Strategies, analysis, and news for FX traders

September 2011 Volume 8, No. 9

The SNB vs. Improving trend signals the Swiss Franc rally: with the Parabolic Time Can the bank stem the tide? Indicator p. 6 p. 22 The gold bubble and the dollar p. 12

Understanding the Canada-Aussie cross p. 28

Contributors .................................................4 Global Markets Swiss National Bank battles the trend ......6
Switzerland’s central bank finally took off the gloves to battle its skyrocketing currency. Has it put the rally down for the count, or are there a few more rounds to go? By Currency Trader Staff

Global Economic Calendar ........................ 32
Important dates for currency traders.

Events .......................................................32
Conferences, seminars, and other events.

Currency Futures Snapshot ................ 33 . International Markets ............................ 34
N umbers from the global forex, stock, and interest-rate markets.

On the Money Is the price of gold irrationally high? ..... 12
Analysis of other bubbles raises questions about gold’s ability to sustain its hyperbolic run. By Barbara Rockefeller

Spot Check Dollar/Swiss.............................................. 20
The August reversal in the USD/CHF pair was truly a unique event, but extrapolating from its characteristics provides some perspective on the market’s trajectory. By Currency Trader Staff

Looking for an advertiser?
Click on the company name for a direct link to the ad in this month’s issue. Ablesys eSignal FXCM Nadex Price Futures Group

Trading Strategies Filtering trend signals with the Parabolic Time Indicator .......................................... 22
An indicator that analyzes the duration of price moves proves to be a useful filter for the parabolic system By Daniel Fernandez

Advanced Concepts The Canada-Australia cross rate ............ 28
Combining these two trending currencies results in a trending cross rate whose returns are directly linked to expected interest-rate differentials and relative asset returns. By Howard L. Simons

Questions or comments?

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September 2011 • CURRENCY TRADER

q Howard Simons is president of Rosewood Trading Inc. and a strategist for Bianco Research. He writes and speaks frequently on a wide range of economic and financial market issues.
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Editor-in-chief: Mark Etzkorn Managing editor: Molly Goad Contributing editor: Howard Simons

q Barbara Rockefeller ( is an international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies, Second Edition (Wiley, 2011), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and How to Invest Internationally, published in Japan in 1999. A book tentatively titled How to Trade FX is in the works. Rockefeller is on the board of directors of a large European hedge fund. q Daniel Fernandez is an active trader with a strong interest in calculus, statistics, and economics who has been focusing on the analysis of forex trading strategies, particularly algorithmic trading and the mathematical evaluation of long-term system profitability. For the past two years he has published his research and opinions on his blog “Reviewing Everything Forex,” which also includes reviews of commercial and free trading systems and general interest articles on forex trading ( Fernandez is a graduate of the National University of Colombia, where he majored in chemistry, concentrating in computational chemistry. He can be reached at

Contributing writers: Barbara Rockefeller, Daniel Fernandez Marc Chandler, Chris Peters Editorial assistant and webmaster: Kesha Green

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Volume 8, Issue 9. Currency Trader is published monthly by TechInfo, Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright © 2011 TechInfo, Inc. All rights reserved. Information in this publication may not be stored or reproduced in any form without written permission from the publisher. The information in Currency Trader magazine is intended for educational purposes only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Trading and investing carry a high level of risk. Past performance does not guarantee future results.


September 2011 • CURRENCY TRADER

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Swiss National Bank battles the trend
Switzerland’s central bank finally took off the gloves to battle its skyrocketing currency. Has it put the rally down for the count, or are there a few more rounds to go?

Conventional market wisdom says central banks can’t fight trends, but in this case the Swiss franc might be the exception. Since early August the massive flight-to-safety bull trend in the Swiss franc vs. the U.S. dollar and the Euro has reversed (Figure 1). The sharp “V” bottom reversal evident on both daily charts has some market watchers saying the dollar/Swiss and Euro/Swiss pairs have established significant lows. In gauging what might be ahead for the Swiss currency,

let’s look at what’s been behind the massive Swiss franc appreciation that has unfolded throughout much of 2011 and what the Swiss National Bank (SNB) did to spark the recent bounce.

First, the Swiss economy is export-driven, which means the 20-percent appreciation in the Swiss franc vs. the greenback over the past 12 months negatively impacted the country’s manufacturing and export sector. “Currency appreciation FIGURE 1: SIGNIFICANT REVERSAL? makes your goods look more expensive,” says David Vermeire, economist at Moody’s Analytics. Recent economic data has, in fact, revealed an overall slowing trend. “Growth in the second quarter slowed,” says Jay Bryson, global economist at Wells Fargo, noting that Switzerland’s Q1 GDP came in at 2.6 percent, compared to 2.9 percent in Q4 2010. Purchasing manager’s data revealed manufacturing has contracted. According to Bryson, the PMI (Purchasing Manager’s Index, a gauge of manufacturing growth) stood at 59 as recently as March 2011. In June it was at 53.4, and at 53.5 in July. “Based on the PMI, I would expect The reversal evident on both charts has some market watchers saying the USD/ to see some slowing in second quarter CHF and EUR/CHF pairs have established significant bottoms. GDP as well,” Bryson adds. “The marSource for all charts: TradeStation ket is expecting a 2.3-percent reading
September 2011 • CURRENCY TRADER

Swiss economics


for the second quarter.” vs. the U.S. dollar, while it rose 5.5 percent vs. the Euro — Nomura forecasts 2011 Swiss GDP at 2 percent, 2012 at paring 23 and 17 percent moves, respectively, at the Aug. 1.9 percent, and 2013 at 1.6 percent. Moody’s Analytics 9 bottom in the USD/CHF and EUR/CHF pairs. Citi FX’s predicts a 2-percent GDP pace for 2011 and 2.2-percent for Anderson offers some perspective on how much volatility 2012. has increased for the Swiss currency in recent months. However, growth forecasts would be revised down if the “In 2005, the Swiss franc traded in a range between 1.53 currency resumes its appreciation trend. “(Forecasts) are at and 1.56, a range of 2.36 percent,” he says. “On Aug. 26 — the mercy of international markets right now,” notes Iesha one session only — it traded in a 2.94-percent range.” Montgomery, associate economist at Northern Trust. There are already signs the franc’s appreciation has Switzerland’s export-driven economy is especially vulimpacted exports and growth prospects. “Expressed in nerable because the country tends to produce so-called Swiss franc terms, exports in June were down almost 11 high-value-added products such as pharmaceuticals, percent year-over-year — that’s a pretty big drop,” Wells machinery and electronics, watches, and precision instruFargo’s Bryson says. “Swiss manufacturers invoice in dolments. lar terms. Let’s say you want to buy a Rolex. That will cost “If Switzerland was a maker of routine goods, they you $5,000. But because the Swiss franc has strengthened would be in deep trouble already,” explains Greg Anderson, director of FX strategy at Citi FX. “But they are a maker of luxury goods — high-end goods — and as a result, they have a little more pricing power and a little fatter margins than, say, some Asian countries.” However some analysts point out the Swiss economy isn’t doing too badly — especially compared to its closest neighbors; the weak link is export-driven currency risk. “We feel the currency strengthening poses a downside risk to the outlook,” Moody’s Analytics’ Vermeire says. “But the (Swiss) economy With Commodity Research Bureau’s is doing quite well. It’s been a strong long range charts, you will see at a performer compared to the Eurozone. glance how long-term trends can create It doesn’t have fiscal problems. profitable trading opportunities. You can (Switzerland) has fairly low unemployplot trendlines for 49 markets on actual ment, and we are seeing continued market performance, rather than market strength for consumer spending.” averages. Get your free copy of this Switzerland’s largest trading partinvaluable trading tool today! ner is Germany, followed by the U.S., Italy, France, and the UK, according to Vermeire. Given their heavy trading with Eurozone countries, the Swiss tend to place a greater importance on the Euro/ Swiss exchange rate (EUR/CHF) than the dollar/Swiss rate (USD/CHF). Futures and options trading involves substantial risk of loss and may not be suitable for everyone. From Jan. 1 through Aug. 30, the Swiss franc gained approximately 12.5 percent

Free charts!

CURRENCY TRADER • September 2011



20 percent over the last year, that is 20 percent less Swiss francs,” Bryson explains. “Exporters are starting to feel it,” Northern Trust’s Montgomery says. “One company asked workers to work an extra two hours per week — for no extra pay — for 18 months. It is starting to affect their competitiveness abroad.” The strengthening currency is also expected to put a dent in the Swiss tourism industry. These currency-driven economic pressures have manifested themselves in the political sphere, as well. “Politicians are feeling pressure from businesses who are seeing their businesses become less profitable,” says

Charles St-Arnaud, FX strategist for Nomura. “The strength of the Swiss franc is destroying the Swiss economy,” says Brian Dolan, chief currency analyst at “Swiss manufacturers are talking about needing to relocate outside of Switzerland if it stays strong. They are already through the fat and into the muscle of the Swiss economy.”

