September 27, 2011
Davide Accomazzo
Email: davide@cervinocapital.com
From the sometimes advantaged viewpoint of my trading room, let’s take a look at a variety of financial markets after what it could be called a “lively” quarter.
Equity markets around the world topped almost simultaneously at the beginning of the quarter (so much for diversification…) and initiated a vicious correction as a result of the renewed failure of Europeans to solve their sovereign debt issue, our domestic ineptitude related to fiscal policy and the subsequent Standard and Poor’s downgrade.
The SP 500 travelled a quick 20% to the downside perforating the 200 day moving average (the line between bull and bear market environment) like the Germans cut through the line Maginot some sixty years ago. The WWII analogy is apropos since around the lowest point in the correction (August 8th), there were 67 declining stocks for every one that rose, the worst ratio in history going back to 1940 when German tanks broke thru French armies...even during the 1987 black Monday the ratio was not so negative (38 to 1). This statistic shows the negativity associated with this move but it is also, most likely, the result of the predominant role of HFT and algo trading as we are getting more and more often this kind of really extreme market internals.
So far 1100 on the SP 500 seems to be strong support but I would not be surprised to see a quick and painful run at the round 1000 mark should Greece
From a technical point of view, we have an extreme number of stocks below their 10 week moving average and also below their 50 week moving average. Such numbers have normally been followed by a rally. Insiders buying was very positive at the bottom of the move and it has now moved to neutral but we do have the announcement by Warren Buffet of his first stock buyback. Whether this is good news as it implies the market overall is cheap or it is bad news because the Oracle of Omaha can’t find good deals outside his own company is still unclear to me.
One thing is certain, volatility should stay with us until Santa Claus comes to town, so it is swing trading time for those with short time horizons or selective buying with some tail risk hedging for the long term investors.
Within the context of equities, our beloved sector (energy infrastructures related Master Limited Partnerships) has started to be attractive again on a spread basis versus the UST 10 year (over 400 basis points) and also versus the BBB benchmark.
Another market we follow closely, gold, has had an interesting quarter. Gold experienced first a rally from a congestion area at 1500 to over 1900, then formed a double top and crashed back in typical shining metal fashion to an overnight low of 1533 and it is now trading around 1650.
The recent volatility of gold should not be surprising to most investors; the shining metal has a long history of violent swings to the upside and to the downside which are a reflection of what gold represents: a 5000 year hedge against fear. Gold in itself produces no cash-flows and has very little industrial demand, therefore its price is largely dictated, and more disproportionately so in the last few years, by speculative flows. In a world of disappearing trust in governments and institutions, 5000 years of trust become a useful characteristic; however, speculative funds are by definition shorter term and often leveraged, contributing to waves of swift and forced liquidation. The recent 400 point sell-off in gold is just the most recent example of gold volatile nature.
From a technical perspective, I expected gold to retrace to at least 1600 as that represented the level of the latest break-out; as previously mentioned, the December futures hit an overnight low of 1532.7, just a little higher than the 50 week moving average presently at 1500.63. The 50 week m. a. has been a good trend indicator containing most retracements in the last few years. Only in 2008 such level was broken significantly (albeit briefly) in the midst of the Lehman meltdown.
Looking forward, I continue to think that gold has regained an important place in most asset allocation models; therefore it should find a constant bid even though regular corrections will still mark its tempo. The most likely scenario at this juncture should be a period of churning as the metal finds its new equilibrium and as it allows for a partial rotation of ownership from the most leveraged and shakiest hands to the longer term players. Of course, just like all markets these days, we remain very headlines driven and should the Europeans fumble their responsibilities one more time, gold should find its footing much more quickly.
In regards to our Gold program, our strategy was built to respond exactly to this unnerving nature of gold. Having a long term upside bias is one thing…being able to hold the position when in the midst of such highly volatile moves is quite another. We built our collared strategy to capture the long term upside bias while significantly protecting our downside exposure. We were always going to underperform parabolic moves to the upside but over the long term we should produce positive returns with much less volatility. Volatility is a good friend of traders but a scary enemy of the longer term investor and gold demands a long term commitment as the financial and political world will require a long time to rebuild trust with all of us.
In FX, the US Dollar has regained some momentum as the Euro needed to price in its life threatening inconsistencies and the Yen was actively managed by the BOJ. The Swiss Franc was run over by speculative funds looking for safety in a world where risk free is an oxymoron, and experienced some mind boggling moves until the Swiss Central Bank decided to peg to the Euro at the 1.2 level (later changed to 1.25). Their promise to print as many Swissies as necessary to stop the inflow of capital is a medicine that may end up killing the patient. We are not trading this market at the moment but we watch intensely for future opportunities.
The Swiss are not unique in their fight against undue currency appreciation; this is just Part Deux of the crisis. In a world of shrinking aggregate demand, nobody wants to import capital (as it means exporting employment) and currency wars will continue to be our headache.
As far as the energy markets, we like crude oil as a trading affair into the end of the year where buying dips and selling rallies may produce profits.
Arrivederci!
Contact details:
davide@cervinocapital.com
