First Quarter 2010 GTAA Currencies

8/14/2019 First Quarter 2010 GTAA Currencies

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o a ac casse oca on

GTAACurrencies

January 9th, 2009

Damien Cleusix

Clue6 First Quarter 2010

am en c ue .com


2/25

1Executive Summary

Currencies

We like the USD here. It is undervalued and the econom is much more d namic and has started to rebalance earlier than

elsewhere. The Fed is now much more pro-active as is the Treasury (not to say that we think they do everything right) than

authorities elsewhere. We do not fear a "foreigner exit" of the US and would rather contemplate some capital repatriation

sometimes this year combined with some US loans contracted by foreigners (from foreign financial US commercial paper

borrowing to local US borrowing in emerging markets, as you know the Bucks can only go down and you can borrow at cheaper

yields than in the local currency) having to be repaid quicker than planned

The trend is making an attempt to turn up and the sentiment dynamic is supportive for the Greenback

.

Yen KAN be talked down. We thus have a 85 floor The trend has turned down for the Yen but we would ideally like to seea higher lows

The Euro remains our "worst G7 currenc " to hold on a valuation and macro risk basis. Euro ean banks have et to write

down a big chunk of their "toxic assets", it is very exposed to emerging market loans, the ECB is playing the ostrich game, the

economy is less diversified and dynamic than the US, it is much more trade-dependent than what observers think, their are big

disequilibria " intra-Euro" with depression like conditions in Spain and Ireland,... All of this is not discounted and remember thatfor every 10% increase in the Euro trade weighted index, you have to take off 0.8% from GDP and the Euro is now almost 25%

overvalued... Add that some European countries have suddenly decided, after a 20% appreciation of the EUR/USD since March

and almost 75% appreciation since 2001 that they should borrow in USD

The Euro trend has probably turned down which is even more significant given the level of overvaluation it had reached in



3/25

2Executive Summary

The CHF is likely to stay, at best, anchored to the Euro now that the SNB has been vocal in its desire to see the CHF decline

The Br t sh Pound s a rly valued but does not deserve to trade at a r value Commercial real estate correction might be

nearing an end with attractive yields starting to reappear but the residential market has a long, long way to go. One has to also

had that M. King and the Exchequer have been actively talking down the currency

Commodities currencies are now very overvalued They profited from the "Chinese inventory build-up" related commodity

rally but enough is enough and that is what the Royal Bank of Australia and its New-Zealand counterpart seems to be thinking

They are at a critical juncture and we would short them with a stop just above the end of last year highs Preferably usingoptions

On emerging currencies, we prefer to stay on the sidelines for now. If we had to we would maintain a long position on the

Taiwan Dollar, the Korean Won and the Singapore Dollar. The more then Yen decline the less attractive the Won proposition will

becomeWe would not short, however, as the carry is too high for most of them.

The trend is still up though



4/25

3Currencies: Valuations Developed

Chart 1Valuations are not very helpful for short-term

forecasts but are essentials to put the short,

medium and long-term trends into perspective.

USD/JPY FairValue ModelChart 2

EUR/USD FairValue Model

The Euro (Chart 10) is now hovering near the

over 20% overvaluation against the USD. In

September we said: We will use any trenddeterioration to increase our short small position further

. ,

has now deteriorated more on this latter

The British Pound (Chart 2) is at fair value after

having been more than 15% below fair value

USD/CHF FairValue ModelChart 4

GBP/USD FairValue ModelChart 3

.

undershoot its fair value by more than 20%before it could embark into a new real

appreciation course

Source: Bloomberg, Clue Source: Bloomberg, Clue

15% overvalued and the in this environnement

this we would say that 20% is the extreme limit

(was there a couple of weeks ago)

