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Last Sunday, one of my friends asked me to take a look at his retirement portfolio during the Super Bowl halftime show.

Because of extreme market volatility over the last few years, Larry has been keeping most of his investments in a “conservative portfolio model.”

Something caught my attention immediately. He was making a mistake that’s fairly common among investors.

Larry had no exposure to emerging markets at all. None. Not a single stock.

So I told him his portfolio wasn’t diversified enough.

This will turn out to be an even bigger mistake this year.

Let me explain….

How My Friend Got Lucky Last Year

Last year was horrible for emerging-market stocks.

The stock markets of Brazil, Russia, India, and China, the so called BRICs, all declined by at least 25%. They performed much worse than the U.S. market, which was basically flat.

What happened? In one word – Inflation.

Those countries started to face rising inflation in 2010. So central banks in most emerging markets started to raise interest rates aggressively in mid-2010. Brazil, for example, hiked rates from 8.75% to 12.5% to fight inflation.  

As you know, stocks hate higher interest rates because it slows down economic growth. So this was a big reason many emerging market stocks had a poor performance. 

So Larry is definitely happy he didn’t have any exposure to emerging markets. But he needs to rethink his strategy because now the tide seems to be turning…

Two Good Reasons to Go Abroad

Those higher interest rates have worked. Inflation has come down in several emerging-market countries, leading their central banks to stop hiking interest rates. In fact, most of those nations have started to cut rates again to stimulate growth.

All four BRIC countries have been easing monetary policy recently. And so have other emerging markets such as Indonesia, Philippines, Turkey, and Chile. With lower interest rates, the outlook for stocks in those countries is positive.

And there’s something else to consider.

Based on a forward Price to Earnings ratio (a measure of how much investors are willing to pay for $1 of expected earnings), BRIC stocks are cheaper than domestic stocks. The BRICs currently trade at forward P/E ratio of 9.6, compared to the S&P 500 ratio of 12.8.

According to this metric, BRIC stocks would have to rally 33% to match the valuation of the S&P 500 index.

Declining interest rates and cheap valuations are good reasons to jump into emerging market stocks now. Should you do it? The chart below says yes!

BRICs Have Started to Outperform

I personally like to look at relative price strength to help me decide when to increase exposure to emerging markets. To help you understand how this works, let’s take a look at the iShares MSCI BRIC Index Fund (BKF), an ETF that tracks the performance of stocks in BRIC countries.

We can see how the BRICs are doing compared with U.S. stocks by simply dividing its price by the S&P 500 index. This creates the relative strength line you see below.

The idea is pretty simple. If the line is rising, BRICs are outperforming U.S. stocks. If the line is falling, they are underperforming. So you want to add exposure to BRICs when the relative strength line is in an uptrend.

Notice that BRIC stocks underperformed domestic stocks for the past 18 months. But the relative strength line has just violated the downtrend, as you can see in the circle in the chart.

Shaping Up for a Great Year

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 This looks like the beginning of a new trend where BRIC stocks perform better than the U.S. market.

The last time the relative strength line violated a major downtrend line was at the beginning of 2009. At that time, BKF started a rally that ended more than 120% higher. It was the perfect time to jump into those markets.

These trends of relative performance tend to last several months, so these latest signs mean that it’s time to jump in again.

So 2012 is shaping up to be a great year for emerging market stocks.

Make sure you don’t make the same mistake as my friend, Larry.

Best Regards,

Evaldo Albuquerque

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Have you heard of PCEPI?

Probably not.

This is the Fed’s biggest and dirtiest secret and it doesn’t want you to know.

But it’s important to understand what “PCEPI” is because it will have important implications for your investment portfolio and what you have to do to protect yourself.

The Fed last week said it will most likely keep interest rates near zero until late 2014. In other words, you won’t earn anything if you keep your money in U.S. money market accounts.

And “PCEPI” is largely behind this latest Fed move.

Let me explain…

How Bernanke Creates the Illusion of Low Inflation

Bernanke thinks “zero interest rates forever” is appropriate because he has a “subdued outlook for inflation in the medium run.”

And that’s where the PCEPI comes in. It stands for Personal Consumption Expenditures Price Index. And it’s what the Fed uses to measure inflation.

The PCEPI tracks the price of some goods, just like the Consumer Price Index (CPI). But there’s a big difference. The PCEPI assumes that consumers switch spending from higher priced goods to those that are stable or falling.

For example, if the price of steak goes up, the PCEPI assumes you will start eating ground beef. So it replaces steak for ground beef in its basket of goods.

Isn’t that a nice trick? No wonder inflation is always low for the Fed.

A Long History of Lies

The Fed has become quite an expert in creating this illusion of low inflation.

In 1980, it changed the way it calculated the CPI. The new methodology made the new CPI rise at less than half the original measure. If the Fed was using the original methodology, the official inflation would be much higher today.

Don’t believe me? Take a look at the chart below from the website, Shadow Government Statistics. This is one of the few organizations that still keep track of the original CPI. Based on that metric, inflation is actually above 10% today.

And it gets worse. Tinkering with the CPI wasn’t enough for the Fed.

So it created the PCEPI in 2000. Because of the substitution effect I mentioned above, this index rises at about one-third less than the CPI.

The Fed’s official inflation is a big lie. That’s like adjusting your clock just to make it look like you’re not late for a meeting. Or tinkering with the balance just to make it look like you lost a few pounds, when in fact you gained.

Inflation should be used to measure the loss of purchasing power, and the resulting decline in standard of living.

But by replacing goods that rise in price for cheaper ones, the Fed is able to keep the official measure of inflation low, despite the dollar’s clear loss of purchasing power.

So here’s a question for you…

If you suddenly have to start eating ground beef because you can no longer afford steak, doesn’t that really mean your standard of living is declining?

The Fed’s measure of inflation is essentially meaningless.

