And the Easiest Way to Buy “Stock” in China’s Growth Story

Also In Today’s Letter…

• Two Reasons Why I’m Focusing on China
• Buy “Stock” in the BRICs
• “Not Too Big to Fail…”

By Sean Hyman Many of you are familiar with the term that Goldman Sachs made so popular: BRIC.

It stands for Brazil, Russia, India and (last but not least) China. They named it and grouped these countries together because they felt that this would be the “engine of global growth” for quite some time to come.

Indeed, another Goldman employee now has another phrase: Chindonesia. It refers to the “growth triangle” of China, India and Indonesia. If you’ll notice, whatever catchphrase these guys come up with, China is always listed as part of the growth engine.

Of course, the global recession put the brakes on this China growth engine for a while. For the past year and a half, China, Brazil, India and Russia have been doing their own internal maintenance to fix their own economies. Each country has had its share of interest rate cuts, stimulus, and bailouts.

But while all four of these BRICs suffered, these powerful emerging markets have also been speeding ahead in the race to recovery. And it looks like China will get their first. In fact, in my opinion, it’s China that’s leading the global economy out of this recession. Let me explain why…

Two Reasons Why I’m Focusing On China (and the BRICs)

First of all, I let the charts show me the way in my trading and investing. Right now, all the charts are showing that China and her sister economies are already on the way to recovering…

The U.S. May Have Lead BRICs into Recession,
But China Is Leading Us Out

I love looking at charts because they show what “IS” happening.

The red/black candle chart is China’s Shanghai Composite Index and the black line chart is the U.S.’s S&P 500.

You will notice that China’s stocks bottomed way back in November (red circle) while the S&P didn’t bottom until five months later (black circle) in March. This means that China has at least a five-month head start on us in recovering.

Also, look at the strength of the trends ever since! China’s stocks almost haven’t even looked back at all. They’re running hard. That means there’s a ton of buying going on which means there’s a ton of confidence in China’s future.

Conversely, the S&P has been range bound over the last few months, at best…even after it got a “later start” to its rally than did China.

Secondly, China’s growth prospects continue to improve, while the U.S.’s growth prospects are completely nonexistent.

Which would you rather have…China’s growth expectation of 8% in 2009 and 10% in 2010 or would you rather have the U.S.’s expected 2.5% contraction?

Personally, I’d go with the growth story. By the way, that’s where all the smart money is headed right now. In other words, this is where the big institutional investors are buying.

As I’ve said many times, it helps to know where the big institutional investors are buying because then you can jump on the trend and reap the rewards.

What is “Safe?” To Me, It’s Where You Can Find Real “Growth”

Some Americans think that U.S. stocks are the only game in town. They believe that U.S. stocks are on the only “safe” investment approach is to invest solely in them.

Leaders of the BRIC Nations pose at the first Summit of the World’s Largest Emerging Economies on June 16, 2009

Of course, the last year and a half has proven them wrong. And in the absence I say that “safe” is seen by going where the growth is likely to happen. Sometimes we get a stigma here about U.S. stocks. They aren’t always the best place to be. Likewise, our currency isn’t always the place to be either.

Therefore, whether you’re an American or a prudent foreign investor, I’d give the same advice: Get a piece of the growth story that will far surpass the U.S. even once the U.S. finally does recover.

Go with the growth engine of the future (China) and not the economy that is spinning its wheels right now (the U.S.).

Buy “Stock” in BRICs

Now there are several ways to take advantage of this growth story in China and the rest of the BRIC countries.

You could buy China-based stocks, or Brazilian-focused ETFs or even ADRs on Indian stocks here in the United States. In fact, I’ve even seen a handful of ETFs that focus solely on BRIC or emerging markets.

But as you know, I’m a currency guy, so I’d rather buy “stock” in these countries overall by simply buying and holding their currencies as these countries continue to recover.

The reason?

For starters, it’s easier. If you’re buying foreign currencies, you don’t have to study specific China, Brazilian or Indian-based companies, as you would if you’re buying stocks or ADRs. You don’t have to look at P/E ratios or net asset values, or check if these foreign companies have debt in their books.

With currencies, you can make a direct investment in a country’s growth without worrying about the specifics of any one company.

Secondly, as a currency guy, I’d also like pairing the strong currencies with weaker currencies. And right now, it’s a piece of cake to pair the stronger BRIC currencies against the weaker dollar. This also has the added benefit of protecting your overall portfolio if the dollar should fall further later this year.

Bottom line: Even the charts are showing that China and her sister economies are months ahead of the United States in terms of growth. It’s time to place your bets right now on which countries you think will win this race to recovery…

Happy Trading!
Sean Hyman, aka Professor FX

P.S. We just finished a special report that tells you how to buy all four BRIC currencies with 100% principal protection. It’s the first principal-protected currency play to come out in months. And it lets you bet on the China growth story without risking a dime of your investment capital. You can get the full details on this incredible opportunity here.

Related Articles:

The Strange BRIC Story…

China’s Quiet Attack on Your Savings Continues

Why Dollar Bulls Hate BRIC Currencies

Fed Finally Says “No” to One Lender

By Chuck Butler Yesterday was a strong day in the currencies. I wrote yesterday about how the euro was inching toward 1.41, but the level had been a tough row to hoe, with the euro giving back ground each time it went higher than 1.41. And that was the case again yesterday.

