Tag Archives: frb

Gold and Bonds Getting Back to Normal

Gold, interest rates and the stock market have a very interesting relationship. Normally, declining interest rates are good for business and bad for gold. Post 9/11 and housing bubble, zero interest rate policies (ZIRP) created an artificial situation that fractured this relationship rendering it virtually useless over the last decade. This began to change last summer when the Federal Reserve Board stated that they would begin slowing the stimulus they’ve provided to the economy thus allowing interest rates to gradually rise. These relationships have begun to sort themselves out over the last three quarters and may actually be telling us something about the current pricing in the gold market.

Continue reading Gold and Bonds Getting Back to Normal

Equity Market’s Race to the Top

The equity markets have just been rip roaring strong. Companies like FedEx, Google, Morgan Stanley, Walt Disney and Boeing have all gained more than 40% this year. The equity markets have made new all time highs, eclipsing the pre-crash highs from 2007 with hardly a shudder and soldiering on past the tech bubble highs of 2000. Recently, the technical analysts at Merrill Lynch came up with a four-year target of 2300 in the S&P 500. This is based on their analysis of the long-term pattern that was triggered by the new highs. The S&P 500 has climbed more than 150% since March of 2009. While I’m the first to admit that I’ve left a lot of money on the table by not sticking with the long side of equities, I’ve been doing this long enough to know that there’s always another trade. Therefore, I will not be committing new money to the long side of the equity market at these levels in 2014.

The way I see it, there are two opposing forces at work here. First, we have the Federal Reserve Board that keeps pumping money into our economy. The Fed continues its easy money policies indefinitely. There are seven voting members of the Federal Reserve Board of Governors. Six of them have been broadly categorized as dovish, in favor of easy money/stimulus. There are four more rotating members from the national Federal Reserve Banks. This is where things may get a bit interesting. Three of the rotating members gaining a vote in 2014 are centrist to hawkish. While the doves are still clearly in control, especially with Janet Yellen expected to assume the Presidency of the Board, the dialogue in the minutes of their meetings could change substantially.

The easy money policies have favored the equity markets in a couple of different ways. The artificially depressed interest rates have forced investors to accept more risk for returns that used to be outside the scope of retiree investing. The stretch for yield has driven a boom in riskier corporate bonds as investors move down the ladder in an attempt to maintain their portfolio’s value. This has caused a surge in lower credit bond prices reminiscent of the sub prime mortgage debacle of the mid 2000’s.  Investors’ lack of satisfaction with the governmentally manipulated yield curve has led them to seek returns in the stock market specifically, through high yield investments like Real Estate Investment Trusts and utilities. What has gone unnoticed is the disappearance of nearly half of the companies listed on U.S. exchanges. Therefore, there’s more money than ever chasing a smaller number of stocks in the last 25 years.

Secondly, we have reached valuations that bode poorly for long term investing. Research abounds on the usefulness of long-term valuation models. Very simply, expecting these returns to continue through long-term investment at these valuations would set an historical precedence. Anything can happen in the world of markets but the odds clearly show that bull markets do not begin when the P/E ratio of the S&P 500 is above 15.  The S&P 500’s P/E ratio currently stands above 19 and Nobel Prize winning Yale economist Robert Schiller’s cyclically adjusted price earnings (CAPE) ratio is over 25. Both of these will continue higher as long as the equity markets continue to climb. Neither is sounding the, “Everyone to cash,” alarm bell. Their history simply suggests that it would be foolish to expect these multiples to continue to climb and climbing P/E ratios are necessary for stock market growth.

Closing in on 2014 has left many money managers whose performance is benchmarked against index averages scrambling to catch up. There are two ways a manager can do this. First, wait for a sell off and try to buy in at a discount. This is part of the reason that the weakness in July, August and October was so quickly recovered. Second, apply leverage so that the manager’s fund gains more than $1 for every $1 the market moves. Leverage seems to be the move of choice. This year has seen a huge inflow into equity mutual funds, which have to be benchmarked to their index. By comparison, each of the last two years saw net equity mutual fund outflows. The added influx of cash has led investment managers into the futures markets, specifically the S&P 500 futures. The most recent Commodity Futures Trading Commission’s Commitment of Traders report shows a 10% growth in leveraged longs as well as a 5% decline in leveraged shorts. Finally, margin debt on the stock exchange itself has also reached an all time high.

