against six major currencies.
• Anyone who knows anything about currency trading knows it’s not normal for a currency to move 23% in such a short time. Forex traders consider a one percent daily move to be big news.
• So it would make sense that the U.S. Dollar Index would have to see a rapid price decline after rising 23% so quickly. It has to go back to the mean, after all. And that’s exactly what happened. The dollar fell 11% between mid-November and mid-December.
• But this drop doesn’t necessarily signal the beginning of a new downtrend. As of now, it only signals a correction. We can see this by looking at a chart below

• As long as the dollar stays above its 200-day moving average, the recent uptrend will stick. But that’s not to say we won’t see dollar weakness ahead.
• It’s possible for the dollar index to trade between 78 and 88 for the next two or three years. It could even move past 88. But betting that it will move under 78 is premature. If you really want to capitalize on a drop in the dollar, wait for a confirmation of the downtrend by allowing the U.S. Dollar Index to trade under 78 before shorting.
• At that point, you could make some good money buying up the Rydex Weakening Dollar 2x Strategy H ETF (MUTF:RYWBX) . For every one percent the dollar losses, you gain two percent. And with Bernanke dropping money from helicopters, it is only a matter of time before the dollar starts seeing bigger drops.

** The Congressional Budget Office estimates that the 2009 budget deficit will reach $1.2 trillion.

• That was one day after President-elect Obama said, “Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery that we are working on at this point.”
• The government has already backstopped the financial markets to the tune of over $8 trillion. Now our politicians are starting to spend obscene amounts of money in a failed effort to “jump start” our economy.
• If the markets continue to suffer, the government will have to cover losses for years in the future. This means they will continue to create funny money to cover those losses. And inflation should become a big concern.

** According to Bloomberg, General Motors said it has enough government loans to cover its worst-case forecast for U.S. auto sales and won’t need more if the economy holds up.

• It’s extremely difficult to believe that a one-time loan to GM would be enough to fix their problems. A former Merrill Lynch auto analyst has said that GM’s plan “all depends on a lot of difficult-to-forecast factors, like the size of the market.” And during congressional testimony, another analyst said Detroit would need up to $125 billion to become whole again. This is very different from the less than $20 billion that GM and Chrysler got from the government in December.
• The truth is that GM is taking a big fat guess on the amount of taxpayers’ money it needs to stay afloat. And to make matters worse, it seems GM’s management is far too detached from reality to make a good business decision.
• Considering GM’s current predicament, why would anyone believe GM to be right about its super-ambitious forecast? Don’t believe a word of it. GM will ask the government for more money this year… more losses will force the government to create more money… and the politicians leading us will be “forced” to spend more to try and “buffer” a recession in vain. Buy gold.

Satyajit Das’s book, Traders, Guns & Money, opens with a great anecdote about a meeting with an Indonesian noodle company. The noodle men were “Indonesians of Chinese extraction,” Das writes. “They were part of the infamous ‘bamboo network’ of ethnic Chinese business interests that crisscrossed South East Asia.” The noodle shop was an old business, playing an ancient and humble trade, the kind you find throughout Asia. Sounds like a nice simple business, right? Yes, but…

The noodle company got itself into some trouble. To simplify the story greatly, it basically lost a lot of money using derivatives to bet on dollar-rupiah movements. The loss suffered was, in fact, more than the capital of the company itself. At one point, Das writes: “What this had to do with producing noodles was a mystery.”

Exactly!

Unfortunately, this kind of story riddles the markets today like worms in an otherwise worthy cut of swordfish. There are so many of these incidences and they are ruining companies and investors across the world. It takes a nasty crisis like the one we are in to expose all these things. And the rot is extensive.

I want to share with you three little-reported events and one historical example that all show how pervasive this mindless risk-taking became during the last few years. They would be almost comical if they weren’t true.

First, consider the sad example of several Mexican and South American companies that made, large, company-jeopardizing currency bets. For example, Mexico’s third largest retailer, Controladora Commercial Mexicana (MXK:COMERCIUBC), recently filed for bankruptcy after losing so much money speculating in the forex markets. What does currency speculating have to do with selling tortillas, milk and eggs? Nothing. That’s the point.

