(EWA) Archives - Mad Hedge Fund Trader

Why the World Hates the Aussie

Discretion certainly can be the better part of valor. That was the feeling that came over me last weekend when I saw the Australian dollar (FXA) plunge to a new three year low against the buck.

I had been mulling over buying the Aussie around the $88 support level for the past couple of months. After all, with a synchronized global recovery in progress, and an international bull market in stocks underway, Australia is usually your first stop on the buy side.

Then the Australian Bureau of Statistics (ABARE) showed up to take away the punch bowl. It reported that December job losses came to 22,600, when the market had been expecting a gain of 7,000. That leaves total employment at 11.63 million and the unemployed at 722,000.

This is the equivalent to a US monthly nonfarm payroll flipping from a forecast +100,000 to -300,000. Yikes! It?s amazing that the Australian All Ordinaries stock index didn?t go to zero yesterday. Talk about a party pooper.

The technical picture couldn?t be more dire. A crucial support level at 88 cents that held all the way back to 2010 suddenly became a distant memory. A brief attempt to break the 50-day moving average to the upside at $90.50 failed miserably. Looking at the eight-year chart below, an undeniable double top is now in place at $105. The current downtrend has $85, and then $80, beckoning on the downside.

Further peeing on the parade from the greatest possible height has been the loose-lipped governor of the Reserve Bank of Australia, Glenn Stevens, who has been talking down the Aussie at every opportunity. In his latest foray, he declared large-scale currency intervention to be part of the central bank?s ?tool kit? to boost the economy. Translate this into plain English, and it means a lower Aussie soon.

You really have to ask why all is not well in the Land of Oz in the face of such unremittingly positive news elsewhere. Looking at the charts below, it is clear that Australia is currently fighting a currency war with Brazil, the other major supplier of natural resources to the world economy. That?s because a lower currency makes a country?s exports cheap in the international marketplace.

So far, Brazil is winning big time. The Real having cratered some 26% against the dollar over the past year, compared to only a 17% decline for the Aussie. Governor Stevens obviously is trying to play a game of catch up. But he has a long way to go.

There are other reasons for the weakness in the Ausie. It may have contracted emerging market disease, whereby investors shun small undeveloped economies in favor of large developed ones. A dependence on commodities is not exactly something you want to wear on your sleeve these days in this deflationary environment. Why have any hard assets in your portfolio as long as paper ones are going to the moon?

The more frightening question is whether the global economy has evolved to the point where it no longer needs Australian exports as much as it did in the past. I have been warning readers for some time that the Chinese economy, Australia?s largest customer, is moving from a commodity consuming export model to a domestic services oriented one.

You don?t need as much iron ore, coal, or uranium when a growing share of your added value is intellectual, and not physical. Stabilizing population growth means you can get away with less food too. This explains why commodity prices have been flat in the face of a Chinese GDP that is still growing at a 7.7% rate. This is all bad news for Australia.

These are all vexing, important questions deserving more first hand, in depth, on the ground research. I think I?ll start by checking out the bikinis at Sydney?s Bondi Beach in two weeks.

Worthy of Further Inspection

Lessons from the Australian dollar

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Last month, I shot out a Trade Alert to buy the Currency Shares Australian Dollar Trust (FXA) December, 2013 $89-$91 bull call spread that turned immediately profitable. A mere four trading days later I sold out, after the (FXA) rallied an impressive $1.2, adding 0.84% to the value of my model trading portfolio.

That turned out to be the absolute top of the move. This is not unusual, as I am legendary throughout the market for picking the perfect tops and bottoms of market moves, and then leveraging up the other way. This is why pros stampeded into my Trade Alerts. Maybe it?s my math and engineering background that enables me to do this with such precision, a world where accuracy is measured to the Angstrom (0.0000000001 meters).

When the market marked my position at its maximum theoretical value of $2.00, that?s all I needed to know. The Trade Alert to get out flew your way the next morning.

After that, the Aussie was deluged with bad news. Reserve Bank of Australia governor, Glenn Stevens, said he was considering intervening in the foreign exchange market to head off its appreciation. Then, the government blocked a $2.7 billion takeover bid by US agribusiness giant Archer Daniels Midland (ADM) for the Australian grain handler, GrainCorp. A ban of foreign takeovers means less capital coming into the Land Down Under. Then, Goldman Sachs followed up with a forecast that the Aussie was heading for $85. After that, it was all over but the crying.

So here we are three weeks later, and I am getting plaintive emails from followers asking me what to do about their Australian dollar positions. The excuses as to why they are still long Aussie are legion, and range from ?I was traveling? to ?my dog ate my homework.? In the meantime, the (FXA) has plunged from $93.80 to $90, spilling much blood among those who still held the position.