The case I’ve laid out says nothing about where we’re going. Liken this presentation to a new home survey. The place has curb appeal. The neighborhood is growing. The government is supporting its growth. Each new home sells for more than the last. What could be wrong with buying now? Well, the inspector may inform you that everything you believe to be true is resting on a shaky foundation. The house may stand for years or, not. Personally, I’d rather be in on the ground floor than looking for a window to jump out of having climbed in at the top.

Insidious Effects of the Dollar’s Decline

The United States is home to the largest and most liquid investment markets in the world. There’s hardly a market one can think of that isn’t exchange listed. This has made the United States the primary destination for excess global capital placement whether it has gone towards the relative safety of government bonds or been more aggressively allocated towards stocks, ETF’s or even the futures markets. The final destination of the investible funds is less important than the singular characteristic that all these investments have in common. They’re denominated in US Dollars and the Dollar’s value may be more meaningful than the underlying asset class.

Investment securities are not protected from the vagaries of their underlying currencies. Therefore, globally allocated investments owned in US Dollars can lose money in a flat market if the Dollar declines. The Dollar peaked in early July and has since fallen by more than 6%. Therefore, if your US equity portfolio hasn’t gained more than 6% since July, you’ve actually lost money. The Governmental shut down has accelerated the recent slide and pushed the Dollar to a new 30 day low for the second time this week. This is only the second time since May of 2011 that we’ve made multiple 30-day lows in the same trading week.

Perhaps more troubling to global investors than the currency-based loss is the fact that the traditional safe haven investments, even in Dollar terms, have not behaved as expected. The primary relationship between the Dollar and the US equity markets since the financial implosion of 2008 has been negative. This has been embodied by Dollar rallies on stock market declines. Very simply, foreign capital gets converted to US Dollars and placed to work through buying declines in the stock market. Conversely, when foreign investors take profits in a rising stock market and convert back to their base currency, the Dollar falls.

We also see this relationship play out in the gold market. Economists on TV tell us to buy gold as a defense against a declining US Dollar. Sensationalists point to the overwhelming debt being created by our country and tell us to buy gold because our country is on the verge of implosion and our currency will become worthless. Speaking of correlations, it’s amazing how many of the people saying this are the ones selling gold investments. Astute investors would notice that the correlation between these two markets has been trending upwards since early June. This means they’re moving in the same direction more frequently rather than opposite each other as expected.

Foreign purchases of US goods have always been Dollar dependent. Every nation and agricultural enterprise within every nation is forced to tie their commodity purchases accordingly. Therefore, it becomes especially disturbing when a weaker Dollar fails to attract foreign purchases of global staples. Beginning in August of 2012 we started to see the commodity markets decouple from the US Dollar. Wheat was the first market to be sated. Corn followed suit in October of 2012 and hogs joined the new normal last November. This means that even base foreign needs have been filled. Therefore, they are more likely to trade in the same direction as the Dollar going forward rather than the typical negative correlation that we’ve seen from bargain hunters looking for inflation in the commodity markets.

The International Monetary Fund (IMF) stated that world Consumer Price Index (CPI) came in at 3.2% year over year for August. This is down from 4.9% a little over a year ago and ties in rather neatly with gold’s last run at $1,800 per ounce early last October. The US unemployment rate is generally believed to be artificially low in the as reported number of 7.3% and Gross Domestic Product (GDP) here in the US came in at a very tame 2.5%. These statistics, combined with a low global industrial capacity usage number suggest that inflation is nowhere near. Furthermore, the Federal Reserve Board’s recent decision not to implement a tapering of the $85 billion per month in economic stimulus reinforces the notion that their primary concern is deflation, rather than inflation.

Many economists believe that we may be near a tipping point in the bull run that has followed the economic meltdown of 2008. The obvious concern now lies in the protection of the wealth that’s been garnered during the recent run. Clearly, the ownership of alternative investments isn’t going to play out the way the pundits have suggested. Therefore, investment vehicles that will profit from a decline in both asset value and currency depreciation should be seriously considered. These include inverse ETF’s as well the futures markets, which will allow the seamless execution of short trades including currencies. Equity futures spreads selling small caps like the Russell 2000 and buying big caps like the S&P500 are also a good idea when expecting volatile, downward markets. Remember that cash is only king as long as the King’s throne isn’t sinking.

Copper Points to Slowing Economy

Copper is often referred to as, “the economist of the metals markets.” This is because of its use in all things that make the economy go round from electronics to commercial and residential construction and general infrastructure. When economic development is robust, copper prices follow suit. More importantly, because copper is a base ingredient in this mix, the price of copper typically precedes any moves in the general economy. Based on the current conditions of the copper market, we expect prices to fall and with it, overall economic activity in general.

