Sunday, September 14, 2008

Currency update for week ending 12 September 2008

Is Uncle Buck back?

Welcome to the latest ECAM update. It has been a few weeks since I've been "in the saddle" as I've been on a well appreciated holiday but it feels good to be recharged and back in the thick of things.

As I alluded to in my last stock market update, the past few months have been unprecedented in economic history. What I find odd (in fact, a bit eerie) is that we are right now living through what is potentially one of the most significant events in financial history in the past 100 years and yet 99.9% of the population ("Joe Six-pack") has absolutely no idea what is happening around him. It kind of reminds me of The Matrix and the "blue pill/red pill" thing.

I find it ironic that in 30 years time we could be potentially sitting down with our grand-kids telling them what it was like in the "Great Depression of the 2000's" and yet the majority goes about their business without a clue what is going on around them.

As most of you know who follow the blog, I try to keep it fairly simple here and cut to the chase.

Here are the facts:

1) This downturn began due to lax mortgage lending standards in the U.S. in the period 2005-2006 which allowed millions in lower income brackets to purchase homes they should never have been able to afford.

This in turn allowed those in ongoing higher income brackets to offload their older, smaller homes to purchase larger and more expensive homes (along with additional multiple "flip homes" they never intended to live in but hoped to sell onwards to someone else at a higher price in a very short holding period).

Enticed by ever increasing profits, the entire banking industry in the U.S. (from the smallest regional all the way through to the largest investment banks on Wall Street) perpetuated the fraud living by 2 rules:

a) don't ask; don't tell and collect the fees (write the mortgage irrespective of the borrowers ability to ever actually be able to pay it back and in the process collect the fees), and

b) dump the paper asap and collect the fees (bundle and sell the mortgage on to others before it is revealed the borrower has no ability to pay for the mortgage you just wrote and collect the premium for putting together the "bundled" loan package)


2) This practice was endorsed by the U.S. government as it gave the false sense of prosperity to it's citizens at a time when the U.S. was becoming increasing more and more uncompetitive on the economic world stage due to globalization (the ability to produce goods at a lower cost base in other countries) and an historic level of increasing government spending. The result was a record current account deficit relative to GDP that mirrors many third world countries and a trade deficit that sucked much of the industrial base out of the U.S. and into countries that were more competitive (China, India and other far east countries).

3) Since the late summer of 2006 the U.S. housing market has been in a downturn. The reason is simple....supply and demand. Anyone who took Economics 101 knows that when supply exceeds demand than price will decline. It is that simple and when supply outpaced demand prices began to fall. When this happened those who could not afford the homes they lied to purchase began to stop payments and those with multiple homes bought with the intent to flip were left holding homes they could not sell at a profit. The combination of the low income types going into foreclosure and the mid to higher income types dumping their inventory at a loss just to offload them led to the current downturn.

4) As a result of the housing downturn, those banks and financial institutions with exposure to the mortgage markets have been decimated. Here is the latest numbers from bankimplode.com (click on links to get the individual stats for the bank of your choice):

