Tuesday, May 29, 2012

Eurozone Recession Intensifying

Topics Covered
  • Eurozone recession intensifying & spreading
  • Treasuries are historically at major extreme
  • Record bullish Dollar bets increase further
  • Italian & Spanish credit situation still worsening
The selling pressure has claimed in risk assets, however recovery rallies - if even present - remain very dull. US equities and Gold have bounced modestly, while Crude Oil still struggles to find support. Treasuries are still sitting near all time record high prices, while the US Dollar has broken above resistance at 82. With such large bullish bets, it remains to be seen if this breakout in the Dollar will be real. The bottom line still remains the same: investors are selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino. At the same time, Asia is slowing down meaningfully. Nothing has been done, announced or hinted by authorities yet and risk off trades are very crowded. Short squeeze could occur at any point in time.

Economic Data
European recession is intensifying, that is for sure. Officially, over one third of European Union members are now in technical recession. Unofficially, I'd argue that probably just about all of them are and so would the falling Euro currency, falling Euro Stock 50 stock prices and falling Bund yields.

Italian Business Confidence continues to deteriorate at the fastest pace since 2008 recession and there is still no sign of a trough. Italian GDP could get more negative soon, putting pressure on borrowings costs (more on that in the credit article below). Italy is a very good barometer for Southern European economies, so as we see confidence plunge here, we can also be sure that the situation from Spain to Portugal and Greece is most likely much worse.
Furthermore, this is now spreading into the EU Core countries. While France is not officially in a recession just yet, French PMI manufacturing is signalling that countries output levels are about to start falling much faster than originally thought and currently reported.

Many of you would be saying... well, we all sort of knew this, so what is your point? While many economists expected some type of recovery by now, the European recession is spreading across the continent. But that is not all. Since Europe is Asian main customer, it seems that the European recession is now also slowing down Asia too. If you are getting a feeling of a deja vu, than I do not blame you.

You see, in 2007 US housing started to fall apart affecting subprime companies. This spread into the US finance system and started affecting major global banks. Eventually, US entered a recession in late 2007 and it started to spread towards Europe. Finally, a mild recession escalated into a Global Financial Crisis affecting Asia too. Throughout the whole ordeal, the word "de-coupling" was constantly used by the bulls.

Today - the starting point is the peripheral Europe (PIIGS) in 2010. Here we are almost year and half later and the crisis is slowing affecting the whole Europe. Even France and Germany are now slowing meaningfully. At present trajectory, it is very possible that Asia is starting to also be affected now too. And "if" we continue down the 2008 road, eventually a global recession could follow once again. However, once again a major word use by the bulls is that the US or even Asia is "de-coupling" from European slowdown. I am not so sure about any of that!

Equity Markets
Nothing new to report.

Bond Markets
Global interest rates move in long term cycles, known as Kondratiev Waves. These cycles last about 50 to 60 years from trough to trough, and from peak to peak. That means, half cycle movements last anywhere between 25 to 30 years. If we look at the chart above of the US Treasury 10 Yr Note Yield, we can draw two major conclusions:
  1. After peaking in September of 1981 at above 15%, Treasury interest rates have been dropping for 31 years. Therefore, we are eventually overdue to a major trough in rates, from which a grand secular Bond bear market will start (rising rates for about 25 to 30 years).

  2. Treasury rates have been trending lower in a basic bearish channel, but ever since the Eurozone Crisis started in late 2009, capital flight has found its way into Treasuries on a major scale. As foreigners continue to pile into this "safe haven", it is starting to look extremely overbought from historical perspective and in a major terminal blow off move, that will eventually mean revert.
Having said that, from the short to medium term perspective, as long as there is no resolution in the Eurozone, Treasuries remain favoured by global investors and could benefit further. Also to note, with possibility of a global recession looming and Asia slowing meaningfully, Treasuries could also benefit for awhile longer - as there is no alternative for the time being. Just like all bubbles, they tend to go much further than anyone can imagine. But be warned that eventually, this grand 30 odd year secular bond bull market will end. And when it ends, mean reversion in interest rates will be very violent.

Currency Markets
Over the last week or two, I have discussed in various articles how traders and investors are very bullish on the US Dollar at present. On Friday, another Commitment of Traders report became published and it showed more of the same, but with further extremes. It is very interesting to see that overall cumulative futures positions showed the largest ever bullish bet on the Dollar. As we can see in the chart below, the market holds close to quarter million contracts, anticipating further greenback appreciation.
If we break down the data, we can notice that Euro and Australian Dollar now hold historical record net short positions. Market turned short New Zealand Dollar for the first time in quarters, Swiss Franc shorts intensified dramatically, while Yen's short positions have been reduced. Hedge funds are still slightly net long the Pound and the Loonie, but I think even those have been reduced further as last week progressed with more selling. The chart above shows that whenever investor quickly pile into Dollars, at least a correction tends to follow.

Another observation should also be considered. If we look at the chart, we can notice that there has been no terminal move (vertical panic rise) in the Dollar with such extreme bullish sentiment. Current price action is not extreme and doesn't signal a trend change right now. Therefore, I am not yet ready to re-enter Dollar shorts, even though I expect the Dollar to correct very soon.

Commodity Markets
Nothing new to report.

Credit Markets
Majority of market participants focus on PIIGS 10 Yr Yields or the spread of those bonds against the equal maturity of German Bunds. This helps them gauge the risk effects that are occurring with the government bond markets. However, I think there is a more important indicator to follow, and that is the short term funding costs that these countries are currently paying when they issue bonds.
In the chart above, we can see that Spanish 2 Yr borrowing costs now stand at 4.34% while the Italian 2 Yr borrowing costs stand at 3.93%. Despite the LTRO program, which made short term funding costs fall temporarily, we are now back to same old again, where short term borrowing costs are at or above 4%.

