News

Good news, social media people! The Securities and Exchange Commission has declared that social media are widely used and available, and therefore suitable venues for releasing official corporate information.  Over at the New York Times DealBook blog, Michael De La Merced notes that the SEC has reversed direction on their intepretation of the Regulation Fair Disclosure (Reg FD) rule.  That rule says that public companies must make important information available to all investors at the same time, so none have any advantage in acting on the news.  The SEC now recognizes that a disclosure via social media meets this test - as long as investors have been notified that such information may be found in those channels.

Sounds like a great way to get a ton of twitter followers, just tell your shareholders that you'll be releasing earnings numbers via your twitter account.  Props to the SEC for recognizing what's really already happening, and also for ruling in the spirit of the rule.  This can only lead to greater transparency of corporate information, and that's always good for investors.

What better way to kick off the new month than with an awkward tech belly flop right in the middle of the New York Stock Exchange hustle and bustle? I really can’t seem to think of one.

Bright and early on the morning of August 1st, Knight Capital, one of the few select members of designated market makers (DMMs) for the NYSE, experienced some “technical difficulties.” Now everyone knows that when this stigmatic term is spouted off in any situation, it’s generally never a good sign – especially when it comes to a DMM for approximately 675 securities being traded on the NYSE.

In an end-of-the-trading-day recap released by MarketWatch, it was reported that Knights technological issues were allegedly causing erroneous trades to be placed on about 140 different securities, some of which were stalwarts on the equities front.

NYSE employees caught their first suspicious whiff of volatility at around 9:30 AM, which provoked both human interventions, as well as automated stop losses called “circuit breakers,” to be triggered. Though the Knight Capital tech spasms did manage some damage during their 45-minute stint, luckily no malfunction contagion escaped beyond the company’s market making unit.

The traditional image of utter chaos ensuing on the NYSE trading floor represents something different than we’re seeing now: actual humans matching buy and sell orders. Today, those orders are primarily all being executed electronically, which unfortunately leaves them susceptible to programming glitches. The repercussions from this don’t materialize so much in the tangible losses investors have suffered, but rather, in the toll they’re taking on investor confidence. After witnessing the Dow flash crash of ’10, the glitches devastating the BATS Global Markets and Facebook IPOs, and now, this algo blunder, its no surprise investor wariness is a concern.

It almost seems as though innovation has gotten a little too ahead of itself. Grandiose ideas are incepted, and technology is there to make them reality – sometimes even before all the glitches can be discovered and properly worked out. However, these issues are not unavoidable; all it takes is the right combination of innovators.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Today, the Facebook black hole sucked yet another casualty into their never-ending post-IPO news onslaught: Morgan Stanley. The bulge bank is currently under investigation by regulators for their potential involvement in some Facebook pre-IPO foul play.

As the lead underwriter of Facebook’s IPO, Morgan Stanley apparently had some inside info on the social network in regards to the future success investors could see after the company went public. Rueters reported that a Morgan Stanley analyst had downsized his revenue projection for Facebook after the network filed documents with the SEC stating there was a chance their revenue could struggle as it’s users attention was turned to mobile devices. The question now that’s ruffling feathers of the FINRA and SEC members is ‘did certain investors receive privileged pre-IPO information that should have been shared more liberally?’

This allegation brings up a very interesting correlation: how the massive influx in tech startups, and in technological advancements in general, is affecting the big banks. For Morgan Stanley, it’s in equity underwriting. An article on CNNMoney revealed the firm has landed deals to underwrite IPOs of some of the biggest names in the web biz, like LinkedIn, Groupon, and of course, Facebook - which have all generated $1.2 billion in fees. As the tech revolution keeps on trucking, Morgan Stanley becomes increasingly reliant on its tech deals for revenue generation. Right now, 13% of their investment banking fees are produced by these deals (Goldman pulls in about 9%, while JPMorgan takes 7% of theirs from tech).