Lehman Brothers - $67.2B (2)Posted on September 11, 2008 6:45 PM
Washington Mutual - $28.6B (2)Posted on September 9, 2008 10:35 AM
National City - $14.9B (0)Posted on September 4, 2008 8:00 PM
CIBC - $10.7B (0)Posted on August 27, 2008 11:44 AM
Bank of Montreal - $1.2B (0)Posted on August 26, 2008 1:02 PM
Deutsche Bank - $155.1B (1)Posted on August 25, 2008 10:02 PM
Goldman Sachs - $84.2B (3)Posted on August 25, 2008 5:15 PM
JP Morgan Chase - $20.1B (3)Posted on August 25, 2008 2:15 PM
Morgan Stanley - $24B (0)Posted on August 15, 2008 1:38 PM
Bank of America - $51.3B (4)Posted on August 14, 2008 11:16 PM
Wachovia - $50.5B (4)Posted on August 13, 2008 3:05 PM
UBS - $92.5B (2)Posted on August 12, 2008 11:22 AM
Royal Bank of Scotland -$41.7B (2)Posted on August 10, 2008 5:34 PM
Citigroup - $144.5B (7)Posted on August 7, 2008 3:43 PM
BNP Paribas - $3.3B (0)Posted on August 6, 2008 11:01 AM
Commerzbank - $1.06B (1)Posted on August 6, 2008 10:08 AM
Societe Generale - $30.1B (0)Posted on August 5, 2008 10:08 PM
HSBC Bank - $27.7B (0)Posted on August 4, 2008 1:12 PM
Credit Suisse - $94.5 B (0)Posted on August 3, 2008 12:20 PM
HBOS PLC - $19.0 B (0)Posted on July 31, 2008 10:45 PM
Fifth Third Bancorp - $3.6 B (1)Posted on July 22, 2008 5:01 PM
SunTrust - $2.0B (1)Posted on July 22, 2008 3:33 PM
Wells Fargo - $27.4 B (2)Posted on July 16, 2008 12:40 PM
US Bancorp - $2.2B (0)Posted on July 15, 2008 12:13 PM
Royal Bank of Canada - $1.4B (0)Posted on May 29, 2008 6:07 PM
IKB - $14.3 B (0)Posted on May 27, 2008 8:13 PM
Mizuho MFG - $5.4B (0)Posted on May 22, 2008 2:09 PM
Bayern LB - $9.8B (0)Posted on May 19, 2008 7:42 AM
WestLB AG - $4.8B (0)Posted on May 19, 2008 7:35 AM
Natixis - $3.4B (1)Posted on May 19, 2008 7:31 AM
Credit Agricole SA-$13.8B (0)Posted on May 12, 2008 5:18 PM
Mitsubishi Financial Group - $760M (0)Posted on April 23, 2008 12:54 AM
Bank of NY Mellon - $118M (0)Posted on April 9, 2008 11:19 AM
Sovereign Bancorp - $1.580B (0)Posted on April 8, 2008 1:29 PM
DZ BANK AG - $2.1B (0)Posted on March 7, 2008 9:52 PM
HSBC - $26.5B (0)Posted on March 5, 2008 5:25 PM

Close to 500 billion dollars has been written off to date and the final number when this all ends may top 1 Trillion dollars. This is challenging the very existence of some of the oldest and most well respected financial institutions in the U.S.

5) While I have been following this for some time, for most the magnitude of the problem did not register on their radar screens until Bear Stearns failed in March, 2008. That was the first of the "Big 5" on Wall Street to go down and it has been increasing getting worse ever since.

To date here are the major failures (takeovers):

-Bear Stearns
-Indy Mac
-Fannie Mae
-Freddie Mac

To come (in the next week?):

-Lehman Brothers

Next in line:

-Washington Mutual
-Wachovia
-Downey Financial

In line with failure of either of the above 4, the FDIC (Federal Deposit Insurance Corporation) will require recapitalization as they will be out of money themselves.

Next to the trough? The problem spreads to the second tier "semi-financial" institutions:

-AIG

Next in line: the American auto makers. My bet (in order):

1) General Motors (mostly due to GMAC financing)
2) Ford
3) Chrysler

This list does not include what could be over 200 local and regional U.S. banks that go into receivership over the next 2 years.

That just gives you the tip of the iceberg as to what is going on right now. Whew!

Anyway, that is your dose of economic reality for today. On to where I am going with currencies.

There is really only one question and that is what is the direction of our favorite uncle; Uncle Buck (the U.S. dollar).

As I mentioned in my last currency update, the USD has been on a rocket ride north the past month. There are many possible reasons why this is the case but dwelling on which scenario is pointless in my mind as it really does not matter WHY......all I care about is what I should do about it.

As I have pointed out in the past, I like to look at weekly charts to give me some idea of where we are at in the medium-longer term view. As such, I will present these charts 1st before getting down to the shorter term and positioning.


Mid to Longer Term Charts:

First I think it is important to identify what the USD is. We all think we know what it means to have a $1.00 bill in our pocket but what does it mean when we compare it to the rest of the world?

In fact, the U.S. dollar index is a ratio measure of the accepted value of the U.S. dollar in relation to its major trade partners.

This is defined as follows:

The US Dollar Index (USDX) is a number that measures the geometric weighted average of the change in six foreign currency exchange rates against the US Dollar relative to March 1973. Those six currencies with their weightings are the Euro (57.6%), the Japanese Yen (13.6%), the British Pound (11.9%), the Canadian Dollar (9.1%), the Swedish Krona (4.2%) and the Swiss Franc (3.6%).

Clearly the Euro and the Yen can have the greatest influence on the value of this index. It was started in March 1973, soon after the dismantling of the Bretton Woods system. At that time, the world's major trading nations allowed their currencies to float freely against each other and the index measures the dollar's general value relative to this date which is set to 100.00.