There is not much too say regarding this apart from emphasising that we are now entering a very dangerous situation. Yes... money printing has kicked the can down the road and it could do so again, but each time that kick seems to be weaker and weaker. If the situations deteriorates further, where short term 2 Yr borrowing costs keep rising towards 5%, a major crisis in Europe could be waiting for us all around the corner.
Credit Default Swaps are also showing a similar picture of worry. While the LTRO program kicked the can down the road by quarter or two (which ever one you want to pick), Spanish CDS are once again making new highs and are now approaching 550 basis points, while Italian CDS are not too far away from their all time highs made late last year.
Finally, when we look at the banking systematic risk in both the United States and in Eurozone, we can see a picture of two different situations. European 2 Yr currency swap rates are close to levels we have seen during Lehman Brothers panic. This tells us that a possibility of a banking failure somewhere within the Eurozone remains very very high. On the other hand, the picture in much claimer in the US for now.

  • My further action depends on political and central bank intervention. During market panics, authorises also panic. It is not until they start to panic, that they actually do something about current problems, which usually take form of some type of reflation policy. However, weak action will make me reduce my longs substantially and rebalance my portfolio towards net short exposure. Italy and Spain are once again moving towards the edge of the cliff, which is a real worry!
  • I still own SPY Calls from earlier last week, so I will not be doing anything in the Equity market for now. I own no other equity positions.
  • I also still own SLV Calls from two weeks ago, so I will not be doing anything in the PMs market for now either. I also own a core Silver position from late December 2011 bottom.
  • I am still looking at Agricultural commodities, with RJA being my favourite way to own this sector. I haven't done anything yet.
  • Other assets on my watch list for some shorter term bullish rebound trades include Australian Dollar (FXA), Russian / Brazilian equities (RSX & EWZ), Gold & Silver physical ETF (CEF), Gold mining equities (GDX / GDXJ) and Continuous Commodity Index (GCC). I haven't done anything here either.
  • It is too early to talk about shorting anything yet, as I am waiting for a market rebound first.

Friday, May 25, 2012

Fund Managers Rising Cash

Topics Covered
  • Global growth and inflation expectations
  • Only handful of managers are taking higher risk
  • Fund managers continue to rise cash & bond levels
  • Commodities are now underweight by fund manager
Today's post specifically focuses on BofA Merrill Lynch Fund Managers Survey. it is one of the best contrarian indicators I know within the market space, as Merrill Lynch surveys about two to three hundred funds every month to get a consensus outlook. This month, the survey period was from 4th to 10th May, with an overall total of 234 fund managers survey representing $669bn AUM. Out of the overall total, 78 are Institutional Funds, 24 are hedge Funds, 47 are Retail Funds and 24 were other. More than 20% of all funds manage over 1 billion dollars. Fund managers are asked to focus on global growth, inflation, profits expectations, asset class and sector weighting positions, plus variety of other questions regarding risk and exposure. Enjoy.

Economic Data
The survey reported that "global growth expectations continued to drop, with a net 15% of fund managers expecting the global economy to strengthen over the next 12 months. This is down from its recent peak in March 2012, but is still well above levels associated with recession." The chart above, which I edited, shows that majority of the time economic slowdowns or recessions intensify with below net 50% of managers expecting weak growth ahead. Currently we aren't even close to those readings yet, but since this is not an normal economic cycle based on strong fundamental growth (like 03 - 07), an external surprise shock out of Eurozone could easily derail growth in an instant.
The survey also reported that, against trend seen in global expectations, net percentage of managers thinking that the Chinese growth will improve rose to an 18-month high reading of above 10%. Major Chinese growth recoveries occur when we see close to net 50% of managers expecting the growth to improve and unfortunately we aren't even close yet.
Moving forward, interestingly the sharp drop in growth expectations also showed a sharp drop in inflation expectations too. The report went onto say that "a net 2% expect inflation to rise in 12 months, down from 21% last month. This paves the way for policy easing." Merrill Lynch went onto to summarise the growth outlook by stating the following:
"After peaking in March, global growth expectations are down for a second month and only 9% see above-trend growth over the next 12 months. But no recession is forecast, and China growth optimism rose to an 18-month high. Inflation expectations dropped sharply and hopes of policy easing continue to rise modestly: 56% now expect Fed QE3 and 65% expect further QE by the ECB."
Equity Markets
Fund managers continued to raise cash in May. Managers weightings towards cash allocations jumped higher this month towards a net 28% overweight, which is up from a net 24% overweight last month. We are now once again reach close to one standard deviation highs, which means fund managers remain fearful.Average cash balances remained the same to previous month at 4.7%. From a  contrarian point of view, reading above 5.0% should be considered as a major buy signal. In 2008 the cash balance reading peaked at 5.5% in December. In 2011 the cash balance reading peaked at 5.2% in August. Both proved to be close to a major bottom in all risk assets, including equities.

While the chart doesn't show exposure to global equities, the survey went onto show that is has modestly been reduced. Merrill Lynch stated that "equity allocations declined to a net 16% overweight from 26% overweight last month as investors took risk off the table. The current allocation to equities falls roughly in the middle of the range relative to history." So in other words, equity managers are not yet in panic mode, but do keep in mind that the survey was done between 4th and 10th of May, which means as selling intensified, managers could have cut their weightings further.

The survey shows that overall risk appetite among fund managers continues to decline for the second month in the row. A net % of fund managers taking higher than normal risk dropped to -35%, down from -21% last month. In the chart above, readings at -40% or below tend to signal extreme readings. Investor perceptions of liquidity conditions are also declining, with a net 23% of managers viewing current conditions as positive, down from 36% of managers last month.

Bond Markets
Merrill Lynch survey also showed that cash is not the only popular safe haven investment right now. Bond allocations also rose in May, as risk appetite waned. A net 33% of fund managers are now underweight bonds, which is down from a net 48% of fund managers only a month ago. Despite a powerful rally in the Bond market, majority of fund managers still seem to be only modestly exposed to this asset class, even with ongoing Eurozone worries.

