The Daily Trading Report

We would like to let you in on our way of thinking……or at least on what we have seen happening and what we “envisage” occurring over the coming weeks.

First cast your eyes on the futures charts below (specifically the USD Index, CAD, Crude, Gold, 30 yr, and S&P 500). What do you see? With the exception of the USD Index (and the Euro) we see markets that have essentially gone nowhere since August – October last year (that is a 5 – 7 month period). OK, so what? Well the longer a market moves in a sideways direction the greater will be the force of the breakout. So when the breakout comes it is liable to be violent.

OK so which way will markets break? Well this is how we see market trends evolving:

It all centres around the behaviour of the Euro. Yes the USD Index is looking rather bullish…….but is it? Take a look at the CAD Future, is this looking bearish? We think not. The USD Index is looking bullish primarily due to the weakness of the Euro which represents 55% of the index. But what happens if the Euro continues to fall? Yes it could but given the record amount of short positions on the Euro future we find it highly unlikely that there will be any more downside in the Euro over the coming weeks.

We believe that the Euro will bounce, because of less than bad data coming from the PIGS “fiasco”. This will lead to the Euro rising above the 1.38 level which will induce a wave of short covering. Needless to say the press will pick up on the dramatic improvement in the Euro and will find positive news to justify the move, maybe they will start looking at the problems of the US again (be it California, New Jersey etc). The big rise in the Euro will of course send the USD Index down.

This will lead to commodities (aka gold and crude) moving above resistance levels to multi-week highs,

Which will lead (or be preceded by the US 30 year yield breaking above the key 4.75 level (the future below 115)

…….and the S&P 500 breaking above the key 1150 level to a multi-week high.

OK it might not occur in that order but we think the “tipping” point will be a bullish breakout in the Euro. What will lead to the Euro breaking higher? Perhaps a butterfly flapping its wings over the middle of the Mediterranean!

Everything in this world is connected…………nothing exists in isolation!

Another nail in the coffin for deflationists! Gold traded at multi-week highs against paper currencies last night. Perhaps the most significant move was gold’s close above $AUD1180. The charts below suggest that something powerful is building in gold……perhaps something that will rival what we witnessed in the late 1980s. The evidence is there as plain as daylight for all to see, of course whether you choose to believe it or not is entirely up to you.

Now we wait on Crude and the CRB to breakout in Aussie dollar terms…..But given what has just happened with Gold (and what is happening with Baltic Freight rates, TIPs vs. US 10yrs we think Crude and the CRB will follow! Watch the CRB and Crude in Aussie Dollar terms. A break above 3.20 and 0.90 in the charts below will be the final nail in the coffin for deflationists!

“In religion and politics people’s beliefs and convictions are in almost every case gotten at second-hand, and without examination, from authorities who have not themselves examined the questions at issue but have taken them at second-hand from other“

This quote from Mark Twain applies equally to investing and economics as well. We say believe not in what others tell you but in what the market is telling you.

Our wealth creation portfolio is up around 17% 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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It appears that capital flows into emerging markets remain strong and there is no credible evidence that the strong absolute and relative (to developed markets) trends are about to come to an end anytime soon.

Emerging equity markets are now higher than they were at the time of the Lehman’s collapse and have yet to show any deterioration in upward momentum. We believe that there is more upside to come in equities because the underlying breath of the market is strong. Small cap emerging equity indices are only a few points away from multi-week highs suggesting that even the highly risky “rats and mice” stocks are continuing to make new highs. Usually prior to any significant correction the underlying market turns down. From a relative perspective emerging market equities continue to outperform the S&P 500, with EEM less than a 2% away from a multi-week high against the SPY.

Emerging bond markets also show no deterioration in upward momentum from both an absolute and relative perspective (relative to US investment grade bonds). The relative outperformance of emerging market sovereign bonds (to US investment grade) also suggests that the appetite for risky assets remains “positive” for whatever reason.

On the emerging market currency front CEW is less than 1% away from another multi-week high signalling a new high for emerging market currencies in general against the USD.

Note the appearance of the two foundation members of the emerging market universe. The South African Rand and Brazilian Real are more or less at multi-week highs. Having spent considerable time in both countries over the last 10 years we question as to how they can still be regarded as “emerging”. Anyway we think the classification of “emerging” is merely semantics.

Given that equity, bond and currency markets are all confirming each other with levels either at or very close to new multi-week highs, we think that more upside is likely in anything emerging market cover the coming weeks. We don’t know what the future holds, but we do know that markets move in trends and we know a strong trend when we see one.

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.

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”!

