Daily Forex Commentary
By Jack Crooks

Key News
- China may raise interest rates twice this year and order banks to set aside more money to slow lending after economic growth accelerated to 11.1% in the first quarter, a survey showed. (Bloomberg)

Quotable
"The sciences do not try to explain, they hardly even try to interpret, they mainly make models. By a model is meant a mathematical construct which, with addition of certain verbal interpretations, describe observed phenomena. The justification of such a mathematical construct is solely and precisely that it is expected to work." - John Von Neuman

FX Trading - reader responses
Reader response from Wednesday's Currency Currents showing the S&P Index relative valuation to the US$ Index:

I think you are not looking at the coupling of the S&P and the dollar correctly. The question "are stocks too high or is the dollar index too low" cannot be answered.

If the dollar drops in value, being a fiat currency, things that have real intrinsic value must rise in dollar terms - this is seen with oil or gold. Since the S&P has risen as the dollar falls, it only proves that stocks have an intrinsic value independent of the currency they are traded in. IBM still has the same value whether purchased in terms of euros, yen or dollars, so as the dollar falls it would still be in demand from investors with a more valuable currency.

A more interesting graph would be the S&P change in relation to gold or a basket of commodities (since individual commodities would be subject to more volatility). My guess without doing the work is that it has risen, but not to the extent shouted by the newswires. Maybe, after these adjustments of true valuation, the stock market is not at an all-time high, or not as high as we would like to think. From EK
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Thank you, Ed! They were great points. So we have included the S&P 500 Index divided by the gold weekly chart below for your review. And Ed is exactly right. In terms of gold, the S&P 500 Index isn't anywhere near its old highs …



Reader response on a dollar bounce, liquidity crunch and top in stocks:

But for us the level of risk has risen considerably more. I am therefore calling this to be the secondary top (in stocks). It will be followed by a violent move down. The hypothesis remains the same. We are heading toward a liquidity crunch. I expect US treasury and the US dollar to rally. The yen will outperform all other currencies. Not in favor of gold temporarily. I am a major bull on NatGas, 30yr Treasury, sugar and yen. We rarely advocate shorting. The last time we did was in 1990 at the top of the Japan mkt. For us this is unusual but we are going to start recommending being short the mkt.

I had this funny feeling at the top of the Japanese mkt. I am, however, able to measure risk with my tools that I did not have back then. I believe a <> is about to reprice the whole structure of the derivatives mkt. The repercussions are not measureable because the size of the market over 400 trillion today has never been tested. Some surprises are coming. By the way, I rode the euro up along with gold and both are sold here. Why? If it is a liquidity crunch then we have better buys a bit later. The anecdotal evidence is building up. People never change. Cheers from sunny Montreal. From YL
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We tend to agree with YL. One of our major concerns, too, is the derivatives market. Many hedge funds will say it's not that big of a deal - their derivatives portfolios have been "stress-tested" by the quants. But have we really seen a market test since hundreds of trillions have been layered on in the last few years? We noticed that it's not just us worried about this stuff. ECB president Tritchet made some comments on Thursday (Financial Times) about the lack of transparency in the derivatives market. He also agreed that yes, derivatives do spread risk, but they don't eliminate it. And that's the bottom line.