What Year is It- CitiFX Jan 2010

8/6/2019 What Year is It- CitiFX Jan 2010

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Market Commentary

07 January 2010 Tom Fitzpatrick (1-212-723-1344)Shyam Devani (44-207-986-3453)

Aron Gera (1-212-723-3469)CitiFX Technicals Portfolio [email protected]

What year is it? Of course we know it is 2010, and with that in mind a very Happy New Year (New decade) to

everybody. What we mean by the comment above is that as readers will know, we, unlike traditional

fundamentalists do believe that history repeats itself. We do believe that different groups of people make the same mistakes (and good decisions) of the past. We do believe in market psychology and crowd mentality.

However there is no one size fits all mentality. Every piece of economic and market data today and every policy decision is not going to fit with one precise moment in time from history.

In the piece below we will look at our favourite market and fundamental charts (techamentals). With each, we will articulate which period in history we believe it most resembles (This focus will look at points from as recently as the early 2000s to as far back as the early 1900s).

In conclusion, we will look to draw all this together to give a sense of what 2010 and beyond holds (with particular focus on the coming months). We will look to revisit this on at least a quarterly basis as we reassess the path of all these building blocks.

So where do we start? What better place than financial markets and within that our spooky chart. After thatwe will cover our favourite financial market charts across the asset classes and then move into focusing onthe Techamentals.

We will not articulate our favourite trades for 2010. A year is a long time and after strong trending moves in2008 and 2009 we suspect that 2010 will have a lot more start/stop dynamics as the end of the year/decadeand the 31 December calendar date resets the clock for bulls and bears alike and levels the playing field.

A lot has happened in the last 2 years and we suspect 2010 will be more about a platform for what 2011 and2012 holds than in itself a year of dramatic one way trades.

Equities Page 2

Fixed Income Page 13

Foreign Exchange Page 18

Gold Page 21

Techamentals Page 27

TechnicalsTechnical Developments in the Foreign Exchange andAsset Markets


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CitiFX Technicals 07 January 2010

Market Commentary

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Equities

Our Spooky Chart suggests that it is 1939 again. If so how will that likely play out? If not, what otherperiods does this picture most resemble?

The spooky chart For those of you who have been following our market commentary for some time, you will remember

that we have been looking at the Spooky Chart for years. As a reminder, it is the overlay of the price action in stocks following the only two occasions where

U.S. equities fell by more than 80%. Those two occasions were the Dow Jones Industrial Averagefrom 1929 to 1932 (fell 89%) and the NASDAQ from 2000 to 2002 (fell 83%).

The chart below shows the price action of the Dow Industrials through the 1930s and the NASDAQthroughout the 2000s.This chart shows the similarity in the behaviour of stocks both in terms ofpattern and time throughout a window of several years.

Source: Aspen Graphics / Reuters 07 Jan 10 Dow drops over 80% from Sep29 to July32 (34 months) while NDX drops over 80% from Mar 00 to

Oct 02 (31 months). Dow posts bullish monthly reversal off trend low in July 1932. NDX posts bullish monthly reversal off

trend low in October 2002. Dow rallies for 56 months (1932-1937) NDX rallies for 60 months (2002-2007) Dow falls over 50% over 12 months (1937-1938credit crisis sound familiar?). NDX falls over

50% in 13 months (2007-2008). Dow bounces 63% in 8 months (1938) between March and November. NDX posts the trend low in November 2008 and bounces only to fall sharply again falling just shortof that low in March 2009 before the real rally begins (that rally has been over 80% in the last 10

months). The S&P and DJIA both posted their lows in March 2009 and have bounced 70% and 64%

respectively. In 1938 the DJIA got back within 19% of the 1937 high. In this instance the figures areo NDX back within 15% of the 2007 higho S&P- Within 28%o DJIA- Within 25%

The 1938 rally was assisted by:o The suspension of the then version of mark to market accounting.o The establishment of the up-tick rule (which was then abandoned in August 2007)

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Market Commentary

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So the overall picture remains very similar at this juncture although obviously not identical. This relationshiphas remained close for over 9 years. If it were to be sustained, what happened next in 1938-1939???

DJIA - 1938 peak and beyond.

Source: Aspen Graphics / Reuters 07 Jan 10 The DJIA rallied into the end of 1938 peaking on the 5 th January 1939 just shy of the trend high. 1939 was characterised by 2 major moves.

o A high to low move of 23% by April o A subsequent bounce of 32% by September.

As a consequence it ended the year down 2.8% That set the store for a choppy and bearish period (sharp moves in both directions) between April

1940 and April 1942 that saw the DJIA eventually base out 42% below the 1938 bear market rally

peak. A replication of this would suggest a staggered bear market into early-mid 2013 with 2011 and 2012being the main down years.