The Federal Reserve Board announced its intentions to begin tapering off economic stimulus on June 19th. As a result, Interest rates have soared. Since the Fed’s announcement we’ve seen mortgage rates rise by nearly a full point from May’s low to multi-year highs. This is a 15% increase in two months. The effect on mortgage applications is already taking hold as we’ve seen a decline in mortgage applications of more than 7% in the last two months. This has led to a 13.4% decline in new home sales for the month of July, the biggest decline in three years. Rising interest rates are slowing the economic recovery that has been led by the housing market.

No copper scenario is complete without discussing China. China is the world’s largest copper consumer, taking around 40% of the annual mining total. Unfortunately, separating the governmentally supported information handouts from the man on the street’s first hand economic observations is a difficult task in a country where information is so heavily monitored and controlled. The major news events this week are twofold. First, a group of Chinese investors are stalling on a $3 billion copper mine investment in Afghanistan. Their reasons are many but the five-year delay they just inserted into the talks suggests that the investors aren’t comfortable with current, physical demand levels. Secondly, Chinese manufacturing data, though signaling signs of expansion last month, appears to have done so through inventory reduction more so than actual production. This was seen in the contraction of new export orders, stocks of finished goods and employment.

Funneling the macro data into something tradable leads us to further bearish scenarios.  Commercial traders were actively listening to Bernanke’s discussion signaling the end of the monthly injections of $85 billion into our economy. Commercial copper traders clearly see this as a negative as they’ve been net sellers in five of the six weeks since the announcement. Perhaps more importantly, this comes after they had accumulated a very large position around the $3 per pound level we’re currently trading at. This suggests that they were locking in future deliveries based on continued economic expansion prior to the Fed’s announcement. Their actions since clearly state their change of attitude going forward and perhaps most importantly from a trading standpoint provides the potential serious selling if they decide there is no longer a reason to own copper at $3 per pound.

Finally, moving to the technical side of the market it appears that copper’s strength over the last three weeks may have more to do with speculative short covering rather than the creation of new long positions. Copper volume reached its highest level since December of 2009 on June 28th. This coincided with the lowest prices seen since October of 2011. Expanding volume coupled with declining prices is indicative of a strengthening downward trend. This becomes even more obvious in light of the rapid decline in volume and open interest over the last three weeks as the market bounced off its lows.

We feel that the slowdown in domestic construction that has been brought about by the Fed’s actions coupled with a large and now, unnecessary commercial long position will force the copper futures market to follow its typical seasonal path and decline through the end of October. This should certainly lead to a test of the psychologically important $3 per pound level. Violating the $3 per pound level leaves only the 2010 low of $2.90 as support before bringing into question the economic crisis low of 2009 near $1.50. Remember that commodities are not corporations. The world can live without another corporation but copper’s base necessity will serve to put a floor under the market. Therefore, a violation of $3 and even $2.90 is possible however, the market will find waiting buyers at bargain prices.

Spread Trading the Russell 2000 Vs. S&P 500

The stock market has made a lot of noise this week with the Dow Jones Industrial Average climbing above 15,000 for the first time in history. In fact, all of the major averages are up about 18% year to date. There is a general consensus that the massive liquidity operations the Federal Reserve board has implemented are the primary contributor to the market’s rally. However, there are several competing theories as to where the top may be. This week, we’re going to take a look at seasonal tops in the Russell 2000 small cap stock index compared to the S&P 500 large cap index to try and lock in some profits while minimizing downside risk.

The Russell 2000 is a stock index made up of small companies with a median market capitalization value of around half a billion dollars. This compares to the S&P 500 market capitalization average of nearly 28 billion dollars. Another way of putting this in perspective is that the Russell 2000’s largest company by market cap is Alaska Air as compared to the S&P 500’s largest company, Apple. The important thing here is to differentiate the small cap growth stocks of the Russell 2000 from the large caps that make up the S&P 500.

The reason for this is that small caps and large caps tend to behave differently. Small caps tend to lead. Therefore, they overshoot the tops and the bottoms. The smaller nature of the stocks in the Russell 2000 means that it takes less money to move the underlying stock. Small companies are also easier to grow. Of course, extra growth comes with extra risk. The composition of the Russell 2000 changes regularly due to new companies being added while others are removed. The large cap indexes like the S&P 500 are more stable due to the massive size of the companies it’s comprised of. Steady, stable, predictable growth is what is hoped for in the S&P 500.

