Decision Time in FX, EURUSD to 95 cents

The dollar is now enterting a final resistance area before challenging March 2020 lows.

EUO chould hit $36 on a breakout, which would mean EURUSD is around 95 cents.

The yen already broke a 40-year downtrend, the euro broke a 20-year support line, and the yen is now threatening to break out of a 20-year inverted H&S pattern. The Fed hasn't even started its QT yet. I can buy the argument of frontrunning, but inflation hasn't come down yet. What is going to make the Fed stop their policy in the next few weeks? If there isn't some massive traumatic event that triggers a U-turn in Fed policy, then my expectation here is for continuation. The yen and euro will accelerate their depreciations.

If this all escalates into something much larger over the next 12 to 18 montths, the stretch target on DXY is 155.

Bizarro Market or Not? Baosteel Is World's Largest Steel Company By Market Cap

One of the important things to understand about the market is that it is always "right" even if it is frequently wrong. The market reflects the aggregate thoughts of the investing public, which is weighted towards the "smart money" as they have more votes (dollars) in the process. When the market behaves in a way that is contrary to your expectations, a very big red flag must go up. Either your expectations are wrong or there is something affecting the market that you haven't unaccounted for. Psychology is one important factor sometimes overlooked. In other cases, economic or financial assumptions may be flawed.

During the housing bubble and the technology bubble before it, there were bears who pointed out the market would fall, but most also wisely said you don't short a psychologically driven market. Bulls incorrectly argued there was a "new normal" or that "home prices don't fall nationally." In the run-up to hyperinflation in Wiemar Germany, the public believed the economy was booming. The stock market rally was seen as proof of the economic boom, not incipient hyperinflation.

Today, here is ZeroHedge trying to make the case for corporate buybacks as one of the few things levitating the U.S. equity market: The US Equity Bubble Depends On Corporate Buybacks; Here's The Proof.

In 2013, responding to confusion about the plunging gold price, I argued the gold market was wrong back in 2011: Gold Lied, Inflation Died. I had a few trade ideas based on my deflationary thesis:

PowerShares DB Base Metals Double Short (NYSEARCA:BOM). Volume is very low now, but it peaks when base metals tumble.

For China, short iShares FTSE/Xinhua China 25 (NYSEARCA:FXI) and be long Global X China Consumer (NYSEARCA:CHIQ).

Emerging markets should underperform Europe, since Europe has already seen several major markets decline. ProShares Short Emerging Markets (NYSEARCA:EUM) is one way to go.

Resource exporting countries and companies will likely be hit hardest: they are threatened by a stronger dollar or weaker commodity demand. Brazil and Australia are two countries to underweight or avoid. Companies without sufficient capital to fund their operations will likely go bankrupt, and many commodity producers and explorers could go bust if they have insufficient capital heading into a crisis.

More conservative plays: iShares Barclays 1-3 Year Treasury (NYSEARCA:SHY), iShares Barclays Short Treasury (NYSEARCA:SHV), PowerShares DB U.S. Dollar Index Bullish Fund (NYSEARCA:UUP), ProShares UltraShort Euro (NYSEARCA:EUO).

Most of those picks were spot on. Brazil tumbled, the euro slumped, the dollar rallied. The worst pick by far was the CHIQ long, FXI short:

As I wrote then:

Gold is not alone in signaling weakness: nearly all commodities are sending a similar signal. On top of this deflationary force, the Chinese leadership appears ready to rebalance the economy towards the consumer sector, something that will dry up demand for many raw materials. Copper faces a far darker future than gold.

So what happened? Why did China's consumer sector go nowhere? Consumer stocks such as Want Want (0151) and Tingyi (0322) are well below their 52-week highs. A mitigating factor is that these stocks are in Hong Kong, but the Chinese herd hasn't caught on to these stocks at the very least because neither experienced "the pop."

Not only did consumer stocks fail to rally, but some of the sectors still suffering from overcapacity have outperformed the A-share market. Cement has done well considering, but steel has really outperformed. China's is currently puking steel because domestic demand is moribund. The performance of the global steel industry and suppliers has been poor:

Yet while SLX is down 20%, Chinese steel companies have double and tripled:

Bloomberg: China’s Baoshan Catches Nippon Steel as Most-Valuable Producer

“Baoshan has an edge over steelmakers in Japan where auto production won’t grow at a pace seen in China,” said Yoku Ihara, who runs Japan’s Growth & Value Stock Research. Baoshan is one of the few Chinese producers that can supply high-end sheets to automakers, making it the “best positioned among so many Chinese suppliers, most of which make construction steel,” he said.

