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Currency Reversal on Scottish Vote

Today’s Scottish secession vote takes a 300-year-old issue and covers it with 21st century journalism. There’s hardly any angle that hasn’t been talked to death. Surprisingly, I’ve found something of major importance leading up to the vote that isn’t being discussed anywhere. The commercial traders in the Commodity Futures Trading Commission’s weekly Commitment of Traders report are making a clear point that they collectively feel that the currency markets are about to tighten, rather than continuing to widen as they have for the last month or so.

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Currency Trading the Scottish Secession Vote

Thursday’s landmark vote to return Scotland to its own sovereignty is becoming a tighter race with each passing day. The interesting part in the analysis is that the money has been flowing into the British Pound and Euro Currency and out of the U.S. Dollar Index. This places the commercial traders’ actions directly at odds with the currency markets’ collective movement over the last two to three months leading into the Scottish secession vote.

We cover the analysis of the following charts in Equities.com.

Currency Reversal on Scottish Vote

us dollar buying into scottish vote
US Dollar Index sees major commercial trader selling heading into Scottish vote.

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Pound Sterling buying before scottish vote
Strong buying of British Pound Sterling heading into Scottish vote.

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buying the Euro into scottish vote
Strong buying of Euro Currency heading into Scottish vote.

Trading’s Gut Check

Actively participating in the markets comes with the understanding that the trader’s gut will be checked frequently and deeply. The primary cause of this is the trader’s degree of certainty in an uncertain world. It’s been proven over and over again that once an individual feels that they have enough information to make a decision, they will. Additional information provided after the fact typically raises the degree of certainty that the correct decision was made, rather than raising the degree of accuracy. So, I sit in front of the Federal Reserve Board’s announcement this afternoon involved up to my eyeballs in the US Dollar, Euro currency, 10-year Treasury Notes and the Russell 2000 stock index.

Each one of these positions is the result of mechanical trading programs that I’ve developed, tested and traded. Therefore, there are no arbitrary decisions or adjustments to be made. This leaves me in front of the screens sitting on pins and needles waiting for a range of possibilities to materialize. Given my experience with the markets, I expect the outcome to be somewhere in the middle. Rarely does it turn out one sided either positively or, negatively.

Let’s review the possible outcomes and the gut wrenching turmoil that comes with sitting on several large positions as I try to close out the books for 2013. My oldest position on the books is short the Euro FX. I stand to profit if the Euro currency weakens against the US Dollar. I’m short the market near the top of its range based on my research into the Commitment of Traders Reports. I know that there’s about a 60% chance the Euro will back off these highs by about a penny and a half. However, the market’s continuing consolidation near these highs puts me in a position where I could be stopped out of the market with a loss even before the Fed announces its decision this afternoon. The market’s proximity to my stop loss order contributes greatly to my angst.

The opposing position to the Euro is my long US Dollar Index position. Again, I’m long the US Dollar Index against a basket of currencies, which is dominated by the Euro. If the Fed suggests that they will begin to taper quickly, the Dollar should rally. Pulling stimulus out of the economy will place fewer Dollars in future circulation thus, increasing the value of the Dollars already in the market. The Dollar would rally and the Euro would fall. Both of my currency positions would be profitable.

Tapering by the Fed would most likely crush my 10-year Note position. Frankly, the discretionary trader in me can create the strongest case for owning 10-year Notes and betting against taper talk. Based on my analysis of the commercial traders in the 10-year Note I fully expect any decline in Treasury prices to be short lived. Commercial traders have accumulated their largest net long position in the 10-year Note since April of 2005. Commercial traders have dominated the big moves in the Treasuries with uncanny accuracy. If they’re right about no taper talk this afternoon, Treasuries will rally substantially and I’ll profit from my position….while losing on my currency trades.

This leads to my final position. I use a pretty fancy program for developing my day trading systems. Whereas my swing-trading program is based on the fundamental data inferred from the collective positions of the markets’ participants, my day trading programs are strictly technical. Knowing that the markets will unfailingly put a man to the test, it should come as no surprise that my day trading programs now have me long two units of the Russell 2000 stock index heading into this afternoon’s announcement. Furthermore, while I have some expectations of how the currencies and Treasuries will react to the Fed’s decision, the stock market’s reaction is far less predictable. If the Fed tapers, the stock market may rally further based on the assumption of a strong economy leading to further gains. However, the collective reaction could very well be violently lower as tapering could signal the end of the free money that many believe has fueled the rally to this point.

