Right now we think it highly likely that going forward we see an increase in the rate of economic deterioration.  Europe is already in a mess but the economy in the United States is now showing signs of its last gasp of growth.  One indicator that we track is the Citi Economic Surprise Index.  In the chart below you can see that economic numbers have been coming in very strong for the past few months.  Based upon previous history it is safe to say that we have peaked or are very near peaking and that economic numbers going forward should start to turn lower.

Citi Economic Surprise Index USD and G-10

Not only are economic numbers expected to turn lower but we are also seeing several signs that inflation is dropping.  One relationship that we follow closely is that of the CRB Raw Industrials Index against the SP500.  As you can see in the chart below the two are usually very correlated.  When the industrials are moving higher stocks usually follow and when they turn down stocks tend to do the same.  Right now there is a disconnect, one that we expect to be resolved with the SP500 moving lower.

CRB Raw Industrials Index and SP500

This relationship matters because if inflation moves lower the stock market will as well.  We can see this very clearly in the next chart where we have overlaid the weekly SP500 with the 10-Yr TIPS breakeven rate.  As you can see these have a very tight relationship.  What you can’t see is that this relationship goes back long before the crisis.  When inflation expectations rise the stock market rises and when they fall the market falls.

SP500 and 10-Yr Breakeven Rate

Other signs that inflation is not upon are that government bond yields are hovering around historic lows.  As you can see in the next chart the 2-Year Treasury yield has been low and headed lower.  Despite all the hype regarding hyperinflation we have not seen any of it, and based upon the messages from the bond market we are not seeing it anytime soon.  In case you are wondering we are seeing the same thing farther out on the curve with 10 and 30 year yields also near their lows.

2-Yr US Treasury Yield

Another sign that we have been following is this chart of the Shanghai composite and the CRB index.  As you can see the two indexes peaked within two weeks of each other and have been steadily working their way lower for the past eight months.  As the nation of commodity stockpiling has slowed down so have their stockpiles.  As this huge underlying commodity bid has vanished it has allowed industrial commodities to drop.

Shanghai Composite and CRB Index

Whether it becomes an all out crash, ala 2008, or not is not known but we are confident that the global slowdown will continue.  So what have we done with this view?  In our model portfolio we are short the AUD/USD as we expect the Australian Dollar to move lower as commodity prices and Asian demand continues to falter.  We are short the EUR/USD via options in a trade we placed back in August.  Recently we bought the USD/CHF as we expect the Swiss Franc to weaken considerably from here.  We are also short the SP500 via options and long the Lehman/Barclays Aggregate index which is highly weighted with US Treasuries and investment grade credits.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

One group of indicators that we follow quite closely are yield spreads.  They work as great risk indicators as well as  economic indicators. In the case of junk spreads they tend to lead rather than coincide or lag the overall economy.  One area where they really shine is at the darker end of the economy.  As you can see in the chart below junk spreads tend to lead the initial unemployment claims by anywhere from two-five months.  For the past four months junk spreads have been inching higher and higher as the economy has noticeably weakened.  What does this mean?  Well if the correlation holds up then we would expect initial claims to move higher.  This would go along well with most of the indicators that we are seeing such as the various manufacturing indexes pointing lower, with the exception of the Chicago PMI, as most indicators whether economic or market are pointing to a weaker economy. (Click on chart to enlarge)

Junk Spreads and Initial Unemployment Claims

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries and Gold.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

We are sick of talking about QE2.  Instead lets look at the EU.   European Credit Default Swaps are blowing out, and really it is the consistently weak countries known as the PIIGS.  Italy is actually doing alright although it too is ticking higher but Ireland, Portugal, Greece, and Spain are once again on the races to see who can suck the worst…again.  If this continues, and it probably will, we will have to revisit  shorting the Euro.  For now we will just sit back and watch.