The China Association of Automobile Manufacturers projects domestic vehicle sales to increase an average of 5 percent to 10 percent a year, with sales last year of 23.5 million units. Japan’s new-car sales rose 3.5 percent to 5.6 million units in 2014, data compiled by Bloomberg show.

FT: Steelmakers braced for China slowdown

On Monday, The World Steel Association, the industry’s main international body, said it expected global steel demand to be largely flat in 2015, at about 1.54bn tonnes. Demand growth will then increase slightly next year, to 1.4 per cent.

“We are releasing a restrained growth outlook for the global steel industry mainly due to the deceleration in China,” said Hans Jürgen Kerkhoff, chairman of WSA’s economics committee.

My default assumption is the Chinese stock market rally has been indiscriminate or that the rally may be a precursor to currency devaluation. Stanley Druckenmiller has voiced the next best explanation China Stock Gains Signal Economic Recovery.

Euro shorts hold steady

ProShares UltraShort Euro (EUO) is an ETF offering 2X the daily inverse of the euro. It has been a winner, but should do very well if the euro cracks the $1.20 level.

Shorts pile back into euro

The euro is still trading above its 2012 low, but conditions are ripe for a challenge of that level. ProShares UltraShort Euro (EUO) is one way to play a falling euro.

Buy puts on the yuan?

From John Mauldin's Thoughts From the Frontline: Changing the rules in the Middle of the Game

“We saw today that 80% of Chinese construction firms say developers are now behind on payments (late cash flow), and that consequently land purchases are already 42% down y/y (slowing local authority cash flow). We also heard that pricing controls means that utility companies no longer have the cash flow to afford vital imports. Q3 corporate cash flow was down 27%.

“China's trade surplus is annualizing this year at USD152bn, FDI [Foreign Direct Investing] @ USD114bn yet its FX reserve increase is USD472bn. The attached chart [below] shows Chinese external borrowings which unfortunately were last updated at the end of last year, but the data would infer these have continued to soar.

“I am being told that European banks are now starting to shrink their foreign loan books to meet domestic needs, with Mexico, Brazil and China all big losers. With China now saying they may run a full-year trade deficit next year, and with them unable to afford to import vital coal and other resources without either suffering domestic inflation or without selling its FX reserves, it may now well be time to consider some sort of puts on the yuan. In fact the only reason perhaps not to is that India may collapse first, reducing the competition for coal and giving China a little more breathing room.

Using a fund such as ProShares Ultra Short China (FXP) may be the best route for retail investors to directly short a decline in the renminbi, although there will be numerous knock-on effects and funds such as PowerShares DB Base Metals Double Short ETN (BOM) should also do well. Direxion Daily Emrg Mkts Bear 3X Shares (EDZ) would also likely be a winner.

I haven't discussed my Marketocracy portfolios in awhile, but I have these types of ETFs in my China fund, which is up about 2% this year. The gains were mainly from a large gold position, which was the largest holding; it's now a very small position. The aim of the fund is to be a play on China, holding either Chinese stocks (always some), but also commodities and currencies related to China. Chinese are heavy gold buyers, hence the gold position. Europe is the largest export market, so ProShares UltraShort Euro (EUO) or PowerShares DB U.S. Dollar Index Bullish Fund (UUP) get added during crisis periods. The largest position is currently FXP, with short funds totaling about 33% of assets, which works out to effectively 70% short exposure based on leverage. Cash is near the mutual fund regulated limit of 35%, with short term bonds upping that to about 40%. My timing has been bad with the short funds, but I'm still of a mind to increase short positions if the market rallies. If timing remains an issue, I'll just move to cash equivalent assets and ETFs such as UUP to ride out the storm.

