Fundamentals Return to Currency Trading

Not only did the currencies rally versus the dollar yesterday, but gold and silver took part in the proceedings too! It’s been a long time since we’ve seen this happen. For the most part, whenever the currencies (minus yen) rallied, gold would back off, and vice versa… Not yesterday! For the first time in a long time, the negativity toward the dollar was front and center… BIG TIME!

The currency rally began early in the morning, and really gained steam as the day went on, and especially after the minutes of the FOMC meeting printed. You see, the Fed Heads had discussed that the economy is in a weakened condition and the economic projections for 2009 and 2010 were actually revised lower. The thing I took out of the minutes was this statement by the Fed Heads… the housing market “remained depressed but seemed to have leveled off.”

Memo to Fed Heads… Better be careful with those kinds of statements… Didn’t you all make a similar statement late in 2007? Look how well that prognostication worked out!

So… This news from the Fed about downgrading the growth outlooks for 2009 and 2010, is the key, folks… You see, during the July 2008-February 2009 timeline, we traded under a different trading theme that was well documented in this letter. But for new readers, the trading theme threw fundamentals out of the window, and rewarded the dollar every time data indicated the economy to be deeper, darker, and more dangerous in the recession/depression. This was against all fundamentals.

But yesterday, with the Fed downgrading growth forecasts, the dollar got sold like funnel cakes at a state fair! Finally! A return to fundamentals! Well, at least for one day that is. We certainly need to see more than one day of this to make any kind of final change in the trading theme trend… But it sure was nice to see for one day!

The Big Dog, euro (EUR), led the way for the other currencies (little dogs) yesterday. The euro finally traded above its key resistance of 1.3740 – a level that had stopped the euro “cold” three previous times. You may recall about a week ago, I told you that this is what happens with currencies, in the time (since 1992) that I’ve followed currencies. They make a run at a resistance level, and get knocked down. They make another, only to get knocked down, and then another with the same result. Sooner or later, traders and market participants will either 1. Take this as a challenge and push the currency through the resistance level, or 2. Give up, take their ball and go home… And the currency then falls back through previous gained ground.

In this case, the euro finally moved higher and through the 1.3740 level, and traded all the way up to 1.38 on the day. The good news for euro holders is that there has been little to no profit taking overnight, and the Big Dog is still trading with a 1.38 handle this morning!

Long time currency followers would have to admit that this all looks very similar to previous periods where the negativity toward the dollar was very strong, and seemed to take on a life of its own. Even your run of the mill dollar bull begins to see things the way his counterpart, the dollar bear, sees them…

I think that the markets have come to the realization that the United States has taken the road that leads to easy monetary policy. And everyone knows what’s at the end of that rainbow… Inflation!

A couple of weeks ago, I participated in an editorial roundtable with the publishers for my “other” newsletter, The Currency Capitalist, and in the meeting I was trying to get everyone to agree with me that China was up to something. This was right after the announcement of their currency swap line with Argentina… Someone raised the question, a very astute question I might add, about why China would want to see the dollar lose value, when they own so many US Treasuries.

I then pointed out something I had researched. China had been stealth-like in doing so, but had shortened their maturities to less then three years… Which would mean that they could allow these to mature and not sell them pre-maturely… Could this be a “time-line” toward the lines of thought that China wants to replace the dollar as the world’s reserve currency?

OK… That was a couple of weeks ago, in a meeting… But yesterday, Chris Gaffney sent me a story that appeared on Reuters… Here’s a snippet…

“China has engineered a subtle yet significant shift in the investment of its foreign exchange reserves, a sign of how it is willing to act on concerns about financing an explosion of U.S. debt…

“China’s move to the shorter end of the U.S. debt spectrum is a defensive tactic adopted by the wider market as well on the view that the United States will have to raise interest rates down the road to control inflationary pressures when the economy recovers from the financial crisis.”

So… Now there are “others” sniffing around this trail of tears I think I’ve discovered… For if there is no “long-term” plan by the Chinese to replace the dollar as the world’s reserve currency, then I’ll have egg all over my face! Well… The good thing for me is that this is a very long-tailed story… And I’ll get to point to it over and over again in the coming years!

Doesn’t that just make you get chills of excitement? HA!

A currency that “I like” but had fallen badly last summer, the Brazilian real (BRL), has really pushed higher in recent months (since March 1st). Yesterday it looked as though it would trade below the 2.00 handle for the first time in eight months! (The Brazilian real is a European-style currency, where as the price goes down, it returns more value versus the dollar.) For those of you keeping score at home, the real has gained 17% since March 1st. With Brazil being a “high yield” currency, the return grows even more… But, that’s in the past… And past performance does not indicate that future performance will duplicate… (That’s for the legal beagles!)

Well… Recall earlier this week I talked about pound sterling (GBP) nearing its 200-day moving average? Well… Forget about it! Yesterday, Standard & Poor’s (S&P) decided to place the U.K. on negative outlook… And the pound sterling quickly became the G-10’s worst performing currency on the day. For those of you wanting to know what’s what with these ratings from S&P… When S&P imposes negative outlook, they foresee a greater than 50% chance of downgrade within the next two years; this is compared to negative watch, which implies a greater than 50% chance of downgrade within the next few months.

I said earlier that the euro had seen little-to-no profit taking overnight, and was trading with a 1.38 handle this morning… It has just slipped below that level, as I prepare to go to the Big Finish… Data wise for the Big Dog, Eurozone PMI’s (manufacturing indexes) surprised to the upside for this month. Now… It’s true that this manufacturing data is still in negative territory, but this data supports the thought that the worst is behind the Eurozone. That remains to be seen… But for now, that’s good news!

In Japan overnight… In yet another sign that the Fundamentals may have re-emerged, if for only one night, the yen (JPY) rallied with the other currencies. Yes, this has not been the case for several months now. When the dollar rallied, yen rallied along with it… But not yesterday and last night… Yen pushed to a 94 handle for the first time in two months!

The data cupboard comes back with a plethora of data this morning… The Weekly Initial Jobless Claims prints first, followed by Leading Indicators and the Philly Fed Index (manufacturing for the region).

And then there was gold… And silver! Year-to-date, silver is outperforming gold! Silver is up almost 25% this year, while gold is up 6.6%. Our newest member to the currency and metals desk, Aaron Stevenson, pointed something out to me the other day regarding silver… “The gold/silver ratio has increase to about 64 from 51 this time last year.” Hmmm… Very interesting…

Speaking of gold… I had a long discussion with a long time customer last week in Las Vegas at the Money Show. We were discussing gold confiscation… I’ve said it before and I’ll say it again, I don’t believe the government would do this again… But… The customer gave me something to think about. In “his scenario” the government devalues the dollar, and pushes gold to $10,000 an ounce… Well… Now that’s “out there”… But as a gold holder, I certainly would love to see $10,000 an ounce… My problem is that I don’t want to see what the U.S. economy looks like with $10,000 gold! It may not be worth it, folks…

The Daily Reckoning