Although the Swiss franc’s story since 1973 is almost exclusively one of appreciation vs. the dollar, the trend has especially accelerated over the past year or so (Figure 2). The dollar/Swiss rate fell from about 1.1700 in June 2010 to .7200 (38 percent) in FIGURE 2: THE LONG APPRECIATION early August 2011. Meanwhile, Euro/ Swiss fell from 1.4500 in May 2010 to 1.0000 (29 percent) in early August. Switzerland, a traditionally neutral country militarily, has always been synonymous with banking and financial secrecy, and the Swiss franc has long been known as a safe-haven currency that attracts funds in times of international tension, or financial uncertainty or upheaval. “It has a long-standing reputation as a safe haven, but it was more attractive to speculators than the yen because the SNB was widely assumed to have given up on intervention — it was seen as impotent,” says Sean Callow, senior currency strategist at Westpac Institutional Bank. “This view has been proven incorrect, but only belatedly, and with interest rates For almost all the floating-rate era, the Swiss franc has gained strength vs. the already around zero the SNB’s policy U.S. dollar. The past year marked one of the sharper downswings in the USD/ choices are limited.” CHF rate. The fact that Switzerland is “a pret-

The bull run


September 2011 • CURRENCY TRADER

ty solid country with good fundamentals” is both a gift and a curse, according to Northern Trust’s Montgomery. “Because of the (good fundamentals), people are buying their currency,” she says. Another factor increasing the attractiveness of Switzerland is its sound fiscal and trade outlook. “In 2010, (the country) saw a 0.4 percent GDP surplus,” Montgomery says. “The 2011 forecast is for a 0.2 percent deficit, but it could swing deficit/surplus.”

Safety play

Amid cascading waves of Eurozone sovereign-debt concerns, U.S. fiscal woes and the recent global equity market sell-off, investors piles cash into the Swiss franc, Japanese yen, and gold, which have all posted impressive gains in recent months. Citi FX’s Anderson says the massive Swiss gains are “primarily (from) risk aversion, and I would blame Eurozone risk aversion as the biggest factor.” Anderson also notes that although both the yen and franc have benefited from safe-haven flows, “unlike the yen, the franc is underpinned by a very strong economy that has outperformed expectations over the past year and a half.” According to Nomura’s St-Arnaud, the massive inflows into the Swiss franc had an extraordinary impact because of the relatively small size of the Swiss economy. “GDP for Switzerland in 2010 was $529 billion in U.S. dollars,” he says. “That compares to the U.S. at 14.5 trillion, France at 2.5 trillion and Germany at 3.3 trillion. [Switzerland] is really small and it doesn’t need a lot of flows to make a big difference in the economy.”

SNB makes a move

Given the anecdotal evidence the increasingly strong franc was adversely impacting Swiss exporters, the Swiss monetary authorities took action in early August. The first step was the move by the SNB on Aug. 3 to cut its target

3-month LIBOR to zero-to-0.25 percent (from zero-to-0.75 percent). In addition to the rate cut, Swiss officials have been “talking the currency down” by threatening intervention or even pegging the currency to the Euro. The peg is considered by many to be a drastic measure unlikely to happen anytime soon, as such a move would require an actual change to the Swiss constitution. “It was a reminder to traders and investors that ‘we (the SNB) have solutions that we can put in place, we are not defenseless,’” says Nomura’s St-Arnaud. The question is whether the SNB will really have teeth if push comes to shove, or if the bank is mostly posturing. “It does look and feel as if the central bank is committed to preventing further Swiss franc strength,”’s Dolan says, citing recent reports that UBS had sent a notice to banks and depositors indicating it might impose a temporary levy on Swiss franc holdings. “It is more likely they will go with capital controls, or restrictions on foreigners holding Swiss francs.” Dolan adds the SNB also has another, more direct, option in its toolbox. “They could impose a tax on foreign deposits — they could cut rates to negative,” he says, noting, however, that for now it looks like the SNB has been successful in shifting safe-haven flows into gold and the yen. Outright SNB intervention also remains an option. But several rounds of intervention in 2009 and 2010 that were ultimately chalked up as a loss make it a less likely solution this time. “The SNB is owned by regional governments, similar to if the U.S. Fed was owned by individual states in the U.S.,” St-Arnaud explains. “It pays a dividend based on profit at the end of the year. Regional governments are concerned about losing that fiscal revenue.”

Market reaction

The Dollar/Swiss and Euro/Swiss pairs bounced dramatically in August in response to the SNB’s various threats.

CURRENCY TRADER • September 2011



The Swiss franc depreciated around 14 percent vs. the Euro between Aug. 9 and Aug. 30 (Figure 3). “We saw more than a 10 percent move in a week,” St-Arnaud says. “It shook up the markets. A lot of investors who were long Swiss franc decided to sell — ‘We’ve had a good ride since April, we’ll take the profits now and leave.’ ” Citi FX’s Anderson says the move may have shaken all the speculative and professional money out of the market, but he also has a warning. “The thing to keep in mind is that Switzerland is a country with, I think, about 9 million people, right next to the Eurozone, which has 338 million people. If (Eurozone investors) are in a panic and want to get their money out of their own currency into a nearby safe haven, it will be very hard to stop that.” In other words, European debt issues remain the wild card in the Swiss scenario. “What they’ve done to date will probably stall further appreciation — if the Euro crisis doesn’t get any worse,” Anderson says. “If it does get

substantially worse, they’ll need to do more. In order for it to be a firm, hard bottom, Eurozone fundamentals need to have bottomed.” Most analysts seem to be leaning toward the August low being a significant, if not necessarily all-time bottom. “Lows are probably in place in the Euro/Swiss and dollar/Swiss,” Westpac’s Callow says. “The most likely next step is engineering negative interest rates so it costs money to hold the franc. A resumption of intervention on Euro/ Swiss is also quite possible. I would expect it to be more of a guerilla-style, keep-the-market-guessing approach, rather than the 2009-10 tactics, which seemed to involve predictable lines in the sand.”

The outlook for the franc is far from clear, but barring a significant derailment of the global economic picture or an exacerbation of the European debt situation, conditions appear to favor continued depreciation in the franc. FIGURE 3: EURO/SWISS “Those who believe the U.S. will not suffer a double-dip recession and that Europe can keep muddling through should be attracted to buying dips in both Euro/Swiss and Dollar/Swiss,” Callow says.’s Dolan offers a similar take and highlights levels to watch in the EUR/CHF pair. “Continue to look to buy Euro/Swiss on dips to the $1.1200-1.1300 area,” he says. “But if it gets below $1.10, that’s an indication of serious financial upheaval in the Eurozone.” Most analysts say the Eurozone sovereign-debt issue is the key to the Swiss franc outlook. If stability emerges in the Eurozone, a firm bottom is probably in place. But another wave of debt crises could send investors The EUR/CHF pair gained more than 13 percent in a week after the SNB took steps to stem the tide of franc appreciation. rushing back into the Swiss franc. y

Watch the sovereign-debt situation


September 2011 • CURRENCY TRADER

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On the Money ON THE MONEY

Is the price of gold irrationally high?
Analysis of other bubbles raises questions about gold’s ability to sustain its hyperbolic run.

The gold price chart looks like a bubble, and we know what happens to bubbles. After a mania bursts, it takes decades for prices to return to their trendline, let alone the previous highs. Bubbles are commonly thought to arise from an excess of emotion and a shortage of clear thinking. In the case of the 1999 Nasdaq bubble, people bought any company with an “e” or a “dot-com” in its name without regard for product, earnings, management, or any other traditional value factor. But in the case of gold, it’s difficult to argue that buyers are irrational. After all, we do have the conditions that could lead to hyperinflation, most prominently excessive

budget deficits. So, is the gold price irrationally high? First let’s look at a classic equity market bubble. Figure 1 shows the Nasdaq from 1980 to the present, with a linear regression line drawn from the beginning of the data to the end of 1998. The linear regression line is extended forward from that point in red, showing the Nasdaq did not get back on trend until 2003, and still has not matched the highest highs from 1999-2000. Now let’s look at a gold chart (Figure 2). The linear regression line is drawn from the beginning of the series in 1995 to the end of 2009, and extended forward in red. If we were to get a crash like the Nasdaq “tech wreck,” we would expect gold to trade at about $1,000 by 2015. Although extending FIGURE 1: NASDAQ BUBBLE linear regression lines is not a widely accepted analytical technique, it’s more than a statistical trick. It graphically displays the wildly abnormal nature of the move and represents the epitome of “overbought.” A move can be abnormal and yet not irrational — consider the Swiss franc (CHF) against the Euro and the dollar so far this year (Figure 3). Here we have the example of an extreme move that is fully explained by the deep desire of some investors for a “safe haven.” Recent dollar/Swiss (USD/CHF) prices are under the linear regression trendline drawn from the beginning of 1999 to the end of 2009, but nothing to set your hair on fire. The Euro/dollar (EUR/CHD), however, had a rising trendline over the same period, making the Euro’s After the tech bubble burst, the Nasdaq did not get back on trend until 2003, and divergence from the regression line’s it still has not matched its 1999-2000 highs. extension even more shocking. Sources for Figures 1-4: Charts— Metastock; data — Reuters and eSignal


