Weekly summary: Stopped out of gold short

I stopped out on the way back up through 1250 today.  It tested down through its 20 day average on Wednesday but didn't stay below for long.  There is some chance the bounce back was expiry related but gold continued higher after the expiration.  Any trapped longs from Monday's breakout have surely been stopped or replaced by stronger hands by now negating one of the drivers for the trade.

The gold rally might get tested in the near-term with the Eurozone fright having past and China resuming currency liberalisation.  I expected a bit more risk seeking this week as markets moved past the fears of a few weeks back but the results were pretty muddled.

• Bonds are still pressing highs but momentum is ebbing.
• Gold is similar with early weakness giving way to a weekly close near highs.
• Equities are heavy but holding recent lows.  It is tough to gauge the impact of the US financial reform debate, with banks trading relatively heavy but wider market moves not reacting to the news flow on that topic.
• the Australian dollar and Canadian dollar should benefit a lot from stabilising macro news.  Both got dumped more on liquidity than fundamentals when the Euro made lows.  The movements this week support the story that stability is returning but only weakly with movements being a bit lacklustre.  Action in the AUD may be slightly muddled by the Australian leadership change but the big news on that front is probably yet to come as the mining tax negotiations get underway.  

On the Eurozone fright, I don't think I had given enough weight to the idea the Germany could abandon the Euro.  The smaller size of the PIGS, and particularly Greece, made me quickly assume that either Greek debt would be written down or Greece would leave the union.  How can anyone benefit from a currency union where the strong members are encouraged to leave?  Anyway, with the Euro keeping gains and moving up through the week my view may be becoming more mainstream.

On China, it seems like the world is still debating whether the announcement last weekend really means anything (or this).  China is in an odd spot of wanting to dip a toe in with gradual currency movements but knowing that once its intentions clear the market will front run the policy.  This makes timing difficult but ultimately it all appears to be heading toward a stronger yuan and stronger Chinese consumption.  This may uncover some domestic imbalances as it goes forward but near term this also points towards stability.

I also wonder if the traders aren't a bit too negative on the G20.  The view seems to be that either there is nothing to talk about or talks might degenerate into an ugly round of finger pointing.  I expect politicians will err on the side of vague positive statements and keeping disagreements out of the public eye.  Even acknowledging that the world can not return to the pre-2008 configuration of trade and capital flows might be viewed as above expectations.

China's Peg Planning

From the NYT:

China's political leadership is actively considering breaking the 11-year link between the dollar and China's currency, the yuan, and tying its value instead to a group of currencies, current and former senior Chinese officials said in interviews. The proposal being weighed at almost daily meetings of the Standing Committee of the Chinese Communist Party's Politburo would use a so-called basket of currencies to set the yuan's value. The yuan would move up and down in currency markets in relation to the average values of the dollar, yen, euro and possibly other currencies like the British pound.

But the initial value of the yuan under the new system could, in dollar terms, be very close to its current value of 8.277 to the dollar.
...
The Politburo's Standing Committee - which includes President Hu Jintao, Prime Minister Wen Jiabao and seven other top officials - has made no decision yet on when or whether to act, and may decide soon or wait as long as next year, the officials said. But the deliberations have taken on a pressing quality, with the Standing Committee meeting almost every day last week to review currency policy. Senior economic officials have been told to be on hand for consultations at any moment.
In a telling instance, Yang Weizhe, the mother of Zhou Xiaochuan, the governor of the Chinese central bank, died at 6:30 a.m. on May 31, but Mr. Zhou was still required to attend a Standing Committee meeting on the currency an hour and a half later.

...

Victor Fung, a Hong Kong tycoon who is chairman of one of the world's largest garment companies and heads the territory's airport authority, said, "They recognize the need to go away from a peg and move toward a basket."
Mr. Fung said each currency's percentage in the basket should match the percentage of China's trade conducted in that currency, an approach favored by many economists. He also said that China should reveal the relative weightings of the currencies in the basket.
But other advisers said Chinese officials were leaning strongly toward switching to a basket without disclosing the currency weightings. Singapore has long done this with its dollar.

A few weeks ago speculative pressures were the reason for not moving. The current sentiment (knowing it is coming but it will be small and hard to time) is probably the best Chinese politicians can hope for.

They sure seem to be focusing on the finer details right now. In currencies I have quite a few yen longs on and most recently shorted AUD/JPY near here (stop at 83.5). That chart is bouncing along just on top of a long uptrend and looks set to have a big reaction to any yen strength. Other than oil, the commodity stocks have not put in much of a recovery so I am also watching the AUD to see if it is pointing out continued weakness there.

Australia at a Crossroads

This is what happened to Australia's currency last night.

The Reserve Bank of Australia (RBA) today raised official interest rates by 25 basis points to 5.5%, just hours before national accounts estimates reported that the economy grew by a dismal 0.1% in the December quarter 2004. This slowed annual GDP growth down to just 1.5%, very low by recent standards. Exports were a big drag on the economy, coupled with falling inventory levels. (from New Economist)

I also ran across this yesterday detailing some other long-term problems the currency may have.

