Trading the markets is sometimes like being a relationship counselor. There are times when it’s easy to see how one thing done or said affects the other’s actions. We use a fancy term for it, correlational analysis. When the correlation is positive, both things move in the same direction and when it’s negative, they move in opposite directions. Pretty straightforward stuff like when the Dollar falls, gold climbs. That’s a negative correlation based on inflation. Similarly, the stock market rises as interest rates decline because businesses find cheaper money for expansion and capital equipment acquisition. Unfortunately, every good therapist knows that relationships change over time. These markets, in particular, are not performing true to pattern.
Fortunately, in the financial world, we have tools that let us quantify these relationships. Now, it’s true that over the last year, gold has rallied and the Dollar has fallen. However, over the last couple of weeks, both the Dollar and gold have rallied. I think there is a significant change in the underlying nature of their relationship that could cause this to continue throughout the summer.
The primary reason for the Dollar’s strength has not been the domestic economy. The strength should be attributed to the global fear of a collapsing Euro, which attracts money to the U.S. as a flight to safety. We’ve talked at length about the troubles in Ireland and Greece. Well, Spain and Portugal are right behind them. The global credit markets are already pricing in the pending defaults. Greek 10 year bonds are yielding north of 16% and Ireland and Portugal are both above 9%. This compares to the U.K. Gilt 10 year yield of 3.3% and the U.S. 10 year Note’s yield of 3.1%. The European Union is caught between balancing what the Union’s lenders will accept as payment versus what rights of autonomy the borrowers will relinquish to remain in the Union itself.
The new catch phrase is a, “reprofiling” of debt. This word isn’t even in Microsoft’s spell check. However, this invention by the European Central Bank is really a synonym for, “default.” They want to extend the maturity dates of Greek debt. The Euro has fallen 7% as we’ve hunted through Webster’s Dictionary for, “reprofile.” The reprofiling or, restructuring of Greek debt would seriously devalue the 50 – 80 billion the ECB has already contributed monetarily and devastate the value of the European Union’s political solidarity.
The same fear of a Euro collapse has attracted money to the gold market. This week, gold hit an all time high priced in Euros. Investors are looking for a safer holding facility for their liquid cash than the Euro currency can provide them with. This move has been extended as the ECB has chosen to cancel its June meeting while reprofiling studies are being completed for their newly scheduled July meeting. Consequently, there have been four trading days in the last ten where both gold and the Dollar have rallied more than half of a percent. This compares to six days in the last twelve months when this has happened.
The rise in the Dollar has also coincided with a flood of money into U.S. Treasuries and a decline in the U.S. stock market. Commercial traders are aggressively rotating their positions from stocks to bonds as the Euro Zone drama is playing out. This is taking the classic low yield/high growth stock market relationship and turning it into a low yield/no growth scenario more consistent with times of fear. We’ve seen commercial money buying 10yr Notes in six of the last seven weeks and selling in the stock indexes in each of the last four weeks.
Reconciling relationships means being able to cope with change and allowing the relationship’s participants to grow in their own directions. Being able to recognize these changes in the marketplace as they are happening requires a sound combination of reading the back-stories and quantifying the participants’ actions.
This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.