Passing the pink flamingo

Friday, May 09, 2008

Recent market price action has started to remind Macro Man of an episode from his distant youth, nearly 30 years ago. People did strange things in the 1970's, and he remembers a "game" played by various households in his neighbourhood in what must have been 1979 or so. One family bought a pink lawn flamingo, such as that pictured to the left, and stuck in the lawn of a neighbour. There followed several months of "pass the parcel", wherein the flamingo would magically appear on the front lawn of a different house every few days or so.

And it seems to have been for macro thematic trades, where the "pink flamingo" of position unwinding has been passed from market to market. First the equity and cerdit shorts got squeezed. Then the curve steepeners got flattened, followed by a vicious squeeze in USD/JPY. The front end strips got whacked as basis blew out, taking bond markets lower generally. Recently, the sacred cow of short USD/Asia has been taken behind the woodshed for a beating.

So the question has for his market compadre readers is this: what's the next pink flamingo, if any? Where are the remaining high conviction, deeply-positioned trades that might get washed out by the hand of fate (and/or the tap on the shoulder from the market risk manager?) He's struggling to come up with many more that are out there. Indeed, some erstwhile favourites seem to be getting traction again; yield curves are steepening, and yesterday's price action in Bunds (a strong rally that appeared to shatter trendline resistance) wasn't justified by Trichet's comments.
So Macro Man wants to know: are there any more pink flamingos out there, or is time to do the Electric Slide on the macro dance floor?

Posted by Macro Man at 9:45 AM  

28 comments:

long international small caps, short macro fund hedge funds

prophets said...
10:57 AM  

There seems to be a flight from Latin American currencies and asset's at the present time.

Banker said...
12:34 PM  

my vote is crude oil, and the pink flamingo has yet to be spotted on the Nymex floor.

Anonymous said...
1:08 PM  

Commodities baby !

Nil

Anonymous said...
1:21 PM  

Yeah, I though the flamingo was lurking in commodity-land...but the bets I made on that basis have, ahem, "underperformed".

Macro Man said...
1:26 PM  

The non-sequitir that hasn't been washed out yet, is mining and energy in all their forms for this is deemed fundamental. There are no limits or tethers, no apparent substitution effects, and no elasticity of demand (so say proponents).

After all voracious BRIC growth (did ya see Indian car sales last month?) will not be so easily deterred as by a mere US slowdown, or backslide in UK or Spanish real estate prices, right?

My friends also tell me its fundamentals, and not speculative excess. I see the logic in the peak oil and fundamental supply-demand arguments based on backwards looking data. And I too am seduced. Yet I see Potash stock turning over USS$3,000,000,000 per day in the USA alone (maybe half again in Toronto) with too-numerous 5 & 10% daily moves, , and Cliffs turning over more than billion, and I ask myself what does it mean and is there a speculative feedback loop here?

The thing is I think we'll see $200 oil, and $500 oil after that. And maybe by then, what's under the ground will be seized by The State on behalf of the People in a fundamental rethink about where property rights end and the perceived National Interest begins. Until a new energy paradigm is discovered and embraced - be it new source or parsimony in use - , things will be rough.

But will it be a straight-line, for between now and then, there is the little chestnut of tactical flamingo positioning, and let there be no mistake: there IS mondo leverage and transitory speculative postioning in these trades, which is why during each deleveraging episode as far back as 2005, when the foot looked like we might slip towards recession, this complex got whacked large. In each pullback, the stocks find new buyers who are shortly joined by the old ones when the the world doesn't end, and who jump back on and in the process take them parabolically upwards in ever-shorter periods, each time a little more in excess of earnings and beyond prior historical cycical comparables, justified by it being a brave new BRIC world. The keystone of the belief: even in a US & EU recession, the market in this complex won't wash out.

All which brings us right back to the decoupling argument, the severity of US recession and its eventual impact upon the mercantile nations sucking up commodities and devouring energy to manufacture for us things that, upon close scrutiny, we probably don't need and by trade account measures, we can barely if at all afford.

