How sustainable is the commodity rebound?


Author Cam Hui

Posted: 29 July 2013

I have seen some buzz and excitement among technical analysts and in the blogosphere about a rebound in the commodity sectors of the stock market. While these sectors were highly oversold and a bounce was not unexpected, my analysis suggest that the sustainability of a rebound is unlikely. The more likely scenario is a sideways consolidation to digest the gains from the tactical rally.

Here is the chart of the metal stocks relative to the market. The group has rallied out of a relative downtrend, which is constructive, but faces some overhead relative resistance. My best guess is a period of sideways consolidation going forward:

Here are the gold stocks against the market. I’m not sure why people are getting so excited here. Sure, the short-term relative downtrend has been broken, but the longer term relative downtrend remains intact.

Here is the relative chart of the energy sector. It bears some semblance to the metals – rally out of a relative downtrend and exhibiting a consolidation pattern.

Longer term, I just get very excited about this sector unless it can show some sustained relative strength to break the pattern of lower relative lows and lower relative highs:

Here is the long term relative chart of Materials. The same comments that I made about energy applies to this sector as well:

The same thing goes for the metals. Well, you get the idea.

Tactically, I also like to watch the high-beta small cap resource stocks relative to their large cap brethren to measure the “animal spirits” of the market to give me clues as to the sustainability of this rebound. Here are the junior golds (GDXJ) relative to the senior olgds (GDX). Unless the juniors can show more strength to break the relative downtrend, it suggests to me that this rally is likely to be brief and fleeting.

Up here in the Great White North, I monitor the relative return of the junior TSX Venture, which is weighted towards the speculative junior resource names, to the more senior and more broadly diversified TSX Index.

Nope. No rebound in animal spirits here either.

The dreams of gold bugs
I also saw some analysis that is supportive of a strong gold rally, but upon further analysis I believe that the analysis could be interpreted in different ways and it is not necessarily supportive of a bullish position in gold. Consider this chart showing the relative performance of the Amex Gold Bugs Index against SPX, which has been rattling around in the blogosphere:

It was pointed out that we are experiencing bullish divergences on the 14-week RSI and in the past three occasions, the HUI/SPX ratio has rallied strongly in favor of HUI. Moreover, the ratio is sitting at a major relative support level and, given the highly oversold conditions and the bullish RSI divergences, conditions are highly suggestive of a strong rally for the golds.

While I would not rule out a tactical rally in gold and gold stocks, I question the sustainability of any bullish thrust. I would point out that the highlighted bullish RSI divergences occurred in a secular bull market for gold and other commodities. It is questionable whether gold remains in a secular bull today. Consider the occasions on the left had side of the chart, where oversold RSI conditions occurred in the HUI/SPX ratio in a bear market. On those occasions, the rebound was only a blip and the downtrend continued soon afterwards.

The key issue to the analysis that underlies the above chart is the question of whether gold is in a bull or bear market. Choose your interpretation and your own conclusion.

As well, there is the Commitment of Traders report showing an off-the-scale reading in the net gold positions of commercials, or hedgers:

The COT report seems highly supportive of a bullish impulse in gold, but consider what happened in 2008 when we saw a similar reading. The COT “buy” signal report date was September 16, 2008. Soon after, the gold price proceeded to tank, though it did recover for several months,

Oh well, back to the drawing board.

Fundamental backdrop is not constructive
It’s not just technical headwinds that the commodity sectors face, the macro fundamental backdrop does not scream sustainable rebound for these late cycle sectors. Walter Kurtz of Sober Look highlighted this chart from Credit Suisse showing the relative performance of cyclical vs. defensive sectors by region. The US and eurozone ratios are fairly flat, while Japan shows a minor uptick and China, which is the major marginal buyer of commodities, is going south.

Can the commodity sectors rebound strongly in the absence of Chinese demand and a so-so performance from the major developed markets?

The signals from China are clear. The new leadership is intent on re-balancing the  economic growth from an export and infrastructure driven model to a consumer drive model. While the government appeared to have blinked last week when Premier Li Keqiang asserted that growth would not be allowed to go below 7%, it seems that any stimulus measures would be highly targeted and localized. In fact, Bloomberg reported that the government ordered 1400 companies to cut capacity in a highly targeted move to shift the focus away from infrastructure spending:

China ordered more than 1,400 companies in 19 industries to cut excess production capacity this year, part of efforts to shift toward slower, more-sustainable economic growth.

