Trade ideas...lets see what we can come up with

[DcifrThs]

Alright folks, i haven't seen a non individual stock based one of these yet so lets start it.

on May 20, 2007, i wrote the following as a brief summary of the overall trends in the global economy:

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well first off, I’d like to break the “economy” into asset classes and countries.

Taking global equities first, we have seen a sharp run up in stock prices worldwide. Growth has been strong and globally synchronized. For the first time ever, all OECD countries are growing simultaneously. Globalization has appeared to link the economies of the world structurally. Chinese growth has obviously been a massive driver and demand from that country does not appear to be slowing. Even if efforts to slow the economy by the govt pan out, a growth rate of 8% is still likely.

A few things have kept equity prices up. First and foremost is the massive # and amt of deals we’ve seen and continue to see. Leveraged buy outs, share buy backs, mergers, acquisitions, and the like all push ever higher on global equity prices. China may also be moving towards a bubble as the # of new accounts to buy equities has shot up at insane rates. Private equity firms are also flushed with cash. All this cash is tied to the next point, fixed income.

Global rates are very low and credit spreads are squeezed tight as a drum. These low rates, when compared to equity yields, make borrowing to purchase companies via cash & debt very attractive. We see this from corporate bond spreads and the deals being done mentioned above. Global capacity utilization at this point in the cycle would usually be getting strained and margins feeling some compression. The globalization though has flooded the world with cheap labor which has kept margins fat and capacity lower than typical at this point of the business cycle.

Emerging market debt spreads above risk free rates have also come in a great deal. At least part, if not all, of this is legitimate. Developing economies have changed the way they handle a booming commodity mkt (and thus a very large income stream for commodity exporters). Typically, those countries would actually be running current account deficits by importing a ton and financing those imports with money that would love to invest in their country given how it's doing. But this time, we see those countries running a current account surplus. This is because they are growing and using the export money to invest in their own country (and around the world, thus running a capital account deficit). Overall this is great, but spreads can’t get much tighter. Further, some commodity exporters are running CA deficits & borrowing funds from around the world to consume. This is troubling since a shock there, even if triggered by that country’s economic situation alone, would likely reverberate across emerging mkts and widen spreads.

As a result of everything above (high liquidity, high growth, global demand), commodity prices are high as well. China demands a great deal of them as does Japan, the US, & Europe.

Moving on to China. Last week (week of may 14th), they finally acknowledged that good 'ol fashioned central bank tightening is really what is needed to slow the economy down. In order to do that, they have to let their currency appreciate vs. the dollar and uncouple their monetary policy from the US (i.e. while the currency is pegged, they can’t raise rates). Otherwise, domestic inflation will rise making the peg worthless (competitiveness will fall as domestic prices rise regardless of the Yuan's level vs. trading partners). This will also help push global rates up as their massive ($1.2 TRILLION) reserves of US bonds will stop accumulating and the US 10yr rates will start to move up.

<font color="red"> Addendum: i would have to rethink that latter remark. US10yrs i thought would be less sensitive to economic conditions since there was so much of china's reserves pushing their prices up. recently, we saw about a 40bp upward move in rates. i think overall, the chinese have a smaller effect than i initially indicated although it is still quite big. SECOND: china has come up with a small way to bring equities down a bit by trippling the stamp tax on shares. this has cooled the market slightly, but not by enough</font>

This slow loosening of the peg is a step in the right direction, but more is needed. China is accumulating a CA surplus far faster than it is allowing its currency to rise. It will need to purchase ever more US dollars (and thus US bonds) to keep its currency in line. So the Yuan is highly pressured to appreciate vs. the dollar.

In terms of currencies, the Yen is also near record lows (121 as of may 18th). Given the low yields in Japan, this has caused a re-appearance of the carry trade, most notably to the US &amp; Australia. These unhedged flows are self defeating in a way and can cause a global risk aversion shock if/when it finally snaps (self defeating b/c selling yen to buy AUD/USDs assets puts more downward pressure on the Yen which makes investment in Japan even more attractive. Eventually, those fundamental economic flows will dwarf the carry trade flows causing those invested in it to repatriate at ever worse prices).

