“Spanish bulls force end to bullfight after injuring three matadors.” This was the headline from the Associated Press that detailed how for the first time in 35 years, the famed San Isidro festival was forced to stop their bullfight after the bulls gored two matadors and tossed a third into the air.
One can’t help but smile at the parallel with the current stock market. This bull market also refuses to lie down and die. It too is causing unheard of casualties amongst those betting against it. The bull market is goring the shorts like these Spanish bullfighters (I don’t usually take pleasure in another human being’s suffering, but bullfighting seems to be a barbaric spectacle and it is good to see the bulls win one for a change… although I don’t think that is going to change the bulls’ fate…)
I also noticed that the bears are having an especially difficult time of it lately. Their plight has turned into a little bit of an internet sensation, with a video of a British Columbia mother black bear saving her cub from highway traffic generating over 225,000 views.
By far my favourite witty comment about this daring rescue of the baby bear was from Mark Dow:
The image of Yellen driving down the BC highway trying to mow down baby bears made me laugh.
I guess the reason that it is so funny is that there is a little element of truth to it.
Yellen & Co. are determined to snuff out any remaining bears who dare fight the move out the risk curve. The ridiculousness of the current situation really boggles my mind.
The Fed made a big mistake the day they ever mentioned the trickle down wealth effect. The idea that you can generate real economic growth from blowing ever increasingly unstable market bubbles is asinine.
Yet here we are again with the Fed leading the charge in an another momentous credit bubble that will surely end in tears.
Right now, I am not fighting the rise in any meaningful way as I am scared about being gored by this monster bull. Like the mother bear, I am trying to simply negotiate traffic and make it through alive.
But make no mistake about it. At the end of the bullfight, the bull always dies, and being a Canadian with plenty of experience with bears, I can attest that they always seem to find a way to survive.
The short Yen is the next accident waiting to happen
Although in the previous post I lamented the relentless bull market, I take solace in the fact that within this rise, there are opportunities to short pockets of extreme overvaluation created by the series of rolling smaller bubbles.
The unusually accommodative monetary policy of the past half dozen years has forced investors out the risk curve. This has created a situation where an asset class or sector starts to rise for solid fundamental reasons, but eventually the rise feeds on itself and causes a speculative bubble.
Remember this chart?
This chart highlights the various mini-bubbles that have sprung up since the start of ZIRP (zero interest rate policy).
What is interesting is the fact that these mini-bubbles have burst causing considerable pain for those too heavily invested, but leaving the grand credit bubble intact.
Although I think that the eventual end game is that governments lose control of the bond market and that inflation rips higher, in the mean time, I am most worried about whatever mini-bubble is largest and ready to pop.
It pains me to say this, but I think that the next candidate is the short Japanese yen trade.
These mini-bubbles that I refer to do not necessarily need to be long only affairs. The reality is that in this day and age of thousands of hedge funds desperately trying to add value in this low interest rate environment, there are mini-bubbles in “macro theme” trades as well.
There is simply so much easy money trying to earn an extra return that any trade that seems to have an edge is overwhelmed with an avalanche of capital.
The short Japanese Yen trade was a spectacular trade for hedge funds in 2012 and 2013. The Yen moved from 75 to 105 in less than one year.
JPY Rate (higher means weaker Yen)</a> </div>
This trade was very popular with hedge funds and was a home run for those that put it on.
However, over the last year, it has basically gone sideways. Although it hasn’t hurt the shorts, profits have been difficult to come by.
This lack of follow through has shaken off some of the shorts, but on the whole, the short positioning amongst the speculative community is still elevated.
JPY CME Non-Commercial Short positions</a> </div>
The speculative short position is by no means as large as 2007. Nor is it as large as it was a year ago.
Yet, it is still much higher than where it has trended in the past.
So far 2014 has proven to be an especially sideways period for the Yen, and for the second time since this big move began, the price has hit the 200 day moving average.
JPY rate with 200 day moving average</a> </div>
The last time the 200 day moving average provided solid support before another move higher (weaker yen). Will hitting the 200 day prove an equally fortuitous opportunity this time?
I don’t have a really solid reason for feeling this way, but I am worried that the short Japanese Yen is an accident waiting to happen.
Call it my spidey sense, but I am worried that the short Yen trade is the next one to come unravelled.
Macrotourist spidey sense</a> </div>
(I don’t know why, but when my spidey sense kicks in, I seem to always get featured in the lookatthisfuckinghipster blog)
Counting on the 200 day average to once again save the day seems a little too easy. Trading is never that easy, and I worry that if it doesn’t hold, the selling (buying back Yen) might accelerate.
A month ago, the short bond trade was also a popular trade that had garnered the hedge fund community large profits in 2013. That trade also had gone largely sideways in 2014 and it too had a large speculative short position.
Although there has been no real fundamental reason to account for the sudden change, the trade has gone in the exact opposite direction over the last month as the trade has been unwound.
After all, hedge funds have had a terrible 2014, and when hedge funds are down, they reduce risk. That means covering shorts as well as longs.
The move higher in bonds caught many market participants by surprise, and I am concerned that the Yen might experience the same sort of move.
My concern is heightened by the fact that the Bank of Japan seems to be signalling that there will be no extra QE coming. The market has been hoping for a summer boost to the program, but at a recent news conference the BoJ removed a phrase describing Japan as being in deflation and reaffirming its belief that it could reach its target without additional stimulus.
Although I am convinced that over the long term we are headed to 125, 150 or maybe even higher on the JPY rate, I am concerned that this summer we might experience a Yen rally that quickly takes the JPY back down to the 95 level or lower.
I would never go long Yen as I think the long term trend is down, but trading without a short Yen position is about as bullish as I get.
I continue to like the long Yen volatility trade. It hasn’t worked yet by any means, but given that I think that the short Yen trade is the next mini-bubble to burst, I think it is especially attractive right now.
Getting more bullish on gold
I am going to make this quick as the post is quickly stretching on.
Investors often mistake gold as an inflation hedge. Gold does move with inflation, but only as it relates to interest rates.
The biggest determination of gold’s valuation is the level of real interest rates (that is the nominal interest rate minus the rate of inflation).
If you have inflation running at 5% but rates are 2%, then gold is relatively attractive. But if you have inflation running at 8% with rates at 12%, then gold is much less so. It is not the level of inflation that matters, but the level of inflation versus the interest rate.
Gold is therefore correlated with the reciprocal level of real rates.
Have a look at this chart of gold vs the reciprocal 30 year real rate:
Gold (yellow line) vs reciprocal US 30 Yr real rate (white line)</a> </div>
Over time I expect real rates to remain decidedly negative, but the move lower of the long end of the bond market over the past year combined with a falling level of inflation, pushed real rates to levels that ushered in the big gold market correction.
However between the bond market rally of the past month and the recent rise in inflation, we have a situation where real rates are once again getting pushed lower. This will mean a higher gold price.