Correlation Breakdown?

It seems to me like for a while assets were moving in a lockstep: If stocks up -> oil up, copper up, credit up, EM up, commodity currencies up, treasuries down, USD down. If stocks down then oil down, copper down, credit down, EM down, commodity currencies down, treasuries up, USD up. You could look at the change in SPX and pretty much read what's going on everywhere else.

Thee past couple days I have been seeing a breakdown in this correlation structure. First of all, stock market seems to be going nowhere on what appears to be pretty good news - certainly something that would have powered the index higher 2%+ back in July. Flattish SPX, down oil (though that's likely because of the DOE number), tsys slightly up, USD up huge.

Are things not as simple as risk on/off anymore? Of course two days do not make for any discernible pattern - and with the stock market more or less flat it's hard to tell if there is even anything really unusual there. But I am wondering if this is a sign of a shift in dynamics.

SNB Needs to Fess Up

That what they really want is for CHF to depreciate by 30%.

Goldman says:

Released: Tuesday, August 25, 2009

Jordan reiterates: no need to change monetary stance

In a speech, his second speech today, SNB board member Jordan stressed again - after an interview on August 18th with the same message - that there was no need for the SNB to change its monetary policy stance. While acknowledging that "also for the Swiss economy indicators are signaling a turn for the better", "dis-inflationary tendencies are still dominating".

More specifically Jordan said that the time for a change in monetary policy has not come. There is "no necessity to act". In fact, the SNB will continue its "very expansionary monetary policy".

The SNB will hold its next quarterly meeting on September 17th.

Is This Good or Bad?

Courtesy of DB research.

It's All Clear Now

I think I am gonna put a fist through my monitor if I see another headline that reads like this.

A Call Option on Commodities Regulation

I am sure we all have been hearing a lot about the move to curtail speculative trading in the commodity markets. I thoight this was an interesting article. Whether one thinks speculators are net positive/negative for the market and the society (I personally think ETFs should be outlawed but let professional speculators speculate) I think it is likely that passage of speculative restriction would at least send the price down temporarily. Could I make money off this?

I thought perhaps I could buy some OTM puts on WTI. Turns out these options are still way too diamn expensive due to volatility and time value. Then I extended my analysis: who gets hurt if such rules get enacted? Can I buy some OTM puts on CME (who owns NYMEX where WTI is traded)? Well, these options are still too diamn expensive. What then - how about shorting CME and hedge out the equity beta portion by going long another exchange stock with minimal exposure to commodities? NYX perhaps?

The two stocks are very highly correlated so it seems to me like the equity sensitivity portion can be hedged. NYX seems to have higher dividends than CME which is good. Must look into how much commodities contribute to CME's earnings.

Though I wonder : is NYX gonna get hammered if that whole HFT thing gets busted up by the gubment?

Switzerland -- Add to My Axis of Evil

CHF up 1% today - biggest upward mover against USD among G10 - despite their central banker said they will continue intervening in the currency market to prevent further appreciation of CHF. They seem to be scared shietless that Swiss economy is in tolilet, and seem more eager than US or Europe to provide whatever assistance need to get things humming. The SNB says they have no plans to alter its policy of intervening to prevent any appreciation of the Swiss franc, providing generous liquidity to the banking sector and purchasing corporate and covered bonds.

Getting smacked on my short on CHF. Thankfully long NOK and JPY, short GBP and NZD doing well.

Crude Timespread - Gittin' Tight

crude timespread tightening hard on today's DOE number.

Do I want to short this sumbeetch? Technically the spread ain't all that tight. I would like to see it pull in another 50cents or so to give more room for error. Fundamentally, I fail to see any reason for strength. distillate stock is way high. And gasoline while it has nearly reached the end of consumption season hasn't budged much. Unlikely refineries would rush to buy more crude even though crack spread remains ok still.

A-shares -- a Leading Indicator for Copper?

1. It is postulated that Shanghai A-shares are now the leading indicator for the world economy. Or at least the world seems to think and react that way. This is because the world believes that China is the growth engine that will power us all out of recession. Any hiccup in China seems to be felt around the world in most major asset classes – especially in commodities and stocks.

