Open interest data can provide us with three key persectives on a particular market. First, and perhaps at its most basic, it provides us with a measure of market liquidity.   Second, it can give us an insight into the total number of participants in a particular contract and whether it is shrinking, expanding or remaining steady.    Finally, open interest provides us with a view on whether a particular market is “attractive” to market players by drawing in funds that would otherwise be used for purchasing other assets.    However, any analysis of open interest must be carefully considered and not taken in isolation as whilst it can be a valuable trading tool it is only one of many and should be used as a gauge of market sentiment and one which can help us with the longer term picture.

In my opinion the best way to use the open interest data is to view it against the spot price chart to which it relates and from which we can draw a number of conclusions.    However, it is vital to understand that open interest is NOT the same as trading volume.  Trading volume represents the total number of contracts that are traded in a day, or whatever timescale you are considering, and that volume includes both squared off  and new positions.  When a new buyer and seller are matched this represents new positions and would count as one new contract whereas closing or squaring positions between existing market participants would not add to the open interest total.  Volume is therefore a measure of the trading activity whereas open interest is much more a indicator of market sentiment.

1.   If  prices are rising and open interest is increasing this is a bullish signal as it implies the entry of new traders into the market who are opening new long positions which therefore suggests a fresh influx of money.

2.  If open interest is increasing while prices are falling could be a bearish signal.  Whilst this may appear contradictory it is generally considered that the influx of funds in this scenario is probably being used for fresh short positions which will therefore lead to further falls in the price.

3.  If the price is rising but open interest is falling this can be interpreted as a precursor to a possible trend reversal.  In simple terms the lack of any additions to the open interest indicates that prices are rising due to short sellers covering their existing positions.

4.  If prices are falling along with the open interest this can be attributed to forced squaring off of long positions. It can therefore be considered as representing a possible trend reversal since the downtrend is likely to reverse after these long positions have been taken out.  To summarize, falling prices with declining open interest can be considered a strong indicator of a potential market turn to the upside.

5.  When prices are moving sideways and we see a rise in open interest we can expect a significant move in either direction which is almost impossible to predict.

6.  If the open interest falls whilst the market is consolidating we can assume that this sideways price action will continue for some time.

The first example of this is now available on the cot report site where you can find an analysis of the open interest for gold against the spot gold chart for the past 2 years.

Am currently working through the COT data and hope to publish open interest charts for silver, oil and some of the currencies.

Good luck and good trading.

What is the best platform for gold trading?  In my view it is Metatrader 4.  Download your free demo copy of the metatrader 4 software by clicking on the following link, download metatrader free, and get started today.

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

Last week market’s reaction to the continuing (and seemingly never ending) banking and economic crisis was swift and predictable: gold vaulted over $1000 as stock indices plunged key support levels – we are all technical traders now! The Swiss index led on worries over bank secrecy and tax evasion – indeed politicians now seem bent on closing down tax havens and hedge funds as they desperately try to find yet more scapegoats for this catastrophe.   We need, they say, a global regulator to keep a closer eye on those sneaky, pesky traders, speculators and tax dodgers.  It’s a pity we, the ordinary trader, investor and taxpayer, do not have our own regulator to oversee all the money the politicians have been tossing around without very much to show for it.   And, as we all know, when the politicians run out of money they will simply print some more!  Citigroup’s November 2008 forecast that gold could reach $2000 this year does not now seem so far fetched.

Joining the Swiss index was the Dow Jones which plunged to a new 6 year low, although the S&P and NASDAQ managed to remain above their lows of November 21 2008.   The Dow closed at 7365 last Friday, some way below the 7449 it reached at November’s low point.   Back in the first week of 2009, it seemed as if everything was going to be fine in the stock market. But now, the whole of that impressive 22% rally from 21 November to 6 January’s 9088 high has been wiped out.  But it’s actually far worse than that.  In fact, American shares haven’t traded this low since 1997.  If you exclude dividends, investors in the Dow haven’t made a bean in the last 12 years. One of the reasons given for the dramatic fall in the Dow was the rumour that Citigroup was in talks with federal officials as a prelude to the government substantially expanding, by as much as 40%, its ownership of the struggling bank.  In fact bank executives hope that it would not be more than 25% .   So long as uncertainty remains then gold will just keep on rising and  stock markets will keep on falling.

