Forex Investment and Currency Trading

• During its recent fall EURUSD seemed to break ranks with any correlation that people focused on, (Interest rate differentials, crude Oil, relative fundamentals etc) severely outpacing any targets these dynamics would have suggested. Bottom line the EURUSD, GBPUSD , AUDUSD moves etc were a function of de-leveraging i.e. issues on the funding side of the balance sheet. In recent days something different seems to be happening suggesting that possibly at this point we should be focusing on the “investment side”.
• On 15th July Gold turned down from $988 after posting a perfect 76.4% bounce off the $845 May low. This was the same day that EURUSD turned off 1.6040. Gold hit the low at $736 on 09/11- That is the same day that EURUSD hit its low of 1.3882.
• The present level of Gold if sustained suggests EURUSD above 1.50????

What else could be a driver here?????
Yesterday U.S. 3 month Government bills move to a yield of 0.02% (the lowest level seen since World War II.) This signals to us (as does the Gold price) that the big concern now is “return of capital” not “return on capital” The “breaking of the buck” by a large money market fund only served to exacerbate this fear. So where is your capital protected??? What are you ideally looking for? Guess would be

1. Capital preservation
2. Diversification
3. Yield if possible and probably short duration (concern about the printing presses)

Where can you get this?????

• Equities? Duh!!!!!
• Preferred stock? Duh!!!
• High Yield bonds? Duh!!!
• Money market funds? Kind of- Pretty much secure and has got yield
• Gold? Sort of …but not risk free- Risk protection
• U.S. Govt debt? The U.S. Govt. guarantees capital even if there is virtually no yield in the 3-month term. Exposure is very liquid and short-term. Secure but not diversified.

So wait a minute. We are 100% confident that the U.S. Government will honour its obligations to its share price (More commonly known as the U.S. Dollar). However are we not equally confident that the German Govt. and the U.K. Govt. will also honour their obligations? Yes.

But German 3 month bills pay about 4% and U.K. about 5% (And neither of them are likely to be engaging in the massive “share issue” taking place on the U.S. balance sheet i.e. dilution)

So would it not therefore make sense to try and “kill all the birds” with one stone? If instead of putting all your eggs in the 1 basket of 3-month U.S. non-yielding bills you for example put 1/3rd in each you have

• Security now spread across 3 different Governments
• Short duration/liquidity while we see how the crisis develops
• 3% yield on the portfolio
• Diversification of risk against the opening of the USD printing presses etc.

Not to mention the fact that in this corrosive environment some USD weakness would now look distinctly like the lesser evil. (Devalues debt, helps exports, buys some time etc. In an environment like this a little inflation is way more preferable than deflation).

Average yield on German and U.K. bills minus yield on U.S. 3 month bills, EURUSD and the Gold price.

 The picture above looks remarkably similar to that seen in mid-August 2007 as the credit crunch first took hold. That was the platform for the start of the EURUSD surge from 1.3360 and the Gold surge from $641.

Average yield on German and U.K. bills minus yield on U.S. 3 month bills, EURUSD

•  EURUSD move was totally at odds with this spread, which stood still during the whole 1.55-1.38 fall. As soon as this spread started to move sharply higher EURUSD turned up just like it did in August 2007.
• In both instances in the last 18 months that a large gap opened on the topside as the spread moved higher EURUSD rallied.
• The surge in the spread this time is pretty much as aggressive as that seen in August 2007.)