Trading Desk Notes - July 29Submitted by Polar Futures Group on July 28th, 2017
The USD index had its lowest weekly close in 15 months, down 10.5% from the 14 year highs made in December when bullish sentiment was at its peak on Trump’s “Make America Great Again” and as the Fed was raising interest rates while other Central Banks were not. We think that just as bullish US Dollar sentiment hit a high in December, bearish sentiment is hitting a high here in mid-summer as the relentless “Political Turmoil” in Washington clobbers the Big Dollar. We bought a small position in the USDX yesterday when it looked like the downtrend was WAY overextended, but we covered that for a small loss this morning. Over the years we have learned that trends in the currency markets almost always go WAY further than seems to make any sense and then they turn on a dime and go the other way!
The Canadian Dollar had its best weekly close in over 2 years, up 8 cents (11%) from the May 5 lows when CAD turned higher in lockstep with crude oil. Bearish sentiment on CAD was extreme at the May lows with a MASSIVE speculative short CAD position in the futures market. CAD initially rallied ~2 cents along with crude oil but then the CAD rally was super-charged by the Bank of Canada’s “change of heart” on interest rate policy.
We think the “drivers” of the CAD rally have been (in order of importance): 1) the dramatic “change” in BOC policy which caused, 2) a dramatic narrowing of the American short term interest rate premium over Canada, 3) covering of MASSIVE short CAD positions, 4) CAD buying by people with risk exposure to a rising CAD who had previously been “trained and rewarded” to remain unhedged, and 5) rising crude oil prices.
(A side note to item 4: We believe that the amount of money in global macro markets that is run by money managers running Other People’s Money (OPM) absolutely dwarfs the amount of money run by individuals...and that these money managers behave differently than individuals running their own money. They have “constraints” of different kinds, not the least of which is that they know they are in competition with one another. For instance, some of the leading pension funds in Canada have reported very good results the last couple of years...in part due to gains made on the value of foreign assets when the value of those assets are reported in terms of a falling CAD. If any of these pension funds decided to hedge some of their FX risk it could add up to a LOT of CAD buying.)
Magazine covers: Rolling Stone magazine had a picture of Justin Trudeau on their cover this week with the caption “Why Can’t He Be Our President?” Also this week Petronas canceled their $36 Billion LNG project in British Columbia. We’ve been waiting for a few weeks to short CAD (all our usual reasons!) and took a small short position near this week’s highs.
Gold: has closed higher for 3 consecutive weeks gaining ~$65 since the early July lows as the USD weakened and real interest rates fell. We’ve noted a relative “lack of interest” in gold (at least compared to the HUGE speculative interest in gold in the first half of last year) and we think that gold hasn’t gone up much given the USD weakness and the variety of potential geopolitical flashpoints. We’re long gold calls as market-wide low volatility means options are cheap.
Crude Oil: has rallied nearly $8 (19%) from its May 5 lows as the USD has been weaker and as the back-and-forth bullish/bearish sentiment swings we have seen YTD have swung to bullish. The key bullish view is that production is falling or will fall relative to demand...whether because of voluntary production cutbacks or by potential “involuntary” production cutbacks...and the frontrunner in this category is Venezuela. The immediate issue is the proposed Sunday “elections” which, if held, may trigger American sanctions including a ban on imports of Venezuelan crude. The country is suffering from skyrocketing inflation with ½ the population living in extreme poverty and oil production has been trending steadily lower...with some analysts forecasting an inevitable total production collapse as the country reaches new extremes of social chaos. Other OPEC members (well nearly all OPEC members) could also be imagined to be at risk of involuntary production cutbacks with Libya and Nigeria at the top of that list.
But geo-political risks have always been a factor in the price of crude oil and over the years the market has swung from pricing in too much or too little risk premium. Josef Schachter (www.Schachterenergyreport.ca) has made a number of great calls on the oil price over the years and he expects WTI prices to fall below $40 later this year...with a possible break below $30 if the stock market suffers a sharp break. (He also sees CAD much lower if WTI falls as he expects.)