Kiwis Don’t Fly – neither will their dollars

New Zealand had its elections this past weekend and the provisional results leave the fate of the next government squarely in the hands of Mr. Winston Peters, the founder of New Zealand First (sound Trump-esque familiar???) party, the Kingmaker. Mr. Peters has worked with both the National Party and the Labour Party in the past but his policies seem better aligned with that of the Labour Party’s at the moment.

Labour party wants to expand RBNZ’s mandate to include a focus on employment and NZ-First wants to go one step further and expand it to also include currency management. Labour wants to slash immigration by 20,000-30,000 annually and NZ-First’s Mr. Peters, who has a long standing anti-immigration stance, wants to slash migration to 10,000 a year – a drop of more than 60,000 annually!

If a marriage between NZ-First and Labour materializes, we fear that the New Zealand economy, which has grown tremendously on the back of rising immigration, will take a hit. As a result, RBNZ’s monetary policy will likely take a stimulatory tilt. Add in an expanded mandate for the central bank and this will be a perfect recipe for prolonged NZD weakness.

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Bluffers Always Raise – to call or to fold

This post is an update on our previous one where we hypothesized that Bank of Canada’s (BOC) first rate hike was a mistake and that if crude oil prices continue to fall then the BOC would have to retrace its steps. Since then, we have had another BOC meeting and to our surprise they hiked again. Judging by the market’s reaction, this came as a huge surprise and the Canadian dollar (CAD) rallied close to 200 points against almost every currency. We remain short CAD but we are getting cautious about our presumed catalyst.

Indicators we watch are painting an oversold crude oil market but price action, so far, is muted. Nonetheless, we remain cautious on our bearish outlook for crude oil. We will watch the tape and let prices dictate our conviction. If crude oil prices make a sustained break above current levels around $50 we will lose conviction on our short bias until prices get back above $61. In that event, we will look to exit our short CAD trades with the intention of re-entering when WTI crude oil prices get to $61/barrel.

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Calling Poloz’s Bluff – Short Canadian Dollar

Back in Jan-2015, Gov. Stephen Poloz outlined the bank’s rationale for a rate cut and explained that the bank had relied on a framework in which their base case expectation for crude oil prices was that it would remain around $60 for the next two years, i.e. 2015-2017, and considering this base case that it was prudent to provide some support to the economy in the form of a rate cut to compensate for lower future oil revenues. As we all know, the reality for crude oil turned out to be quite different.

At the most recent monetary policy meeting, the BOC hiked its policy interest rate by 25 bp; what makes it strange is that the year-over-year rate of growth of Canadian core CPI is the lowest it has been going as far back as the 80s!

Crude oil’s price stabilization since early 2016 has led to a substantial unwinding of the CAD shorts, which has further fuelled strong rallies in all CAD pairs. In our view, this CAD rally is about to lose its steam; we have initiated short positions in CAD against the USD, the EUR, and the GBP. The main risk to our trades is that crude oil prices firm from here. While we think the chances of this are low, we will closely watch the crude oil market for signs of strength and continue to evolve our thinking should it be necessary.

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Rigel’s Currency Corner – Long GBP/AUD

This article is a continuation of our short Australian dollar “AUD” thesis. In this post, we zoom in on the battered British Pound Sterling “GBP”. We are of the view that all the negative news (BREXIT, lack of a clear majority in the parliament, Carney’s recent remarks) is most likely priced in to the GBP. On the other side of the equation, we see plenty of signs that China is most likely headed into a recession and we don’t think this has been priced in to the AUD.

  • China iron ore prices show no signs of bottoming. The pain continues!
  • There has been a sharp turn around in China’s inflation surprise index. With the demographic time bomb that is ticking in China, it is deflation surprise that we should be interested in, not inflation surprise!
  • China’s broad money, as measured by M3, grew at an average rate of around 15% from 2001 to 2013. It started decelerating in 2014 and is continuing to decelerate. It is now growing at a year over year rate of just over 10%! Decelerating money supply is a harbinger of ‘slowing economic activity’ / recession.
  • What is even more alarming is that China’s yield curve, as measured by 10 year yield minus 2 year yield, has now inverted. Another warning sign of a recession to come!
  • All signs are now pointing to a recession in China and being short AUD is a sure way to play that game.

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Rigel’s Currency Corner – Long EUR/AUD

On the monthly chart of the currency pair, if you count the 2008 high of 2.08 as the high and 1.16 low of late-2012 as the low, then the price action fits the following pattern:

  1. The ‘high to low’ move was followed by a clean break of the 76.4% retracement level and a successful test of the 61.8% retracement level of that move.
  2. The pair found support at the 76.4% retracement level, broke through the 61.8% level and successfully tested the 50% retracement level.
  3. The pair found support, again, at the 76.4% retracement level and as of this writing is testing the 61.8% retracement level around 1.5125.

A clear close above 1.5125 should open up further possibilities of retesting the 50% retracement level at around 1.62, that’s a thousand points if you are a forex trader.

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The Ascent of Aurum – Long Gold

Exactly a year ago, in May-2016, we published our analysis of Gold demand trends provided by the World Gold Council. We wrote:

Gold price charts and physical gold demand trends offer a dichotomous view on the future of gold price. On the one hand, the extremely lose [sic] monetary policies of the world, and the phenomenal 1st quarter performance of gold relative to every other major asset in the world makes for a very compelling bullish case and on the other hand the physical gold demand trends paint a very bleak, if not scary, picture.

The World Gold Council recently published their 1st quarter 2017 report on gold trends but this time our analysis of that report leaves us with anything but a bearish outlook on gold. We have turned massively bullish on gold and we will outline our reasons below.

Our thesis rests on three reasons:

  1. Declining global mine production in years to come — a result of past, massive, haircuts to capex by some of the largest gold miners around the world. Gold miners’ Capex has declined 65% from 2012 to 2016.
  2. Gold is a safe haven asset and according to world Gold Council’s most recent report on demand trends, current uncertainties in China and Europe are driving these flows.
  3. Technical analysis of gold price chart reveals a strong bullish set-up at a time when this trade is far from being crowded.

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Long Vega of Vega – an update on the breadth of the US stock market

Breadth of the US stock market (number of new highs minus number of new lows) is pointing to continued weakness in the markets.

Over the last five years, on average, the price of the S&P 500 index has been about 20% above its long term mean. This dynamic broke down in June-2015 and it coincided with a text-book-correction: dropped 20%, tested support and bounced off. Since then, however, it has struggled to go over 16% of its long term mean. The last two times it tried to get above 16% (Feb-2017) and (May-2017) it turned back down. The market has lost its upside momentum.

Every time the ratio of 1 month S&P 500 volatility to 3 month S&P 500 volatility spikes, it, almost always, is accompanied/followed by a decline in S&P 500. Why would this time be any different?

When an asset that has been appreciating for the last 8 years turns lower even by small amounts, the introduction of negative daily returns to its return distribution tends to increase the volatility of that asset by a meaningful amount. While we are long volatility we think a better trade structure might be to focus on acquiring long exposure to volatility of volatility of the US stock market. In our view, one of the best trades for the next 12 months is to be long Vega of Vega. We will continue to develop this idea and post our thoughts on an ongoing basis.

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