Posts Tagged ‘currencies’
Currencies: The Quickest Way to Grab Profits from Emerging Markets
By Evaldo Albuquerque
Dear Sovereign Investor,
In 1989, Stanley Druckenmiller, former money manager for George Soros, made millions off the German deutschemark after the Berlin wall fell.
In 1992, Soros did even better. He became an overnight legend when he grabbed a sweet $1 billion in a single day just by shorting the British pound.
What do these two traders have in common?
You could argue they applied their big macro themes to the currency market. But in reality, it’s even simpler.
They just followed the investment money. They knew the countries with the strongest fundamentals would attract the most investors – and the most cash. And the weakest countries would chase investors (and their money) away.
So they simply bought the currencies from the fundamentally strong countries and shorted the currencies from the fundamentally weak countries.
Simple, but brilliant.
Years later, it’s still embarrassingly easy to copy this killer strategy. But you need to know where the investment money is flowing. Today, it’s flowing straight into emerging markets like never before.
A New Era of Emerging Markets Has Already Begun
It’s no secret that emerging markets have done a complete 180 over the last decade. Take Brazil for example.
When I was growing up in Brazil, the country was a mess. We had very high unemployment rate, hyperinflation, political instability, you name it.
Today, Brazil has an all-time low unemployment rate, record consumer confidence, and an uncontested thriving economy.
Brazil is not alone. Many other emerging market nations are going through the same experience. What happened to them? They simply learned from their past mistakes.
During the 1990s, there was no better place to find economic turmoil than emerging markets. The Mexican peso crisis in 1994, the Asian crisis in 1997, and the Russian debt default in 1998 were some of that decade’s highlights.
Surviving a crisis is a harsh lesson for everyone involved.
Naturally after enduring a crisis, most emerging markets wanted to ensure it never happened again. So leaders started making some serious reforms.
Today most emerging markets are collecting the fruits of those reforms. Most are sitting on piles of cash.
That’s one of the reasons most emerging markets recovered so quickly from the recent global recession especially compared to the big developed nations like the U.S. and E.U.
Emerging Markets: Where The Action Is
The contrasting situation between emerging market and developed nations creates a mixture of push and pull factors.
Developed nations are plagued with very high levels of debt, weak economic growth, and rock bottom interest rates. This bad scenario doesn’t attract investors. Instead it pushes investment cash outside the country.
Emerging markets have low levels of debt, very healthy economic growth, and rising interest rates. That’s why more and more investors are turning to emerging markets.
In the last few quarters investors have been pouring billions of dollars into emerging market nations. The graph below shows how these countries’ stronger growth is attracting investment cash, according to the estimates from the Institute of International Finance.
As you can see, these emerging markets are becoming little cash cows for investors from all around the world…
The Best Way to Profit From These
Incredible Opportunities
It’s amazing how much money is flowing into these emerging markets. These capital flows are very important to currency traders because it practically guarantees these countries’ currencies will rise against the dollar.
They create very profitable trends for those who are trading in the spot market, especially when there’s a well defined trend in the dollar. And that’s exactly what we have right now.
Thanks to Bernanke’s new $600 billion quantitative easing plan, you know the dollar is heading no place but lower.
As a currency trader, you can simply pair these stronger emerging market or “exotic” currencies with the weak dollar for some decent gains.
During the last weak dollar trend over the summer, I helped my Exotic FX Alert subscribers pair the weak dollar with the stronger Mexican peso and Polish zloty for gains of 46% and 108% (among others).
It’s a simple strategy. But it really is as easy as watching where the capital flows will head next and being ready to jump on these opportunities in the spot Forex market.
Bottom line: Emerging markets are where the money is heading.
Best Regards,
Evaldo Albuquerque, Editor
Exotic FX Alert
What Could Lift the Dollar?
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The most recent employment data in the U.S. came in significantly better than what was expected. And the financial markets reacted in a different way this time. Interest rates went screaming higher, the stock market surged, gold fell and the dollar shot up.
In a normal environment a stronger dollar following better U.S. economic data sounds perfectly reasonable, but in the current “risk-centric” environment good news has been bad news for the dollar. That’s because it has emboldened risk appetite, which has translated into investors selling dollars in exchange for higher yielding/higher risk currencies.
This time the improving data gave investors the idea that the Fed could begin reversing its zero interest rate policy sooner. That got the dollar moving higher. And that got the wheels turning for a bounce in the weak dollar trend.
