May 15, 2010

Market Insights - 15 May 2010

Here is the latest issue of Market Insights.  For your convenience, can also follow us on Facebook and Twitter.  In case you have questions, comments or suggestions please email: info@fxistrategies.com

In This Week's Issue
• Weekly Snapshot
• Chart Of The Week
• Weekly Barometers 
• Are We Approaching The End-Game Of The Euro?
• Finding Salvation In Gold
• Recommended Video 

Weekly Snapshot
• Gold prices hit a new all-time high climbing to $1,249 per ounce on Friday (Reuters)
• The Euro fell to 1.2359 against the US Dollar, lowest  level since November 2008 (AP)
• US Michigan consumer sentiment index rose to 73.3 in May (Bloomberg)
• US Industrial production increased 0.8 percent in April after having risen 0.2 percent in March (NBER)
• Retail and food services sales in April 2010 increased 0.4% to $366.4 billion from March (ESA)
• US Rates on 30-year mortgages hit 4.93%, lowest level in 2010 (AP)
• Euro area and EU27 GDP up by 0.2% in the first quarter of 2010 (Eurostat)
• Industrial production is up by 1.3% in the Euro area (Eurostat)
• US trade deficit in goods and services in March 2010 increased 2.5%, to $40.4 billion (ESA)
• US Senate votes 96-0 to audit Federal Reserve (LA Times)
• The US The Securities and Exchange Commission asks exchanges to devise new trading rules (Reuters)
• SEC: No evidence of a "fat finger" error by one trader that caused last week's market plunge (MarketWatch)
• Fannie Mae reported an $11.5B Q1 loss, and asked the government for another $8.4B in aid (WSJ)
• EU sets up €750bn ($1 trillion) Eurozone/IMF defense package to protect Euro from disintegration (AP)

Charts Of The Week
The Gold bulls are not just alive - they are kicking again.  Gold futures reached an all-time high of $1,249 per ounce.  Just how significant the recent rise in the Gold price has been is best seen when converting the Gold price to Euros.  On Friday, Gold broke through the €1,000 barrier for the first time ever.

Gold Price in US Dollars   Gold Price in Euro
Gold Futures   XAU-EUR

Weekly Barometers

Stock-2010-0514   FX-2010-0514
     

Are We Approaching The End-Game Of The Euro?
The demise of the Euro is just about upon us; that is the impression one can get from reading the financial news where the overall majority of economic commentators have been hammering the Euro to the proverbial death-bed.  Indeed, it has become more and more difficult to find supporters of the single currency in recent weeks.  The easy culprit is of course Greece and some of its Mediterranean neighbors who are at the center of this sovereign debt crisis which has been dragging the Euro lower and lower. 

Ultimately, the markets will decide whether the Euro is “toast” or not.  In the meantime, there are a few considerations however and before completing writing off Europe and its single currency, let us remember that every crisis also creates an opportunity.  One of these potential opportunities from a declining Euro can be seen in this week’s performance of the German Stock Market.  The DAX is up nearly 6% for the week.   Since this is so relevant and rather timely, I wanted to share some of my sentiments towards the current Euro trashing.  The following is part of an email I sent to a friend this week:

The EU certainly has its problems but I am somewhat amazed how all eyes are on Greece when our very own backyard is such a mess too. I have a long list of issues with the whole market mess but just briefly...

California is in a pile of @#$% and other states and municipalities are in big trouble too. I am also slightly amused that New York still has a AAA rating.

The Euro hit a low of 1.2359 today and it looks like will be testing the 1.2300 area which was the lowest it reached during the financial crisis. I attended a panel discussion yesterday about the very same subject.  Concerns about further bad news especially from Spain and Portugal are making it more likely that speculators will continue to push down the Euro.

But just from a trader's gut perspective, we're now approaching a hugely oversold territory on the Euro. While I'm still holding my horses, there might be an opportunity on the horizon.  When the sentiment is so bad and everyone is talking about the certain demise of the Euro, that's probably a good time to put on your contrarian hat. It was not long ago when everyone on the street said the US$ was "toast";  we know what happened since...

Looking at things from a different angle, a lower Euro bodes well for the export oriented countries in Europe not just towards the US, but also towards China.  By contrast, China's currency being pegged to the US Dollar has a slightly harder time now in terms of exporting their products to Europe at competitive prices.  The Euro fell almost 20% against the US Dollar in the past 6 months but that means the Chinese Yuan appreciated against the Euro by the same amount. 20% is a fairly big hit in terms of pricing products competitively. 

Yet another thought, China is sitting on somewhere around $2 trillion worth of US$ denominated assets (presumably much more than that as I don't trust those official stats) which are mainly in US Treasuries but also in a vast pool of foreign currency reserves.  These reserves are a problem for China and their Central Bank has been actively looking for ways to diversify such a huge one-sided risk.  The Euro at these beat-up levels is slowly looking attractive for a long-term play.  It may not be in the form of an outright currency purchase; the safer option for them might be German Bunds or Equity.

While this Euro slaughtering is going on, it may be a good time to look into other currencies which are somewhat isolated from general sovereign debt concerns.  The typical commodity currencies like Candy, Aussie and Kiwi come to mind with the Aussie Dollar leading the way in terms of a positive interest yield - central bank rates in Australia are at 4.5% now as opposed to 0.25% in the US.  But one could also look into other countries which are fundamentally in better shape possibly Norway and Singapore, maybe Korea (although I must do more homework on that).  All those are not without risk of course especially if global demand dries up. But for now, they seem a bit more attractive than a pure Euro/USD currency play.

