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.