Discretionary traders face conflicting data like this all of the time and pick and choose which markets they’re in and when they’re in them. Systematic traders follow the signals generated by their programs without question. The cruelest aspect of trading is the market’s uncanny ability to seek out a traders’ weak spot and twist agony’s knife. I’ve been actively trading for more than 20 years and the trepidation of a pending report never goes away. This is where the classic line, “Plan your trade. Trade your plan” has the most value. Remember, additional information acquired after the fact doesn’t increase the odds of being right, it simply tricks the mind into greater certainty of the existing thought pattern.

Not Quite Time for Gold to Shine

The gold futures market is still looking for support since reaching a high near $1,800 per ounce in early October. The market had fallen by nearly $200 per ounce as recently as early this month. Fiscal cliff issues as well as tax and estate laws fueled some of the selling. However, commercial traders were the dominant sellers above $1,700 per ounce as they sold off their summer purchases made below $1,600. I believe the gold market has one more sell-off left in it before it can turn higher with any sustainability.

Comparatively speaking, gold held its own against the Dow in 2012 with both of them registering gains around 7% for the year. However, the more nimble companies of the S&P 500 and Nasdaq soundly trounced the returns of each, registering gains of 13% and 16%, respectively. The relative advantage of gold in uncertain times may be running its course. There currently is no inflation to worry about and CEO’s are learning how to increase productivity to compensate for increased legislative costs. Finally, the S&P has risen by about 19% over the last 10 years while gold has rallied by more than 250%. Therefore, sideways market action in gold over the last couple of years seems justified.

Meanwhile, seasonal and fundamental support for gold hasn’t provided much of a kick over the last two months. Typically, the Indian wedding season creates a big source of physical demand in the gold market from late September through the New Year. In fact, the strongest seasonal period for gold is from late August through October in anticipation of this season. This effect should be gaining strength due to the rise of the middle and upper middle classes in India yet, the market seemed to absorb this support with nary a rally to be had. I think we’ll see the market’s second strongest period, which begins now, and runs through the first week of February provide us with a tradable bottom and rally point.

Finally, the last of the short-term negatives is the strength of the U.S. Dollar. The U.S. Dollar trades opposite the gold market. Gold falls when the Dollar rallies because the stronger Dollar buys more, “stuff” on the open market and while we’ve talked about commercial traders buying gold, they’ve also been buying the U.S. Dollar Index. Commercial traders have fully supported the Dollar Index at the 79.00 level. The Dollar Index traded to a low of 79.01 on December 19th followed by a recent test of that low down to 79.40. The re-test of the 79.00 low has created a bullish divergence in technical indicators suggesting that this low may be the bottom and could lead to a run back to the top of its trading range around 81.50. This can also be confirmed in the Euro Currency and the Japanese Yen. The Euro currency futures market has seen commercial traders sell more than 120,000 contracts in the last six weeks as the market has rallied from 1.29 to 1.34 per Dollar. Meanwhile Japan’s new Prime Minister, Shinzo Abe, has turned the country’s monetary presses up to 11 in an attempt to jump-start their domestic economy.

The absence of an expected rally in the gold market through the last few weeks leads me to believe that the internals simply don’t support these price levels, yet. Therefore, the market will continue to seek a price low enough to attract new buyers beyond the commercial traders’ value area. Typically, this would lead to a washout of some sort that may force the gold market to test its 2012 lows around $1,540 per ounce before finding a bottom.

Furthermore, the flush in gold would most likely be accompanied by a rally in the U.S. Dollar and could push it back above the previously mentioned 81.50 level. Proper negotiation and resolution of the pending debt ceiling would most likely exacerbate both of these scenarios while also including a large stock market rally. Conversely, a legislative fiasco would lead to a Dollar washout, as the global economies would lose faith in our ability to manage ourselves and treat our markets accordingly. Therefore, in spite of the inter-market, fundamental and technical analyses we will keep our protective stops close on our long Dollar position while waiting for an opportunity to buy gold at discount prices for the long haul.

