Uncertainty, Risk, Liquidation --> Strong $

A: Lets change it up a bit and look at what has happened in the currency market in the past week or so, that I feel is worth discussing. This is a world of uncertainty. Uncertainty in the credit markets, uncertainty in the banking industry, uncertainty in the ultimate economic impact, and uncertainty in global growth effects. Usually, in times of uncertainty a safe haven play would be to buy Gold in addition to US Treasuries. While there has been a flight to quality into US Treasuries that is evident by a rise in bond prices and a drop in yields, there has NOT been a rush into buying Gold? Why, you ask? Because this is a liquidity squeeze and that means positions of all kind are being liquidated to what is ultimately king. And right now, CASH IS KING! Let's analyze.

Liquidation - In finance, liquidation is also sometimes used as convenient shorthand for converting an asset to cash.

Uncertainty - The lack of certainty, A state of having limited knowledge where it is impossible to exactly describe existing state or future outcome, more than one possible outcome.

Risk - Risk is a concept that denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or future event. In everyday usage, "risk" is often used synonymously with the probability of a known loss.

Given these times of uncertainty, we are seeing a liquidation of assets to cash to either unwind a long position that is on the wrong side of a trade to reduce exposure to risk OR to convert an asset to cash to pay off a debt, margin call, or other. In past times of uncertainty, we would see a flight to quality in the bond market (bond prices rise as stock prices fall) and a rising interest in safe plays such as Gold. But this time around, Gold is not seeing an uptick. Perhaps waiting for fed cuts?

Here is the drop in Bond yields as a flight to quality takes place and investors seek the safety of US Treasuries. As bond prices rise, the yields fall as is evident by this 30-day chart of the 10YR which saw a drop of 30 basis points (0.30%) in yields:

Now, lets take a look at the chart of Gold prices in the past 30 days when these credit concerns finally reached the surface. No real surge? Keep your eyes on it though.

Notice how the price of Gold in the past 3 weeks is relatively flat! No sharp movements at all. In fact, one can argue that there is an unwinding of positions across the asset classes in response to the current liquidity crisis. Lets be open-minded here, hedge funds, pension funds, major banks, etc. do hold positions in commodities like Gold and in times of extreme stress where cash is needed fast, they may be forced to liquidate positions that otherwise would be held! What other asset holdings will have to be liquidated if times get real hairy?

Now lets take a look at what the US Dollar Index has done in the past 5 trading days:

Quite impressive considering the threats of the credit crunch on the US economy? But why is this happening? I'm hearing differing angles from traders which include:

1. Funds are liquidating ALL asset classes
2. Yen Carry Trade liquidation
3. Pressure on Euro due to credit fears hitting their housing market. US Housing already deep into correction and expected to recover sooner than any European housing downturn due to credit crisis.
4. Shorting of Euro
5. Cash is KING and rush to load up on US greenback

Whatever the reason is, there is obviously some buying going on in our currency as evidence by the chart. Is this the start of a comeback for the US greenback? Probably not, but who the hell knows. What I do know is that the US dollar has been hit for so long and is near record lows against the Euro that its hard to argue against a contrarian play in the US dollar. To see how bad the US dollar has been hit, lets chart out the US Dollar vs. Euro over the past 5 years:

Ouch. Just an ugly chart for us Americans holding US dollars. Just think, out of all that money you made in either the housing market or the stock market, most of the gains got wiped out due to inflation and the falling value of the US dollar. Yay America! Go us!

There is a reason why foreigners are buying NYC real estate and its mainly because they are taking advantage of currency trends! Here is an example over a 5YR period to give you an idea of how much more house a buyer with Euro's could buy here in Manhattan real estate simply due to the falling value of the US dollar and the relational rising value in the Euro.

EURO BUYER IN AUG 2002

1 Euro = $0.97 US Dollars

500,000 Euros BUYS $485,000 worth of US Housing

EURO BUYER IN AUG 2007

1 Euro = $1.37 US Dollars

500,000 Euros BUYS $685,000 worth of US Housing

Today, based on currency trends alone a 500,000 Euro buyer can now buy $200,000 MORE HOUSE in New York City than they could 5 years ago! If I went back a few more years it would have been even more as when the Euro was introduced in 1999, it fell to a low and was once trading $0.82 or so on the US dollar. Amazing stuff.

Keep an eye on how the credit crunch effects the Eurozone economies because if it does hit hard over there you will see a selloff in the Euro as a result; clearly a bet that some hedge funds are now taking with the Euro near an all time high against the greenback. You know the old saying BUY LOW & SELL HIGH, well lets see how that plays out in the currency world.

If the US Dollar does mount a comeback and the Euro buys significantly less US Dollars down the road than it does today, it may remove a key fundamental driver to the Manhattan real estate marketplace as foreigners see less attractiveness in buying US assets based on currency trends.

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