May 11th, 2012

Why the fixation on foreign exchange?

I’m always surprised and bewildered seeing the “Alert” image and hear the special effects sound whenever CNBC wants to say something about foreign exchange and make it appear as if something really significant has happened.  This morning it was a “breaking news” story about a move (or absence of a move when actually one was expected) in the €EU.

I understand that currency fluctuations are important since the world figuratively revolves around the free exchange of wealth (money) and goods.  And I also understand that countless speculators, investors and governments are involved in foreign exchange markets.  Furthermore, I understand that currency markets are extremely leveraged since the players can put on and lever up to huge positions with small equity of their own.  And finally I understand that the exchange values of one currency against another is based on supply and demand amongst all those players tempered by the policy positions of governments and central banks who attempt to influence (control) and stabilize those exchange values.

But as a trader who trades foreign exchange only on an extremely limited basis through ETFs, I don’t understand foreign exchange as a trading vehicle when currencies don’t fluctuate really that much.  Take the €EU (Euro) as an example.  It may be hard to believe given all the discussion about sovereign defaults and debate about the currency’s possible breakup, the €EU today is where it was in 2006 as reflected in the price of FXE (the Rudex CurrencyShares EuroTrust ETF:

The following chart compares the $US Index (a composite exchange rate index for a basket of currencies of our largest trading partners) with the more volatile S&P 500 Index:

To add another dimension to the €EU’s volatility, I superimposed the FXE on a chart of YUM (Yum Brands) for the same period to compare the two (the FXE is in blue):

Businesses surely need to pay attention to foreign exchange since those fluctuations impact revenues, costs and profits but I don’t understand where the fascination for individual investors comes from given that you’d wind up paying margin interest and wouldn’t earn the dividend yield (which in the case of YUM is currently 1.6%).

Why do most of the search results for the term “technical analysis” focus on foreign exchange?  If it weren’t for the huge margin possibilities (up to 90%) which makes it a more risky game, why should the average investor be interested at all in foreign exchange?  I can’t predict the future of the €EU or the $US but my guess is that fluctuation in the short run future won’t be all that significantly different than they have been in the past regardless of the EU outcome.  Can someone please answer the question “What am I missing?”

May 9th, 2012

Buffett and Precious Metals

It’s been some time since last discussing precious metals so I thought I’d revisit those charts to see if something new might be revealing itself.  What struck me was the near perfect patterns in both the charts that stretch back almost a year to the early days of the European sovereign debt crisis began in August 2011.  The only problem is that one can interpret the emerging patterns as either consolidation (flags) or as reversal (right triangles or head-and-shoulders) depending on whether you’re a gold bug or Warren Buffett.  On CNBC this past Monday, Buffett stated that

When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1600 and Berkshire is $120,000. Or you can take a broader example. If you buy an ounce of gold today and you hold it at hundred years, you can go to it every day and you could coo to it and fondle it and a hundred years from now, you’ll have one ounce of gold and it won’t have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year. You can buy more farmland, and all kinds of things, and you still have 100 acres of farmland at the end of 100 years. You could you buy the Dow Jones Industrial Average for 66 at the start of 1900.” Gold was then $20. At the end of the century, it was 11,400, and you would also have gotten dividends for a hundred years. So a decent productive asset will kill an unproductive asset.

As is usually true with statistics, there are several interpretations depending on what you’re trying to prove.  Forbes points out in that same article that Berkshire would have outperformed gold over the 20 years since Buffett started Berkshire Hathaway but the reverse was true over the last 10 years as gold far outshined Berkshire stock.

What do the charts say?  Again, it depends on the frame of mind of the observer:

Both charts contain familiar features:

  • descending channels;
  • potential necklines;
  • a zone that could indicate whether the controlling pattern is a consolidation or reversal;
  • lack of clarity as to whether price will cross below the potential neckline

I’m not an economist but it would seem to me that with all the uncertainty surrounding the future of the Euro money would continue to boost the prices of precious metals.  Instead, Euro Zone investors have been dumping money in what they assume to be the world’s last safe haven, the $US … even when they earn near next to nothing.

