Second Quarter 2011 GTAA Currencies

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Second Quarter 2011 GTAA Currencies Powered By Docstoc
					        Global T ti l
        Gl b l Tactical
        Asset All ti
        A t Allocation
            GTAA
             Currencies


            Second Quarter
              March 23rd , 2011


             Damien Cleusix
             damien@clue6.com
             d i @ l 6


Clue6                             Second Quarter 2011
   Executive Summary                                                                                                              1

   Currencies
   The USD is becoming increasingly undervalued against most currencies. It is at a 40 years low on a real broad trade-
   weighted basis. Its economy is much more dynamic and has started to rebalance earlier than other developed economies.
   Companies have been cutting costs aggressively and are much more competitive in the international markets.

   The big problem remains that the Fed is suppressing real government bond yields through quantitative easing. Ceteris
   paribus, the USD will have to be more undervalued on a PPP basis to be in equilibrium. Indeed, the deficit of interests
   payment foreigners are receiving has to be compensated by a lower price I.e. lower USD (this is another reason why
   emerging markets with negative real yields have very undervalued currencies on a PPP basis). At current levels we think the
   compensation is large enough.

   The declining USD is pushing other Central Banks/Treasuries to become increasingly aggressive buyer of USD to weaken
   their own currencies. They then have to recycle their newly acquired USD and in so doing are exerting a downward pressure
   on real rates in the US and thus weakening the USD. This can not last forever. This will end by a radical redesign of our current
   monetary system and the sooner the better. The winner… Gold.

   Sentiment is increasingly supportive for the USD. Speculators had their biggest USD net short position ever a week ago and
   have covered a third despite continued USD weakness (a positive divergence. Assets in the the Rydex Weakening Dollar have
   surpassed assets in the Rydex Strengthening Dollar fund but have yet to spike briefly higher as they usually do when the USD
   decline exhausts itself.

   There is a big global short USD position which is growing by the day as the increase in foreign central bank reserves can
   not be completely explained by their current account balance and the net foreign direct investments. Hot money is flowing
   to emerging markets and we are on the look out for canaries…

   A new “Homeland Investment Act” could be voted in the month to come which could offer some support for the USD as it did

Clue6                                                                                                               Second Quarter 2011
   Executive Summary                                                                                                                2

   at the end of 2004, while oil price rising further might reach a level where its historical highly negative correlation with the USD
   turns positive as it does when oil price rise enough to break the back of the macro up cycle.

                          overvalued,
   The Euro is 7-10% overvalued after its recent rebound (more like 20-25% overvalued if you are leaving in Spain and much
   more if you are Greek). Yields spreads remain favorable and in synch (which is even more important) but the spread momentum
   has been faltering in the past 2 weeks despite M. Trichet "strong vigilance".

   Sentiment is not supportive with Speculators having accumulated a large net long position and a short-term positive risk
   reversal divergence.

   The Euro has been supported by the strong growth in emerging markets and the rapid inflows of hot money. Indeed
   exports to emerging markets are contributing strongly to the recent performance of the European core area and Emerging
   Central banks
   C t l b k are b         b l i their             holding toward greater di
                    busy rebalancing th i currency h ldi t      d     t diversification (
                                                                               ifi ti (even if th did not th would h
                                                                                               they       t they            to
                                                                                                                    ld have t
   sell some USD to keep the mix stable). We should also remember that a big chunk of emerging markets credit expansion is and
   has been financed by European banks. So if emerging markets slow down is larger than most expect (our scenario) Europe
   and the Euro are likely to suffer much more than the US and its currency.

   The trend is up but extended. We would exit long positions at least until we get an upside break. We would sell 1.5-3% OTM
   calls with 1-3 months maturity and would start to build an outright short position on a move below 1.39 and increase it if it
   moves below 1.375. We would use an initial stop at the high the Euro will make before it move below our trigger zone (so not
   1.4248 but higher or lower depending where the current intraday rebounds stop).

   Longer-term we maintain that the Euro could fall below 1. We think that it will bottom near 0.7 if it survives. Crazy? We met
   the same skepticism when we forecasted a rise above 1.5 when the ECB started to intervene when it was hovering near 0.85
   almost 10 years ago. While supportive political decisions might be taken in the near future (but it seems they won't as is usual) ,
   th problems won't di
   the    bl                        d ill
                     't disappear and will come b k l t t h t th
                                                 back later to hunt them. Th system, b th political and fi
                                                                           The      t     both liti l d financial h t b
                                                                                                                      i l has to be
   reformed but we will probably need a new crisis.

Clue6                                                                                                                 Second Quarter 2011
   Executive Summary                                                                                                                 3

   The Yen overvalued by at least 25%. And the authorities have now started to intervene again (this time jointly) putting an
   implicit floor below 80. The potential sterilization of the BOJ Yen selling and increase in the size of its balance sheet relative to
   other countries should push the Yen lower. With regard to repatriation, it is a myth. There are no data confirming it after the
   Kobe earthquake. Yields spreads are diverging negatively with price. This should ultimately leads to a lower Yen.

   There is a big non-commercial net long position which is diverging with price (net long position not increasing on Yen
   strength). “Housewives” have a huge net short position against the USD, the AUD and most other currencies. Position that
   large have historically led to Yen weakness in the short-term.

   There are/have been continued big inflows of hot money in the past 8 of months with the Yen rising despite the broad balance
   of payment registering a deficit of more than 5% of GDP.

   We        ld    d break b       84.5 for    l
   W would need a b k above 84 5 f a clear change i th cyclical t d U til th
                                                     h     in the                                 t t     is to ll downside
                                                                     li l trend. Until then, our strategy i t sell d    id
   volatility (USD/JPY puts with strike from 80.5 and below and 1 to 3 months to expiry). We would get outright long (the
   USD/JPY) on a move above 84.5 with a stop at the rising 65 days exponential moving average or on a new move below 80.5.
   Our first target would be a move to 93.5-94 and then 100. We would totally hedge the Japanese equity holding of “gaijin”
   investors.

   The British Pound is now slightly overvalued and deserve to trade at a bigger discount with lower real short-term yields
   than in the US. Many accidents are just waiting to happen with notably the residential real estate market. Authorities will use,
   among others, a depreciation of the Pound to support the British economy. Yields spreads are not confirming the recent Pound
   appreciation.

   Speculators are net long but they have sold some on strength which is a bearish divergence. The risk reversal is still in
   synch with the cross.

   The British Pound is in the middle of its up channel entering an important resistance zone. We might contemplate taking a short

Clue6                                                                                                                  Second Quarter 2011
   Executive Summary                                                                                                               4

   position on a move below 1.60. We are seller of upside volatility on a move above 1.65. We would sell 1.675-1.69 1-3 months
   to expiry calls.

   The CHF is more than 50% overvalued. The SNB has its hands partly tied having been to early to the party. It has
   already intervened massively and is running out of options (we would not be surprised to see capital controls be introduced on
   further strength. They could take the form of a tax on foreign money entering the country or negative yields on CHF
   denominated deposit owned by foreign entity). Walls of money are still heading to Switzerland from European banks while
   many holders CHF-denominated mortgage in Eastern Europe are slowly but surely getting squeezed. As for the JPY the yields
   spreads have not confirmed the recent CHF strength.