Now this is where things could get messy for Morgan Stanley. If the looming Facebook-IPO-info situation does blow up, their juicy chunk of equity underwriting fees could be looking a little less hearty - fast.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

There’s a massive amount of commentary in the news and among market participants about JP Morgan and the big loss it reported earlier this week. The politicians, and anyone else calling for stricter regulation of the banks, are having a grand old time with this development, suggesting that Dodd-Frank and the Volcker Rule were exactly intended to avoid this sort of thing happening. Actually, I’d argue that they are (or should be) designed to ensure the security of the financial system (FDIC insurance being there to protect depositors). To that end, here we are with no risk to the financial system from the JPM loss because the bank has a “fortress balance sheet”.

Isn’t that what every bit of discussion and legislation has been about the last few years? Shouldn’t we be looking at this case as being a perfect example of why all banks should have such strong balance sheets?

We cannot possibly expect banks to never have losses. In this case it was a bad trade/hedge decision and execution. In another case it could be a higher level strategic business decision (acquisition, entry into a new market, etc.). Just as we cannot prevent individuals seeing negative consequences from either rational or stupid activities, we cannot expect companies (banks, automakers, or otherwise) to have every decision produce a positive result. It’s a question of risk management and having the cushion to ensure the inevitable issues don’t get transmitted through the system.

That’s my political/social rant for now.

Getting into the trade
As for what JPM actually did to suffer the loss, it’s a pretty convoluted thing that most individuals won’t understand well and really don’t need to in any case. I won’t try to explain the details of it here because frankly I’m trying to work through what the Thomson Reuters reporters have pulled together thus far and we may never get the whole story regardless. What it seems to come down to is JPM having a short position in the credit default swap (CDS) market, which essentials is akin to going long a bunch of corporate bonds (taking credit risk). It’s hard to see this as any kind of hedge since JPM would have credit risk in its portfolio from the lending it does.

The hedge aspect seems to be from using different CDS instruments to go long later, but there was a maturity mismatch. It’s kind of like trying to hedge 10yr Notes with 2yr Notes in that it is different than a simple interest rate hedge because you have created a yield curve exposure (yield curve could flatten or steepen). JPM seems to have been caught out by events influencing the two maturities of CDS in different ways.

And of course all of this tends to get exacerbated by relatively illiquid market conditions and the fact that JPM essentially became the market at a certain point. This is part of what created the problems in 2007 and afterwards when the financial crisis began to unfold. There was suddenly no one to take the other side when institutions wanted to get out of their positions, and actually folks (read hedge funds) actively working against them.

Focus on the hedge structure
The hedge mismatch is something worth thinking about if you look to do hedging in your trading or investment activities (most individuals don’t, but some do). One thing I hear often among forex traders is their action (or intention) to use one currency pair to hedge a position in another.  For example, a trader might go long USD/CHF to hedge a long position in EUR/USD. The rationale here is that you remove the USD-related risk because you have a long USD position matched up with a short USD position.

Here’s the problem, though. While you do remove the USD risk, you have now added a short CHF exposure. You’re now long EUR/CHF. This is an entirely different trade than the one you started with.

Hedging should be about reducing or eliminating a certain risk, not about creating a new one. JPM seems to have made two mistakes. They introduced a “curve” risk by hedging with shorter-dated CDS, and they introduced a liquidity risk by being so big in a relatively illiquid market. Make sure you don’t create new risks with your own hedging.

It has been quite an exciting day here at Currensee as we’ve been receiving generous coverage on a press release published this morning by the Wall Street Journal’s Market Watch. The premise of the piece highlighted how Currensee’s Trade Leader Investment Program has grown to include over 100 institutional partners who are currently offering the program to their investors and clients.

It is interesting to look back over the timeline beginning at the programs initial inception back in October of 2010, when it was available only to retail investors. It wasn't until roughly a year later that we started providing institutional investors the option of offering the program to their clients, which include asset managers, hedge funds, family offices, introducing brokers, and other financial institutions.

The press release also illustrated how the relatively new realm of online trading platforms are reshaping the way trading happens by allowing investors some degree more control. Javier Paz, senior analyst of Aite Group, explains some components that have contributed to the monumental shifts in forex trading.

"The abundant liquidity of the Forex markets has given rise to a new breed of professional-level traders. This development, along with the popularization of trade-replication technology and prudent copy-trading rules, are the biggest developments in institutional investing since the creation of hedge funds."