But with another round of our own debates on our deficits, federal budgets and taxation coming at the beginning of the year after the Presidential election, so analysts say it’s going to be like falling off a cliff.  If anything happens to interest rates here it’s going to have to be that they go higher and bond prices are going to decline.  Foreign investors are going to begin seeing increased risk in US bonds and will jump ship quicker than they climbed on board.

With all that upcoming uncertainty in the $US, I can’t imaging that the emerging pattern in precious metals isn’t a consolidation and, with all due respect to Warren Buffet, there won’t be another run higher beginning towards the end of the summer.  For all those conspiracy afficionados out there, perhaps Buffett wants us all to sell our gold so that he can scope it up at this price and lower.  After he’s bought all he wants and these prices , he could even come back in August and say that everyone should own some gold and thereby start pushing the price higher.  He’s a nice guy but he didn’t get to be the richest man by being a sweetheart.

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October 18th, 2011

Cramer, the Windsock

I went out a limb Sunday night and found on Monday that I was in good company. As Cramer said in tonight’s show: “On Monday, highly regarded Wall Street technician Burt Dohmen sent the “Mad Money” host a chart that painted a very bleak picture for the market.”

It’s interesting that Cramer said that regardless of the good earnings reports yesterday, our stock market was being driven buy Prime Minister Merkel in Germany. On Monday he said,

“It’s not that the earnings can’t be trusted, it’s that the futures are too powerful and their levels are set in Europe, not here…..the market sold off hard as investors grew nervous following news there ‘during the upcoming summit’, according to Germany’s German Finance Minister. Wolfgang Schaeuble said European governments will not resolve the crisis at the EU meeting scheduled for Oct. 23.”

If the market had gone up instead yesterday he probably would have said it was because good domestic results trump anything happening in Europe. He tells a good story that follows the market but he doesn’t say anything that would allow you to cobble together a strategy that’s valid beyond his next show.

But that was just 48 hours ago. Tonight he said: “But right before Tuesday’s close, Dohmen changed his mind and now takes the opposite view. Why? Because the facts changed … the charts changed and his reading of them changed too, which is how it’s got to work.” What did he see and, since we’re looking at the same data, am I changing my point of view also? Here’s the picture (click on image to enlarge):

Yes, the Index did cross above the upper boundary of the trading range but it fell below the lower boundary just a couple of weeks ago [interesting that the talking heads neglect to mention that in their crowing about today’s late-day move]. But about the only ramification of that breakthrough was to sucker me in to buy more 3xShort Index ETFs. There was no follow through; in fact, the market surged a quick 6-7% to today’s close. Not only is the market trying to convincingly escape this trading range but it will next have to cross above the two descending longer-term moving averages (100- and 200-day).

It is correct to say that when facts on the ground change, you have to change your strategy. The biggest challenge is identifying as unequivocally as possible what the facts truly are. I’m awfully close to admitting that. A close above those two moving averages would push me to moving from a net short position to 10-15% net long.

December 15th, 2010

Revisiting the DXY, UUP and UDN

In “$US: A Reversal or Consolidation Pattern” of October 20, I wrote:

“Technical analysis is probably applied more often and with less controversy to foreign exchange than it is to stocks ….. The $US exchange rate has been in a narrow range since 2004 ….. Some might see it as a partially formed complex inverted head-and-shoulder with the neckline currently at around 87.50. Others might see a symmetrical triangle with the exchange index currently bouncing off the bottom trendline ….. I’m not sure which I think is the more likely outcome. To much national debt=another move down. Agreement among the finance ministers=reversal pattern and move up. What say you?”

Up to now, the supporting trendline held and the value of the $US relative to other currencies has temporarily improved. I say “temporarily” because the currency has now balked at a zone that’s been a support several times over the past 18 years (click on images to enlarge):

Although not very volatile, if you want you can play the foreign exchange market through the following two ETFs: UUP (a long position in the $US) or UDN (a short position). I indexed both of these ETFs against DXY [since UDN moves contra- to UUP they or on left and right vertical axes], the US Dollar Index against a basket of major trading partner currencies (the first chart above), and found that they move fairly closely together ever since their introduction in February 2007:

There are several other more volatile approaches if you believe the $US will ultimately break below the lower boundary trendline of that symmetrical triangle including: commodities of all sorts, precious metals and shorting US Treasuries in the expectation of higher interest rates that probably will be demanded by foreign holders of those bonds that offers them some protection against declines in the value of the Dollar.

