Tuesday 27 April 2010

Tuesday 27 April 2010 www.blackswantrading.
com
Key News
 The euro slipped on Tuesday after Germany demanded painful new austerity
measures from Greece in return for badly needed financial aid, with investors likely set
to push high risk European sovereign bond yields up further. (Reuters)
 China faces a cloudy international economy that is likely to drag down export growth
later in the year, squeezing exporters' profits and stoking trade friction, a senior Chinese
commerce official said. (Reuters)
 Spanish unemployment in the first quarter of this year surged to a record high over 20
percent, according to media reports, (Reuters)
Quotable
“The world is a tragedy to those who feel, but a comedy to those who think.”
Horace Walpole
FX Trading – Special Report Reprint
REPRINT: Key Reasons Why the Euro is Heading to Par or Beyond against the US Dollar
The following is a reprint of the report we sent to our clients over a month ago. (This report
is the second part of a
report we published in
June 2009 explaining why
the major structural
problems within the
European Monetary
Union could lead to a
breakup. If you would
like a copy of our original
report, please request via
email.)
There have been changes

to some of the charts, i.e.
spreads, we present in
this piece, but our forecast for the euro has not changed.
In fact, here’s a quick peek at the Greece/ German 10-yr interest rate spread …exploding
even higher to record levels in the last two weeks ... indicating how quickly the market is
now catching up to the inherent risks of Sovereign default.
The only question we have is whether or not the euro goes to par quickly on some type of
Eurozone crisis, or just grinds lower and
lower in the months ahead. Either way, we
want to remain positioned short the euro
against the dollar and ride this move for all
its worth. This research piece lays out the
key reasons why we are confident in that
view.
Summary Rationales:
1. Sovereign default is a real
possibility; at best the market is
under pricing the fiscal risk
facing the Eurozone and its
potential impact on the euro.
2. Germany’s incentives to remain
in the European Monetary Union
are fading fast; they are now playing hardball but their growth is in jeopardy.
3. Even if the zone muddles through the crisis, the euro likely grinds lower on
valuation and risk.
Euro Spiraling Lower
Greece and friends likely lead to the path of sovereign default; if not default, we could see
a huge hike up in risk across the zone; that alone would likely hammer the euro.
Greece is on everyone’s radar screen. And though the other fiscal basket case countries
have been mentioned, the market doesn’t seem to have caught on to the fact that taken
collectively the countries of Greece, Spain, Portugal, Italy, and Ireland have a worse debt
profile than Greece. Hard to believe but true…
Portugal Spain Italy Ireland Greece Total PIIGS