Ireland 5-Yr CDS

Portugal 5-Yr CDS

Greece 5-Yr CDS

Spain 5-Yr CDS

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-Right now we are riding out Ben “The Bubble” Bernanke’s bubble (long a slug of “risky” assets) but are looking to short the Euro soon.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

So hopefully it is fairly obvious that we are in deflation or at least disinflation.  If that isn’t obvious enough then read our previous posts.  If nothing else you will see that it has been our view since at least June of 2009 is that we are in deflation.  That being said we are currently long gold.  Some of you might be thinking that we must be smoking crack, after all how can we be long gold if we dont see inflation anytime soon.  Because of the general perception that gold is an inflation trade we thought it would be useful to look at the current situation.

Currently the situation in Europe is pretty bad.  The EU is essentially in complete disarray as new problems seem to surface every couple of weeks.  Everyone but the EU knew that the PIIGS had problems but now Hungary, Belgium, and even France are coming up in the news as problem areas.   We are seeing currency issues, debt issues, liquidity issues, structural issues, etc.  The EU right now is like the Lindsay Lohan of regimes with all of its issues.  All of this adds up to what is the largest fear, a sovereign default.  If this were to happen, or when it happens we will see some major turmoil across all markets.

So what are investors doing right now?  The have been fleeing the Euro and Euro denominated assets.  No one wants EU based stocks, bonds, or the Euro.  As they leave the Euro they have been going into the US Dollar, US Treasuries, and into gold.  Yes, they are leaving the Euro to buy gold.  While investors across the world have been buying gold the trend has been especially obvious in the EU and its neighbors.  We can see this in the following charts.

Here is GLD the gold ETF.  As you can see it has been steadily moving higher but only recently started hitting new highs as it sold off back in December and took a long time to consolidate.

GLD-Gold

For real evidence that gold is going up on worries of a sovereign default we need to look at gold priced in Euros.  As you can see in the chart below gold in Euros consolidated but has barely even pulled back during the past year and has really accelerated to the upside over the last few months.

Gold in Euros

Being very tied to the mainland Europe, and having a weak economy as well many UK investors have also been buying gold to get out of Pounds.  While not quite the move of the Gold/EUR this has been a strong and steady move.

Gold in Pounds

Finally lets look at gold in Swiss Francs.  As you an see the trend has been pretty much the same with a steady move higher and very tight consolidation.  One thing worth noting with the Swiss Franc is that in a normal crisis investors would be taking their money out of their regular bank and putting it in Swiss banks.  This time around Switzerland gave up their role as the ultimate bank by giving away their client list to the I.R.S.  We think that Swiss Banks will be looking back and shaking their heads at that move.  This is not the only reason (the Swiss want a weak currency for example) for the relatively poor performance of the Swissy but it does not help, especially in the long term.

Gold in Swiss Francs

Comparing gold in US Dollars to gold in European currencies it is obvious that people want out of the Euro and see gold as a reasonable substitute.  Hopefully this helps answer why gold can be a good investment even if we are in a deflationary environment.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long GLD

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

One of the many indicators that we track is that of the Los Angeles and Long Beach port data.  Combined these two ports handle almost 50% of the shipping traffic for the United States so they are obvioulsy useful in order to follow global trade.  As you can see in the chart port data s very seasonal.  You can see that total trade (the green line) typically peaks in October and typically bottoms in February.  Sometimes this cycle is off by a month in either direction but for the most part it’s very consistent. (Click on chart to enlarge)

LA and Long Beach Port Data

While total shipping volume, outbound plus inbound containers, is down over 25% from the peak back in September of 2007 it is important to look at the same month due to seasonality.  Looking at shipping volume from Feb 2010 against the peak Feb in 2007 shipping is down -13.7% or 118,562 containers.