<font color="red"> Addendum: we now see the carry trade being even more attractive as AUS, USA, &amp; EUR have all seen their economic prospects rise more than expected, pushing the yield differential even higher</font>

The dollar is also very weak vs. the Euro and the Pound. This weakness, however, is warranted as the US needs to borrow ever greater amounts in order to keep financing the massive CA deficit. The figures are truly staggering and an even weaker dollar is possible so long as imports remain as high as they have been in the recent past (we’ve had some good news on this front in the past few weeks, but not enough).

In terms of the domestic economy, we saw some weak growth #s in the first quarter and a slight reduction in the inflation rate, which is still outside the fed’s “comfort zone.” The mkts are still pricing in cuts though and given the consumer confidence we’ve seen and the Chinese apparent yielding to US trade concerns (rate hike &amp; peg movement), that/those cut/cuts isn’t looking too likely. A realization of no cuts int eh future may also put a damper on equity prices. The housing issue we have seen hasn’t dampened consumer confidence but has put a dent in growth as we saw from Q1 estimate. Overall though, the economy looks good and inflation is still a touch high. I’d think the next rate move will be a hike, not a cut. Especially since the slack in the global economy felt as a result of global low wages is reducing and wage pressures may rear their ugly head sooner than expected.

<font color="red"> Addendum: while growth was revised down by over 50% to 0.6% for Q1, the overall economic outlook has increased substantially as of this writing as can be seen by the pricing of fed funds futures &amp; options. a rate hike is now much more favorably viewed and the probability priced in for a cut has been pared back a lot. </font>

Finally, we have low (relative to historic) mkt volatility. Any one of those de-stabilizing things mentioned above can cause this to spike as it did in February. A rise in risk aversion will hurt global asset prices across the board (save the US treasuries &amp; gold, which has done well due to high liquidity). Increases in global rates may catch many not pricing them in off guard.

So, to wrap up, the major themes we have going on are

1) syncronized global growth as a result of highly correlated business cycles.
2) low rates/high liquidity
3) high commodity prices
4) strong emerging mkt growth that doesn't look panic/currency devaluation prone.
5) a carry trade that has a potential to destabilize the lowly volatile environment.
6) weak and weakening US dollar
7) strong US economy w/ a touch of inflationary pressure
8) low (implied/expected) volatility

In the future, I'd look for a global pull back in equities and US assets as risk premia adjust from their currently tightly squeezed position as the last leg of the cycle finally starts to come into full swing. I’d be long volatility as we are strained as it is and there are many points from which a scare could emanate.
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Now, i'd like to see what we can come up with working off that + the recent occurrances that are not taken into acct as of the time of that writing + stuff i missed/didn't include etc...

one example from another thread is the idea i had for the diff bet between silver &amp; gold. another could be a simple short silver, short gold. so from the commodity picture, i think a trade consisting of the following would be a good place to start :

outright: short gold
diff bet: short gold spot, long gold futures

outright: short silver
diff bet: short silver spot, long silver futures

diff bet: short gold long silver (bet gold falls more than silver)

as of the writing above, i was quite strongly short US 10yrs. now that they've sold off significantly and are more realistically reflecting the interest rate environment i'd have pulled a lot back from that. i'm still slightly short in my mind though, may -15% vs. -85% a few weeks ago.

i was also neutral to short US equities. maybe at most about -10%. now i'm about neutral (0%) as they've fallen a bit to reflect the IR repricing.


sssssssssooooooooooooo, lets hear some trading ideas &amp; discussion.

this thread should be great for anybody going into interviews any time soon.

thanks and lets get started,
Barron

[DcifrThs]

glancing over my usual reading i see two possible good trades:

1) long crude oil at 64.81. possible hurricanes (small bullish signal) and strong growth may push prices higher. i'm not hugely strong on this trade, i'd say +20%

2) long GBPvsUSD as the rise in us10yr yields has drawn a good number of people towards the US. but inflation and growth are both faster in the UK and there. i'd be at a signal of maybe +15 to +20% after today's drop in the pound. if the fall continues, i'd put in a bit more.