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 Wary of Risks Ahead

 

Commercial traders are building the case for their negative
outlook on the stock market. Their actions in several markets can be seen as
increasingly defensive over the last several weeks. Their behavior is also
beginning to be confirmed by several technical indicators, some of which are at
levels that haven’t been seen in nearly 15 years.

Last week we used the employment situation, profit margins
and earnings to suggest that it would be an historical event to start a new
bull market leg upwards from these levels and therefore, the short term pop on
the debt ceiling rally could be sold in the stock index futures market to
generate a short term profit. Deeper analysis reveals that selling stock index
futures at these levels may be an appropriate hedge for the longer term.

We all know that trading volume declines in the summer
months and the, “dog days of August.” Lower volumes and fewer market
participants leads to higher volatility. Monday morning’s sell off in the
S&P 500 was dramatic enough to make me sit up and take notice. The market
opened at 9:30 better than 1% higher thanks to the resolution of the debt
ceiling deal. The market then promptly sold off nearly 3% in a couple of hours.
The speed of its fall is what is noteworthy. A closer look shows that the
number of market participants as measured by open interest is the lowest it has
been since 1997. Open interest peaked in December of ’08 at more than 755,000
contracts. It is currently under 300,000.

Declining open interest becomes increasingly negative the
farther the market moves. Friday’s close marked the first week the S&P has
closed under its 40 week moving average since September of last year. A simple
timing model using the 40-week average and some interest rate calculations will
provide far superior risk adjusted returns simply by staying out of a weak
market that is trading below this level.

Moving to commercial trader analysis, we can see that they
have increasingly sold stock index futures since mid-June, in line with the
debt ceiling concerns. Their defensive trading behavior can also be seen in
their purchases of U.S. Treasuries. They have been solid buyers over the last
several weeks with a strong emphasis on short duration maturities like
Eurodollars and the 2 and 10 year Treasury Notes. The last part of the
inter-market puzzle is the strong move to U.S. cash reserves via the U.S.
Dollar Index. Commercial trader buying has increased by a startling 70% or,
more than 17,000 contracts in the last week.

Given the troubles coming to a budget agreement I looked
into why money was coming into the Dollar. The simple answer is that it’s a
value play relative to the Euro currency and the gold market. The recent
European Central Bank bailout of Greece is seen as a band-aid on a chain saw wound.
Two ECB questions remain, when will Greece default and will Italy and Spain be
next? The markets continue to question whether they will be able to continue
paying their debts and this can be seen in the record high interest rates they
are being forced to pay in the open market.

Finally, commercial traders see the typical safe haven of
gold as overvalued. Small traders and funds are holding a near record long
position in the gold market. The concern is that when the stock market fails
and cash needs to be raised, it can only come from positions that are
profitable. This would lead to profit taking in the gold market and drive it
lower. Since small traders and funds are typically quicker to react to major
market moves, the concern is that when the gold market falls, it could fall
quickly and deeply. This would wash out many of the small traders and put gold
back into play for the commercial hands waiting to buy the market again.

Ending on a High Note

The market has stated repeatedly throughout 2010 that it’s good to own, “stuff.” Tangible assets with a finite supply have increased in value because they are known quantities. The United States and the European Union are devaluing their currencies through various forms of Quantitative easing and investors face growing concern that fiat currencies lack real meaning. The combination of low interest rates and limited supply has pushed the commodity markets to the front of the attractive investment sectors in 2010 and should continue to shine in 2011 as the U.S. economy falters under the weight of its own debt while reinventing itself as a global service provider rather than global manufacturer.

 

The commodity markets posted new investment interest highs in 18 markets in 2010. This means that almost half of all mature domestic commodity markets reported all time highs in outside investor interest. These markets not only include the headline leaders like gold, silver and oil but also cotton, which has doubled since August. Furthermore, investors are using the commodity markets to hedge their own portfolios in the face of uncertainty in the cash markets. Three commodity markets reached all time highs in investor interest on the short side. The S&P 500, 10 year Treasury Note and the Euro currency all set new records in 2010 for net investor short interest. These markets were sold in record numbers in anticipation of stock market declines in February, an expected rise in Treasury yields in April and a weakening of the Euro currency in May.