In the UK the FTSE too reacted badly as the key 4000 level was taken out – round numbers are always so important and they seem to act like magnets for both bull and bear traders and investors.   When markets reach key levels such as the FTSE 4000 it will keep trading around it for a while and likely spend a few sessions moving either side until it becomes exhausted before deciding to break either higher or lower.     With so many key levels now apparent – in indices, metals and commodities I can never remember a time when there was so much expectancy in the market.  Sadly my feeling is that the market will not be a good place for bulls or long only traders and investors. Last year two analysts, Albert Edwards and James Montier of SocGen wrote: “We see global equity markets falling some 70% from their October 2007 peak…..expect the S&P to bottom around 500 (versus the 1,575 peak) and the FTSE around 3,000” When these predictions were first published they were very controversial whereas now they seem all too real.   The fall in the value of all our assets, be it homes, pensions, money or bonds has deep and severe implications for the future and does not bode well for the political stability of many countries.    The reality for many is, of course, unemployment.  In the US almost 5m are claiming unemployment benefit while in Russia unemployment has reached 6.1m.   China’s unemployed are estimated at  around 20m.   Daily announcements of huge job cuts will continue and no longer shocks as firms try to stay in business.

As equity indices continue to push each other lower, gathering speed on the way down top quality Treasury paper will continue to command a massive premium, yield curves should flatten as central banks desperately try to stop the rot. The dollar too reacted badly to the Citigroup rumour and it dropped like a stone on Friday against the euro as hedge funds had (allegedly) sold the dollar on the pretext that US banks were in a worse position than their European counterparts.   However, as explained in last week ‘s newsletter the  European banks are facing a much more difficult situation as this crisis is threatening to destroy the EU itself.   It is Germany who is drafting the rescue plan to prevent default on the edges of the Eurozone in order to prevent a full-blown collapse of Europe’s monetary system.     The euro’s sudden rise last Friday can also be explained in technical terms as buy orders were triggered once it reached 1.2650.  For currency traders Friday afternoon can be a nightmare as the only market session open is the US so price action can sometimes break down as volatility rises.  However, this can also provide some excellent trading opportunities.  Today the dollar has clawed back most of the euro’s gains as we head back down towards 1.2650.   We can also expect a positive dollar reaction to Hilary Clinton’s recent visit to China.  The Chinese have expressed great delight in her visit especially as there was no mention of human rights or currency manipulation.  Instead economic relations and cooperation were the order of the day – ergo expect the sale of T Bills to rise.

As fast as the equity markets plunged so gold and silver soared and both these commodities are rapidly turning into the next asset bubble  or as Steve Ellis of RAB Capital says the next “mania asset”.   He writes in the FT:  “Gold is currently one of the few remaining major asset classes where a case could be made for it to rise in a parabolic fashion. Once the psychologically significant $1,000 an ounce is breached convincingly, the speed of the move beyond that level could accelerate sharply. One precondition for a mania is there must be uncertainty about how the asset is properly valued which allows “new era” thinking to take hold. This is very true for gold.”   Well we have pushed past $1000 and once above the $1000 mark the only technical indicator is fear.  A look at the cot data, which I updated earlier today, shows htere is still plenty of bullish momentum for both gold and silver – silver more so than gold.  In case you have not seen these charts before it is the left hand side of the graph which represents the latest trend. The data is my own interpretation and based on the numbers reported by the “Commercials” – ie the major producers.
The bubble in gold and silver is not replicated in other commodities.  After slumping by more than 50% last year, corn, wheat and soybeans have rebounded by almost 25% from their December lows.  Yet, for now, the scope for any further gains looks limited.  Investors had been looking forward to smaller harvests and therefore higher prices as Argentina (a key exporter,) is drought stricken and on course for its lowest soy production in at least 5 years.  Farmers in America are planting 9% less wheat this season and tight credit markets have hampered their  spending on fertilisers, which also points to smaller supplies.  The weather, as always, is the great unknown and it too could contribute to smaller harvests.  However, wheat inventories are at a six year high and the “key question” as the UN has pointed out “is demand, not supply”.  Agricultural commodities are not nearly as recession proof as investors assume.  Corn will fall in the US as ethanol consumption is down, while feedstock consumption too is falling as the demand for meat in the emerging markets drops.  As the International Council for Grains has said “immediate supply and demand outlook for grains remains generally bearish”.

Trading Tip:   Markets and prices always fall faster and harder than we think or would like and if not handled properly will simply induce in us a complete state of paralysis.   Sometimes the panic and fear is deliberately induced by the market makers and prices will only stop falling when the last “bull” has thrown in the towel.  Having been on the wrong side of the market on more than one occasion I know what it feels like to see my positions simply vaporize before my eyes.   So how can we protect ourselves from suffering such catastrophic losses? First it is imperative that you have a plan which will take account of the events which are currently unfolding.  Unfortunately the majority of traders and investors can only seem to cope with a long only strategy.  This is either because they do not know how to trade short or do not fully understand correlation and hedging.  One of the best ways to remedy this is to consider the use of options and in particular buying puts which will increase in value as the underlying asset falls in price.  Although this can seem a complicated subject to master it is worth the time and effort as it does provide the opportunity to trade both sides of the market in a relatively simple way.
Fortunately options are now readily available to retail traders and a good place to start is the education sections of either CBOT or the CME.  I have also published a number of free sites and details of these can be found on the front of the COT.
In the meantime stay safe and good luck with your trading and investing.
Regards.

