Global Macro Notes: Watching the World Burn

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 |  Includes: AGU, CCJ, DNN, FXI, HAO, JJC, OIL, POT
by: Mercenary Trader

By Jack Sparrow

There is a scene in the movie The Dark Knight where the Joker commits the ultimate act of nihilism. After amassing a huge pyramid of cash, he simply sets it on fire, making a clear statement as to his take on material wealth.

I am reminded of that scene by current market gyrations and the likely end game for the epic inflation / deflation battle.

In the short run, deflationary forces continue to build as Fortune 500 corporations and money center banks hoard the gusher of liquidity directed at them by the Federal Reserve.

In the long run, however, the liquidity trap realities of “pushing on a string” will eventually force the Fed and their European counterparts to go nuclear in their emergency deflation-fighting measures – at which point the intrinsic value of those pharaonic cash pyramids will go up in smoke and ash, just like the cash in the Joker’s warehouse.

Goldilocks Malaise

The here and now of the situation is a sort of “Goldilocks Malaise,” which has in turn morphed into a late Summer rally. We are coming off a sweet spot in the equity cycle where corporations are able to continue ringing profits out of brutal cost cuts, while at the same time investors are snapping up corporate bonds like crazy and otherwise acting in “risk on” fashion to avoid the pain of near-zero returns on cash and cash equivalents.

This rally has also been enabled by the results of the European “stress tests,” which, it seems, were more an exercise in smoke and mirrors than anything serious. Nonetheless, the stress tests did their job in giving those with a deep desire to be bullish the perfect excuse to justify that desire.

Though possessed of a very strong sense this is all going to end in tears, we are positioned on the long side of this market (as will be noted shortly).

In recent updates (and prior to the current breakout), we noted the following:

  • [From July 31st comment] As long as economic conditions are bad enough to keep ZIRP intact and inflation pressures absent, yet not so bad as to get in the way of short-term corporate earnings gambits and leveraged layup stimulus exploits, it’s all good in the neighborhood… which is a big reason why markets have seemingly flipped (as of this writing) to a “late Summer rally” posture (with we Mercenary Traders adjusted accordingly).

  • [From July 28th comment] The really enticing scenario, at this point, would be a sort of Soros-style “false trend” broad market rally that gets itself good and extended headed into the fourth quarter — giving time and room for delusions to dissipate and harsh reality to reassert itself most fully from overbought levels.

The China Tell

Going over my notes and charts Sunday night -- and as Mike McD hit on earlier today -- the striking piece of weekend news was the manufacturing slowdown in China.

“China’s manufacturing grew at the slowest pace in 17 months in July,” as Bloomberg and others reported, “as the government clamped down on property speculation and investment in energy-intensive and polluting factories.”

News of this type is “bipolar,” in that it can be taken as bullish or bearish as sentiment dictates.

  • The bearish interpretation: China is slowing down, so the entire global economy is at risk of slowing down... more reason to be concerned about deflationary pressures, misallocated capital, bank loans gone bad, post-euphoria credit collapse, and so on.
  • The bullish interpretation: China is slowing down, which means inflationary pressures in China can ease, which in turn gives Beijing more room to inject a round of fresh stimulus. If the patient’s heart rate is falling (i.e. the pace of growth is slowing), the doctor then becomes free to inject a little more juice.

Markets clearly and indubitably went with “Door No. 2” on Monday, as the major China ETFs went flying out of the gate (as did copper and crude oil). This was a strong "tell" in respect to general sentiment and pent-up buying power.

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That said, the bullish action in China now seems a classic example of a George Soros style “false trend.”

The intermediate-term fundamentals for China are terrible, and actually quite frightening. There is a whole litany of woes the dragon faces now – not life-threatening, necessarily, but most certainly of market-crashing caliber.

But none of those concerns need apply in the near term... “a rolling loan gathers no loss,” as the Wall Street wags like to say, and markets have shown a persistent and uncanny ability to ignore ominous warning signs for extended periods of time. (This is nothing new; the markets have always been thus.)

Riding the Rally

As detailed in recent comments, this rally is not to be trusted.

With that said, the habits and sentiments of long only managers and yield hungry investors are so entrenched, and so well-backed by fire power, that the hopes, dreams and manifest tendencies of the permabull crowd have become important fundamental inputs in and of themselves.

In trying to make sense of any market movement, it is thus critical not just to 1) heed the price action, but also to 2) remain keenly aware of the potentially “irrational” and “illogical” biases of the market participants themselves.
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Given the above, the two areas where my opportunistic long exposure is concentrated at the moment are fertilizer and uranium.

The “ferts” have seen breakout type movement in recent days as the threat of Russian wheat shortage concentrates hearts and minds. Aside from fertilizer, agriculture in general will be a very lucrative area to look for upside opportunity in the coming quarters and years, as the protein-craving dynamic of emerging market appetites is well established.

On the uranium side, uranium mining is an industry that has been re-ignited by signs of China stockpiling and aggressive plans for nuclear power plant construction around the globe. As with agriculture, there are fair reasons to see uranium as an area of renewed speculative activity, with nuclear re-establishing itself as a growing and respectable alternative to fossil fuels.

Waiting for the Fall

Though net long at the moment, bullishness does not come with any great sense of comfort or conviction. If anything, this rally feels like a giant Soros-style “false trend” as mentioned – one to be ridden to the point at which it is discredited, and then abandoned or reversed.

It is my humble prediction that those investors who use upside market movement to renew their long-term faith in hope jags – "maybe everything is okay because the market is going up again” – will again get what they deserve as payment for being naive.

Given the nature of the macro-economic backdrop we face and the serious “top down” problems that “bottom up” practitioners so desperately seek to ignore, it is only a matter of time -- though it is hard to say how much time -- before another jolt of sovereign-related crisis drops this market like a hot rock.

And yet, and yet... the general positioning as of this writing (August 4th) is long-oriented and will remain so until there is clear sign that “animal spirits” have maxed out, setting the stage for another raid on the bear side.

Disclosure: Author long FXI, HAO, JJC, OIL, POT, AGU, CCI and DNN