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Friday October 24, 2008 - 18:29:49 GMT
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Just when it started to look safe for a dollar correction…

Key News
• Global stocks plumbed multi-year lows as fears of a global recession mounted. London’s FTSE 100 dropped below 4,000, and there were sharp falls in Asia and across Europe. Futures pointed to a 550-point fall for the Dow. (FT)
• Key Reports Due (WSJ):
10:00a.m. Sep Existing Home Sales: Expected: +0.4%. Previous: -2.2%.

"But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime."

      Frederic Bastiat

FX Trading – Just when it started to look safe for a dollar correction…
Though we luckily have not had the experience, and the physical pain is obviously different, this move in the dollar today seems to us the psychological equivalent to being chomped on by a 20 ft. long white shark.  Blam!  Right from out of the blue depths and you are mangled even if Mr. Jaws is just playing with you.

Yesterday, we were gaining some confidence a dollar correction lower was in the cards, thought our longer term view the dollar is in a multi-year bull market remained unchanged.  No doubt, with hindsight, one of our worst short-term calls in history, among many bad short-term calls over the years.  But thankfully we didn’t have a big position—the damage is enough with a small one.  And kicking ourselves we are, as we should have known better (thought still quite happy with our emerging currency short positions against the buck).

The percentage moves in the major currencies today can represent 6-months to a year type moves in “normal” markets.   We need no other gauge to determine how much fear is out there in the world. 

As I write, stock futures in Chicago are limit down.  And that great safe haven bet we hear so much about, gold, is a lot lower again today.  Can we once and for all get off the idea that gold in a world where credit is king is primarily a liquidity-driven asset? 

Our validation for that statement is the correlation we’ve seen over the last seven years in gold and every other major asset class globally that was boosted by dollar liquidity flowing from dollar-based credit.  And the fact that we are in what the doom and gloom gurus predicted with their broken-clock theories--“financial Armageddon”--or darn close and yet their formula for success: buy gold and sell the dollar has failed miserably. 

In fact, it wasn’t too long ago when many believed commodities could only go one way—up.  Jimmy (I love China) Rogers was the biggest cheerleader of this mantra chant.  And to his credit was very right very much before anyone believed him on commodities. He gave his usual chant back in July in Vancouver. I spoke at the same conference and simply said: commodities prices do not have to go up—simple as that.  Especially in a world when demand is plunging.  I am not recounting this to toot my own horn here (well, maybe a little).  I am sharing this to show you that even the “best” gurus can get it wrong in a very big way. And if you do your simple homework on the global macros, and think of ways the consensus can be invalidated, it will help you get out of the way of steamrollers. 

In July 2008 we were all aware of the credit crunch, a key factor of confidence for us, as you know, for our dollar bull market call.  And though we were less confident then, we believed commodities were in jeopardy precisely because global demand was already being market lower at the time.  Thus, not rocket science to suggest commodities don’t have to go higher and all that money in commodities that was acting as a hedge for the inevitable dollar fall to zero would have to exit.  Again, very much part of our dollar rally call. But, chuckles from the audience there were when I said at the time commodities don’t have to go higher.

This chart we have labeled—Game Over! It shows the commodities index divided by the US dollar index on a weekly basis:

 (Chart unavailable in text format.)

The chart above, we think, depicts a sea change.  A reality based sentiment-driven sea change in the shape of the global economy and global financial system as we used to know it.  Stored wealth in the form of financial (stocks, corporate bonds, non-dollar and yen currency deposits) and real assets (houses, art, wine, coconuts) has been punished; and based on what’s happening so far today, could be punished much more.  This means it is unlikely there will be any reversal of sentiment to risk appetite in the near future and there is a good chance it could take years for it to return.  Sea changes in global financial systems can sometimes have that effect.

If we continue to be right about our long-term dollar call (always a guess no matter how much past validation to this point) we would expect that line in the chart shown above will retrace everything it gained since the great dollar bear market in late 2001 began.  And if the country to which all commodity bulls seem to have hitched their wagons—China--was to experience serious social disruption, triggered by a massive plunge in exports which in turn triggers soaring joblessness, we would expect to see the line in the chart above slice through its old lows back in early 2002 like the proverbial hot knife through butter. 

The upshot: Money, what is left, continues to flow back to the center, that market that has done most to fund these past bubbles—the US.  And despite the warts deep seated in the US economy, the buck wins by default in this game.

So, how do we make money in currencies right now?  Well, maybe the move today is overdone and if you are nimble it’s time to jump in for a bounce.  Or maybe this is the final move the dollar bears have been waiting for and represents the time to sell the doomed dollar in earnest (still a possibility if the Fed pushes rates to 0%; but keep in mind Japan’s currency trended up in price during much of the time it instituted a zero interest rate policy).  We think the long-term path of least resistance continues to be up for Mr. Greenie.  But, you can see from that mixed bag of worms analysis, we are going to play a bit of wait and see.

 Be very careful out there.

Jack Crooks
Black Swan Capital LLC


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