Trades for next week

Date in	Product	Product	Avg Price	Exposure (notional)	Target	Stop
4/8/2009	EURGBP	FX	0.89625	60,000	0.930	0.885
4/8/2009	USDJPY	FX	99.82675	(200,000)	96.500	100.000
4/8/2009	Long Heating Oil Cracks	Commodity	7.77	10,000	16.000	6.000
4/8/2009	GCM9	Commodity	883.15	100,000	924.000	870.000
4/8/2009	Long 10yr (short rates)	FI	2.89	(75,000)	2.650	2.890
4/8/2009	Long HYG	Credit	70.43	75,000	80.000	70.000
4/13/2009	CL $48 call	Commodity	2.5	2,500	4.000	-
4/13/2009	Short HGM9 Comdty	Commodity	214	(10,000)	130.000	230.000
4/13/2009	Long USDCAD	FX	1.22	75,000	1.260	1.205
4/13/2009	XLF April $10 put	Equity	0.15	1,000	0.300	-
4/13/2009	ESM9	Equity	859	(100,000)	680.000	868.000
4/13/2009	Long USDBRL	EM	2.17875	200,000	2.310	2.126
4/13/2009	Short soymeal	Commodity	308	(50,000)	280.000	322.000
4/14/2009	Short DXY	FX	84.72	(100,000)	83.750	85.500

 

Thoughts for next week

FX:
The move in Gold and long bond are at the forefront of my view. The dollar bear camp is very quickly accumulating ammunition. The move higher in CL has not helped either. Add to this, the location of EURUSD at the 1.29 level, near where it stopped in November and you have a dangerous scenario for USD. With a confirmatory close above 1.3387 I would look to get long EURUSD. This being said, if we break the 1.23 Oct 08 low, which MS is looking for, we should see another leg down to the Nov 05 low of 1.16. This would make Gold and Oil significantly vulnerable, should they not follow EUR to these levels. I think this scenario is less likely in the short term though.

Getting long EURCHF seems to be the best trade out there right now. Given the Cbank’s very strong comments,

“With short-term interest rates practically at zero, the national bank can not counter a renewed appreciation of the CHF with a rate cut. If needed, other instruments would have to be used to prevent a renewed appreciation of the franc or even trigger a depreciation … In general, a central bank can always increase the absolute amount of its own currency in circulation. The national bank could sell CHF against 1other currencies without limits. In an extreme case, it could commit itself to buying foreign currencies at a fixed rate,”

and the rally off the October lows gives me confidence in this scenario. Adding my conviction, is the extreme amount of length in CHF that must be unwound, and the potential pivot in EURUSD outlined above.

Commodities:

Natural gas:

Fundamentals:

Figure 1 - Production still sharply up YoY! When will shut-ins begin?

Weather has generated 80 bcf of incremental demand in USA since the start of the year. Despite this, inventories are very high, due to incredibly weak IP. This winter’s draws have been 4.4 bcf/d weaker than a year ago. As weather demand softens, this should become more apparent to the market, and we will edge towards shut-in mode.

According to GS, $5 natural gas is where fuel substitution starts away from other sources of energy comes into play. Still, it will have to remain below these levels (without a subsequent fall in resid) for this to impact the market. GS estimates this switch could consume 1.5 bcf/d. Switching from coal, should price relationships remain in place, should take an additional 1.3 bcf/d out of the market by this summer.

Figure 2 - Cheap versus resid, but not so cheap vs coal yet

Trade ideas – bearish positioning for front end of the curve and look for a steepening towards the back (long dec 10 vs short dec 9). Also flattening at front (outright short dec 9) and further cash market weakness should persist.

Metals:
The mexican standoff

Copper vol has eased dramatically to 38, despite realized vol of 53 (also dropping). We would be selective buyers of puts. Aluminium exhibits similar characteristics with implied vol at 28 and realized at 36. Very few of these producers have cut yet, and we are entering “mexican standoff” mode. These markets are dramatically different from the crude oil market, which is dominated by a cartel. In these highly fragmented markets (especially ali) we enter a classic game of “chicken”. We expect prices to have to drop substantially below analyst estimates before production cuts occur. Essentially they would have to drop to levels where at least one major producer would be forced to declare bankruptcy. This scenario has not been the case for Zinc, and we would remain bullish here.

In copper we would be wary of a break above the Jan highs of 1.57, and would have a hard stop at this level. Technically I would like the market to test the channel highs of 1.48 before I became significantly short, however I would remain bearish at 1.45.

