Currency

Forecasting, Causality, the Black Swan, and your Edge

Posted by Jack Crooks - Currency Currents

on Wednesday, 9 August 2017 17:23

Quotable

“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge. ” Lao Tzu, 6th Century BC

Commentary & Analysis

Forecasting, Causality, the Black Swan, and your Edge

Screen Shot 2017-08-09 at 9.44.54 AM

I shared this seemingly simple equation with you recently; and today I would like to add a few comments and delve deeper:

The currency equation of expected total return:

Screen Shot 2017-08-09 at 9.46.14 AM

This equation says the primary rationale for holding a particular currency is to maximize total return, and expected total return is a function of the real yield achieved (nominal interest rates minus the inflation rate) and the future exchange rate (that which we are trying to forecast).

Do rising real yields cause the exchange rate to rise … or is it a rising exchange rate, impacting the fundamentals, which leads to rising yields?

 

In the real-world prices are driven by tangled web of rationales which manifest into a complex array of feedback loops. I think this explains why it is so painfully difficult to determine which variables lead and which follow in a supposed correlation. The world “supposed” is used because correlation is not causality; and worst still, causality itself is suspect as Sir Karl Popper explains (below).

I could give you plenty of examples of when a currency’s relative yield dropped, yet the currency soared, and vice versa. It is rarely an A+B=C causation (though I plead guilty at times pretending it may be that simple). In fact, if you were to stop and calculate the odds of forecasting correctly based on your inherent A+B=C causality mindset, you might start to question the efficacy of ever forecasting again. 

In chess, there are 400 different possible positions after the opening two moves. There are 72,084 move combinations after each player has made two moves and over 288 billion scenarios after four moves each. The Shannon Number, which represents a conservative lower bound of the game-tree complexity of chess (the total possible move variations), is thought to be between 10^111 and 10^123. By comparison, there are 10^81 atoms that make up the known universe. I think we can all agree that national and global markets and economies are far more complex thanchess. So tell me again why you think you can predict what will happen next in the markets or in the economy….

                                                                                                          Bob Seawright, The Prediction Game
Maybe we should stop looking for causality as a source of confidence for our forecasts; especially if our causality flows from deductive reasoning.

Why we cling to Beliefs

Karl Popper, a German philosopher, referred to the black swan in his 1953 essay on The Problem with Induction. Induction application in the financial world is best known as “back testing.” Reading Popper gives one a deeper understanding of why we cling to beliefs so tightly and assume we can confidently project our expectations into the future and be confident we will be right.

Popper was fond of the philosopher David Hume and used his reasoning for much of the basis of his argument about induction, carrying it further. Popper wrote [my emphasis]:

But Hume held, at the same time, that although induction was rationally invalid, it was a psychological fact, and that we all rely on it. [We do rely upon it in our everyday life and it serves us well in lots of areas. But because “every moment in the market is unique” it serves us less well there.]

Thus, Hume’s two problems of induction were:

1) The logical problem: Are we rationally justified in reasoning from repeated instances of which we have had experience to instances of which we have had no experience?

Hume’s unrelenting answer was: No, we are not justified, however great the number of repetitions may be. [The point here again each moment in the market is unique; it’s may rhyme with the past, but there are differences.]

And Hume added it did not make the slightest difference if, in this problem, we ask for the justification not of certain belief, but of probable belief. Instances of which we have had experience do not allow us to reason or argue the probability of instances of which we have had no experience, any more than to the certainty of such instances.

2) The following psychological question: How is it that nevertheless all reasonable people expect and believe that instances of which they have had no experience will conform to those of which they have had experience? Or in other words, why do we all have expectations, and why do we hold on to them with such great confidence, or such strong belief? 

Hume’s answer to this psychological problem of induction was: Because of custom or habit; or in other words, because of the irrational but irresistible power or the law of association. We are conditioned by repetition; a conditioning mechanism without which, Hume says, we could hardly survive.

Okay! I realize this is getting thick, hang in there, almost there.

Popper agreed with the first part of what Hume talked about; the logical problem. But Popper, couldn’t accept the irrationality of the second part—the psychological problem.

It is here where we get to the black swan. Popper posed that yes we must use experience of past instances to advance our knowledge but we must accept the fact that just because so many past instances were effectively consistent, or the same, it does not therefore mean a theory based upon those past instances has been proven. The reason he says this is because there may be some future instance out there which invalidates all that has come before it, and it only takes one such instance to do that. Therefore, all theories can be falsified, but they cannot be proven simply by past experience.

