Gold Is A Currency Trade

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.



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,

Disclaimer-We are long GLD

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Did China Buy Too Much Copper?

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)



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,

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

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Title: Did China Buy Too Much Copper

Give Me Fuel Give Me Fire

Gimme fuel, gimme fire, gimme that which I desire,

Can’t fight the need for speed,

I’m loose, I’m clean, I’m burning lean and mean, and mean.

Ignite the open trail,

Excite, exhale, comin on, hot from hell, yeah hot from hell.

-Metallica “Fuel for Fire”

Where has all of the money gone? We know that the world should be running out of green ink any day now due to the Treasury printing money 24/7, but with all of this money coming into the economy we would have expected runaway inflation.  Up to now we have seen, for the first time in decades, steady deflation.  In fact as you can see in the chart below, since 3/1/09 YoY CPI has been negative. (click on chart to enlarge)

CPI 12-Month % Change


One reason why we have not seen any inflation is due to the personal savings rate going up and private sector leverage going down.  For baby boomers and really anyone who has been investing for the last 15 years, things are looking bad.  From 1995 to now, investors using a 70/30 stock bond mix, rebalanced monthly and adjusted for inflation, have seen a CAGR of only 3.89%.  Add to that the debt loads that most people have, and it makes sense that the personal savings rate has shot higher and from all estimates looks to be going higher still. (click on chart to enlarge)

Personal Savings Rate


So the question remains where has all the money gone?  Looking at the  WSBASE which defined by the St Louis Fed as the sum of currency in circulation, reserve balances with the Federal Reserve Banks, and service-related adjustments to compensate for float-it is obvious that overall money supply has absolutely exploded to the upside. (click on chart to enlarge)



So where has all of this money gone if not into the general economy? In a relationship first pointed out by Andy Kessler, the WSBASE has tracked tradeable assets like the SP500 and corporate bonds since the March bottom.  If you look at the two charts below you can see that movement in the WSBASE has led the SP500 and Dow Jones Corporate Bond Index by about a month. (click on charts to enlarge)

SP500 and WSBASE




When no one else wanted to own assets the Fed stepped in and became the buyer of corporate assets and has been the fuel that has driven this market higher.  In a vacuum this is not a bad thing, but we are not in a vacuum.  With the government putting all of the money into tradeable assets and not into the real economy, we end up with a market that could go down in flames at any moment.  What happens if the Fed backs away and stops buying?  If they stop buying, we run the risk of everything falling again and taking us right back to where we were.

The Fed in their infinite wisdom and bubble loving culture, continues to trade one bubble for another.  This time however, it appears as thought the bubble has not only been engineered by the Fed, but they have been the driving force behind it all.  As opposed to the housing bubble–where the Fed lowered rates and left them low but allowed people to build the bubble with their stupid home buying–this time the Fed lowered the rates, borrowed the money, and is spending the money.  Unfortunately for us when the bubble pops “the money” is really our money, and we come out on the losing end….again.

Happy Trading,

Disclaimer-In our weekly newsletter The Macro Trader we are long SPY, LQD, HYG, DBV, and UDN

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: Give Me Fuel Give Me Fire

Debt Deflation and the Japanese Yen

In our last post we discussed our views on deflation and how it will  be around  longer then most investors think.  Most people are stuck on the idea that hyper inflation is just around the corner and that you must be buying gold, most other commodities, and Asian stocks and at the same time short the US Dollar, Japanese Yen, US Treasuries, and US stocks.  Eventually this may be the right stance, but for now we think, along with the market, that it is the wrong view for the short and medium term.

The main issue stems from the idea that because the government has printed a gazillion dollars that we MUST have hyper inflation tomorrow.  The reality is that until that money is actually in circulation it will not cause inflation.  If you look at the financial situation of most banks it is obvious that not only are they not lending, but they are still so weak that they can’t lend.  Until they have rebuilt their balance sheets they will remain weak and unable to do any large scale lending on anything but bad terms.

Add to this the fact that consumers are saving more and more and you have massive debt deflation.  Consumers that are employed are paying down debt while the unemployed are unable to go into much more debt as credit card companies have curtailed their lending and the housing ATM is shut down.