The press release definitely brings into perspective just how much this facet of trading is adapting to available technology as a means of improving the way forex investors navigate the world currency markets. Thank you so much to MarketWatch, Elite Group, and the many others who found this information worthy of posting on their blogs and sites - we really appreciate it! Find the full press release here.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

FINalternatives is the premier, independent source for news on the alternative investment industry. They wanted to learn a little more about Currensee so they called our CEO, Dave Lemont, for the inside scoop. Here are a few questions and answers from the interview. The entire transcript can be found here.

Can you tell me something about Currensee?Dave Lemont Currensee

We’re all about creating an alternative investment for the world’s currency markets, that’s the mission of the company. We’ve essentially created a completely new way to invest. We find emerging managers all over the world and then you…can build your own little fund of funds directly on the internet by selecting these Trade Leaders that we present to you—and by the way, we do a ton of due diligence on them...You pick them, you build your fund and in a single account, you can have multiple managers, and we replicate the trades from the managers’ accounts into your account.

The other cool thing is, because it’s foreign currency trading, it’s not correlated to the stock market. It’s very much of an alternative investment. And based upon how volatile the stock market has been this year, people need alternative investments. And the other beauty is, you don’t need to know anything about foreign currency trading—all you need to know is how to read a performance chart on risk and reward, the same as you’d read a performance chart when picking a mutual fund. It’s a very powerful alternative investing tool….And the returns have been very exciting. It’s really possible to build a very exciting portfolio for yourself or select a single Trade Leader, as we call them.

How do you choose your Trade Leaders? What criteria do you use?

We’re looking for emerging managers, and by emerging managers I would say these are professional people that have experience managing money —somewhere in the $1 million to $25 million range. Not that we would reject someone managing more, but we’ve also found that people managing tons of money no longer have the returns. And so we’re looking [for managers] at the right stage of their career, where they’re building their career and essentially, their challenge is gathering assets, but they’re fantastic traders…They do it all day long, it’s their only job, it’s the way they make an income. We give them the platform to gather the assets and they do what they do best. We take care of the rest.

As for the Trade Leaders, let’s face it, we’re picky. We’re looking for managers who have strong returns, meaning the returns should be anywhere from 1% to 10% per month, but their drawdowns are below 20%, hopefully below 10% in terms of the maximum drawdown that they would ever experience…And the most important thing, I would say, is people that manage their own money in a very disciplined manner, by that I mean, if they have a strategy that says, ‘I’m willing to risk 1% of my account on my trading day,’ that when they’re losing, they close. When they’re winning, they take their profits. Somebody that has a strategy and they exhibit to us that they are honoring that strategy to the ‘T.’

Now, the way we do due diligence is, we have a pretty strict process they have to follow: We interview them, we review their risk management practices, we run background checks, we invest with their system, with our own dollars, in a live account, and…we make sure that what they say they’re going to do is what they really do. And then we test the replication side of it, so we need to make sure that when we replicate their trades from one account to another that our correlation is strong.

Who is your target client?

One is [the] foreign currency traders…that aren’t very effective on their own…and they’re looking to diversify their trading by following someone who’s a great trader. Most Forex traders lose money and our program gives them a way to be in the market by putting Trade Leaders to work for them. But the bigger market that we’re after is what I would call the ‘active investor.’ The active investor is someone who, he may trade managed futures or ETFs, or he’s very active with his financial advisor, and he’s always wanted to take advantage of foreign currency markets but he doesn’t know how to trade. He wants to participate in alternative investments, and we’re perfect for him.

The other market [is] institutions. We continue to build partnerships with large hedge funds, family offices, funds of funds, and other asset gatherers. These folks are simply looking for great traders that offer alternative investments, and they love the fact that we allow the risk to be controlled…

What kind of risk control do you offer?

There are three risk controls: an overall drawdown control, that when you’ve lost a certain amount, the system will stop. An open drawdown control, so just the open positions tracking and then a leverage control that allows you to de-lever, so, if the Trade Leader trades like, 5 to 1, you could say, ‘I only want 50% of that,’ now it creates a 2 and ½ to one leverage. If the customer is a high-net-worth person who signs a special contract, they’re allowed to lever up. But only if they sign a contract that says they understand the risks. So they may say, ‘Well, this guy is pretty conservative, I might take a little more risk than he takes and double the size of his trades.’ And we’ll allow you to do that, but you must sign a special agreement for it.

