China, FOMC, Dollar?
The Chinese market took it on the chin and was down 8.5%, the most in years. That is trickling over into the European markets and we are seeing the pre-market futures in the U.S. under pressure. Last week the US markets closed lower with no late rally. This morning will certainly be a test of the recent lows and it will be interesting to see if any rally comes in the late trading session after the Europe markets close.
It is that time again, time for the Fed to meet and to release a statement IF they are to raise rates or make any policy changes. By now you should know my take – there will be no RATE hikes this meeting and I seriously doubt there will be one in September. While the Fed likes to talk the talk, they certainly don’t walk the walk. At most, if any rate hikes come it would be a 25 bps hike, which is ceremonial at best since we are already running a zero to 25 bps range. (Note a rate hike to 25bps just locks it at the upper bound of the current range). Perhaps such a move will hush the Hawks (those that want rate hikes).
I do not expect much from the meeting – other than a reiteration of being “data dependent”. With everything going on with Europe (Greece) and now the China market sell-off, it will further justify a gun shy Fed.
New Fed Governors?
It has been a long time without a full bench of Fed Governors, in fact from my brief research I can’t find any time in history with so few Fed governors for such an extended period of time. President Obama just appointed another Fed governor (waiting for Senate confirmation). We have been running with only 5 of the 7 governors for some time, all of whom have been appointed by President Obama. A Fed governor is appointed to a 14 year term, with one expiring every two years. Part of the reason for long terms and the rotation is to avoid (to some extents similar to the Supreme Court) a sitting president to appoint ALL the governors. This will be the first time since inception that one President will appoint all 7 Fed governors.
President Obama just nominated Kathryn Dominguez (University of Michigan economics professor). My brief research on her shows impressive credentials (also taught at Harvard and a Yale grad), however I must add she is deeply rooted in the same Keynesian ideology – thus creating a group of governors that will no doubt always agree. President Obama had also nominated former Bank of Hawaii Chief Exec Allan Landon a few months ago. With the last to seats now appointed, we could expect the Senate hearings to start.
Courtesy of Ford School UMICH
Unfortunately after watching a few of the Senate hearing appointments of the past, it seems more about ideological stumping without any serious economic related questions. Probably because those on the Senate committee have little knowledge of economics or math and are most likely using any FREE airtime to sound smart as they stump for the next election cycle.
Additionally, I am sure some horse trading for approval votes is certainly in the cards. Sadly it is more of a political process that is ushering in the rank and file academic Keynesians. I can only hope that the Bank of Hawaii CEO appointment was a Presidential favor from the home state and he is a Hawk. Unlike the academics who write a pleather of papers and lectures – in which we are able to get a good understanding of their ideology, Allan Landon has been in the working world. With the good rating of Bank of Hawaii – one can only hope he is far more conservative in monetary policy than the rest.
Commodity Sell-Off or Dollar Rally?
Courtesy of wikipedia
Economies of all scales work from the simple and undisputed law of supply and demand. The problem is that we can’t simply assume that price alone is a simple measure of that supply and demand. The simple reason is the measuring stick in which we use (the dollar) is in flux.
Most commodities are priced in dollars and thus it is easy to assume that when gold, oil, or any other commodity rises or falls (in dollar terms) it is simple driven by the law of supply and demand. However, there are other factors at work that we MUST take into consideration.
First, what about the dollar value as it relates to other currencies? We don’t live in a bubble in which we are the only producers, users, buyers/sellers of oil for instance. What happens if the dollar appreciates in value against the basket of foreign currencies, how does that impact the price of goods (especially imported goods) or commodities?
If we look at the dollar index (the dollar vs. a basket of currencies) it has appreciated over 19% in the last year, while Gold for instance is down 15% in the same period. One can’t help but wonder is gold selling off or is it the dollar rally? It could even be a combination of both.
We must understand that the dollar’s value (buying power) has several components; money supply (M1, M2, M3), inflation, and rate of exchange (against other currencies). This makes these all contributing factors to commodity pricing.
