The Daily Trading Report

We are not so interested in commodities in USD terms we are perhaps more interested in commodities in non USD terms. Last week was key for commodities in breaking out against the USD, but we think that this was merely chapter one! Multi-week highs in commodity prices in USD, EUR, CHF, GBP, JPY, and CAD terms = global inflation! The behaviour of the US long bond (30yr) would have us all believe that inflation is not a problem, but the behaviour of the commodity market, in whatever currency takes your fancy, is telling something completely different!

It is looking increasingly likely that commodities are about to break higher in non USD terms and this is where the “meat” of the commodity story lies! The final nail in the coffin of the deflationists will be when commodities in AUD terms break higher. We think this occurrence will happen before year end!

When commodities break higher against the AUD watch out holders of TLT and IEF…..we think you will be better served by being long TBT!

Our wealth creation portfolio is up 20.94% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

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Yes the long awaited breech of the $75 level has finally occurred! The road is now open for a new high in Crude….i.e. above $150. We think that all the efforts by the Fed in rescue and bailout packages have only served to dramatically enhance the probability of crude making another multi-year high over the coming months! Of course only time will tell.

We think that the next big leg up in crude is now getting into gear and accordingly it is not too late to get exposure to oil. We say this because of confirmation of the breakout in crude in the broad commodity market (CRB), currency markets (Aussie Yen and USD Index), and fixed income (TIPS vs. US 10yr)

And where oil goes so too does the big CRB Index. Last night the CRB also closed at a multi-week high. This suggests that the rise in commodities is broad based. A number of individual commodity contracts also hit new multi-week highs.

Our favorite means of gaining exposure to the broad commodity group is via the ETF DBC. Now we have TIPs at a multi-week high vs. the US 10yr so the bond market is now confirming what we are seeing in the commodity market.

The USD Index closed last night well below its last line of support. Now the next level is at the 72 level – some 4.6% away from current levels! This is a sizeable fall for the USD Index but we think that it will probably get to the 72 level before year end!

So don’t be surprised to see the Aussie trade at parity before year end! Of course the Australian Reserve Bank Governor, Glenn Stevens, stating that “Australia cannot be too timid on rate rises” does not do much for bearish sentiment towards the Aussie dollar. And of course last but not least is the Aussie Yen cross which has been a proxy for the carry trade and a leading indicator for commodity prices. It broke to a multi-week high (above 82) last night.

The wheels of inflation are now in motion and those wheels to us appear somewhat bigger than what the average punter/economist can wildly imagine.

For the last four months trading commodities, commodity currencies vs. the Yen (such as the Aussie Yen), and TIPs vs. the 10 year is probably about as close as one gets to good old fashioned trench warfare. Just when the inflationists are about to break through the deflationists lines of defence they mount an intense counter attack. However, there is evidence that each time the deflationists mount an attack they make less ground each time, i.e. the bulls are gradually moving their defensive line forward. This suggests to us that the deflationists are slowly losing the ability to hold their line. Once (should we say if) the inflationists break through they are likely to move deep into deflationist territory…..i.e. on breaching $75, crude is likely to move quickly to $100!

Perhaps the two most important indicators we continue to watch for hints of a breakout in commodity prices (the CRB above 270) is the Aussie Yen and TIPs relative to the US 10 year. Breakouts in these two indicators will give a powerful confirmation of an impending breakout in commodity prices.

Sometimes the waiting is the hardest part!

Our wealth creation portfolio is up 16.32% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

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Depending on how you look at it, Inflation premiums have either broken to multi-week highs or are very close to doing so! Note the how close the ETF TIP is from breaking out against the US 10 year. Also note that inflation protected bond funds have already broken out against the US 10 year. Which chart do we believe? Well take an eyeball average of both and it suggests that we have inflation premiums at multi-week highs.

This behavior suggests on should expect commodity prices to break to the upside over the coming days/weeks. We have found that the behavior within bond markets leads the behavior of commodity markets themselves for whatever reason, perhaps it relates to liquidity.

Our wealth creation portfolio is up 19.06% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Intra-day the Kiwi has reached a multi-week high against the Yen. This came on the back of an increase in the price of milk. Milk products account for some 20% of New Zealand’s export earnings.

We think that the breakout in the Kiwi Yen is very important because it highlights a continuation of the:

1. high yield trade;
2. demand for commodity currencies;
3. inflation premium in bonds…..which should be followed by higher commodity prices.