Let me tell you how many trading rules these people violated:

1) When positions go deep in the money, you always place a stop loss at your cost, below the market. That way, you are effectively playing with the ?house?s money.? Your worst case scenario is that you break even.

2) You can?t travel and trade. I structure these trades so they can breathe and you don?t have to watch your screen 24/7. But you can?t disappear off the face of the map counting on notes in bottles washing ashore to keep you up to date.

3) Understand your own risk tolerance. Before you enter every trade, calculate how much money you are willing to lose if it goes against you. Then, if it hits that point, get out in the most automatic, emotionless, automaton way possible and go on to the next trade. There are plenty of fish in the sea, over 100 this year alone. You don?t need my permission to take a loss.

4) Don?t look at any position in isolation, look at the entire portfolio. I design these things so that some will be going up in value at any given point in time, and others down, in all market conditions. That way, one will hedge the other, limiting losses. In the case of the (FXA), your hedge was in being short the Treasury bond market (TLT), (TBT), which was profitable, and mitigated your losses if you didn?t get out of the (FXA).

5) You?ve got to watch the news. Bloomberg, Reuters, and the Wall Street Journal can get you a headline faster than I can send out a Trade Alert. When the Australian central bank governor started flapping his gums about possible intervention to push his currency lower, that?s all you needed to know. Hasta la vista, baby.

6) I am not always right. In fact, this year?s trading statistics show that I am wrong 15% of the time. That is less than almost anyone else. But wrong is wrong. Don?t let that 15% cost you all your profits for fear because you lack discipline.

I don?t think the Australian dollar is going down forever. In fact, there is still a reasonable chance that the Currency Shares Australian Dollar Trust (FXA) December, 2013 $89-$91 bull call spread will close at its maximum theoretical value of $2.00 by the December 20 expiration.

Central bank intervention can only dictate the direction of a currency for only short periods. After that, fundamentals take over. In the face of a 2014 global synchronized economic recovery, that means UP for the Aussie.

International interest rate differentials are the primary factoring in determining direction over the long term. With overnight Aussie rates at an all time low of 2.5%, further cuts are unlikely, lest the real estate bubble there inflates further. That means the next directional change in Australian interest rates is up, and that will be great news for the Aussie.

Suddenly, The Aussie Isn?t Looking So Good

Ringing the Register with the Aussie

Diary, Newsletter

This is our 13^th consecutive closing profitable position, and 19^th consecutive profitable Trade Alert when you include our remaining open positions. I have only seven more winners to go before I break my old record of 25.

Since I strapped on this trade last week, the (FXA) has popped a full 1 ? points to the upside. It?s tough to say where these options are really trading, they are so illiquid and the spreads so wide. If you didn?t do the trade at all, just consider this part of your educational effort.

However, the Currency Shares Australian Dollar Trust December, 2013 $89-$91 bull call spread was marked at their maximum possible value of $2.00 by the market makers at last night?s close. So I am going to take the hint and close the position. At this price we have harvested 75% of the potential profit, and we still have a full month to run before the December 20 expiration.

Yes, I should have been more aggressive, moving the strikes closer to the money, farther out in expiration, and bigger in size. But it?s always easy to say that about your winners.

To close the position just put in a limit order for the entire spread at $1.95 and wait for the market to come to you, even if it is for a few days. It is impressive how much they are crushing volatility in the options markets in the run up to the Thanksgiving holidays, so you should eventually get done.

Then you can plow the money back into other trades, such as buying global stocks and commodities, and shorting bonds and the yen. You can also buy back the Aussie on the next two-point dip.

I still believe that we are in bull mode for the Aussie longer term, and that we should make it above par, or $1.00, next year. The recent reforms announced by China (FXI) last week certainly remove any doubt about the northward direction.

It all provides fresh rocket fuel for the global synchronized recovery in 2014, which I have been predicting since the summer. A parallel pop in Australian stocks (EWA) confirms this view. So if you aren?t in the options and own the (FXA) outright, I?d hang in there.

The Aussie has been Hopping

Loading Up on Australia

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It looks like I?m Waltzing Matilda again. I am going to use the two-cent drop last night to scale into a long position in the Australian dollar. This is a dip in the (FXA) that gives up one quarter of the four-cent move off of the August 88 cent bottom.

The decline was triggered by dismal employment data showing that 10,200 jobs were lost in August. Many analysts had been expecting job gains. To give you some perspective, this is equivalent to the US getting a nonfarm payroll of (minus) -150,000 out of the blue when everyone had been expecting an improvement of a similar amount. Yikes!