   Speculators have a huge net CHF long position.

   The i is            t d d below its
   Th pair i very extended b l it 200 and 50 d  d   days exponential moving average. Thi configuration h hi t i ll l d t a
                                                                   ti l    i            This     fi    ti has historically led to
   “return to the mean”. The technical structure remains favorable to the CHF with no identifiable trend change. While we do not
   usually fight trends, we would take a short position at the current 0.8980-0.9015 level. If we can move above 0.935 and then
   0.975, the move could extend to last years high.

   Commodities currencies are overvalued… The AUD is probably more than 35% above fair value while the NZD is 15-20%
   overvalued. The CAD is more than 10% overvalued. They have profited from the "Chinese inventory build-up“, Emerging
   Markets boom, institutional love affair and more recently QE2 related commodity rally. We think that the latter rally is very
   long on its tooth so…

   Speculators have a large AUD long position while there is a negative divergence building in the risk reversal.

   The AUD might be in the process of forming a complex top. It looks distributive to us. Remember that when the AUD
   corrects,               have       aterfall shape.                                                    juncture anymore.
   corrects it tends to do ha e a waterfall shape We can not recommend a long position at this j nct re an more The le el of     level
   overvaluation and the fragility of the foundation of its strength makes it to risky. We are seller of upside volatility on a move

Clue6                                                                                                                Second Quarter 2011
   Executive Summary                                                                                                           5

   above 1.02 and would even take a tiny outright short position to profit from the probable RBA selling. We would have to wait
   for some technical deterioration before we are willing to fight against the carry with more commitment but a close below the
   recent 0.985 lows would be a move in the right direction.

   On emerging currencies, we prefer to stay on the sidelines for now as valuation are not attractive and authorities seems
   to have decided, especially in Latin America, that their currency will not be allowed to strengthen. If we had to we would
   maintain a long position on the Taiwan Dollar and the Singapore Dollar. The more then Yen decline the less attractive the Won
   proposition will become so we are no longer recommending the South Korean currency for those who have to be long…We
   would not short, however, as the carry is too high for most of them. There will come a time were we will short emerging market
   currencies opportunistically, as we last did in 2008 but not yet.




Clue6                                                                                                            Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                                    6
                                                                                                           EUR USD
                                                                                                           EUR-USD 2 Years Real Rate Differential and EUR/USD
   Chart 1                    EUR/USD Fair Value Model                                        Chart 2                Real Effective Exchange Rate




Source: Clue6                                                                              Source: Clue6


      Valuations are not very helpful for short-term forecasts but are essentials to put the short, medium and long-term trends into perspective.

                                               7 10%                                              20 25%
      The Euro (Chart 1) is now approximately 7-10% overvalued against the USD (the Euro is 20-25% overvalued for the PIIGS and only slightly overvalued for
      Germany). We strongly believe that the Euro will ultimately massively undershoot fair value. We maintain our spring 2008 forecast of an ultimate fall below
      parity toward the 0.7 level.

      Real yields are higher in Europe than in the US and the differential is increasing which has historically been bullish for the Euro (Chart2). Note that t while real
      yields tended to leads the cross by approximately 12 months, it has been coincident since early 2005. The “coincident relationship” can be in part explained by the
      increased use by foreign financial companies of the US commercial papers market and the large global short USD position we have documented in the past few
      years.


 Clue6                                                                                                                                                Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                       7
   Chart 3         USD-EUR 2 Years Yield and Swaps Differential                     Chart 4         USD-EUR 2 Years Yield and Swaps Differential




Source: Clue6                                                                    Source: Clue6




                                                     3 4)                                          Euro.                           strong vigilance
      Nominal 2 years and swaps spreads (Chart 3-4) are also moving in the right direction for the Euro But note that despite the “strong vigilance” of
      M. Trichet and the ECB, the differential hast not been moving up as quickly as the EUR/USD.

      We have not yet a clear divergence as was the case during the preceding turning points but we might be near so one chart to have on its monitor …




 Clue6                                                                                                                                    Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                     8
                                                                                                USD JPY
                                                                                                USD-JPY 2 Years Real Rate Differential and USD/JPY
   Chart 5                 USD/JPY Fair Value Model                                Chart 6                Real Effective Exchange Rate




Source: Clue6                                                                   Source: Clue6




            p          (       )     pp         y
      The Japanese Yen (Chart 5) is approximately 25% overvalued.

      On Chart 6 one can see that real yields are still higher in Japan but the spreads is making lower highs (higher lows on the graph) which can be
      considered a mild positive divergence.




 Clue6                                                                                                                                  Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                        9
   Chart 7          USD-JPY 2 Years Yield and Swaps Differential                     Chart 8          USD-JPY 2 Years Yield and Swaps Differential




Source: Clue6                                                                     Source: Clue6




                                               7 8)
      Nominal 2 years and swaps spreads (Chart 7-8) are diverging positively with the most recent low significantly higher than in November 2010 .

      This has historically led to a weaker Yen. A chart confirmation would pave the way for one of those wonderful trade we strive to find.




 Clue6                                                                                                                                     Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                   10
                                                                                                 USD GBP
                                                                                                 USD-GBP 2 Years Real Rate Differential and USD/GBP
   Chart 9                 GBP/USD Fair Value Model                                 Chart 10               Real Effective Exchange Rate




Source: Clue6                                                                    Source: Clue6




                        (       )       y g y                       p                  y                              y
      The British Pound (Chart 9) is only slightly overvalued. We expect the currency to undershoot its fair value by more than 20% before it could
      embark into a new structural appreciation course. A fall to parity is not to be ruled out and would imply a 35-40% undershoot to fair value as was
      the case in 1985.

      The US have a relative real yield advantage which is supporting our forecast of GBP undershoot (Chart 10).




 Clue6                                                                                                                                  Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                            11
   Chart 11        GBP-USD 2 Years Yield and Swaps Differential               Chart 12      GBP-USD 2 Years Yield and Swaps Differential




Source: Clue6                                                              Source: Clue6




                                               11 12)
      Nominal 2 years and swaps spreads (Chart 11-12) are diverging negatively with the most recent rally in the Pound not confirmed but the
      differentials.

      This has historically led to a weaker Pound.




 Clue6                                                                                                                           Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                   12
                                                                                                 USD CHF
                                                                                                 USD-CHF 2 Years Real Rate Differential and USD/CHF
   Chart 13                USD/CHF Fair Value Model                                 Chart 14               Real Effective Exchange Rate




Source: Clue6                                                                    Source: Clue6


      The Swiss Franc (Chart 13) is overvalued by more than 50% which is similar to when it made its last secular top against the USD in 1995.
      With such a divergence from fair value, we would advise longer-term investors who like to make a couple of move per decade to sell their CHF
         iti     d buy USD. Investors with CHF d
      position and b USD I            t     ith      denominated accounts should stop t h d th i USD and b more. S i pension f d should
                                                            i t d          t h ld t to hedge their              d buy       Swiss      i funds h ld
      increase their real-estate investments in the US or at least start to build the necessary USD cash to be aggressive on further weakness in the US
      housing market in the US.

