The Bubble Pops In Silver

05/08/2010 - 05/08/2011

The chart above is a chart for ishares Silver Trust compard to the S&P GSCI (Goldman Sachs Commodity Index) for the past year.  The ishares Silver Trust closely follows the movements of silver while the S&P GSCI serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time.  In this chart, the ishares Silver Trust is the black line and the blue line is the S&P GSCI. As you can see, ishares Silver Trust is still up 90% even after last week’s 70% decline, while the S&P GSCI is still up 20% after declining about 10%.  At this time we believe that commodities, especially Silver have a ways to go before getting back to more reasonable levels.  There will probably be buyers on dips, but I wouldn’t be surprised to see Silver go towards $25 as speculative positions are reduced further.  The next major support level for Silver now comes in around $26, with immediate support being at $34.  Considering Silver led the way down on last week’s commodity sell off, we think that silver is the “canary in the coal mine” for commodity movements and will be keeping our eye on it. Given that QE2 ends next month, we believe that commodities and stocks will sell off and then consolidate in the weeks ahead.

AUD/USD and Copper Breakdown

Febuary 15th,2011 - Present

Back in February 15,2011 when Copper peaked at $4.64, AUD/USD was at parity or 1.0. Between February 15 and May 2nd Copper declined 10% to 4.1 while AUD/USD rallied 10% to 1.10. Since May 02,  Copper has continued to decline by another 5.26% while AUD/USD has declined 3%. Based on these movements and calculations, it means there is still a 13%  spread between these two assets.  So either copper is undervalued by 13% or AUD/USD is overvalued by 13%. Given that commodities took a big hit last week,  we believe that it is AUD that is overvalued and will continue to sell off. A 13% decline for AUD/USD at the current level of 1.0700 means it would have to decline to  about .9400 before the spread was closed. The only major support for AUD/USD comes in at .9700, with short term support at 1.0450.

We will post updates about this as the market progresses in the weeks ahead.

FXIB 2011 First Quarter Review and Market Outlook

Foreign Exchange Market

Since the start of the year, the US dollar has weakened considerably against the other major currencies with the Dollar Index declining from 80.85 to 76.84. The US Dollar performed the worst against the Euro, losing 6.56%.  The US Dollar also lost 4.03% to the British Pound, while losing 1.02% to the Swiss Franc,. The US Dollar  lost 2.14% to the Australian Dollar, and it  lost 3.08% to the Canadian Dollar respectively. The only major currency the US Dollar ended the first quarter stronger against was the Japanese Yen which the USD gained 2.84%.  We believe the primary reason for the US Dollar decline this quarter can be largely attributed to QE2 program which is injecting $3.4 billion excess dollars every business day into the market. In turn, these funds are then seeking out high yield or “risk assets” in foreign countries which drives the US Dollar lower. As of late, some of the most popular risk assets have been in Europe and Australia. We believe on fundamental level  the Euro is severely overvalued considering that Ireland is still experiencing problems with their banking system and certain European countries  interest rates spread (compared to German Bunds) continue to increase.  A report was released last week that showed some Irish Banks require a total of $20 billion more  in capital, which would bring the total amount to about $57 billion. The Irish government is in the process of shoring up its banking system with assistance from the ECB. Over the last month, we have been hearing more hawkish comments from the ECB about inflation and interest rate hikes.  The ECB  tends to pays more attention to headline inflation rather then core inflation.  We feel that this is the wrong time for the ECB to be raising interest rates as it can compound Europe’s problems further due to the problems not being fully resolved at this time. Regardless, the market seems to be enjoying the more hawkish talk from the ECB by driving the Euro higher to a recent high of 1.4247 . We believe that the Euro is setting up a classic “buy the rumor, sell the fact” in regards to a ECB rate hike. There is no guarantee the ECB will hike rates and we believe cooler heads will prevail.   As for the Australian Dollar, recent estimates show that the Australian dollar is overvalued by 30% on a PPP adjusted basis. The rise of the Australian Dollar has been very impressive considering all the bad weather over this quarter from excessive flooding, earthquake to a typhoon. The Australia government and RBA is predicting that the damage from the flooding will cost the economy $9billion and that in all the natural disasters will cut about .5% in GDP growth.  Considering that Australia expanded 0.70 percent in the fourth quarter of 2010 over the previous quarter, we feel a .5% decline in GDP growth could push Australia into a recession. If this was to occur, we believe the RBA would  lower interest rates and consequently weaken the Australian Dollar.  It is interesting to note that the odds of an Australian rate cut now higher than a UK rate hike, with odds of a rate cut around 34% while previous odds were at 5%. Another currency pair that we are closely keeping an eye on is the Swiss Franc. Even though it ended the first quarter virtually unchanged against the USD,  it seems that there is no limit to how far the Swiss Franc can strengthen. During the quarter, the Swiss franc strengthened as much as 4.63% to a new record low of .8907 but ended the quarter at .9188. The SNB has recently been commenting that the “strong Swiss franc and the weak global economy are urging the central bank to continue to stick to its cautious monetary policy”.  We believe the primary driver behind the rise of the Swiss Franc over the past year is that the Swiss Franc is now viewed as a safe haven in a environment of European sovereign debt crisis and a uneven global recovery. The strong Swiss Franc is helping keep inflation under control but is negatively affecting Swiss exporters.  The SNB believes that a strong global recovery and resolving Europe’s sovereign debt problem will make the Franc weaken and we are inclined to agree with them.