Steel, ferroalloys, electrolytic aluminum, copper smelting, cement and paper are among areas affected, the Ministry of Industry and Information Technology said in a statement yesterday, in which it announced the first-batch target of this year to cut overcapacity. Excess capacity must be idled by September and eliminated by year-end, the ministry said, identifying the production lines to be shut within factories.

China’s extra production has helped drive down industrial-goods prices and put companies’ profits at risk, while a survey this week showed manufacturing weakening further in July. Premier Li Keqiang has pledged to curb overcapacity as part of efforts to restructure the economy as growth this year is poised for the weakest pace since 1990.

Does this sound like a government that is panicked about growth falling below 7% and is anxious to stimulate at all costs? Do these measures sound like they are supportive of a short-term spike in commodity demand?

In short, the rebound in gold and other commodity prices appear to be temporary and the bear trend will likely re-assert itself after a short rebound. This does not look like the start of an intermediate term uptrend.

For commodity bulls, the current environment is like the unfortunate case of being locked up by the secret police and having your interrogator go home for the evening. You may think that the torture is over, but the beatings will continue when he returns in the morning.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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The gold bulls’ final defense


Author Cam Hui

Posted: 27 June 2013

OK, so gold had a very ugly day. For some perspective, here is the long-term chart of gold stretching back to the start of the last gold bull:

This precious metal recently dropped through one important uptrend (dotted line). There is, however, one ultimate last line of defense for the gold bulls, which represents the uptrend stretching back to 2001 (solid line). Uptrend support appears to be at roughly $1150.

There are a number of hopeful signs for gold, at least in the short-term. Tim Knight at The Slope of Hope indicated that silver may be forming a bottom at these levels:

As well, Ed Yardeni showed that there is a high level of correlation between gold prices and TIPS:

Here is a short-term chart of GLD and TIP. TIP rallied today, though GLD sold off. This represents a short-term divergence, though minor, that cannot go on forever.

In short, precious metals appear to be setting up for a relief rally at these levels. However, keep an eye on the longer term trend to judge whether the gold bulls’ last stand is successful or not.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned. 

Commodities poised for revival


Author Cam Hui

Posted: 07 Jun 2013

Yesterday’s stock market selloff was an event that we haven’t seen in some time, as major averages fell over 1% across the board – and globally. Nevertheless, I saw a glimmer of hope for the bulls, as commodities were performing well despite the carnage. If a deep cyclical sector like that is displaying rising relative strength, it suggests that the end of this correction may not be too far off.

Commodities unloved and washed out
Simply put, the commodities complex is unloved, washed out and showing signs of investor capitulation. The chart below from BoAML shows the aggregate large speculator (read: hedge fund) net position from the Commitment of Traders report in the CRB Index. Large speculators have liquidated their net long positions from a near crowded long level to net short. Moreover, readings are consistent where declines have halted in the past.

Here in Canada, the junior resource companies are beyond washed out. The chart below of the relative performance of the junior TSX Venture Index against the more senior TSX Composite is at all-time lows – and below the level of the capitulation lows seen following the Lehman Crisis.

Here in Vancouver, which is the heart of junior mining country, I personally know of scores of well-qualified people who are in the industry who are struggling with the difficult environment.

Green shoots
In the midst of this bleak landscape, I am seeing nascent signs of recovery for the sector. What is encouraging was the positive performance shown during yesterday’s ugly selloff. One of the top recent performers has been industrial metals, which has:

  1. Rallied through a downtrend;
  2. Staged an upside breakout through a wedge; and
  3. Staged an upside breakout through a resistance level yesterday – which was impressive given the headwinds provided by the risk trade.

At the same time, gold seems to have made a temporary bottom and it’s starting to grind upwards as the precious metal is displaying nascent upside strength.

I am watching carefully the Brent price, which is a better proxy for world oil prices, for signs of an upside breakout through a downtrend. We almost achieved the breakout yesterday, but not quite.