      Real yields are higher in Switzerland (Chart 14) but the spreads has been contracting. As with the Euro, the relationships between real yield
                                                                 coincident.                     US-CHF
      spreads and the Real Effective Exchange Rate is now almost coincident A move to a positive US CHF spreads would be the last nail in the CHF
      structural upswing coffin.

 Clue6                                                                                                                                  Second Quarter 2011
         Currencies: Valuations – Real Rate Spreads                                                                                                     13
   Chart 15        USD-CHF 2 Years Yield and Swaps Differential                      Chart 16        USD-CHF 2 Years Yield and Swaps Differential




Source: Clue6                                                                     Source: Clue6




                                               15 16)                                                                                    differentials.
      Nominal 2 years and swaps spreads (Chart 15-16) are diverging slightly with the most recent rally in the CHF not confirmed but the differentials .

      This has historically led to a weaker CHF.




 Clue6                                                                                                                                    Second Quarter 2011
         Currencies: Valuations                                                                                                                                                       14
   Chart 17                      AUD/USD Fair Value Model                                              Chart 18            AUD-USD 2 Years Yield and Swaps Differential




Source: Clue6                                                                                       Source: Clue6

      The AUD (Chart 17) is more than 35% overvalued and is an accident waiting to happen… There are many reasons for its strength (positive real yield spread, strong economy,
      links to China,…) but too much is…too much…

      Nominal i ld   d           diverging negatively and th h
      N i l yields and swaps are di    i       ti l                 for    than    th      (Chart 18). Watch t
                                                        d they have f more th 6 months now (Ch t 18) W t h out…

      We have documented in the past the excess of the Australian housing market and the big impact a bursting of the bubble would have on its concentrated and real-estate exposed
      financial system. Don’t forget that Australian banks are also using more and more the international markets for their short-term liquidity needs. All in all this will end badly, very
      badly. “Jusqu’ici tout va bien, jusqu’ici tout va bien, jusqu’ici tout va bien… l’important c’est pas la chute c’est l’atterissage” M. Kassovitz, “La Haine”. Note also that there are
      more and more officials warning of the potential disastrous consequences of the current situation (W. McKibbin of the RBA, D. Murray of the Future Fund, …).

      Australian pension funds should liquidate their Australian real estate assets and buy similar assets in the US. For AUD-based
      investors this will be one of the trade of the decade.

 Clue6                                                                                                                                                                Second Quarter 2011
         Currencies: Valuations                                                                                                                  15
   Chart 19                 NZD/USD Fair Value Model                             Chart 20     NZD-USD 2 Years Yield and Swaps Differential




Source: Clue6                                                                 Source: Clue6



      The NZD (Chart 19) is 15-20% overvalued.

      Nominal yield and swaps spreads have also been diverging negatively (Chart 20).

      If you want to be long, do it against the AUD.




 Clue6                                                                                                                             Second Quarter 2011
         Currencies: Valuations                                                                                                                                                   16
   Chart 21                PPP Deviation vs. PPP GDP per Capita                                      Table 1                    Latin America Adjusted Valuations




                                                                                                  Source: IMF, Clue6




Source: Clue6


      Looking at valuations for Emerging Markets can be deceptive. Using PPP, FEER, BEER or other models, most seems to be chronically undervalued.
      In 1964, Balassa and Samuelson presented an economic model (today known as the Balassa-Samuelson effect) to explain the “Penn effect”.

      The “Penn effect” was the observation that price levels where systematically higher in richer countries compared to poorer one. Balassa and Samuelson demonstrated that
      productivity in tradable goods and as a consequence wages are lower in poorer countries. As a result the relative price of non-tradable to tradable goods and services increase in
      richer countries. This lowers the PPP. In the chart 21 we have regressed the PPP implied over/undervaluation with the GDP per Capita (at PPP). The expected strong relation is
      apparent.

      South American currencies (Table 1) should be avoided and among them the darling of carry trader the Brazilian Real which is probably more than 40% overvalued. If
                                   (        )                              g            g         y                                    p       y
      you had the fact that both the Banco Central do Brasil and the government are actively trying to weaken it, one should stop playing the bigger fool game. Don’t short the
      carry is too large but there will be much better time to harvest it.


 Clue6                                                                                                                                                            Second Quarter 2011
         Currencies: Valuations                                                                                                                                      17
   Table 2                South-East Asia Adjusted Valuations                                 Table 3           Eastern Europe and Africa Adjusted Valuations




Source: IMF, Clue6                                                                         Source: IMF, Clue6




      South-East Asian currencies (Table 2) have appreciated in the past 9 months. We would exit our long position we advised to take at the height of the crisis early in
      2009 on the Singapore Dollar and the Korean Won now. We repeat that the next major move for the Chinese Yuan is a big depreciation so GET OUT. The
      Indonesian Rupiah was one of our favorite in the past but we would exit positions at current levels as it is now approximately 30% overvalued according to our
      methodology (and over-owned as we have showed in our fixed income and equity sections).

      Eastern European currencies (Table 3) where identified as highly undervalued back in January-March 2009 and, after a swing from overvaluation in March-
      April 2010 to slight undervaluation early last autumn and at the beginning of this year, are now overvalued again. We would avoid them at current levels as
      Hungary will have to be bailed out in the next 24 months (and when it does do not expect investors to be very discriminate toward the region)

      South African and Turkey currencies are overvalued and should be avoided.


 Clue6                                                                                                                                                Second Quarter 2011
        Currencies: Valuations – Sentiment                                                                                                     18
 Chart 22-23    ML Fund Managers Survey Valuation Perception                 Chart 24       ML Fund Managers Survey Valuation Perception

        Sentiment                  USD                                                                         JPY




                                                                              Source: ML
                                   EUR




                                                                                                                opinion.
   When it comes to valuation, fund managers surveyed by Merrill Lynch have historically been accurate in their opinion

   Chart 22, 23 and 24 do confirm our valuation analysis.

   The USD is undervalued while the Japanese Yen and the Euro are overvalued.




Clue6                                                                                                                            Second Quarter 2011
         Currencies: Sentiment                                                                                                                                                 19
                                     Non-Commercials
                    Dollar Index and Non Commercials Net Future Positions
   Chart 25                          in Foreign Currencies                                         Chart 26                   Dollar Index and Rydex Investors




Source: Bloomberg, Clue6                                                                        Source: Rydex, Clue6


      Non-Commercials had, a week ago, their biggest historical net USD short position (Chart 25). They have since covered more than 90’000 contracts (almost a third) even if
      the USD has continued to decline.

      We use this data by looking both at absolute levels, relative 2-3 years levels and divergences between positioning and the USD. What you will usually see at important turning
      point is first an extreme in both absolute and relative positioning followed by a reversal in those positions. Then you will see the USD continuing making new highs or lows
      without flows confirmation (move down but non-commercials will cut their net short position)… One should get more aggressive on the second spike in net positions (but it will
      be not as extreme as the previous one… It usually plays out under a 3-6 months period).

