Commitment of Traders

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.

In Late 2006, the S&P 500 futures market traded around 1435 and the commitment of traders was at an extreme net long position. The market fell shortly after only to manage a miraculous rise in the face of hedge funds going bust and an exploding and over-leveraged credit market. In mid-2008, the S&P 500 futures also traded around these levels, from where the epic collapse really began. Six years later, the S&P 500 futures traders are the most bullishly positioned they have been since those heady over-confident days. Still believe the talking heads that there is money on the sidelines waiting to be put to work? Still convinced that there will be some epic rally if the 'fiscal cliff' fallacy is resolved? Positioning (real money) trumps Sentiment (AAII surveys etc.) every day in our book. The Bernank will be pleased at his success.

At a time in the year when the market should be at a standstill, and when all trading should be over, the tension in the S&P is unprecedented, driven by two main factors: the ongoing Fiscall Cliff confrontation, which now appears set to not be resolved by Christmas, and very likely to persist into the new year, and what happens with hotel AAPLfornia, as suddenly it has become a liability to show LPs any holdings of the fruit in the year end statement. The two events combined will likely see furious market volatility persist well through the year end, and since volumes will further die down, we may well see massive stock moves on odd lots. And while AAPL is trading under $500 for the first time since February following last night's Citi downgrade, the confusion over the Fiscal Cliff persists, with The Hill first reporting that Boehner is willing to cave on the debt ceiling extension,  even as Boehner himself subsequently tweeted that "Any increase in the debt limit will require a greater amount in spending cuts and reforms." So back to square one, with a red herring proposal that Boehner can say we offered to the president and the president turned down. Japan continues to attract a lot of attention with the ADHD market desperate to hope that the coming of Abe 2.0 will be much better than that of 1.0, when in one year he achieved nothing and then resigned due to diarrhea. Judging by the action in the USDJPY, we may be a few short hours away from closing the gap that sent the pair to 84.30 first thing, and proceeding to unwind the near record JPY commitment of traders short position as the JPY realizes this time will not be different. Quiet calendar in the US, with the Empire State Manufacturing Index expected to print at -0.5 at 8:30 am Eastern, TIC data to show China's ongoing TSY boycott at 9 am, and a hawkish Jeff "Mutiny on the Eccles" Lacker speech at 1 pm.

The US dollar moved lower over the past week against the major currencies, with the notable exception of the Japanese yen.  The greenback's technical tone has deteriorated.  The euro and sterling appear to have convincingly broken above significant down trend lines.  With the holiday season upon us, there seems to be no compelling technical reason not to look for a continuation of dollar weakness into the end of the year.  Few are incentivized to fight the trend.

The extent of the Fed's easing, and the implication of its guidance, suggests an even more dovish posture than the expansion of QE3+ (remember it was purposely open-ended, unlike QE1 and QE2). While the euro zone economy appears to be contracting this quarter at a slightly faster pace than in Q3, the slowdown in the US is more dramatic.  Growth may be more than cut in half from the 2.7% annual pace seen in Q3.   The fiscal cliff is the main cause of consternation at the moment.  Although there is private negotiations taking place, the public posturing is what investors have to guide them, and it is not particularly flattering.

Remember when back in March Goldman presented the "Long good buy: the case for equities", when they, and everyone else of course, said the once in a generation opportunity to short bonds and buy stocks is here (and when BlackRock chimed along, saying the time to go all in... BlackRock ETFs.... is here)... Or when in September, right after QEternity, Goldman, having blown up previously on said trade, reiterated its call to go long stocks and short bonds (and when BlackRock chimed along again, saying the time to go all in... BlackRock ETFs.... is here). Well, so much for that. Or rather, those. As of last week, the speculative long exposure in the 10-year Treasury more than doubled in the past week, soaring from 79,296 to 169,456 net contracts, the highest position since March 2008. Looks like Uncle Ben will need to come up with more creative and counterintuitive ways to get traders to stop frontrunning him in purchasing every bond in the open market, and herd them into buying stocks...

Gold climbed $11.80 or 0.69% in New York yesterday and closed at $1,712.70. Silver surged to a high of $32.232 and finished with a gain of 1.36%.

Gold in USD (2 Year) With Support At 100 and 200 Day Moving Averages - (Bloomberg)

The slings and arrows of outrageous EUR positioning remain key to figuring out where next in this on-again-off-again currency. The last six weeks or so have seen a dramatic regime shift from smooth transitions from risk-on to risk-off to more staccato-like jumps and trends as the world hangs on every rumor and flashing red headline. We note three things that may be critical to understand where we go next: 1) EURUSD has entirely recoupled with its EUR-USD 'swap-spread' implied fair-value - removing the 'chaos premium' in the pair, and providing less room for upside without broad-market agreement; 2) EURUSD has decidedly lagged the very impressive rally in European sovereign risk (suggesting the latter may be a little over-exuberant); and 3) Despite every talking head telling you about 'all the EUR bears', both Commitment of Traders and Citi's FX positioning indicator have shifted notably more positive - with the latter, as Steve Englander notes, beginning to show significant EUR longs. Now that an active segment of the market actually seems long EUR and associated currencies, the 'good news' bar is a lot higher, and the impact of bad news will be more readily visible.