Before we begin, it is worth saying that every currency should be purchased or sold on its own merits. However, for the sake of this post, I will be grouping currencies into their regional baskets such as G3, Euro content currencies, commodity exporter currencies, Asian currencies, global emerging market currencies and so forth.
Chart 1: Global EM (GEM) currencies have been the centre of attention in media
Source: Bar Chart (edited by Short Side of Long)
The media has been obsessed with Emerging Market currencies as of late. Whether it was the Indian / Turkish / Indonesian deficit trouble last year or the Ukraine Crisis into early parts of this year, it seems that the majority of the global EM currencies have actually bottomed out, despite constant negativity. Media has a great habit of obsessing over a story which has just about run its course.
The chart above makes an interesting observation on six EM currencies, all of which came under selling pressure throughout the last 12 months. It seems that majority bottomed either in September 2013 or March 2014. A number of currencies made lower lows into 2014, while some refused to make lower lows - even with additional unfavourable news.
Chart 2: EM currency index has been rallying despite media negativity…
Source: Short Side of Long
The problem with reading business newspapers, watching business channels, or reading investment bank reports on certain subjects, like the recent Emerging Market currency issues; is that these reports come out around the time a major trend reversal is about to happen. If we consider Chart 2 above, we can see that EM Currency Index has been declining for over three years already. Yes, that is right, over three years.
However, mainstream media only woke up to this during the final panic sell off and the bottoming phase in early 2014. It seems that just when everybody was getting ready for a EM blow up, the currencies decided to rally. This is why I always advise to follow the markets instead of following lagging economic data or business news. After all, markets are a discount mechanism and by the time something becomes obvious to the public, it's obviously wrong.
Chart 3: European Euro suffered a sharp sell off at overhead resistance
Source: Short Side of Long
European continent currencies such as the euro, franc, pound, zloty, krona and so forth have all performed well out of the July 2012 lows. In other words, despite the strength the US dollar has shown against various global currencies, European currencies actually outperformed. However, there seem to be signs that we are now reaching an inflection point and a possible reversal in this two year outperformance, where the dollar strength could make a comeback.
The euro suffered a very powerful reversal at a resistance about three weeks ago and has been under selling pressure ever since. According to the recent commitment of traders (COT) report released on Friday, hedge funds and other speculators have now turned net short the euro (refer to Chart 3).
Technically speaking, before we can confirm the euro’s new downtrend, we need to see the triangle in Chart 3 break on the downside. If you missed shorting the euro three weeks ago, you might get a second chance soon enough. Keep a close eye on this setup!
Chart 4: New Zealand Dollar is the new commodity currency darling!!!
Source: Short Side of Long
In the commodity currency space, the new investor darling has become the New Zealand Dollar aka the Kiwi. Hedge funds and other speculators have been obsessed with betting on the currency with large net long positions, as the currency attempts to push into new record highs. Whenever I talk to various friends within the country who are traders and investors, they seem to adore the Kiwi and hold forecasts that it might even reach parity with the Aussie dollar. Personally, I doubt this.
While the Kiwi might have some limited upside left, I have to admit that I haven’t seen “group think” on a currency this strong, since the Euro Crisis in 2010/11. Back than, just about everyone believed that the Euro will split apart and disappear and yet it recovered with a superb rally. To further this case, even the hated and heavily shorted Australian Dollar seems to have run through its short covering rally. Hedge funds are increasing their net longs by the week.
So how should one position for the future?
Investors need to understand that the post Lehman correlation between global currencies has broken down somewhat since 2012. Chart 5 clearly shows that the US dollar has been weak against European currencies as of the last several quarters. I believe this is now reserving, and I would move out of the euro and the pound.
At the same time, the greenback has shown strength against the yen, commodity currencies and EM currencies for a long time already. However, one needs to assess every currency on its own merits (as stated above), because out-performers like the Korean Won and New Zealand Dollar have bucked this trend.
Chart 5: USD has been weak against EU currencies but strong elsewhere
Source: Short Side of Long