                                                                                                                                          26).
      The USD bottomed last year as Rydex traders assets in the weakening Dollar funds surpassed the one in the strengthening fund (Chart 26) This is the case again but we
      are not seeing a spike in the weakening dollar fund asset. This is puzzling.


 Clue6                                                                                                                                                           Second Quarter 2011
         Currencies: Sentiment                                                                                                                           20
                                        Non-Commercials
                           EUR/USD and Non Commercials                                                          EUR/USD and 3 Months 25D
   Chart 27                     Future Net Position                                    Chart 28                      Risk Reversal




Source: Bloomberg, Clue6                                                            Source: Bloomberg, Clue6



      Similar to the aggregate USD position the non-commercials positioning and price have diverged last week (Chart 27).

      On the chart 28 (and ensuing risk reversal graphs) one can find where the RR is relative to its short-term (red) and intermediate-term (blue) range.

      A move below 0.5 while the cross is making new highs is a bearish divergence with a move to 0 a strong warning. The reverse is true when the cross
      is making new lows. The last signals were given at the high in November and a low in June

      The risk reversal is diverging for the Euro (Chart 28) and this is a bearish set up.


 Clue6                                                                                                                                     Second Quarter 2011
         Currencies: Sentiment                                                                                                                     21
                                        Non-Commercials
                           USD/JPY and Non Commercials                                                    USD/JPY and 3 Months 25D
   Chart 29                     Future Net Position                               Chart 30                      Risk Reversal




Source: Bloomberg, Clue6                                                       Source: Bloomberg, Clue6




      Non commercials                                           29).                                      place.
      Non-commercials have a large net long Yen position (Chart 29) We have a nice negative divergence in place

      There no short-term risk reversal divergences in place (Chart 30).




 Clue6                                                                                                                               Second Quarter 2011
         Currencies: Sentiment                                                                                                                               22
   Chart 31           TFX Net Retail JPY/USD Margin Position                          Chart 32          TFX Total Retail Yen Net Short Margin Position




Source: TFE, Clue6                                                                 Source: TFE, Clue6



      A lot has been said about “Japanese Housewives” in the past few years. So let’s see what they are up to.

      They are extremely short the Yen against the USD (Chart 31) after having been very long when the Yen reached 0.94 in April 2010 and short
      almost all of the Yen Rally sine 2006. Note that while this data should usually be used as a contrarian indicator, spikes are another matter. Spike in
      Yen Short position are usually associated with bottoms for the USD against the JPY. Thee reverse is true at tops.

      They continue to play the carry trade in full . They are very long almost all major and carry crosses against the Yen (Chart 32). Here again
      spikes (short yen against other currencies) after prolonged decline in the USD against the JPY are usually associated with a future depreciating Yen.


 Clue6                                                                                                                                         Second Quarter 2011
         Currencies: Sentiment                                                                                                                    23
                                        Non-Commercials
                           GBP/USD and Non Commercials                                                   GBP/USD and 3 Months 25D
   Chart 33                     Future Net Position                              Chart 34                     Risk Reversal




Source: Bloomberg, Clue6                                                      Source: Bloomberg, Clue6




      Non-commercials h
      N                                t long position (Ch 33) N
                      i l have a GBP net l       iti (Chart 33). Note that there i a clear di
                                                                       h h       is   l                             i l      liquidating h i long
                                                                                           divergence as non-commercials are li id i their l
      position on strength.

      There is no divergence on the risk reversal (Chart 34).




 Clue6                                                                                                                              Second Quarter 2011
         Currencies: Sentiment                                                                                                                            24
                                        Non-Commercials
                           USD/CHF and Non Commercials                                                           USD/CHF and 3 Months 25D
   Chart 35                     Future Net Position                                     Chart 36                      Risk Reversal




Source: Bloomberg, Clue6                                                             Source: Bloomberg, Clue6




      Non-commercials are very long the CHF (Chart 35)
      Non commercials                              35).

      There are no short-term divergence on the risk reversal but note that it is currently higher that in September (Chart 36).




 Clue6                                                                                                                                      Second Quarter 2011
         Currencies: Sentiment                                                                                                                       25
                                        Non-Commercials
                           USD/CAD and Non Commercials                                                      USD/CAD and 3 Months 25D
   Chart 37                     Future Net Position                                 Chart 38                     Risk Reversal




Source: Bloomberg, Clue6                                                         Source: Bloomberg, Clue6




      N          i l have th i bi
      Non-commercials h               t t long position on th CAD ever (Ch 37)
                          their biggest net l     iti      the         (Chart 37).

      There are some identifiable divergences on the risk reversal (Chart 38).




 Clue6                                                                                                                                 Second Quarter 2011
         Currencies: Sentiment                                                                                                                      26
                                        Non-Commercials
                           AUD/USD and Non Commercials                                                     AUD/USD and 3 Months 25D
   Chart 39                     Future Net Position                                Chart 40                     Risk Reversal




Source: Bloomberg, Clue6                                                        Source: Bloomberg, Clue6




      Non-commercials have a big (too big) net long AUD position (Chart 39)
      Non commercials                                                   39).

      There is a large medium-term risk reversal divergence (Chart 40). This is bearish for the AUD.




 Clue6                                                                                                                                Second Quarter 2011
         Currencies: Sentiment                                                                                                 27
                                        Non-Commercials
                           NZD/USD and Non Commercials                                NZD/USD and 3 Months 25D
   Chart 41                     Future Net Position           Chart 42                     Risk Reversal




Source: Bloomberg, Clue6                                   Source: Bloomberg, Clue6




      Non-commercials are net short the NZD (Chart 41)
      Non commercials                              41).

      There are no risk reversal divergences (Chart 42).




 Clue6                                                                                                           Second Quarter 2011
         Currencies: Sentiment                                                                                                                           28
  Chart 43          EUR/USD FXCM Customers Positioning                               Chart 44         USD/JPY FXCM Customers Positioning




Source: FXCM                                                                       Source: FXCM




     Forex on-line traders are, on aggregate, on the wrong side of a trend more often than not.

     On Chart 43 one can see that traders have been decreasing their short position on Euro strength which something which usually happen near short-
     term turning points.

     They are net long the yen but have decreased their long position substantially recently (green line bottom panel) (Chart 44).




 Clue6                                                                                                                                     Second Quarter 2011
         Currencies: Sentiment                                                                                                                        29
  Chart 45          GBP/USD FXCM Customers Positioning                             Chart 46        USD/CHF FXCM Customers Positioning




Source: FXCM                                                                    Source: FXCM




                                               45).                           data,
     They are undecided on the GBP (Chart 45) Note that looking at daily data they moved to their largest net short GBP position since the beginning
     of 2010. When we see a spike like this, this has usually been a good time to exit the GBP.

     They are net short the CHF but have been decreasing rapidly their short position (even more with the recent update) (Chart 46). This is supportive
     for the USD against the CHF.