The Swiss Franc (Chart 4) is overvalued, as

always, but has now reached a level of

overvaluation where the currency has

struggled in the past


, ,


5/25

4Currencies: Valuations Developed

AUD/USD FairValue ModelChart 6

USD/CAD FairValue ModelChart 5

The Canadian dollar (Chart 5) is slightly

overvalued (more than that if we look at the

istoric valuation range), w ile t e NZD (C art

7) is in a danger zone being more than 20%

overvalued

The AUD (Chart 8) is now more than 30%

overvalue an is an acci ent waiting to appen

There are many reasons for its strength (strong

economy, links to China,) but too much istoo

much

Furthermore Australia is showing the same kind of

NZD/USD FairValue ModelChart 7

excess we wou say even more on Source: Bloomberg, Clue Source: Bloomberg, Clue

the credit and housing side as the US and the UK Timing the day of reckoning is impossible but

the day will come when Keep an attentive eye on it

.

Using PPP, FEER, BEER and 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

-


,.

and services increase in richer countries. This lowers the PPP.


6/25

5Currencies: Valuations Emerging

Chart 8In the chart 8 we have regressed the PPP implied

over/undervaluation with the GDP per Capita (at

PPP). The expected strong relation is apparent.

South-East AsiaAdjusted Valuation

Table 1PP Deviationn V.s.PPP GDP per Capita

We then compared the PPP over/undervaluation

with the over/undervaluation obtained by

regressing the GDP per capita (Tables 1, 2 and 3).

ou - as s an currenc es a e ave

continued their move toward slightly overvalued

levels since our last presentation. The Singapore

Dollar (even if the currency is used actively by

the monetary authorities) and the South KoreanSource: IMF, Clue6

Source: IMF, Clue6

Eastern Europe and

AfricaAdjusted ValuationTable 3

South America

Adjusted ValuationTable 2on those metrics

South American currencies (Table 2) should be

avoided based on those metrics...

Eastern European currencies (Table 3) where

identified as highly undervalued back in January-

March 2009 and are now back to fair value which

is not justified given the potential risks lying

We exited the long Ruble position recommended

in early 2009 back in September and would

continue to stay away for now South Africa and

Source: IMF, Clue6

Source: IMF, Clue6



7/25

6Currencies: SentimentChart 10Chart 9

o ar n ex an on- ommerc a s e u ure os ons

in Foreign Currencies

Non-Commercials had a big net USD short position at the end of last year (Chart 9) and are now almost flat. We use this data by looking both atabsolute levels, relative 2-3 years level and divergence between positioning and the USD. What you will usually see at important turning point is

Source: Rydex, Clue6Source: Bloomberg, Clue6

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 flow 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

Rydex traders have not been as aggressive as last year but the Rydex leveraged-Strengthening Dollar Fund has now more assets than the leveraged-


Weakening one (Chart 10)


8/25

7Currencies: SentimentChart 12Chart 11 FXCM Customers PositioningEUR/USD FXCM Customers Positioning

Source: FXCMSource: FXCM

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

We have used the FXCM in the past to prove this point On Chart 11 one can see that while they remained stubbornly short the EURO into the top

above 1.50, they suddenly decided around those level that it was a good idea to be long

On a currency pair basis, they are now long the Yen (they where short up to the 86-87 level), long the Pound and the Euro while they remain short


.


9/25

8Currencies: SentimentChart 14Chart 13 TFX Net Retail AUD/JPY Margin PositionTFX Net Retail JPY/USD Margin Position

A lot has been said about Japanese housewives in the past few years So what are they up to currently

Source: Clue6Source: Bloomberg, Clue6

They are very long the Yen (VERY LONG) after having been short almost all of the Yen Rally sine 2006

They have also rediscovered the joy of the carry trade. They are very long the AUD/JPY (Chart 14) and the NZD



10/25

9Currencies: LiquidityChart 16Chart 15 USD/JPY, Risk Reversal and their CorrelationDollar Index and Financial Foreign Outstanding CP

Foreign financial companies have continued their trend toward heavier borrowing of USD on the US commercial paper market (Chart 15) Could

they get squeezed has in 2008


And do not forget, has we said in September that we have seen a proliferation of debt issued in USD (Germany, Spain,) the rationale being that

not only do we have to pay lower interest but as the USD is doomed to fall it will cost less to pay the principal Well they might have a nasty

surprise


r s reversa s vergence w e cross as een an ea w n or e en n e pas u on e o er an we are near eve s o

optimism on the USD (on this measure) which have triggered a contra-trend rally on the Yen (Chart 16)


11/25

10Currencies: LiquidityChart 18Chart 17

Momentum

Rate of Change

The export to GDP ratio momentum remains positive for the USD (Chart 17) This is even more remarkable given the absolute fall in global trade in the past 18 month.