External Debt
229.7% 156.7% 125.6% 294.0% 190.7% 199.3%
as % of GDP
*Gov’t
funding need
101.2% 101.5% 128.1% 131.5% 118.4% 119.2%
as % of tax
revenues
*Not one country can satisfy its funding needs through current tax receipts. Source: Leto
Research
The therapy plan to improve the ugly fiscal picture of the PIIGS above is austerity (more on
this regarding Germany’s dominance of trade in the next section). Okay, fine. But, look
Black Swan Capital’s Currency Currents is strictly an informational publication and does not provide personalized or individualized
investment or trading advice. Commodity futures and forex trading involves substantial risk of loss and may not be suitable for you. The
money you allocate to futures or forex trading should be money that you can afford to lose. Please carefully read Black Swan’s full
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closely at the bottom again, titled Government funding need as a % of tax revenues; this
means that now, before any level of austerity has been imposed, these countries cannot
fund government needs. Austerity measures should lower government needs, granted, but
it will also clobber existing tax receipts because the burden of austerity will fall on the
private sector; they are already overburdened with debt and taxes.
Additional burdens placed on the private sector will likely increase bankruptcies and social
unrest and kill growth in these countries. Collectively the economies of these five represent
approximately 33% of the entire Eurozone economy.
Once the market realizes that so-called austerity measures won’t work, all of these
countries bonds will most likely get hit very hard, pushing yields sharply higher, making
funding that much more difficult.
Who’s left to bail them out?
The government has already spent hundreds of billions bailing out the European banking
system thanks to the impact of the credit crunch by distributing taxpayer funds to take the
bad debt off the bank balance sheets. All that “saving of the banking system” even though
PIIGS country balance sheets were already in dismal shape makes you wonder. Now it
appears there is a train wreck in the making.
The PIIGS are collectively sitting on a whopping $2,946 billion (€ 2,166.6 billion) of short-
term external debt; and a colossal $8,152 billion (€ 5,994.2 billion) of the long-term
variety.
It appears to us the market has not priced in this funding risk.
Below is a series of charts showing the 10-year bond spread for each of the countries above
compared to Germany (the solid credit in the Eurozone at the moment); it means these
countries have to pay that many more basis points in yield to borrow (sell their bonds) on
the open market:
Portugal: 130 basis points over Germany. Spain: About 80 basis points over Germany.
Italy: 84 basis points over Germany. Ireland: 143 basis points over Germany.
Greece: 335 basis points above Germany. (Updated above)
Summary:
10-year benchmark bong
Country spread above Germany in External Debt as % of GDP
basis points
Spain 80 156.7%
Italy 84 125.6%
Portugal 130 229.7%
Ireland 143 294.0%
Greece 335 190.7%
Key point: Relative to individual debt levels, there is a lot more risk to be priced into these
bonds. Another interesting point is this: When you look at the individual spread charts
above, what really stands out is the fact that, with the exception of Greece, spreads in the
remaining countries have not yet reached their credit crunch highs set back in the fourth
quarter of 2008. Risk of default among any one of these countries likely means all these
spreads will surge above those old highs.
German incentives to be a part of the European Monetary Union are fading fast.
One key important factoid to remember when thinking of the European Monetary Union is
this: One of the primary goals was to provide German industrialists with a captive market
for exports. Close to 50% of German exports are now derived from the Eurozone
economies.
If the solution to the current crisis is for countries to implement deep austerity, it will
clobber Germany’s exports. And yet that seems the only alternative, and here’s why:
Germany has a massive lead on all these countries in terms of labor productivity, which
translates into massive manufacturing efficiencies compared to the rest of the countries in
the Eurozone. How can these other countries export their way out of their fiscal problems
when they effectively compete with Germany for the same relative export share? They
cannot. And it is highly unlikely Germany would purposefully toss away its manufacturing
advantage for the sake of Eurozone unity.
In fact, it is precisely because these countries took on so much debt to buy German
industrial and consumer goods that has led to the fiscal crisis and massive German current
account surpluses.
German Current Account Balance SA:
Introduction of the
euro as a single
currency…
Credit crunch slam to the

German current account
surplus, then a rebound on
government stimulus; now we
are entering the austerity
stage…
German Industrial Production thru Jan 2010:
Despite the global “recovery,” the German engine is sputtering a bit.
Two key points:

1) German politicians will effectively commit political suicide if they ask their taxpayers
to backstop the PIIGS —you saw the massive exposure above; that is why Angela
Merkel, the German president, has driven a stake through that idea of Germany
offering some type of guarantee for Greek debt after that idea was initially floated.
2) If as we suspect, growth in the Eurozone grinds lower and lower, it hits the
paymaster—Germany—quite hard. It’s growth will in turn be slowed, and thus it
will be that much less willing to take on new commitments; this is likely why German
finance minister Schäuble recent hard-line comments implicitly hinted at a German
escape from the Union; and explicitly said those who don’t keep their promises
should be penalized and/or expelled.
Bottom line: Germany is the economic engine that drives the Eurozone economy. If
German growth contracts as a result of austerity across the zone, it will feed directly into
the price of the euro and push it lower. If one or more of the countries in the zone decide
they want to leave, the euro likely takes a big hit even if it remains intact. And on the less
likely chance that Germany signals it is done with the experiment known as the euro, it
would be lights out for the single currency.
Even if the Eurozone muddles through the euro likely grinds lower on valuation and risk.
It is highly unlikely the PIIGS, facing such fiscal woes, can export their way out of the
problem. It seems the best outcome is a broad acceptance of austerity measures. Success
on this front will hammer relative growth across the Eurozone. So the euro, as a currency,
is now left to find its own level in a slow-growth high- risk environment where the central
bank can ill afford not to keep monetary policy loose.
Monetary aggregates, consumer lending, rising unemployment, and subdued inflation

