Commitment of Traders
We have one simple question - does the following small drop (which we happen to have seen before) in Gold ETFs, which at least according to the mainstream media, has been responsible for the recent slide in the price of gold, appear to justify the absolute surge in gold futures and options short exposure as per the Commitment of Traders report, which for yet another week, saw the biggest net short positioning since 1999. And no, we are not really confused - as we said "according to the mainstream media"...
The US dollar rose to new multi-month highs against several of the major currencies, including the euro, Swiss franc, British pound and the Japanese yen. The BOJ, BOE and ECB meet last week and none changed policy. The Swiss National Bank meets on March 14 and is also unlikely to change policy. The Federal Reserve meets the following week and is widely expected to stay its course. It is not monetary policy then providing the new trading incentives.
Nor can the dollar's gains be attributed to political uncertainty in Europe stemming from the inconclusive Italian elections, as was the case previously. The immediate shock has worn off and Italian stocks and bonds have recovered the lion's share of those initial losses.
Overview of the drivers of the fx market, a discussion of the price action and a review of the latest Commitment of Traders report from the futures market. Contrary to ideas that QE3+ is the dominant force and dollar negative, the net speculative position is now long dollars against all the major currency futures but the Australian dollar and Mexican peso. The dollar's gains though appear to be a function of events outside the US.
Instead of looking at the daily bar charts for the major currencies that we provide every week, given the large moves, we thought it might be helpful to look at the longer term charts. It is one thing for pundits and other observers to argue that QE drives currencies down, it quite another to operationalize and use that as a decision-making rule for investing or trading the foreign currencies. The way people make money in the markets is not being right more often, but disciplined risk management. Technicals allow one to quantify risk and admit where one can be wrong.
An overivew of the price action in the foreign exchange market and what it might mean in the week ahead.
Here is a review of the technical condition of the major currencies. In my professional experience, I know few purist fundamental traders in the foreign exchange market. Even for those, like myself, who study the macro economic and political fundamentals, technical analysis allows us to quantify the risk. Those who make money in the markets, do not do so because they are right more often, but rather they are disciplined risk managers. Technical analysis provides a way to manage the risk by helping to identify where we are wrong. It is offered here not as a substitute for fundamental analysis, but as a complement.
Here is an oveview of the forces that are driving the foreign exchange market and price targets for the euro and yen. We identify the ECB meeting as a potential challenge to the existing price trends, but expect it to see the tightening of financial conditions in the euro area as partially a reflection of positive forces, especially that banks have reduced, on the margins, the reliance on ECB for funding. Draghi will likely attempt to calm the market down with words not a rate cut. Also we see the "currency wars" as being exaggerated, not just because the foreign exchange market has alsways been an arena of nation-state competition, but that it is primarily in the realm of rhetoric among the G7 countries. Few, including Germany, who have expressed concern about what Japan is doing, have objected to the Swiss currency cap. There is not a bleeding over into a trade war. The push back against the Japan (among the G7) appears to have slakcened a bit. Officials prefer Japan not provide price targets for bilateral exchange rates (like dollar-yen), but if stimulative monetary and fiscal policy weakens the yen, that is ok.
Here is a weekly over view of the currency market from a technical perspective. The divergence between the performance of the dollar against the euro-bloc, with the exception of sterling, and the other major currencies is noteworthy. In the analysis, I suggest a few opportnities for near-term contrarians. I fully appreciate that some readers eschew technical analysis and regulate it to the same space as numerology and witchcraft. Yet, even still, it is useful to recall Keynes' view that the markets are like a beauty contest and the trick is not to pick who one thinks is the most beautiful, but to pick who others will think most beautiful. Moreover, technicals allow one to quantify how much one is willing to lose in a way that fundamental macro-economic analysis doesn't. It is a tool then for risk management.