1937 - Setting the scenea. March 9, 1937: Roosevelt asks nation to turn over all privately held gold and calls for a

reorganization of the judiciary in one of the famous fireside chatsb. August 1937: Recession beginsc. June 13, 1938: Fair Labor Standard Act Passed to regulate minimum wage, overtime, equal pay,

recordkeeping, and child labor for employees of enterprises engaged in interstate or foreigncommerce

d. March 30-31,1938 WSJ Headlines:i. Government coordinates laws over railroads

ii. Western Pennsylvania Coal Firms Discussing Stabilization Program To Remedy PresentChaotic Price Structureiii. World Markets Break--SEC Head to Suggest Easing Tax on Utility Unit Exchangesiv. Government extends loans to municipalities, industries and states

1938 Setting the Scene : World War IIa. War Pressures Mount

i. September 1, 1939: Germans invade Polandii. September 5, 1939:US neutrality


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Market Commentary

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iii. September 3-10: Great Britain, France, and Canada declare war on Germanyb. May 1940: The War Cabinet Crisis

i. May 10: Germany invades Western Europe; Chamberlain resigns and Churchill becomePrime Minister of England

ii. May 28: Belgium surrenders to Germanyc. December 7, 1941: Japanese Bomb Pearl Harbord. April 28, 1942 : A Call For Sacrifice Speech; Roosevelt proposes seven fold program to stabilize

cost of living:i. First, we must, through heavier taxes, keep personal and corporate profits at a low

reasonable rate. *** Roosevelt proposed imposing 100% tax rates on wages earned exceeding $25,000 per year

ii. Second, we must fix ceilings on prices and rents.iii. Third, we must stabilize wages.iv. Fourth, we must stabilize farm prices.v. Fifth, we must put more billions into war bonds.vi. Sixth, we must ration all essential commodities which are scarce.vii. And seventh, we must discourage installment buying, and encourage paying off debts

and mortgages.

In addition to the concerns about another great depression we have also heard concerns about the lostdecade as seen in Japan. That makes the chart below also interesting at this juncture.

Comparison of the turn lower in the Nikkei from the 1989-1990 peak and the NDX from the 2000 peak.

Source: Aspen Graphics / Reuters 07 Jan 10 Relatively simplistic overlay suggests a down move into mid 2013

To a certain extent all of this fits closely with our big picture overview that the dynamics of recent years havenow moved from financial deleveraging to economic deleveraging and that this repair process will be a dragon the economic potential for some time to come.

On the other side of the argument is that we cannot really know what an unprecedented policy approach toan unprecedented financial crisis (at least in our lifetime) may translate to in terms of market and economicdynamics. So if the spooky overlay is no longer valid what other pictures in terms of the equity marketcould transpire?


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Market Commentary

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DJIA Fall of 1901-1903 compared to 2007-2009

Source: Aspen Graphics / Reuters 07 Jan 10 1903 fall was 46% over 29 months compared to 54% over 17 months Within 16 months we were back at the 1901 high and continued upwards. By early 1906 the next

meltdown began

Verdict: Similar pattern in fall but time frame, depth and dynamics of rally are different- Not a goodmatch.

1901 Setting the Scene: US Steel Corporation becomes 1 st billion dollar industry; powerful interestpurchasing control of various railroad companies

a. July 1, 1901: September 15, 1901: Steel Strikeb. September 6 -14, 1901: President McKinley is shot; dies thereafterc. Latter 1901: Drought destroys agricultural crops; US central banks money are largely tied into

agricultured. May - October 1902: Anthracite coal strike; estimated cost of $150,000,000e. March 1903: Increasing labor demands; challenges building activityf. July - August 5, 1903: Pressure builds on several banks, trust and railroad institutions; failures ensueg. September 14, 1903: JP Morgan underwrites new bond issue to save US Steel Corp.h. November 6-17, 1903: President Roosevelt recognizes the new Republic of Panama; signs treaty

granting American controli. December 1903 Banks report show that reserves building, lending extending


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Market Commentary

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DJIA Fall of 1906-1907compared to 2007-2009

Source: Aspen Graphics / Reuters 07 Jan 10 1906-1907 fall was 48% over 22 months compared to 54% over 17 months. Trajectory of recovery has been similar and if continued could see us close to 2007 high by late

2010/early 2011. That rally peaked in late 1909 and the 1907 low was revisited in late 1914

Verdict: Similar pattern in fall, time frame and depth and dynamics of rally are also similar Looks avery good match. In addition some of the dynamics below about what happened in that period areinteresting.

1906 Setting the Scene: Earnings and wages in railroad industry massively increasinga. February 8, 1906: Hepburn Rate Bill gives ICC extraordinary power over railroadsb. April 18, 1906: San Francisco earthquake results in large capital flows from New York to

California, for aidc. September October 1906: Series of hurricanes destroys agriculture cropsd. January February 1907: Investigation of Harrison roads by Interstate Commerce Commission

causes uneasinesse. August September 1907: Series of railroad troubles; foreign tensions risef. October 1907:

i. Difficulties for Mercantile National Bank, failure of Knickerbocker Trust, and morebank runs

ii. City of New York declares if they cannot raise $20-30 million by November 1, the city willbe insolvent

g. November 4-11, 1907:i. Encouraged by Mr. J.P. Morgan, President Roosevelt approves U.S. Steels

takeover of TC&I to relieve market strains despite Sherman Antitrust Act lawsii. Mr. J.P. Morgan finalizes a series of efforts to support the market: obtains large

donations of private capital and pressures larger institutions to support smallerinstitutions.


