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ICAP On The Correlation Collapse
Submitted by Nic Lenoir of ICAP
We have been making a case for long USD positions against JPY, AUD, and EUR recently. A quick look at the DXY chart shows that a close through the 50-dma would trigger a collapse of a massive carry trade. We are no there yet, but there are reasons to believe it is a strong possibility.
First looking at the Gold chart, the weekly candle is dreadfully bearish, we have had weekly divergence on every new top since 2006, and we failed close to the multi-year channel resistance which is currently at 1256. So technically, while the reversal pattern is not complete yet, since the bearish hammer needs confirmation next week to form an evening star, we have quite a handful of bearish elements.
Then we looked at the 90-day correlation between gold and stocks. We find interestingly that the market goes through approximately 1 year cycles of sharp positive or negative correlation, the interesting constant being the duration of the cycles. They correspond to various states of market regimes. The past 9 months have been marked by a strong correlation of all risky assets. After a strong period of risk aversion, low rates and government backstops have pretty much encouraged money managers to buy anything other money markets in low yielding currencies. Interestingly it looks like we are at the peak of this correlation cycle, and the post NFP price action this morning with equities AND the USD rallying while commodities are being sold aggressively is a good confirmation of what our correlation cycle peak indicates. Note that this is a 90-day correlation, so the correlation chart will reflect the turn with a lag. Being at the top basically mean we have already turned.
A turn in correlation can mean two things: the first case is that we enter a period of consolidation as part of the simultaneous bull market in commodities and equities where the correlation will go down to zero before picking up in a year as the next leg of the bull market starts. This would leave us with a year of choppy price action where the various asset classes decorrelate and little progress is made. The second case is a return of risk aversion. In that case the correlation would get into a negative 1Y cycle which has historically been synonymous with asset destruction. One thing is for sure, the short-USD buy anything else regime is now over, and certainly this will have interesting consequences on relative value strategies. An easy conflicted sector comes to mind and it is commodity stocks. If commodities and equities decorrelate, then surely there will be a downside story no matter what to stocks in the commodity space, which means the best one can hope would be to break even. Selling calls can be a good way to express the view.
Bear in mind, as the chart of the correlation between Gold and CPI shows, there is no comparison possible with the last gold spike of the last 70s in terms of underlying framework. Gold has been a reactionary trade against fiat currencies and a hedge for asian central banks against their USD holdings. The trade is basically a carry trade, and has been fueled with a lot emotion with targets of 5,000 being mentioned for the most enthussiastic analysts. However, it is all conditional on a sharp pick up in inflatoin that has yet to manifest itself, and with 10% unemployment and quite a bit of capacity slack it is doubtful that this scenario is imminent.
Since I started typing the S&P futures have reversed their advance, not surprisingly so as overall when market structure breaks down it tends to affect equities negatively. We will watch carefully 50 day moving averages in FX, and the 100-dma in Dax. We have also been pointing out the strong divergence on daily scale of the S&P and DAX the past week, so we have a pretty strong case for a reversal building. Brace yourselves, this move could have some legs.
Good luck trading,
Nic
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As long as Bammy is on TV touting his magical works, this aint going to happen. God, I just cant stand his bragging and those fools cheering in the back ground.
He must truly believe that his poop doesn't stink.
It's one thing to be a BS artist - it's something entirely different when you believe it yourself. Behold!
I concur!
He's only saying what he is told to say and he believes what he is told.
“You go into these small towns in Pennsylvania and, like a lot of small towns in the Midwest, the jobs have been gone now for 25 years and nothing’s replaced them. And it’s not surprising, then, they get bitter, they cling to guns or religion or antipathy to people who aren’t like them or anti-immigrant sentiment or anti-trade sentiment as a way to explain their frustrations.”
IMO law and order in the coal and rust belt hangs by a thread. The middle class is being pushed down and the lower class is expanding. And the lower class will hold its peace for only so long. Then there will be violence.
