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.

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Since launching The Macro Trader in November of 2007 our subscribers were able to avoid the crash of 2008 and while we were not as short as we would have liked we were profitable, all this in a year wen the SP500 was down -38.5%.  Recently we publicly called the downturn in the Euro in our blog post entitled “Is It Finally Time To Short The Euro“  as well as calling the correction in the stock market with our post “It’s Time For A Pullback In Stocks.”  While we definitely do not get everything right we do strive to provide some of the best and most actionable research available.

If you have been a blog reader and enjoy what you read then take a $1 trial to our weekly newsletter The Macro Trader.  Simply click on subscribe, pick your subscription and you will be given the first month for $1 and then either be billed monthly, quarterly, or annually depending upon what you choose.

In our weekly newsletter we cover stocks, bonds, commodities, and currencies.  We run a model portfolio using ETF’s so that our research is accessible to both retail and institutional investors alike.  Every other week you will receive an extensive letter with tons of in depth research and on the other weeks you will receive a shorter version with summarized versions of our views and any new actionable trade ideas.  In addition to the weekly letter we also send out regular mid-week updates with trade ideas, research, commentary, etc.  If you want great research and actionable trade ideas spend the $1 for a one month trial, it is likely the lowest risk trade out there.

Happy Trading,

Dave@TheMacroTrader.com

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Over the past year one of the biggest themes has been to short the US Dollar and go long anything that is considered risky.  If you bought stocks, any grade of corporate bond, commodities, even real estate stocks and you would have made money.  Many strategists, The Macro Trader included, used the falling US Dollar as a reason to go long stocks, bonds, commodities, etc.  The reason of course is that since the March bottom the USD and the SP500 have been almost perfectly inversely correlated.  Well that relationship appears to be breaking down right now as the US Dollar has been rallying and other risk assets have not been falling in sympathy.

In the chart below you can see how as the US Dollar has fallen, the SP500 has risen.  In fact when there is a wiggle in the USD there is an opposite move in the SP500.  As you can see in the bottom right hand corner the USD is rallying while in the top right hand corner the SP500 is still looking strong. (Click on chart twice to enlarge)

US Dollar vs SP500

Of course if this inverse correlation is falling apart the correlation between the SP500 and the Euro is also falling.  Apparently, at least for now, you are able to be short the EUR/USD and still be long stocks and make money.  Looking at the chart below you can see almost the exact opposite of what we see with the US Dollar.  As the SP500 has moved higher the Euro has climbed as well until the last few weeks as the Euro has tumbled and equity markets as well as other risk assets have managed to remain strong and in many cases hit new highs. (Click on chart twice to enlarge)

Euro vs SP500

What do we take from this?  One thing is that the carry trade using the US Dollar was not as heavy as many people feared.  Another thing is that the market is always changing and that many intermarket relationships work well in some periods and fall apart in others.  As always it is important that we have solid risk management principles and that we are open to change.  For now we are short the EUR/USD and long equities…but that could change tomorrow.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is long several equity index ETFs such as IWF, EWZ, and MOO and we are short the FXE-Euro 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: US Dollar Correlations Breaking Down
URL: http://www.themacrotrader.com/2009/12/16/us-dollar-correlations-breaking-down/

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We have heard about the so called economic recovery for months now and while it is true that markets are higher we have our doubts that any of this optimism is seeping into the real economy.  Because of this we tend to believe that we are headed for a double dip recession, assuming that we ever got out of the first one.

Lately we have started to see renewed signs of a downturn in some of the economic indicators that we follow.  All things employment have been bad with the unemployment rate, exhaustion rate, and unemployment 27 weeks or longer rates up.  Anyone that is seeing an upturn in employment must be on an acid trip as there are no signs of anything but more unemployment.  Just Wednesday we had housing starts come in lower than expected.  One indicator that we follow is the Citi Economic Surprise Index.  They have them for all of the G-10 nations and it does a good job of showing if economic numbers are doing better or worse than expected.  As you can see in the chart below the index is turning over in both the United States as well as the G-10 indexes. (Click on chart twice to enlarge)

Citi Economic Surprise Index

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is actually long various indexes but since he’s negative on the economy is looking to lighten up on the first signs of weakness.

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: Is The Recovery Slowing Down?
URL: http://www.themacrotrader.com/2009/11/19/slowing-economic-recovery/

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One of our major themes here at The Macro Trader over the past two years has been to short Europe.  We mean that in a general sense as we have been short Spain and Italy off and on for over a year and are bearish on most things EU relative to most of the world.  One area that we have been looking at a lot lately is that of the Euro.