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

Whether it was a case of ‘sell the news’ or a technical sell off, there’s no getting away from the fact that yesterday’s fall will have left central bankers and government officials cursing.

The rule book is being re-written by the week, as officials try one solution after another. Much was made of Bernanke’s expertise on the Great Depression, and arguably his dramatic interventions have helped stave off a financial apocalypse. However, right now it’s a blank slate, the scary thing about the current crisis is that nobody really knows how bad it will get, and when it will turn around.

Lloyds Group threw the markets another banking cluster bomb on Friday; seemingly out of nowhere Lloyds announced a £7bn write-down in HBOS’s corporate division. The shares closed the day down nearly a third on the news. According to CEO Eric Daniels, these losses reflect the application of a more conservative recognition of risk, and the further deterioration in the economic environment. Analysts at JP Morgan wrote a note the previous day saying “If the regulator were to require a more ‘comprehensive’ stress buffer, given that none of the banks have raised capital since, it would probably require them all coming to market, and probably requiring government capital.” (Cited in http://ftalphaville.ft.com). Judging by the HBOS announcement and the market’s reaction, JP Morgan may not be far off the mark.

Another concern was the data released from the ECB which stated that borrowing from the marginal lending facility hit 10.4 billion Euros, well above recent averages and the highest since November 10th. It may be a blip, but this lending spike could imply that a major bank is in trouble. Irish banks are seeking recapitalisation and UK banks are thought to making use of the ECB’s facilities as well as their European counterparts.

Bank of England Governor King, warned that Britain is in a ‘deep recession’ with the rate of contraction potentially reaching as high as 6%. Exactly where a deep recession becomes a depression is up for debate, and perhaps such a label can only be applied in retrospect. Markets are taking each day and each economic announcement as they come, with the unfortunate result being a continuation of short term volatility. Still, markets have held above the November lows for now. If these levels fail, it could be the defining point of 2009 for world stock markets.

Oil continues to drop as global economic activity falters. On the other hand gold is on the rise and pushing back up towards $1000, as investors seek out safe havens while stock markets gyrate and central banks scour their text books for the next plan of action.

This week’s top trading events are the release of the MPC meeting minutes on Wednesday. Analysts will be looking for clues as to the likelihood of further cuts towards zero for UK interest rates. Later that afternoon we have Fed chairman Bernanke speaking, followed by the release of the FOMC meeting minutes. Following the same theme, the Bank of Japan announced their overnight call rate in the early hours of Thursday. There is unlikely to be any movement, but the following press conference could spark some volatility as traders react to any additional central bank interventions.

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

As markets around the world lurch from crisis to drama and back again we are still waiting the outcome (if any) of the Paulson plan to save the US banking system and economy thereby avoiding a 1929 style crash and depression.  However, while grown men weep in Washington, banks continued to fail – Washington Mutual in the US and Bradford and Bingley in the UK, it is safe to say that this maelstrom is unlikely to end any time soon as the nightmare on Wall Street moves decisively onto Main Street.  Last week’s massive swings in the markets may have provided plenty of copy but in reality many are missing the point: it is the chronic lack of trust between banks which is the cause of this mayhem, resulting in a mass flight to quality.  Interbank rates are dysfunctional – when a bank would rather earn less than 4% from a central bank than 6%+ from the market then there is something seriously awry.

A recap on last week’s banking woes started with Denmark ’s Central Bank rescuing that country’s 6th largest bank, EBH, its second rescue in 10 weeks after two others agreed to be bought out last week.  By Wednesday Gulf Arab States’ Central Banks said they were ready to provide more liquidity, if needed in the parched interbank market.  Kazakhstan established a $5b rescue fund for its banks.  Hong Kong ’s Bank of East Asia suffered a run by depositors who queued all night to get hold of their money.  Even as I write the ECB is meeting to discuss Fortis Bank – the virus continues to spread.     “Bank failures are caused by depositors who don’t deposit enough money to cover losses due to mismanagement” sounds just about right and uttered, by all people, Dan Quayle – VP under George Bush Senior!!

The solution to this unfolding catastrophe is to throw money at the problem much like the Japanese banking crisis of late 1980s – explained in detail at www.yen-to-dollar.com.  Then, as now, this is only likely to prolong the agony as well as killing off enterprises and companies which are basically sound but whose credit dries up. Once again this week’s economic data is almost irrelevant even though important Q3 numbers are expected:  Japan ’s Tankan Survey, UK PMI, ECB interest rate decision and US Non Farm Payroll on Friday.  Each of these would normally be expected to move both equity and forex markets.  However, given the fear and paralysis together with a number of holidays worldwide, market conditions will be both thin and highly volatile. At the centre of this storm is the fate of the US dollar with its implications to all markets and countries.  Setting aside the long held desire of the like of Venezuela , Iran and Russia whose dearest wish is to see an end to the dollar, the fate of the US dollar is inextricably linked to all other markets.   An agreement in Washington this weekend may see a dollar bounce and equity markets respond in kind, however, this may prove only a temporary reprieve.    Ambrose Evans-Pritchard who is always an interesting read explains in his latest blog post how there is now a very serious risk of a run on the dollar.  http://blogs.telegraph.co.uk/ambrose_evans-pritchard/blog/2008/09/23/financial_crisis_does_the_us_face_a_fullscale_run_on_its_currency.

