In yesterday's missive, we explored the question of if the economy was slowing enough to cause a meaningful correction. The conclusion was that since (a) stocks tend to look ahead six months or so and (b) the indices were recently at fresh all-time highs, the market might be looking beyond the current weak(ish) economic data to brighter days in the second half of the year. However, if the data were to worsen noticeably from here, we might be in for a rough ride.
This morning I am going to expand on this theme a bit by looking at "the story" that some asset classes may be telling right now. Specifically, we'll look at what's been happening in the bond market as well as the action in the metals pits.
Let's start with the story that the bond market has been telling of late. Below is a chart of the 10-Year Treasury Note Yield.
U.S. 10-Year Treasury Yield
First, let me apologize for my lack of skills with Paint. But with a bit of explanation, I think "the story" will be clear. From December 2012 through early March 2013, you can see that the yield on the 10-year was in an uptrend. Generally speaking, the move from 1.55% to 2.05% was in response to improvement in the economic data. The bottom line to the story here is that better data means higher yields.
So, what has been happening since mid-March? In short, the data has been coming in a bit on the punk side. In addition, the crisis in Europe began to percolate again. So, how did yields react? Yep, you guessed it; yields have fallen from 2.05% to 1.70%. Thus, the story from the bond market seems to suggest that there is some weakness in the economy - and/or very little inflation.
Now let's turn our attention to the metals market. Obviously gold has been having a rough go of it lately as the yellow metal lost about $200 in just a couple of days. While investors have become accustomed to volatility over the past five years, this move redefines the concept. In fact, Ned Davis Research tells us that the move in gold was a 7.2 standard deviation event, meaning that it would happen about once every 2.7 million years.
My colleague, David Wismer, did an excellent piece on gold's bid dive yesterday, so I'm not going to go into all the reasons behind the move again this morning. In addition, the "gold story" really doesn't correlate well to the economy. But there may be something else at work here, so I'll come back to that in a bit.
While the movements in gold may not traditionally be associated with the state of the economy (unless there is a crisis at hand, of course), copper most certainly does. So, let's see if "Dr. Copper" has a story to tell right now, shall we?
iPath Copper ETF
I'm going to guess that you don't need a PhD in economics to get the picture here. Again, we see the general rise that began last November, indicating that the economy was improving. However, around mid-February that trend broke and has been going the other way ever since. And most importantly, this copper proxy has been going the other way in a big hurry since April 9th.
Anyone versed in global macro trading will tell you that the story from "Dr. Copper" here is clear - all is not well in the economy. However, the veracity of the decline over the past couple of weeks does make one wonder if something else - or something more - might be at hand.
Next let's look at steel. After all, while some metals such as gold and silver may be traded for other reasons, the uses of steel are pretty straightforward.
Market Vectors Steel ETF
If you are starting to see a pattern developing here, give yourself a gold star because "the story" from the action in steel appears to be the same one coming from Copper and bond yields.
To be fair, a hefty amount of the recent downside volatility can be pinned on China as this weekend's data confirmed that the growth rate of the world's second biggest economy is not what it was cracked up to be. Therefore, the "China Demand Trade" may have encountered some selling of late.
We can also look at the story coming from the action in coal. While not a metal, coal can be tied to economic activity. In short, if manufacturing plants are increasing production they will need more coal - and vice versa.
Market Vectors Coal ETF
Does this chart look familiar? Yea, I thought so too. So the message is "growth slowing," right?
If we are talking about the general trend of yields, copper, steel, and coal, yes, it would certainly seem that the story being told is one of slowing growth. However, if we are looking at the more recent dance to the downside, there might be something else to consider.
Whenever something extraordinary happens in the markets and there isn't an obvious catalyst associated with the move, it usually means that some hedge fund master of the universe has "blown up." In English, this means that the fund has hit its maximum drawdown allowed and/or is being forced to liquidate. And on Wall Street, forced liquidations aren't pretty. There is no manager carefully selling into strength over a period of days, weeks, or months. No, generally we're talking about somebody dumping a boatload of something on the market in a very short period of time.
Another thing that happens in these situations is that word of the liquidation gets out. And for the sharks swimming on Wall Street, this is like blood in the water. Once the Street gets wind of a liquidation, everybody jumps into the same trade at the same time. The end result? Something akin to the 7.2 standard deviation decline in gold we just witnessed.
Unfortunately, I have absolutely no proof that a big gold manager - or better yet, a big metals manager - has blown up. But since the economic "story" hasn't changed dramatically over the past week, this sure makes sense to me. So, until we know for sure, I'm not sure I'd be bombing into the "sky is falling" story that's being told by the bears right now. A "growth slowing" story is one thing, but the recent move in the metals sounds like something else. Oh, and yes, I do indeed reserve the right to be wrong on that story once all the facts are made available. But until then, I'm going to keep watching and looking for the real story.
Turning to this morning... It appears that the flip-flop pattern has returned as stocks look like they will move opposite from the day before for a fourth consecutive time today. The improved mood is being led by a rebound in Europe, where a solid bond auction in Spain and hope for a resolution in the Italian elections has put some green on the screens across the pond. Finally, there are some fairly big numbers out in the U.S. this morning that bear watching. But so far at least, the futures are pointing higher in the early going.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
- Shanghai: +0.17%
- Hong Kong: -0.26%
- Japan: -1.22%
- France: +0.88%
- Germany: +0.47%
- Italy: +1.20%
- Spain: +1.31%
- London: +0.38%
Crude Oil Futures: +$1.26 to $87.94
Gold: +$14.80 to $1397.50
Dollar: lower against the yen, euro and pound
10-Year Bond Yield: Currently trading at 1.716%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +4.84
- Dow Jones Industrial Average: +48
- NASDAQ Composite: +10.32
When you believe in a thing, believe in it all the way, implicitly & unquestionably. -Walt Disney
Positions in stocks mentioned: none
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