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Correction Time?

The first trading week of the year started with subdued activity with people still getting over their holiday hangovers. However, lackluster volumes were expected until the big non farms data released on Friday. There were a few dominant themes for this week's market action in European and American sessions, and they all point towards chances of some small corrections and confusion about market direction over the next week:

Commodities sell off:
The week started of with a sell off across the board in commodities. This could be attributed to two factors. Firstly, it could be some profit taking coming into the new year for longer term traders/investors. Commodities finished 2010 on a high, with exceptional performance in the metals, with copper leading the bull run. Gold finished above 1400, and has now corrected to 1369. (This is certainly not a very big move and does not suggest that the bull run in gold is over, especially given the fact that inflation will tend to be the dominant theme for the global economy over the next year. Buying dips in gold and silver would be the obvious thing to do in such a scenario, although the market does tend to punish those who fall for the obvious more often than not. Still, there are a significant number of bullion bulls out there and I would definitely not like to sit on a short in gold and hope for a bust.)
Secondly, floods in Australia's Queensland province added to the zest for the sell off. Queensland is one of Australia's commodity rich provinces and cotton futures in particular took a big hit after the flooding news came out.

Crude oil finished lower for the week below the $90 mark. $100 is largely seen as the inflection point for oil, that is prices above it would not be good for equities. In crude related news; Russia has recently opened a pipeline to China. The Chinese contributed significant amounts towards laying of the pipelines and this is a big step for the two countries. The world's no.1 producer of oil is supplying directly (20 year deal) to soon to be the world's no.1 consumer!

FOMC minutes and unemployment data:
The Federal Open Markets Committee released their December minutes on Tuesday. It was interesting to note the reasons given for a rise in government bond yields. The minutes stated that "market participants pointed to abrupt changes in investor positions, the effects of the approaching year-end on market liquidity, and hedging flows associated with investors’ holdings of MBS as factors that may have amplified the rise in yields". This essentially means that the Fed is of the opinion that the slight rise in government bond yields has been a result of normal market activity. It is interesting to note that the yields have not broken out of their 30 year long downtrend and until they do, there is no reason to believe that the rise is indicative of nervousness about the fiscal situation in the US.

The vast array of unemployment data that came out this week did nothing but confuse investors. First there was the ADP number of 297,000 for December which came out on Wednesday, which was triple the market estimates and lead to a decent market rally after the commodity sell off in the beginning of the week. This number was truly unbelievable and there was a fair amount of skepticism regarding this number and its inflated outlook due to the number of holidays in December skewing the data collected. The non farms number of 100,000 or so jobs created in December was significantly below the market estimates which had been skewed upwards due to the over optimistic ADP numbers. Surprisingly (for me) the headline number which came out on Friday was in line with the Goldman Sachs consensus (a real turn around for the analysts at GS!). However, the bearish headline number did not move the markets as much as it would generally because the unemployment rate fell to 9.4%, a healthy decline from the previous 9.8%. As a result of the mixed data, markets might be in for a turbulent ride next week, however they will recognize the fact that the Fed will not stop it QE2 programme on the basis of the slight drop in the unemployment rate, with their mandate stating that they are looking to achieve a 7% rate before reconsidering the magic market injections.

Euro weakness:
The Euro continued to tumble this week against the dollar, trading at 1.29 on the spot price. This is the first time the Euro has been at these levels since the summer of gloom with the Greece crisis etc. The week started off well with an amazing increase in German factory orders but later in the week news also filtered out about another Spanish Caja in trouble, needing about $1 billion in aid. With investors looking to focus on only the positives in the American economy with the 9.4% number, dollar strength might continue to be the theme over the next week, which may in turn cap the upside for US equities. Trichet and co. have a load of work to do this year, convincing investors that the bigger economies are not in trouble. Facts floating around such as Iraqi bonds being safer than the peripheral countries debts, are not going to make life easy for the ECB. China has stepped in a few times over the past weeks to say that they are buying Spanish debt etc, but I dont think that markets are looking at these statements by the Chinese as a panacea. Any practical investor would know that the Chinese are just trying to diversify their currency holdings, and are desperate to have something to hold on to other than the dollar.

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