Is the Market Running Short of Parking Slots?

A runaway rise in Gold and negative yields in US short-term treasuries offer one of the two conclusions: a rush for safety amongst investors or too much money chasing too few assets. For the first hypothesis to be true, the risky assets need to show a meaningful fall. Given steady to rising equities and commodity prices, love for risk hasn’t lost, despite the sliding trend of economic data from the U.S. and Europe. Clearly, money’s steeplechase for asset classes continued last week defying long-held fundamental relationships. The dichotomy has created a large divide between money managers and fundamental economists. We feel that “reflation” tactics of the U.S. will fetch flak from around the world and the recovery could potemtially come under its own weight.

Running short of parking slots?

Earlier this year, Warren Buffet, George Soros and many others expressed fears about the unexplainable rise in asset prices and 1970s-type inflation. The first part of their expectations is proving to be true, gradually but steadily. Several indicators prove this point; let’s have a closer look.

U.S. banks continue favouring U.S. treasuries over lending as best bet (Geithner admits tight credit for smaller companies yet); the rush is accelerating towards the year-end. U.S. 3m treasury yields turned negative last week as demand for paper rose. We came across a similar phenomenon this time last year when yields turned negative briefly. Given improved cash flows and financial conditions of banks this year, we would not be surprised to see more money at disposal of banks, thus spreading negative yields further up the tenor.

This could be an year-end phenomenon, but it speaks loud and clear about risk appetite of U.S. banks and the surplus money at their disposal. It also states that despite a steep rally in asset prices globally in hope of economic recovery, U.S. banks do not see meaningful business opportunities. Negative yields, an extraordinary case, reminds one of Jim Rogers, who sees bubble in U.S. Treasuries. He could be right, but other asset classes are not different.

Gold rose about 10% this month and 41% in last 12 months. Although Gold has been on the uptrend for last few years (2002: +23%, 2003: +19%, 2004:+5.5%, 2005: +18%, 2006: +22%, 2007: +31%, 2008: +5.6%, 2009 (todate): +31%), bets on Gold’s continuous rise have been cummulating to a new records. Net speculative Long position in Comex Gold is above 32 million Oz equaling notional value of about $50bn. Besides, about 1600mt have been held by investors in several ETF funds equaling about $80bln. Dollar’s weakness and lack of investible avenues is one of the biggest driver for prices higher. Gartman finds a bubble in gold but is friendly with the trend.

Industrial commodities are no exception to the trend. Despite close to record inventories (and rising) in Crude, Natural Gas, Nickel, Aluminium, Tin and multi year high stocks of other base metals viz: Zinc and Lead, their prices have bounced sharply from year’s lows. Total LME stocks of all traded products rose to a record above 6 million tons recently and are rising yet. Base Metal stocks in Shanghai are at 540kt, a record level, while Copper stocks in Comex have been rising too. Most of the research agencies expect metals to be well supplied in 2009 and 2010; they forecast a deficit developing only from 2011. However, prices continue to defy the statistic, a clear indication of money chasing this asset class as well. Some see bubble developing in Chinese asset markets, especially real estate; the largest consumer of metals.

Money needs place to hide, to park itself. Too much money starts running short of available parking slots and creates bubbles. Formation of bubbles could extend over several months and years together. The latest move in asset prices show a divorce from fundamentals and hence talks of bubbles. Having seen a bubble burst recently, some are fearful of a relapse with smaller pre-crisis bubbles growing bigger. World leaders and thinkers viz: German finance minister, Chinese officials, Bill Gross [PIMCO] have started raising issue and pointing fingers on each other. We think that debate could intensify further, pressing the U.S. Fed to to take some money tightening (not rate raising) measures and create ripples in the market which is thriving on dollar carry trade. Given the extremely lopsided market, we feel that first quarter of next year could be quite challenging for money managers.

The last week

Base metals and Gold pulled sharply higher without support from the Dollar and equities. It clearly looked like new money rather than short covering. Commitment of Traders report suggests continuous accretion of longs across commodities.

Antaike revised Chinese Aluminium consumption forecast upwards meaning about 500kt of additional consumption than previously thought. Given strong regional premiums for Aluminium, this isn’t surprising. However, Aluminium led the complex higher on the back of this news-story. Besides, news of hike in non-residential power tariff by 5.7% in China also helped the sentiment for Aluminium.

Antaike’s report suggested that Chinese secondary output of Lead in Jan-Sep rose 53% y-o-y, the principal driver behind rising lead production. Given short supply of lead concentrate in China, this news isn't surprising.

There were talks in the market about CTA activities in few base metals; traders expect an accentuating move by CTAs.

Physical market
Physical premiums for aluminium and zinc remained firm . Rotterndam premiums for Aluminium ticked slightly higher while some trades in the U.S. indicated small re-stocking demand. Copper premiums remained depressed in most of the regions.

Year-end stock clearing by traders could push down premiums in weeks to come. However, we expect Aluminium and Zinc demand to hold up.

Market mood
With 3m Oz of open interest at $1200 Dec-09 Call of Comex Gold, all eyes are on expiry on Monday. An unsuccessful attempt of surpising the option seller could mean a quick price correction for the rest of the week.

Most of the base metals are looking good technically and could push higher especially after a firm close last Friday. A revisit of $7000 for Copper and $2350 for Zinc and $2100 for Aluminium could be on cards this week.

However, those watching the bigger wave should be focusing on currencies which are (arguably) close to inflexion points. The Euro has failed above 1.5050 several times and is pushing close to the bottom line of the up-trend channel. Mirroring this, the Dollar index seem to be supported below 75 and is suggesting a double-bottom, but needs validation in the coming weeks. Similarly, the Japanese Yen seems to have made a double bottom at the 87-88.50 range. While all these suggest a possible strength in the Dollar, we would watch for break-outs (JPY >94, USD Index > 76.50, Euro < 1.46) before betting against the trend.

Author's Disclosure: None