Gold Is A Currency Trade

So hopefully it is fairly obvious that we are in deflation or at least disinflation.  If that isn’t obvious enough then read our previous posts.  If nothing else you will see that it has been our view since at least June of 2009 is that we are in deflation.  That being said we are currently long gold.  Some of you might be thinking that we must be smoking crack, after all how can we be long gold if we dont see inflation anytime soon.  Because of the general perception that gold is an inflation trade we thought it would be useful to look at the current situation.

Currently the situation in Europe is pretty bad.  The EU is essentially in complete disarray as new problems seem to surface every couple of weeks.  Everyone but the EU knew that the PIIGS had problems but now Hungary, Belgium, and even France are coming up in the news as problem areas.   We are seeing currency issues, debt issues, liquidity issues, structural issues, etc.  The EU right now is like the Lindsay Lohan of regimes with all of its issues.  All of this adds up to what is the largest fear, a sovereign default.  If this were to happen, or when it happens we will see some major turmoil across all markets.

So what are investors doing right now?  The have been fleeing the Euro and Euro denominated assets.  No one wants EU based stocks, bonds, or the Euro.  As they leave the Euro they have been going into the US Dollar, US Treasuries, and into gold.  Yes, they are leaving the Euro to buy gold.  While investors across the world have been buying gold the trend has been especially obvious in the EU and its neighbors.  We can see this in the following charts.

Here is GLD the gold ETF.  As you can see it has been steadily moving higher but only recently started hitting new highs as it sold off back in December and took a long time to consolidate.



For real evidence that gold is going up on worries of a sovereign default we need to look at gold priced in Euros.  As you can see in the chart below gold in Euros consolidated but has barely even pulled back during the past year and has really accelerated to the upside over the last few months.

Gold in Euros


Being very tied to the mainland Europe, and having a weak economy as well many UK investors have also been buying gold to get out of Pounds.  While not quite the move of the Gold/EUR this has been a strong and steady move.

Gold in Pounds


Finally lets look at gold in Swiss Francs.  As you an see the trend has been pretty much the same with a steady move higher and very tight consolidation.  One thing worth noting with the Swiss Franc is that in a normal crisis investors would be taking their money out of their regular bank and putting it in Swiss banks.  This time around Switzerland gave up their role as the ultimate bank by giving away their client list to the I.R.S.  We think that Swiss Banks will be looking back and shaking their heads at that move.  This is not the only reason (the Swiss want a weak currency for example) for the relatively poor performance of the Swissy but it does not help, especially in the long term.

Gold in Swiss Francs


Comparing gold in US Dollars to gold in European currencies it is obvious that people want out of the Euro and see gold as a reasonable substitute.  Hopefully this helps answer why gold can be a good investment even if we are in a deflationary environment.

Happy Trading,

Disclaimer-We are long GLD

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Is The Rise In LIBOR Due To Liquidity or Growth?

With the recent rise in LIBOR we have been reading a lot of concerns over what it all means.  The two main arguments that we have seen is that either it is due to liquidity concerns or it is due to the supposed recovery in the United States economy.  For many reasons we obviously fall on the side of this being led by fear and liquidity rather than due to a recovery and an expectation of the Fed raising rates anytime soon.

3-Month LIBOR


The first thing that would lead us to assume that this is due to panic and not recovery is the way in which LIBOR is rising.  What we mean is that if you compare it to T-Bills it usually trades very much in line except in times of fear.  Looking at the chart below you can see that the last three times that it has diverged was also when we had banking system fears.  The top in the summer of 2007 which kind of started off the whole mess, fall of 2008 when the world seemed to be falling apart in front of us, and then in late winter 2009 when we already had the ZIRP in place but it looked like things might be getting even worse.  Of course once things got back on track and the end of the world as we know it was at least postponed the relationship got back in line with LIBOR at a slight premium to T-Bills like regular times.  Another thing that we find odd is that if LIBOR is rising on a recovery then why aren’t T-Bill or  2-Year Treasury yields climbing?  Would bond investors not drive yields higher if they thought this recovery had legs?

3-Month LIBOR and T-Bills


Looking at other money market spreads shows much of the same thing.  Namely that spreads are going up, this by the way is usually not a good thing.  Looking at the TED spread, LIBOR-OIS spread, and 90-day commercial paper-T-Bill spread you can see that they have all been climbing since the Greece and EU problems really started to gain some attention.

Money Market Spreads


Now lets look at some spreads in other nations.  It should come as no surprise that they are also on the rise.  In the first chart we have the EURIBOR-OIS spread, after spiking higher it has continued to inch its way basis point by basis point wider and wider.



Next up is the TIBOR-OIS spread.  As you can see it is also rising although a lot slower then in the US or in the EU.  As we will see in a few charts however that is how it always is.



Finally we have the UK LIBOR-OIS spread. Again it should not be much a surprise that it too has been climbing quite a bit.  The UK is weak and its nearest mega-economy the EU is weaker.  Banks are and should be scared.