Barron

[Fishhead24]

A little late to the party(Warren Buffet in below 80), but going long BNI(Burlington Northern).

The main reason I like this play is the continued surge in crude oil being coupled with the continued push for biofuels(mainly ethanol in the midwest). With most of the biofuels located in the midwest, the railroad industry is going to profit from the extra overload to transport the fuel to upper northeast, Florida, and California.

Put me down for LONG BNI at the current 88.5 price level.

-FH-

[Mr. Now]

DcifrThs,

You seem to be saying that gold and silver are going to break down significantly.

Both are sitting at 1-year trend lines after being much higher. This is normally where buying comes in and shorts cover.

The long bond is rolling over a 27-year trendline. Normally that means traders see real inflation (in excess of govt estimates) and demand more yield to hold those bonds.

Normally this kind of action in the bond market torpedoes stocks and bond pricing. if stocks and bonds are trending south, what's left in terms of asset classes to park inflation-aware money? Certainly not cash or real estate now.

The worldwide liquidity explosion caused by the Fed's expansion of money supply (and competitive moves by other central banks) must find a home eventually. Where is it going to go?

Right here, long metals at the 1-year trendline, with a 3% stop has very favorable Sharpe characteristics.

Charts:
Gold ETF
http://stockcharts.com/h-sc/ui?s=GLD...;dy=0&amp;id=0

Silver ETF
http://stockcharts.com/h-sc/ui?s=SLV...;dy=0&amp;id=0

[Fishhead24]

I respect Dcifer greatly and because of that have personally gone from being bullish on silver to neutral.

[SlowHabit]

For long-term value investors, do you take into account this type of information?

I assume not or else my road just got a little longer.

[DcifrThs]

[ QUOTE ]
For long-term value investors, do you take into account this type of information?

I assume not or else my road just got a little longer.

[/ QUOTE ]

this thread is specifically aimed at active managers (alpha), not long term passive allocations (beta)

Barron

[DcifrThs]

[ QUOTE ]
DcifrThs,

You seem to be saying that gold and silver are going to break down significantly.

Both are sitting at 1-year trend lines after being much higher. This is normally where buying comes in and shorts cover.

The long bond is rolling over a 27-year trendline. Normally that means traders see real inflation (in excess of govt estimates) and demand more yield to hold those bonds.

Normally this kind of action in the bond market torpedoes stocks and bond pricing. if stocks and bonds are trending south, what's left in terms of asset classes to park inflation-aware money? Certainly not cash or real estate now.

The worldwide liquidity explosion caused by the Fed's expansion of money supply (and competitive moves by other central banks) must find a home eventually. Where is it going to go?

Right here, long metals at the 1-year trendline, with a 3% stop has very favorable Sharpe characteristics.

Charts:
Gold ETF
http://stockcharts.com/h-sc/ui?s=GLD...;dy=0&amp;id=0

Silver ETF
http://stockcharts.com/h-sc/ui?s=SLV...;dy=0&amp;id=0

[/ QUOTE ]

first off, you need to speak english.

1 year trendlines?
27 year trendlines?

you do realize that now is the present and the coming time period is the future right? and neither are anything like the past?

"favorable Sharpe characteristics"

are you talking about risk vs. return (again based on past trends and a stop loss?? ) ? if so, then why not just say it...especially when we're talking about alpha generation (where the risk-adjusted-retur is called the information ratio) and not beta (where the passive risk adjusted return is called the sharpe ratio)

anyways, despite all the foreignese in yourpost, you ask 2 great questions:

[ QUOTE ]
where will money go?

