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  • Intermarket Analysis And Long Gold Trade As A Systemic Hedge Strategy In Emerging Markets

    Long gold trade is an important systemic hedge strategy in Emerging Markets; Inter-market matrix helps traders and investors to properly position themselves in current volatile markets:

    A few extra comments on value of gold as an ultimate disaster and inflation hedge, and value of Inter-Market Analysis as a tool that allows to analyze long-term expectations when decision-making time is limited.

    With bipartizan debt deal compromise reached, markets concentrated on negative sentiment and plenitude of bearish news ranging from slowdown of the U.S. economy to debt crisis in Europe to poor major economic indicators. The evergrowing sell-off expectations bring up the following systemic hedge and interest rate considerations:

    1. Out top choice hedge recommendation for macro portfolios: Gold is a top strategic hedging choice as we enter a decade of rising interest rates.

    2. Following inflation expectations, world bond prices will drop and repo rates will rise bringing down bond carry trade profits. In addition to volatile EM FX rates, Emerging Markets bond portfolios' P&L will be significantly affected by rising repo rates and overall inflation expectations. We expect further EM bond market correction later on this year through 2012.

    1. Gold:

    At this point, gold seems to be the only viable hedge, assuming prevailing negative market expectations that could potentially turn into a self-fulfilling flash-crash prophecy.

    Things to consider: Gold is a long term institutional long bet. Similar to rates, gold price moves in very long cycles - up to 20 year up and down cycle. Even though I think that gold is definitely overbought in the current cycle (2004-2011), the current trend is still up. The main point is that even if there is good news next week, I do not expect there will be a steep fall in the gold price. On the contrary, if the news is bad, rising inflation expectations will push cost of gold futures/forwards upward given expectation of the increasing interest rates.

    Strategy Description: Systemic hedge on Aug 2 volatility increase.
    Exit Signal: Market stabilization
    Tracking the trade: August 2, 2011 P&L +2.7%
    July 29, 2011 - Long Gold Futures, Buy @$1,615
    August 2, 2011 - Stay put @$1,658

    On these charts, we can see that rise in gold prices, was a lead indicator of the raging U.S. inflation in late 70's early 80's (78-81) when Fed Rate yielded close to 20% (Same issues as today: America was fresh out of Vietnam war that ended in 1975). The artificially low interest rates in the U.S. have led to an ever-increasing expectation of eventual jump in interest rates, hence the ever-rising gold price. However, a big difference was that under Carter administration, U.S. gross federal debt was under 40% of the U.S. GDP. Today, the U.S. Federal Debt is close to 100% of GDP and being drained by Social Security, wars in Afghanistan and Iraq. In absolute terms, overleveraged America is much worse now, while heading into a decade of high interest rates:

    Chart 1. Long term gold cycle (Source: Yahoo Finance)

    Chart 2. Fed Funds Rates 1957 - Present

    Chart 3. Historical Gold Prices

    2. World bonds price to experience correction following decades-proven Inter-market relationships:

    To explain our long term view on the bond market, I have put together an Inter-Market Trading Matrix from the U.S.-centric perspective. Some of these observations are based on works of John Murphy. This matrix can be used to easily identify macro trading opportunities and relationships between different asset classes, and determine how current macro-economic decisions will affect the world long-term, i.e. ramifications of the U.S. debt austerity deal, end of QE2, ECB inabiity to handle European debt crisis, uncertainty about China's economic growth, etc.

    The below matrix demonstrates basic decision making process that a typical macro investor would follow and potentially profitable trades that would follow. The simplest of the trades would of course, be a classic trade of negative market/Flight to Safety sentiment, i.e. 4 pairs: Forex: [long USD, short EM FX], Commodities: [Short Brent/Crude, Long Gold], Equities [Long Volatility, Short Equities], Interest Rates [Long Inflation, Short Bonds].

    Macro Trading Matrix

    Here's an example of such an inter-market matrix driven macro trade. From macro credit perspective, EM markets have a higher beta. Therefore we can recommend U.S./EM asset trade that would be betting on faster rate of EM asset change compared to a comparable U.S. asset. An extremely profitable example of such a trade, would be an equal notional trade - going long on the Brent oil contract and selling short ERX (Triple-leveraged energy). ETF.

    This is a notional-neutral bet on spread reversal. The underlying trade reasoning is the following - due to volatility spike on U.S. debt crisis, U.S. market energy will be falling faster than Brent Price (brent is more supply/demand driven) and spread will return to historic average (from $31 to $39) between Brent and ERX - See SGP screen on Bloomberg (ERX US Equity vs. C01 Comdty):

    Here is the trade P&L: [Updated August 5, 2011]

    This pair trade generated 16% positive P&L in one week, between July 25 and August 5, 2011.

    Potential Exit Signal: Spread between Brent and ERX ($116.76 - $75.32 = $41.42) rises above 1 year mean spread of USD$39.9. Sell on mean reversion.

    Notional: $500K long, $500k short.

    Tracking the trade's performance:
    [Updated August 5, 2011]

    Friday, August 5, 2011:
    P&L (July 25 - August 5, 2011): -$34,807 (Brent) + $193,600 (NYSEARCA:ERX) = Net +-ve $158,793 profit (16% in two week / holding period return)
    Long Brent 109.59 (Down -$8.2 or -6.96%)
    Short ERX: 53.00 (Down -$33.5 or -38.72%)
    Spread of $57 between ERX and Brent shows that the pair is oversold and time is to consider reversing the trade once the market conditions turn.