After being overvalued by 40% back in March of 2008 the Euro fell about 20% as investors went into risk aversion mode and bought the US Dollar.  Since March of this year the Euro has once again climbed into wildly overvalued territory again and is currently about 35% overvalued. As you can see in the chart below when the Euro gets very far above or below the 20% bands it has a relatively sharp tendency to revert to the mean. (Click on chart twice to enlarge)

EUR/USD PPP Chart

Our view is that sometime in the next few months we will have a modest US Dollar rally as investors leave the Euro.  In fact this is one of the primary reasons why we think that gold has been working out so well.  Basically the EUR, USD, and JPY are all really weak and investors are doing anything possible to diversify out of them.

One tool that we use a lot to gauge our timing in regards to trading currencies via PPP valuations is that of the different volatility indexes.  While you can monitor the EVZ Euro VIX, we also look at the JP Morgan G-7 VIX so to help us gauge the risk aversion in other G-7 currencies as well.  Right now this is important as there are several currencies overvalued by 20% or more, but that is for another post.  Anyways as you can see in the chart below the JP Morgan G-7 VIX is at relatively low levels and is showing little sign that anything is happening yet.  (Click on chart twice to enlarge)

JP Morgan G-7 VIX

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-The Macro Trader is currently not short the EUR/USD  but that will change at some point.

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: The Euro Is Overvalued
URL: http://www.themacrotrader.com/2009/11/13/euro-is-overvalued/

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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/

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Since the start of our newsletter we have been using a relative strength table that looked at Fidelity Select Sector Funds to show what industry groups are leading and which groups are lagging.  The relative strength calculation is similar to the style used by Bill Oneil and IBD but is slightly shorter term in nature. We used the Fido Funds due the their price history and breadth of different groups.  Now that there are not only enough different industry group ETF’s, but also the needed price history we have revamped the model to use ETF’s instead.

We publish one list for United States industry groups and one that is focused on global ETF’s with several country and a few sector specific ETF’s.  These tables are valuable in a few ways.  One is that we have developed a trading model based upon them that uses the rankings along with buy, sell, and money management rules.  Over time this model has beaten the market with far less risk.  The other way that these tables are useful is that they show you what is strong and what is weak.

While this concept is not rocket science we are consistently surprised how little attention it is given by other traders.  By using relative strength we can see what is really working and where investors are going.  Many times the supposed “hot sector” is not really that hot.  By looking at the tables we can see what is really working and what is not.  For instance looking at the Global RS Ranking table below you can see the leaders and the laggards.  While it is no surprise that Brazil is at the top when was the last time you saw someone on CNBC telling you to buy Indonesia or Turkey?  Yeah we missed that segment as well. (click on table twice to enlarge)

Global RS Rankings

Right now this table is confirming to us that for the most part developed nations are weak and should be sold and that emerging markets are strong and should be bought.  No, this is not the first or the only tool that told us this same thing but it is one way in which we can systematically be long the best areas of the world and short the worst areas of the world.  It also gives us a road map of where investors are putting their money and where they are withdrawing it.

Another point worth noting is that while we are starting to run this as a “standalone system,” the system represents only a part of our portfolio.  In our trading and our newsletter model portfolio we use several different methods in order to build a less correlated portfolio trading across asset classes.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are long EWZ-Brazil, EWT-Taiwan, and EWM-Malaysia

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: Macro Trading Using Relative Stength
URL: http://www.themacrotrader.com/2009/11/10/macro-trading-relative-strength/

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A lot is made of relative returns and how one strategy or fund does against the SP500.  While not the best benchmark for something like Global Macro it is nonetheless the benchmark that everyone is most familiar with and that is used the most on CNBC and in magazines.  So how does global macro stack up to the SP500?

The chart below shows how $1000 invested in the SP500 and the Barclays Global Macro Index would have done for YTD for 2009.  As you can see the SP500 while getting off to a rocky start is now leading the macro index by 9.68% so far.  While the performance of the SP500 has been impressive the other side of the story is that to get the 18.04% return in the SP500 you first had to go through a -19.56% drawdown in January and February to get it.  Contrast that to the Global Macro Index where you had a -2.06% drawdown and a 6.63% return YTD.  Yeah you are outperforming with the SP500 but the volatility has been huge. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 2009 YTD

Of course nine months is not usually the best representation of a strategy.  Going from 1997 to the end of September 2009, how has the SP500 done in absolute and relative terms?  Since 1997 the SP500 has given a total return of 42.70% and a CAGR of 3.07%.  The Global Macro Index on the other hand has delivered a total return of 237.91% in the same time and a CAGR of 10.92%.  Looking at the chart below you can see that while the SP500 has periods of serious out performance, over time it has lagged in a big way. (click on chart to enlarge)