Ag’s:

Long-term bullish. Short-term…eh?
We like wheat longer-term, however we would look for dips to become a buyer.

Figure 3 - Wheat vs EURUSD

$6.65 is the 2009 USA break-even wheat price. We think credit market and EM weakness will create supply issues that are likely propel the market higher. However, we would not be buyers due to our short equities / long volatility / short USD bias. We will look for prices to approach their 600 support levels before buying, and at those levels we would maintain a 5.5 stop. Wheat inventories remain low.

We would look to own wheat over corn and corn over soybeans, due to our view on demand fundamentals. We think a shift away from animal protein in Asia and EM is overdue.

Oil:

Technically bullish, fundamentally bearish. The move in EURUSD discussed above will likely propel oil next week. Last week’s price action was fairly interesting. Despite an extremely bearish inventories number (6.1 vs 1.4), WTI climbed dramatically WoW to finish close to the highs. A break above 50 would be bullish for WTI.

We continue to like the front-end flattening and back-end steepening trades. I will be back with a further analysis of these trades later this week.

Good luck!

I'm back

It has been a while since I posted last. Unfortunately, due to my position I was not able to post public commentary. However, I am pleased to announce that I am once again able to maintain this blog. Posting will be sporadic per usual, but should be weekly at a minimum. Please feel free to post comments, especially if you think I'm wrong (which is often the case).
Good luck!
EC

Short Silver

Commodity de-levering theme. Silver appears especially vulnerable.
At this point my portfolio appears increasingly vulnerable to a large drop in the dollar, so will be looking at some hedging options later this afternoon.

Nat Gas cover

Although I still believe in the fundamentals driving this trade, I covered my long nat-gas long at 10.135, after the market moved higher by nearly .40 in a few hours. This market has moved in my favor too swiftly, and I wish to take a profit. I'd like to re-enter the trade once this settles (although, knowing the volatility of the nat-gas market, this may never happen). Nonetheless, I'd rather protect my profit in this environment. Maintaining ths short CL leg, but watching it very closely.

Canada

Short CAD/USD.
The US dollar has depreciated substantially, and its relationship with commodity prices has been exceptionally tight this year. Whether commodities are a leading or lagging indicator tied to the USD is subject to debate (though commodities are certainly not responsible for the lion's share of the USD's weakening). However on a daily basis, the two have tended to trade in lockstep. Although this trade has already moved, I would like to go long the USD and short the CAD, on the basis that commodity price crashes, and the severe damage done to their export-driven economy by the run-up in the CAD's value earlier this year (there has been a string of defaults and near defaults for Canadian exporting companies) will hurt their postive balance of trade status, and will force a correction in the currency. I'm expecting approximately a 50% retracement from where the currency moved last year. Price target is $1.05. Hopefully it will reach this level sooner rather than later.

Re-entering copper

After sitting patiently for a week, as copper moved higher, I think that now is an opportune time to re-enter the trade. I'm going short copper due to the continuing theme of commodity de-leveraging, which, due to the nature of margin calls, could very quickly turn into a negative feedback loop and drag the entire asset class down dramatically. Barron's had an interesting article highlighting the level of speculative activity in the space, and I believe they are correct. The only commodity I would continue to be long of would be Natural Gas, for the CFTC commitments of traders report shows that it is still positioned materially net-short. However it is trading above $10, a psychologically important level, and if it shows signs of weakness in here, I will most likely cover this trade today, as it has been nicely profitable, and leave the short CL leg of the trade on.

Also, going short Sugar and Palladium, as those appear to be the most vulnerable to the withdrawl of the "fast money" in commodities, seems to make a great deal of sense, although it is a very risky trade, and one that I would not put my capital to work on. However I will continue to watch these two in the coming days.

Closing copper

Copper has fallen substantially today, and I've been fortunate enough to be heavily short the metal. I was able to cover at 3.5140 and 3.5120, as I think it is, temporarily, oversold. Look to re-enter the trade at close to 3.57.

Closing CHF

The USD is staging a strong recovery and this will probably persist for several days, as there are signifigant amounts of capital bet against it, with large gains to protect. I am taking profits on my long CHF position today.

Closing cotton

Due to the previous commentary and potential for commodity de-levering, I am closing my position in cotton, and looking for a re-entry point in the mid $0.60's.