The euro did trade higher than 1.41. It was 1.4120 when I left the office. But, as I turn on the screens this morning, the single unit has fallen below the 1.41 figure.

I think we’ll probably see a day when the risk aversion campers come back out to play, given the news on CIT. The government just broke the news to the lender, CIT, that they would NOT receive any Federal assistance. (I guess they didn’t have any ex-Goldman Sachs employees at CIT!).

This news has pushed stock futures down this morning. It’s also put the “risk” of yet another market-shaking bankruptcy on the table.

CIT Plummets As Fed Says “No”

Who Really Qualifies for Government Money?

You know me. I would prefer that the government stayed out of all this. So on one hand, I’m not sorry that the government is leaving CIT out in the cold. On the other hand, it really raises the question as to just what are the qualifications to receiving federal funds?

We all know Lehman Brothers, (Goldman’s biggest competitor at the time) didn’t qualify. But AIG did… Of course AIG owed Goldman a ton of money. Maybe that’s the qualification! Okay, that’s enough. Let’s move on to what this means for currencies.

So if the risk aversion campers come back out to play today, that means we could see pressure on the currencies once again. That is, unless we saw a break in the link between stocks and currencies…

If that happens, traders and investors would look at the fact that the “green shoots” are nothing but dandelions, and the U.S. fundamentals are rotten. That would cause more deficit spending, more dollar printing, more monetizing debt, and all the other things that should, fundamentally speaking, weigh heavily on the dollar!

All of the currencies, except yen, are yesterday’s highs this morning. With risk aversion back on the table, Japanese yen is rallying again. This going back and forth from one day to the next is really beginning to give me a rash! I’m tired of it!

Fed Prints Fiction: What It Means…

Did you see the results of the FOMC’s meeting minutes yesterday? In case you didn’t, the minutes read more like a novel from the fiction section of the bookstore.

The Fed revised up growth for the rest of this year and next year. Although the Fed raised their growth forecast, they raised the expected ranges for the unemployment rate through the forecast. So what I took from the minutes is that the Fed doesn’t believe the unemployment problem will begin to seriously reverse itself until 2011.

So I just don’t know where the growth will come from. And yes, I’m very well aware of the fact that labor is a lagging factor of growth. But with 1 in 5 people unemployed, I don’t see where the growth will come from… Do you?

Oh and U.S. Foreclosure filings hit a record in the first half of 2009. More than 1.5 Million properties received a default or auction notice or were seized by banks in the first six months of this year.

That’s a 15% increase from 2008’s first half… One in 84 U.S. households received a filing. But the Fed sees growth? Maybe if this data was showing a bottom. But from what I see, it looks like house prices are still searching for a bottom.

“I’d Like to Give These Economists a Piece of My Mind…”

Speaking of the Fed, I read this in the Wall Street Journal…

“More than 175 prominent economists are warning that “the independence of U.S. monetary policy is at risk” because of attacks on the Fed. They are urging Congress and the president to “avoid compromising [the U.S. central bank's] ability to manage monetary policy as it sees fit” and to refrain from politicizing its decisions on emergency loans to financial institutions.

“The move to publicly defend the Fed’s role reflects growing unease among academic economists, former Fed officials and some investors that the vehemence of the criticism from Congress of the Fed’s handling of the financial crisis suggests a readiness in Congress to weaken the freedom the Fed has to move interest rates as it see fits.”

Hmmm… I would like a list of those 175 prominent economists so I can give them a piece of my mind. While the Fed is “supposed” to be independent, its mere existence is questionable at best!

Why not let the markets decide what interest rates should be? Again, though, I won’t get into all this deeper, because, it would take over the entire letter for weeks. But it’s something to think about as we close out today…

That’s it for today… And for me, for two weeks! Yes, I’ll be gone, first to Vancouver, and then when I return, I’ll be heading down the road on vacation with my family. Before I got sick two years ago, the Butler family would pack up our camper and head to Southwest Missouri for a vacation. My kids love camping! So, it’s a week of relaxation for me. No cell phones, no laptops, no communication, as we are very deep in the Ozark Mountains! This will be the first time since I got sick two years ago, that we’ll attempt camping again. I’ll let you know how it goes.

It’s time to make this a Tub Thumpin’ Thursday!
Chuck Butler

…Just Began This Week

Also In Today’s Letter…

• Finally, “Stock-Like” Options on Exotic Currencies
• Your Checklist for Buying these NEW Currency Options
• Earthquake Hits the Kiwi: What to Expect Next…

By Ashish Advani Yesterday, I explained why the perfect storm may be forming for the Mexican peso. I told you why a recent political twist has completely changed my opinion about the peso.

But I also told you how short the peso with just released put options now available on the NASDAQ OMX (Philadelphia Stock Exchange).

But frankly these new Mexican peso options are just part of the story. In fact, the NASDAQ OMX just launched three other NEW currency options this past Monday.

This is huge folks.

The Philly Stock Exchange first introduced these “stock-like” currency options back in July 2007 – a full two years ago this month.

