Tag Archives: european union

Is Brexit the End of the EU? by George Friedman

This Week in Geopolitics
Is Brexit the End of the EU?
By George Friedman

June 27, 2016
The vote has come and gone. A major European nation has chosen to leave the EU. The markets have had their obligatory decline. A weekend has passed. It is time to think about what exactly has happened… and what it means, if anything.

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Trading Ukraine Uncertainty

Removing the politics of the Russia-Ukraine issue and focusing on the economic implications of Russia’s bloodless annexation of the Crimean peninsula puts some trading opportunities on the table as global risk premiums jump. In order to do this, a couple of suppositions must be declared. First and most importantly, the United States will not actively engage Russian troops. In many ways, this is a replay of the Georgian conflict in 2008. Georgia was in revolt against Russia and wanted closer ties to the European Union and the US. Their cause was quickly championed by Western leaders until it became obvious that neither the European Union, The United States nor, NATO would take any military action to defend Georgia against Russia. This episode set the precedent for the current situation.

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Effects of Deflating the Yen

The Japanese economy has been on life support since their stock market peaked in late 1989. This is also when they began to lose their productivity gains in manufacturing and technology against their neighbors. Their immigration policy and small family sizes have shrunken the labor pool to a point that even with consistent per capita GDP growth, they continue to fall behind fiscally. Their new Prime Minister, Shinzo Abe is attacking deflation in Japan in a way that makes Ben Bernanke look like a spendthrift. The obvious objective of deflating the currency is to make Japanese exports cheaper on the open market. This will grow GDP and spur new hiring thus, improving the domestic Japanese economy. The big questions are, how long can currency depreciation boost their economy, what are the side effects and lastly, will it work?

Japan is an interesting country in that they are a manufacturing country with very little in the way of raw materials or commodities to use in the production process. Therefore, Japan must import virtually, all of the raw materials they use. They’re becoming a high tech assembly country as opposed to their classic vertical production model. Their days of making the steel that goes into the car is over and so are many of the old jobs. It has become cheaper to import Chinese steel than to make it their selves. Currency depreciation will provide an initial rise in Japanese exports, as the inventory that has already been produced will be cheaper on the open market. However, these gains will be offset by newly purchased production inputs paid for in depreciated Yen.

The export market has been the key to Japan’s post WW2 growth. In fact, Japan’s balance of trade (exports-imports) had been mostly positive for 25 years before the tsunami hit in March of 2011. Prior to the Tsunami, Japan generated about 30% of its energy from nuclear power. They are currently running only 3 nuclear reactors out of 54. Manufacturing countries require large energy inputs and Japan uses more than 25% of their gross revenues to import energy and they are third in global crude oil consumption and imports. Depreciating the Yen will severely impact their energy costs. For example, the Yen has declined by 30% since November. That would be the equivalent of paying around $5.00 per gallon of gasoline, right now. This is what Japan will be paying to fuel their manufacturing centers.

This leads us to the effects of a depreciating currency on the local population. The Japanese private citizens are the ones bearing the brunt of this policy in two ways. First of all, Japanese citizens will be forced to pay more for everything that isn’t locally sourced and produced. This will trim their discretionary spending and put a crimp in local small businesses and service providers. Getting less for your money is never enjoyable. Secondly, the individual Japanese citizens are paying for the currency depreciation because the there is no international market for Japanese bonds selling at artificially low rates. The Japanese government is forcing their citizens with historically high savings to use it to buy underpriced Japanese Government Bonds. This transfers the debt from the government to the taxpayer.

I have no idea why the Japanese people haven’t revolted. I’m sure much of it has to do with culture. We tend to speak out in protest while they tend to tow the party line. It will be very interesting to see how this turns out as pensions go unfunded and taxes rise to pay for the massive social programs Prime Minister Abe has in store. Japan’s total debt (public + private) is now more than 500% of GDP according to The Economist (9/19/2012). The U.S. total debt to GDP ratio ranks 7th in the world at just under 300%.

The massive devaluation that is taking place will allow Japan to gain market share in the short term, especially against high quality German manufacturers. Continuation of this policy will put the European Union in a very uncomfortable spot. Germany is their economic leader and the country that would be hurt most in a competitive devaluation campaign. This may finally force the European Union to ease further in an attempt to remain competitive outside the Euro Zone. Easing euro Zone monetary policy may be the next link in the chain as the race to the currency bottom heats up. Finally, the pundits have coined a new phrase to help the guy on the street differentiate currency wars from fiscal policy. Welcome to, “coordinated global easing.”

