ONE-TWENTY TWO - A collection of personal articles on financial markets including analysis you can use
Jul
31

The Turkish Lira Approaches All-Time Lows As the Central Bank Fails to End the Selling

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on July 31, 2015. Click here to read the entire piece.)

A month ago, I pointed out how the Turkish lira had reversed all its post-election losses. I argued that the lira was due to resume its weakness as the Central Bank of the Republic of Turkey (CBRT) seemed content to wait out inflation pressures rather than act monetarily.

I closed out the trade today (July 30, 2015) as the lira approached its historic low against the U.S. dollar (historic high on USD/TRY). While the trade turned out OK, I paid out a good chunk of the profits to roll (or carry or interest). The trade took a lot longer than I anticipated, so I learned another great lesson on the importance of timing especially against high-yielding currencies. As a result, I am also now more interested in monitoring the possibilities for going the other way, that is bullish the lira, going forward.


The trend remains firmly in favor of the U.S. dollar over the Turkish lira

The trend remains firmly in favor of the U.S. dollar over the Turkish lira


Source: FreeStockCharts.com

{snip}

In last week’s monetary policy decision, the CBRT decided once again to leave interest rates steady. The market responded by selling the lira as the CBRT reiterated familiar language:

{snip}

I noted that the CBRT does not raise the specter of higher rates to fight the inflationary impact of a depreciating currency. Instead, the CBRT is looking to increase liquidity in foreign exchange.

The CBRT describes monetary conditions as already tight, so there seems little interest in hiking rates to address inflationary pressures. Emphasis mine in the related quote below from the monetary policy statement:

{snip}


Turkey's current account balance is indeed ever so slowly improving

Turkey’s current account balance is indeed ever so slowly improving


Source: The Inflation Report 2015-III from the Central Bank of the Republic of Turkey

Given the CBRT thinks that today’s tight conditions are already working against inflationary pressures, it seems unlikely that a rate hike is in the cards anytime soon. Moreover, Turkey has tight monetary policy even as overall economic conditions are precarious:

{snip}

Overall, I get the sense that the CBRT is more worried about economic weakness than inflation. This is not a bias conducive to the higher rates that might sustainably strengthen the lira.

{snip}


iShares MSCI Turkey (TUR) drops to a new 18-month low

iShares MSCI Turkey (TUR) drops to a new 18-month low


Source: FreeStockCharts.com

Be careful out there!

Full disclosure: no positions

(This is an excerpt from an article I originally published on Seeking Alpha on July 31, 2015. Click here to read the entire piece.)

Jul
30

Trading Lessons from the Elections In Turkey

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on June 14, 2015. Click here to read the entire piece.)

Turkey held national elections on June 7th. The events were well-covered given Turkey’s central location amid a set of geopolitical hotspots and its (former) place as a fast-growing emerging market.


Turkey sits amid several geopolitical and economic hotspots

Turkey sits amid several geopolitical and economic hotspots


Source: Google Maps

The elections had a strong impact on the Turkish lira and the Turkish stock market. The trading action provided another one of those great demonstrations of trading on a market narrative.

{snip}

From the perspective of the presumed operating narrative, the market’s reaction made little sense to me. So I faded pops higher on USD/TRY from Sunday through Wednesday for very short-term trades. {snip}


Quick trigger post-election trading against the Turkish lira quickly gives way to some relief

Quick trigger post-election trading against the Turkish lira quickly gives way to some relief


At the time I was fading USD/TRY, I did not realize that Turkey’s central bank moved quickly to try to support the currency. {snip}


The overall trend for USD/TRY remains firmly upward

The overall trend for USD/TRY remains firmly upward


While my read of the narrative worked out, I stopped short of anticipating a complete fill of the post-election gap. {snip}


The post-election dumping of the Turkish lira did not last long

The post-election dumping of the Turkish lira did not last long


Source for above charts: FreeStockCharts.com

As the chart above shows, it is very easy to see from a technical perspective how USD/TRY could complete a gap-fill. Such a move would perfectly align with the converged 20 and 50-day moving averages (DMAs). I would look to accumulate more in that case, but end the trade if downward momentum persists.

The narrative going-forward is more complicated because at any time, encouraging news about the formation of a government could generate more downside for USD/TRY. Moreover, the central bank could take further actions to try to support the currency. If either event occurs, I will be inclined to switch the trading bias n USD/TRY back to short.

{snip}


Did iShares MSCI Turkey (TUR) just print a double bottom?

Did iShares MSCI Turkey (TUR) just print a double bottom?


Be careful out there!



Full disclosure: long USD/TRY

(This is an excerpt from an article I originally published on Seeking Alpha on June 14, 2015. Click here to read the entire piece.)

Jul
30

Turkish Lira Completes A Post-Election Reversal As Central Bank Waits On Inflation

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on June 28, 2015. Click here to read the entire piece.)