How to Protect your Assets from the Fed’s Lies

The best way to shield your assets from inflation is by having solid exposure to commodity currencies. Those are the currencies that will rally the most when the true inflation is rising.

And the reason is simple. Because commodities are priced in dollars, when the buck loses value, the price of these hard assets increases. So by investing in commodity currencies, you can protect your wealth against inflation.

Commodity Currencies Love the Fed’s Inflationary Policy

Based on the Fed’s calculations, we will never have inflation. But that’s a big illusion.

The truth is that you are losing purchasing power as the Fed continues to attack the dollar.

The best way to protect your portfolio is to invest in commodity currencies, such as those I have shown above. I would buy those on any dips.

Best Regards,

Evaldo Albuquerque

P.S. The U.S. unemployment rate dropped to a near-three-year low of 8.3% in January, as the economy added 243,000 new jobs, the largest since April 2011 and far above forecasts. Job growth in November and December was also revised upwards. At the same time, U.S. consumer spending remains stagnant and the dollar continues its death by a thousand cuts. However, amid this confused economic picture, there is a way to put those sinking dollars to work in an overlooked part of the currency market. It’s a strategy that is persistently dishing out substantial returns. In spite of the tough market out there, every investor needs a trump card. To learn the secret of how to grab double-digit gains – even in markets as volatile as this – click here…

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I feel sorry for Mr. Draghi, the European Central Bank chief.

About a month ago he announced his own version of quantitative easing, pushing the euro lower. For a moment, he thought he would steal the title of “best money-printing central banker” from Bernanke.

How naïve…

When it comes to destroying the value of a currency, nobody can beat Bernanke.

Last week, the Fed counterattacked the ECB’s actions by announcing that it would keep interest rates at near-zero until late 2014. Bernanke also let the market know he would not hesitate to print more money.

This is a new battle in the ongoing currency war. At the end of this war, there will be only a few winners, and a lot of losers.

However, there are a few things you can do to make sure you’re not one of the losers.

And the most important thing is to diversify away from the dollar into stronger currencies and assets.

Let’s look at it this way…

The Race to the Bottom Goes On

The two most important central banks in the world, the Fed and the ECB, are now trying to destroy the value of their currencies. It’s truly a race to the bottom.

Who will win the race? Until recently, it looked like the ECB had left the Fed behind. It was attacking its currency in a much more aggressive way.

Luckily for us, it’s easy to measure the money-printing activity. We just have to look at the size of the central banks’ balance sheet. It’s an easy way to measure how much money and credit central bankers are pumping into the system.

You see, central bankers print money by injecting capital into their banking system. They take financial assets in exchange for that money. Those assets show up in their balance sheet. So when the balance sheet is growing, it means the printing press is running at full speed.

Take a look at the chart below. You can see the Fed’s and the ECB’s balance sheet. During the first half of 2011, the Fed was much more aggressive than the ECB.

But since August of last year, the ECB’s balance sheet has been expanding much faster than the Fed’s. No wonder the euro dropped during that period.

Until Recently, the ECB was Winning the Race to the Bottom

The Next Battle is Coming in February

The ECB’s balance sheet is growing because it’s providing three-year loans to banks. In exchange, the ECB gets financial assets, such as Portuguese bonds, as collateral. It has also purchased some sovereign bonds for its own account.

The ECB’s balance sheet has now expanded to 29% of the euro zone’s gross domestic product. In the past six months, the ECB has injected a whopping €500 billion into European banks. That’s more than the Fed did in all of QE2.

The ECB keeps denying it’s implementing its own version of quantitative easing. But that’s what it is.

In fact, while the Fed’s balance sheet grew nearly 18% over the last year, the ECB’s grew 37%. Just in the last three months, its balance sheet has grown at an annual rate of 90%.

And the second round of money-printing in Europe is coming this month. At the end of February, the ECB is expected to lend as much as €1 trillion to European banks.

Protect Your Finances from This War

If you still have any doubts whether we’re facing deflation or inflation, you just have to look at what the Fed and the ECB are doing. With the two most important Central Banks on the planet printing money, there’s no question that inflation is a bigger threat to your finances.

That’s why it’s important that you diversify away from the dollar into stronger currencies, such as the Norwegian krone, Singapore dollar, and Australian dollar.

Another big winner of this currency war will turn out to be gold. The yellow metal is the perfect way to hedge against money-printing and the ongoing currency war.

In fact, gold has taken notice the ECB and the Fed are both attacking their own currencies. It’s already up 8% this year.

I hope you followed my advice in September and took advantage of last year’s gold correction. In that article I mentioned if gold fell close to $1,500, it would be a great opportunity to buy the yellow metal.

The biggest winner in this currency war will be gold.

And if you don’t invest in gold and diversify away from the dollar, you may end up being the biggest loser.

Best Regards,

Evaldo Albuquerque

P.S. While America falters, our continued investigations have led us to countries where economic growth, profit and freedom all share the same side of the same coin. The Sovereign Society’s Executive Director, Erika Nolan and Jeff Opdyke, Investment Director, are planning a tour to one of those places, Uruguay, from February 27, 2012 to March 3, 2012. We’re taking a handful of sovereign-thinking individuals with us to wine and dine with hand-picked experts, who will share secrets most Americans will never discover. This is a unique opportunity to visit this fascinating South American nation and, at the same time, learn how to secure your wealth in the future. Spots are limited, so please get in touch as soon as possible to make your reservation.

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The S&P 500 index has been on a tear. It just had the best Januray since 1997. And it seems nothing can stop stocks from rising. But now it’s the time to start being careful. The index is approaching the critical level around 1,350. We will likely see a correction around that level. Take a look at the chart below.

Last year, the S&P 500 completed a Head and Shoulders pattern that indicated stocks would move lower. And they did. But now stocks are once again trading higher than the so called neckline of that pattern. This is a bullish signal. The level 1,300 now should act as a support, meaning that a lot of traders will be buying stocks around that level.

