While the Buck May Bounce, the
Dollar's Decline is the Pro's Best Friend

Today's comment is by Sean Hyman, Currency Director and editor of Money Trader.

Dear A-Letter Reader,

The dollar has dropped a whopping 5% in just the last two months.

Why? More and more banks have reported even more write-downs from their balance sheets. These billion-dollar write-downs have impacted their stock prices.

It's also affecting employment. The major lenders have already started laying off employees to compensate for the billions of dollars they're writing off in their books, as my colleague Mike Burnick has pointed out. The scary part is: This isn't anywhere near over yet. I see many more layoffs and write-downs coming soon on Wall Street.

Wall Street has a knack for letting bad news hit the wires slowly and gradually. You won't hear about a major economic situation until it's already happened - months later.

It's part of their job to keep investors calm and collected - enough to keep pouring money into the NSYE. And they're masters at marketing their investments - so they only report what they have to when they have to.

So I predict there will be a fundamental catalyst that will give the dollar a short-term bounce soon.

Jim Rogers Says "So Long" to the Buck

Just last week, Jim Rogers stated that in the upcoming months he should have all of his money out of the U.S. dollar. (He's trading up his dollars for Chinese yuan.) Around the same time, Warren Buffett announced he was still bearish on the dollar also.

Out of all of the years I've been watching Buffett, he has never gotten involved with foreign currencies. He waited until these most recent years when he saw the falling dollar eroding his gains. As his corporations have had more international exposure, he's had to take action by buying euros among other currencies.

When you've been working on Wall Street as long as I have, you're used to analysts saying one thing and then watching their brokerage firm do the exact opposite. That's why I always like to see what someone does rather than what they say. You're not very quick to trust what many say once you've been trading a while.

However, Rogers and Buffett aren't pressured by anyone to make their comments. After all, they don't have to draw a paycheck from anyone. They make billion-dollar decisions that pay off huge in the long-term. So pay attention when veterans like these talk. They aren't traders, so they have large macro views worth noting.

As you can see from the chart below, even downtrends have bounces upwards. We're long overdue for a bounce in the dollar. Right now, we're more extended away from the dollar's downtrend line than we've been in the past year. So look for a short-term bounce around the corner.

Do realize though that the big money will be watching for this bounce only to turn around and sell the dollar. After all, it's less risky to sell a rally nearer to its downtrend line than it is to sell very far away from it. Meanwhile, novice investors will think any bounce is signaling the bottom for the dollar. And they'll get trapped with the dollar falls again.

Novices Pick Tops & Bottoms, Pros Follow Trends

Novices try to pick top and bottoms in currencies. The pros with the "smart money" follow the trends. They stick with trends until some event triggers that a particular trend is coming to an end.

Novices don't realize that fundamentals drive a currency. Fundamentals are the basis for any major trend in the currency markets.

Until this fundamental picture starts to turn a lot brighter, there's no reason to think that things will change. After all, why should the dollar start a sustainable uptrend when GDP is slowing, housing is slumping, credit is tighter, layoffs are increasing and the Fed is cutting rates?

Reading the Tea Leaves

So what would cause the dollar to change directions into a new uptrend? Corporations would need to expand and grow at a faster pace that brings on inflation and wage expansion. This would cause the consumer to start buying big-ticket items once again. That would spur retail sales and further the growth.

When inflation gets too high, the Fed has to step in with rate hikes to help "cool" the economy. These signs are the beginnings of a turn around in the dollar. After all, the dollar doesn't always rally when the first rate hike starts.

Until things like this start to unfold, we'll have to scratch our heads and wonder why the Treasury talks about having a "strong dollar policy" yet allows it to slide into the toilet.

SEAN HYMAN, Currency Director

P.S. Currencies affect every aspect of your life - from your bank accounts and stock portfolios - to when the gas pump will finally stop pumping below US$40 a tank. I can help you gauge where the "smart money" is headed next, so you can manage those dollars in your pocket. Catch my insights and the rest of our currency commentators five days in a week in our FREE currency E-Letter, My Two Cents. Click here to sign up now.

More Questions and My Answers
About Those "Leaky" SIVs

In response to my A-Letter comments last week (The Next Market Shock Meltdown on Wall Street: a Tale of M-LECs and SIVs), I received a number of reader responses.

