Long Euro Is The Ultimate Contrarian Trade

May.30.12 | About: CurrencyShares Euro (FXE)

Okay, maybe not the ultimate contrarian trade; I would say that honor belongs to uranium (NYSEARCA:URA) and nuclear power (NASDAQ:NUCL). But certainly, the idea of going long the Euro is very unpopular -- something that should get the attention of contrarians. In this post we'll take a look at some reasons why it might be an idea worth pursuing.

Here are the three basic reasons:

1. What's the Euro Worth Without the Weak Hands? A common subject when it comes to the Euro is whether or not Greek, and other similar countries in the Eurozone that face an insurmountable debt crisis, will end up leaving the Euro and returning to their own nation-state currencies. Personally, I don't foresee this happening; I agree with The Epoch Times in that a return to the drachma increases the chances of a currency devaluation so strong that it would be more painful than the austerity measures the Eurozone via Germany seeks to impose. Think about it: would you feel comfortable putting your money in drachma?

But let's say Greece leaves the Eurozone. In that case, what is the Euro worth without the burden of Greece's stagnant, debt-ridden economy? I believe it is worth more than if Greece were to stay in the Eurozone. So for those who believe Greece and others will exit the Euro, I think it is worth considering that this situation could ultimately be bullish for the Euro.

2. COT Report Shows Extreme Short Position. This article from SeekingAlpha contributor Ralph Shell notes that the latest COT Report showed speculative bears have increased their position to 219,642 short contracts -- a recent record. Eventually, these shorts are going to have to cover. And what happens when they do? A massive rally. With short positions at extreme, record levels, I think a case can be made that covering is imminent.

3. It's All Relative. The case for a stronger Euro is not so much about anything positive about the Euro; rather it is about how weak the US dollar is. The US still has more debt than the Eurozone and UK combined. I believe debt is the real driver of currency values in our current times; economies that are saddled with more debt ultimately have more room to fall. The rationale here is simple: all these countries are insolvent and so the more debt they have and continue to acquire, the more they will need to print money to pay off their debts -- which means the more they will need to devalue their currency. In light of how much debt the US economy has and continues to acquire via record budget deficits, I think it is only a matter of time before the US debt problem becomes the focal point.

I should note that I've held this view for some time, and I did not expect the Euro/US dollar exchange rate to fall below 1.28 let alone 1.25. Still, though, I consider a move to 1.60 and beyond as far more likely than a move to parity. The magnitude of the US debt problem should not be ignored, nor should the impact of the reversal that will occur when Euro shorts begin to cover their position.

I prefer to do all my currency trading via forex brokers in the forex market, although those who prefer to utilize ETFs may be interested in (NYSEARCA:FXE) -- the ETF tracking the value of the Euro. And while I think the Euro is oversold, I favor other opportunities in the currency market, namely the Canadian dollar (NYSEARCA:FXC) and the Australian dollar (NYSEARCA:FXA), as I believe they have significantly better fundamentals than the Euro.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.