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Market Commentary

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Panic of 1907: From Wikipedia, the free encyclopediaThe Panic of 1907 , also known as the 1907 Bankers' Panic , was a financial crisis that occurred in the United States when the New York Stock Exchange fell close to 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies.The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered into bankruptcy. Primary causes of the run include a retraction of market liquidity by a number of

New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops.The crisis was triggered by the failed attempt in October 1907 to corner the market on stock of the United Copper Company. When this bid failed, banks that had lent money to the cornering scheme suffered runs that later spread to affiliated banks and trusts, leading a week later to the downfall of the Knickerbocker Trust CompanyNew York City's third-largest trust. The collapse of the Knickerbocker spread fear throughout the city's trusts as regional banks withdrew reserves from New York City banks. Panic extended across the nation as vast numbers of people withdrew deposits from their regional banks.The panic may have deepened if not for the intervention of financier J. P. Morgan, who pledged large sums of his own money, and convinced other New York bankers to do the same, to shore up the banking system.At the time, the United States did not have a central bank to inject liquidity back into the market. By November the financial contagion had largely ended, yet a further crisis emerged when a large brokerage firm borrowed heavily using the stock of Tennessee Coal, Iron and Railroad Company (TC&I) as collateral.Collapse of TC&I's stock price was averted by an emergency takeover by Morgan's U.S. Steel Corporation a move approved by anti-monopolist president Theodore Roosevelt. The following year, Senator Nelson W.Aldrich established and chaired a commission to investigate the crisis and propose future solutions, leading to the creation of the Federal Reserve System.

Anecdotal note: (ironic as it is) A huge (at the time) deposit by John D. Rockefeller of $10mm in October 1907 into National City Bank secured its health and left it with the deepest reserves of any bank in the city. National City Bank went on to become Citibank, then Citicorp and finally Citigroup until histor y virtually repeated itself almost exactly 100years later.


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Market Commentary

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Source: Aspen Graphics / Reuters 07 Jan 10 1912-1914 fall was 44% over 27months compared to 54% over 17 months Trajectory of recovery was more aggressive with the 1912 highs revisited and beyond by 1915. However a year later in 1916 another market collapse began.

Verdict: Similar pattern in fall, time frame and less so in depth. Dynamics of rally are less similar. Nota great match

1912 Setting the Scene: Continued agitation against trusts, Wilson is elected Presidenta. October 8, 1912: 21 institutions report they have less than reserve requirementb. July 23-30, 1914:

i. Conflict: July Crisis with Russia, Word War seem imminentii. Liquidity crisis; needed liquidity exceeds central banks balance sheets

c. August 1 December 14, 1914: Markets are closedd. December 23-24, 1914: Banks and brokers restore pay on Wall Street to prior levels; Call Money

rates falls from 3% to 2.5% for first time


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Source: Aspen Graphics / Reuters 07 Jan 10 1916-1917 fall was 40% over 11 months compared to 54% over 17 months Trajectory of recovery has been similar and if continued could see us close to 2007 high by late

2010/early 2011. That rally peaked in late 1919 and the 1917 low was revisited in late 1920

Verdict: Similar pattern in fall, time frame and depth. Dynamics of rally are also similar. Looks like avery good match.

1916 Setting the Scene: World War Ia. November 7, 1916: Wilson is re-elected President; US advances large loans to European

powersb. April 6, 1917: US Declares war on Germanyc. August 1917: US Government begins active regulation of key commoditiesd. December 7 -19, 1917:

i. US Declares War on Austria Hungaryii. Government prepares to direct railroad operations


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Market Commentary

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DJIA Fall of 1929-1932 compared to 2007-2009 Depth of move and timeframe do not fit for us here. The 1929-1938 overlay is the dynamic that looks moreappropriate in our spooky chart

1929 Setting the Scene: Steel and automotive industries continue expansion, end of building boom,declining agriculture prices

a. 1929:i. Agricultural: overabundance of wheat and low pricesii. Depressed New England textile industryiii. Depression in southern statesiv. Call Rates reach 20% by end of Marchv. Federal Reserve Bard warns of excessive use of bank credit and speculation; fear

mount concerning how the Fed will curb speculationb. Bankers pool led by J.P. Morgan & Company was formed to cushion the marketc. June 17, 1930: Hawley Smoot Tariffd. January and February 1932: Federal Home Loan Bank Act and Glass Steagall Acts passed,

respectivelye. June 22-July 2, 1932: The term New Deal is coined.

i. Roosevelt: I pledge you, I pledge myself, a new deal for the American people.

ii. The Depression Papers of Roosevelt are published to show drastic increases inemployment from public work projects.


Source: Aspen Graphics / Reuters 07 Jan 10 1973-1974 fall was 45% over 11 months compared to 54% over 17 months Trajectory of recovery has been similar and if continued could see us head higher in the coming

months

Verdict: Similar pattern in fall and depth but shorter timeframe. Dynamics of rally are also similar andwould suggest further recovery for most of 2010 towards 2007 high. That rally was followed by a

further 7 years of choppy range trading.

1973 Setting the Scene: Arab-Israeli, Watergate Scandala. Jan 18, 1873: Cease fire with Vietnam declaredb. October 15, 1973: OPEC oil embargo announcedc. August 8, 1974: Nixon Resignsd. December 19, 1974: Paris Summit of European leaders results in European Regional Development

Fund to transfer money from richer to poorer regions


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Conclusions: The 1929-1938 overlay still remains our favourite because of the combination of such a long

timescale and a number of similarities in the fundamental backdrop. Our next favourite has to be the 1906-1907 banking crisis 1901-1903 and 1912-1914 are neither great pattern matches anymore or have similar

fundamental backdrops 1916-1917 has a similar pattern but not really a similar fundamental backdrop.