Back in January this year when the British pound was falling in a crumpled heap a certain investment great came out and said this about the GBP:

“For the last 26 years, the U.K. has been selling oil, the North Sea. That’s what’s saved the U.K. in the past three decades. It’s finished. The North Sea oil is running out. Within the decade, the U.K. will be importing oil again. And then they’ve got nothing to sell… I mean, again, I hate to say it, but I would not put any money in the U.K. I’ve sold all of my sterling…”

To be fair he also had this to say about commodities and emerging markets:

“The real opportunities remain commodities and emerging markets. I continue to think that real assets are the best place to be because that’s where the shortages continue to develop. If the world economy develops and gets better as Mr. Geithner says, then obviously raw materials will be the best beneficiary. If the world does not get better, raw materials will still be the best beneficiary because the governments are printing so much money all over the world, and throughout history that has led to higher prices.”

Some of you may remember that the famous investor was Jim Rogers. For the time being he has been wrong about the GBP (in USD terms at least) but right about commodities and emerging markets in both GBP terms and USD terms. Anyway the point here is not so much on how wrong Rogers has been about the GBP (perhaps he has a much longer time perspective than us and in which case he may well not be wrong) but rather to highlight that when you hear comments from a highly respected commentator/investor justifying the current market action when by all historical accounts the market is in an extreme oversold or overbought condition…….odds suggest that the market is ripe for a reversal.

Whilst commentary on the GBP is far from being extremely bearish as it was in the 1^st quarter of this year it still remains in a generally bearish state. Yet the GBP continues to hold out against the US and looks as if it is getting ready for the next big move up.

Investing in currencies is a very different art than investing in stocks because currency investing is a relative game. Whilst a currency is to a country what a stock price is to a company the valuations of a currency are expressed as a relative (to other currencies) whereas a stock price is expressed as an absolute. So whilst the fundamentals of Great Britain may appear to be poor (as Rogers points out)……they are perhaps not as bad as those of the US. Of course now it comes down to which currency is a better of a bad bunch.

We think that the GBP has more upside, however…..if you are a long term investor then perhaps Rogers was right all along. Perhaps he just forgot to say against which currency he was valuing the GBP. We have a funny suspicion he had in mind the GBP against the Aussie.

We have yet to witness any wild bullish claims about the prospects of the Aussie dollar so we believe that its upside is far from over. But as always happens, the Aussie will climb until such a point that the crowd reaches universality of bullish opinion and then will start to move against the crowd. Enjoy the ride.

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 is more or less bearish business as usual for the USD. Across the board the macro trends that began late last year remain firmly in place. The USD Index remains firmly gripped within a bear trend and there is little hint of any impending change to that trend. We place considerable emphasis on the behavior of emerging market currencies and emerging market bonds relative to US Treasuries to gain insight into the likely direction of the USD Index. For the time being at least emerging market currencies as a whole (depicted by the ETF CEW) are close to breaking to a new high against the USD(the South African Rand already has). This behavior is confirmed by the relative outperformance of emerging market bonds relative to the US 10 year. Emerging market bonds are still yielding about 9% (as per the yield on the SEI International Emerging Bond Fund SITEX) whereas the Yield of the US 10 year is about 3.3%. Whilst emerging market bonds will always (famous last words perhaps) trade at a premium to US Treasuries, the current premium (about 500 pts) is still excessive and suggests that emerging market bonds have more upside left and that emerging market currencies are likely to continue their assent against the USD over the coming weeks/months.

Keep watching the ETF CEW, its holds the key to understanding so many macro trends trading place in global financial markets.

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.

The USD Index sits on a knife edge! At 79.00 it is a mere 50pts above support at 78.50. Once it breaks this level then we think it will quickly fall to the next level of support which is at 72.00. We will put our heads out and say that it will at least trade at the 72 level before year end. We don’t want to have preconceived ideas but now that the financial crisis is over (perhaps we are sticking our heads out again) it appears that the USD is in the process of resuming its bear trend that started way back in 2002. We don’t think that the efforts of the US treasury or the FED over the last 12 months has done anything to improve the competitiveness of the US economy and fundamental outlook for the USD. Looking to the markets it appears that it is destiny in motion for the greenback. Across the board most currencies are on the brink of breaking to multi-week highs against the USD and some, like the Brazilian Real and South African Rand, have already moved to multi-week highs. We think that the USD Index will follow the lead set by the Real and Rand, we certainly are.

But wait there is more! The global bond market continues to suggest that the USD is heading lower. Yesterday the global government bond ETF “BWX” moved higher against its US equivalent “IEF”. It is only a matter of time before our favorite FXA and FXC positions move to a multi-week high against the USD and get to parity.

Our wealth creation portfolio is up 15% from the beginning of the year with approximately 40% of the volatility of the  S&P 500.