…Or in other words, from a purely logical point of view, the acceptance of one counter instance to the view that, “All swans are white,” implies the falsity of the law “All swans are white”— that law, that is, whose counter instance we accepted. Induction is logically invalid; but refutation or falsification is a logically valid way of arguing from a single counter instance to—or, rather, against—the corresponding law.

This logical situation is completely independent of any question of whether we would, in practice, accept a single counter instance for example, a solitary black swan in refutation of a so far highly successful law. I do not suggest that we would necessarily be so easily satisfied. We might well suspect that the black specimen before us was not a swan. And in practice, anyway, we would be most reluctant to accept an isolated counter instance. But this is a different question. Logic forces us to reject even the most successful law the moment we accept one single counter instance. [Thus, can there ever be a market “theory”?]

The theory, or law, that all swans were white was falsified once a black swan living in Australia was discovered. Till then, everyone knew all swans were white. Done deal!

Of course, everyone knew Triple AAA-rated tranches of securities were safe—they had been in the past. Everyone knows municipal bonds will be fine because the default rate has always been low in the past. Everyone knows that gold is the only real money. Everyone knows inflation is a monetary phenomenon. Everyone knows the dollar must go down. Everyone knows that China will rule the world soon.

We could go on and on into infinitum with what everyone thinks they know. But interestingly, the things we seem to think we know often don’t even have the consistent instances of induction in their favor. We cling to ideas in the financial world that have been falsified before but seem to gather a second life. This isn’t even close to the word logical. But customs and habits are powerful motivators.

The Sufi summarizes Popper 

“There is an old Sufi tale about a mullah (Nasruddin) who was discovered by a passer-by searching in the dust outside his house. What was he looking for, the stranger inquired? A key, said the mullah. Where did he drop it? “In the house” replied the mullah. Then why was he looking in the dust outside? Because here he was in bright sunlight, whereas in the house it was dark and difficult to see.

“It happens to us all the time. The solution to worthwhile problems is never out there in the open. The key to financial markets is elusive. It must be so, by definition. The price-discounting mechanism ensures that the majority are always looking out there in broad daylight, when the key is somewhere else, in the shadow.

                                                    John Percival, The Way of the Dollar

Identifying the divers of currencies is quite elusive.

“Finally, one had to see if there were other relationships which had any predictive value for currencies like inflation, trade, money supply, oil prices, economic growth, et al. So far, the conclusion is that few such relationships and none of the relationships that most observers seem to rely on are useful for predicting the dollar                

                                           John Percival, The Way of the Dollar

I think this is where the trend followers get it right. They don’t try to explain all (or any) of the reasons why prices are heading in a certain direction; they simply want to “ride the bucking bronco” for all its worth, to quote Dunn Capital Management’s founder Bill Dunn.

So, we started off with a seemingly simple and sensible equation. But in this short time, I think I have shown it is neither simple nor sensible.

So where does this leave us?
I am not sure where it leaves you. But it leaves me with a few conclusions:

“It’s tough to make predictions, especially about the future.” ― Yogi Berra

1. Currency trading, unlike other asset classes, is primary a sentiment-driven vehicle. Sentiment analysis should be the primary focus of currency analysis. [Tao of Markets]

And though we should monitor things like yield differential and economic growth and capital flows closely, we should not attempt to forecast that stuff. Let others do all the forecasting. We need only concentrate on two things: 1) the consensus rational and 2) potential for surprise to the consensus rationale.

“Our success or failure will rest on our ability to anticipate prevailing expectations and not real-world developments.” – George Soros, The Alchemy of Finance

2. If what you are doing (your edge) works for you, then don’t let anyone tell you what you are doing is flawed.

The upshot: Avoid, or at least be very suspect, of those who hold themselves out as experts. Experts, or gurus, have no better handle on what the future will hold than you do. The difference is the experts make a lot more predictions about the future; then they selectively highlight the ones which panned out; the ones that didn’t they hope will slide down the memory hole.

Our guesses about the future have been working out well lately. Our positioning (below) was primary based on our expectation the crowd was becoming too bearish on the dollar (sentiment)… 

Screen Shot 2017-08-09 at 10.13.01 AM

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Here is an explanation of our trading style and methodology used to generate ideas for our customers.

Thank you.
Regards,

Jack Crooks
Black Swan Capital www.blackswantrading.com

info@blackswantrading.com

Phone: 772-349-6883 

USD Daily & Monthly

Posted by Gary Tanashian - NFTRH

on Tuesday, 8 August 2017 13:19

Since I am hanging out there with a view on USD that goes against all current trends (up in the anti-USD trade and down in Uncle Buck), may as well micro-manage it until resolved.

