Global Macro Notes: Bullish Hedgies and Oil Set to Boil

February 21, 2012
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Felix is looking on the money so far.

From Felix Zulauf’s Market Prognosis, one of the smartest things we read last week:

Legendary Swiss investor Felix Zulauf believes that the current rally in risk assets is likely to last until at least the end of March, but that global sharemarkets will again succumb to downward pressure in the second half of the year.

In a wide-ranging interview with Business Spectator, Zulauf, who is president of Zulauf Asset Management and who has been a member of Barron’s Roundtable for more than 20 years, paints a gloomy picture of debt-laden industrialised countries, where central banks have no choice but to print money in an attempt to stave off dire deflationary pressures.

He also predicts that dwindling demand from the West will force China to redouble its efforts to boost domestic consumption, but that this will reduce China’s rate of economic growth.

The whole piece is worth reading… Zulauf’s well articulated world view largely meshes with ours.

Meanwhile the S&P has shown “relentless strength” according to Bespoke Investment Group, with 1% decline days nowhere to be seen… the Dow just kissed 13,000, its highest level since May 2008… and the Nasdaq tagged the backboard with its highest close since, drum roll, December of the year 2000!

Where is all this bullishness coming from?

It’s a “no news is good news” phenomenon, applying in particular to bad juju from Europe and China. In other words, as long we get  “no news” of meltdown, default, civil unrest gone wild etc, sovereign and systemic risks are pushed aside.

Why? Because money managers have some catching up to do. As Reuters clarified on Monday, hedgies are ramping up the risk:

Hedge funds are cranking up their bets in equities and credit in 2012′s buoyant markets in the belief that the euro zone, U.S. and Chinese economies will fare better than many were fearing last year.

Many funds think the European Central Bank’s long-term refinancing operations (LTRO), which flooded markets with 489 billion euros ($644 billion) of cheap cash in December and provide more this month, are a turning point in propping up the region’s battered banks.

They are also betting that China, which is facing a fifth successive quarter of slowing economic growth, will experience a so-called ‘soft landing’, while the U.S., which saw its fastest growth in one-and-a-half years in the fourth quarter, is firmly on the recovery path.

The average hedge fund rose 2.6 percent in January but this was behind the S&P’s 4.5 percent gain, according to Hedge Fund Research, and some funds missed out on the rally after taking a cautious stance towards the end of a turbulent 2011.

Many managers are now hiking borrowing to make their favorite bets punchier, or shifting the balance between their long and shorts to help them profit from market gains.

“What we’re hearing from a number of managers is that the appetite for risk has risen,” said Frank Frecentese, global head of hedge fund investments at Citi Private Bank.

“Their view on Europe is that the possibility of an extreme left-tail event has lessened, the U.S. is doing moderately better than expected and the risk of China … heading for a hard landing has lessened.”

But what about Greece? Fuhgedaboudit… as long as the European talking heads can continue to “kick the can down the road,” the deflationary pain of the periphery countries is someone else’s problem.

As many others have observed, the bailouts are not meant to help Greece, but the banks in harms way should the system go down. As long as it functions, let liquidity and U.S. optimism rein.

One big danger for bulls is high and rising crude oil. Independent oil trader Vitol thinks $150 could be back in the cards. Via the Financial Times:

The world’s largest independent oil trader says oil prices could jump this year to a record high above $150 a barrel because of growing tensions with Iran.

Ian Taylor, chief executive of Vitol, said on Tuesday that the commodities trading house’s main scenario was for crude oil prices to remain at around current levels of $120 a barrel for the balance of 2012. But he warned: “Geopolitical risk, especially in the Middle East, creates potential material risk to the upside.”

Mr Taylor said oil prices could even surpass the record high of nearly $150 a barrel set in mid-2008. “It is unlikely, but it is possible,” he said when asked whether prices would rise to a new record.

Airline investors certainly didn’t appreciate the ominous outlook for crude.

US Airways Group (LCC, chart above) was representative of Tuesday’s action in the group, with ALK, DAL, JBLU, LUV etc all showing similar range expansions to the downside.

Oil has risen to its highest levels in 9 months. A geopolitical flare-up — likely tied to Iran at this point — could lead to a huge spike overnight. At the same time, we are wary of the heavy speculative position in oil.

As our friend Peter Brandt pointed out in his excellent chart review of the energy complex this week:

There is a MAJOR problem with the bull scenario in WTI Crude Oil — the open interest story. There is currently a near record open interest of 1.29 million contracts.