2. It is also postulated that industrial metals have taken on a very financial assets-like nature (especially as of late) due to excess Chinese liquidity turning many there into speculators in the booming metals market. correlation between the two assets are at the highest point in a while.






3. If you believe that copper and A-shares have the same underlying drivers (speculative fervor of the chinese public and accommodative financial policy), then it’s worth a look at current price action where the A-shares have been sharply down. Call me crazy but it seems to me like copper has the tendency to trail the A-shares on big moves.

4. So, given the recent big fall in A-shares give us a tradeable signal? Obviously, it all comes down to getting the direction of risk right. If the A-shares go on a sustained drop then I would think every risky asset in the world would follow. BUT if you have a mandate to trade copper the A-shares could provide a useful turning signal.

DISCLAIMER: I obviously do not spell out all the details of my research and will intentionally leave out some crucial stuff. Also, it is quite possible that I might already have established a position in any trade idea I discuss here.

It is All About Timing Now

Some very large swings last Friday, yesterday and today. This has been a difficult time to trade with correlations all going to either +1 or -1. It has been a while where I can look at price change of just 1 currency, commodity, bond future (US), or an equity index and can tell how everything else would be doing.

With the green shoots rally running out of steam and Q2 earnings (or more like heavily adjusted operating earnings with bucket loads of one time charges and cost cuts) out of the way investors are looking for direction - risk on or off?

In a way I am getting tired of reading up and studying fundamentals when none of the shiet seems to matter. I was able to find some decent relative value trades earlier on but those trades are becoming harder and harder to find.

Timing trades is really all about the ability to withstand mark-to-market losses, so it's crucial that you work for the boss who can tolerate some short term roller coaster ride. I can afford to put on longer term trades in my personal account and just added to my equity short position earlier today.

Spank'd

The markets are getting whipped harder than Bruno at a swinger's party.

Thankfully my commodity positions are up. Currencies are not doing so well except long Yen - the scandis are killing me.

Personally I think this is the beginning of a big retracement. But then I made this call about 3 or 4 times already since April. Thankfully I didn't act on those gut feeling those times. I have more conviction though this time because my dad called me last week to ask what stocks to buy. He is the perfect contrarian indicator. hope he doesn't die on me soon. Be well pops-

What do you guys think? What are good trades to put on now - not last Friday? My firm overall isn't as well positioned if this downslide continues. Hope it doesn't folk up my bonus.

Could Someone Please Tell Me

Is it time to short?

Another V Theory

Here is a new one on the V-shaped recovery that I heard (bloomberg):

Instead of a so-called New Normal of subdued growth, the U.S. may be heading for a robust recovery. The worst recession since the 1930s has created a reservoir of demand that will buoy the economy, say a growing number of economists led by James Glassman at JPMorgan Chase & Co., former Federal Reserve Governor Laurence Meyer and Stephen Stanley at RBS Securities Inc.

“Whenever we have plunged off a cliff and fallen into a deep hole in the past, for a while the economy has a tendency to bounce back very quickly,” said Glassman, a senior economist at JPMorgan in New York. Glassman and his colleagues this month
said forecasts of 3 percent to 4 percent growth in coming quarters may be too low given “pent-up” consumer demand.

It would be nice if "pent-up" demand would get you what you like. Kinda hard to buy stuff if you have no money. I am overall bearish longer term because I do not see where the money would come from. Basically US economy has been built on mirage of value creation and easy credit since about 1998. I don't see why anyone thinks things should go back to 2006 level.

Gone Shopping-

Americans aren't shopping, but guess who are - them Chinese folks.

Am catching up on all the major econ news from this week and got to read deeper into the Chinese data from earlier in the week. I don't put much faith in their official data. Hiell, it's hard enough to figure out what US numbers are saying and how they're put through the sausage maker, data released by Chinese government?

One thing that has surprised me about China is the continuing strength in consumption. Granted that they come from much a lower base and do not have anywhere near the room to cut back as they do in OECD, I am surprised the reduction in exports hasn't trickled down to hurt consumption and retail sales.

One explanation might be (from Bloomberg):

``This [retails sales number] is encouraging,'' said Sun Mingchun, an economist at Lehman Brothers Holdings Inc. in Hong Kong. ``But it's too early to say whether it can be sustained, because part of the increase was supported by the stock market.''


