Chart View: Why China’s currency will not be weaponized…

Friday 11 October 2019

Quotable

“Nature does not hurry, yet everything is accomplished.’

--Lao Tzu                                                    

Commentary & Analysis

Chart View: Why China’s currency will not be weaponized…

currency wars.png

Many analysts have been predicting China will “weaponize” its currency; i.e. push it sharply lower against the US dollar as punishment for US trade “aggression.”  On first blush, this sounds sensible.  But I don’t believe it aligns with what China is trying to accomplish with its currency; and in fac, it would be a very risky strategy near-term.

Two things seem clear: 

  1. Over time, China wants its currency to displace the US dollar as the world reserve currency. Granted, this is a long-term process. But thinking strategically, as we know Chinese leaders tend to do, a volatile currency based on whim and retaliation would not benefit ongoing objectives of having countries settle trade with China in yuan (renminbi); i.e. they want to build a stable track record aligned with the ongoing development of Belt and Road is my guess.

  2. A big devaluation would lead to capital running from China as fast as it can. We have seen this before. When China devalued its currency (or it fell sharply against the US dollar) between 2014 and 2016 capital flow turn negative in a big way for China.

101119 china deval and flows.png

 Though it is not showing up on this chart, we know capital has been running out of China.  President Xi risks an avalanche of funds running from his country if he decides the currency is the tool to blunt US “aggression.”  Granted, capital controls would be strict, but leakage would happen nonetheless.

And one more chart to note.  A bit complicated but some key points:

  1. China’s relative yield spread is now rising against the US (blue)

  2. Emerging market stocks (purple) are tracking on China’s currency (gold); so, if you buy into the appreciating yuan theme, EEM is cheap longer term.

  3. The Australian dollar (green) appears extremely cheap if the yuan appreciates (yes, we are long Aussie and took off some s/t profits there yesterday).

101119 cny eem aud yield.png

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Video: Reasons why the dollar is in a long-term bear market…

Thursday 10 October 2019

Quotable
“Impossible is a word to be found only in the dictionary of fools.”

--Napoleon Bonaparte

Commentary & Analysis
Video: Reasons why the dollar is in a long-term bear market…

dollar crashing.jpg

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US $ Index Falling 52% From Here? ....Join Me in Live Webinar at Investor Expo and I will explain why this may happen....

US $ Index Falling 52% From Here? ....Join Me in Live Webinar at Investor Expo and I will explain why this may happen....

Jack Crooks here…

Given what we know now, it is hard to imagine the US dollar falling 52% from here.  But if the macro environment turns dollar vicious for the dollar, and I believe it easily can, a 52% decline would not look crazy.  Here is a chart mapping this potential decline....

100919 dollar index.png

Today, I am taking part in a 4 speaker Trading Educator Forum.  Please join me and I will share why I am looking for a multi-year bear market for the US dollar which is already underway. 

It’s all online so you can join in from the comfort of your own home or office.

I will be speaking at 11:00 a.m. PDT (2:00 p.m. EDT)

Topic: The US dollar: Is a major top near?  If so, why?  And my favorite fx trading ideas...

It’s also 100% Free, and recorded so make sure you click the link below to attend (or if you can’t make it) add this amazing event to your personal trading library.

Join me, and let’s take our trading to the next level.

⇒ Click Here to instantly register for InvestorExpos.com ⇐ 

By clicking this link you will automatically be registered to attend

I hope to see you there.

Thank you.
Jack Crooks

jcrooks@blackswantrading.com
Black Swan Capital, LLC
www.blackswantrading.com 
Ph: 772-349-6883

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Trading Lessons from Cool Hand Luke: Get your mind right!

PDF Version

Tuesday 8 October 2019

Quotable

“We do not see things as they are but as we are.”

--Samurai Trader’s Maxim Number One                                                                        

Commentary & Analysis

Trading Lessons from Cool Hand Luke: Get your mind right!

cool hand luke.jpg

My all-time favorite currency guy is John Percival (now retired and living comfortably in the French countryside I understand).  My respect for his insights over the years is immense.  John has likely forgotten more about currency trading than most people will ever know.  In his newsletter, Currency Bulletin, and book, The Way of the Dollar, John was emphatic about the “four knows:”

1.    Know your reasons

2.    Know your risks

3.    Know your time frame

4.    Know yourself

Books have been written on each of these four knows, some good, others not so (I have list of my favorite investment books posted on my site here if interested). 

