Are Assets Out of Whack?

 |  Includes: FXC, FXE, GLD, OIL, UDN, UUP
by: Market Blog

By David Berman

Are you mystified by the market these days, wondering how far the gains in gold and oil can go, and how low the U.S. dollar can fall? There is certainly a lot of momentum at work here. Avery Shenfeld, chief economist and strategist at CIBC World Markets, likens the recent action to that of a freight train “rumbling down the track, allowing nothing to get in its way.

“It’s a cliché, but few traders really are brave enough to step in front of a moving freight train,” he said in a note.

In other words, the market appears to be ignoring some news that should be slowing this train. For example, the euro wasn’t exactly rocked by Portugal’s need for a financial bailout.

“The market is ignoring all of Europe’s fiscal and banking troubles and trading off a single indicator, interest differentials, and the prospect they will widen further in Europe’s favour as the Fed stands pat and the ECB hikes,” Mr. Shenfeld said.

At the same time, oil prices have moved to new post-recovery highs following news of a fire at a Libyan oil field, even though few observers are expecting much in the way of Libyan oil exports anyway. And oil also ignored a rate hike by China and its move to increase petroleum product prices.

“With so much momentum, there’s no reason why oil can’t tack on another $20, no reason why the Canadian dollar can’t touch $1.10, no reason why the euro can’t be driven to $1.50,” Mr. Shenfeld said.

But will they? “With enough leverage, hedge funds and hot money traders can push just about any financial variable to any extreme they fancy. But we economists, or at least the economy, eventually rule the roost,” he said. “When market prices get far enough out of line, a stern enough reality check from the fundamentals can send the same investors fleeing in the other direction.”

As for what could derail the train, he has a few ideas. A resolution to the conflict in Libya would likely bring down oil prices. The euro could be hit by evidence of flagging growth following budget cuts by various governments. The Canadian dollar could be hit by oil prices retreating below $100 a barrel, or by a signal from the Bank of Canada that the strong currency would delay rate hikes.

Mr. Shenfeld’s advice: Don’t get caught by being the last off the moving freight train.

Disclosure: None