1919-1921 also has a similar pattern but not really a similar fundamental backdrop 1973-1974 also has a similar pattern but not really a similar fundamental backdrop althoughin the 1975-1976 era some techamental similarities do appear

The bad news if we are back in 1939 the rally may be all but done.

The good news is that it would suggest a relatively benign year overall for equities albeit a choppy one.

The good news is that if we are in 1908 the rally has further to run into late 2010/early 2011

The bad news is that that would simply seem to delay an inevitable renewed 3-31/2 year bear market

All of this makes 2010 a work in progress but argues that 2011-2014may not be so kind.


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Market Commentary

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Fixed Income

U.S 2 year yields - 1992-1994?We believe this picture most resembles 1992-1994 post the savings and loan crisis of 1989-1991

Source: Aspen Graphics / Reuters 07 Jan 10 U.S. 2 year yields have closed above the 55 week moving average and our overlay with 1992-1994

suggests that over the medium to long term this is likely to have been a significant developmentindicating higher yields going forward.

Note that the overlay above shows that once the 55 week moving average was breached followingthe double bottom pattern in November 1993, the market went through a period of consolidation forseveral weeks before yields started to shoot up in Jan 1994.

While history may not repeat itself exactly, the overlay has been very good with respect to the 55week moving average and it would not be surprising to see some short term consolidation herebefore further higher yields over the medium term.

The double bottom neckline is at 1.44% which is the next medium term resistance level to focus on(high from June 2009). Above here would suggest an accelerated move higher to at least 2.25-3.0%

Such a move would only likely materialize if the Fed was back to a tightening path. If we do break this 1.44% area in the foreseeable future we suspect the timeframe before renewed

Fed tightening could narrow significantly.

Resistance(almost)

False break

False break

Break

Resistance

Spike

Spike

1992-1993

2008-2010Break. Consolidationfollowed by a rise inyields again?


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U.S 10 year yields - 1993? 1998? 2003? Or something new?

Source: Aspen Graphics / Reuters 07 Jan 10 We remain very much of the view that the cycle low in 10 year yields was posted in late 2008 just as

it was in late 1993, 1998 and 2003. Those turns on average led to a 265 basis point rise in 10 year yields which in this instance would

target 4.705 which is pretty much the channel top. However we think a greater move higher than any seen to date in nearly a quarter of a century could

ultimately be on the cards.

The present pattern looks very much like an inverted head and shoulders bottom with a movethrough 3.90-4.0% suggesting as high as 6%. This would be the first time since the bull market began in 1981 that we would see a higher high in

yields than the prior cycle. This, together with the chart on the following page leads us to believe thatthe 27 year bull market in fixed income came to an end in late 2008.

1993

1998

20032008


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U.S yield curve- Deja vu or a new era????U.S 2s versus 10s

Source: Aspen Graphics / Reuters 07 Jan 10 Much fanfare has been made about the fact that the 2s versus 10s curve has broken to new highs

in this move. Our response to that is hold your horses. That is EXACTLY what happened in 2003 when it went to 275 basis points compared to the 270

basis point peak in 1992. Funnily enough it also inverted slightly more in 2000 than in 1989 butwasnt different then either.

We believe the chart below is the Best interest rate chart in the World and what it does will likelyprovide us with a host of information.


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U.S 2s versus 5s

Source: Aspen Graphics / Reuters 07 Jan 10 Over a space of the last 20 years this chart has been amazingly symmetrical. 3 times it inverted more than 20 basis points

o June-1989- Just as the savings and loan crisis/economic downturn took hold. The Fedeasing cycle began almost immediately

o Dec-2000 - As the Equity market rout took hold. The Fed began easing within weeks.o November 2006- When the favourite buzz from the markets (and the Fed) was that it was

different this time It was not warning of trouble around the corner but rather an aberrationof demand over supply from the Sovereign wealth firms. As a consequence the Fedwaited 10 MONTHS before the easing cycle began. Well we guess people were correct. Itwas different this time - just not in the way they thought.

3 times it has steepened to 161 basis points o July 1992 during the easing cycle, economic downturn, housing and savings and loan crises.

That high was revisited 3 months later. o August 2003 after the stock market meltdown and Fed easing cycle. That high was revisited

the following month. o June 2009 following the worst housing, credit, stock market, financial, economic meltdown of

our lifetime. That level is now being re-tested. Will it break or will it hold? We will respecthistory and wait and see. If it holds the big supports, as in 1993 and 2004, it will be the 120-125 basis point area. One or either level looks likely to give way decisively in the comingmonths if not earlier. When this break comes our assessment would be as follows.

There are 4 likely scenarios: o Breaks 161 basis points with 2 year yields moving higher. This would suggest to us that

we have supply and potentially inflation concerns with the market perceiving the Fed asbehind the curve

o Breaks 161 basis points with 2 year yields heading lower. This would suggest supplyconcerns in a sluggish non-inflationary economy.

o Breaks 120-125 basis points with 2 year yields heading higher. Classic return togrowth/economic health with Fed increasing focus on inflation and getting ready fortightening cycle (Exactly what happened in 1993 and 2004)

o Breaks 120-125 basis points with 2 year yields heading lower. Hello Japan. Deflationarydynamic with too much debt in the system. Of all the outcomes this would likely be the worstof the lot.