Similarly, Sadia (NYSE:SDA), a poultry producer; Cemex (MXK:CEMEXCPO), a cement outfit; and Gruma in tortillas – all lost huge amounts of money on currency bets. Aracruz Cellulose (NYSE:ARA), the much admired pulp giant of Brazil, owes more than $2 billion to its banks for making bets on currencies that went sour. What was once a great franchise has been brought to its knees. It will take years to pay that back and debt payments now make up 40% of its pre-tax earnings.

The second example of mindless risk-taking is the story of so-called “portable alpha.” Apparently, the brain trusts that run pension funds thought this strategy sounded like a good idea. What is it? I still don’t understand it fully. But it basically amounts to a leveraged bet on the stock market. If you lose, you lose big as many pension funds are finding out. So now the Pennsylvania state employees’ pension fund, for instance, will have to take a multi-billion bath on this exotic investment strategy.

As the Wall Street Journal reports: “The stock-market downturn could force the Pennsylvania state employees’ pension fund to make cash payments of $2.5 billion or more to trading partners on Wall Street.” The fund has only $27 billion in total. At least, it had $27 billion.

Several other funds have reported billion dollar losses on portable alpha strategies. I can only imagine how many more institutional investors are in the same boat. The people running these things and advising these people should all find other work.

The third example is so-called “accumulators,” which is another kind of tactic for placing highly leveraged bet on stocks, currencies or commodities. I don’t want to get into the details. It’s so complicated; it would take me a page to explain it. Just know that, like “portable alpha” if you are wrong, you lose big.

And yet all kinds of wealthy individuals and businesses have gotten wrapped up in these things. Accumulator losses are showing up in some unlikely places. For instance, VeraSun Energy Corp. (OTC:VSUNQ), which makes ethanol, filed for bankruptcy in part because of big losses on accumulators tied to the price of corn. Citi Pacific (ASX:CIY), a Chinese conglomerate, lost $2 billion on accumulator contracts linked to currencies.

Billions and billions of dollars lost on nonsense. There was no reason for anybody to buy these things – especially when they clearly did not understand the risks involved. The losses are so bad in Hong Kong that Any Xie, an independent economist, said recently that “Accumulators are ruining Hong Kong.”

I’ll offer one other example of this kind of recklessness that is both a historical and contemporary study: Goldman Sachs.

I just recently finished perusing Charles Ellis’ new history The Partnership: The Making of Goldman Sachs. I was particularly interested in the early history of Goldman Sachs (NYSE:GS). I thought I would come away thinking how Goldman Sachs used to be a simpler business. I thought Goldman’s history would show how it took prudent risks with adequate equity backing those risks. My conclusion would then be that the current crop of leaders at Goldman were just reckless and ruined a franchise that had been around since the 1880s.

In fact, that’s not what I learned at all. From Goldman’s earliest days as a commercial paper specialist it operated with minimal capital. All through its history, it has been a business that took big risks and often took huge losses. That Goldman even exists at all today is something of a financial miracle.

In reading this history, I was struck by how the company found itself in the soup again and again and again. In the 1920s, one of the biggest speculative busts was in investment trusts in which a small amount of capital supported a spider’s web of investments in other companies. Guess who had the biggest blow-up of them all?

Goldman was big in this through a subsidiary called Goldman Sachs Trading Corporation, which basically lost everything for its investors. Ellis writes:

“While all the investment trusts suffered, Goldman Sachs Trading Corporation – because it was so large and so highly leveraged…became one of the largest, swiftest, and most complete investment disasters of the twentieth century.”

The loss to Goldman Sachs itself was enormous. It basically wiped out thirty years of profits and eliminated the “fruits of all the labors of a generation.”

Fast forward to 1970 and the biggest bankruptcy in the country at that time. You find Goldman was waist-deep in it. Penn Central at the time of its bankruptcy in 1970 was the eighth largest corporation in the country. Again, Ellis writes: “the loss it [Penn Central] threatened to impose on Goldman Sachs was not only larger than any prior loss, it was larger than Goldman Sachs.”

And so it is today, that the company once again finds itself in the middle of yet another big crisis that threatens its very existence. I don’t know about you, but I have to wonder about all the brains at Goldman Sachs and all the people who say what a great firm it is. Seems to me, for such a bunch of supposed geniuses, they routinely shoot themselves in the foot, time and time again. You don’t find Berkshire Hathaway fighting for its life every decade.