Since I laid out a post-election trading strategy on the Turkish Lira (USD/TRY) two weeks ago, events have gone on a very slow burn. The currency and the stock market have been surprisingly calm overall despite the unfolding wrangling to form a government. Post-election gaps filled this past week.


iShares MSCI Turkey ETF (TUR) quickly filled the post-election gap but has stalled at resistance from the 50-day moving average

iShares MSCI Turkey ETF (TUR) quickly filled the post-election gap but has stalled at resistance from the 50-day moving average

The Turkish lira has also filled the post-election gap and now pivots around its 50-day moving average

The Turkish lira has also filled the post-election gap and now pivots around its 50-day moving average


Source: FreeStockCharts.com

So the narrative for a complete reversal of the post-election gap played out after all. {snip}

There remains an important economic wildcard looming over this trade. As the charts above show, the Turkish central bank issued its latest statement on monetary policy on June 23, 2015 (I used Google Translate to read it). That event happened to coincide with the current top on TUR. The Bank decided to keep rates constant despite the weakening currency. The continued lack of action implies that the Bank may still feel political pressure to avoid rate hikes even after the recent election should have relieved some of this pressure.

On the inflation front, the Bank seems content to hope inflationary pressures abate on their own. {snip}


Turkey has made tremendous progress in controlling inflation

Turkey has made tremendous progress in controlling inflation


Source: TradingEconomics.com

The Bank pointed to volatility in food and energy prices and to “uncertainty in global markets” as reasons for staying cautious on policy. {snip}

Be careful out there!

Full disclosure: long USD/TRY

(This is an excerpt from an article I originally published on Seeking Alpha on June 28, 2015. Click here to read the entire piece.)

Jul
29

A Busted Stock Trader In China: Real Life Pain

written by Dr. Duru
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On July 29, 2015, Nightly Business Report included a poignant segment featuring the painful story of a busted stock trader in China. The path from hope (greed?) to despair sounds like a classic with a twist. At least this particular trader took too many cues from the Chinese government, a government whose policies have clearly help lead many ordinary citizens to ruin.

We are accustomed to hearing market stories in the aggregate. Pundits and analysts debate the faceless numbers and wrangle over the significance or insignificance of the collective pain to the larger collective of the Chinese and global economy. I find it worthwhile to pause at least a moment and appreciate that real people with real pain suffer behind the spectacular headlines.

I recommend watching the few minutes of video (see below for the clip). If you just want a quick skim, I provide some key bullet points below with some editorial.


Yang Cheng, a farmer from rural southwest China, laments his losses in the stock market and the financial damage done to his family

Yang Cheng, a farmer from rural southwest China, laments his losses in the stock market and the financial damage done to his family.


Source: Nightly Business Report

  • There are 90 million retail investors in China. That is small in China, but that is equal to 4.5x the entire population of New York and almost 30% of the population in the U.S.
  • Rural farmer Yang Cheng from SW China began trading in 2008. Given he must have directly experienced the frightening volatility of the financial crisis, I would have assumed he learned very valuable lessons, VERY quickly. Apparently not.
  • Traditionally, the average Chinese citizen shuns the stock market as it is considered an unreliable investment. Surely the financial crisis cemented that attitude among many.
  • This attitude changed in 2014 when the government started promoting stocks as part of a grand plan to open markets and expand the economy. NOW I understand why the Shanghai Composite Index (SSEC) exploded to the upside even as China’s growth was starting to slow! As part of its desperation to stoke growth, I assume China viewed its moribund stock market as a potential lever for papering over a slowing economic engine.
  • In response, Cheng invested $64K in the market AND the money of his relatives….he bet it ALL on ONE local mining company. In other words, Cheng went full throttle into commodity-related play just ahead of a massive and historic acceleration in the worldwide collapse in commodities.
  • Cheng claimed that when the market (presumably the Shanghai Composite) hit 4000, he realized the risks were pretty high. So, I find it odd that he did not proceed to cash out and lock in at least some of his gains. Perhaps commodities were already lagging in China and Cheng was waiting for his investment to catch up? Some more details here would have been VERY helpful.
  • What IS clear is that Cheng became swayed by public opinion on government policies. He said these opinions effected his judgment. I assume this claim means that the public was generally in loud approval of the government’s stock promotion game. The government had animated the herd and the groupthink hysteria was well underway.
  • Cheng’s demise began after his broker convinced him to try margin trading. He took his approximately $200K portfolio and leveraged up to $1M of buying power!!!
  • When the market broke down in early July, Cheng’s broker forced him to liquidate. Cheng was left with a DEBT of $200K. This is a classic tale of letting greed replace one’s better judgment. Perhaps in time Cheng will understand that the government, public opinion, and his broker are not the only ones at fault.
  • Cheng bought a train ticket to Beijing to visit with the regulator of the stock market. He was turned away in what may be the last time he ever believes his government will help manage and improve his life. NBR implied that many other investors have attempted similar trips in search of relief.

This final quote sums up the tragedy and the pain:

“I don’t know what to do. I trusted the government too much. I won’t touch stocks again….I have ruined everyone in my family.”