Now the Philly Exchange was not the first to introduce currency options, but they were the first to offer “stock-like” currency options that trade just like options on your favorite shares of IBM or Coca-Cola.

If You Can Trade Stock Options, You Can Trade These Currency Options

These “stock-like” options trade as closely to stock options as possible. You can buy these currency options at the same times as stock options every day (9-4:30 EST five days a week), have the same expiration dates (third Friday of the month), and they’re dollar-denominated, so they’re settled in dollars just like any stock option.

Just like regular stock options, your risk in buying these options is strictly limited. You only ever risk the amount you paid for the option or your “premium.” Then if your option should expire worthless, you only lose your initial investment.

Also, they’re available through any options-approved stock account. This means you don’t have to open a new account if you’re already trading stock options.

What’s exciting about currency options is such leveraged products truly have the potential for larger gains. In fact, regular retail investors have the potential to make double or triple-digit gains off such options.

In other words, you can make Forex-type gains on these options with fewer trades a year.

Finally, “Stock-Like” Options on Exotic Currencies

For the past two years, investors have only been able to buy these stock-like currency options on six currencies: the euro, pound, Swiss franc, Australian dollar, Canadian dollar, and Japanese yen. In short, you’ve only been able to buy these options on the major currencies on the NASDAQ exchange.

But now, the NASDAQ is starting to branch out. This week the NASDAQ OMX introduced call and put options on FOUR new currencies including two exotic currencies…

• Mexican Peso
• New Zealand Dollar
• South African Rand
• Swedish Krona

These options started trading this past Monday. As I mentioned yesterday, I most interested in the put options on the peso at this point. I’m watching these offerings closely to see if there are any entry points.

For your part, if you’re interested in investing in these currency options, I recommend keeping a sharp eye on the trading volumes for these currency options in the days and weeks ahead before you start playing in this expansion in the options markets.

Your Checklist for Buying Currency Options

Indeed, when you’re evaluating these new currency options, there are few things you should keep in mind including…

Duration to Expiry: You should choose currency options with maturities far out so that the currency has the time to develop the direction you choose. But remember, too much time to expiry will mean that you are paying too much for time value of the option. So choosing the right expiry date is critical.

Strike Price: It is also important to select the correct strategy for the option strike price. The strike price refers to an option’s level of execution. You could choose between In the Money, At the Money or Out of Money Options.

Premiums: You should carefully consider the premium that you are paying for any currency option. Premium consists of time value and intrinsic value.

Intrinsic value is the difference between strike price and spot price (as long as intrinsic value is not zero or negative). Total Premium – Intrinsic Value = Time Value.

Liquidity: Currency options are not as commonly traded as stock options, so you must watch the liquidity in these markets. You want greater liquidity for your option trades. Also keep in mind, often the trader who is buying or selling an option from you could be a very large brokerage or bank. So the liquidity will always be there in a traditional sense.

But since these options do not trade very frequently, you are, at times, at the mercy of the liquidity provider for option pricing. For options pricing, no one can deny you the intrinsic value of an option. But the liquidity provider can always estimate the time value. You must consider this carefully when choosing an option, which may have too much time value in it.

Again, I’m watching all four of these currency options. And I’ll be back here in FX University if I see some more opportunities arise in these options in the future. But in the meantime, take a look at these new offerings. You can learn more about them here.

Yours in FX Profits,
Ashish Advani

EDITOR’S NOTE: Just in the past nine months, our Global Currency Options have used these types of “stock-like” currency options to grab gains of 92%, 105%, 114%, 135%, and up to 213% on single currency plays. All the while, they’ve only risked the initial cost of each option contract (another serious benefit of currency options). Find out more about their option strategy here.

Related Articles:

A New Era of Currency Investing Begins…Today!

Option Envy Part I

The New Dollar-Denominated Options

What to Expect Next Down Under…

By Chuck Butler Another All-Star Game, another win for the American League… I truly believed that with Tim Lincecum going for the National League that we would win this year. But that didn’t work out…

I did truly enjoy the game though, and got to experience it with sons, Andrew, and Alex, with Darling Daughter Dawn’s husband, Jerry. A truly memorable night…

The currencies slowly moved a bit higher yesterday, and the euro is back to 1.40 this morning. The move came as stocks rebounded some, after reports of a better than expected earnings report for Goldman Sachs.

Hmmm… Now, doesn’t that just tick you off a little? Just a couple months ago, Goldman changed to a Bank Holding Co., so it could take TARP money.

Then Goldman paid it back a month ago. Now, the company prints a Moon Shot profitable earnings report.

I guess I should be happy for them. Unfortunately, I smell a rat…

It’s as if the risk aversion crowd just took their dollars and yen and went home! They are nowhere to be found this morning! The euro is pushing toward 1.41 again, which lately has been a tough row to hoe for the euro. Every time it gets close to 1.41 or even past it, albeit briefly, it comes back… So, it will be interesting today to see if the euro can add to the overnight gains.

The negativity toward the U.S. dollar and the so-called green shoots is really building steam once again.

Speaking of green shoots, we saw Retail Sales for June yesterday.

The “experts” believed the report would print at a positive .4% gain, following up May’s .5% gain. And that’s exactly what it did! Just goes to show you that no matter how bad this recession/depression is and no matter how many people are unemployed consumers will still spend!