Currency Markets
Nothing new to report.

Commodity Markets
The survey also showed that fund managers reduced their allocation to commodities this month as well. A net 2% of fund managers are now underweight commodities sector, as opposed to net 8% overweight in April. Commodity prices suffered further declines after the survey was concluded, so it is also very possible that fund managers reduced their commodity weightings even further as well.
Relative to the survey's history, which spans for over a decade, global fund managers are very underweight the Materials Sector, with mining companies being out of favour. The survey went onto report that "the current allocation to resources is low at net 10% of fund managers being underweight this sector." This signal is now very similar to last months, but has yet to produce a buy signal. Also to point out is that majority of mining companies drifted lower since the survey was down, so there is a chance managers have reduced weightings here even further.

Credit Markets
Nothing new to report.

  • I still own S&P 500 Calls from earlier in the week, so I will not be doing anything in the Equity market for now.
  • I also still own SLV Calls from last week, so I will not be doing anything in the PMs market for now either.
  • I am still looking at Agricultural commodities, with RJA being my favourite way to own this sector. I haven't done anything yet.
  • My further action depends on Western central bank further actions. Weak action will make me reduce my core holdings and close out Calls.
  • Other assets on my watch list are Australian Dollar, Russian / Brazilian equity ETFs and Gold Mining stocks.

Wednesday, May 23, 2012

Dollar Bulls At Record Highs

Topics Covered
  • Assets are not responding to money printing
  • Break even rates signal a risk off environment
  • US Dollar net long positioning at record levels
The selling pressure remains in risk assets, despite modest recoveries in certain asset classes. While US equities staged a powerful reversal on Monday, Crude Oil is still moving lower. Gold is also giving up its gains. Treasuries are sitting near all time record high prices, while the US Dollar is flirting with its resistance at 82. The bottom line still remains the same: investors are selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino. Nothing has been done, announced or hinted by authorities yet and risk off trades are very crowded. Short squeeze could occur.

Economic Data
Nothing new to report.

Equity Markets
Away from the the shorter term buying opportunity currently present in the equity markets, due to oversold levels and high bearish sentiment, I want to point investors to a warning flag in the whole risk asset space. The chart below shows that major global equity indices have currently failed to march higher, despite large amounts of liquidity, money printing, rate cuts and stimulus promises around the world. Many investors seem to be dumbfounded as to why I've turned bearish "all of a sudden", while I'm dumbfounded as to why many investors, some of which I respect a lot for their skills, "still remain bullish".
They say bull markets climb a wall of worry, while bear markets slide a slope of hope. There is always a amazingly strong argument as to why one should stay bearish at the bottom and contrary to that also stay bullish at the top. Today, this argument comes in the form of investors belief based on their recent conditioning. Since March 2009, majority have now become trained to listen and trust into central bank activities, so hardly anyone is getting "too bearish" anymore. This is perfectly illustrated by the Investor Intelligence Survey chart below. While there is a certain amount of pessimism within equities, as they have sold off by, majority are not really bearish or panicking to mark a true bottom. It seems that investors are clam or even better put... complacent. They hope the central banks will save the day.
Whatever the problem and whatever the risk, we know central banks stand ready to act, right? They told us that. As an aside note, I have actually created an email folder, where I place emails from every investor I talk that has mentioned something similar to the following quote: "central banks will not let things get out of control". Believe me, it is currently the most popular folder in my inbox. In my opinion, central banks can only postpone the crisis, not prevent it. And they have been doing their job posting it with QE2, Operation Twist and LTROs. I am pretty sure they will try to post pone it again with QE3 and/or another LTRO. We will find out soon enough, but more importantly - will it work? The quote in the chart below is from a great market technician by the name of Tom McClellan. It was said in early 2011, as Russell 2000 was storming ahead to new highs. If we were to apply the same wisdom to today's price action, we can see that something is not right within the market environment. If there is plenty of liquidity (apparently), with central bank program after program, so why aren't small caps responding?
I've stayed bullish for as long as possible in this cyclical bull, but now cracks within the market are starting to appear left, right and centre. In a bull market, one is meant to stay bullish until there is a sign of an end in both the business cycle and the market cycle. Jesse Livermore was quoted saying that a 100 years ago and it is still true today. During last years market crash and European turmoil, I called the bottom in equities on October 04th and insisted that a recession will not occur. I remember one very popular blogger put forward an outlook that 2011 was going to be the worst bear market ever in financial history - now he thinks equities, as well as all other risk assets, will rise into 2013/14 and no recession will occur.

For me, the wall of worry has disappeared. Equity revenues have completely recovered, earnings are now at record highs and gross profit margins are at never before seen sky high levels. Personally, all I see is hope. Hope of central bank intervention, hope that Greece doesn't default, hope that China stimulates and hope of further rise in equity earnings. No investor should be blamed in this uncertain and volatile time. It is hard out there. My outlook here is bearish on almost all risk assets and I could be just as easily wrong as I am right. But, in my opinion, the market is talking to us. Wrong or right, those who can understand its code, can prepare for the worst, but still hope for the best.

Please remember that this is a secular de-leveraging cycle and capitalism / free market in the West is trying to write off bad debts, starting with Greece. Politicians and central bankers are not letting the free market operate and with excess liquidity measures (money printing programs) they are only kicking the can down the road. However, eventually the free market will force its way in, but the longer we postpone it, the worse it will be. A default of some type is coming sooner, rather than later. What I am trying to say is that despite QEs and LTROs, risk assets seem not to be responding anymore, as majority are failing to make new highs. Be very careful!