I think this will be a severe recession. The world will not decouple. Resource use and with it, commodity price inflation, will ameliorate, it will feel like shit, and its anybody's guess where energy and commodity prices correct to when the late pukers finally throw in their speculative towel.

"Gillies", pithily predicted yesterday, over at Setser's board:

"...if/when oil gets to $40/barrel again, everyone will be wishing it was back at $200 . . ."

-C-

Anonymous said...
1:26 PM  

Never say never...but I think we will never see $40 oil again. "Recession" in a place like China means 5-6% growth. Some of the numbers on Chinese oil import projections are scary, and it is in those circumstances that peak-ish oil could result in the $500/bbl oil that you cite.

While I concur that there is a fair amount of spec/investment flow into commodities/oil, some of it will, I think, be pretty sticky- from pension funds and the like.

The people who know more about oil than I ever will seem to think that downside is now limited to $90 or even $100. While a bum-clenching recession could easily mean a breach of those levels, the economics of that industry have changed so much over the last few years that the 'bum clencher' floor hsa risen substantially.

Macro Man said...
1:54 PM  

Silver has largely been supported by speculative buying, particularly buying by ETF's. As GLD has seen outflows following the recent reversal, SLV buying has held up and even increased. Now this could be due to traders using SLV to go long because of the high premiums due to actual delivery, but consider the following:

Underlying supply and demand in 2007, prior to inventory or investment adjustments, was a surplus of 806 tonnnes. ETF's absorbed about 1,600 tonnes though. If we see any capitulation in this investment demand I think we could have the next flamingo on our hands. And a lot of this demand is tied to what is going on in gold, and I think from previous posts we know how MM is seeing gold.

Ryan said...
2:48 PM  

The interplay between leverage and commodities and structural SNAFUs can cause all manner of unforseen mayhem. in 05 and 06, there was an apparent arb: buy the GOM producers and short oil. IN fact, why not take them private against an oil hedge? Now, aside from the hedge being enormous, imagine the variation margin on the move from 50 to 125 on 5 or 10 years of forward output! Melt-up indeed! But these work two-ways. One need only recall Metallgesellschaft's little oil trading fiasco and the cascade that created i the oil market from a benign 18 to 9/bbl.

As I say, I am sympathetic to all growth and supply arguments. But tactically, with lots of spec leverage and lots more spec activity at HIGHER levels, and the real economy rolling over in many places, one cannot help but think the "long" dogmatists should consider protecting their tails (the left one at least)...

"Cassandra" said...
2:57 PM  

Ryan, from 1/1/07 to date, GLD is up about 37%, while SLV is up 28%. So, your thesis seems to be mistaken.

Banker, I'm not sure I see any flight from Latin American currencies. The Brazilian real has been fluctuating 1.66-1.70 over the last month. The Mexican peso has been 10.45-10.60. No trend ins evident. Those are the dominant currencies.

If there is a pink flamingo, it coild be oil. We're on a point of the supply curve that's very steep and of course the demand curve is also steep. So, small drops in demand could result in large drops in price. Alternatively, small drops in supply could cause very large price increases.

Nouriel Roubini says the next major shock is in the financial area, commercial real estate, especially. My guess is that what gets the pink flamingo is anything done on margin.

--Charles of MercuryRising
www.phoenixwoman.wordpress.com

Anonymous said...
5:54 PM  

By the way, MacroMan, it must have been a cold fish to the face reading Keith Bradsher's piece in the NYT. Chinese exporters demanding euros and shunning dollars. Maybe Voldemort is buying dollars, but his wards certainly sound like they're in rebellion.