Many believe if your reasons for a trade are right you have most of the trading game conquered.  But that is not true.  It’s not true because the market can find all kinds of ways to take your money even if you reasons for a trade are right. 

Of the “four reasons,” John warns the last one on the list, know yourself, is the hardest of them all to know

After years of playing at this game, making some great trades along with many excruciatingly bad ones, having some good runs met by nasty drawdowns, I couldn’t agree more with John: this game hinges ultimately on knowing yourself. 

I’d like to flesh this out a bit more with Luke’s help… READ MORE

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Hodgepodge Charts of the Day

PDF Version

Friday 4 October 2019

Quotable “Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth.”
― Marcus Aurelius, Meditations


Commentary & Analysis

Hodgepodge Charts of the Day

chalkboard sswans sharp.jpg

USD $ Index Daily: Everyone seems to love the dollar for all the reasons we already know about, such as: relative yield, US growth, safe haven play, China, Europe, Brexit, the Tooth Fairy, and Santa Clause. I hope I haven’t missed anything. But, the Joker of the Market loves it when everyone is facing the same direction. So, if you love the dollar, be careful; as there are longer term rationales suggesting the dollar may turn lower soon and enter a long-term bear market. These include: US recession, political upheaval, Chinese e-yuan leapfrogging SWIFT technology, a positive Brexit surprise, money flow to Europe on big fiscal stimulus from Germany and others, commodities bull market, the Tooth Fairy, and Santa Clause. We may not be at the point of a major turn, obviously; however, we can hear the Fat Lady warming up her voice…

100419 dollar index fed.png

Stocks to Commodities Ratio and US $ Bull and Bear Market: Note the stock/to commodities ratio as shown below is very much near where the last commodities bull market cycle begun back in 1999. I.E. a bull market cycle in commodities (lower stocks to commodities ratio) has been equivalent to a bear market in the US dollar. (Think of it as real goods priced in dollars going up; or relative value of the dollar declining.) So, maybe we are getting close to a turning point.

100419 stocks commodities.png

Dow Theory Confirmation: We are not experts on Dow Theory (we aren’t experts on anything really); but it doesn’t seem we have seen the Transports validate the latest high in the Industrials. Robert Rhea phone home!

100419 dow theory.png

Gold and the US Dollar Index: We like gold long-term. And usually gold and the dollar are negatively correlated; i.e. gold up dollar down, and vice versa. This relationship goes to that idea a good suit should cost one ounce of gold priced in dollars. Granted ,I don’t wear $1500 suits, but the really important people do.

100419 gold.png

US 10-year bond yields: Many, including Karl Marx, believe zero interest rates mark the end of capitalism. Money can no long find profitable places for investment. Thus, reflecting the end of capitalism as a dynamic system. So, we have placed Elizabeth Warren’s upcoming presidency (not sure how to really weight that possibility) as marking the effective end of capitalism in America and possibly marking the low in interest rates. A scary outcome for those who understand socialism and believe Mrs. Warren is a practitioner (she may be no such thing of course; and instead be the true champion of middle- and lower-class Americans, and implement policies that rebalance the skewed positioning that cannot be denied: Those who have access to capital to grow their wealth are doing very well; those who depend on their labor are not.) We may find out soon. We use Mrs. Warren as the example because she is leading in the national polls as the 2020 challenger to President Trump and it seems Americans are warming to socialistic policy ideas. We do not want to get into the morass of politics in this publication. Politics in America is now extremely polarizing, and we don’t care to play.

100419 long term bond yield.png

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Forecasting, Causality, the Black Swan, and your Edge

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Thursday 3 October 2019

 Quotable

"Those who have knowledge, don't predict. Those who predict, don't have knowledge. "

Lao Tzu, 6th Century BC                                                                                                      

Commentary & Analysis

Forecasting, Causality, the Black Swan, and your Edge

fairy god mother.png

I share this seemingly simple equation, add a few comments and wade more deeply into the fog:

The currency equation of expected total return:

↑Expected Total Return = ↑Interest Yield + ↓Inflation + ↑Future Exchange Rate                          

This equation says the primary rationale for holding a particular currency is to maximize total return, and expected total return is a function of the real yield achieved (nominal interest rates minus the inflation rate) and the future exchange rate (that which we are trying to forecast). 

