Sanity Returns to the Currency Market

Good day… Wow! What a day it was yesterday on the currency/metals desk here at EverBank. Finally, some sanity returned to the markets as investors moved out of their dollar holdings and into both currencies and metals. Gold was up over $80 yesterday, and continues to climb this morning. The Aussie dollar (AUD) was up over 2%, climbing back above $0.80 and the euro (EUR) climbed back above $1.45. The dollar was up pretty much across the board, making for a very busy day here on the desk.

Chuck also had a great day down in San Diego with FXU. He sent me the following late last night which he asked me to share with you:

“Like a bridge over troubled water…

“Yes, the ‘bridge loan’ that AIG received from the U.S. Government the other day reminded me of the awesome Simon and Garfunkel song “Bridge Over Troubled Water”… Because this is what it is… Plain and simple! And not one analyst who should know what’s going on inside of AIG believes that they will be able to pay back that $80 billion in two years… Uh-Oh! But hey! Let’s push the problem out two years, and deal with it when we get there again, eh?

“Those are the kind of games they’re playing. Oh, the games people play now; every night and every day now; never meaning what they say now; never saying what they mean… Old Joe South, I bet he didn’t know that his song from the ’60s would be used to describe the Financial Tsunami going on…

“Gold buyers saw the writing on the wall (FINALLY!), when the U.S. government had to step in to make that ‘bridge over troubled water loan’ to AIG. The Treasury and Fed had tried to get deep pocket brokers to make that loan, and they would not even touch it with the Treasury’s ten-foot pole! So… The credit crunch has become an epidemic. It’s not a credit crunch… It’s a credit blockade! And so… Gold rose $88 in one single day! WOW! This was going on as people were talking about an end of gold’s run… They had to swallow hard on that one-day move in gold!

“And the Dow dropped 450 points, and the euro rose to 1.4350… Think maybe, just maybe, the market participants have finally woke up and smelled the coffee? I don’t know folks… Today will be a BIG indication of what’s to come… Because when an asset goes up 10% in one day, like gold did, it’s bound to see some profit taking the next day… But if that profit taking can be held to a minimum… Watch out!

“Oh, and back to gold for a minute before I hand this back to Chris, who is doing a great job Pfilling in on the Pfennig, and that is a note from a charts person who tells me that gold’s move back to $745 was simply filling in the gaps that it skipped on the way to $1,000. If that’s true… We all know that when assets go back to fill gaps, they form a new base to move higher once again.”

Chuck tells me the presentations at FXU went great yesterday, people were lined up around his table to speak with him. What great timing for Chuck and the rest of the folks at FXU to be out educating investors about the opportunities in the currency markets! They will be heading to Dallas today and then take a break before heading back out on the road. If you get an opportunity, I would definitely suggest trying to get to one of these events.

The bailout of AIG was supposed to calm investors’ fears of a financial collapse, but instead it exposed just how bad things are, and investors headed for the ‘safe haven’ of U.S. treasuries. But foreign investors, whom the United States is reliant upon to finance our huge deficits, have started to move their funds back out of the United States.

And unfortunately the bad news on Wall Street just keeps coming. I heard on the radio this morning that Morgan Stanley is very close to reaching an agreement with Wachovia to be bought, and Washington Mutual officially put themselves on the sale block. Wachovia has a big presence in St. Louis after swallowing A.G. Edwards, but I question if they are healthy enough to take on Morgan Stanley. Sounds to me like they are just desperately trying to grow big enough to be considered ‘too big to fail’ by the Fed. Things are definitely getting pretty crazy out there.

Central banks around the globe took coordinated action to try and soothe the markets, pumping almost $250 billion into the credit markets. Finance officials are struggling to try and restore confidence in the markets as banks have stopped lending to one another. As I mentioned yesterday, Bernanke has the printing presses working double time. But even ‘Helicopter Ben’ won’t be able to restore investors’ confidence.

