Yesterday I interviewed the hyper-smart Adrian Douglas (see his bio below the videos). We covered a wide spectrum in the first 20 minutes. Most notably, Adrian gave his short-term outlook on both the metals along with analysis on the junior market and how he selects juniors. He also touched on supply in the physical markets along with currencies, commenting “Debt crisis’ go hand in hand with currency crisis. Investors all around the globe are starting to connect the dots that it’s unavoidable.”

For in-depth research and actionable investing ideas for Gold and Silver, click here to check out Jordan Roy-Byrne’s Gold & Silver Premium.

John Mauldin

The news is somewhat “All Greece, All the Time,” but most of the pieces miss the more critical elements, and today we’ll look at what I think those are, as well as at the important point that Greece is a precursor of a new era of sovereign risk. Plus, we glance at a few rather silly recent comments from economists. It will make for a very interesting discussion.

A Path-Dependent World

Path-dependence explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. In essence, history matters.

With regard to the future, the choices we make determine the paths we’ll take. As I’ve been writing for a long time, we’ve made a series of bad choices, often the easy choices, all over the developed world. We’re now entering an era in which our choices are being limited by the nature of the markets. Not only are we in a path-dependent world, but the number of paths from which we may choose are becoming fewer with each passing year.

Our economic future is more and more a product of the political choices we make, and those are increasingly difficult. We have no good choices. We’re left with choosing the best of bad options. Some countries, like Greece, are now down to choices that are either dire or disastrous. There’s no “easy” button.

Let’s look at how Greece came to its current rather dismal predicament. And we’ll look at why it may be even worse than many pundits think.

First, we need to go back to the creation of the euro. Most of the Mediterranean countries that are now in trouble were allowed into the union with an exchange rate that overvalued their currencies relative to the northern countries, but especially to Germany. That meant that Greek consumers could buy products and services that previously may have been out of their reach. Plus, with government debt at low rates, the Greek government could borrow more to finance deficit spending, without the threat of higher interest rates. And Greece began to increase its debt with abandon.

Additionally, as it now turns out, Greece basically lied about its finances in order to gain admission to the union. It never complied with the fiscal discipline that was required for entrance.

With the high exchange rate, however, came the consequence of higher labor costs relative to, above all, Germany. While reviewing some economic facts about Greece, I came across the factoid that Greek workers had the second highest level of actual hours worked. But even with that, Greece was running a trade deficit that is currently 12.7% of its GDP.

And with the onset of the current recession, their fiscal deficit went from bad to worse. Their total debt is now €254 billion, and they need to finance another €64 billion this year, €30 billion of it in the next few months.

Bottom line, without some help or a bailout, they simply won’t be able to borrow that money. And since a lot of that money is for “rollover” debt, it means the potential for default if they cannot borrow it.

European leaders said today that Greece won’t be allowed to fail, hinting of a bailout. But there are a lot of “buts” and conditions.

Click to read Page 2 at Minyanville …

There’s a reason why economies have based their currencies on something tangible since at least the Roman Empire. As John Allison explains, if we don’t do the same, high government debt and the threat of stagflation will never go away:

Last year, the US Dollar was the butt of monetary jokes. In fact, some suggested it was worth as much as toilet paper. With Trillion dollar deficits and 0% interest rates, those with common sense looked to other currencies for capital preservation.

In a moment of cosmic irony, some global investors are now fleeing to the safety of the US Dollar. Headlines about Greece possibly defaulting on their debt has investors wondering which is truly the worst of all possible worlds?

Last week, Ben Schott put together an incredibly valuable chart showing the S&P credit ratings of countries and US states. This is an excellent resource to keep on hand for those Candide moments when your mind wanders:

(Hat Tip: Barry Ritholtz)

Our partners at INO MarketClub have a free short video about trading FOREX (i.e., currencies). Click here or either image to watch now.