Households are switching money from bank deposits to the share market.

``I make about 5,000 yuan a month investing in stocks,'' said Peng Li, 25, a student eating at the food court of the Mix C Shopping Mall in Shenzhen. ``I spend most of my money on eating and shopping with friends.''

I am probably not the only person thinking shiet might hit the fan over there. People using an asset bubble as an ATM for spending? I have seen this movie before. When is the billion dollar question. I ain't shorting yet.

Lack of Confidence

US consumers not feeling all that upbeat according to the latest UoM survey. Is that really a surprise to anyone? Every data point says there ain't no hiring and wage is dropping a stone tied to an even bigger stone.

Is it time to go long WMT and short consumer discretionary again? Made some decent money last year on that bet.

Huge risk reversal on the news. Thank god I somehow timed the long Yen bet. But still punched hard in the face by long AUD and NOK. Short Kiwi not serving as a hedge. What in the hiell is the deal with the NZD???

Takin' a Day Off-

NOK, the greatest currency known to mankind, takes a day off today.

But thank the lord I went long JPY in a big way two days ago.

Who knows what the hiell is going to unfold next week... one battle at a time.

Why in the folk did I short Kiwi...

I Ain't Afraid of No Inflation!

At least not in 2009.

No big surprise in CPI. 0% MoM and -2% YoY for headline. Ex-energy and food 0.1% MoM and 1.5% YoY. Main surprise for me was fall in food prices despite generally higher prices as observed in commodity markers. Maybe lower labor costs accounts for downward surprises. Apparel prices climbed despite all the sales I see everywhere. I recently ordered 5 Lacoste polos from their webstore but returned them all. I already have a few and I ain't buyin' nothin' that I don't have no need fo'-

Going long inflation seems to be a very crowded bet thats is getting more crowded. People thinking too simplistically - following scenarios that generally unfold in emerging countries. I would be seriously looking at putting on some anti-inflation trade later this year to early next year.

Is There a Play Here? - LME Copper Curve

What's up with the LME copper in backwardation?



When the copper inventory is going up?



LME warrant cancellations are going nowhere:




Comex copper curve looks way different:


Time to short the timespread in LME copper? My guess is the backwardation might be caused by long only money and trend followers jumping in?

For Your Weekend Entertainment

I highly recommend Harsh Times. If you thought Christian Bale was an insane mofo based on his outburst on the Terminator set, then you obviously never saw this hidden gem from 2005. Bale plays a former Army Ranger who tries to get his life back together upon his return to LA from Afghanistan, and shiet just goes very, very wrong from there. It flows and feels a lot like Training Day which was another amazing movie.

Coppin' all that copper

Very well put by the DB research team:

LME metals were strong again, with copper and nickel posting fresh 2009 highs. We believe the positive tone of the US Fed has boosted investors’ confidence, while base metals were little affected by an unexpected fall in US July retail sales
and disappointing job data. We think Chinese demand has been the most important force driving metal prices this year. In fact, we find that since the beginning of the year, the correlation between the LME copper price and the Shanghai Composite Index is 89% compared to an average of 30% between 2006 and 2008. We also think China’s importing appetite is also a major factor. Our “back of the envelope” calculations reveal an extraordinary stockpile. Given our forecast China will consume 6066Kt of refined copper and will produce 4072Kt, we estimate an import requirement of 1994Kt. In the first seven months of the year, China has imported around 2100Kt, meaning the country has already covered its required tonnage. When annualized at current levels, China will import roughly 4200Kt in 2009, leaving a surplus of 2200Kt. If realized,~30% of next year’s requirement will be covered meaning China has essentially brought forward future import demand meaning imports in 2010 could be vastly reduced. During a recent field trip, our metals and mining analyst Julian Zhu found a variety of producers and smelters who have nothing to do with copper but are hoarding the metal as a result of excess liquidity in the economy. We believe that as new RMB lending decreases, such speculative activity will be reduced

Nemo had talked about this in one of his postings on Macro Man. I think copper short is a good trade but I think it would be 100% correlated to the stock market, and there is no interesting trade to be done with the curve given the boring shape. How can I play this?

