Tag Archives: interest rates

Weekly Commodity Strategy Review

We only published twice this week as my attention was focused on bringing a new Commitment of Traders trading program online. The primary improvement in this version is its ability to lock into large moves and score the occasional big win as opposed to the statistically based days past entry exits we’ve employed for the last few years. I’ll share more after some time trading it on my own account to examine its behavior.

Back to the independent research that separates us from 80% of the commodity trading population. We began this week with a look at the consolidation in the gold futures market for TraderPlanet. We said, “We believe the recent shift towards a more bullish stance by the commercial traders could provide the spark for this market to breach the $1,225 resistance and….”(Yesterday’s high was $1227.7)

Continue reading Weekly Commodity Strategy Review

Weekly Commodity Strategy Review

We looked at the recent commercial buying in the US Dollar Index on Monday, noting that, “Even though commercial traders remain heavily net short, their recent purchases have been strong enough to shift their momentum back to the positive side.” We also looked at technical support that has been tested and held, throughout this week.

You can find the full piece featured at TraderPlanet.

Timing the Dollar Index

Tuesday was probably our best call. Equities.com featured our crude oil analysis in, “Crude Oil Spike is a Selling Opportunity.” We stated that, “our simple take on the way these usually work is that we’ll get one more spike of some type above the recent congestion that has built up. This morning’s trade near $61 is the spike we’ve been waiting on. ”

The market peaked Wednesday around $62.50 and has quickly fallen back near $58 per barrel.

We went macro with our own piece again this week as a follow up to, “The Interest Rate Conundrum” of two weeks ago. Originally, we focused on the world’s central bankers and the recent International Monetary Fund meeting in Washington. Their primary purpose was to discuss what it would take to US and global interest rates to rise and when. Apparently, Bill Gross had the answer and the markets listened in a BIG way. Even if interest rates aren’t your topic, the swings on the charts I posted are truly dramatic.

Interest Rate Conundrum Resolution

Bonds Creeping Towards Lower Yields

The multi-year bond rally has continued unabated. Therefore, it’s no surprise that our mechanical, long only trading program following the commercial traders in the bond market has had a good year winning 7/8 trades as you can see on the chart below, for net profits of more than $5,000 per contract.

The current setup suggests that this roll should continue.

Continue reading Bonds Creeping Towards Lower Yields

2014 – Equity Flop & Commodity Hop

I thought taking a vacation at the end of 2013 might allow me to come back to the markets with a clear head and new viewpoint. My hope was that a little detachment would bring the forest back into the picture at 35,000 feet. I’ve now caught up on my reading and research and find the markets just as schizophrenic as they were when I left. While the markets remain as confusing as ever, our trip did provide me with the sense of awe that comes from physically standing in the presence of thousands of years of history. One thing is for certain; mankind always finds a way.

Continue reading 2014 – Equity Flop & Commodity Hop

Tidal Shift in the Bond Market

The recent spike in Treasury yields could very well be signaling a change in trend direction. We rarely try to pick tops or bottoms in major trending markets. It simply doesn’t pay. However, we’re seeing lots of corroborating evidence that this may signal a shift in the global macroeconomic outlook. Therefore, this is one of the rare times when a pull back within the interest rate sector may not be a buying opportunity. In fact, if this is the beginning of the Great Unwinding we need to focus on all of the evidence to obtain a complete picture view, all the way from the trading screens to the man on the street.

The trading screens always provide the first clues of market direction. It’s important to remember that prices and yields trade inversely to each other. Therefore, when the price of the security rises, the interest rate declines. The opposite is also true. This is why we can talk about all time high prices and record low yields in the same sentence. The 10-year Treasury Note is the global proxy for US interest rates.

The last leg of this rally began in late November of 2007. The employment situation was starting to deteriorate and interest rate adjustment was the primary tool the Federal Reserve used to pump life into a faltering economy – prior to the economic collapse. The Fed lowered rates by a quarter point in four out of the last five months of 2007. They lowered rates eight more times in 2008 and finally committed to a zero rate policy in February of 2010.

The combined inventive efforts at the Fed eventually drove the 10-year rate to an all time low just under 1.5% in the cash market and an all time low on the 10-year futures of 2.3%. This is where it starts to get interesting. The 10-year Note has been trading at a negative real return for over a year. This means the interest generated by the instrument’s yield would not keep pace with inflation’s erosion of principle. The recent sell off has pushed its nominal yield above 2% while inflation is expected to remain a hair under that mark. Thus, bringing our first, “normal” look at a yield curve in ages.

The high water mark set in early May was fueled in part by Japan’s concerted depreciation of the Yen. The markets were well prepared for this. The US has provided massive stimulus over the last five years. Europe has added their share over the last three years through Greece, Spain and now, Cyprus. The logical next step in a globally competitive devaluation race was obviously a form of Quantitative Easing by Japan. Commercial traders here in the US stocked up on 10year Notes, accumulating their largest long position since February of 2008. Their expectation was that we would continue pushing the zero bound interest rate plan.

This may very well be one of the rare times when the commercial traders are just plain wrong. Historically, they’ve been very good at forecasting rate direction. This time the largest trading group may have been faked out as a whole. Two important points bring this home. First of all, their buying did fuel a rally to new highs…by a hair. Secondly, the weekly chart is beginning to show an obvious reversal bar. Will this turn into an, “Everybody out of the pool,” moment? I doubt it. However, I do expect them to continue to offload recent purchases, which will build up resistance on any attempted rallies.