The irony of Cheng’s pain is that the index is still well above where he went all in. This story is another reminder that we outsiders should find little comfort in the fact that the stock market still has healthy year-to-date and year-over-year gains. We can only imagine the massiveness of the mounting losses if the Chinese government fails to keep this game propped up.


The Shanghai Composite Index 'magically' holds onto support at its 200-day moving average (DMA). With the index still well above last year's breakout I have to wonder whether the pain is only just beginning.

The Shanghai Composite Index ‘magically’ holds onto support at its 200-day moving average (DMA). With the index still well above last year’s breakout I have to wonder whether the pain is only just beginning.


Here in the U.S., Cheng’s capitulation is the kind of pain that makes Wall Street salivate. Bigger and better capitalized investors and traders take this opportunity to pick up the pieces and find incredible value where once the panicked and hapless were forced out of the game. For now, China’s government is effectively playing that role, and the big fish have to be just as scared as regular investors given the draconian limits China has placed on trading.


Parabolic moves higher rarely end well. Unlike SSEC, the iShares China Large-Cap (FXI)  is now negative year-to-date.

Parabolic moves higher rarely end well. Unlike SSEC, the iShares China Large-Cap (FXI) is now negative year-to-date.


Source for charts: FreeStockCharts.com



Be careful out there!

Jul
29

Forgo the United States Oil ETF In Favor Of the United States Gasoline ETF?

written by Dr. Duru
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I recently read an article that attempted to dive into the nuances of trading the United States Oil ETF (USO) versus the United States Gasoline ETF (UGA). I suddenly realized that through all the nuanced comparisons the forest was being lost for the trees. Since at least 2009, UGA has greatly outperformed USO. In fact, the dominance is so great that for longer-term holders UGA is the clear winner.


UGA clearly dominates USO in long-term performance

UGA clearly dominates USO in long-term performance


Source: FreeStockCharts.com

A pairs trade shorting USO versus going long UGA is an even better long-term strategy and would have delivered positive long-term gains despite the recent plunge in the oil patch. Most of these gains come thanks to the accelerated out-performance of UGA over USO in 2015.


The ratio of UGA versus USO demonstrates the out-performance in even greater clarity.

The ratio of UGA versus USO demonstrates the out-performance in even greater clarity.


Source: StockCharts.com

These charts make me rethink how I approach the oil trade (for example, see “The Commodities Crash Accelerates: Scenarios for Trading Oil“). My only hesitation from jumping on a trade that assumes UGA out-performance over USO is that the UGA/USO ratio has accelerated so much in 2015 that a pullback seems to be very likely just from a technical standpoint. Moreover, USO seems very likely to bounce soon and initiating a short would be much better to do at higher prices from current levels.

Note that I have executed the USO rangebound trade as described in the earlier piece.

Be careful out there!

Full disclosure: long USO call options, short USO call and put options

Jul
28

T2108 Update (July 28, 2015) – An Important Stock Market Turnaround

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 28.7%
T2107 Status: 35.2%
VIX Status: 13.4
General (Short-term) Trading Call: Neutral
Active T2108 periods: Day #192 over 20% (overperiod), Day #3 under 30%, Day #7 under 40%, Day #47 under 50%, Day #64 under 60%, Day #263 under 70%

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
SDS (ProShares UltraShort S&P500)
U.S. Dollar Index (volatility index)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).

Commentary
The market simply could not wait for the U.S. Federal Reserve to give its usual “all clear” signal this time around.

The Fed announces its next monetary decision tomorrow (Wednesday, July 29). The market looked like it was headed into true oversold conditions just in time to let the Fed work its powers of soothing. In the T2108 Update for last Friday, I laid out all the bearish signs that had converged as T2108 hovered above oversold conditions. I was hoping that the S&P 500 (SPY) would retest support at its 200-day moving average (DMA) just as T2108 broke below 20% (oversold): such a combination would trigger my rules to aggressively buy the index. Instead, the index PERFECTLY retested its 200DMA (you can’t make this stuff up!) while T2108 stubbornly got only as low as 24%. T2108 did not even crack the low from the previous cycle of fear.


The S&P 500 completes a picture-perfect retest of 200DMA support with a subsequent rally of 1.2%

The S&P 500 completes a picture-perfect retest of 200DMA support with a subsequent rally of 1.2%


Although my ideal trading conditions did not trigger, I was still prepared to benefit from a bounce because the volatility index, the VIX, triggered the related “fade volatility” trade. On Monday, the VIX traded above the 15.35 pivot. With T2108 “close enough” to oversold (meaning it is below 30%), I nibbled on some put options on ProShares Ultra VIX Short-Term Futures (UVXY).

%stocks>40DMA was 24.8% at lows today. #VIX struggling around 15.35 pivot. $UVXY fades. #120trade #T2108 S&P 500 bounce off 200DMA $SPY

— Duru A (@DrDuru) Jul. 27 at 07:53 AM


I had expected to accumulate MORE puts on UVXY ahead of the Fed. Instead, I ended up taking profits as the volatility index plunged well below the 15.35 pivot.