Reserve around the world have been rising (Chart 18) 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 Greenback rally and some countries going bustFurthermore, as an example, China has decreased its

holding of US Assets as a percentage of its foreign exchange reserve from more than 80% in 2002 to less than 60% (and the decline is not only due to the USD

depreciation of the past 7 years but this is a contributing factor) . The more quickly reserve rise, the more USD has to be sold just to keep the currency mix stable, ceteris

paribus

Another factor is the fact that forei n holder of US assets are more rone to hed e the currenc that US holder of forei n asset. This as mmetr can ex lain 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 atmonth end


12/25

11Currencies: LiquidityChart 20Chart 19 DEM/USD vs. Two Years Relative Yields

Balance NSA

Japan merchandise trade balance has stabilized but it still implying a much lower Yen (Chart 19).


In the meantime the real 2 years yield differential between the US and Europe is slowly approaching a USD positive configuration (Chart 20) and

our relative bullishness on the US vs. Euro economy will help to move this differential in the right direction for the USD



13/25

12Currencies: Central BanksChart 22Chart 21 NZD and RBNZ InterventionAUD and RBA Intervention

The Reserve Bank of Australia has continued to intervene in the market (Chart 21)and is clearly indicating that it consider the AUD to be

Source: RBNZ, Clue6Source: RBA, Clue6

overvalued.

The Reserve Bank of New Zealand has been vocal, particularly through its governor, A.Bollard, about its discomfort with the level of the NZD In

the past 2 years the Bank has intervened at the 0.75-0.8 level (Chart 22)



14/25

13Currencies: SeasonalityChart 24Chart 23 USD/JPY TR Seasonality (since 1989)EUR/USD TR Seasonality (since 1989)

The USD is usually strong against the Euro earlier in the year, especially in January (Chart 23) but the usual December weakness did not play out in

Source: Bloomberg, Clue6Source: Bloomberg, Clue6

December We said that we were the December USD weakness been recommended everywhere and that it would likely make it a loser this year

good news for December 2010 when nobody will dare to play the seasonality and it will work again

The Yen is also usually weak earlier in the year (Chart 24).



15/25

14Currencies: SeasonalityChart 26Chart 25 USD/CHF TR Seasonality (since 1989)GBP/USD TR Seasonality (since 1989)

The Pound and the Swiss francs are displaying a similar seasonal pattern with the CHF especially weak earlier in the year (Chart 25 and 26)

Source: Bloomberg, Clue6Source: Bloomberg, Clue6



16/25

Currencies: Graphs 15EUR/USD

The Euro failed to penetrate the above head resistance identified earlier and is now in the process of forming a new down channel.

A move above the 1.47 level would change trend change assumptions.

Euro strength should be sold


Longer-term we maintain that the Euro could fall below 1


17/25

16Currencies: GraphsUSD/JPY

Was the move toward 85 a beautiful Yen bulls trap? Look like we made the bottom and that we can now embrace at least a multi-

month rally with intermittent corrections. Target for now is 103-108

Now in a short-term up channel with 94.75-95 as next target We would use a decline below 88 as a stop


Can the Yen be pushed lower by the Hatoyama administration Yes it KAN


18/25

17Currencies: GraphsGBP/USD

Diamond

Potentially broke down from a diamond formation A sustained close below 1.57 would see the move accelerate to the downside

We maintain the sub 1.2 target we gave in the Autumn of 2007 but prefer it to the Euro at current levels


lows sequence


19/25

18Currencies: GraphsUSD/CHF

We can only repeat what we said in September

You can play it if you have good contacts at the SNB otherwise we would stay on the sideline


at usd 300


20/25

19Currencies: GraphsAUD/USD

At a critical juncture

Would be short here with a stop above the November highs

Best to be played with a 3-4 months backspread rebalanced every 2 months (selling in money put on the AUD and buying more out of the money put on the

AUD).


