FXIS Market Insights

At the end this week’s FOMC meeting, the Fed made an implicit announcement of QE2.  No, not the Queen of England nor its name-sake ocean liner.  The Fed was hinting at a new round of Quantitative Easing (QE2.0 for our readers under 35) if economic growth were to approach sub-par values.  The prospect of possibly another trillion dollars of new money to be injected into the financial markets had no benign effects. 

Silver shot above $21, the highest in 30 years and Gold was at $1,300 an ounce (by the way, we lost count as to how many new all-time records occurred in the past two years).  The effect in other markets was not insignificant either.  The 2-year Treasury yield fell to an all-time low of 0.42%, the 5-year yield fell to 1.33% just a few ticks away from the all-time low of 1.26% during the darkest days of the financial crisis.  Clearly, the market is more afraid of deflation than inflation at the present moment.

At the same time, the 2008/09 default response in terms seeking safety in the US Dollar has now turned into a flight out of the US Dollar and back to other safe havens such as assets that may provide somewhat of a hedge against the obvious dilution in real Dollar terms; hence, the new all-time high in Gold.

While deflation is the obvious concern at the moment, one cannot ignore the fact that there is a notion of inflation risk on the investor horizon.  How far that horizon may be is difficult to assess but it is out there and it may hit US denominated investors sooner than they expect, particularly when valued in real US Dollar purchasing power compared to other currencies (Bond investors may want to re-assess the risk of holding longer dated bonds too).  Let us look at some of the symptoms of this new flight to safety.

The US yield curve is still quite steep and there is an almost 4% difference between the very short and long-term rates.  Compared to Japan, which did indeed experience two decades of de-facto deflation, Japan’s yield spread between short to long-term bonds is below 2%.

US Yield Curve	Japan Yield Curve

In terms of equities, they can also provide a hedge against inflation.  When returns on cash and yields on short-term bonds are near zero, capital has to look elsewhere for yield.  Much of the emphasis in terms of assessing stock market performance is typically towards the economy.  If the outlook on the economy is positive, investors usually anticipate better returns for companies and stocks are the default pre-emptive strategy to benefit from the prospects of higher company earnings and higher stock prices.  Hence the notion that the stock market is a leading indicator of the real economy. 

There is however another argument.  What if investors were not anticipating a growing “US” economy but they were simply concerned about the possibility of another trillion dollars of easy money flooding the markets?  Concerns about the real value of the US Dollar may then explain why stocks have been holding up so well, despite the fact that the outlook for the US economy has not improved nearly as much as some expected.  There is a way to measure this trend by examining how the US Dollar correlates to the Stock market.  US Stocks and the Dollar had an alarmingly consistent negative correlation of about –0.50 since the beginning of 2009.  In plain English, each time the Stock market moved up by 1 point, the Dollar would move down by 1/2 point and vice versa.  That would explain at least in part why Equities in the US have been holding up and where a good portion of capital has been flowing to in search of yield which is apparently non-existent in short to medium-term fixed income instruments.

Source: www.etfreplay.com

The concerns about a loss of purchasing power also had the obvious impact in currency markets.  The US Dollar lost ground against most of the major currencies in recent weeks.  The Australian Dollar has gained back nearly all the losses from the financial crisis and is back to its pre-crisis level.  The strength of the currency has been in part due to the rise of Gold and other commodities but it is also a result of the roughly 4% yield differential between the Aussie and the Greenback.

US$ versus Australian Dollar

But the fall in the US Dollar has not been primarily caused by the yield differentials from the currency pairs.  This has been evident in rise of numerous other currencies with equally low short-term yields.  The Dollar caved in against the The Swiss Franc (now below parity) and it even reached a new all-time low against the Singapore Dollar.

US$ versus Swiss Franc	US$ versus Singapore Dollar

More significantly, the US$ fell to a 15-year low against the Japanese Yen. Despite last week’s central bank intervention, the US Dollar has retreated again, making the Japanese currency more valuable.  

US$ versus Japanese Yen	US$ versus Japanese Yen (Monthly)

There is a common theme in all this: A race to the bottom. 

Currently, the US Dollar is clearly leading this race in terms of being closest to the bottom.  Considering the current landscape of interest rates however, the Japanese have been scraping the bottom for two decades now and that may provide some insights into the dilemma of some of the G20 nations.  Japan, which had near zero rates for an extended period of time and yet, their currency has been at a 15 year high against the Dollar.  Clearly, the strong Yen is a problem for the export-driven Japanese economy.  With rates at the bottom, there is limited room to maneuver  in terms of stopping the rise of the Yen any further.  The recent intervention of Japan is point in case as it did little to change the market trend. 

The US administration officially wants a strong US Dollar but that would obviously undermine a number of stated goals i.e. reducing the trade balance (increasing exports rather than imports), reducing the deficit and reducing the effective cost of interest on its debt.  Instead, as long as the world can be lulled into the perception of no or minimal inflation while the values of other non-cash assets are appreciating, the government is effectively reducing its true debt burden. 