In New Zealand: An Earthquake and an Interest Rate Guarantee

Reserve Bank of New Zealand (RBNZ) Governor Bollard just gave a speech last night.

As far as I’m concerned, his speech pretty much drives the final nail in the New Zealand rate cut coffin. Bollard’s speech was titled, “Savings, Investment, Funding Markets Are Key to Recovery.“

In the speech, Bollard really made a point of expressing his fear of reigniting the housing market. Therefore, I was sure after reading the speech that the RBNZ will NOT cut rates further, since the governor fears reigniting the housing market!

And we all know those low interest rates ignite housing bubbles!

Meanwhile, there are reports this morning of a major earthquake hitting New Zealand… 7.8 magnitude.

Once again, currencies are the great “shock absorber” market, so we’ll see this quake hit the kiwi’s price in the short-term. But afterward, it would probably be a springboard for the currency, given the re-building needed.

Aussie dollars are back to 80-cents again this morning. I’m sure there were some moves from kiwi to Aussie on the earthquake news.
The Washington Post

That’s it for today… Back to the All-Star game last night: A great moment by our catcher, Yadier Molina, getting a two-out RBI hit. And some spectacular defense by all-world player, Albert Pujols. But that was after a first inning error. Ugh! Okay. It’s over… The All-Star week is over.

OK… Then let’s make this a Wonderful Wednesday!
Chuck Butler

(Important: New Strategy Just Released Yesterday Plays This Long-Tail Currency Story)

Also In Today’s Letter…

• A Political Twist of Fate Looks to Sink the Peso
• Introducing the NEW Way to Short the Peso
• 5 Key Reasons Forex Traders Avoid the Buck

By Ashish Advani Frankly, this new currency story is a complete surprise, even to me.

While Mexico has been facing setbacks for over a year, the trouble really deepened about a little over a week ago. In short, the “real trouble” is coming from a completely unexpected political twist that could seriously harm Mexico’s recovery in the medium-term.

On top of that, Mexico is still facing the run-off from the global recession, a potential sovereign debt downgrade, lower oil prices, and a myriad of smaller issues that are coming together to create the perfect storm for both Mexico and the Mexican peso.

But on the “glass is half full side” of this story, shorting the Mexico peso this month could be one of the strongest currency plays for the next few weeks, or even months.

I may have found an interesting way to play this currency story. Just yesterday, the NASDAQ OMX, or Philadelphia Stock Exchange, launched a new currency option that lets you short the Mexican peso.

I’ll get into the specifics on their new option offerings in just a second…including the one thing you absolutely have to know about these new peso options before you buy.

But let’s examine Mexico’s troubles first…

A Political Twist of Fate

As I said, a political twist of fate threw the Mexican peso into the “sell column” for me.

Up until a week ago, President Felipe Calderón at least “appeared” to have the necessary tools and ideas to help pull Mexico through its current recession. He also had the necessary political weight to push those ideas through Mexico’s Congress.

But on July 5th, President Calderón lost his footing in Mexico’s government. The former ruling political party, the Institutional Revolutionary Party (PRI) did almost a clean sweep of Mexico’s mid-term elections.

The PRI more than doubled its seats in the lower house of Congress. The opposing party also won key seats in parts of Mexico that at least in theory were supposed to go to Calderón’s party, the National Action Party (or PAN).

This all adds to the concern that the government will struggle to raise taxes needed to narrow a swelling budget gap. This political loss increases the risk that a much needed fiscal reform will not take place soon.

For the next three years, this means it will be much more difficult for President Calderón to pass key pieces of legislation that could help Mexico’s economy. Not to mention, the opposing party now has the power to push the President out of the government altogether.

So there you are: A surprise “strike one” for Mexico’s economy and the Mexican peso.

A Sovereign Debt Debacle Waiting to Happen

For weeks now, the media has been tossing stories back and forth about how Mexico will soon lose its sovereign debt rating soon.

There has already been a war of words ensuing between the Mexican Government and the agencies about a possible downgrade.

Let’s assume for once that the media expectations are correct.

If Moodys, Standard & Poors or Fitch were to downgrade Mexico that would mean this nation would lose key institutional investors, who are only allowed to invest in sovereign-rated nations.

In other words, watch for a river of investor cash to flow out of Mexico should they lose their sovereign rating.

Really, this is just the beginning. As I said there are countless issues in Mexico causing the perfect storm for the Mexican peso right now…

Think U.S. Troubles, Only on a Grander Scale

If that wasn’t enough, Mexico is also facing the same recessionary problems we’ve been battling here in the U.S., only on a much grander scale.

Why is that? Well in a smaller economy like Mexico, smaller issues have the potential to have a much larger impact. For instance, unemployment is plaguing Mexico just as it is here in the U.S., but those unemployment numbers (while comparable to the U.S. on a population basis), have the potential to affect the Mexican peso’s price.

It’s the same with their auto sales. Right now, in Mexico auto sales are down 48%. Our sales in the U.S. are down too.

But in Mexico, auto sales are a much larger piece of the overall smaller economic pie. That means auto sales can potentially affect the peso’s price much faster than our auto sales will affect the dollar.