Commodities

Commodities saw their third consecutive quarterly gain as geopolitical risks stemming from unrest in North Africa and the Middle East drove energy prices higher. We also saw some unfortunate natural disasters strike the Asia-Pacific region in which commodity production will be reduced. In this process, all of the three major commodity indices outperformed the MSCI World stock index, which returned 4.3% for the quarter. Strongest was the S&P GSCI, with its heavy exposure to the energy sector, returning 11.6% while the DJ UBS, with its broader approach, returned 4.4%. In the middle we find the Reuters Jefferies CRB index coming in at 8% for the quarter. Gold finished slightly higher gaining .98%,  the tenth quarterly rise in a row and  the longest winning streak in more than three decades.  Resistance is currently firm towards 1,450 as investors have been scaling back positions ahead of the possible cessation of quantitative easing in the U.S. and a return to normalized interest rates. This reduces the competitiveness of gold and silver being non interest bearing assets. Cotton, a market with rising demand from Asia and problematic supplies, was the big winner in the commodity arena posting gains of 38% for the first quarter. This is after coming off 2010, a year that saw cotton prices skyrocket by 90%. This  market has rallied by more than 400% since 2008. Grain markets wound up with mixed results for the first quarter: wheat was down 4% while corn was up 10% and soybeans gained 1%.

Looking Ahead at the Second Quarter

Higher commodity prices and a weaker US Dollar is a good recipe for inflation, so we do expect core inflation to increase this quarter. Based on comments from the FOMC members over the last few weeks,  we believe that the US Federal Reserve will end QE2 as planned in June of 2011.  By our estimate Bullard,  Fisher, Plosser, Lacker, and Kotcherlakota  have all advocated that the US Federal  Reserve start looking at an exit strategy, a “preemptive strike on inflation”. Some of the FOMC members have not only called for raising interest rates by end of 2011 but that the Federal Reserve also start draining excess liquidity from the market at the same time. We did get reports last week that the US Federal Reserve was testing its reverse repo liquidity drain facilities. The trouble that the US Federal Reserve now faces is when and how to start exiting from a very accommodating monetary policy without negatively affecting the US economy,  but before the US is saddled severe inflation.  On another positive note,  the US economy  added 429,000 jobs in the first quarter – which will allow the US to have a more sustainable recovery. Once QE2 ends:  we  believe that commodities, stocks and bonds will sell off while the US Dollar rallies.  We do not foresee another Quantitative Easing program unless the US economy takes a turn for the worse.

AUD/USD and Copper Correlation

For the past 20 years, the correlation between copper and the Australian Dollar has exceeded 70 percent. Over the past three years, the correlation has been as high as 93 percent. Although copper may not be one of Australia’s top commodity exports, it is still equivalent to more than AUD$5 billion of annual trade. The following chart shows the correlation between the AUD/USD and copper.  As you can see, in October of 2008 the Australian Dollar hit a new low of 0.6006 against the US dollar. Over the preceding years, the Australian Dollar rallied to record high of 1.02542 in December of 2010 and is currently at 1.0136.  This is a 70% rally  and consequently we believe that the Australian dollar is unsustainable at these levels.  At the same time, in December of 2008 Copper hit a all time low of 1.255  and in February of this year put in a new high of 4.6495 and is currently at 4.495. China is one of coppers biggest consumers, so the economic data that comes from China can significantly impact the movements of copper. China will need to start slowing down their economy to avoid overheating which could reduce the amount of copper China imports.  To capitalize on this correlation, I would look for divergences. Say for example  copper rallies, but the Australian Dollar sells off,  you could trade it by going long AUD/USD and/or shorting copper.   It is important to keep in mind that correlations can and do change over time, so what may have worked before may not necessarily work again. It is hard to say whether it is the price of copper that influences the Australian dollar or the Australian dollar that influences copper, all we can say for certain is that these two move in tandem due to Australia’s commodity based economy.

