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Tuesday August 28, 2007 - 10:26:50 GMT
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Ultimately a probability bet it is!

Key News
• Barclays has been left with an exposure worth several hundred million dollars to failed debt vehicles created by its investment banking arm amid growing scrutiny over its links to Sachsen LB, the failed German public sector bank.  (FT)
• The [UK] house price boom of recent years could be set to slow to a near standstill next year even assuming the credit market storm blows over. (FT)

Key Reports Due (WSJ): 
7:45a.m. ICSC Chain Store Sales Index For Aug 25. Previous: +0.2%.
8:55a.m. Redbook Retail Sales Index For Aug 25. Previous: -0.7%.
9:00a.m. Aug Richmond Fed Manufacturing Index. Previous: 4.
10:00a.m. Aug Conference Board Consumer Confidence. Expected: 105. Previous: 112.6.
5:00p.m. ABC/Wash Post Consumer Conf For Aug 26. Previous: -20.


“The indirect effects of greater uncertainty and higher volatility are more important in today’s world. Tracking the transmission of economic shocks from one country to others used to be straightforward when trade linkages were the main channel of contagion.  For example, countries with greater trade exposure to the US and/or commodity markets tend to have highly synchronized business cycles.  However, with increasing globalisation, cross-border financial links have also become an important source of transmission across the world. As a result, although direct effects of the liquidity squeeze may remain small, we should not ignore the indirect effects of greater uncertainty and higher volatility in global financial markets. In other words, market dislocations and growth fluctuations can now spread through an intertwined set of financial and economic channels that could magnify the shock.”  

                               Serhan Cevik and Katerina Kalcheva

FX Trading – Ultimately a probability bet it is! 

Cross-border financial links are much tighter in a “globalized” world, no doubt.  Thus, contagion is more than a four letter word.  When these cross-border financial links are supercharged with leverage, as they are, it’s difficult to believe we’ve seen the worst of it. 

We think the first round of risk-reduction effectively pulled the pin on many hedge fund grenades.  As these explode, the whiff of confidence we saw among the financial market Tout TV crowd—hoping, praying, and saying anything that might help their story—will likely explode too.  And of course, this crowd will blame the Fed for the woes instead of what is always the case: greed and a belief the future will somehow resemble the most recent past leading to complacency.  (This is not to say that central bank policy isn’t to some degree culpable as contributing to the crowd’s complacency.)

If I hear this mantra call of the recent past one more time I think I’m going to scream, “The dollar is going lower and gold is going higher.  Sure, gold isn’t acting like it should, but it will.  And the bargains in gold stocks are incredible.”  Scream I will not because it’s wrong.  But because of two things: the arrogance with which those who looked at a weekly chart say it, and the mindlessness of the mantra at the core.  Unfortunately, in the newsletter world one can’t escape this arrogance—it seems the general nature of a so-called “guru.”  And as the newsletter world is set up as the parent-child relationship game, arrogant “gurus” not only survive, but seem to make the most money; just I case you needed a little insult added to intellectual injury. 

Again, it’s not that the “gurus” will be necessarily wrong—it’s just that their arguments, lack of critical thinking, and seeming source of their knowledge is so flimsy for the most part.  If the future resembled the recent past we wouldn’t be in the midst of a global credit crunch.  And because we are in the midst of a credit crunch it means some things have changed.  And if some things have changed, why should there be any degree of confidence that trends that existed before things changed (which had reasons likely well beyond the grasp of most of us, though the price trend validated our rationales) will reassert themselves? 

At Black Swan we talk and write about things as if we have some knowledge of them.  This is unfortunately how we communicate our views.  And we have stepped into and will continue to step into the guru trap, for the fact that we tell a story about markets (provide our guess is all it is) in public immediately subtracts from our ability to be objective.  And it assumes we have some reliable source of knowledge.  What you don’t see is that no matter how much confidence we may exude about a particular theme—there is continuous self-doubt in us simply by the mere fact we have verbalized a story based on, themes driven by the recent past, and all the time knowing that all knowledge is flawed.  Full circle back to the criticism we just flung at so-called “gurus” who mantra-like love gold and hate the dollar—we plead guilty. 

“What should we do, I suggest, is to give up the idea of ultimate sources of knowledge, and admit that all human knowledge is human:  that it is mixed with our errors, our prejudices, our dreams, and our hopes: that all we can do is grope for truth even though it be beyond our reach.  We may admit that our grouping is often inspired, but we must be on our guard against the belief, however deeply felt, that our inspiration carries any authority divine or otherwise.”
                                  Karl Popper

This all may sound a bit psycho-babble-ish to you, and maybe it is.  But there is a point to this ramble.  And it’s this, and we need the help of one more quote to finish it:

“An edge [in trading] is nothing more than an indication of a higher probability of one thing happening over another.”

                                  Mark Douglas

No matter how we dice and slice this stuff we call speculation, or investment, it is nothing more than a probability bet.  It always has been, and it always will be. 

Ah ha!  So working from that definition, maybe the most recent past lays out the highest probability for the future?  Hmmm…maybe that’s why they call them “gurus” after all. 

One probability bet that we’ve been sharing lately is the idea that maybe the path of the British pound won’t resemble the recent past.  Lately we’ve been wrong about this.  But if the assumption that cross-border financial linkage bonds this global system together and the derivatives side of the fence is where most of the problems are emanating, than we would suggest London could get hit harder than most places. 

And if London takes it on the chin, UK growth will suffer.  If UK growth suffers, the Bank of England’s may likely cut interest rates.  Of course this rating cutting game could all be relative in a world where many central banks are racing to do the same.  But either way, it doesn’t bode well for a currency that on a purchasing power parity basis is the most overvalued of the majors. 

GBPJPY Monthly Chart: Last month, before the four letter word of contagion cascaded throughout our fair land, this pair tested its 1992 high…


Is it a decent probability bet?  Asking that simple question does what is needed: if forces us to boil it down to a yes or a no.  That’s a requirement if we want to play the game; that we know for sure. 

Jack Crooks


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