The Eurozone debt concerns have finally taken their rightful place as a daily front -page news story. Tuesday, Spain brought 2.5 billion Euros to market in 12-month bonds. The average rate for the auction was 3.45%. This is 45% higher than previous month’s auction rate. For the sake of comparison, it’s hard to find a 12-month CD over 1% here. Wednesday, 20,000 Grecians rioted in response to the latest round of austerity cuts. Finally, European Central Bank President Jean -Claude Trichet is calling for an expanded role of the bailout fund. These headlines all echo the same theme…uncertainty.
Uncertainty is a bigger impediment to fully functioning markets than fear or, greed. Uncertainty prevents planning and prevents action. While Europe digests their own financial crisis, we can take a look at the effects of our own actions here as well as what to expect in the coming months.
Throughout the late summer and into fall, many leading analysts suggested that the domestic stock market was a much better investment than the domestic bond market. This includes people like Warren Buffet, James Paulson and Alan Greenspan. Their general assertion was that the effects of the loose monetary policy put in place to provide liquidity and jump- start the economy was holding interest rates at artificially low levels. Therefore, the risk premium, which compares investing in stocks versus bonds, had swung in favor of equities. The fourth quarter has clearly proven this to be correct with the stock market up 9% so far in Q4 while the 30yr. Treasury bond has declined more than 9.5% in price.
Most of this rally has been based on the unwinding of the fear and carry trades. Investors must constantly balance yield versus safety. Lately, the investment world has become virtually unmanageable to the individual investor attempting to figure out what the global leaders will put into play, how it will affect their portfolio and finally, what actions can be taken to capitalize on that analysis if it is correct. For example, it was generally accepted that the domestic stock market, metals markets and the U.S. Dollar could not simultaneously trade in the same direction yet, that has been the case of the fourth quarter. In fact, a decline in commodity prices combined with a rise in borrowing costs would put a real squeeze on the carry trades that have been placed over the last two years.
One solution to this puzzle is to focus on individual pieces. Sometimes, we don’t have to know what the final picture looks like. Eventually, if we keep putting the pieces in the right places, the picture will take shape. Therefore, some of the assumptions we will be working with are:
– The U.S. is ahead of Europe in dealing with the financial crisis.
– The U.S is still the largest safe haven economy.
– Euro weakness will make the Dollar seem strong by comparison.
– Developing Tiger countries are the engines driving global growth.
These ideas will continue place us on the long side of the commodity markets, while trading both sides of the Stock market and the U.S. Dollar. The markets should become less predictable and volatility should increase as the risk premium between the currency, equity and commodity trades continues to tighten. This will place many asset classes on equal footing and leave alpha to be gained only through the careful examination of the individual issues within those asset classes.
Out of the 36 markets that we track on a daily basis, 25 of them are facing negative commercial trader momentum. As we discussed a couple of weeks ago, some of these markets are near all time speculative limits. In fact, crude oil just set a new record for speculative long positions this week. This means that professional money managers are putting money to work buying crude oil while the people who produce it are selling all they can. The ability to follow the money flowing through the individual commodities provides a degree of certainty. This allows us to take action, using bottom up, micro economic analysis while the people at the top are still trying to figure it out on a macro economic basis.
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.