Staying Constructive on Commodities and Their Currencies!

Let's face it, commodities have de-coupled from the USD and supply/demand relationship due primarily to one reason - liquidity. If the global economy is not going to do better, commodities will do well because central bankers will continue to run printing presses. If the global economy is going to sustain the recovery, commodities will also do well because demand for things such as oil and cotton will go up. Most importantly, the charts agree! The Aussie has recouped most of the decline against the dollar since the latest correction while the dollar index (DXY) has gone up primarily due to weakness in the Euro and the Pound. Even though the Canadian dollar and the New Zealand dollar have lagged behind the Aussie, their respective charts have shown pockets of strength and look ready to move higher. Politicians have to realize that printing money does not enrich countries and it will continue to destroy the purchasing power of consumers in the U.S. and the developed nations in Europe through currency devaluation. Therefore, I am recommending buying the commodity currencies against the USD, EUR and GBP and buying commodities such as copper and sugar. On the other hand, I continue to believe that the dollar, being the "tallest midget in the room," will strengthen against the Euro and the Pound as the greenback benefits from the debt crisis.

"King Dollar" For Now...

As written in one of my previous posts, I thought the USD would break the symmetrical triangle and head lower, but instead it has managed to stay within it and moved up. This is why I have turned very bullish on the dollar in the short term, and I believe the rally still has legs. The greenback has been so strong that it has even gained against the Japanese yen. In the meantime, sovereign debt, especially on the longer end, has continued to sell off as worries regarding the European debt crisis intensified. Ireland officially received its bailout package today, yet the euro weakened once again. This is classic "good news, bad price action!" In terms of equities, the Nikkei, led by higher USD/JPY, and the S&P, benefitting from a stronger dollar, have outperformed stocks in Europe and emerging markets.

What can you expect in the short term? Unfortunately, I believe the trend should continue as the "King Dollar" is poised to strengthen further against its counterparts while equities in Japan and the U.S. will continue to outperform as risk aversion and carry trade reversal continue to unfold. Therefore, I am buying the dollar and selling everything else. As a pair trade, I recommend selling short Europe and emerging markets while buying Japan and U.S. as hedges.

Things Have Been Moving Counter-Trend Lately, What Should You Do?

Euro has tanked, dollar has gone up, yen has weakened, stocks have corrected while long-term bonds have continued to fall! What in the world is going on? On the currencies front, I am currently neutral on both the euro and the dollar while feeling slightly bearish in regards to the yen. I remain a bull in stocks and short-term bonds while having a negative bias towards long-term bonds. Why? While the EUR/USD cross has been under severe duress lately, the bottom of the rising channel has held up. On the other hand, the dollar index was able to sneak back into the symmetrical triangle after briefly penetrating it following the announcement of the larger-than-expected QE2 program. I currently have no positions in either the euro or the dollar as I am staying on the sidelines waiting for more clarity. However, the yen seems to have found a short-term bottom as all major yen pairs have moved up recently. For instance, USD/JPY has risen to a 5-week high after today's rally before stalling at the 50-day MA.

Fundamentally, while the PIIGS remain a risk to the ongoing global economic recovery, I do think there is enough liquidity in the markets to sustain the rally in most assets since central banks globally have pumped trillions of dollars in their respective financial systems. In the U.S., economic data has been surprising on the upside and confirming that while the recovery has been slow, double-dip is unlikely. Assets in emerging markets will continue to do well due to the size of the QE2 program. However, risk in the LT bonds has increased given higher inflation expectations as a result of massive stimuli.

Just Quickly Reiterating What I Wrote About Chinese Stocks 6 Months Ago

Since July 5th, Chinese stocks are up ~30%!

Date: Wed, 19 May 2010 19:13:38 -0400

few reasons why im bullish....

M2 money growth of 25% last year means inflation is coming, if not HYPER inflation

now let's see where they can put their money

real estate = negative, because they have already OVERdone it
deposits = negative, real interest rate will be negative given record low interest rates
gold = slightly positive, but chinese are already largest owner of gold, so you can argue this is sorta OVERowned as well
stocks = positive since inflation is good for stocks in general, some money out of real estate will flow into consumer industry, plus chinese love to pick bottom, and like it or not, the stock market is about 60% below peak in '07

anyways i was bored, but i do expect chinese stocks to be much higher from current levels by yearend

What's Next For The U.S. Dollar? I Believe It's Going Lower!