Bond Markets
The chart above shows US Treasury Break Even rates over a ten year maturity, which is a measure of expected inflation within the system by market participants. It is also a great measure of risk on and risk off trends. As we can see right now, inflation expectations are falling, which means deflation trade is dominating. Equities, commodities and foreign currencies have all taken a beating since March of this year. So far, every single deflation trade / risk off trend has been paused by central bank action. Fundamentals are bad as debt levels continue to grow from 2007 levels, but the can is being kicked further and further down the road. As inflation expectations fall, Ben is most likely getting an itchy trigger finger. Is QE3 on its way and more importantly will it work beyond the short to medium term sugar rush?

Currency Markets
According to the COT report on Friday, cumulative net long USD positions have now reached record bullish levels. With almost 28 billion dollars betting on the greenback, this is the highest bullish position since at least 1999. Hedge funds are shorting the Euro at record positioning, while also remaining net short the Yen and the Franc. Bullish positioning can be seen in the Loonie as well as in the Pound, while commodity currencies like Aussie and Kiwi have seen major reductions of net longs.
Recent Merrill Lynch currency survey I received, which came out on 14th of May, showed that EUR/USD positioning is now at historical extremes. This is what the newsletter went onto say:
"The net long in USD vs net short in EUR has reached a survey high. Last month’s move was driven by a significant increase in USD longs, this month’s change resulted from a considerable increase in EUR shorts. April’s increased optimism could be rationalised by fading QE3 expectations, this time round, the Greek election results have been the dominant driver. While the net percentage of investors expecting Greek debt restructurings has declined from 55% to 50%, 15% of investors now expect two or more countries to restructure from 9% a month ago."
Finally, last weeks currency article also showed that Public Opinion is very very high on the Dollar. I still hold a core position in Silver and do not own any US Dollars at present. From a contrarian point of view, I believe all risk assets have a chance to create a major short covering rally, if a catalyst is given (money printing, another bailout, more Chinese rate cuts, etc etc). If the short squeeze occurs, I will evaluate further.

Commodity Markets
Nothing new to report.

Credit Markets
Nothing new to report.

  • I bought some S&P 500 Calls on Monday as the rally started. That could have been capitulation from the short term breadth, sentiment and technical indicators. Therefore, after a re-test of lows a recovery rally could start. However, I believe main trend is down, so eventually I want to short equities.
  • I bought Silver Calls mid last week, so I will not be doing anything in the PMs market for now. My further action depends on Western central bank further actions. Weak action will make me reduce my core holdings and close out Calls.
  • Finally, I am looking long and hard at all Agricultural commodities. I believe the bull market will resume soon. My watch list has been Wheat Calls & Softs ETF, but I am considering just buying the overall sector through RJA once again. I still have not done anything yet and I might not until selling pressure globally eases.

Sunday, May 20, 2012

QE Rumours Spreading

Topics Covered
  • Philly Fed & ECRI predict weaker growth ahead
  • Fed to the rescues, but will another mild program work
  • Despite constant oversupply news, Wheat takes off
  • Sugar, Coffee & Cotton are the forgotten asset class
The selling pressure intensified in certain risk assets, while others staged a recovery rally. It seems that the US equities are now playing catch up as S&P 500 fell hard every single day this week. Commodities were mixed this week, with economically sensitive industrials like Copper and Crude Oil selling off, while Gold rallied. Wheat exploded higher as record net shorts got squeezed. Treasury Bond prices hit another record this week. Japanese Bond yields approached 2003 lows, while German Bunds hit another record low yield. The US Dollar finally posted a reversal candle on Friday after a historical run.  The bottom line still remains the same: investors are selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino.

Economic Data
There was a lot of news, noise and data on the economic front this week. One that really stood out for me was the release of the Philly Fed Index. Economist expectations for the survey were at positive 10, but the actually number surprised everyone by a mile, coming in at negative 5.8. Business activity is contracting again, by the looks of things. While not perfect, Philly Fed is a decent leading indicator in predicting potential recession ahead.
As we can see in the chart above, last year the signal gave us a warning, but Central Bank intervention with a lot of Twisting & LTROing postponed the outcome. While the stock market made new bull market highs into April of 2012 (on very skeptical internal breadth strength as reported many times on this blog), many economic indicators including the Philly Fed Index, have not confirmed the advance with fundamental data, and instead posting negative divergences. Current setup between Business Activity and the stock market resembles those of late 1999 and early 2007, just before the recession.
Philly Fed Index is not the only leading indicator that signals warning flags ahead. ECRI Weekly Leading Index continues to show a major negative divergence between Main Street (economy) and Wall Street (stock market). On top of that, despite a recent pop several weeks ago, ECRI also continues to post readings below its 2 year moving average. This lets us know that the economy has been decelerating since April of 2010, while the central bankers have extended this recovery beyond its actual fundamentals. How long can money printing keep the floor under stock prices?

I am afraid that the stock market has been rising on "thin money-printing air" for awhile now, so a reversion to the mean could be a seriously bad outcome, as it might overshoot to the downside in quarters and years ahead. It is not only Philly Fed or the ECRI indices that signal weakness ahead - broad economic data figures have collapsed compared to their expectations in recent weeks all across the world from the US, to the EU and GEMs. Citigroup Economic Surprise Index in the chart above, instates this perfectly. Naturally, bonds are outperforming equities again, but more importantly the Stock / Bond ratio has not confirmed S&Ps new highs either.
Not to worry, say a lot of investors. Money printing is in fashion, as we can see in the chart above. Every investor out there has been trained to follow central bankers to figure out if a risk off trade will be supported by more stimulus. Investors I speak to, majority of whom I respect a lot for their very good market skills, seem to think that the Fed is about to engage into another program of some type. Sure, why not! Operation Twist is ending anyway. But my question to you is, will another program similar to what we have seen since late 2008 (chart above), actually help the stock market and the economy?

