Is The Currency Market About To Become Unglued?

Often when big brokers are pitching a certain investment, it is a pretty good sign to avoid that investment. Currency trading increased significantly in 2009, but the serious sovereign debt problems around the globe could lead to a currency collapse. See the following post from Daily Wealth.

Several weeks ago, I was invited to a client meeting in Miami held by the wealth-management firm AllianceBernstein.

Bernstein's investment research has long been regarded as the best on Wall Street.

Why? Bernstein does honest, thorough work because it doesn't engage in investment banking. It's paid to be right, not to sell retail clients down the river to pull off a public stock offering or sell a bond.

In Miami, the firm's head economist spoke about the dynamics of the global currency markets and explained AllianceBernstein's trading strategy. It borrows in four to six currencies with low interest rates and buys four to six currencies with higher interest rates. This diversified approach reduces risk substantially. And it has historically produced better average returns than the S&P 500 with less volatility.

The presentation was designed to entice wealthy U.S. investors to open leveraged foreign-exchange trading accounts with AllianceBernstein. And I must say, the presentation was among the most sophisticated I've ever seen. The economist really knew his stuff. But... I was deeply troubled by the presentation.

In my experience, whatever the big brokers are pitching to retail clients, that's the thing most likely to blow up next. One year it's dot-com stocks, one year it's mortgage backed securities, one year it's commodity futures, and so on...

I'd never seen a Wall Street firm give a leveraged currency presentation to retail clients before. While this kind of trading can be very profitable, it is extremely risky – especially right now.

For the first time since just after World War I, we have serious sovereign debt problems in all of the major currencies. And for the first time in the history of man... we have a global monetary base that's not anchored to any real asset.

In fact, the largest reserve assets of the world's monetary system are the obligations of a bankrupt nation (the U.S.) that must print money to afford its own annual deficits (read my essay on this here).

This is a recipe for disaster.

I believe the entire system of paper money – globally – is coming unglued. The result will be a kind of volatility and disruption to the global economy the world hasn't seen since World War I, when the gold standard ended in 1914.

Ironically... ignorant of these enormous risks... retail investors are running full speed ahead into foreign-exchange trading.

Deutsche Bank reports its currency trading platform for retail clients saw a 40% increase in customers during 2009. In the U.S., foreign-exchange volume was up 28% last year – almost entirely because of retail trading.

I suspect these numbers will continue to grow for a while, but I urge you to avoid this looming disaster. It will be devastating to unsophisticated traders who don't practice sound position sizing and don't use stop losses.

While trading foreign currencies has been a good strategy for a long time... what will happen to those strategies as volatility soars and the large currencies collapse? No one knows.

But one thing I do know for sure: It won't end well for retail investors. Someone has to hold the bag for all of the world's paper money. Who do you think will end up holding the bag? Retail investors... or giant institutions like AllianceBernstein?

My advice for anyone itching for a currency trade: Trade worthless paper dollars for gold bullion. Trade them for silver. Repeat as often as possible.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.