Now all we need is a confirmation of the breakout in the Kiwi/Yen by the Aussie/Yen and Brazilian Real/Yen. We think that this confirmation will happen over the coming days.

Notice how the Aussie Yen has gone nowhere since mid June……and also notice how the high in June corresponded with the high in West Texas Crude in June. Since mid June the Aussie Yen made another multi-week high but crude and the CRB struggled to do so. Of course this is stating the rather obvious. Perhaps what is not so obvious is that the commodity currency yen crosses have been a leading indicator for the behavior of crude and by default the broad commodity group since late last year.

The key levels to watch for now are:

1. AUD Yen – 82.0
2. Crude – $75
3. CRB – 270

These levels should be broken in consecutive fashion over the coming days. Breaches of these levels will have disastrous consequences for those banging on about deflation!

You may be wondering about the significance of milk! Just go into a supermarket and try to come out with a product containing an ingredient that is not a derivative of milk………even your daily glass of wine has a preservative which is a derivative of milk! It is kind of strange to think that wine growers in California and New Zealand Dairy farmers have a lot in common. Yes everything in this world is connected in more ways than you know! Beware of the consequences of rising payouts for Kiwi “cow cockys”!

It is the simple things in life that matter. Deflationary conditions are characterized by fixed income securities (corporate bonds and treasuries) outperforming commodities and during inflationary conditions underperforming commodities. Yes one could get technical and look at long dated fixed income securities (20-30 yr) vs. commodities but we choose to keep the analysis simple. We know that financial markets move in trends but there is a whole lot of white noise in between. From a simple observation it seems that commodities have been outperforming fixed income securities as a general group since the start of the year. However, the performance of fixed income securities relative to commodities has been negligible since early June. Yes that is stating the rather obvious, of course the million dollar question is; in which direction will fixed income move relative to commodities?

We continue to believe that the charts below will break down. We say this because of the inability of non inflation protected treasuries to break higher against non inflation protected treasuries and due to our fundamental outlook. Yesterday there were two important news releases one concerning New York factories orders and the other concerning US producer prices. In both cases analysts/economists estimates were well below actual figures. This suggests to us that analysts are well “behind the curve” in terms of pricing in inflation.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a9kyqIpQktTg

http://www.bloomberg.com/apps/news?pid=20601087&sid=a0jz9TBzHhxo

Watch the market, it tells you all you need to know about what is likely to happen (human behavior moves in trends). Interestingly enough, when you study the market hard enough, economic news announcements rarely take the market by surprise. It seems news announcements only take those who think they can outsmart the market by surprise.

Our wealth creation portfolio is up 16.3% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

The commodity market continues to frustrate us……perhaps we should take a course in mastering the art of patience. We have been bullish on the broad commodity group ever since December last year, but have little or nothing to show for our efforts since the start of June. However, it appears the bullish forces continue to build. Our favorite commodity index is the “old” CRB Index (called the CCI mirrored by the ETF “GCC”). In essence the CRB CCI is an index of 17 commodity futures where each is equally weighted. Unlike other commodity indices like the Goldman Sachs (which has about a 65% weighting to crude) no one commodity or commodity group (energy, agricultural, softs, industrial metals, & precious metals) has an unequal impact on the index. Accordingly, the CRB CCI gives a good representation of the performance of the “average” commodity. Where to from here? Well the CRB remains in a bull trend with a series of higher highs and higher lows. A bullish confirmation will be achieved once (perhaps if) the CCI closes above the 430 level.

We think that the bond market holds important clues as to the impending direction of commodities. The world bond market is far more liquid than commodity markets and experience has taught us that the action within world bond markets leads commodity markets. Rising commodity prices generally indicates rising inflationary expectations. Accordingly, the behavior of the premium attached to inflationary protected bonds gives us an appreciation of perhaps what the smart money is pricing in. In short rising inflationary premiums suggest that commodity prices are likely to move higher.

We look at the inflation premium of TIPS and also of Inflation Protected Bond Mutual funds as a guide to what to expect on the commodity front. From the two charts below one can observe that inflation premiums stated to pick up in December last year and rose dramatically until June this year. However, there has been essentially no change to the inflation premium since the start of June (some 14 weeks). OK so does this signal a top? Is the next move down, i.e. a reduction in inflationary premiums? While it would be nice if markets move in linear type trends of course in reality they do not – they tend to zigzag their way up. We see nothing wrong with the up-trend of the inflationary premium at this stage. The sideways movement is part of a consolidation of the previous 5 months gains. Yes perhaps one should wait until there is a break to the upside in both charts before taking a position; however, we are not ones to sit on the fence. So we wait, touch wood often and sleep with a rabbit’s tail!