September 2011 • CURRENCY TRADER

The other gold bubble

One reason to worry about the current gold bubble is that we’ve experienced a gold bubble in relatively recent history, and it turned out like most other bubbles: horrible losses for those who failed to exit in time. Gold inflated from $390.80 in November 1979 to a high of $874 (futures basis) less than two months later on Jan. 22, 1980. Gold then proceeded to fall for the next 20 years, reaching the double-bottom lows of $254.10 in July and August 1999 (Figure 4). This incident gave those who wanted to refute the argument that gold is an inflation hedge all the proof they could possibly want. Over those 20 years, inflation rose by more than 100 percent. According to’s calculation, what cost $100 in 1979 would cost $228.69 in 1999. Current gold buyers cite different motivations. Some say they are engaging in asset diversification — and considering the disappointing equity market FIGURE 2: GOLD performance over the past decade, diversification is not a bad idea. If you bought the S&P 500 at its March 2000 high, you were underwater 30 percent by the end of August 2011. Others are buying gold because certain central banks have said they are buying gold. Another reason for interest in gold is the attraction of doing something “outside the box,” although jumping on a bandwagon is not particularly original. However, as with the 1979-1980 gold bubble, fear of inflation is the real motivator of the current gold bubble. And these days we have major governments with debt-to-GDP ratios at or over 100 percent, a ratings downgrade of U.S. debt, and probable default by a member of the EMU (Greece).

of value? The answer lies in whether you believe we are at risk not only of inflation, but hyperinflation, which is defined as an increase in prices of more than 50 percent in a single month. Hyperinflation is actually quite rare, but there have been 28 cases in the 20th century — including Argentina, Brazil, Poland, and several USSR successor states in the past two decades. (A 29th case is France at the time of the French revolution, at a time when the franc was paper money.) The most famous case was the German hyperinflation of the early 1920s, illustrated in Table 1 and Figure 5. The latter graphic, which shows the devaluation of the deutsche mark over a three-year period, is the scariest chart of all time to gold buyers. As a practical matter, hyperinflation causes a true currency crisis. Regular inflation may promote currency depreciation, depending on what else is going on in the BUBBLE

Inflation vs. hyperinflation
Is the sovereign-debt crisis a justification for buying gold as a store

A crash comparable to the Nasdaq’s “tech wreck” would send gold to approximately $1,000 by 2015.

CURRENCY TRADER • September 2011



Barbara Rockefeller Currency Trader Mag Sept 2011 Figure 3: Swiss Franc “Bubble” (EUR/CHF in red and USD/CHF in black)

1.85 1.80 1.75 1.70 1.65 1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65

1.70 1.65 1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 2




















The Swiss franc’s recent behavior vs. the dollar and Euro illustrates that a move can be abnormal but not irrational. (EUR/CHF in red; USD/CHF in black)

900 850 800 750 700 650 600 550 500 450 400 350 300 250 200 150 100 50 0 1969 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200

Barbara Rockefeller Currency Trader Mag Sept 2011 NEW Fig 4: 20-Year Drop from 1980 Bubble

After exploding to the upside in 1979-1980, gold proceeded to fall for the next 20 years — while inflation rose by more than 100 percent.

economy and business cycle, but not a crisis per se. In fact, U.S. inflation is currently at historically low levels, and unless the economy revs up more than anyone now thinks is likely, inflation is likely to remain low for many quarters and perhaps for years to come. Federal Reserve chief Ben Bernanke would not have said rates would remain on hold (at near zero) for another two years if Fed economists had any indication inflation is unlikely to remain not only low, but abnormally low. As a result, although the hyperinflation argument for a dollar crisis is conspicuously absent, many analysts persist in forecasting inflation and perhaps hyperinflation. Why should anyone buy into the scenario in the face of hard evidence to the contrary? There is, unfortunately, a reason. Historically, hyperinflation is caused by excessive government deficits. As illustrated by Swiss economist Peter Bernholz in Monetary Regimes and Inflation (Edward Elgar, 2003), 12 of the 29 cases of hyperinflation since the French Revolution were directly “caused by the financing of huge public deficits through money creation.” How much is “huge?” The historical evidence points to public expenditure that is 40 percent funded by public debt. Deficits don’t always result in hyperinflation and currency depreciation, but all cases of hyperinflation and currency depreciation were preceded by huge public deficits financed by money creation. Be careful to note the difference. Bernholz has stated in interviews the debt he was referring to is money created by a central bank specifically for government spending; it does not refer to debt purchased by foreigners or held by domestic entities that do not resell it to the Fed. In fact, Bernholz estimates that only about 13
September 2011 • CURRENCY TRADER


percent of U.S. government spending is financed by money creation. He sees no danger of hyperinflation in the U.S. For hyperinflation to occur, you need not only excessive public deficits, but also compounding conditions, such as wages keeping pace (or nearly keeping pace) despite rising unemployment. This outcome is usually attributed to the power of labor unions, which in the U.S. today are fairly well de-fanged. Remember, when President Richard Nixon took the dollar off the gold standard in 1971 — a de facto currency devaluation — he also imposed wage and price controls. In fact, the biggest losers from hyperinflation and currency devaluation are the wealthy who receive the bulk of their income from interest and dividends. One of the consequences of hyperinflation is the substitution of another currency for the depreciating one. In the 1980s you could travel to many countries, including Brazil and most of Africa, and never change your dollars for local currency — everyone was happy to take dollars. The substitution of a hard currency for the devaluing local one drives down the supply of local money.

Deficits don’t always result in hyperinflation and currency depreciation, but all cases of hyperinflation were preceded by huge public deficits financed by money creation.

A “barbaric relic”

This raises the intriguing question of what Americans would use to substitute for a falling dollar. Gold doesn’t qualify — it’s not money. The supermarket and phone company wouldn’t know how to account for payment in gold, even if we had gold coins available. Perhaps electronic gold (“e-gold”) will take off and become popular. But until then, the absence of a currency to substitute for dollars poses interesting questions, including how the money supply could contract, as substitution forces it to do under the usual hyperinflation crisis. Clearly it would take central bank action. The conditions Bernholz says are necessary for a monetary regime to recover from hyperinflation and a currency crisis include: an independent central bank; and “absolute limitation of the amount of credit which can be lent by the central bank or other monetary authorities to the governCURRENCY TRADER • September 2011

ment in the future to cover its budget deficit, or the losses of government-owned or subsidized enterprises.” Other necessary fixes include: changing the exchange rate to another, more stable one; obtaining foreign bridging loans; revaluing all private long-term credits at the expense of debtors; and removing all capital and trade controls. Bernholz includes raising the money supply to levels consistent with GDP, but that assumes currency substitution has taken place, which probably is not likely in the U.S. Those who read only a part of Bernholz and fear hyperinflation in the U.S. are failing to note some other issues that don’t apply to the U.S. First, Bernholz is from Switzerland, which has been neutral and managed to avoid war since 1515. Deficit spending for defense and war purposes comes under the same stern opprobrium as any other deficit spending. None of the 29 hyperinflation cases Bernholz studied involved a major geopolitical leader. That doesn’t mean the rules don’t apply to such a country, but it almost certainly means that those under its influence are more willing to hold its debt than pure academic economics would dictate. Japan comes to mind. Japan held $907 billion in U.S. dollars at the end of April 2011. Presumably many other countries that fall under the U.S. defense umbrella (South Korea, Australia, Germany) are motivated to hold dollars, too. All of Bernholz’s 29 cases are drawn from actual hyperinflation and currency crises in countries that were not the issuer of the world’s reserve currency, including Zaire, Armenia, Kyrgyzstan, Zimbabwe, and Azerbaijan. These countries could adopt dollars or Euros or some other currency as their medium of exchange, driving their own devaluing currencies out of business. As already noted, however, there is no readily available substitute currency that would drive the devaluing dollar out of circulation. Many of the rescues of hyperinflated currencies, including the German one in 1923, entailed issuing a new currency. How, exactly, could the U.S. pull that off? It seems institutionally impossible.


Dates Feb. 1920 to May 1921 May 1921 to July 1922 July 1922 to June 1923 July 1923 to Nov. 1923 Internal Prices +4.6% +634.6% +18,094% +854,000,000,000% Price of Dollars -37.2% +692.2% +22,201% +381,700,000,000% Cost of Living* +39.2% +417.9% +13,573% +560,000,000,000%

* Includes only food until June 1923. All data are from The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany by Costantino Bresciani-Turroni (Augustus Kelley). The data were calculated by the Statistical Bureau of the German Reich.

The most famous case of hyperinflation occurred in Germany in the 1920.