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         Currencies: Liquidity                                                                                                                                   30
   Chart 49             Dollar Index and Financial Foreign Outstanding CP          Chart 50                Dollar Index and Financial Foreign Outstanding CP




Source: “Current efforts to enhance global financial supervision “,BIS,
Stephen Cecchetti                                                               Source: Bloomberg, Clue6



      The structural net short USD position has been at the center of our forex analysis in the past few months as it was in 2008.

      The USD line on Chart 49 show the aggregate amount of USD required (net) by Canadian, Dutch, German, Swiss UK and Japanese banks. That’s
      usd 1.2 trn. Remember that those obligations could only be met through currency swap arrangements between Central Banks in 2009.

      Foreign financial companies have increased their borrowing of USD on the US commercial paper market in the past few months (Chart 50). We
                                                                                 rallies.
      are not far from the 2008 and 2010 highs which preceded USD short covering rallies



 Clue6                                                                                                                                             Second Quarter 2011
         Currencies: Liquidity                                                                                                                                                           31
   Chart 51                       EUR/USD Basis Swaps                                               Chart 52            Germany Total Net International Investment Position




                                                                                                                             Euro Countries Net International
                                                                                                                                   Investment Position




Source: Bloomberg, Clue6                                                                         Source: BundesBank, Clue6, Macquarie for the Euro-Zone Members Countries Net Position

      EUR/USD basis swaps are the cost for an institution to swap EUR for USD (chart 51). In the current situation it costs an Euro owner who wants to borrow USD 40 basis points
      per quarter. It is another sign that there is a shortage of USD, notably for European institutions.

      Another central elements when looking at today's macro landscape is the analysis of the “who have” and “who have not”.

      Germany has but what does it have. Its net international investment position has moved sharply higher since 1999. Part of the net foreign position improvement is endogenous
      capital export resulting from Germany current account surplus among others but there was a very large autonomous capital export stemming from banks (notably Landesbanks). A
      significant part (relatively speaking) of Germans banks foreign investments are going to depreciate significantly. Do you remember Landesbank involvement in US sub-primes
      through their SIV. They have also invested in shaky sovereign and corporate foreign banks and loaned significant amounts, directly or indirectly, to borrowers who won’t be able
      to pay back.

      Where will the “have not” find the money they need when risks will be factored again in investors investing decision, we are still looking for an answer…

 Clue6                                                                                                                                                                     Second Quarter 2011
         Currencies: Liquidity                                                                                                                                                                                32
                                                                                                                                               Dollar Index and World International
   Chart 53                  Foreign Reserve Currency Allocation                                                     Chart 54                      Reserve ex Gold Momentum




Source: Bloomberg, Clue6                                                                                         Source: Clue6

      Central Banks relative USD holding has continued to decline (Chart 53) but remember that most or even more is due to the USD relative decline. Anyhow the trend seems to have accelerated in Q4. This is
      best seen in China. China has moved from more than 80% USD allocation in 2003 to 52% today . With an acceleration in the past 12 months when it moved from 64% to 52%.

      Reserves around the world have been rising much faster than what the improving US current account would suggest. This has only been the case in the past when USD was borrowed short… This tends
      to end up with a big USD rally and some countries going bankrupt.

      According to the Chinese State Administration of Foreign Exchange (SAFE) almost usd 40 bio. of the usd 470 bio. increase in foreign reserves was hot money (not a result from the trade and foreign direct
      investment balance). Hot money inflows averaged usd 25 bio a year since 2001. The trend is also clear in Brazil, India, Indonesia and many other countries. Why borrow in local currency when one can borrow at
      much lower rates in a currency which is doomed to depreciate ad vitam eternam (The USD). There is a big net short position being built in the system and this will ultimately lead to a big, sorry BIG short
      squeeze.

      The       i kl           i     h
      Th more quickly reserve rise, the more USD h to b sold j to k
                                                 has be ld just keep the currency mix stable, ceteris paribus…
                                                                      h            i     bl        i     ib

      Let’s not forget the fact that foreign holder of US assets are more prone to hedge the currency that US holder of foreign asset. This asymmetry can explain some of the high correlation between the
      USD and risky assets… when risky assets rise, some more USD have to be sold to hedge the increasing assets… This is particularly visible at month end.

 Clue6                                                                                                                                                                                      Second Quarter 2011
        Currencies: Liquidity                                                                                                                                                                                  33
                                                                                                                Upside Pressure on Domestic
                                                        Foreign Capital Flows                                            Currency


                                                                                                                                                                      Central Bank Intervenes (Buy
                                                                                                                                                                       foreign currencies, international reserves
Domestic Authorities start                                                                                                                                                             increase)
to impose capital controls.
(When they feel they can not control the
       foreign flows anymore.)
                                                                                                                                                                 Central Bank sterilizes the increase
                                                                            Domestic Assets Rise                                                                                q     y             g
                                                                                                                                                                 in domestic liquidity resulting from
                                                                              (assets rise before the money                                                       its forex intervention (It sells short-term
                                                                            reaches the Central Bank coffers)                                                      paper to reabsorb the domestic currencies it had to
                                                                                                                                                                                 sell to by foreign ones)


     Inflation starts to be a
             concern



                                                                                The domestic economy
                                                                                       booms.                                               Domestic Actors start to believe that their
            Central Bank Tighten (Rise domestic short-
                  l    k i h                                                                                                            currencies has only one way to go against foreign
              term rates, increase banks reserve requirements,…)                                                                       currencies… UP. (They borrow in foreign currencies. Credit outside
                                                                                                                                                    of the domestic Central Bank control is created.)
           Source: Clue6


   Understanding the Emerging Markets “Liquidity Loop” is essential to put what is currently happening in perspective and to understand what it will ultimately lead to.

   Facing large foreign capital flows, domestic Central Banks intervene to limit the gain of their currency. By buying foreign currencies they are, ceteris paribus, expanding their monetary base which, if
   unsterilized, usually leads to faster economic nominal growth.

   It is important to note that the foreign money buy domestic assets or is borrowed by local actors before it reaches the central bank. The Central Bank/local authorities have thus to tighten/impose
   capital controls when they estimate that the domestic economy is overheating. This initially leads to more rapid inflows (as foreigners try to buy before they can not anymore) and foreign currency
   denominated borrowing by local actors (as the interest spread with between domestic and foreign currencies increase).

   It makes sterilizing more costly and central banks start to do less sterilizing but more monetary tightening (short-term rate rise, bank required reserve increase,...). The later is also a consequence of
   rising inflation which also leads central bank to accept a more rapid increase in their currencies which can further increase capital inflows and domestic foreign currency borrowing. Finally the circle
   is broken and...

