The C$ drop alters the investing landscape dramatically. The 25% plunge in the loonie since November, 2007 makes foreign diversification less appealing, exporters more attractive and inflationary pressures greater. How so?

Today’s commentary concerns the last carry trade left in the markets, i.e. gold.  Gold peaked at $1032 in March this year; however, since then it has fallen steadily, trading as low as $734.  While this fall has been in line with a rising USD dollar, it has also been orchestrated. 

Gold has been falling in an environment of rising inflation and rising uncertainty, and I've spoken in the past about gold de-coupling from the USD correlation one day.

It’s all falling apart. The world fears the global financial system is on the verge of collapse and a long drawn out recession could be in our future. It’s going to be a long one and the commodity bull has been stopped in its tracks.

Oil, coal, uranium, copper, nickel, and other base metals are steadily declining in price almost every day. It seems like there is almost no let up in the selling at times.

Panic and risk avoidance continues to dominate the investing landscape on Friday, resulting in the zigzag rollercoaster ride in the markets. The Dow has been losing blood again, despite repeated calls of a market bottom by market analysts and bloggers. The S&P 500 index is posting its biggest ever weekly decline this week. In this climate of high uncertainty, no one really knows anything better than another. People are saying the market should be in a bottom anytime soon, or even now.. Even in a bear market, prices don’t really dive down in a straight line, but make a series of lower highs and lower lows, so not having done that indicates a high level of fear among investors. The fear gauge - VIX 9(^VIX, the volatility index)0 - has shot up to another record high in intraday trading Friday.

Adding to this widespread fear is the realization that rules are constantly changing in the stock trading game. Remember the short-selling ban, which was recently imposed then lifted? Well, that may be reinstated again, but under different circumstances. On Friday afternoon, it was reported that NYSE and NASDAQ are seeking a 3-day ban on short-selling of individual stocks should they fall 20% from the prior day.

For the first time since March 2003, the Dow Jones Industrial Average broke 8000 at the open of the US markets. However just as quickly as stocks dropped 600 points, it recovered more than half of its losses in the first 15 minutes of trading and actually moved into positive territory 35 minutes into the trading session. The capitulation followed by the major short squeeze suggests that we may have seen a near term bottom. This type of volatility drove the VIX index to a record high of 70.

Currency Traders Waiting for the Buying Opportunity

Interestingly enough, we have not seen much of a reaction in the currency market. This suggests that the capitulation is only in stocks and traders are waiting for the bounce to get in. The day is early so many things can change and equities could sell off again, but for the time being, it appears that the buyers of EUR/USD, GBP/USD and USD/JPY are sitting on the sidelines waiting to get in. If stocks start bottoming out, carry trades could actually bounce today. No one will want to be short carry ahead of the G7 and G20 meeting this weekend – we expect a bounce.

Another day, another plan from the US government that failed to impress the markets.

Thursday morning, the Treasury said that they will be injecting capital directly into banks by taking an equity stake. In theory, this announcement should give banks the peace of mind to start lending as a direct capital injection from the US government should reduce the risk of counterparty failure. More specifically, Bank A would be less worried about Bank B running out of money to meet their daily obligations which would hopefully make Bank A more willing to lend to Bank B.

If you would have told the "economists/analysts" on CNBC or Bloomberg six months ago that the next interest rate move by the Fed would be down, you would have most likely been laughed at. You see, market capitulation in any market is often relative. For many, just when you feel comfortable with a trading range, or trend, it changes. When we slashed rates down to 2%, many individuals (even the doves), said that's more than enough.

A couple bank failures, takeovers, bankruptcies, and bail out later and the markets were screaming for a rate cut. This time it was a cry for a globally coordinated cut, and that's what markets got. It happened to be to the tune of a 50 BP move by the Fed, ECB, BoE, BoC, and the Swedish Riksbank.