Other countries have a currency problem from another perspective.  Take Australia, which is an exporter of many raw materials including minerals and precious metals, all of which have been on the rise recently.  Combine the increase in commodity prices with a rising Australian Dollar and the country is approaching levels that negatively impact their exports to countries like China.  China which in turn pegged its currency to the US Dollar and is by many still perceived as 30-40% undervalued, has to swallow the cost of the combined price increases of raw materials with the additional net price increase from say the Australian Dollar when valued in Chinese Yuan.  From Australia’s perspective, concerns about a further increase then are real as well.

A similar case applies to Brazil, which has been trying to stem the rise of its currency for some time now.  While their economic success in the past few years must be largely attributed to the increased demand of commodities and the resulting rise in their prices, they too are now approaching values (commodity price combined with higher exchange rate versus USD or Chinese Yuan) that may pose problems for their exports.  The US$ versus Brazilian Real has been approaching lows of pre-crisis levels in recent months.

US$ versus Brazilian Real

And where is the Euro in all this?  Earlier this year, in the midst of the Greek sovereign debt crisis (which isn’t over by the way), the Euro has been plastered as “toast” all over the financial news media.  The fall of the Euro however, showed some very positive effects particularly with regard to export-driven economies like Germany.  Germany’s economic recovery this year may not necessarily be the effect of superior policy by their administration but rather a lucky windfall from the ~20% fall of the Euro versus the two currencies that also happened to be major target markets for their exports, namely the USD and CNY.

Euro versus US$

Going back to our theme of today, a panacea for a sluggish domestic economy may indeed be the de-facto devaluation of a currency versus other major currencies.  For command economies like China, this can easily be done with a simple administrative declaration.  Other countries like Switzerland and Japan have been trying to stem the rise of their currency with a combination of market intervention and policy moves, both can be costly for their central bank and treasury.  Other export-driven countries like Brazil have been using taxes and duties to slow down the inflow of capital which made its currency so strong.  Australia may also find itself at a point where currency appreciation must be slowed down or stopped.  While each country has to weigh their methods of managing currency risk, there are no easy and unilateral choices.  None of these choices are without repercussions.  The benefits of some short-term relief i.e. a brief period of a boost in exports from the windfall of lower currencies must be balanced with the long-term caveats of the loss of purchasing power.  The theme of today suggests another concern, perhaps most evident by the rise in the value of Gold.  It is the growing mistrust of governments and their (mis)handling of public finances which makes the notion of a stable currency a problematic one. 

The race to the bottom is on.  In currency terms, there are a few favorites right now but the prospect of diminishing returns from too strong a currency is a concern. Some administrations will be toying with the “D” word.  “D” may be best known for deflation but it may play out more significantly as a Devaluation or Dilution them with respect to the major currencies.  Buckle up, we’re already in the midst of the race...

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy... 
• Gold price at yet another record high touching $1,300 on Friday (Reuters)
• US durable goods orders in August 2010 decreased 1.3%, to $191.2 billion (ESA)
• US new home sales unchanged in August, annual sales pace remains second slowest on record (AP)
• Brazil's state oil company Petrobras raised $70bn in the world's largest public share offering (IPO)
• German IFO business climate index climbed to 106.8, its highest level in over three years (Economy.com)
• US leading economic index increased 0.3% in August to 110.2  (Conference Board)
• Bank of Japan intervened in the currency market for the second time in just over a week (AP)
• Total American consumer debt declined for the seventh straight quarter to $11.7 trillion (NY Fed)
• China’s prime minister, Wen Jiabao, ruled out large-scale appreciation of the yuan (Economist)
• The Federal Reserve kept the interest-rates target at zero to 0.25% (AP)
• The Fed hinted at more quantitative easing causing treasuries and gold to rise, dollar fell sharply (Reuters)
• US housing starts were 598,000, up 10.5% from the prior month and up 2.2% from the prior year (ESA)
• US economic panel declares recession ended in June '09, longest downturn since World War II (NBER)

Weekly Market Barometers

Charts Of The Week
The markets took the view that the Fed will implement QE 2.0 at some stage.  A renewed flight towards safety and in anticipation of a US dollar dilution prompted new highs in Gold, more pressure on the Dollar and ultra-low short-term yields yet again...

2-year US Treasury Yield		5-year US Treasury Yield
Source: http://globaleconomicanalysis.blogspot.com/

Interesting Video 
Please consider this rather interesting interview with Bob Prechter, founder of the Elliott Wave International.  While the current market mood has turned positive recently, he warns of the risks of further bubbles.  Certain technical indicators could see a devastating fall in US markets.  Decide for yourself whether his worst case scenario of the Dow falling to 2000 is pure insanity or whether it deserves some merit...

Bob Prechter’s Head & Shoulder Warning
Below is a clearer version of the chart Bob Prechter alluded to in his interview.  We should find out relatively soon whether the market agrees with him tilting south towards the neckline, or whether all this technical mumbo-jumbo is just talk.  The green line indicating a rough guestimate for the top of the right shoulder going forward represents the hurdle the markets must take to proof Mr. Prechter wrong.