So is trade improving or getting worse?  By breaking the data down into performance by month we can see if this January and February are better or worse than other years.  In the chart below you can see that for 2010 Jan and Feb were both actually slightly above their historical averages.  The average January sees traffic shrink by -3.10% and this year it only shrank by -3.05%.  February sees an average decline of -4.42% and for 2010 it only declined -2.89%. (Click on chart to enlarge)

Port Data Seasonality For Jan And Feb

Frankly right now the data isn’t screaming at us.  Numbers are coming in close to the historical norms but overall there is little to get too worked up about. Basically port data is currently telling us that the recovery is still in progress but that nothing is really improving or declining.  What would be a constructive sign would be to see March where we have a historical average increase of 10.69%.  A large miss would be a bad sign while an average or even slightly higher number would be considered by us to be very bullish.

Happy Trading,

Dave@TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

One important indicator for gold is the Goldollar index.  The Goldollar index is formulated by taking the price of gold and multiply it by the US Dollar Index.  This has the effect of giving us the trend of the price of gold isolated from movements in the US Dollar.  As far as we know the Goldollar index was devised by the McClellans of McClellan Oscillator fame.  Just as the developers intended we use this index to help forecast and confirm what the price of gold is likely to do and what it is currently doing.  If the Goldollar index breaks out to the upside gold usually follows, and if it tanks then gold follow to the downside as well.  While it is not perfect it has definitely aided us in our trading.

So what is the Goldollar index showing us right now?  As you can see in the chart below the Goldollar index in the lower pane looks similar to the gold chart in the upper pane.  The main difference is that the Goldollar index has broken out from its consolidation and is right at its highs and gold is not.  While not the holy grail, and therefore sometimes wrong this would indicate to us that in the relatively near future gold will be moving higher. (Click on chart to enlarge)

Gold and Goldollar Index

Disclaimer-currently hold no position in gold but that is likely to change soon

Happy Trading,

Dave@TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

Since the Match 2009 bottom many correlations have held extremely well.  We covered one in a previous post titled “US Dollar Correlation Breaking Down” and other ones here.  We can now add one more broken correlation to the mix.  TIPS and GOLD have been trading very much inline with each other over the last nine months or so.  The primary reason for the correlation is that since they are both seen as inflation hedges they should trade together.

As you can see in the chart below gold and TIPS have trade very much in line for most of the last nine months.  Over the past two weeks however the two instruments have diverged with TIPS going higher and gold going lower. 

GLD-Gold ETF and TIP-TIPS ETF

So the big questions are why are these diverging and how can we make money from it.  You irst have to decide if you think inflation is going up or down and if you think TIPS and Gold are good inflation hedges.  If gold is a good hedge and you think that inflation is going to increase then you would want to be a buyer of gold.  If you think that inflation is set to decrease or that inflation expectations are overdone then you would likely want to short TIPS.  The other main way to trade this is to bet on a convergence and a return to correlation.  To take advantage of this you could buy gold and short TIPS.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-No positions in the securities mentioned.

Bookmarks

There is some interesting news out of China that they may in fact re-export some of their copper stockpiles.  Here is the link to the Bloomberg story “China May Re-Export Copper on Stockpiles.”   While not a rally killer by itself this is pretty damning evidence that a major part of the rally in commodities came from Chinese stimulus buying.  This was more bargain buying than an actual demand driven rally.  This could lead to a good sized move down as demand has not picked up inline with supply and now China is not only done buying but may even start to sell.

As you an see in the chart below copper has been in a steady uptrend since the end of 2008 and the move preceded the rally in other risk assets that started in March 2009.  The trend has been very consistent and is up about 130% in that time. On the chart below you can also see that as China has presumably stopped their buying we have seen a momentum divergence as the copper rally has slowed down.  (click on chart twice to enlarge)

Copper

We would be wary of any move higher in copper and are currently looking at some possible shorts in the copper related ETF/ETN products JJC-Copper ETN and DBB-Base Metals ETF on a break of the trend line.  If China which appeared to be the only buyer earlier this year, and is such a huge part of the emerging growth story, has too much then who is left to buy?

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are not currently long or short any industrial metals but that could change at any time.