The relative performance of energy stocks against the market is starting to show positive relative strength, which is another early warning of shifting leadership.

Macro and market implications
While I understand that commodities and commodity related stocks are unloved, washed out and poised to rally. These combination of sold-out sentiment and early signs of rising relative strength are pointing to a recovery in these sectors.

From a macro perspective, the recovery of deep cyclical sectors like these are consistent with a relatively upbeat outlook for growth economic growth. In that case, the environment for equities is encouraging and any correction should be relatively shallow – barring any macro surprises,

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Giving the bulls the benefit of the doubt


Author Cam Hui

Posted: 25 May 2013

OK, I was partially right. On Monday, I wrote that commodities were setting up for a rebound (see Commodities poised to rally?):

All of these conditions are lining up to suggest that commodities are poised to rebound. The euro, commodity sensitive currencies and gold are all at key technical support levels. As I write these words, precious metal prices are substantially in the red. Watch for signs of stabilization, or better yet, reversal on the day. If that were to happen, expect that the rotation back into cyclical sectors will continue and stock prices to continue to grind higher.

I was partly right. Gold appears to be turning around here, though it is more correlated with the safety trade than the risk trade. The chart of GLD below shows a constructive bottoming process, with overhead resistance at about the 150 level.

On the other hand, the rotation into deep cyclicals hasn’t fully developed yet. Consider copper as an example. The red metal has rallied through a downtrend and seems to be consolidating sideways. 

Other industrial metals remain in a downtrend, though.

And oil prices, as measured by Brent global oil price benchmark, are still in a downtrend and has not participated yet in a commodity upswing.

Though natural gas seems to march to beat of its own drummer as it staged an upside breakout, driven by positive fundamentals.

I remain constructive on the rotation into the deep cyclicals. Despite the market’s freakout over Bernanke’s off the cuff remarks* about the possibility that the pace of QE might be tapered, followed by a poor HSBC manufacturing PMI out of China and Japanese stocks cratering by 7% (though they are recovering as I write these words), the technicals for the cyclical trade looks intact.   Consider this relative performance chart of the Morgan Stanley Cyclical Index (CYC) against the market. These stocks held up well in light of the mini-panic over the last couple of days.

Joe Fahny wrote that he is seeing very jittery traders and signs of panic, which suggests to me that any pullback is likely to be short-lived: 

Today is May 22, 2013. The general market declined by less than 1% (0.82% to be exact) and my phone has been blowing up with panic by people who are IN the market!!! My trading friends are either calling or texting me with serious worry, and even a few stories of mini “blow-ups” today. I’ve never seen anything like this in my 17 year career! God help these people when (not if) we get a serious correction.

As well, Barry Ritholz pointed out this piece of analysis from Jeff deGraaf [emphasis added]:

Jeff deGraaf, technician extraordinaire (formerly of Lehman now at Renaissance Macro Research) makes an interesting observation about the heavily overbought markets.

Last week, the S&P500 had ~93% of all stocks trading over their 200 day moving average. Normally, this degree of overbought should lead to a correction. As you can see in the inset box, it sometimes does. 

However, if you are looking out a year, we see that over the past 3 instances, markets have been higher.

Is the market overbought? Yes. But these conditions constitute what my former Merrill Lynch colleague Walter Murphy termed a “good overbought” condition.

I am inclined to give the bull case the benefit of the doubt for now, though I am maintaining a risk control discipline of tight and trailing stops.

* Paul Volcker once remarked that as Fed Chairman, he was so guarded about his public remarks that if he went to a restaurant, he would say, “I’ll have the steak, but that doesn’t mean that I don’t like the chicken or the lobster.”

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Commodities poised to rally?


Author Cam Hui

Posted: 21 May 2013

Much has been made of the upside technical breakout experienced by the US Dollar last week, but when I dissect the components of USD strength, I found that much of the breakout was attributable to Yen weakness. In fact, the other components of USD are all testing support, which suggests that the euro and commodities are poised to rally here.