So how high can the stock market go from here?

My guess is the index is heading to 1,350, thanks to all the money-printing from the Fed and the ECB. But I would be extremelly careful buying stocks around that level. Last year there was a lot of selling pressure around that level, so I expect to see the same again.

It’s also important to consider that stocks are extremelly overbought, and everyone is bullish. The sentiment survey of the American Association of Individual Investors currently shows investors less bearish than at any time since late 2010. So it’s extremelly likely we will get a significant correction around 1,350.

This is important because the S&P 500 and the dollar are moving in different direction. So if stocks fall, the dollar will most likely recover a little. Since the dollar is extremelly oversold against most currencies, it’s also reasonable to assume a dollar correction.

Of course things can remain overbought for a long-time, and I would not make any bets just based on the overbought level. But keep in mind that 1,350 is a key level. I will be looking for defensive trades if I see signs stocks are reversing around that level. And that means buying the dollar for a short-term trade.

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The Fed announced this week it will keep interest rates at zero until late 2014. There’s no question this is bad news for the US dollar. However, we could see a short-term rebound in the dollar soon. Take a look at the daily chart of the dollar index below. This index measures the performance of the buck against six other major currencies.

As you can see, the dollar is now testing a key support line. This is key because it’s the neckline of a major inverse head & shoulders pattern. Once the dollar broke above that neckline, it confirmed the dollar was in a big uptrend. But that was before the Fed’s statement.

The dollar has been dropping for the last few days. The latest Fed announcement will now put more pressure to the downside. But if this key support line holds, the dollar should move higher from here.

However, I think the most likely scenario now is the dollar will end up breaking below that line. When that happens, we will have a false inverse head and shoulders. In that case, the dollar could move much lower. False breakouts tend to lead to massive moves in the other direction.

In this particular case, the breakout above the neckline was indicating the dollar would move higher. But now it looks like this was a false signal. So keep watching that line. If the dollar index breaks below it, Bernanke will get what he wants: a much weaker dollar.

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One of the charts I’m watching right now is the MSCI Italy Index. It tracks the performance of Italian stocks. As you can see in the chart below, Italian stocks tanked last year, as investors started to price in the risk of a severe recession in the country.

But stocks have been rallying recently. So the Italian stock market is reflecting that things may not be so bad. Italy may end up not having a severe recession because of all the austerity measures it’s implementing.

While the stock market seems to be bottoming, it’s still to early to say if the trend is turning. If the index closes above the recent high level (the horizontal line), we will have a double bottom pattern. This will be a stronger indication the trend is turning and things will turn out to be ok in Italy.

Another chart worth watching is the yield on Italian 10 year bonds. Notice the chart below is almost like a mirror image of the stock market. That happens because if the economy doesn’t have a deep recession, it will be easier for Italy to pay its debt.

So now that market sentiment has been improving, the yield on Italian bonds are coming down. If economic data starts to surprise to the downside however, stocks in Italy will move lower, and yields will move higher.

Those two charts will help you decide when is a good time to short the euro. Is stocks fail to break to the upside, the euro will most likely head south once again.

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Mr. Market is a very tricky character.

He always does what you least expect.

Take last year, for example. The consensus at the beginning of 2011 was that global economic growth would be healthy, and that it would be a good year for stocks.

We all know it didn’t turn out that way. The market had lots of ups and downs, and finished the year at breakeven.

This year started with the consensus that global growth would face a lot of challenges, so stocks and commodities would have a tough time. So the least thing anyone expected was for the market to begin the year with a big rally in stocks and other risky assets.

And of course that’s exactly what we’re getting. That’s how Mr. Market operates. And that’s why it pays to bet on unpopular assets. It’s no different in the currency market.

One of the most unpopular currencies has just started a big rally.

It’s Time to Love This Hated Currency

When looking for trading opportunities, it’s always a good idea to start asking “what is it that everyone hates right now?”

Late last year, I asked myself that question. What is the most hated emerging-market currency right now?

The Mexican peso was on the top of the list. It was one of the worst-performing currencies of 2011, losing about 18% of its value just in the second half of the year alone.

That’s a huge move in the currency market. To put it in perspective, the euro, also a contender for the most hated currency in the world, lost less than half of that during the same period.

The least thing anyone expected late last year was for the Mexican peso to start a big rally. So I jumped right into the trade.

There are two particular assets that helped me make that decision. Let me explain.

Finding Something Fishy in the Charts

When I trade the Mexican peso, I always have to check how two other assets are doing: stocks and oil. The reason is simple.

The Mexican economy still depends a lot on the U.S. economy. We buy about 80% of their exports. So if our economy is doing well, their economy tends to do well too. So far this year, economic data has been surprisingly strong in the U.S. No wonder stocks have been rallying.

The Mexican government is also very dependent on oil revenues. As a major oil producer, its economy tends to do well when the price of oil is rising.

So both the stock market and oil have been rallying. With the S&P 500 trading above 1,300 and oil above $100, the Mexican peso should be shooting through the roof, right?

But it didn’t happen. Check out the chart below.

Mexican Peso Has a Lot of Catching Up to Do

Please click here to view larger image

It’s clear there’s a pretty strong correlation between the Mexican peso, stocks, and oil. They moved together for the past 3 years. But while oil and stocks started a major rally in October of last year, the peso just moved sideways and was left behind.

It didn’t make any sense.

It’s Not Too Late to Profit

The Mexican peso is only now starting to move in the “right” direction. So it still has a long way to go catch up with the S&P 500 and oil.

An easy way to profit from that in the spot market is to short the pair USD/MXN. By shorting the pair, you will be betting the peso will appreciate against the dollar.