All of these anecdotes scream at me to avoid the complex and the leveraged, which often means a potential for a mega-loss if you’re wrong. The problem is these kinds of bets infect many companies, as I’ve shown, even when they have nothing to do with the core business. Even otherwise seemingly simple enterprises, like making tortillas or producing chicken, have been hurt.

The advice I have is not novel, but bears repeating since so many seem to forget it. Stay away from anything you don’t understand. (All those folks who lost money with Madoff in his $50 billion Ponzi scheme would’ve saved themselves a lot of money just with this single insight.) And avoid excessive leverage. It’s one thing to lose money. It’s another thing to lose it taking on stupid and pointless risks.

Source: Mindless Risk Taking

This from Taipan Daily:

Has the U.S. Treasury bubble popped? It’s starting to look that way.

USTs gapped higher in mid-December, traded in a quiet range til year’s end, and then immediately went into freefall with the start of the new year.

This wasn’t a total surprise. On Dec. 23rd, in a Taipan Daily piece titled “A Treasury Bond Mystery and a Currency Clue,” I gave a summation of what was happening and how to play it:

Based on end-of-year accounting factors and a supply-limited window of foreign investor buying, USTs could be a good candidate for a quick, sharp break (much like the dollar’s swift fall) early in the 2009 calendar year.

An aggressive put option trade – near-term firecrackers relatively close to expiry – could be one way to play this. If done right, it’s the kind of trade where you either lose the small amount you invested or make five times your money in a fingersnap.

There were multiple trading days available to follow up on that hunch. If you chose to act on it with near expiry options as I suggested, you should be sitting on some very nice gains right now.

With that in mind, I still stand by the rest of what I said in that piece:

If I were to make a short-term play like this, I would do it with money I could afford to lose – probably no more than one or two percent of my total trading account. And if the trade paid off, I would take the money and run at the first sign of stabilization (rather than waiting around for the Fed to bid bonds up after the break).

The Yogi Berra Effect

Now, it may well be that treasuries keep tumbling. But this isn’t a trade I would look to build on… at least not for now. As I said two weeks ago, I’d pocket the cash sooner rather than later.

Why? For one, the play just feels too damn obvious now. Everyone and their brother “knows” treasuries are overvalued.

That kind of consensus makes me nervous as a long-tailed cat in a room full of rocking chairs, and Barrons heightened the feeling by putting USTs on their Jan. 5th cover. Get Out Now! the Barrons headline blares.

“The bubble in Treasuries looks ready to pop,” the lead piece goes on to add, “sending prices on government debt sharply lower.”

With the whole Barrons yelling “Get Out Now!” bit, I can’t help but think back to some famous old Economist covers, two of which I have framed. “Drowning in Oil” and “The Disappearing Dollar” both marked major trading bottoms. When a view becomes conventional wisdom – or popular enough to merit cover treatment – odds increase that the news is fully discounted.

It’s the Yogi Berra effect, slightly modified for markets: “Nobody’s in that trade anymore, it’s too crowded.”

Reasons to Be Wary

Another factor that makes me nervous, as I also mentioned in December, is the Fed.

Falling treasuries mean rising interest rates. The Fed doesn’t want rising interest rates… especially when the central banker worry du jour is deflation.

And speaking of deflation fears – which are tied to factors like forced saving, canceled business, and overall economic contraction – how about the recent ISM data?

As the above FT chart shows, ISM readings for both new orders and prices paid just hit their lowest levels in more than half a century. Evidence further shows that manufacturing has slowed markedly all around the world.

In other words, the threat of global slowdown still looms large. If the current market rally is just a trading rally – which can’t be ruled out – then treasuries could head back up again.

The Dollar is a Three-Time Loser

So despite the recent downside action – which was predictable based on end-of-year accounting factors – USTs still have a few things going for them. The Fed could yet intervene in a big way if treasuries fall too far, and investors could scurry back into USTs if the new year trading rally fades.

