Wednesday, March 17, 2010

Key Currency Decision Coming

Currencies are going to make a key decision over the next few days, as the Dollar is now at trendline support. This should have a big impact on Commodities and Commodity-based economies, as it will determine the next leg of the Dollar Carry Trade.

The US Dollar is at key support

The British Pound is at key resistance

UDN is the ETF that moves inverse to the US Dollar. It is effectively a weighted basket of several foreign currencies.

Here is a chart comparing UDN to China (FXI). China peaked in November on the Dubai default scare. The US Dollar bottomed a few days later as money looked to the Dollar for safety. The Dollar sold off and then rallied again in January/February on the Greece scare.

The Dollar has had a mild pullback, as stocks have gone higher over the past month. Now you have FXI and UDN testing the tops of their trends. A decision is near for the next leg up or down for Stocks, Commodities and Currencies.

Here is the ETF for Australia (EWA). You can see that price is little changed since October. But look at the trading pattern – a series of higher highs and lower lows. William O’Neil calls this “wide and loose”, others call it a Reverse Symmetrical Triangle. What it is is a lot of institutional indecision.

This pattern is the lowest common denominator entry point for trend reversals. EWA still has to hit a new high to set up the pattern, and then a sell has to trigger. The pattern may fail and EWA may break out from here, but the setup will be worthy of your attention if you own commodities or stocks.

That is the whole point of this blog. You can’t tell the future, but you can be ready in advance if the setups are there. You have to be! I actually hired a second consultant to help me simplify my money management. His job is to help me distill the market down to key leadership and see stuff like this as it is setting up.

I can’t keep track of 800 companies, but I can observe whether Large is outperforming Small or Domestic is outperforming International. And I can keep track of something as simple as this chart, because #4 was a key buy level and #3 was key short. I don’t need too many of those trades to make my year or miss too many blow my year.

You will see a different tone to this blog. It will be very mechanical – much more simplified. I will do a lot less trading in 2010. I will be waiting for setups like EWA or UDN/UUP and when they trigger, I will commit money with stop losses, in case the market tells me that I am wrong. A chart like EWA gives me a very clear idea of when I should be committing new capital and taking profits.

Here is a chart comparing UDN to Gold (GLD). You can see that Gold is the anti-Dollar. So a breakout in UDN will probably be good for Gold and a breakdown in UDN will probably be bad for Gold. We’ll see how it plays out. I would probably be focusing on GLD on a break above 112.5 if UND can break out. However, if UDN has another leg down, then I will be holding off on new Gold purchases.

The next crisis may be forming. It is a potential trade war with China over the valuation of their currency. Paul Krugman dropped a bombshell on Sunday when he wrote things like the following in the NY Times –

“China’s policy of keeping its currency, the Renminbi, undervalued has become a significant drag on global economic recovery. Something must be done.”

“Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.”

“It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.”

“The Peterson Institute for International Economics estimates that the Renminbi is undervalued by between 20 and 40 percent.”

“In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand. “

Now you can agree or disagree with Krugman’s logic. That is not the point. The point is that you are now getting key economic figures talking about a trade war with China, where the purpose of the war is to massively devalue the purchasing power of the US Dollar.

I know that the long run path of the US Dollar is lower, because it is the only way to get jobs back home and inflate our debt away. That said, my brother once told me that “markets go to the most logical place, in the most painful manner possible”. So keep an eye on UDN and commodities and stuff like EWA, because a big decision is coming very soon – one way or the other.

Sunday, March 14, 2010

Lehman Repo 105

I don’t know if you have been following this, but the final report on Lehman Brothers’ bankruptcy was released this week and it pretty much affirms the fear that many people have that the banking system is effectively unregulated and banks are allowed to lie about the value of the assets they hold.

The Pawn Shop is Open
Repo 105 was an accounting device used by Lehman to manage its balance sheet, so that it appeared at each quarterly reporting that Lehman had a lower leverage ratio than was actually true. Basically what Lehman did was “sell” assets at the end of the quarter for more than they were actually worth, through complex accounting tricks and then promised to “buy” them back after the quarter closed to bring them back onto the balance sheet. It was done to make it look like they held fewer assets and more cash.

They did it a lot and they did it for years. They were cooking the books. Management got rich, by giving themselves bonuses based on the fraudulent numbers –

What were the regulators doing about it? Stress Tests
They kept running new less-stressful tests until Lehman qualified as a going concern.

These transactions were not disclosed on SEC filings and they were not called into question by Lehman’s auditor. These transactions were only done to misrepresent Lehman’s numbers to the markets.

We all know that this stuff is going on. Think of what Greece was doing, using Goldman to create accounting tricks to make it appear that they were not spending as much as they actually were. Think about states like California, where they are using accounting tricks like pulling revenue in from next year by making you pay 80% of this year’s taxes by June 30th (close of the fiscal year) and pushing spending out until July 1st.

From CNBC last week –

“Accounting rules require that banks write down the value of those loans on their books, and experts tell me that if banks really accounted for all the losses in the home loan market, they'd all be insolvent.

That's why the Obama Administration has created this kind of shell game in the first place.

I stole that shell game idea from housing consultant Howard Glaser: "We're spending tens of billions of dollars on a tax credit to get people to purchase homes, we're spending federal money to keep them in their homes through the modification program, and now we're going to pay them to move out of their homes. This is not a sustainable system for the housing market. It's a shell game. Bernie Madoff could have created this system," Glaser told me today.”

How many other banks are pulling this stuff? How many states and countries are using accounting tricks to appear to be solvent?

The only reason Lehman finally blew up is because they finally ran out of good assets to promise. They literally got to a point where they were using assets as collateral with other banks and the banks told them that the collateral had no value. Lehman was asked to promise other securities as collateral and when they could not offer any, there was a run on Lehman and they collapsed.

Heralded author Brian Ritholtz had this to say –

“All in all, the entire system failed. The situation is utterly disgusting, and if the investing public pulls its money out of the completely corrupt public markets for a generation or more, it would not surprise me . . .”

Let’s see if anybody actually goes to jail or has to repay bonuses over this.