Looking at the three spreads over the last few years you can see in the chart below that the global banking crisis affects them all.  Another thing worth noting is that Japans spread (the yellow line) may be rising slower but the swings have been far more muted the whole time.  Of course Japan has been dealing with a broken banking system for almost two decades now.



We will end this post with one last indicator that we follow closely and that is the VIX.  This volatility index is simply an average of stock, bond, currency, and commodity volatility indexes.  If most asset classes are seeing an increase in volatility it rises and if most are declining it goes down.  As you can see in the chart below it has been going up the last few months as many market participants are once again focusing on risks.

Average VIX


In closing we have many concerns in our current situation.  Some pundits claim that markets are headed higher and that we are under estimating the recovery.  They say that everyone is too worried and that the fundamentals are strong.  We apparently are looking through an entirely different lens.  With the EU continuing to deteriorate we cant help but wonder how investors can look at the rise in LIBOR as anything but bad.  While Greece is indeed a small nation the Euro is what is at stake.  Yes, the same Euro which is probably the biggest economic experiment of the last 30+ years.  In addition to the EU we have “regular” geo-political concerns as well like Iran, the Korea’s, and our future energy supply.  So while we could of course go higher we definitely should be concerned.

Happy Trading,

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Charts That Make You Go Hmm…

10-Yr Swap Spreads hit their lowest level since 1988 on 3/9/10 hitting 3.25.  How many more days until they go negative? (Click on chart to enlarge)

10-Yr Swap Spread


Go short Treasuries, its the most obvious trade ever right?  While they might go up or down the MOVE Index continues to forecast less and less volatility, which at least to us indicates that the market is not expecting yields to change a whole lot anytime soon. (Click on chart to enlarge)

MOVE Index


Not sure if Chanos is right on China being in a huge bubble, but looking at the chart it appears as though at least a few investors are less than bullish. (Click on chart to enlarge)



We just crossed the one year anniversary of the current rally/bull market the other day.  Over that time on a weekly closing basis the SP500 is up over 66%.  This has been the largest one year rally in over 60 years.  We are starting to hedge our long exposure as we are currently cautiously bullish. (Click on chart to enlarge)

SP500 1-Yr Rolling Returns


Back in December we shorted the Euro on the basis of the EU being weak, overvalued, and sentiment becoming far too one sided.  In these pages we also looked at buying the USD on a technical basis. Looking at the USD and T-Bills however shows another reason for the USD rally. (Click on chart to enlarge)

US Dollar and T-Bill Yield


Happy Trading,

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The Euro Revisited

Back in December when we wrote our post “Is It Finally Time To Sort The Euro” we got a lot of flack for saying that the US Dollar was bottoming out and that the Euro was going to drop.  We received e-mails telling us about all of the problems with the US and why the Dollar is going down forever.  Our basic answer has been that while the US has tons, and by tons we mean trillions upon trillions, of problems the US Dollar is not going the way of toilet paper anytime soon.

While we knew of many of the problems in the EU when we wrote our post we had no idea how bad and how fast they would manifest themselves.  As you can see in the chart below since our post the Euro has broken down, consolidated at the 200-day moving average, and then broke down some more. (Click on cart to enlarge)

EUR/USD Daily Chart


So what do we see going forward?  In our earlier post we showed a chart of the EUR/USD purchasing power parity that showed the Euro as being 35% overvalued relative to the US Dollar.  As you can see in the chart below the Euro has narrowed the valuation gap considerably but is still 22% overvalued to the USD.  We would not be surprised to see the EUR/USD hit the 2008 lows around 1.25 before finding strong support.  (Click on chart to enlarge)



Happy Trading,

Disclaimer-In The Macro Trader newsletter we are short the EUR/USD

Shorting the Euro and Buying the Swedish Krona

One trade that we currently like is that of shorting the EUR/SEK.  As you can see in the chart below the Euro has been losing ground to the Krona for most of the past year.  It formed a large head and shoulders top and then consolidated in a long bear flag until recently breaking down.  We think that this trade could go down to 9.5 over the next few months. (Click on chart to enlarge)

EUR/SEK Weekly Chart


We have been bearish on the Euro for some time now and lately the news has been going our way as many of the problems that were buried have been coming to the surface.  Not only is Greece in shambles but Spain, Italy, and Portugal are also near disaster as their debt costs continue to go up while their economies languish.  As the PIIGS continue to worsen there is more and more momentum building that could eventually kill the Euro.  We doubt that this happens any time soon but if the PIIGS are unable to correct their course it will happen.

Along with our negative view on the Euro another  thing that we really like about this trade is the extreme overvaluation of the Euro relative to the Swedish Krona.  As you can see in the chart below the Euro is trading at a 42.58% premium to the Swedish Krona.  While it has been outside of the 20% bands for a while now, we think that it is due time for a major correction on the weakness in the Euro and the relative strength of the Krona. (Click on chart to enlarge)



Happy Trading,

Disclaimer-In The Macro Trader newsletter we are short the EUR/SEK