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        Currencies: Liquidity                                                                                                                                                        34


                                                                                                            Central Bank tightening aggressively
        Inflation starts to be a
                                                                                                              and domestic authorities capital
                concern
                                                                                                                     controls increased

                                                       The domestic
                                                      economy slows
                                                       significantly

                                                                                                          Foreign Capital
                                                                                                             Outflows
                                                                                                                                                                     Foreign currencies
                                                                                                                                                                      rise (usually the
           Domestic Assets                                                                                                                                              USD is THE
              Decline                                                                                                                                                      winner)
                                                                                                     Domestic Actors struggle
                                                                                                      to repay/roll-over their
                                                                                                      foreign currencies debt
             Source: Clue6                                                                                    (short squeeze)




  ... what took years to build unravel in a matter of days/weeks. Inflows turn to outflows, domestic actors have to pay back or can not roll-over their foreign currency borrowing
                                                                        collapse.                starts                                        own
  (their short position is you prefer) the domestic currency and assets collapse A vicious cycle starts. The USD is the currency you wan t to own.

  The problems are compounded this time as the liquidity created by the developed markets central banks is flowing more or less directly toward emerging markets and
  commodities making the process particularly powerful.

  While capital will flow to emerging market on a long-term basis, on a cyclical basis we are closer to the end of the current wave than the beginning (as C. Gave uses to say, it will
  be like the sea after you have detonated a large bomb below the surface, first you will see small dead fishes emerging, only after you will see the dead whales so be on the look out
  for struggling small fishes… like Vietnam to be ready for the big ones). Don’t be the marginal provider of liquidity. Step up and do it when nobody else want (well when nobody
  has done it for some time…).

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        Currencies: Liquidity                                                                                                                           35
                       FX Intervention in the Past 12                                                                           Non-FDI
                                                                                                            FX Intervention Vs. Non FDI
   Chart 55              Months (as a % of GDP)                                       Chart 46                     Capital Inflows




              Source: UBS                                                                   Source: UBS




   Let’s look at the current figures
   Let s                     figures…

   On Chart 55 and 46 one can see the level of FX interventions and the non-foreign direct investments capital inflows.




Clue6                                                                                                                                     Second Quarter 2011
        Currencies: Liquidity                                                                                                                         36
 Chart 57                 Monetary Base Growth and Sterilization                   Chart 58                 Yen and MOF Interventions




            Source: UBS                                                         Source: MOF, Clue6


   On Chart 57 one can see the influence of the Net Foreign (NFA) and Net Domestic Assets (NDA) contribution to the base money growth.

                                                  intervening.
   Even developed Central Banks have/are actively intervening

   On Chart 58 one can see that the BOJ recent interventions. The most recent ntervention should work as it was coordinated with other Central
   Banks. The last coordinated intervention in 2000 saw the Euro appreciate in the following days then retesting its lows before embarking into a multi-
   years ascension which say the currency almost double against the USD.

   If the intervention is unsterilized and the BOJ embarks into a new round of quantitative easing, the depreciation of the Yen could be very
   significant, wit a move above 125 in the next18-24 months a distinct possibility.
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         Currencies: Liquidity                                                                                                                          37
   Chart 59                  JP Morgan Real Broad USD                             Chart 60                    JP Morgan Real Broad EURO


                           Plaza Accord




           Louvre
           Accord

                                                                                       Joint              ECB
                                                                                       intervention       intervention



Source: JP Morgan, Clue6                                                       Source: JP Morgan, Clue6




           joint interventions h
      Past j i i          i         been rather successful even if the Louvre A
                               have b       h          f l          h              d       l bl        l    h S downside momentum (Ch 59-60).
                                                                              Accord was only able to slow the USD d id           (Chart 9 60)

      Cynics could say that they work when the goal is to weaken the USD and not that well when the reverse is true but we would rather say that the
      USD was not that undervalued when the Louvre Accord was signed and the US not very committed.




 Clue6                                                                                                                                    Second Quarter 2011
         Currencies: Liquidity                                                                                                                          38
   Chart 61               AUD and RBA Interventions                                  Chart 62                NZD and RBNZ Interventions




Source: RBA, Clue6                                                                Source: RBNZ, Clue6



      The Reserve Bank of Australia has continued to intervene in the market (Chart 61) but it has yet to step ups in a meaningful way (but it is more
                 y                             p y)          g     p                            g                            y
      active every time the AUD move above parity). It might hope that the rise in the AUD tighten the domestic monetary condition. It knows that the
      country is the home of the biggest housing bubble in the world with an overly exposed banking system. It can not risk to pop it. Rising rates too
      quickly might cause that risk. Furthermore it is a way to protect the domestic economy (limiting the resource sector boom to get out of control from
      rising commodity prices which are pushing its term of trade up.

      The Reserve Bank of New-Zealand is in a similar position even if we would not be surprised that it sold some NZD on the aftermath of the
      Christchurch earthquake (Chart 62).


 Clue6                                                                                                                                    Second Quarter 2011
        Currencies: Liquidity                                                                                                                     39




                                     Source: BOJ, Federal Reserve, Clue6




          q                 g                                                                        , y g                   g
   The US quantitative easing has been blamed for the USD decline. While correlation is not causation, they might be something to it.

   Looking at the relative growth of the Fed and BOJ balance sheet, one can see that if the BOJ start to ease quantitatively on its own, the Yen might
   loose some ground.




Clue6                                                                                                                               Second Quarter 2011
        Currencies: Liquidity                                                                                                                         40




                                              Source: Goldman Sachs



   The 1995 Yen strength was not related to the Kobe earthquake (or at least not as closely as many analysts have recently argued). As one can see
                                             p          (             p               (g              p                     )           g
   on the above charts, there were no real repatriation (defined as Japanese entities (government, companies, households,...) sell foreign assets to cover
   domestic needs). The earthquake losses are mainly domestically insured. Repatriation in Japan has usually been seen when there were global
   financial tensions, not domestic one. We would not be surprised if some large Japanese institutions took advantage of the JPY rapid appreciation to
   buy some for foreign bonds.

   When talking about repatriation, one has also to keep in mind that US corporations are hoarding large amount of cash (past profits) outside of
   the US. While a large part is probably held in USD, a new “Homeland Investment Act” to let corporation repatriate offshore income with a highly
   discounted tax rate would probably be a catalyst for a strong USD rebound. The first version at the end of 2004 lead to a 14% rise in the USD.

Clue6                                                                                                                                   Second Quarter 2011
         Currencies: Trade                                                                                                                         41
                           Dollar Index and Export to GDP Ratio                                       USD/JPY and Japanese Merchandise
   Chart 63                     4 Quarters Rate of Change                         Chart 64                  Trade Balance NSA




Source: Bloomberg, Clue6                                                       Source: Clue6




      The export to GDP ratio momentum has turned positive again (Chart 63). This is structurally bullish for the USD (and this time it is not as 18
      months ago due to a decline in nominal GDP).

      Japan merchandise trade balance has been improving markedly since the 2009 lows but remains much lower than in the past (Chart 64). It
      has even started to roll over again which is JPY-negative.




 Clue6                                                                                                                               Second Quarter 2011
        Currencies: Trade                                                                                                                42




                                      Source: Nomura




                                                                                        hich                        pressure push
   The USD/JPY is currently more than 10% below the Japanese exporters’ breakeven rate which increase the political press re to p sh the Yen
   lower.