Not to sound negative, but I truly believe we have just started to see the fallout. Yesterday the unthinkable happened, as a huge money market fund ‘broke the buck’. The nation’s oldest money market mutual fund, The Reserve Primary Fund, traded below $1 because of its exposure to debt from Lehman Brothers Holdings Inc. The event marked only the second time a money market fund has broken the buck. The fund had $62.6 billion in assets as of September 12 and held $785 million in Lehman Brothers short-term debt, representing 1.2% of total assets. Shares of the money market fund are now valued at 97 cents.

The Credit Default Swap market will likely start to take center stage in the financial market meltdown. These CDS’s are basically insurance policies written by companies guaranteeing the holders of debt instruments against default. I heard there are over $70 trillion worth of these outstanding, but it isn’t clear just who has written all of these. The CDS market was what brought down AIG, as they had sold CDS’s to investors around the globe. AIG decided to get into this market a few years ago, and quickly became one of the biggest players. But they didn’t fully understand the risks associated with this market, and looked at it the same way they looked at homeowners insurance; figuring that they just needed to sell a lot of insurance policies so that a loss of one home would be made up by the premiums earned on all of the other homes.

But a fire at one home typically doesn’t spread to all other homes, while a default by one bond issuer quickly turns into problems for other bond issuers. So when things started going bad in the mortgage markets, losses on these Credit Default Swaps began to accumulate out of control. And now you and I are on the hook for all of these. This is why Paulson and Bernanke felt it was necessary to bail out AIG; foreign governments and investors own many of these CDS insurance policies. If AIG was allowed to fail, these foreign investors would have been burned badly, and the U.S. financial system is dependent on the continued inflow of capital from these overseas investors.

But foreign investors obviously have begun to lose faith in the United States, and will continue to demand higher compensation for providing the money that the U.S. government and economy depend on. That, in turn, will translate into higher interest rates here in the United States, and a lower U.S. dollar. The average American will face lower living standards as borrowing costs are pushed higher and the dollar is pulled lower.

I’ll get off my soapbox now and get back to the currency markets. The Swiss National Bank is expected to leave their main lending rate at a seven-year high today to ensure that inflation will slow below its 2% limit. The Swiss central bank continues to weigh the downside risks to the economy against the inflation pressures. The Swiss Franc (CHF) has been one of the best performers recently, with investors moving out of carry trade positions and purchasing the Swiss franc to pay down their loans.

Yesterday’s housing data showed another drop in both housing starts and building permits to 17-year lows. It was also reported that the United States current account deficit had grown to $183 billion during the second quarter of this year. We will likely get more bad data for the U.S. today, as the weekly employment data will likely show an uptick in the initial jobless claims and a drop in the leading indicators for August. Nothing here is expected to give any support to the falling dollar.

While it is normal to see a bounce after such a big move in the markets, I just don’t see anything that will turn around the recent fall in the U.S. dollar. Gold and silver also continue to move up this morning, as investors look like they are continuing to flee the U.S. equity markets and look for safer places to park their money. Today is looking like it is going to be another big day for the currencies, better get this out so I can start picking up the phones.

Currencies today 9/18/08: A$ .8066, kiwi .6760, C$ .94067, euro 1.4478, sterling 1.8252, Swiss .9144, ISK 92.49, rand 8.1677, krone 5.755, SEK 6.6315, forint 167.82, zloty 2.3115, koruna 16.547, yen 104.67, baht 34.07, sing 1.4291, HKD 7.7820, INR 46.49, China 6.8394, pesos 10.7685, BRL 1.8892, dollar index 78.55, Oil $99.35, Silver $12.924, and Gold… $879.06

That’s it for today… As I mentioned above, yesterday was a very busy day on the trade desk, with investors rushing to get back into the currency and metal markets. The metals calls have been especially frustrating, as we still can’t get access to silver coins. We can still offer the silver pooled accounts, which I believe is the most efficient way to hold the metals. Dealers tell us they are expected to start receiving shipments of silver coins from the mints sometime later this month, but as of right now they aren’t available. We do have gold coins/bars available, but again I feel our pooled accounts are the best way to hold either metal. Hope everyone has a Tub Thumpin Thursday!!!

Chris Gaffney
September 18, 2008