--Charles of MercuryRising
www.phoenixwoman.wordpress.com

Anonymous said...
6:16 PM  

Markets appear to be at a transition point. The sentiment reversal concentrated in financials and the ease with which they are raising capital has largely led to a short-covering rally that has featured bad internals - poor breadth and weak volume. Market is in search of "the new shoe to drop theme." Oil playing its traditional role of central bank of last resort, capable of demand destruction has reached centre stage judging by the amount of ink that it is getting. It seems to link in with what is happening in Asia - the short sited energy subsidy - which unsustainable. The other theme that may eventually play is the fading US stimulus - tax rebates are put in the car and the Fed rate cut heroin impact on growth dissiapates by Q4. Meanwhile the demise of housing collateral or rather calling a bottom in this remains the key to sustainable upturn. My overall take is that it is quite easy to imagine a bearish outcome. But tactically, I do not see this has a big theme market. It is a market of overanalysed themes which one gets excited about for a few days, where the SP500 can move 40-handles or more, but just when you think you can sink your teeth into a macro theme, something comes along to ruin the day and turn "fun into tragedy." Now that the bears are set up for a meltup in the Reds and stocks return to the lows, and Oil going to $500 I wonder what that good news is. If I were holding bearish positions, I would buy Oil puts. As unlikely as $90 oil sounds, it is your worst nightmare. It is the consumption tax cut that the consumer needs so desperately given the current state of his balance sheet, job insecurity and a rising food and energy costs. If not a collapse in oil, tell me what you think is the good news item that will be on the FT page in 10-days to explain why stocks are back up to 1425 or higher?

Mr. Prop said...
10:04 PM  

judging from these comments, maybe just go long oil vol. either way, it seems like it's going to be a bumpy ride.

tmcgee said...
1:05 AM  

Ryan,

Can you point me to a source that suggests surplus production of silver. I ask because within the tin foil hat community, where the gospel according to Ted Butler is regularly preached (I like "prought" as the past partiple for some reason), it is "truth" that silver has been instructural deficit since the Romans handed some over to a guy called Judas.

I have always found this idea suspect - I understand markets can fail to work for years at a time, but not for decades!

Your input would be much appreciated.

Eventhorizon said...
2:02 AM  

> small drops in supply could cause very large price increases.

And in this world of assumptions/speculations noone has said a word of a possible attack on Iran.

Doesn't anyone here prepare for plan C?

Onoto said...
2:05 AM  

The next pink flamingo can easily be Treasury bonds. This is something the deflationistas refuse to consider when the argue for a commodities crash. Sure commodities are a bubble, but so are T-bonds, and they both won't pop at the same time. So which pops first?

Well, the Chinese hold the pin for both bubbles, now don't they? Will they deal with inflation through contraction or revaluation? A maxi-reval takes down bonds, a tightening campaign (a real one) takes down commodities.

I think its the reval.

David Pearson said...
2:14 AM  

David,

What happens to YEN, SGD BRL, and GCC currencies on "big RMB reval"?? Lots of losers whichever course is taken, but who are the big winners from a reval? Vietnam (which has a nasty inflation pob itself)?, India Korea or others that have allowed their units to strengthen? Doesn't this relieve only a bit of the tectonic pressure?? Ultimately, doesn't the system need BOTH reval and de-frothing?

Whatever happened to fiscal and monetary policy coordination within a country??

"Cassandra" said...
1:29 PM  

Cassandra,

I think all peggers succumb to a China reval with revals of their own. Food riots or manufacturing market share? Not a tough choice.

Dollar deval is a two stage rocket. Stage I, the Euro and unpegged exporters, is complete. Stage II, the peggers, is ahead of us, and more insidious since they also finance our spending mania.

Stage II means the free interest rate lunch is over.

Nominal yields soar, Bernanke accommodates, yields rise more; housing plunges more; fiscal bailout cost climbs; crowding out; accommodation; dollar deval; higher nominal yields...

How does it end?

In a torrent of tears, but maybe not those of commodity speculators.

David Pearson said...
6:05 PM  

David,

Thanks for sharing your thoughts.

I am still attempting to understand how, if long rates are finally untethered with all the havoc it wreaks, that the mercantile world won't follow the US into meaningful recession, reeling as they would be from the double shock of loss of competitiveness from reval and seeing their largest customer gone catatonic and their second largest also ill. If the train falls into the ravine, the commodity caboose will not be spared. One can argue it's the last to go but we're all in this together now.

What happens AFTER the wreck in the new new future with respect to energy prices and scarce commodities I will not argue.

"Cassandra" said...
8:59 PM  

Cassandra, the reserves accumulated in Asia and the emerging markets are large enough to allow them to go Keynesian for a while, probably long enough for the economy to stagger back up. One of the interesting features of the Bradsher article I linked is the expressed desire of Chinese to sell internally. Furthermore, the developing world stands to make its largest productivity gains by internal investment.