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 Support in the Canadian Dollar

The Commodity Futures Trading Commission releases its Commitment of Traders data weekly. This data tracks the amount of buying or selling in the commodity markets by the markets’ primary trader categories. I review this data every Sunday night when I begin compiling my trading plan for the coming week. The Canadian Dollar has hit my radar for each of the last three weeks as the commercial traders’ position has grown faster than at any time in the past and their total position has only been exceeded once in the history of the data set.

The Commitment of Traders data goes back to 1983 in the Canadian Dollar and the first meaningful blip on the radar shows up in February of 1986 when the Canadian Dollar bottomed around $.69 cents to the U.S. Dollar. Commercial traders went from neutral to net long more than 9,400 contracts, the equivalent of nearly $1 billion dollars at full contract value. The market rallied nearly 6% over the next three months. Commercial traders next set a record long position in March of 1990 at 10,270 contracts or, just over $1 billion at full contract value and the market rallied 5.5% in the next few months.

Commercial traders’ buying the futures doesn’t always lead directly to a rally. There are times when it simply slows the decline as they cover short positions, as well. There are considerable spikes in August of 1993 and January of 1995 when the Canadian Dollar had been on a steady decline since its $.90 cent peak in 1991. In fact, the commercial buying peaked at 28,000 contracts at the bottom of the market in January of 1995. In this case it’s important to remember the old rule, “Whether getting long or, covering shorts; buying is buying.” It would take another three years and the, “Asian contagion” to generate enough commercial interest to eclipse the buying peak at the 1995 trough.

The Canadian government has done an amazing job of revamping their monetary policies and budgets over the last 15 years. The primary impetus for this was the 1995 budget, which cut governmental spending across the board while allowing greater freedom to the individual provinces as to how they could spend the federal money they received. The provinces were then able to target the funds to their individual needs. Furthermore, the corporate tax and capital gains taxes were restructured to facilitate capital expenditures and new business generation. Finally, they implemented a federal General Services Tax. This is similar to the European Union VAT (Value Added Tax), which is a consumption tax that is paid proportionately by higher income people who spend more.

These changes significantly improved the Canadian economy. Their workforce has grown substantially. Unemployment has declined and jobs have been added to the economy. Welfare recipients declined along with the percentage of people below the poverty line. In fact, the number of low-income families declined by more than 30%. This was all achieved while cutting their debt to GDP ratio from 80% down to 45%. Their current debt to GDP has now reverted back around 85% due to the economic collapse. Meanwhile, our debt to GDP ratio has surpassed 100%. There is no question that our neighbors to the north are doing a far better job of maintaining their budget than we are.

The total net long record for commercial traders in the Canadian Dollar is 105,543 contracts. Commercial traders accumulated a net position of $10.5 billion dollars worth of Canadian Dollars in January of 2007 when the market was trading at $.85 cents to the U.S. Dollar. The Canadian Dollar then reached a record high of $1.10 by early November that same year. Equally important, these same commercial traders had pared this position down by more than 90% at the high water mark. That, my friends, is pretty darn good trading.

Currently, we have seen commercial traders’ positions increase from 4,431 contracts in mid January to more than 86,000 contracts, currently. The Canadian Dollar is currently trading around $.97 to the U.S. Dollar. This market has held above $.95 for the better part of the last three years. We view the strong commercial purchases as a sign of supporting the market at these levels. Commercial traders have demonstrated their forecasting ability admirably in the past and we will lean on them for support as we buy into this market. However, managing risk is always our number one concern. Therefore, we will place our protective stop under the current swing low of $.9650 in the June Canadian Dollar futures as we anticipate a move back to parity with our U.S. Dollar.

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.

Greek Default Imminent

The Greek elections were confusing on multiple levels and this may be the catalyst that pushes Greece out of the European Union. Aside from the obvious economic issues, which was my primary focus, the confusion created by the press questioning Greece’s ability to form a new government left me positively dumbfounded. Here in the U.S. it’s a simple matter of counting up the votes and inaugurating the winner. Greece is a parliamentary republic, which means the President is ultimately decided by the 300 member Parliament.

Greece’s top vote getter in the election was Antonis Samaras of the New Democracy Party. However, he won less than 20% of the popular vote and his party only secured a third of the Parliamentary seats. The Parliament holds their Presidential vote after the popular vote determines the Parliament’s makeup. Thus the Presidential vote should be proportional to the Parliament’s popular vote. Typically, Greece’s elections are very similar to ours in that there have only been two parties with any real shot at gaining power. The second leading vote getter, Evangelos Venizelos, of the PASOK party, Greece’s other dominant political party was able to garner 13% of the popular vote and a mere 41 Parliamentary seats.