Barbara Rockefeller Currency Trader Mag Sept 2011 Figure 6: German Mark under Hyperinflation Source: Wikipedia

The newly minted gold bugs think we need a return to the gold standard. This is unworkable in about a dozen ways. First, a gold standard does not eliminate inflation — or deflation. Money supply is dependent on supplies that can surge and contract with the vagaries of mining discoveries and technology. As Bernholz points out, metallic standards have the biggest resistance to inflation, followed by “a discretionary paper money regime” with an independent central bank. But the discretionary paper money regimes do a far better job of stabilizing GDP, unemployment and real interest rates. FIGURE 5: GERMAN MARK UNDER HYPERINFLATION

Second, there is not enough gold ever mined to fund the U.S. economy, let alone the rest of the world. Only about 166,000 tons of gold have been mined throughout all history, according to the World Gold Council, and of that, governments hold roughly 29,000 tons. All the gold in the world is therefore worth about $7.5 trillion (at $1,500 per Troy ounce). U.S. money supply alone is $8.4 trillion (July 2011) and there is an equal or larger amount outside the U.S. We could not return to the gold standard without a severe contraction in every single economy in the world. A central bank constrained by a gold standard would lose control over internal price stability, employment, and market stability. This is the context in which economist John Maynard Keynes issued one of his most quoted phrases: “When stability of the internal price level and stability of the external exchanges are incompatible, the former is generally preferable.” He added, “There is no escape from a ‘managed’ currency, whether we wish it or not. In truth, the gold standard is already a barbaric relic.” It is important to note that Keynes did not say gold itself is a barbaric relic, but rather the gold standard is a barbaric relic. He was warning that a system dependent on something as undersupplied and subject to market fickleness as gold was inherently unstable.

De Gaulle’s teaching moment
The devaluation of the deutsche mark over this three-year period is a freightening chart for gold buyers.

The gold standard has another problem — and one we have experienced before. Following complaints of a “dollar shortage” in the 1950s and early 1960s, French president Charles de Gaulle in 1965
September 2011 • CURRENCY TRADER


launched an attack on the U.S.’s “exorbitant privilege” of being the reserve currency issuer, a position that provided automatic buyers for U.S. debt and, thus, lower financing costs for its government. In response to this state of affairs, France announced it would convert $300 million into gold; Spain followed with a $60 million conversion. The 1964 trade deficit was about $3 billion and, by mid-1965, U.S. gold reserves had fallen to a 26-year low of $15.1 billion (valued at $35/ounce). De Gaulle was perceived to be playing the “gold card” to get the U.S. to agree to the French proposal for a new international reserve unit of account — the CRU (“collective reserve unit”), which would be gold-backed and give the biggest voting rights to member countries with the most gold. In 1967 de Gaulle withdrew France from the U.S.-led “Gold Pool” (which eventually became the Group of Ten, or G10) established in 1961 to provide emergency intervention funds. (The group was managed by the Bank of England, whose pound shared reserve currency status with the dollar.) The purpose of the Gold Pool was to share the costs of maintaining the price of gold at $35/ounce among several central banks, rather than depleting U.S. gold reserves. However, the willingness of a single member, France, to act in its own interests rather than the collective good led directly to the collapse of Bretton Woods when the dollar had to be taken off the gold standard in August 1971. De Gaulle’s timing was conspicuous in that it forced a crisis when a cyclical economic downswing was occurring. 1967 was a bad year for the two reserve currency countries. The U.S. was inflating a fiscal deficit for its unfunded war in Vietnam, and the UK economy was weakening. Capital outflows from British pounds to U.S. dollars to gold accelerated, with a record 80 tons of gold sold in London in a single five-day period. (The pound was devalued by 14 percent in November 1967 — its first devaluation since 1949.) By the end of the year, U.S. gold reserves had fallen to $12 billion. By March 1968, the Gold Pool had sent nearly 1,000 tons of gold to the Bank of England’s weighing room; the U.S. Air Force delivered emergency supplies of gold from Fort
CURRENCY TRADER • September 2011

All the gold ever mined could not fund the U.S. economy, let alone the rest of the world.

Knox. On March 15, 1968, the U.S. asked for a two-week closing of the London gold market. In April, the Group of Ten gathered in Stockholm, a meeting that gave birth to the Special Drawing Right (SDR). Note that SDR’s were called “paper gold,” but they were never called “money.” SDRs are for the exclusive use of governments — corporations and individuals cannot use them. (For more information about the reserve currency issue, see “The reserve currency dilemma,” Currency Trader, June 2011.) At the time of Bretton Woods in 1944, the gold coverage of the dollar was about 60 percent. By the time the U.S. went off the gold standard in August 1971, gold coverage had fallen to 22 percent. Under the gold standard, the only way the Federal Reserve could expand money supply would be to buy more gold at the expense of other projects, including the interstate highway system, defense initiatives such as SAC, and so on. Abandoning the gold standard was a shock, but on the whole was a healthy development for the global economy, which expanded during the next decade at a far faster pace than before. Finally, in the event of a global banking liquidity crisis, the issuer of the reserve currency has a responsibility to provide cash to all other central banks. According to economic historian Charles P. Kindleberger, the Bank of England’s inability to perform this function in the 1930s (Britain went off the gold standard in 1931) was one of the contributing causes of the Great Depression. During the 2008-09 financial crisis, the Federal Reserve lent to 14 central banks under dollar-swap lines. According to the General Accounting Office’s audit of the Fed released in July 2011, of the $16 trillion lent on a short-term basis, the Fed gave more than $3 trillion to private foreign banks such as Royal Bank of Scotland, Barclays, Deutsche Bank, BNP Paribas, UBS and Credit Suisse. The Fed lent as much as $1 trillion to central banks under the swap lines agreement, just renewed in August for another year. Also, the European Central Bank (ECB) used the agreement for a reported $500 million loan to a so-far unnamed European bank. Why do these banks want dollars? More than 90 percent of cross-border loans are dollar-denominated; the Eurodollar market surpassed the domestic dollar market a

continued ON THE MONEY

few years ago. By December 2008, the Eurodollar market was $9.7 trillion, more than U.S. M2 money supply at the time ($8.054 trillion) even if you subtract the banknote component. And there are more dollar bank notes outside the U.S. than circulate inside the country. In other words, if the U.S. returned to a gold standard, it would have to give up infrastructure projects, defense spending, and social spending to buy gold to fund the banking and commercial activities of foreigners. And in the end, the U.S. would still be vulnerable to a mean-spirited foreign leader like de Gaulle who could demand the gold be shipped to him. You have to ask yourself whether it would be wise to return to a system that has already failed, and failed at the instigation of a single foreign leader.

No turning back

Viewed from this perspective, the gold standard is an overly burdensome price to pay for price stability. No U.S. central banker or treasury official — or politician — entertains the idea because returning to a gold standard would cause a contraction of the U.S. economy to one-tenth of what it is today. Unemployment would soar. The social

and political disruption would be tremendous. William Jennings Bryan’s “cross of gold” speech in 1896 correctly identifies the gold standard as contrary to the interests of workers (while it favors creditors and the rich). Therefore, it is irrational to buy gold on the grounds the U.S. will return to a gold standard, either voluntarily or because it is forced to do so by hyperinflation and a dollar crisis. It is not irrational to buy gold on the basis of its price rise. We know Western investors seek diversification in gold. Various newly rich populations (India, China) are demanding gold, along with several central banks. But it would be irrational to continue to hold gold out of obsession if and when the bubble bursts. When the gold bubble bursts, as all bubbles do — and don’t forget that governments have a vested interest in preventing gold from becoming too big an obsession — the sensible course of action for a smart trader is sell it just like any other security, to lock in a gain or to prevent a further loss. So here’s the only question you need to ask about gold: Where’s your stop-loss? y
For information on the author, see p. 4


September 2011 • CURRENCY TRADER

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The August reversal in the USD/CHF pair was truly a unique event, but extrapolating from its characterics provides some perspecitve on the market’s trajectory.

