Weekend Update

Equity markets: My long-side trade earlier this week failed because it was one day early and I didn’t have the stomach for the downside volatility which was the first move. Short-term, equity markets are still neutral – with a slight upward bias absent headline news. That “absence of news” could last for the rest of the summer. But the volatility is going to remain. Equities are still not pricing in an economic slowdown – much less another deleveraging/crisis cycle. But they are heavily oversold. That said – half of the “oversold”ness has already been corrected – simply by going nowhere for a few days. So any new equity investment has to lean bullish rather than simply leaning towards an oversold scalp. And intermediate-term – I am more bearish than I was this time last week.

Credit markets: Like last week, these are the key markets. But these generally deteriorated a bit this week. In Europe, Italy/Spain yields fell (presumably because of ECB buying) while Germany/France yields rose. Interbank/overnight/TED spreads are still widening – but are not a problem yet. The ECB may have succeeded in buying a bit of time – but at the cost of directly revealing to Germans what the cost is going to be for them. Ultimately, any credit crisis from Europe is going to be indicated by a)debt auction timing from the four key eurozone sovereigns, b)spreads between the four, c)a banking collapse because of those spreads, and d)indications from Germany as to which way they (the taxpayers not the govt) are leaning re a longer-term fix. I suspect fiscal/transfer union may become the ultimate fix here but that is gonna be a tough sell to Germans who don’t work in banking/exports.

In the US, riskier credit bounced a bit. But the financial sector did not and the first post-AAA 30 year Treasury auction did not go well. And none of it has priced in another deleveraging/default cycle. Treasury funding could become a problem – but the bad news cycle on that is almost certainly over for a few months.

Currencies: The downgrade last week did not affect the dollar as much as it could have. The swissie was the worst performing currency after they intervened. So much for a post-downgrade safe haven. Followed by the two commodity currencies (C$ and A$). Gold was the best performer followed by the yen. The dollar and euro are now lashed together via swap lines. The safe haven trade is still the operative one which doesn’t bode well for equities or commodities. And since the dollar is not going to be downgraded again this week – and since gold/yen are, like the swissie, at/near their breaking points for intervention – I expect the dollar/euro links to weaken a bit and for the dollar to resume its role as safe haven. There simply is no alternative right now and until there is one – the dollar is both the reserve currency and the safe haven currency. Period.

Precious metals: All four performed better than currencies – in order gold (because of the gap up over last weekend), platinum, then a gap to silver, palladium. Going forward, I think the forces that are driving them and the price volatility that results are going to provide for good trades. Longer-term, they will all outperform currencies so offer good risk-reward v cash. Cash however still has the optionality value. All will get some safe haven demand. Gold/silver are the two most vulnerable to deleveraging in the very crowded Western “paper precious” market – and that WILL create big fast price swings. Silver/palladium are the two most vulnerable to poor economic outlooks. Gold/platinum have the lowest-risk downside – but gold’s potential downside is $300 lower than platinum’s – and both will likely respond first to whatever the central bank “trickle-down” (aka QE/bailout) response is to this deflation run. Platinum/palladium have the best response to either short-term supply shocks (S Africa strikes) or longer-term physical supply/demand bottlenecks. In a word – there is opportunity here, and if one is wrong about the shorter-term trade then its ok because the longer-term picture is good. But this applies mainly to the metal/physical itself — not to the miners or options or futures or ETF’s or anything else.


Weekend Update – part2

Now for indicators:

Equity markets:
Short-term – Slightly bearish
Intermediate-term – Very bearish

Markets may be extremely oversold – as in historically oversold – but show no indication of a bottom yet. The tiny number of individual equities that are showing early signs of reversal/strength are – exclusively – either the bearish ETF’s (where technical analysis generally doesn’t work because it triggers too late), bond/safe haven proxy ETF’s, or penny stocks. Sidelines for me.

Credit/bond markets:
Are showing early signs of stress. Riskier, lower priority, and longer-term are being sold relative to higher rated, short-term, or higher priority. Not signs of stability or bottoming or EOTWAWKI priced in. Credit is a leading indicator. This is not a correction for equities. Credit is where the first buy opportunities will pop up. In particular, this is where to get out of the dollar after the current dollar-inflow panic stabilizes/subsides.

International equities:
Nothing looks good here. On an intermediate-term basis though, this is where to focus equity buying when this panic runs its course.

