Bet on the euro against the U.S. dollar?

I'm kidding, right?

Didn't I read this past weekend's headlines, which brought news of yet more agony from the euro-zone? Spain is about to be the next European economy to collapse and follow in Greece's footsteps; the Spanish stock market fell another 2.2% on the first trading day of this week alone. Europe as a whole is in little better shape, now that it is in a confirmed recession.

In light of all this -- and there's much, much more -- how can anyone in their right mind bet on the euro?

Contrarians, of course, are not fazed by the incredulity of a particular position. On the contrary, that's when they often begin to get interested.

The contrarians' instinct is bolstered by comparing where the euro [EURUSD] stands today to where it stood two years ago, when Europe's sovereign debt crisis was just getting into full swing. In terms of U.S. dollars, it currently trades for $1.25. Two years ago, at the end of May 2010, the euro stood at $1.23.

That contrast is nothing short of amazing. Despite two years of virtually uninterrupted awful news about Europe in general and the survivability of the euro itself, the currency is nevertheless trading a couple of percent higher now than then.

Yet, you'd never know that from reading the news headlines.

But the numbers don't lie. And they are telling us that participants in the currency market collectively believe the euro to be slightly more attractive today than it was two years ago, at least in terms of U.S. dollars. And while it's always possible that they are completely deluding themselves, we shouldn't be too quick to declare this to be so. The currency markets are the largest in the world -- far bigger and more liquid, in fact, than either the U.S. stock or U.S. bond market. Those markets contain some of the smartest and shrewdest investors the world over.

So we should at least take seriously the possibility that the euro isn't a doomed currency.

Extremely bearish sentiment among speculators is another contrarian reason to take that possibility seriously. In the latest reporting week, according to the Commodity Futures Trading Commission, speculators' net short position in the euro rose to an all-time record high.

Though these speculators represent only a small fraction of the overall market, they often exercise an outsized influence on the short-term trend. And because they tend to be momentum players, they tend to exaggerate that trend -- in the current case, for example, forcing the euro to fall further than it would have otherwise.

That's why contrarians are betting that the euro will rally against the U.S. dollar.

For the record, I should stress that contrarian analysis can't provide guidance on the direction of the euro's long-term trend relative to the dollar. Instead, it should be viewed as a shorter-term tool that gives us insight into where we stand relative to that long-term trend.

So it's entirely possible that the euro someday will trade at much lower prices. But, if contrarians are right, its path to those lower prices will include at least a short-term detour to higher prices.

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