After nearly a year of relentless appreciation in the Swiss franc, the currency made a sharp turnaround in August in response to steps taken (and threatened) by Switzerland’s central bank to bring the market back to earth (see “Swiss National Bank battles the trend,” p. 6). The U.S. dollar/Swiss franc pair (USD/CHF), which had already ended July at an all-time low monthly close of .7855, tumbled another 10 percent over the next seven trading days to .7064 — a move that has been matched or exceeded only four other times since 1973 (and three of those instances occurred over a three-day span in mid-December 2008 during the financial panic). The pair dropped 6.4 percent intraday on Aug. 9 alone; after a oneday pause on Aug. 10, the market then rallied nearly six

percent on Aug. 11 (Figure 1). By Aug. 29, the pair had rallied approximately 14 percent to around .8200, and appeared poised to break the string of seven consecutive lower monthly lows — a streak that had not been matched since 1992. Finding U.S. dollar/Swiss franc reversal moves as dramatic as the Aug. 8-11 turnaround is an exercise in futility — literally. Using the close-to-close moves from Aug. 8 to 9 and Aug. 10 to 11 (both at least 4 percent in absolute terms) reveals this specific pattern has occurred precisely zero times over the past 40 years; downsizing the required move to 2 percent (a 2-percent close-to-close decline followed two days later by a 2-percent close-to-close rally) produces only 10 previous instances. It is only by reducing the required move to 1.5 percent that an analyzFIGURE 1: ABOUT FACE IN THE DOLLAR/SWISS PAIR able sample size of 29 instances appears (although the relationship of this pattern to the much-larger August 2011 pattern is certainly debatable). Figure 2 shows the dollar/Swiss pair’s median trajectory over the next 40 days, along with the overall performance of the USD/CHF pair (i.e., the median close-to-close changes for all one- to 40-day moves since 1973). The percentage of times the pair closed higher (than the close of the final bar of the pattern) at each interval is also included (lighter blue line, right axis). The bullish postpattern results are in stark contrast to the dollar/Swiss pair’s long-term downward bias, although the odds of a gain are not solidly above 50 percent until approximately day 10. As of The pair dropped 6.4 percent intraday on Aug. 9 then (after a one-day pause) Aug. 30 (13 days after the conclusion rallied nearly 6 percent on Aug. 11. of the pattern), the current up move Source for all: TradeStation had far outstripped the pattern’s
September 2011 • CURRENCY TRADER



median performance — which leaves open the possibility of a near-term correction, even if the slightly longerterm bullish projection shown here remains in place. A related and even longer-term perspective is shown in Figure 3. This chart shows the USD/CHF pair’s oneto 26-week trajectory after a two-week pattern: a 3-percent or larger decline from the close of one week to the next week’s low, followed by a 3-percent or larger rally from the same low to the next week’s high (the conditions in place as of the week ending Aug. 19). Again, these parameters represent a much smaller move than the August 2011 example, but it was necessary to reduce the size of the move to produce the 25 examples represented in Figure 3. The most interesting aspect of this chart (which shows both the median and average post-pattern moves) is that it shows a rally occurring through weeks 6-8, after which the gains trail off — the market’s long-term downward bias reasserts itself. At week 26, the median gain was barely positive and the average was below 1 percent. After 52 weeks, the average and median return was negative (not shown). For Swiss franc traders, the key questions are the extent to which the big August rebound might correct, whether there are more European debt debacles on the horizon, and whether Swiss monetary policies will be sufficient to sustain the reversal. y
CURRENCY TRADER • September 2011

The bullish post-pattern results diverge from the dollar/Swiss pair’s historical downward bias.


Price rallies through weeks 6-8, but the market’s long-term downward bias subsequently reasserts itself.



Filtering trend signals with the Parabolic Time Indicator
An indicator that analyzes the duration of price moves proves to be a useful filter for the parabolic system.

The biggest of weakness of trend-following techniques is their susceptibility to losses during ranging conditions. Almost any trend-detection tool can generate profits when the market is engaged in extended trends, but almost all of them will give back those gains when the market swings back and forth in a trading range or choppy congestion. The Parabolic Stop-and-Reverse (PSaR) system is a trend-following technique developed by Welles Wilder FIGURE 1: SAMPLE SIGNALS

that revolves around his parabolic stop — a trailing stop designed to move closer to prices as time passes. When the parabolic stop level is penetrated, the current position is liquidated, a new trade in the opposite direction is simultaneously established (the “stop-and-reverse” component), and the parabolic stop is then calculated for the new position. (“Calculating the parabolic stop” provides an example of the stop’s calculation.) Although the basic PSaR system is generally good at highlighting the current trend, it tends to get whipsawed by even relatively mild retracements, making it a less-than-ideal component of an algorithmic trading system. If you attempt to trade the PSaR mechanically, you’ll find big gains from sustained trends are often eliminated during trading-range periods when the PSaR repeatedly switches from one side of the market to the other. To address this problem, the following system uses a new indicator designed to filter PSaR signals and allow trades only when the trend identified by the PSaR has a high probability of follow-through.

The PSaR Time Indicator
The strategy always has a position in the direction that meaningful trends are forming, and it exits when the opposite-direction PTI line exceeds the 70th percentile. Source for all: MetaTrader

Analyzing the PSaR shows that when a trend move that is as long as the longest move in the immediate past develops, the move has an increased probability of success until an equally
September 2011 • CURRENCY TRADER October 2010 • CURRENCY


EUR/USD Avg. annual profit Max. drawdown Ann. profit/drawdown Reward/risk Win % Profit factor No. of trades Avg. risk per trade Ulcer Index Spread (pips) 6.62% 16.68% 0.40 1.63 54% 1.9 93 2.31% 5.56 2 AUD/USD 5.42% 18.84% 0.29 1.8 47% 1.58 90 2.27% 7.18 3.5 GBP/USD 2.21% 23.14% 0.10 1.42 44% 1.14 110 2.24% 11.61 3.5 Portfolio 15.88% 34.53% 0.46 1.7 48% 1.58 293 2.27% 15.48 -

long move forms in the opposite direction. We will attempt to capitalize on this with a new indicator, the “PSaR Time Indicator” (PTI), which calculates the percentile rank of the current PSaR cycle length (i.e., the duration of the most recent trend as defined by the PSaR) relative to the longest cycle length of the past 50 periods: a value of 100 means the current cycle is the longest of the past 50 days; a value of 75 means the current cycle is 75 percent of the length of longest cycle of the past 50 days, and so on. The indicator plots separate lines for up-trending and down-trending cycles so only cycles of the same type are compared, as shown in Figure 1. (MetaTrader code for the indicator can be copied from the Currency Trader website by clicking here.)

trade size would be: (0.01*100,000 / (100,000*0.0123)) = 0.81, or $81,000. Figure 1 shows several sample trades from 2009 in the Euro/U.S. dollar pair (EUR/USD). The strategy always has a position open in the direction that meaningful trends seem to be developing; once the opposite-direction PTI line exceeds the 70th percentile, the trade is reversed. The system operates on the basic PSaR premise — following the most recent trend move and always being in the market — but it applies a more robust approach to consider determining what constitutes a viable trend signal.

Testing the system

PTI strategy

The system we will test trades PSaR signals according to the cycle lengths determined by the PTI. The strategy goes long whenever the uptrend PTI exceeds 70 percent and closes a trade when the downtrend PTI value exceeds 70; the rules are reversed for shorts. Like the original PSaR, the new system is always in the market. However, because the system factors cycle length into its trade signals, it ignores many smaller price swings, thus avoiding many of the whipsaw trades that plague the basic PSaR. The system adjusts its position size according to volatility using the 14-day average true range (ATR): Position size = 0.01*(account balance) / (contract size*14-day ATR) For example, assuming a $100,000 account balance, $100,000 contract size, and a 14-day ATR of 0.0123, the
CURRENCY TRADER • September 2011

The strategy was tested on daily data in the British pound/U.S. dollar (GBP/USD), Australian dollar/U.S. dollar (AUD/USD), and Euro/U.S. dollar (EUR/USD) pairs from Jan. 1, 2000, to June 1, 2011. Table 1 summarizes the system’s performance, as well as the trading costs for each currency pair. Generally, the results suggests the strategy works better on currency pairs that tend to produce relatively steady trends (EUR/USD and AUD/USD); performance deteriorates significantly in pairs with much more non-directional volatility (GBP/USD). The overall portfolio results were best in terms of their risk-adjusted return, with an average compounded annual profit to maximum drawdown ratio of 0.46 — outperforming any of the individual currency pairs in this regard. The system’s equity curve was particularly smooth for the most recent five years of the test period, although profits accumulated slowly during the first four years of trading (Figure 2). However, despite its general ability to capture trends, Figure 3 shows 2008 — a year of massive



After generating profits slowly during the first four years of the test, the system’s equity curve trended higher very smoothly during the last five years.

