Splashing cash and watching rabbit ears

Flash's latest blog for paddypowertrader:

Splashing the cash and watching the rabbit ears

I’ve had a decent couple of trading days since the last blog. My risky retailers gamble paid off quicker and better than I expected; Darling’s VAT cut fuelled some speculative buying of beaten down shopkeepers, something I didn’t fully anticipate.

My thinking at the moment is that a combination of Christmas cheer, end of year relief, and Obama anticipation could be just enough to keep equities afloat into the New Year. So for the time being I’m happy to stay running with my equity longs, and I’ve been building them up a bit. In the retail sector, I have long positions in Kingfisher, Sainsburys, Marks and Spencer and Morrisons supermarkets, and at the start of Tuesday I added longs in Vedanta Resources, Game Group, Barclays and BT.

The Fed splashes out

Now that quantitative easing (a fancy term for printing money) has seriously taken hold, it’s led me to revise my opinion on gold. The Fed has been working the printing presses hard over the last few weeks. How do we know this? Well, they’re not issuing bonds as fast as they’re buying up assets, bailing out banks and underwriting bad debts. So rather than raising cash from the wider market they’re just pumping out dollars. An awful lot of dollars. This particular bailout is going to cost the US more than it cost them to do World War Two. One analyst says that it’s the biggest, most expensive programme of public spending in American history.

Going for gold

Set against the inflationary effect of printing money, credit remains tight and demand is muted, so this will have a restraining effect on prices. So I’m not expecting gold to go back to $1000 but there will continue to be some upward pressure if the dollar continues to weaken; and nervous investors are looking for somewhere, anywhere to put their money that might help it to retain its value. Commodity prices in general are likely to rise if the dollar weakens, which will also help gold.

So I’m staying long gold for now, with half my gains from my £2/pt long from $729 protected with a stop at $798, and I added to my position this morning by buying another £1 at $817, with a stop set at 798. This is because I’m anticipating a bit more downward slippage for the dollar, particularly against the yen and the euro, and because I think commodity prices in general are showing signs of firming up over the next few months.

Don’t believe the eurohype

I missed out on most of the currency moves; I was away from the screen for most of Friday and Monday, and so didn’t find a good point to get in. There were some great trading opportunities on offer in EUR/JPY and EUR/USD, but I just wasn’t there at a moment I felt confident to put the trade on. Despite the monster gains in the indices since last week, the dollar is continuing to weaken against the yen. My GBP/USD short was stopped out for a £500 gain at 1.53, and my EUR/GBP short is finished too – stopped out for around £50 of profit. But, looking ahead, I’m still inclined be bearish on the euro, even against sterling – bits of the eurozone are in such poor economic shape that even if France, Finland and bits of northern Europe only get ‘mild’ recession, other places – particularly eastern and southern Europe will have a seriously dragging effect. Unemployment, plummeting property prices and very weak demand will leave all currencies battered, but it’s hard to see how European Central Bank will be able to manage the very different needs of its constituent countries. These tensions are going to cause some structural problems for the eurozone, which might not be able to shake off recession as fast as the UK and the US. So I’m looking for an entry point to go short EUR/GBP again.

Is the dollar’s run done?

Does all this mean the dollar will weaken substantially? I’m not so sure. If credit wasn’t so tight, then we’d see huge capital flows into the economy, and soaraway inflation. But perhaps the money being printed is offsetting the money that has been blown up in the process of deleveraging. Trillions of dollars have drained away as share prices have collapsed, banks have written off assets and complex derivative bets have gone horribly wrong. There’s also the effect of ‘dollar repatriation’ where investors sell off risky assets overseas and stick their money back under the mattress at home. A lot of funds have been selling hard, because everyone wants their money back, partly to avoid defaulting on their debts. Everyone, Flash Rabbit included, is conserving as much cash as they can.

And a bit of inflation, in a period where demand is weak, could be a good thing. Inflation means that the value of debts go down quicker over time, relative to wider price rises; in times of inflation, basically debts ‘deflate’. Plus lower interest rates will work through. It’s going to get cheaper to borrow money, if you can find someone who’s willing to lend you some. Across the developed world, fiscal stimulus is temporarily putting a bit more cash in people’s pockets – much needed cash. As interest rates fall, households and businesses will find their debts easier to pay, with more disposable income trickling back into the economy.