In fact, that’s exactly what I did when I saw this divergence in the chart. I recommended that my Exotic FX subscribers buy the peso.
We now have open profits of about 60%, using 20:1 leverage. And we’re shooting for tripe digit gains.

But it’s not too late to bet on the peso.

According to my analysis, the pair USD/MXN will move down to 12.90, at least. That’s a potential profit of 50% from current levels, using 20:1 leverage. And if stocks continue to move higher, the pair will drop much lower than that. It is now oversold, but I would short USD/MXN on any pullbacks.

This year we will see lots of ups and downs in the S&P 500. Trading the Mexican peso will be one of the easiest ways to play that volatility in the stock market.

Stocks have started the year on the right foot. And so has the peso. Until very recently, everyone hated the Mexican currency. But now it’s starting to get some love.

Under this positive investment sentiment, the peso remains a very good bet.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

P.S. As anxious investors seek a haven from the European debt crisis and protection from the impending threat of higher inflation, our job at The Sovereign Society is to search out new trends for important, new investment opportunities in places few others are looking. One such opportunity is the advent of digital currency. Our in-depth research reveals this economic phenomenon has created a number of extraordinary investment opportunities. For access to our unique research report, click here.

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As you know, the market views copper as the metal with a PhD in economics because it tends to be a good indicator of global economic health. When global economy is growing at a healthy pace, copper tends to rise. When it’s not, copper tends to fall.

Copper has just broken a consolidation pattern to the upside. Check out the daily chart below. It shows copper broke to the upside of a consolidation pattern known was triangle. This is good news for commodity and commodity currencies. It’s a sign we’re in a “risk on” environment.

The real test for copper will come at the 3.88 level, where the 200 day moving average is now trading. Right now copper is at 3.72. I suspect copper will fail to break above that level, as investors realize the recession in Europe will be worse than expected, and it will end up affecting the global economy.

Besides that, copper has been following stocks higher, as investor sentiment improves. But investors are extremelly bulish right now, which is another reason to be careful. With the S&P 500 testing the key level around 1,300-1310, we could see a pullback in stocks and copper in the short-term.

But I have to admit…if the S&P 500 closes above 1,305 at the end of this week, I will have to rethink my overall bearish view. So far, I’m playing this improved market sentiment by buying the Mexican peso, which has been working quite well. My Exotic FX subscribers are up by over 2,000 pips on that trade.

If this good market sentiment persists, with copper and stocks breaking higher, commodity currencies should perform really well.

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Buying the dollar is the right trade right now. But this may not be the best time to jump in. It’s just a really crowded trade. Everyone loves the dollar, and hates the euro right now. I want to go long the dollar, but I’m waiting for the right time. We may get a good opportunity next week.

Take a look at the weekly chart of the dollar index below. The RSI indicator at the bottom shows the index is now approaching overbought levels. The most important thing to watch however is how the price will close on Friday.

As you can see, I’m using a Japanese candle chart for this analysis. The last time the dollar index was at the same overbought levels, that week closed with a Japanese candle pattern known as doji. We’re seeing something similar developing this week.

This kind of pattern develops when the price opens and closes at the same level. So the candle ends up having no real body. This indicates indecision, and usually is a sign the trend is close to peaking in the short-term.

If the dollar index closes this week with a doji, it’s very likely we will get a good correction next week, especially with the dollar approaching overbought conditions. I would use any dollar correction to establish new long dollar positions.

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Think of a number. I’m serious… this is a matter of financial life or death.

How about 1,257?

That’s the S&P 500 equity index closing level for last year.

It’s also the closing level for the year before, 2010.

And it’s the level where the index was trading back in 1999.

In other words, the stock market went nowhere last year, and if you bought the equity index in 2011 you made no money.

As a matter of fact, it’s been going nowhere for the last 12 years.

But it certainly doesn’t feel like that. Last year’s chart of the index looks like a design of a new roller coaster, with crazy ups and downs. So does the chart of the last decade.

What’s going on? What happened to the good ol’ buy-and hold-approach?

That static number – 1,257 – holds the key to what you should do next, and exactly why you should do it.

The Bear Market of 2000 until Who Knows When

We need to understand what’s going on here.  Let’s take a huge step back and look at the big picture. Let’s go back all the way to 1810.

Throughout its history, the market has gone through long periods of just moving sideways or lower.

These are called secular bear markets. That’s exactly what we’re in right now, as you can see in the long-term chart of the S&P 500 index below.

The Current Secular Bear Market Started in 2000

Please click here to view larger image

Those multi-year bear markets happen constantly throughout history. It’s the market’s way of cleaning up the mess accumulated during the long-term boom periods.

During secular bull markets, when stocks are moving up, investors feel so good they end up making careless mistakes.

Greed takes over, and investors lose their common sense. That results in financial excesses, misallocation of capital, bubbles and fraud.

This is exactly what happened from 1980 to 2000. The excesses of those decades resulted in a huge credit bubble. Now the market is trying to clean up the mess. This will take some years.

On average, bear markets last 18 years. The economy also usually goes through at least four recessions to clean up the excesses that were built up during the good years.

We’ve been in a bear market for 11 years now, and we’ve only had two recessions so far. The shortest bear market in history lasted 16 years. All these historic data suggests the current bear market is far from over.

Adjust Your Strategy

Most investors who are approaching retirement lived through the last bull market. They got used to the “buy and hold” approach.

That’s appropriate during bull markets, but not during bear markets.

If you’re among those investors who are still buying the S&P 500 index and holding it for the long-term, you need to adjust your strategy.

What will happen to your portfolio if there’s another big crash in the next two-three years, just when you’re expecting to retire?

The “buy and hold” approach is dead – at least for the next five years.

A New Year’s Strategy to Survive and Thrive

What’s your New Year’s resolution? Get fit? Get out of debt? Quit smoking?

If you’re a “buy and hold” investor, who buys the S&P 500 index for the long-term, I have a New Year’s resolution suggestion for you…

Last year, we saw some crazy up and down moves. We can expect the same kind of market movements for the next few years.

