July 10, 2010

Technical Outlook On The Euro

We have had numerous inquiries as to our view on the Euro in recent weeks.  Our stance has turned from neutral to moderately bullish since the beginning of summer mainly for a number of technical reasons I would like to point out now.

a) The massive Euro trashing since the beginning of the credit crisis prompted a herd of speculators to short the Euro.  In addition, institutional investors began reducing their Euro exposure in various ways heading for “safer” currencies such as the Swiss Franc or heading home to the “safety” of the US Dollar altogether.  That created a massive shift towards short positions, many of which would eventually have to be covered.  Some profit taking did occur indeed and as we pointed out a few weeks ago, the contrarians started to get back at buying Euros.  Jim Rogers, the famous hedge fund manager, announced his contrarian move exactly one month ago:

“Everybody is so bearish about the euro that it looks like now is a good time to buy the single European currency.”

b) We examined the downward sloping trend line a few weeks back as well.  The Euro which clearly oversold at some point not only made its way back into the still downward sloping medium-term trend channel, but it has now also started to test the upper boundary of the channel.  The coming weeks will shed some light as to whether the trend is actually changing from bearish to bullish for good.  Hold on to your horses for now...


c) The Euro decline appeared too fast and too drastic IMHO.  Despite the massive debt problems of the Club Med countries (Greece, Portugal, Spain, Italy) and the resulting austerity measures which will put a financial strain on all of the Eurozone countries, a major currency does not just loose 20% of its value without some re-adjustments.  At some price levels, enough buyers will come in taking advantage of relatively good values thereby causing a retracement in prices. Looking at the massive decline from about 1.51 to 1.18 level, a technical reversal based on Fibonacci retracements levels could see the Euro go to at least 1.3125 (38.2% retracement) without changing the underlying trend.  That gives us still about 400 points of good potential short-term upside.


d) A look at basic moving averages further exemplifies the severity of the Euro decline this year.  Since the beginning of July however, we broke through the 50 day moving average (red line).  The 200 day moving average (blue line) is still quite a ways ahead and it may take some time to get there but it is a target on the horizon.  


These basic technical factors have been our main rationale for being moderately bullish in the medium term.  

In addition, we believe that the mood has shifted from “the Euro is toast” to “there are plenty of dark clouds ahead”; at least that is our sentiment from some of the discussions with traders.  Whether the Euro will make it long-term is yet another question.  However, unlike some commentators, we believe that the notion of “taking the pain now” via the various European austerity measures is the right way of dealing with the economic challenges ahead.  Too much debt and too much leverage was one of the key factors that brought about the worst economic crisis since WWII.  The US solution of using yet more debt and more leverage cannot possibly be the right approach for a sustainable recovery.  For now, we are just delaying the inevitable by “kicking the can further down the road” and hope that whoever needs to kick next has a rather mighty kick.  In view of the upcoming Worldcup final tomorrow, maybe we should consider some soccer players to become the next political leaders...

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