In the forex market the dollar bell weather pair is the dollar yen.   At the moment it is the Japanese banking system which is perceived as being insulated from the general crisis and the yen has strengthened accordingly.   For forex traders 104 is now pivotal.  For those of us who can remember the days when risk was seen as good it was the relentless selling of the Japanese yen in the carry trade pairs which led to many a profitable trade – oh happy days!  The moral of the above:  The public’s faith in the great and the good to get us out of this mess is both touching and probably misplaced and just remember that in the end it’s always the taxpayer who picks up the bill.

Trading Concept:  As traders and investors it is vital we understand correlation and how different markets and instruments relate and move in respect of one another.  Two examples:  In forex the euro dollar and dollar swiss are almost 100% negatively correlated – going long on both euro dollar and dollar swiss would make no sense at all (or even short on both) as they would cancel each other out.  Currently the correlation between oil and the dollar is inverted – a weak dollar has led to a massive increase in the oil price – however this relationship is more fluid and may change in the future – my latest blog http://www.prices-oil.org gives a daily update and comment on the oil price.  It’s also available in a Chinese version.

Good luck and good trading.

Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

Last week all equity markets fell to multi year lows.  Some made these on Tuesday, others on Friday.  In Europe , the Netherlands AEX, London FTSE and Swiss SMI indices all fell to their lowest levels in over three years on Tuesday while the German DAX fell to its lowest level in over 2 years on Friday October 3rd. In the Pacific Rim Australia All Ordinaries made a double bottom – level not seen since December 2005.  Hong Kong lowest since July 2006 and the Nikkei fell below 11,000 for the first time since 2004.  Nifty of India too fell on 30 September to 3715, its lowest price since April 2007.   The US markets fared even worse – the Dow has actually fallen 4000 points since last year.

These falls were also mirrored across markets including commodities (lack of demand now coming through).  Silver, oil, palladium (used in the car industry) were badly hit.  It seems that traders and investors are cashing in everything and pouring money into safe havens such as Treasuries.  This would also partly explain the recent surge of the dollar against nearly all currencies except the yen.   However, this current financial turmoil has still some considerable way to go and will probably gather pace and whip up even more fear as it goes along leading to,  not a recession but,  a full blown depression. Difficult as it may seem it is vital to try and remain detached from the fear and hysteria and try to understand, not only how the financial world arrived at this point, but also the likely outcome of this meltdown.     Sadly the omens for a speedy resolution to the crisis are not particularly good as we are already one year into this downturn.  However, two interesting indicators to use to gauge emotion and sentiment of a market are the VIX and Coppock.

The VIX – the fear indicator reached unprecedented levels last week although it began to send out warning signals as far back as May/June 2007 -http://www.making-bread.co.uk/trading-article5.htm and an important part of the trading toolkit.  Meanwhile the Coppock indicator is useful as means of establishing when it is safe to re-enter the fray – http://www.making-bread.co.uk/trading-article1.htm.  This week’s economic data will simply continue to confirm that recession is not merely a threat but a reality.  The BOE and Bank of Japan have to decide on interest rates.  BOJ is expected to keep rates at 0.5% while the BOE is coming under increasing pressure to cut sooner rather than later.    Under normal circumstances interest rates would influence the currency market.  With an interest rate differential of almost 5% one would think traders would be buying the British Pound against the Japanese Yen.   In fact the exact opposite has happened with the charts indicating possible further falls for the Pound.  As this pair correlates strongly with the Euro Yen both have similar chart patterns.  Both pairs can also be highly volatile but very profitable if traded correctly.

Finally, one of the most interesting aspects of last week was the price of gold which, given its status as the ultimate safe haven, did not rise as expected.  Indeed the gold chart shows that the price may even fall in the short term.  Interestingly the CBOE recently launched the Gold Vix to measure market expectation of the volatility of gold prices http://www.ft.com/cms/s/0/7afb1bfe-5ff9-11dd-805e-000077b07658.html

Trading Concept:  Volatility is not to be feared but understood and, where possible harnessed.

Good luck and good trading.

Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

“Any bull market covers a multitude of sins, so there may be all sorts of problems with the current that we won’t see until the bear market comes”.  Ron Chernow

If you didn’t think it could get any worse then I am sorry to be bearer of bad news but tomorrow, Tuesday 21st, could be make or break day for the markets when $360bn worth of defaulted CDS contracts are due for settlement -  http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3224615/Markets-hold-breath-as-360bn-Lehman-swaps-unwind.html not only describes this in more detail but also explains why the coordinated bank bail outs have, so far, failed to restore a modicum of calm to the markets.   My own view is that the wild whipsawing we have been seeing will continue until the end of this month at which point we will also have to consider the effect on the markets of the US Presidential Election.