The recent Fed and ECB programs have not helped the MSCI World Equity Index, which has failed to make a new high for the first time since March 2009 and has not confirmed S&P 500's new high into April 2012 - not confirmations are everywhere! What I am trying to say is that the investors are becoming immune to small doses of sugar highs in the proximity of half a trillion dollars or euros per junkie hit, while the real economy keeps drifting lower. Therefore, I am now turning bearish on the economy, the stock market and majority of risk assets, as I am becoming very worried that we have approached a major top since the cyclical bull market began in March 2009.

One would ask, what would turn me bullish on the economic cycle and the risk assets again? A massive money printing exercise by world's leading central banks (Fed, ECB, BoE, BoJ, SNB etc) with mutli-trillion dollar scale, but unfortunately, that might only come after a major shock occurs. I asked myself 3 simple questions, from which I gauge macro investment opportunities and risks in coming months and quarters:
  1. Do you think the Fed will act since S&P 500 has come off by only 10% in the last 2 months?
  2. What amount would be enough in a Fed / ECB program to restore confidence properly? 
  3. Do you think Greece will default in coming months and shock the system like Lehman in '08?
Answer those questions for yourself and/or answer them in the comment section of the blog.

Equity Markets
Nothing new to report.

Bond Markets
Nothing new to report.

Currency Markets
Nothing new to report.

Commodity Markets
I still remain super bullish on Agriculture, however. Agriculture is not really a risk on asset majority of the time and moves a lot more on supply and demand news. Regular readers of this blog should know that I have been EXTREMELY bullish on Wheat especially, predicting prices as high as $9 per bushel even this year, if not by next. And of course this is all despite constant oversupply news. I have argued for months that Wheat does have short term oversupply, but that the news has already been discounted due to record net short positions. The whole time Wheat failed to make new lows and trend down lower, despite bad news - which from a contrarian point of view tends to be very bullish!
In my opinion, eventually we are moving towards another major shortage of Agricultural supplies similar to 2008. Constant crisis periods from Lehman Brothers to Greece have created an under-investment environment in all commodities, but especially Agriculture. Even with falling demand due to average economic activity, supply across the board is falling much quicker on the historical basis looking back to 1960s, creating shortages. We have a shortage of equipment, shortages of farmers, shortage of supplies and shortage of just about anything Agri-related. It is becoming ever harder to feed Chin-dia and its 4 billion people population, which is slowly becoming a net importer of global grains and softs. 

Moving along, I remain neutral on the Soybean sector, due to a very powerful rally in recent months. However, I think the Soft complex is now a completely forgotten asset class and this is why I am turning my focus towards it. Let us look at the three main components in a quick summary - Sugar, Coffee and Cotton:

  • Sugar peaked in February 2011. From 37 cents towards 20 cents, the price of Sugar has now lost 44% in the space of 16 months. Public Opinion has collapsed in recent weeks. Daily Sentiment Index stands at single digit readings, while hedge funds have reduces net long positions substantially in recent weeks, according to the COT report. Furthermore, Small traders are now shorting Sugar again. Technically, Sugar got extremely oversold in recent weeks with RSI dipping very low for extend periods of time. We could be bottoming out soon enough.
  • Coffee was the last to peak in May 2011. From $3.10 towards $1.72 cents, the price of Coffee has now lost 44% in the space of 14 months. Public Opinion has collapsed in recent months, to much lower levels than 2008 bottom. Daily Sentiment Index stands at single digit readings for weeks on end, while hedge funds are now shorting Coffee for the fist time since late 2008 bottom, according to the COT report. Technically, Coffee is extremely oversold on the weekly chart, with a potential of an MACD buy signal developing. 
  • Cotton peaked in March 2011. From $2.25 towards 78 cents, the price of Cotton has now lost 65% in the space of 16 months. Public Opinion has completely collapsed this week. Daily Sentiment Index stands at 5% bulls, while hedge funds are now shorting Cotton for the fist time since late 2008 bottom, according to the COT report. Technically, Cotton just collapsed hard this last two weeks during the market panic with daily RSI at ridiculously low levels. The price is extremely oversold from all perspectives and all time frames. pretty much, Cotton has been  totally murdered!

Credit Markets
Nothing new to report.

  • I want to buy S&P 500 Calls soon. I am still waiting for signs of a bottom in the equity market sell off. Short term capitulation could be near, followed by a rally - even a very powerful one. Eventually, as we recover weeks or months from now, I want to short stocks.
  • I have recently bought Silver Calls on Wednesday, so I will not be doing anything in the PMs market for now. My further action depends on Feds and ECBs further actions. Weak action will make me reduce my core holdings and close out Calls.
  • Soft commodity ETFs (Sugar, Coffee & Cotton) are also on my watch list. Finally, in Agriculture, I am also looking at buying long dated OTM Calls on Wheat too. Prices in Grains and Softs can go higher despite risk off environment, if supply concerns elevate further.

Thursday, May 17, 2012

Panic Grips The Commodity Markets

Topics Covered
  • Equities becoming short term oversold
  • Dollar up 13 days in the row at 4SDs
  • Precious Metals sentiment extremely bearish
The selling pressure continues across the board in risk assets, while safe havens are bid. While the US equities have been outperforming rest of the global equities, Dow Jones is still down 9 out of the last 10 days. Commodities have been under most pressure, especially metals and energy (apart from Natural Gas). Treasury Bonds are now up 9 weeks in the row, with German 10 Yr Bunds having reached record lows of 1.44% this week. The US Dollar is up 13 days in the row, which has never occurred before. Finally, Grains have held up very well in the last few days, while Softs remain weak. The bottom line is investors are selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino.

Economic Data
Nothing new to report.

Equity Markets
S&P 500 has failed to hold above polarity line "in the sand" at 1,350. That is not a very good sign, and could signal that the breakout we experienced in middle of February is just a bull trap, despite a new bull market high. As some wise man once said, market top is a process and not an event, so I wouldn't rush to short equities just because of this. In that regard, maybe this is a sign that the process has started, however I am not yet looking at opportunities to short the market, especially with the current price action. What do I mean by that?