As the global financial markets continue to deflate we have a few trends that are benefiting from this.  One that we have already covered is that of going long US Treasury bonds.  Another trend that we have shared with our subscribers is that of going long the Japanese Yen.  Long viewed as the funding currency for the carry trade , over the past 18 months the Yen has changed course and is now a safe haven currency.  Every time that investors have fled risky assets such as stocks and corporate debt then have flocked to the Yen.  As investors increasingly realize that the current threat is continued deflation and not inflation we think that they will gravitate out of stocks and into Treasury bonds and the Yen.

In the chart below (click to enlarge) you can see that since 1998 the Yen had been consolidating until breaking out back in March of 2008 as the financial crisis accelerated with the demise of Bear Stearns.  This breakout later pulled back before breaking out again and making a large move lower.

Japanese Yen 15-Year Weekly


As you can see in this chart (click to enlarge) the last two pullbacks have found support at the 50% retracement levels.  While we don’t think that Fibonacci levels have some mystical power, we do use them to find opportunities to buy pullbacks in a trend.

Japanese Yen 3-Year Weekly With Retracements


Finally as you can see in this daily chart of the last year (click to enlarge) you can see that we finally have broken out of an almost year long consolidation.  While not a perfect triangle it obviously contracted more and more until finally breaking out over the last few days.

Japanese Yen 1-Year Daily Chart


Looking at the 15-year long term chart of the Yen we are expecting a move up to 114 and would not be surprised to see it make new highs at 120 in the coming months (If you are looking at the USD/JPY cross the levels would be 88 and 80).  Although anyone who is a macro trader is no doubt aware of this move we have found that most equity investors skip over currencies and fixed income themes, thinking that they have nothing to do with them.  The reality is that the currency and fixed income markets can give great signals for when risk is high or low and should be followed by all investors.

Happy Trading,

The Macro Trader

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: Debt Deflation and the Japanese Yen

Deflation And What We Are Doing About It

We decided that it was worth sharing our views of the inflation/deflation debate with all of our readers. In our weekly newsletter we are already positioned to take advantage of some of the current as well as potential trends that will benefit from our scenario.

The following are our views on different parts of the puzzle that show that we are currently in, and will likely be experiencing deflation for longer then most people seem to think.


Here are some interesting, and unfortunately not surprising, savings rate numbers. The current savings rate is 5.7%, the all time high in 5/1/75 was 14.6%, the all time low was in 8/1/05 with a savings rate of -2.7%, the historical average is 6.8%, and the 10-Year average is 1.7%. As you can see in the chart the past year has seen a huge uptick in the savings rate as consumers are trying to pay off debt and save some money.

Personal Saving Rate


Of course as savings go up spending goes down. While this is good for the individual household it is a negative for the overall economy as it means less money is being spent on items from housing to cars to clothes. While this could just be an abnormal blip in the scheme of things there are

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several reasons to think that this time the trend will hold for a while.

Baby boomers as a group don’t have anywhere near the funds to retire. After 2008 wiped out 42% of the worlds wealth they should be scared and saving for their rapidly approaching retirements. Once the economy starts to pick up they may very well start spending like it was 1999 again but we don’t think that they will because while most people are ok with the idea of working a bit past the age of 65, they do not plan on working into their 80’s and 90’s.

If the savings rate gets back up to the historical average of 6.8% or higher and then stays there for a while, it will be a huge drag on the economy. As consumers buy less and less, pricing will likely come down. We are already seeing this in the form of huge sales in stores across the nation. Many retailers have already had several markdown sales and it is safe to assume that this trend will continue for at least the next year or so. If our projections are right and the savings rate gets back to “normal” we will likely see a re-pricing as most businesses just accept that fact that their profit margins will be smaller going forward.


The monthly proclamations of a bottom by the NAR notwithstanding we have yet to see anything resembling a bottom in real estate. The Case Shiller 10-City index is down 33% from its peak and the 20-City index is down 32%. Both charts look the same, which is to say each month is lower then the last month. So far there has been no bottom.

