Tag Archives: u.s. dollar

Reasons for U.S. Dollar’s Strength


This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk in investing in futures.

It has been noted that the U.S. Dollar makes a high or a low for the year in January approximately 2/3 of the time. Some prominent market mavens are attributing the Dollar’s strength to “strong cyclical forces at play” while others believe that the Dollar’s time as the currency of last resort is nigh. Both positions appear, to me, to be based on more on rhetoric and black magic than on sound fundamental analysis. Those of you who’ve asked me about the Dollar have gotten the same response from me since the commodity futures market’s bottom in December. I don’t understand the Dollar’s strength. I can advise on technical levels and pattern recognition but, I don’t have a fundamental thesis to frame my trading in this market at this time. The following article by John Mauldin of www.frontlinethoughts.com has provided me with a framework I can wrap my head around. I hope it helps you as much as it has myself.Andy.

The Risk in Europe

I mentioned last
week that European banks are at significant risk. I want to follow up on that
point, as it is very important. Eastern Europe has borrowed an estimated $1.7
trillion, primarily from Western European banks. And much of Eastern Europe is
already in a deep recession bordering on depression. A great deal of that $1.7
trillion is at risk, especially the portion that is in Swiss francs. It is a
story that could easily be as big as the US subprime problem.

In Poland, as an
example, 60% of mortgages are in Swiss francs. When times are good and
currencies are stable, it is nice to have a low-interest Swiss mortgage. And as
a requirement for joining the euro currency union, Poland has been required to
keep its currency stable against the euro. This gave borrowers comfort that they
could borrow at low interest in francs or euros, rather than at much higher
local rates.

But in an echo of
teaser-rate subprimes here in the US, there is a problem. Along came the
synchronized global recession and large Polish current-account trade deficits,
which were three times those of the US in terms of GDP, just to give us some
perspective. Of course, if you are not a reserve currency this is going to
bring some pressure to bear. And it did. The Polish zloty has basically dropped
in half compared to the Swiss franc. That means if you are a mortgage holder,
your house payment just doubled. That same story is repeated all over the
Baltics and Eastern Europe.

Austrian banks
have lent $289 billion (230 billion euros) to Eastern Europe. That is 70% of Austrian
GDP. Much of it is in Swiss francs they borrowed from Swiss banks. Even a 10%
impairment (highly optimistic) would bankrupt the Austrian financial system,
says the Austrian finance minister, Joseph Proll. In the US we speak of banks
that are too big to be allowed to fail. But the reality is that we could
nationalize them if we needed to do so. (And for the record, I favor
nationalization and swift privatization. We cannot afford a repeat of Japan’s
zombie banks.)

The problem is
that in Europe there are many banks that are simply too big to save. The size
of the banks in terms of the GDP of the country in which they are domiciled is
all out of proportion. For my American readers, it would be as if the bank
bailout package were in excess of $14 trillion (give or take a few trillion).
In essence, there are small countries which have very large banks (relatively
speaking) that have gone outside their own borders to make loans and have done
so at levels of leverage which are far in excess of the most leveraged US
banks. The ability of the “host” countries to nationalize their banks
is simply not there. They are going to have to have help from larger countries.
But as we will see below, that help is problematical.

Western European
banks have been very aggressive in lending to emerging market countries
worldwide. Almost 75% of an estimated $4.9 trillion of loans outstanding are to
countries that are in deep recessions. Plus, according to the IMF, they are 50%
more leveraged than US banks.

Today the euro
rallied back to $1.26 based upon statements from German authorities that were
interpreted as a potential willingness to help out non-German (in particular,
Austrian) banks.

However, this
more sobering note from Strategic Energy was sent to me by a reader. It nicely
sums up my concerns:

“It is East
Europe that is blowing up right now. Erik Berglof, EBRD’s chief economist, told
me the region may need €400bn in help to cover loans and prop up the credit
system. Europe’s governments are making matters worse. Some are pressuring
their banks to pull back, undercutting subsidiaries in East Europe. Athens has
ordered Greek banks to pull out of the Balkans.