The inability of either of the primary parties, who both favor austerity measures, to win a majority of Parliamentary seats further muddies the political waters and this is the cause of the, “Greece has failed to form a government” confusion. Greece is now going through the bargaining process with each candidate trying to win enough Parliamentary votes from the other parties to meet the two third’s vote necessary to become President. Currently, neither of the primary parties, New Democracy or Pasok has been able to do it. The anti austerity radical and left wing parties that secured a record proportion of the popular vote have also failed in their turns to corral the necessary votes. This forces a second round of voting, which will require three fifths of the vote to win and will be held next month. Finally, if they are unable to reach a three fifth’s majority, the Parliament is dissolved and a new election is held. The new President will be the one who gets the most votes.

The Greek people appear to be ready to default on their debt. The ability of the radical parties to gain such tremendous support, and possibly the Presidency, is a clear illustration that the Greek people are tired of living under German rule. The austerity cuts that we hear about on TV are very different to the Greek people who have seen their pensions cut in half, government payrolls and compensation slashed as well as nearly 10 tax hikes in the last two years.

The outflow of funds from Greek banks is accelerating at an alarming rate. Businesses and private citizens alike are scrambling to pull every Euro they can get their hands on out of their banks and into another country for safekeeping. Corporate and private deposits have fallen by 20% over the last year and more than 30% since 2009. The inability to form a government over the last week has accelerated the withdrawals to the tune of $700 million in the last week alone. That panic has caused the head of the Greek Central Bank to issue a statement suggesting that there is plenty of liquidity within the banking system and that there is no need to withdraw cash. Obviously, he’s trying to quell the fears of his countrymen by whistling past the cemetery in the dark.

Greece did repay $556 million in foreign notes due to private investors who refused the 53.5% haircut on the brokered swap agreement. However, the situation is unraveling quickly. The rescue fund administrators have already begun withholding funds because the Greek vote drastically reduces their willingness to adhere to current austerity measures. The next line in the sand comes before the end of June when Greece is due nearly 40 billion Euros. The fear is spreading as Spanish yields are now above 6.5%. We stated 6% as their tipping point and now, even the Italian bonds are above that number. Finally, a Greek default will trigger losses around the world and due to the interwoven nature of swaps and derivatives, we don’t really know what that will look like…..no matter what we’re being told.

The Bernanke Put – Euro Style

The Spanish debt auction proceeded in an orderly fashion
even as yields crept higher. The general consensus appears to be that Spain is
too big to fail. I would suggest that Spain might be too big to save. Spain is
the European Union’s fourth largest economy and 14th largest in the
world. Last week, their credit rating was lowered to BBB+ by the Standard &
Poor’s rating agency. This week, they announced that their GDP had contracted
by 0.3%. This quarter’s decline marked the beginning of Spain’s second recession
since 2009. Finally, the composition of their debt makes any positive economic
headway in the next few years nearly impossible.

The interest rate benchmark is the 10-year bond or note.
Spain saw full participation at yields of 5.82%. There are two important points
to be made here. First, the participation rate is measured by the bid to cover
ratio. It was quite a bit stronger than the last auction in March, coming in at
2.9 compared to 2.4 for the last auction. The second point is the yield of
5.82%. The alarm bells sound when Spanish debt yields hit 6% on the 10-year
note. That’s the magic number at which Spain can no longer afford to refinance
or, rollover the financing of their budget. Spanish yields have solid
resistance between 6.125% and 6.25%. They peaked at 6.625% in November 2011.

The International Monetary fund released a report on the
European Union and the global debt issues entitled, “Global Financial Stability
Report.” Spain’s BBB+ credit rating is three notches above junk status. According
to the IMF the probability of default on BBB+ credit has risen from 0.734% in
2007 to 6.05% at the end of 2011. I believe that the recent pitches by the
BRIC’s (Brazil, Russia, India and China) to contribute to the bailout funds and
push the total available reserves to $430 billion has been received by the
markets as restoring confidence, rather than preparing for financial

Spain’s primary source of trouble is the bursting of a
housing boom bubble. Sound familiar? Here in America we struggled through the
economic crisis as unemployment peaked at 10%. Meanwhile, the number of homes
in foreclosure peaked at 8.12 million in January of 2010 and drove home values
here down approximately 25%. Spain’s unemployment rate is nearly 25% and close
to 50% for people under 25. The Spanish real estate boom put 80% of the
population in home ownership. Foreclosure rates are now topping 10% at some
banks and the unemployment situation is creating a death spiral. This is
leading to marked to market values on repossessed homes as much as 60% below
their peak. Marked to market values leave the repossessing bank with an
over leveraged asset and reduces their capital base further constricting their

