Macro Trading Update

Submitted by Nic Lenoir of ICAP

The breakdown in correlations has many traders confused, and the light volumes are not really making trends easier to spot. However, this is something we had warned about and we have been monitoring on several occasions using the 90- or 120-day correlation between gold and stocks. Our assessment was that the correlation would at best go to 0, and in case of severe market movement possibly inverse and go down around -0.80 after 9 months when commodities and equities traded in perfect harmony. Traders have been pointing out that with EURUSD where it is trading right now we "should" (assuming the same market dynamics that have ruled markets since March 09 are still in place) have SPX under 1,000. The question is what now? Let's look at markets individually, which is always the approach we favor given that correlations are as good as they last.

For one thing as long as the S&P futures are stuck between 1,085 and 1,115/1,119 we have little to get overly excited about. The story of the S&P future is one of exacerbated and shameless bearish divergence, and lately we might add acute boredom. By any technical or historic measure we are still expecting a sharp correction lower in equities, but we won't try to front-run the market as we have wasted a lot of exhaustion of short-term indicators in a narrow range, and the Dax has broken out to the upside. The only certainty is that when the market breaks out, whether it's up or down, the move will be sharp. If we manage to stay in that range until next week we would consider January or February 1,100 straddles as the realized vol of the move coming up should far surpass what the Vix is pricing as it continues to drop.

Different story for foreign exchange markets and Gold where markets are trending impressively. Gold is testing a key support here as can be seen on the daily chart, and we have divergence of momentum indicators on a 3-hour and hourly scale. However a clean break here along with new lows in RSI on the hourly chart would indicate we have more to go and we will go challenge 1,026 or even 992. Again I would like to point out that at this point breaking 992 would invalidate that we remain in a bull market. So if we fail to close above 1,092 we are bound to go challenge the key trend support. Conversely a hold here would open the way for a retracement to 1,142 or 1,171. Note however that even if we bounce here it is unclear the market will resume right away its bullish trend as the recent sell-off has the structure of an impulse, which is not a satisfactory pattern for a correction.

EURUSD is clearly not done selling off either. We are in wave 3 lower, and the sub-count of the 3rd wave detailed on the hourly chart shows we are most likely still within sub-wave 3/. Given that the 200-dma is at 1.4194 and daily RSI is at 32 it is possible that we bounce here for a coupel days, but the resistance is now 1.4666 and if we bounce there we still have potential to go down to 1.4080 as part of the current impulse. In short, the downtrend is intact for now and there are no reasons to assume we will not keep going. Fairlue is thought to be around 1.20/1.25, and given the woes of the weaker economies in Europe and the backlog of unreported credit losses of German banks, we could well go trade below fair value for a change at some point in the second half of 2010.

Finally US treasuries remain under pressure today. The next support zone for the 10Y future is 115/115-25, and in the medium term we target a re-test of the key support and neckline of a massive H&S at 113-25. A break there would probably spell a lot of trouble.

Good luck trading,

Nic