“The sums
needed are beyond the limits of the IMF, which has already bailed out Hungary,
Ukraine, Latvia, Belarus, Iceland, and Pakistan — and Turkey next — and is
fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where
the IMF may have to print money for the world, using arcane powers to issue
Special Drawing Rights. Its $16bn rescue of Ukraine has unravelled. The country
— facing a 12% contraction in GDP after the collapse of steel prices — is
hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch.
Pakistan wants another $7.6bn. Latvia’s central bank governor has declared his
economy “clinically dead” after it shrank 10.5% in the fourth
quarter. Protesters have smashed the treasury and stormed parliament.

“‘This is
much worse than the East Asia crisis in the 1990s,’ said Lars Christensen, at
Danske Bank. ‘There are accidents waiting to happen across the region, but the
EU institutions don’t have any framework for dealing with this. The day they
decide not to save one of these one countries will be the trigger for a massive
crisis with contagion spreading into the EU.’ Europe is already in deeper
trouble than the ECB or EU leaders ever expected. Germany contracted at an
annual rate of 8.4% in the fourth quarter. If Deutsche Bank is correct, the
economy will have shrunk by nearly 9% before the end of this year. This is the sort
of level that stokes popular revolt.

implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece
and Portugal as the collapse of their credit bubbles leads to rising defaults,
or rescue Italy by accepting plans for EU “union bonds” should the
debt markets take fright at the rocketing trajectory of Italy’s public debt
(hitting 112pc of GDP next year, just revised up from 101pc — big change), or
rescue Austria from its Habsburg adventurism. So we watch and wait as the lethal
brush fires move closer. If one spark jumps across the eurozone line, we will
have global systemic crisis within days. Are the firemen ready?”

While Rome Burns

I hope the writer
is wrong. But the ECB is dithering while Rome burns. (Or at least their banking
system is — Italy’s banks have large exposure to Eastern Europe through
Austrian subsidiaries.) They need to bring rates down and figure out how to
move into quantitative easing. Europe is at far greater risk than the US.

Great Britain and
Europe as a whole are down about 6% in GDP on an annualized basis. The Bank
Credit Analyst sent the next graph out to their public list, and I reproduce it
here. (www.bcaresearch.com)
In another longer report, they note that the UK, Ireland, Denmark, and
Switzerland have the greatest risk of widespread bank nationalization (outside
of Iceland). The full report is quite sobering. The countries on the bottom of
the list are also in danger of having their credit ratings downgraded.

Aggregate Sovereign Credit Risk

This has the
potential to be a real crisis, far worse than in the US. Without concerted
action on the part of the ECB and the European countries that are relatively
strong, much of Europe could fall further into what would feel like a
depression. There is a problem, though. Imagine being a politician in Germany,
for instance. Your GDP is down by 8% last quarter. Unemployment is rising.
Budgets are under pressure, as tax collections are down. And you are going to
be asked to vote in favor of bailing out (pick a small country)? What will the
voters who put you into office think?

We are going to
find out this year whether the European Union is like the Three Musketeers. Are
they “all for one and one for all?” or is it every country for
itself? My bet (or hope) is that it is the former. Dissolution at this point
would be devastating for all concerned, and for the world economy at large.
Many of us in the US don’t think much about Europe or the rest of the world,
but without a healthy Europe, much of our world trade would vanish.

However, getting
all the parties to agree on what to do will take some serious leadership, which
does not seem to be in evidence at this point. The US almost waited too long to
respond to our crisis, but we had the “luxury” of only needing to get
a few people to agree as to the nature of the problems (whether they were wrong
or right is beside the point). And we have a central bank that could act

As I understand
the European agreement, that situation does not exist in Europe. For the ECB to
print money as the US and the UK (and much of the non-EU developed world) will
do, takes agreement from all the member countries, and right now it appears the
German and Dutch governments are resisting such an idea.