California Pizza Kitchen (CPKI)

Our first chart is from our partners at FusionIQ. Their Chart of the Week is California Pizza Kitchen (CPKI). “Shares scored a new FusionIQ timing BUY signal as well as a FusionIQ short squeeze last week. Additionally shares are forming a complex technical bottom and a pending breakout once it can close above $ 17.00. Two possible entries are to buy into any weakness or to wait for the close above resistance near $ 17.00. Our preference is for the latter scenario as there is a higher degree of confidence in the trade if resistance can be eclipsed, though in thsi scenario you will have a higher cost basis.” To learn how you can get an edge trading/investing with FusionIQ’s powerful platform, click here to watch my product review and take advantage of our special Wall St. Cheat Sheet 20% discount.

Nikkei (Click for Larger View)

David Singer let’s the lines speak for themselves in this analysis of the Nikkei. (Source: Singer’s Market — more sweet charts over there.)

S&P 500 in Other Currencies

Precision Capital Management submits: “How much of the current stock market rally is due to devaluation of the US Dollar?  Above tries to answer this question by pricing the S&P 500 in other currencies.  The S&P 500 has retraced about 45% of its down move, but if you’re a Canadian or European investing in the US, currency fluctuation risk has eroded about a third of this.  In otherwords, if you’re a Canadian and want use of the money you invested in US stocks, after you sell the stocks and convert back to Canadian Dollars, you’ve only gotten a 33% return.  If you’re in Euros, then 31%; Japanese Yen, 25%.  Worst off are the poor Australians, who’ve barely seen new highs since April 2009 and are at less than half of the 45% return in US Dollars, coming in at a meager 21%.” (Source: Precision Capital Management)

S&P 500 Futures

Dr. Brett Steenbarger takes a look at the Market Profile of the midday breakdown in the S&P 500 Futures on Friday: “Note the expanded selling volume (and overall volume) as large traders sold the ES futures as we neared the morning lows. The inability to sustain buying above vwap (and greater volume at bid vs offer) were important downside tells, as were the intermarket themes of strong dollar and weak commodities as the morning wore on. This sets up the earlier morning lows (and high volume regions highlighted by the arrows) as potential resistance for bounces.”(Source: TraderFeed)

“The Professor” Corey Rosenbloom at Afraid to Trade offers us a longer term look at Gold. Although it’s breaking out on the shorter-term charts, the chart above clearly indicates there exists resistance above which must be cleared for the next bull rally to run. (Source: Afraid to Trade)

Gold Priced in Multiple Currencies

Precision Capital Management offers a very interesting look at Gold priced in multiple currencies. The state: “Gold is one of the leading indicators we follow at our website.  Everyone seems to have noticed the spike up this week in gold, but how do we determine if the move is real, or merely a fakeout?  To confirm that gold is advancing on its own merits as part of a longer term move, which is not the result solely of US Dollar weakness, we want to see confirmation of an up move in gold priced in other currencies.  Above shows gold priced in the Canadian Dollar (CAD), Australian Dollar (AUD), Japanese Yen (JPY), and the Euro (EUR).  When gold began its last advance in November 2008, the move was confirmed by higher lows in the commodity currencies of the CAD and AUD, as well as the EUR (even though there were lower lows in the JPY and USD gold).  Eventually, there were higher lows in the JPY and USD gold at the beginning of December 2008.  Accordingly, for the gold bull case, early confirmation would be to see current lows in AUD, CAD and EUR gold respected on the first pullback (especially in the former two as they are commodity currencies), preferably accompanied with a break through overhead resistance.” (Source: Precision Capital Management)

Gold with Fibonacci Indicators

Our partners over at RatioTrading bring us yet our third and final perspective on Gold: “As demonstrated in this chart, Gold has historically respected key Fibonacci Ratio levels and with Gold retesting all time highs, where could it be headed?  Well as we look historically over the past year or so we see that in many instances when the GLD broke out and made a new low, it went right to either a 1.272 Fibonacci extension ($73) or a 1.618 ($65).  Now , as we are approaching a serious line of resistance, the big question is where are we going?  The expectation we have is that IF GLD can break out at the very least it should get to $100 which has also been an area of resistance.  However, if it can get more momentum then expect $104 to come quite quickly. Remember, trade your plan, have rules and implement them with discipline.  It’s the only way to survive in these markets!” (Source: RatioTrading)

Here are two beautiful longer-term charts from Barry Ritholtz. Above we can see unemployment looking back at the 10-year moving average like Neil Armstrong from the moon. In the chart below, we can see that every month this year has been far more harrowing than the months in years past. Hold on to your hats (Source: The Big Picture)

Do you have a dank chart worthy of a Chart Junkie? If so, click here to email us the link. (Note: DO NOT send us files. We will not open the email!)

