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Thursday December 15, 2005 - 11:25:36 GMT
Black Swan Capital -

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“And when we think we lead, we are most led.”

Lord Byron

FX Trading
Two former tried and true one-way bets are now moving the other way together—gold and $-yen, as you can clearly see in the chart below:

Does it mean the rationales so easily provided by those in the know are also falling by the wayside or is this just a “technical correction” to remove some speculative froth?

For the mathematically inclined in the crowd, the equation goes something like this:

Price Extremes = Consensus Extremes + Speculative Extremes

Two major consensus extremes in yen and gold, respectively, were:

• Japan won’t hike rates till late in 2006 and money flow from Japan to higher yielding currencies means the yen stays weak
• There is massive inflation in the system and gold is reflecting the decline in the purchasing power of all currencies

The speculative extremes were apparent in the open interest numbers (he says with the gift of hindsight).

We’ve seen oil prices crushed on rationales that were at least as solid as those in gold and the yen—even more so to the believers. But, as they say, the jury is still out. A lot of smart people believe crude will make another major run. And the Peak Oil crowd is alive and well, even though they have a bit less cash in their pockets.

Multi-day, multi-week, and multi-month corrections are always to be expected during the big moves—which are measured in years. It is the magic of the market—it shakes us out of “good” trades where we lack conviction. And in leverage markets, out wallets usually reflect much of said conviction.

“Hence the excruciating paradox of financial markets, that sentiment is most bullish at the peaks when prices have only one way to go which is down; and most bearish at troughs vice versa: at the top there’s no one left to buy, and at the bottom on one left to sell. This paradox is absolutely central to the working of all financial markets and we need all the help we can get to understand it so thoroughly that it becomes part of our nature. The more bullish things are, the more bearish they are”

John Percival, editor of the Currency Bulletin

As said, these excruciating paradoxes operate in fractal time frames, if you will. Otherwise this stuff would be way too easy. There would be no need for the plethora of analysts (if only wishing could make it so) constantly telling us “why” something happened—usually with a great degree of confidence after the fact. But think of them this way, they too are part of the process as they help create the flawed rationales to build speculative consensus leading to extreme speculation and extreme prices that allow us to potentially profit.

This ramble is leading to a point, I hope. It goes to what George Soros has said many times—and as mad as this makes my learned economist friends, here goes:

“I contend that market valuations are always distorted: moreover—and this is the crucial departure from equilibrium theory—the distortions can affect the underlying values.”

Why are they always distorted? Market valuations are based on the “participants’ bias.”

“People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations and constantly changing outcomes. The process is reflexive,” according to Mr. Soros.

And in what asset class at the moment does there seem a strong, if not extreme, consensus? We would argue the stock market. Stay tuned.

Jack Crooks
Black Swan Capital


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