 

The stock and bond markets are unlikely to lure money away from the commodity markets in 2011. I think it’s very likely that we’ll see our economy slip back into recession by the third quarter of 2011 with unemployment climbing above 10.5% and moving past 11%. Generally speaking, the economy needs to create more than 100,000 jobs per month to hold the unemployment rate steady from the previous month. Eight million jobs have been lost since the recession began in December of 2007. Those jobs have not been replaced since the National Bureau of Economic Research signaled the end of the recession this past June. In fact, Princeton economist Paul Krugman states that the economy needs to create 250,000 jobs per month, every month, for the next five years just to get back to where we were before it all hit the fan in ’07. Finally, small business creation and growth is what drives the employment picture and the National Federation of Independent Businesses monthly surveys simply do not support a robust recovery picture.

 

This general picture is further supported by the most recent commitment of traders data commercial trader momentum in the S&P 500 turned negative to join the Dow and Nasdaq, which had already turned. Negative momentum across all three major indexes has been a reliable forecaster of topping action in the stock markets including the recent tops in April. When we combine this with the strong buying action across the short to mid term treasuries this past week, it’s clear that professional money is moving to safer bets to start the new year.

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.

Foreign Alternatives to Domestic Problems

People interested in the safety of investing short term cash
in certificates of deposit who are unhappy with yields they’ve been receiving
may want to consider some other options. The total return on CD’s has been
hammered throughout the economic crisis by the compounded effects of the
declining U.S. Dollar and the fiscal stimulus packages designed to lower
interest rates and create inflation. This has created a net negative return for
the people who are most reliant on income generating, principal protected
investments.

The fiscal stimulus plans have been designed to keep
interest rates low with the intention that low rates will spur economic growth.
The hope has been that businesses will take advantage of these low rates by
borrowing money and putting it to work increasing their gross revenues and
hiring more workers in the process. However, early on in the economic crisis
when the Federal Reserve Board began printing money and slashing rates, the
money they created was bottlenecked by the banking industry trying to heal
their own balance sheets and make up for their own overextension into the sub
prime real estate lending market. Thus, much of the initial stimulus never made
it to small businesses that might have been willing to borrow early on. The
depth and severity of this crisis has since scared off those same businesses as
it has dragged on and on with no pickup in consumer demand. Now that the money
is finally flowing, businesses have no need to ramp up production.

The official unemployment rate is 3.5% higher now than it
was when the economy collapsed in October of 2008. I have a hard time cheering
about an unemployment rate just because it’s less than 10%. Perhaps a more
telling statistic is that the number of employed people aged 16 and over has
declined by 5.8 million people over the last two years. The fiscal stimulus
package has not been designed to create employment. The effect is a mild opiate
for the masses in the form of increased subsidies and treatment of the economic
symptoms like home and auto loans without establishing a rigorous protocol for
fixing the economy and weaning the public off of its pain medication.

The haphazard way in which the fiscal stimulus has been
doled out has been viewed by the world as U.S. Dollar negative. The U.S. Dollar
Index, which is down approximately 14% since the crisis began, only tells part
of the story. This index is calculated by the value of our Dollar against a
basket of foreign currencies. The Euro Currency, Japanese Yen and the British
Pound dominate that currency basket. These three countries, which total more
than 80% of the U.S. Dollar Index each have their own economic crises to deal
with and are therefore, not reflective of the global value of our currency.

The only real source of global inflation at the moment is in
the emerging countries. China is main headline and rightfully so. China holds
the key to the next wave of developing middle class. Their growing consumer
base will fuel the next round of global economic recovery, along with India,
Brazil and numerous smaller Asian economies. These countries are experiencing
their very own, “Industrial Revolutions.” Their metamorphosis is happening much
faster than the one in our history books and it is their healthy economies that
can provide those seeking principal protected earnings some measure of value.

Those of you invested in domestic money markets and CD’s are
well aware of the deleterious effects of declining interest rates and a falling
Dollar. The compressed yields aren’t enough to offset the waning value of the
principal denominated in U.S. Dollars. Fortunately, the global economy brings
global alternatives. Our firm trades currency futures. We do not have access to
foreign certificates of deposit or, global money market accounts. These ideas
are from my personal finance management and are being passed along because they
are investments that I’m personally entertaining.

