US Dollar, turning around?

May 12 (Bloomberg) — For the first time since December 2005, futures traders are turning bullish on the dollar.

The difference in the number of wagers by hedge funds and other large speculators on a gain in the greenback versus the euro, known as net longs, was 21,315 on April 29, figures from the Commodity Futures Trading Commission in Washington show. There were net-short positions in each of the previous 123 weeks. At the same time, traders have stepped up their purchases of options that profit from the dollar’s appreciation.

The measures are making long-suffering proponents of the dollar optimistic that this time the currency’s rally may hold, especially if the Federal Reserve’s Open Market Committee refrains from additional interest-rate cuts. The Dollar Index traded on ICE Futures in New York, which tracks the currency against six trading partners, is up 3.7 percent from an all-time low of 70.698 set on March 17.

“There is kind of a sea change taking place at the moment,” said Mitul Kotecha, head of foreign-exchange research in London at investment bank Calyon, whose forecasts on the euro-dollar exchange rate in the first quarter were more accurate than those of the two biggest currency traders. “It’s probably the early sign of perhaps a more sustained turnaround.”

 

Themes…currency

With the previous post detailing the potential bottom in the Japanese Yen, how about the US$? Again using interest rates as the valuation metric, we know the following;

*Rates were being increased by Bernanke’s Federal Reserve
*Rates were reversed in response to the Banking crisis, brought on by a housing bust.

We can speculate on the following;

*Banks, via a variety of measures have started to stabilise
*With stabilization in the financial system, inflation becomes the priority
*Inflation control will see rising rates
*Rising rates, will see a strengthening US$
*The Fed has hinted that the previous rate cut to 2% was the last.

 

Investment Themes

Investment themes, a way to make money in the market. Not a market timer’s methodology, but a valuation methodology. The current market has foxed many, here is one example, from a “professional money manager”;

Theme-less
by The Fly on May 2nd, 2008 at 3:50 pm

I’m sure “The Fly” is making most of you scratch your heads, thinking “what the fuck is this asshole doing”?

One day I hate stocks, the next they’re grrrreat!

Frankly, I am running, without reason. Currently, I am theme-less. I’m just walking around the forest of fucktards, with rifle in hand, picking off game.

Right now, I am long (NILE: 46.16 +2.17%), (WB: 29.62 -1.53%), (LAZ: 37.11 +4.65%), (FMCN: 39.69 -3.74%), (CTRP: 65.00 -2.72%), (NVDA: 22.23 -1.33%), (HD: 29.1019 -0.61%), (JOE: 41.0999 -1.67%), (RIG: 158.174 +0.21%), while having short exposure in (SMN: 30.524 +0.17%), (SRS: 82.90 +1.91%), (SKF: 96.01 +2.15%), (FXP: 64.72 +8.41%), (POT: 201.73 +1.52%) and (LEH: 45.81 -1.08%).

By the way, “The Fly” is Master and Commander of the putrid shares of LEH, just like (HANS: 35.90 +1.61%).

Basically, I don’t have the slightest clue, regarding the near term direction of the market. I’m just trying to be in as many plays as possible, taking gains where I can.

I’ll be utilizing my “time machine” this weekend, in order to get a better feel for the near term direction of this God forsaken market.

I highlight this individual for a couple of reasons. The first is that the “Fly” is anonymous, no-one knows who he is, save as a presence on the internet.

The second reason, is that this individual personified the “Theme investing” style. I followed various themes from his blog on a valuation basis, BWLD [fat people] MVIS [innovative tech] and a few others that escape the memory currently.

As can be ascertained from the quote, “Fly” has either lost, or given up his niche in the market. So, a post on themes.

When credit creation is the rule, and it has been for almost 100yrs now, money will flow to a sector, eventually in excess creating first a bull market, and then, eventually, a bubble.

This rule, by the Law of Opposites, dictates that other sectors will be deprived, relatively, and then absolutely, of new money flowing in, possibly exacerbated by money flowing out, creating a bear market.

Thus, we can state: When the investment community is fascinated by a major investment theme, outstanding opportunities are developing, or are already available elsewhere.

Currently, commodities of all shapes and colours are the investment theme, steel, fertlizer, grains, coffee, and cooling somewhat…Gold/Silver and other precious metals

Second, the timing thereof, will always be fraught with difficulty. The keys to successful theme investing are valuation, total returns and patience.

Here, from the flyonwallst blog site from November 2007, was my post regarding a theme. You will also note the inclusion of said security within the portfolio. I am going to purposely contradict myself, as currency, is almost impossible to value, save on one metric alone, Interest rates, so here is the article;

OPPORTUNITY
The US market and emerging markets are ranging from marginally overvalued with catalysts to the downside, to, grossly overvalued speculative time bombs.

I now offer you a quote from Horace and “Ars Poetica”, for those of you who possibly visited my blog, you will remember it;

“Multa renascentur quae iam cecidere cadentque quae nunc sunt in honore”

The moral being that bull markets invariably create bear markets, and that eventually, the bull markets revert to bear markets, while bear markets grow to bulls.