In our software, if you were to follow Trade Leader 1 and Trade Leader 2 and Trader Leader 3 in your single account, we allow you to set drawdown controls on each one of these leaders, and even the amount of leverage they control. So, you can say, ‘I don’t ever want to lose more than 5% or 10% or 2%’ and then, if that were to happen, we shut the system off….Part of trading is not just winning but controlling when you lose and [trying to ensure] that the day you lose is not such a terrible day that you can’t recover from it.

These controls are extremely popular with the high-net-worth and the institutional market for us. When a pair that a Trade Leader trades—foreign currency traders trade the dollar/Swiss or the dollar/yen—feels too volatile, the investor or asset manager can say ‘I don’t want to see any trades from this pair in my account today,’…You are able to have that level of control.

Click here to read the full article previously posted on www.finalternatives.com

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

The Canadian economy has been the envy of the developed world in the recent past, as North America’s largest country weathered the global recession far better than most and, the subsequent recovery has been sufficiently robust to allow both output and employment to return to their pre-recession levels by the middle of 2010.  However, sharply rising house prices alongside a rapid increase in household debt has raised concerns that the so-called ‘Northern Tiger’ is simply an accident waiting to happen.

It is clear that the ‘Northern Tiger’ entered the downturn with critically-important advantages that allowed policymakers to cushion the blow and jump-start a recovery through aggressive monetary easing and extraordinary fiscal stimulus.  These included a strong fiscal position, credible monetary policy, a well-functioning financial system and private sector balance sheets that were not as stretched as much of the Western world.

The Bank of Canada reduced its policy rate to near-zero at the height of the global financial crisis and, because the monetary transmission mechanism was not impaired, consumers were able to exploit generational lows in borrowing costs.  Households took full advantage of the extraordinarily easy monetary policy, which allowed consumption to regain its pre-recession level by the third quarter of 2009, while the boost to housing demand enabled residential investment to recover its previous peak in just 18 months.

The monetary stimulus alongside other policy measures, designed to insulate the housing market, precipitated a marked turnaround in house prices.  The decline in prices from the autumn of 2008 to the spring of the following year, was contained to just ten per cent, while the subsequent rebound in the market has seen prices jump almost 15 per cent above their previous peak.

The Canadian experience stands in sharp contrast to their southern neighbour, the United States, where house prices continue to languish some 30 per cent below their peak, with little sign of a turnaround as far as the eye can see.  However, Canadian house prices had already enjoyed a marked increase from 2003 until the global crisis struck, such that valuations today cannot be described as anything else but elevated.

The average priced home in Canada today is valued at more than five times median family income, as against just three times a decade ago when valuations were close to their historic average.  The situation in Vancouver is even more alarming where the average price exceeds eleven times family income, more than double both the national average and the figure that prevailed at the start of the new millennium.

In spite of the disturbing valuations, Canadians appear to have been seduced by the rise in prices and, a recent survey conducted by the Canadian Association of Accredited Mortgage Professionals, revealed that “almost 60 per cent of respondents thought that now was a good time to buy.”

The rise in house prices alone, is not sufficient to pose a systemic threat but, when combined with high levels of debt, the cocktail could potentially prove explosive.  In this regard, household debt has expanded at twice the rate of personal disposable income since the recovery began during the summer of 2009 and, by the end of last year; the debt-to-income ratio had increased to more than 148 per cent – a level that eclipsed U.S. household indebtedness for the first time in more than a decade.

The additional borrowing, primarily in the form of mortgage loans and home-equity lines-of-credit, means that a Canadian with a two-storey home spends almost half of his household income on mortgage servicing, with the share closer to 70 per cent in Vancouver.

Furthermore, the Bank of Canada estimates that “the proportion of Canadian households that would be highly vulnerable to an adverse economic shock has risen to its highest level in nine years, despite the improving economic conditions and the ongoing low level of interest rates.”  The central bank adds that “this partly reflects the fact that the increase in aggregate household debt over the past decade has been driven by households with the highest debt levels.”

