Seeking Alpha
Research analyst, ETF investing, short only, debt
Profile| Send Message|
( followers)  

Summary

· Extending the debt ceiling deadline by weeks does not remove uncertainty and keeps the hedge trade alive. A prolonged political dysfunction in the U.S. could portent a diminishing risk appetite, undermining equities

· Ahead of 17 October's debt ceiling deadline, the path of equities may be volatile and directionless. Q3 earnings may give an excuse to sell rather than a reason to buy equities

· Sentiment on safe haven asset classes has soured. Redemptions from ETFs and money market funds holding U.S. Treasuries could gain momentum and keep yields elevated

· Until the U.S. Treasury actually defaults, any budget deal struck in congress is likely to be disinflationary, preventing gold from gaining traction. Weakness of gold may persist

· Investors who share this view may consider hedging their long equity positions and shorting precious metals through Boost's short ETPs:

1. Boost Russell 1000 3x Short Daily ETP (3USS)

2. Boost NASDAQ 100 3x Short Daily ETP (QQQ, QQQS)

3. Boost Gold 3x, 2x or 1x Short Daily ETP (3GOS, 2GOS or 1GOS)

4. Boost Silver 3x or 2x Short Daily ETP (3SIS or 2SIS)


(Click to enlarge)

The damage done to the bond markets may prove longer lasting even if an agreement to extend the debt ceiling deadline temporarily is reached. U.S. T-bills have not recovered and together with yields on the long end, stay elevated. Postponing the event of imminent default prolongs uncertainty, potentially undermining the U.S. economy. It raises the risk on all assets, including equities. With outflows gaining momentum from U.S. Treasury funds and not reversing from gold funds, safe haven assets see key drivers of support eroding. Investors who share this sentiment may consider hedging their long equity positions and shorting precious metals by buying Boost's short ETPs:

1. Boost Russell 1000 3x Short Daily ETP (3USS)

2. Boost NASDAQ 100 3x Short Daily ETP (QQQS)

3. Boost Gold 3x, 2x or 1x Short Daily ETP (3GOS, 2GOS or 1GOS)

4. Boost Silver 3x or 2x Short Daily ETP (3SIS or 2SIS)

A temporary extension will hold back economic activity and keep equity investors on edge

A deal whereby the debt ceiling is extended by several weeks only, as opposed to a Democratic backed plan where borrowing levels will secure spending decision until 2015, is the most likely outcome. However, merely postponing the U.S. government's imminent default at a time when much of the government remains closed is not going to revive investor confidence, nor will it provide a boost to producer and consumer sentiment. Hundreds of thousands of employees remain unpaid. With uncertainty likely to dissuade households and businesses from making spending and investment decisions, it will continue to hold back U.S. economic activity in Q4.

If the stand-off continues in November, it would arrive at a particularly sensitive time for investors who are looking towards Black Friday, when Americans go on a shopping spree after Thanksgiving. The risks are growing that consumer spending will disappoint, potentially driving expectations lower for Q4 earnings. With the earnings season for the Q3 already under way, investors may start reacting more sensitively to earnings releases, with any positive surprises potentially giving investors an excuse to sell rather than a reason to buy.

Given the relative positive response on equity markets so far, a temporary face saving solution to both the debt ceiling and the budget may not be enough to help equities regain traction. Until the 17 October deadline is passed, when the U.S. Treasury is expected to run out of money, the path of equity markets in weeks ahead may be volatile and directionless. The risk for equities remains on the downside.

Outflows from ETFs and money market funds underscores investor's low level of confidence

Since the shutdown began this month, safe haven assets have seen investors' support slipping. While the Fed remains the main buyer of U.S. Treasuries to the tune of USD 45bn per month, investors are pulling out from U.S. Treasury ETFs at an accelerating rate. The average outflows from the largest U.S. Treasury ETFs amounted to 6% of AUM last week[1], a peak level of redemption this year and coinciding with money market funds run by large U.S. fund managers like BlackRock and Fidelity selling their short-term Treasury holdings. This is why U.S. Treasury yields on the short end of the yield curve remain elevated (see chart) and why, as a result, the burden of the U.S. Treasury to roll over maturing debt is growing. Following the reputation damage done to money market funds during the 2008 credit crisis, it is unlikely that financial institutions and money managers will return to U.S. T-Bills anytime soon. Not until certainty is set in legislation that raises the debt ceiling.

Any budget deal will be deflationary, undermining gold as an inflation hedge

At the same time that the safe haven status of U.S. Treasuries is put in doubt, gold is failing to regain investors' appeal. Since the QE tapering rumours started in May, only to be followed by the Fed's decision to delay it last month, gold has been exceptionally volatile. Given its 'safe haven' status, it is ironic that its implied volatility, which has been hovering around 25% since July (see chart), exceeds the implied volatility of the S&P 500 by ~10%, in effect rendering U.S. equities a less riskier asset class than gold. However, gold's diminishing appeal is not only reflected in its dismal price performance, falling 4.2% in September and 4.7% in October. It is also evident in the shrinking size of gold ETFs. Although redemption by investors have slowed, the major gold ETFs continue to suffer from outflows, and this despite growing default fears by the U.S. with potential catastrophic implications for financial markets and economies. Beneath gold's lacklustre performance is the assumption that a default will be averted and that any deal struck in Washington is likely to focus on spending cutbacks which is seen as disinflationary. Hence, until the U.S. Treasury is pushed into default by missing its first timely payment, likely sometime after the 17 October debt ceiling deadline, the disinflationary environment is likely to continue putting gold under pressure.

With the 17 October debt ceiling deadline nearing, the heightened uncertainty created by the deadlock in congress may compel investors to hedge their long positions in equities more so than to seek shelter in safe havens. Until the U.S. government is actually forced into defaulting on its first obligations since it last defaulted in 1979, it may be an opportunity to short gold, too.


[1] Boost ETP estimates, based on the largest providers of U.S. Treasury ETFs

Source: Looming Fiscal Cliff, Broken Safe Havens. Here Is Why To Hedge.