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!