%stocks>40DMA was 24.8% at lows today. #VIX struggling around 15.35 pivot. $UVXY fades. #120trade #T2108 S&P 500 bounce off 200DMA $SPY

— Duru A (@DrDuru) Jul. 27 at 07:53 AM



The volatility index (VIX) plunges 14% ahead of the Fed's opportunity to reassure markets

The volatility index (VIX) plunges 14% ahead of the Fed’s opportunity to reassure markets


The Australian dollar added confirmation that the market hit an important turn-around as it held steady against the Japanese yen. On Monday, AUD/JPY approached the previous low but did not break it.


The Australian dollar holds support against the Japanese yen. A fresh breakdown would have flagged a freshly bearish signal.

The Australian dollar holds support against the Japanese yen. A fresh breakdown would have flagged a freshly bearish signal.


Despite all these positive signs of a turn-around, I am definitely NOT giving the “all clear” signal just yet. The bearish signals that led to this latest encounter with oversold conditions are not yet invalidated. For starters, the S&P 500 needs to at least close above its 50DMA; even better, it needs a new all-time high. AUD/JPY needs to clear recent congestion (say over 92.4) rather than get turned back like a brick wall. T2107, the percentage of stocks trading above their 200DMAs, rallied today with the market but this longer-term signal remains BELOW the low of the last cycle of fear. I will be monitoring all these signals including the VIX.

I am NOT using the Shanghai Composite Index (SSEC) as a market signal, but I AM intrigued to see how well the market rallied even as SSEC gapped down to start trading in China and closed with another loss on the day. The Chinese government is clearly still watching the technicals closely. The gap down was stopped cold right at 200DMA support. THIS stuff you CAN make up – at least the Chinese government can!


How long can the Chinese government keep the Shanghai Composite Index propped up with so much selling pressure and entry at such obvious buy points?

How long can the Chinese government keep the Shanghai Composite Index propped up with so much selling pressure and entry at such obvious buy points?


In other important/interesting trading action, I have Caterpillar (CAT), Grub Hub (GRUB), and Apple (AAPL).

As regular readers know, CAT is my favorite hedge against market bullishness. Today, however, it turned into my favorite play on oversold conditions. My trading mentor has created a fantastic stock scan website called SwingTradeBot. On Monday, one particular scan caught my eye:


There was CAT! After seeing the stock had closed four days in a row below its lower-Bollinger Band (BB), including a post-earnings gap down, I immediately put the stock on my buy list. This kind of selling pressure leads to oversold conditions and few stocks can sustain positioning beyond the BBs for long. Monday’s doji, aka a small body, is another classic bottoming sign that shows that buyers and sellers fought to a stalemate.

The term “Gilligan’s Island Buy Setup” is a bit silly and not intuitive. Here is the definition from a concept called “hit-and-run trading” from the book Hit & Run Trading: The Short-Term Stock Traders Bible. Copied from the SwingTradeBot site…

  • A stock must gap open to a new two-month low. The bigger the gap the better.
  • The stock must close at or in the top 50 percent of its daily range and equal to or above the opening.
  • For the buy: The next day only, buy 1/8 point above today’s high.
  • Risk 1 point.
  • Carry the position overnight if it closes strongly.

CAT easily met the first two conditions with Monday’s close. Tuesday’s open met the third condition. Risking just over a point would break to a fresh multi-year low, so the fourth condition was easy. Given the strong open, and the high odds that an oversold bounce was underway, I loaded up aggressively on call options. I was prepared to hold until the close to test the last condition. Much to my surprise, in less than an hour, my position had already doubled in value, and CAT was up around 2.5%. Under THOSE conditions, I had to take the profit off the table in extreme gratitude. If I had waited for the last condition, I would have seen the position growth almost 4x as CAT closed up 3.3%.

The buying volume and trading action was SO strong that CAT effectively left behind an abandoned baby bottom. This pattern traps bears who chased the last gap down only to find themselves in an instant loss on a gap up the next day. The CAT bears are now under pressure to close and run. This pattern alone makes me more optimistic for the market in the short-term. THIS could potentially be the most important turn-around of all the turns I have shown in this T2108 Update.


Caterpillar (CAT) sprints higher and leaves behind a a STRONG bottoming pattern on equally strong buying volume. Shares traded on the day surpassed the previous selling days.

Caterpillar (CAT) sprints higher and leaves behind a a STRONG bottoming pattern on equally strong buying volume. Shares traded on the day surpassed the previous selling days.


GrubHub (GRUB) had a chaotic day of post-earnings trading. The previous day, a downgrade instantly knocked the stock down to retest of all-time lows. Traders and investors naturally feared that the downgrade indicated GRUB had very bad news in store. Instead, GRUB produced pedestrian numbers, far from alarming. The resulting gap up rammed the stock right into resistance at the 50DMA. Sellers went to work immediately from there. It took me a while to understand what could be going on. And then I saw that a conference call was coming at 10am Eastern. So, essentially, whoever did not get a chance to panic and sell the day before was scrambling to use the post-earnings gap up to get out ahead of what HAD to be the real bad news. The stock made a fresh all-time low just ahead of the conference call. The stock bounced from there and chopped away to a net 7.2% gain on the day.

