The Rack Trade Cometh & Killeth

The following trade is causing some mega pain and panic unwind within the energy trading community:

Long Crude Oil futures/Short Natural Gas Futures

It’s painful enough to be squeezed, but to be taking it at both ends is unbearable and you can see it in the chart.

It looks like the rack trade should be close to ending  but still wouldn’t jump in here.   We have experienced and know all about these rack trades.  Very painful.

Just when you think you’re nice and hedged up, it hits the fan.

Compliments of the Polish Rifle,  Dougie Skrypek.

 

Rack Trade

 

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Rome Is Burning, Again

This is insane. It is getting old and hard to breath.  Godspeed to those suffering.

 

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Mr. Market’s Biggest Headwind

At the end of September, we posted our analysis of the structural changes taking place in the Treasury market,  The Gathering Storm In The Treasury Market 2.0,  which was very well received and still getting thousands of hits per week.

Crowding Out

Our analysis focused on “crowding out”, mainly, the changing supply and demand dynamics in the Treasury market.  We flagged the sharp increase in new Treasury supply this year and the coming years, and the declining demand, mainly, what was once “free money” from:  1) foreign central banks;  2) U.S. government trust funds, such as Social Security which is now in deficit; and 3) The Fed, which is now a net seller of Treasury securities as quantitative tightening is full steam of head, forcing the Treasury to issue an additional maximum of $30 billion into the market to refinance the FED’s maturing Treasury portfolio.

Treasury_Financing Needs

 

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Treasury_%_Marketable_GAS

 

Treasury_SOMA_Maurities and Rolloff

We concluded the extra supply and declining demand is putting almost unprecedented stress and pressure on the world’s financial markets.  That is the marginal supply of liquidity/savings/capital, however, you label it, available for all global asset purchases is not unlimited unless complimented by quantitative easing, and is being sucked into the U.S. Treasury market.

Interest Rates

We also noted in the piece that the only possible case for Treasury yields to remain at current levels or to move lower was for haven flows to increase.  Selling in other asset markets, such as stocks and emerging markets, with the money moving into Treasuries.

Even still, we expect real yields to move higher.

Moreover,  as markets increasingly fret over the growing fiscal deficit and how it will be funded, we suspect the political conflict in the U.S. is going to get very loud and ugly over the next few years.

Place your bets on how to lower the deficit to relieve market pressures.   Cutting entitlements or raising taxes?   Or both?

Jim Grant

Finally,  Jim Grant nailed it last week, confirming, at least to us, our analysis.  Keep it on your radar, folks.

…the expected burden of Treasury security supply in the market this year..we are talking about the biggest dollar amount of securities for sale as a percentage of GDP since World War II, 1945.  – Jim Grant, @2.35 minute mark  

Jim Grant_Nov12

 Click here for interview

Big changes coming to the Global Macro Monitor.   See here for details. 

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Is The U.S. Dollar Over/Undervalued?

If you are planning on retiring to a country other than the United States, you may want to have a glance at our following analysis.

Purchasing Power Parity

We have taken the October IMF WEO database and backed out their Purchasing Power Parity dollar deflator to get a sense of how cheap or expensive each currency in the world is relative to the US dollar.    When traveling to a foreign country, you can get a sense of the home country’s currency valuation by the purchasing power of your dollar in the local market for goods and services.

That, in a snapshot, is the concept behind Purchasing Power Parity exchange rates, which is long-term currency valuation measurement.   It gets more complex when considering other factors, such as the local GDP per capita, for example.

Nevertheless, the following analysis is a crude 10,000-foot view of dollar valuation throughout the world.  It does, in general,  pass the Economist’s Big Max Index smell (yummy) test,

THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalize the prices of an identical basket of goods and services (in this case, a burger) in any two countries.  – Economist

Conclusions

Based on the 2018 data, there 172 currencies in the world undervalued to the U.S. dollar, ranging  from 83 percent to 1 percent.    There are 16 currencies overvalued to the dollar, ranging from a high of 37 percent in Switzerland to 0.9 percent.

All of the G20 currencies are undervalued except Australia.   Our friends Down Under may have a different view.  Must be their housing market.

Don’t get to caught up in the exact data points.  We view them as decent approximations and in the zip code.