The dollar has continued to show strength following that turn in sentiment, but the prospects of a sooner move on rates has now been dismissed. The knee-jerk reaction in the markets that priced in an earlier hike in rates was subsequently fully reversed.
What is now underpinning dollar strength is a shift in market focus toward some of the headwinds facing the global economic environment. That’s swinging the risk appetite pendulum back toward safety, which is positive for the dollar.
So what can keep this momentum going in the dollar?
Answer: Growing risks to the global economy.
Let’s take a look at some of the specific catalysts that could fuel more demand for dollars …
Catalyst #1: Rising Prospects of a Sovereign Debt Crisis
First it was Dubai that stoked fear in the financial markets over the Thanksgiving Day holiday. Now, Greece has been called on the carpet over concerns that the nation will struggle to meet debt commitments. Fitch downgraded Greece to just three notches above the lowest investment grade status.
Debt problems in a global crisis have the ability to be contagious. And that can destroy investor confidence in the capital markets of such countries, and in the global economy. And when confidence wanes, capital flees. That’s a recipe for falling dominoes.
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| First it was Dubai that rattled the markets. Now Greece’s debt has investors worried. |
Catalyst #2: Problems for the Euro
The recent downgrade in Greece turns the market focus back to the problems that exist in the Eurozone, and that’s putting downward pressure on the euro … which means upward pressure on the dollar.
The European Union’s growth and stability pact limits all member countries to a budget deficit of 3 percent of GDP. But Greece is running a budget deficit of 12.7 percent of GDP, over four times the limit.
In fact, on average, the 16 member states of the single currency are running a budget deficit more than twice the 3 percent limit!
So the uneven performance in Europe will likely call into question the viability of the euro currency again. Another bout of speculation of a break-up of the euro is hugely dollar positive.
Catalyst #3: Growing Uncertainty Surrounding Economic Recovery
Now that sovereign debt problems are surfacing, investors are getting concerned about the sustainability of this recovery. After all, the unprecedented global fiscal and monetary response was an experiment. The outcome is unknown. And the underlying problems related to the crisis still exist: Bad debt, reduced wealth and tight credit to name a few.
Moreover, when you answer a liquidity crisis with more liquidity, you’re bound to create more bubbles. While ground zero for the credit crisis was the U.S. housing market, new bubbles in real estate are developing in the areas that were relative outperformers in the downturn (such as China, India and Canada).
In Shanghai, housing prices were up 40 percent in October from the same period a year earlier. And in a story about the Canadian housing market this week, Bloomberg quoted a real estate agent as saying, “Where else in the world do you have agents lining up overnight to buy a condominium?”
To someone here in the U.S., that sounds familiar.
Catalyst #4: Protectionism
We’ve already seen evidence of restrictions on global trade and capital flows. Considering protectionism was a key accomplice in fueling the Great Depression, this activity represents a major threat to global economic recovery.
After the lessons from the Great Depression, the leaders from the top 20 countries of the world vowed to avoid protectionist activity. But actions from the G-20 countries are speaking louder than words. New trade restrictions have been erected by most of them since the pledge was made.
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| Trade restrictions could derail global economic recovery. |
Perhaps the biggest factor in the protectionism threat is China’s currency policy. Even after recent tour stops in China by U.S. President Obama and European Central Bank President Jean-Claude Trichet to lobby for a stronger yuan, the Chinese have remained steadfast on keeping their currency weak. As this issue with China’s currency gains in intensity, expect protectionist acts to rise in retaliation. And expect collateral economic and political damage.
Bottom line: If sovereign debt problems and the prospects of a double dip grow, you can expect investors to pull in the reins on risk. And this time, they might not be as eager to turn the risk appetite switch back on. That could give the buck a strong lift … a lift that might last longer and rise further than many expect.
Regards,
The Fed’s Perfect Scenario
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If you consider all of the structural problems in the U.S. economy, there has not been a lot of progress toward getting things back on track. The root causes of what created the near debilitating financial and economic crisis still remain:
Banks are still saddled with toxic assets,
Housing prices are still 30 percent lower,
Foreclosures are still hitting new record levels,
Credit is still tight and demand for credit is still contracting sharply,
And now …
The U.S. government has thrown trillions of dollars at the problem. And the actions they’ve taken, for the time being, have helped to avoid a collapse of the financial system that would have caused a massive run on banks, a standstill of economic activity and a worldwide economic depression.