The break will come either way almost certainly this year and shouldguide us on everything from the curve to the general direction of

interest rates, Fed policy and the underlying economy.


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Market Commentary

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Foreign Exchange

EURUSD - 1992?

Source: Aspen Graphics / Reuters 07 Jan 10 This is a chart we have been watching since 2004. It is an overlay of EURUSD today (Red) with

EURUSD as its components (Pre-inception) during the 1985-1992 bear market. The USD weakened from 1985-1987 and 2002-2004 The USD strengthened in 1988 and 2005 The USD weakened in 1989-1991 and 2006-2008 The USD had a strong multi- month rally in 1991 and 2008/2009 The USD weakened to new lows in 1991-1992. And 2009-2010????

The USD has only had 2 periods of significant demand since the bear market began in 2002 2005: The HIA (Homeland Investment act). This created USD demand as favourable tax incentives

encouraged U.S. Corporations to repatriate overseas profits for favourable tax treatment. 2008: The credit crisis: This created demand for USD as market participants got caught in the

liquidity trap. Outside of these 2 periods the USD has never rallied more than 10% against the EURO (high to low)

since the bear market began in earnest in 2002. After a strong rally higher into December 1991 EURUSD retraced 10% lower before the final move to

new highs. This would suggest that at most EURUSD could move into the mid to high 1.30s beforea renewed rally to the low 1.60s.

One additional point here is that as people shout about a Dollar crisis - we should avoid revisionist history.This fall in the USD versus the EURO has been slower and less aggressive than that seen in 1985-1992. To

replicate that low to high move in percentage terms we would need to see EURUSD at 2.15.What factors will likely keep the USD weak barring a new EVENT

Reserve diversification. Too many USD holdings have been built up over 2 many years as the USDwas given unparalleled reserve currency status. In a FIAT currency system that status comes with arequirement for accountability as well as fiscal and monetary discipline. It is hard to argue that wehave lived up to that requirement and reserve holders are likely to continue to diversify.

Reluctance from China to make a big revaluation. While this happens they and other Asian Centralbanks will continue to accumulate USD reserves which they will then continue to diversify into otherassets and currencies.

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European problems: Here we have a contrarian view. We do not believe that any of the existingEurozone countries will leave or get thrown out of the Euro or that they will default. As aconsequence they will have no choice (as Ireland has already shown) but to take remedial action.They cannot devalue. They cannot stimulate monetarily. Their budget deficits have ballooned. Theonly way out will be a combination of assistance and fiscal austerity (likely more of the latter and lessof the former). At the same time monetary policy will be maintained at an appropriate level for thebig countries

What does that mean?o Economic activity at the periphery of Europe is likely to be sluggish at best and severelyrecessionary at worst

o Welfare and support programmes and education funds will get decimated and likelyincreasing means tested in these countries

o The public sectors will have to shrink in size and endure wage cuts in these countrieso Unemployment will remain structurally high in these countrieso Monetary policy will remain tight in these countries

While this may be an economic negative we believe it is a currency and bond market positive. As a reserve manager do you want to accumulate more currency of a country that has loose

monetary and fiscal policy and is attempting to reflate / inflate the problem (analogy U.S.A. inc isengaged in a massive share dilution i.e. printing and debasing Dollars that pay no dividend anymorewith zero per cent short term interest rates?)

OR

Would you prefer to own the currency and bonds of the region that is taking pain, is very inflationfocused, is in greater deflationary danger as a consequence.(analogy :Europe inc is cutting costs,laying off workers , retaining the value of the share price, and creating a very attractive Realdividend yield with high real short-term interest rates)

For us it is highly likely that this will be more positive for Euro bondsand the currency.


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Market Commentary

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USDJPY- 1999-2004-2009

Source: Aspen Graphics / Reuters 07 Jan 10 Following the major bull market in USDJPY in 1995-1998 we re-entered a bear market. The lows in the significant down moves in USD were effectively put in on thanksgiving week 1999,

thanksgiving week 2004 and thanksgiving week 2009 In 1999 and 2004 those lows were just above the line in the sand of 101 in USDJPY. Those levels

were re-tested in Q1 2000 and Q1 2005 before USD sustained a sharp rally higher. Why did USDJPY hit 101 in 1999 and 101 and 2004 but reach levels below 85 in 2009? We believe the answer is China. When 101 held in the first 2 instances the U.S. was Japans largest trading partner. However, after

2004 2 things changed o China revalued the Yuan o China became Japans biggest trading partner.

In 1999 and 2004 when USDJPY traded towards 101 USDCNY was fixed and therefore the low inboth instances in CNYJPY was around 12.30. Following the 2005-2008 revaluation of the Yuan andnow the return to a fixed exchange rate around 6.8270 a move to 84 on USDJPY would generate aCNYJPY rate of 12.30. Barring a Chinese revaluation we therefore believe that 84 on USDJPY is thenew line in the sand for USDJPY and will be difficult if not impossible to overcome.

As a consequence of this view and our view of higher U.S. yields we think it is quite likelythat on a 12-24 month period we could see USDJPY close to 110.

CNYJPY

Source: Aspen Graphics / Reuters 07 Jan 10 IF USDCNY was not adjusted and CNYJPY once again rallied to the 16.00-16.25 area as it did after

the 1999 and 2004 lows it would put USDJPY at 109-111

?