Do rising real yields cause the exchange rate to rise ... or is it a rising exchange rate, impacting the fundamentals, which leads to rising yields?

In the real-world prices are driven by a tangled web of rationales which manifest into a complex array of feedback loops.   I think this explains why it is so painfully difficult to determine which variables lead and which follow in a supposed correlation. The word “supposed” is used because correlation is not causality; and worst still, causality itself is suspect as Sir Karl Popper explains (below).

I could give you plenty of examples of when a currency’s relative yield dropped, yet the currency soared, and vice versa.  It is rarely an A+B=C causation (though I plead guilty at times pretending it may be that simple).  In fact, if you were to stop and calculate the odds of forecasting correctly based on your inherent A+B=C causality mindset, you might start to question the efficacy of ever forecasting again. 

“In chess, there are 400 different possible positions after the opening two moves. There are 72,084 move combinations after each player has made two moves and over 288 billion scenarios after four moves each. The Shannon Number, which represents a conservative lower bound of the game-tree complexity of chess (the total possible move variations), is thought to be between 10^111 and 10^123. By comparison, there are 10^81 atoms that make up the known universe. I think we can all agree that national and global markets and economies are far more complex than chess. So tell me again why you think you can predict what will happen next in the markets or in the economy….”

                                          Bob Seawright, The Prediction Game

Maybe we should stop looking for causality as a source of confidence for our forecasts; especially if our causality flows from deductive reasoning. 

Why we cling to Beliefs

Karl Popper, a German philosopher, referred to the black swan in his 1953 essay on The Problem with Induction. Induction application in the financial world is best known as “back testing.” Reading Popper gives one a deeper understanding of why we cling to beliefs so tightly and assume we can confidently project our expectations into the future and be confident we will be right. 

Popper was fond of the philosopher David Hume and used his reasoning for much of the basis of his argument about induction, carrying it further. Popper wrote [my emphasis]:

But Hume held, at the same time, that although induction was rationally invalid, it was a psychological fact, and that we all rely on it. [We do rely upon it in our everyday life and it serves us well in lots of areas.  But because “every moment in the market is unique” it serves us less well there.]

Thus, Hume’s two problems of induction were:

1)      The logical problem: Are we rationally justified in reasoning from repeated instances of which we have had experience to instances of which we have had no experience?

Hume’s unrelenting answer was: No, we are not justified, however great the number of repetitions may be. [The point here again each moment in the market is unique; it’s may rhyme with the past, but there are differences.]

And Hume added it did not make the slightest difference if, in this problem, we ask for the justification not of certain belief, but of probable belief. Instances of which we have had experience do not allow us to reason or argue the probability of instances of which we have had no experience, any more than to the certainty of such instances.

2) The following psychological question: How is it that nevertheless all reasonable people expect and believe that instances of which they have had no experience will conform to those of which they have had experience? Or in other words, why do we all have expectations, and why do we hold on to them with such great confidence, or such strong belief?

Hume’s answer to this psychological problem of induction was: Because of custom or habit; or in other words, because of the irrational but irresistible power or the law of association. We are conditioned by repetition; a conditioning mechanism without which, Hume says, we could hardly survive.

Okay! I realize this is getting thick, hang in there, almost there.

Popper agreed with the first part of what Hume talked about; the logical problem. But Popper, couldn’t accept the irrationality of the second part—the psychological problem.

It is here where we get to the black swan. Popper posed that yes, we must use experience of past instances to advance our knowledge but we must accept the fact that just because so many past instances were effectively consistent, or the same, it does not therefore mean a theory based upon those past instances has been proven. The reason he says this is because there may be some future instance out there which invalidates all that has come before it, and it only takes one such instance to do that. Therefore, all theories can be falsified, but they cannot be proven simply by past experience.

