Jumpstarting the Japanese Economy

The Japanese economy has languished in a deflationary environment for years. The recent Parliamentary elections have ushered in the potential for major shifts in policy, both ideologically and practically speaking. The election of Shinzo Abe as the new Prime Minister and overwhelming support for his Liberal Democratic Party will allow the new regime to control both the upper and lower houses. Therefore, no bargains or watered down policy will need to be struck. The sweeping results are a clear statement by the Japanese people that they expect action to be taken to loosen the money supply, inflate the economy and devalue the Yen.

Japan’s economy is roughly 1/4th the size of ours and places them as the fourth largest economy in the world. Therefore, full-scale policy shifts are rare and require a good bit of fortunate timing to implement. There are enough pieces in place to see more unilateral action by Japan as Mr. Abe focuses on the immediate needs of his people rather than finding the right political fit for Japan within the global political dynamic.

Deflation has been the key to the Japanese economy since the late nineties. Over the last 13 years they’ve recorded two inflationary years – 2006 and 2008. Mr. Abe wants to target new inflation and growth targets of 2% and 3%, respectively. Japan hasn’t recorded inflation above 2% annually since 1991. He expects to reach these goals through pressuring the Bank of Japan to loosen lending requirements and purchasing construction bonds for public works projects as their own method of Quantitative Easing. He also expects to include the first steps of domestic military spending to assert their claim to islands in the South China Sea as well as domestic pork barrel subsidies and governmental contracts to boost domestic GDP and help bring them out of recession.

However, considering that Japan already has one of the highest debt to GDP ratios in the world, ranking only behind Zimbabwe, Mr. Abe’s intentions are being watched closely by the credit agencies who already have Japan in a negative watch position and susceptible to further outright credit downgrades. Currently, Moody’s and Standard & Poors rate Japanese debt as equally trustworthy as countries like Chile, Macau and Bermuda. These are drops in the bucket compared to the weight the Japanese economy brings to bear on world trade. Fitch is the only rating company still holding Japanese credit at A+.

Inflating the economy by selling government treasuries is also designed to devalue the Yen against the major world currencies and help fuel their export dependent economy. The Yen has strengthened considerably over the last few years trading from a low of 115 Yen to the U.S. Dollar in July of 2007 to as high as 75 Yen per Dollar this time last year. Currently, the Yen is trading around 84 Yen to the Dollar. Japan is the second largest holder of U.S. Dollar reserves behind only China. Therefore, it could require a tidal wave of selling to make a dent in their $1.25 trillion in U.S. Dollar reserves.

The trading scenario is the mirror image of, “Don’t fight the Fed.” Japan has the financial power Mr. Abe has the political power and the support of the Japanese people. This should manifest itself as cheaper Yen and higher yields on the Japanese Government Bonds. Therefore, I expect the 75 Yen per dollar high set last year to hold and would like to sell Yen at 80. Note that these quotes have been provided in the number of Yen per Dollar while CNBC and U.S. futures quotes will show the inverse, which is what percentage of a Dollar will one Yen buy. Currently, one Yen will buy .00186 worth of a Dollar. Be careful to compare apples to apples when checking market prices.

The next big piece of this puzzle will be the inflationary effect on Japanese Government Bonds (JGB’s). The previous yield high was made in 2007 along with the bottom in the currency. The JGB reaction to the election announcement was swift. The futures have put in a full bearish reversal bar on the monthly chart. This is the first one we’ve seen in this market since June of 2003. Adding to the power of the reversal is the double top formed with the current high nearly matching the June ’03 high to the tick. Looking for places to sell Japanese Treasuries and currency as part of a long-term trade would be well advised as the timing and opportunity for real political and monetary change happens far less than the politicians would have us believe.

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.

Commercial Traders Cap Copper

Copper is frequently referred to as the economist of the metal markets. This is because copper is used in nearly everything that’s made. If it’s not in the final product, it’s certainly in the production facilities and the machines used to make it. Therefore, one assumes that the more copper a business or country buys, the more production they see in their near future. This is part of the reason copper has such a high correlation with rising stock markets. In fact, the correlation relationship between the copper market and the S&P 500 hasn’t been negative since the financial meltdown in early 2009.

The copper market made an all time high in January of 2011 at $4.7735 per pound. Since then, the market has consolidated primarily between $3.25 and $4 per pound. The consolidation continues to tighten and can be easily seen on a weekly chart as the trend lines that define the highs and lows continue to converge. The news will tell you that the reason the market is in limbo is due to the fiscal cliff negotiations and that once a deal is struck, the market will see enough of the estimated $2.5 trillion pent up dollars in the domestic corporate coffers to push it back beyond its highs.

I would suggest an alternative scenario in that the copper market has been fueled by growth overseas in developing markets and that it may have run its course for the near term. The top performing stock market for 2012 is Turkey. Their market is up nearly 50% for the year. Much of their success has been due to their ability to create a stable and labor friendly manufacturing center. Rounding out the top ten for the year are – Pakistan, Philippines, Thailand, Estonia, Nigeria, Kenya, Denmark, Germany and India, respectively. Germany is the only G7 country on the list and India is the only one of the BRIC’s to make the list. Clearly, this has been a good year for developing countries.