There have been some large moves in the foreign exchange market in recent days. The euro posted its largest rally in four months last week. The yen has fallen to its lowest level against the dollar since June 2010 and extended the declining streak to nine consecutive weeks, something not seen since 1989. The Canadian and Australian dollar rose to multi-moth highs, as did the Mexican peso.
In last week's technical note, we suggested the key question whether the sharp drop in the major foreign currencies following the avoidance of the full fiscal cliff in the US was trend reversal or overdue correction. We favored the latter and looked for the underlying trends to continue. They did.
Now market participants face a different question. Given the out-sized moves, have the trends become stretched? The answer, we propose, is more nuanced than last week. There is not one answer for all the major currencies we review here.
Having moved to the sidelines due to the uncertainty of the US Presidential election and the Fiscal Cliff negotiations (as well as the holidays), investors are beginning to creep back in the marketplace. And they’re in for a surprise.
Gold dropped $8.20 or 0.49% in New York on Friday and closed at $1,656.30/oz. Silver slipped to as low as $29.22 in London, but it then rallied to as high as $30.25 in New York and finished with a gain of 0.2%. Gold finished down 0.05% for the week, while silver was up 0.53%.
Friday’s U.S. nonfarm payrolls for December were 155K, 150K was expected and this was down from the previous data of 161K. The unemployment rate was still an elevated 7.8% suggesting a frail U.S. jobs market.
One of the most important decisions participants in the foreign exchange must make is whether to view the dramatic pullback in most of the major foreign currencies seen in the early days of the new year as a reversal of the trend or as simply an overdue correction. Our technical analysis sides with the latter and we anticipate renewed dollar weakness in the period ahead.
We would be forced to reconsider if the euro fell through the $1.2980 area or if sterling fell below $1.60. Although the dollar's sharp gains against the yen have left it over-extended, we see no compelling technical sign that a reversal is at hand. Just like ECB's Draghi wielding Outright Market Transaction scheme drove down Spanish and Italian yields, Japan's Abe's rhetoric has been sufficient to drive the yen down without lifting a finger or spending cent.
While we first presented this chart over the weekend, we believe it is worth repeating the rather amusing correlation between the collapse in net VIX futures non-commercial spec interest (yes, the traded VIX, which courtesy of the New Normal's relentless synthetic reflexivity has a huge impact on the trillions in underlying assets: think massive leverage) as per the CFTC's weekly commitment of traders report, and the arrival of Brian Sack's replacement as head of the NY Fed's trading desk, Simon Potter, the same former UCLA Econ PhD who recently delivered a very ornate speech explaining central bank interactions with financial markets "through the prism of an economist." Now at least we know how said "interactions" look outside of "Market Manipulation for Econ PhD Dummies" and in practice.
There were some readers who took offense at our "bloodbath" recap of yesterday's market action (modestly different from that provided by MarketWatch). And, all else equal, a modest 28 step drop in the E-Mini/SPX would hardly be earthshattering. However, all else was not equal, and based on peripheral facts, the reason for our qualifier is that as of last week virtually nobody was prepared for a move as violent and sharp as the one experienced in the last minutes of trading yesterday. In such a context a "mere" 1.5% drop in the futures market has a far more pronounced impact on participants than a 10% or even 5% drop would have had, had traders been positioned appropriately. They weren't. So what was the context? Let's find out.
The holiday week saw the dollar consolidate against most of the major currencies. The yen was the main exception as its losses were extended under the aggressive signals coming from the new Japanese government.
At the end of the week, the other key consideration, the US fiscal cliff made its presence felt. The recent pattern remained intact. News that gives the participants a sense that the cliff may be averted encourages risk taking, which means in the foreign exchange market, the sale of dollars and yen.
News that makes participants more fearful that the political dysfunction failed to avert the cliff and send the world's largest economy into recession, generally see the dollar and yen recover. This is what happened in very thin markets just ahead of the weekend as Obama's ling last ditch negotiating stance seemed to reflect a retreat from his earlier compromises.