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Market Commentary

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Commodities

Gold- 1979-1980 or 1976-1980?We remain unashamedly and unambiguously bullish on GoldGold-weekly chart

Source: Aspen Graphics / Reuters 07 Jan 10 Gold continues to trade well technically having broken out of the triangle formation and through the

neckline of the inverted head and shoulders. Subsequently that neckline was re-tested before it moved higher to new all time highs. This head

and shoulders targets a move towards $1,340 and we would not be surprised to see this level by endQ1 2010.

However, overall we retain our view that Gold will eventually rise above $2000 at least. Funnilyenough you will often hear mentioned in fundamental circles that on an inflation adjusted basis thepeak in Gold at $873 in 1980 would translate into a price of around $2,000+ in todays terms.

Our target above $2,000 is more simplistic.


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Gold - Monthly chart

Source: Aspen Graphics / Reuters 07 Jan 10 The last bull market in Gold (1976-1980) was a move (low to high) of 764% (just happens to be our

favourite Fibonacci number). A replication of that percentage move off the $253 low would give a level of $2,185 If the present pace of appreciation was maintained (no acceleration or deceleration to this trend of

impulsive moves and consolidation periods) then end of 2012 would actually be the logicaltimeframe.

For choice, we would think it could be earlier as strong trends often reach their peak with an

acceleration in the move. A classic example of this was seen in the last bull market. It took 3 yearsand 2 months to rally $340 (from $101-$441). It then corrected to $365 the following month andrallied another $408 in 2 months to the Jan. 1980 high at $873 (event risk did help here with theRussian invasion of Afghanistan)

Such a dynamic would suggest we are in the 1979-1980 period Now for the shocker: This is the conservative view. Let us take the Gold chart back a little further

764% rally


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The last bull market in Gold did not really start in 1976. It began in 1970

Source: Aspen Graphics / Reuters 07 Jan 10 Gold moved off its fixed peg at $35 as we headed into the FIAT currency era. Between 1970 and 1980 it rose by a multiple of 24 times. This was a difficult economic period. Note: After a marginal new all time high on the DJIA in early 1973 (taking out the prior peak set 7

years earlier in 1966 just as in 2007 we broke over the 2000 high) we saw a sharp fall (as per ourequity piece above). The subsequent rally actually got back with 4% of the 1973 high by 1976.However it was not until a decade later in 1983 that the 1973 high was decisively overcome.

Gold and the DJIA at the 1976 pivot

Source: Aspen Graphics / Reuters 07 Jan 10 The peak in the relief rally in the Equity market into Sept 1976 (It essentially treaded water from

March to Sept, set a marginal new high and turned. So the Lions share of the rally took place over15 months.

Pause

?


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Gold and the USD-Index-1976

Source: Aspen Graphics / Reuters 07 Jan 10 The short-lived USD rally ended as the Equity market peaked and the Gold rally began in earnest. Between 1976 and 1978 the USD-index fell 24% It then range traded for another 2 years until the Gold rally ended in January 1980. Between 1971

and 1980 USDDEM fell 53% high to low. A similar move off the 2000 peak gives us 1.0950 while a move off the point in 2002 when the bear

market began in earnest would give us USDDEM of about 1.0670. This would equate in EURUSD terms to a level of 1.78-1.83

Low to high so far in this trend it has multiplied less than 5 times - that hardly qualifies as a bubble It did have a nearly 2 year pause from 1974 to 1976 (after having multiplied 5 times) and then from

1976 to 1980 it multiplied 8 times. Let us put this bubble into perspective.

o Between 1990 and 2000 the NDX multiplied 30 timeso Between 1950 and 1990 the Nikkei multiplied 470 timeso Between 1982 and 2007 the DJIA rallied by a multiple of 18o Between 1998 and 2008 Crude rallied by a multiple of 14o Between 2001 and 2008 the Baltic dry index rallied 14 timeso Between 1996 and 2007 the Shanghai composite rallied 12 times

We could go on and on but the message is that in the last 40 years we have seen rallies in asset marketsthat have far exceeded what we are seeing on Gold at this point. That is even before you even factor in thewhole FIAT currency system crisis.

So why cant Gold eventually replicated the decade from 1970 to 1980 or even the 4 year period after thecorrection into 1976 (using the $680 2008 correction as a starting point).

Such a dynamic would suggest that an ultimate peak in Gold could bemuch higher than our $2000+ target and possibly as high as $5000-

$6000 in the years ahead .


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Market Commentary

26

However it is a bit of a shame that when the music stops all your discretionary purchases made with creditare obsolete. You have no savings. You have built up huge debt. Your assets are falling in value and yourinflated wealth is now deflating. Have a good day.

We (the savers), however are in a strong fiscal position with large reserves and savings which will now tideus through for some time to come. In addition we will now diversify our stash into other FIAT currenciesand assets (including Gold whose supply you cannot increase on an infinite basis courtesy of Hewlett

Packard (printers) and Hammermill (paper).

But we digressback to the yellow stuff

As we can see below, during the period of Economic moderation and Nirvana in asset markets, Gold wasnot needed. The FIAT currency system was just fine without it, thanks.

However

Source: Aspen Graphics / Reuters 07 Jan 10

Since 2001 the shoe has been firmly on the other foot and Gold has been an out performing assetperiod.

