Gold & JPY

Please have a look at the following gold/jpy chart (price of gold measured in yen and not in dollars):




It is striking to see that gold (despite being in the news headlines) has not moved anywhere really in the last 7 months or so. The story behind everything (gold, oil, equity markets, euro, Asian currencies, BRIC currencies etc.) is just dollar weakness.

It is Hard to be a contrarian....

1) It is hard to be a contrarian. It is hard because going against the main stream is already quite a difficult thing. There are common wisdoms and a contrarian just does not buy them. There is a trend in place and the contrarian keeps suffering each day because ‘’the market is always right’’. A contrarian keeps asking himself whether maybe, just maybe his view is wrong and he is missing some crucial elements that the majority of the market can see.
2) From such a contrarian perspective the famous statement from Mr. Keynes comes to mind: ‘’The market can stay irrational much longer than one can stay solvent’’. In current markets that would apply to the strong rally in equity markets. This market could continue to move up for all the consensus reasons such as the belief that the worst is behind us, that the economy will pick up strongly in 2010, that China will replace the US or simply because we are entering into a phase of asset price inflation.
3) Another strong consensus view is the bearish dollar view. Every week there is a new famous person that is seeing it as an inevitable fact that the dollar must go lower. After the IMF it was Pimco then Buffett and finally Stieglitz. Tough to be a contrarian against such heavyweights.
4) The Jackson Hole central bank conference resulted in a signal that the world central banks will keep rates low for the foreseeable future. So the liquidity charged equity market rally can continue and it did so accordingly this morning. Consequently the dollar remained under pressure.
5) I am not buying into that whole scenario. The world is still leveraged. Current valuations seem to expect the rosiest of all worlds. The liquidity bonanza cannot go on like this for ever. Following my philosophy to sell when its high (and when all others are buying) I will build an equity markets short position this week (by buying puts on the S&P).
6) I am also looking to buy the dollar against the consensus view. I expect us to keep range trading until labour day (Sept 7th). If my scenario of a rather big move lower in equity market materialises, the dollar will go up on the back of this.

Time for a spurious correlation to get tested?

What do we mean?
It feels like the market has fallen in love with the very questionable correlation of Equities UP EURUSD UP and Equities DOWN EURUSD DOWN
Why do we say questionable? The fact is that this relationship has worked well during the financial de-leveraging period seen between July 2008 and March 2009. However outside of that period that relationship is spurious at best. In fact when one looks back to 1995 to a period incorporating both bullish and bearish equity trends and bullish and bearish USD trends the relationship does not hold up to scrutiny.

In the equity bull market period of 1995 to 2000 the pretty close relationship was that Equities went up and the USD went up and equities went down and the USD went down. Overall during that period we had a bull market in Equities and a bull market in the USD as capital flooded in the U.S.A.
Between 2000 and 2002 as equities fell the USD also fell overall. In both markets the most impulsive part of the move came when Equities fell sharply from March 2002 to August 2002 and the EURUSD went from .8600 to 1.02.
From March 2003 to December 2004 as Equities rallied strongly the relationship broke down and higher equities also saw a weaker USD(Could it be that the move to artificially low rates by the Fed of 1% by June 2003 and held there until June 2004 provided cheap liquidity to invest around the World?)
But, then in 2005 as Equities continued to move higher the USD then strengthened. Why? There were predominately 2 reasons.