FIGURE 3: 2008

The PTI helped filter out whipsaw trades, but it also resulted in the strategy reacting slowly and taking losses when large trends unfolded quickly, as was the case in 2008.

trends resulting from the financial crisis — was actually only slightly positive (+10.08 percent). Most trendfollowing systems (especially those based on breakout techniques) put up some of their best all-time numbers in 2008. In the case of the PTI, very strong, swift directionality usually catches the system off guard; because of the PTI cycle-duration filter, it takes time for the system to switch direction, which often leads to significant losses during highly volatile periods — the system takes a significant loss before it aligns itself with the new trend. Although the system had five negative years, these were very small compared to the profitable ones: The largest losing year was 13.87 percent and the largest profitable was 74.35 percent. The PTI system also shows the potential to be a good complementary strategy for other trend-following systems, as its best years (2005-2006) were generally the worst ones for many trend-following systems. Was the PTI successful in reducing PSaR losses from whipsaws during ranging markets? Figure 4 shows how the system behaved during a ranging period when the PSaR oscillated strongly between down-trending and up-trending signals. While the unfiltered PSaR would have taken more than 20 positions within this period, the PTI strategy took only four.
September 2011 • CURRENCY TRADER



Relative cycle lengths are particularly small during ranging periods, which inevitably leads to a great reduction in the number of positions. The figure shows the outcome during this period was basically neutral, as positions were entered and closed at a pivotal point (near the center of the range) generated by the PSaR cycle lengths and price action. The strategy also performed quite well when trading ranges developed within larger, longer-term trends (Figure 5). The orange circled positions are losing trades; the green ones are winners. Although in this case the strategy took two losing trades because of the low trigger threshold for down-trending positions (because of the recent prevalence of short down cycles), the system was profitable during both the consolidation and trending phases of the move, successfully gauging market direction, thanks to PSaR cycle length. Overall, the PTI helped reduce losses in ranging conditions and improved upon the original PSaR concept. The values used in testing were not optimized, and thus offer some promise of the strategy’s robustness. Areas for further exploration include introducing separate cyclelength thresholds for entries and exits and applying the strategy to a different currency portfolio. y
For information on the author, see p. 4 CURRENCY TRADER • September 2011

During a period when the PSaR oscillated strongly between down-trending and up-trending signals, the PTI-filtered strategy reduced the number of signals from 20 to four.


The system was profitable during both the consolidation and trending phases of the move.



Calculating the parabolic stop
Early in a trade the parabolic stop is farther away from price and provides some room for countertrend movement. As time passes, it draws progressively closer to prices. For simplicity, the following discussion is given in terms of long trades; the rules are inverted for short trades. The formula for calculating the parabolic stop level (P) for tomorrow’s trading day (when using daily price bars) is: Ptomorrow = Ptoday + AF(EPtrade – Ptoday) Where, Ptoday = today’s parabolic stop value. AF = acceleration factor, which begins at a default value of 0.02 and increases in 0.02 increments for each bar that establishes a new high during the trade, to a maximum of 0.20. The larger the acceleration factor, the more closely the stop trails price. EP = the extreme price since the trade was initiated (highest high if long, lowest low if short). is no parabolic stop level for today. This means the initial stop for the trade (1.2475) must be used as Ptoday in the formula. Plugging in these values results in: Ptomorrow = 1.2475 + .02(1.2580 – 1.2475) = 1.2477 If tomorrow the stock rallies to a new high of 1.2600, this becomes the new EP and the parabolic stop level for the following day would be: Ptomorrow = 1.2477 + .04(1.2600 – 1.2477) = 1.2482 Note that the acceleration factor increased from 0.02 to 0.04, and that the previous day’s parabolic value is now used in the formula. The AF increases by 0.02 only for a bar that establishes a new EP (high price) in the trade. If the pair had not made a new high, the previous high of 1.2580 would have been used as the EP and the AF would have remained at 0.02.

Calculating the value of the PSaR The value of the PSaR is calculated for each bar Assume a long trade was established yesterday in according to the equation PSaR(n+1) = PSaR(n) + a currency pair at a price of 1.2545, with an initial AF*(EP-PSaR(n)) where EP is the highest/lowest stop-loss of 1.2475 that is still in effect today. Today’s point since the last PSaR shifted above or below a high of 1.2580 was higher than yesterday’s high of bar’s close and AF is an acceleration factor which is 1.2560, which means it’s the extreme price (EP in usually 0.02 and increases with each PSaR calculathe formula) since the trade began. The calculations tion (before a shift) to a maximum value which is for tomorrow’s parabolic stop level are: generally chosen as 0.2. Whenever there is a switch of the PSaR from above to below price or vice versa Ptomorrow = Ptoday + AF(Htoday – Ptoday) the value of the PSaR for the new cycle is either the EP value for the previous cycle or the high/low. The Where, indicator therefore signals an up-trending movement when its calculated value is below the current price Htoday = Today’s high (the extreme price). and a down-trending movement whenever the opposite is true. Because this is the first day of the calculation, there


September 2011 • CURRENCY TRADER

CURRENCY TRADER • September 2011



The Canada-Australia cross rate
Combining these two trending currencies results in a trending cross rate whose returns are directly linked to expected interest-rate differentials and relative asset returns.


It almost sounds like a bad vaudeville joke: What do you get when you cross Canada with Australia? Several things come to mind, actually, and this is where that line of thinking shall end. We have looked at the CAD individually (see “Canadian Dollar: Remember the forgotten currency,” February 2006) and as a cross rate to both the Euro and the yen (see “Canada on the cross rates,” May

2010). And Australia has been addressed both by itself (see “What’s down with the Australian dollar?” March 2008), as a spread to the New Zealand dollar (see “Getting carried away with the kiwi,” July 2008), and as a factor in the Indonesian rupiah (see “Indonesian rupiah: River deep, Bali high,” March 2011). Both Canada and Australia have large resource sectors, and both have very large customers in FIGURE 1: AUD/CAD CROSS RATE AND EXPECTED INTEREST RATE DIFFERENTIALS their neighborhoods (the U.S. and China). Both countries suffered less in the 2007-2009 global financial crisis, as their banks did not go overboard on the sort of egregious risktaking seen in the U.S. and Europe, although this may be the result of Canada’s protected status for its banks more than anything else. Australia was one of the first G-20 countries to raise its short-term interest rates (in October 2009) to slow its growth rate and inflationary pressures. Canada, a member of the more The AUD/CAD FRR6,9 differential led the cross rate by the expected three months into the start exclusive G-7, became of 2011. the first country in
September 2011 • CURRENCY TRADER


that group to raise its short-term interest rates at the start of June 2010.

A well-behaved cross rate

The global financial crisis of 2007-2009 and the free-money responses to it by most of the world’s central banks had the nasty side effect of placing many short-term interest rate markets in a state of “perma-expectations” — the belief that while short-term rates are quite low now, they must rise and rise soon. This would have been a nicer theory if it had been supported by any actual evidence, but such has not been the case. Japan has demonstrated perma-expectations can last longer than you care to play the game of waiting for rates to rise, and the U.S. seems destined to follow this path as well. Carry and volatility The AUD/CAD cross rate is something of an exception, If international equity diversification is a closet currency perhaps because neither central bank turned on the printtrade, then all parties involved are getting a little more ing presses just to see what would happen. If we calculate comfortable with that closet. If we map the excess return both currencies’ forward rate ratio between six and nine from borrowing and lending the CAD against the relamonths (FRR6,9), which is the rate at which we can lock in tive equity market performance, we find the relationship borrowing for three months starting six FIGURE 2: RELATIVE EQUITY PERFORMANCE HAS FOLLOWED CROSS RATE months from now divided by the ninemonth rate itself, we see the AUD/CAD FRR6,9 differential led the cross rate by the expected three months into the start of 2011 (Figure 1). If the market expected Canadian short-term rates to start rising faster than their Australian counterparts, the CAD firmed against the AUD and vice versa. After the start of 2011, this relationship and most others of its kind started to weaken as artificially low shortterm interest rates and money printing around the world disAs the CAD strengthens within the AUD/CAD cross rate, Canadian equities will outperform torted many market Australian equities, and vice versa. signals. This relatively neat
CURRENCY TRADER • September 2011

and tidy behavior (yes, we must appreciate the irony here as neither country’s self-image is very big on the “neat and tidy” quotient) extends to the very investable relative stock market performance of the two countries. Mapping the relative total returns of the Canadian and Australian stock markets in USD terms inversely to the cross rate reveals a very strong contemporaneous correlation between the two markets (Figure 2). As the CAD strengthens on the cross rate, Canadian equities will outperform Australian equities, and vice versa. Once again, this is a demonstration of how much international equity diversification has turned into nothing more than an expensive way to trade currencies.