At this juncture, given the continued financial and in particulareconomic uncertainty, we continue to believe that Gold will retain the

store of value moniker that has served so well over the last 8-9 years.In addition we believe it is very possible that this move could far exceed

our minimum $2000+ target


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Market Commentary

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Techamentals

Our favourite Techamental indicator is becoming increasingly interesting

Initial claimsMost like 1975-1978 or 1980-1982?

Source: Aspen Graphics / Bloomberg 07 Jan 10 Is now back below the major peaks posted in the last 35 years.


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Market Commentary

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Overlay of initial claims and the unemployment rate.

Source: Aspen Graphics / Bloomberg 07 Jan10 Looking at this chart it should not surprise you to see that initial claims are much more dynamic than theunderlying unemployment rate. They tend to turn first and provide an early warning sign of the possible peakor trough in that rate of unemployment.In Jan 2006 for example initial claims hit their low and turned. In October 2006 the unemployment rate hit itslow of 4.4%. Going back to initial clams, the peak we have hit in this cycle so far is 669k in March of 2009. This is

almost identical to that seen at the peak in Sept 1982 at 695k.

Late last year this started to fall in a fashion dramatically similar to that seen in 1982

In December 1982 having averaged negative 190k in the prior 3 months non farm payrolls printed -14k.We replicated that almost exactly last month with the print of -11k.

We ended up with 3 out of 4 months positive at the start of 1983 with an average monthly gain of 150k andthe Fed tightened in May. Remember NFP lags initial claims and the unemployment rate lags NFP. TheDecember unemployment rate printed an equal high in 1982 to November but January 1983 saw it fall backby the 4/10ths spike seen in November to 10.4% and 10.1% by May. We have already taken back 2/10ths ofthat spike last month. Is a 9.8% unemployment rate on the cards tomorrow?Given our notes above about the 1976-1980 period a few other interesting statistics are.

1975- Unemployment peaks at 9% in May. In the week straddling end May early June initial claims were100k off their high and continued to fall to 349k be Feb 1976

1980- Unemployment has interim peak at 7.8% In July. In the first week of August 1980 initial claims were109k off their high and continued to fall to 399k bay Dec 1980.

?


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Market Commentary

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1982- Unemployment peaks at 10.80% in November (structural high).In the end November/first week ofDecember initial claims were 138-162k off their high. They continued to fall to 341k by March 1984(Structural turn)

1992 - Rise in unemployment peaks in June at 7.8%. Initial claims in early July were over 100k off their high.They fell to 313k by Dec 1992

2003- Rise in unemployment peaks at 6.3% In June. In the first week of July 2003 initial claims were over100k off their high. By April 2004 they were at 324k.

Everybody on the face of the planet finally got on board with the idea that this unemployment rate will justcontinue to deteriorate in a straight line. Nothing goes forever in a straight line. Since April 2008 we have had

just 1 down tick in the unemployment rate (A 0.1% drop in July 2009) in a move from 5% until last month.

In the 13 year deterioration from 1969-1982 we saw a 1.5% drop in 1970-1973, a 3.4% drop from 1975-1979 , a 0.6% drop in 1980.

We are by no means saying at this point that we may be about to put in the ultimate peak in thiscycle. Time will tell on that. All we know is that for the past couple of years every consensus view has gotcaught out and maybe it is the turn of unemployment.

The other important dynamic is that initial claims in these periods (1989-1991 and 2000-2002) were early warningsigns for the yield curve and ultimately Fed policy and interest rate direction.

So as per our 2s versus 5s curve earlier this suggests what happens here will be key in what thecurve and ultimately the Fed does.

Final note here. It was at this point in initial claims with an unemployment rate at 10.1% in 1983 thatthe Volcker Fed raised rates.

As always this is still all a work in progress but we are convinced that the dynamic in the indicatorsabove. Initial claims, yield curve, 2 year yields to funds, 2 year yields directionally, 5 year yields

directionally, NFP and ultimately the unemployment rate will provide the plank for market perception,Fed rhetoric and ultimately Fed action (or not) as we begin 2010.


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Market Commentary

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For now our bias is to believe that the present monetary policy is as much about fear as anythingfear ofthe potential of another great depression, fear of a lost decade like Japan. Fear is not a good monetarypolicy. Yes we can couch it in terms of output gap and other economic indicators but the reality is that toolow interest rates, not too high, helped us get into this mess. Where in life do you see that using the samedecision making process that caused the problem to solve the problem works? We cannot think of one.

For now this policy/rhetoric does not seem to be changing and it looks like we can be reasonably confident

that it will not do so imminently. However watch out if the Cancer patient goes into remission (U.S.A.) andwe get some further positive signs from initial claims and/or non-farm payrolls. This could lead to some backtracking in the extended period of time commentary and possibly even the Fed funds rate itself.

A look at where we stand on other Techamental indicators says to us that the bar for this may notbe as high as people (And the Fed) think.

HousingIt is far too early to get bullish on housing. However, at the same time, a number of indicators suggest atleast some stabilization.Existing home sales and housing starts.

Existing home sales have rallied quite strongly since January of 2008. The peak in the cycle for thisnumber took place in Sept. 2005- 4 months ahead of the peak in housing starts.

The low so far seen in this cycle for housing starts was April last year- 3 months after Existing homesales turned.