Commodity de-levering

Commodities markets today are hearing rumours that the CFTC will begin to impose more stringent margin requirements for non-commercial speculators. Although this will give commercial traders a signifigant advantage (and large firms that are not qualified as commercial will most likely buy energy assets in order to make their traders such), it may serve as a method of wringing out much of the liquidity that commodities have sopped up, and transfering it to equities and fixed income securities, as well as possibly reducing oil prices and price volatility. More importantly in the short term, it would force traders in highly levered commodities to liquidate their holdings. This would most liquid commodities, but especially those that are trading well above their net non-commerical position averages. This includes Copper, Corn and Wheat most prominently. This would be bullish for Natural Gas, which is largely net short (all readings are as of March 11).

This increases my confidence in the bearish case for HG. I would also go long Natural Gas and short an equivalent amount of Crude Oil.

2008 returns

Year to date returns and positions.

Closing SPX

Although I think the US economy is still poised for a severe slowdown, I would like to reverse my short position in the SPX. Given the actions of the Federal Reserve, and the decline of the dollar, there is currently a credible risk that the S&P will rally. I will maintain the position that the global economy will slow substantially via my short position in Copper, however equities contain too much risk to take a directional bet right now.

Francs in Pounds

Going long the CHF/GBP cross (so short the pound, and long the franc), as the UK has many of the same systemic economic problems that the US faces, and with the recent decline in the USD their central bank will be forced to cut rates so that the appreciation of their currency relative to the dollar does not substantially damage their already wounded economy.

Copper in Yen

Adding to my short copper position, correlated with long yen of equal size (creates a bet on the price of copper in yen, as making the trade in dollars creates an inadvertantly bullish position on inflation, which is wrong). I believe this trade has a signifigant amount of room to fall, and the cash that entered commodities as a safe haven from equties will exit copper once the market "normalizes".

Covering Yen

Last night felt like an over-reaction to the poor economic news coming out of the US. Although the long-term picture has not improved (it is materially worse), I traded out of half my position at 96 (which was all the forex market lifted me for). I believe that there will be an opportunity to re-enter this trade, and I look forward to doing so. However this concludes one of the most violent weeks of currency movement, and I believe that the markets had become overly emotional. I hope to re-enter this trade at close to par.

Closing CMBX

The recent rally should be used as an opportunity to exit any CMBX trade while maintaining any short in commerical RE equities. Although at historic highs, the second leg of the credit crisis has, unfortunately, just begun, and there will most likely be a better entry point to purchase these securities than now.

Copper

It's been said that copper "has a PhD in Economics", as it's price directly responds to the economic cycle. As we are in the downward economic leg of this, it is no surprise that copper has sold off in the past months. However, I just read a well respected economic report that discussed the outlook for copper demand in the next two years, which projected a 10% increase in copper demand from China and a 2% reduction from the US. Given the abysmal state of the US economy, particularly new home construction, which is the destination of most copper, I believe these estimates are extremely optimistic. Although there are currently supply disruptions, these are short-term, and the long-term picture is much bleaker than the market is currently factoring in (the report also stated that they were on the conservative side, with a 16% gain being the consensus view). These reports assume a global de-coupling between the US and China, which simply is not true. Once the market loses the marginal demand consumed by China, an inelastic market like Copper will experience precipitous price declines.

One risk here is the continued devaluation of the US dollar due to our trade policies. Copper, being a global commodity, is a natural hedge against inflation, which could spur more buying as the dollar drops further. Therefore, it would be prudent to pair this trade with a position in either TIPS or a DXY (dollar index) short, though the DXY poses a great deal of its own risks.

CMBX

CMBX (CMBX-NA-AAA-4 is pictured) is being thrown into the same pool as sub-prime, and this comparison should not be made. CMBS are investment properties (where the owner largely realizes the inherent risk), and most importantly they are backed with a substantial equity cushion. CMBX is getting particularly hard-hit, as it is the subject of selling pressure by managers attempting to hedge positions in individual mortgages. Commerical real estate does have a way to drop before it reaches it's settling price, and the owner is properly compensated for his risk via an appropriate cap rate, however it appears that "true AAA" CMBX CDS is overpriced, as the risk of default is overstated given the size of the typical equity cushion above CMBS (which is much more signifigant than residential).

Long CMBX (Short CMBX CDS), Short Commerical RE Equities

Also short SPX, long Cotton

Closing Gold

Gold appears to have overstayed it's welcome. Although it has had a strong run, it has overshot it's historic ratio to the USD/EUR by a substantial margin. The market is now excessively long the commodity. In addition, the potential for the IMF to sell gold positions into the market in order to fund it's budget deficit poses a serious downside risk. This, among other issues, has the potential to tip the speculative position over, as it cannot remain this extended.