This action was a lesson in the dangers of panic. For me, it was a lesson in patience as I rushed in to buy into today’s panic. The subsequent bounce did allow me to get out with a gain, but I would have performed a LOT better by simply waiting for some (ANY!) sign of buying interest.


GrubHub (GRUB) violently trades around earnings

GrubHub (GRUB) violently trades around earnings

This 5-minute chart shows the sharp sell-off in the morning just ahead of the 10am conference call. Cooler heads prevailed in the end.

This 5-minute chart shows the sharp sell-off in the morning just ahead of the 10am conference call. Cooler heads prevailed in the end.


After all the pre and post-earnings angst, Apple (AAPL) is simply trading at the lower end of an on-going trading range. The 50DMA remains the presumed pivot within this trading range. I missed the nice surge off post-earnings lows. I am looking for another bounce off the bottom of the trading range. (I know I still owe you readers an update on all the pre/post-earnings data on AAPL!)


Apple (AAPL) continues to stick by its trading range

Apple (AAPL) continues to stick by its trading range


Among today’s scans from the SwingTradeBot is this one…


My eyes once again lit up. I know I said in “The Only Remaining China-Based Trade I Like” that I am going to leave Baidu (BIDU) alone even with its tendency to bounce sharply from steep sell-offs. Given my experience with CAT, I am likely going to make an exception this time if BIDU meets the “Gilligan” criteria tomorrow. Stay tuned…!


Sellers squash Baidu (BIDU) well below its lower-Bollinger Band. Buyers took BIDU 6 points off the low. Can it at least reach its pre-earnings low before sellers return?

Sellers squash Baidu (BIDU) well below its lower-Bollinger Band. Buyers took BIDU 6 points off the low. Can it at least reach its pre-earnings low before sellers return?



Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: short AUD/JPY, long AAPL call options

Jul
28

The Australian Dollar Suffers Pressures From All Corners – Except Rate Expectations

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on July 28, 2015. Click here to read the entire piece.)

When I last wrote about the Australian dollar (FXA), it was wavering at the 0.74 support level against the U.S. dollar. More importantly, market expectations for an August rate cut from the Reserve Bank of Australia (RBA) were soaring. Now, the 0.74 support level has given way and rate expectations have cooled off significantly.


The Australian dollar (FXA) continues to break through successive support levels and now sits at levels versus the U.S. dollar last seen May, 2009

The Australian dollar (FXA) continues to break through successive support levels and now sits at levels versus the U.S. dollar last seen May, 2009


Source: FreeStockCharts.com

The market's expectations for an August rate cut have plunged rapidly

The market’s expectations for an August rate cut have plunged rapidly


Source: ASX RBA Rate Indicator

Markets are also expecting just one more rate cut going forward, perhaps as far out as early 2016…


Just one more rate cut to go for this cycle of looser monetary policy?

Just one more rate cut to go for this cycle of looser monetary policy?


Source: ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve (as at market close on July 28, 2015)

The plunge in rate expectations is a big surprise since it comes at the same time that China is roiling with its Shanghai Composite Index (SSEC) still breaking down…


The Shanghai Composite Index (SSEC) exploded to the upside exactly a year ago. Even Monday's 8% plunge did not set a new low for the current sell-off.

The Shanghai Composite Index (SSEC) exploded to the upside exactly a year ago. Even Monday’s 8% plunge did not set a new low for the current sell-off.


Commodities-related stocks like Caterpillar (CAT) have confirmed in earnings that the mining sector important to Australia continues to implode…


Caterpillar (CAT) is falling the way of commodities as it revisits levels from late 2011

Caterpillar (CAT) is falling the way of commodities as it revisits levels from late 2011


Source: FreeStockCharts.com

And Fortescue Metals Group (FSUGY), a domestic iron ore miner, confirmed on July 23, 2015 what many analysts have feared and projected: China’s steel consumption has peaked. {snip}


Recent earnings failed to stem the downward momentum for Fortescue Metals Group

Recent earnings failed to stem the downward momentum for Fortescue Metals Group


Source: ASX – prices in Australian dollars

{snip} The Flash China General Manufacturing Output Index printed at a 16-month low for July. {snip}

As if all that were not enough, on Friday, July 24th, the Standard & Poor’s tip-toed around a potential downgrade of Australia’s top-rated debt….:

{snip}


The British pound has beaten a steady path up the staircase against the Australian dollar

The British pound has beaten a steady path up the staircase against the Australian dollar


Source: FreeStockCharts.com

Be careful out there!

Full disclosure: long and short the Australian dollar against several currencies

(This is an excerpt from an article I originally published on Seeking Alpha on July 28, 2015. Click here to read the entire piece.)