Bulls on the Canadian housing market dismiss such facts and, argue that a U.S. style meltdown is unlikely given the tightly-regulated mortgage insurance market.  The banking sector is not permitted to hold uninsured high loan-to-value mortgages – currently, greater than 80 per cent – and, since the government not only owns the Canadian Mortgage and Housing Corporation (CMHC), which accounts for more than two-thirds of the mortgage insurance in force, but also provides a 90 per cent guarantee on private mortgage insurance obligations, policymakers play a major role in the evolution of underwriting standards and can thus, contain potential excesses.

The government may well exert a strong influence on underwriting standards on paper but, in reality, the government-backed guarantees have introduced moral hazard through the transfer of default risk from bank shareholders to taxpayers.  Bank management are incentivised to play hard-and-fast with the written rules and, should a negative shock arise, the CHMC has little room to absorb the losses.  The government-owned company currently insures $536 billion in mortgages as compared with just $11 billion in equity – or just two per cent equity against its total exposure.  It’s easy to envisage a scenario in which the taxpayer is left holding the bag.

The ‘Northern Tiger’ has attracted plenty of admirers in the recent past but, upon close examination, an accident may well be in the making.  Will it happen?  Time will tell.

Originally posted on: www.charliefell.com

 

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

At what point do we stop wondering what the crystal ball will show next?  Lately, every time I turn on the TV, the newscaster is announcing a new prediction for our economic future.  Sometimes two channels are simultaneously reporting completely different forecasts.  At this rate, how can one put faith in any of these hypotheses?  Will we eventually tire of these predictions (which are really nothing more than educated guesses) or will we just give up and roll with the punches?

Our favorite Irish economist Charlie Fell explores our "Prediction Addiction" in his latest blogpost.  Read the full article here.

 

Prediction Addiction

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Human beings are hard-wired to detect patterns and identify causal relationships amidst the constant stream of new information.  This behaviour can be traced to our ancestral past on the African savannah many millennia ago, where the ability to shape expectations from small samples of data, enabled our hunter-gatherer ancestors to successfully forage for edible fruits and seeds, stalk prey, avoid predators, find shelter, and seek mates. 

Scott Huettel, a neuroeconomist at Duke University, explains that, “The brain forms expectations about patterns because events in nature often do follow regular patterns:  When lightning flashes, thunder follows.  By rapidly identifying these regularities, the brain … can expect a reward even before it is delivered.

The ability to anticipate outcomes from regular patterns undoubtedly helped our ancestors to flourish but, Huettel warns that, “in our modern world, many events don’t follow the natural physical laws that our brains evolved to interpret.” The human brain is designed to conserve scarce neural resources, and so much so, that it requires only a single confirmation to anticipate a recurring pattern.  Huettel notes that as a result, “The patterns our modern brains identify are often illusory…

Pattern recognition and subsequent tactical buy or sell decisions are part and parcel of active investment management.  Investors however, often place too much emphasis on the recent past when forming expectations about the future – top-down analysts make tactical calls based on recent economic data, while technical analysts divine the future on historical patterns in stock prices.

Investors’ ‘prediction addiction,’ as the behaviour has been called by the financial columnist, Jason Zweig, is particularly relevant today.  Economists are busy shaving their economic growth forecasts for both this calendar year and next, following a string of disappointing data that fell well short of expectations.  Meanwhile, technical analysts are arguing for a reduction in equity allocations, given price action in the major stock market averages that confirms a change in the underlying trend.

Recession fears are afoot and investors are in need of guidance that will preserve capital and/or yield profits amid the uncertainty.  Indeed, anticipating turning points in the business cycle and, adjusting asset allocation accordingly, is central to successful top-down investing.

Unfortunately, economists have a patchy forecasting record at best, having failed to anticipate every one of the last five recessions.  Indeed, the monthly publication, Blue Chip Economic Indicators, noted in July 1990 that, “the year-ago consensus forecast of a soft landing in 1990 remains intact” – the economic expansion peaked that very month!

More than a decade later in March 2001, fewer than five per cent of economists anticipated that there would be a recession that year, even though a downturn was set to begin just days later.  More recently during the spring of 2008, the calls for a soft landing were almost deafening, despite the fact that the deepest recession since the 1930s was already underway.