IMHO, of course.

Charles of MercuryRising
www.phoeniwoman.wordpress.com

Anonymous said...
10:01 PM  

eventhorizon,

The "structural deficit" in silver is just a consequence of the fact that silver used to be a monetary metal and now is no longer. Up into the '90s, a large quantity of silver supply was coming from government stockpiles. This is no longer true.

You can call this a "deficit" if you like. From the economist's perspective, it makes no difference whether the silver is coming out of a hole in the ground or a hole in Washington. Holes are holes and silver is silver.

On the other side of the trade from Ted Butler and his wacko buddies with the tin-foil headgear are the Jeff Christians and Jessica Crosses of the world. (Ie, CPM Group and Virtual Metals.) At the risk of libeling these people, we can call them the hairspray analysts.

Just as the tin-foil analysts are suspicious of phantom supply from Wall Street, the hairspray analysts are suspicious of phantom demand from Wall Street. Just as Butler is in the business of separating those who sell silver contracts into "legitimate" and "manipulative" shorts, and classifies sales from dubious entities such as governments as a "deficit," Christian and Cross (who really should be tag-team televangelists) will tell you that there is such a thing as "physical demand" and "investment demand" for PMs. You won't be surprised to hear that, in the hairspray world, the supply which satisfies the latter demand is a "surplus." Fearful symmetry!

The truth is that Butler & Co. are in the business of selling newsletters, and Cross, Christian & Co. are in the business of selling reports and hedging strategies. Everybody's got to dip their beak.

In reality, the precious-metals markets are and always have been in perfect balance. There are exactly as many sellers as buyers at the current price. Markets do not record the motivations of either, scurrilous though they may be.

It's a mug's game to try to distinguish between "physical" and "investment" or "speculative" demand for PMs. Everyone who owns nontrivial quantities of silver or gold, especially the latter, thinks of it as a financial asset - especially in India, the leading "physical" market. (Google "investment jewelry" if you don't believe me.) It's also a mug's game to distinguish between "legitimate" and "manipulative" contract sellers - no one has any idea what assets those who are short may hold. (Eg, I suspect the silver shorts about which Butler fulminates hold a combination of physical silver, mining hedges, and mining shares - they may be maturity transformers, but this is about as shocking as gambling at Rick's Cafe.)

The general fallacy is in analyzing PMs as though they were, say, wheat. They are much more like dollars or euros. Production and consumption are not terribly meaningful or important concepts for these goods. The question is: where are they, and who owns them?

That said, volumes and flows in the PM ETFs are certainly interesting. The ETFs buy and sell metal as arbitrageurs. When the holdings of, say, GLD, rise, it means that if these holdings did not rise, the price of gold in GLD would otherwise have exceeded the price of gold on the traditional market. And the converse, of course, when GLD's holdings fall (as they have recently). Since it is probably safe to assume that the end holders of GLD are Westerners, this tells us something about gold flow between the East and the West. Either is capable of sucking gold out of the other, and both have a lot of the stuff.

My best guess is that the recent falls in PM prices (note especially the decoupling against oil) are due to traditional-market feedback effects of the recent spike. There is (a) sticker shock and market timing on the part of traditional buyers, and (b) an avalanche of scrap from traditional owners who feel suddenly "gold-rich," ie, have a level of savings above the level they prefer.

Both of these can best be described as medium-term effects - they are negative feedbacks that act as a brake on the market, and probably limit the upward trend to 20 or at most 30% a year. Still a little more than T-bills last time I checked. But if it ever comes through on the wire that Bernanke is out and Volcker is in, run, do not walk, to the "sell" button.

Mencius Moldbug said...
10:55 PM  

there are so many interesting threads here that it is hard to know where to start.