First of all, the market price is now becoming oversold. Sure, if the panic continue to set into the overall environment, prices "could" get even more oversold like in August 2011. But I am not so sure that will happen straight away. We discussed the topping process theory above, and since the price is still above the 200 day MA, we have to respect that the bulls are in charge and could create a recovery at any point.
Second of all, sentiment readings in various surveys, including AAII (chart above), show excessive amount of bears relative to bulls from the short term perspective. In previous occurrences this has almost always created a decent bounce (at least) or even a strong rally. Obviously negative sentiment in an uptrend, while prices are above 200 day MA, have a stronger possibility of delivering a contrarian signal than during a downtrend when prices are below 200 day MA.
SentimenTrader's own indicator - which is collective information of volume, options, breadth, fund flows, sentiment surveys and insider buying - shows excessive pessimism in the short to medium term as well. Previous occurrences when readings got this low (inverse on the chart), almost always managed to create some type of an intermediate low in the equity market. From there, either a bounce or a proper rally ignited. Some short term swings are also possible.
Statistically, Dow Jones is now down 9 out of the last 10 days. Futures indicate that Dow is about to do a 10th down day out of 11. Historically, this is quite a rare event. How rare? Only 20 times over the last 110 years of decent market history. Stats show that out of the 20 times this occurred, only three times it has been while the Dow was above its 200 day MA. In other words, this type of selling pressure usually occurs during bear markets, so it is even more rare during bull markets. Eventually, the streak will be broken.

Furthermore, as a slight note, intermediate corrections usually run for about 30 days at most and decline between 5 to 10 percent. The current correction is now running for 31 days and S&P futures have declines almost 7.5% from intra day high to current levels (as of writing this article). Finally, moving onto breadth, we have the following readings in the short term indicators, which are now signalling oversold levels:
During intermediate corrections of an uptrend / bull market, various breadth readings listed above have currently reached levels where the market staged rallies in the past. With bearish sentiment and oversold technicals confirming this outlook, we should soon start to stabilise. However, if we do not rally, investors should take this a warning signal that a more serious correction is at hand (10% or more).
Due to the election year seasonality currently being in progress, the stock market tops being a process, currently breadth / sentiment being very low and finally technicals oversold, I am willing to give the stock market the benefit of a doubt, despite breaking below 1,350. I'd expect a recovery from current levels as long as the price does not break very hard below 1,300. If the rally starts, I will judge it with a magnifying glass to try and pick up any major signals of either further weakness or potential strength.

Bond Markets
Nothing new to report.

Currency Markets
As I am writing this article, the US Dollar is up again. This now makes the advance a 14th day streak, something that has never ever... ever happened. The longest streaks US Dollar has managed was 11 days in July as well as in September of 1975. Furthermore to this overbought historical stat-measure, the price of the Dollar is also trading in its 4th standard deviation away from the mean. This is also quite a rare event, which indicates short term overbought readings.
Looking at the sentiment, it is obvious that a love affair in the US Dollar is currently present. Obviously it has less to do with love to be honest, and more to do with the fears coming out of Eurozone. So let us call it the fear affair, or fear trade. Nonetheless, when majority get this afraid, usually something opposite is going to occur. In other words, while anything is possible in today's market environment, due to such wide spread fear, I am reluctant to think that a major panic is about to occur right now, similar to that of Lehman in 2008. Authorities or global central bankers could signal uniform action of some type to clam the markets in the short term. Key word is "could"...

But, I must say something else too. Technically, the US Dollar is at a resistance, which we last saw in middle of January 2012. Therefore, since Mr Market loves to trick us all from time to time (pulled a few tricks on me lately too), maybe we can see the DXY Index break above 82 resistance. At this point, technical analysts would think that a major rally would be starting, while the rest of us contrarians would let the move exhaust and than most likely short it. So do keep the technical picture in mind.

Commodity Markets
Yesterday, Gold price fell towards the 29th of December bottom at around $1,530. The price was so oversold, that we managed to reach into 4th standard deviation on the downside (opposite of the US Dollar's upside). Technical RSI level is now as low as Lehman type of a reading during 2008. Other than that, no other time has Gold been this oversold apart from the 1999 low in mid $250 price range per ounce. 

Daily Sentiment Index yesterday reported that futures traders are extremely pessimistic. Currently, we only have 5% of bulls on the yellow metal. Silver and Platinum are just about the same too. Public Opinion by SentimenTrader as well as Hulburt Gold Newsletter Sentiment Index, both confirm this outlook too. Silver and Platinum Public Opinion is totally depressed. Finally, I am pretty sure that a lot of hedge funds cut their Gold futures positions, which we will see in tomorrows COT report (and obviously next Fridays too).
Furthermore, looking at the GLD fund flows, it is evident that retail investors hit the panic button all this week into yesterday. Dumb Money pulled out over 5 billion dollars out of the ETF. I personally think that after a three month decline in both Gold, Silver and Platinum, now is the worst time to be selling. I am obviously talking from a shorter term perspective, so this doesn't have to mean that the correction is over is over in this sector.
Other than the Precious Metals sector, all other commodities are also extremely oversold too, apart from Natural Gas as already started above. Continuous Commodity Index has suffered an extremely oversold condition and could be ripe for a bounce. Agriculture continues to show signs of a bottom, by first re-testing and than strongly bouncing of its major lows. Sentiment in the overall commodity complex is very very dismal. Be it Crude Oil (energy), Copper (metals), Cotton (fibre), Wheat (grains) or Gold (money), all major sub-sector groups are ready for some type of a bounce from extremely oversold conditions and insanely high bearish sentiment.

Credit Markets
Nothing new to report.

My watch list currently consists of SLV Calls and S&P 500 Calls. I will be executing both / either in coming days or week, depending on price action. At present, I do not recommend any core holdings in futures, ETFs or other tangible assets, due to the systematic risk from Greece. Options reduce downside risk and increase upside potential.