As I write this
(on a plane on my way to Orlando) German finance minister Peer Steinbruck has
said it would be intolerable to let fellow EMU members fall victim to the
global financial crisis. “We have a number of countries in the eurozone
that are clearly getting into trouble on their payments,” he said.
“Ireland is in a very difficult situation.

euro-region treaties don’t foresee any help for insolvent states, but in
reality the others would have to rescue those running into difficulty.”

That is a hopeful
sign. Ireland is indeed in dire straits, and is particularly vulnerable as it
is going to have to spend a serious percentage of its GDP on bailing out its

It is not clear
how it will all play out. But there is real risk of Europe dragging the world
into a longer, darker night. Their banks not only have exposure to our US
foibles, much of which has already been written off, but now many banks will
have to contend with massive losses from emerging-market loans, which could be
even larger than the losses stemming from US problems. Plus, they are more
leveraged. (This was definitely a topic of “Conversation” this
morning when I chatted with Nouriel Roubini. See more below.)

The Euro Back to Parity? Really?

I wrote over six
years ago, when the euro was below $1, that I thought the euro would rise to
over $1.50 (it went even higher) and then back to parity in the middle of the
next decade. I thought the decline would be due to large European government
deficits brought about by pension and health care promises to retirees, and those
problems do still loom.

It may be that
the current problems will push the euro to parity much sooner, possibly this
year. While that will be nice if you want to vacation in Europe, it will have
serious side effects on international trade. It clearly makes European
exporters more competitive with the rest of the world, and especially the US.
It also means that goods coming from Asia will cost more in Europe, unless
Asian countries decide to devalue their currencies to maintain an ability to
sell into Europe, which of course will bring howls from the US about currency
manipulation. It is going to put pressure on governments to enact some form of
trade protectionism, which would be devastating to the world economy.

Large and swift currency
swings are inherently disruptive. We are seeing volatility in the currency
markets unlike anything I have witnessed. I hope we do not see a precipitous
fall in value of the euro. It will be good for no one. It is a strange world
indeed when the US is having such a deep series of problems, the Fed and
Treasury are talking about printing a few trillion here and a few trillion
there, and at the very same time we see the dollar AND gold rising in value.

Lost in the Confusion

Lost in the Confusion


Amid the roar of the financial chaos and their ability to affect,
seemingly every market, one sector has been quietly building a base and should
be renewing buying interest. Remember back in late May and June during the
wettest spring ever when the concerns of crop planting were making the local
news? The ensuing run up in grain prices soon had everyone beating the drum of ethanol’s
demand on corn prices and the cost of bread, chips and cereal.

Since the grain markets peaked in July, many of them have
sold off considerably. Soybeans have fallen from an all time high of $16.47
down to $11.00 per bushel. Corn and wheat are also off 30 – 35%. The main
reasons for this sell off has been the exceptional growing conditions helping to
make up for the wet spring as well as the typical seasonal pattern the grain
markets have of selling off once the crop has been planted. Further pressure
was added this summer by the rise in the U.S Dollar and the global demand
reduction associated with increasing purchase costs as a result of the exchange

Soybeans and wheat continued to decline this past week amid
the global uncertainty of the financial markets and a general flight from
derivative based investment. However, corn made its low of $5.00 per bushel
more than a month ago. Also, the corn market failed to make new lows amid the
financial panic. Technically, corn need only close above $5.67 to setup a
genuinely bullish breakout of a double bottom.

Fundamentally, while the corn crop has grown well, the late
planting has had an effect on the maturation process of the crop. The saying
being floated by the corn pundits is, “Looks good from the road but not in the
field.” This year’s crop will be especially vulnerable to an early frost or
cool late summer as the late planting is affecting the finishing of the crop.
Lastly, and most importantly, the global corn crop began this year at one of
the tightest stocks to usage ratio on record. Basically, this means that there
was less of the previous year’s corn crop still available in the pipeline at
the beginning of this year’s planting season.