03/06/2011 Click-to-Enlarge

Gold Update for 01/18/2011

01/18/2011 Click-to-Enlarge

In our previous post “Is Gold the Canary in the Coal Mine” we talked about the commodity rally and how this year we could see commodities consolidate or sell off.  We also mentioned that immediate support came in at 1360 (which has largely held up over the last few  days). If bearish momentum on gold picks up,  the green 100 day Moving Average will be the next level of support. If that breaks we are expecting the next area of support to be down around 1322.  If that goes, then the next support comes in at the 200 day Moving Average.  As for topside resistance, gold has been unable to get above 1432 and consequently a triple top lies in that area.

FXIB Fourth Quarter and Yearly Review With 2011 Outlook

Foreign Exchange Market

Fourth Quarter Review
In our fourth quarter outlook we predicted that the market had overpriced in the US Federal Reserve Quantitative Easing program and that the US economic recovery would strengthen. The US economy did produce stronger growth this quarter and the US dollar did initially rally once the market knew what the Quantitative Easing program would consist of. Some important economic events we witnessed this quarter includes Ireland being bailed out by the EU, China hiking interest rates and reserve requirements, and commodities continuing to rally.

Yearly Review
The US dollar finished the year stronger against the Euro, at the start of 2010 the exchange rate traded around 1.43, and finishes the year at 1.3365. The primary driver for the US Dollar gaining against the Euro is the European Debt crisis making Euro denominated assets less appealing to investors.  The Yen also made significant gains against the US dollar  in which at the start of 2010 the exchange rate was at 92.50 and finishes the year at 81.00. This year saw the Yen at record levels against the major currency crosses. The  US dollar finished slightly stronger against the British Pound, in which the exchange rate started at 1.61 and finishes the year at 1.55. The following should come no surprise, but the Australian Dollar made significant gains against the US dollar, rallying from .90 to 1.0200. The Australian economy has been  strongly supported by this year’s rally in commodities and Chinese growth. The Swiss Franc finished stronger against the US Dollar due to its “safe haven” status amidst the European Debt crisis. The Swiss Franc started the year at 1.0300 and finishes at .9300. The US Dollar also finished weaker against the New Zealand Dollar, as the New Zealand Dollar rallied from .7250 to .7800.  Last but not least, the US Dollar fell against the Canadian Dollar as the exchange rate went from 1.0550 to finish the year at .9900. The reason for the US Dollar decline this year can be largely attributed to a slow recovery and the US Federal Reserves Quantitative Easing  program in which the market severely overpriced.

The 2010 Commodity Bubble
Commodities posted a record gain as adverse weather slashed global crops, debt woes in Europe boosted demand for precious metals as investment havens and China consumed more of everything from cotton to copper. The Thomson Reuters/Jefferies CRB Index of 19 raw materials jumped 29 percent in the last six months of 2010, the most since the gauge debuted in late 1956. Last month the gauge reached 333.67, the highest since Oct. 1, 2008. Cotton extended a rally to an all-time high, silver rose to a 30-year peak and coffee jumped to the highest since 1997. In 2010, commodity prices beat gains in stocks, bonds and the dollar as China led the recovery from the first global recession since World War II. Crops were ruined by Russia’s worst drought in at least a half century, flooding in Canada and parched fields in Kazakhstan, Europe and South America. Corn and soybeans recorded the biggest second-half increases in five decades. We at FXIB believe commodities are in a bubble and have been in a bubble since the third quarter of 2010. Recent economic reports from China are indicating that the Chinese economy is starting to slow down and this should start to take the steam out of commodities. We at FXIB are expecting the commodity bubble to deflate in the first half of 2011 as market prices become more aligned with fundamentals. The US economy has not recovered to pre-2008 levels but yet commodity prices set new record highs that exceeded 2008 levels.

Looking Ahead at the First Quarter and  2011

We have identified 11 potential risks for 2011 that we will be keeping an eye on:

Potential US Dollar pluses:

1. European sovereign debt crisis intensifies, driving European yields higher.
   
2. European Central Bank drops vow to remove stimulus; adds liquidity instead.
3. UK adds to Quantitative Easing to offset economic drag of fiscal austerity.
4. Chinese property bubble bursts.
5. US yields rise as US economic recovery gains strength.
6. US adopts comprehensive long-term fiscal program modeled after Simpson-Bowles Commission recommendations
7. USD retains and builds on reserve currency status as central banks shun euro and reduce existing holdings.
8. Geopolitical uncertainty in Iran, Korean Peninsula revive USD safe-haven status.
9. Bank of Japan, Bank of England, and European Central Bank embark on expansive new monetary easing, including Quantitative Easing.
   