Spanish banks packaged their loans for resale on the
commercial credit market as mortgage backed securities. These securities were
prime at the time of origination. However, as their economy has declined the
nonperformance of these loans has placed more of them in the default category.
Some of these mortgage pools now contain up to 14% of mortgages more than 90
days over due. The obvious conclusion is that many Spanish banks are in

The European Central Bank and the IMF have teamed up to try
and save Spain from themselves. The Troubled Asset Relief Program (TARP)
committed $470 billion to U.S. banks and the auto industry in order to keep
people in their homes and on the job. The $430 billion that has been pledged to
save Spain will not be enough to cover the mortgage losses. Furthermore, the
average Spaniard’s primary asset is their home, which accounts for
approximately 80% of their net worth. The Spanish debt will be hard to spread

This leads to the IMF report on national household
deleveraging within the constructs of a banking crisis, which found that the
deleveraging process trims an average of 1.45% of GDP. European corporations
are already hurting. The lowest levels of corporate credit have skyrocketed
from 2% of total corporate credit to almost 16% of total corporate credit in
the last 5yrs. How will the ECB decide which ones are worth saving and how will
Spain feel about relinquishing their sovereignty to the decisions of the ECB
and the IMF? Government has never been very successful at manipulating markets
over the long haul. I believe the bond auction was palliative only because
investors are certain the ECB will backstop their purchases just as we have
grown accustomed to the Bernanke Put here in the U.S. Finally, when government’s
lose control of the markets they have been manipulating, the disaster is

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.

Sharecropping in Greece

This week’s article is based on a piece I read by Michael
Hudson. He is a research Professor of Economics at the University of Missouri,
Kansas City and President of The Institute for the Long –Term Study of Economic
Trends. His writing is quite dense. I had his articles on one screen and
Mirriam-Webster’s online dictionary up on another. That being said, his basic
thesis is that the European Union’s design has allowed private banks to make
sub prime loans for individual countries’ internal development with little
thought as to whether they had the ability to repay them. Unlike our own sub
prime debacle, it is ending in foreclosure by the banks on entire countries,
instead of just individual houses. He calls this the, “sharecropper” model of
European lending that will create poverty stricken and dependent countries
within the European Union.

The first issue
he raises is with the globalization of the financial industry and its primary
purpose of collecting fees and generating revenue based on the maturation process
of the debt it services. Accounting processes in the last 10+ years have
evolved into a shell game. The idea, following Enron’s lead and supported by
major financial firms like Goldman Sachs, Chase and J.P. Morgan allowed private
banks to make loans large enough to subsidize governmental funding programs
like health care and infra structure loans by creating financial swap

The swap contracts they created are basically like
adjustable rate mortgages with the addition of a second variable. Obviously,
the first variable on an adjustable rate loan is the future interest rate. The
second variable is the foreign exchange rate. The value of the loan is
calculated at the time it is made but the repayment value would vary based on
the relationship between the currency in which the loan was made and the
currency that it is repaid with. For example, in 2003, the Euro and the Dollar
traded at the same value. A loan made in Dollars to the European Union of
$1,000,000 would carry a swap value of the agreed upon interest rate
fluctuation plus an agreed upon currency exchange rate fluctuation. The Euro is
currently worth $1.45. Therefore, the current repayment value of the loan could
have been cut nearly in half based on currency fluctuation. Think in terms of
controlling the new crop seed money.

The swap contracts they created allowed private banks to
lend money to foreign governments, which would be repaid through national
lotteries, airport landing fees, toll roads, etc. The banks profited and debtor
countries, like Greece, remained within the European union’s 3% budget deficit
rule because cross currency swaps were not recognized as official government
debt. The reality was that the accountants at the large institutions found legal
but, covert ways around the European Union’s Maastricht Treaty. The Maastricht
Treaty made no provision for financing individual countries directly by the
Union. The unintended consequence was a shadow lending industry that went
completely unregulated and spiraled out of control. Imagine the U.S. sub prime
debacle on a scale large enough to finance Greece, Ireland, Iceland, Portugal
and Spain combined! Hudson equates this to a land grab of national revenue
producing assets.

The second issue that Hudson raises is the process by which
the debt that is created by the banks and squandered by the individual
governments is then transferred to the general population for repayment to the
original lenders. The borrowing governments use the money received to expand
their balance sheets, which in turn allows them to issue new debt on the open
market. This debt is purchased by the large French and German banks that now
hold roughly 35% of Greece’s debt and can’t afford Greece’s inability to pay.

