Tuesday June 21, 2005 - 11:27:26 GMT
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Black Swan Capital - www.blackswantrading.com
Euro: A selling opportunity or overdone?
“If a man can see both sides of a problem, you know that none of his money is tied up in it.”
After a 50-basis point rate cut from the Swedish central bank, traders now believe the euro will test its recent lows at the 1.20-level. Maybe! And maybe more! The yield differential favoring the dollar continues to grow; it seems the key driver here.
But the idea the ECB may cut interest rates soon should be no surprise given the economic backdrop in Europe. So, is this a setup for euro rally? Or is it another selling opportunity?
We have been expecting a euro rally/bounce—only to be stymied on the fiercely negative euro sentiment. (The open interest level in the euro future, traded in Chicago, has jumped by over 40,000 contracts in the last two sessions alone.)
We don’t wish to overstate the simple technical view—as the self-feeding nature of currency markets has a way of looking past anything technical. “Overbought” and “oversold” are simply relative terms at a point in time. As we said yesterday, we may be lurching into a virtuous circle for the dollar. Or we could simply have moved into “Capitulation to the trend” in our Currency Life Cycle guide, as laid out below (from Currency Currents 1/14/05):
1. Extreme bearishness—this is the stage where “shoe shine boys” are shorting the currency and can articulate the rationale to anyone and everyone who will listen. This is when things seem the most bearish, but are in reality most bullish (as later can be seen with the elusive gift of hindsight).
2. Conversion flow—this is the stage when bears start to question their “so obvious” rationale for being short. It is the stage where the flaw in perception of the crowd begins to be recognized by members of the crowd. Conversion flow has an early stage and a more advanced stage. It is why we see increased volatility when the trend changes. The players begin to realize something has changed. But they realize it at different times.
3. Perception of the trend—this is the stage where the crowd recognizes that a new trend may be underway. They have discarded the old rationale and are beginning to accept the new one.
4. Capitulation to the trend—now the trend is fully underway. The crotchety old diehard bears can’t hold out hope any longer—they capitulate and buy into the new trend. Often this is a sign that the new trend is actually becoming a bit stale, for now even the diehards are along for the ride.
5. Extreme bullishness—now the “shoe shine boys” are buying the currency and are articulating the rationale to anyone and everyone who will listen. This is when things seem the most bullish, but are in reality most bearish.
We were told in a Bloomberg story recently, that US dollar perma-bear Mr. Warren Buffet has still not capitulated—he is hanging tough with his reported $21 billion (with a b) short position in the greenback. It doesn’t make sense for Mr. Buffet to telegraph his exit. But we would expect some public announcement once his position is liquidated. Then we would know we are well into stage 4 Capitulation.
For now, we are remaining open to our view the euro bounces in here—but it better start soon or Mr. Buffet and others may just change their minds.
Black Swan Capital
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