Tuesday, May 15, 2012

Quick Update

Market conditions are extremely oversold in all risk assets right now. Some assets have entered a four standard deviation price range away from their normal mean. Sentiment is super bearish across the board for many global stock indices and major commodities, to the point where an inflection point could easily occur. Certain commodities and European equity markets are slaughtered. Numerous assets are down 8, 9, 10, or even 11 weeks in the row. Other assets are down 8, 9, 10 or even 11 days in the row. These are extreme historical statistical events dating back decades. Something has to give soon...
It all points to a possibly of a major bottom occurring eventually and a massive buying opportunity. Having said that, if we continue down this selling road and we do not get a rally in risk assets soon, which drags us outside of oversold conditions, than we could crash from these oversold level. That is right... we could crash from here! Markets tend to crash when fear and panic spreads, while the technical conditions refuse to exit oversold readings. With no buyers coming into the market,  prices just sink lower and lower until full blown panic takes hold of all market participants.
Greece seems to be the catalyst yet again. If Greece leaves the EU and completely defaults on its bonds, banks from all around the Eurozone (even globally) will incur huge losses. Since majority of these EU banks are leveraged anywhere from 20 to 1 towards 40 to 1, liquidation in risk assets will take place to square off the balance sheet and reduce banks overall leverage. Some banks might even blow up. Even if the event lasts only for a several days, price levels could sink really really quickly. Similar type of event occurred In September and October of 2008 during Lehman Brothers bankruptcy. A more mild version occurred during MF Global liquidation just several months ago.
Personally, the current market conditions have certain type of Lehman II resemblance. On the other hand, technicals, sentiment and price data seems to point to an inflection point buying opportunity. I am not sure which one it is going to happen, the market will decide for all of us very shortly. Strong price action reversals could / should be bought for a rally, while further breakdowns could / should be major warning signals. 

Therefore, I would advise all to be very careful and take necessary precautions to protect yourselves in coming days and weeks. Hedge your core holdings in portfolios and reduce leverage. Leave cash on sidelines for a buffer. Finally, for those die hard contrarians out there... they should use this post (and the current market sentiment) as a signal that maybe it is time to buy right here... right now! Good luck.

Sunday, May 13, 2012

Summary Post Turbulence

It is Sunday afternoon, the 13th of May here in Asia. This week in the US one of the more important data factors I noticed was the fact that consumer confidence continues to improve towards a four year high. In my opinion, this is a contrarian signal, which will eventually be negative for the business cycle. Upturns start at consumer confidence troughs while company earnings are depressed, while recessions occur as confidence starts to peak and company earnings reach record high. We are at the latter, not the former.

In Europe, Spanish IP collapsed further than expected by -7.5%, French IP weakened by -0.9%, while German Factory Orders and IP surprised on the upside (up 2.8% while economists expected 0.8%). Swedish and United Kingdom IP remained quite flat, while Italian IP came in at better than expected figure of 0.5% positive. BoE kept its interest rate decision unchanged, with no further QE, helping the Pound outperform. In Asian, South Koreans kept their interest rates unchanged as well. There are signs of Asia slowing further. Malaysian IP and Indian IP showed a serious slowdowns. But the real focus was China, with major economic data being released on Friday, which included IP, Retail Sales and Inflation.
Chinese Industrial Production was very slow compared to expectations, coming in at 9.3% versus 12%. Chinese retail sales also disappointed and their CPI came in below expectations, giving the officials more room to ease. Chart above shows that during periods of slow growth and negative surprises, China still has plenty of room to ease. As the economic data disappointed, I've debated the possibility of China cutting their reserve ratio by this weekend, and before I even finished this write up, PBoC has already acted with a 50 basis point reduction. The impact should be felt in the asset markets, but before we turn our focus there, let us see what the credit markets are saying.

Credit lines within the economy are like the arteries of a human body. During any turbulent panic sell off stage in the financial markets, the first thing I like to do is check if the credit risk is rising to the point it could possibly create a systematic lending freeze and choke off global growth, like in 2008. After all, we are still in a de-leverging environment and the banking credit lines pose one of the biggest risk to the world economy.
First thing I notice on the positive side, is that the 3 month LIBOR OIS spread in both United States and Eurozone is quite clam for the time being. There are no major systematic banking risks here at present.
In his recent article, Chris Puplava also shows that Eurozone equity markets have become disconnected from the true picture of Financial Stress in both US & EU. In other words, relative to the risks in the credit markets, EU equities have become oversold and should bounce back. This lets us know from the short term that everything on the surface seems to be ok.
However, if the start digging deeper, things are not as rosy as they seem. Scott Grannis recently discussed the European credit conditions over on his blog. Instead of me writing a summary, I will just quote him:
"...Eurozone financial conditions are still under a lot of stress; Euro swap spreads reflect a significant degree of systemic risk. The U.S. has largely avoided Eurozone contagion, but the threat of a banking collapses in Europe still weighs heavily on investor sentiment around the world."
Eurozone Government bond yields continue to diverge as the Core countries are used as safe havens, while Peripheral countries, especially with a strong focus on Italy and Spain, trade as risk assets. Spanish 10 Yr is over 6% yet again, while Italy is not too far behind. LTRO has postponed the final crisis, but not solved it. Credit Default Swaps on these countries also confirm the move as they keep rising higher too.
Large money is now parked in a German 2 Year Bund, where the yield has fallen below Japanese deflationary 2 Yr yields of same maturity. Let me be clear about this - flight to quality due to a possibility of a systematic risk. German is NOT in deflation like Japan, Germany is NOT cutting interest rates to 0.1% like Japan and Germany is NOT in an overwhelmingly strong recession for yields to be this low.