Perhaps the study of historical price patterns performs better.  After all, stock price data is not reported with a lag and, unlike economic data, is not subject to revisions that continue several quarters after the fact.  As William Hamilton, the fourth editor of the Wall Street Journal wrote in his 1922 classic, ‘The Stock Market Barometer’ – “The market represents everything everybody knows, hopes, believes, anticipates, with all that knowledge sifted down to ... the bloodless verdict of the market place.”

The study of historical price patterns suggests that a further decline in the major market averages may lie in wait.  The 18 per cent fall in stock prices from their recent peak late-April, resulted in a bearish ‘Death Cross’ signal on August 12, as the stock market’s 50-day moving average of closing prices dropped below its 200-day moving average.

The ‘Death Cross’ is considered by technical analysts to be a portent of future weakness, but is the signal’s presumed ability to anticipate turning points and enhance investment performance supported by the historical record?  To find out, the ‘Death Cross’ and its converse, the ‘Golden Cross’, are employed as tactical sell and buy signals respectively, for a simple long/short strategy and, the investment results – excluding dividends – are compared with those generated from a straightforward buy-and-hold strategy.

The historical record shows that before the most recent ‘Death Cross,’ there had been 63 tactical signals since the summer of 1949 – 32 buy and 31 sell signals – which, gives weight to the late Paul Samuelson’s criticism in 1966, that ‘The stock market has predicted nine out of the last five recessions.

The buy and sell signals resulted in 33 winning trades and 30 losing trades, which is not much better than a coin toss.  More importantly, the price return generated by the long/short strategy saw an initial $10,000 investment compound to $537,000 over the period, as against $775,000 for the buy-and-hold strategy.

The historical evidence suggests that the ‘Death Cross’ adds no value to the investment process.  However, a more complete examination of its credentials reveals that it subtracts from investment performance during secular bull markets, which are characterised by powerful up-trends with only the briefest of interruptions; it adds to performance during secular bear markets, which are characterised by a protracted sideways pattern that is punctuated by violent downward price swings.

The bearish indicator provided ample warning to investors of impending danger, close to a market top in both the autumn of 2000 and the winter of 2007.  Has the ‘Death Cross’ sounded an early warning bell once again?  Time will tell.

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

From the aftermath of the debt ceiling crisis and the S&P downgrade to the release of the latest unemployment numbers, we’ve been busy counting the latest stories in the world currency markets. Check out our top picks of the week:

News on the S&P downgrade made headlines and many wonder what’s next for the U.S. economy. After a tumultuous week in the stock market, the CBOE Market Volatility Index rose 26 percent, marking a 29-month high. Some investors are stressing a need for new currencies and stock exchanges either in the form of a world economic system managed by the International Monetary Fund or cyber currencies. Meanwhile, gold futures soared due to the rating cut, reaching a record $1,697.70 an ounce. The U.S. Securities and Exchange Commission launched an investigation last week, asking Standard & Poor’s to provide information on employees who were informed of the downgrade decision before it was announced. Concern has once again risen for the European economic crisis as falling shares in French banks prompted finance and budget officials to search for new ways to trim public deficit. Employment numbers released last week show that U.S. unemployment benefits have dropped to a four-month low. These statistics have already impacted the currency markets; both the USD/JPY and USD/CHF have increased, which “releases the hot air” out of the franc and the yen. Japan continues to face problems with the rising yen, as the currency’s increase against the U.S. dollar leads to a cut in Japan’s export sales.

 

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

In his latest article, "Secular Trends In Gold", Irish Times columnist Charlie Fell examines what the skyrocketing price of gold means for investors.  Could it be a golden investment opportunity?  Read full article here.

 

Secular Trends in Gold PDF Print E-mail
On this day in 1982, the secular bear market that had weighed on stock returns since the late-1960s, reached bottom – with share prices almost 65 per cent below their secular peak in real terms and no higher than levels first reached way back in 1954.  As stock prices stumbled and erased years of upward progress over the course of the drawn-out bear market, gold rewarded disillusioned equity investors who sought its protection. 

Indeed, by the summer of 1982, gold’s purchasing power had jumped almost fourfold from the level that prevailed when the downtrend in the major stock market averages got underway fourteen years earlier – even though the high real interest rates required to fight runaway inflation, had terminated the secular bull in the precious metal two years previously.