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Did China Buy Too Much Copper
URL: http://www.themacrotrader.com/2009/11/10/china-copper-commodities/

Bookmarks

Why are bonds going up at the same time that gold is climbing? Real yields are the highest that they have been since the late 1980′s and the third highest in the last 100 years, investors expecting slow to negative inflation and growth are buying and will keep buying as they grasp for yield. (click on chart to enlarge)

10-Year T-Note Real Yield

Why has the SP500 continued higher even when earnings have been weak and unsustainable and demand has been virtually non-existent?  There are several contributing factors such as the oversold condition, sentiment, etc. but our favorite one is that the Government is debasing our currency and in the process it is driving asset prices but not their actual values higher, if your investment in the SP500 is up but the actual value of your dollar is equally low then have you actually made any money? (click on chart to enlarge)

SP500 and US Dollar Index

If we are in a deflationary environment then why is gold climbing higher?  No one wants to hold the US Dollar so instead of being a inflation/deflation play the current move of gold is based more on the devaluation of the US Dollar than anything else-It’s a currency trade. (click on chart to enlarge)

GLD-Gold ETF and US Dollar Index

If housing is cheap, interest rates are low, and everyone wants to trade their US Dollars for other assets than why aren’t housing sales going through the roof?  While your mortgage broker may be calling and saying that rates are at or close to all time lows the reality is that real rates are at their highest levels since 1987, cheap money my #%$. (click on chart to enlarge)

Real 30-Year Fixed Mortgage Rates

If demand is so weak than why has oil been so strong?  Once again it gets back to not wanting to hold US Dollars, when the USD bounces oil will likely get hit hard. (click on chart to enlarge)

West Texas Crude Oil and US Dollar Index

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long some GLD-Gold ETF

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: One Question, One Sentence, and One Chart Answers
URL: http://www.themacrotrader.com/2009/10/08/macro-trading-one-chart-answers/

Bookmarks

If over the past six months or so it has seemed as if you were partying like it was 1999 it might be time to reevaluate your stance.  One thing that we have been taking a closer look at lately is the pricing of risk.  Obviously when investors think that risks are low they will demonstrate risk seeking behavior.  We have seen this as the SP500 has climbed 56.6% from the March lows to the highs on 8/28/09.  With a rise like that you would think that 2008 never happened, of course if you believe that then you also believe  in a land of make believe with money trees, the fountain of youth, and SI models for all of us.

Of course some investors counter saying that while things could be better we are seeing the beginning of a recovery.  They then say that while the market will likely climb slower, that it will still climb higher.

While the above scenario is possible, anything is possible.  The more important question is to decide if the rewards outweigh the risk involved in being long equities right now.  Or even if at this point the better risk reward trade is to the downside.

Lets look at a few “risk gauges” or “fear indexes” as the press likes to call volatility indexes.  The first is of course the VIX.  After spiking to all time highs in October and November of 2008 we are already well on our way towards what was considered a “normal” level back in early 2008 before Bear Stearns.  The potential risks were obviously very mispriced at the beginning of 2008, are they mispriced again?  While likely not as off as they were at the beginning of 2008 we still think that there are a lot more real and potential risks then the market is currently pricing in. (Click on chart to enlarge)

SP500 VIX

What about foreign markets?  How do investors perceive the potential risks abroad?  Well if the VDAX is any gauge then investors see a rosy future in Europe as well.  Again maybe there are no big risks and maybe the EU is rock solid.  Then again maybe not.  With the complete lack of liquidity that businesses have had over the past several months in the EU it is really surprising that the VDAX is back to pre-crisis levels. (Click on chart to enlarge)

German DAX VIX

What about other asset classes?  What are investors saying about potential risks?  Using the MOVE Index which measures the range in which Treasury yields are expected to move over the next 12-months we can see that even here investors are becoming increasingly complacent.  What happened to the runaway inflation that we keep hearing is right around the corner?  Right now the market is saying that we will be in a 130 basis point range for the next 12-months. In The Macro Trader weekly newsletter we are long the TLT 20+ Year Treasury ETF and are expecting a bigger move then is currently implied via the MOVE index. (Click on chart to enlarge)