If you’re not able to get in and out of the markets like a professional, it’s a matter of absolute financial survival that you adopt a tactical approach.

You need to protect your portfolio during the devastating declines that take place in secular bear markets.

The Forex market offers an easy way to do that.

One of my favorite ways to protect my portfolio during those downturns is to short emerging market currencies.

Those currencies tend to get crushed during market downturns, and shorting them is an easy way to profit.

During the 2008 stock market crash, for example, currencies such as the Hungarian forint, South African rand and Mexican peso lost more than 35% of their value.

You can even use those gains to offset some of the losses in your stock portfolio.

Nobody knows for sure when the next stock bull market will begin again.

But history suggests it will take at least another five years.

The next few years will likely be a “trade or die” environment – and my advice is to trade.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

P.S. Don’t miss The Sovereign Society’s ONLY offshore event of 2012.  This is your chance to take advantage of our January discount to attend the 11th Annual Total Wealth Symposium. Now you have the opportunity to join us in beautiful Los Cabos, Mexico at a drastically reduced price. To ensure you don’t miss the opportunity to attend this action-packed, wealth-boosting event at a steep discount… I strongly urge you to reserve your spot today. For full details, click here.

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Europe’s woes will not be banished – and this week, just when you thought it was safe, things got even worse.

Spain announced its 2011 deficit will be much deeper than anyone thought – and that means it will almost certainly need a bailout, sooner or later.

Borrowing costs for countries like Italy and Spain are still skyrocketing, which makes it harder for them to roll over their debt.

Meanwhile, trading in UniCredit, Italy’s largest bank, was suspended after shares tumbled in response to a heavily-discounted share offering. This indicates the bank is having trouble raising capital, making it a strong candidate for another European bank failure.

How Low Can it Go?

There’s no question that all this is bad for the euro.

But how low can it go?

We don’t have a crystal ball, but we have the next best thing – chart patterns.

One of the most reliable chart patterns, known as Head & Shoulders, is now saying the euro could drop all the way to $0.90.

If you’re not familiar with this pattern, you can read this article I wrote last year explaining how it works.

In that article, I also showed how this pattern could have saved your portfolio from the 2008 stock market crash.

It’s basically a pattern that indicates that an asset will move lower, much lower.

Let’s take a look at the big picture for the euro. Below is a monthly chart that goes back to 2001, when the euro started a major bull market. Notice there’s a massive potential Head & Shoulders forming right now.

Please click here to view larger image

I say “potential” because this pattern is only complete if the price closes below the black line, known as neckline.

Right now, that line is at 1.24, so the euro is still trading above it – but not by much. It’s trading around 1.27 today.

One of the great things about this pattern is that once it’s complete the price usually falls by the same distance that separates the top of the head and the neckline. So you can use that distance to project a minimum target.

The target in this case would be around $0.90, which is much lower than anyone expects the euro to go.

But can the euro really close below 1.24?

Well, another Head & Shoulders pattern, this time on the weekly chart going back to 2010, shows it will certainly happen.

Notice that the price has already closed below the neckline. Using the distance between the top of the head and the neckline, you get a minimum price target of 1.22.

Please click here to view larger image

The Fed Will Keep the Dollar Weak

My observation about the Head & Shoulders is not a prediction. It’s just, well, an observation.

I rarely disagree with the pattern because it’s very reliable. But I find it hard to believe the euro will move all the way to $0.90. Why? Because of the Fed.

If the euro drops that much, it will mean the dollar will be much stronger – and the Fed won’t allow that to happen.

It wants a weak dollar to boost the U.S. economy through exports.

Besides, if the euro drops much lower, Europe will very likely be in a very deep recession.

The euro zone accounts for about 16% of the world economy. If we get a deep recession over there, it’s unlikely the U.S. will be immune.

If a recession spreads from Europe to the U.S., the Fed will have a good excuse to start printing money again, driving the dollar lower.

Nonetheless, the Head & Shoulders pattern indicates the major trend of the euro remains down, and it could move all the way to 1.22 in the weeks ahead.

Profiting from the Smaller Currencies

And if it closes below 1.24 on the monthly chart, we will have strong evidence the euro zone is falling apart, and the euro will move much lower.

It also shows that, if the euro fails to close below 1.24 on a monthly chart, it could have a big rally, much like it did in 2009 and 2010.

There will be a lot of demand for the euro around 1.22-1.24. So my instinct is that will be a great level to buy the euro for a short-term trade.

But for now, any euro rally is a shorting opportunity. I will be betting against the euro by shorting smaller European currencies, such as the Czech koruna and the Polish Zloty.

Very few people believe the euro will move all the way to parity. I don’t know anyone who believes the euro will move below it.

But the Head & Shoulders says the euro’s downside risk is much larger than anyone thinks, and it could still move all the way to $0.90.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

P.S. The early-session jump is global equities this morning that followed the robust U.S. jobs report got knocked back to around flat by those pesky Europeans later in the day. In the middle of long-term bear market, little else is to be expected. The days of buy and hold are dead. But there is another way. There is always a bull market in currencies, so if you’re looking for rapid-fire profit opportunities and bullet-proof body armor that minimizes your risks – take a look at the 8-minute “profit windows” my colleague, Tom Gregory, has uncovered. Tom is one of the world’s top global currency traders and he’s helping investors just like you take advantage of these profit windows as they open and shut up to 14 times a day. Let me correct that: he’s not just “helping” … he spends two hours, three days a week, literally walking investors through the trades so they sign off richer than when they sign ed on. Take a look right here.

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For the past year, the “risk on”/”risk off” trade dominated the markets. When risk is on, investors sentiment is good, so stocks, commodities, and higher yielding currencies rally, while the dollar drops. When risk is off, the opposite happens.