The U.S. dollar, on the other hand, looks like a three-time loser to me. Consider:

• If the Fed intervenes to support treasuries (in order to keep interest rates low), they will do so at the expense of the greenback. The Fed has to print dollars, or otherwise release dollars, in order to buy USTs in the open market.
• The powers that be (a.k.a. the Fed and Treasury) are implicitly supportive of strong treasuries (per the stimulative effect of lower interest rates) and a weak currency (also stimulative for exports).
• Whether the global economy rises or falls in 2009, the U.S. dollar no longer benefits from the foreign investor inflows that were once so strong.

In the “good old days,” when Americans were buying shiploads of “stuff” on credit from China – and paying with mountains of paper dollars – China happily recycled those dollars back into U.S. assets: equities, treasuries, mortgage backed securities, stakes in private equity firms, and so on. All this recycling was supportive of the greenback.

The same thing happened with the oil bought on credit from the middle east. The paper dollars sent to Saudi Arabia, Abu Dhabi and so on came right back home in the form of large purchase orders for dollar-denominated assets. This recycling factor kept the game going.

Now those U.S. dollar props are history. China’s risk appetite is shot, the oil exporters are no longer flush, and all parties are aware that the Fed wants a weakerdollar, not a stronger one, in order to stimulate U.S. exports and encourage local spending choices.

Multiple Scenarios

For these reasons, I am looking to build a sizable short U.S. dollar trade in the near future. I like the fact that a falling dollar is a probable outcome in multiple scenarios.

For instance, if the global economy bounces back in 2009: Emerging markets outperform, banks begin to lend, the Fed’s “quantitative easing” prescriptions kick in with a lag… and the dollar falls.

If the global economy gets worse: The new year equity rally fades, treasuries move higher, the Fed takes even more radical measures with its “quantitative easing” plan, the trillion-dollar stimulus ceiling is shattered… and the dollar still falls.

If the global economy gets much, much worse: Foreign holders of USTs get nervous and start dumping all remaining dollar-denominated assets… the Fed loads up on treasuries as a desperate buyer of last resort to keep interest rates low… and the dollar flat-out crashes.

You get the idea. There are certainly “dollar up” scenarios one could concoct, but in my view they are outnumbered by “dollar down” at least three to one.

In light of all this, I’ve been keeping an eye out for a tactical point of entry ever since the dollar’s sharp break a few weeks ago.

Based on the old trading truth that failed breakouts are some of the most convincing signals, we could see an excellent short-side entry point if – and it’s important to note the “if” here – the USD follows through on a reversal-type failure to the downside.

Source: Don’t Stay Short Treasuries – Short the Dollar Instead

This from Sovereign Society:

Think back to the beginning of 2008. If you’re like most investors, you were probably wondering just how low the dollar might fall in 2008, and how much higher oil would surge. But, Mr. Market surprised us in a big way in 2008.

Now the question seems: How much higher will the dollar go, and will oil continue to plunge lower?

Many were so surprised by awesome and swift change of fortunes in 2008. So let’s take a look at some of the reasons for the swift reversal of fortunes for these two major asset classes. There are solid fundamental reasons why the oil-dollar relationship has been so tight, and will likely continue in 2009.

The Secret to Currencies: It’s About Money Flow

I’ve had an opportunity to talk with a lot people about currencies this year. And the most asked question by far is this: How can the dollar rally when the U.S. economy is doing do poorly, to say the least? It’s a good question. Let me explain.

One of the things you must always keep in mind when dealing with currencies is this: The price of a currency is determined by the currency’s supply and the demand for that currency. It is that simple!

Though it can get complicated when we go through all types of analytical gyrations in order to figure out exactly where supply and demand sit. Now, think about the credit crunch. It was a sea change event in the global economy that completely altered the supply and demand dynamics for every single asset class — stocks, bonds, commodities, and currencies.

Let’s look at how these key asset classes acted together during the last market cycle, i.e. before the credit crunch changed everything. If you examine the chart below I think you will see that one key asset class — the dollar — didn’t play well with others. It went down as the other asset classes went up.

The chart below is a bit convoluted, I know. But, it is important to understand because it helps explain how money flow is critical to forecasting the dollar’s path. As you can see below, the dollar index tended to travel in the opposite direction of gold, oil and stocks before the credit crunch hit the global markets in 2007.