MOVE Index

Even in the currency markets we are seeing extreme complacency.  Apparently investors the world over are back to selling dollars in exchange for anything.  While the USD has its issues other currencies do to.  Right now the currency markets are not participating in the Keynes beauty pageant where you are trying to pick the girl that you think the judges will think is the beautiful.  No, with the current state of the global economy we are in the least ugly pig contest where we are only trying to find the least ugly.  That being said investors do not appear to see a lot of volatility any time soon. (Click on chart to enlarge)

JPM G-7 VIX

Even the emerging market currency volatility index is showing complacency. What happened to the banking issues in Eastern Europe? Apparently they vanished, or at least that is what it seems as though the market is telling us.  (Click on chart to enlarge)

JPM Emerging Market FX VIX

Even commodities markets are pricing in realtively low risk. While the price history of the Crude Oil and Gold volatility indexes does not go back as far as we would like, you can get a feel for what is happening as both indexes are dropping at a very steady rate.  Do investors really think that volatility will stay that low?  What happened to the oil spike if demand comes back?  And what happens if gold breaks $1000 on fears of hyper inflation?  (Click on charts to enlarge)

Crude Oil VIX

Gold VIX

Another excellent tool to evaluate the blind risk taking happening right now in the stock market is the JunkDEX invented by Bill Luby over at VIX and More.  By taking an equal weighting of junk stocks AIG, FNM, C, CIT, and BAC you can see how crazy or composed investors are acting. While we have seen, and actually use, an index of high momentum stocks we had never thought of making an index that tracks junk stocks to gauge investors risk appetite.

As you can see in the chart of the JunkDEX below the junk led the market off the bottom and then lagged until the last month when the index shot up +157.36% in a little over a month.  While it has pulled back over the last two days we are still in awe that investors are dumb enough to buy this junk at these prices. (Click on chart to enlarge)

VIX and More JunkDEX* vs SP500

After looking at all of this we need to ask ourselves if the rewards outweigh the risk to stay long?  Or if we should be flat or short.  In case you have not guessed we currently think that the risk reward is pointing to the downside.

Looking at the QQQQ we have a setup with a solid risk to reward situation. As you can see in the chart below the QQQQ has rallied back to its 50% retracement level, its 200-week moving average, and its downtrend line extending from October 2007.  While it could of course rally higher we like the risk reward enough to have put on a modest short position in our weekly Macro Trader newsletter. (Click on chart to enlarge)

QQQQ-NASDAQ 100 ETF

While not quite as nice of a setup as the NASDAQ 100, the SP500 also looks like a solid risk reward trade to the short side.  As you can see in the chart below of the SPY-SP500 ETF it has rallied up to the upper Bollinger Band and has already started to come back in.  We are looking for a move back to at least the $95-96 area. (Click on chart to enlarge)

SPY SP500 ETF

Obviously anything can happen.  The market could go up every day for the next year, or it could go down every day, but our job as traders is to look for the best risk to reward scenarios that we can find and place trades on probable scenarios and right now we think the most likely scenario is for the market to at least have a pullback if not a correction back towards its 200-day moving average.  Of course if this happens we will see the volatility indexes tick upwards to more realistic levels given our current economic environment.

*Our JunkDEX differs a bit from the one you can see at VIX and More.  After looking into it we found that  we built the index by simulating a $1000 investment in the index and in the SPY and Bill built it by normalizing the index starting value so we have slightly different values.  But don’t worry as the chart looks essentially the same and shows the same investor insanity.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In The Macro Trader newsletter as well as our accounts we are currently short some QQQQ-NASDAQ 100 ETF and long some TLT 20+ Year Treasury ETF.

If you’re getting value out of our posts, you can do us a favor by linking to us and mentioning The Macro Trader to friends and co-workers. Here’s the link information for this article:
Title: Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed
URL: http://www.themacrotrader.com/2009/09/02/mispriced-risk-macro-trader

Bookmarks