We’ve all heard the old adage, “Sell in May and walk away.” There is a bit of truth to this as the primary stock market gauges are typically flat through the summer with a bit of upside bias and lots of downside volatility. In fact, this seasonality is even more pronounced in the Russell 2000, which tends to bottom in August. In other words, growth is minimal while full risk exposure remains. This is not an ideal risk to reward scenario. Over the last ten years, the Russell 2000 has called the late spring / early summer top correctly eight times. The two years it was wrong were 2008 and 2009 when the markets had already been beaten down. The average profit on the trade I’m about to detail was $4,250 for the other eight years.

There are two different ways to lay this trade out. The complicated way would be to find the least common multiple of the underlying futures contracts and work out the rest of the equation as percentages and then translate the percentages back into dollars and cents. Fortunately, we can simply use the futures contracts as they are and buy an S&P 500 futures contract while simultaneously selling a Russell 2000 futures contract.

This application takes advantage of the Russell 2000’s larger built in multiplier. Calculating the value of the Russell 2000 futures contract is as simple as multiplying the index by its $100 multiplier. Thus, a June mini-Russell 2000 contract trading at 970.00 has a cash value of 970.00 X $100 = $97,000. Meanwhile, the mini-S&P 500 has a built in $50 multiplier. Therefore, the mini-S&P 500 futures contract has a cash value of 1625.00 X $50 = $81,250. Buying one mini-S&P 500 futures contract and selling one mini-Russell 2000 creates a net short cash value of  $15,750 worth of small cap stocks.

The maximum value for this spread position was $16,671 in May of 2011. This represents the farthest the Russell 2000 futures have climbed above the S&P 500. We recently made a high of $16,200 two weeks ago.  Currently, this spread is trading at $15,350. I expect the recent April high to hold. If the market trades above the recent high of  $16,200, I will exit the trade at a loss. Recently, the average price for this spread is around $11,500. Therefore, I will use this support as the first place to look for profits. This sets up a trade that is slightly short the stock market through exploiting seasonal and market capitalization biases. Furthermore, this trade has had a relatively high historical winning percentage and is currently providing us with a 4-1 risk to reward ratio.

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.

The Value of the U.S. Dollar

The Federal Reserve Board is printing money at an unprecedented rate. The ECB is following suit. The Bank of England and China are both cutting rates to spur their economies and global sovereign debt is piling up like manure behind the elephant pen. Clearly, our currency is being devalued by the day. Some would argue that there’s a race to devalue among the major global currencies as the G7 nations attempt to boost exports and spur their respective domestic economies. Tangible assets like gold and silver or soybeans and crude oil may be the only true stores of value left in an increasingly wayward world. We read this every day. The truth is far less dramatic. In an ugly world, the U.S. Dollar is the prettiest of the ugly sisters at the ball.

The U.S. Dollar Index is exactly where it was four years ago. This is interesting considering that the aggregate money supply in the U.S. as a result of the quantitative easing programs has nearly doubled since the housing market collapsed. Theoretically, doubling the supply of U.S. Dollars should mean that each new dollar is worth half as much. Take this one step further and it’s logical to assume that if each new dollar is worth half as much then it should take twice as many dollars to make the same purchases that were made in 2008 yet, the Consumer Price Index is only 4.5% higher than it was then. Finally, I would suggest that considering the growth of the money supply and its characteristic devaluation, we should see an influx of foreign direct investment picking up U.S. assets at bargain basement prices. While logical, this is also incorrect as the U.S. Department of Commerce shows that foreign direct investment only exceeded U.S. investment abroad in 6 out of the last 20 years with 2005 as the most recent.

What has happened through the artificial manipulation of interest rates in the world’s largest market is that the U.S. Dollar has begun attracting large amounts of money as U.S. and global investors park their cash while waiting for clarification on the world’s major financial and political issues. Real interest rates in the U.S. are negative at least 10 years out. The Euro Zone is no closer to resolution. China is in the midst of changing leadership in a softening economy. Finally, what was an assured re-election of President Obama is now a legitimate race.