We would even start to buy some very deep out of the money puts 0.8 and below every month This was advised in the summer of 2007 on the NZD and bothAUD and NZD in 2008 We were playing black swans and we feel one is coming here in 2010


21/25

20Currencies: GraphsNZD/USD

Same configuration as the AUD but less overvalued

Could fall quicker than the AUD initially because of its lower liquidity but would buy the NZD against the AUD above 1.3



22/25

21Currencies: GraphsBloomberg JP Morgan Asia Dollar Index

Approaching the top of its rising channel

Would anticipate a correction to at least 110.5-111


A close below 109.5 would signal a trend change


23/25

22Currencies: GraphsBloomberg JP Morgan Latin America Currency Index

Weaker than in Asia but still an up trend for now

Local authorities have clearly expressed their concern about the strength of their currencies


Would exit the carry positions here but not short too expensive in term of carry


24/25

23Currencies: Conclusion

We like the USD here. It is undervalued and the economy is much more dynamic and has started to rebalance earlier than elsewhere. The Fed is now

much more pro-active as is the Treasury (not to say that we think they do everything right) than authorities elsewhere. We do not fear a "foreigner

exit" of the US and would rather contemplate some capital repatriation sometimes this year combined with some US loans contracted by foreigners

(from foreign financial US commercial paper borrowing to local US borrowing in emerging markets, as you know the Bucks can only go down and

you can borrow at cheaper yields than in the local currency) having to be repaid quicker than planned

The trend is making an attempt to turn up and the sentiment dynamic is supportive for the Greenback

The Yen is a short at this uncture. The political resolve of the Hatoyama administration has been put to rest and now the Yen KAN be talked

down. We thus have a 85 floor The trend has turned down for the Yen but we would ideally like to see a higher lows

The Euro remains our "worst G7 currency" to hold on a valuation and macro risk basis . European banks have yet to write down a big chunk of

their "toxic assets", it is very exposed to emerging market loans, the ECB is playing the ostrich game, the economy is less diversified and dynamic than

the US, it is much more trade-dependent than what observers think, their are big disequilibria " intra-Euro" with depression like conditions in Spain

and Ireland,... All of this is not discounted and remember that for every 10% increase in the Euro trade weighted index, you have to take off 0.8% fromGDP and the Euro is now almost 25% overvalued... Add that some European countries have suddenly decided, after a 20% appreciation of the

EUR/USD since March and almost 75% appreciation since 2001 that they should borrow in USD

The Euro trend has probably turned down which is even more significant given the level of overvaluation it had reached in November

The CHF is likely to stay, at best, anchored to the Euro now that the SNB has been vocal in its desire to see the CHF decline

The British Pound is fairly valued but does not deserve to trade at fair value Commercial real estate correction might be nearing an end with

attractive yiel s starting to reappear ut t e resi ential mar et as a long, long way to go. One as to also a t at M. King an t e Exc equer ave

been actively talking down the currency

It might be forming a diamond top with a target near the low of last year



25/25

24Currencies: Conclusion

Commodities currencies are now very overvalued They profited from the "Chinese inventory build-up" related commodity rally but enough is

enough and that is what the Royal Bank of Australia and its New-Zealand counterpart seems to be thinking

They are at a critical juncture and we would short them with a stop just above the end of last year highs Preferably using options

On emerging currencies, we prefer to stay on the sidelines for now. If we had to we would maintain a long position on the Taiwan Dollar, the

Korean Won and the Singapore Dollar. The more then Yen decline the less attractive the Won proposition will becomeWe would not short, however,

as the carry is too high for most of them.

The trend is still up though


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First Quarter 2010 GTAA Currencies

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