Jul
27

The Commodities Crash Accelerates: Scenarios for Trading Oil

written by Dr. Duru
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Several authors have pointed out the difficulties in fashioning trades to take advantage of the movement in oil prices (for a recent example, see “Is Gasoline The Smart Oil Play? UGA Vs. USO“). Analyses counting off the bullish and bearish arguments on oil can fill many tomes. For example, there is fear of a drop in Chinese demand, renewed builds in inventory, and a painfully slow adjustment process on the supply-side. The main positive catalyst to consider is that the negative catalysts cannot get much worse. One of the most recent twists on the oil-related headlines is Morgan Stanley’s warning regarding the potential for a complete collapse in oil prices. It invoked images worse than the crash of 1986.

The reporting Bloomberg article pointed out that OPEC has surprisingly ramped up production ever higher even as fundamentals in the market do not appear to support the additional supply. The article includes a chart showing that OPEC now supplies a full 1 million barrels per day above and beyond the peak from 2014. Morgan Stanley thinks that OPEC is now stretched to the max. However, if Iran and Libya pile on along with on-going run-ups in U.S. production then “there would be little in analysable history that could be a guide for what’s to come.” This kind of looming fear is presumably behind the recent revival in OVX.

Through all the headlines, one bet continues to perform up or down – using options on the United States Oil ETF (USO) to bet on the rangebound performance of oil. I first described this bet in March. In early June, I provided an update to show the profitability of the trade as the rally off all-time lows stalled for the United States Oil ETF (USO). Now USO is challenging its all-time low again as (WTI) oil runs into the lows from March. Those lows in turn were levels last seen during the recession.


United States Oil ETF (USO) is now challenging what had looked like a sustainable bottom

United States Oil ETF (USO) is now challenging what had looked like a sustainable bottom


Source: FreeStockCharts.com

If recent lows on oil break, the next stop could very well be the lows from the last recession.

If recent lows on oil break, the next stop could very well be the lows from the last recession.


Sources: US. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma [DCOILWTICO], retrieved from FRED, Federal Reserve Bank of St. Louis, July 27, 2015.
US. Energy Information Administration, Crude Oil Prices: Brent – Europe [DCOILBRENTEU], retrieved from FRED, Federal Reserve Bank of St. Louis, July 27, 2015.

I have chosen this tension-filled moment of increasing volatility to get on board with the rangebound trade. I provide here a refresher on the trade and another update on performance.

After I laid out my “simple scenarios” for trading the United States Oil ETF (USO) in mid-June, the base case of trading around the 50-day moving average (DMA) – consistent with the assumption of rangebound oil – lasted for just 8 trading days. A 16% spike in the CBOE Crude Oil Volatility Index (OVX) on June 29th launched the bearish conditional on the simple trade. USO “only” lost 2.4% that day and almost reversed all its losses the next day. It was not until a massive breakdown on July 6th that USO delivered confirmation of the bearish bias. OVX also closed above its pre-OPEC level and provided final confirmation of the bearish bias for USO per my simple scenarios.


The CBOE Crude Oil Volatility Index (OVX) is on the rise again and is threatening to break out.

The CBOE Crude Oil Volatility Index (OVX) is on the rise again and is threatening to break out.


Source: FreeStockCharts.com

It now appears OVX will remain elevated. A new uptrend will be in place if OVX breaks out above 44 or so. If such a breakout occurs, I will quickly move to trading an inverse oil bet like ProShares UltraShort Bloomberg Crude Oil (SCO) or even shorter-term put options until OVX ends the uptrend.

The original rangebound trade had the great advantage of selling put and call options right around the time OVX peaked; thus, the trade sold short hefty option premiums. That advantage shows in the results: with USO a bit below the levels where the trade was executed, the short January $19 and $20 2017 options have combined to deliver profits. The calculations below compare approximate option prices on March 5, 2015 versus prices on July 27, 2015.

Jan 2017 USO call options sold short
$19 Call: $3.42 vs $1.75 = gain of $1.67 or 49%
$20 Call: $2.95 vs $1.47 = gain of $1.35 or 50%

Jan 2017 USO put options sold short
$19 Put: $3.50 vs $4.85 = loss of $1.00 or 39%
$20 Put: $4.06 vs $5.50 = loss of $1.11 or 35%

For comparison, the net profit spread on this trade was around 15% on May 29th. Now, it is 10%. This 5% drop in the spread has occurred while USO has plunged 23%. This behavior is a feature, not a bug. Long-dated rangebound trading should perform within a tight window in the short-term since it is not a directional bet. Over the course of time, the gains should expand with greater speed if all is working according to plan.

In finally executing my own rangebound trade, I am first assuming that USO will NOT drop another 23% in two months. That would be the rough equivalent of oil dropping to or below $40, close to the recession lows as shown above. As a precaution, I started off my trade small anyway (after all, OVX is still well off its high this year). I sold equal amounts of January 2017 $15 put options versus January 2017 $19 call options. I picked $19 as the upside target given it coincides with the current level of the now declining 50DMA. I did not sell the same strike for the call options as the put options to reflect my bias that odds favor USO to trade higher than lower many months down the road. I also capped extreme losses from a massive and sudden upside surprise on USO by buying well out-of-the money USO call options. This slightly reduces profit potential but greatly increases comfort.