Clue6                                                                                                                      Second Quarter 2011
         Currencies: Intermarket                                                                                                                       43
   Chart 65                 Dollar Index and Crude OIl                              Chart 66             Dollar Index and ISM Momentum




Source: Bloomberg, Clue6                                                         Source: Clue6




      The USD and oil price have had a negative 0.7 correlation in the past 25 years (Chart 65).

      This is true that the USD tends to decline when crude oil rise but this is only true up to a point. When oil gets so expansive that global growth
      falters, this become USD positive.

      The USD tends to perform well when the ISM manufacturing index has a negative momentum, especially when the ISM is below 50 (Chart
      66).


 Clue6                                                                                                                                   Second Quarter 2011
         Currencies: Seasonality                                                                                                                   44
   Chart 67                EUR/USD TR Seasonality (since 1989)              Chart 68                USD/JPY TR Seasonality (since 1989)




Source: Bloomberg, Clue6                                                 Source: Bloomberg, Clue6




      There are no real seasonal edges i the months to come (Ch 67 68) Th USD h tended to b relatively week until mid-September b i was
      Th               l        l d       in h    h         (Chart 67-68). The has d d be l i l           k    il id S      b but it
      supposed to be strong in the past 3 months…




 Clue6                                                                                                                               Second Quarter 2011
         Currencies: Seasonality                                                                                                                      45
   Chart 69                GBP/USD TR Seasonality (since 1989)                  Chart 70                USD/CHF TR Seasonality (since 1989)




Source: Bloomberg, Clue6                                                     Source: Bloomberg, Clue6




      Th P d h hi         i ll been strong the A il J l period (Ch 69)
      The Pound has historically b          h April-July   i d (Chart 69).

      The USD/CHF has usually been week into mid-September (Chart 70).




 Clue6                                                                                                                                  Second Quarter 2011
         Currencies: Seasonality                                                                                                                            46
   Chart 71                AUD/USD TR Seasonality (since 1989)                       Chart 72                Asia/USD TR Seasonality (since 1999)




Source: Bloomberg, Clue6                                                          Source: Bloomberg, Clue6




      The AUD has historically been strong in April and June with a hick up in May (Chart 71).

      The same is true for the NZD (Chart 72).




 Clue6                                                                                                                                        Second Quarter 2011
           Currencies: Graphs                                                                                                                                        47
                                                                                EUR/USD




    The E     is t th t    f it        th ld i i      h    l t th       ti
    Th Euro i at the top of its 3 months old rising channel at the same time as it is pushing toward an important resistance area (red area on th graph and down trend line
                                                                                   i     hi t      d i       t t it                ( d         the    h dd       t d li
    from the 2008 peak. It is also far away its 200 and 50 days moving average which has historically led to at least a consolidation.

    We would exit long positions at least until we get an upside break. We would sell 1.5-3% OTM calls with 1-3 months maturity and would start to build an outright short
    position on a move below 1.39 and increase it if it moves below 1.375. We would use an initial stop at the high the Euro will make before it move below our trigger zone
    (so not 1.4248 but higher or lower depending where the current intraday rebounds stop).

    Longer-term we maintain that the Euro could fall below 1. We think that it will bottom near 0.7 if it survives. Crazy? We met the same skepticism when we forecasted a
    rise above 1.5 when the ECB started to intervene when it was hovering near 0.85 almost 10 years ago.
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          Currencies: Graphs                                                                                                                    48
                                                                      USD/JPY




    We would need a break above 84.5 for a clear change in the cyclical trend. Until then, our strategy is to sell downside volatility (USD/JPY puts
    with strike from 80.5 and below and 1 to 3 months to expiry). We would get outright long (the USD/JPY) on a move above 84.5 with a stop at the
    rising 65 days exponential moving average or on a new move below 80.5. Our first target would be a move to 93.5-94 and then 100.

                                                                   investors
    We would totally hedge the Japanese equity holding of “gaijin” investors.



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           Currencies: Graphs                                                                                                   49
                                                                       GBP/USD




                                                                               Diamond Top




    The British Pound is in the middle of its up channel entering an important resistance zone.

    We might contemplate taking a short position on a move below 1.60.

    We are seller of upside volatility on a move above 1.65. We would sell 1.675-1.69 1-3 months to expiry calls.


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           Currencies: Graphs                                                                                                                      50
                                                                       USD/CHF
                                                                                                        Head & Shoulders




                                                                                                                 Head & Shoulders
                                                                                                                      Target




    The large head & shoulders top identified last year has reached it 0.93-0.95 target early in 2011. The pair is very extended below its 200 and 50
    days exponential moving average. This configuration has historically led to a “return to the mean”. The technical structure remains favorable to the
    CHF with no identifiable trend change.

                          y g           ,                       p
    While we do not usually fight trends, we would take a short position at the current 0.8980-0.9015 level. If we can move above 0.935 and then
    0.975, the move could extend to last years high.


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           Currencies: Graphs                                                                                                                                    51
                                                                              AUD/USD




    The AUD might be in the process of forming a complex top. It looks distributive to us. Remember that when the AUD corrects, it tends to do have a waterfall
    shape.

    We can not recommend a long position at this juncture anymore. The level of overvaluation and the fragility of the foundation of its strength makes it to risky.
    We are seller of upside volatility on a move above 1.02 and would even take a tiny outright short position to profit from the probable RBA selling.

    We would have to wait for some technical deterioration before we are willing to fight against the carry with more commitment but a close below the recent 0.985
    lows would be a move in the right direction. Stay tuned.

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           Currencies: Conclusion                                                                                                                  52

  The USD is becoming increasingly undervalued against most currencies. It is at a 40 years low on a real broad trade-weighted basis. Its
  economy is much more dynamic and has started to rebalance earlier than other developed economies. Companies have been cutting costs aggressively
  and are much more competitive in the international markets.

  The big problem remains that the Fed is suppressing real government bond yields through quantitative easing. Ceteris paribus, the USD will have
  to be more undervalued on a PPP basis to be in equilibrium. Indeed, the deficit of interests payment foreigners are receiving has to be
  compensated by a lower price I.e. lower USD (this is another reason why emerging markets with negative real yields have very undervalued
  currencies on a PPP basis). At current levels we think the compensation is large enough.

  The declining USD is pushing other Central Banks/Treasuries to become increasingly aggressive buyer of USD to weaken their own currencies.
  They then have to recycle their newly acquired USD and in so doing are exerting a downward pressure on real rates in the US and thus weakening the
  USD. This can not last forever. This will end by a radical redesign of our current monetary system and the sooner the better. The winner… Gold.

                         g y pp                            p                    gg                    p               g
  Sentiment is increasingly supportive for the USD. Speculators had their biggest USD net short position ever a week ago and have covered a third
  despite continued USD weakness (a positive divergence. Assets in the the Rydex Weakening Dollar have surpassed assets in the Rydex Strengthening
  Dollar fund but have yet to spike briefly higher as they usually do when the USD decline exhausts itself.

