March 6. Commodity Resurgence

First, a quick overview of the state of the market. Most interest rate futures closed at their lowest levels since early February as stocks continue to rebound and the non-farm payroll report showed sturdy employment growth. Reuters pointed out that many gains were in lower wage occupations: “Retail payrolls increased 54,900 adding to the 62,100 positions created in January. Leisure and hospitality jobs rose 48,000, with employment at restaurants and bars increasing by 40,200.” I don’t quite understand how retail employment is doing so well, given relentless reports of store closings like Sports Authority, Staples, etc. But I guess I can grasp the need for more bartenders. In any case, the job picture is improving.

The larger overview has to take into account the turnaround in many commodity markets. For example, the Bloomberg Commodity Index closed essentially at the high of the year. Lumber, copper, gold, oil, coal…all have had powerful rallies.  Mining shares have surged. Iron ore is up over 40% from the December low! Not only that, but there has been a significant change in the WTI curve. As an example, consider the spread between June 2016 and June 2017 Crude (CLM16 to CLM17). In mid-February, the near contract was at a discount of $7.22, as of Friday it had narrowed to $4.72, an indication that the market is coming more into balance. (More on this below).

Not surprisingly, the US curve is responding to these signals (to some degree). Near Eurodollar spreads rose to new highs Friday. For example, EDM16/EDM17 one-year calendar settled 29.5, fully 20 bps above the February 11 low of 9.5. In my morning note of March 2, I mentioned early signs of a turn, with high yield junk funds seeing strong closes on inflows, stabilization in crude oil, and a widening of the ten year treasury to tip (inflation indexed note) spread to a new recent high. This spread closed 153 on Friday, over 30 bps higher than the Feb 11 close. Treasury vol is near the lowest of the year, an indication that fears of a commodity/oil driven panic that spills over into stocks has significantly abated.

There is one LARGE caveat to this picture however, and that is weakness in financial shares. While the SPX has rallied just over the 0.618 retracement from the Nov high to Feb low (2116 to 1810; 0.618 ~2000), the major financials have badly lagged. JPM, WFC and USB are around the 50% retracement, but GS, C, BAC and AXP have recovered only to the 0.382 Fibonacci retracement or less. Large foreign banks look even worse. The Fed’s new proposals to limit counterparty exposure, not to mention Kashkari’s big bank break-up plans, will likely continue to weigh on the financial sector. Another related concern is that Moody’s “Oil and Gas Liquidity Stress Index” measuring companies facing credit problems, hit a new high of 27.2 compared to a peak of 24.5 in the last recession.

In any case, consider the chart below, which is the Bloomberg Commodity Index in red vs the 2/10 treasury spread in white:

bcom v 2-10

The BCOM index is near the high of the year and through the high of early February, while 2/10 isn’t responding strongly…yet. This week brings auctions of 10’s and 30’s, which could support a steepening move.


Outside of the US, the ECB meeting is this week, and the euro is starting to reflect concerns that the central bank won’t be nearly aggressive enough to destroy its value (expecting a 10 bp cut in the depo rate and €10 billion new QE). EUR closed just above 110, right around the midpoint of the past year’s range.

China’s parliament meeting started this weekend, with growth shaved down to 6.5%. From Reuters, “… the draft goal of running a fiscal deficit equivalent to 3 percent of GDP, while up from the previous year’s target of 2.3 percent, still disappointed some who had hoped for a number closer to 4. “The budget deficit of 3 percent is not enough and should be increased,” economist and former central bank advisor Yu Yongding told Reuters on the sidelines of the meeting.”