Precious Metals:
Gold is looking OK here. That said, I suspect that going forward, it is too late to buy/add for short-term play here. Safe-haven demand is likely to be met/exceeded by ETF holdings sold to meet margin calls elsewhere. India is not going to be the physical demand savior at these prices. Silver is looking bearish. The inflation play is dead for now. And the SLV ETF is far too crowded with day-traders and speculators. Platinum is looking VERY good. Chinese are buying it hand-over-fist – for jewelry and long-term physical investment – now that platinum is roughly the same price as gold. The platinum/gold ratio of 1:1 is now where it was in the depths of 2008 and before that in the 1990’s (when China was far poorer). At these prices, auto industry demand does not matter. If platinum takes 5% of the gold jewelry market, that will equal auto industry demand. So, the most likely scenario is that it tracks gold for the short-term with far better upside/downside risk when things settle down. Palladium will follow platinum but with a bit more short-term downside risk and a bit more long-term upside.

Fuhgeddaboutit. Agriculturals are the best buy here and there is no hurry. Metals and oil are hugely subject to dishoarding of stockpiles – ie what was demand over the last 2 years can turn around in an instant and become supply.

Uggh. The swissie is the only major safe-haven currency that has not successfully debased. It is extremely overbought and Europe is clearly panicking into it. But the SNB has just announced its version of QE so as/if either the panic subsides or peaks, the swissie will plummet. Shorter-term, at current levels, the swissie is riskier than the dollar. I think the price is now too high for “recognized safe-havenness”. Way too early for commodity currencies – but a mix of second-tier “safe havens” – pound? swedish krone?

Weekend Update

A huge “newsy” week last week helped throw global markets into a serious tailspin. The two biggest are questions re what the ECB can do re Italy and the debt ceiling and downgrade kerfuffle for the US. The latter in fact exacerbates the problems of the former since it throws a risk premia spotlight on France and UK (the two weakest remaining AAA sovereign).

Impact of the Downgrade — Dead on analysis. The downgrade will exacerbate political schisms in the US as both sides will choose to blame the other (or shoot the S&P messenger) instead of dealing with the problem. The downgrade has more impact on European/global financials than it does on US financials because of the dollar’s reserve status. Trade ideas (assuming no major coordinated PR/actual move by ECB/G7): Long safe havens (Gold, CHF, global big-caps with rock-solid balance sheets and dividends) — this current decline is the last decline for awhile where the dollar will be a safe haven compared to most – you do not want to be in dollars when it ends; long Treasuries (shorter-term) and Euro-periphery debt (on yield spikes). Short euro, short “infrastructure”/commodities (coal, steel, shipping, copper, A$), short bunds, short financials.

Case for Going Global – Stronger than Ever Another dead on (longer term) analysis with a couple aha’s! for me. G7 govt bonds are pricing in slow/no growth; “emerging” govt bonds are pricing in 6-9% growth. ie – G7 is expensive, EM is cheap — on pure yield/price. EM’s have 2x more foreign exchange reserves than the entire G7 combined – and far lower govt debt. EM’s are undercapitalized (aha! – inflation there is more a consequence of “hot money” inflows relative to a small existing capital stock – iow – their inflationary pressures will drop as their GDP grows). G7 countries are all in for decades of deflationary pressure and capital exodus. EM equity markets still have lower PE’s – so they are pricing in slow growth. Trade flows are increasingly among EM’s themselves – and that will accelerate. Big disconnect/opportunity. Volatility is here to stay – because capital productivity increases (which precede GDP increases) in EM’s won’t be smooth and because G7 relative decline will also be herky-jerky. Trades: Long EM bonds, short G7 bonds. Long capital surplus countries (mostly Asia). Long commodities. Long EM equities – esp mass consumer and infrastructure – not traditional exporters. Long/watch solid financials focused on allocating capital to EM’s — ie with no legacy balance sheet in G7.

That latter link is intermediate-term. Shorter-term, the trade is still risk-off – and for EM’s that can mean “hot money inflows” turn on a dime into “hot money outflows”. But these are the opportunities to buy the dip.

My own thoughts. Any conflict between “hyperinflationists” and “deflationists” is over for awhile. The hyperinflation scenario is dead. Deflationists have won. Non-G7 will be dealing with inflationary surges – but those pressures will diminish over time. G-7 is solidly in deflation — until such time as existing debt is repudiated. Which is emphatically NOT happening any time soon. Yes – prices of non-asset “stuff” will increase in G7 and squeeze the snot out of consumers (esp the poor and the middle class and the young). But that is NOT hyperinflation or money printing.

