Tag Archives: chinese economy

Global Uncertainty Strengthens Dollar

Five years ago the financial world was coming to an end. The stock market tanked and interest rates went negative due to the unsurpassed flight to safety in U.S. Treasuries. Most of this was due to greedy lending practices that claimed to be championing President Clinton’s thesis that everyone in America should be able to own a home. Lax lending requirements that were intended to get lower income earners into their own homes travelled up market and allowed upper middle and upper tier earners to refinance their houses at artificially low rates to buy second homes and Harley’s. Once again, misguided bureaucratic endeavors have been perverted by greed. The roaches in China are beginning to surface and the banking system stress tests in Europe are uncovering the depth of this five-year-old issue and once again, the primary beneficiary of these actions will be the U.S. Dollar.

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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.

Diversification is not Immunization

Every market crash or bursting bubble is like the ice cream truck calling kids to the street. Portfolio managers and re-balancers know they get the opportunity to truly be heard only when something goes wrong.

Most people live their lives reacting to new stimulus. If something hurts, they don’t do it again. If something works, there’s no reason to change. Portfolio managers attempt to anticipate areas of pain and mitigate that pain wherever possible. However, there are times when efficient portfolio analysis, modern portfolio theory and just plain common-sense investing will still force one to endure periods of pain.

Portfolio composition is usually based on a collection of assets that tend to relate to each other in a predefined and expected way.

There are three basic relationships:

— Positive correlations: Two asset classes rise or fall together, predictably.

— Negative correlations: One class rises when the other falls and vice versa, predictably.

— Non-correlational: No predictable relationship.

The right balance of these relationships across multiple asset classes will smooth out returns and help to insure the predictable performance of one’s portfolio.

There’s an old saying from statistics 101: “Correlation does not equal causation.” We can measure how markets move relative to each other, but without understanding their relationships, we can’t say for certain what caused what. Sometimes, understanding “why” has a bigger impact on one’s portfolio than the actual mix of assets.

Last week we saw many markets fall. The stock market is lower, as are precious metals, bonds, grains, coffee, sugar, cocoa, crude oil and the energy markets. Many of the classic market relationships people use to balance their portfolios failed to behave in the anticipated manner and did not balance the risks associated with investing. Markets can and do, behave in unanticipated ways.

Commodity markets have been trending toward generally higher prices. The stock market has also had a nice rally and is up more than 9 percent since Labor Day. During this time, the Federal Reserve Board also announced a second round of quantitative easing to keep interest rates low and weaken the U.S. dollar. Consequently, bonds have rallied in price while the dollar has fallen.

The sudden about-face in many of the markets is twofold. First, the news regarding Ireland’s financial health has become increasingly pessimistic. Ireland was on the financial default radar, along with Greece, more than six months ago. Ireland has been very proactive in implementing domestic austerity measures to rein in spending. Furthermore, Ireland has also steadfastly maintained its financial issues are limited to a few banks that became overleveraged during their own housing bubble.

Unfortunately, the European Union has the same fears about Ireland and Greece we did in the U.S. with our own domestic banks and that is that every bank was more overextended than initially thought, requiring an even bigger lifeline to maintain solvency. Finally, Portugal and Spain are also on the verge of financial insolvency themselves.

The second fear to hit the markets was China’s announcement Wednesday its economy may be overheating again. Rumors are circulating China may follow several banks in Korea in raising its interest rates to slow down inflation and thus, economic growth. The data coming out of China certainly reinforces the idea it may constrict lending in the near future. China has a published cap on the amount of money its nationalized bank will lend in any calendar year and it is quickly approaching that ceiling.  The fears are also evident in China’s stock market, which has slid more than 5 percent in the last few sessions.

These two events combined to cause havoc in our domestic markets as they immediately unraveled the underpinnings of our market rallies. The Chinese news sucked the demand out of the commodity markets. China’s clampdown on inflation is pulling money out of the commodity markets and reducing overseas demand for raw materials. The news from Ireland and the European Union has the equity markets spooked. For many investors, the 50-percent correction in the equity markets from our own financial crisis is all too real and all too recent. Our domestic stock market’s rally and the quickly approaching year’s end makes it easy for many traders and investors to simply pull money out of the markets.

News events shock the markets and broadly sweeping economic forces create seismic shifts in market behavior. During these turbulent times, typical market relationships may fail to behave in the predicted manner.

As the Chinese economy becomes a first class consumer, we must accept our role as a supplier, rather than our historical position of end line consumer. As a supplier, we need to recognize the demand-needs of our trading partners. This is a broadly sweeping change that will affect the commodity markets for years to come.

News from Ireland and the European Union can shock the stock market, reawakening nightmares of 2008, but plans can be made to account for these events.

It does require proactive management of one’s portfolio. The old days of the passive hedge and allocation strategies may be gone.

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.