suggest the European Central Bank cannot afford to be tight.
European M-2 growth is falling:
Money is not getting into the real economy; consumer credit is falling:
Unemployment continues to rise in the Eurozone:
Inflation is under control; year-on-year % change in CPI:
Key Point: This is hardly an environment where the European Central Bank can hike rates;
in fact we think there is a good chance if growth grinds down the ECB may actually cut
interest rates.
We think US dollar interest rates will soon be above Euro interest rates on the short-end of
the interest rate curve; US rates are already higher on the long end:
US yield curve (black) vs. Eurozone yield curve (red):
Thus, US yield differential could soon trump the Eurozone by a large margin. Yield
differential is one of the two most powerful drivers for currency prices over the longer and
intermediate-term time frames; the other is relative growth.
 Yield differential
 Relative growth
The US economy looks far better to us than the Eurozone on both counts here.
[By saying this, we are by no means saying the US is wart free. We are implying one key
aspect of currency pricing that is often overlooked—currency pricing is a relative game.]
Below is an interesting chart comparing the yield on US 10-year benchmark bonds to 10-
year German bunds, and below it is the price action of the US dollar index. You can see the
direct correlation. As this yield differential rose in favor of the US dollar i.e. German yields
fell relative to US yields on the 10-year benchmark, the dollar rose; a perfect example of
yield differential at work.
US 10-year Note Yield (black) vs. German 10-yr Note Yield (red) Daily:
US Dollar Index Daily:
We believe this spread will continue to widen for two reasons:
1) US economic growth picks up and its long yields rise accordingly
2) German bonds continue to be the safe haven in Europe because of the risk of
holding the PIIGS bonds; that and lower growth likely means German bond yields
stay or fall further over time.
…thus, more money flows to the US on a growing positive yield differential and increasing
risk across the Eurozone.
According to the latest Economist magazine’s Big Mac index of March 17th, 2010, used for
measuring relative fundamental values of global currencies against the dollar, they show
the Euro area currencies presently about 25% overvalued against the US dollar.
EURUSD = 1.3500 – 25% fundamental overvaluation = 1.0125
Close to par against the dollar only if the fundamental valuation premium is stripped away!
It’s why we titled this research piece: “…Par or Beyond…”
The rising risk of implosion of the European Monetary Union is rising. That risk is the
catalyst for a very powerful self-reinforcing process that chases huge pools of capital away
from the euro and into US capital markets to hide. We think the euro at par will become a
reality. A fall to 0.8300 against the dollar would only represent a round-trip ticket from
where the bull market in the euro began back in late 2000—stay tuned and stay short the
euro.
Jack Crooks
Black Swan Capital
22 March 2010
The clock is ticking on the EURO

Is there a day when all the “at-risk” Eurozone
members will declare group default?
Doubtful.
Is there a day when traders will in unison

decide Europe will be the laggard for years
to come?
Maybe. But it’ll be nearly impossible to

pinpoint that day until it is well past us.
Is there a day when the euro will suddenly cease to exist?
Tough to say. But in all likelihood that day isn’t coming before the day the value of the euro
reaches par with the US dollar. That day is coming fast.
Yeah, yeah, yeah – nothing goes straight up, or straight down ... blah, blah, blah. But as
steady and paced as we think this euro move to US dollar parity will be, things like this can
sneak up on you. It’s great if you can time the pullbacks perfectly and enter then. And it
almost hurts when you miss a big daily, or weekly, move.
But the fact is, when you’re playing for a major, longer-term move like this it makes sense to
be in the market. Of course, you don’t want to be blind about it. Even in lasting moves,
there are time to be careful and times to be gutsy. And you can do this in the longer-term ...
or the shorter-term, depending on your appetite for risk and your investing approach.
Don’t waste anymore time.
TICK ... TOCK ... TICK ... TOCK ...
(Here’s our website if you need us: www.blackswantrading.com.)

Tuesday 27 April 2010

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Tuesday 27 April 2010 www.blackswantrading.

FX Trading – Special Report Reprint

There have been changes

Euro Spiraling Lower

Portugal Spain Italy Ireland Greece Total PIIGS

Who’s left to bail them out?

It appears to us the market has not priced in this funding risk.

Greece: 335 basis points above Germany. (Updated above)

German Current Account Balance SA:

Credit crunch slam to the

German Industrial Production thru Jan 2010:

Two key points:

Monetary aggregates, consumer lending, rising unemployment, and subdued inflation

European M-2 growth is falling:

Inflation is under control; year-on-year % change in CPI:

US yield curve (black) vs. Eurozone yield curve (red):

We believe this spread will continue to widen for two reasons:

1) US economic growth picks up and its long yields rise accordingly

EURUSD = 1.3500 – 25% fundamental overvaluation = 1.0125

The clock is ticking on the EURO

Is there a day when traders will in unison

Maybe. But it’ll be nearly impossible to

Is there a day when the euro will suddenly cease to exist?

Don’t waste anymore time.

TICK ... TOCK ... TICK ... TOCK ...

(Here’s our website if you need us: www.blackswantrading.com.)

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