"when people lose everything, they lose it"
-forgot who originally said it but celente always says it
gee Marv,
...a great feat of pontification you have going there. Nothing stops the vampire squid from sucking prosperity out of the middle class like guns and religion - if you dont understand that you soon will, even the white shoe boys (as calente calls them) at GS and JPM will. Maybe before the last job is outsourced to china - they get good tax breaks i hear.
Ok, nevermind, back to glib erudite armchair replay of world events, we'll catch the social breakdown later on the nightly wrapup, man you guys are good, ...funny too.
Uhh Anonymous, that's a quote from Barack Obama when he was campaigning for President.
Thanks NIC for your input. We too are closely watching a breakdown in the "previously established correlations" that have developed over the last several months. They (if develop) will be subtle, but good indicators for future potential trends that could develop into 2010. Thanks buddy...
Looks like the "Kolivakis filth gear" is broken. Whatever is going on, it doesn't look bullish. Two days, two reversals? This is not a healthy market. Given the level of government backstop to get us here, I would venture to say that there is virtually no "real" equity in this market. There is a flashing warning sign to get out. If you haven't, don't tarry.
I do not get how this gold chart is bearish.
Even if gold reacts from here somewhat the uptrend stays.
No signal of trend change here.
The risk-trade might include paper gold, but considering bullion risky is strange.
Moreover, not only gold but stocks and bonds are down too.
If that should become a trend, Uncle Sam will have to pay way more for borrowing money what makes the deficit worse. To ease matters Ben prints money that goes to a part into gold…
how can you have a "massive" carry trade if no one is lending? there is no carry trade in assets that don't provide a carry
I wonder if it is the banks themselves, taking the reserves and speculating with them.
That's kinda the way I assumed it to be, but then again I don't know anything.
1) Prime brokers are doing EVERYTHIGN they can to gain market share, including upping their advance rates. Hearing they are allowing leverage above & beyond 3x even on the most illiquid stuff as if THEY LEARNED nothing and hope to experience a hysterical illiquidity sell off once again. That margin lending is usually indexed to LIBOR
2) Dont forget how much the Fed is lending, at 25bps or less. The Lender of last resort is allowing for virtually unlimited borrowing at nearly nothing. That liquidity is turned around and pumped into financial assets.
Regardless of paradox, the carry trade lives.
AUD 3 month notes pay the carry. That's just off the top of my head. There are probably other opportunities in the Brazilian Real, too.
Frankly I disagree with the gold inflation corelation. It seems that Nick forgot to mention lack of confidence as another gold bull factor. I think today tanking of gold through dollar pumping,could have been organized by the big banx on purpose.One has to know when is the delivery date for the Dec contract and how many contracts has been liquidated through stop losses. I honestly believe that every extra dollar that foreign banx will have from now on will be transferred into gold,not because of a love relationship,but for lack of confidence in the fed actions.
The 50ma of dxy was 75.74, currently,it is 75.81. A break out?
How do you like gold now, bitches?
Hope my post doesn't get censored again.
We will make new equity lows according to my charts and my USD indicator has been giving BULLISH warnings for some time and I'm still expecting a dollar rally.
My indicators can identify trend changes before they occur.
They warned me of an impending market crash back in early *2007*
http://www.zerohedge.com/forum/market-outlook-0
The problem is that Superfly has taken credit for the current state of the market.
He will also be forced to own what happens next.
Great note, Nic. Thanks for sharing it with us.
I read these pieces with great interest & today was no exception. If I follow correctly (which admittedly is not always the case) the correlations will now reverse. If gold went up in sympathy with the S&P, isn't the reverse correlation that gold would go up as the S&P goes down? (If you chart gold & the dollar, the inverse correlation hasn't been quite so literal since late-2008 so, presumably, the reverse of the inverse will be similarly impure...)
In other words, I can "agree" & still see gold going higher in 2010.
Just my two cents...