09.10.2009
The third quarter of 2009 did not produce much excitement. The biggest surprise came from sugar prices which rocketed higher due to a large speculative interest. A quarter ago when we published the summary of the second quarter then we wrote that the third quarter would be uninteresting with most of the traders on vacation and therefore low volatility. This is exactly what happened.
The following prices rose during the third quarter: SP500 stock index, US 10 note and 30 year bond, copper, gold, silver, sugar, cotton, coffee, cocoa, Japanese yen, euro, Canadian and Australian dollar.
The decliners were as follows: crude oil, natural gas, US dollar, British pound, soybeans, corn, wheat and others.
Besides the rapid movement of sugar prices third quarter was a real test for traders as price movements were limited and therefore you had to look for good opportunities patiently. The second half of July and most of August are historically low volume and low volatility trading months as most of the traders are on holidays and market liquidity is simply nonexistent.
During these low volatility times the greatest danger comes from increased trading volumes as price movements are limited and therefore many increase position limits. We did not take this path and preferred to stay conservative. This proved to be the right way. Those who did not stay conservative most likely gambled with natural gas and sugar which lead them to losses. In regards to these specific instruments we stayed prudent and considered mostly risks not potential profits. This proved to be the right decision to make.
During the third quarter we mostly traded the following instruments: gold, crude oil, euro, British pound, Japanese yen, coffee, sugar, soybeans, cocoa and others. Sugar surprised the market and after the price moved outside of regular boundaries we stopped trading the sugar futures.
The surge in sugar prices took place due to extreme weather conditions in Brazil (very rainy) and India (dryness). Nevertheless when time passed so did improve the conditions both in Brazil and India. One of the other factors was the unusually massive speculative interest in sugar futures. During the current year we have seen the same short-term madness with soubeans, cocoa, cotton and coffee. At the end of the third quarter speculants found themselves a new victim in the form of gold which saw also a massive inflow of speculative funds. In regards to sugar we expect the next quarters (until March) to be quite volatile. We prefer to trade sugar very conservatively.
What to say about crude oil? Crude oil is floating above 70 dollars a barrel only because of a potential military action against Iran by US and its allies. Options market tells us every single day that market participants are nervous and are therefore buying call options with any price available. Soon the best possible time for a military strike in terms of weather conditions arrives. We suggest to stay cautious.
During september gold was undoubtedly the most attractive trading instrument with high volatility present. Major drivers for gold's surge have been the decling US dollar, inflow of funds into gold futures and inflation worries. We do not consider it likely that we will see inflationary pressures during upcoming quarters and have therefore traded gold futures quite actively. Nevertheless one should consider his risks extremely carefully when trading gold futures.
One of our favorite groups among trading instruments is grains. During the third quarter grains have historically shown low volatility. However, we expect some good trading situations to emerge in the fourth quarter.
Among currencies Japanese yen, Canadian and Australian dollar presented some good trading opportunities in the third quarter. Currencies end the year usually quite wildly so we could get a few good moments. Aussi and loonie will stay volatile but they should be traded with risks in mind.
We will be sellers of US treasury futures should they move dramatically higher. Our interest to sell treasuries will not end any time soon. Even at current levels treasury yields are too low when one considers the fact that Fed will end its program pretty soon. Further market interest can be obtained only by higher yields. Yields will therefore most likely rise unless dollar starts to appreciate fast.
The world has changed and we are on the verge of new radical changes. During the quarter we often wrote that normal market mechanics and logic has stopped working and global financial markets have become nervous. We cannot change the fact that americans have stopped consuming and therefore global economy is suffering. For many decades the world produced and americans consumed. With the proceeds the world bought US debt which meant that money flew once again toward consuming. This cycle has now seen its end.
Americans have turned to saving and no longer consume. With this the world has ran into a serious problem as the global growth engine does not get enough fuel as we see lower consumption everywhere. It seems that human beings are built to think that stock prices, real estate value, GDP and individuals life standard must only move higher. The sooner an individual and a country realizes that this is not the case the better. We must stop believing in and living by this illusion.
Something happened when Chinese economy started to grow substantially faster than before and China became a part of world economic picture. China understandably helped to boost global economic growth. The economies of developed countries started to grow too fast. The developing countries became developed countries too fast. Every single person became too greedy to obtain even more wealth. Today it is clear that the global prosperity in the year 2006 and 2007 was just an illusion. It should never have taken place, not during current decade.
Americans are in a lose-lose situation today. In order to avoid social collisions and drops in political ratings government has to support the economy with enourmous stimulus packages. They are in a mission of recreating the illusion that was never supposed to exist. For a long time Americans lived in a fairy-tale where real estate prices ONLY rise and one could consume and live just on the proceeds of real estate appreciation. This fairy-tale has ended.
Despite the fact that the fairy-tale ended the government and the Fed are actively printing new dollars to recreate the fairy-tale. This crusade will soon most likely generate a new chaos. With the new dollars that the Fed is printing it buys treasuries and therefore increases the monetary base which in the medium-term decreases the buying power of the US dollar. It is quite likely that foreign investors will soon stop buying US treasuries as the decline of the dollar will eat into yields and more. When we reach this turning point then we will most likely see a new financial crisis. We are ready for this but many or even most are not. Somehow people have a perception already today that a new wave of economic growth has begun and one can once again earn risk-free profits on the stock market. These people are extremely wrong.
Dramatically high unemployment rate, decreasing lending on behalf of banks, increasing government debt, deflation/inflation fear and a rotation from consuming to saving will have a negative effect on the economy for years to come. This is the new normal.
We are walking towards the new quarter with self-confidence and conservatism. In regards to our investment activities we are prepared for a war in Iran, inflation or deflation, dollar-panic and other possible events that these events can trigger and more. We are living at complicated times and we have to act accordingly.