Pointless But Official 
The National Bureau of Economic Research did it again; with uncanny precision they concluded that the US recession had ended more than a year ago. 

The Business Cycle Dating Committee of the National Bureau of Economic Research met yesterday by conference call. At its meeting, the committee determined that a trough in business activity occurred in the U.S. economy in June 2009. The trough marks the end of the recession that began in December 2007 and the beginning of an expansion. The recession lasted 18 months, which makes it the longest of any recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months.

Last Four Recessions and their Durations
12/07   -     6/09       18 months
3/01     -     11/01        8 months
7/90     -     3/91          8 months
7/81     -     11/82      16 months

While this is about as useful as telling us what the weather was last week, the inquiring mind is wondering how many highly paid economists have been working around the clock to figure this one out. Sadly, that brain power could have been used to come up with solutions for the creation of new jobs and new industries, ideally to achieve sustainable long-term economic growth. Instead, it is another example of bureaucratic waste. Is this is a precursor of the new financial overhaul bill's effectiveness?

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Gold has been “back in the game” so to speak for a good decade now; in fact, it’s not just been back, the price of Gold has increased almost 4-fold since 2000 - not bad at all compared to the otherwise “lost decade” of investment returns.

Spot Gold – Monthly Chart

This week alone, there were three new all-time price records for the shiny metal.  The big impetus for the near $30 price jump earlier this week was the news that central banks would be net buyers of Gold for the first time since the late 1980s, purchasing about 15 tons of bullion this year.

Spot Gold – Daily Chart

Perhaps equally important is the fact that some of the biggest central banks have slowly phased out their sales of gold bullion while only the IMF was seen as a net seller of Gold recently. In the past decade, central banks have sold 442 tons of gold on average each year but the massive off-loading has stopped in recent years.  That may be one explanation why there is some sentiment of “this time is different” in the Gold market.

On the corporate end of the market, most commodity producers are typically net sellers in the futures markets as well, often using automatic hedging programs as part of their corporate hedging strategy.  This week however, Anglo Gold Ashanti, the world’s biggest gold miner, announced that it will wind up its hedging program and stop forward gold sales by 2011.  Other gold producers will certainly follow suit, if they haven’t done so already and that may have been the second impetus for a continued rise in the gold price this week.

From a global macro perspective, there may be a few other rationales as to why the price of gold may increase further still. First off, there aren’t many alternatives in terms of bullish market sentiment; as one trader recently put it: “Where else can you put your money these days?”  Investors are still scared of a potential double-dip.  You can sense a fear of a follow-up recession on the one hand on the other hand, capital is longing for yield in an environment of negative real interest rates. The thirst for yield has been a huge factor leading investors to look elsewhere, often towards emerging markets or, as in this case, towards Gold.

Then there is the ongoing argument about inflation/deflation.  While Gold’s record as an inflation hedge has been rather mixed historically, the inflation argument has been a huge factor spurring investor demand.  The peak price of Gold in 1980 is somewhere between $2100 - $2300 when adjusted for inflation.  Therefore, one should not be surprised to hear estimates of anywhere between $1500-$2000 as price targets for the next 6-18 months.  Some of the most vocal Gold bulls have called for a price target of $5000 within this decade.

Conflicting signals most everywhere you look while Gold has been a sort of sacrosanct in all this. And yet, what are the long-term prospects of holding Gold as an investment?

Although most financial analysts may have a good laugh about this, one should not discount the emotional aspect of an investment.  There is an undeniable feel-good factor about Gold.  Most investors would hold Gold not as bullion but in form of Gold certificates, Gold futures or one of the many other forms of non-physical Gold investments such as ETFs. But despite that, an investor may get a sense of security and comfort from investing in a commodity that is sure to outlive most government policies.

It is exactly that mistrust of governments and their apparent inability (across all party lines) to balance budgets which is yet another factor for the flight towards safety.  That flight has been most apparent in the US recently. A good indicator for that has been the renewed flight out of the US Dollar.

Indeed, US Dollar weakness explains some of the recent price rises of the shiny metal. Gold in Euro terms has had its peak at the beginning of this summer in the aftermath of the Greek sovereign debt crisis.  Since then, the rise in Gold has not been as pronounced when expressed in Euros. The €1,000 level for Gold would seem like an important testing ground for Gold prices to move higher in the near-term.

Gold Price in Euro (Daily Chart)

Longer-term price targets are more illusive and certainly harder to asses. Keeping in line with the Gold versus currency theme, yet another measuring stick might be the Australian Dollar.  Often called a “commodity currency” itself, the Aussie Dollar may be another indicator for the true price of Gold. From that perspective, the recent rise in Gold is even less pronounced and over A$1,000 below the all-time high in early 2009 during much gloomier times in financial markets. While the long-term trend is certainly bullish still, we need to see “higher highs” rather than descending highs on the upside (yellow highlights in the chart below).