As a very general rule when the market is going down into an election it favours victory for the party not in office.  If it is going up into the election, it favours the party in office.  The US Presidential Election can also have an effect on the US Dollar – again in general, a democratic win has tended to be positive for the dollar whilst a republican win has nearly always led to dollar weakness.     A good indicator for the dollar is the dollar index which is used extensively in the currency markets as a sentiment indicator.  The ticker code is USDX and being a futures index is quoted on the NYBOT (New York Board of Trade).  The index represents the relationship between the US dollar and six major currencies:  the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc.  Having been in decline since 2000 – the start of he Bush term it has only recently started to regain some ground -  http://www.netdania.com/Products/FinanceChart/FinanceChart.aspx

There are various reasons for this dollar recovery including the dramatic fall in the price of oil – some 50% since its high in July.   Earlier this year I wrote extensively on the oil price in my blog: http://www.making-bread.co.uk/myblog as an example of how an asset bubble can just gather so much momentum that traders and investors lose all sight of logic and reason.    How far the price will now fall will depend in part on OPEC and whether there is a coordinated move to cut supplies.   “The Axis of Diesel” article from Saturday’s Times newspaper http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article4965242..ece summarizes the current geo political and economic position very neatly.

You might wonder why I am focusing on issues which could be considered too global and perhaps irrelevant to traders outside of the US or the forex market.  However, the old adage that when America sneezes we all catch a cold (or in this case pneumonia) still holds and with the global banking and financial systems resembling a cat’s cradle global has suddenly become very local.   My own view is that regardless of your country, market or trading style a basic understanding of the economic fundamentals as well as the geo political dynamics can only help you make better trading and investing decisions.  Trading Tip:   The financial world is awash with indicators, news and opinion both fundamental and technical which can overwhelm even the most seasoned of traders and investors.    All indicators are either lagging or leading and while they may work some of the time they won’t work all of the time.  One of the best reference books I have come across on fundamental economic indicators and how they impact the various markets is by Bernard Baumohl: The Secret of Economic Indicators.   The book covers both the US as well as the most important world economic numbers.  Enjoy!

Good luck and good trading.

Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

Dysfunctional and irrational markets continue and I have already said will continue until the end of this month as the need to raise cash and prop up various institutions intensifies.  Valuable assets will continue to be dumped as the financial chaos extends into unimagined and surprising parts of the global market.   The past week saw every major index make new multi year lows apart from the Swiss SMI and the Dow Jones.  However, it is not the fact that we are hitting new lows it is the extent of the decline which shows absolutely no immediate sign of ending.  This is hardly surprising given the extent of the bull run from which markets are now retreating.   There were also stunning declines across the board: silver falling to $865 on Friday, a loss of nearly 60% in value from the 2115 level posted in March.  Gold dropped to $681, down $367 from its all time high of March 18 and crude oil falling to $62.65, totally ignoring the OPEC threat of a cut in production.   Numbers this week will simply reinforce the view that the global economy continues to head south.  Forget a recession – the key word is depression and a new era has arrived.

The debate as to how and why we arrived at this state has started and will, no doubt, continue for many years to come.  Since last year the blame for the current mess has been levied at the door of the poor sub primers, the bankers who lent them the money in the first place, regulators too stupid to understand what was going on, hedge funds profiting from the fiasco, outright speculation and just about everyone else for being just plain “greedy” – so there.  Whilst there is an element of truth in all of these and sub prime mortgages may have been the trigger the seeds of destruction for this disaster of epic proportions were sown by the policy makers and their economic advisers some years ago. You may also have read that Bill Clinton is the latest culprit to be named  when back in 1994 he implemented the “The National Homeownership Strategy: Partners in the American Dream” http://www.businessweek.com/the_thread/hotproperty/archives/2008/02/clintons_drive.html   Clinton’s repeal of the Glass Steagall Act has also been indicted  http://www.investopedia.com/articles/03/071603 as a possible cause.   Also add in Alan Greenspan’s recent confession that he “may” have got things slightly wrong when interest rates were kept too low for too long!

However, the best explanation I have found so far and one I would like to share with you is the wholesale adoption of an economic theory known as New Keynesianism.  At its heart stands the so called dynamic stochastic general equilibrium model which nowadays is the main analytical tool of central banks around the world.  In this model, money, credit or a financial market play no direct role.   The model’s technical features ensure that in the long run financial markets have no economic consequences.  Central banks are told to ignore headline inflation and focus on core inflation excluding volatile items such as food and oil.  The model also ignores asset prices and only deals with the consequences of an asset price bust.  An economic model in denial of financial markets seems to me, not only totally bizarre, but is only going to continue to perpetuate the cycles of boom and bust which have brought us to this state in the first place.  It also ignores the global nature of the financial market and seems hardly fit for the 21st century.