…Or in other words, from a purely logical point of view, the acceptance of one counter instance to the view that, “All swans are white,” implies the falsity of the law “All swans are white”—that law, that is, whose counter instance we accepted. Induction is logically invalid; but refutation or falsification is a logically valid way of arguing from a single counter instance to—or, rather, against—the corresponding law.

This logical situation is completely independent of any question of whether we would, in practice, accept a single counter instance for example, a solitary black swan in refutation of a so far highly successful law. I do not suggest that we would necessarily be so easily satisfied. We might well suspect that the black specimen before us was not a swan. And in practice, anyway, we would be most reluctant to accept an isolated counter instance. But this is a different question. Logic forces us to reject even the most successful law the moment we accept one single counter instance.  [Thus, can there ever be a market “theory”?]

The theory, or law, that all swans were white was falsified once a black swan living in Australia was discovered. Till then, everyone knew all swans were white. Done deal!

Of course, everyone knew Triple AAA-rated tranches of securities were safe—they had been in the past. Everyone knows that gold is the only real money and cryptocurrency is pure hype. Everyone knows inflation is a monetary phenomenon. Everyone knows the dollar must go up. Everyone knows that China will rule the world soon.

We could go on and on into infinitum with what everyone thinks they know. But interestingly, the things we seem to think we know often don’t even have the consistent instances of induction in their favorWe cling to ideas in the financial world that have been falsified before but seem to gather a second life. This isn’t even close to the word logical.  But customs and habits are powerful motivators. 

The Sufi summarizes Popper

“There is an old Sufi tale about a mullah (Nasruddin) who was discovered by a passer-by searching in the dust outside his house. What was he looking for, the stranger inquired? A key, said the mullah. Where did he drop it? “In the house” replied the mullah. Then why was he looking in the dust outside? Because here he was in bright sunlight, whereas in the house it was dark and difficult to see.

“It happens to us all the time. The solution to worthwhile problems is never out there in the open. The key to financial markets is elusive. It must be so, by definition. The price-discounting mechanism ensures that the majority are always looking out there in broad daylight, when the key is somewhere else, in the shadow.

                                              John Percival, The Way of the Dollar

Identifying the divers of currencies is quite elusive. 

“Finally, one had to see if there were other relationships which had any predictive value for currencies like inflation, trade, money supply, oil prices, economic growth, et al. So far, the conclusion is that few such relationships and none of the relationships that most observers seem to rely on are useful for predicting the dollar.”

                                               John Percival, The Way of the Dollar

I think this is where the trend followers get it right.  They don’t try to explain all (or any) of the reasons why prices are heading in a certain direction; they simply want to “ride the bucking bronco” for all its worth, to quote Dunn Capital Management’s founder Bill Dunn.

So, we started off with a seemingly simple and sensible equation. But in this short time, I think I have shown it is neither simple nor sensible.

So, where does this leave us? 

I am not sure where it leaves you. But it leaves me with a few conclusions: 

“It's tough to make predictions, especially about the future.” 

― Yogi Berra

1. Currency trading, unlike other asset classes, is primary a sentiment-driven vehicle. Sentiment analysis should be the primary focus of currency analysis. [Tao of Markets]

 And though we should monitor things like yield differential and economic growth and capital flows closely, we should not attempt to forecast that stuff. Let others do all the forecasting. We need only concentrate on two things: 1) the consensus rational and 2) potential for surprise to the consensus rationale.

 “Our success or failure will rest on our ability to anticipate prevailing expectations and not real-world developments.”

                                          George Soros, The Alchemy of Finance

2. If what you are doing (your edge) works for you, then don’t let anyone tell you what you are doing is flawed.

The upshot: Avoid, or at least be very suspect, of those who hold themselves out as experts. Experts, or gurus, have no better handle on what the future will hold than you do.  And most often experts talk and theorize, and have no skin in the game. It is why experts make lots of predictions about the future; there is no downside in a world where the attention span is about a nanosecond, experts bad ideas slide quickly down the memory hole.  But should experts get it right, it becomes a key item on their resume.  To call this is agency problem is masterclass understatement.  

Our guesses about the future have been flat out lousy the last two months; but for the year we are doing okay.  If you would like to see our track record, subscribe to our service, or request a free trial, you can do so at our site.

Thank you.

Jack Crooks
President
Black Swan Capital

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