There are plenty of areas to question and debate the decisions made by the U.S. Treasury, the Fed and other government types. But the stabilizers and backstops, to this point, have managed to avert an economic freefall. Of course, the ultimate outcome of policy actions has yet to be determined.
But it’s clear that the U.S. and economies around the world remain fragile.
Even so, people are grasping tightly to the idea that a sharp bounce back is in progress and that a return to normalcy is near.
For the Fed, it’s this type of optimism that is driving a perfect operating scenario.
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| Government action has averted financial disaster, but global economies remain fragile. |
What Is the Fed’s Perfect Scenario?
If the Federal Reserve and the U.S. Treasury could have scribbled out a wish list for financial market conditions last March when global economies and global markets were in freefall, it might have looked something like this …
Wish #1: Please give us rising stock prices.
Rising stock prices improve the sentiment of investors and consumers. They replenish some lost paper wealth and make companies feel better about the future. It’s amazing what a 64 percent rise in stock prices can do for confidence.
Wish #2: Please give us stable interest rates.
Demand is massively depressed by things like evaporated consumer wealth, tight credit, and high unemployment. And deflation has been, and remains, the immediate problem.
The Fed’s answer: Zero interest rates and “printing money.” These tools are at work to prevent a deflationary spiral and to influence low mortgage rates to curb the housing implosion.
But consumer credit and mortgages are priced based on market-driven interest rates, not rates set by the Fed. So a move higher in market interest rates, like interest on 10-year Treasury notes and Libor, would create a big problem for the Fed. It would drive up interest rates on consumer credit and mortgages, which would create even bigger problems for consumers and for the housing market. But that hasn’t happened.
Wish #3: Please give us stable commodity prices, especially oil.
Crude oil is down 50 percent from its high a year ago. In a period where consumers are more inclined to save, not spend … stable gas prices are critical.
Wish #4: And a gradually declining dollar wouldn’t hurt …
This is the icing on the cake. Even if global demand for everybody’s exports is still in the gutter, the effect of a weaker currency on GDP is a nice kicker. A weaker dollar means we import less and perhaps we export a little bit more … but most importantly, the net value that comes from importing less and exporting a little more is a key positive contribution to GDP.
Despite all of the fear about the future of the dollar, it’s important to realize that a weaker currency is actually good for an economy when economic growth is depressed. Our trade balance is narrowing and our current account balance has diminished dramatically.
Now, when the economy is growing at a healthy rate, then a stronger currency is preferred because it helps improve quality of life.
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| A weaker dollar is actually good for a depressed economy because it helps narrow trade and account balances. |
A Gift Without Staying Power
By coincidence, or not, all the Fed’s wishes have come true. And this confluence of gifts from the financial markets has bought some time to address some of the structural economic problems. But the structural problems haven’t been repaired.
Financial markets are rarely compliant to wish lists, especially when the performance defies fundamentals. At some point, the markets will find fundamental equilibrium.
The key question is: When will markets revert to reality?
That’s the hard part.
The U.S. stock market continues to be the gauge of how investors feel about the prospects of a sustainable recovery. Higher stock prices equal more optimism. And more optimism equals higher risk appetite.
But at this stage, the idea of chasing returns that are not supported by fundamentals is a high-risk, low-reward proposition. And it’s not hard to find a reference point of the type of pain that can be associated with the divergence between market prices and fundamentals.
It was only twelve months ago that currencies, commodities and stock markets made sharp and abrupt collapses.
As for the Fed and the Treasury’s wish list … when the rise in stocks ends, so will confidence and any hopes for a sharp economic recovery. And when confidence wanes, investors feel more risk averse.
What Does That Mean for Currencies?
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| Fears of the dollar’s demise may be premature when compared to other currencies. |
Despite all of the ugly issues surrounding the U.S. economy, it will have among the smallest of economic contractions in 2009 compared to other G-7 countries, second only to Canada. And for 2010, the U.S. is expected to outperform all other major developed market economies.
That says something about the state of the rest of the world.
And when it comes to the dollar, and currencies in general, you have to respect the relative nature of currency values. Currencies don’t operate in a vacuum.
A country’s currency is never valued based on how well or how poorly its particular economy is doing in isolation. It’s always measured against another country’s currency. So it is always valued based on how a particular economy is doing relative to another economy.
For those that are fearing darker days for the dollar, remember that the least ugly currency can still win the beauty contest. Also, any rise in risk aversion is a positive for the dollar.
Regards,