Macroman, if your oil experts think the downside in oil is limited to $90, I would argue that they have drunk the kool-aid. Oil averaged about $70 in 07, and -- as you know well -- was in the 50s in early 07. The world has changed since then, but I am sure it has changed all that much. And I deeply believe in some of the macro-oil dynamics krugman laid out in a class (in my view 90s paper): when oil is rising, it is easy for folks (like the Saudis) to set a few fields aside; when oil is falling -- especially if it falls below new much higher revenue targets -- there is an incentive for countries to pump more. Sure, the saudis have a lot more structural power now than in the 90s and they might be willing and able to defend a new floor, but it still strikes me that there is more downside in at least some states of the world than $90.

I agree with those arguing that the big winner from a one-off chinese reval are places like India and Vietnam. They can appreciate behind the reval with far fewer worries about competitiveness and the like. It also helps to lower the fiscal costs of various import subsidies, including those for oil (notably in cHina). And who knows, China might be setting itself up for a reval by slowing the pace of appreciation (v the $) to a stall. The big loser is the Gulf: they still save mostly in dollars (best I can tell, taking into account central bank portfolios) but consume mostly in Asia. An Asian reval before they have diversified would reduce the Asian purchasing power of their dollar assets.

That said, I have been impressed by how sticky the existing system has been. Governments rarely embrace big sudden changes on the currency front willingly -- there is usually a desire to "feel the stones". make an adjustment and then see what happens. Even countries facing enormous pressure to depreciate in the 90s often tried 1/2 measures -- brazil in 99 being a prime example. on the downside, those 1/2 measures usually were quickly overwhelmed. but a determined government can always fight off pressure for appreciation for a while, so the 1/2 measures in the face of strong upward pressure continue.

think of all the stakes in china's currency policy -- the one off reval disguised as a shift to a basket, then a period of holding rmb appreciation below the appreciation implied by the forward/ keeping appreciation + interest below US rates to deter more speculation, then a period of somewhat more appreciation, but with periods where the appreciation stalled, then a steady and far faster move from nov through end march, and now a stall. At no point tho did China get ahead of global developments; it always lagged.

My best guess therefore is that any subsequent move will be too small to end expectations of a bigger move in the future -- which would imply ongoing intervention and ongoing support for US treasuries.

bsetser

Anonymous said...
12:03 AM  

Miss Cassandra,

Indias currency appreciation has been nullified in a matter of weeks.

Its back to 41 levels where it was a year ago etc.

Asian currencies are getting clobbered. somebody pls help !

Anonymous said...
8:31 AM  

Saw you cited by Dow Jones:

http://www.businessspectator.com.au/bs.nsf/Article/Migration-patterns-EJSRZ?OpenDocument

mOOm said...
11:34 PM  

What I'm trying to figure out is this:

Whose lawn does NOT have a flamingo on it?

Shall we put Holmes on it? I haven't heard from the chap in a while.

I wish to convey a modest hypothesis to him, regarding the Case of the Missing Bid: flamingos eat bids. We have flamingos galore, hence no bids.

Anonymous said...
7:53 AM  

long agricultural-focussed equities has to be pretty consensus and has been nearly one-way traffic so far.

darthtrader said...
8:12 AM  

Pink flamingos to land on the lawns of

Brazilian Real( its been wearing kevlar for the past 5 years)

UK Pension funds who have now come up with the bright idea of investing in bits of paper that give them future ownership of commodities, which of course they can never take delivery of.

Ocean Finance - how come that company is still going ? Is it secretly backed by the SWFs? or Al Qaeda ?

Speedcameras - still due a major correction.

How big are Downing Street gardens and at what density can one pack pink garden flamingos? There must be room to squeeze in one or two more.

Richy Rich said...
9:52 AM  

Thanka to all for an interesting debate. I'd certainly concur that commodities/commodity equities have a broad and deep positioning...but that's no guarantee that they correct, particularly as the fundamental "anchor" is, in my view, stronger than it is for , say, EUR/USD at current levels or the Nasdaq in 99-00.

At this point I feel like we don't have enough data to know whether China has changed its currency tune, or just squeezing the specs. Wgile Vietnam and India may, in the fullness of time, benefit from a maxi-reval in China, for the time being each is wrestling with its own domestic issues. Sadly enough, as I own some now virtually zero-delta INR calls!

Macro Man said...
1:20 PM  

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