At first glance, the USD breakout looks impressive, especially on the weekly chart:

Now consider how weak the JPYUSD has been:

Now consider the EURUSD rate, which is testing technical support:

The commodity weakness story is well known. Disappointment over Chinese growth has been a principal driver, but the flip side of that coin has been USD strength. The commodity sensitive Aussie Dollar is also testing a key technical support zone:

So is its cousin, the Canadian Dollar.

In fact, if you were to consider the EURAUD cross as a measure of the strength of Europe, the euro is turning up against the commodity sensitive Aussie Dollar as it has staged an upside breakout through a resistance level. Viewed in that context, is the euro that weak or is it just weak against the USD?

As I have shown, most of the other components of the USD Index other than the Yen are sitting on technical support. I also wrote to watch for the re-test of the recent bottom in gold as a clue to market direction (see The golden canary in the coalmine). As the chart below shows, GLD hit that technical re-test level on Friday and the silver/gold ratio is stabilizing indicating that most of the blind panic selling of gold is over.

All of these conditions are lining up to suggest that commodities are poised to rebound. The euro, commodity sensitive currencies and gold are all at key technical support levels. As I write these words, precious metal prices are substantially in the red. Watch for signs of stabilization, or better yet, reversal on the day. If that were to happen, expect that the rotation back into cyclical sectors will continue and stock prices to continue to grind higher.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Upside breakouts everywhere


Author Cam Hui

Posted: 16 May 2013

As the major US averages grind to more new highs, I am seeing signs of confirmed upside breakouts everywhere. Consider, for example, this relative performance chart of SPY against IEF, which is the ETF for 10-year Treasuries. The ratio staged an upside breakout on the weekly chart, with relative resistance a some distance away indicating considerable upside potential for stocks.

Across the Atlantic, the FTSE 100 staged an upside breakout:

The same could be said of large cap eurozone stocks, as represented by the Euro STOXX 50:

And then there’s Greece. Yes, remember that Greece? The Greece whose rating that Fitch recently upgraded.

The European markets are healing, as the WSJ reports even Greek companies are now tapping the bond markets for financing:

Greek commercial refrigeration and glass bottle producer Frigoglass’s debut bond sale is the latest sign investors are growing more optimistic about Greece, the company’s chief executive said in an interview with Dow Jones Newswires Tuesday.

Frigoglass Monday sold a €250 million ($324.3 million) five-year bond–the second debt sale from a Greek company in as many weeks as the country’s corporate bond market emerges from a deep freeze.

The risk-on mood was also reflected in this account of Slovenia’s successful bond financing, after Moody’s downgraded the country to junk after its roadshow:

Then the big day came – books reopened, bids were even stronger than during the first attempt and Slovenia sold 3.5bn worth of 5 and 10y bonds. On Friday, the new Sloven23s traded up by more than 4 points, which means yield fell by more than 50bp from the 6% the government paid. A fairy tale ending.

Key risks
Though momentum is positive for stocks in most developed markets, it isn’t necessarily all clear sailing ahead. My biggest concern is that China and China related plays look punk. Here is the Shanghai Composite in a well defined downtrend:

Industrial commodities are also exhibiting a similar downtrend pattern:

The AUDCAD currency cross, where Australia is more China sensitive and Canada more US sensitive, looks downright ugly.

In the US, Ed Yardeni pointed out that forward Street consensus earnings growth is showing signs of stalling. While this isn’t a bearish signal yet, it does bear watching. Should forward estimates growth turn negative, it would create considerable headwinds for equities.

My takeaway from the current environment of powerful stock momentum is, “It’s ok to get long, but don’t forget to look over your shoulder and maintain a tight risk control discipline.”

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The golden canary in the coalmine


Author Cam Hui

Posted: 14 May 2013

Shortly after the market closed, the WSJ published Jon Hilsenrath’s article Fed Maps Exit From Stimulus in which the Fed discusses a gradual withdrawal of QE:

Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy—an effort to preserve flexibility and manage highly unpredictable market expectations.

No doubt the markets will get spooked by this “leak” and as I write these words, ES futures are moderately in the red. The question is, “How much and how far?”