It appears in the USDA grain reports that given the acreage planted, the projected
yield and demand for this year’s crop will do little to ease this issue. While
we move to global “on demand inventory,” it’s important to know that commodity futures
supplies are static. Government’s can print money. Stock exchanges can forbid
short selling and banks can be bailed out. However, neither the U.S. Federal
Reserve nor the European or English Central Banks can create more corn. Those
who have been losing sleep over the next financial market, “Breaking News
Bulletin,” may wish to consider something more grounded.



P –

F –


The High Cost of the Last Penny

This is a very succinct article on the high cost, both monetary and human, of squeezing the last dime out of a product and the consequence of “earnings blindness” and not being able to see past this quarter’s numbers.

There are some positive investment strategies touched upon below. We can help with short term metals and treasury commodity futures trading. Our customers’ accounts are in segregated funds and are not borrowed against or loaned out as collateral.

We haven’t been around as long as Lehman but, I am the second generation and I believe in the process of handing the reigns over to the next generation. Therefore, we will continue to endeavor in catching the fat part of the trade and leaving the tails to those who are unwilling to see the head.


The Fall of Lehman: How To Fix It – Part II

By Michael Lewitt

History has a funny way of humbling men. So do markets. Perhaps the most disturbing aspect of Lehman Brothers’ fall is that it comes almost seven years to the day after 9-11. That day was supposed to teach us humility, and the fall of Lehman, coming six months after the collapse of Bear Stearns and coupled with Merrill Lynch’s disappearance as an independent company, are the result of a complete lack of humility on the part of those executives charged with leading the world’s most important purveyors of capital in the post-9-11 world. For all the talk of pulling together in the wake of the terrorist attacks that shook America to the core and that supposedly set our priorities straight, Wall Street rushed headlong back to its mindless pursuit of profits and speculation without consideration for the consequences of its actions. Now the chickens have come home to roost.

In April 2008, HCM published a controversial essay entitled “How To Fix It,” in which we outlined our (unsolicited) recommendations for how to correct the excesses that led to the credit crisis that began in mid-2007 and brought us to this historic day. We are republishing that issue of the market letter by attachment for those who did not read it the first time. Our key recommendations, which seemed much more radical in April than they do today, were the following:

  • Improve financial industry regulation and replace substance over form in the regulation we have.
  • Place absolute leverage limitations on financial institutions at much lower levels than the 30:1 levels that led to this crisis.
  • Place an absolute limitation on hedge fund leverage.
  • Regulate Wall Street compensation by basing it on multiple years’ performance, add clawbacks and high water marks, and limit cash compensation that is paid out and weakens these firms’ balance sheets.
  • Tax private equity firms’ carried interests at ordinary interest rates rather than capital gains rates and restrict private equity firms’ ability to go public.
  • Outlaw off-balance sheet entities.
  • Reinstitute the uptick rule with respect to short selling.

Finally, we made the point that too much economic activity in the United States was aimed at speculation rather than production. For example, the equity markets are increasingly dominated by quantitative investment strategies that are driven by considerations that are totally divorced from considerations of fundamental value. At the same time, the credit markets are increasingly utilized to finance change-of-control transactions for private equity firms that are done simply because low cost financing is available, not because a project is going to add to the productive capacity or capital account of the nation. As we wrote in that April issue, “t some point, society has to figure out that the way an investor earns his money is even more important than the amount of money he makes. This is why human beings were vested with moral sentiments, so they could distinguish the quality of human conduct from the quantity of its results.”

These changes cannot and will not be effected simply by legislative fiat. It is incumbent upon the gatekeepers of capital – the fiduciaries that make the decisions about allocating capital – to bring discipline to the system. This will require a rethinking of their priorities and a willingness to add to their investment calculus considerations that exceed their own narrow interests about short-term investment returns. Our system requires a new concept of fiduciary duty that encompasses systemic as well as single-firm interests, and that focuses to a greater degree on risk-adjusted returns than raw numerical returns. Obviously the forces that led to this weekend’s events have been building for many years, and the changes needed to fix the system will not be made overnight. But we should not let this occasion pass to reflect on what has occurred.

