From Heinz:
Friday, October 29, 2004
the dollar revisited
i saw yesterday that the venerable 'Economist' magazine has penned a rather bearish article on the dollar - the only relief (for gold investors) is that it didn't make their front page. the Economist often comes out with bearish articles AFTER a huge move in the requisite direction has already occurred.
remember their infamous 'drowning in oil' cover story? it predicted $5 bbl. just as we hit the multi decade lows around $10, and oil prices have been going up and away ever since.
if one ever needed an example illustrating the inability of fundamental analysis to capture major turning points in markets, this was it. at the time, all the statistics seemed to prove out the Economist's contentions, but later it turned out that a) the statistics were wrong (600m. bbl. of crude had gone 'missing') and b) that the authors had neglected the fact that major lows ar made when the bad news are overwhelming, and seemingly destined to only get worse.
nevertheless, their article on the dollar is well worth reading and makes valid points:
economist.com
the fundamental case for a weaker dollar seems a lot better than that for a continued slide in crude was in '98/'99 , and although it is close to major support levels, it sure looks otherwise technically very weak.
also, currency trends are more inert than other trends. my own view is that the LONG TERM bearish case is very solid, but i'm less certain than the rest of the world about the short to medium term outlook - the combination of nearby support and near unanimous, or at least extremely lopsided, bearish sentiment makes me wary. wary, but not to the point where i'm saying a bounce is a 'done deal'.
speaking of probabilities, extreme market moves (read: blow-off rallies and crashes) often occur when the probabilities do seem very low. i.e., blow-off rallies can happen in a very overbought looking markets, and crashes in very oversold looking ones.
one only needs to recall various tech sub sectors in late '99/early '00 as examples for huge blow-offs, and the Russian rouble '98, or Argentine bonds in '01 as good crash examples.
so one should probably contemplate the dollar's position with this low probability event at the back of one's mind - and we can state that the necessary preconditions for an outsized slide are certainly present.
recapitulating from an earlier dollar discussion, the Fed's flow of funds reports show that the foreign held net long position in dollar based assets is at a record high - and contrary to expectations, or conventional wisdom, foreign holders of dollar DEBT (foreign held dollar debt is dollar bullish, since it requires dollars to be paid back) have REDUCED their exposure instead of increasing it (i.e., if there's a carry trade, overseas investors in the aggregate are not engaging in it).
at the same time, the biggest buyers of dollars are foreign central banks - to such an extent that they are indeed 'drowning' in dollars. so we have here yet another typical crash precondition, namely that a bunch of bureaucrats is trying to manipulate the market. bureaucratic market meddling has famously failed in 99% of historic cases. the rare occasions of 'success' owe more to the fact that the requisite markets were about to embark on a move in the desired direction anyway, like e.g. the case of the BoJ's buying of stocks from bank portfolios beginning in '02, or the HK monetary authority's buying of stocks in '98. in fact, the BoJ's action may ultimately prove counterproductive since it's the BoJ that now has the profits on its books, while the banks have incurred a vast opportunity loss.
so we have a situation here where market participants sit on a huge overhang of dollars, and all of themknow very well that its slide to date has only been slowed down by the most massive bureaucratic market intervention the world has ever seen.
and now they're all watching the major support level creeping closer - or rather, being approached with slightly unnerving speed.
they are also aware that the fundamental backdrop for the dollar in the form of an exploding current account deficit (at historic highs both in absolute and relative to GDP terms) and a likewise exploding budget deficit keeps deteriorating - and is doing so at an unnerving speed as well.
and this is the typ of situation that can translate into a panic at some point, in spite of lopsided bearish sentiment and oversold technical conditions.
it's akin to a sinking ship with not enough life boats, where the passengers have been informed that a recent breach of the hull is nothing to worry about. the ship's the biggest ever built, and its construction is said to be sophisticated enough to ensure keeping it afloat even though it has just rammed an iceberg. to emphasize the point that everything's o.k., the captain (his name's Uncle Al) urges everyone to keep dancing in the ball room, and the orchestra of course keeps playing as if nothing had happened.
and yet, the passengers can't help being aware that the ship is listing ever more and that it becomes progressively more difficult to keep one's balance.
'oh well' they say, 'no reason to worry - we still have the lifeboats in case the captain's confidence is misplaced'. but then suddenly a rumor begins to spread - there aren't enough lifeboats, because no-one figured they would ever be needed (think 'dynamic hedging with derivatives').
at that point no amount of rationalization can keep the herd from stampeding - nevermind that the biggest ship ever built was considered by EVERYBODY to be unsinkable.
worldmarket.blogspot.com |