Fast forward to today and the downgrade of U.S. government debt by Standard & Poor’s, alongside the escalating euro-zone sovereign debt crisis, confirms that the primary downtrend in Western stock markets that commenced more than a decade ago, is alive and well.  U.S. stock prices at current levels are almost 45 per cent below their secular peak in real terms, such that all capital gains since the spring of 1997 have been erased.

Meanwhile, gold continues to frustrate its critics, as the price of the precious metal edges ever higher and is up almost fivefold in real terms since the dot.com equity bubble began to deflate more than a decade ago.  Once again, the precious metal has served its owners well and proved to be an effective offset to lacklustre stock market returns, even though investors’ primary concern during the current secular bear has been the potential for demand-side deflation, and not the disturbingly, high inflation that precipitated the downtrend in stock prices during the 1970s.

Secular bear markets in stocks are characterised by a downtrend in the multiple that investors are willing to pay for one dollar of trend earnings, and are precipitated by movements away from price stability towards runaway inflation or demand-side deflation arising from the unravelling of unsustainable debt balances.  These are the same conditions in which the diversification properties of gold spring to the fore, as the accompanying economic uncertainty increases the precious metal’s allure.

Gold’s performance through the inflationary 1970s following President Nixon’s decision four decades ago, to suspend the precious metal’s convertibility into U.S. dollars for official holders, is well-known and has contributed to the universally-accepted premise that the yellow metal is an effective inflation hedge.  The conventional wisdom stands in sharp contrast to the late-Professor Roy Jastram’s conclusion in his 1977 classic, ‘The Golden Constant.

Professor Jastram analysed the behaviour of gold prices in the U.K. from 1560 to 1976 and in the U.S. from 1800 to 1976.  His work revealed that the precious metal proved to be an excellent store of value through the long sweep of history, but his analysis also showed that it was an ineffective inflation hedge over relatively shorter intervals, as its purchasing power declined during inflationary episodes.

The real value of gold for example, dropped by more than 20 per cent in the U.K. in each of the periods 1702-1723, 1752-1776 and 1793-1813, while it lost two-thirds of its purchasing power from 1897 to 1920.  This somewhat surprising result can be explained by the precious metal’s monetary role in the Gold Standard, and by definition, the purchasing power of money declines during inflationary episodes.

An update to Jastram’s work by Jill Leyland in 2009 reveals gold has served as an effective inflation hedge since the collapse of the Bretton Woods system of fixed exchange rates four decades ago, as individuals sought the protection of the precious metal during periods of rapidly rising prices.

Jastram’s study also showed that the purchasing power of gold tended to increase and often markedly, during deflationary episodes, which again can be explained by the precious metal’s close links to the monetary standard.  Since the precious metal only performed well under deflation when the Gold Standard was intact and has served as an effective store of value since the end of dollar convertibility, some commentators believe that it would perform poorly – should the developed world succumb to a destructive debt deflation.

The logic is wide of the mark.  Individuals scramble for liquidity and flee financial assets during deflations, but the deteriorating credit quality of currency issuers and the resulting loss of confidence, mean that gold is typically preferred to paper currency as a hoarding vehicle.  To quote former-Federal Reserve Chairman, Alan Greenspan – “Gold... is relevant wholly because of the historic and widespread perception of gold as an indicator of a flight from currency.” Thus, should the U.S. economy enter a recession or the euro-zone sovereign debt crisis continue to rage, the resulting deflationary pressures and loss of confidence in currency would, in all likelihood, result in a higher gold price.

Gold’s diversification properties are not only apparent through a secular bear market in stocks, but also in the face of periodic crises that lead to substantial declines in equity values.  As Jill Leyland remarks, “Men and women have turned to gold in times of distress, whether, political, economic, or personal…”  Indeed, the verdict of history shows that gold has increased in value during each of the most savage downturns in stock prices of the past 50 years including 1973-74, 1987, 2000-2002, and 2007-2009.

Gold is the ultimate hedge against instability and uncertainty.  Given that a return to price stability is unlikely anytime soon, while tail-risk in the form of inflation or deflation is high, the environment is near-perfect for gold to shine.  The recent parabolic upward move however, suggests that it would not be advisable to initiate positions at current levels.  Nevertheless, far-sighted investors should raise strategic weightings on weakness.

 

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