Digging deeper into the numbers behind the copper market we find some signs that the market price may not be supported by the development of the aforementioned economies. In fact, the deeper we dig, the more it looks like the market is being propped up by inflation expectations and speculative purchases. The main issues are the Chinese and U.S. economies since they are the number one and two copper consumers in the world, respectively.

Commercial traders have sold more than 12,000 contracts, about 25% of their position, over the last month and now hold the smallest net long position since late April. This selling has been enough to turn commercial traders’ momentum negative and set up a sell signal as the last bit of this rally has been driven by speculators and index funds.

This type of behavior is typical of a market that is moving sideways. Speculative participants tend to be buyers at the highs and sellers at the lows for two primary reasons. First of all, they’re afraid to miss the next big move. Secondly, they can’t match the commercial traders’ staying power and end up forced out of the market every time the market looks like it’s about to fall. This is exactly why we use the commercial traders to signal which side of the market we should be on and then use the speculators to create a bounce to sell or a dip to buy within the context of our overall outlook.

That being said, we will be looking for opportunities to sell March copper futures on any speculative rallies that stop short of the downward sloping trend line from the January 2011 highs, which now comes in at $3.7330 on the weekly chart. We’ll maintain this stance as long as commercial traders continue their selling pressure as we believe that is what will ultimately force the speculators to abandon their long positions.

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.

Hog Futures About Face

Trading is always a measured risk and best guess scenario. We use the tools and information we have access to in an attempt to predict future market direction and magnitude. This must be balanced against the risk and then the odds, along with the risk and reward scenario must be calculated to determine if the trade is worth taking. Every once in a great while multiple forces align themselves and make the task of calculating variables much easier. This is the current situation in the lean hog futures where fundamental, technical and seasonal factors have all combined to put a halt on this market’s rally and set the market up for a profitable short position based on declining hog prices over the next two weeks.Trades lasting more than a day or two require a proper assessment of the lay of the land. This means starting with the fundamentals. The greatest fundamental impacts on hog prices are the price of corn and Chinese demand. The high price of corn over the 2012 crop year did cause breeding sow numbers to decline. However the increase in hog prices due to Chinese demand was enough to allow farmers to hold on to breeding sows that in normal years would’ve been sent to liquidation. Research from Purdue University showed that, “increased lean hog prices combined with lower feed costs have translated into reduced losses of about $30 per head – about 40 percent coming from the lower feed prices and 60 percent from higher lean hog futures.”The equation of measuring herd sizes, slaughter rates and feed prices is better left to the professionals and universities. The end result of their analysis is their actions in the markets. Tracking their buying and selling as well as their magnitude provides a single variable that can be measured against price. This simplified equation of the degree of commercial trader buying or selling relative to the current market price can be tracked through the Commitment of Traders Reports published weekly by the Commodity Futures Trading Commission. Commercial traders have sold more than 20,000 hog futures contracts since the end of September. Clearly, the commercial traders see their market as currently over-valued.Seasonally, hogs are coming into their weakest period of the year. Hogs tend to slow down in the heat of summer. They feed less. They breed less and their prices tend to rise. Moore Research has shown that hog prices tend to decline dramatically during the first two weeks of December. This follows the end of summer and the expiration of consumer demand once the packers have stocked the stores for the Holidays. Moore Research has shown that hog prices have declined during the first two weeks of December in each of the last 15 years by an average of 4.15% for an average profit of $935 per contract. Their numbers provide an estimated target of 82.45 in the February lean hog futures while the average ending price provides an outside target of 60.00. Perhaps a weighted average is a better yardstick due to the structural change in the Chinese demand growth. This makes 74.50 a more likely outside target.Technically speaking, the hog market set itself up for a perfect reversal. The hog market has rallied nearly 15% since making the September lows and spent most of last week churning near the highs. Monday’s trade brought an outside bar along with a close in the bottom 10% of the day’s range. Psychologically, this meant that the market tried to move higher and couldn’t which resulted selling pressure as weak longs were flushed out of the market once it breached its lows from the previous week. The close in the bottom 10% of the range after an outside day is a textbook reversal pattern from the Larry Connors book, Street Smarts. Linda Raschke, a well-known trader specializing in quantitative analysis, developed this strategy. This forecasts lower prices ahead based on her work.The markets rarely provide traders with this many clues to future direction or opportunity. Frankly, traders with enough experience may simply consider this a very well baited trap. Therefore, risk controls must always be put in place. There’s no telling when a seasonal pattern may not hold true and there’s no point wasting years’ profits on stubbornness. Protective buy stops will be placed above the reversal bar’s high at 87.775. Profits will be taken at a minimum target of 82.45 the average decline or, December 18th, the end of the seasonal weakness.

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.