Firstly by the end of 2004 the whole World was bearish USD and short accordingly and then in 2005 we had HIA (The homeland investment act) which provided a once off benefit to companies to repatriate overseas profits at preferential tax rates. As a consequence of this once off event the USD strengthened for most of 2005.
Then from 2006 to 2008 we once again saw the USD weaken as equities went higher continuing the trend in place since 2002.
From mid 2008 we have pretty much seen the de-leveraging trade where lower equities gave a strong USD and vice versa as risk positions were unwound, credit stresses were severe and USD funding was a big issue for the Europeans
The dynamic today, however, does not seem the same as then. A lot of the USD funding stresses seem to be behind us, the TARP and the stress tests seem to have soothed the financial market concerns. U.S. interest rates are effectively at zero, the housing market remains stressed and the economic data remains poor (sometimes better than expected but poor nonetheless)
The Fed has told us (As recently as today) that the USD is back to being a full blown funding currency
• Interest rates are effectively at zero
• They do not anticipate “normal” growth for a number of years to come and have little inflation concerns.
• They contemplated an expansion of “QE” (can this backdrop really make housing or Fixed income a “bargain” i.e. why would capital now flow into the U.S.?
We are effectively printing money, engaging in massive monetary easing, engaging in massive fiscal easing, running up huge budget deficits, still running a large trade deficit. Is this a set of policies that would normally be supportive of a currency? We don’t think so.
What the chart above shows is that the relationship between the USD and the stock market comes and goes depending on what else is going on.
If we accept that the dynamics mentioned above should in normal circumstances be currency negative we need to ask what would the counter dynamic be that would create contrary excessive USD demand like we saw in the 2nd half of 2008?
If we cannot answer that question and we know over time that the evidence of a constant reliable tie between the direction of the USD and the equity market is patchy at best then it is not a stretch to believe that as we have now moved from financial de-leveraging to economic de-leveraging that the USD can move in a more fundamental fashion. If so the fundamental policies noted above are likely to weaken the USD over the course of 2009 into 2010 irrespective of whether equities rally further or indeed fall. What may differ in bouts of risk on/ risk could be the currency of choice on the other side to buy against the USD.
With the U.S. consumer retrenching, losing jobs, worried about mortgages/pensions/college fees etc and SAVING the gap in an economy 72% driven by the U.S. consumer is going to continue to require a big Government presence in monetary and fiscal policy as well as printing money
As a final note on a day when the S&P posted a bearish key day reversal EURUSD had its highest daily close in the up move from the 1.2457 March low and closed over the pivot post FOMC 1.3739 peak. In addition USDCAD closed below a major technical level at 1.1465.
It is early days but this may well be the early warning sign that the USD trade is no longer the risk on risk off trade that it has been since last July and that we may be on the cusp of more sustained broad based medium term USD weakness.

"Sell the printers"

With only a few hours left until the FOMC discloses its decisions there is an interesting (short term) decoupling taking place: Equity markets are down but the dollar fails to benefit of it. This points towards more eurusd gains. It is also worthwhile to note that the market is short eurusd and eurjpy according to IMM data and this to most extreme degree of the past six months. There has also been a pickup in option trading activity with good buying demand for eurusd upside option ranging from 2 days to one week to three week tenors.
This remarkable price action confirms views of holding on to current eurusd long positions. There might be a bit of squeeze following FOMC but price action currently speaks a loud message and it is worthwhile to keep selling the printers.

Managed Futures

The top performance of Managed Futures in 2008 led many investors to flood into managed futures throughout last year and into the start of 2009 chasing those positive returns. But while the stock market has continued its slide into oblivion thus far in 2009, managed futures haven’t exactly started out 2009 where they left off last year.
Past Performance is Not Necessarily Indicative of Future Results

Asset Class YTD Performance
Hedge Funds 1.09%
Cash 0.28%
Managed Futures -0.73%
Bonds -3.21%
Commodities -3.42%
US Stocks -18.62%
World Stocks -18.82%
Real Estate -36.58%

Key: YTD performance numbers are estimates as of 2/27/09 (1/31/09 for Hedge Funds) Managed Futures = Credit Suisse/Tremont Managed Futures Index, Cash = 3 mo T-Bill rate, Bonds = Vanguard Total Bond Market ETF, Hedge Funds = Credit Suisse/Tremont Hedge Index, Commodities – Reuters/CRB Commodity Index, Real Estate = Dow Jones Wilshire Real Estate Securities Index, World Stocks = MCSI World Index (ex USA), US Stocks = S&P 500 Index

