Staying Flexible

I have been anticipating a bounce in the US dollar index even while expecting the US dollar to trade lower vs. the Yen.

Many have asked why. The answer centers around a dislike of the Euro and British Pound. So before proceeding with thoughts about flexibility, let's stop for a moment and take a look at a few of my reasons to dislike the Euro and the Pound vs. the US dollar.

• German banks are arguably as bad off if not worse than US banks.
• Property bubbles in parts of the Eurozone are worse than in the US, Spain being the primary example.
• The property bubble in the UK is as bad if not worse than the US.
• Anti-dollar sentiment is extreme.
• The Euro has benefited from a huge diversification out of dollars especially from oil producing states. At some point diversification will end.
• There is still a prevailing attitude that the US will enter recession and somehow the Eurozone and UK will avoid that recession. I do not support that view.
• There is a prevailing attitude that Bernanke will keep slashing rates to zero while the ECB will hold the line. I suspect the ECB will start cutting rates and at some point the Fed will pause to consider.
  

However, opinions are opinions and facts are facts. The fact is the Euro rocketed higher, and the fact is I have been surprised by the resolve of Trichet in holding the line at the ECB. Indeed, the willingness of the ECB to hold the line may account for that last blast higher on the Euro. Can the ECB hold out forever? I do not think so, but that is an opinion not fact.

As for Bernanke, here is the key question: Will he pause for more data or will he continue nonstop on a path to ZIRP? Perhaps we have a clue in two dissenting votes at the last FOMC.

Viewpoints vs. Trading Positions

It's one thing to have a viewpoint and it's a second thing to actually trade that viewpoint. Can one have a viewpoint and not trade it? Of course.

I have had no personal stake in currencies for a long time. I seldom trade currencies even though I frequently have a viewpoint about them.

Sitka Pacific Capital Management, the firm I represent, does trade currencies (in a small portion of one particular strategy). Recently we were long the Yen vs. the US dollar and did very well with the trade. But that position was closed and as of March 19 we went long the US dollar index via UUP. Here is a chart of the US$ index to consider.

US Dollar Daily Chart



click on chart for sharper image

Inquiring minds may be asking "Was there any reason to buy that second circled area above vs. the first?" The answer is yes, there was a reason. The reason has to do with intermarket analysis of gold, the Euro, and the dollar. Let's start with a chart of the Euro.

$XEU Euro Daily



click on chart for sharper image

Given that the Euro is by far the largest component of the US$ index at 57.6% it does not make a lot of sense to go long the US$ index until it looks like the Euro is headed lower vs. the dollar.

I circled a trendline break above, but there were three prior trendline breaks in the channel drawn, so what makes this the correct one?

Gold Confirmation Context



click on chart for sharper image

Heading into the end of 2007, the triangle continuation pattern in the above chart suggested gold would break up, and if it did, the Euro channel would likely resolve to the upside.

In contrast, Sitka Pacific's long US$ trade was initiated on a break in the Euro confirmed by a break in gold.

However, we anticipated the break in gold first, and in fact exited gold (GLD) positions near $980 on the way up, not on the way down..

Why?

• Sentiment in gold seemed to be hitting extremes.
• Seasonality
  

The latter was a key factor. Gold tends to peak in a January-February timeframe. The seasonal peak season is usually August through January or February. In this case it ran through mid-March. However, with gold at or near $1000, and with favorable seasonality expected to end anytime, the risk-reward scenario simply did not look good to us, and the Euro looked extended.

If there was further upside in gold, we figured a retest would let us back in at this level. And on the break of the Euro, with gold confirming, we went long the US dollar thankful of not having to do two things at once.

Bear in mind that Sitka has four trading strategies we offer to clients and although none of our strategies holds a position in physical gold or silver (or gold or silver ETFs), one strategy still remains with a long position in mining stocks. The strategy with a position in miners is a commodities related strategy. Clients in that strategy are aware it is for long term positioning and/or part of an overall asset management strategy.

Within our commodities strategy, our physical gold and silver positions were eliminated and we may (or may not) lighten miner positions as well.

As far as energy goes, many of our strategies lightened up or eliminated energy plays in the same timeframe we went exited gold and went long the dollar. For now, it is important to note these plays are likely to be intermediate corrective positions as opposed to long term positions.

Reader Questions On Gold And Silver

On a daily basis I receive many emails on gold and silver. The influx of such emails inevitably increases after a big pullback like we have just seen. The typical email is something like this: "Should I exit now?"

I usually respond with my position that gold is likely to do well in extremes (deflation or hyperinflation), that gold is money, that gold may experience a significant correction, that perhaps we are in that correction now, and perhaps that correction will go on longer than most think.

To answer the question properly however, one needs to know and understand additional factors such as: A person's timeframe (short, intermediate, long), an individual's tolerance for risk, the person's rationale for the trade, when one got in the trade, how big one got in the trade, leverage if any, whether or not that investment in gold was part of an overall strategy, whether that overall strategy was carefully thought out, and whether or not one has the mental fortitude to stay with a long term thesis even if the individual's timeframe is long.

Seemingly simple questions can thus be complex and working with clients on those factors is part of our overall service at Sitka Pacific.

A Time To Go Long Equities?

To everything, turn turn turn, there is a season...

After being market neutral in our "Hedged Growth" strategy and extremely high in cash in our "Absolute Return Strategy" since last summer (click here for strategy details), we have now gone net long. This positioning may or may not last.

Did we dive off the deep end?

No, not really. We are not long mortgages, junk bonds, credit swaps, derivatives, or the typical momentum plays. Furthermore, should the S&P double bottom break, we will may change our tune quickly, without notice. In the meantime here is the type of value play we are increasing exposure on. Are you ready?

Wal-Mart (WMT) Weekly Chart



click on chart for sharper image

WMT’s 9-year technical consolidation may be ending. Sitka Pacific went long on the trendline break. Fundamentally, Wal-Mart is at 1999 prices even though earnings are substantially higher and international growth is picking up. A negative factor is Wal-Mart has plenty of debt, but that debt seems serviceable based on cash flow. We like Wal-Mart (for the time being anyway) as a value play.

What's In and What's Out?

• Gold and Silver are out.
• Energy is out.
• A bounce in equities with a concentration on value plays is in.
• A bounce in the US dollar is in.

That is how Sitka Pacific is playing the current setup as of mid to late last week.

We are willing to change our mind quickly if wrong, and without notice. Flexibility is now more crucial than ever.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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