At least that was the case until recently. But something is changing. In the past, the euro also rallied under “risk on” environment. In other words, the euro had a strong correlation with other “risk on” assets, such as the S&P 500 and the Australian dollar.

But the correlation is breaking down. Take a look at the daily chart of those three assets below.

Notice that recently, the equity market and the Aussie have been moving up, while the euro is dropping like a rock. What’s going on here?

There are 2 possible interpretations:

1) The drop in the euro suggests the situation in Europe is much worse than expected. Soon all hell will break lose, and the euro will drag the S&P 500 and the Aussie down in a classical “risk off” move.

2) The drop in the euro suggests the ECB is embarking in its version of money-printing, which is good for risky assets, such as stocks and the Aussie. So the euro could fall even in a “risk on” environment.

The correlation breakdown suggests the market favor interpretation #2. So we could continue to see traditional risky assets rallying, despite the collapse in the euro.

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Yesterday the stock market had a great day, breaking above its 200 day moving average. This is a bullish sign. However, it’s too early to tell if stocks will continue to move higher in the next few weeks.

As you can see in the chart below, the equity index has crossed above that important moving average a few times last year, but failed to hold above it. The moving average is now around 1,260. Let’s see if the index can hold above that level.

The chart also shows the index remains in a big consolidation pattern, moving sideways. It’s a massive triangle that will have important implications, once there’s a breakout. The real test for the S&P 500 seats around 1,300. It needs to break above that level to make the bulls’ case valid.

If the index breaks that triangle to the downside, it will be a sign the bears have taken control. The market then will have the potential to test last year’s low levels.

For the currency market, it’s important to watch what is going on with the S&P 500 because many currencies, such as the Mexican peso and the Australian dollar, tend to follow that index.

If the equity index breaks to the downside, it will be a good time to buy the dollar against those currencies. If it breaks to the upside, it will be a good time to buy those currencies against the dollar.

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Here’s a sure way to make money – the world’s best investors and traders follow this simple rule:

Buy low, and sell high.

The rule seems simple enough, but few people are able to follow it. Generally, it requires going against the crowd – which, of course, is much easier said than done.

Most people feel safer going along with the majority, but the truth is that the most profitable trades are usually those which go against the grain.

Today, shorting the euro is one of the most crowded trades in the financial markets. So should you go against the crowd and buy the euro?

Before we answer that, first we need to take a look at what being a contrarian really means.

The Art of Being Contrarian

Only a small handful of people understand what it means to be a contrarian investor or trader.

For a start, it’s not just about moving in the opposite direction to everyone else. There’s no point in going against the crowd just for the sake of it.

The crowd is actually correct most of the time.

But my experience has shown me that it’s the turning points where most people get things wrong.

So just because everyone is bearish on an asset doesn’t mean it will soon rally. And just because everyone is bullish on an asset, it doesn’t mean it will soon crash.

The most important thing is timing… in other words, when to go contrary. And, for that, you need to be able to justify your contrarian view with a logical and well-reasoned argument.

Let’s apply this idea to the most crowded trade in the Forex market -— the euro.

Finding the Right Turning Point

Everyone hates the euro now.

According to the latest data from the Commodity Futures Trading Commission, bets in the futures market against the euro are now at an extreme level.

Hedge funds and other large speculators have 113,697 more bets that the euro will fall against the dollar than gain on it.

That’s a net-short position similar to what we had back in May 2010, during first episode of the Greek crisis. In June, the euro started a massive, multi-month rally that pushed the currency up by more than 24%.

That’s the perfect example of how the crowd was wrong at a turning point. Is the crowd wrong again this time? I believe the chart below holds the answer.

One Number Holds the Key to the Euro’s Future

This number is probably the most important driver of financial markets these days. It’s important not only for the euro, but for commodities and stocks across the globe.

I’m talking about the yield on Italian bonds.

The yield on 10-year bonds, for example, has been trading very close to the critical 7% level. Such a high borrowing cost is not sustainable.
It also suggests the latest measures taken by the European Central Bank have not increased confidence in the European bond market.

Italy’s Higher Borrowing Costs is Pushing the Dollar Up, and the Euro Down

Click here to view larger image

The chart above shows the yield on Italy’s 10-year bond and the performance of the fund UUP. This ETF measures the performance of the US Dollar against six other major currencies. So it’s a good way of measuring the strength of the buck.

Notice that during the first half of 2011, Italy’s borrowing cost was pretty stable, with the yield trading below 5%. The dollar was in decline during that period, while the euro was rallying.

But the yield on Italy’s bond started to get out of control back in September, moving quickly towards 7%. Since then, the fund UUP has rallied about 6%.

When to Strike in 2012

Everyone loves the dollar, and hates the euro. So is now the time to go against the crowd by shorting the dollar and buying the euro?

I don’t believe it. There’s no question shorting the euro is a crowded trade. But it’s a trade that can be backed up by facts.

The high yields indicate the problems in Europe are not solved. As long as borrowing costs remain elevated, the euro will most likely remain under pressure.

So I don’t think it’s time to go contrary on the euro trade — at least not just yet.

Sure, we could see a short-term rally, perhaps up to 1.33. But I suspect there will be a lot of selling pressure around that level.

I would use any rallies to establish fresh short positions.

In May of 2010, when a short position in the euro was also at an extreme, the currency fell another 5% before rallying. With the maximum leverage available in the Forex market, that’s a move of 250%.

Remember, the crowd is right during the trend, but often wrong at the turning points.

The euro remains in a downtrend, so it’s not time yet to go against the crowd. We will start 2012 with a weak euro and a strong dollar.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

P.S. Investment director at The Sovereign Individual Jeff D. Opdyke has researched and written an important new report you should know about. He has identified an overlooked investment niche he calls “micro booms.” His research has uncovered a number of booming pockets around the world, where investment returns significantly exceed traditional plays in U.S. stocks, bonds, ETFs and mutual funds. For access to this free, important investment research on global “micro booms,” click here…

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You can put a lipstick on a pig, but it’s still a pig.

