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Macro consensus trades into 2016 have not worked well, at all. This week
saw a large flush out in positioning across financial markets. There are
three consensus trades that we feel have been particularly squeezed and what
we believe was a final clearout of these position sent other assets, such as
gold, to extreme levels that present a number of trading opportunities.
The Fed Will Hike, Others Will Not
This was the premise of most consensus trades into 2016. Whilst the market
was not convinced that Yellen was going to increase rates as much as the dot
plot suggested, hikes were expected nonetheless. This dynamic shaped a number
of trade ideas into 2016 across asset classes. We were not convinced of such
hikes, which we wrote about extensively in late December, based a widening of
credit spreads seeing real borrowing costs increase, reducing the need for
hikes. However we did not anticipate that the market would so vigorously
discount all chances of any hikes this year.
Equities – Financial Stocks To Outperform
In the stock market there was a view that banking stocks would outperform
the wider index this year. An increase in the Fed Funds Rate would improve
margins and see financial stocks outperform other sectors. This consensus
trade has been doubly hit.
Firstly, the Fed hikes have not come, and expectations of them coming any
time soon are near zero. Secondly, the widening in credit spreads that we
highlighted in December have spread across a number of sectors. What began as
a few energy companies struggling with a collapse in oil prices, flowed on to
other materials and mining companies, selling fuelling more selling, and
eventually leading to credit concerns at some major European banks.
Currencies – USD To Strengthen
In sympathy with the view that “the Fed will hike, others will not” were
major bets that the USD would continue to strengthen versus other major
currencies. In no pair was this consensus view stronger and positioning
larger than in USD/JPY.
The vicious gold spike mid-week was mainly caused by a weakening of the US
dollar versus the Yen. A consensus trade going into 2016 was that the US
dollar would strengthen compared to the Yen, given that the BoJ was loosening
monetary policy while the Fed was hiking rates. This view was turbocharged
with the BoJ announcing negative rates not so long ago. However, this trade
has been proven wrong, as the US dollar has in fact fallen considerably
against the Yen.
With many exiting this trade, after being proved wrong, the market moved
too far. This has pushed USDJPY notably below the US dollar index as a whole.
Thus the US dollar has been dragged lower, which has pushed gold higher.
Bonds – Prices To Fall As Fed Hikes
As yields rise, bond prices fall. With many expecting a number of Fed
hikes this year, investors sold bonds expecting prices to fall. As Fed hikes
appeared less and less likely, investor’s scrambled to buy bonds and this has
fuelled a major rally. As a result, bonds priced out almost all chance of a
rate hike in the next 12 months and gold consequently soared. The pricing for
future rate hikes has now returned to less extreme levels with bonds falling
back from their rally mid-week.
However, gold has not followed bonds lower, which means the metal is
likely to fall from here. Bond pricing currently implies that gold should now
be around $1190, which is approximately a $50 decline from the close on
Friday.
Consensus Trade Stopping Sends Gold Too High, Too Fast
We believe gold has now come too far, too fast. The scramble to stop out
of the macro consensus trades so far this year has sent gold on its biggest
rally in recent years. The largest of bounces in gold since the peak in 2011
prior to the current was following the end of the bull market and the break
in April 2013. The current bounce has moved marginally higher than this in
percentage terms.
Other technical factors also show gold to be too high. The RSI finished
the week at 82.13, but on Thursday moved to the highest level since the peak
in August 2011, when the Eurozone was on the brink of collapse and the Fed
was engaging in massive QE. Even in these massively bullish conditions gold
still sold off after the RSI approached 90. Therefore it is highly likely
that gold will be sold off in the near term. The next $50 move in gold is
lower.
Mining Stocks Getting Giddy
Just as we are of the view that gold has come too far too fast, mining
stocks have done the same if not more. We do not think this move is
sustainable. A spike in spot gold does not magically remedy many of the
underlying issues that gold mining companies face. We are particularly wary
of companies with debt that need to be rolled over in a poor credit
environment. We have touched on some of the detail with our subscribers this
week and intend to cover this in a dedicated article for publication shortly.
Trading Strategy
Having held the view for all of 2016 that there was minimal risk of a fall
in gold prices we now have the opposite view. Gold will not fall to re-test
the lows, but the next $50 move is down, and our positioning reflects that
view. We are positioning for a bounce in general stocks, but a drop in gold
miners. It’s been a rough and rocky ride this month, but that only creates
trading opportunities and in this environment we believe options are key to
limiting downside and optimizing risk-reward dynamics. You may see our full
trading record here and you can subscribe via either of the buttons
below.
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