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  • Don't Ignore Iran Looming on Horizon
          While the market vigorously debates the prospects of a V-shaped recovery and the proper valuation of the S&P 500, a serious material issue is developing in the Middle East. Investors need to be acutely aware of the developments in Iran as it threatens to become one of the most serious international political crises since WWII. This summer's stolen election has allowed the hardliners, led by President Ahmadinejad, to publicly and privately strong-arm their reformist opponents. Recently, there has even been rumors of the impending arrest of one of the reformist candidates from this summer, Mehdi Karroubi. The old man, Ayatollah Khamanei, seems firmly behind the provocative foreign policy pursued by the regime and there has been zero reluctance to use the conservative Basij militia and Revolutionary Guards to crush any public dissent. Some optimists see the seeds being sown of a liberal democratic Iran in the future. While this may eventually turn out to be the case, recent developments suggest that the conservatives are using this time to strengthen their hold on power.

         This suppression of dissent is allowing the regime to freely pursue its goal of developing a nuclear weapon and building a military threat to Israel. I personally do not believe that Ahmadinejad is a deranged religious fanatic seeking to annihilate Israel; he is simply a rational strategist seeking to increase his nation's ability to project power. Unfortunately, there is a very low probability that he can accomplish this without Israeli preemption. Prime Minister Netanyahu will be firm in maintaining the military option and as the clock runs down, the probability of an Israeli attack will skyrocket. Experts say such a strike may occur within the year. There is no possibility the Israelis will allow themselves to be deterred by another Middle Eastern state with a nuclear weapon. Surgical strikes by the Israelis against the Syrian nuclear facility (actually believed to be a proxy facility for the Iranians) last year and the 1981 strike on Iraq's nuclear Osiraq nuclear facility were successes. These nations were not prepared to engage the military might of Israel in response. Yet the situation is markedly different with Iran. President Ahmadinejad has built his political career on denouncing and threatening the “Zionist colony”: he would lose a great deal of legitimacy if he were to back down. The Iranian military would respond forcefully to an Israeli preemption and the fallout would be disastrous with the U.S./Iraq/Saudi Arabia caught in the middle.

         The decision by the Iranian leadership to build “10 new enrichment facilities, buried under the mountains” should be seen as a flashing red warning signal that the regime will not back down from their escalations. Naively, the Obama Administration is quoted today as saying that “the door is not shut” on the recently offered compromise for the Iranians to ship their uranium to Russia for further enrichment for a medicinal reactor. The US appears softer than ever in the face of Iran's repeated rejection of this offer and its continued escalations. It is clear to everyone, especially the ever suspicious Israelis, that Iran's intentions are to build a bomb in the near future. Exhibit A: there is absolutely no reason for the Iranians, who sit on oil supplies that can last hundreds of years, to be putting billions of dollars into building a civilian nuclear energy programme. This is not to mention that Iran's hiding of the Qom facility makes it clear that they were up to something they didn't want anyone in the West to know about. Finally, the FT is reporting that the Iranian cabinet will debate whether to enrich their uranium to 20% (3-5% is the normal civilian level of enrichment) at their next meeting.

         Unfortunately, the exit door on this brewing crisis is rapidly closing. The U.S. has shown zero success with its engagement policy and Russia/China remain significant barriers to effective multilateral action. Additionally, it increasing seems that the Iranians simply aren't interested in a diplomatic solution. Their attempts to hide the enrichment program seem to indicate they aren't trying to extract concessions. The North Korea solution, uneasy coexistence with a nuclear weapon, is impossible because of the Israelis. If conflict does occur, the economy will suffer massive impacts from what will be an incredible spike in the price of oil. World trade will be jeopardized and Dubai will almost certainly be forced to default by fleeing capital. If the U.S. is drawn in it will require increased deficit spending that will slam the already stretched bond market. The dollar carry trade will unwind, further endangering most of the gains in equities we've seen over the previous year. Double dip could be an understatement.


