Greenback recovers as risk reverses

As futures traders, you'll undoubtedly not like reading this one but with the Chinese Cen-Bankers in tightening mode, it'll very likely unfold similarly to the experience endured under Volcker as Reagan was taking office. During the period in question US rates skyrocketed to 20% prime.

Note that I'm not suggesting a re-occurance in either the US or China but on the other hand, after the Hunt Bros. bubble burst, I firmly believed I'd never live to see Gold at 850 again either... Two differences in this instance occur to me... 1st - the Chi-Coms won't be nearly so drastic as Volcker because they won't want to destroy their first REAL economic primacy. 2nd - as our rates will remain low almost indefinitely, futures cost-of-carry (as evinced by contango) won't expand accordingly, and might even shrink. Thus, we'll probably only experience an acceptible drop off in commodities supply/demand imbalances. Still, the wild upside ride seen recently should ameliorate. I've been around long enough to have learned (the HARD way) not to make long-term predictions in critically event-driven markets. Nevertheless, all else being equal, this seems a logical argument for the moment. The US Dollar recovers as risk reverses Despite fears of its imminent demise post-QE2, the USD staged a healthy rebound this past week, aided in part by EUR weakness. To be sure, the bulk of USD strength was seen against the European single currency, as peripheral sovereign debt concerns flared up again (more below), but the buck gained ground against the JPY, too, on the back of higher US Treasury rates. QE2 wasn't supposed to work like this; the USD was supposed to go down and Treasury yields were supposed to fall. But the exact opposite has happened, suggesting that extreme one-sided positioning played a role. While position adjustments are typically of a short duration (e.g. a couple weeks), we think this may end up being a more significant shift in market direction, likely lasting into year-end at the minimum. As we indicated last week, we see relative growth prospects as the horse pulling the cart (monetary policy) and leading currencies and here lies the basis for our view of further USD recovery potential. The commodity bubble is bursting After defying gravity for a few days as the USD recovered, commodity markets have fallen back to earth with a thud. Margin requirement increases, fears of Chinese rate hikes (more below), over-extended positioning, and the USD recovery were all contributing factors to the reversal. We would also note that commodities (rising) have been diverging from the Baltic Dry Index (falling), viewed as a proxy for global commodity demand, for the last two months at least. In commodities, too, we think there is further downside potential as global growth prospects are marked lower on weaker European, Japanese and potentially Chinese demand. We would also note that the G20 agreement to disagree will allow emerging nations to continue to pursue capital and possibly currency restrictions, likely slowing growth and undercutting demand in those countries. If the US dollar recovers further as expected, that should also weigh on commodity prices ahead. In gold, prices are closing just below the daily Kijun line at 1370, suggesting potential down to the cloud around 1310/15. Silver is closing above its 25.85 Kijun line, but the massive shooting star on the weekly candles suggests further weakness ahead. WTI crude oil is finishing out on a critical pivot at $84/85/bbl, and weakness below next week would suggest declines to $80/bbl and lower ahead. (click headline for full FUTURES MAGAZINE article) T. W. Merryman Managing Director Interconti, Limited (Market Research Analysts) Chicago, IL 60604 e: intercon@intercontilimited.com w: www.intercontilimited.com