Also, just the sheer fact that the recession is NOT over in the U.S. is affecting Mexico.

We neighbors to the north just happen to be Mexico’s largest trading partners. In fact, the U.S. buys 85% of Mexico’s output. When we’re in trouble, we don’t buy as many of their goods. Obviously this affects Mexico’s overall GDP and import numbers.

Or in short, when we’re in trouble, they’re in trouble by extension. So is the peso.

And with oil down about 18% from its recent highs, it adds even more pressure on the peso.

Introducing the New “Short” on the Mexican Peso

As I mentioned, yesterday the NASDAQ OMX, also known as the Philadelphia Stock Exchange, introduced one of the most interesting shorting products to come out on the Mexican peso in a while.

This exchange now offers put options on the Mexican peso.

Up until yesterday, the NASDAQ OMX only offered options on six major currencies. But now they’re branching off into exotics.

As a refresher, a put option contract on a specific currency gives you the right but not the obligation to SELL a specific currency at a specific price. You buy “put options” when you believe a currency will sink over the long run.

Just as always, any currency options offered through the NASDAQ OMX are just like regular stock options. They trade at the same times as stock options every day (9:30 am – 4:00 pm EST). They’re dollar-dominated like regular stock options. And you can buy them through a regular stock options account.

We’ve written about them several times here in FX University before. So to learn more about options in general, you can refer back to my colleague, Sean Hyman’s articles on currency options here. (See Part I and Part II of his recent options series here.)

And now, the NASDAQ offers options on the Mexican peso. You can learn more about their most recent offerings here.

Now, personally I would love to make an all out recommendation for this option, but I want to offer you a word of caution first. This new option just launched yesterday, so I recommend waiting and holding off investing until the liquidity rises on this particular play. You can track the liquidity by visiting the NASDAQ OMX’s currency option site.

But the point is: The rationale behind shorting the Mexican peso is almost overwhelming at this point. And a put option could be an interesting way to play this Mexican peso story, once the liquidity rises.

Keep an eye on these new option offerings…they’re quite intriguing strategies to play currencies for the long-run.

Yours in FX Profits,
Ashish Advani

P.S. It’s not just the Mexican peso. Yesterday, the NASDAQ OMX launched three additional new currency options. I’ll be back tomorrow with the full story on these three newbies in the option world. Also, to all my Global Currency Option subscribers: I’m closely watching all these new option offerings. I will be back to you soon with the right recommendation, with all the details you need to buy puts and calls on these new options when I believe the time is right.

5 Key Reasons Forex Traders Avoid the Buck

By Sean Hyman Sometimes the most strategic currency play is to completely avoid the dollar…yes, even when you’re Forex trading.

In fact, there are several key reasons why Forex traders like to avoid the dollar and trade what are called “crosses” instead.

Crosses (aka “cross-rates”) are any currency pair that doesn’t involve the dollar. Crosses include currency pairs like the EUR/JPY (euro/Japanese yen), EUR/GBP (euro/British pound), or GBP/CHF (British pound/Swiss franc).

There are several key reasons why you want might want to follow their lead…

1. The U.S. dollar may be the world’s reserve currency, but that also means that countless tiny factors play into the buck’s value. Interest rates, major political moves, not to mention global events in all corners of the world can send money rushing for (or away from) the buck. For that reason, many traders have a hard time getting a “feel” for where the U.S. dollar is heading. So rather than playing a guessing game, they simply avoid the buck altogether.

2. Some crosses can be more volatile. That means they have the potential to jump higher or fall farther faster. Some traders like these types of quick movement because it gives you more opportunities for larger gains. This is why they have a love for pairs like GBP/JPY, which trade about 100 pips more a day than a “major” pair like EUR/USD.

3. Others like to technically trade crosses because they don’t have as much impact as dollar pairs often do. You see, U.S. news is the biggest mover of currency pairs. So if you want to trade off of technical signals from the charts and not get as many surprises from news announcements, then you can trade the crosses.

4. Spreads are narrowing for cross rates more and more all of the time. (This is important because remember Forex dealers charge you the spread between each trade as their fee.) There was a day when the only reasonable spreads out there were in the majors. However, many cross rates have spreads between their buy/sell quotes that are half of what they were just a couple of years ago. As volumes increase in these crosses, the spreads narrow and draw even more traders into the pairs. So what once was a roadblock to some traders is no longer a problem.

5. Trading crosses offers more of a diverse trading portfolio than just trading EUR/USD, GBP/USD, USD/CHF, etc. If the dollar moves in a huge way, it’s going to affect all of those pairs even though they have other foreign currencies involved. However, if you have EUR/USD and GBP/JPY and you get a “dollar event” that moves EUR/USD, it doesn’t necessarily directly affect GBP/JPY. Therefore, you’ve diversified your risks.

I’ll be back soon with more Forex-trading tips. Until then…

Happy Trading!
Sean Hyman, aka Professor FX

…Courtesy of Russia’s President

Also In Today’s Letter…

• Dollar Leads with Risk Aversion Back in the Markets
• “If I Had My Way, We’d Keep the World’s Reserve Currency”
• FX 101: Why Currencies Hate Quantitative Easing

By Chuck Butler I hit the snooze button again, so I’m writing from home this morning. Then I’ll shoot into work. We’re a bit short handed this week, so I’m sure everyone will arrive at the office, not see my car, and be a little panicked.