    Tags: Iran
    Nov 30 9:37 PM | Link | Comment!
  • Historical FX Charts Tell Truth on Dollar
         The overwhelming consensus of the day seems to be that the dollar is destined to suffer drawn out weakness against all major currencies. Try as we might, a good contrarian case for the dollar's long-term salvation is difficult to argue. Despite the extreme crowd that is packed into this trade and the potential for a rapid unwind (Roubinionthatpoint), we are convinced of the decline in relative economic power of the U.S. Additionally, fears of monstrous federal debt and excessive dollar liquidity alleviate fears of the trade overcrowding. One of the most important considerations for forecasting FX trends over the years is the long-term support and resistance levels. A look at the long-term charts for the dollar against other major currencies shows that dollar weakness or strength over the next 5 years may depend on the individual pair. First, lets take a look at the yen in terms of the dollar (credits go to
         First, note the early 1995 high in the yen, which in USDJPY was at 79.75. This high is of major technical import, as any dollar bear scenario would require a penetration of this level. The BoJ and MoF currently seem intent on using whatever policy measures possible to weaken the yen as it approaches this level. While it seems some are predicting a near collapse in the USDJPY (Sumitomo projects that dollar yen reaches 50), Japan maintains significant structural deficiencies.  Japan's debt-to-GDP ratio is significantly higher than the U.S.'s at 197.3% compared to 90.4% in the U.S. in 2010 (OECD estimates). The rise of the Democratic Party of Japan has apparently led to increased concerns about Japan's fiscal position and a steady increase on 5 yr CDS on Japanese government debt. The Telegraph recently published a story entitled: "It is Japan we should be worrying about- not America". All this leaves out the fact that the age demographic problems Japan will encounter over the next 10-20 years will be far more severe than those in the U.S. For all these reasons, we believe that the 1995 high in the yen will not be broken and that we are seeing a bottom in the dollar yen relationship.  
         Next lets take a look at the AUD USD relationship:
    Based on this chart, we believe that the Aussie will continue to show long-term strength against the dollar.  Our thesis is based on the support area around 0.6 which the Aussie has held in '86, '98, and finally in late '08 and earlier this year. Despite the breakdown in 2001-2003, the Aussie recovered to above 0.6 and has rallied sharply from the level this year on strong volume. The fact that Australia has far superior long-term fundamentals (limited demographic issues, 15.4% debt-GDP ratio in '08) and is a commodity-driven economy will help the Aussie gain ground against the dollar over the next few years.  
         Here is an historical chart of the Swiss franc in terms of the dollar:
    There is a clear long-term bullish tint in place here, driven by the trend running along the '85 and '01/'02 lows. Though the franc is overbought and may not break out above the resistance at 1 on its first try, the most likely possibility is a consolidation for a breakout. Switzerland's place as a relatively calm place to park capital amid the swirling currents of change in the forex space, coupled with neutral fundamentals may preserve this uptrend.  
         Finally, we examine a chart of sterling in terms of the dollar:
    Similar to the yen, we believe that dollar weakness against the pound will be muted. The pound has established a fairly clear trading range between 1.4 and 2 since the late '80s. In conjunction with this technical signal, we believe that continued weakness in the British banking system, a structurally weak British housing market, and rising public indebtedness will ensure that the dollar maintains a semblance of strength against the pound.
         It seems clear that the sweepingly broad predictions of the dollar's demise should be treated with caution. Instead, a case specific analysis shows that while some of the commodity based currencies (AUD, CAD) will show increased strength against the dollar (as will the euro most likely), there are plenty of nations which may not be in a position to gain ground in the face of the dollar's retreat. We believe the use of historical forex charts is extremely effective at providing relevant support and resistance levels that can be incorporated into more fundamental arguments.  

    Disclosure: the author does not own a position in the dollar, franc, pound, yen, or Aussie

    Tags: UUP, dollar, yen, euro, CHF, AUD
    Nov 29 1:19 AM | Link | Comment!
  • Eurodollar in Position for Next Breakout
         There are very well defined technical levels appearing in the eurodollar cross over the previous 2 months.  The uptrend is well defined over the previous year, starting with the completion of a double bottom in February '09.  Additionally, since the beginning of June the pair has established a nicely cut uptrend line:

    The 1.500-1.505 area has served as resistance since September, stagnating the seemingly interminable advance of the Euro.  Nevertheless, the 1.4850 level has proved to be powerful support, forcing the eurodollar into a consolidation range which seems to be developing in a bullish fashion.
          Interestingly, while the eurodollar has consolidated, equities have continued to rally to new yearly highs.  Its very possible that the weak dollar-strong US equities correlation may break down at some point in the future as investors begin to realize there is a point at which the U.S. dollar is too weak for a healthy expansion of the economy.  We may be seeing the beginnings of a change in this correlation. The technical levels in the eurodollar are converging during a time of low-volume holiday trade that may potentially mean increased volatility.

    Scenario 1: Eurodollar breaks through 1.505.  There is little question this means continued dollar weakness will proceed.  The only question is how tired the sell off is, considering how crowded the trade is presently.  

    Scenario 2: Eurodollar penetrates the uptrend line.  This is less likely because of the solid consolidation pattern seems to be hugging the 1.5 line, but would most likely only lead to a test of the lower trend line from back from this summer.

    The author does not hold any position in the eurodollar.

    Tags: ERO, Dollar, Euro
    Nov 23 5:55 PM | Link | Comment!
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