The European Central Bank calls its operation to provide liquidity to banks Long Term Refinancing Operations (LTRO).  But what the ECB is really doing is its version of Quantitative Easing.

They said they wouldn’t print money. But that’s excactly what they are doing. You just have to look at the size of the ECB’s balance sheet to conclude that. The two versions of QE here in the U.S. led to an explosion of the Fed’s balance sheet. Notice in the chart below that the same is now happening with the ECB’s balance sheet.

For the past six months the euro has been moving lower because of the debt crisis. It has dragged everything down with it, including commodities and stocks. But now that the ECB is printing money, what will happen with this correlation?

In theory, printing money should be great for stocks and commodities, and bad for the euro. So we should see this correlation breaking down. Euro should move lower, and commodities higher.

The problem is that everyone is shorting the euro now. It’s the most crowded trade. I still think the euro will move lower, but before shorting it I would like to see a significant rally.

Regarding commodities, I think we will need to see better economic data coming out of China. In other words, we need more proof that China will not have a hard landing.

In 2012, if we get a combination of ECB and the FED printing money, and more signs that the economic situation in China is stabilizing, commodity currencies will have a big rally.

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Besides the possibility of the Eurozone blowing up anytime, there’s another thing that’s keeping some investors awake at night: a possible China crash. The consensus is that China will not have a hard landing. It’s only going through a normal economic slowdown. Nothing to worry about.

But some famous investors are betting China will have a hard landing. Jim Chanos is one of them. He’s shorting Chinese stocks. He became famous after shorting Enron in 2001 and homebuilders in 2007.

If you think China will crash, there’s a much easier way to make that bet than shorting Chinese stocks. You just need to short the Australian dollar.

There’s no questions the Chinese economy is slowing down. That’s why Chinese stocks have not performed well this year. Some stock investors are concerned the Chinese economy may indeed have a more severe economic slowdown.

This year Chinese stocks are down by more than 22%. What’s interesting is that the Aussie is down by just 2%. That’s odd. Australia is highly dependent on China. If China crashed, the Aussie would crash as well. No question about it.

As you can see in the chart below, the Shanghai stock exchange (green line) has recently made a new low. Meanwhile the Aussie (blue line) has been holding its ground. Notice that they usually tend to move together. But in the last few months Chinese stocks failed to bring the Aussie down with them.

In other words, while stocks are pricing in a possibility of a hard landing, the Australian dollar has been ignoring it. I don’t know how much longer the Aussie can hold its ground. All I know is the action in Chinese stocks is not good news for the Aussie.

Notice the Aussie is now moving sideways, within a triangle. Watch that pattern. If it breaks to the downside, the Aussie will most likely try to follow the lead of the Chinese stocks by moving lower.

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When you play roulette in a casino, you can choose between two colors: red or black. If you bet on red, and the ball falls into a red pocket on the wheel, you win. If it falls into a black pocket, you lose.

It’s simple. For most of this year, the financial market has been just one huge roulette casino, with two options: “risk on” and “risk off”.

In roulette, sometimes the ball falls into a black pocket. Sometimes, it falls into a red one. If you always bet on the same color, you will lose a lot of times.

Throughout the year, the market also alternated constantly between “risk on” and “risk off”. The constant shift in sentiment made this year very difficult for long-term investors.

The bad news is 2012 is likely to be another casino.

The good news is there are simple ways to make money in this market.

Pick Your Color: Black or Red

Investing has become a binary decision, much like the roulette’s black and red options. You have to choose between “risk on” and “risk off”.

When sentiment is good, risky assets such as stocks and commodities rally. When sentiment turns sour, safe-haven assets, such as the dollar and Treasury bonds rally, and risky assets plunge.

The constant cycle of hope and anxiety is a nightmare to long-term investors.

When “risk off” dominates, the whole market goes down. Even stocks of great companies with a bright future suffer. The baby is thrown out with the bathwater.

According to Bianco Research, in the entire history of the S&P 500 there have been 11 days when more than 490 stocks that compose the index moved in the same direction. Of those 11 instances, six have occurred since July 2011.

Volatility is the Name of the Game

2011 will go down in history as one of the most volatile years ever, with the stock market having more ups and downs than a roller coaster.

The S&P 500, for example, has travelled the distance between 1,100 and 1,200 seven times just in the second half of the year. The constant swings in market sentiment were very frustrating for most investors.

Hedge funds, for example, had the worst year since 2008. Even star investors, such as John Paulson and Bill Gross, have not done well this year.

Paulson, who made billions of dollars by betting against the U.S. housing market, saw his two largest funds drop by 29% and 44%. Gross, arguably the best bond investor ever, had one of the worst years of his career.

What’s Causing so Much Volatility?

Policy makers are behind a lot of this volatility.

In the U.S., the debt ceiling debate, not only resulted in the U.S. losing its AAA debt rating, but also increased the risk of a recession. That sent the markets into a wild ride.

In Europe, leaders can’t reach an agreement on how to solve the crisis. They have mastered the art of kicking the can down the road. So there’s still a risk of a full-blown European crisis, which could bring down the global financial system. No wonder markets go schizophrenic every time there’s news out of Europe.

In China, policy markets are trying to prevent a real state bubble from popping. If they fail, one of the main engines of global growth will face a major crisis. No country will be safe. So investors are nervous about that as well.

When the Market Gives you Lemons, Make Lemonade

2011 was a pretty volatile year. Since none of our global problems have been resolved, we’re in for more of the same in 2012.

We’re likely to see another macro-driven and highly correlated market. There will be little regard to individual company fundamentals.

While this risk on/risk off market is a nightmare to long-term investors, it’s the perfect environment for short-term traders.