If our current troubles are to be laid at the door of New Keynesian thinking then surely repeating those steps which got us into this mess in the first place:   negative interest rates, a rapid expansion of money, bailing out banks and  an ever increasing national debt will simply ensure that we will be doomed to repeat this cycle ad infinitum.   I will be dealing with market cycles in future newsletters and in particular, how to profit from them.  Trading Tip.  The Baltic Dry Index and why we should understand its significance?  This is the key barometer of global freight activity and therefore world trade.  The index fell 11% in just one day last week.   The reason, aside from a drop in demand, has been the total breakdown of trust between banks which is essentially what we mean by the credit crunch.  The shipping market has crashed because it is built on trust and credit which has completely dried up.  Many ship owners cannot get banks to issue letters of credit (trade finance) particularly on cargoes on price volatile commodities as they no longer look like adequate collateral.  Even those who can get letters of credit are finding that their counterparties may no longer trust the credit rating of anything other than large, well established banks, many of which are now charging huge premiums.  Letters of credit now cost three times the going rate of a year ago.  This is leading to grain cargoes piling up in ports in the Americas and has even led Brazil to use its foreign exchange reserves to increase credit lines for exporters in a bid to keep to keep trade moving.

Good luck and good trading.  Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

Newsletter for w/c 3rd November 2008:

“Revenge is often like biting a dog, because the dog bit you” Austin O’Malley

Last week’s markets were characterized by an element of exhaustion as de-leveraging eased, allowing many instruments to bounce from extremely oversold levels while keeping volatility high.  For example the German Dax bottomed Friday October 24th at 4014 yet by Friday 31st October was up to 5066, a rise of 26..5%.  In the Americas both Brazil Bovespa and Argentina’s Merval fell to 29,435 and 819.36, their lowest in 3 and 5 years respectively, yet by the end of the week they had rallied 20%.   By the end of the week, India’s Nifty was back to 2921 for a gain of nearly 30% within the same week.  Commodities continued to make new lows as oil completed a 60% decline since its $147 dollar high back in July.   Silver fell to 840 on the overnight market on October 28 yet 2 days later was back up as high as 1064, a 25% gain over 2 days.

It was against this background that the ambush (or short squeeze to give it its correct term) of hedge funds by Volkswagen, Porsche and probably the German government was an extraordinary  event.  Over 100 hedge funds collectively lost a staggering £24 (approx $40 billion dollars) on a doomed gamble that Volkswagen shares would continue to fall because of the global economic downturn.  It was the “safest play in town.  In fact Porsche had been secretly building up a 75% stake in VW via intermediaries which must have been particularly galling to the “hedgies” given Porsche’s iconic status as the car of choice for many in this industry.

Regardless of the legality of the move by VW and Porsche there was scant sympathy for the hedge fund industry who many have blamed for contributing to the current financial problems, not least in their aggressive shorting of financial shares.

However, whilst hedge funds can certainly be held to account for contributing to the current financial meltdown the reason it has all gone so horrible wrong is that most so called experts in this industry do not really understand risk and have been using (and still use) inappropriate mathematical tools and models to measure and manage risk.  These tools and models are all based on the statistical device of the bell curve where the focus is on the norm, and any major departure such as a 1000 point drop in an index is seen as a rare event and its effect therefore negligible.   Listening to an investment banker earlier this year explaining that the reason their housing price model failed was because it did not take into account housing prices ever falling, was sufficient evidence that this approach is now wholly inadequate.

For me one solution has come from the world of fractals and in particular the work of Benoit Mandelbrot and Nassim Nicholas Taleb, the latter being the author of “The Black Swan”  which many traders and investors may have already heard of.   Commonsense tells me that all markets are much more volatile than the experts would have us believe and that this past year has not been a “once a lifetime event” but something which can happen at any time.   We have to accept that conventional measures of risk are not only outdated and outmoded but severely underestimate potential losses.  For better or worse our risk exposure to huge losses is actually much bigger than we think it is.  One only has to look at the risks when trading on margin where losses can exceed initial deposits to see this in graphic detail.  Professional traders (or at least those who should know better) are often horrified at the leverage offered by most forex brokers.  The maximum for retail traders should be around 1 to 5 or a maximum of 1 to 10 and yet the average offered by most brokers is around 1 to 100, up to a suicidal 1 to 400.  If you are trading anywhere near these levels I would strongly suggest you stop and reconsider.

Trading Term:  De-Leveraging:  After a long period of loose lending by institutions who should have known better (some banks lending at 40 to 1 by using little understood financial instruments and fancy paperwork and then moving the details of their financial misbehaviour off their balance sheets where regulators could not see it) the reduction of this debt is now a number one priority and will be the cause  of continuing turbulence.    This has had a big impact on the currency market as many of the debts were incurred in dollars and yen.  It is estimated that US investors alone were holding $5 trillion of foreign equities which are now being repatriated.   It is this which has contributed to the recent surge of the dollar.