A brief survey of domestic six month CD’s provides us with
investment opportunities ranging from a low of 0.05% at Fifth Third Bank to a
high of 0.20% at Chase and PNC Bank. Compare those with the following six-
month foreign currency deposit rates; South African Rand- 3.68%, Norwegian
Krone – 0.6%, Mexican Peso – 2.14% and the Australian Dollar at 3.25%. These
investments are not free money and the risks need to be understood. These risks
include but are not limited to, the currency exchange rate between the U.S.
Dollar and the currency you choose to invest in and also include interest rate
policy shifts within the individual countries. However, as it becomes clearer
and clearer that the United States’ Federal Reserve Board is going to continue
to push for lower rates and flood the market with cheap Dollars via their
second round of Quantitative Easing, it becomes increasingly important to protect
the value of what we have and that means trading shiftless Dollars for global
industrial development.

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.

Bucking the Dollar’s Decline

The main argument supporting inflation is based on the current prices in the commodity markets. The argument postulates that the massive injections of capital through low interest rates and the government’s active purchase of long term treasuries is debasing the U.S dollar and making our products cheaper on the international market. The logic is sound in assuming that price paid has a direct relation to the exchange rate. However, since 2007, the U.S. Dollar Index is down less than 5%. This doesn’t seem so bad on the surface until one considers that because the U.S. Dollar Index is trade weighted with more than 40% of its allocation going to the Euro currency futures, it doesn’t accurately reflect the Dollar’s value against the developing Asian nations and thus, the world.

 

United States’ businesses have made their profit margin through purchasing goods and services overseas at a favorable exchange rate and reselling them domestically for years. As a country, we have enjoyed our success for many years. During this process, we helped to develop an economic infrastructure overseas that we failed to remain competitive with domestically. The economies in these countries have continued to develop and strengthen and so have their currencies. We’ve seen the Dollar decline by more than 20% against the Indian Rupee and nearly 30% against the Japanese Yen since ’07. The Chinese Yuan/Renminbi is artificially capped by their government and has only been allowed to rise 7% against the Dollar over this same period.

 

The fact that the countries we’ve done business with for years are now stealing some of our economic thunder should come as no surprise. We’ve witnessed this story throughout history as cultures adapt new foreign technologies to their own use and use their production advantages of cheap labor, fewer legal restrictions and years’ worth of foreign direct investment to implement the same business plan in their own country, thus exploiting their own competitive edge in labor and capital, just like we did here, 100 years ago.

 

Productive land is the only production input with any upward price pressure. The inflation argument based on commodity prices is domestically tied to the agricultural land component of the economic equation. We have not seen inflation in labor as our own unemployment rate hovers under 10%. We have not seen inflation in the capital markets as the Federal Reserve Board recently committed to near zero interest rates for the foreseeable future. Finally, non- agricultural land has seen a crash in the housing market, which is being followed by the commercial market. Arable farmland and mineral deposits are the only sources of upward price pressure.  The growing middle class of India, China and other Asian nations is creating a consumption premium in the finite goods that must be grown or mined through their new found purchasing power.

 

Fortunately, we are able to benefit from the growing agricultural demand to help offset the years of domestic overspending. The United States still holds a strong lead in grain production. U.S. grain exports are on a tear this year and are expected to continue. China has been an importer of corn for the first time in 14 years and their soybean imports are up more than 5% from last year. We should be able to exploit this advantage as the developing middle class in India, China and the rest of Asia continue to move up the personal consumption ladder, which includes eating more of what they want and less of what they can afford. We will also see a surge in textiles and technology purchases as their disposable income climbs.

 

The net result of this is a changing shift in the floor prices for commodities as the world adapts to new levels of consumption and global production catches up. The old normal of $4 beans and $400 gold is long gone. The panic low of the economic meltdown in December of ’08 was $4.40 in soybeans and $700 in gold. Markets like corn and sugar never broke their upward trends. Currently, corn is supported by China’s continued imports while India remains the largest gold consumer.