Mapping the excess return from borrowing and lending the CAD to the relative equity market performance shows this relationship became extremely close during the financial crisis of 2008 and remained that way into 2010. FIGURE 4: RELATIVE BOND PERFORMANCE NOT LINKED TO CARRY RETURN

The relative performance of bonds for each country vs. the excess return on the currency carry trade shows a greater convergence between the markets from 2001 to 2005. Canadian bonds have outperformed after 2005 mostly because of the continued U.S. bull market in government debt.

became an extremely close one during 2008 and remained that way into 2010 (Figure 3). In a broader macroeconomic sense, we can say the policy responses to the financial crisis made both macroeconomic growth and the premia paid for risky assets beholden to artificially steep yield curves; as carry expanded, equity markets followed. Although it was not supposed to be this way, as the late Walter Cronkite might have said, “That’s the way it is.” Longer-maturity sovereign bonds present a different look in time relative to the currency carry trade. If we compare the relative performance of bonds for each country against the excess return on the currency carry trade, we see much greater convergence between the markets from 2001 to 2005 (Figure 4) than was the case with equities. Canadian bonds have outperformed after 2005 largely as a function of a continued bull market in government debt in the U.S. The net result is, while equities are supposed to have greater specific risk and therefore provide greater diversification, an investor now receives greater diversification for sov-


September 2011 • CURRENCY TRADER

Japan has shown how “perma-expectations” about rising interest rates can remain unfulfilled for longer than most people are willing to wait; the U.S. seems destined to follow this path.

ereign debt than for equities. vide is a measure of diversification for global equity invesFinally, let’s take a look at the cross rate in terms of the tors. That is a small price to pay. After all, when was the insurance options traders are willing to pay. If we map last time you heard a profitable trader talking about how the excess volatility of CAD forwards for an AUD holder, well he or she was diversified? y defined as the ratio between option implied volatility and For information on the author, see p. 4 high-low-close volatility, minus 1.00, we find it has tended to move inversely to the direction of the AUD per CAD cross rate (Figure 5). The Canadian dollar FIGURE 5: EXCESS VOLATILITY FOLLOWS THE TREND IN AUD/CAD CROSS RATE long has been one of the more straightforward markets for new currency traders because it tends to be one of the trendiest of the major currencies (see “Let the trend be your friend: The majors,” January 2009); the Australian dollar was second in that ranking. Given the presence of two trending currencies, should anyone be surprised their cross rate is not only a trending market in itself, but that it flows directly from expected interest rate differentials and is linked directly to relative asset returns? The excess volatility of CAD forwards for an AUD holder has tended to move inversely to the The only thing this direction of the AUD/CAD cross rate. cross rate doesn’t proCURRENCY TRADER • September 2011 31

CPI: Consumer price index ECB: European Central Bank FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. FOMC: Federal Open Market Committee GDP: ross domestic product G ISM: nstitute for supply I management LTD (last trading day): The final day trading can take place in a futures or options contract. PMI: urchasing managers index P PPI: roducer price index P Economic release (U.S.) GDP CPI ECI PPI ISM Unemployment Personal income Durable goods Retail sales Trade balance Leading indicators Release time (ET) 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m.

September 1 2 3 4 5 6 7
U.S.: August ISM manufacturing report U.S.: August employment report


Brazil: Q2 GDP and August CPI and PPI U.S.: Fed beige book Australia: Q2 GDP Canada: Bank of Canada interest-rate announcement Japan: Bank of Japan interest-rate announcement U.S.: July trade balance Australia: August employment report France: Q2 employment report Mexico: Aug. 31 CPI and August PPI UK: Bank of England interest-rate announcement ECB: Governing council interest-rate announcement Canada: August employment report Germany: August CPI UK: August PPI LTD: September forex options; U.S. dollar index options (ICE)

22 23 24 25 26 27 28 29

U.S.: August housing starts and FOMC interest-rate announcement Germany: August PPI Hong Kong: June-Aug. Employment report South Africa: Q2 employment report Canada: August CPI South Africa: August CPI FDD: September forex futures U.S.: August leading indicators Brazil: August employment report Hong Kong: August CPI Mexico: Sept. 15 CPI Mexico: August employment report


9 10 11 12 13 14 15 16 17 18 19


U.S.: August durable goods France: Q2 GDP U.S.: Q2 GDP Canada: August PPI Germany: August employment report South Africa: August PPI U.S.: August personal income France: August PPI India: August CPI Japan: August employment report and CPI

Japan: August PPI France: August CPI UK: August CPI U.S.: August PPI and retail sales India: August PPI UK: August employment report U.S.: August CPI Hong Kong: Q2 PPI

1 2 3 4 5 6
U.S.: September ISM manufacturing report UK: Q2 GDP Brazil: September PPI UK: Bank of England interest-rate announcement ECB: Governing council interest-rate announcement

The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.

Hong Kong: Q2 GDP LTD: September forex futures

Event: Sixth Annual Free Paris Trading Show Date: Sept. 16-17 Location: Paris For more information: Go to Event: The World MoneyShow Vancouver 2011 Date: Sept. 19-21 Location: Vancouver Convention Centre For more information: Go to Event: The Futures & Forex Expo Las Vegas Date: Sept. 22-24 Location: Caesars Palace, Las Vegas For more information: Go to Event: FIA Futures & Options Expo Date: Oct. 10-12 Location: Hilton Chicago For more information: Go to
September 2011 • CURRENCY TRADER


10-day move / rank 0.41% / 0% 1.43% / 38% 0.15% / 0% -0.21% / 0% 0.28% / 20% -3.85% / 50% -1.68% / 24% -0.21% / 0% 1.56% / 50% 0.41% / 0% 20-day move / rank 1.78% / 78% -2.54% / 66% 0.69% / 27% 0.22% / 2% -2.21% / 56% -4.12% / 100% -5.39% / 85% -0.91% / 34% -3.30% / 61% 1.78% / 78% 60-day move / rank -0.81% / 30% -1.04% / 32% -0.06% / 3% 4.37% / 73% -0.17% / 9% 2.64% / 3% -6.38% / 92% -0.30% / 3% 3.32% / 25% -0.81% / 30% Volatility ratio / rank .28 / 5% .48 / 72% .47 / 43% .16 / 8% .29 / 20% .21 / 45% .35 / 28% .25 / 2% .33 / 62% .28 / 5%




Vol 353.8 137.6 103.1 112.9 102.8 47.2 38.8 28.5 6.5 5.0

OI 176.0 118.5 100.6 129.8 110.2 51.1 121.7 55.2 29.7 5.1

Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. Note: Average volume and open interest data includes both pit and side-byside electronic contracts (where applicable). LEGEND: Volume: 30-day average daily volume, in thousands. OI: 30-day open interest, in thousands. 10-day move: The percentage price move from the close 10 days ago to today’s close. 20-day move: The percentage price move from the close 20 days ago to today’s close. 60-day move: The percentage price move from the close 60 days ago to today’s close. The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. For example, the % rank for the 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it shows how the most recent 60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100% means the current reading is larger than all the past readings, while a reading of 0% means the current reading is smaller than the previous readings. Volatility ratio/% rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

BarclayHedge Rankings: Top 10 currency traders managing more than $10 million
(as of July 31 ranked by July 2011 return) July return 12.80% 8.80% 6.70% 5.53% 5.24% 4.60% 4.13% 3.40% 3.16% 2.67% 8.92% 4.80% 4.50% 3.15% 2.25% 2.10% 1.68% 1.49% 1.26% 1.17% 2011 YTD return 14.04% 1.34% 44.44% 10.79% -1.68% 1.24% 25.69% 3.76% 0.84% -7.44% 16.44% 29.33% 21.39% 43.14% 6.42% -1.14% 2.37% 1.35% 10.01% 11.71% $ Under mgmt. (millions) 12.9 637.0 64.7 950.0 15.0 19.0 45.0 19.3 152.0 245.0 2.7 4.6 3.0 1.1 4.0 2.4 6.2 2.0 2.3 8.9

Trading advisor 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. CenturionFx Ltd (6X) Alder Cap'l (Alder Global 20) 24FX Management Ltd QFS Asset Mgmt (QFS Currency) JCH Capital Mgmt (Global Currency) Alder Cap'l (Alder Global 10) MIGFX Inc (Retail) Sunrise Cap'l Partners (Currency Fund) Cambridge Strategy (Asian Mrkts) Currency Insight (Diversified Sys.) Iron Fortress FX Mgmt Halion Capital (Conservative) Wealth Builder FX Group (Low Risk) Norman Conquests (Forex) Greenwave Capital Mgmt (GDS Beta) GTA Group (FX Trading) Blue Fin Capital (Managed FX) BEAM (FX Prop) Baron AM (Quant Strategic FX) Overlay Asset Mgmt. (Emerging Mkts)

Top 10 currency traders managing less than $10M & more than $1M

Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

CURRENCY TRADER • September 2011


CORRECTION: Due to errors in the gain/loss percentages in the August and July 2011 International Markets, this month’s “previous” columns display what the rankings should have been after corrections were made.