Before the World Had Heard of a “Credit Crunch”

2001 – 2007: Gold, Stocks and Oil Hit Multi-Year Bull Market. Notice that each of the asset classes, except the dollar, launched into a multi-year bull market back in January 2001! Back then, Fed, European Central Bank (ECB), and Bank of Japan (BOJ) all juiced the markets with liquidity. At the same time, investment banks added even more liquidity by creating literally trillions of dollars in new derivatives.

Think of this era as a dollar-based liquidity explosion for all asset markets except for the major funding source for all this growth: the U.S. dollar.

Fast Forward to 2008: Now, let’s take a look at this same chart after the credit crunch hit the global markets in 2008. The dollar (red line) bottomed the week of March 10th, then gold (brown line) topped at the same time. By then, stocks (blue line) had already topped. A few months later, oil (black line) also topped in July.

We Watched Gold, Stocks and Oil Top Out While the Dollar Surged

What happened? Why the big change? Money flow! Money poured back into the U.S. as the impact of the credit crunch forced major institutions to deleverage their positions.

The big players were (and still are) fighting for their lives. They had to sell risky asset investments overseas and bring money home. And we’ve also witnessed big repatriation of retail mutual funds back into the United States. In four months thru October 2008, U.S. residents sold a net US$126 billion of foreign securities.

So, this is why it didn’t matter that the U.S. economy was in the tank and getting worse. Money flowed back into the dollar because of the credit crunch! Remember, it is supply and demand.

We had, and continue to have, a situation where the supply of dollars (in the form of trillions in dollar-based derivatives) is evaporating. In other words, we’re seeing a lower dollar supply worldwide. At the same time, we’re seeing a massive decline in global demand as all the major economies are entering what could be a very deep recession!

Where Are We Headed in 2009? Another Big Surprise in the Making!

Unfortunately for most people, I expect global economic conditions to get a lot worse in 2009 before they start getting better. Why do I say this? Because global trade and demand has vanished at an astonishing rate and seems to be accelerating downward.

Consider these facts:

1. In November, Japan recorded the biggest single decline in exports ever; back into a nasty recession and deflation they go!

2. China exports declined in November for the first time in seven years; unemployment is soaring as factories close everywhere in the country; the export model is in jeopardy; social stability is paramount in China at the moment.

3. Global marine shipping rates have fallen up to 95% and more.

4. Plunging energy prices have eviscerated the Russian economy so the government is now draining reserves; major social unrest is in the cards.

5. Spain is in panic mode — ditto for Ireland, Italy, Greece, Portugal, and other members of the European Union.

6. Germany (the engine of euro growth and model of fiscal discipline) is heading into deep recession — latest consensus forecast is 2.7% decline in their economy.

7. The U.K. economy is staring into the abyss; and it looks to get worse.

8. Credit for emerging market nations has virtually disappeared. Export demand for their goods has vanished. They are relying on emergency International Monetary Fund (IMF) loans as a stop-gap measure, but the IMF tap has its limits.

9. The U.S. consumer has finally stopped shopping and is saving. That’s a good thing long-term for capital creation, but it’s a disaster in the short-term because the U.S. consumer is the catalyst for global demand and rising unemployment means no rebound by Mr. Consumer anytime soon.

Governments are pumping up money supply, cutting interest rates, and spending taxpayer money as fast as they can, but it doesn’t seem to be helping much.

This tells me that the major market deleveraging will have to run its course before economies begin to respond. And in a deleveraging phase, as I showed you above, the dollar (the world reserve currency) tends to do well…or at least be supported.

But there is another major surprise on the horizon that I believe will lead the dollar to its next big rally phase — concern that the European Monetary System, which represents the euro currency, will come apart!

The euro is the key currency competitor against the dollar. When the euro does well, the dollar does badly, and vice versa. But as global demand continues to shrink, I expect key member countries — either Italy, Greece, Ireland, Portugal, or Spain — to completely abandon all fiscal responsibilities they must maintain as members of the European Monetary System. And that will hurt the euro.

It makes sense, and here’s why.

Euro Member countries have no sovereignty on monetary policy. That is set in Brussels by the European Central Bank (ECB). And the ECB is woefully behind the interest rate curve. And the big member country — Germany — is railing against providing a major stimulus to support the rest of the union members. Why should Germany pay for other countries lack of discipline?