October 20th, 2010

$US: A Reversal or Consolidation Pattern

In one sense, we’ve been fortunate living in the US because it’s made the value of our savings and assets stable. That may soon be changing however. The high national debt level is interfering with the $US position as the worldwide de facto store of wealth, the place to where everyone runs to protect the value of their assets from political stress, monetary upheaval or military conflict.

The spotlight will be directed again this weekend on foreign exchange as the G-20 group of the central bankers of the top 20 countries meet in South Korea on Friday and Saturday. The burning question is whether or not there’s competition or cooperation among the industrialized countries and the emerging market countries like China, Brazil and Korea in the relative values of their currencies.

To underscore the conflict that potentially might be brewing, the Brazilian finance minister announced he would not attend the meeting. Last month he “accused leading nations that will be represented at the meeting of waging an ‘international currency war’ by devaluing their monies to boost exports at the expense of other nations.”

The problem essentially boils down the thing we’ve been so proud of up to now, our “high standard of living” compared with the rest of the world. That high cost of living has forced us to export manufacturing to the rest of the world due to their lower labor costs and their lower “standard of living”. Now, the rest of the world is thriving on the inflow of funds coming from all that manufacturing while our debts are increasing; the cost of living in those countries are increasing while we’re fearful of deflation.

Money is very liquid and seeks the highest return. A solution is to try to offset that wage differential by changing currency exchange rates: making the Chinese Yuan more valuable, reducing the value of the Dollar, Euro, etc. One way governments do this through changing the competitiveness of various currencies by changing the interest rates governments are paying on their debts.

The exchange rate value of $US in terms of an average index of foreign currencies is:

Technical analysis is probably applied more often and with less controversy to foreign exchange than it is to stocks. When you look at the above charge you can clearly see a confusing picture. The $US exchange rate has been in a narrow range since 2004 between the blue trendlines. Some might see it as a partially formed complex inverted head-and-shoulder with the neckline currently at around 87.50. Others might see a symmetrical triangle with the exchange index currently bouncing off the bottom trendline.

The truth of the matter is that exchange rates are not exactly like stocks, they don’t appreciate or depreciate indefinitely; they fluctuate within ranges. If you see an inverted H+S reversal then you also see some risk in holding your precious metals, materials and foreign stocks. If you see the congestion as a symmetrical triangle consolidation then there could another leg down and precious metals, materials, etc. is a safe place to be.

I’m not sure which I think is the more likely outcome. To much national debt=another move down. Agreement among the finance ministers=reversal pattern and move up. What say you?

August 5th, 2010

Deflation: Déjà vu All Over Again

The last post generated more discussion than most and rightly so. Gloom abounds in and around the market these days. On the fundamental side, there’s the stream of CNBC guests discussing the prospect, risks and negative consequences of deflation. On the technical side there’s the blizzard of warnings sent out doomsayer like the people at Elliott Wave. This is what they wrote in a promotional piece I recently received from them:

“The major stock indexes lost more than HALF their value, but it’s not because “half” of all shareholders tried to dump their stocks. Not even close….More people can still decide to sell, but it won’t take many. When they do, prices can fall a lot further.”

If you want to know how all this will end, I recommend you read “Lords of Finance”, one of Best Books of the Year on the NYTimes Book Review in 2009, by Liaquat Ahamed. Ahamed traces the actions of the four major central banks of the first half of 1900’s from the start of WW I to German hyperinflation to the Roaring 20’s to the Great Depression to the risk of deflation in the US to the start of WW II. Going through it was like reading a historical mystery, you couldn’t wait to see what the next shoe would be to drop.