As more and more investors and traders enter the currency markets in an attempt to find better and faster returns it is important to understand that this market is going to be even more volatile and unpredictable.  Also as it is also largely unregulated it is vital that anyone thinking of participating truly appreciates the extent of the dangers and risks inherent within it.

Good luck and good trading.

Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

“Regardless of how you feel inside, always try to look like a winner.  Even if you are behind, a sustained look of control and confidence can give you a mental edge that results in a victory” Arthur Ashe: 1943-1993.

While the 2008 US Presidential Election campaign will be discussed and forensically analyzed for many years to come, there is no doubt that a powerful combination of youth, first time voters as well as a spectacular harnessing of the internet (in particular Web 2 tools) were ultimately responsible for Barak Obama’s win.

The Obama Presidency also heralds a seismic shift for traders and investors as the heady days of laissez faire free market capitalism comes to an end and a more regulated, less speculative landscape emerges.   Stock markets around the world were momentarily energized by this momentous victory.  In Europe most indices had risen substantially by the 4th November.  For example the Dutch AEX, having fallen to 231.50 on October 27th surged to 291.13, a reversal of over 25%.  The German Dax rallied from a low of 4014 on October 24th to a high of 5301 on November 4th, a gain of 32%.  The London FTSE too rallied from its low of 3665 on 27th October to a high of 4639, a gain of almost 27%.  However, by the end of the week all had fallen back by an average of 10%.  Optimism may have entered the markets but volatility was far from dead.

Market volatility was even more pronounced in Asia and the Pacific Rim.  The Hang Seng of Hong Kong posted a one week gain of 43.5% from its multi year low of 10,676 on October 27th to a high of 15,317 last week.  India’s Nifty too gained over 43% during this same period.  Japan’s Nikkei too gaining over 30% but like the European indices these too failed to consolidate these gains and fell back almost 15%.  The US markets too rallied but like all the others failed to capitalise on their gains.  Hardly surprising as the October US Non Farm Payroll numbers on Friday put the US job market squarely into recession.  The speed and magnitude of the decline in the lack of new jobs underlines both the severity of the September credit crisis and the magnitude of the task facing the new President.

Elsewhere market falls were also the result of dramatic interest rate cuts.  In the UK the Bank of England cut base rates by unprecedented 1.5% while the ECB restrained itself to a 0.5% as central bankers and governments all try to avert an economic meltdown and attempt to steady the financial ship.   Neither cut in interest rate did much for either the British Pound or Euro.  The carry trade continues to unwind and investors and traders bail out of anything which smacks of speculation, hence the continued falls in oil and other commodities.  As has been mentioned before the worst is far from over for either the UK or Europe, with Asia and the Pacific Rim now catching the tail of this worldwide financial hurricane.

An interesting take on the entire credit crisis has been suggested by Liam Halligan whereby he suggests simply locking away all top bank executives regardless of type and refusing to let them out until they fess up to each other, admit their mistakes and reveal what toxic investments they are actually holding.  An AA meeting for addicted bankers – ie bankers addicted to debt and risk using other people’s money.    We can but hope!

In the meantime what of the future and how to profit from the enormous changes which will result from this Presidency?   If, as expected, governments bring in more stringent regulations for markets and financial instruments in an effort to avoid future asset bubbles traders and investors may have no choice but to look at conservative asset classes such as bonds and simple deposit accounts.    Calm, orderly market conditions with no volatility can appear seductive but dangerous as traders and investors soon become frustrated with little or no return from their safe haven investments.  Ironically it is at this point that many turn to trading and investing in more volatile instruments in an attempt to achieve higher returns.

Trading Tip:   It is often tempting when shares prices are falling (or in this market plunging) to be tempted to rush in and buy because they look cheap.  Beware and do not be tempted to rush in too soon – even though the likes of Warren Buffett and Anthony Bolton are now saying that this could be the time to buy.  The likes of Warren Buffett have such deep pockets he can afford the market to take a further turn for the worse.  He also takes a very long view.  Shares are always cheap for a reason.  Panicky investors have pushed prices down to unprecedented levels – the CBOE VIX recently reaching 80 while others are just plain rubbish.

Two classic tests for a cheap stock are a low price/earnings ratio (P/E) and a high dividend yield.  Falling equity markets quickly throw up “buys” on both measures.   For example a share priced at 100p with a full year dividend of 5p per share and forecast earnings per share for the next year of 10p, then the share price is 10 times  forecast earnings, so the p/e ratio is 10 while the dividend yield – the annual dividend as a percentage of the share price is 5% (5p/100p x 100%).  However, if the share price suddenly collapses to 50p with earnings and dividends remaining unchanged, the P/E halves to 5, while the dividend yield doubles to 10% (5p/50p x 100%).  The stock now looks much cheaper in relation to forecast earnings – a low P/E – but also offers a higher income return, but is it a buy?.  Not necessarily, as investors in supposedly cheap, high yielding bank shares, have been finding out to their cost.

