Issue #62: Wednesday, April 15, 2009

Top 5 Currency Pairs That Promise to Recover First, Plus the 3 That Will Sink

By Sean Hyman As I’m sure you know, there really is no such thing as a true “recession” in currencies.

You simply can’t crush currencies as an asset class like you can stocks or commodities, because currencies are a relative asset (in other word, currencies are priced against each other, so when one goes up, another must go down). This means one currency must be rising at any one time.

And during the worst worldwide recession in our lifetimes, we’ve seen once again that you can’t crush the entire currency market – even when all other asset classes are sinking.

But here’s the thing: While this recession hasn’t destroyed currencies, it has affected currencies in the market. Specifically, some currencies took a beating in the global recession and some got a second wind at the same time.

As Chuck said above, it’s all risk or nothing for a while now – meaning traders are either buying up the low-risk, low yielding currencies, or riskier, high-yielding currencies.

For the past year, you can see from the chart below that the low-risk Japanese yen reigned supreme with a whopping 42.9% unleveraged gain. The Swiss franc and also the U.S. dollar made tremendous headway too…all of them making over 13% on the year (unlevered).

2008: High Yielders Lost, Low Yielders Won!

On the other hand, the high yielders like the Kiwi dollar (NZD), Aussie (AUD) and British pound (GBP) got killed…all down 11% – 16% on an unleveraged basis.

As risk aversion set in, money fled the assets that had worked for many years, back to back…and instead ran to the beaten down low-yielding currencies.

So how are things looking for 2009? Is that same theme continuing on as the recession lingers on, or are things changing?

Well let’s take a look at the snapshot below to see how things are shaping up in 2009 so far.

The Return to the High Yielders Has Begun…Slowly

Commodity Currencies Make a Serious Comeback

This year, the Aussie dollar has been on a tear …up 7.69% so far (in just over three months). It has been the notable leader, even almost doubling the return of the Kiwi dollar at 4.03% so far this year.

Who are the big losers? For starters, the Japanese yen has fell by 8.9% and the Swiss franc dropped 5.54%

So what has changed? There has been an overall return to risk seeking vs. the former risk aversion in the markets.

Why? Aren’t things still bad out there in the global economy? Sure they are. But traders in the market are noticing that certain aspects of the economy are showing signs of improvement. In other words, yes we’re still in a recession, but traders are seeing some light at the end of the tunnel. That’s affecting how currencies trade.

Other big institutional players are thinking the same thing. This is why they are betting on a recovery and positioning themselves for it by the turn around in their positions.

The Fear Gauges Are Dropping Like Rocks

You see, all of the fear gauges have calmed significantly (VIX, TED spreads, LIBOR rate, etc.).

The stock markets of the world have stabilized for now. Most importantly, there has been a pick up in commodities. Last year, they literally fell off a cliff. This year, not only have commodities stopped the bleeding, but some have even started new uptrends.

This is causing some of the main commodity currencies to lead the way to recovery, while the lower yielders (like the Japanese yen and dollar) are starting to reverse their gains.

The Leaders of the Pack!

Considering our government has been throwing trillions of dollars at the economy to force a recovery, commodities could see a turnaround this year. Too many dollars will be chasing a finite amount of goods. This really gives pairs like AUD/USD, AUD/CHF, NZD/USD and AUD/JPY, NZD/JPY great prospects for this year.

Canada is a commodity currency too but it has lagged the commodity currency pack lately. That’s because Canada is more closely tied to the slowdown in the U.S. than Australia or New Zealand. So it won’t pick up as much steam until the U.S. economy gets to rolling. Once it does, it will play a bit of catch up with the other commodity currencies.

So commodity currencies will be the first leaders of the recovery. The European currencies will fall into second place as they take a backseat to the raging commodity currencies. But they still hold more appeal than the U.S. dollar that’s getting “out-printed” more than any currency in the world…or the “lowly” low yielding currencies (JPY and CHF).

Therefore the Japanese yen, U.S. dollar and Swiss franc will bring up the rear. Traders will shun these low-yielding currencies in any kind of recovery. The U.S. will lose its luster because when times are good, foreign currencies prosper more than it because they appreciate and earn more interest.

The yen and Swiss franc earn next to nothing as far as interest and have a history of pretty much staying that way (in relation to many other currencies of the world).

Therefore, if good times are ahead and the worst is behind, there’s no incentive to buy more of these two currencies.

Now I realize that some currencies like the British pound are also low yielding right now, but it has a history of being a high yielder. So once good times return and stay that way for a while, the U.K. will start raising rates once again. Also, the pound has gotten so beaten down so quickly, that it may have overshot what it really should be valued at.

So if good times are ahead, and I believe they are… you will eventually see the pound recover. However, the ones to focus on for now are the commodity currencies. They are your strongest leaders so far in 2009.

The Smart Money Buys Before the Recovery is Obvious!

Keep in mind that institutions don’t wait to buy until the data starts to show that the economies are recovering. They preemptively buy ahead a few months or so while the discounted pricing is still there.

Many investors won’t start buying up the high-yielding currencies until they see proof that the economy is turning. The problem with that is that most of the data lags anywhere from a month to a quarter, so you’re seeing it all in hindsight.

However, if you watch commodities like copper, the CRB index, gold, silver, lumber, oil, etc. you will see the pick-up in the economy much sooner than if you just wait for the government reports to come out.

The trick is to wait long enough to where the worst is over but not so long that you miss the good prices. If you buy in that time, you come out ahead. If you buy later on, you will certainly do okay, but not get well above average returns like these big institutional players will do.

EDITOR’S NOTE: All our currency experts have their eyes on exactly when key currencies will pull out of this worldwide recession first. In fact, in next month’s issue of Currency Capitalist, Chuck Butler will tell you about two key currencies NOT listed in this article that have managed to beat the recession outright. Plus, our currency portfolio will give you two of the easiest ways to buy both these currencies ahead before they climb any higher. Don’t receive our monthly Currency Capitalist yet? Click here to learn more about a 100% risk-free trial, for pennies a day.

Sean Hyman, “Professor FX” and Long-Time Currency Analyst Explaining How You Can Succeed in the Currency Markets.
Sean Hyman spends his days teaching his fellow professionals in the industry how to trade the $4 TRILLION currency market. Now he brings his 15 years of financial experience to you. From long-term currency strategies, to quick FX-trading moves usually reserved for the professionals, Sean will tell you everything you need to know to succeed in the currency markets.