In summary, credit markets are giving us a mixed picture. Certain indicators like Corporate Credit Spreads, Libor rates and Financial Stress indices are showing positive signals. However, other indicators are showing anticipation of a default like event similar to that of Lehman Brothers during 2008. In my opinion, there is no other reason for the German 2 Yr Bund to be trading at 0.07% yield. Therefore, smart money is more interested in return of their capital, instead of return on their capital. Default risk is most elevated in Eurozone banking system, as Scott Grannis explained above, but I do not think it signals armageddon just yet (but... it is coming eventually).
Since I believe the worst is still not going to occur immediately, than we could rule out a crash from current oversold conditions (markets can crash from oversold conditions). Therefore, Chinese rate cut could be the perfect news event to kick off a rally from an oversold readings that the commodity complex finds itself in. In the chart above, we can see that the technical picture of the Continuous Commodity Index (equal weighted) is very depressed. We are also over-stretched on the downside away from a 200 day MA. The price has now declined ten days in the row.
Many individual commodities are extremely oversold too. In the chart above we can see that every single commodity is now trading close to or outside of 2SDs range apart from Natural Gas. That means, as a worst case scenario, at least a rebound is in the cards very shortly. Commodities are not the only oversold assets either. I believe global equity markets have also suffered quite a setback in recent months as well. Looking at S&P 500, one would be saying that the damage was minimal and that the VIX did not jump enough, but that is a very US-centric view. Global equity market correction from the 2012 peak currently stands at following % readings:
  • Spain down 24% & Italy down 20%
  • Russia down 15% & Brazil down 13%
  • France down 13% & Germany down 10%
  • Japan down 12% & India down 11%
Traders with shorter term outlook should definitely note that there are number of bullish divergences occurring within the internals of the equity market. These include: % of Stocks Above 50 MA, McClellan Oscillator and 10 day Advance Decline line amongst others. This should make even the biggest perma bears hold back on pessimistic activities, for the time being. The chart above shows that despite S&P 500 making a lower low, a lot of breadth indicators do not confirm this move and have now setup a bullish divergence. In other words, it seems as if the market is willing to go higher from here and even take out previous peak at 1,422. I won't be participating and instead would rather be looking for a short at higher levels from here.
Two main pieces of the puzzle need to fall into place, if we are to have a risk rally occur. First would be stabilisation of the Euro and the second would be a Treasury Bond sell off. Let us focus on the Euro first. In the chart above, we can see that the outlook on the Euro keeps deteriorating closer towards extremely bearish levels again. This week up to Tuesday, hedge funds increased their net short exposure on the Euro by one third and all of this despite Euro still trading close to the $1.30 level. I think that up to Friday, those net short positions increased even further, even towards record highs. US Dollar is now up 10 straight sessions in the row too, which is overdone. All of this could setup a mother of all short squeezes!
The second piece of the puzzle is the sell off in the Government Bond safe haven assets. Money coming out of Treasuries could boost risk assets, if only temporarily. I say that because systemic risks still remain in place and not everyone will get out of bonds. In the chart above, Tom McClellan talks about a possibility of a Treasury market top as majority of the bad news becomes discounted for now. On top of that, German 10 & 30 Yr Bunds yields have dropped to record low yields for six straight sessions. Sentiment here is now very bullish according to the German Animusx Survey. Finally, the US 10 Yr Note rally is now way overdone and overbought. Bloomberg recently reported that:
U.S. 10-Year Notes Add to Longest Gain Since ’88 - Treasuries had the longest streak of weekly gains in more than 13 years after elections in France and Greece added to concern governments may struggle with deficit- cutting plans used to combat the region’s debt crisis.
If these two assets move in the right direction (Euro bounce and 10 Yr Note sell off), than I definitely think risk on rally could ignite as the conditions are very ripe for it. These are: extreme bearish sentiment, oversold technical readings, constant weekly outflows and overall general news / media fear.


Finally, as an aside note, I would like to focus on Gold here: Running the chart from left to right, we can see that Gold went slightly vertical for awhile and peaked around $1,920 on 06th of September 2011. Sentiment was extremely positive with 97% bulls according to DSI and fund flows extremely bullish. The price corrected into 26th of September and fell to the intra day low of $1,535. Sentiment reached 16% bulls, price moved outside of its 2SDs range and fund outflows showed record panic selling. A counter trend rally started and Gold amazingly still managed to finish the year on the upside, clocking its 11th annual gain in the row (I'm very nervous about this).
However, out of a rally price eventually peaked at $1,802 failing to make a new high, on 08th of November 2011. A three stage sharp sell off occurred into 29th of December low towards $1,522. Once again sentiment reached extremely bearish levels of only 7% bulls, priced moved outside of its 2SDs range and physical Gold Tonnage left the ETF in a panic.

Such an extreme sentiment warranted a powerful rally again and that is what we got. Prices rallied from intra day lows for about two months straight without a pause towards $1,790 per ounce on 29th of February 2012. Gold once again failed to better its previous high and made another lower peak. Following the peak, Gold tumbled into its 4th monthly decline (if we include May) and currently stands at $1,578 per ounce. Just like during previous troughs, Gold is oversold at 2SDs outside of its range, sentiment is extremely bearish at only 7% bulls on the Daily Sentiment Index and we have now recorded 10 out of last 11 weekly ETF fund outflows.

I personally think we are at another intermediate bottom for Gold at these levels. A rally should start eventually, and those entering shorts or selling Gold right now, will most likely find themselves wrong footed in coming weeks. Sentiment is negative, retail selling is persistent and prices are oversold - all music to a contrarian investor. 
However, the question is, how strong will this rally be? If this eight month correction in the Gold bull market is really over than price should recover above $1,800 and march higher. If they do not exceed $1,800 and post a higher high to regain a bull market trend, from current oversold and extremely bearish conditions, than I will be expecting more downside for Gold below $1,530 support. This is especially true because Gold is currently trading below its 3.5 year uptrend line and 200 day MA.