The problem with this analysis is that employment data is a lagging indicator, sometimes a deep one. A few things have happened since these numbers were collated. The China hard landing has been taken off the table, emerging markets (EEM) have been screaming, and there have been massive short covering rallies across the entire hard asset space. Looking at just this single data point is the equivalent to driving ninety miles an hour and only looking at the rear view mirror.

You wanted a dip to buy? This is a dip.

The steadily improving China data puts not just the Aussie in a fresh new light, but all Australian assets. If it is sustainable, then Australian stocks also look great down here as well. The Australia iShares ETF (EWA) has told you as much, rocketing some 16% off the August lows, triple the gains seen here in the US. Australian bonds are the only security you want to walk away from, which are likely to see further losses matching those in the US.

You?ve gotta love Australia. It is the low cost producer of a whole range of economically sensitive commodities, including iron ore, copper, natural gas, coal, tin, gold, wool, wheat, beef, and others. Get it right and you make a fortune. It is the leveraged play on an improving global economy. Call it a call option on the world. If you have any doubts about the attractions of the Land Down Under, just spend a free summer afternoon strolling Sydney?s Bondi Beach.

If you want some independently confirming data on the likelihood of this turnaround, look at the chart below of the Baltic Dry Index, which reflects the cost of chartering dry bulk ships to carry stuff like iron ore and coal. It has been absolutely on fire, blasting up by 100% in the past four weeks.

This morning?s unbelievable 31,000 drop in weekly jobless claims to 292,000, a new five year low, reaches the same conclusion. It is a far more contemporaneous data set, and reflects a return to a normal economy. The Australian jobs data is so old it has hair growing in it.

The unfortunate aspect of this Trade Alert is that (FXA) options are fairly illiquid, and trade at double the normal spread found in the foreign exchange options market, so execution here is crucial. Put in a limit order for the spread that works for you. If you don?t get done, just walk away and wait for the next Trade Alert, of which there will be many.

Or you can just buy the (FXA) outright, given that the August low on the charts is looking pretty solid. Buy some Australian shares (EWA) too, while you?re at it, and throw a couple more steaks on the barbie!

Suddenly, Australia is Looking Very Attractive

My Tactical View of the Market

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The easy money has been made on the short side this year for a whole range of asset classes. While we will probably see lower lows from here, the risk/reward ratio for taking short positions in (SPX), (IWM), (FXE), (FXY), (GLD), (SLV), (USO), and (CU) are less favorable than they were two months ago.

Of course, the ultimate arbiter will be the news play and the economic data releases. It they continue to worsen as they have done, you can expect a brief rally in the (SPX) up to the 1,340-1,360 range before the downtrend resumes. First, we will revisit the old low for the move at 1,290. Then 1,250 cries out for attention, which would leave us dead unchanged on the year. Lining up next in the sites is 1,200. But to get that low, probably by August, we would need to see something dramatic out of Europe, which we may well get. For the Russell 2000, look to sell it at the old support range of $78-80, which now becomes overhead resistance, to target $72 on the downside.

Don?t underestimate the devastating impact the Facebook (FB) debacle will have on the overall market. Retail investors lost $6 billion on the deal after institutional investors were given the heads up on the impending disaster and stayed away in droves. The media has plenty of blood on its hands on this one. The day before the pricing, one noted Cable TV network reported that the deal was oversubscribed in Asia by 30:1. Morgan Stanley reached for the extra dollars, increasing the size, and boosting the price by 15%. It all came to tears.

Expect investigations, subpoenas, congressional hearings, prosecutions, multi million out of court settlements, thousands of lawsuits, and many careers ended ?to spend more time with families.? Horrible thought of the day: Apply Apple?s (AAPL) 8X multiple, which is growing at 100% a year, to Facebook, which is not, and you get a (FB) share price of $5. None of this exactly inspires confidence in the stock market.

Notice that emerging markets have really been sucking hind teat this year, dragged down by falling commodity prices, a slowing China, and a general ?RISK OFF? mood. This is probably the first sector you want to go back in at the summer bottom to take advantages of their higher upside betas.

The Euro went through the old 2012 low at $1.260 like a hot knife through butter. On the breach, a lot of momentum programs automatically kicked in and doubled up their short positions. That is what has taken us all the way down to the high $124 handle in the cash. Let?s see how the market digests this breakdown. The commitment of traders report out on Friday should be exciting, as we already have all-time highs in short positions in the beleaguered European currency.

The problem is that any good news whispers or accidental tweets on the sovereign debt crisis could trigger ferocious short covering and gap openings which the continental traders will get a head start on. So again, this is not the low risk trade that it was months ago.