As you can see in the table above, managed futures as an asset class have merely been treading water thus far in 2009.
Now, this still puts MF at the top of the table above in terms of performance relative to the more mainstream investments in stocks, bonds, and real estate; but some of the investors who have heeded the advice of Attain and others to diversify into managed futures are starting to ask where their returns went? Their asking why managed futures are seeing flat performance if volatility remains high and stocks and commodities continue their death march to zero.
Many of those early adopters who got into managed futures just as the credit crisis started worsening (early to mid 2008) saw very nice returns the 3rd and 4th quarters of 2008 with managed futures. Many of them were used to seeing week after week of profitable movement in their accounts, and after getting used to that pattern for 20 weeks or so, don’t know what to think of this new pattern of one week up, two down, one up, etc.
Others were more of late adopters – having gotten in near the market lows (until today) over the past few months. These folks find themselves in a similar mental state, having put money into managed futures as a play to try and make some money during this bear market, but seeing nothing but flat to down performance so far.
And finally, there are those who haven’t pulled the trigger yet. There are those who are waiting in cash (hopefully), or still trying to catch the falling knife of the stock market despite many gashes in their hands (and pocketbooks) and finally seeing the futility of that game. These investors may be thinking they are too late to the managed futures party.
The question on each of these groups’ minds is what is going on? And more specifically, where are the high returns we saw in 2008? Where are the gains amid the stock market losses? What will 2009 look like for managed futures?
Managed Futures are just fine, thank you.
The short answer is that nothing is going on. Managed Futures are not broken. They are not taking a break. They have not lost their status as a great crisis period investment. They are doing just fine.
What is really going on is a bit of a perception problem, in our opinion. People were used to profits week after week with their managed futures programs as moves normally seen happening over the course of a year were happening in mere days and weeks. These people now have to adjust to a more normal environment where such moves take several weeks to materialize, and that is admittedly tough to do psychologically.
The mental problem is that we just came through one of the best periods of all time for managed futures, and with that fresh in investors’ minds it is only natural to want that period of greatness to continue along indefinitely.
It’s like your team winning the Super Bowl or World Cup one year, and then just having a winning season the next year. The winning season is nice, but you constantly lament how and why they can’t return to the big game and bring home the championship. For many of us, we aren’t content to just have a winning season – we want the championship.
Unfortunately, we can’t have the championship every year. In investing terms, this means we shouldn’t expect any investment to simply go straight up and make money month after month, quarter after quarter. One of our favorite metaphors for this is ‘trees don’t grow to the sky’, and we’ve seen with the Madoff and Stanford cases that anything which does show those types of returns is probably a scam.
Risk/Reward Mismatch
It may not be all in our heads, however; as there could be a more technical reason for the flat performance over the past three months.
Many managed futures programs use some form of market volatility to size their trades and determine how many contracts of each market to trade for an account they manage. In a simple example, if a market has a range of 10 points normally, and you wish to risk 30 points per trade, you could do three contracts in that market (30/10 = 3: risk/volatility = contracts). Now, if the range of that market, which many managers equate to the possible loss or risk of that market, shoots up to 30 points, the manager may only be doing 1 contract (30/30 = 1).
This all works fine and well most of the time, when the market movement is roughly equal to the amount the market is moving on average over the past x number of days. But something unique has happened since about mid December through the end of February. That something is a risk/reward mismatch of sorts, where the potential positive return many CTAs are planning on has decreased because the average move of the markets they track has roughly been cut in half since the volatility peaks in Oct/Nov, while the average range which includes that Oct/Nov period has remained high.
In this scenario, trades are being placed right now with risk based off the highly volatile period, but profit potential is only based off the now lower market moves, which are much smaller than they were back at the peak of the crisis.
For example, each of the following markets has a 15 day average range only about ½ of what it was in late October, early November. Crude was moving about $6.75 per day, and is now averaging just $2.96. Corn was at an unbelievable 26.12 down to 12.98 now, and the Euro was at 348 a day versus 190 now.
So, while managed futures programs would usually love an environment where Crude is moving $3 a day and Corn 12 cents – when those levels are less than half what they were just two months ago, there is the potential for a risk/reward mismatch, where the risk is based off $6 moves in Crude, but the profit is linked to $3 moves.
This mismatch will work itself out in the normal course of business for systematic programs like APA and Clarke as the algorithms they use to measure volatility will put more and more weight on the market conditions we're in now, and less and less on those of a few months ago. Meanwhile, this may be part of the reason discretionary managers have scaled back their trading a bit; where a return to normally matched risk and reward might allow them to get back to business.
Where do we go from here?