US downgraded to AA

Well it looks like S&P is the ratings agency with courage. After the close, they downgraded US Treasury debt to AA+ with a negative outlook. The US has been rated AAA since 1917 when credit rating first started. Assuming they don’t get arrested on charges of terrorism or something, I expect that a few other AAA sovereigns may soon follow. I don’t actually expect this to cause problems but who knows. One thing it does do is slightly raise the risk and volatility of everything going forward. All financial algorithms rely on a “risk-free” rate at their core – and that is what the US Treasury market has functioned as for the last 30 years – ever since financial algorithms crossed from academia to Wall Street. That risk-free rate is now, absolutely, a little bit riskier than it was yesterday. At the margins, that could really explode some highly leveraged multi-gazillion derivatives market. It will certainly serve as a slight incentive to deleverage. It could also cause some substantive problems at some money market funds. That said, it is only long-term debt that is now rated as AA – and I suspect short-term debt is at the core of derivatives and algorithms. Here are S&P’s comments.

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated sovereign peers (see Sovereign Government Rating Methodology and Assumptions,” June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population’s demographics and other age-related spending drivers closer at hand (see “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now,” June 21, 2011).

Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.

This news does explain the markets today. The ratings agencies always leak the news of sovereign downgrades to the government. And our wholesome public servants at Treasury quite obviously feathered their own nests and provided inside information to their Wall Street buddies. Yet another reason why the time has probably now passed for peaceful change.

Weekly Market Summary

I’m changing my summaries to weekly. It’s a bit less noisy than the daily indicator summary. And a weekly summary allows for a slightly different view and a better investment plan.

Short-term: Slightly negative
Intermediate-term: Neutral

Last week’s pullback turned out to be, generally, more healthy than indicative of something worse. That said, roughly 2/3 of equities still look like this is a false rally overall for them. Like last year, it looks like we are in summer noise mode and have established a trading range for the Memorial Day to Labor Day timeframe.

Strongest currencies last week were the two safe-havens – yen and swissie. US$ isn’t a safe-haven until debt ceiling argument is resolved. Weakest currencies last week were euro, A$, and emerging currencies. The swissie is the only currency that is a bit overbought over the last month. It could be vulnerable to either a “risk on” move or a short-term resolution of the US$ “safe havenness”. No currencies are oversold. Longer-term, the barbell currency trade (A$ and swissie) that has performed well over the last year looks overbought – while the US$ looks oversold. Overall, currencies are not indicating a direction for other markets.

The healthiest looking equity markets look to be (in no order): Canada, Japan, HK, Singapore, Taiwan, Malaysia, and Mexico

Europe is unraveling

fast and overnight it seems. This could get really ugly if bank runs start. Banks do not have to reserve their holdings of sovereign debt. One of the globalizing regulations put in by the Davos crowd over the last two decades. Akin to mandating that all AAA-rated collateralized mortgage debt be considered top-tier capital – which caused the 2008 crisis to be a global one. Do these clowns force Mr Magoo to write all their regulations or is Mr Magoo just the brightest mind in the room when they write them?

The euro dropped and dollar rose by 0.7% in a whoosh after Christine LaGarde new head of the IMF didn’t rule out anything re Greece and said “the IMF is not a cash machine”. Equity markets will drop the same %. Most commodities will drop more. Short-selling will likely be banned again soon – not that that is a wise thing to do. Get liquid – not leveraged.

I do think I know why the market rose in the tail end of June. That’s when the Fed and central banks started pumping more liquidity into the system. Gave their buddies and pals a two-week heads up to clear out positions before the SHTF and before they have to head off to the Hamptons and St Tropez for August.

One advantage of being a minnow. It doesn’t take as long to clear out positions

Currency Move Coming

The US dollar looks like it is poised for a significant multi-month move.

On a daily chart, it has been forming a bottoming wedge for a few months and it broke out to the upside today. That wedge – lower highs and higher lows converging to one point (roughly 75 on the US$ index) at around the end of the month – ie just when the debt limit/default politics stuff is resolved.

On a weekly chart, the dollar index has been cycling between roughly 74 and 88 since 2006. It is near the lows of that range. The two sharp upsurges since then have been the liquidity crunch of late 2008 and early 2009 and the first euro/Greece crisis of 2010. Both of which were panic safe-haven surges – reversed by the Fed implementing a QE program to trash the dollar. I think this rebound will be a bit different from the last two. Don’t know how.

The key currency pair is dollar-euro. Both have serious problems and news events are likely to drive both – and thus the dollar index and equities/commodities. Swiss franc is in turn going to key off the euro zone but it looks very overbought and could be subject to intervention by the Swiss central bank.

June 22, 2011

Short-term: 2 green, 1 yellow, 1 red
Intermediate-term: 3 yellow, 1 red
Composite: Neutral

A poor follow-through day is not good news for this bounce. And most shares had no liquidity – high bid-ask spreads, computer/automated programs drove most of what did trade.