It was also perhaps a little like reading a science fiction novel since the similarities between then and now was so eerily similar. Reading the last few chapters also revealed what might be down the road in our future. The economy in 1931 was in the Great Depression and, like there is today, there was also a great divide between those wanting budget cuts and increased taxes to balance the budget and those who wanted the US to increase Federal supports. The constraint was that the US was on the gold standard. That meant that government finances were limited by the amount of gold held by the Fed and the Treasury.

Deflation was the fear then too and no one knew how to end it. After consulting with economists of different points of view, Roosevelt surprised them all shortly after taking office by taking the dollar off the gold standard, effectively resulting in a $US devaluation.

“Taking the dollar off gold provided the second leg to the dramatic change in sentiment, which had begun with the bank rescue plan, that coursed through the economy that spring….injected $400 million into the banking system during the following six months. The combination of the renewed confidence in banks, a newly activist Fed, and a government that seemed intent on driving prices higher broke the psychology of deflation, a change reflected in almost every indicator. During the following three months, wholesale prices jumped by 45 percent and stock prices doubled. With prices rising, the real cost of borrowing money plummeted. New orders for heavy machinery soared by 100 percent, auto sales doubled, and overall industrial production shot up 50 percent.”

I’m no economist, but I disagree with people like Larry Kudlow who continue to argue for “kind dollar”. He recently wrote

“In sound-money terms, it would be okay with me if the Fed held the monetary base steady for a long, long time. That would keep the dollar stable and would probably keep gold prices steady. If investors actually believed in a stable policy, perhaps the greenback would rise while gold fell.”

I think that, if it becomes more an more apparent that we are on the verge of sliding into a deflationary period, I would keep my on the following indicator:

That’s the US Dollar Index. It worked to stave off deflation in the 1930’s and 40’s and it will probably work now. Plus, perhaps the only way we can pay off our debts is to deflate our way out of them. It wasn’t a bad strategy then and it may not be a bad one now.

May 26th, 2010

Why Gold Prices Aren’t Rising

There’s much conversation these days about how commodity and precious metals prices have stalled or even declined (as represented by their respective ETFs) with the slow down in the worldwide economy and volatility in international currencies and financial markets frequently being given as the explanation.

At times like these, wealth’s tendency is to reduce risk (i.e., sell assets) and seek safety. Since the locus of today’s uncertainty is the EU, one such safe-havens appears to be the $US, causing it to appreciate 16.28% against a basket of foreign currencies since December 1.

Gold has been another traditional safe-haven throughout history. And yet, due to our usual provincial view of the world, Americans question gold’s traditional role because its price has increased only marginally, to 118.47 for the gold ETF today vs. 117.37 at the close on December 1, 2009. With all the turmoil in Europe and its Euro, why hasn’t gold appreciated if it’s such a safe-haven.

It depends on which currency of the foreign exchange prism you viewed the price of gold. If you lived in Paris or Geneva or Sydney, you probably wouldn’t be asking the question. For example, the price of gold in Euros has appreciated 25.5% since December 1. Gold’s price has also appreciated for those who look at it in terms of Swiss Francs, UK Pounds, Australian Dollars and Japanese Yen (click on image to enlarge):

Because gold is a store of wealth, it’s price fluctuates both in terms of it’s underlying supply/demand relationship and in terms of the exchange value of the specific currency into which you want to convert it, something that’s also true for other commodities like oil, copper or silver.

Gold appears to us to not have appreciated because the $US has increased in value relative to other currencies so much in such short a time. In retrospect, those in Europe who were looking to dispose of their Euros could have been essentially indifferent between converting them into either $US or gold since their prices (in terms of Euros) have moved essentially in tandem. What does it mean for us in the US? So long as the $US is considered as much a safe-haven as the precious metal, it could be difficult to look for gold to appreciate much. But how safe a haven is the US actually?

Again, in our provincialism, we criticize the sovereign debt crises of Greece, Spain and other European countries and recommend courses of action they need to take to fix their problems but don’t look in our own backyards to see the mess we’re in. The US debt represents 24% of the world’s sovereign debt (followed by the U.K. with 16%) and yet only around 2.59% of our debt is back up by of gold ranking us 54th among all countries (while the U.K. ranks 92nd with less than 0.15% of their debt being backed up by gold).