If you are interested in real-time market analysis, click here to follow Wall St. Cheat Sheet on Twitter.

Jonesing for more charts? Try these posts:

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Chart Junkie 6.22.09

As traders thirst for 24/7 access, FOREX continues to increase in popularity. I cannot surf any investing or trading site without a barrage of ‘FOREX Trading Account’ ads flashing like 42nd St. signage before Giuliani was mayor of NYC.

Currency trading became relatively popular during the recent bear market in the US Dollar. Basically, trend traders spotted a clean textbook trend. Then the heard flocked to the pastures. But FOREX is a complicated world full of governments, huge institutional traders, and 24/7 reactions to a global information stream.

I recently spoke with professional FOREX trader German Santos to help us figure out where to start. German, a former embedded hardware/software engineer known as pipmaestro on the StockTwits Recommended list, was kind enough to school us on the basics of FOREX trading.

German Santos

Damien Hoffman: German, what is the exchange called “FOREX”?

German: The foreign exchange (FOREX) market is the most liquid market in the world — far surpassing the combined average daily volume of the equities and futures markets. Central banks utilize the FOREX market to stabilize and protect the value of the nation’s currency. Banks facilitate trades on behalf of clients. Banks also speculate for their own accounts. Corporations with foreign exposure hedge their currency risk. Hedge funds and retail traders speculate and attempt to benefit from the interest rate yield. Finally, travelers require currency conversion services for use in countries visited.

Damien: What currencies trade on the FOREX?

German: The US dollar (USD), Euro dollar (Euro), Japanese yen (JPY), British pound (GBP, sterling or cable), Swiss franc (CHF or Swissy), Australian dollar (AUD or Aussie), New Zealand dollar (NZD or Kiwi) and Canadian dollar (CAD or Loony) are the most heavily traded currencies. The EURUSD, GBPUSD, USDCHF, USDJPY, USDCAD, AUDUSD and NZDUSD are amongst the most actively traded pairs. [Pairs are the relationship between two currencies.]

The US dollar is the world’s reserve currency. Most commodity prices are quoted in this currency. The European Union’s Euro is influential because the combined member state GDP approaches that of the United States. As a result, the EURUSD is arguably the most actively traded pair. The USD, JPY and CHF are known for their safe haven status.  The USDCAD, AUDUSD and NZDUSD are known as the commodity currencies because of their close correlation to oil, gold etc. The USDJPY, GBPJPY and other yen “crosses” had been used by traders implementing the carry trade strategy (described later) because of the yen’s virtual zero interest rate characteristic. Currency pairs such as the GBPJPY are known for their high intraday volatility, whereas the USDCHF is relatively stable. Currency pair characteristics are dynamic in nature and can change with time.

Damien: Can you explain how the currency “pairs” work?

German: The basic retail FOREX trading instrument is the currency pair. A transaction consists of the selling of one currency in exchange for the purchase of another. Let’s use the EURUSD pair as an example. An exchange of US dollars for Euro dollars occurs when you purchase the EURUSD pair. The EURUSD is purchased when there is an expectation that the Euro will increase in value relative to the US dollar. Conversely, an exchange of Euro dollars for US dollars occurs when you sell the EURUSD pair. The EURUSD is sold when there is an expectation that the US dollar will increase in value relative to the Euro.