True bear markets offer very low risk entry points with huge potential upside reward potential. True bear markets are reviled by investors as they have underperformed for long periods of time, frequently teasing with cyclical bull rallies in a secular bear trend.

I have emphasized, at least for those paying attention the importance of a catalyst within investment decisions. This is not an area that I have particularly emphasized within my own investments or trading. It is however an attribute that has been on prominent display on this blog for those who were attentive.

The catalyst in this particular opportunity is particularly important as the quantitative valuation is pretty much useless. The numbers themselves provide only the merest hint and they are difficult in any case.

Thus, we are left with an almost pure qualitative play.

Japanese Yen

Japan has been in a deflationary spiral for some 20yrs now. The stock market, the real estate market, the currency have all been in a secular downtrend.

Why now?

A number of qualitative factors and one quantitative factor; I shall dispense with the quantitative factor first.

Japanese interest rates are slowly working their way upwards, from 0.25% to 0.5% currently, with further rises planned. Higher interest rates will strengthen, in time the currency.

Let’s now move to the qualitative factors; interest rates around the rest of the world have been slowly rising, faster in New Zealand, Iceland and Australia. As the world economy slows, so these rate rises will slow, freeze, or start to reverse.

Bankruptcy proceedings, both business and consumer are accelerating here in New Zealand. As the US economy slows, so the exponential growth in China will start to slow. The Chinese economy is addicted to export led growth, internal consumption is anaemic.

Thus, a closing of the interest rate spread and thus the carry trade, successful for the last 20yrs will come under increasing pressure.

Further, overpriced assets, that find themselves correcting will also find themselves if purchased with cheap Yen, under pressure to reverse.

Real estate values have again started to rise in Tokyo and other cities. Goldman Sachs, Morgan Stanley and Citibank have been purchasing commercial property in the last couple of months, positioning themselves for the end of the great Japanese bear market.

Rising real estate prices, in time force a rise in the interest rate, which for the purpose of this trade is a good thing.

Currencies trend for very long periods of time and the potential for this trade due to the massive undervaluation engendered by the carry trade is large.

Who are you trading against?

In manias, the last people to get sucked in tend to be the amateurs, seduced by the idea that markets only ever move in one direction. That easy money can be made, that the leverage available via margin can make them very rich, very quickly.

Some time ago, possibly 2 months, an article appeared detailing the extraordinary story that Japanese housewives were dominating the Fx market, engaged in the carry trade. Thus, you are trading against the leveraged Japanese housewife.

It is easy to take an unleveraged position within the Japanese Yen via FXY an ETF that has previously been mentioned on this blog.

In summary, we have some quantitative data via interest rates and numerous qualitative underpinnings to catch a secular bull market in its infancy.

 

The Treasury is not printing

There seems to be an enduring misconception that the Treasury is printing currency, and that this excess currency is driving inflation.

This simply is not the case.

This is a chart of M1 money, or currency. It clearly shows that far from expanding, M1 is actually contracting.

Inflation, defined as; a reduction in purchasing power, is being driven by a depreciating US$, which is exacerbated by real interest rates that are negative. The real rate is negative, as the Fed was forced to bail out the US Financial system. One major problem that necessitated this course of action was the inversion of the Yield curve, and the perculiarities of convex duration on MBS. [see http://leduc916.wordpress.com/2008/02/28/bondjames-bond/#comments]

 

US$

 

Commodities

I shall start examining the case for commodities.

 

Gold

From the comments section, a question on Gold.

Gold currently is simply trading as a currency. The US$ being the reserve currency has been in serious trouble recently due to the Banking crisis. Make no mistake the intrinsic value of Gold as a commodity with regards to industrial use and jewelry is far below current levels. This mega-run by Gold is in response to the almost collapse of the US Banking system.

This crisis has necessitated the cutting of interest rates in an emergency fashion. Thus has an already weak US$ plunged in tandem with the falling rates.

Here we see as the interest rates have fallen, so the 10yr Bonds have increased in price. The market is now starting to suspect that further rate cuts may not be required to further bolster the Balance Sheets of the majority of the Financials, thus, their price has come off, increasing their yield. This will [and has] cause a rally in the US$

With the rally in the US$, the alternative reserve currency, Gold, has sold off.

Therefore with regards to the question of Gold, we basically arrive at the following question; what will the Federal Reserve policy be on further interest rate cuts?

The answer is really in two parts;
*The Banking system has been saved.
*One more rate cut may be required, as momentum is difficult to stop dead in it’s tracks.

Thus, in the longer timeframe, Gold has probably pretty much topped out in this cycle. However, there will be Gold bulls who refuse to buy this argument, thus there will be increased volatility, as there may well be at the bottom of the US$

For my money, Gold as a LONG trade is finished, you missed the boat at $300oz. As a SHORT trade, you are looking at high volatility and the difficulty of staying in the trade.