Git Your Rubber On-

Consider these condom for your feet. Just a thin layer of rubber to protect the bottom of your feet and toes while allowing you to feel the surface almost as if you are barefoot.

I bought these bad boys last week and have been wearing them to gym daily. Instantly I noticed that normally I stomp too hard my heels when I walk with regular shoes on. These VFFs (Vibram FiveFingers) force me to walk more softly on the balls of my feet. I found them particularly good doing balance workouts like kettlebell. Hope these help with my plantar fasciitis.

Consumers refuse to consume

Or maybe they cannot because credit card companies are kicking them out. Either way retail sales numbers came in as a big disappointment. The most worrisome aspect is that ex-auto and gas continues to fall. People are losing jobs, getting their salaries cut, credit card companies are kicking them out and banks refuse to make loans. Oh yeah, and they lost 40% of their savings in the stock market last year. If you also own a house then you really are seriously FOLKED.

How can US rebound if consumers refuse to spend? Even more importantly for traders: can China rebound if US consumers don't consume?

Where will CHF go from here?

So CHF has been my biggest short position since July. The bad news is that it has been appreciating against the Dallah. The good news is that it hasn't gone up as much as the other currencies I am long against the Dallah.

Swiss producer and import prices data came out for July. Long story short prices are falling and disinflationary pressure is mounting (but that seems to be the case everywhere in the world). rate hike not anywhere in sight (but that is also the case pretty much everywhere in the world).

SNB had stated that stronger CHF would be undesirable given its fragile, trade-dependent economy, but it seems unlikely that SNB would actively intervene.

For the foreseeable future I think CHF would just remain a very low beta currency.

BTW, I am net short CHF versus EUR but in my portfolio I trade everything against USD for simplicity sake.

Norway - the greatest country of all time

Norwegian Krone - the greatest currency of all time

NOK rockets up more than 2% today on Norges Bank's unexpectedly hawkish statement and improved economic optimism. They seem to think the Norwegian economy is doing just fine especially compared to the Eurozone.

I have made some decent money in NOK during the past couple months.

I bet the market turns the other way tomorrow and give back at least half today's return.

In the FX space, today was another typical day of S&P500 up - DXY down. I am long the high beta currencies against the low beta ones while maintaining low risk level.

Fed - does anyone care?

The way things are rockin' along, the Fed better just keep its mouth shut and not spill something stupid.

Unsurprisingly, the statement took a more upbeat tone on the economy.

I don't think the Fed would hike interest rate up until unemployment definitely starts to fall. Fed-led security purchasing program looks like it's on pause for the time being.

Oil? I don't see no fundamentals at play here

DOE released oil inventory numbers today and it is bearish all around with inventories in crude, gasoline and distillates all up substantially. As of now crude is hanging in there but refined products are down - despite a pretty big rally in stocks and USD taking further pounding.

How the hell is crude at $70 when demand is just not there? keep in mind that crude was around 25 bucks as of end of 1999 when the economy was booming. Has EM demand increased that much (maybe it has)? Because as you see below, US demand hasn't gone anywhere (although this probably isn't the best measure of inventory as implied demand is backed out from inventory changess).



And inventory is still sky high:


People say industrial production/manufacturing is rebounding but distillate inventory keeps piling on.




Now, it is entirely possible that distillate buildup was due to refiners taking advantage of very generous crack spread lately. To me, interesting trades are to be made in cracks. I have no idea whether oil should be at 60,70 or 80. Personally I am inclined to short but don't want to get caught on a wrong side of a directional trade in this market.

gasoline crack:

Commodity thoughts - Aug09 GS view as well as mine

• So far the biggest gainer has been base metals
o GS attributes this to EM’s outperformance over OECD in terms of economy (EM – specifically China and India hanging in there strong at least in terms of GDP).
• GS thinks that OECD economy is in an earnest upswing given the PMI and US employment numbers and that this would mean improvement in energy (they mean crude) demand.
o Energy a lot more geared to developed world demand.
• GS is very bullish on US econ in H2 due to huge boost in manufacturing.
o Q2 GDP showed inventory liquidation steeper than previously thought. That means more inventory that must be restocked.
o Ratio of ISM new orders to ISM inventory is at the highest point since 1975.
• My guess is that neither metals nor crude has been moving based on fundamentals. They will fall from here if stock market falls. It’s based more on investor appetite more than anything else.
o We need to see some slowdown in WTI inventory buildup – another big build today.