Faced with an imminent financial meltdown and a looming depression, one might have expected Congress, inspired with a rush of patriotism, to have stepped vigorously to the plate to pass Paulson's rescue package without delay.

Instead, Congress delayed, causing increased market panic before eventually doing the deed. But, in doing so, they had the nerve to demand their own 'commission' of over $100 billion dollars of 'pork barrel' add-ons, or over 15 percent of the total package. These extras will simply be added to the tab charged to the American taxpayer! So much for the end of ear-marks.

We all know and heard of the tired analogy “don’t try to catch a falling knife” to describe the temptation of jumping into a declining market. There are certainly too many analysts or money managers that have been completely eviscerated and butchered by calling the bottom prematurely in the financials and housing market since fall of 2007. Don’t like playing with knives? Here’s a better analogy to use instead of the requisite kitchen cutlery.

Remember when you were a kid and your smart-ass uncle would wave a dollar in front of you and say: “If you can catch the dollar as it falls between your fingers, it’s yours.”

At no time over the past two years has any mention been made of inflation pressures reducing, and up until just last week we have heard that inflation pressures are still at the fore of central bankers' minds. The Bank of England, the ECB, the Swiss National Bank, the Federal Reserve, and the Reserve Bank of Australia, have all stated that inflation has held them back for looking at any kind of rate adjustments. We have been told, and can see in what we pay each day at the check-outs, that inflation really is an issue, and in a low interest rate environment we will now see inflation strip further the gap between 4-5% inflation, and 1.5% interest rates.

The 3% gap in the U.S., and the 1-2% gap regionally, between interest and inflation rates have been ignored in the rate cuts on Wednesday, but make no mistake that these cuts will be reversed as quickly as possible in an effort to maintain price stability. The ECB, for example, have hung their hat on higher inflation rates, forcing them to hold rates higher and right now, will need to see a dramatic return on their gamble to cut. That pay-back will come in the form of equity markets moving higher, confidence returning, and consumers re-setting their budgets on the back of a floor being put in on their investment portfolios, and house values.

In a July 24, 2008 article, Commodity Breakdowns Warrant Defensive Action, I wrote the following based on the ugly look of the chart of financial stocks (XLF):

"While financial stocks have hit a violent intermediate bottom and could rally for a while longer the odds favor lower lows in the months ahead as housing prices continue to decline. The chart below illustrates the structural nature of the problems facing the housing and financial industry. There are fundamental reasons financial stocks have been hit so hard, reasons which go way beyond short selling. Additional bank failures in the coming months would not come as a surprise, which is supported by the rapid deterioration of the sector. Since our economy has become so dependent on the availability and use of credit, these problems will continue to impact U.S. and global growth."

The stream of news regarding bailout plans and credit markets remains endless, and market gyrations are still continuing, albeit to a much smaller extent. Today (Thursday) is one rare day this week whereby price swings are not that wild, and traders and investors actually have some time to digest all the humongous moves in the stock and forex markets, and to consolidate their fears.

Yesterday central banks around the world, including the Fed, issued a joint statement regarding the cutting of benchmark interest rates in their respective countries - an unprecedented, never-before move.

The two main valuations of a currency pair are regional Forward Growth prospects and Interest Rate outlooks, and both, right now, are in turmoil as central banks look to correct the crisis of confidence. The fact that most regions cut rates at the same time will negate the interest rate side of a currency pair valuation in the near-term, and therefore it is left to forward growth prospects to pick up the slack.

That leads to the U.S. economy maybe coming out on top, and to the fact that it seems to be ready to do whatever it takes to instill confidence, and at any cost. That may lead to the dollar getting bought in the near-term; the fact that the economy is in a poor condition may be negated by the fact that that the other regions are entering a phase of unknowns, and the markets do not work well with unknown situations.

The latest downward spiral in the global commodity and stock markets, coinciding with several high profile bank failures, is conjuring up fears of the calamities of the Great Depression of the 1930s. European and Asian stock markets are plunging as terror and panic hits Wall Street. The US Congress finally passed a massive $700 billion rescue package to unclog the credit markets, yet US stock markets have continued to plummet, shedding $1.5-trillion in value last week. 