The composition of this open interest represents a near all-time record short position by commercials and long position by the large speculator (including the funds).

Typically it does not pay to bet against the commercial interest in the futures market, especially when the commercial interest is so heavily slanted in one direction — but there are rare exceptions. So, while further gains in price are possible — even to the extent of the targets identified in this document — one must question where the additional buying will come from given the extended commitment of the speculator at present. A close below last week’s low in Crude Oil could lead to cascading stops.

The problem with geopolitical events is the low probability of an actual conflict. It’s the poker equivalent of drawing to a straight flush: If it happens, Oh, Mama! But odds are the more boring result will prevail…

We are more constructive regarding the outlook for metals, particularly base and industrial metals.

Copper, for example, kicked off the week with a big boost, likely on China’s easing news, to key off $3.70 support. From China daily:

China’s central bank on Saturday announced to lower banks’ reserve requirement ratio (RRR), underling its efforts to ease short-term credit crunch and secure growth in the wake of a lacklustre external market.

The cut, the second of its kind in three months, will drop the RRR by 50 basis points to 20.5 percent for large commercial banks and 17 percent for mid- and small-sized banks, the People’s Bank of China (PBOC) said in a statement on its website.

The move will become effective on February 24 and release an estimated 400 billion yuan (63.54 billion US dollars) in capital into the market.

Copper is potentially playing off support in the $3.70 per pound area.

If optimism on Europe and China holds — more can kicking, more rate cutting, more money printing blah blah blah — then there is reason to believe bullish fund managers can continue to press their bets against an optimistic backdrop.

The threat of an oil spike will weigh, as will the threat of Europe’s duct tape finally splitting at the seams… but how tired are those tunes?

So tired, and so well ignored, that the professional bears are spilling tears in their beer and throwing up their hands — as Bob Janjuah of Nomura illustrates (via ZeroHedge):

I am not well equipped to navigate bubbles where tactical views and secular views are all thrown into the melting pot together, where there is no visibility, where – as one client put it to me recently – we have Monetary Anarchy running riot, where the elastic band between the ‘real’ economy and the current liquidity-fuelled markets is stretched further and further beyond credulity, and where history tells us that policymakers will happily stand by whilst bubbles are being pumped up, and hope that they are onto their next job before it all comes tumbling down.

My personal recommendation is to sit in Gold and non-financial high quality corporate credit and blue-chip big cap non-financial global equities. Bond and Currency markets are now so rigged by policy makers that I have no meaningful insights to offer, other than my bubble fears.

We feel ya Bob. That’s why we aren’t trying to guess when the manipulation circus will end.

Just picking our spots, taking our shots and riding trends…

In the Mercenary Live Feed we are currently positioned for “more of the same,” with a strong bias toward industrial and metal miners, bullish exposure capping bearish by more than 2 to 1.

Finally, the most intriguing read of last week was also a sad one, as another trading legend inches towards the door.

In “A secretive hedge fund legend prepares to surface,” Fortune peeks under the kimono of Louis Moore Bacon, the founder of $15 billion AUM Moore Capital Management.

In the piece we learn that Bacon has had to endure his second down year in the past four (minus 2.2% in 2011)… that his “heir apparent” left to start his own fund… and that rather than succumbing to the financial equivalent of a rectal probe from the Securities and Exchange Commission, Bacon is seriously considering the “family office” route already taken by Stan Druckenmiller and George Soros.

(By the way, check out our Exit Soros Retrospective if you didn’t catch it the first time around.)

The Fortune piece is filled with interesting tidbits like this:

Bacon has created a culture at Moore of long hours and exacting standards. Of the numerous portfolio managers Moore has employed over the years, only about a dozen have been given $1 billion or more to manage, with the lion’s share being handled by Bacon himself. And traders, who earn a base salary of $250,000 a year at most, live in fear of having their capital and resultant bonuses scaled back if they make a bad trade and aren’t given time to earn back losses.

“Louis wants to make sure that if you have a bad stretch, he can get rid of you,” says one fixed-income trader who walked away from a potential job at Moore because of those concerns. “Louis feels like he’s the manager of the Yankees. He can have a different team every year and they can still win the World Series.”

The global macro titans are retiring, Fortune asserts, because the mega-profitable, home-run style “macro bets” are getting harder to find.

That’s good news to us, though — the next generation — because markets move in grand cycles, and the current drought will be a monsoon quickly enough. (Long bonds and the yen are already looking good…)

JS (jack@mercenarytrader.com)


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