Watch gold for clues to market direction
For me, the canary in the coalmine is the gold price, which is highly sensitive to expectations of monetary stimulus. Gold has staged a tactical V-shaped bottom and the silver/gold ratio has stabilized, which is constructive (see Watching silver for the bottom in gold). Gold rallied to fill in the gap left by its free fall in April – so now what?

With the news that the Fed is starting to think about an exit from QE, the near term downside risk is evident. There are many opinions about the fallout of this “leak”. Josh Brown has two sides of the story. On one hand, he believes that with sentiment excessively bullish, we aretactically headed for a hard correction. On the other hand, he seems more relaxed longer term.

As for myself, I am watching for a re-test of the April lows in gold to see if that low can hold as a sign for the risk-on trade. Longer term, the April decline caused considerable short-term technical damage, but the long-term uptrend remains intact. The other key issue is whether the uptrend can hold here.

A Lost Decade or a “beautiful deleveraging”?
Will this Fed action be a repeat of the Japanese experience where the authorities go through ease-tighten cycles that caused ups and downs in stock prices? This will be a test of Ray Dalio’s beautiful deleveraging thesis where the United States has undertaken just the right mix of austerity, money printing and debt restructuring.

David Merkel wrote a timely post recently entitled Easy In, Hard Out (updated):

My view is that there is no such thing as a free lunch, not even for governments or central banks.  Any action taken may have benefits, but also imposes costs, even if those costs are imposed upon others.  So it is for the Fed.  At the beginning of 2008, they had a small, clean, low duration (less than three years) balance sheet on assets.  Today the asset side of their balance sheet is much larger, long duration (over 6 years), negatively convex, and modestly dirty as a result.

He went on to outline the risks [emphasis added]:

Fed tightening cycles often start with a small explosion where short-dated financing for thinly capitalized speculators evaporates, because of the anticipation of higher financing rates. Fed tightening cycles often end with a large explosion, where a large levered asset class that was better financed, was not financed well-enough. Think of commercial property in 1989, the stock market in 2000 (particularly the NASDAQ), or housing/banks in 2008. And yet, that is part of what Fed policy is supposed to do: reveal parts of the economy that are running too hot, so that capital can flow from misallocated areas to areas that are more sound. At present, my suspicion is that we still have more trouble to come in banking sector. Here’s why:

We’ve just been through 4.5 years of Fed funds / Interest on reserves being below 0.5% — this is a far greater period of loose policy than that of 1992-1993 and 2002 to mid-2004 together, and there is no apparent end in sight. This is why I believe that any removal of policy accommodation will prove very difficult. The greater the amount of policy accommodation, the greater the difficulties of removal. Watch the fireworks, if/when they try to remove it. And while you have the opportunity now, take some risk off the table.

Zero Hedge put it more forcefully:

It is possible a steep decline in financial assets would ensue with the lowest part of the capital structure being hurt the most. TheFed has chased investors all in the same direction; into risk-seeking securities. Few care about “right-tail” events, but should investors decide to pare risk in reaction to a hint of ‘tapering’, the overshoot to the downside may surprise many. The combination of too many sellers, too few buyers, and dreadful (and declining) liquidity means a down-side overshoot is highly likely. It would provide the Fed with their answer as to whether they have been creating market bubbles.

It appears that the Federal Reserve is well aware of these risks. In a speech last week, Ben Bernanke said that the Fed was closely monitoring the market for signs of excessive risk appetite, such as reaching for yield [emphasis added]:

We use a variety of models and methods; for example, we use empirical models of default risk and risk premiums to analyze credit spreads in corporate bond markets. These assessments are complemented by other information, including measures of volumes, liquidity, and market functioning, as well as intelligence gleaned from market participants and outside analysts. In light of the current low interest rate environment, we are watching particularly closely for instances of “reaching for yield” and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals. It is worth emphasizing that looking for historically unusual patterns or relationships in asset prices can be useful even if you believe that asset markets are generally efficient in setting prices. For the purpose of safeguarding financial stability, we are less concerned about whether a given asset price is justified in some average sense than in the possibility of a sharp move.

The Fed being aware of a problem is the first step. Whether they can either react, either preemptively or after the fact, in the correct manner is another problem.