Beware the ominous rabbit ears

But – just take a look at the long term chart on the S&P 500, which looks suspiciously like a classic ‘double top’ or pair of rabbit ears. We are back at the 800 levels of 2003 and 1997. Doesn’t look like it’s headed back up to 1500, does it? The best we can hope for is a sideways move or some sort of slow ‘slope of hope’. There’s some resistance at the 750 – 800 level but if we drop below this then we are a looking at 500, or much, much worse.



And yet – a lot of equities are still trading cheaply, even in relation to reduced future earnings. And governments are pumping out the policies and cranking the printing presses like there’s no tomorrow (because perhaps there isn’t).

By the end of January we could well see another 2000 point move on the Dow – and I’m not confident to say in which direction it’s likely to be. Remember the Dow was trading well above 10000 eight weeks ago! And it’s precisely the existence that ‘wall of worry’, that uncertainty and anxiety, that makes me think that this is a good opportunity to be cautiously bullish. If you can withstand the inevitable volatility, my view is that for a good number of large cap equities, the risk/reward ratio is to be found more to the upside than the downside, at least for the next couple of months.

Meltup, and meltdown

Total nightmare. At least Flash had the sense to buy some gold this morning. And is Citibank safe?

Reuters has this:

NEWS
- G20 leaders head to U.S. for summit to address worst financial crisis in 80 years
- Euro zone data shows bloc went into recession in Q3, first time since common European currency formed
- U.S. retail sales suffer record decline in October
- Citigroup Inc to shed 10 pct of global workforce. Sun Microsystems Inc cutting 5,000 to 6,000 jobs
- GM's Opel seeks 1 billion euros in German state aid, Western Europe car sales plunge 15.5 percent in October
- Freddie Mac reports record $25 billion quarterly loss, draws on $100 billion Treasury Department lifeline
- U.S. Fed Chairman Bernanke says central banks worldwide ready to do more to support faltering growth - U.S. Senate to take up auto bailout bill, unemployment on Monday
- U.S. banking regulator unveils plan to prevent about 1.5 million foreclosures, breaks ranks with Bush administration
- Pakistan asks International Monetary Fund for $9 billion bailout
MARKETS
- U.S. stocks fall, Dow <.DJI> slides 337.94 points, or 3.82 percent. Dow slides 5 percent for the week
- European stocks close higher as oil shares storm ahead
- Stock markets up in Asia <.N225>, but pare sharp gains by half
- Oil drops 2 percent as Euro zone enters recession
- Interbank lending rates for dollars up for second day
- Dollar rises against a basket of major currencies, falls against the yen
- Gold futures up more than 5 percent in heavy buying ahead of G20 summit
QUOTES
"By working together, I'm confident that with time we can overcome this crisis and return our economies to the path of growth and vitality." - U.S. President Bush in his weekly radio address to air on Saturday.
"The funds and guarantees that may be required would be invested in product development and manufacturing sites in Germany and would by no means be spent outside of Europe." - Opel statement.
"You'd have to be a brave investor to be a bargain hunter now. There are bargains out there, but you'd have to be prepared to hold them for a considerable amount of time." - Peter Dixon, an economist at Commerzbank in London.
"People are going to wait on the sidelines and see what comes out of (the G20 meeting) before they start to take a view with respect to what's going on next week." - Robert Blake, senior currency strategist at State Street Global Markets in Boston.
"Frankly, we at Dow are looking at an '09 that looks like a pretty protracted global recession, probably going into 2010." - Andrew Liveris, chief executive of Dow Chemical Co , the largest U.S. chemical maker.
EVENTS
Saturday, Nov 15
WASHINGTON - President George W. Bush and French President Nicolas Sarkozy are expected to meet world leaders at an international financial summit of G20 nations to examine ways to overhaul the financial system (Compiled by World Desk, Washington, +1 202 898 8457) Keywords: FINANCIAL/SNAPSHOT

Back in the water

Well, Flash has been dipping his toes back into the market, and whilst he's not exactly striking off out to sea, he's waded in with some good calls over the last few days.

He was onto the turn in USD/JPY and followed it through with a couple of NZD/JPY longs today which have been delightful. He caught the big rally this evening in the Dow and S&P. He's shorted EUR/GBP and so far that's more than 100 pips on side. He thinks the euro ought to revert back down to the 0.70 mark against GBP and that's what he's gunning for. The weakness of the eurozone really hasn't hit home yet, whereas in the UK a lot of the doom is firmly out in the open.