Case Shiller 10-City Index


Not surprisingly housing sales numbers don’t look much better. In spite of the monthly bottom calling we continue to see more new lows every few months. As you can see in the chart below we are just off of new all time lows since the data series started in 1963.

SA Housing Sales


Zooming in a bit you can see that while we have had several blips over the last few years none of them have lasted for more then a few months and all have led to new lows. Our best guess is that we are headed lower in the next few months.

SA Housing Sales-A Closer Look


As if residential housing was not enough, the commercial real estate market is playing catch up. Residential peaked in June 2006 and commercial held up until October of 2007. Since October of last year however commercial has made a valiant effort to catch up and is now down -29.48% since then. In fact from March to April alone it dropped -8.62%. If real estate has found at bottom it is keeping its location secret because none of the data that we have seen points to it.

Moody’s REAL Commercial Property Price Index Composite(CPPI)


Of course you may be thinking that there has to be some commercial real estate that has found a bottom. This may be the case on a geographic basis but it is definitely not the case when it comes to segments of the commercial market. As you can see in the chart below industrial is the strongest part of the market and yet it is still down -14.26% from its highs. Apartments are next being down -19.01%, followed by retail which is down -23.11%, and finally office space which is down a whopping -30.22%. Judging by the massive drop this last quarter it is safe to assume that we have a ways to go before we really hit the bottom.

Moody’s REAL Commercial Property Price Indices


In case you haven’t noticed employment has been horrible and getting worse. One of the newest “in indicators” is the exhaustion rate. While this indicator is not new it has luckily not garnered much attention over the years because it only gives a real signal once or twice a decade. The exhaustion rate is the rate at which people come off, or exhaust, their unemployment benefits without having securing a job. Why is this the “it indicator” right now? Well if you look at the chart below you can see that we are not only at all time highs but are actually at 49.23%. Yes, that means that almost half of the unemployed are done receiving unemployment money. That of course leads to even less money to spend on anything.

Exhaustion Rate


After looking at the exhaustion rate chart it should come as now surprise that unemployment is high. In fact it is at its second highest level ever at 9.4%. As bad as unemployment is right now, it is going to get worse before it gets better. We will likely hit at least 11% ,and we would not be surprised to see 12-14% unemployment before jobs data bottoms out.

Unemployment Rate


At this point it should not be much of a surprise but as you can see in the chart below, average weekly hours and non farm payrolls data are also both declining on a year over year basis.

Average Weekly Hours and Non Farm Payrolls


So how does all of this effect deflation? If people are not working then they are not able to spend as much on consumer goods and services. That includes clothing, food, entertainment, transportation, etc. If they stay unemployed long enough and fall off of their unemployment benefits then they are able to spend even less. Along with the lack of, or at least severely impaired, spending power there is a host of other side effects, which includes everything from defaulting on credit cards to defaulting on their mortgages. As consumers spend less, businesses have to lay off more employees as sales drop off and margins are squeezed with exacerbates the situation. One consistent relationship is that of the unemployment rate and capacity utilization. As unemployment rises, capacity utilization drops as demand falls out.

Unemployment and Capacity Utilization (inverted)


If there is no demand then there is no spending. If no one is spending then there can be no inflation. If things are contracting then we are in deflation. One more indicator that shows this is that of the output gap. The output gap is the difference between the amount that we can produce and the amount that we are currently producing. In the chart below a positive number indicates under-utilization, and negative numbers reflect over-utilization. If the line is rising things are getting worse and if it is declining things are improving. As you can see the line has risen quite a bit and at least for now is showing no signs of turning around. The output gap is a good indication of available demand. As you can see. the output gap is bad and getting worse as demand continues to decline.

5-Year Output Gap


While we could go on and on about banking we will try and keep it short. Most people are pointing to the charts from the Fed on bank reserves and saying that they will cause hyper inflation. Yes, the monetary base is at historic highs but guess what? Until that money is actually in circulation it does not cause inflation. You can print ten quadrillion dollars but if you bury it in a hole then it does not cause inflation.