    Tuesday, August 2, 2011:
    P&L: -$8,600 (Brent) + $101,800 (ERX) = Net +-ve $93,200 profit (9.3% in one week / holding period return)
    Long Brent 115.93 (Down -1.72%)
    Short ERX: 68.88. (Down -$17.62 or 20.36%)

    Monday, August 1, 2011:
    P&L: -$5,000 (Brent) + $70,000 (ERX) = Net +-ve $65,000 profit (6.5% in one week)
    Long Brent 116.76 (from top 119.5 on open)
    Short ERX Change: 74.75. (Down 14%)

    Friday, July 29, 2011:
    Friday: P&L: -$5,000 (Brent) + $65,000 (ERX) = Net $60,000 profit (6% in one week)
    Long Brent 116.76 (Down 1%)
    Short ERX Change: 75.34. (Down 13%)

    Wednesday, July 27, 2011:
    P&L: Brent ($721) + ERX ($21k) = Net $22K (2.2%)
    Long Brent 117.96 (Up 0.14%)
    Short ERX Change: 80.38. (Down -4.30%)

    Monday, July 25, 2011 (Open the position)
    Buy $500K notional of Brent future at $117.79
    Sell $500K notional of ERX. (either underling or ATM put) at $86.5

    Additional inter-market trade indicators (Source: John Murphy, "Intermarket Technical Analysis"):

    The below intermarket-relationships demostrate value of the trade cycle for portfolio management and proactive investing:

    There are also additional trade/economic cycles that affect trading and investment decisions:

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Aug 15 12:29 PM | Link | Comment!
  • Commodity Strategy: Model Trade of the Week Update [Short Euribor and German Bonds vs Long U.S. Equity Futures]

     


    Trade Open: August 12, 2011
    Trade Close: August 15, 2011

    Net absolute dv01 (if all positions were at profit) = -$7.3k, since they are not perfect long/short combinations.


    Trade parameters:

    $280k margin cash

    $29 mln notional + fx trade

    Stop and limit orders, alternatively OCO (one cancels/initiate another) to cut losses quicker.

    3 Day P&L: $50K

    Cash Margin Used: $280K

    3 Day Net Return: 18%



    Strategy Description – Market (August 12) is set to stabilize today:

     

    Short:

    ·         Short Euribor 3 month future – expectation that liquidity will improve

    ·         Short USD, Long Euro – on receding volatility, U.S. is relatively better than Europe

    ·         Short Euro Schatz futures (Here’s thinking that European markets should decrease appetite for short-duration (1.75-2.25 years) German Sovereign debt on positive equity markets in Europe

    ·         Short 10 year UST

     

    Long:

    ·         Long SPX and Dow Jones Spet 11 futures (U.S. is relatively better than Europe)

     

    Out of these bets, 10 year UST lost some cash as a directional “short on top” bet but still is an effective hedge. We still expect that USTs should sell off after record high last week.


    Strategy P&L:
    Long Eur/Short USD @1.4268 Close @1.4300, $10 mln notional, @$32K profit
    Long Emini SPX @1,174 Close @1,184, 10 Contracts, @$5K profit
    Long Dow Jones Emini @11,143
    Close@11,314, 10 contracts, @$8k profit

    Short Euribor 3 Mo @98.76 Close @98.715, 100 contracts @$14k profit
    Short Euro Schatz  @109.33 Close @109.345, 100 contracts @-$4 loss
    Short 10 year UST @129'11 Close @129'16, 30 contracts @-$5k loss

     

    Notional:

    Emini SPX 59K notional x 10 contracts = $590k notional

    Euribor EUR246K x 100 = EUR24  mln notional = $16.6 mln

    Euro Schatz Bonds Eur109K c 100 contracts = eur 10.9 mln notional = $7.6 mln.

    Dow Jones future $56k x 10 =contracts = $560K notional

    10 YR UST $129.5K x 30 = $3.9mln notional

    Total: $29 mln notional

     

    Aug 16 7:40 AM | Link | Comment!
  • Commodity Strategy Update: Trade of the Day on U.S. Market Open [Long CHF and 10 year Treasury]
    August 10, 2011 - Trade of the Day:
     
    10AM UPDATE - Analysis proved correct. Market is 440 bps down. Model portfolio returned healthy 10% leveraged P&L.

    Notional weighted-average trade:
    Long CHF / Sell weighted basket of AUD, JPY, SEK, TRY, USD, and ZAR.
    Long 10 Year U.S. Treasury
    Short S&P 500 E-mini.
    Short Euro / Long USD
    Short Ruble / Long USD

    Enter 8:00 AM ET - Exit 10:30AM ET, August 10, 2011


    8AM EST
    From technical analysis point of view:
    Markets move in waves + flight to safe haven in absence of CHF direct intervention. Looks like market is capable of absorbing additional CHF liquidity rather quickly. CHF basket in combination with long 2/10 is a good high prob intraday trade this morning on S&P emini already down 2.3%  intraday on profit taking and Uk growth news.
     
    From fundamental point of view:
    Euro markets did not follow through as high as it was expected – hence initial nervous move into USD, CHF and gold, out of WTI/Brent . Along with CHF, 10 year is following emini intraday, up 0.30% (As well as Short Eur/Long USD @1.43617 for 50bps +ve p&l) .  Btw, OIS spread on eurolibor is highest in 2 years.





    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Aug 10 10:27 AM | Link | Comment!
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