Category Archives: Currencies

EURUSD is the Key and Desperation to Avoid Painful Adjustments as a Near Term Catalyst

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The above is EURUSD as seen through FXE. It is compared with XLF and the S&P 500 index.

I continue to learn. I admit, my call to cover shorts was premature (and wrong). Obviously one “Fading Near Term Catalyst” I neglected to consider was that politicians would not even recognize that there is a crisis of confidence in their ability to lead and instead would attack the markets as the cause of the EUR crisis instead of a reflection of the judgement of the participants.

Witness: Merkel Pushes Extra EU Rules, Seeks to Widen Short-Selling Ban

The issue is not really the naked short selling ban, which is more or less a ban on counterfeiting and not a bad thing. Rather it’s the following:

“Merkel said Germany will lobby governments to introduce a tax on financial markets, and for ratings companies to come under European supervision so governments regain “primacy” over markets.”

Who knows where this goes… and governments regaining “primacy” over markets sure sounds a lot like not having functional markets. Is the government going to ban downticks? These measures have an extremely high risk of increasing the risk premium required to participate in the market thereby lowering prices.

In my view, there still remains no incentive to own any EUR denominated asset as at this rate, EUR is headed lower still. And it could get worse. My fear is that even the Europeans might not want to own EUR denominated assets.

Seems like Europe will be the first forced to address imbalances, and at this rate they are on the road to addressing imbalances in a non-coordinated way… as separate countries eventually with separate currencies.

If Europe doesn’t print money in mass, then it will suffer a debt driven deflationary depression as governments cut spending to reduce deficits and are then stymied by declining GDP. If it does print money, then EUR denominated debt will be dumped for dollars and reserves will be depleted.

The link to the S&P would be that the dollar value of european revenues of large companies would decline with the economies of europe. And so equity prices would decline is my guess.

I more than suspect that these swings have caused long term damage to retail investors confidence in the functioning of the equity market which removes an important price stabilizer from the market. Expect volatility to remain elevated for a while – weeks or months.

And until there is a base found in EURUSD, volatility will continue and asset prices will head lower.

Therefore, still not adding positions and have cut things that I am not super comfortable owning for years, but I admit that I also trimmed some shorts a bit which in hindsight was super premature.

So…. Low bids are likely to be hit in the coming weeks.

Still trying not to lose money.

Arthur O’Keefe, São Paulo Value
http://www.spvalue.com

Correlation is Higher Than You Think. Covering Shorts, Flattening Risk on Fading Near Term Catalysts

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I spend a lot of time on analyzing and understanding risks, especially the concept of risk factors. I don’t try to explicitly name or quantify risk factors between investments, rather I just try to understand the major driving risk factors in a portfolio. Then I try to understand when or if the influence of common risk factors may change.

Above is S&P, EURUSD, XLF, RKT, and AIPC. First I would note the correlated indicies – S&P, EURUSD, and XLF. It may not be intuitive, but being long the EUR was to be long the S&P and the XLF for the last month. So to be bearish on the EUR was to be bearish on the other two as well.

If there is declining confidence in EUR, I eventually expect that link to break as assets flow to the USD denominated assets. Additionally, structurally, I think the US is stronger than Europe.

By now, as well, European leaders are on notice, and there is a high risk that more drastic action is taken. I don’t think it will be terribly effective in the long term, but there is an increased risk of volatility out of this, and in my opinion volatility should only be borne with a proper compensation for having to lose sleep dealing with it.

So I think it’s worth it to cut USD based shorts being used to hedge EUR risks.

Secondly, observe RKT and AIPC. Both were influenced somewhat by the crisis in that their individual volatilities increased (10% swings in the value of RKT is abnormal) but ultimately their value held – so for now (and I think going forward as well) they are not tied to the EUR which gives confidence that they can be in a portfolio as outsized positions.

I don’t want to be one to flip sentiments on a dime – but trying to make money in a choppy market is a bit like this…. I have long term and short term views. Long term, I expect riots in Europe as the ramifications of austerity measures becomes clear. The measures may or may not hold. Even if they take place, they may not be effective as GDP gets crushed from the withdrawal of government spending (look at the case of Ireland right now). So long term, I am still very scared and very worried for Europe. There has been little done to address imbalances in the banking sector there as well, and I continue to think that there is real risk of continued bad news.

But I don’t expect Europe to bring down the US. From my perspective here in São Paulo, things are booming in Brazil, and I suspect the rest of Latin America, ex Venezuela, is hanging in there as well. I am mildly bullish on the US in that it’s still the technology king of the world, and its people (my people) are amazingly adaptive. Growing up in Louisiana, I’ve seen my share of busts – oil price fluctuations in the 80’s caused a mini-boom accompanied with a property boom that then crashed when oil prices crashed. It took a number of years, but eventually the state recovered. Seeing the after effects of Katrina as well gave some understanding of the power of government stimulus and trials and tribulations to rehabilitate an area. It’s possible that New Orleans is better now than it has ever been on a number of measurements.

So we’ll see. I have little interest in owning anything Euro right now until I understand where this process goes, but I also suspect the link between S&P (and XLF) and EUR will weaken going forward, and so action should be taken in concordance with this view. I’m covering my shorts (which is not to say that I am going 100% allocated), as like most value investors, I don’t really like being short for the long term nor do I try to make money in downturns….

I just try not to lose money.

Arthur O’Keefe, São Paulo Value
http://www.spvalue.com

Can Things Get Worse? Risk is that Greece is the Start and not the End. Volcano Returns, Euro Imploding, Banks Attacked, Random Selloffs

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The above, of course, is EURUSD.

People should be scared as this is not the currency of a Banana Republic and it is *not* being attacked from outside. The currency is falling from within and this will be very difficult to stop. What we are witnessing is a crisis of confidence from *within* the Eurozone.

Rational people are pulling money out of weak banks and shifting to stronger ones. Similarly people are selling questionable bonds to buy stronger paper. Who’s taking the other side?The lender and buyer of last resort is apparently the ECB which means that debt liquidation/monetization looking like a certainty.

But this doesn’t occur in a vacuum. Europe, possessing lots of quick-thinking and history-studying people, is seeing it’s own inhabitants front-run the ECB by selling Euros and buying gold. This creates a vicious cycle that will be extremely difficult to stop and can go to levels vastly beyond what the mainstream is talking about.

The tricky thing about crisis of confidences is how they can get out of hand very quickly. If all of Europe starts to run, we can see the Euro go to 10 cents. Of course it won’t get there with a European Union intact – stronger countries will be forced to pull out to protect the lifestyles and purchasing powers of their inhabitants.

One thing is for certain, there are some banks already broken in Europe and we haven’t heard anything about it and no one is discussing it. So likely more surprises ahead.

Anyway, my 3 warnings here turned out to be rather timely… and I still don’t see much change. In addition to the debacle of the Euro, the Volcano is back, liquidity has disappeared while the market behaves like a rigged slot machine, and banks are being investigated for various dubious acts during the last excessive lending period.

This is the time to only own things that you are comfortable not selling for a few years – as the market could very well indeed shut down for all purposes.

Do not add risk needlessly in this environment in my opinion. Deflation is back. Use cash to pay down any debts as deflation should continue and any excess should be used only to buy low cost producers on the bid (or below). Low bids are likely to be hit in the coming weeks.

Try not to lose money.

Arthur O’Keefe, São Paulo Value
http://www.spvalue.com