Gold Price in Australian $ (Monthly Chart)

So then, should you keep your money in US denominated assets, in Gold or in other currencies? 

Although I advise caution when considering Jim Cramer’s recent call that “all” investors should have 10% of Gold in their portfolio, an allocation of Gold as part of a diversified portfolio certainly makes sense for some investors - slightly more sense for US$ based investors. Despite the massive bull run during this decade however, Gold in itself is a “non-yielding” asset which means it does not provide any returns other than price appreciation. In fact, there is a cost associated with holding Gold (e.g. the Gold ETF “GLD” has an expense ratio of 0.4%) and that has to be considered when assessing the time frame for holding Gold.

The comparison is not perfect but you may consider Gold similar to an investment in non-dividend paying stocks (rest assured that Gold prices would never fall to zero though).  The commodity component of Gold however, can make prices quite volatile and that is something every investor has to weigh-in as well.  While equities provide no relief in terms of smoother returns these days, you could still make the case of assessing the yield factor.  From that perspective, high-yielding currencies like the Australian $ with about a 4% interest rate differential to the US Dollar may be an option.  In terms of volatility, the ride in Aussie Dollars has been just as bumpy as the ride in Gold (see volatility comparison below).  Purely from a yield perspective then and granted you are comfortable with the “bumpy ride”, the positive yield in Aussie Dollars does look very attractive.

30-day Volatility: Sep 18, 2007 – Sep 17, 2010

Chart courtesy of: www.etfreplay.com    GLD = Gold ETF  FXA = Australian $ ETF

In terms of investor demand, allure and price sentiment, the shiny metal appears to have all the qualities that keeps it a “hot” commodity.  Without calling any price targets, rest assured that it will be an interesting ride ahead.  Buckle up and enjoy the ride...

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy... 
• Spot gold hit a new all-time high of $1,282.75 before closing the week at $1,274.50 (Reuters)
• US Consumer Price Index increased 0.3% in August on a seasonally adjusted basis (BLS)
• US consumer sentiment at weakest point since August 2009 (Reuters)
• US poverty rate jumped to 14.3% in 2009, its highest level since 1994 (CNNMoney)
• US producer price index increased 0.4% percent in August, seasonally adjusted (BLS)
• US current-account deficit increased to $123.3 billion, or 3.4% of GDP in Q2 of 2010 (ESA)
• A new study says Americans are $6.6 trillion short of what they need to retire (CNBC)
• Euro area annual inflation was 1.6% in August 2010, down from 1.7% in July (Eurostat)
• Greece needs to raise €4.7bn via treasury bills until end of October (Eurointelligence)
• Swiss Franc reached parity versus the US Dollar (Reuters)
• U.S. import prices increased 0.6% in August, after rising 0.1% previous month (BLS)
• The Yen fell from a 15-year high after Japan intervened in currency markets; first time since 2004 (AP)
• Japanese Prime Minister Naoto Kan beat Ichiro Ozawa in a vote for control of the ruling party (Bloomberg)
• US retail sales in August were $363.7 billion, up 0.4% from July and up 3.6% from the prior year (ESA)

Weekly Market Barometers

Chart Of The Week
It doesn’t take much to realize how the slowly crumbling US infrastructure affects the lives of everyone living and doing business in this country.  Visitors travelling on US highways, let alone LA freeways or some of the notoriously poor US City streets and neighborhoods must feel like they are in a third world country.  

Please consider this sobering report on America’s infrastructure: US Infrastructure Report Cards

The current administration has been pumping billions of dollars into stimulus spending, repairing some of the poor roads and bridges.  Commendable in a way and yet, this strategy is mostly creating jobs for low-skilled manual labor in the interim; and it is not sustainable in the long run.  The money that could have been used to give incentives for new technologies and manufacturing capacity, is no longer available now.  As much as these infrastructure needs are important and desirable, they can only be sustained from a well functioning and vibrant economy.  We should look towards the developing world that endured poor roads (for decades) when it couldn’t afford them.  As living standards improved along with the growth of their economies, they begun fixing and improving infrastructure.

The world has changed; for the better in some developing countries and for the worse in what is still considered the first world or developed world.  While US roads will continue to be bumpy for a while longer, the global economic playing field has become a lot more level...

Source: http://www.infrastructurereportcard.org/report-cards

Recommended Read 
Just in time for the 2nd anniversary of the fall of Lehman Brothers, Basel III is out with a set of new regulations for Banks.  Please consider The Money moves on.   More regulation is certainly upon us but it remains questionable whether it can detect AND prevent the next crisis lurking in the dark...

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Although some countries have recently started to free themselves from the shackles of the great recession, the US economy is still struggling to find a firm footing despite massive stimulus efforts by the administration.  A persistently high unemployment rate, officially at 9.6% but possibly much higher considering the record percentage of long-term unemployed, residential & commercial property markets still in the doldrums, record delinquencies & bankruptcies, the list goes on...