The dollar index suggests that the greenback is currently trading at a very critical point where a big move either way will determine the next 10 points. Treasury Secretary Tim Geithner today rejected the theory that the government is trying to devalue the dollar, saying that "it is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity, to (be) competitive." From my experience, when government officials start making statements to support their currency, the currency normally heads lower because the market loves to punish verbal interventions. On the other hand, the "Obummer" administration actually wants a weaker currency as politicians continue to believe that a weaker dollar will benefit exports. The truth is that this country simply does not manufacture enough to benefit from the dollar devaluation.

From a technical perspective, the USD/CHF cross has always had a close resemblance to the dollar index, and the pair has broken down from the symmetrical triangle, and therefore, I am expecting a similar outcome for the dollar index. If you agree with my analysis, I believe EUR/USD and AUD/USD remain the best bets.

QE II Is Next For Other Usual Suspects!

The Fed has successfully achieved its objectives with the QE II program, which was aimed to support the markets (both equities and bonds) while devaluing the U.S. dollar. However, every country in the world needs a weaker currency in order to protect their exports and sustain the economic recovery, therefore, I believe the developed countries will most likely find reasons to ease more and the emerging markets, facing inflationary pressure, will logically increase taxes on capital inflows to limit currency gains. For example, Brazil last week doubled its foreign capital inflow tax rate to 4% from 2% to curb Real's strength, and I expect other developing countries to take similar measures. What do all these ultimately mean? I believe it will be excessive inflation and real assets such as commodities, and yes, even real estate (especially in distressed markets such as the U.S. and Japan) will fare very well in the next few years. This is the worst time to hoard cash as investors because your savings will be eroded by all the cheap money. This is why I think all assets will continue to do well in the short term, including equities, bonds, commodities, and real estate. On the currencies front, given all the liquidity, I expect commodity currencies' strength to continue as investors chase yields.

Protectionism To Further Constrain Global Growth?

Washington just did it again! A currency bill was passed in the House today which seeks to impose trade sanctions against countries who manipulate their currencies... They are obviously targeting China, and the bill is deemed voter-friendly as the election is around the corner. What does this mean? This is just an anecdote of the "de-globalization" which has taken place following the financial crisis. As you may already know, globalization contributed to the above-trend growth seen in the past three decades during which financial and human capital were allocated more efficiently, leading to increased growth. However, developed countries are facing high employment in the aftermath of the credit bubble, politicians are being pressured to create jobs anyway they can, which is unfortunately counter-productive. Therefore, we are entering a period in which growth is going to be below-trend, negatively impacted by regulation, protectionism and aging population.

Bull Market or BS?

S&P's first attempt at 1,150 failed 2 days ago as the index was stalled at 1,149 and has since dropped 24 points to close at 1,125 today, below the critical 1,130 level. If you had been bullish as I had been for the past month (see "Turning Bullish! Resilience in Tech Shares and Sell-off in Treasuries Stir Optimism!"),  you have to re-consider your positions here. While I am not ready to exit my longs as I am awaiting more bearish confirmation, I did buy some puts today because they were still cheap. Not surprisingly, tomorrow is going to be a very important day as the market should decide which way it wants to go for the next couple weeks. A close below 1,130 again will undoubtedly push the index to its 200-day moving average (1,117). A close above 1,130 will likely drive the index towards 1,150 again.

Big Ben Wants To Print More Money...

Looks like Mr. Bernanke is willing and ready to implement more quantitative easing (a more beautiful term to say printing money), and as a result, gold has risen to a record and USD has tanked recently. Will this trend continue in the short term? You Betcha! While I remain bullish on the greenback in the long term, the market wants to focus on the U.S. in the near term as investors seem to believe that the U.S. is the only country that will need more QE. As traders, we never fight the market, and I am no exception as I am currently long the GBP/USD and looking for opportunities to short the USD anyway I can. From a technical perspective, the USD started its big downtrend in 2001 after the tech bust and 9/11 and fell to as low as 73.56 (DXY) in March 2008. It has since entered a symmetrical triangle, which is a consolidation formation, suggesting indecision among investors. It hit the top of the triangle on June 7th and started falling once again and looks to be headed to the bottom of the triangle.

