Congratulations to Chuck!

Good day… I want to start this mornings Pfennig off with a note Chuck sent the trade desk last night:

“The doctor called, and I’m CLEAN! My scans were clean, and, I’m officially off the Sutent, and considered a ‘Cancer Survivor’ now! YIPPEE!”

I know the markets are in a state of turmoil, but that great news from Chuck took precedence over anything I could write about the currencies. It looks like Chuck’s positive attitude, along with all of our prayers have beaten back the cancer (I guess his doctors and the new medicines deserve some of the credit also). Congratulations to Chuck; can’t wait to shake his hand when he returns from the first week of the FXU tour. But now lets move on to the markets.

I was so focused on the Wall Street turmoil yesterday that I failed to mention that the FOMC will be meeting today. Just a few weeks ago, the markets were calling for an interest rate increase by the Fed to tackle inflation. But the events of this past weekend, along with a dramatic drop in the price of oil, have many calling for another interest rate cut. The central bank has already injected billions of money into the markets to try and calm them after the bankruptcy of Lehman. The Federal Reserve yesterday added $70 billion in reserves, the most since the September 2001 terrorist attacks. The funds were needed as banks and financial firms tightened up their lending in reaction to the financial turmoil.

Firms with healthy balance sheets and cash available to lend out just don’t trust other firms who are looking for capital. The credit markets have seized again, and overnight lending rates were heading dramatically higher until the Fed stepped in and increased the money supply through overnight repos. But this increase in money supply is by definition inflationary, and if they can’t pull it back in from the markets, the long term impact is to cause further downward pressure on the dollar.

Chuck had this to say about events this weekend: “OK… A Financial Tsunami… That’s the best description of what I saw happening yesterday, after Sunday’s announcement of Lehman and Merrill Lynch… But the biggest fish so far is probably AIG, and all their problems. You see, AIG is facing a downgrade in ratings, which means they will have to post more collateral on their loans. Collateral that they don’t have! Stocks plunged 500 points yesterday. It’s a Financial Tsunami, and the dollar is caught in the headwinds!

“I just don’t get those that say the dollar will be a ‘safe haven’ during this time, how can the country that is causing the Tsunami have a ‘safe haven currency’? I would think the currencies of Japan, Singapore, Switzerland, and China would be the safe havens… With the euro experiencing perceived problems, investors are a little skittish toward the euro (EUR)… But, remember this, the euro is the offset of the dollar!”

As Chuck points out, U.S. treasuries are still being sought out as a safe haven for parking cash during these troubled times. A quick look at the treasury markets yesterday showed that two-year note yields dropped 44 basis points, or 0.44%, to 1.79% – the biggest decline since Sept. 17, 2001. The 10-year bond gained over two-full points as investors parked cash waiting to see what is going to happen. I actually understand why investors are parking cash in these treasuries, as they don’t feel they can trust the banking system or commercial paper markets and need to just find a quick place to hide during this “Financial Tsunami” as Chuck calls it.

But will these investors be happy sitting in these U.S. treasuries with rates below 1% on short term bills and a top rate of just 3.93% on the 30-year bond? Why would anyone be happy holding these treasuries when their real yields (adjusted for inflation) are actually negative? Inflation in the United States will be reported this morning, and is expected to show the Consumer Price Index rose 5.5% from August of last year. So while investors may have gone to Treasuries as an immediate knee-jerk reaction to the crisis, I don’t expect them to stay there long. The smart investors will start to look for other places to move these funds. And right now, the best opportunities are in markets outside of the U.S. dollar. If the FOMC does decide the lower rates today, or generates a dovish statement, investors will begin to move back into the better prospects that can be found in countries outside of the United States.

Gold started to move back off its recent lows, but the move to hard assets wasn’t as dramatic as I thought it would be. After all, if investors are looking for a ‘safe haven’, how much safer can you get than gold? One argument that I have heard against gold is that you can’t get paid any interest on your gold holdings, but if you are willing to earn a negative real yield on U.S. treasuries, an investment in gold actually becomes even more attractive. Logically, events like those that occurred this weekend should set off a buying frenzy in the metals markets. But while gold and silver both rose slightly yesterday, they are down this morning.

So precious metal prices are down, just when you would expect them to be rising. And judging from the calls to the desk, supplies of minted coins for both gold or silver are getting harder to find. Our metal dealers tell us that the mints just haven’t been able to keep up with demand for gold and silver coins, but prices for these commodities continue to slide. Just doesn’t make any sense to me, but I’m not the only one perplexed by the metals markets. I read a piece by our friend The Mogambo Guru yesterday that makes a good case for investors to add gold and silver to their portfolios at current prices. Investors should have a portion of their investments in gold or silver, as a hedge against inflation, and against a possible meltdown of the current financial system.

In addition to the inflation data and FOMC rate announcement, the TIC flow data will be released later this morning. The numbers are expected to show that foreign investors slowed their total net purchases of U.S. investments during July. With the latest crisis, I would expect the August numbers to show a reduction. This number is important, as the United States needs to attract foreign capital in order to fund our ever increasing deficits. If we are unable to attract enough foreign capital, the dollar will need to move lower, or interest rates need to move up. A combination of these two is the probable outcome over the long term.

The dramatic increases in market volatility continue to benefit the Japanese yen (JPY) and Swiss franc (CHF), both of which turned in good performances versus the dollar yesterday. These currencies continue to move up as investors exit leveraged carry trade positions. With reversals of these carry trades, the high yielding currencies of Australia (AUD), New Zealand (NZD), and South Africa (ZAR) have been sold. In fact, all of the emerging market currencies are down versus the U.S. dollar, with the Brazilian real (BRL) and Mexican pesos (MXN) off over 1% during the past five days.

Unfortunately the Aussie and Brazilian real have gotten caught up in the sell-off of commodity prices and the risk aversion trades. I continue to believe that long-term, the commodity riches held by these two countries will support their currencies, but short-term, it looks like they will continue to be sold. Investors looking for shelter from this storm should look at the Asian currencies of China (CNY), Japan, or Singapore (SGD). Investments in the Swiss franc also look to continue to appreciate.

I’ll end it there, as the markets are going to be interesting again today. I think the FOMC will hold rates steady, but hint at the possibility of support for the economy which means lower rates by year-end. But the Fed could succumb to calls from the stock jockeys for a rate cut to help steady the stock markets. If this is the case, look for a general sell off in the U.S. dollar as investors exit the ‘safe haven’ of U.S. treasuries. Should make for an interesting trading day.

Currencies today 9/16/08: A$ .7904, kiwi .6521, C$ .9315, euro 1.4199, sterling 1.7823, Swiss .8999, ISK 91.77, rand 8.1755, krone 5.826, SEK 6.8084, forint 171.84, zloty 2.3918, koruna 17.010, yen 104.13, baht 34.29, sing 1.4331, HKD 7.7792, INR 46.935, China 6.845, pesos 10.7722, BRL 1.8149, dollar index 78.83, Oil $93.05, Silver $10.855, and Gold… $778.40

That’s it for today… Just have to say congratulations to Chuck again! Chuck spent yesterday in Seattle, and is in transit to San Diego where FXU will hold class tomorrow. San Diego is one of Chuck’s favorite cities, and the crowds were expected to be quite large, so I’m certain he will give a great presentation. After San Diego, FXU will move across the country to hold class in Dallas on the 19th. If you are near any of these towns, I would suggest trying to get registered, as these will be great opportunities to learn how to protect your portfolio during these tough financial times. Hope everyone has a Totally Terrific Tuesday, I know ours will be!

Chris Gaffney
September 16, 2008