Ever since the US equity markets recovered from their darkest days (S&P500 at 666.79 in March-09) and recouped some 60% from then until the end of 2009, the disconnect between Wall Street and Main Street couldn’t have been more obvious.  Financial Institutions who had been on the brink of destruction before, suddenly raked in massive profits while the real economy barely lingered on. The first half of 2010 saw quite a pull-back with all major market indices heading South again.  The S&P 500 was down 9% during the first six months of this year.  Worse yet, Chinese Stocks got hammered nearly three times as bad with the Shanghai Composite showing a loss of 26% for the first half of the year.  Stocks have so far been leading the real economy while the negative performance of the first half of 2010 is still being digested.  If this relationship of leading and lagging indicators holds true, the US job market is not going to see any improvement for the remainder of this year.

Looking at the US market from a pure technical trading perspective, there are some reasons to be cautiously optimistic, at least in the medium term. Although the S&P500 is still over 100 points away from its recent high, the index just pierced through an important bearish resistance line on the upside. At the same time, the major support levels at 1000 and 1040 areas held up well so far.  

Another indicator, the popular Fibonacci retracement levels, confirm that the recent short-term down cycle since Mid-August has been reversed as prices moved outside the typical retracement levels; probabilities are higher for a retest of 1130.

The major US Indices are barely at break-even for the year right now but these basic technical indicators give rise for a decent enough chance to gain some additional ground beyond the 1130 level on the S&P.  A rally beyond that would be gravy, particularly in view of the outlook for the real economy.

 

 

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

The Vanguard Group announced this week that it is now offering a new ETF tracking the S&P500 Index at a rock bottom expense ratio of only 0.06%.  Please consider: Vanguard offers 500 Index Fund ETF Shares

Vanguard S&P 500 ETF (ticker: VOO) features an expense ratio of 0.06%, the lowest expense ratio in the industry among ETFs based on the S&P 500 Index or any other large-capitalization domestic benchmark (source: Morningstar, Inc.).

The Vanguard group of funds have generally been exemplary advocates for average investors providing good value for money. That also shows in the range of financial products which are typically on the lower end of costs to the investor.  Hence, this new ETF is clearly a positive development, particularly in light of the recent trend to bring more complex ETFs (at much higher expense ratios) to the market.  It may also send a signal to the industry to consider lowering their fees, more so when many of them are highly correlated with the major market indices anyway (see earlier commentary).  

Still, there are certain caveats to consider.  As always, you should read the prospectus before investing.  A copy of the prospectus can be downloaded here: Vanguard S&P 500 ETF – Prospectus

Further, one should consider watching the price and trading behavior of this new ETF for a while.  The most heavily traded benchmark ETF (also happens to be the oldest ETF) is the SPDR S&P500 (ticker: SPY) with current net assets of about $72Bn - certainly an index fund that won’t get into any kind of liquidity bottle necks, no matter how big of a trade you may wish to put on.

One should also consider watching the tracking strength of VOO for a while.  As we noted before, many of the more recent and more complex ETFs are doing a poor job in tracking the underlying assets for a longer period of time.  This should not be the case for VOO but just to be safe, give it some time and then track back how it actually performed against the benchmark.  There are numerous ways in which you can do that.  One of the easiest ways to compare is with the help of one of the many sites (e.g. www.stockcharts.com) that offer direct comparisons on their charting tools.

 

Let’s check back in 4-6 months to see how this ETF tracked the market.  You can then better assess whether the 0.03% savings in expenses over the mother of all ETFs, SPY, is actually worth it. In the meantime, hats up to Vanguard for giving a refreshingly positive signal to the investing community!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy... 
• Spot Gold edged down to $1242 on Friday, the first weekly decline in more than a month (Reuters)
• Vanguard offers new S&P 500 ETF (ticker: VOO) with an expense ratio of only 0.06% (Vanguard)
• Euro reached a record low against the Swiss Franc on concerns about Europe’s economy (AP)
• German exports fell in July by 1.5% compared with the previous month (Eurostat)
• Yield spreads on Greek and Irish bonds reached record highs over German Bunds (Economist)
• Yield on Portuguese ten-year government bonds reached the highest level in four months (Economist)
• US trade deficit in July 2010 decreased 14.0 %, to $42.8 billion (ESA)
• Bank of England held interest rates at a record low of 0.5% for the 18th consecutive month (AP)
• US slipped two places to become fourth in an annual ranking of business competitiveness (WEF)
• Bank of Canada raised its key interest rates by 25 basis points to 1.00% (WSJ)

Weekly Market Barometers

Chart Of The Week
The inter-connectedness of global financial markets has been on the rise in recent decades which is evident, among other signals, in an increase of correlations among the major financial markets.  Point in case: The recent credit crisis, with its epicenter in the US, rapidly advanced to Europe and to most emerging economies as well.  This week’s chart of the week gives yet another indication of how the global financial system has been experiencing economic strains in tandem.  Courtesy of iMFdirect and Reza Moghadam comes a good illustration of how the impact of market stresses has changed over the years.  Particularly illuminating is the increasing significance of emerging markets.  While prior financial crises may have been contained to the advanced economies before, judging from this chart, it has been much more difficult to find a place to hide...