[/ QUOTE ]
and

[ QUOTE ]
what is the current driver of asset prices?

[/ QUOTE ]

these are two aspects that i've neglected. since growth is high and capacity is tight, inflation will drive asset prices. when that is the case, precious metals tend to do well.

but at the same time, increases in global yields tend to be bad for precious metals.

overall, i think we are in new territory here as i just reviewed my long term charts (1960-2006) and we haven't seen a time like this yet where liquidity is widely available, stocks are at record levels, emerging markets are sustainably growing, inflation is still fairly contained (we're seeing bp or single % moves in the developed world) and bond yields are also moving by less than %s.

so overall i dont think right now is a time you want to use past trends to predict price moves. the global growth overall has pushed silver &amp; gold prices up (as well as oil &amp; copper) from about 2002-2007. EDIT: just to be clear, by runup, i mean absolutely unprecedented growth in oil, gold &amp; copper (except when gold skyrocketed to like $1700 an ounce). the drivers of this have been the massive amt of liquidity (mostly for gold) and huge growth of emerging mkts while synchronized with every single developed country (copper &amp; oil).

so i'd think that right now, despite the historic relationship between inflation &amp; precious metals, a reduction in growth (or an increase in yields) will drive their prices down, not up.

the question is then, where will all this money go? well, i think some if it will structurally be withdrawn from the system. this is just what central banks do in order to raise interest rates (they sell treasury securities &amp; take cash out of the system and simply hold it).

also, as rates rise, cash does become more attractive relative to gold &amp; silver.

so despite the fact that i only understood about 1/2 of your post, i think i'm comfortable enough with your major points to offer the above explanation.

in short,

1) historic trends are not likely to apply right now (and tend to be a horrible way to trade).

2) growth slowing &amp; yields rising imo are likely to now push prices of precious metals down, not up despite the fact that traditionally having inflation coming in above expectations increases demand for precious metals. in this case, i think the runup in their prices over the past 4 years (which has been HUGE), is going to turn the other way as growth slows &amp; yields rise.

3) the liquidity that has been introduced via loose money will be at least in good part withdrawn from the system (literally) by central banks.

Barron

[DcifrThs]

Regarding trends:

for those that have online subscriptions to the FT (which should be a massive % of people on this forum), please see this:

Confused by a fair weather trend

for those without access, the comment&amp;analysis piece by John Authers w/ the FT chronicles the problems with trading using trendlines.

2p2 i don't think would be happy if i posted copywritten material so i can't post the whole article for all.

i can, however, post the intro:

[ QUOTE ]
“The trend is your friend.” That is an old saw on the market, and it has made many rich. In the hurly-burly of the dealing room, clear trends – or at least trends that are clear if you can look up the chart on a Bloomberg terminal – give traders something to hold on to. There is an unfortunate corollary. When the trend breaks, you have nothing to hold on to. That is when panic ensues

[/ QUOTE ]

the article then goes on to explain how the peaks of each cycle have been the same or lower than the ones that preceeded it. the business cycle was thought to be ever reducing in amplitude as it relates to inflation &amp; bond yields.

that trend analysis proved dead wrong thursday morning as the us10yr yield passed 5.05% (the trend line of demarcation). then, after a loonnngnggg time where us10yr yeilds wouldn't move by more than a few bps in a day, jumped to 5.13 and then to 5.24%.

that was a small panic caused by the holding of trends in the face of logic &amp; data and then being forced to realize that trading strategy was wrong.

one goal imo is to never make that kind of mistake.

Barron

[DcifrThs]

one quick clarifying thought:

if you have any questions please ask!! the only way to learn is try to poke holes in ones own theories. similarly, what would cause all these trades to be wrong? what should i look for to adjust my theories?

another thing i want to clarify is that "slowing growth" isn't a near term thing. as real rates come up, investment will slow and growth will start to come down but there's always a lag. risky asset prices, on the other hand, will adjust immediately in the expectation of slower growth in the future.

Barron