Wednesday, October 12, 2011


Elvis sang it in 1962: “Suspicion! Torments my heart. Suspicion… keeps us apart.” His peaceful relationship was being torn apart by his suspicion that his woman was not, in fact, what she appeared to be. The investment world is a little like Elvis’ love life… things may not always be what they appear to be. In the investment world it pays (literally) to be suspicious.
Case in point: on September 1, 2011, the US dollar made an important show of strength. Market technicians would say the US dollar broke above a down trend line. On the same day, the Euro broke below an up trend line. Those were important events. I know that we are supposed to believe that western currencies trade in a free market, but I am suspicious that there is something hidden. Things may not be what they appear to be. I suspect there is another bank crisis looming – a crisis like the 2008/9 sub prime mortgage bank crisis. Only this time the culprits are the European nations of Portugal, Italy, Ireland, Greece and Spain. These so-called PIIGS of Europe are having difficulty paying their debts and are facing the usual consequences: bail outs, higher interest rates and credit downgrades. All this is old news. But September 1, 2011 marked a suspicious event in the currency world. It triggered a short term rise in the US dollar and a short term fall in the Euro. Something’s not right here.
In my investment book Beyond the Bull, I explain that in the financial world, everything is connected to everything else. This is how foreign exchange is connected to the European banking system:
European banks are highly leveraged. For every Euro of capital a bank has, it can create over 25 Euros of debt. By way of comparison, conservative Canadian banks can create less than 20 CDN dollars of debt for every CDN dollar of capital. The strange part is that the European banks hold most of their capital in US dollar denominated investments, even though the majority of their loans are in Euros. You can see how troublesome it is for them when the US dollar is weak and the Euro is strong. It really puts the squeeze on the European banking system. Their capital base drops in value because it is mostly US dollars. When the US dollar is weak, the European banks could have to start calling in their loans… for every one Euro their capital shrinks, theoretically, they’ll have to call 25 Euros of loans. That’s what went wrong in 2008/9. And one of the ways that crisis was handled was by strengthening the US dollar. In the three months from August to November 2008, the US dollar rose 20%. That means the European banks’ reserves would have risen by almost 20%. This currency driven increase in European bank reserves contributed to the saving of the banking system. My suspicion is that the September 2011 up surge of the US dollar and down surge of the Euro was a deliberate manipulation of the currencies. The G-8 nations have started to move the US dollar up and the Euro down because there is another bank crisis brewing.
Let us not be like Elvis; his suspicion was a curse that was ruining his love life. Let our suspicion be a blessing that will enhance our financial lives. Like Elvis, we don’t know what’s going on behind the scenes. But, unlike The King of Rock and Roll, we can use our suspicion in a constructive way.
In 2008, many of us were caught off guard – we were not suspicious enough. But not this time. Let the September 2011 up surge of the US dollar and the down surge of the Euro be a warning for us. Let us mentally prepare for a possible down-jolt in the stock market. Let us review our plan “B.”
In my investment book, Beyond the Bull, I encourage people to develop their own investment techniques. At my investment firm, CastleMoore Inc, we have preplanned investment techniques. We are ready for a crisis. Here are the essential ingredients for a good plan B: (1) observe the financial world, looking for something specific, (2) when you objectively observe that “something specific,” act in a pre-planned way. In this case, we see the sudden rise of the US dollar and simultaneous decline of the Euro. By the process of logic combined with suspicion, we recognize the increased risk in the stock market and the possibility of a 2008/9 style decline. In fact, the stock market sell-off of August of 2011 might have been the beginning of such a decline. What specific financial event can we look for that will be our signal to sell? And what will we do when we see it? What’s our plan B?
The world of finance is so much simpler than Elvis’ world of love and relationships. A financial plan B is just a matter of good business practice. What would Elvis have done if he found his woman with another man? For Elvis, plan B involved mending a broken heart. For us, a financial plan B means avoiding a broken heart.

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1 comment:

chrispycrunch said...

Great write-up Ken. Keep it up!