Streetracks Gold Trust (GLD) recently added 8 tonnes of gold to it's holdings, and now controls close to $20bln of the commodity. This is largely held by retail investors. The volatility of this investor class and trend-following nature of their trading is concerning whenever they are so long of a single position. Although dollar weakness will most likely persist through the middle of this year, the long gold position is no longer a good method of playing this. The Gartmann letter believes gold will hit $1000 shortly. I would rather take substantial profits off the table rather than risk them for a marginal $50 gain, and look at investing in other (net creditor) currencies in order to play the dollar weakness. It is also unclear that the Euro will be able to sustain it's current positon, versus the Dollar or globally. This trade, however, deserves much more research.

Short SPX, Long CT

Cotton

The recent run-up in agricultural commodities has left one crop relatively untouched. Cotton has failed to rise in the same manner that other agricultural commodities largely due to the fact that it is not a food product which, with an increase in global wealth, benefits from the increased global consumption of meat as opposed to plant protein, a process which is far less efficient in terms of energy, food and water. Cotton lags badly behind its all time high, while other crops are experiencing dramatic price increases due to increased consumption and the drop in the USD purchasing power.

Given the high price of Corn and Soybeans, and relative un-profitability of Cotton, especially as agricultural input costs increase, I believe that spring farmers will devote substantially more acreage to the former crops, creating supply constraints for cotton at the end of the season. This is good news for holders of Cotton futures.
Although there remain several risks, notably the growing use of GM cotton in India, which is materially increasing yields and the global slowdown which could impact China's consumption of the crop, I believe that the fundamental factors are strong enough to push cotton prices higher. It enjoyed a material gain today, and I am going to look to add to my position at lower prices. A relative-value method of placing this bet would be to go long cotton and short the DJ-AIG index, which would hedge against the coming macroeconomic slowdown, however given the recent volatility of this index, I believe placing the straightforward purchase of CT contracts represents a less risky position than the hedged position, at least at the present.

Long Gold, Short SPX, Long CT

Cotton versus other agricultural commodities, and cotton acreage planted (only updated annually) versus price.

Some pertinent articles:
http://southeastfarmpress.com/cotton/commodity-prices-0219/
http://southwestfarmpress.com/cotton/future-prices-0215/

Recession

It appears confirmed that the US is indeed entering a recession, though definitions of that term are somewhat subjective. Startlingly weak consumer spending will undoubtedly cause great pain for all companies in the consumer value chain, most notably those that are the most levered and sit closest to the consumer (retail, credit cards etc). Most likely, consumer advertising, and other discretionary business expenses will also suffer sharp, if delayed, reductions as spending a large amount of capital on gaining the attention of consumers who are not willing to spend will no longer be justifiable on an ROI basis. These points may be obvious to most investors, however, there is still a substantial short opportunity here, as the plummeting broad equities markets will impact the weakest companies most severely.

Short SPX, Long Gold

The great unwind

Global markets continue lower today, with US markets closed. JPY is up substantially, with carry trades being unwound rapidly and the Bank of Japan mulling a rate hike. This bodes poorly for Japan's trade-based economy. It also has serious repercussions for net debtor currencies, or any economy that has positively benefited from the carry trade in the past. I would look to go long JPY and CHF, however as this trade has already moved fairly substantially. Start with a small position then attempt to buy dips (if any).
SPX futures are down over 3% overseas. This, unfortunately, is still the beginning of the decline. The steepness and severity over the next few weeks will tell us a great deal about how long and deep the full recession will be. Full position short SPX futures.
Gold is being pulled down by equities, however, again, with the activity in equities and FX it "should" be higher rather than lower. Unfortunately, Gold ETF's are being redeemed. I am holding a small position in the metal, and am looking to add to it over time, especially once the correlation between Gold and equities disintegrates.

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Ugly

Equities finished the day substantially lower today, following poor readings from the Philadelphia Manufacturing Index. This is substantial because it appears that, with the close nearly 40 points below yesterday's close, the SPX has broken any support levels that previously held it in place. The equities sell-off also prompted traders to reduce positions in precious metals, when, in theory, this news should have been bullish for these commodities. This appears to be the beginning of a multi-year sell off, and the data offers little reason to believe that this correction will be less severe than that which began eight years ago. While a 30% decline in the SPX may be appear unlikely to many long investors, the chart shows more exaggerated moves have occurred in the last decade, during a crisis that did not have as strong roots as the housing/wealth effect/consumption decline we are currently in the beginning of. I do not believe it is too late to go short, and today proves that this bear market will have longevity.
Short SPX, Long Gold
 
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