Source: http://blog-imfdirect.imf.org

Recommended Read 
We have been discussing the increase of correlations across various markets on numerous occasions.  More recently, there has been a trend among Mutual Funds and ETFs to increasingly track similar underlying assets.  Result:  Even higher correlations of individual funds with the overall market.  Please consider yet another sign of a disturbing trend:  Contrafund's Danoff Stymied as Correlation Frustrates Top Stock Pickers 

Six of the 10 largest U.S. stock funds show correlations of 0.99 this year, meaning they moved almost completely in sync with the market. Managers are struggling to stand out and attract new money as fear of another crisis prompts investors to move in and out of markets without discriminating between securities, industries or geographies. Robert Doll, BlackRock Inc.’s chief equity strategist, said while stocks moved in lockstep before, this is the longest he has seen correlation persist across markets.

With that in mind, you may want to check your current holdings of mutual funds and see how they fare against the market.  If they correlate with the market anywhere close to the 10 largest stock funds, you should not be paying more than the typical low-cost index fund. 

Recommended Video
The Financial Times featured an interview with Jean-Claude Trichet, president of the European Central Bank.  Mr. Trichet gave some insights on the lessons learned from the recent financial crisis as well as the more recent sovereign debt crisis of some Southern European nations.  Central Bankers, much like most economists, have a way of dodging direct questions.  However, Mr. Trichet was relatively straightforward in this interview.  When asked whether he believed that the worst of the financial crisis was over, he noted:

We have to remain permanently alert, I call that credible alertness. My sentiment is that this succession of challenges seems to be very much a structural feature in the present world because we have a number of very powerful underlying reasons: Technology, Flash trading, Shadow banking.  Technology is moving at extraordinarily high speed.  We have globalization, we have the fact that the magnificent success of China, India, Brazil and Russia and the other emerging world are there and they call for enormous structural changes.

More to the point, and very much in line with our theme of highlighting the increased correlations and inter-connectedness of financial markets, Mr. Trichet had the following to say:

We had a silent revolution, the G20 substituted the G7 countries; the governance of the world is now fully shared with the emerging economies.

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

Noteworthy... 
• US nonfarm payrolls fell 54,000 in August and the unemployment rate was 9.6% (BLS)
• US Private-sector payroll employment continued to trend up modestly 67,000 (BLS)
• US home prices in June were 3.6% above their year-earlier levels (S&P)
• Euro area and EU27 GDP grew by 1.9% compared with Q2 of 2009 (Eurostat)
• Canada’s economy grew by 2% in the second quarter of 2010, compared with a 5.8% growth in Q1 (Economist)
• Australia's economy grew by 1.2% in the second quarter and by 3.3% on the previous year (Economist)
• China's purchasing managers index rose by a surprisingly robust 0.5 points to 51.7 (Eurointelligence)
• India's economy grows most since 2007, GDP rose 8.% in Q2 from a year earlier (Bloomberg)
• Global foreign exchange reaches an average daily turnover of $4 trillion compared to $3.3 trillion in 2007 (BIS)
• Germany's unemployment rate fell to 6.9% from 7.6% a year earlier (Economist)
• US consumer confidence improved to 53.5 (1985=100), up from 51.0 in July (Conference Board)
• Japan announced a $130 bn stimulus package including low interest loans for financial institutions (Economist)
• US Dollar fell to new 15 year low against the Japanese Yen at 83.58 (Reuters)
• Euro area unemployment rate stable at 10.0%, EU27 stable at 9.6% (Eurostat)
• SEC declined to charge Moody’s for violating securities laws rating derivatives (NY Times)

Weekly Market Barometers

Chart Of The Week
Having just travelled a fair amount in the past two weeks, I had the impression that there are some positive signs in the real economy. The hotels I stayed at were not fully booked, but it was more difficult to find rooms than during the last two years.  Courtesy of www.calculatedriskblog.com comes a nice chart reflecting that experience as well.  US consumers are certainly not back to their pre-crisis spending sprees but there are some positive signs on the horizon.

Source: www.calculatedriskblog.com

Recommended Read
While banks and institutions are busy studying the new financial overhaul bill, some of the institutions who had been contributing players in creating the bubble leading to the credit crisis have gotten away with a slap on the wrist; others simply got away on technicalities. Please consider: No Charges for Moody’s in Ratings Violation.

“Because of uncertainty regarding a jurisdictional nexus to the United States in this matter, the commission declined to pursue a fraud enforcement investigation,” the S.E.C. said in its report.

Wonderfully crafted words such as the “uncertainty regarding a jurisdictional nexus” is what does it for me; the inquiring mind has to wonder how “jurisdictional nexi” are going to be handled in the new financial overhaul bill...

Good luck and good investing!

Disclaimer
Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Please note that there is no requirement and no commitment to make any payments to FX Investment Strategies LLC in order to access our published information be it via email or via website publication. All information is publicly available without any required monetary consideration.  Any payments or donations made by you are deemed to be voluntary and cannot be considered as payments for investment advice given to you.