Flash even bought some equities today. That might be a bit premature, but you never know. He's increased his long position in British Airways, and bought back into Morrisons Supermarkets, Game Group, BT and Cineworld. So far, except for BA, all up a bit. Perhaps a bit more in the morning. The logic (?) on BA is that they're now so cheap that they're vulnerable to an investor or two with deep pockets who wants to buy an airline swallowing them up. Iberia buys into BA, BA buys Iberia, AA ties up with BA, a kind of mating game for global domination. Look what happened on the Cathay Pacific rumour the other week. And they're now so cheap that he intends to hold them for a couple of years, even if they drop by a third. He's only got a few hundred shares - good for a 10% discount on flights which he'll make use of and make back his losses that way (someone said "It's like a discount travel card with unlimited upside"). In the long term Flash thinks the airline industry is pretty screwed, but there will still be winners and losers. And he thinks, perhaps irrationally, that BA is more likely to be a winner.

He even bought some BHP Billiton shares the other day - that's been a bit of a white knuckle ride, but they're in the black.

His reasoning on Billiton is that the resources stocks are oversold and sooner or later there will have to be some sort of reinflation. On the other hand the miners are very exposed to emerging markets which are going to be totally crunched. On balance though he thinks there's some long term value there. Particularly if the dollar devalues a bit. This is what is preoccupying him at the moment. He can see that EUR/USD could well be heading for parity, which he'd welcome, as he's short EUR/USD, and in which case cable would logically move down to the 1.40 - 1.50 mark. He thinks euro interest rates will have to come down pronto otherwise the gummed up markets will stay gummed up, and borrowers will be reaching for their suicide pills. A certain amount of dollar devaluation could actually be disinflationary for the rest of the planet - a bit of retracement could help balance things out - provided commodities don't go climbing mountains, which seems unlikely because there ain't much cash in corporate pockets left to buy stuff with, and what cash there is people are hoarding.

The consumer world outside of the USA hasn't completely felt the benefit of the collapse in commodity prices yet, because the dollar has simultaneously strengthened. A certain amount of weakening might be a good thing. Countries with high domestic inflation are going to get even more screwed as the dollar climbs, and their currency falls, and thus imported inflation kicks in. Look at Iceland. On the other hand, all of the big thematic trades, the carry trades, the long commodities bet, the Asian/Russian tiger bet, the emerging market infrastructure plays, have completely unravelled. And we're not allowed to short the financials any more, so they've taken even more of a hammering. So the dollar provides the flight to safety, and Flash thinks that's got further to go - plus people will be taking money out of more 'risky' emerging markets and putting their cash into the relative safety of US equities. And there could well be an Obama effect as the US digs itself out of its political pit which could boost equities some more. A more interventionist government will provide some fiscal stimulus and start spending on public infrastructure - schools, rail, roads, energy, that sort of thing. Once the spending tap gets turned on there will be some reinflation, particularly becuase the spending won't be financed by taxes, it'll be financed by borrowing. A New Deal of sorts, and the beginning of another reinflation bubble (and perhaps a journey southwards for the dollar?) So being long the Dow and S&P seems like the right call, although he's been trying to do this for months and has been totally caned. Caution is needed. Position sizes are small, stops are in place and he's watching carefully.

The big toxic call - and the next source of jarring volatility - will be what happens with emerging market currencies which are collapsing all over the place - Iceland, Hungary, Pakistan, Russia. One explanation for the vicious sell offs of the last few weeks is that anyone with assets has been selling them to raise cash - not just hedge funds, but insurance companies, pension funds, Russian oligarchs, retail investors, you name it. But particularly people with foreign currency debts - eastern european countries, but also the UK - as their currencies have plummeted have been forced to sell euro (and dollar) denominated assets to raise the cash to service these foreign currency debts, which have been getting more and more expensive by the day. So there's a self-reinforcing cycle of liquidation and deleveraging, made worse by the fact that the usual hedging strategies (the carry trade, shorting the dollar, buying commodities etc) have completely broken down. The easy pop, as usual, has been at hedge fund redemptions, and undoubtedly the hedgies will have had to get out of some painful trades which will have compounded the problem, but the real dealers here are the investment banks and the retail banks and their big corporate customers - they're locked into cycles of liquidation just to keep their cash flow afloat, especially when bad debts are on the rise and the cost of overnight borrowing is still pretty prohibitive. This might also partially account for the selloff in gold.