In terms of trading these via ETFs, the major currencies are available and can be traded just like stocks.  So you don't have to lever up 100:1 and trade futures or spot currency contracts.  You can trade currency ETFs just like any other ETF via your typical online stock broker.

FXE = Euro, FXA = Aussie Dollar, FXC = Canadian Dollar to name a few.

To my knowledge, there are no ETFs for Singapore $, Norwegian Krona or Korean Won on US Exchanges (found some in the UK though), but there are entire country ETFs for Singapore (EWS) and Korea (EWY); those would be equity plays with some currency exposure built in.

It is definitely a challenge to try and make some sense of global markets these days.  Very poor visibility and plenty more volatility are almost forcing you to stay on the defense for now. Until we see some of the "fog" clearing up it's best to keep your seat belt fastened...

Finding Salvation In Gold
Not all that glitters is Gold but the most precious of all metals continues to exude its luster upon the investment community.  Volatility in financial markets, the fear of further sovereign debt issues in Europe and the possibility that the sovereign debt crisis might spread across the Atlantic has been driving up the price of Gold to new record levels this week.  As long as economic uncertainty prevails, investors will flock to the perceived safe haven assets, Gold being one of them. 

Henry Blodget of Business Insider acknowledges the great run gold has had in the past 10 years but he also expresses concern that some investors may climb on board this late in the game hinting at the precipitous gold run of the 1980’s and its sharp decline after the gold bubble burst.  As he calls it,  Gold has been “the most well advertised trade in the world”.

"But let's remember people love investments that have done well in the recent past and gold has had this tremendous run," Henry says in the accompanying segment, expressing concern about the onslaught of "buy gold!" investment ads on radio and TV.

 

Where do we stand now?  Are we near the end of the gold bull run or is this just the beginning of a much longer and more massive long-term price appreciation leading to $2,000 or even $5,000 an ounce?

Let us go back in time and look at the gold price of the past 4 decades to get a better reference point.

historic_gold

A few things to note here.  Unlike some Gold bugs may have you believe, Gold does not have a good track record as an inflation hedge.  For more than two decades, it essentially stayed in the same narrow price range generating a loss of real value compared with average inflation rates.  It was only after 2002-2003 when the precious metal took off and appreciated in value while stated inflation in the US was benign.

Let me throw in some numbers (please note these are rough averages):

The 1972 average Gold price in today's money was just under $300 whereas the 1980 average Gold price in today's money was about $2,000.  The 1990 average Gold price in today's money was $660 but it was only $370 for the year 2000.  Not much of an inflation hedge after all...

A slightly different picture emerged in the past ten years when Gold started to take off. The Gold run since 2002/2003 has been more gradual and much longer than the Bullion craze of the 1980’s.  That could hint at a more sustainable price development this time around.

Then there’s the debate about the inflation adjusted price of gold.  In today’s Dollars, the 1980’s price would be about $2,000 which is used by the Gold bugs as a rationale for the next major target; they suggest that Gold will reach at least $2000 an ounce within this decade just to be on the same page with inflation as compared to the 80’s.

Opponents of a continued Gold  rally claim the same Price Spiel in explaining the lousy track record as an inflation hedge.  Despite the worst financial crisis since the Great Depression and continued concerns over ballooning government deficits, so their argument, Gold has not provided enough of a risk diversification, all things considered. 

Last not least, there is the cost of holding gold; not a substantial one (e.g. the Gold ETF “GLD” has an expense ratio of 0.4%) but that cost also tends to rise in periods of higher inflation and higher interest rates.  Short of buying gold bullion, the cost of holding gold over the long-term can eat substantially into the inflation-hedge aspect of Gold which is something many gold buyers motivated by inflation concerns do not factor in.

For a trader, Gold has always been and continues to be an attractive commodity and “commodity” is the key word here.  Gold is not a substitute for currencies nor could governments truly go back to the traditional gold standard wherein currencies are backed by an equivalent amount of Gold.  Just to play with the numbers a bit more, the US was holding 8,133.5 tons of Gold at the end of 2009.  That amount is worth about $313bn and represents only about 2% of the US GDP - hard to imagine a gold price at which the US Dollar could truly be backed by... 

Having said that, one should consider Gold and other commodities as well as some select currencies as part of a well diversified portfolio.  How much of a percentage depends on numerous factors including personal risk profile, investment experience, net worth and investment horizon.  The average investor who is holding a substantial amount of his portfolio in typical mutual funds or market tracking ETFs such as VTI or SPY already has some exposure to Gold, commodities and currencies through companies whose profits rise and fall with the prices of these assets.  Simple examples are Oil companies or Gold Mining companies. 

In addition to the inherent exposure from the overall benchmark one should still consider these types of asset classes separately with the view of fine-tuning a balanced and well-diversified portfolio. But as Henry Blodget suggests, be careful with the “most well-advertised trade in the world”;  recalling the “Buy Land In Florida Ads” one should not blindly buy Gold thinking it could continue to rise forever.

Recommended Video 
Please consider this interesting video, a glimpse into the future of real-time research and investing.  This  new development in online technology allows you to search for specific events in the present, the past AND in the future... Enjoy!

Good luck and good investing!

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