But I’ve got a surprise for them, something they’ve never seen before… Me coming in late!

Well it looks like risk is under pressure once again. That means foreign currencies are under pressure as we kick off this week’s trading. The only thing I can see that’s causing this risk aversion is the corporate earnings season.

For instance, four different banks are reporting their numbers this week. That includes Goldman (yes, remember they’re a bank holding company now… The ex-chief, and ex-Treasury Sec. Paulson, made sure that the change was made so that Goldman would qualify for TARP last year!) We also have JP Morgan, Bank of America, and Citigroup…

Data wise, there are a few top-shelf reports out this week. Just the idea that these reports will show more dandelions than green shoots is probably wearing heavily on the risk assets this morning too.

Dollar Leads with Risk Aversion Back

As I write, the euro is sitting just below 1.40 at 1.3985, so no real harm is being done at this time. But still the bias is to sell the risk assets like currencies and commodities as we start the week.

You know, I’ve harped about this for so long now, that I sound like a broken record (or a scratched CD for the younger crowd). I’m talking about the fact that risk assets like currencies and commodities are swimming in the same barrel with stocks.

For months, I’ve been hopin’ we would return to the fundamentals. In a “normal” market, these asset classes have VERY little in common with the stocks.

But of course, this is NOT a normal market. As such, stocks are tied to the majority of foreign currencies for the time being. And I’ve known for a while now that stocks were going to be under pressure from the corporate earnings season. With that “link” still in place, the majority of commodities and currencies would suffer right along with stocks.

Key Data Points to Watch This Week Before You Trade

The one piece of data we get today is the Budget Statement…

Last month, the Budget Statement printed an awful deficit of -$189.7 Billion (May). Historically, June prints at a surplus. But, April is usually a surplus too, and April was nowhere near a surplus this year!

Year-to-date receipts for the government are down 18%, and year-to-date outlays are up 19%. That doesn’t bode well for “history to come into play here.”

Last Thursday, the Weekly Initial Jobless Claims printed the lowest level for this data series in more than six months. The number came in at less than 600,000! But still, the number is still staggering. That’s one reason why commercial construction in the U.S. is set to decline 16% this year, followed by a 12% fall in 2010.

No jobs = no need to build offices for the “ghost jobs’ that the BLS adds each month, because…they don’t exist.

No need to get me started on the BLS (Bureau of Labor Statistics) this morning. I have to be clear and concise to get this out the door and me off to work!

Well with the risk aversion back on the table… The two main beneficiaries are still the Japanese yen and the U.S. dollar. Swiss francs are on the “kids table” but still a part of the beneficiary crowd…

The risk aversion crowd is taking the traditional high-yielding currencies to the woodshed. That includes the Aussie, kiwi (New Zealand dollar), and South African rand. The Brazilian real is seeing a bias to sell, but for the most part has hung in there.

The Real Reason Russia’s President Carries a “World Reserve” Coin

Did you hear that Russian President Medvedev, showed off the “new world currency coin” at the G-8 meeting last week? He also said…

“We are discussing both the use of other national currencies, including the ruble, as a reserve currency, as well as supranational currencies. So here it is! This is a symbol of our unity and our desire to settle such issues jointly.”

He then pulled a new coin out of his pocket and displayed it to the attendees. Now, don’t get all tied up and twisted at this point. This was simply a “symbolic” move.

Of course, there aren’t mints all over the world rushing to get these coins minted and out the door. But, if you get the “symbolic” part, then you understand what Medvedev was attempting to do here. He was simply showing the G-8 attendees that if they really thought about it, they could see the need to move from a dollar reserve system.

To help them visualize it, he had a coin to pass around!

I can’t believe that right now, with the whispering campaign to get an alternative reserve currency that the dollar isn’t getting sold today. I guess the whispering will have to get louder, for this to make any real waves….

If I Had My Way, We Would Keep the World’s Reserve Currency

You know, I’m not for this “global currency.”

I’m not for removing the dollar as the reserve currency, because I know all of the “perks” we enjoy by carrying the reserve currency! I’m just here to give you my take on what’s happening… And unfortunately all this noise about a new world reserve currency is happening.

I do believe, however, that given our deficit spending, and our ever–growing National Debt, that the dollar deserves to be whacked. That’s just how things are done.

Treasuries will get their comeuppance too one day. You can’t just keep printing and printing and thinking that “buyers” will be there at the bond auctions every time you print more.

That’s it for today… I went to the Futures Game yesterday, to sit through a four-hour rain delay. Ugh! Let’s hope the rain stays away for the next two days! Home Run Derby tonight, All-Star Game tomorrow night.

The family is all going to the Fan-Fest today, while I’m at work. Well, somebody has to work, right? My beloved Cardinals went into the All-Star Game break on a good note, winning 6 of 10 on the road trip to end the 1st half of the season.

