Chart 1: GEM currencies have been in a downtrend for almost 3 years
Source: BarChart (edited by Short Side of Long)
As usual, the financial media starts paying attention to any issues, like the current GEM currency sell off, near the end or the climax part of the trend. The chart above shows that the currencies like Turkish Lira, Indian Rupee, Brazilian Real and South African Rand amongst others, have been in a downtrend against the US Dollar since middle of 2011 (Turkish Lira since November 2010). That means, these currencies have been weakening for almost three years, and yet only in the last few months has the attention turned towards them.
Majority of these currencies have now either re-tested or exceeded their 2008 Global Financial Crisis lows. That is not to say that these currencies will not continue to weaken further, however their cyclical downtrends are prolonged and it might be a bit too late to short them blindly right now. Furthermore, US Dollar has recently entered terminal blow off phase against some of these currencies, indicating panic. This is usually witnessed near the end of the trend.
Chart 2: Weakness in GEM currencies can usually mark a crisis low
Source: Nomura Research
The chart above isn’t recently updated, as certain GEM currencies have really been battered over the last 6 month time frame. However, the point of the chart is to show you, the reader, that powerful sell offs and underperformance in the Emerging Market currency space usually signals a crisis low of some kind. Whether it was the Asian Financial Crisis in 1998, the default of Argentina in 2002, Lehman bankruptcy in 2008, or the Euro Crisis episodes in 2010/11 – it is obvious that GEM currencies get hit hard first, due to contracting liquidity. However, from the contrary point of view, extremely oversold levels usually mark the crisis low.
Second observation I would like to make is that, between 2002 and 2008 GEM currencies (just like many other risky assets) performed superbly without too much volatility or downside risk. On the other hand, since 2008 GEM currencies have been extremely volatile and constantly sold off against the likes of strong count parts like the USD. It should be common knowledge to all investors that low market volatility precedes market turbulence, while high market volatility precedes market opportunity. In other words, continued turbulence should eventually present an opportunity, as we’ve seen a crisis after crisis since ’08.
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