 

The most compelling case, in my opinion, is in soybeans. Soybeans are fully supported by both China and India through solid demand in feed and cooking products. Technically, the soybean market has been trapped in a $2 sideways range for more than a year, trading between $8.75 and $10.50. Furthermore, as of January of this year, commercial traders, via the Commitment of Traders Report had actually accumulated, and held a net long position in this market until the recent test of the $10.50 highs. This implies that both soybean producers and end production consumers believe this area to be, “fair value.” Finally, we are on the cusp of the seasonally strongest time of year for the active soybean commodity futures contract. Therefore, any disruption in supply could generate a violent breakout higher, easily approaching $12.50 per bushel or, $10,000 per futures contract.

 

The United States will continue to benefit from our major advantage in farmable land and push it’s agricultural technology efficiencies to the utmost. Unfortunately, as a country, we would be lucky to cover 2% of the national debt through agricultural profits. A better personal finance option is to put the only source of domestic inflation to work by studying the markets themselves and learning how to take advantage of the supply and demand dynamics of a global agricultural imbalance.

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 in investing in futures.

Volatility’s Perfect Storm

Volatility’s Perfect Storm

I’ve been actively trading the stock indices – S&P 500, Nasdaq, Russell 2000 and Dow futures for 20 years and I’ve never seen a day like today. It was truly a, “Perfect Storm.” I believe this will happen more and more frequently in the future as the three main reasons for May 6th’s volatility are gaining momentum all of the time.

First, public complacency was the highest it has been since the summer of 2007. Every bailout and new government program bolsters the warm and fuzzy investor psyche that allows us to believe everything will work out. The Volatility index measures the cost of protecting your stock portfolio through the purchase of put options. Put options are like buying portfolio insurance. If you hedged your $300,000 stock portfolio it would have cost you approximately $8,500 in put premium to protect the full value of that portfolio through June, from any downside risk. That same insurance policy in the afternoon would have been worth $23,625. Considering the value of your portfolio equaled the decline of the stock market, you would’ve lost 3.25% on your $300,000 or, $9,750. The difference between the $8,500 paid up front versus the current portfolio’s value of $290,250 plus the current value of the insurance policy $23,625 means that your net worth on the stock market’s biggest point loss day in history would have actually INCREASED by $5,375. The increase in the VIX is the reason for the inflated option premium and the magnitude of the rally of the VIX bears testament to the market’s general complacency.

Secondly, All of the markets are tied to each other. That’s why we are Commodity AND Derivative Advisors. In the age of electronic commodity trading, one issue always affects another one and that one in turn, affects another on and so on. Every trade in an outright market like the S&P 500, Euro Currency or, Japanese Yen will have an effect on the other markets related to it. This has, in effect, created one giant butterfly effect. In the age of algorithmic trading, where the minutest of market inefficiencies are exploited by aggressive capital placement, abnormal market moves will become self fueling. Many of these models use markers based on the model’s expectation of, “normal,” relationships to its data points. When things get pushed beyond the model’s, “normal,” expectations you have a case of, “If you liked stock ABC at $12 a share, you’re going to love it at $4 a share.” There were at least two stocks in the S&P 500 that traded to 0, today. This means they were broke, bankrupt, didn’t exist. Two Fortune 500 companies disappeared on someone’s lunch break and by the time the employee got home from work, no one knew the difference. Twenty minutes of electronic market butterfly effect.

Finally, as the market began to fall, the media was showing the Greek police force in full riot gear after passing their severe austerity vote in an attempt to procure financing from the European Union. Furthermore, the context of the day’s discussion among the talking head TV pundits was the doom and gloom surrounding the demise of the European Union, civil protest and bankruptcy in Greece with the specter of Spain’s impending default as a backdrop. Doom and Gloom sells. Traders, both retail and institutional are listening to the end of the world as we know it while watching the stock market meltdown and trading programs are ticking off one sell order after another in an attempt to be the first ones to market with their orders. The pursuit of greater bandwidth on their data feeds, faster processors in their computers and deeper levels of quantifiable algorithms put them in the lead in the race to the bottom and right back up. Welcome to the new age of 24 hour doom and gloom media coverage, total connectivity and computer programs replacing common sense trading. We specialize in common sense trading.

 

This methodology 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. This method is meant for educational purposes and to illustrate the correlation between the commercial’s trading and its effect on creating turning points within the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures. The information contained herein comes from sources believed to be reliable, but are not guaranteed as to accuracy or, completeness.

 

Pandora’s Grecian Riddle

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 in investing in futures.