I prefer to watch the golden canary in the coalmine to see how the markets react, or over-react to the news that the Fed is mapping out a plan to gradually withdraw from quantitative easing.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Commodity weakness is likely localized


Author Cam Hui

Posted: 25 Apr 2013

The old Cam would have been freaking out. The first version of my Inflation-Deflation Trend Allocation Model depended solely on commodity prices as the canaries in the coalmine of global growth and inflationary expectations. The chart below of the equal-weighte Continuous Commodity Index is in a well-defined downtrend. The weakness isn’t just restricted to gold, but other commodities like oil and copper are all falling.

However, we found with further research that adding global stock prices to commodity prices as indicators gave us a better signal, in addition to giving us a more stable signal.

Equities not confirming weakness
The three axis of global growth are the US, Europe and China. I am finding that signals from all three regions are not really confirming the signals of weakness given by falling commodity prices. Consider, for example, Caterpillar’s earnings report yesterday. The company, which is a cyclically sensitive bellwether, reported punk sales, earnings before the opening bell and revised their outlook downwards [emphasis added]:

We have revised our outlook for 2013 to reflect sales and revenues in a range of $57 to $61 billion, with profit per share of about $7.00 at the middle of the sales and revenues outlook range. The previous outlook for 2013 sales and revenues was a range of $60 to $68 billion and profit per share of $7.00 to $9.00.

“What’s happening in our business and in the economy overall is a mixed picture. Conditions in the world economy seem relatively stable, and we continue to expect slow growth in 2013,” said Oberhelman.

“As we began 2013, we were concerned about economic growth in the United States and China and are pleased with the relative stability we have seen so far this year. In the United States, we are encouraged by progress so far and are becoming more optimistic on the housing sector in particular. In China, first quarter economic growth was slightly less than many expected, but in our view, remains consistent with slow growth in the world economy. In fact, our sales in China were higher in the first quarter of 2013 than they were in the first quarter of 2012, and machine inventories in China have declined substantially from a year ago,” said Oberhelman.

“We have three large segments: Construction Industries; Power Systems; and Resource Industries, which is mostly mining.While expectations for Construction Industriesand Power Systems are similar to our previous outlook, our expectations for mining have decreased significantly. Our revised 2013 outlook reflects a sales decline of about 50 percent from 2012 for traditional Cat machines used in mining and a decline of about 15 percent for sales of machines from our Bucyrus acquisition,” said Oberhelman.

In other words, CAT remains upbeat on US housing. China is weak-ish and mining is in the tank. It seems that much of this negative outlook has been discounted by the market. While the stock fell initially, it rallied to finish positively on the day on heavy volume.

For now, the US economy look OK. I agree with New Deal Democrat when he characterized the high frequency economic releases as “lukewarm”. We are not seeing gangbusters growth, but there is no indication that the economy is keeling over into recession either. The preliminary scorecard from the current Earnings Season is telling a similar story. The earnings beat rate is roughly in line with the historical average, although the sales beat rate has been somewhat disappointing.

Risk appetite rising in Europe
Across the Atlantic, Europe is mired in recession. However, there is little sign that tail-risk is rising. I have been watching the relative performance of the peripheral markets in the last few days as stocks have weakened. To my surprise, European peripheral markets have been outperforming core Europe, indicating that risk appetite is rising. Here is the relative performance of Greece against the Euro STOXX 50:

Here is Italy:

…and Spain:

Well, you get the idea.

Weakness in China?
What about China? Chinese growth has been a little bit below expectations, such as the March Flash PMI released overnight. Shouldn’t weakness in Chinese infrastructure growth would be negative for commodity prices? Isn’t that what the commodity price decline is signaling?

Well, sort of. Maybe. We have seen a great deal of financialization of commodities as an asset class. An alternate explanation of commodity weakness is the unwind of the long positions of financial players . Indeed, analysis from Mary Ann Bartels of BoAML shows that large speculators have moved from a net long to a net short position in the components of the CRB Index:

One key gauge I watch of Chinese demand is the Australian/Canadian Dollar cross rate. Both countries are similar in size and both are commodity producers. Australia is more sensitive to Chines growth while Canada is more sensitive to American growth. As the chart below shows, the AUDCAD cross remains in an uptrend in favor of the Aussie Dollar, though it is testing a support region.

