Saturday, 28 May 2016

The Suboptimality of Overcrowded Markets

As virtually every globally traded asset is either at or near historic highs or historic lows, the majority of trades appear to be over-crowded at these levels. Equities are near all-time highs, so almost all traders are bearish on the indices; that leads to shorts piling in at relatively the same levels, before being squeezed out of their positions by the slightest uptick, as shorts rush to cover, which tends to lead to over-extended short-lived rallies fueled by marginal panic buying. After all, if one is short and wrong, one is equally as right to go long, and vice versa. Similarly, as commodities trend upward after showing relatively strong support near their 2016 lows, the majority of traders have piled in long, as commodities show the greatest potential upside. However, as a June hike from the Fed and negative interest rates in Europe also give potential for a strong dollar, any significant pullback in commodities induces panic selling, as traders dread being on the wrong side of the trade and either sell-out or attempt to go short at slightest sign of weakness. The lack of market direction should permeate equities and commodities until the Fed makes its official announcement on June 15, when the volatility of fear-induced panic trades dissipates into a general directional bias for commodities and equities.

Monday, 23 May 2016

A Bullish Case for Crude Oil

Today's pullback in WTI is possible opportunity to go long WTI here at a favourable entry price in the range of 47-44, with a roughly 44 SL and a 50-52 TP.  Present market sentiment is bearish toward crude, which makes the effects of a market surprise to the upside above 50 dollars the perfect catalyst for crude to trade up to the 52 area, fueled by panic buying from traders that find themselves both caught short and wont to miss the then-evident potential upside. The market's bearish sentiment toward crude is apparently attributable to the widespread belief that The Fed will in fact choose to raise interest rates by 25 basis points at the next FOMC meeting on June 15, price trading along a flattening slope with a roughly 5% pull back, and bearish consensus among the analysts. However, the technical and to a lesser degree general conditions are arguably equally as bullish. Though the move in percentage terms since January appears to be a bit over-stretched, it has been supported by relatively strong, consistent volume and relatively weak volume on correction days. Add to that the current stagflation environment, the fact that potential inflation from QE 1-3 and TAARP has yet to fully work itself through the entire economy, and the effects that ZIRP has had on the propensity of consumer spending, one can reasonably expect some unexpected upward price pressure for commodities in general in the near/short term.

#CrudeOil at 47.72 via @investingcom -

Tuesday, 17 May 2016

Crude Oil Bulls: on the Right Side of the Trade for the Wrong Reasons

Crude Oil (CL / USO) prices have recently seen a steady increase that began the first month of this year, which has led to a resurgence of crude oil bulls and subsequent target increases by analysts at the major investment firms. However, crude oil bulls are on the right side of the trade for the wrong reason. Rising prices at the current time have less to do with baked in supply/demand statistics and more to do with the phenomenon of stagflation. Consequently, prices are likely to rise steadily toward $50 and beyond during the near to medium term, irrespective of marginal changes in the aggregate supply/demand outlook.

Stagflation (high inflation rates at the same time the economy has high unemployment rates) has had, and will continue to have a greater bearing on pushing crude oil up to $50, and higher thereafter into 2017. In a stagflation environment, an increase in aggregate demand, a decrease in supply, or other factors that affect supply and demand schedules are not necessary conditions for higher prices. This fact alone can push WTI Crude Oil (CL / USO) prices much higher in the short term and is also reinforced by prices naturally reverting to the long term mean. The term Stagflation is a portmanteau of the terms stagnation and inflation, and was coined by economists during the Carter administration of the 1970s, wherein for the first time in its history the nation's economy was simultaneously in recession with inflation rising. It seems as though this phenomenon has reappeared, disguised. For instance, as opposed to the 1970s, government spending, M2, debt-to-GDP, government spending as a percent of real GDP growth, and nominal public debt are at all time highs; while real GDP growth and real wages during the past eight years are at all-time lows. Such circumstances leaves any potential real growth dependent upon sustained unsustainable debt-finance spending, which adds considerably to future price inflation.

A Hesitant Fed

An unlikely Fed hike in 2016 also puts future downward pressure on the USD and corresponding upward pressure on Crude prices. As mentioned above, real GDP growth is at an all-time low (sub-three percent for eight consecutive years), giving the Fed little if any margin for error in terms of causing a recession by raising rates prematurely (primarily in an election year). A recession before the general election equates to a major blunder for Obama, and consequently a blow to Hillary Clinton's chances at becoming POTUS. A rate hike induced recession is also likely to bring the Fed's credibility in question - an issue Donald Trump has already raised on the campaign trail and is likely to revisit in one form another during the debates. Likewise, the Fed's credibility would suffer even greater public scrutiny should they decide to raise rates, only to have reverse their position and cut again. Hawkish interest rate policy is virtually out of the question, as it risks putting undue upward pressure on the dollar and decreasing both M2 and total output as a result. Sub-three percent growth coupled with low relative productivity does little to persuade Yellen and the FOMC to rein in any potential increase in GDP growth that they may be lucky enough to muster up.


Current ECB and BOJ monetary policy would aggravate any hawkish policy decision by the Fed. Domestic conditions that appear conducive to a rate hike will likely be offset by global conditions which are underpinned by unprecedented dovish policy by the ECB and BOJ. Both central banks have stated repeatedly that they will print an infinite amount of paper to keep their currencies relatively low in order to prevent a deflationary spiral. Unfortunately, the Fed has the same policy, and wishes to avoid deflation by any means necessary. As a result, an interest rate hike as small as 50 basis points can result in a compounded effect of the USD being bid up to unsustainable levels, as the USD is believed to be a safe-haven currency and as investors pile into the dollar in a desperate search for yield, which will only be exacerbated in an environment of negative rates and near-zero growth. As long as the ECB and BOJ maintain a monetary policy regime intended to avoid deflation at all costs, the Fed will be in the same boat with very little incentive to rock it. A strengthening dollar in such a scenario implies a relatively weaker EUR and JPY, which threatens to reduce the effectiveness of the Fed's ZIRP.