Daily USD is in its 2nd day of flagging after breaking the harsh downtrend channel, post-jobs.

usd1-1

….continue for more charts and analysis HERE

…also from NFTRH:

Participation from the S&P 500’s ‘equal weight’ components is thinning out markedly after putting on a mini-surge in June.

….continue reading HERE

U.S. Dollar: This Crash Signals the End

Posted by Lior Gantz for Streetwise Reports

on Monday, 7 August 2017 13:38

As the Dow breaches 22,000 and the U.S. dollar slides, Lior Gantz, founder of Wealth Research Group, discusses portfolio positioning

Apple reported earnings this week and the stock surged, taking the Dow Jones above 22,000 points for the first time in history. 

Gantz8-4-17-1

This is our script playing out as Wealth Research Group laid out months ago—we called it the Blow-Off Top.

The future holds broad indexes like the S&P 500, Dow Jones and NASDAQ soaring into all-time highs until there are no buyers left—we are two to three quarters away from seeing this.

At this point, investors purchasing stocks are doing so at the highest valuations the stock market has ever experienced.

Most sophisticated investors are like us at this point: 

1. All our Wealth Stocks, in which we took positions in for fair valuations, are part of our long-term core portfolio, and we won’t sell unless they become incredibly overvalued, which is when we’ll consider taking profits.

Remember that in the long run, compounding will get you to financial independence—it never fails, and we are positioned in the highest-quality businesses in the world.

2. Cash allocation should be around 20%, as liquidity will allow us to seize opportunities quickly.

But the biggest news yesterday isn’t the Bitcoin fork, which didn’t damage the cryptocurrency in the least. In fact, Bitcoin Cash is up 50% in a day the last time I checked. It’s not Dow Jones at all-time highs, either—it is the USD index breaking down.

Our top cryptocurrencies are on fire.

U.S. Dollar Index

This isn’t normal for the world’s reserve currency—this is highly unusual, and I want us to be prepared.

The USD rose 40%+ from early 2011 to the end of 2016. It was a massive uptrend, with huge implications for the global economy, but 2017 has seen a strong reversal. 

The first six months of 2017 were the worst six-month stretch for the dollar since 2011. 

The dollar is down more than 10% total in 2017. On July 21, the U.S. dollar hit a new 52-week low. That’s the first 52-week low we’ve seen in the dollar in more than a year.

After new 52-week lows, the dollar has fallen 1.3% in six months, 2.9% over the next year, and 4.8% over the next two years. 

The last time that the U.S. Dollar Index declined by 10% or more in a period of 151 trading days was back on April 29, 2011. At the time, gold was trading for $1,540.25, and over the following four months, it soared by $354.75 (a 23% gain) to a new record high of $1,895.

From today’s price of $1,270, a 23% move would take the price to $1,562, which would make 34% of the world’s undeveloped assets economic once again—certain high-quality mining shares will absolutely go parabolic.

This will be such a legendary run that you’ll probably be able to fund a decade of retirement from the profits you’ll bank.

Historically, from 1971 through today, when the U.S. Dollar Index declines by 10% or more during a period of 151 trading days, gold has gained by a median of 18.7% over the following 12 months. 

Gold Forward vs. Dollar Trailing

The way we’re going to get ahead of this trend is by holding our physical gold and silver coins and bullion—that’s our insurance for mismanagement of the fractional reserve banking system.

On top of that, we have been smart about partnering with the best management teams that can turn raw deposits into cash-flowing mines. And with the coming commodities bull market, these seed investments, which were made at times of severe pessimism, will be our biggest gainers.

Energy Index

Energy is the key to a commodities bull market.

When oil prices rise, the commodities sector, as a whole, becomes the focal point of the investment universe.

It’s either tech or commodities, and we get to benefit from both because we have been early to the cryptocurrencies sector, and we will be the pioneers of blockchain stocks as well.

Simultaneously, we have a foothold with the most solid mining companies out there.

The dollar is suffering a bear market, and while middle class America is losing purchasing power, our portfolio is completely hedged.

Lior Gantz, the founder of Wealth Research Group, has built and runs numerous successful businesses and has traveled to over 30 countries in the past decade in pursuit of thrills and opportunities, gaining valuable knowledge and experience. He is an advocate of meticulous risk management, balanced asset allocation and proper position sizing. As a deep-value investor, Gantz loves researching businesses that are off the radar and completely unknown to most financial publications.

Want to read more Gold Report articles like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent articles and interviews with industry analysts and commentators, visit our Streetwise Interviews page.