This is the Achilles Heel of the European Monetary Union — Since member countries have no fiscal responsibility, they can spend all they want and the ECB has no say or power to stop them. They can also spend, as little as they want if it suits their citizens’ needs. In other words, there is a lack of political sovereignty behind the key member states that form the Eurozone, and back up the euro.

In an environment where most countries — and their politicians — are scrambling desperately to provide stimulus to their citizens, I expect several member countries in Europe to abandon their Brussels-based fiscal shackles and break the bank.

If that proves true, it will rattle the foundation of trust and cooperation the euro was supposedly built upon. Trust and cooperation work fine when everyone is making money and growing.

But in the dark days of a downward business cycle, with the wolf at the door, it’s everyone for himself. This is the first major test of the euro as a currency during a major down cycle.

Don’t be surprised if it fails. And if it does, it would be very bad news for the euro and would usher in a whole new wave of money flowing to the U.S. dollar — a wave more-than-likely to trigger a powerful leg up in the greenback.

The Next Direction for the Dollar…

It should be an interesting year. But once again, I’m betting the dollar will rally. Be prepared.

Source: The Dollar: The Biggest Surprise Currency Of 2008… Plus, What’s Coming In 2009

This from Investment U:

Investing requires tough decisions. What to buy? When to buy? How much?

But none more difficult than this: Admitting the fundamentals no longer support an investment you own. Or, as the French philosopher Geoffrey F. Abert summed it up over 900 years ago, “It often takes more courage to change one’s opinion than to stick to it.”

And today I’m living proof.

Just three weeks ago, to the day, I declared, “The dollar’s not done.” I laid out my case about Jim Roger’s being wrong.

But I’m officially changing my stance on the falling U.S. dollar.

To be clear, it’s not because I finally saw the light, recognized the error of my ways, or heeded the “sage” advice of so many of you that wrote in to chastise my “foolishness” or “ignorance.” And I didn’t get a personal phone call from Jim Rogers, either.

I don’t cave to bullying or criticism. Just fundamentals. And the bottom line is this – for most of the year, the fundamentals supported a stronger dollar. Enough so to allow my subscribers to lock in gains shorting the euro versus the dollar of 12%, 58%, 60%, even 267%.

But those fundamentals changed. Big time. So here’s what you need to know, and how this fundamental change could be as profitable as the last one.

U.S. Dollar Doubts Surface As Investors Give Up On Yield & Value

My first doubts about the U.S. dollar surfaced when investors gave up on yield and value. In return for, well, no return. Remember, last week I reported demand for four-week Treasury bills – offering ZERO percent interest – outstripped supply four times over.

If that wasn’t bad enough, I noticed investors on the long-end of the bond market weren’t investing any smarter. All they want is “safety-only,” too. Case in point – the yield on 10-year and 30-year Treasuries fell below 3%.

Forget below average. Such paltry yields represent the lowest levels in the last 50 years.

So what’s the big deal? Well, it’s the equivalent of Bank of America putting out a curbside sign during the real estate run-up advertising “no-documentation1% mortgages.” People can’t resist cheap money. And we shouldn’t expect our elected representatives to show any better restraint. They will borrow cheaply and spend freely, while they can.

And it’s the extent of this spending that troubles me, and threatens the dollar the most.

The Flood is Coming and There’s No Ark to Save The Dollar

Forget the $530 billion of government debt that flooded the market last quarter. Or the $550 billion estimated for this quarter. President-elect Obama is planning a tsunami.

If you have any doubt, just consider the trend in estimates for his soon to be released economic stimulus package.

• A few weeks ago, $500 billion was the consensus number.
• Then it crept up to $700 billion.
• Now, Republicans and Democrats alike believe the final plan will top $1 trillion.
• And that’s on top of the $4 trillion price tag for his proposed middle-class tax cut and universal health care.

The only way to absorb the impending and massive Treasury issuances will be for the Fed to flood the market with dollars. Or put more plainly, to run the printing presses 24/7 – which many of you already suspect they’re doing.

Arguably, these factors alone should be enough. But I’m stubborn. I wanted one more thing before I let go of my dollar bullishness. And yesterday I got it.