 

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In Honor Of Veteran’s Day: The Butterfly Effect

To honor Veterans’s Day,  we are reposting our June 2017 butterfly piece, which illustrates how sleepwalking can lead the world into a war that nobody wants.

French President, Emmanuel Macron, warned today about sleepwalking into another great conflict.

“I know there are old demons which are coming back to the surface. They are ready to wreak chaos and death. History sometimes threatens to take its sinister course once again.  – President Macron

 

Vets

 

History’s Biggest “Butterfly Effect” Occurred On This Day

The butterfly effect is the concept that small causes can have large effects. Initially, it was used with weather prediction but later the term became a metaphor used in and out of science.

In chaos theory, the butterfly effect is the sensitive dependence on initial conditions in which a small change in one state of a deterministic nonlinear system can result in large differences in a later state. The name, coined by Edward Lorenz for the effect which had been known long before, is derived from the metaphorical example of the details of a tornado (exact time of formation, exact path taken) being influenced by minor perturbations such as the flapping of the wings of a distant butterfly several weeks earlier. Lorenz discovered the effect when he observed that runs of his weather model with initial condition data that was rounded in a seemingly inconsequential manner would fail to reproduce the results of runs with the unrounded initial condition data. A very small change in initial conditions had created a significantly different outcome.  — Wikipedia

On this day in history, June 28, 1914, the driver for Archduke Franz Ferdinand,  nephew of Emperor Franz Josef and heir to the Austro-Hungarian Empire,  made a wrong turn onto Franzjosefstrasse in Sarajevo.

Just hours earlier, Franz Ferdinand narrowly escaped assassination as a bomb bounced off  his car as he and his wife,  Sophie,  traveled from the local train station to the city’s civic city.   Rather than making the wrong turn onto Franz Josef  Street, the car was supposed to travel on the river expressway allowing for a higher speed ensuring the Archduke’s safety.

Yet, somehow, the driver made a fatal mistake and tuned onto Franz Josef Street.

The 19-year-old anarchist and Serbian nationalist, Gavrilo Princip, who was part of a small group who had traveled to Sarajevo to kill the Archduke,  and a cohort of the earlier bomb thrower, was on his way home thinking the plot had failed.   He stopped for a sandwich on Franz Josef Street.

Seeing the driver of the Archduke’s car trying to back up onto the river expressway, Princi seized the opportunity and fired into the car, shooting Franz Ferdinand and Sophie at point-blank range,  killing both.

That small wrong turn,  a minor perturbation to the initial conditions, or deviation from the original plan,  set off the chain events that led to World War I.

Archduke_Jan27

Stumbling Into The Great War
Fearing Russian support of Serbia, Franz Josef would not retaliate by invading Serbia unless he was assured he had the backing of Germany.   It is uncertain as to whether the Kaiser gave Franz Josef Germany’s unequivocal support.   Russia, fearing Germany would intervene, mobilized its troops forcing Germany’s hand.

The great European powers thus stumbled into a war they didn’t want through complicated entanglements and alliances, and miscalculation.  Russia backing Serbia;  France aligned with Russia,  Germany backing the Austro-Hungarian Empire;  and Britian, who really didn’t have a dog in the fight except her economic interests, aligned with France and Russia.

Later the U.S. would enter the war due to Germany’s unrestricted submarine warfare threatening American merchant ships and the Kaiser floating the idea of an alliance with Mexico in the famous Zimmerman Telegram, which was intercepted by the British.

Of course, some will argue that Great War in Europe was inevitable

The great Prussian statesman Otto von Bismarck, the man most responsible for the unification of Germany in 1871, was quoted as saying at the end of his life that “One day the great European War will come out of some damned foolish thing in the Balkans.” It went as he predicted.  – History.com

Nevertheless,  maybe the course of history would have been different if not for that wrong turn on June 28, 1914, which created the humongous butterfly effect, which we still experience the consequences this very day.

The botched Treaty of Versailles  sowed the seeds the for World II.  The War contributed to the Russian revolution and Cold War.  The redrawing of borders in the Middle East after the War created the conditions for the instability and breakdown to tribalism the region experiences today.