Currency pairs are typically quoted to the second or fourth decimal place. Furthering our example, if the EURUSD quoted price = 1.4000, then 1.4000 US dollars are required to purchase 1 Euro dollar. If after purchase the value of the EURUSD pair increases to 1.4100, the transaction close will result in a net gain of 1 US penny per Euro returned (minus spread and commission). In conjunction with leverage and your account type, the penny gained on the EURUSD pair could represent anywhere from 1 US dollar (a nano account) to 1 thousand dollars (a standard account) per contract.

Damien: Can you explain how you arrived at those values?

German: For many currency pairs like the EURUSD, the smallest change in price occurs at the fourth decimal place (0.0001). For other pairs (like the yen pairs), the smallest change in price occurs at the customary second decimal place (0.01). The minimum change in price is called a pip (percentage in point). For our EURUSD example, a pip represents a value from 1 US penny to 10 US dollars — again depending on account type. The pair increased in value from 1.4000 to 1.4100, or 100 pips. For a nano account, 100 pips x 1 US penny per pip = 1 US dollar gained per contract.  For a standard account, 100 pips x 10 US dollars per pip = 1 thousand US dollars gained per contract. The actual monetary value of each 1 pip increment varies based on the chosen currency pair and account type. So always verify with your broker.

Damien: What is a “carry trade”?

German: In addition to profiting from the rise and fall of the currency value, the interest rate differential between the currency owned and currency sold will either add to or subtract from your account on a daily basis at the close of the session. Trades specifically designed to profit from this interest rate differential are known as “carry trades.” Of course, owning the currency with the inferior interest rate results in a debit to your account on a daily basis. The amount credited to or debited from your account per open trade varies with currency pair, position size, and broker. The yen crosses had been the classic example of the carry trade until recently when the interest rates of countries like the United States and Britain essentially migrated to yen levels.

Damien: If traders are serious about trading currencies, how do you recommend they proceed?

German: Choice of FOREX broker matters! Adequate broker capitalization is crucial. Go to http://www.cftc.gov/marketreports/financialdataforfcms/index.htm and download the latest month’s report. Stick with companies that have the highest capital structures and are engaged in a reasonable marketing campaign. The federal government continues to increase the capital requirements for FOREX brokers and each occurrence seems to cause a broker to go the way of the dodo bird!

Also, abandon all notions of getting rich quick. Because of leverage and due to the fact that even a broken clock is correct twice a day, the FOREX market can give you the illusion of being able to make a huge amount of money quickly. The market can randomly reward you for bad trading behavior. Until you execute your bad trading habit one too many times and the account proceeds to blow up. Capital preservation is critical simply because you need enough time to be able to discover those “bad trading habits.” Go slow. Preserve your capital. Learn the fundamentals. Achieve consistency.

The FOREX-industrial-complex will dazzle you with all types of entry/exit systems guaranteed to have you on your island sipping margaritas in no time. The entry/exit component, however, is just one leg of a three legged stool. Learn all you can about risk, money management, and trading psychology. Familiarize yourself with the concepts of position sizing, expectancy, risk-reward ratio, win-loss ratio, and the random re-enforcement mechanism. Books by Van Tharp, Alexander Elder, Mark Douglas and John Murphy will go a long way towards helping you understand the fundamentals of trading.

Ultimately, there is no substitute for practice, practice, practice. Screen time is crucial in helping you make the transition to consistency and ultimately profitability.

Damien: In your opinion, what are the best free FOREX resources on the web?

German: The best free FOREX education resources on the web that I have seen are: babypips.com and the education sections of informedtrades.com and learningmarkets.com.

Damien: German, thanks for all this great information! I hope you will come back and teach us more in the future.

German: Thank you, Damien. Enjoy the journey and I’ll see you on the field.

If you are interested in real-time market analysis and trades, click here to follow Wall St. Cheat Sheet on Twitter.

If you are interested in trading currencies, click here to follow German Santos.

Feel like sponging up more Trading Basics? Try these posts:

Trading 101: Fibonnaci Indicators with Pro Trader Abdel Ibrahim

Risk Management for Small Caps with Trader Kunal Desai

Top Three Mistakes New Traders Must Avoid

Getting Started Trading: The Setup