The U.S. Dollar Index Breaks An Uptrend

Recall, in July the U.S. dollar index bottomed out and entered a confirmed uptrend. But after rattling off about a 20% gain, everything just came unglued. And yesterday, the U.S. dollar index officially broke through the uptrend line. So look out below. Because there’s no telling where the next support level rests.

That being said, I don’t think it’s time to do the opposite of my previous recommendation, and get long the euro. Not hardly. The recent hawkish comments out of the European Central Bank scare me. They won’t be able to escape this financial crisis either, no matter how defiant the rhetoric. Plus, euro-zone banks still need to unwind as much as $800 billion of dollar-denominated leverage.

In short, the upside in the euro versus the dollar will be subdued. Not to mention, a far better opportunity exists shorting long-dated Treasuries.

As The Bond Market See-Saws…

The bond market is remarkably simple – it’s a seesaw, with interest rates on one end & bond prices on the other. When one goes up, the other goes down.

If you have any doubt, consider recent history. As the Fed aggressively cut interest rates, bond prices went vertical. Up 20% in some cases. That’s unheard of for bonds. And it represents our newest bubble (first real estate, then oil, now treasuries).

Make no mistake, this bubble will end just the same.

• First, because the government can’t get away with near zero yields forever. Investors will eventually demand a respectable return on their money. Especially foreign governments. In the last quarter alone they increased their U.S. debt holdings by 12%, according to Bloomberg. To load up even more will require additional compensation.
• Second, because inflation is around the corner. Never has a world government spent (or planned to spend) so much and avoided it. The only way to curb the resulting inflation will be for the Fed to abruptly reverse course, and begin raising rates at the first signs of an economic recovery.
• Bottom line, the only way for rates to go from here is up, which means bond prices will head the opposite direction.

Again, I aim to be transparent in my analysis. Always. And that includes defying Lillian Hellman’s observation that “people change and forget to tell each other.”

Consider this your notice. My outlook for the falling U.S. dollar has changed, albeit quickly.

This isn’t an apology. It’s simply a head’s up that more compelling opportunities exist. One a fellow colleague summed up perfectly, “If you don’t short Treasuries right now, you’re dumber than investors buying them for a zero percent return.”

A bit harsh. But hard to refute.

Source: The Falling U.S. Dollar: Taking An About-Face

This from Money Morning:

The plethora of bank and corporate bailouts, stimulus plans and interest-rate cuts that the U.S. government has produced over the last three months can only lead to one outcome: The U.S. dollar has to decline.

During the crisis so far, the dollar in general, and U.S. Treasury bonds in particular, have been regarded as a “safe haven,” making the dollar strong and pushing long-term U.S. Treasury rates downward. In the New Year, however, this is likely to change – the weight of the added supply of dollars in circulation will be too great for the greenback to shrug off.

Back in November 2007, when I wrote about the U.S. dollar becoming the “Bernanke peso,” I suggested that the dollar – then trading at $1.50 to the euro – would get weaker. Alas, I was wrong: It is currently trading at $1.29 to the euro, although it did reach $1.60 in May. However, I recommended buying not euros, but yen. The chaos of 2008 has reversed the decline in the dollar against the euro, but not against the yen, which has reached Yen 92.8 = $1 compared to a rate of Yen 114.8 = $1 when I wrote the piece. A gain of 24% against the dollar is not bad, and indeed I defy you to find a stock market that has done as well over that period.

The fundamentals tending to weaken the dollar remain. The U.S. trade deficit was $57.2 billion in October, which annualizes to $700.3 billion – down but a little from the 2006 peak of $758 billion. Although the recession and recent sharp decline in the value of U.S. oil imports will reduce the U.S. trade deficit further – perhaps to $500 billion annually – there is still no reason why foreigners should continue to so highly rate the currency of a country that is running a $500 billion balance-of-payments deficit, and a $1 trillion budget deficit.

After a pause during the summer, the U.S. money supply has begun rising again rapidly. The excess money has flowed into Treasury bonds, sending the yield on the 10-year bond down to a recent 2.71%. The distortion in the market can be shown by the yield on the 10-year Treasury Inflated Protected Securities (TIPS), which was 2.44%; that combination of prices said that investors expect U.S. inflation to average a mere 0.27% annually over the next 10 years.