This will be a very busy week for me, lots of writing to get done, and all the All-Star festivities. I go to my new oncologist this afternoon for the results of my scans on Friday, so all that and doctors stuff on top! Ugh! Oh well, next week I’m off to Vancouver and then I head off to vacation! So busy, busy, busy. Okay, time to go.

Hope your Monday is absolutely Marvelous, I tell you!
Chuck Butler

EDITOR’S NOTE: Leaders from the BRIC countries have been making noise for months that they want another, stronger world’s reserve currency. In fact, Russian President Medvedev’s comments at the G-8 meeting are just the most recent in a long line of “anti-dollar” sentiments. You can get the full story on these latest verbal threats to the dollar here.

By Ashish Advani Here in FX University, my colleagues and I often rail against Quantitative Easing (QE) and say it’s bad for currencies. But do we all understand why that is so?

One of my paid subscribers just asked me how QE can be so bad for a currency when it forces liquidity into the markets (more dollars to stimulate the economy). This got me thinking. So I started surfing the Internet to see how other outlets explain QE. Here’s a snapshot of what I found below…

Investopedia describes Quantitative Easing as …

“A government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.”

Investopedia explains QE as…

“Central banks tend to use quantitative easing when interest rates have already been lowered to near 0% levels and have failed to produce the desired effect. The major risk of quantitative easing is that although more money is floating around, there is still a fixed amount of goods for sale. This will eventually lead to higher prices or inflation.”

Meanwhile, Wikipedia says…

“The term quantitative easing describes an extreme form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero.

“Normally, a central bank stimulates the economy indirectly by lowering interest rates but when it cannot lower them any further it can attempt to seed the financial system with new money through quantitative easing.

“In practical terms, the central bank purchases financial assets, including treasuries and corporate bonds, from financial institutions (such as banks) using money it has created ex nihilo (out of nothing). This process is called open market operations. The creation of this new money is supposed to seed the increase in the overall money supply through deposit multiplication by encouraging lending by these institutions and reducing the cost of borrowing, thereby stimulating the economy. However, there is a risk that banks will still refuse to lend despite the increase in their deposits, and in a worst case scenario, possibly lead to hyperinflation.

“Quantitative easing is sometimes described as ‘printing money’, although the central bank actually creates it electronically by increasing the credit in its own bank account.”

From my perspective, the Wikipedia definition above is quite accurate. Now let’s understand what it means…

In normal times, central banks ease and tighten credit and monetary supply in the economy through increasing / decreasing interest rates. But that’s not really quantitative easing. This is standard monetary policy.

However, in times of crisis (like now) the U.S. monetary policy is at a standstill because interest rates are at near zero levels. In Europe rates are still at 1% so there is still some room. But when a central bank cannot stimulate growth using monetary policy, it has to resort to QE.

In a simple analogy, if a company is worth $100 and has 100 shares outstanding. The value of each share is $1. Now the company decides to print and circulate an additional 100 shares. What will happen to the value of each share? It will drop in half, right?

Similarly at times of QE, central banks create money out of thin air and circulate it in the economy. But the net value of the county has remained the same.

So the value of each dollar before and after the printing event will change and the value of the dollar will drop. That’s why QE is bad for the value of a currency. It leads to inflation as too many dollars are chasing the same amount of goods and services.

Any central bank that implements QE is basically agreeing to let the currency value fall. QE can never be good for the currency, ever…

Yours in FX Profits,
Ashish Advani

Related Articles:

Fed-Head Confirms: We’ll Have 0% Interest Rates for Years

The War on Deflation

If I Tried This, I’d Go to Jail…

One of my subscribers posed the following question to me:

“I’ve read analysis on the outlook on the AUD gaining strength as China grows. Australia supplies a lot of the commodities that China consumes. So it is logical the Australian Economy will grow and the AUD will strengthen. On a fundamental basis, I agree with the analysis.

“However, on a Chinese cultural basis, the assessment may be off somewhat. It is my understanding that the average Chinese person saves a considerable amount of their income. This would impede an economic recovery led by an internal stimulus. The Chinese economy is export driven, and not domestically driven.

“Therefore, I believe that the Chinese “recovery” will take longer than anticipated, thus driving the AUD lower. I could be wrong about the Chinese exports recovering, if the consumer demand in Brazil and South America pick up…a lot! I don’t see that happening on the scale that the US imported from China, however.

So how do you bridge the gap between a potential AUD rise and the slow recovery that is expected?”

How Will the China Story Affect the Aussie Dollar?

I thought this was a great question to share my answer with you dear readers. Here’s my response…

Dear Joe,

I see the reconciliation of the diverging views on the Aussie dollar as one of timing here. I have had several spirited discussions on this very issue.
Here are my thoughts on that very issue…based on my several visits to China. And these visits were deep into the heartland rather than staying in 5-star hotels in Shanghai /Beijing and back…

China is undergoing a sea change in its growth story. While exports are still going to remain a bulk of their growth story for now, the trend is weakening. Internal consumption has been on the rise. Savings has been the norm for a few generations but this is gradually shifting. I strongly believe that China will lead the world out of this recession (and George Soros on NPR said very much the same this week).

The Chinese growth story is much smaller than the U.S. Consumer (about 1/3rd in size) but it is growing. So the recovery will be slow as a smaller engine is pulling the global economy out of the rut. But when you add India – you have another small engine pulling along, and suddenly the small China engine has a companion. I believe this combined engine will lead the world out of its current recession.

