Saturday, June 4, 2011

Market Dynamics and delveraging

On Friday, we continued the sell-off in risk assets. Commodities, Equities and most High Yield bonds continued their weakness...the fly in the ointment, and in our markets there always seems to be one, are the EURO and the Dollar Index. The usual correlation is that smartly down markets are accompanied by a smartly up Dollar. The trouble is that markets rife with over leverage and malinvestment funded by Fed QE and other programs causes dislocations to normal correlations. It has happened a lot in our markets. So, here we are again., and many market particiapants are getting hosed in their long risk assets (equity and commodity) plays. A recent popular trade has been short Euro due to all the chaos over in the EU of late. Well, wouldn't you know it, people have no buying power left after the drubbing in risk assets, and their participation in highly leveraged Forex and commodities trades. So, they get hosed and are forcibly extracted from those trades, especially the ones with the largest volatility, risk of continued loss and with the greatest current loss. So, there we have it, people are over-leveraged and forced to deleverage.

Ironically, the reality is that the risk-off trade has a long way to go and that will further reduce the amount of dollars available with which to purchase all assets, which in turn will generate a strongly rising dollar and weak "risk-on" trade. The funny thing about this market is that if you trade arb or correlations to lower your risk, you are ironically doing the opposite - you are increasing your risk without the reward being in proper relation to said risk. People are blowing up everywhere and I expect it to continue. I also expect that Euro longs will have a VERY tough time of it once its deleveraging is complete.

Additionally, on the fundamental side, the ECB and the troika has come up with another harebrained plan to kick the can down the road on the same variation as attempting to put out an oil fire with more oil. The Greek public stand little chance of going a long with it and, therefore, any agreements between current government officials, large banks, the EU, ECB and individual euro union members have little chance of performing, letalone being consummated - try as they might. Throw in general market structure for the debt money system and you don't get a pretty picture. The EURO is dead just as the debt currency system is dying.

On a purely technical note, I am about to get a confirmed reversal trigger on the dollar and also one on the EURO. These are usually highly reliable. So, unless the euro rallies very hard from here and the dollar falls hard from here...odds are not good for continuation of the current retracements turning into trends. To understand the reliability of these triggers, I posted about them related to a reversal in risk assets early in the week and they played out perfectly. Now, we are waiting on the dollar and the EURO.
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