Barclays Global Macro Index vs SP500 1997-September 2009

Not only has the SP500 lagged in total return but when looking at the risk taken to achieve the anemic 42.7% you really have to step back and rethink a long only equity approach.  In fact if you have been in a SP500 index fund since 1997 we excuse you to go bang your head against the wall for a few minutes.  Once you are back look at the chart below of the drawdowns that you had to endure to get that awesome 42.7% total return.  Yes, you see two drawdowns over -45% each.  In 2002 we were down -46.28% and in early 2009 we were down -52.56%.  All this for a return that was not much better then sitting in T-Bills. (click on chart to enlarge)

SP500 Drawdown 1997-September 2009

Looking at the same chart for the Global Macro Index below we can see that the drawdowns are far lower and shorter in duration.  In fact the worst drawdown that we have seen so far is -6.42% in October 2008 and right now we are at new equity highs while the SP500 is still -31.78% below its highs.(click on chart to enlarge)

Barclays Global Macro Index Drawdown 1997-September 2009

Does this mean that everyone should go out and invest all their money in global macro and buy our weekly global macro newsletter?  No, on the first and yes on the latter.   All kidding aside what this does show is the fallacy of long only equity investing.  While being 100% invested in equities is great when they are moving higher you get absolutely crushed when things come crashing down.  In global macro you are not beholden to the possibility of equity risk premia but instead are able to look for the best risk to reward opportunities out there in any asset class.  This includes stocks, bonds, commodities, currencies, and more.  This flexibility to go where the best opportunities are enables the global macro investor to outperform not in any given year but in a full market cycle.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-We are a global macro research company and are therefore a bit biased in our investment views.

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: macro trading vs SP500 1997-September 2009
URL: http://www.themacrotrader.com/2009/10/07/macro-trading-vs-sp500-1997-september-2009

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In our last post we discussed how we at The Macro Trader think that risk is vastly under-priced.  We looked at several different volatility indexes as well as Bill Luby and VixandMore.com’s JunkDEX.  The JunkDEX shows how well stocks like AIG, FNM, C, CIT, and BAC are doing.  As you can see in our previous post “Volatility Indexes, Risk Appetite, Mispriced Risk, And Where We Think We Are Headed” the JunkDEX  has had a monster rally.  Usually this would signal at least a short term top as speculative fever burns out.   Obviously the rally was not done and we are up since then.

To more quantitatively show the huge run up in risky assets we went looking for some factor based indexes that would show the performance of “good” and “bad” companies.  In our search we came across some custom stock baskets from Goldman Sachs that use Edward Altman’s famous Z-score to separate stocks into strong and weak balance sheet indexes.

The Altman Z-score uses 5 financial ratios.  Altman took the 5 ratios and using statistical techniques was able to build the Z-score which predicts a companies probability of failure.  The higher the score the safer the business is and the lower the score the more danger there is of insolvency.

As was to be expected the performance between the weak and the strong balance sheet stocks has been drastic over the last 6-months.  As you can see in the chart below the low Z-score basket has vastly outperformed the high Z-score basket.  In fact the weak balance sheet basket has done almost twice as good as the strong balance sheet basket of stocks. (click on chart to enlarge)

Goldman Sachs SP500 Strong and Weak Balance Sheet Baskets 6-Months

While the result is not too surprising it is an example of bad investor behavior.  Academics as well as practitioners have found time and time again that safe low volatility stocks outperform risky volatile stocks over a full market cycle.  In fact if you look at the chart below you can see how the roles between the strong and the weak balance sheet baskets are totally reversed.  The strong balance sheet stocks are positive for the last five years while the weak balance sheet stocks are still very negative.  Another thing to notice is that the junk stocks went down a lot faster and more consistently then the quality stocks when the market tanked over the last two years. (click on chart to enlarge)

Goldman Sachs SP500 Strong and Weak Balance Sheet Baskets 5-Years

So what are we to take from all of this?  We think that the market is far too speculative given the current economic backdrop.  Earnings while “better then expected” are at record lows, unemployment is at highs not seen since the depression, we are experiencing deflation for the first time in several decades, the consumer is retrenching and not consuming, and really the only true “green shoot” was that it is not yet the end of the world.

Yes, we can go higher from here but the odds do not favor being heavily long right now.  Our basic forecast at The Macro Trader is that in the not too distant future we will have a correction if not worse and we will be able to buy stocks at a better price then where they are currently sitting.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In The Macro Trader newsletter we are short some QQQQ-NASDAQ 100 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: Is Risk Dead? Or Is This A Bear Market Junk Rally?
URL: http://www.themacrotrader.com/2009/09/11/is-risk-dead-global-macro-trader/

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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

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