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Wednesday December 26, 2007 - 13:34:28 GMT
Black Swan Capital - www.blackswantrading.com

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Prices do fluctuate ...

FX Trading – Prices do fluctuate…
We maintain the visceral belief that all prices are flawed because said prices are based on flawed future expectations.  Future expectations are flawed because people, at least those of the financial persuasion, cannot predict the future.  And we believe all fundamentals are not only fleeting, but are also impacted by price, in a nasty little feedback loop.  Yes, the same price that we are trying to forecast based on the fundamentals.

This bit of logic circle is why we consider trading nothing more than a probability bet. And if you are making probability bets, it’s always good to have alternative scenarios lingering somewhere in your head to allow for a modicum of flexibility when the market shouts “you’re wrong.”

Yet, given our skepticism about prices in general, we sure can’t think of a better way.  Markets are the best we can get—and the freer the better.  Unfortunately we have to be happy with quasi-free, because our institutions are made to meddle.  And though we realize when everyone recognizes a problem, we’ve probably seen the worst of it i.e. which represents the essence of discounting that is reflected in prices of free markets, one wonders when viewing charts like the one we noticed recently, shown below, if most of the discounting is done, or if there is yet another big shoe to drop:

[Chart not available in text format]
 
Source: Robert Folsom, Elliot Wave International

If there is another shoe to drop, we would think it might fall from the hedge fund crowd.  The major banks are coming clean, though there may be more surprises.  But the major hedge funds a.k.a. “masters of the universe,” are surprisingly quiet.  Maybe fund managers are less herd-like and a lot smarter than we realize. 

Robert Folsum added these comments to the chart shown above:

“We all understand that the value of ‘paper assets’ is inherently unstable, because that value is subject to very rapid up-and-down swings, a.k.a. bubbles.

“So, when paper assets are a relatively small percentage (5% or less of GDP) of national wealth, the economy won't be badly damaged if that small percentage fluctuates widely.

“But -- when paper assets rapidly increase to the levels of recent years (20% or more of GDP), well, a bubble that swells... and then deflates... can wreak economic havoc. That scenario is unfolding right now in the real estate market, and among lenders who ‘spread around the risk’ to every corner (and under every rug) in the entire financial system.”

We agree that paper has spread risk to ever corner of the financial system.  But we disagree that paper has added volatility or instability and is “inherently unstable.”  Stuff, or real assets, which are still controlled by nature has proven very unstable over the years.  It’s why those economies least dependent of stuff have become most stable or less volatile.  In fact, it seems the explosion of paper, and the revolution of consumer finance, has added more stability, if one measures in terms of GDP.    Business cycles have been sanguine for a while now and we think paper has a lot to do with it.  But are there limits to this and are we, or have we, reached those limits?

 We can only guess.  But we do know that the ebb and flow between a “yes” and “no” answer to the question of whether or not we’ve reach limits of paper is presenting us with some very good currency trading opportunities—assuming of course we stay flexible. 

This week, the market is acting as though paper is still a good thing.  Mr. Market seems happy central banks have dumped hundreds of billions more into the system.  And when Mr. Market is happy, as we said on Monday (Bull Market in Stocks = Bear Market in the US$), the US$ is sold.  [Note: Deep down we know it’s never that simple.  But sometimes it’s best to keep it simple when you can’t find anything better to hang your hat on.]

But it is eggnog season.  And there is likely a very-not-so-merry-vested hedge fund interest out there that prefers to push balance sheet explosion activity into 2008. 

So, if you don’t like prices now, just stay tuned—they do fluctuate.

Jack Crooks
Black Swan Capital

 

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