Understanding the market gyrations of the last few trading days is to say the least problematic. Most of the correlations that have dictated market direction over the last 12 to 24 months are offering zero insight into recent trading action.
For example, as discussed often in my missives, credit markets have been leading equity. However, in the last three weeks that strong almost infallible trend has ceased to exist. If we use the CDX index as a simple guide we will see that credit has improved while equity markets have hit new lows. The last time the S&P 500 traded at these levels in early June the CDX index was priced around the 130 level. Today, the CDX index trades around 120 (and would be 5-6 points tighter without the inclusion of Gulf of Mexico player Anadarko Petroleum (NYSE:APC)). In the past couple of years a 10 point tighter move in the CDX index would have led to a strong move higher in the S&Ps.
The Euro action today offers more evidence of correlations gone amuck. As the Euro surges higher today and the US$ breaks down we could expect equities to rally. Instead, equities are lower and to add insult to serious injury commodities collapsed.
So, we are faced with the following question: Will past correlations reassert themselves or are we entering uncharted waters? The following posts from Zero Hedge offer a compelling argument that the water may be new and filled with shoals. Moreover, the last post regarding BP may in fact be the proverbial elephant in the room….
EUR Surging As Banks Scramble To Cover Liquidity Needs With 30 Day Euro Repos Hitting One Year Highs
An ongoing topic discussed recently is the slash and burn ongoing in Europe as banking counterparties have exactly zero confidence (and less with each passing day) in their counterparties. The backstop by the ECB of everything (for now) is the only thing keeping the system from collapsing. Yet with the ECB now at over $1 trillion in backstop funding for European banks, there will be a point beyond which not even the central bank’s “credibility” will be enough. Today, we are seeing a spike not only in Libor and Euribor (both EUR denominated), but most notably in the 30 Day Repo rate. The result is a scramble to fund EUR positions. Whether the catalyst was this morning’s 6 Day ECB liquidity providing market operation at this point is immaterial: the outcome is one of the biggest surges in the EURUSD in the history of the pair, which at last check was fast approaching $1.25.
Gold Below $1,200 As Asset Liquidations Spread Like Wildfire
The European liquidations we discussed earlier courtesy of the ECB MRO and the repo rate spike, which resulted in a massive EURUSD covering squeeze, have followed through into industrial commodities such as oil and lastly into gold. And as liquidations are merely emblematic of a broken liquidity system (as the name implies), the unwind behind the scenes must be fierce. On the other hand, as the only recourse to prevent an all out systemic collapse should the deflationary trend continue, from Ben Bernanke’s perspective, is just to print more money and thus solidify the position of the precious metal as undilutable and a currency which can not be backed with toxic MBS and Greek Sov Bonds, today’s sell off is a much welcomed respite for the commodity which traded at record highs as recently as this week. Also, our recent disclosure of PM market manipulation via disclosed COMEX-OTC arbing by such former behemoths as AIG then (and presumably JPM now), should only add to your comfort that once the finger on the scales is removed, the natural reaction will be that of a coiled spring.
Morning Gold Fix: June 30, 2010
Commentary courtesy of www.fmxconnect.com
Gold traded in a wide range on Tuesday as markets reacted to frightening news. Slowing growth from China shocked the market, driving oil prices more than $3 lower,dropping the Standard & Poor 500 ~30 handles and leaving gold and the dollar as the prime beneficiaries. More contagion fears from Europe and paltry consumer confidence reports didn’t help matters either. Gold sold as low as $1228 per 100 troy ounces on Tuesday before ultimately closing just over $1246, a $4.80 gain for the day.
Yesterday’s activity was in our opinion a microcosm of the main drivers currently having a tug of war on the precious metals markets, i.e. deflation risk and European sovereign default risk. Forget inflation for now. Sure Gold is a hedge for inflation, but so is your house, or a Cadillac. Our own analysis almost never seeks to predict price movement, but instead seeks to understand if observed correlations between events and price movement are in fact causations. Yesterday was a great day to provide a clean data point in what we think are the main movers of gold currently. Our conclusion is simple and may have been obvious to readers, but we are ecstatic to have a better handle on the “whys” of market movement. As reactionary traders, it allows us to know better what to do in an event. Do we step in front of it, or do we go with a trend? Do we take profits or add to positions?
Our suspicions are simple: deflationary events drive gold lower, sovereign default risk drives it higher. The dollar, stock market, and bond market are secondary as proxys now (OMG, I can’t believe I said that… Gold is its own asset now!)
Guest Post: Sultans Of Swap: BP Potentially More Devastating than Lehman
As horrific as the gulf environmental catastrophe is, an even more intractable and cataclysmic disaster may be looming. The yet unknowable costs associated with clean-up, litigation and compensation damages due to arguably the world’s worst environmental tragedy, may be in the process of triggering a credit event by British Petroleum (NYSE:BP) that will be equally devastating to global over-the-counter (OTC) derivatives. The potential contagion may eventually show that Lehman Bros. and Bear Stearns were simply early warning signals of the devastation lurking and continuing to grow unchecked in the $615T OTC Derivatives market. What is yet unknowable is what the reality is of BP’s off-balance sheet obligations and leverage positions. How many Special Purpose Entities (SPEs) is it operating? Remember, during the Enron debacle Andrew Fastow, the Enron CFO, asserted in testimony nearly 10 years ago that GE had 2500 such entities already in existence. BP has even more physical assets than Enron and GE. Furthermore, no one knows the true size of BP’s OTC derivative contracts such as Interest Rate Swaps and Currency Swaps. Only the major international banks have visibility to what the collateral obligations associated with these instruments are, their credit trigger events and who the counter parties are. They are obviously not talking, but as I will explain, they are aggressively repositioning trillions of dollars in global currency, swap, derivative, options, debt and equity portfolios.
Disclosure: No positions