Existing home sales

Housing starts


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Market Commentary

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Housing starts - Most similar downturn? 1972-1975

While no amount of imagination could describe these numbers as good they do appear to havestabilized

In addition monthly momentum has turned up from levels that historically have seen large spikes inthe nominal numbers when at an extreme low. Given that the base of this move is so far below lowsseen in other down cycles the danger of a strong spike in 2010 has to be considered.

Housing starts and non-farm payrolls- 1975?

History shows a strong correlation between strong bounces in non-farm payrolls and the knock oneffect in housing.

?


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Market Commentary

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Other TechamentalsConsumer credit- 1975-1978?

After the binge from the 80s all the way to 2007 we saw a massive contraction here between 2007and 2009.

While a move back to the heady heights seen in the bubble period is unlikely anytime soon wehave seen notable improvement from the contraction low seen in April this year.

ABC Consumer confidence- 1994?

Similar position to that seen in mid to late 1993 before it turned higher and the fed began tighteningin January 1994.

The beginning

The middle

The end


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Market Commentary

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Consumer confidence- 1975?

Still some work to do but at least back to the range of major lows seen in the last 35 years.

Capacity utilization-1975?

Still a lot of spare capacity butback above the 1982 lows and close to the levels seen in may 1983 just before Paul Volcker tightened rates


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Market Commentary

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Chicago purchasing managers index. 1975 or 1980?

Back at almost exactly the same level we saw in May-June 1983 when Paul Volcker raised rates(With unemployment at 10.2%)

Manufacturing ISM- 1975? 1980?

Very much back to the upper part of the range seen in the last 60 years. Back to the middle of its range in its 12 year history.

While we have many challenges ahead these charts suggest a muchmore normal picture than many of the headlines and rhetoric might

indicate. That is not to say things are good, but the World has not endedjust yet.


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Market Commentary

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Conclusions:

Equities:o We retain our view that we are in an aggressive bear market rally (cyclical bull market) within the

structural bear market that will see us lower in the coming years.o Our favoured overlay is the 1938 period with 1908 a close 2 nd. In the modern era 1976 is the closest

fit.

Fixed income:o We retain our medium term view that we will see long end yields higher again in 2010 and maybe for

even longer. In the near term further consolidation / correction lower in yields is still possible.o We continue to believe that 10 year U.S. yields could eventually head towards 6% (2012?)o We think the Fed should tighten sooner rather than later but do not know if they will. We think the

combination of 2s versus 5s, 2s versus Fed funds and the initial claims charts could provide theanswer.

o It is worth noting that long end yields surged in the 1976-1980 period.

Foreign Exchange:o We remain firmly in the USD bearish camp and still look for EURUSD to head towards 1.60 and

above in the coming months.o Thereafter remains a work in progress but at this point we remain concerned that the move could

end up being even longer and higher.o The similarities in the backdrop to 1976 suggest the USD could lose another 25-30% in the next fewyears.

Gold:o We remains unabashed bulls for Gold into 2010 and beyondo We believe $1,300 plus is achievable - possibly as early as Q1 and that $2,000+ could be seen by

2012 or earlier.o The outlying view is that Gold is sitt ing in a similar position to that seen in 1976 and could ultimately

head much higher than $2000.

Overall:o The best analogy we can think of is that the cancer is in remission following some therapy (U.S.A.

and fiscal and monetary stimulus)o The dynamics in coming months may make things look better than they are resulting in 2010 being a

choppy year.o The relapse will develop in 2011-2012 but potentially in a more inflationary environment than we

think today. As a consequence the Fed may be forced to act during this remission period to fulfill itsdual mandate

o Crystal ballo Q1 - Q2- Trending moves sending USD lower against Euro off a mid to high 1.30s platform

above 1.60, Gold higher towards $1,300+, yields higher equities in a range. o Q2 - Q3- Fed changes tack. Goes more hawkish as inflation concerns + more stable

employment picture suggest and possibly deliver rate hikes. Equities shake but recover intoyear end. USD does better for a while. Gold may even correct lower.

o Q3 - Q4- Choppy and relatively directionless tradingo 2011-2012:

Inflationary growth Higher bond yields on inflation and supply concerns Equities suffer Gold continues to dominate asset markets EURUSD heads higher than anybody thinks - possibly over 1.80 and USDJPY

heads back to 110.

What year is it? As can be seen there are a host of different market andfundamental dynamics here. However if we are forced to define where inhistory this combination most closely resembles the answer is 1975-1976


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Market Commentary

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CitiFX Technicals Portfolio

CitiFX Technicals Products

Today's Highlights - Sent Monday, Tuesday and Wednesday. Technical Strategy focused publicationdetailing important technical developments in the past 24 hours and looking at possible implications forother markets. Main focus is the FX market but the piece also covers important developments inEquity, Fixed Income and Commodity markets, especially where we believe the moves are significantfor FX. The publication also includes a daily grid with short comments on each major currency pair andsupport/resistance levels

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Bulletins Ad hoc pieces sent where we believe particularly significant developments have takenplace. Often based on interrelationships between markets.

Portfolio Updates - We run a portfolio on the back of our ideas/views and as such send e-mails

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Market Commentary

38

CitiFX Value Added Services & Products

FX TechnicalsTom Fitzpatrick New York 1-212-723-1344 [email protected]

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CitiFX Value Added Services & Products


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What Year is It- CitiFX Jan 2010