There is one other chart that punters should concern themselves with, it is the stock chart of the biggest Japanese trading house, Mitsubishi (8058:JP). The performance of Japanese trading houses is very tired to the fortunes of commodities(and by default shipping). Again the picture portrayed by Mitsubishi is somewhat of a mirror image of the charts above. A major buy signal for both Mitsubishi and commodities will be generated if the ¥2000 level is broken.

The longer a market moves in a sideways direction the greater the intensity of the subsequent breakout. We continue to believe that the breakout will come to the upside for the CRB. Sometimes the waiting is the hardest part!

Our wealth creation portfolio is up 16.3% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Early in my career I worked with an old and seasoned commodity and forex trader who was for many years my mentor. He was always so proud of the fact that he was an “above average” trader because he knew that he was merely “average”. Now that struck me as a very bizarre thing to say given that he was one of the most successful traders that the bank ever had! But after a while it all started to make sense. Forces and interrelationships at work within the market were too complex for him ever to fully understand or comprehend. So instead of trying to essentially outguess the market and holding opinions as to what he thought was going to happen, he turned to listening to what the market was telling him (or to use his language what “tune the canaries were singing”), i.e. what was actually happening. This “listening to the birds” philosophy made him not just an above average trader but an exceptional one.

So instead of trying to sound intelligent to others and yourself, take time out to listen to the market’s canaries! What are these four proverbial canaries in the mine shaft” telling us?

The canaries are chirping real loud now!

Our wealth creation portfolio is up 14.9% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

It looks like Gold is having another go at breaking above that elusive $1000 level! We think that this time around it will move “over the top” Goodness knows how far it will move once it clears $1000! What makes us think that Gold is about to break out? Well apart from the gold price it is the strength of:

1. Silver, we would not take gold’s strength too seriously unless there was associated strength in silver (and of course vice versa),
2. Base metals, strength copper helps because silver should follow what copper and nickel does (silver is also a base metal),
3. Gold miners, at least that is a confirming factor,
4. US Treasuries, usually gold goes up when US treasuries go down but gold and silver have been going up when US treasuries have been strengthening. The question is what will happen to G & S when treasuries go down (which we expect),
5. Aussie Dollars, the Aussie has been unmoved by the recent weakness in equities and we find that currency markets are more efficient than commodity markets (i.e. commodity currencies are leading indicators for commodities themselves).

So we wait with crossed fingers……..everything seems to be falling into place!

Our wealth creation portfolio is up 14.6% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.

Commodities continue to take it hard! The CRB Index along with the other big commodity indices (like the Goldman, Rogers and Dow AIG) have fallen by some 6% over the last month and have gone essentially nowhere since early June. Is this cause for alarm? Well as they say “it isn’t over until it is over”! Commodity indices and supporting indicators have got more room to move before they start painting a bearish scenario for commodity markets.

As far as the bond market goes, there has not been any breakdown in the outperformance of inflation protected bond mutual funds relative to the US ten year. Furthermore, there has not been any meaningful breakdown in the value of the Aussie dollar, which from a currency market perspective is a great proxy for the outlook for commodities in general. We place considerable emphasis on the signals being generated by the bond and currency market because they are more often than not leading indicators for what happens in commodity markets themselves.

There has been no breakdown in the out performance of commodities (the CRB) relative to US treasuries (the US 30 year) and there is a reasonable amount of room left before there is a confirmation of a breakout.

As far as commodities go themselves there is also room to move before a bearish breakout is signaled. The CRB has support at about the 230 level (8%) from current levels, and Oil (perhaps the most important commodity) is still 12% above its “last line” of bullish support at $60.

So for the time being at least we have to give the commodity/inflation trade the benefit of the doubt. We realize that markets move in broad based trends but that there is often lots of noise to shake the weak hands out of the market. We think that the fall in the CRB index over the last month is just that……the market’s attempt to disguise its true intentions. From a fundamental perspective we are somewhat comforted by the fact that the ISM Manufacturing Survey has moved above the 50 level signaling economic expansion. Growth and lots of liquidity are perfect breeding grounds for high inflation and high commodity prices. Perhaps a higher silver price yesterday was more than just a hint!

Our wealth creation portfolio is up 14.6% since the beginning of the year with approximately 40% of the volatility of the S&P 500. This portfolio is not leveraged.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history.