In more significant “under the headlines” news, word is leaking out that money market funds in the US are now heavily levered to commercial paper issued by European banks. They do not have significant business in the US that generates USD. So how are they going to generate the dollars to pay off the commercial paper? Money market funds — marketed as a “safe” cash alternative — have now become a major bet on a currency squeeze and on the balance sheet quality of European banks and on a Greece bailout. With zero rewards to be delivered to fund holders – if the bet pays off. Money markets have now become part of the Wall St scam. The Federal Reserve knows this – it was mentioned by Bernanke at his press conference yesterday.

This creates a perverse problem. There is no escape from volatile markets in “cash”. At least not if that cash is in the form of money markets. Money market fund holders are now checkmated. We are now a full participant (well not a “full” participant since we will receive no rewards/bonuses – only expenses/risks) in all the financial chicanery merely by “sitting on the sidelines” with “cash” in a “safe” money market fund. If those scare quotes scare you, they should. Because when risk is transferred to those who are merely demanding that a currency serve as a unit of account; then the currency no longer really functions as money.

This really has become a completely insane financial world. Zero-yielding money market funds now require a freaking HEDGE in order to preserve the principal. Longer-term, this means only one thing — get physical gold and silver in your possession and out of the banking system. Not futures, not leveraged, not with debt, not miners, not ANY of the financial/paper crap that has built up around everything. That doesn’t mean all your “cash” devoted to that — because, like it or not, gold/silver are NOT legal money and they never will become so. They may become de facto money if/when the entire financial/legal de jure fiat money system breaks apart. But that is solely emergency fund or EOTWAWKI.

For everything else — your long-term plans re “retirement” (a quaint 20th century notion that will soon die) or other long-term saving — you are stuck in the world of financial risk with no escape (and no reward unless you actively manage that risk). And in that world, the dollar is actually massively undervalued against other currencies — most especially against the Swiss france, the commodity currencies (A$, NZ$, C$), and to a lesser extent Yen, Euro, Pound. Unfortunately also, in that world, “value” doesn’t really drive trading strategies in shorter time horizons.

As an aside. This is perhaps another example where we will be forced to emulate the “Japanese housewife”. Who recognizing that their savings would yield nothing but still risk everything, decided to embrace the risk, learn about it, and become a currency carry-trader.

Early Asia Trading

The Eurozone announced a delay in “settling” the Greece bailout. Not good news for global markets that are desperate for something to end uncertainty rather than create more. Korea has advised its banks to prepare their currency exposures for another global credit crunch. Overnight interbank lending rates in Shanghai have risen by 3 percentage points – not basis points – percentage points.

Whatever the real reasons for this — and I’m pretty sure the wizards of the universe will never say what they are — it looks like another financial panic is about to begin. If banks won’t lend to each other wholesale, then all other lending will cease shortly and the “risk off” trade is about to become a panic to liquidity.

August 11, 2010

A massively massively ugly day in the markets — on very light volume. This was not selling pressure. It was a complete absence of buyers — on a day when the euro was crushed and the dollar thus rose. If this is what a dollar bounce looks like, then expect it to culminate in a market crash.

Short-term: 1 yellow, 3 red – tend red
Intermediate-term: 1 yellow, 3 red – tend red
Stock targets: 66% swimming, 23% neutral, 11% neutral

I’m surprised that the intermediate-term indicators rolled over so sharply this close to what is an interim top. But it is not good news. We are a long long way from fair value. The last time the intermediate-term indicators were this negative was right at the bottom (June 30 and Jul 1) — but that was an expected whipsaw at the tail end of a near bear-market move down. With both short-term and long-term indicators so negative — so near a top; there is nothing for bulls to make a case for. Nothing is oversold. Nothing is “fair value”. And clearly no one is “buying”.

It is entirely possible that the world’s plunge protection teams will again try manipulating the markets upward here. But as for me, I’m simply gonna start preparing obscene stink-bids and wait — mostly in cash — for what is likely to be a very ugly autumn. Yeesh — we got this move down without even any rumors of sovereign debt problems or Israel attacking Iran or trade protectionism/currency disputes or somesuch. This brittleness reminds me of only one month — August 1987.

I still don’t know why the euro tanked today. That accounted for roughly 2.34 of the 2.82% loss in the SP500. There was apparently a rumor of Fed opening swap lines re Ireland, a rumor that the EU wants Germany to put its bailed-out bank liabilities on its sovereign balance sheet, a rumor that Spain has already quit its “austerity” program. Regardless, I’m not going to wait to find out. Long-term, the euro and pound are as crappy as the dollar. And it appears that the short-term “safe havens” are the yen, the dollar, and gold.