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Is the Euro Signaling Problems Bigger than Cyprus?

Mar 19, 2013
Ron DeLegge

Negative price action in the euro since February has told investors/traders which side of the trade to be on. Meanwhile, mis-information relentlessly keeps coming out of Europe.

Just 20 short months ago, the three largest banks in Cyprus passed the EBA and ECB’s so-called “stress test” with flying colors. But now they’re in trouble; very big trouble. 

In case you missed it, banks in Cyprus are closed until Thursday to prevent mass withdrawals by customers. The banking crisis (NYSEARCA:EUFN) was sparked by an international bailout package that would have taxed depositors to finance the bailout. Although the Cypriot Parliament rejected the plan, it’s probably a safe bet that Cypriot banks won’t be ready for business on Thursday.

Eight months ago, Spain (NYSEARCA:EWP), Italy (NYSEARCA:EWI) and Greece were the major credit default concern – not Cyprus. Is this the rogue wave that will – once and for all – lead to the euro’s demise?

Cyprus 101
The Republic of Cyprus is an island country located in the Mediterranean Sea, just east of Greece. Cyprus is also one of the European Union’s (EU) 27 sovereign member states (still in good standing, last time we checked), and a uses the euro currency. What about its people?

Wikipedia says:

“Cypriots are among the most prosperous people in the Mediterranean region, with GDP per capita reaching $30,000. Their standard of living is reflected in the country's "very high" Human Development Index and Cyprus is ranked 23rd in the world in terms of the Quality-of-life Index.”

Put another way, Cyprus is not an emerging market like Greece (NYSEARCA:GREK).

Unfortunately, Cyprus is heavily indebted with a debt-to-GDP ratio of 127%. And although its economic output is miniscule compared to France, Italy, and Germany, the significance of Cyprus cannot be understated.


Beware of Misinformation 
The misinformation about the severity of the eurozone crisis and its scope continues. Right after Cypriot banks got a clean bill of health in 2011, the Cyprus Finance Ministry issued a misleading statement saying: “The measures which the banks are taking or planning to take will further increase solvency.” He was wrong.

Just today, Fitch Ratings re-affirmed the EU’s long-term credit rating to “AAA.” The timing of Fitch’s announcement is eerily suspicious in nature. Why, of all days, would Fitch issue such a statement? Is it to instill confidence in Europe’s rather shaky credit market? Or is it because Fitch really believes everything is great?

Oddly, out of the same mouthpiece, Fitch acknowledges:

“Outstanding EU loans have increased significantly since 2008, up to €55.7bn at end-2012. This is mostly attributable to the EFSM program, under which €48.5bn total loans to Ireland and Portugal were approved.”

You decide whether to believe that metrics like this are worthy of AAA investment grade status.

The euro’s clues
We cannot overstate the importance of ignoring the rhetoric and misinformation coming out of Europe and its PR handlers. Had investors just watched the price action in the euro, it would’ve told them everything they need to know – and more.

On Feb. 10, via our Technical Forecast we wrote:

“The Euro continues to sell off and has now pierced its monthly pivot. A break of the blue uptrend channel support trendline would likely provide a high probability sell setup as the uptrend since the November lows ends. This past week price also caused the RSI momentum indicator to fall below its uptrend line, a confirming signal that the trend is at a minimum stalled out, but more likely, changing. Given the prevailing bullish sentiment and commitment of speculators to a continued rally in the Euro, from a sentiment standpoint, the odds are indeed better for sellers of the Euro here versus buyers.”

Since early February, the ProShares Ultrashort Euro ETF (NYSEARCA:EUO) has gained more than 11% while the Euro Currency Shares (NYSEARCA:FXE) has sunk and stunk -7.5%. Despite the bullish propaganda coming out of Europe, being short the euro was the right side of the trade because that’s what technicals were confirming.

Moral of the Story
The ECB has now stated it will extend liquidity to Cyprus. (Monetary liquidity, not Kool-Aid) And so it is, the roots for the next financial crisis have been firmly planted with more of the same old hat.

Don’t let the today’s fascination with Cyprus lead you to miss the big picture. As our euro trade clearly illustrates, high probability trades still abound, while we wait for other mega investment themes to play out.

The ETF Profit Strategy Newsletter identifies key support levels in the euro and other major ETF categories. These levels must hold, to prevent asset prices from falling further. No major rally begins without a break above resistance and no meltdown starts without a break below support.

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