Hindsight is the best sight, but the chaos gripping the markets started with US Treasury’s reckless decision to allow Lehman Brothers to fail, which set-off an unstoppable chain reaction that unleashed a torrent of panic selling on global stock markets, and froze the European and US banking systems. LEH left its creditors holding $150 billion of near worthless bonds, and common and preferred shareholders were completely wiped out. “Until the day they put me in the ground I will wonder, why we were the only one that was not rescued,” former Lehman chief Dick Fuld told Congress on Oct 7th.  

We have been literally begging the Federal Reserve, the European Central Bank and the Bank of England to work together to stem the bleed in equities, and they have finally done it (What is the Fed Waiting For? And Panic Selling in FX Begs Coordinated Easing). For the first time since Sept 2001, central banks around the world have delivered a coordinated interest rate cut. Coming 2 days before the G7 meeting and 1 day before the BoE interest rate decision, their move sends a strong message to market that the central banks are holding nothing back in their attempt to unlock the credit markets, stabilize the stock market and stimulate growth.

Given that the Bank of Japan stood aside, the move is bearish for USD/JPY. However the impact on the Euro and British pound is limited because the interest rate differentials between those currencies and the US dollar remain unchanged. "Unprecedented" is the buzzword in the financial markets these days, and today’s rate cuts were nothing short of that.

Before the US stock markets opened Tuesday morning, the Federal Reserve announced a plan to buy commercial paper directly from issuers in yet another attempt to unfreeze the credit markets. Although this led to a rally in US stocks, USD/JPY and other carry trades, the rally was short-lived. Having been up as much as 165 points intraday, the Dow Jones Industrial Average ended the US trading session down 508 points.

For the Federal Reserve and the US economy, the new commercial paper funding facility is a step in the right direction because it lends directly to business sector. However what the Fed ceases to realize is that the lack of liquidity comes from the lack of confidence and so far, their approaches have been too conservative to warrant a recovery in confidence. We have been calling for coordinated easing by central banks around the world, but the Reserve Bank of Australia has now raised the bar by cutting interest rates 100bp. In response to the turn in equity markets, Fed Chairman Ben Bernanke has finally buckled when he said that the Federal Reserve is ready to cut interest rates. Unfortunately a quarter point rate cut at this point is not enough, especially when compared to Australia’s full percentage point cut. If the Fed had surprised the markets with a 25bp rate cut last week after the House’s approval of the bailout plan, that one-two punch to the credit crisis may have done the trick, but now the Fed needs to do more if they want to put an end to the hemorrhaging that we have seen across the financial markets.

On Monday,  I opined on the Fed’s hesitation to cut rates when such a call should be a slam dunk. Why not step forward with the intermeeting cut?

Could the Fed possibly have given up hope on rate cuts, and instead intend to focus on other policy measures? Fed Chairman Ben Bernanke yesterday made clear that given the deterioration in the real economy, a rate cut was on the table:

Lots of chatter in various circles, including my weekend comments, that we could see the banking crisis in the U.S. and Europe mutate into a currency crisis in Europe. It is not an idle question to wonder what it might take to break -- or maintain -- the Euro if stresses continue given massive bank bailouts, comprehensive deposit supports, etc.

Here is Wolfgang Munchau in the FT:

The Euro has been falling recently versus the Dollar.  Why?  There have been many theories proposed, but I want to offer my own theory this evening.  Fiat currencies are political creatures, and are only as strong as the political entity issuing the fiat currency (fiat — it’s currency because we say that it is).

The intersection of politics and economics is tricky.  Currencies, and confidence in currencies are ephemeral.  I look at the Eurozone and ask a simple question: Who stands behind the Euro?  Who will lay out tax revenues to support it in a crisis?  Who will be the lender of last resort?