Disclosures:
1) Statements and opinions expressed are the opinions of Lior Gantz and not of Streetwise Reports or its officers. Lior Gantz is wholly responsible for the validity of the statements. Streetwise Reports was not involved in the content preparation. Lior Gantz was not paid by Streetwise Reports LLC for this article. Streetwise Reports was not paid by the author to publish or syndicate this article. 
2) This article does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer. This article is not a solicitation for investment. Streetwise Reports does not render general or specific investment advice and the information on Streetwise Reports should not be considered a recommendation to buy or sell any security. Streetwise Reports does not endorse or recommend the business, products, services or securities of any company mentioned on Streetwise Reports.
3) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the interview or the decision to write an article, until one week after the publication of the interview or article.

Charts provided by Wealth Research Group

 

What’s Feeding The Weakness In The Dollar

Posted by Martin Armstrong - Armstrong Economics

on Wednesday, 2 August 2017 15:26

Trump-DownTrump & Chaos

US President Donald Trump may be a good businessman, but in politics, he just does not get it. Politics is all about ego and back-stabbing. It is not about logic and the art of the deal. After just ten days in the office, Trump’s communications chief, Anthony Scaramucci has been forced to resign. The Chief of Staff John Kelly demanded a clean new start and and that meant the dismissal of Scaramucci. This last week had caused a lot of trouble, when Scaramucci attacked the now dismissed Reince Priebus and Trump’s chief Steve Bannon with vulgar words. Trump is under pressure, because he has not implemented many announced projects so far. He is kept spinning around in circles fighting things like gays in the military creating so many new wars and hatred alienating support for projects he promised like tax reform.

So far, Trump is a man who does listen, but he is also a man who is very much his own. He is out of his league in politics. This is not about the best deal for the country. This is indeed more than a swamp – it is an entire ocean of corruption and self-interest. Negotiating a business deal is a one on one arrangement with each having a self-interest. This is a multi headed beast with no possible way of confronting on so many levels simultaneously for every politicians has his own self-interest, which has nothing to do with the good of the nation. Trump has to STOP creating so many new wars and stop the personal tweeting to get even. Just get on with the tax reform before it is too late or he will find himself losing support from the people in 2018.

It has been this downturn in Trump’s administration that feeds the weakness of the dollar.

….also from Martin: 

Our European Tour – Part II – Seizing All Bank Accounts Throughout EU

 

 

Chart View: GBP/JPY and EUR/USD…

Posted by Jack Crooks - Currency Currents

on Tuesday, 1 August 2017 23:18

Quotable

“Good tests kill flawed theories; we remain alive to guess again.” –Karl Popper

Commentary & Analysis

GBP/JPY the risk trade?

The chart below shows cross-rate for the British pound versus the Japanese yen (GBP/JPY). Short this pair is our favorite trade should we finally get some risk (aka risk-off) flowing into this market (global stock sell-off). 

Screen Shot 2017-08-01 at 3.36.18 PM

And in the chart below you can see how GBP/JPY has moved relative to S&P 500 stock and Nikkei 225 stock index. The yen plays a safe-haven role when risk rises. So, if risk flows into the market we would expect the yen to act relatively strong compared to the rest of the currency pack. And if risk rises, the UK economy looks vulnerable. And increasing concern about the UK economy, in this still low inflation world would suggest traders might further push out any BOE rate hike expectations; likely weakening the pound. 

Screen Shot 2017-08-01 at 3.36.43 PM

EUR/USD Again…

We’ve been getting burned in our efforts to short EUR/USD lately. But hope springs eternal and maybe you can see some hope for euro shorts in the two charts below.

1. EUR/USD Weekly – Heading into a key resistance level at 1.1875. A good place to correct the powerful move from the 1.0339 low; before going higher. 

Screen Shot 2017-08-01 at 3.37.08 PM

2. EUR/USD vs. German Dax (stocks) vs. 2-year spread (Eurozone – United States) Daily...we emphasize two points here: a) Despite the sharp rally in the Euro against the dollar, the yield spread hasn’t followed. It goes to point it isn’t always about yield differentials, but the expected yield differential. With the Eurozone growth improving, the expectation is for a rising spread in favor of the euro; and b) Note the tight correlation between the movement in German stocks and EUR/USD. Money flow to European stocks equals buying euro.

Two “buts” here. 1) What if the ECB disappoints; and 2) what if we have a major, or even, minor correction in stocks. And not seen here is the fact the US stock market is outperforming the German stock market. Maybe time for a bit of rethink among the red- hot euro bulls? 

Screen Shot 2017-08-01 at 3.37.36 PM

 

Regards,

Jack Crooks
President, Black Swan Capital

www.blackswantrading.com

info@blackswantrading.com.