Simultaneous unprecedented monetary policy from the world's largest central banks, the red flags of signs of the reappearance of stagflation, and a justifiably hesitant Federal Reserve, combine to form the ideal catalyst for higher crude prices, regardless of the marginal supply/demand outlook. As evidenced by the ineffectiveness of the Doha talks between Russia and Saudi Arabia in terms of affecting the outlook of future crude prices, obstacles to higher prices in the near future are increasingly insignificant.

Sunday, 15 May 2016

Saudi, Russian Freeze Fallout Does Little To Change Crude Outlook (04/20)

At this point, several factors suggest that the result of the Doha talks has little to do with the real overall global supply/demand outlook. Firstly, slowing global economic growth makes a production freeze self-defeating. The Saudi and Russian governments are both starved for cash; reducing any form of income when growth is necessarily dependent upon deficit spending is comparable to shooting yourself in the foot with your own gun. The Saudi government is running at a near record budget deficit, so a production freeze means they would be forced to add to that deficit, or add to the difficulties of paying it down, i.e. reducing government expenditures

Secondly, the Russian economy is currently in recession. They're unlikely to opt to worsen the effects by cutting back on revenues, which are sorely needed for fiscal stimulus. Russia's debt to GDP ratio is not nearly as high as Saudi Arabia's, however, slower global growth and lower oil prices have taken a toll on government revenues which provides a generous incentive to forego a production freeze.

Finally, since 2009, essentially every government and central bank of the developed world has sustained asset prices by way of various forms of fiscal stimuli. This has hiked up sovereign debt levels in the process without creating any self-sustaining, productive, economic activity. As a result, government and central bank spending/printing is currently required on a perpetual basis in order to maintain any level of meaningful GDP growth (an extreme of the Keynesian Cross/Multiplier model).

Since 2012 Saudia Arabia's total government revenue fell by roughly (-56%); from $1.2 trillion to $546 billion today. Losing 14% percent of government revenues for four consecutive years while the country's economic growth relies on government spending details a situations that is just short of a national economic crisis. Add to that the fact that the Saudi regime is currently undergoing a reorganization of leadership in which the final decision on economic policy is held by a younger, locally educated man with decidedly different perspectives on the relegation of power and resources.

Fragile internal politics, falling revenue/subsidies, and tepid global economic growth has created risk averse regimes that are unlikely to gamble too heavily on the ability to manipulate global oil prices via a freeze in production.

Draghi and the ECB Forcing Potential Dovish Move From Fed

Will Yellen and the Federal Reserve simply stand idle while Draghi and the ECB one-up them by increasing both the quantity of "Quantitative Easing" purchases and the length of the program? Because last Thursday the ECB announced that it plans to increase the scale of their QE printing program from 60,000,000,000 a month to over 80,000,000,000 USD per month, or exactly 1,075,200,000,000 USD annually, which makes the ECB's annual bond purchases 55,200,000,000 greater than Fed's most recent QE program. Furthermore, in addition to extending the length of the program to 14 months, Draghi also made it clear that the actual length of the program could be indefinite if economic circumstances render it "necessary."

The primary concern for the Fed is offsetting the potential effect that an Infinite Draghi Put could have on the dollar. Draghi has made it clear that he will stop at nothing in order to avoid deflation and hit the ECB's 2% inflation objective, as evidenced by his remarks regarding QE, stating that the end date of the monetary easing program is tentative and did not make any reference to a maximum threshold for QE or a minimum threshold for interest rates. Since low velocity of money in the euro area has dampened the inflationary effects that one would expect from the ECB's QE, and forecasts for sub 2% global growth do not provide any clear tailwinds for economic activity, Draghi has, and will continue to have to, resort to printing/devaluing the Euro in order to meet his unilateral inflation objective. Draghi telegraphed this to markets by announcing an increase in bond purchases at each consecutive one of the previous three ECB press conferences (will Greece be getting any of that free money? I think not. They'll be left to fight it out with the IMF for temporary revolving loans to keep their government from collapsing. Brexit Grexit, anyone)?

The problem is that the Fed, too, has inflation objectives; the Fed, too, wishes to avoid deflation at all costs; and a weaker Euro resulting from Draghi's kamikaze policy necessarily implies a relatively stronger USD, of which the Fed has little utility, in terms of its dual mandate.

Notwithstanding, Draghi and the ECB waited until the Fed washed their hands of QE before unleashing the mother of all QEs: an increase in the ECB's QE program by +33, an extension of the program until well after the US elections (and "further if necessary"), topped off with negative borrowing costs. Draghi appears to be in the exact position that Yellen wishes to be in, given that it has been eight years since the last recession, the business cycle is currently overextended, and QE with NIRP is likely the only option to cushion a severe slowdown.

On the other hand, Yellen and the Fed are in a relatively opportunistic position; they have more room to move than the ECB does, as the 10Y is still well over 1%, they haven't been forced to take rates into negative territory, and they still haven't done a Reverse Operation Twist or QE4. Slowing global economic growth as forecast by the IMF earlier in the month may mean the Fed will be forced to use those tools, however, optionality gives them relative strength, as all of the ECB's cards appear to be on the table.

Draghi's decision to ramp up QE even further and extend the program indefinitely is certainly an impediment to the Fed in terms of its ability to maintain downward pressure on the dollar while entering into the final stages of the present business cycle.