This week, financial advisors have been informed of some new disclosure and reporting rules.  As expected, the impact of the Dodd/Frank Bill is already foreshadowing a ridiculous amount of additional paperwork - mostly silly work as one of my colleagues would call it.  Financial regulation is a double-edged sword and changes were necessary, no arguments there. However, it is questionable to what extent investors will be better off, safer, and whether the financial system will any more stable after implementing the new financial overhaul bill. 

I had a chance to glance at some aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act but as soon as I opened this document, I had to close it again; I simply couldn't find the courage to actually read through some 800 pages of legalese.  So here is my offer:  I will buy anyone dinner who can muster up the courage to read this and give me a concise 20 minute plain English summary...

Going back to regulatory reform, my views are sadly quite cynical which is evident in the many references you can find in previous articles:

• Market Insights 14-Feb-2009

• Mark-to-Market or Mark-to-Myth?

• It's all about Tim Geithner

• Market Insights - 25 July 2009

• Market Insights - 24 April 2010

• Overhauling The Financial Services Industry – Really?

So what's it going to be after the dust settles and this monstrosity of an overhaul will eventually be implemented?  My take is that investors and the general public will have to foot the bill in one form or another.  Clients will loose out in having to pay higher fees. Smaller firms, such as our tiny practice, will find it increasingly difficult to swallow the cost of dealing with regulators and may be forced to team up with a larger firm, losing some of their coveted independence. Already overregulated jurisdictions such as the US and the UK must carefully evaluate what's at stake.  In the UK, several banks have been warning that they might relocate to business-friendlier jurisdictions.  HSBC just announced its clearest warning over relocation, warning that it might relocate its headquarters to Hong Kong.

The choice for many of these institutions is clear as well; they will be following the money and economic growth which has been in emerging markets.  London hosts the investment banking headquarters of many international financial institutions including some high profile US and German banks.  If those divisions can operate from London, why can't they move their investment banking headquarters to Hong Kong, Singapore or other jurisdictions that would give incentives to operate at substantial cost savings? 

While US investors must wait until the Dodd/Frank Bill is implemented to find out whether salvation is nigh, capital won't.  As the markets and institutions assess the impacts of new reform, we are going to be faced with a very different financial landscape in the near future. Investors might then also need to assess whether it makes more sense to "follow the money".

If you had slept through 2008/2009 you would truly wonder what that financial markets hysteria was all about – In the world of FX, it’s as if the credit crisis never happened.  At least that is the impression one gets by taking a first glance at the recently released data from the Bank of International Settlements (BIS) in Basel, Switzerland.  The growth of the foreign exchange appears relentless reaching a mind boggling $4 trillion in average daily turnover in April 2010.  Here are a few of the highlights of the BIS report:

• Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007, with average daily turnover of $4.0 trillion compared to $3.3 trillion.
• The increase was driven by the 48% growth in turnover of spot transactions, which represent 37% of foreign exchange market turnover. Spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion in April 2007.
• The increase in turnover of other foreign exchange instruments was more modest at 7%, with average daily turnover of $2.5 trillion in April 2010. Turnover in outright forwards and currency swaps grew strongly. Turnover in foreign exchange swaps was flat relative to the previous survey, while trading in currency options decreased.
• Foreign exchange market activity became more global, with cross-border transactions representing 65% of trading activity in April 2010, while local transactions account for 35%.
• The percentage share of the US dollar has continued its slow decline witnessed since the April 2001 survey, while the euro and the Japanese yen gained relative to April 2007. Among the 10 most actively traded currencies, the Australian and Canadian dollars both increased market share, while the pound sterling and the Swiss franc lost ground. The market share of emerging market currencies increased, with the biggest gains for the Turkish lira and the Korean won.
• The relative ranking of foreign exchange trading centres has changed slightly from the previous survey. Banks located in the United Kingdom accounted for 36.7%, against 34.6% in 2007, of all foreign exchange market turnover, followed by the United States (18%), Japan (6%), Singapore (5%), Switzerland (5%), Hong Kong SAR (5%) and Australia (4%).

There will be plenty of discussions and opinions as the full BIS report is going to be analyzed in the coming weeks. For now, we would like to focus on just two sets of data: The distribution and ranking of currency pairs as well as the geographical distribution i.e. where most of the FX trading takes place.