Imagine You Are On the Deck of The Titanic (Because You Are)

It is clear to us that the Federal Reserve and United States Treasury are not underestimating the enormity of the crisis. Continuing to write checks to bail out the private sector would have been the wrong decision, but the fallout is going to be severe. The next domino to fall may be the insurance giant, American International Group, Inc. (AIG), which is facing credit rating downgrades that will force it to post more collateral (that it doesn’t have )on a large volume of credit insurance contracts. AIG is a much larger systemic threat than Lehman Brothers ever was, so this situation is profoundly serious. In HCM‘s judgment, investors should not try to pick a bottom in today’s or this week’s market. The market is going to experience extraordinary volatility today and over the immediate future. Play the market at your own risk and only with money you can afford to lose. The indices are heading significantly lower, as we have previously forecast. Gold, short-term U.S. Treasuries, short-term Swiss and German government paper, the Swiss franc, and certain Asian currencies like the Singapore dollar are the safest places to park your cash for the moment. The U.S. dollar continues to be debased (less against the Euro, which remains compromised, than against Asian currencies and the Swiss franc), particularly by the startling and historic decision by the Federal Reserve to accept equity securities at its discount window. If nothing else, that decision alone suggests the enormity and depth of the crisis we are facing. We never thought we’d live to see the day that the American central bank would accept equity as collateral for loans. We have to admit that took us by surprise and made us very nervous.

Spread Trading Gold vs. Platinum

Many customers have been asking spread strategy questions
and last week’s action in the gold and platinum markets provides us with a
wonderful opportunity to have this discussion.

Take a look at the
attached chart.

The red line on the
bottom is how much gold is worth relative to platinum (gold close/platinum
close). This is a monthly chart and you can see that the spread, along with
platinum, have broken their trends going back to ’01. This means that the
prices of these two metals are converging. One should be short platinum and
long gold. The way I see it, the price of platinum has been beaten up far worse
than gold. I think the global slow- down scenario may be impacting the
manufacturing base for platinum more than inflationary/deflationary issues are
effecting the speculative nature of the gold market. Gold has also held above
its trend line, in spite of the U.S. Dollar’s significant rally.

Profitable spread trading requires more than predicting the
general directions of the two markets involved. The size of the contracts, tick
size and volatility also need to be considered. In this example, there is only
one platinum contract to choose from. However, there are four actively traded gold
contracts in three different sizes and on two different exchanges. Even the simple
assumption that one full size contract of each should be sufficient would be
incorrect. Recently, platinum is moving around $67 per day in the futures
market and gold is moving around $25 per day. Would it be appropriate to try to
even these out by trading two gold contracts versus one platinum contract?

Here is the method I use as a commodity broker to appropriately size my spread
trades. First of all, I calculate the average range for each market relative to
the time frame I expect my trade occur in. In this case, I am looking at
monthly charts. Therefore, I calculate the 21 day average range for each market
and come up with $21 for gold and $67 for platinum. The next step is to
multiply each of these average daily ranges by the market’s point value. Gold
is $21 X $100 = $2100 per day average movement. Platinum gives us $67 X 50 =
$3350 in average per day movement.

Clearly, one full
size contract of each is not an even spread. Now, since we know that we only
have one platinum contract to work with, our only opportunity for proper sizing
in the futures market (there are option strategies available, as well), is to look
at the list of available gold contracts. One full size gold contract gets us to
$2100 per day and leaves us with a $1200 per day deficit to make up. Chicago’s mini
sized gold contract is 33.2 oz. (1/3 full size). That would bring our total to $2793
on the gold side of the trade. This won’t square the ledger. New York’s mini
sized gold contract is 50 oz. (1/2 full size). That would make our total $3150.
That’s pretty close. Obviously, the other option is to use two Chicago mini
contracts and bring our total to $3486. At this point, it comes down to
personal bias. Would one rather be more or, less long gold relative to

I hope this brief description answers more questions than it
creates. However, please feel free to post any ideas, comments or, issues.