How long before the focus shifts from the Euro as a week currency to the Pound and then the $US? Perhaps the traditional June 30 fiscal year-end for Federal, state and local governments and the debates that will ensue regarding deficits, budget cutting, and defaults will be the trigger sending foreign money to again flee for safety, joined this time by Americans, causing the $US to decline and gold and other commodities to increase.

May 11th, 2010

Gold: The Next, Last Bubble

  1. Bubbles
  2. Were you a Beanie Baby collector? People would search near and wide for their next Beanie Baby, they’d pay ridiculously high prices on Ebay for the most recently issued doll or the one they were missing in their collection. Websites sprung up listing “market prices” of different dolls; exchanges were even created. Was that fad much different than a kids’ versions of Tulipmania in 1635 or the South Seas Bubble of 1720 in England or the DotCom Bubble of the 1990’s and the Real Estate Bubble of the last decade?

    Bubbles usually involve assets whose value is subjective and difficult to evaluate or measure. Often these are collectibles or other forms of assets don’t serve a productive societal purpose or generate any form of income. Buyers who, for reason known only to them, rationalize a value that’s exuberantly higher than the asset’s current market price. Since the asset generates no income on its own, these buyers bid up the price and acquire it in the hopes of selling it sometime in the future at a higher price, hence the term “greater fool theory”.

    “These individuals will continue to purchase regardless of market levels, considering only the willingness of other individuals in the market to pay higher prices. At this point the bubble inflates itself, because a growing portion of the market is self-referencing, making decisions while looking inward…..euphoric levels of valuation are validated by the market, and intelligence is measured only by profits, not reasoning and judgment.” Financial Genius Before the Fall by Jacob Freifeld 1996

  3. Bretton Woods (see Wikipedia)
  4. With World War II was still raging in 1944, all 44 of the Allied nations gathered in Bretton Woods, N.H. to establish a system of rules, institutions, and procedures to regulate the international monetary system (and create the IMF). The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold; the IMF was to bridge temporary imbalances of payments.

    As the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. ran balance of payments deficit and trade deficits for the first time in the 20th century. In 1970, because of foreign governments’ redeeming their dollar holdings into gold, our gold coverages paper dollars declined 33 percentage points, from 55% to 22%. Fearing a devaluation, Germany left the Bretton Woods standard forcing the $US to a 7.5% devaluation relative to the Deutsche mark.

    In an attempt to prevent further devaluations, President Nixon unilaterally ended the direct convertibility of the United States dollar to gold and thereby essentially ending the Bretton Woods system and resulting inflation and wage price controls here.

    Since 1971, gold’s value in $US has increased from a low of $63 to today’s high of 1219.90 (from

  5. Gold: The Next, Last Bubble

    Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value, and occasionally, a standard of deferred payment. Fiat money is without intrinsic use and derives its value by being declared by its issuer (country, group of countries like the EU) to be legal tender. In other words, it must be accepted as a form of payment within the boundaries of the country, for all debts, public and private.

    The financial crises in the EU and our own staggering and still escalating national debt underscores that the world’s spending and obligations has outgrown it’s ability to pay. Inflation is coming and there isn’t any way around it. The policies that pulled us out of the recent economic crash put trillions of new dollars into circulation. That makes all of our existing dollars worth less… but it increases the value gold and silver. In other words, currency is being devalued around the world-even in China.

    The rise in the price of gold didn’t start last month or last year. It really started to run (see chart above) about the same time as the US deficit started to balloon due to the recession following the DotCom Bubble Crash and 9/11. Rather than slowing down, the worldwide financial crises and recessions could accelerate the rise. Consequently, gold now has characteristics similar to the objects of earlier bubbles with two exceptions: its demand is worldwide and governments could stop it by agreeing to fix currency exchange rates fixed to gold.

    Until that happens (it may come at any time), the price of gold will probably act the same as did for beanie babies, tulips, tech stocks or stocks in companies that promise to develop mines on Mars and the moon (ala, South Seas Company stock).

Note: Subscribers to Instant Alerts saw me starting to add precious metals stocks and ETFs to my portfolio back in April.