The inflows to the U.S. Dollar are easily tracked through the commercial trader positions published weekly by the Commodity Futures Trading Commission. The U.S. Dollar Index contract has a face value of $100,000 dollars. Commercial traders have purchased more than 25,000 contracts in the last few weeks, now parking an additional $25 billion dollars. The build in this position can also be seen in their selling of the Euro, Japanese Yen and Canadian Dollars. The Dollar Index is made up of these currencies by 57%, 13% and 9%, respectively. Collectively, commercial selling in these markets adds another $5 billion to their long U.S. Dollar total. The magnitude of these moves makes commercial traders the most bullish they’ve been on the U.S. Dollar since August of last year which immediately led to a 7.5% rally in the U.S. Dollar in September.

The degree of bullishness by the commercial traders in the U.S. Dollar forces us to examine the markets most closely related to it in order to monitor the spillover effect a rally in the Dollar might create. The stock market has traded opposite the Dollar for all but four weeks in the last two years. The last time these markets traded in the same direction on a monthly basis is August of 2008. The current correlation values of – .29 weekly and -.43 monthly suggest that for every 1% higher the Dollar moves, the S&P500 should fall by .29% and .43%, respectively. Therefore, a bullish Dollar outlook must be coupled with a bearish equity market forecast.

Finally, we see the same type of relationship building in the Treasury markets. The U.S. Dollar is positively correlated to the U.S. Treasury market. This makes all the sense in the world considering foreign holdings of U.S. debt have increased over 5% through the first seven months of 2012 (Fed’s most recent data). The bulk of these foreign purchases of U.S. debt are repatriated immediately to eliminate currency exchange risk. This process of sterilization forces interest rates and the Dollar to trade in roughly the same direction. This relationship turned briefly negative between April and June of this year on a weekly basis while one has to go back to March of 2010 to find a negative correlation at the monthly level.

Obviously, the trade here is to buy the U.S. Dollar. The negative speculative sentiment coupled with the bullish and growing position of the commercial traders could fuel a forceful rally. Small speculators typically accumulate their largest positions and are the most wrong at the major turning points. A recent study in the Wall Street Journal discussing individual traders’ biggest mistakes puts it succinctly. Small traders’ biggest mistakes, accounting for 60% of the total responses are being too late to get in and too cautious to take the next trade. Once burnt from exiting the last trade too late, the small investor is too scared jump in the next trade which reinforces the negative feedback loop they typically end up stuck in. Take advantage of this analysis and at least, prepare yourself with an alternate game plan.

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.

Commodity Bubble Targets

The commodity bubble of 2008 was a textbook bubble. Multiple
markets participated and supply and demand had nothing to do with value.
Commercial traders were losers when the prices traded did not reflect their
view of market fundamentals. When oil reached its high of $147 per barrel,
there were tankers circling the delivery ports, killing time as prices rose,
waiting for instructions to enter and unload. Many commodities were witnessing
a flood of new capital in the form of Exchange Traded Funds. The oldest pure commodity
ETF, the SPDR Gold Trust, started trading in 2004. Since that time, more than
$1 trillion dollars has flowed into commodity based ETF’s. A recent calculation
suggests that energy ETF’s control the equivalent of 1.6 million futures contracts,
which is equal to the total futures market open interest.

There are two easy money policy events that spurred this on.
The first was September 11th. In the face of tragedy and
uncertainty, the government and the Federal Reserve Board instituted an easy
money policy to prop up demand in a shell-shocked population. This, in turn,
fueled the housing boom and the cash out mortgage refinancing boom. Excess cash
found its way into all investment vehicles until it all unraveled in the
economic collapse of late 2008. The institutions’ response was the second event
that brings us to where we are – easier money, QE1 and QE2.

The result of easy money is cheaper dollar based commodities
in the face of growing global demand. We can see the devalued Dollars’ effect
on commodity prices in the face of the economic collapse of ’08. Commodity
prices put in a higher floor than they had from September 11th
through the bubble top in ’08. The ’08 bottoms in the commodity markets have
simply served as a new, higher floor price. The market has since traded higher
on growing global demand, ETF investment and a falling Dollar. Therefore, the
recent rallies are not bubbles, and that is the scary part.

I’d like to point out that my preference is for sound
economic policy and rational investment strategies. These would include curbing
U.S. spending, allowing China’s currency to freely float and opening up foreign
commodity exchanges to cross hedging. However, given the current architecture
and political leanings we will trade as if we’ve witnessed a two- year basing
and consolidation pattern with the major rally yet to come. This is where
things get stupid.