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

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We have been amused by the comments of treasury secretary Geithner earlier this week in Saudi Arabia regarding the USD.

“A strong dollar is in the interest of the United States. Of course, I deeply believe that,” Geithner said. “Our commitment … to the world and of course, the American people, is to make sure we’ll put in place the policies that can sustain confidence in this economy and this financial system.”

As long time students of political history we believe that political speeches/commentary is nothing more than propaganda. So we don’t take them too seriously. However, what we do take seriously is the underlying reasons for such “banter”. The mere fact that Geithner (and others) have had to resort to these “road show” tactics to support the USD says something in itself. It suggests that there are significant bearish forces at play which are known to the US treasury and not well understood by the general public. At a more micro level experience tells us that when management of a company consistently engage in practices to “talk up” the stock price of a company, more often than not, it ultimately results in disastrous consequences with a significant fall in the company’s stock price, sometimes even bankruptcy. Granted, a company is not exactly a country. However, the same principles apply. When it is all said and done a company is merely just one very big company. Actually many companies are bigger than most countries so perhaps lessons learnt from studying the behaviour of companies are equally applicable to countries. In any case we believe that a currency is to a country what a stock price is to a company. If the USD was genuinely strong, or at least its prospects were, then it is very unlikely that we would see a push by the US treasury/government to “up sell” the USD.

Let us listen to what the market is saying in light of Geithner’s comments? The USD Index has fallen since Geithner’s comments on the 14^th of July. To us this is a bad omen. If Geithner’s “deep beliefs” and talking up efforts are not holding up the USD what will? Global capital flows continue to suggest that the USD Index is about to break to a new multi-week low. Just look at the behaviour of currencies like the Real, Rand, Aussie, and Kiwi to name a few:

The charts above suggest that the next big move is likely to be to the upside.

Subscribers to our paid service are privy to our portfolio, sector weightings, and trade history. Our un-leveraged portfolio is up 10.24% from the beginning of the year.

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We have been watching with interest the behaviour of both the USD Index and the US 30 year treasury over the last two months given the weakness of equity and commodity markets. We have been saying for some time that the lack of “bullish” conviction in the USD Index has been a rather telling factor that the “risk aversion trade” would not get far and that the weakness in equity and commodity markets would be shallow. Note what we said on July 10^th at thedailytradingreport.com. It now appears that the USD is about to challenge the 78.50 level which is its last line of support before last year’s low at 72. We believe that the USD Index will fall below 78.50 over the coming days and then before year end it will have at least traded below the 72 level.

In support of a falling USD is the failure of the US 30 year to break-out of the down trend that began at the start of the year. From a longer term perspective a breach of the 115 level on the US 30 year opens it up to the 105 level which is a significant movement from current levels. We are reasonably confident that the US 30 year will trade at 105 before year end.

In support of lower US treasuries (and by implication a lower USD Index) is the continued outperformance of non US 10 year govt debt (BWX and PREMX). This suggests that “pure” USD assets are rapidly falling out of favour with international investors (and probably many US investors). If US 10 treasuries are underperforming emerging market 10 years sovereign debt this situation is rather serious

So we continue to position ourselves for a weaker USD and weaker US treasuries. Of course we are not expecting them to go down in a straight-line fashion. It is going to be a bumpy ride but we have time on our side.

We have a number of trades on which reflect our bearish USD and UST stance which we discuss with subscribers.

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

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The weakness in the Dow Industrial is not being echoed by the USD Index……or if it is then it is a very faint echo! This is rather different behaviour than that which occurred over the last 12 months where every time there was weakness in the Dow it was preceded with rather substantial strength in the USD Index.

So what do we trust…….the break down in the head and shoulders formation in the Dow or the lame performance of the USD Index? We believe that currency markets are far more powerful than equity markets so we are sticking to the evidence put forward by the currency market. We also believe that the front runner to currency markets is world bond markets.

The bond market’s action suggests the USD is about to break down again. The charts below are the relative performance graphs of ETFs that track developed market debt ex US (BWX) and emerging market debt (PCY) relative the US 10 year treasury. In both cases the up trends over the last 4-6 months are strong with little to suggest that the up trends are about to come to an end anytime soon. With the breakdown in the Dow we would have expected that these relative graphs to also have broken down by now ……but they haven’t. We don’t know what the future holds but we do know that underlying macro investment themes move in observable trends. In essence we track and trade these trends. Right now the trends below are up……..which paints a rather bearish picture for the USD Index

We would be using any strength in the USD Index to increase short positions……we are sure that by year end the USD Index will be trading at a multi-year low. We believe that there are more effective ways to get short exposure to the USD than simply buying the ETF UDN or shorting USD Index futures.

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

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