The moral of the above is that when markets are in such turmoil and upheaval even tried and tested indicators are suspect and cannot and should not be used in isolation.     Patience is the virtue as we wait for the dust to settle on the fallen.

Good luck and good trading.  Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.

“When things are bad, we take comfort in the thought that they could always be worse.  And when they are, we find hope in the thought that things are so bad they have to get better” Anon

Even as the leaders of the G20 met this weekend in an emergency summit to discuss how best to prevent the world economy imploding markets continued to swing wildly from hope to despair and back again.  Quite what politicians hope to achieve while credit market remain frozen and banks continue to mistrust each other merely confirms their utter impotence in this catastrophe.    What is emerging is that no one political leader, banker of any description, regulator or economist has any idea of what to do.   Indeed the conclusion of the summit seems to be go home and do what you think is best for your own economies!

In the US we find the classic example of rearranging the deckchairs on the Titantic as Henry “Hank” Paulson’s dithers about the $700 bn bailout money.  Apparently it is now not to be used to buy up mortgages but instead deployed to prop up failing institutions (perhaps).   This, of course, assumes anyone actually understands what he is saying in interviews and speeches.   One could say he is to finance what Rumsfeld is to military strategy.

By Thanksgiving, which is next Thursday, banks have usually squared away their positions ahead of December’s financial year-end.  This would usually allow auditors time to sign off the accounts and the executives the luxury of planning how to spend their end of year bonus, which in the case of many usually amounted to the GDP of a small emerging country.    Such halcyon days are now just a dim and distant memory as banks now desperately try to find as much cash as possible to ensure they are still in business in the New Year.

Alongside the dysfunction in the credit markets we are also witnessing an unnatural dollar rally in the currency markets where we have the dollar rising on bad economic news and falling on positive.   This inverse relationship was particularly evident last Thursday and Friday.  On Thursday the Dow closed 552.59 points up having been down over 300.  As the Dow climbed in the last three hours of trading the dollar fell against the euro from 1.2520 to 1.2854.  The pattern reversed on Friday as the Dow lost 400 points in the last hour of trading and the dollar gained almost 200 points as the euro fell from 1.2797 to close at 1.2603.

For many traders and investors the concept that a rising Dow Jones does not necessarily equate to dollar strength is difficult to understand as it is so counter intuitive.  A rise in the Dow should lead to a rise in the dollar?     However, the relationship between the Dow Jones and the forex market is not to be found in the euro dollar pair but rather with the Yen crosses (the carry trade pairs) and, in particular, the euro/yen.   On Thursday afternoon as the Dow accelerated higher the yen crosses and their components all raced skywards.  From 2.00 to 4..00 pm the euro/yen shot up from 120.00 to 126.05.     Positive moves in the Dow and euro/yen are often taken as signs that market participants have perhaps recaptured their appetite for risk and that the worst may soon be over?  However, in my opinion these moves should only be viewed as a reflection of the continuing uncertainty and extreme volatility still present in the market and, with care, could present a short term trading opportunity.

Trading Tip:  With entire governments unsure of how to resolve their individual economic problems some are looking at previous measures such as exchange controls, nationalisation and protectionism.  Although each has been tried (and ultimately shown to have failed) we need to be aware of the implications if any of these measures are actually enacted by our respective governments.

The first is exchange controls.  Tried at various times in the past and now threatened by Russia as investors (and Russians themselves) stampede out of the rouble.  Russia’s problems have not been helped by the collapse of the oil price and its recent attempt to assert itself as a military force with its invasion of South Ossetia.

Sterling too is facing a crisis of confidence and has sunk to a 12 year low.  Gilt sales are falling and with the Governor of the Bank of England comparing the UK’s problems to an emerging market how long before the UK joins Iceland and Ukraine in establishing exchange controls?  Under normal market conditions governments would simply raise interest rates to stem the flow of money but in the current climate this is not likely to happen.

The second measure is nationalisation which in the UK has already taken place with Northern Rock and the government acquiring stakes in a number of other banks.  The US has already nationalised AIG and President Elect Obama also appears to favour a bailout of the car industry.

The third measure, and the one most likely to re-emerge, is protectionism which has always lurked below the surface in many countries.    Even before the financial crisis took hold, the failure to reach an agreement in Doha and the recent election of a Democratic president does not bode well for the concept of free trade.   Even if Obama were to offer support to particular UK industries which prompted other countries to retaliate the global trading system is already fragmenting as evidenced by the collapse of the Baltic Dry Index (explained in more detail in an earlier Newsletter).

Good luck and good trading.

Anna

©2010 Market Analysis. All Rights Reserved By Anna Coulling.