When measuring things we can’t get our heads around it helps
to use analogs. This is when we compare something we’ve already experienced and
know to something we’re presently trying to understand. You’ll hear this in the
markets as, “This wheat market is trading like the Australian drought of ’07.”
Or, when the market collapsed in ’08, people were comparing it to the crash of
1929 and the depression was to follow. Traders also use this to compare charts.
We disregard the scale numbers on the charts and simply try to find similar
patterns. Comparing patterns allows us to measure amplitude, the size of the
moves and the rhythms of the markets.

Using analogs, chart pattern recognition and a little
quantitative analysis, we come up with bubble targets we can’t quite get our
heads around. Here are some examples: Corn – $11 per bushel, Wheat – $22 per
bushel, Cattle – $1.50 per pound, Sugar – 47 cents per pound, Crude Oil – $250
per barrel. Some markets have already hit their targets like gold, silver,
coffee and cotton. Therefore, the end prices of these markets will end with the
old adage, “The only cure for high prices is, high prices.” How high will just
have to be seen to be believed.

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.

Stock Market Players are Increasing their Bets

There’s a difference between a tradeable rally and a fundamentally sound trend. The stock market has been exceptionally strong since Labor Day, turning positive for the year around the middle of September. During this period the two dominant news themes have been the Republican party’s campaign gaining momentum and the Federal Reserve Board’s verbalization of their willingness to do whatever it takes to keep the economy churning. Additionally, we are heading into the strongest seasonal period for the stock market on an annual basis. When these factors are combined with equity managers who have to put money to work on the long side to keep pace with the index, we see a stock market that defies logic by gaining momentum as it rallies.

 

The S&P has had three outside bars in the last five trading sessions. Typical market movement is just over one outside bar per month. Analysis of these three days shows that they all started lower based on overnight concerns and finished higher on the day’s trading here in the U.S. Whether the buying that came in was from fund managers trying to get capital into the market at a discount, traders covering their short positions or foreign money coming in to buy our equities at a dollar denominated discount is irrelevant. Buying is buying.

 

We’ve clearly identified the trend is higher. There are sectors with fundamental support like Potash, ADM, ConAgra, Freeport McMoran and so forth. These commodity based companies should rally in an economic environment dominated by a declining dollar. It’s good to own, “stuff.” In fact, the basic materials sector is up over 20% on the year, led by precious metals. An argument can also be made that the historically low interest rates have created a new type of carry trade, where borrowed money is being put to work owning, “stuff.”

 

The flip side of the stock market’s rally combines technical resistance, bearish commercial positions and a deteriorating labor market. Technically, resistance comes in another 2.5% higher around the April highs at 1200. Also, the market has lost about 15% of its open interest since making the August lows. Healthy trends are supposed to gain open interest as they progress.

 

Moving to the commercial positions, the open interest peak at the August lows coincided with the last commercial net long position. Over the last couple of weeks, the commercial traders have moved to a dead net short position. This includes a record short position in the Nasdaq. This type of behavior is a perfect illustration of why we follow the commercial traders. Small speculators and funds were accumulating short positions at the August lows while the commercial traders were buying the market against them. We are seeing the exact opposite play at the market’s top, right now. Small speculators and funds are putting money to work in the market as the commercial traders have gone from long position liquidation to outright short position initiation over the last two months.

 

Finally, the public unemployment rate held steady at 9.6% for the month of September. However, looking deeper into the data, we see that the economy has added only one month’s worth of new jobs over the last year and 90% of those jobs have gone to hiring workers over the age of 65. Employers are paying minimum wage for experience and reliability, not rebuilding long- term work forces. The data also shows that part time workers for, “economic reasons,” which means they can’t find full time employment is the highest ever recorded. The last piece of doom and gloom comes from Richmond Federal Economic Conditions Survey, which shows that companies are issuing a hiring freeze with the one of the largest single month declines that the Number of Employees Index recorded in the last decade. This is reinforced by the plunge in the Workweek index and the New Orders Index.

 

We may be approaching a climactic event in the stock market. The data spreads that went into crating this article have never been wider. The Federal Reserve Board is talking about a second round of quantitative easing. Their dialogue has created a rush into tangible assets like the commodity markets. It is supplying an artificial floor for the stock market and it has created a rush to buy short and medium treasuries. These moves are based on conjecture and hyperbole. What if the Fed sits tight? The markets have provided the Fed with the action they’ve been unable to create through their own actions. Inflation, low interest rates and a healthy stock market are exactly what they’ve been trying to construct. What happens when these bubbles burst?

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.