Nat Gas
• High inventory
• Cooler than usual summer has been a drag on demand
• Right now the concern is that storage will be breached. Once we pass that point we might see a sustained rally in natgas as people shift attention to reduction in drilling. Price has to recover to induce more drilling.
• I think the current situation is like when WTI tanked as it nearly breached the storage limit at cushing.
• Almost time to go long 2010 Nat Gas? Long Aug10 with a view that injection would be below 5yr average?


Base Metals
• Manufacturing is going strong – Chinese and US PMI ticking up consistently
• US auto and housing sector – which are especially metals intensive – appear to be recovering.
• Nickel the most closely aligned with speculation and risk taking – it has the highest $/ton so lowest storage cost.
• Hence it is also the most vulnerable to reversal in investor flows
• A decent RV trade for shorting risk appetite? -> Long copper short nickel
o Short nickel could also be a way to bet on Chinese lending tightening. Suspicion is that loose money has caused many companies to stockpile metals for SHFE-LME arb. Reduction in credit would make that trade less profitable.

Corn
• Price has traced back after a nice run in july as crop concern over crop condition has eased.
• Thinks the general price level is low and has limited downside. Likes for a medium term long bet.

Soybean
• Export demand has been very robust and that has help push price up.
• Old crop inventory has been falling (due to high exports)

Wheat
• Supply seems ample worldwide
• In US, weather has been good for current growing season. No upside catalyst in sight.

Coffee
• News of tight supply has caused a recent rally

Sugar
• Continues to surge as below average monsoon season bodes poorly for Indian harvest. At the same time, Brazil has been getting too much rain which caused some concerns there.
• India is No.1 consumer and No.2 producer (behind Brazil)
• Fundamentals look good but did the price run too high?

Housing - Does it matter anymore?

A lot of macro guys seem to be looking at housing numbers very carefully. But I ask why? Is that to time the so-called next wave of defaults (ARMs, jumbo ,prime)? My guess is that housing defaults are not as correlated to price (although I think I saw one study that asserts 19% of defaults were people voluntarily walking away from underwater homes or something to that effect) but more to unemployment. Home prices are more of a symptom than a driver, although I reckon a drastic and swift plunge from here can have a severe (additional) feedback effect into the economy.

Home price, however, I think would serve as a barometer for the longer term picture of US economy. Karen Weaver of DB put it well:

The obvious takeaway of falling home prices and being underwater is what it does for defaults. But there's a bigger implication, which is that when we look at the economy over the past decade or two, it's been very much a consumer economy.

What has been driving the consumer hasn't been gains in incomes. What has been driving them is easy credit and rising home values. And the fact that their home price was rising and they could borrow against that through home equity lines or loans or refinancing, it augurs for a very different economy going forward if people don't have that option.

For many years Americans grew accustomed to using their homes as an ATM. I would say consumerism had gone wild in US to a point of a competitive sport. What happens if consumers never recover? I sure hope credit never becomes so easy flowing again. Good ideas usually get taken too far extreme until they become destructive.

Interesting point to ponder - but not very useful in terms of trade idea generation in the near term.

Nat Gas - Production vs Rig Count

A buddy asked me a question earlier and I thought it's worth posting here.

He e-mailed me the following charts: historical natural gas production and rig count. As you can see the number of rigs have plummeted while production has held up. How is this?

First, by definition the Baker Hughes counts drilling rigs - these are rigs that are in drilling stage and not yet in production. Think of these as future production indicator. Another way of think of is this: if rig count fell to zero then nat gas production should fall at a natural rate of depletion (wells lose productivity as more and more gas sucked out), which is estimated at around 30% a year.

Say if we started 2009 production at 60Bcf/day and there was 0 rig count throughout the year by end of 2009 production would stand at around 42Bcf/day.

BAKEGAS Index


DOEGPROD Index

Watch it!!!

Eastbound and Down - my new favorite comedy show. Going through season 1 from Netflix now. I was watching the first episode on my iPod while running on a treadmill, and I damn near fell off laughing. The only other time that happened was when I first started watching The Office (US version).