All The Doom and Gloom Aside, Euro Is Going Higher!

Yes, Greece will default, Ireland is bankrupt.... but I do think the EUR/USD will continue to move higher in the short term due to the following reasons. First, the Euro trade became so one-sided in May that the pair was due for a significant bounce since hitting a bottom at ~1.18. Second, while some countries in the Euro zone are in fact heavily indebted, U.S.' fiscal condition is probably in a worse shape and is currently the most indebted nation in the HISTORY of the world. Third, major economies in Europe such as Germany, driven by exports, are doing relatively better as a result of strong demand from consumers in emerging markets. All these fundamental data points suggest that unless the U.S. starts to tighten its belt or its economy starts to grow at a normal rate again, it might be hard to justify further downside for the Euro in the near term. Technically, the Euro just broke a strong resistance at ~1.3270 today and looks poised to go higher with the next key resistance at 1.35.

The Bulls Are Back In Control! What's Next?

The S&P successfully broke through a key technical level (1,130) and managed to close above it for the first time since May. I believe we will continue marching higher with the next key resistance at 1,150 followed by 1,170. While 1,150 will be a difficult test, I think we will most likely break it and test 1,170 before the end of the month. Besides technicals, I believe there are other reasons behind this bullish run. First, from a sentiment perspective, people were simply too bearish, driven by weaker economic data and European debt worries. Second, dividend yields (2%-3%) are attractive given record-low interest rates globally as major developed countries such as the U.S. and Japan have kept their rates near zero. While it is difficult to predict equity prices in the longer term, the worst is probably behind equities this year.

BOJ Just Intervened! Politicians Never Learn...

BOJ finally intervened to weaken the yen on the heels of Prime Minister Kan's pledge. All the yen pairs are currently up anywhere from 150 to 200 pips while the dollar has strengthened. I had shied away from buying the yen for the past couple of weeks and I will continue to stay on the sidelines for the time being. I remain skeptical of the intervention and continue to believe that it will fail to curb the currency when it's all said and done. The government has $700B unrealized losses in its FX account, and the intervention will add to its fiscal burden. This will decrease the attractiveness of Japanese bonds, and potentially push interest rates higher (barring further quantitative easing), which could make the deflation problem worse. These politicians just did what they do best, which is kicking the can down the road...

Does Australian Dollar Confirm S&P 500's Bottom @ 1,010?

It has been well documented that a strong correlation exists between the AUD/USD cross and S&P 500, so what is AUD/USD chart telling us about the S&P 500 index? The cross found its top in November last year when it hit 0.94 and had since consolidated before retesting 0.94 on 4/11. The S&P, on the other hand, kept rising during the same period before peaking at 1,220 on 4/23. This is one of the many instances where currencies have served as leading indicators for the stock market. The Aussie dollar started declining from 0.94 and hit a bottom at 0.8050 on 5/26, which was the 38.2% retracement of the bull run from 11/2008 to 11/2009. It has never looked back from that point, and last traded at .9210. Similarly, the S&P 500 fell to 1,010 on 7/2, reaching the 38.2% fibonacci retracement. I believe this suggests that S&P has most likely bottomed out this year at 1,010, and I expect the index to retest the April highs at 1,220 sometime this year. I recommend buying cylical stocks (commodities, banks, consumer and housing) as they tend to outperform during the early cycle of an economic recovery.

On Vacation...

I am on vacation until Monday. If you are bored, here is a good article you can read. It's written by William Pesek of Bloomberg about Japan, the yen, and more.

http://www.bloomberg.com/news/2010-09-01/crying-wolf-has-cost-in-world-of-growing-pain-commentary-by-william-pesek.html

Buckle Up! Volatility Is Coming!