Albeit, it will be slow and gradual and not a “V” shaped recovery as the stock jockeys would like to project.

Now as far as direction of Aussie dollar is concerned, it may gyrate in the near-term but in the longer term, if you can believe the China/India growth story, then we are going to see strong growth in Australia and the Aussie dollar. All this is over and above what the U.S. Government and Treasury policies are doing to debase the US Dollar which would increase the values of all other currencies by default.

Hope that clarifies the question!

Back in the day when I was a stock trader, I became accustomed to how stock shares were quoted. When you bought or sold something, you were always buying only one asset. (For instance, companies like IBM, Google, GE, etc.).

However, when I came over to the currency market, I noticed right away that currencies were quoted differently. Suddenly, instead of buying or selling single companies, I was buying “pairs” of currencies.
At first, I didn’t understand why.

But as with every first-time Forex trader, I was thrown into the deep end of the pool and I quickly learned to swim. I came to understand very quickly how currency pairs work.

Basically, when you’re buying a currency pair, you’re simply buying one currency and selling another.

So if you’re “buying the EUR/USD” you’re really buying the euro, and selling the dollar because you believe the euro will rise against the dollar. If you’re “selling the EUR/USD,” you’re really selling the euro and buying the dollar, because you believe the euro will drop against the dollar.

Easy right?

Even more than that, I realized that every asset is a paired trade when you think about it. For instance, when you buy Google’s stock, it’s really like buying the “GOOG/USD” pair. Why? Because you’re betting that Google will rise much more than just holding dollars or depositing your dollars into a savings account.

So say you believe Google’s stock will rise. This means you also believe that buying Google’s stock is a better investment than simply holding your cash in a savings account. As such, you exchange your dollars for Google’s stock.

In the same way, you value a currency by comparing it to what you think another currency is worth. After all, the dollar could perform one way vs. the euro (EUR/USD) and a totally other way vs. the Japanese yen (USD/JPY).

It’s Simple: Put your Money into the “Best Currency vs. the Worst Currency!”

It’s entirely possible that the dollar could lose value when compared to the euro but gain value when compared to the yen, for instance.

So the dollar’s strength is measured by its strength against another currency. In other words, a currency’s strength is determined by how much of another currency it could buy at the time. If your dollar can buy more foreign currency today than you could yesterday, then your dollar is stronger. If not, it’s weaker.

Always Pair the Strong with the Weak…

Therefore, currencies are a “pairing game.” You always want pair the absolutely strongest currency with the poorest performing currency.

As I often say, “If I could rig a boxing match, I’d want to put the strongest fighter vs. the weakest fighter. Then I would bet on the stronger fighter.”

Well, that’s exactly what we’re doing with currencies.

Some traders determine the “strongest fighter” by looking to the charts to see how well a currency is performing (trending) vs. other major currencies. Yet other traders will look to see which country has the best fundamentals overall and which has the poorest.

No matter what your strategy, you do need to have an opinion. Not only that, you need to have a “strong opinion” on the pair you choose. This will keep you from bailing out of a trade too soon if the long-term trend is still in place.

Time to Choose Sides: Are You Playing Offense or Defense?

Right now, there are “two sides” of economic thought in the Forex market. On one side of the fence, we have traders who believe deflation will carry on and central banks and governments of the world can’t possibly pull us out of it anytime soon.

Those traders are the ones who feel their “strongest currencies” are the dollar and yen vs. most other foreign currencies (especially higher yielding currencies that have the most to move down in interest rates like Australia or New Zealand).

In other words, these traders are now shorting the AUD/USD, AUD/JPY, NZD/USD and NZD/JPY pairs since they feel that the deflation will draw people to the dollar and yen and away from the “high yielders.”

On One Side: Move Aside Recession!

On the other side of the fence, traders believe inflation is returning and that the global economy is on the mend.

They feel that we are past the trough of the global recession and we’re working our way out back into expansionary/inflationary mode and away from deflation and an economic contraction.

These traders are buying the countries with the highest inflation rates (again, like Australia, New Zealand and the U.K.) vs. the defensive plays of the dollar and yen.

So they’re buying pairs like AUD/USD, AUD/JPY, GBP/USD, GBP/JPY, NZD/USD and NZD/JPY for instance.

My View: You Can Always Count on the Government
to Print Their Way Out of Trouble

It will be a while before we see which side wins. Personally, the way I see the fundamental data tilting, it’s all tilting towards the latter crowd rather than the former crowd.

However, whichever side you’re on, if you have an opinion about where the world economy is headed, then you have an opinion you can play in the Forex market with specific currency pairs.

Remember, you always want to “rig the fight” by putting your strongest candidate against what you feel is your “worst candidate” in the currency market. By doing this, you will put yourself in the best position to profit as your worldview plays out.

EDITOR’S NOTE: Now is your chance to learn all the ins and outs of trading currency pairs. This past April, three currency experts explained all their most closely guarded secrets to trading both major and exotic plays to a packed house in video. The good news? We were there recording this whole Three-Hour Currency Crash Course. You can secure your copy here.