Copper - time to short?

An article on Bloomberg today - a ML metals analyst Michael Widmer commented that copper price might have overextended itself given its recent rally despite sharp rise in inventory.

I have done some work on metals inventory vs price and found that there isn't much one can infer one way or another. On a daily basis it does not seem to matter at all. On a longer horizon it works OK but then how practical is it to hold a metal position for a whole month based on last month's inventory data (this is analyzing data on monthly frequency and constructing trades that way). No clear relationship among inventory, warrant cancellations and price that I could decipher. As you see in below chart that on monthly basis inventory and price movement seem to be quite negatively correlated, but as you can see in the period 2005-2006 it is hardly a sure thing.

HOWEVER, this just might be enough argument to push me into going short copper - finally.

I did not see this coming

US job market on a rebound? This one I did not see coming at all.

The July report that just came out is actually pretty solid and looks even better once you break down the details. Manufacturing sector looked particularly good, which cut only 52,000 workers versus 131,000 in July. Probably has something to do with the auto industry.

Temporary workers fell by relatively small 10,000, which is solid as this tends to be a leading indicator for the overall labor market. All in all the unemployment rate actually fell to 9.4%, from 9.5% last month - but part of that reduction was due to reduction in the labor force base being reduced by 160,000 . Are these those who gave up on looking for jobs? You figure some of these would be offset when people decide to re-enter the job market.

This is MAJOR! We have not just a second derivative but a first derivative in reverse here! Am I a believer? No, not quite yet.

Higher metals price -> Higher supply?

Due to a huge increase in metal prices this year a large portion of previously closed production capacity (due to high cost of operation) should now be profitable again. The question is: will production come roaring back?

According to Barclays, globally around 3.8Mt of idled aluminum production, 1.2Mt of zinc concentrate, 500Kt of lead concentrate, 190Kt of nickel concentrate and 265Kt of copper concentrate production would be profitable at current prices. To put in context, those numbers are around 9%, 10%, 6%, 14% and 1.5% of 2008 total worldwide production, which are substantial. If all of that production came back online that it could really impact prices.

However, there is more to re-starting production than current price. Barclays estimates it could cost $25mm to restart each 100Ktpy of zinc mine as well as $25-50mm for capex. These are some huge sums of money especially in this tight credit environment (which could explain why miners have been so eager to sell new equity – a quick search on Bloomberg returned 225 pages worth of new stock offerings since Jan 1 2009). Given the financial constraint in this environment the producers will wait and see to make sure that higher prices are here to stay on a sustained basis – and that will introduce even further delay to restoration of production capacity.

The only place where production activity is picking up in a major way seems to be China – where the government is pumping money (their version of stimulus) to prop up basic materials and heavy industries.

Listening to various Q2 earnings calls for miners/refiners it does not seem to me like they're rushing back to crank up production just yet.

USD - capital flows?

So I am trying to get some more insight on drivers of USD. With all this talk of rush to risk taking and dumping of USD-denominated assets I decided to look deeper into the Treasury international capital flows data. As you probably know, the US Dept of Treasury provides capital flows data on a monthly basis albeit a long delay. So long that it likely is useless as any sort of trading indicator. Still, I just wanted to see if there is a consistent relationship.

Looking at monthly flows data vs performance of DXY Index the answer seems to be no. Doing a rough stat analysis (my favorite kind), out of 114 months starting Feb 2000, only in 51 months did DXY move consistently with flows data (outflow = DXY down, inflow = DXY up).

Just looking at the data since the start of financial crisis, the relationship isn't clear. In Dec 2008 DXY dropped huge 6% despite net inflow of $70B, and the index gained about 8% in Jan and Feb 2009 despite total net outflow of about $230B. The first chart shows the relationship.

I did some further analysis including trade data, but that did not shed any additional light.

On an interesting note, below is rolling 12months net capital inflow for US. This persistent positive capital inflow is needed to offset as persistently negative trade deficit. Despite the huge inflow during the crisis period US is looking like it is having trouble attracting foreign capital. Where is it going to from here? An interesting economic question but probably not one that provides a tradable thesis.