While equities have been trading in a tight range on low volumes during a seasonally slow summer, I expect volatility to increase as traders and fund managers return from vacation. Given deteriorating fundamentals, I believe upside for the S&P is probably capped at 1,130 with significantly more downside risk. Although I am not in the double-dip camp, I believe uncertainty has persisted due to worsening economic data and looming November election, and should continue to weigh on the markets. Until we get better economic data and clarity out of Washington, investors' appetite for risk will remain low. The VIX (CBOE volatility index) has been consolidating in a tight range (~23-28) as well after escaping a steep downtrend and looks poised to break out. I believe the VIX should break to the upside as risk aversion typically increases as we approach year-end.

Will Japan's Intervention Curb Yen?

On the heels of a rising yen, Japanese leaders recently warned about potential intervention in the currency market and announced measures last night aimed to weaken the currency, proposing new economic stimuli and easing monetary policy further. Will these steps be enough? The government has been incompetent for the last two decades as it has failed to solve the deflationary spiral resulted from a major credit bubble in the late 1980's. On the other hand, demographics are extremely unfavorable as aging population (1/3 over age 65) also adds to deflationary pressure. The Bank of Japan has kept interest rate at zero and the government has taken on huge amount of debt (debt/GDP nearly 200%) in order to boost economic activity. You might wonder why the yen has risen given these terrible data points. The answer is Japanese businesses and households had sent their money from cheap loans and savings abroad to invest in higher-yield assets, taking advantage of the interest rate differential. The carry trade worked beautifully during the boom years, but was halted and reversed when countries from the U.S. to Germany to China were forced to slash interest rates in order to cope with the worst recession since the Great Depression. As a result of the reversal, a shortage occured, and supply/demand has driven up the yen to 15-year highs. Therefore, I believe the yen will continue to strengthen and should retest its all-time high vs. the USD (79.74 in 1995) as countries in the developed world are still years away from raising rates, making their respective currencies good carry-trade candidates. From a technical perspective, the USD/JPY cross currently looks oversold, so I recommend waiting for a retracement before shorting again.

Bad News, Good Price Action!

We again got terrible data out of the U.S. this morning as both durable goods order and new home sales came in below consensus estimates. However, while the S&P took a deep dive in early trading, it quickly bounced off the low at 1,040 (key technical support) and ended the day up 3.5 points. Good news, bad price action (sell), good/bad news, good/bad price action (hold), bad news, good price action (buy). Therefore, I maintain my short-term bullish view on the market and will be looking to buy stocks that have been hit hardest such as technology shares. I believe stocks like IBM, Microsoft, Intel, etc. offer decent value with dividend yields in the 2%-3% range.

Will The Gold Bubble Finally Burst Due To Disinflation and Rising USD?

Despite my disbelief in the gold story, I have actually been riding the uptrend and profitting along the way because "bubbles always go higher than you think!" In recent days, the metal everyone loves has been losing momentum since reaching an all-time high at $1,265, so what is next for gold? Historically, gold has done well during periods of inflation and/or USD weakness (since all commodities are denominated in USD). For example, gold did exceptionally well in the 80's because we had enormous inflationary pressure. The latest bull run in gold started in late 1999, corresponding with the start of the bear market for the greenback. However, I believe we are currently living in a disinflationary/deflationary environment as debt-deleveraging on every level (federal govt, state govts, businesses, and households) continues to weigh down on consumer prices. On the other hand, the Dollar has shown pockets of strength as fear has halted the carry trade and attracted flows to the currency. Technically, the metal has completed a 5-wave uptrend (check Elliot Wave Theory for more detail), suggesting that a correction is likely and imminent. In addition, while gold has continued to appreciate in recent months, gold producers' shares have surprisingly lagged, providing more confirmation for my thesis.

Actionable recommendation: Short gold at spot (1,225) or around 1,265 (all-time high) with stop loss somewhere above 1,300 (depending on your risk tolerance) and take profit around 1,044 (38.2% retracement).

Turning Bullish! Resilience in Tech Shares and Sell-off in Treasuries Stir Optimism!