In another heartwarming story about China, there’s this from Bloomberg: The Communist Party has directed one of the country’s largest state-run defense contractors, China Electronics Technology Group, to develop software to collate data on jobs, hobbies, consumption habits, and other behavior of ordinary citizens to predict terrorist acts before they occur. *link at bottom

I don’t typically include anything about politics, but one can’t escape the shifting global landscape. There were a couple of amusing posts on the Drudge Report. First, from the Washington Post, “Psychologists and massage therapists are reporting ‘Trump anxiety’ among clients, and are offering services to relieve this stress.” The second is from the Financial Times, noting that Jerry Springer is “stunned” by the republican race. Really? The man who has done more than anyone else in US history to find and celebrate the lowest common denominator is shocked? I’m sure there’s concern in DC. The median household income there is $69235. In similar sized metro areas, Atlanta’s is $46439 (67% of DC) and Denver’s is $51800 (75%). Well sure, if the money stops flowing because it can no longer buy influence, it can certainly provoke anxiety.

One more observation about oil and ETFs/ETNs. In mid-January, even as oil was rallying, the iPath ETN OIL was slammed lower, wiping out a premium to its net asset value.* On Friday, Blackrock suspended issuance of Gold Trust Shares (IAU) due to demand for gold (the fund has seen inflows every day in 2016, and trades at a premium to NAV). Gold soared to a new high. The world of ETFs can clearly distort markets. The USO (United States Oil Fund) owns anywhere from 20% to a third of the open interest in the front CL contract. (Currently has 112k CLJ6 vs 566k open).  It wasn’t too long after the OIL debacle that the extreme contango in the oil curve started to abate. I am not recommending any sort of trade strategy here, just a reminder that ETFs are the tail wagging the commodity dog.

Two more quick notes: First, from the Daily Mail, “Auctions held by Sotheby’s and Christie’s last month sold a collective $210million worth of art, representing a huge 45 per cent drop from the $381million sold at similar events the year before… Among those to be hit by the slump has been Christie’s International, which reported a five per cent decline in annual sales after five years of growth.”

Second, and this could have a profound effect of student debt going forward, and therefore on the economy: Northwestern University announced that “students who qualify for financial aid will no longer have to borrow to pay for their education.” * Could be a game changer if others follow suit; there’s over $1 trillion outstanding in student debt.


Trade thoughts

As alluded to above, I am inclined to buy the curve through options.  The fact is, however, that spreads have already had a decent move, and if the Fed shifts back into a more hawkish demeanor, then the dollar will likely again rally and the commodity resurgence would fizzle. In other words, I view the commodity rally as being a bounce from deeply oversold territory (for now). Central bank manipulations of currencies can have a big impact on commodities priced in dollars.

Last week I mentioned this: With EDU6/EDZ6 at 4.5, I like buying EDU/EDZ 9900 put calendar at 6.0 (settled 6.25). I think the market should be more inclined to price hikes into the beginning of 2017 rather than just prior to the election. [Friday 3-March settles, EDU6 9900p 4.5 and EDZ6 9900p 12.25 so 7.25s, up 1 bp]   I still favor this sort of trade.

I also mentioned the following ideas: All euro$ calendar spreads are “cheap”. The question is, how do you hedge if you’re wrong? For example, last Thursday EDU’16/EDU’17 settled at just 13 bps (and settled 16 on Friday).   One way is to buy calls in Greens. For example, pay 16 or less in EDU’16/EDU’17 and pay 3.0 for Green April 9925 calls (settled 3.25, 16 delta), ref 9886.5. The thought is that the green calls will provide at least some offset if spreads don’t widen. [EDU’16/17 settled 28.5 and 2EJ 9925c settled 1.0, so up 10.5]



2/26/2016 3/4/2016 chg
UST 2Y 79.7 87.0 7.3
UST 5Y 124.0 138.1 14.1
UST 10Y 176.4 187.9 11.5
UST 30Y 263.5 270.3 6.8
GERM 2Y -54.7 -54.0 0.7
GERM 10Y 14.7 23.8 9.1
EURO$ M6/M7 15.5 29.5 14.0
EURO$ M7/M8 23.5 29.0 5.5
EUR 109.33 110.06 0.73
CRUDE (1st cont) 32.78 35.92 3.14
SPX 1948.05 1999.99 51.94
VIX 19.81 16.86 -2.95


Below are supporting links and other interesting snippets:

Posted on March 6, 2016 at 6:44 am by alexmanzara · Permalink
In: Eurodollar Options

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