Dollar’s Strength an Anomaly?

The U.S. Dollar surged through its daily resistance and is well on its way into the overhead weekly resistance between 75.88 and 77.24. Although the rally has been impressive, it’s important to maintain the perspective that the Dollar is in a bear market. Even if we were able to rally another 300 points, that would only bring us back to the 38% retracement level from the ’06 highs.

Of recent interest in the Dollar’s surge are the factors that television commentators claim are fueling it. The major factors receiving notice are, the decline in energy prices and commodities in general, the European Central Bank’s deflationary comments and finally, the worse than expected jobless claims number. The following factors are deflationary and the U.S. equity markets are rejoicing.

I would ask the question, “Have the preceding factors created a bottom in the economic cycle or, are we seeing a more general global slowdown?” I believe that the domestic economic issues have not been addressed and that a globally deflationary environment will create more problems for the U.S. Dollar than it will solve.

First, examine the chart on import prices. The double top may have proven to be the limit. Clearly, it has already begun to turn down. This index includes oil which, when priced separately, is 5% higher than imports in general. Oil is germaine to the topic because the $25+ decline has NOT been priced in and will contribute greatly to the establishment of this chart’s double top.

If, in fact, overall commodity prices are topping out then, this will also reduce demand for U.S. commodity exports. Exports have helped to offset the declining Dollar over the last two years as global demand and globally anomalous weather patterns have made the U.S. the supply center for the world. Dollar strength and, or a global slowdown will curb the primary growth engine for the U.S. economy. What effect will this have on a sluggish employment picture?

Obviously, the unemployment pressure is still to the upside. Will global commodity deflation offset the cost of a declining employment base? According to many pundits, the tax refund checks have gone to cover current expenses, rather than paying down debt. That leaves many people still looking for meaningful employment opportunities. This is most clearly illustrated in this week’s jobless claims.

The past two weeks’ claims have surpassed the historically significant 450,000 threshold. As you can see from the chart, this threshold is frequently accompanied by a recession. Based on the previous factors, I fail to see continued strength in the U.S. Dollar or, the U.S. economy. While the equity markets have broached the 20% bear market threshold and, recently bounced, I still view this as a selling opportunity in both equities and the Dollar.

It appears that this is beginning to be priced into the interest rate markets as well. Inflationary pressures are easing. This is taking the pressure off of the Federal Reserve Board to tighten rates at the next meeting on September 6th. Furthermore, the declining employment picture will add pressure to hold or, LOWER, rates at meetings through the end of the year. This stance is contrary to the hawkish inflationary stance that has been their premise for much of this year. Finally, the combination of a declining equity market in an election year would also add to the shift in the FOMC’s position from hawkish to dovish. The last chart is beginning to tip the market’s hand as it points to lower rates ahead……once again leading to a lower Dollar.


Defending the $ and Popping the Bubble

Yesterday, Bernanke stated that a weak Dollar was not in America’s best interest. Typically, this statement would be argued against based on a weak Dollar’s contribution to exports helping to grow a weakened domestic economy. Bernanke’s point, I think, is that inflation is a bigger worry than recession. Dollar based commodities, primarily grains and energy are having a greater negative impact on our economy than can be offset through higher exports. Inflation in these primary goods is acting as a tax on the American consumer. Right now, the economy cannot create enough high quality jobs fast enough to offset the economic pain that is felt at the gas pump and grocery store.Further more, Bernanke also stated that he will work with Secretary Paulson to defend the Dollar’s decline. This is important because the Federal Reserve and the Treasury are separate entities. It is a big deal that Bernanke used language such as, “In collaboration with our colleagues at the Treasury…” as well as, “…ensuring that the Dollar remains a strong and stable currency.”

These are strong words from the chairman of the Federal Reserve. The perfect storm could be brewing……strengthening Dollar combined with regulatory action, via the CFTC closing the “swap loophole” on Commodity Index Traders could bring liquidation across the commodity spectrum. It will be important to check the Commitment of Traders Reports for position changes.