A current USD quote of 80.00 means the dollar's value has fallen 20% against these six other currencies since this base period established in March, 1973

Note the U.S dollar index is unique because, as the defacto world’s reserve currency, 6 individual currencies are factored into determining the accepted value of the USD. This is totally different from other currency "pairings" which only involves direct comparison between 2 countries' currencies.

Also I must point out that the 2 largest contributors to the USD index are the Euro and the Yen (totaling 70% of the valuation of the USD index). As such, they must be watched very closely and the others less so.

As I have pointed out previous on the blog, I use the 13 and 34 week exponential moving averages combined with MACD mid-point crossovers to identify major changes in markets. I have pointed these out on each of the currency charts below.

I will let you review the charts before commenting:


US Dollar 3 Year weekly (click on all charts to enlarge):



Canadian Dollar 3 year weekly:



Australian Dollar 3 year weekly:



British Pound 3 year weekly:



Euro 3 year weekly:



Japanese Yen 3 year weekly:



Swiss Franc 3 year weekly:



Gold 3 year weekly:



West Texas Intermediate Crude 3 year weekly:



Clearly it can be seen from the above charts that (with the exception of the Japanese Yen which appears to be making a possible turn around and WTIC which is damn close to a 13/34 and MACD bearish cross) that not only are the world's major currencies falling in relation to the USD but also the defacto quasi-currencies (gold and oil) are also in intermediate to longer term declines. As such, from an intermediate to longer term standpoint I am now bullish USD and bearish every other currency (and also by default commodities including gold and oil) with the exception of the Japanese Yen.

Shorter term it is not quite so obvious. I won't go through all the charts but want to include the biggies:

USD Daily 6 month chart:



As I mentioned on my last currency blog in mid-August, the USD had made a tremendous rise off the bottom @ 71.31 on 15 July. We had seen this sort of move before over the years and I honestly did not expect it would be of such a magnitude. I also expected a short term reversal given the overbought nature of the price climb. This did not happen.

Also under full disclosure, I hedged my long Euro/Australian dollar positions by buying double long USD ETF's on 07 August when the USD index price closed above the 200 day moving average and the resistance @ 73.89. I am holding those long dollar positions to date.

The short term chart finally appears to be turning around. The USD is still overbought and there is no reason to not expect price to decline to either the bottom of the channel (78.40) or to the last area of short term resistance near 77.40.

USD 10 year daily chart:



On this longer term daily chart it is clear the USD got stopped in it's tracks at a previous level of support that became resistance (support level from 2005 @ 80.39; price hit 80.38 and broke south).

It would not be uncommon for price to fall to back test the trend line; in fact that is what ultimately that is what I would expect. From that retest I would expect the overbought condition to be alleviated and a new round of USD buying to begin.

Euro 1 year daily chart:



Still massively oversold and bounced off support @ 138.45. If it can get above 143.14 on this bounce it has a good chance to run back to 148.97. That appears to be the true "line in the sand" as far as the Euro is concerned.

Japanese Yen 1 year daily chart:



Broke below previous support @ 92.23 but has recovered back above. Currently stuck in a range between 92.23 support and the 50 day moving average (92.51) and resistance formed by the 100 (93.69)and 200 day (93.94)moving averages. If it can clear both these levels and the previous local high (94.12).

I think the Yen looks really good on a long play. I will be a buyer in my personal account through those levels.


Bottom Line:

The US dollar appears from all intermediate to longer term charts to have turned a corner and is bullish. There is no doubt there are a 1000 fundamental reasons why that should not be the case but "it is what it is".

Short term the dollar is overbought and due for a pullback. I will be moving out of the Euro and Aussie dollar positions once this short term pullback is complete and the next up leg has begun.

I will also be moving out of the International bond fund due to its unhedged exposure to USD strength (as discussed previous). I will probably do this in line with the short term fall in the dollar.

Ultimately I am still looking at rolling the whole thing over into equities (as discussed previous) in anticipation of a rally into the end of the year but there is no indication at this time that it is safe to do so.

As of today, my positions remain as follows:

-50% Fidelity International Bond Fund*
-25% Fidelity Australian Dollar Fund*
-25% Fidelity Euro Fund*

*percentages are as per how funds were originally allotted. Due to market fluctuations and ongoing equity monthly purchases these amounts vary 1-2% from that posted.


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