So what is the outlook for managed futures in 2009? Most observers agree that we’re not out of the woods in terms of volatility by a long shot. And that should be a good thing for managed futures programs once the risk/reward mismatch outlined above works itself out. But no one knows for sure what the future holds. Volatility could rocket back up to the ’08 highs, or plummet from here down to the ’05 lows.
The reality is that any and all investments return to their mean. Managed Futures were due for a slowdown after coming through one of their best periods of all time. Perhaps more accurately, the economic crisis fueled market sell-off was bound to slow down (if it hadn’t, most assets would now be worth nothing), and with it slowing down so did the opportunity for profit for many managed futures programs (while risk remained high).
The reality and more normal pattern for managed futures is the positive gamma/option buying profile of frequent small losses interspersed with rare but more significant gains. The return stream will at best look like steps on a staircase, with moves up followed by relatively flat periods before another leg up, and at worst will resemble hilly landscapes with steep peaks and deep valleys. It will not look like a straight line at a 45 degree angle.
Unrealistic expectations are more often than not why investors lose money with managed futures. They may enter into managed futures during periods like the one we just came through, and expect an immediate return similar to the ones they just witnessed happen. But more often than not, the market may be going through an adjustment or consolidation after a large move which drove those returns, leading to a flat to down period just as the investor gets involved. This sort of negative feedback can lead to unhappiness and getting out of managed future just as the consolidation period is about to end and new moves may drive new profits. Don’t fall into the trap of getting in at the top and out at the bottom.
To ground oneself, investors should not equate managed futures with oversized positive returns every month, month after month. Even in this once in a century market crisis, that just isn’t realistic; and expecting such will only lead to the negative feedback loop outlined above. As the saying goes, Rome wasn’t built in a day, and investors need to let managers go through at least a few market cycles to see how they do. It is best to expect months of boredom and small losses with exciting spikes higher every now and then.
This isn’t the buy and hold myth perpetrated by your stock broker (a myth which seems to be showing its faults now that we are back to 1997 levels in the stock market), but it also isn’t a get rich quick scheme. It’s best to give a CTA program at least a full year to prove their worth in your portfolio, if not much longer. Generally speaking, the longer time frame your managed futures program operates on, the more time you need to give it to perform. Some CTAs may not even have all of their positions on for a few months after you start with them. Rome wasn’t built in a day, and managed futures managers can’t simply will their programs to make money. They need the proper set ups and market environment, and normally those take some time to set up.
Of course, unlike the buy, hold, and hope method – you should also have a worst case scenario “line in the sand” to get out of any CTA program in your portfolio if it breaches 1.5 times its past Max DD (or whatever level you are comfortable with). That is your protection from one program causing undue stress on the whole portfolio.
In conclusion, remember that the reason you probably got into managed futures was not just for the positive returns, but for the possibility of positive returns when general markets and economies are heading lower – for the non correlated performance.
But non correlated performance doesn’t mean opposite performance, it just means different performance. So there may be times when both go down together but at different intervals, or when both are up for the year but with one making the move early in the year and one later in the year. And there may be times like the last two months, when stock markets are reeling and managed futures are just surviving, trying not to lose too much while awaiting the next breakout moves which will fuel profits.
So don’t necessarily expect another round of fireworks in 2009. It may be a different year. You may just have to live with average managed futures performance. Of course, that’s the proverbial “ace in the hole”. Managed futures average performance is light years better than anything else going on right now, with a compound rate of return since 1980 of 13.5%, a worst losing period [max DD] of -15.6% (compare that with the current -55% peak to valley drawdown in US stock markets), and the last losing year back in 1999. [All numbers based on the BarclayHedge CTA Index. Past performance is not necessarily indicative of future results].

An average year….we should be so lucky!

NZDUSD: Watch the long term 76.4% Fibonacci

o NZDUSD has tested and SO FAR held the 76.4% Fibonacci retracement of the whole bull market that started in 2000 which comes in at 0.4915 (the low so far has been 0.4912).

o A close below here (preferably on a weekly close basis) would suggest extended long term losses down towards the 0.45 area with interim supports at 0.4785 and 0.4560

o If the market bounces back we suspect it would likely reflect a USD weakness story as the NZD continues to look weak across the board.

Long EURUSD

EURUSD looking set to move higher


We are going long EURUSD at 1.2825 with a stop loss at 1.2650 and a target of at least 1.33+ (55 day moving average).
The set up here looks very similar to that seen in early December prior to the sharp move higher in EURUSD.
• In late November/early December EURUSD moved lower from 1.3081 to 1.2549. This level became a platform for a sharp rally to 1.4720 over just 14 days. On 4th December EURUSD posted a bullish key day and never looked back.
• This time we have had a move lower from the 9th Feb high at 1.3095 to a low at 1.2513-almost identical to December. In addition we have broken out of the down channel from the 1.4720 high.