10. Bank of Japan joins Asian neighbors in actively managing the JPY FX rate
11. Commodities bubble bursts as fear of dollar collapse abates.

Potential US Dollar Minuses

1. US and Japan join global sovereign debt crisis; gold and other metals benefit
2. US yields fall as US economic recovery flags; deflation fears revive
3. UK economy rebounds despite austerity; Bank of England raises rates to contain inflation
4. US yields soar as government fails to get a handle on fiscal policy and market loses confidence
5. Risk appetites rise, fueled by a rush of global central bank liquidity sending metals, agricultural products and energy sharply higher
6. Emerging markets continue to grow steadily, drawing capital from developed markets
7. JPY resumes climb versus USD and Asian currencies as Japan keep money at home rather than seek higher returns abroad
8. European sovereign debt crisis abates; banks replenish capital
9. China engineers a soft landing, restraining inflation without damaging asset markets
10. India overtakes China, becomes the market focus in emerging markets
11. Euro regains market confidence, dollar’s share of reserves declines

Is Gold the Canary in the Coal Mine?

Click-to-Enlarge (01/05/2011)

For most of 2010 commodities  rallied to new highs, most notably Gold.  Since the start of the new year commodities have been selling off, whether this is a just a blip or the start of a new trend it is hard to say.  Regardless, Gold failed to break through the triple top at $1,430 and immediate support is now found at $1,360, with further support at $1,315.  If $1,315 breaks there is no support till the 100 day moving average (blue line) currently at $1,277. What is important is yesterday Gold broke through a bullish trend line that has been in place since late July.

Gold Hits Record High at $1,410 a Troy Ounce

11/08/10 Click to Enlarge

Earlier today gold hit a record high of $1,410 a troy ounce due to investors fears about Europe debt crisis and the US Federal Reserve printing $75 billion dollars more a month to monetize Government debt.  At this same time last year on November 8, 2009 gold was trading around $1,100. Thats a 37% increase year over year. As long as the Federal Reserve continues to print money and investors remain fearful about the global economic recovery, gold will probably keep going up.  Any sell offs should find support down around $1,315 and could be a place to pick it up and go long again.

Is USD/CHF the Canary in the Coal Mine?

10/26/10 - Click to Enlarge

For the past few weeks we have been expecting the dollar to rally and today we finally got another confirmation that the US dollar could finally be turning the corner.  USD/CHF  closed above the bearish trend line that has been in place since early June and consequently we think that the dollar could extend gains against the major currencies.  For the dollar to extend its gains, we would like to see Gold go below $1,300 an oz. Gold is currently trading at $1,335 well off its all time record high at $1,387. We have been keeping an eye on Federal Reserve statements and at this time we believe that at least 3 of the 5 voting members for next month FMOC meeting are hesitant about more QE. We are expecting QE around $500 billion,  the market has priced in a QE program of around $1 trillion so anything that is less then $1 trillion in QE should support the US dollar.  And of course, if the Fed doesn’t do any QE next week then the US dollar will rally.  At FXIB we believe that more QE is pointless and will have minimal impact on the recovery due to bond yields being near record lows. More QE will only create higher inflation as the economy recovers.  In regards to US bonds, bond yields have finally broken out of their bearish trend line. The  stronger yields have been supportive of the US dollar today, and is another confirmation that the US dollar could extend recent gains.

For the rest of this week we are looking for the dollar to continuing rallying against the Swiss Franc, Euro and commodity currencies.

TBT Update

 

10/18/10 - Click to Enlarge

10/18/10 – Click to Enlarge

 

On September 17th I wrote about going long TBT (ProShares UltraShort 20+ Year Treasury).  Here is an updated analysis of the TBT trade.   TBT broke above the bearish downtrend, which we were looking for and stayed above it for more than a month now.  Since breaking the trend line it has moved in a sideways pattern recently double topping at 34.43.  With the outlook of the fed’s quantitative easing coming more into play it will push treasury yields lower and subsequently TBT as well.
How to Play:
I am of the mindset that the QE2 program will be less than expected and that investors are tired of picking up 2.3% yields on 10 years.  Money will begin to flow out of treasuries like it has the last couple of weeks and move into emerging market currencies and bonds.  As a result of this changing  money flow, I would look to buy  dips toward the bottom of the sideways trend around 30.55 and selling at the top of the range 34.  A break above the top would be a very bullish sign for TBT and a possibility to increase long positions.  As with all trades that have major news announcements, (Fed’s quantitative easing) keep positions light until after the dust has settled, then look to rebuild.