June Performance

Index	June%	YTD %
S&P 500 TR	-5.23	-6.65
MSCI EAFE	-1.16	-14.72
上海 Shanghai	-7.48	-26.82
Fund
Entertain.Trends	0.01	8.84
Green Dragon	1.54	5.30
Best of Funds	0.19	1.18
Pharma & Dogs	1.09	4.18
China Fund	-2.77	-5.50
SoftwareSecurity	-0.23	4.35
Yield to Me	0.13	-0.67
Catch a Falling Knife	11.13	-8.84

Another bearish month and another decent performance from my model portfolios. These have mainly been on autopilot this year, turnover has been low for all but the "Best of Funds" portfolio, but that's the one I most actively adjust. Turnover was almost 10% last month as I went in and out of gold miners and short ETFs, and turnover was 300% in the past year. Turnover has been high in general in the past year, however, due to playing the short-side with inverse ETFs.

Right now, my single largest position is ProShares UltraShort Euro (EUO). I have a monster position in "Best of Funds", but it is a smaller position across almost all the portfolios. At the moment, it is my highest risk-to-reward trade, given my high expectation for continued euro weakness in the long-run. Generally it does not pay to hold a leveraged or inverse ETF due to the negative effects from compounding the daily value reset, but the (generally) low volatility of currency movements results in a much smaller performance drift. Also, this compounding works in the investors favor when the position is moving consistently in the investor's direction.

The Euro Bounce

It looks like the euro will rebound now, with the first leg down completed. Based on a Fibonacci retrace of the decline this year, the $1.31 area is probably the furthest it will go, though I expect won't make it far beyond the mid-$1.20 range. I'm not interested in playing the rebound though, I think this will offer chances to add to ProShares UltraShort Euro (EUO) and eventually go back into double short ETFs such as ProShares UltraShort Europe (EPV).

In my Marketocracy portfolios, I added to existing EUO positions today, in case this is just a spike. I plan to continue slowly adding if the euro continues to rebound.

The wildcard here is the politics. On the positive side, good news will just be a part of an overall rebound in the currency, but in the back of my mind, I'm still wondering if some European government won't send the euro tumbling again with an ill-timed announcement.

Euro is the key

At different times, there's a dominant theme that is either responsible for or a result of the major economic forces in play. Right now, the issue is deflation and how European nations deal with the "euro standard", which functions in some ways similarly to the gold standard, in that the nations cannot individually choose to print money. In the early 1930s, it was European sovereign defaults that triggered the second leg of the global decline, a move that made the depression Great. Once again, European sovereign debt is at the center of attention...

Still holding EUO...

Buying some gold miners

In one account, my only position for several months has been ProShares UltraShort Euro (EUO). I picked up Anadarko Petroleum (APC) last week. I expected the broader market sell-off, but thought APC sold off too much on the news of the leak in the Gulf. I think they're a great company, but if it breaks down, I'd sell and wait to buy it back at a lower price, especially since the miners may become much more attractive soon. At the moment I'm down about 4% in APC.

Today, I just moved back into Nevsun (NSU), a gold miner that was profitable for me from late 2008 to summer 2009. I sold out and it went up 100% after that. I also picked up some Seabridge Gold (SA) and possibly some Evolving Gold (EVOGF; EVG.V) if my limit order goes through.

Gold continues to be strong and I believe that gold miners can benefit if gold rises or stocks rise. Plus, if the euro reverses, gold and stocks may both rally. I think one can do fine holding an ETF here, such as Market Vectors Gold Miners (GDX) or Market Vectors Junior Gold Miners (GDXJ).

Euro Breakdown!

The euro finally ended its consolidation phase and the next leg of the decline is on the way.

In Where is the euro going?, I said $1.25 or about $125 for CurrencyShares Euro Trust (FXE) was the point of major resistance. This move could take us to that level.

UUP is a diluted play against the euro, EUO is a daily double short on the euro, but will suffer from the compounding of the daily position. In the past year, FXE is flat, but EUO is down 5%. During a sustained decline, this distortion will work to the trader's advantage and a little more than double the decline in the euro can be achieved. That said, if you stay in it too long and sit through the consolidation periods, or worse, simply buy and hold for a long period of time, your returns will erode. In the past two years, FXE is up a few percentage points, but EUO is down about 15%. EUO is a trading vehicle, not an investment.

The big question is how the market reacts. Aside from the decline in January (which appears smaller here because I am comparing the S&P 500 to the euro), the U.S. stock market has been moving up in absolute terms, and as the chart shows, even more in euro terms. It is looking like the January drop was mainly China related, as many emerging markets and China stocks fell the most. However, if this recent rally is to end, this move in the euro could be the signal.