The current account deficit has grown to more than 7 per cent of the economy for the first time in half a century, as the nation racks up foreign debt to pay for consumers' hunger for imports.
The deficit in the last three months of 2004 totalled an estimated 7.1 per cent of gross domestic product, far larger than that which prompted the warning by the then treasurer, Paul Keating, in 1986 of Australia becoming a "banana republic".
And if not for very favourable trade prices, the deficit would have been far higher than $15.2 billion.
The shortfall is one item in a trifecta of economic and political headaches for the Government. (from The Sydney Morning Herald)

Australia seems to be at an interesting monetary crossroads. On one hand their economy is slowing but on the other they have a perceived real estate bubble and strong consumption based on borrowing.

I thought last year that Australia's economy would slow as the result of rate hikes and that rate cuts and currency weakness would be the outcome. I would still rather sell the AUD than own it but I guess it will be the economic weakening that brings the currency down rather than rate cuts. I also wonder if they will see a knock on effect from any U.S. problems just because of similar current account structure.

Low Enough?

We definitely got some better participation on the downside yesterday afternoon but on the whole it was not really a panic. This AM the theme seems to be that yesterday was more likely an end than a beginning. That is the camp I am in (I pitched my tent last week), but I would guess patience is still the order of the day with the trade being crowded. SPW, EXTR, and TTN performed strongly and are in good technical shape.

FNM will reach the bottom of its upward sloped range around 65. With the bears recently stumped (stomped if you prefer) by the positive market reaction to the preferred issue I would say this is the best chance since '03 of breaking lower. The level should hold at least once if you have a strong heart and a full wallet but given the way the stock moves around being short with a stop around 68 seems like the better trade.

I was stopped out on my AUD / Yen trade and will probably revisit that theme late next week. There was some chatter yesterday that after Chinese New Year (Feb. 9th) the exchange rate of the Yuan would finally be adjusted. The chatter went on to say that Japan would not let the Yen strengthen whatever China does. It may be the case that Japan will intervene and maintain a semi-fixed policy against the dollar but my guess is that the market will want to test the theory at the 100 level before letting them off for rhetoric.

Where I Stand

Currencies
Near the end of last year I put on a tiny Short GBP long Yen trade and I am now looking to exit and look for a bounce to reshort. I also reentered a short AUD long Yen trade when it got back below my original stop. I plan to just keep rolling down my stop there. EUR/Yen has moved below the 135 level which I considered an important breakout and I will now be looking to short that on a bounce as well. Through the great dollar rally of 2005 the Yen has barely budged and I simply don't trust the dollar long term against the currencies that have been supporting it these last couple of years.

Bonds
I have been outright wrong on interest rates in the U.S. for the last couple of months. I don't see how the market can continue shifting its estimates of short-term rates higher while the long-end stays down. If the market anticipates a slowdown why isn't it showing up in commodity prices or the equity markets? I continue to see it as an accident waiting to happen and would prefer to own foreign bonds for interest rate exposure. Either the Japanese short end or the European long-end with the currency hedged.

Stocks
The markets are in a good position now both in price and by the market psychology to resume the rally from last year. I would own companies that make something whether it is a technology product or machinery, I just prefer something physical. I am generally nervous about the financials because they are most exposed to a credit event. They have still not really reacted to the changes at Fannie Mae (FNM) or the general deteriorating credit of consumers. I am short-term bullish only and if I wasn't comfortable trading actively I would just be investing in a foreign stock or bond index.

Hand Sitting

While I tend to agree with the consensus that we will rally into mid January based on seasonal factors, I find this view a bit difficult to trade. I am almost exclusivlely long here but far from fully invested and plan to make partial sales and roll up stops as we go. August was a good time to be long and now seems like a good time to figure out what comes next.

This morning the GBP took a solid thumping. Below 190.13 it will complete a double top against the USD. I have been playing around short the AUD against Yen (stopped a couple days back) and am now playing a bit short GBP against Yen. Neither chart really shows trend lower yet so I am just getting involved a bit and hoping to put on some more substantial trades later.

I am watching the second upgrade of the precious metals stocks in two days and wondering what is going on. Are they upgrading them for technical reasons? Was I simply noticing some sort of pre-upgrade accumulation? Who knows I guess. It is a bit annoying as I prefer being active in a vacuum to buying into upgrades. The charts still look nice though.

Follow the bouncing ball

As the USD bounces this morning, I am thinking a bit about just how crowded that short is. I am not sure I have ever seen a trade in 10 years that is so widely believed in. Even I believe in it. Because it is crowded though I will watch carefully as the DXY (Dollar Index) approaches that 87 level. I will also consider other shorts against Asia (like GBP/JPY) before getting into dollar positions.

Also, the Reserve Bank of Australia, ECB, and Bank of England all have meetings this week. The election is distracting a lot of people but these meetings are significant because both Australia and Britain nearing the end of their rate hikes. At the turning points the markets will focus on nuances to see what to expect next. And of course the FOMC meets next week for what should be its last rate hike for a while.

Mostly I am looking through the election because it is ungamable. The candidates will only make subtle differences to the markets and even a tied election will eventually get resolved. Life will go on pretty much the same as it is today.