Rank Currency 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Swiss franc Japanese yen Great Britain pound Chinese yuan Euro Singapore dollar Swedish krona Hong Kong dollar Taiwan dollar Thai baht Indian rupee Brazilian real Australian Dollar Russian ruble New Zealand dollar Canadian dollar South African rand Aug. 25 price vs. U.S. dollar 1.2617 0.01304 1.64594 0.1567 1.44258 0.829735 0.15806 0.128275 0.03448 0.03334 0.02176 0.624525 1.048705 0.03455 0.82953 1.01192 0.13862 1-month gain/loss 3.26% 2.39% 0.96% 0.90% 0.44% 0.28% 0.10% -0.06% -0.63% -1.51% -2.86% -2.94% -3.35% -4.03% -4.04% -4.08% -5.46% 3-month gain/loss 11.33% 6.80% 1.98% 1.88% 2.48% 3.47% 0.30% -0.24% -0.06% 1.35% -1.40% 1.98% -0.55% -1.79% 4.28% -1.12% -2.92% 6-month gain/loss 17.09% 6.93% 1.68% 3.04% 4.74% 6.04% 1.02% -0.01% 2.77% 2.13% -0.78% 4.17% 4.23% 0.35% 11.04% -0.25% -1.68% 52-week high 1.3779 0.0131 1.6702 0.1568 1.4842 0.832 0.1662 0.129 0.03510 0.03385 0.0227 0.65 1.1028 0.0366 0.8797 1.059 0.1518 52-week low 0.9638 0.0116 1.535 0.1466 1.2646 0.7342 0.1338 0.1281 0.0312 0.0314 0.0211 0.5558 0.8823 0.0314 0.6987 0.9406 0.1352 Previous 5 8 12 15 14 9 6 17 16 7 11 3 4 13 1 2 10

Country 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Mexico Australia South Africa Canada Hong Kong Brazil Switzerland Japan Singapore U.S. UK India France Italy Germany Index IPC All ordinaries FTSE/JSE All Share S&P/TSX composite Hang Seng Bovespa Swiss Market Nikkei 225 Straits Times S&P 500 FTSE 100 BSE 30 CAC 40 FTSE MIB Xetra Dax Aug. 25 33,904.38 4,280.50 29,349.45 12,284.31 19,752.48 52,953.00 5,298.20 8,772.36 2,765.74 1,159.27 5,131.10 16,146.33 3,119.00 14,944.61 5,584.14 1-month gain/loss -4.44% -7.02% -8.47% -8.57% -11.40% -11.70% -11.95% -12.71% -12.80% -13.32% -13.40% -14.44% -18.20% -21.26% -23.97% 3-month gain/loss -4.49% -8.18% -7.69% -10.67% -13.17% -16.46% -18.04% -6.90% -11.32% -12.21% -12.59% -9.53% -20.62% -28.21% -22.13% 6-month gain loss -8.07% -13.08% -8.18% -12.58% -14.17% -20.85% -18.95% -16.67% -8.58% -12.17% -14.50% -8.78% -23.37% -33.13% -22.28% 52-week high 38,876.80 5,069.50 33,060.28 14,329.50 24,988.60 73,103.00 6,739.10 10,891.60 3,313.61 1,370.58 6,105.80 21,108.60 4,169.87 23,273.80 7,600.41 52-week low 31,172.70 3,829.40 26,873.08 11,617.80 18,868.10 47,793.00 4,695.30 8,227.63 2,680.83 1,039.70 4,791.00 15,987.80 2,891.11 14,199.10 5,345.36 Previous 11 5 8 9 4 15 12 1 2 7 3 10 13 14 6


September 2011 • CURRENCY TRADER

Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Currency pair Franc / Canada $ Yen / Real Pound / Canada $ Euro / Canada $ Pound / Aussie $ Euro / Aussie $ Euro / Real Franc / Yen Aussie $ / Canada $ Aussie $ / New Zeal $ Aussie $ / Real Euro / Pound Canada $ / Real Pound / Yen Euro / Yen Pound / Franc Euro / Franc Aussie $ / Yen New Zeal $ / Yen Canada $ / Yen Aussie $ / Franc Symbol CHF/CAD JPY/BRL GBP/CAD EUR/CAD GBP/AUD EUR/AUD EUR/BRL CHF/JPY AUD/CAD AUD/NZD AUD/BRL EUR/GBP CAD/BRL GBP/JPY EUR/JPY GBP/CHF EUR/CHF AUD/JPY NZD/JPY CAD/JPY AUD/CHF Aug. 27 1.24684 0.020875 1.62655 1.425585 1.569495 1.37558 2.309895 96.775 1.03635 1.264195 1.67921 0.876455 1.62031 126.25 110.65 1.30453 1.143355 80.44 63.625 77.615 0.831185 1-month gain/loss 7.65% 5.43% 5.26% 4.71% 4.46% 3.92% 3.48% 0.93% 0.76% 0.74% -0.43% -0.48% -1.18% -1.34% -1.87% -2.23% -2.72% -5.57% -6.27% -6.29% -6.40% 3-month gain/loss 12.59% 4.74% 3.13% 3.64% 2.55% 3.05% 0.48% 4.23% 0.57% -4.63% -2.49% 0.49% -3.04% -4.52% -4.05% -8.40% -7.95% -6.89% -2.36% -7.42% -10.67% 6-month gain loss 17.39% 2.63% 1.93% 5.00% -7.05% 0.49% 0.55% 9.52% 4.49% -6.14% 0.06% 3.01% -4.24% -4.90% -2.03% -13.16% -10.55% -2.51% 3.85% -6.70% -10.99% 52-week high 1.3569 0.0212 1.6412 1.4316 1.7507 1.4334 2.3842 105.790 1.0513 1.3746 1.7515 0.9038 1.7096 139.19 122.63 1.6 1.3766 89.46 67.97 88.95 0.9818 52-week low 1.0113 0.0186 1.5302 1.2811 1.4806 1.2947 2.1671 81.29 0.9366 1.2354 1.527 0.8175 1.589 124.06 106.43 1.1778 1.0376 74.57 56.86 77.23 0.7477 Previous 11 14 18 20 15 17 19 4 10 21 7 9 6 8 12 13 16 3 1 2 5

Country United States Japan Eurozone England Canada Switzerland Australia New Zealand Brazil Korea Taiwan India South Africa Interest rate Fed funds rate Overnight call rate Refi rate Repo rate Overnight rate 3-month Swiss Libor Cash rate Cash rate Selic rate Korea base rate Discount rate Repo rate Repurchase rate Rate 0-0.25 0-0.1 1.5 0.5 1 0 4.75 2.5 12.5 3.25 1.875 8 5.5 Last change 0.5 (Dec. 08) 0.1 (Oct. 10) 0.25 (July 11) 0.5 (March 09) 0.25 (Sept 10) 0.25 (Aug 11) 0.25 (Nov 10) 0.5 (March 11) 0.25 (July 11) 0.25 (June 11) 0.125 (June 11) 0.75 (July 11) 0.5 (Nov.10) Feb. 2011 0-0.25 0.1 1 0.5 1 0.25 4.75 3 11.25 2.75 1.625 6.5 5.5 Aug. 2011 0-0.25 0.1 1 0.5 0.75 0.25 4.5 3 10.75 2.25 1.375 5.75 6.5

CURRENCY TRADER • September 2011


Argentina Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore Argentina Brazil Canada France Germany UK Australia Hong Kong Japan Singapore

Q1 Q1 Q1 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q2

Release date
6/17 6/3 5/30 6/29 8/16 6/28 8/30 6/1 8/12 5/31 8/15 8/19

-5.2% 1.3% 2.1% 0.9% 0.6% 1.7% -6.4% -0.2% -1.1% 7.8% -0.3% -3.3%

1-year change
9.9% 4.2% 6.0% 1.5% 3.7% 4.6% -3.6% 1.2% 9.9% 17.2% -1.3% 4.2%

Next release
9/16 9/6 8/31 9/28 11/15 10/5 11/29 9/7 11/11 8/31 11/14 11/25


Unemployment AMERICAS

Q2 July July Q1 June April-June July May-July July Q2

Release date
8/22 8/25 8/5 6/3 7/28 8/17 8/11 8/18 8/30 7/29

7.3% 6.0% 7.2% 9.2% 6.1% 7.9% 5.0% 3.4% 4.7% 2.1%

-0.1% -0.2% -0.2% -0.1% 0.0% 0.2% 0.0% -0.1% 0.1% 0.2%

1-year change
-0.6% -0.9% -0.8% -0.3% -1.0% 0.1% -0.2% -0.9% -0.4% -0.1%

Next release
11/21 9/22 9/9 9/1 8/31 9/15 9/8 9/20 9/30 10/31



Argentina July July July July July July July Q2 July June July July Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

Release date
8/12 8/19 8/19 8/12 8/10 8/16 8/24 7/26 8/22 7/29 8/26 8/23

0.8% 0.2% 0.2% -0.4% 0.4% 0.1% 0.9% 90.0% 0.2% 1.1% 0.0% 1.5%

1-year change
9.7% 6.9% 2.7% 1.9% 2.4% 2.7% 5.3% 3.6% 7.9% 8.6% 0.2% 5.4%

Next release
9/14 9/6 9/21 9/13 9/9 9/14 9/21 10/26 9/22 8/31 9/30 9/23



Argentina Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

July July June July July July Q2 Q1 July July July

Release date
8/12 8/19 7/30 8/19 8/5 8/25 7/26 6/13 8/15 8/10 8/29

0.9% -0.3% -0.1% 0.7% 0.2% 2.7% 0.8% 3.5% 0.7% 0.2% -0.1%

1-year change
12.5% 5.1% 6.1% 5.8% 5.9% 8.9% 3.4% 8.2% 9.9% 2.9% 9.1%

Next release
9/14 9/29 9/9 9/20 9/12 9/29 10/24 9/15 9/14 9/12 9/29

As of Aug. 31 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.


September 2011 • CURRENCY TRADER