There’s no place better to explore macro ideas than the currency market. Emerging market currencies offer the best opportunities, because they are very sensitive to changes in sentiment.

When risk is on, emerging market currencies rally against the dollar, which is viewed as safe-haven. So you can easily profit in a “risk on” mode by buying currencies such as the Mexican peso, the South African rand, or the Hungarian forint.

When risk is off, you do the opposite. It’s as simple as that.

There will be a lot of market volatility next year. You can do nothing, and just watch markets go up and down in wild moves. Or you can use those moves to profit in the Forex market.

The market will give you lots of lemons next year. Make sure you make lemonade!

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

P.S. With global stock and commodity markets in turmoil over lingering Eurozone fears, and the volatility looking set to continue well into 2012, we believe our recent interview with one of the world’s top currency traders has become essential reading. This week, even gold – often a safe-haven for investors – has taken a severe battering. But our mission at The Sovereign Investor is to find ways for our members to profit, even when markets are spiraling downward. For access to this essential information, click here…

This year will go down in history was one of the most volatile ever. The stock market has been crazy. There’s an ongoing tug of war between bulls and bears. You can see that battle going on in the daily chart of the S&P 500 index.

It’s forming a big symmetrical triangle. This consolidation area indicates uncertainty. Buyers and sellers are fighting for control of the market. Who will win this tug of war?

Keep an eye on how this triangle will develop. A breakout of this triangle will likely lead to a big move in the market.

Some analysts have been betting on an end of year rally. But things are not looking good. With the S&P 500 trading below its 200 day moving average, there’s a good chance the market will remain weak.

In the last few months the index failed to break above the average not once, but three times. This is a bad sign for the bulls. It indicates there’s a lot of selling pressure. I suspect the bears will win this tug of war.

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Some are calling it the most important election ever.

Given the immense challenges our country is facing, there’s no question next year’s election will be key to the future of America. In the short-term, the election will also be important for stocks.

You see, the stock market tends to follow certain seasonal patterns.

You’ve probably heard about “sell in May and go away”. That is perhaps the most famous seasonal pattern on Wall Street. It refers to the tendency of the stock market to decline from May to September.

It has been very consistent throughout the years. This year was no exception. The market fell 17% during that period. That’s why it’s important to follow these seasonal patterns.

Looking ahead, the next major pattern to consider is the coming presidential election year.

Since election years have been great to investors, a lot of people are optimistic about next year. But as I will show you, there’re good reasons to be cautious…

Why the Stock Market Loves Elections

The last two years of any presidential mandate tend to be great for stocks. According to the Stock Trader’s Almanac, the market has climbed by an average of 13.6% per year for each of the last two years of an administration since 1832.

The reason is simple: the incumbent party always tries to stimulate the economy during the last two years in order to win votes and secure re-election.

So many investors hope 2012 will turn out to be a great year for stocks. But if you blindly follow this seasonal pattern, you can end up in a world of pain.

There are a couple red flags to consider.

Every Rule has Exceptions

This year, the stock market is down by about 3%. So, unless we have a massive rally until the end of the year, this will actually turn out to be a bad year for stocks – against the trend. To the trained observer, that’s the first red flag.

Another red flag is the fact that 2011 is literally looking a lot like 2007. Take a look at the daily chart of the S&P 500 below. In 2007, stocks dropped below its 200-day moving average (blue line) and failed to cross above it. That’s exactly what’s going on right now.

Let’s also keep in mind that 2008 was an election year. I probably don’t have to remind you that investors suffered one of the worst bear markets on record that year, in spite of the election.

Bad News: 2011 Looks A Lot like 2007

Pleaes click here to view larger image

If Santa Doesn’t Show Up this Holiday Season…

So how can you tell if 2012 will actually turn out to be a horrible year? Well, it’s impossible to know for sure. But in the short-term, there’s another seasonal pattern that gives us clues.

I’m talking about the Santa Claus rally. Stocks tend to rally during the last five trading days of the year and the first two days of the New Year.

Since 1950, this seven-day rally has resulted in an average gain of about 1.5%. More importantly, when there’s no rally, the next year tends to be a bad year for stocks.

In 2007 for example, the market went down 3% during those seven trading days. The following year turned out to be the worst election year ever for the stock market.

So if Santa Claus doesn’t visit the stock market this Christmas, 2012 may turn out to be a lot like 2008.

Opportunities to Profit

But for the Sovereign investor, that’s an opportunity for profit in the Forex market.

The dollar has been moving in the opposite direction of the stock market. So if stocks fall, the dollar will rally.

You can easily profit from that by buying the dollar against currencies that are more volatile, such as the Australian dollar and the Mexican peso.

So if Santa Claus doesn’t show up this holiday season, 2012 may turn out to be a good year for the greenback.

Best Regards,

Evaldo Albuquerque
Editor, Exotic FX Alert and Currency Capitalist

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There has been a lot of talk that the eurozone will break up and Germany will end up going back to its previous currency, the mark. Although this could happen, that’s not the most likely scenario. Germany will do everything it can to save the euro.

I recently saw an interesting chart in New York Times. Take a look at the chart below. It compares unemployment in Germany with the rest of the eurozone, including the peripheral countries (Portugal, Italy, Spain, etc…), over the last five years.

Over the last five years, unemployment has declined in Germany.  Since the German economy is highly dependent on export, there’s no question the euro has played a key role in boosting the economy and driving unemployment lower.

If Germany were to move back to the mark, it would have a much stronger currency than the euro. Its exports would become way too expensive. It would be a disaster to its economy.

Germany has a good reason to fight for the euro. They will have to pay a hefty price for that in the form of financing other troubled nations until they get their houses in order. But at the end, I think leaving the eurozone would have a much higher cost.

Although the euro will most likely remain very weak in the coming months, it will survive this crisis in the long-term. Germany won’t let it fail.