The other factor in commodity pricing, unlike stock, is the infinite amount of possible contracts. Each stock has a finite supply of shares. One can certainly short stock, but even short stock is limited since one must borrow shares before selling it, thus keeping the pool of shares finite. In the commodity pricing world (futures primarily) there can be far more open contracts than actual physical delivery. Thus someone can actually buy more gold or sell more gold futures than there are actual reserves to physically deliver. There has been little concern about the abundant amount of future contract vs. physical delivery since only a small percentage is actually physically delivered. However, we must remember while improbable, it is certainly not impossible. One only has to read the Kyle Bass story on the $1 billion in physical gold delivery which was 30% of the COMEX reserve at the time.
What is important to understand is that the “paper” market (futures) is far larger than the actual deliverable. Much like the Kyle Bass story, the Hunt Brothers tried to corner the Silver market. They realized it was theoretically possible to do so – from the understanding of how future contracts work in conjunction with physical deliverables.
In the oil market for instance, oil demand worldwide has increased and continues to do so, but oil prices are down considerably. Again, is this really a question about oil’s direct supply and demand, or is more a function of dollar appreciation?
China released their gold reserves a week ago (first time in 5 years), which increased 60% since 2010 to 1,658 tons and worldwide gold purchases (physical) continues to increase. Yet the following day, gold futures came under significant pressure. Total open interest is 650,000 contracts on futures (including ITM deliverables), representing 65 million troy ounces. Total registered gold in ALL US depositories is 48.2 million troy ounces. So if all contracts were converted to physical we would come up short 16.2 million troy ounces or about $18.5 billion short. The point is – many times there are far more future contracts than deliverables.
In the energy market according to Mr. Chirichela (Energy Management Institute) only about .5% of NYMEX contracts are actually physically delivered at settlement. When Kyle Bass asked the CME about what would happen if more contracts were converted to physical deliverables than they had reserves, the CME responded – that would NEVER happen.
The questions I continue to ask myself are commodities undervalued or is the dollar overvalued? How much further can the dollar rally, while the Fed continues to keep rates at zero and increases the money supply? How much have commodities fallen because of actual physical supply/demand?
These are all questions that can’t simply be answered by the price of commodities; one must understand all the aspects and variables involved.
For now it seems, to me anyways, that commodities are undervalued when measured by an almost 20% rally in the dollar. Especially when with a very easy Fed monetary policy that doesn’t look like it will change anytime soon.
Support & Resistance
We have broken below that 17,500 level and I will be watching the market into the close if we get any rally to close above that level.
The tech heavy index seems to be holding on well. Looking at 4500 as the short-term low and if there is a rally into the close we could get back above the 4,550 range.
The SPX is holding up better than the Dow Jones. The real low support is 2050, which we could visit today or tomorrow (before the FOMC meeting). I suspect 2050 – 2080 consolidation volatility zone heading into the FOMC meeting.
The Russell’s recent fall is a little more alarming to me as I this index as a general measure of order flow for the equities market. The steep Thursday and Friday drops to test support and this morning looking to open even below the 1220 zone means that we could visit the 1210 area before we see any support. The Fed’s meetings start tomorrow, but they meet for two days and we are already into this low area. Unless we see strength into the close – I am a little concerned about the possibility of a market sell-off.
The Fed will try to calm the markets after turning negative on the year. Greece and now China is starting to create gun shy investors. Confidence the Fed will remain easy could send this market into a strong rally.
There is no reason to suspect a hawkish Fed. Dovish comments combined with concern would lower the probability of the speculated September rate hike even further. Of course I don’t believe that a rate hike is coming, but most of the market does (and has for years it seems).
If this is a double bottom in the equity markets and we get a strong Dovish message from the Fed, eliminating the probability of a September rate hike, we could be lining up for a strong 2nd half rally.
It is Greece and now concerns in China that continue to loom over the markets – the Fed has to lower those concerns. Perhaps suggesting that money is flowing INTO the US from those concerned markets could help boost the equity markets again.
I have never been a believer that the equity markets represent our economic strength or weakness and those that try to correlate the market with the economy are fools to do so. Yet perception does drive investment decisions, regardless of economic reality.