The other primary point to make is the effect of the rise in interest rates on the housing market and its effect on the anemic economic recovery 99% of us have participated in. The national average 30-year mortgage has climbed by nearly 25% over the last few weeks rising from 3.4% to 4.2% according to Bankrate.com. This will have a big impact on the housing market, which had just begun to clear some inventory. This will also affect mortgage refinancing just as the deadline for governmental forgiveness approaches. The result of the spike in interest rates has caused a decline in the broad S&P 500 of nearly 4%. Meanwhile, the homebuilders ETF (XHB) has declined by almost 10%. The homebuilders have been a primary driver of the broad market’s rally since 2012 gaining nearly 100% in two years.

Higher interest rates are the last thing any of the major economies can afford. Half a decade’s worth of rate cuts, Quantitative Easing and Operation Twist, etc. have created a coiled spring of leveraged money hunting for that last bit of yield. The major reversal bar in the 10-year futures coupled with a large, unprofitable, commercial trader’s position could leave them left holding the hot potato. At its worst, this spike in rates steers us towards stagflation. An environment with rising inflation and no growth characterizes this. How far it spills over into the markets is unsure. Please call with any questions as this may well mark the inflexion point of what has been THE dominant trend over the last five years.

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.

Capitalizing on Fear in the S&P 500

The S&P 500 is within spitting distance of the 2007 highs. Remember 2007 when the economy was rolling along and everyone used the equity from their first house to buy a second or, third? Home ownership became everyone’s entitlement – the American way. Five years of deleveraging later and we’ve figured out that corporations know how to manage their businesses better than the bureaucrats know how to run our economy. Corporate balance sheets are healthy and Interest rates are at all time lows. Unfortunately, the government can’t figure out spending for a quarter, let alone an entire fiscal year.

We have written extensively on the topic of using stock index futures to hedge your retirement account. Typically, the response is, “How can I sell something I don’t own?” This week we are going to discuss Volatility Index futures. This is a product offered by the Chicago Board Options Exchange and it trades opposite the stock market. Therefore, buying VIX futures provides protection from a downdraft in the stock market while simultaneously limiting the risk of the hedge position.

First, it’s important to understand that volatility in the stock market is primarily associated with fear. Stock market declines put fear into the market’s participants. Fear generates wild swings in the market. Therefore, volatility increases with fear. The stock market collapse of 2008 was even wilder than the post tech bubble crash of 2000. The winter of 2008 saw the average monthly range in the S&P 500 increase to more than 145 points per month. This meant that the stock market had an average range between the month’s high and low of more than 20%. This continued for eight consecutive months.

VIX futures trade monthly and they are a direct measure of the volatility expected within the next 30 days. Therefore, if the price of the VIX futures is 17.00, the market expects that the S&P 500 futures may move as much as 17% over the next 30 days. The all time high for the VIX futures is 80.86, set in November of 2008.

This leads us to the second point. Fear is an emotion. Emotional actions exceed rational behavior in the markets. The all time high in the VIX futures suggested that the market could be priced more than 40% higher or lower from the prices we were trading at the time within 30 days. The S&P 500 closed at 812 in November of ’08. The VIX price suggested that by Christmas, we could’ve been trading as high as 1136 or as low as 487. The reality was that we traded from a low of 730 to a high of 836 in December of 2008. Clearly the imagination of the market’s participants got the best of them.

VIX futures are also an easy market to conceptualize in both pricing and movement. The current price is the market’s expected volatility between now and the expiration of the contract. The April VIX futures are trading at 16.50. That implies a volatility envelope of 8.25% higher or, lower. Volatility must be measured as a +/- envelope.  This suggests that the S&P 500 futures, which are currently trading near 1484, should be between roughly, 1606 on the high side and 1362 on the low side when the April VIX contract expires. The all time high for the S&P500 is 1695 in March of 2000 and the market hasn’t traded above 1600 since September of 2000.

The pricing of VIX futures is simply $1,000 multiplied by the index level. The April VIX futures trading at 16.50 has a full contract value of $16,500. This represents a multi year low. The all time low was 12.77 set on May 11th, 2007 while the previously mentioned all time high of 80.86 goosed the full contract value up to $80,860. May, 2007 was the same month that the S&P 500 traded back above 1500 for the first time since the 2000 tech bubble burst and should help to provide an apples to apples comparison of the relationship between the VIX futures and the broadest stock market benchmark, the S&P 500. The real key is that while the S&P 500 declined by 50% for a potential loss of $37,500 between May of ’07 and March of ’09, the VIX futures surged by more than 600% or, a potential profit of more than $68,000.

The trade that we are looking at hinges on two ideas; One, that political discord among the bureaucrats in charge of the U.S. budget will find a way to add some drama to the markets or, secondly that buying the VIX futures provides a supported position with limited risk as a hedge against another 50% decline in the stock market.

The 3.73 point difference between where the April VIX futures are currently trading and the all time low of 12.77 equals a potential loss of $3,730 dollars per contract, which is about equal to a minimal 5% decline in the mini S&P 500 futures at $3,710. However, any decline more serious than that could set the market’s emotions roiling and we’ve already illustrated the excess returns achieved through owning volatility futures, rather than outright shorting of the stock indices.

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.

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