In conclusion, the preliminary verdict from the market is that commodity weakness is localized – for now. Barring further weakness in commodity prices and the other indicators that I mentioned, the implication is that US stock market action will be choppy because of the uncertainty caused by commodity weakness and Earnings Season, but any downside will be limited. As the point and figure chart of the SPX below shows, the S+P 500 remains in an uptrend and I am inclined to give the bull case the benefit of the doubt for now.

So relax and chill out.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. 

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Something’s not right about this rally


Author Cam Hui

Posted: 2 Apr 2013

OK, so the SPX made a new high. Many of my momentum models are bullish, but my relative strength work (see my previous post on combining momentum with trend following techniques) is making me scratch my head.

To explain, my work based on a paper by a team of researchers at Cass Business School entitled The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation suggests that when the market is experiencing an uptrend, you should go for broke and buy the “hot” sectors of the day. On the other hand, when the market is falling, buying the “hot” sectors is a recipe for disaster.

A risk friendly market trend
First of all, my trend following and momentum models is pointing to a risk-on market. Consider the relative returns of SPY (stocks) against IEF (7-10 year Treasuries) below. Unquestionably, we are seeing an uptrend in the risk trade:

The risk-on trade isn’t just restricted to stocks vs. bonds. The same effect could be seen in the credit market, where junk bonds are outperforming:

Defensive leadership
Here is what’s bothering me. We are obviously seeing an uptrend in the stock market, as evidenced by the new highs. However, sector leadership is gradually shifting away cyclical sectors to defensive sectors and industries. Take a look at what the leadership is today.

The chart below shows the relative returns of Financials (XLF) against the market (SPY). Financials are in a well-defined relative uptrend against the market.

Here are the Transportation stocks, which is a small cyclically oriented industry. These stocks are also in a well-defined relative uptrend.

OK. So far so good. Now here comes the surprises. Look at the relative strength in Healthcare:

…and the turnaround in the relative strength of Utilities:

Commodity cyclicals lagging
I have written that cyclical sectors are displaying a pattern of relative sideways consolidation after an uptrend (see An uncomfortable bull). I won’t repeat myself, but you can click on the link and see the charts there.

What’s bothering me is that commodity related sectors are lagging badly. Consider the equal-weighted Continuous Commodity Index, which is in a minor downtrend. Though it doesn’t seem disastrous and commodity prices have firmed somewhat in the past three weeks, the price action of the commodity complex is not exactly signaling a robust global recovery.

On the other hand, the price action of industrial metals look downright ugly.

Here are some price relative charts of commodity sensitive stock markets against ACWI, or the MSCI All-Country World Index. Australia looks ok, but it’s the exception.

Canada, on the other hand, is in a relative downtrend and has been underperforming since last November.

Here is Brazil. Enough said here:

Here is the relative chart of South Africa (in black), though its relative performance may be linked to the relative performance of gold stocks (in orange):

The relative performance of the cyclically sensitive South Korean market is not exactly inspiring either. South Korea remains in a relative downtrend, though it has staged a relative rally in the last week or so.

What’s going on?
Frankly, I am puzzled by the nature of the sector leadership when the market is making new highs. My momentum and trend following models are telling to stay long. My relative strength models are telling me to rotate into defensive sectors like Utilities and Healthcare. When I net this all out, I wind up in a fairly neutral position.

Something’s not right about this rally. Mohamed El-Arian of Pimco pretty much said the same thing when he indicated that the Markets are sending unusual signals [emphasis added]:

The rally reflects slowly-improving economic conditions, relatively robust corporate profitability and anticipation of stronger domestic and foreign inflows into the equity market. Yet this is far from the whole story.

Investors need only look at where some other benchmarks ended the quarter to get a feel for the unprecedented and artificial nature of today’s capital markets.

Few would have predicted that the impressive equity performance would be accompanied by a 10-year U.S. Treasury rate as low as 1.85 percent, a 10-year German government bond (bund) rate as low as 1.29 percent and gold as high as $1,596 an ounce. Think of this as the markets’ way to signal to investors some key issues for the quarters ahead.

More on this topic in subsequent posts.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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