(For more context on my interest in trading commodities in the middle of an accelerating crash, see “The Commodities Crash Playbook: A Long Overdue Rewrite And Revision“).

Be careful out there!

Full disclosure: short USO put options, long and short USO call options

Jul
27

The Only Remaining China-Based Trade I Like

written by Dr. Duru
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The Shanghai Composite Index (SSEC) plunged 8.5% to start trading for the week. The ripple effects were wide and far-reaching even as arguments continue floating that the collapse in China’s stock market matters little outside of China and does not truly reflect on economic conditions in the country.

Apple (AAPL) CEO Tim Cook summed up a lot of the soothing words to-date during last week’s earnings conference call (from the Seeking Alpha transcript of AAPL’s Q3 2015 earnings conference call):

“…we remain extremely bullish on China and we’re continuing to invest. Nothing that’s happened has changed our fundamental view that China will be Apple’s largest market at some point in the future. It’s true, as you point out, that the equity markets have recently been volatile. This could create some speed bumps in the near term. But to put it in context, which I think is important, despite that volatility in the Chinese market, they’re still up 90% over the last year, and they’re up 20% year-to-date, and so these kind of numbers are numbers I think all of us would love.

Also, the stock market participation among Chinese household is fairly narrow. And the stock ownership is very concentrated in a few people who put what appears to be a smaller portion of their wealth in the market than we might. And so I think generally this has been, at least as we see it, maybe it’s not true for other businesses, that this worry is probably overstated. And so we’re not changing anything. We have the pedal to the metal on getting to 40 stores mid next year. As we had talked about before, we’re continuing to expand the indirect channel as well.”

Cook went on to quote a McKinsey study that estimates China’s middle class will grow from 14% to 54% of households from 2012 to 2022. I now put such estimates right up there with the iron ore miners who continue to lean on very bullish assumptions about China’s steel consumption over the next 10, 20+ years. They are using these forecasts to help them look past the current acceleration in the 4-year long collapse in commodities.

Regardless, I think no one should take any comfort in a massive short-term loss just because the gain over a year or so is still tremendous. Such a setup only tells me that the market still has plenty of room to fall and reverse course. One must wonder why the Shanghai Composite index exploded as it did just as China’s economic growth rate was finally slowing down.


The Shanghai Composite Index (SSEC) exploded to the upside exactly a year ago. Even today's 8% plunge has not set a new low for the current sell-off.

The Shanghai Composite Index (SSEC) exploded to the upside exactly a year ago. Even today’s 8% plunge has not set a new low for the current sell-off.

This monthly chart shows that since 2000, the Shanghai Composite Index has actually spent most of its time in decline. For all its explosiveness, the latest short-lived frenzy stopped well short of pre-crisis highs.

This monthly chart shows that since 2000, the Shanghai Composite Index has actually spent most of its time in decline. For all its explosiveness, the latest short-lived frenzy stopped well short of pre-crisis highs.


Source: FreeStockCharts.com

We have heard the “do not worry” in the financial news. Take July 27th’s Marketplace where various analysts weighed in on the insignificance of China, the world’s #2 economy…

  • China’s financial markets are mostly closed off to those outside of the country – foreigners own less than 2% of Chinese shares.
  • China is just 7% of U.S. exports.
  • A lot of the growth in China was bad growth: credit-fueled, over-investment. So, a slowdown in China will have a healthy cooling effect and transition China into more of a consumer than producer.

The last point was of course a masterful way of turning an alarming negative into a positive!

The stock market churn has been so unimportant that the Chinese government has panicked and executed extreme measures to manipulate market behavior. We outsiders received a swift reminder of the true nature of Chinese capitalism and likely the expectation in China’s financial markets that the government SHOULD “do something” to take control of the situation. Of course, China’s manipulation is probably just an overt and more heavy-handed version of the government intervention in Western economies to bring order out of the chaos of the financial crisis.


Yet, the extreme nature of the Chinese government’s interference makes its stock market extremely unattractive. No true rule of law seems to exist, and the government is free to do anything, including jail people who “illegally” sell their stocks, to accomplish its objectives. Own stock one day under one set of rules and wake up the next day with a different set. Under these circumstances, I am trying hard to avoid Chinese-related stocks, even my favorite Baidu (BIDU) which got crushed in after-hours about 8% after reporting its earnings. Normally, I would be licking my chops to jump on cheaper shares and take advantage of BIDU’s tendency to bounce sharply off oversold levels.

However, there is one China-related trade that still looks as good as ever: iShares MSCI Emerging Markets (EEM).