Still, the 2010 lows at $1.18 are now on the menu. I would sell all the ?good news? rallies from here two cents higher. Aggressive traders might consider selling penny rallies, like the one we got today. Notice that the Euro is rallying into the US close every day. This is caused by American traders covering shorts, not wishing to run them into any overnight surprises.

The Japanese yen seems to be stagnating here once again, now that the Bank of Japan has passed on another opportunity to exercise more much needed quantitative easing. Therefore, I will use the next dip to get out of my September put options at a small loss. There is a better use of capital and bigger fish to fry these days.

The Australian dollar has been far and away the world?s worst major currency this year, falling from $110 all the way down to $94 on a spike. It now languishes at $97. I long ago stopped singing ?Waltzing Matilda? in the shower. I hope all my Ausie friends took my advice at the beginning of the year and paid for their European and American vacations while their currency was still dear. We could see as low as $90 in the months to come.

Gold (GLD) and silver (SLV) still look week, as this week?s failed rally attests. The strength of the Indian rupee still has the barbarous relic high priced for the world?s largest buyer, and this will continue to weigh on dollar based owners. But we are also reaching the tag ends of this move down from $1,922. Speculative short positions are at a multi-year low. It would take something pretty dramatic to get me to sell short gold again. For the time being, I am targeting gold at $1,500 on the downside, $1,450 in an extreme case, and $25 in silver.

We are well into the move south for oil, which peaked just at the March 1 Iranian elections just short of $110/barrel. The market now seems to be targeting $87 for the short term. The global economic slowdown is the clear culprit here. But in the US, we are starting to see a clear drag on oil prices caused by the insanely low price of natural gas. You can see this clearly on the charts below where gas has been rising while Texas tea has been plunging. Utilities and industry are switching over to the cleaner burning ultra cheap fuel source as fast as they can. As a result, greenhouse gas emissions are falling faster in the US than any other developed country, according to the Paris based International Energy Agency. Sell any $4 rally in crude and keep a tight stop.

When China catches cold, copper gets pneumonia. So does Australia (FXA), (EWA), for that matter. The China slowdown will most likely continue on into the summer, knocking the wind out of the red metal. If copper manages to rally back up to $3.60, grab it with both hands and throw it out the window. Cover when you hear a loud splat. That works out to about $26.50 in the ETF (CU).

It all points to a highly choppy and volatile ?RISK ON? rally that could last a week or two. It will be a time when you wish you took your mother in law?s advice to get a real job by becoming a cardiologist or plastic surgeon. Do you want to know when I want to reestablish my shorts? If you get a modestly positive nonfarm payroll on at 8:30 am on Friday, June 1, that could deliver a nice two day rally that would be ideal to sell into.

Cross Asset Class Analysis Warned ?RISK OFF? Was Coming

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Last week saw a dramatic deterioration in the economic data that has been the foundation of the Great Bull Market of 2012.

First, we read minutes from a Federal Reserve meeting suggesting that QE3 has been put on a back burner. Then the Department of Labor?s Friday nonfarm payroll report poured gasoline on the fire, coming in at 120,000, versus an expected 210,000. Until this week, the best you could say about the data flow was that it was mixed. Now it is decidedly negative.

Whenever we see sea change events like this bunch up over a short time period, I like to show readers my cross asset class review, which I conduct on a daily basis. This discipline is great at showing which securities are trading in line with the rest of the world, and which ones aren?t. And guess what is looking outrageously expensive right now?

The charts show that trouble has in fact brewing for a few months. Asset classes have been rolling over like a line of dominoes. This is the way bull markets always end, and this time should be no different.

The Australian dollar (FXA) saw the weakness coming first, which peaked on April 6.

The Australian stock market (EWA) followed, peaking on February 28.

Copper (CU) warned that trouble was coming, peaking on February 12.

Then Gold (GLD) faded on April 12.

And Silver (SLV) on February 28.

Bonds never bought the ?RISK ON? on scenario. The ten year Treasury ETF (IEF) is down less than three points from its 2011 peak, instead of the 15 points we should have gotten if the economy had truly entered a sustainable stage in the recovery.

Only equities (SPX) didn?t see ?RISK OFF? coming

Because it was all about Apple (AAPL), which added $225 billion in new market capitalization this year. That amounts to creating the third largest company from scratch, right after Exxon (XOM).

The final message of all of these charts is that equities alone have been powering up for months while every other asset class in the world has been dying a slow death. Experience shows that this only ends in tears for equity holders. I?ll let you adjust your own positions accordingly.

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Worthy of Further Inspection