From Nic Lenoir of ICAP
It is not a new theme: asset prices are a function of liquidity expressed in USD. This is the direct result of inflation in USD denominated products having become a pure function of credit creation in our post-2000 world economy where the US has a low enough capacity utilization that wage inflation no longer exists, all commodity prices are expressed in USD, most products are traded in USD, and emerging markets are driven by credit-generated Western demand given the mercantilist nature of their economies. We have spoken on this at length in the past showing the effect on asset prices of the printing press, and conversely the dangers of a strong USD when 2/3 of global liquidity is actually not denominated in USD (this figure is slightly misleading given the fact there are other currencies indexed on the USD but certainly it is close enough to give an order of magnitude). If there are still any doubters just look at the weekly Gold chart since 2001, and then compare it to global aggregated liquidity expressed in USD for the same period. Both charts are using a log scale... enough said.
My entire focus right now is on the commodity complex. The reason why is simply because I believe the post-dotcom economy is completely unsustainable, and this is not only starting to be very much apparent to the general public but also fiscally very expensive to maintain. However, governments are inventing all sorts of accounting trickery, legal vehicles, and running the printing presses overtime in order to preserve the status quo. Maintaining this situation, which is quite the opposite of an equilibrium (consumers don't produce, structural deficits, unfunded liabilities, pegged currencies preventing the markets to rebalance trade etc...), will lead to bubbles and complete mispricing of financial assets. Only when financial markets are taken to extremes that provoke public anger turning into violence will politicians be forced to actually think of the structural issues without having the luxury of hoping that the next one in the seat will be the one facing the task. If bonds sell-off riskier assets will be repriced lowed to reflect higher rates in turn provoking greater demand for bonds. So the most likely culprit for the end game will be commodity prices since nobody will ever complain if stocks rise 400% (a 10% drop is a national emergency). Only when commodity prices are high enough that they put the entire system at risk will we be forced to let nature take its course, companies and governments default, and experience the deflationary shock that we cannot ultimately avoid. This reflection became much more concrete than theoretical when I watched on the news cops dressed as civilians being lynched by the Tunisian mob over the weekend.
This led me to look closer to commodity markets and assess where we stand. First it seems clear to me that Gold is not really the relevant commodity to follow because it is an investment and does not hurt the consumer. Instead I feel the Rogers Commodity Index is a better proxy as it encompasses the broader commodity complex as an asset class. In terms of Elliott Wave consideration we have pretty much a classic 5-leg impulse since last July which means a correction is quite imminent. This by the way is pretty much in line with observations made yesterday that VIX is at levels where risk usually is repriced. I was in favor or reloading DXY longs at 78.80 yesterday. As long as the 61.8% retracement at 77.85 is not bypassed I would stick with the trade, especially given the fact we made money during the last rally in early January given us staying power in the trade. Another way to express this trade would be to sell AUDCAD here as we retested the 50-dma, observing a stop if we bypass 1.0030.
Concurrently this made me rethink my outlook on Fixed Income for the very near term. While I have been an advocate of Bund underperformance, the market seems to be struggling to move lower here. I would close out shorts and even consider a tactical long to play a pull back towards 125.50 before we sell off toward our medium term 121.45 target. I think 10Y US Treasury futures have overall not really traded like they made lows yet since mid-December but I see resistance around 121-25 so I would be rather neutral here after yesterday's sell off as we are in the middle of the range here.
Last but not least even though it is not related, I would also recommend closing the EURCHF / European equities trade we recommended in late December. I added the chart showing the spread between the 1M change in EURCHF and Eurostoxx, both adjusted for their implied volatility. As we can see the gap in the risk aversion shown by the EURCHF pair and the the risk appetite shown by European equities has been filled.