Clearly that’s nonsense; the explanation is that yields on long-term Treasury bonds have been driven far below their economically appropriate level. In other words, U.S. Treasury bonds are currently benefiting from a bubble, and like the bubbles that we’ve seen in Japanese stocks, real estate, U.S. tech stocks, the American housing market and global commodities, this bubble, too, will ultimately burst.

The budget deficit in the 12 months through to September was $455 billion, but that’s expected to expand to close to $1 trillion in the year to September 2009 – and that’s even before President-elect Barack Obama’s stimulus plan, which is expected to cost at least $500 billion, and could possibly cost that much a year over several years.

If that’s surprising, consider this: The U.S. budget deficit was $237.2 billion in October 2008, a record monthly figure. That puts a huge strain on the U.S. Treasury Department’s financing capacity, and will probably result in the U.S. Federal Reserve printing yet more money, since the alternative would be for the huge amounts going into Treasuries to choke off demand for private investment – not the desired objective. With more money being printed, inflation is likely to soar and the dollar to weaken.

Net foreign purchases of long-term U.S. securities declined to $793 billion in the 12 months to September 2008, from $1.03 trillion in the previous year. Of those purchases, Treasury bonds and notes represented $385 billion, up from $192 billion in the previous year, while purchased corporate bonds shrank from $447 billion to $168 billion.  Thus, the “flight to quality” has so far been enormously helpful in enabling the U.S. Treasury to finance its growing budget deficit; in October and November it will doubtless have been even more so.

Once the inflow into U.S. Treasuries slows, or the huge volume of Treasuries issued simply overwhelms it, the dollar will weaken and Treasury yields will rise. At that point, there is likely to be a stampede for the exits from the Treasury bond market, which will be self-reinforcing. As a wise investor, you could prepare for this stampede in four ways:

• First, you could have a modest holding of the Rydex Juno Fund (MUTF:RYJCX), the price of which is inversely linked to T-bond prices (the fund shorts Treasury bond futures.). The fund has had a poor record since its inception in 2001, and it probably makes little sense to put too much money in it. However, given the scenario we’ve sketched out here, the fund will do a lot better in 2009.

• Second, you should have bond, cash and stock holdings in foreign currencies, particularly the euro and the yen (but not British pounds sterling; with a housing bubble and a bloated financial sector, Britain has many of the same problems as the United States). Aside from foreign-currency-denominated stocks and bonds, you may want to consider a foreign-currency-deposit account through EverBank, which offers foreign-currency certificates of deposit (CDs), albeit at low interest rates, at present – only 1% on a 12-month Euro CD for example. [Editor’s Note: EverBank also offers a product called the EverBank Asian Currency Portfolio. Readers can find out about all the bank’s products by contacting the folks at EverBank’s World Currency desk at (800) 926-4922. Be sure to mention product ID #12534. We should also mention that Money Morning has a marketing relationship with Everbank, but that’s only because we believe in its products.]

• Third, you should hold some gold, which is likely to profit from a dollar collapse – for example through the SPDR Gold Trust fund ETF (NYSE:GLD), which has ample liquidity, with $17.6 billion outstanding, and which tracks the gold price directly.

• Fourth, you may make a modest (no more than 1% to 2% of your portfolio) speculation in currency options, which are traded on the Philadelphia Stock Exchange. Since the yen has already enjoyed a considerable run against the dollar, the best speculation might be to purchase out-of-the-money euro call options, which will rise in price once the dollar starts falling against the euro. Personally, I prefer to buy the longest possible options available, to give the market time to move in my direction. So, I would go for the September 140s (PHLX: XDEIH), giving nine months to maturity at a strike price about 8% out of the money (the euro being currently at $1.29). Currently these are trading at $4.55 offered, so you would have to pay $455 for each 10,000 euros on which you purchased an option.  Your break-even would thus be $1.4450. If the euro is trading above that level next September, you would gain, so if it matched its May peak of $1.60, you would make $2,000 per contract. If it was below $1.40, you would lose your investment of $455 per contract.

Source: With Billions in Bailout Funds Flowing, the “Peso-fication” of the Dollar Continues