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Tuesday 27 April 2010 www.blackswantrading.com

Key News

The euro slipped on Tuesday after Germany demanded painful new austeritymeasures from Greece in return for badly needed financial aid, with investors likely setto push high risk European sovereign bond yields up further. (Reuters)

China faces a cloudy international economy that is likely to drag down export growthlater 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 20percent, 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 whythe 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, heres a quickpeek at the Greece/ German 10-yr interest rate spreadexploding

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.
http://www.blackswantrading.com/http://www.blackswantrading.com/http://www.blackswantrading.com/

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Black Swan Capitals Currency Currents is strictly an informational publication and does not provide personalized or individualizedinvestment 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 Swans full

disclaimer, which is available at http://www.blackswantrading.com/disclaimer

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 realpossibility; at best the market is

under pricing the fiscal risk

facing the Eurozone and its

potential impact on the euro.

2. Germanys incentives to remainin 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 onvaluation 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 everyones radar screen. And though the other fiscal basket case countries

have been mentioned, the market doesnt seem to have caught on to the fact that taken

collectively the countries of Greece, Spain, Portugal, Italy, and Ireland have a worse debtprofile than Greece. Hard to believe but true

Portugal Spain Italy Ireland Greece Total PIIGS

External Debt

as % of GDP229.7% 156.7% 125.6% 294.0% 190.7% 199.3%

*Govt

funding need

as % of tax

revenues

101.2% 101.5% 128.1% 131.5% 118.4% 119.2%

*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 Germanys dominance of trade in the next section). Okay, fine. But, look

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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 wont work, all of these

countries bonds will most likely get hit very hard, pushing yields sharply higher, making

funding that much more difficult.

Whos 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 thoughPIIGS 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 thesecountries 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.

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Italy: 84 basis points over Germany. Ireland: 143 basis points over Germany.

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

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Summary:

Country

10-year benchmark bong

spread above Germany in

basis points

External Debt as % of GDP

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 Germanys exports. And yet that seems the only alternative, and heres 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

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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:

German Industrial Production thru Jan 2010:

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

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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 taxpayersto 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 thepaymasterGermanyquite hard. Its growth will in turn be slowed, and thus it

will be that much less willing to take on new commitments; this is likely why Germanfinance minister Schuble recent hard-line comments implicitly hinted at a German

escape from the Union; and explicitly said those who dont 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,

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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:

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Unemployment continues to rise in the Eurozone:

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

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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):

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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 overlookedcurrency 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:

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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

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2) German bonds continue to be the safe haven in Europe because of the risk ofholding 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 Economistmagazines Big Mac index of March 17th

, 2010, used for

measuring relative fundamental values of global currencies against the dollar, they showthe 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!

Its 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

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where the bull market in the euro began back in late 2000stay 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 itll 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 isnt 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. Its 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 youre playing for a major, longer-term move like this it makes sense to

be in the market. Of course, you dont 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 thelonger-term...

or theshorter-term, depending on your appetite for risk and your investing approach.

Dont waste anymore time.

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

(Heres our website if you need us:www.blackswantrading.com .)
http://www.blackswantrading.com/currency_investor/http://www.blackswantrading.com/currency_investor/http://www.blackswantrading.com/currency_investor/http://www.blackswantrading.com/positiontraderfx/http://www.blackswantrading.com/positiontraderfx/http://www.blackswantrading.com/positiontraderfx/http://www.blackswantrading.com/http://www.blackswantrading.com/http://www.blackswantrading.com/http://www.blackswantrading.com/http://www.blackswantrading.com/positiontraderfx/http://www.blackswantrading.com/currency_investor/

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