"When you have a conviction, you will get beat up by the market!" Frankly, this is the best advice I have ever gotten during all these trading years. I covered my shorts last Friday and actually bought some technology stocks (RIMM, AAPL, GOOG, to name a few) because I was surprised by the resilience in these technology shares. While the broad market was down, the Nasdaq finished the trading day in the green, and it was one of the few days in which technology stocks outperformed the overall market in recent months. In addition, treasuries retreated from recent highs as yields on 10-year notes increased to 2.6120%. I believe these two divergences are a good indicator of where the market is headed for the next couple weeks due to the following reasons. First, technology stocks have underperformed the market and have been the laggards throughout this correction, so any strength in the sector should be bullish for the market. Second, panic seems to have subsided somewhat given the positive reaction in the bond market last Friday. Third, the S&P quickly tested the 1065 level and found strong support there, suggesting to me that we might be headed for the top of the trading range again (first stop at ~1100, then perhaps ~1130).

Be Selective When You Short The British Pound!

The five common GBP pairs are: GBP/USD, GBP/JPY, GBP/CHF, GBP/AUD, and GBP/CAD. If you are bearish about the Sterling, make sure you have done enough homework before you short it because you can easily find yourself on the wrong side of the market. One of the reasons is that all these pairs are historically distressed as a result of the banking crisis in 2008 when the British financial system almost fell on its knees due to souring bets on subprime mortgages. Therefore, four out of the five pairs (with the exception of GBP/USD) have been consolidating within a tight range, making the risk/reward less compelling. However, the GBP/USD had a strong run from the middle of May until early August, rising from ~1.42 to ~1.60, thus making it the best target to bet against, in my opinion. As you can see from the chart, the pair declined sharply from 1.60 and has since been trading in the 1.5560-1.5690 range. I recommend selling the cross around 1.5625 (middle of the trading range) with a take profit and stop loss at 1.5355 and 1.5765, respectively. Happy trading! :D

Since Most Things Are Consolidating, Let's Talk China!

To trend traders, nothing is more painful than when things are in consolidation mode, which is what we have currently. Since there is nothing much to trade, I have decided to talk about China. China, as we all know, has successfully leaped from an agriculture-driven economy to one that is powered by exports, made possible due to cheap labor costs. The country alone has stolen the entire manufacturing base in the developed world and is currently the biggest exporter in the world (Germans will argue otherwise). However, I believe the export-driven growth model ended in 2008 when American consumers, hamstrung by debts, began to retrench and save. On the other hand, the massive stimulus implemented by the Chinese government has dramatically increased inflationary pressure, illustrated by rising food prices and wages. Slowing export demand and higher wages, coupled with excess capacity and strengthening Yuan will continue to adversely affect the sector, in my opinion. Government officials have noticed the problem and directed their focus to growing domestic consumption. However, while China recently surpassed Japan as the #2 economy in the world, its per-capita income ranked #127, lagging behind countries such as Albania and Algeria. As a result, I believe the re-balancing will happen very slowly and the economy remains very vulnerable to external shocks. History tells us that no country has risen to power without a major crisis, and therefore, I suspect "this time is different" for China...

S&P Stuck in Trading Range (1056-1129) ...

The fact that S&P has been stuck in a tight trading range shouldn't surprise anyone... I believe the index is oversold in the short term and could quickly retest 1,100 before falling again. It recently broke down from a rising wedge and fell nearly 57 points from its previous peak (1,129), suggesting a quick sucker's rally isn't out of question. Fundamentally, there doesn't seem to be any short-term catalyst which can get the index out of its trading range, and therefore I remain extremely short-term sighted and continue looking for quick long and short opportunities. While I remain pessimistic over the growth prospects in the U.S., I do not foresee a "double-dip" for the economy due to record-low interest rates and pending election in November. I believe the Democrats are willing to shoot every bullet in order to keep the ship from sinking before the election.

US Dollar Still Technically Bullish!

I believe the U.S. Dollar rally started in late November following a better-than-expected job report has legs despite recent weakness. The Dollar index (DXY) last peaked at 88.70 on June 7th and corrected by nearly 60% to 80.09 in two months. Technically, the index was able to hold the uptrend at 80.04 (previous major low), and has since broken out of the downtrend. Therefore, I would be very cautious about shorting the greenback in the near term and would be looking for opportunities to long the dollar against the usual suspects (Euro, British Pound, and commodity currencies), but would leave the USD/JPY and USD/CHF alone as the JPY and CHF have remained strong given their safe-haven status.