Jan. 18–INTERNET TRADING OF CURRENCIES A DIFFERENT ANIMAL: Beneath the conventional chairs and tables of the world economy, a hectic cat-and-mouse game is under way in the financial markets.

Thousands of ordinary investors here and overseas, the mice, are playing with a few giant banks, the cats, in trading currencies.

Until a few years ago, individuals rarely thought about exchange rates, unless they were about to take a trip.

Today, the Internet is awash in sites offering direct trading in currencies. With no commissions, cash down payments as low as 1 percent and 24-hour action, the direct foreign exchange (forex) market has captivated many Nasdaq day traders of the late 1990s.

“It’s like the dot-com craze, but it’s currencies,” said Edward Velazquez, chief executive of V-Tek Capital, a hedge fund adviser.

Known among law enforcement officials as a den of thieves, the retail foreign currency market gained some respectability in recent years.

A reform of the commodities trading laws in 2000 enabled the federal government to regulate over-the-counter currency-trading operations that aren’t traditional financial institutions.

Last month, the National Futures Association, the self-regulatory organization of the futures industry, implemented rules seeking to toughen standards.

Ironically, the regulatory initiatives have placed an implied stamp of approval on the game.

Andrew Busch, foreign-exchange strategist for BMO Nesbitt Burns, said retail over-the-counter currency-trading volume is booming. It represents about 10 percent of the $1.3 trillion daily trading in currencies, he said.

Once the domain of megabuck hedge funds, over-the-counter forex has gone down market.

Currency-trading desks at major banks have been hollowed out by mergers, such as last week’s J.P. Morgan Chase-Bank One deal, and by the consolidation of European national currencies into the euro, said Craig Russell, a forex dealer at AlaronFX.

As a result, traders are hanging out their own shingles on the Internet, he said. In some cases, just a few hundred dollars are needed to open an account.

Moreover, the fad has a distinctively global scope. Asians and Europeans are far more conversant in the dynamics of currencies.

One dealer, Xpresstrade in Chicago, says more than 30 percent of its volume is generated from outside the United States via the Internet.

“If you grow up in Europe or Asia, you are accustomed to other currencies and other languages,” said Dan O’Neil, a principal at Xpresstrade.

The standard bet currently is that the U.S. dollar is toast because of U.S. government and trade deficits. But last week the dollar rallied sharply, perhaps signaling a trend reversal.

Who knows? But what small-time currency traders, glued to their computer screens, don’t realize is this: Of all the financial markets, trade in currencies is the most immune from logic and discernable economic forces.

Meanwhile, the world’s biggest banks are more than happy to pocket the profit between the wholesale price of currencies, which they charge each other, and the higher retail price paid by everyone else.

Unless evolution has changed, cats still feed on mice.

Bill Barnhart is a financial columnist for the Chicago Tribune. Write to him in care of Your Money, Room 400, 435 N. Michigan Ave., Chicago, IL 60611, or via e-mail at yourmoney@tribune.com.

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(c) 2004, Chicago Tribune. Distributed by Knight Ridder/Tribune Business News.

BMO, JPM, ONE,

Jan. 11–Normally, investment managers like to “talk their book.” They’re great at touting the investments they already own.

But the cheerleading among managers of small-cap equity funds is remarkably restrained, considering the banner year the sector enjoyed in 2003.

Investors, take the hint.

Stocks representing the smallest one-tenth of the stock market, measured by equity market capitalization, soared 84 percent through November, the latest figures of the Center for Research in Securities Prices at the University of Chicago Graduate School of Business.

By comparison, the Dow Jones industrial average returned 28 percent last year, including dividends.

Small-cap stocks had their best year since 1967, according to Ibbotson Associates in Chicago.

So you’d think fund managers would be flogging small caps in 2004.

But it’s not happening. Here’s why:

Most managers of small-cap stocks at registered mutual funds failed by a wide margin to match the sector’s gain.

A notable exception was the Oberweis Micro-Cap Fund, which more than doubled last year. The average return by small-cap funds was 44 percent.

Traditional managers of small- and micro-cap portfolios for institutional investors on average fared no better against the benchmarks.

“We were left at the track,” said Michael Crowe at Mesirow Financial. Crowe stuck to his discipline and made 44 percent in micro-caps. “Our companies have earnings. Stocks with no earnings were the best.”

So who enjoyed the big gains? The image comes to mind of wild-eyed amateur day traders boosting stocks they know only by ticker symbols–an image that emerged in the late 1990s.

But that’s not what’s been going on, said private investor William Jurika, the retired founder of the California investment firm Jurika & Voyles.

“You’ve had a lot of hedge funds started, and they are taking the place of the day traders,” he said.

Investment partnerships plunged into micro-caps last year. The reason was simple, said Jurika, a veteran of small-cap investing who runs a hedge fund.

“In the shadow of Enron and WorldCom and the collapse of the Internet [stocks], things just got amazingly squashed,” he said.

“You had the opportunity to buy companies that venture capitalists had financed a few years earlier when they had not developed their product and didn’t have any revenues.

“You were able to buy them more cheaply than the venture capitalists had paid to get in when the companies didn’t have anything. You had the opportunity to make three or four or five times your money.”

But hedge funds can’t advertise to the public. Their ability to generate price momentum by touting their holdings is limited.

Moreover, hedge funds have no obligation to maintain an advertised investment style.

“I’ve built quite a bit of cash now,” Jurika said. “We’ll just sit on that, whether it takes a year or two.

“One of the most dangerous times for an investor is after he has had a great success.”

–Bill Barnhart is a financial columnist for the Chicago Tribune.

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To see more of the Chicago Tribune, or to subscribe to the newspaper, go to http://www.chicago.tribune.com/

(c) 2004, Chicago Tribune. Distributed by Knight Ridder/Tribune Business News.

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