 

Pandora’s Grecian Riddle

Here’s a riddle for you. What could make the U.S. Dollar and Gold rally while keeping short term interest rates exceptionally low, in the face of a bleak domestic economy?

The answer: bigger troubles overseas finally finding their way into the light.

I have said for the last 6 months that there is big trouble brewingin Old Europe and the Mediterranean. Many of you who absorb information fromsources other than CNBC and Fox Business channel are already aware that Greeceis on the verge of catastrophe. Members of the EU met in Brussels yesterday,February 15th for the primary purpose of discussing what to do withGreece’s inability to bring their budget in line with national their nationaldebt expenditures, currently totaling about 300 million Euros. They will alsoneed to secure financing of more than 50 million Euros to maintain operationsthrough the end of this year. Currently, their deficit represents about 12.7%of GDP. Jean- Claude Trichet and the rest of the EU policymakers want thisnumber to be brought down to 4% for 2010. It is my understanding that there isa tacit agreement among members of the EU that deficit financing cannot accountfor more than 3% of GDP for EU members.

To put this in perspective, our debt levels here in the U.S. arerunning at approximately the same percentages as Greece. This would be theequivalent of the U.S. cutting its budget deficit, currently around $1.3trillion by more than $550 billion both this year and next. Can you imagine thecivil unrest this would create or, what it would mean to Medicare, welfare orsocial security? How about schools, police forces and the postal service? Thisis what the approximate proposal by the EU would cause in Greece.

Obviously, the next thought is, “its Greece. So what? How badcould it be?” Remember that we’re talking approximately 300 billion Euros.According to John Mauldin, this represents 2.7% of European GDP. Remember BearStearns? They held less than 2% of U.S. banking assets. The issue here is thatthe other members of the European Union would not have the collectivecoordination to operate swiftly and decisively in the event of contagion.Russia in 1998 had a very clear operating system. Decisions were made anddirectives were carried out. Argentina in 2002 was also able to implement thedefault, restructure, revalue and grow procedure within less than a year.However, according to yesterday’s meeting, as reported in both “The Guardian”and the “Telegraph,” there is virtually no consensus among what should be done.The mandate to cut debt was issued but, what enforcement power is there tocarry it out? How long will the other nations allow the European Union as awhole to be seen as impotent in the world financial markets?

Of course, Greece has choices. Most plausibly, they agree to EU concessions and implement them fractionally – like the teenage child that whose completion of the chore list is underwhelming, to say the least. Secondly, they could default on their debt. This would throw the country into a depression.However, unlike Russia and Argentina, who both had a wealth of natural resources to fall back on, over 75% of Greece’s GDP comes from the service sector and less than 4% comes from natural resources, which consist mainly ofagriculture. Therefore, they will not be able export their way to economic recovery the way the Russia and Argentina have. Finally, they could vote to remove themselves from the European Union. The benefits would include a devaluation of their debt and an instant competitive edge in labor pricing.Unfortunately, any savings – monetary or land (mark-to-market), left in Greece would be devalued immediately and it would leave them unable to securefinancing on the open market for quite some time.

Going back to where we started, I asked the question, “What would make the Dollar and Gold rally while keeping short term U.S. interest rates low?” As of this morning, (2/16/10), European Union leaders have broken offtalks with Greece over what to do. A Grecian default would place a huge strain on Germany, Switzerland and France, the three primary holders of Grecian debt(Mauldin). Great Britain and Spain are stuck dealing with their own problemsand the Swiss won’t get involved. If the EU were to bail out Greece, what wouldIreland say? Here in the U.S. we arbitrarily chose to save some firms and letothers fall by the wayside. Think Bear Stearns versus Goldman. The fallout was substantial. I can’t imagine the political chess game that involves picking which country to save and allowing which one to fail. From a tradingperspective, and this is about trading – not political rhetoric, this eventwill create uncertainty in the financial markets. Holders of Euros will diversify. Whether they buy U.S. Dollars directly or, simply move money out ofthe Euro and into other currencies, this action will devalue the Euro. Furthermore,this uncertainty will attract more money to Gold. Finally, uncertainty in theEuro Currency will reassert the U.S. debt markets as king, thus keeping short term rates low for the foreseeable future.

Any questions, please call.Andy Waldock866-990-0777