One email in particular covered a range of topics, and included some really good follow up questions for me. So I thought I'd respond here for the benefit of all readers. Enjoy...

Q. I am assuming that money market funds and corporations that have excess cash to invest buy the commercial paper issued by SIV's.

Yes, some of this toxic commercial paper (CP) does in fact lurk in the portfolios of money market funds. In fact, a few in the U.S. came under severe stress due to this issue in July, although no big funds had problems in terms of "breaking the buck" (when a money market fund falls below a dollar bid). However, most of the SIV paper resides with banks, brokers, hedge funds, and other institutional investors.

Q. Does the entity that sets up the SIV put up some cash to start the SIV?

Yes, in the case of Citigroup (the King of SIVs), they have started several with a total capital base of US$300 billion. Some of this "seed capital" is put up by Citigroup itself, the rest is from outside investors.

Q. If you look at a lot of these investment banks they have gone from 8% or 10% shareholder equity compared to total assets to 4% recently. So they have leveraged up. Looks like they are leveraging up even more using SIV's.

Exactly right! The spreads earned by the SIVs (the interest rate difference between their cost of borrowing, and the yield received on the debt they purchase) are pretty small to begin with, so it's a game of leverage, which is why the sub-prime credit crunch is far from over.

That's because there are several layers of leverage involved. That makes it more difficult for investors holding this paper to know just how big their ultimate exposure is. Whenever you add lots of leverage, even small changes in underlying asset value can result in huge losses (see Long Term Capital Management - or this year's example - Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund).

Q. It would seem that if the SIV market implodes, there will be a rush to buy short-term treasuries (short rates will go down) and a forced sale of long-term debt causing long rates to go up.

Two year Treasuries have in fact been soaring in price (sending short-rates lower) since August when CP markets began to seize up. There may or may not be a "forced sale" of long-term bonds, it depends on the type of debt.

Treasury bonds for instance may actually attract buying as a "flight to quality trade." But I would be leery of "risky" debt securities, such as high-yield corporate bonds, which suffered some distress during July and August.

If the SIV market does "implode" in a big way, with several forced liquidations then, to paraphrase the great Warren Buffett: We would have an extreme-low tide of liquidity and we'd find out exactly how many Wall Street firms were swimming naked...which would be a very ugly sight to see!

MIKE BURNICK, Senior Editor & Global Markets Analyst

EDITOR'S NOTE: These leaky SIVs continue to drain assets from Wall Street. That's just one indicator that this sub-prime, credit crunch is far from over. Look for more aftershocks to ripple through financial market as we head into 2008. Mike will be watching these trends closely, so you can profit from these aftershocks with well-timed option plays. Just last week, he recommended a dynamite play to capitalize on Wall Street's real-estate-induced woes. Click here to test-drive Market Shock Trader right now - completely risk-free of course - so you can profit from the ongoing credit market shock.

Privacy & Rights

Since the Government's Eavesdropping Anyway, You Might as Well Get Free Phone Service

Here's a new wrinkle in telephone service: If you allow your conversations to be monitored by voice recognition software, you can call anyone, anywhere in the world, for no charge.

That's the offer that a start-up company called Pudding Media just offered its customers. Here's how it might work, according to a company press release:

"It's Saturday night. You plan to go to a movie with Ashley. But which movie should you see? Time to call her and decide. You surf to ThePudding.com and call Ashley for free. As soon as you start talking about movies, a list of local movies, complete with reviews and show times appear on the screen. Now, what about dinner? Just talking about where to get dinner, and offers for local restaurants are displayed. Now you and Ashley have everything you need for dinner and a movie! Oh and just a few clicks and you've reserved the tickets and a table. Sweet!"

I must admit that I have misgivings about allowing someone to monitor my telephone conversations. However, I have no objection to services like Pudding Media, because the monitoring is truly voluntary, and you actually get something in return.

Now, if the National Security Agency would just be as helpful when they secretly monitor your calls as authorized by the grossly misnamed "Protect America Act." But I suspect that the recommendations from ThePudding.com might be more helpful.

To learn more about how you can protect your privacy on and off the phone, click here.

MARK NESTMANN, Privacy Expert & President,
The Nestmann Group
www.nestmann.com