A map marked with crude chinagraph-pencil in the second decade of the 20th Century shows the ambition – and folly – of the 100-year old British-French plan that helped create the modern-day Middle East.

Straight lines make uncomplicated borders. Most probably that was the reason why most of the lines that Mark Sykes, representing the British government, and Francois Georges-Picot, from the French government, agreed upon in 1916 were straight ones.  — BBC News

If Franz Ferdinand had not been murdered on this day in history,  that conflict between the Serbs and the Austro-Hungarian Empire may have been contained to just the Balkans.   Maybe.

The butterfly effect.  Think how many small events, decisions, mistakes, one small turn, or “minor perturbations” in plans have had enormous consequences in your own personal life.

 

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Sector ETF Performance – November 9

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Sector_ETF_YTD

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Global Risk Monitor – November 9

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Crude Testing Critical Support…Will Stocks Follow?

The near WTI futures price is down 21 percent since peaking on October 3rd as traders front ran the Iranian oil sanctions, which went in to place this week.   Fearing spiking oil prices, the U.S. granted waivers to eight of Iran’s largest buyers of crude – China, India, South Korea, Japan, Italy, Greece, Taiwan, and Turkey.

KeyStone Cops Markets

Now fearing the world is amply supplied, traders are selling crude down and down.  The U.S. now produces more oil and than Saudi and Russia.

The United States has increased output to more than 11 million barrels a day, surpassing Saudi and Russian production. Saudi Arabia and Russia have also been increasing output to offset the drop in Iranian exports. – CNBC

Testing Key Levels

After bottoming at $42 on June 1, 2017, WTI’s 2-year uptrend has been violated and now testing critical Fibonacci retracement levels.   It has already sliced through the .382 at $63.48 and is now set to test the .500 at $59.39.  The next key level is the .618 at $55.29, which,  if broken, it significantly increases the risk of giving it all back.

Crude prices are a trending machine and usually need a significant fundamental change, such an OPEC cut,  to reverse the trend.   We urge caution.   Watch and wait mode, folks.

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Crude Oil And The S&P

Not exactly a perfect correlation, but the chart illustrates both stocks and the oil price tend to move together.  Moreover,  such a large price divergence as seen over the past month is not sustained.   We suspect crude is sending a signal that stocks are going to, at best, struggle here or move lower.

Crude_Oil_4

Crude Prices And U.S. Jobs

We have written quite a bit about the U.S. labor market over the past year.

The only sector, which has experienced outsized employment growth since January 2017 has been in mining with job growth over 17 percent since President Trump took office.  The rise in the oil price has generated demand for roughneck hiring in the oil patch.

The following chart illustrates how mining support service hiring tracks the oil price but with a lag, from anywhere between 2-8 months.   If past is prologue,  the downturn in prices won’t begin to be felt in the oil patch for another month or two.

Some big changes coming to the Global Macro Monitor, see here:

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How Trade Helps Both Sides – PIE

Interesting piece explaining comparative advantage.  Though it shows the gains,  those cake and pizza makers in each country get hurt.   We always propose taxing some of the gains from winners to help the losers.

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GMM’s Pre Post-Mortem On The Midterm

Just a quick note on the midterms as we await for the full results.

The Lavender Wave (pink + blue) that we were expecting did materialize, though not as strong,  and swept the Republicans from the House.  Suburban and college-educated women came out big last night, and a record number of over 100 women were elected to Congress.

This will truly be the year of women flexing their political clout. – GMM

It looks the number of House seats lost will come in at around 37, which puts the 2018 midterm the third worst showing for a first-term post-war president, and worst for a Republican president.   It is 17 seats lower than what the presidential approval model predicted but certainly not an outlier.  See chart.

The pick-up of Senate seats by Republicans was historic,

It was the first time since the nation started directly electing senators in 1914 that a party has won control of the House without gaining seats in the Senate. – USA Today

 

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Midterm Results In A General Election

As soon as the full results are in, we plan to overlay the midterm results into a general election framework based on votes from each Congressional district.    That is we will aggregate this data state-by-state and calculate the electoral college.

We have no idea how the data will shake out.  Stay tuned.

Midterm_ResultsNote:  The variance of the data points seems to increase the lower the presidential approval rating.  Got it, only three data points,  but indicates heteroskedasticity

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