Germany and France then use their political clout to
engineer a European bailout (QE1 & 2 in the U.S.) to protect the banks and
people of their countries but, in actuality, saddle their own productive
economies with repaying a less productive country’s debt. French and German
taxpayers, unwilling to cover the debts of an irresponsible borrower force
austerity measures on Greece to punish them. However, raising taxes to pay back
the loans does more to damage Grecian productivity than to curb spending. This
places Greece in an even deeper hole forcing them to seek more bailouts to fund
nationalized welfare programs like health care, garbage removal, infra
structure maintenance and so on. This, controls the labor.

Finally, the European Union, as opposed to individual
lending institutions, offers to buy or, lease national services and landmarks
like, the Parthenon or their airports and roadways that would guarantee long
term loan repayment revenue streams. The banks would keep their profits and
remain solvent while Greece gets their own spending habits under control.
However, this process would also strip Greece of their primary national
industry – tourism. Consider this the, “land” portion of the equation.

The spiraling cycle of forcing people to pay more while
making less through controlling the seed money, labor and land is why Hudson calls
this subsistence the, “sharecropper” business model of the Euro financial
institutions, which he believes will end in revolt just like it did here in the

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.

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.

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.

Crude Oil and the World Market

Crude Oil and the World Market


May has been an interesting month in the crude oil futures market. The crude oil market has sold off more than 25% of its value in the last month. It has gone from trading at over $90 per barrel down to $67 per barrel. The selloff has been based on two primary concerns; First, the continuing slowdown in Europe and secondly, the growing strength of the U.S. Dollar. However, commercial traders are betting that these concerns will be more than offset by continued growth in developing countries and declining domestic production through the politicizing of off shore drilling.

The European Union is going to face continued economic pressure as they deal with the after effects of their own credit bubble. We have written extensively about the troubles in Greece, “Pandora’s Grecian Riddle.” We also suggested that Greece would merely be the first European Union to succumb to the hubris of its own administration and that this would quickly be followed by Spain and Italy. An appropriate parallel is to the individual financial giants here in the U.S. as the government decided who lived and who died. For the purpose of understanding the selloff on crude oil, the important takeaway is one of simple human basic need. The countries in the European Union will experience a manufacturing slowdown. However, they will continue to cook, heat their homes, drive their cars and maintain the base needs of fully developed countries.

The growing strength of the U.S. Dollar has made crude oil cheaper because crude oil is traded on U.S. exchanges and priced in U.S. Dollars. Therefore, as the Dollar rallies, so does our purchasing power. However, since the beginning of May, the Dollar has only rallied about 7%. Obviously, this does not account for crude oil’s 25% decline. Of course, astute readers will recall that in February, when the Dollar rally began, crude oil experienced a 14% drop on a 4% rally in the Dollar. This created a selloff down to $70 per barrel before rallying back to $90. Therefore, the correlation remains within normal boundaries.

The growing case for crude oil bargain hunting at these levels can be made through the case of the developing middle class of very large Asian populations. The demographic argument states, broadly, that money follows population growth and education. Psychologically speaking, people first seek to meet their basic needs of food, shelter and clothing. As these needs are met and existence transitions to living, the population wants better food, nicer clothes, DVD players and cars. These populations will develop their economies from the inside. However, their production facilities will require more raw materials to produce an equal amount of goods than the efficient production facilities in developed countries. Their higher rate of consumption will help to support global demand for fossil fuels.

British Petroleum’s recent disaster in the Gulf will further constrict domestic supplies going forward. No one can argue the magnitude of this disaster. Many more Americans will truly see and feel the impact of this environmental calamity because it happened in the Gulf, rather than in Alaska, like the Exxon Valdez. The emotional impact will rally voters to back Obama’s moratorium on offshore drilling and put further National Park drilling in jeopardy.

Finally, let’s look at the market internals themselves. Commercial traders, via the Commitment of Traders Report have continued to buy the market the entire way down through this decline. This means that the people who live and die by this market feel that these are value prices. Their trading programs are not based on swing trading. Their trading methodologies are based on fundamental factors like supply and demand and currency exchange rates. They also incorporate seasonal usage data into their trading algorithms, which suggests the crude oil market should continue to see increased demand through the end of August.

The sum conclusion of this selloff in crude oil is that it should be viewed as a buying opportunity for the long term. This is one of the situations where efficient portfolio analysis would suggest that allocating a portion of an overall portfolio to inflation sensitive, fundamental goods would not only put your trading in line with the commercial hedgers, but also provide some overall portfolio diversification.

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.