Look at the chart below of the Adjusted Reserves. As you can see it is at record high levels. While it is extremely high it is not in circulation yet and likely will not make it to consumers for some time.

Adjusted Reserves


This number is extremely high due to all of the money that has been printed over the past year in response to the financial crisis. But the inflationistas are missing one important point, namely that until banks have rebuilt their reserves they will not be lending. As long as residential and commercial mortgage defaults continue banks will continue to rebuild their balance sheets. Once they have a stable asset base they will start lending and we will likely see some really high inflation but until then we will be in a deflationary environment as the money is not being put into circulation.


Commodities are another reason that many use to justify their inflation arguments. After having a good bull market from the end of 2002 until fall of 2007, they took off and got a bit parabolic for the first half of 2008 before crashing and coming back to levels not seen since 2002. Of course as anyone who has filled up their gas tank knows, commodities have started to climb once again moving from 200 up to 250 from the March lows.

Commodity Research Bureau Index


The rise has been widespread with energy, base metals, agriculturals, and even precious metals rising considerably. Aside from precious metals it appears as though the primary reason that we had such a strong rebound was due to buying out of China. In the first two quarters of the year the Chinese government decided to use some of their surplus to buy raw materials. They bought a lot of copper, secured oil contracts, and stocked up on everything else. Now it appears as though their buying is slowing to a trickle of what it was and with the run up in prices they are taking a break as they will likely get to buy more at lower levels.

While the buying out of China may help commodities put in a bottom, it does not appear as though it will drive them much higher. With the possible exceptions of precious metals and energy we see most commodities turning in flat to slightly negative results for the rest of the year. With the demand destruction that we have seen over the past year commodities have a tough road ahead of them before they will be able to climb higher.


So where does all this leave us? Demand has been absolutely crushed on several fronts: People are finally saving and paying down debt instead of spending. Real estate is still falling, and with inventories as high as they are, will likely not fully recover for years. Employment is as bad as at any time in the Post WW2 era. Banks are still impaired and unable/scared to lend. And with all this demand destruction commodities are unlikely to continue upwards for a while.

Finally there is the matter that while we can speculate on inflation we are currently in deflation as can be seen in the chart below of the CPI. We have officially been in deflation for the last three months and while it might slowdown a bit we will likely stay in a deflationary environment for longer then most people think.

CPI-YoY % Change 1922-Now


What are we doing?

So if we believe that we are in deflation what do we do about it? The best deflation trade that we have found is to be long bonds. As we stated in our last blog post as well as the last few newsletter we are long TLT-20+ Year Treasury Bond ETF. Not only are we in deflation but the trade was decent on its own merits.

Real yields on Treasury bonds at the end of May were at their highest levels since February 1995 and right now they are at 4.76% for the 10-Year and 5.58% for the 30-Year. In an environment where we expect most assets to fall or go nowhere, we think that Treasury Bonds offer good value.

10-Year Treasury Bond Real Yield


Treasury bonds got almost as oversold recently as they were overbought back at the end of 2008. By normalizing the trend using a 200-day moving average we build reversion to the mean charts that show how far above or below securities are from their mean. In the case of the long bond our charts showed that it was extremely oversold and that it was a good time to start building a position.

TYX-30-Year Treasury Bond Yield Reversion to the Mean Chart


Looking at the chart of the TLT we could see it running up into the 100-105 range over the next month or two as investors take advantage of deflation, the oversold conditions, and the favorable real yield.

TLT 20+ Year Treasury ETF


While the long bond is definitely our favorite deflation trade, it also makes some sense to go long the US Dollar and/or the Japanese Yen as investors flock towards safety. Other trades would be to short stocks and short commodities in anticipation of them falling as demand continues to decline and margins shrink.

And what about inflation? We actually do believe that eventually all of this printed money will lead to some hefty inflation but right now we are in deflation. Additionally the inflation trade is the most overcrowded and one sided trade in the financial markets right now. If we are right we will do well, and with the aid of risk management if we are wrong we will be stopped out for a small loss.

Happy Trading,

The Macro Trader

Disclaimer-We currently hold positions in TLT

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: Deflation And What We Are Doing About It