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Surprise Trouble in Mexico

Ashish Advani (July 14, 2009)

Tuesday, July 14, 2009

(Important: New Strategy Just Released Yesterday Plays This Long-Tail Currency Story)

Also In Today’s Letter…

By Ashish Advani Frankly, this new currency story is a complete surprise, even to me.

While Mexico has been facing setbacks for over a year, the trouble really deepened about a little over a week ago. In short, the “real trouble” is coming from a completely unexpected political twist that could seriously harm Mexico’s recovery in the medium-term.

On top of that, Mexico is still facing the run-off from the global recession, a potential sovereign debt downgrade, lower oil prices, and a myriad of smaller issues that are coming together to create the perfect storm for both Mexico and the Mexican peso.

But on the “glass is half full side” of this story, shorting the Mexico peso this month could be one of the strongest currency plays for the next few weeks, or even months.

I may have found an interesting way to play this currency story. Just yesterday, the NASDAQ OMX, or Philadelphia Stock Exchange, launched a new currency option that lets you short the Mexican peso.

I’ll get into the specifics on their new option offerings in just a second…including the one thing you absolutely have to know about these new peso options before you buy.

But let’s examine Mexico’s troubles first…

A Political Twist of Fate

As I said, a political twist of fate threw the Mexican peso into the “sell column” for me.

Up until a week ago, President Felipe Calderón at least “appeared” to have the necessary tools and ideas to help pull Mexico through its current recession. He also had the necessary political weight to push those ideas through Mexico’s Congress.

But on July 5th, President Calderón lost his footing in Mexico’s government. The former ruling political party, the Institutional Revolutionary Party (PRI) did almost a clean sweep of Mexico’s mid-term elections.

The PRI more than doubled its seats in the lower house of Congress. The opposing party also won key seats in parts of Mexico that at least in theory were supposed to go to Calderón’s party, the National Action Party (or PAN).

This all adds to the concern that the government will struggle to raise taxes needed to narrow a swelling budget gap. This political loss increases the risk that a much needed fiscal reform will not take place soon.

For the next three years, this means it will be much more difficult for President Calderón to pass key pieces of legislation that could help Mexico’s economy. Not to mention, the opposing party now has the power to push the President out of the government altogether.

So there you are: A surprise “strike one” for Mexico’s economy and the Mexican peso.

A Sovereign Debt Debacle Waiting to Happen

For weeks now, the media has been tossing stories back and forth about how Mexico will soon lose its sovereign debt rating soon.

There has already been a war of words ensuing between the Mexican Government and the agencies about a possible downgrade.

Let’s assume for once that the media expectations are correct.

If Moodys, Standard & Poors or Fitch were to downgrade Mexico that would mean this nation would lose key institutional investors, who are only allowed to invest in sovereign-rated nations.

In other words, watch for a river of investor cash to flow out of Mexico should they lose their sovereign rating.

Really, this is just the beginning. As I said there are countless issues in Mexico causing the perfect storm for the Mexican peso right now…

Think U.S. Troubles, Only on a Grander Scale

If that wasn’t enough, Mexico is also facing the same recessionary problems we’ve been battling here in the U.S., only on a much grander scale.

Why is that? Well in a smaller economy like Mexico, smaller issues have the potential to have a much larger impact. For instance, unemployment is plaguing Mexico just as it is here in the U.S., but those unemployment numbers (while comparable to the U.S. on a population basis), have the potential to affect the Mexican peso’s price.

It’s the same with their auto sales. Right now, in Mexico auto sales are down 48%. Our sales in the U.S. are down too.

But in Mexico, auto sales are a much larger piece of the overall smaller economic pie. That means auto sales can potentially affect the peso’s price much faster than our auto sales will affect the dollar.

Also, just the sheer fact that the recession is NOT over in the U.S. is affecting Mexico.

We neighbors to the north just happen to be Mexico’s largest trading partners. In fact, the U.S. buys 85% of Mexico’s output. When we’re in trouble, we don’t buy as many of their goods. Obviously this affects Mexico’s overall GDP and import numbers.

Or in short, when we’re in trouble, they’re in trouble by extension. So is the peso.

And with oil down about 18% from its recent highs, it adds even more pressure on the peso.

Introducing the New “Short” on the Mexican Peso

As I mentioned, yesterday the NASDAQ OMX, also known as the Philadelphia Stock Exchange, introduced one of the most interesting shorting products to come out on the Mexican peso in a while.

This exchange now offers put options on the Mexican peso.

Up until yesterday, the NASDAQ OMX only offered options on six major currencies. But now they’re branching off into exotics.

As a refresher, a put option contract on a specific currency gives you the right but not the obligation to SELL a specific currency at a specific price. You buy “put options” when you believe a currency will sink over the long run.

Just as always, any currency options offered through the NASDAQ OMX are just like regular stock options. They trade at the same times as stock options every day (9:30 am – 4:00 pm EST). They’re dollar-dominated like regular stock options. And you can buy them through a regular stock options account.

We’ve written about them several times here in FX University before. So to learn more about options in general, you can refer back to my colleague, Sean Hyman’s articles on currency options here. (See Part I and Part II of his recent options series here.)

And now, the NASDAQ offers options on the Mexican peso. You can learn more about their most recent offerings here.

Now, personally I would love to make an all out recommendation for this option, but I want to offer you a word of caution first. This new option just launched yesterday, so I recommend waiting and holding off investing until the liquidity rises on this particular play. You can track the liquidity by visiting the NASDAQ OMX’s currency option site.

But the point is: The rationale behind shorting the Mexican peso is almost overwhelming at this point. And a put option could be an interesting way to play this Mexican peso story, once the liquidity rises.

Keep an eye on these new option offerings…they’re quite intriguing strategies to play currencies for the long-run.

Yours in FX Profits,
Ashish Advani

P.S. It’s not just the Mexican peso. Yesterday, the NASDAQ OMX launched three additional new currency options. I’ll be back tomorrow with the full story on these three newbies in the option world. Also, to all my Global Currency Option subscribers: I’m closely watching all these new option offerings. I will be back to you soon with the right recommendation, with all the details you need to buy puts and calls on these new options when I believe the time is right.