  There is a big global short USD position which is growing by the day as the increase in foreign central bank reserves can not be completely
    p          y                                              g                               y         g        g g
  explained by their current account balance and the net foreign direct investments. Hot money is flowing to emerging markets and we are on the
  look out for canaries…

  A new “Homeland Investment Act” could be voted in the month to come which could offer some support for the USD as it did at the end of 2004,
  while oil price rising further might reach a level where its historical highly negative correlation with the USD turns positive as it does when oil price
  rise enough to break the back of the macro up cycle.

  The Euro is 7-10% overvalued, after its recent rebound (more like 20-25% overvalued if you are leaving in Spain and much more if you are Greek).
  Yields spreads remain favorable and in synch (which is even more important) but the spread momentum has been faltering in the past 2 weeks despite
  M. Trichet "strong vigilance".

  Sentiment is not supportive with Speculators having accumulated a large net long position and a short-term positive risk reversal divergence.


Clue6                                                                                                                                  Second Quarter 2011
           Currencies: Conclusion                                                                                                                    53

  The Euro has been supported by the strong growth in emerging markets and the rapid inflows of hot money. Indeed exports to emerging
  markets are contributing strongly to the recent performance of the European core area and Emerging Central banks are busy rebalancing their currency
  holding toward greater diversification (even if they did not they would have to sell some USD to keep the mix stable). We should also remember that a
  big chunk of emerging markets credit expansion is and has been financed by European banks. So if emerging markets slow down is larger than most
  expect (our scenario) Europe and the Euro are likely to suffer much more than the US and its currency.

  The trend is up but extended. We would exit long positions at least until we get an upside break. We would sell 1.5-3% OTM calls with 1-3 months
  maturity and would start to build an outright short position on a move below 1.39 and increase it if it moves below 1.375. We would use an initial stop
  at the high the Euro will make before it move below our trigger zone (so not 1.4248 but higher or lower depending where the current intraday rebounds
           g                                                  gg       (                    g                p      g                        y
  stop).

  Longer-term we maintain that the Euro could fall below 1. We think that it will bottom near 0.7 if it survives. Crazy? We met the same skepticism
  when we forecasted a rise above 1.5 when the ECB started to intervene when it was hovering near 0.85 almost 10 years ago. While supportive
  p                     g                               (                y                  )       p                  pp
  political decisions might be taken in the near future (but it seems they won't as is usual) , the problems won't disappear and will come back later to hunt
  them. The system, both political and financial has to be reformed but we will probably need a new crisis.

  The Yen overvalued by at least 25%. And the authorities have now started to intervene again (this time jointly) putting an implicit floor below 80.
  The potential sterilization of the BOJ Yen selling and increase in the size of its balance sheet relative to other countries should push the Yen lower.
         g         p                    y                               g
  With regard to repatriation, it is a myth. There are no data confirming it after the Kobe earthquake. Yields spreads are diverging negatively with price.
                                                                                                 q              p               g g g         y      p
  This should ultimately leads to a lower Yen.

  There is a big non-commercial net long position which is diverging with price (net long position not increasing on Yen strength).
  “Housewives” have a huge net short position against the USD, the AUD and most other currencies. Position that large have historically led to Yen
  weakness in the short-term.

  There are/have been continued big inflows of hot money in the past 8 of months with the Yen rising despite the broad balance of payment registering
  a deficit of more than 5% of GDP.

  We would need a break above 84.5 for a clear change in the cyclical trend. Until then, our strategy is to sell downside volatility (USD/JPY puts
  with strike from 80.5 and below and 1 to 3 months to expiry). We would get outright long (the USD/JPY) on a move above 84.5 with a stop at the


Clue6                                                                                                                                    Second Quarter 2011
           Currencies: Conclusion                                                                                                                 54

  rising 65 days exponential moving average or on a new move below 80.5. Our first target would be a move to 93.5-94 and then 100. We would totally
  hedge the Japanese equity holding of “gaijin” investors.

                                                                                                                 short term
  The British Pound is now slightly overvalued and deserve to trade at a bigger discount with lower real short-term yields than in the US. Many
  accidents are just waiting to happen with notably the residential real estate market. Authorities will use, among others, a depreciation of the Pound to
  support the British economy. Yields spreads are not confirming the recent Pound appreciation.

  Speculators are net long but they have sold some on strength which is a bearish divergence. The risk reversal is still in synch with the cross.

  The British Pound is in the middle of its up channel entering an important resistance zone. We might contemplate taking a short position on a move
  below 1.60. We are seller of upside volatility on a move above 1.65. We would sell 1.675-1.69 1-3 months to expiry calls.

  The CHF is more than 50% overvalued. The SNB has its hands partly tied having been to early to the party. It has already intervened massively
               g         p      (                    p              p                                            g       y
  and is running out of options (we would not be surprised to see capital controls be introduced on further strength. They could take the form of a tax on
  foreign money entering the country or negative yields on CHF denominated deposit owned by foreign entity). Walls of money are still heading to
  Switzerland from European banks while many holders CHF-denominated mortgage in Eastern Europe are slowly but surely getting squeezed. As for
  the JPY the yields spreads have not confirmed the recent CHF strength.

   p                   g             gp
  Speculators have a huge net CHF long position.

  The pair is very extended below its 200 and 50 days exponential moving average. This configuration has historically led to a “return to the mean”.
  The technical structure remains favorable to the CHF with no identifiable trend change. While we do not usually fight trends, we would take a short
  position at the current 0.8980-0.9015 level. If we can move above 0.935 and then 0.975, the move could extend to last years high.

  Commodities currencies are overvalued… The AUD is probably more than 35% above fair value while the NZD is 15-20% overvalued. The CAD
  is more than 10% overvalued. They have profited from the "Chinese inventory build-up“, Emerging Markets boom, institutional love affair and
  more recently QE2 related commodity rally. We think that the latter rally is very long on its tooth so…

  Speculators have a large AUD long position while there is a negative divergence building in the risk reversal.



Clue6                                                                                                                                 Second Quarter 2011
           Currencies: Conclusion                                                                                                                  55

  The AUD might be in the process of forming a complex top. It looks distributive to us. Remember that when the AUD corrects, it tends to do have a
  waterfall shape. We can not recommend a long position at this juncture anymore. The level of overvaluation and the fragility of the foundation of its
  strength makes it to risky. We are seller of upside volatility on a move above 1.02 and would even take a tiny outright short position to profit from the
  probable RBA selling. We would have to wait for some technical deterioration before we are willing to fight against the carry with more commitment
  but a close below the recent 0.985 lows would be a move in the right direction.

  On emerging currencies, we prefer to stay on the sidelines for now as valuation are not attractive and authorities seems to have decided,
  especially in Latin America, that their currency will not be allowed to strengthen. If we had to we would maintain a long position on the Taiwan
  Dollar and the Singapore Dollar. The more then Yen decline the less attractive the Won proposition will become so we are no longer recommending
                    g p                                                                     p p                                  g                g
  the South Korean currency for those who have to be long…We would not short, however, as the carry is too high for most of them. There will come a
  time were we will short emerging market currencies opportunistically, as we last did in 2008 but not yet.




Clue6                                                                                                                                  Second Quarter 2011

				
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