The latest breakdown in iShares MSCI Emerging Markets (EEM) has taken the ETF to lows from 2013

The latest breakdown in iShares MSCI Emerging Markets (EEM) has taken the ETF to lows from 2013


Source: FreeStockCharts.com

Chinese stocks are just a part of EEM, but I find EEM to be a good theme-based play on what is happening in the emerging markets that are greatly influenced by what is really happening in China. Most importantly, the options for EEM seem chronically under-priced. They rarely seem to take into account what I think are high odds for EEM to break sharply upward or downward. The 7% decline in 10 trading days has taken EEM past its lower-Bollinger Band (BB). Selling volume is picking up. A sharp bounce seems in the cards sooner than later.

I like to play EEM by going long “strangles”: the simultaneous purchase of out-of-the-money call and put options. The past several strangles I have executed on EEM have all made enough money on the put side so quickly that I was compelled to take profits. I keep hoping the call side of the trade will add to the profits but to no avail. This time around, I am expecting the profits to come from the upside. But the beauty of these strangles is that I am able to stay relatively agnostic about direction. I care a lot more about the speed of the move.

Here is an example of a trade I might initiate (I will announce it on StockTwits and Twitter with the #120trade hashtag), all options expire on August 21, a little over three weeks from now: the $37 call options sell for $0.52/0.57 bid/ask, the $35 put options sell for $0.37/0.40. If EEM just challenges resistance from its recent high, the call options deliver at least a triple and deliver plenty of profit to pay for the put options along the way. If EEM continues a plunge from here, I would expect increasing options premium to help make the puts at least valuable enough to pay for the call options. Either scenario can easily happen in three weeks. Previous experience tells me that one of them should play out within the next week.

There are of course other trades I have referenced that have direct dependence on China, like Caterpillar (CAT) and the Australian dollar (FXA). However, I China is not my #1 consideration for these trades.

Be careful out there!

Full disclosure: long AAPL call options, long and short various currencies against the Australian dollar

Addendum
The Nightly Business Report (NBR) for July 27th provided a few companies with large share of sales in Asia.

S&P 500 companies with the highest revenue exposure to China:
Skyworks Solutions (SWKS): 62%
Yum! Brands (YUM): 52%
Qualcomm (QCOM): 48%

Other companies with a large share of their sales in Asia in general:
Abbott Labs (ABT): 31%
3M (MMM): 30%
Schlumberger (SLB): 24%
ConocoPhillips (COP): 22%
Boeing (BA): 25%



Jul
27

The Commodity Crash Accelerates: A New Juncture for Buying Gold

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on July 27, 2015. Click here to read the entire piece.)

This month’s acceleration in the now 4-year sell-off in commodities seems to indicate that markets are getting serious about bracing for a tightening cycle from the Federal Reserve. I have mainly bought and traded gold as a hedge on Federal Reserve monetary policy. From this perspective, I can understand why gold (and commodities in general) is sliding in what SHOULD be the last few months before a first rate hike. However, based on the behavior of the futures markets in the past six weeks or so, I have concluded that there is a good possibility the Fed could capitulate on its pledge to hike rates in 2015 – especially given the case for a rate hike remains very mixed given weakness in global economies that now include Canada’s official entry into the club of advanced economies moving backward on rates.

While many analysts continue to insist that Fed is determined to start hiking rates in September, the 30-Day Fed Funds Futures as published by the CME Group Fed Watch have consistently produced different conclusions. {snip}


The odds for the timing of a first Fed rate hike has generally increased in the last month, but September is not even on the market's radar.

The odds for the timing of a first Fed rate hike has generally increased in the last month, but September is not even on the market’s radar.


Source: The CME Group Fed Watch

{snip}


The odds for a first rate hike flip from December to October on June 5th

The odds for a first rate hike flip from December to October on June 5th

The odds for a first rate hike flip back to October from December on June 15th

The odds for a first rate hike flip back to October from December on June 15th

The odds for a first rate hike flip from December to January, 2016 on July 2nd

The odds for a first rate hike flip from December to January, 2016 on July 2nd


Sources: The CME Group Fed Watch

So while commodities are sliding sharply this month, the possibility of a Fed surprise makes current levels very enticing. The time to buy insurance is when the market provides it at a heavy discount and not when it is dear. I now see some signs in the SPDR Gold Shares (GLD) and in Google Trends that favor starting or adding to positions.

{snip}


The losses in SPDR Gold Shares (GLD) have accelerated this month

The losses in SPDR Gold Shares (GLD) have accelerated this month


Source: FreeStockCharts.com

My commodity crash playbook does not cover gold directly because of its role as a currency, but the principles of respecting trends and momentum have aptly applied. {snip}

While Friday’s bounce is encouraging, I am even more intrigued in the possibility of a bottom because of a shift in market sentiment as shown by Google Trends. {snip}


Google trends is flashing a buy signal as the search term "buy gold" surges in July without an accompanying pop in "sell gold"

Google trends is flashing a buy signal as the search term “buy gold” surges in July without an accompanying pop in “sell gold”


Source: Google Trends

{snip}

Be careful out there!

Full disclosure: long GLD

(This is an excerpt from an article I originally published on Seeking Alpha on July 27, 2015. Click here to read the entire piece.)

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