1. Global foreign exchange market turnover by currency pair

Daily averages in April, in billions of US dollars and percentages

Currency pair	1998		2001		2004		2007		2010
	Amount	%	Amount	%	Amount	%	Amount	%	Amount	%
USD/EUR	.	.	372	30	541	28	892	27	1,101	28
USD/JPY	292	19	250	20	328	17	438	13	568	14
USD/Oth	140	9	152	12	251	13	498	15	445	11
USD/GBP	122	8	129	10	259	13	384	12	360	9
USD/AUD	44	3	51	4	107	6	185	6	249	6
USD/CAD	52	3	54	4	77	4	126	4	182	5
USD/CHF	82	5	59	5	83	4	151	5	168	4
EUR/JPY	.	.	36	3	61	3	86	3	111	3
EUR/GBP	.	.	27	2	47	2	69	2	109	3
EUR/Oth	.	.	17	1	35	2	83	2	102	3
USD/HKD²	14	1	19	2	19	1	51	2	85	2
EUR/CHF	.	.	13	1	30	2	62	2	72	2
USD/KRW²	2	0	8	1	16	1	25	1	58	1
JPY/Oth	9	1	4	0	11	1	43	1	49	1
USD/SEK³	3	0	6	0	7	0	57	2	45	1
USD/INR²	1	0	3	0	5	0	17	1	36	1
EUR/SEK³	.	.	3	0	3	0	24	1	35	1
USD/CNY²	0	0	.	.	1	0	9	0	31	1
USD/BRL²	3	0	5	0	3	0	5	0	26	1
USD/ZAR²	6	0	7	1	6	0	7	0	24	1
JPY/AUD²	1	0	1	0	3	0	6	0	24	1
EUR/CAD	.	.	1	0	2	0	7	0	14	0
EUR/AUD	.	.	1	0	4	0	9	0	12	0
JPY/NZD²	0	0	0	0	0	0	0	0	4	0
Other pairs	30	2	23	2	36	2	90	3	72	2
1  Adjusted for local and cross-border inter-dealer double-counting (ie "net-net" basis).  2 Included as main currency pair from 2010. For more details on the set of currency pairs covered by the 2010 survey, see the statistical notes in Section IV. 3 Included as main currency pair from 2007.  4 OthEMS/OthEMS: the data cover local home currency trading only. Source: Bank of International Settlements

As before, the top spot went to the US Dollar/Euro currency pair reaching over $1 trillion each day in 2010. It is indeed remarkable to see that the second spot made by Dollar versus Japanese Yen is only half of the USD/EUR volume. Despite the recent flight towards safety, pushing the Japanese Yen to a 15 year high against the US Dollar, this currency pair has lost considerable comparative market share towards other currency pairs.  Overall, the US Dollar is still the Alpha Dog among the currencies with over 42% of all trading worldwide, followed by the Euro with just under 20%.  The chart below is a nice depiction of the distribution of currency pairs since 2001. Not surprisingly, some of the emerging market currencies have graduated onto the world stage, a trend which is bound to continue and more likely to accelerate.

2. Geographical Distribution of Global Foreign Exchange Market Turnover

Daily averages in April as Percentages of Global Turnover

Country	1998	2001	2004	2007	2010
United Kingdom	35.8	35.2	42.3	44.0	45.8
United States	17.0	17.1	23.8	24.2	23.8
France	11.8	9.6	11.4	8.1	7.2
Japan	9.2	2.3	2.3	3.5	3.3
Switzerland	1.7	1.4	0.9	2.8	2.9
Singapore	1.6	0.5	0.6	2.6	2.9
Netherlands	1.0	3.6	1.4	1.2	2.3
Germany	8.5	13.9	3.2	4.2	1.8
Canada	1.9	1.5	0.9	0.9	1.5
Australia	0.8	1.5	1.0	1.0	1.5
Spain	0.8	3.0	0.9	0.8	1.1
Italy	1.2	3.5	2.8	1.4	1.0
Hong Kong SAR	0.7	0.4	0.8	0.8	0.7
Sweden	1.0	0.5	0.6	0.6	0.7
Denmark	1.2	0.9	0.8	0.5	0.6
Norway	0.8	0.4	0.4	0.3	0.4
Korea	0.0	0.0	0.1	0.2	0.4
Belgium	1.4	2.1	2.3	1.0	0.4
Brazil	…	0.0	0.1	0.0	0.3
Ireland	0.5	0.9	0.9	0.3	0.3

In terms of the geographical distribution, it is also fascinating to see how the number one place, the United Kingdom with the majority of trading arising from within the City of London, has managed to outpace everyone else including the US. London still hosts the largest number of international banks of any place in the world so the data is somewhat skewed in a sense of looking at the pure country distribution.  For instance, most of the big German banks channel their investment banking and trading operations from within London.  Nevertheless, London is still the most desirable place to be situated merely by the fact that it is in the sweet spot (time-wise) of the 24 hour Forex market. As far as the US is concerned, the impending implemention of the The Dodd-Frank Bill and the US Consumer Protection Act make it all the more likely that the US will not be able to catch up with other locations when it comes to the derivatives portion of the Foreign Exchange turnover.  While the UK has also implemented a number of new rules towards tighter market supervision by giving the Bank of England much more regulatory powers over all financial institutions, the UK is more likely to leave the traditional foreign exchange market functioning the way it has been.  However, in line with the trend of the rapid growth of transactions in emerging market currencies, we will most likely see the bulk of the ongoing growth in emerging market locations as well.  Too bad we have to wait another three years to see the next BIS report.