Most eastern european countries, with their swiss and euro denominated mortgages and loans are in the grip of utter panic now - this piece has a more lucid analysis than flash can manage at this time of night. That's why the Swedbanks etc exposed to another wave of sub-prime in eastern europe are looking at some big, big trouble - pointed out in this piece months back. So he's expecting the euro, but even more than the euro, the dollar to continue to appreciate against the emerging market currencies - difficult to see what can stop them, really. There's a self-reinforcing cycle there as EM countries have to sell their foreign exchange reserves in euros and dollars to prop up - buy back - their own currencies.

The gold short isn't working so well - whether this is a short term bounce or an indicator of some sort of inflationary pressure will no doubt reveal itself in the next couple of days. Flash thinks gold has further to go down but it hit his target of $720; but there's a lot of resistance to further falls in the $720 - 30 range; the dollar would need to make another move upwards for gold to resume its southwards drop, it seems. For now Flash is just running a small, lossmaking gold short from $744 and will watch and wait.

Flash sells out...and buys in... yet again

Will he ever learn?

Very nasty trading indeed but Flash is dropping in a few long equity positions.

He bought some BA at 115, some Game Group at 150, some Firstgroup at 490, some Royal Bank of Scotland at 100, and some more Kingfisher at 130. He also picked up some BT at 142. All, with the exception of RBS, showing a bit of a profit.

And yesterday evening, and again this morning he sold some gold and reinstated a EUR/USD short from around the 1.37 mark.

So far so good. Not trading the indices yet - he wants to see a more sustained rally before he burns any more cash there.

And, pasted below - here are his current thoughts on gold and USD as posted to the paddypowertrader blog (with acknowledgements to people in the know who have helped him think this through).

"Long term, broadly speaking, I’m still very bullish on USD, for the reason that a lot of emerging market economies have expanded on the basis of buying up cheap USD-denominated assets and using cheap dollars as a source of funds to expand lending. Now that liquidity/credit is tightening, and growth is rapidly slowing, they are selling off dollar denominated assets and scambling to call in lending- USD foreign exchange reserves held by overseas governments are falling. PLus EM currencies are tumbling all over the shop - partly because commodity prices are falling, demand for exports is slowing, and so their economies can’t make so much cash in real terms, so the prospects look really dire for them.

In this environment, and especially with a shrinking US trade deficit, my reading is that the dollar becomes stronger - remember that US weakness is RELATIVE to weakness everywhere else, and in my view, the weakness pretty well everywhere else (partly as a result of sub-prime etc in the US) is set to get worse. In the US however, taxpayer bailouts notwithstanding (and interestingly, everywhere else is now going down this road, so we;re all in the brown stuff) there are the beginnings in place for some sort of recovery, especially as inflation is going to go almost to zero in the next 12 months, because of recession/demand destruction/contraction in output.

So that then leads to gold. It’s hard to see how gold can go up, other than with short term panic bursts of trading like we’ve seen over the last week, when the rest of the commodity environment is so disinflationary. PLus if the dollar strengthens I agree that gold will become more expensive here relative to the dollar (and I expect sterling and euro to tank even more in the next few months as recession really bites), but that doesn’t mean that the PRICE of gold, denominated in USD will go up. In fact I’m expecting it to fall. A lot. So my view remains resolutely long USD, short gold, and then trickling in a bit of long equity over the next few weeks and months.

But of course I could be wrong…….

THe opposing view says that the bailouts are deeply inflationary. I’m not quite sure I buy that argument - I think the rate cuts signal a shift away from a single-track focus on inflation towards looking at the downside risks of outright recession. And I think that the downshift in house prices, commodity prices and even - likely real terms wages as the labour market becomes tighter and more competititve- should stave off some of the inflationary pressure. Demand is more than muted, it’s almost utterly destroyed. Of course the flipside of currency devauation against USD for EUR, GBP, and even more worrying places like Iceland and Russia will be deeply inflationary - but that in a way will just strengthen demand for ‘hard’ currency like the dollar. Hence dollars retain their value. And remember, if we take a historical view, gold is still trading near its recent mega highs and the dollar is not that far off some of its lows. I’m still gunning for EUR/USD parity, especially if the slowdown in Europe (especially southern and eastern europe) turns into something even nastier, which seems entirely possible to me.

And I can see that in an environment of outright bust gold would have an appeal - but I expect a slow, painful bottoming out rather than outright bust.

So this morning I sold some gold and reinstated a EUR/USD short. I wonder if I’ll be able to hold it through the volatility…"