Tuesday, December 15, 2009

EUR A Disappointment

Although Christmas markets are in full swing, with the concomitant reduced risk profiles, low volumes, and general lack of interest (at least judging by the paucity of comments in recent posts), that doesn't mean that there's nothing happening. The DGDF crowd are being taken for a visit behind the woodshed, as EUR/USD hsa traded to its lowest level since October 2 so far this morning.

Perhaps it's the news that Austria's banking sector may be imploding, though if that's the case Macro Man is left to wonder why Eurostoxx futures are up on the day. Or perhaps it's the latest Krishna Guha article in the FT, suggesting that the Fed may address liquidity policy before monetary policy- a move that could entail a discount rate hike. One wonders how likely that really is, however, before both the end-of-year turn and, perhaps more importantly, Bernanke's confirmation for a second go-round as Fed chairman.

No, the rationale would appear to revolve around a large pink bird that's fond of standing on one leg. It seems quite clear that DGDF has been a popular theme and trade, and that given Voldemort's predilection for buying euros positioning has been rather heavy in EUR/USD. Overlaying the (admittedly flawed) HFR macro fund index with the euro-centric DXY reveals a pretty high degree of correlation.
So what's with the euro fetish? Well, those who trade currencies for a living have become accustomed to seeing the euro rock and roll into the end of the year. Indeed, looking at the returns in November/December for the last ten years, it's not hard to see why punters may have loaded up on long euro positions.

Macro Man, for example, ran a long euro delta until last week on the rather cynical view that every other punter would drive hi position into profit. Needless to say, that was a disappointment, and once again provides proof that a "greater fool" investment strategy is not the road to fame and fortune.

What's made the euro's recent weakness particularly galling, however, has been its underperformance of equity markets. While it's become cliched that "it's all one trade", Macro Man can confirm from bitter experience that trying to hedge a long euro exposure with equity puts results in nothing but a one-way ticket to the Pain Cave.
While Macro Man is coasting into the end of the year, as he starts preparing his mental strategies for 2010, he is trying to draw a few lessons from his disappointing EUR/USD experience in Q4:

* Avoid Greater Fool trades
* Keep a closer eye on flamingos
* If he wants to buy a hedge, he should go to a garden center (cheers, RK)


Anonymous said...

Good morning,

Was is DGDF please?


Professional Gringo said...

The EU was shocked when they learned that Pres. Barry-O was NOT awarded the Heisman Trophy.

Soon enough though, the SUV driving Americans will cause the Earth to spontaneously combust and form a second star and then it's just curtains for us all anyway.

Just two reasons why I was short eur/usd. Hope it helps.

Anonymous said...

DGDF - Dollar Going Down Forever

view from 51 said...

the tide of liquidity is leaving the eurozone exposing some nasty wreaks for unsuspecting sailors..
eire,spain,greece austria, et al

Anonymous said...

Or you can buy a crate of Stella!
On a more serious note maybe this heralds the return of more varied cross asset class correl, rather than the risk on/off regime.

Anonymous said...


Anonymous said...

viewfrom51 is correct. I would also add that the DGDF is going to change in 2010 to OGDF...O as in oil. The other winner for 2010 that I might add would be a spread of long nat gas and short crude.

Anonymous said...

another good hedge strategy


Anonymous said...

Anon 12:25
And why can short crude/long natgas
in yr view be a winner in '10?

Anonymous said...

sorry: to Anon 12:32 that question

Anonymous said...

MM -

I think the problem is not "greater fool trades", its your timing of them. In order to make money from these trades you can't be the last fool in, you need to be one of the first fools in.

Anonymous said...

Anon @1:08
What will be the incentive of oil exporting nations facing growing deficits and liquidity crunch? Also in combination of oil glut already hanging on the background?

Clean energy policy and timely Exxon Mobil purchase of XTO will be the drivers for nat gas market.

leftback said...

LB returns from a few days sitting out with a disgusting virus and an injured toe (hope the knee is doing well, MM) to find not much has been happening - other than a massive steepener - but the PPI was even hotter than expected today, which might increase selling of Ts. Given that gasoline prices are now at a 2-month low and crude has rolled over, LB views this PPI data point as stale data, and the expected selling of the long end today will probably prove to be an over-reaction.

If the economy is really as weak as many believe, then this may be the steepest yield curve we are going to see for quite a while. Even IF we were to see positive jobs data (!) or hawkish FEDspeak, the selling would probably be concentrated at the short end. So this seems like an advantageous time for some traders to think about moving out in duration. I am convinced many will not agree.....

MM after watching L'pool v Arsenal on Sunday, your secret identity has been unmasked. You're Howard Webb!! (Stonewall penalty on Gallas but HW has been reading MM's Stevie G diver propaganda....). OK, I admit, we are awful. Steeler-esque, in fact. Cheer up, though, West Ham bailout on the way.

Macro Man said...

Au contraire, LB: I've got a full head of (aftre this year, rapidly-graying) hair. At this point I'm not sure if even Portsmouth is even worth the epithet of Steeler-esque.

Anonymous said...

Anon 1:41
Most of OPEC enjoys solid surplusses and no liquidity crunch. Don't confuse the Dubai situation (which has very little oil to export) with OPEC and oil-exporting nations.
Most, if not all of OPEC can live with oil in $50-60 range.
Oil glut? OECD stocks are in order of 63-65 days of global demand. A tight market is in order of 52-54 days of demand. So that 'glut' is very relative. It's a 'quiet' M.East at the moment. We need a few headlines on Iran, Israel,Saudi Arabia ,etc and that 'glut' is gone in no time. Is there a downside to oil? Yes, likely. Will we see a 30-something price of crude in 2010? I doubt it.
The 'event' risk in crude is currently priced very low but could come back at any time.

Anonymous said...

Oh dear - treasury longs must be a bit miffed at their bubble bursting. Oh well, I'm sure they are consoling themselves shorting commodities - good luck with that too.

Gary said...

Vacation is even more boring than sitting in the office...

Exxon buying XTO tells us absolutely nothing about oil prices or natural gas prices -- particularly not for any short term horizon

In XOM's annual report, XOM says flat out what people in the oil business have known for years: the ROI of buying oil equities vastly exceeds the ROI of developing new fields. The marginal cost from new fields is much higher than spot prices

XOM says it paid USD $13.42 BOE (barrel of oil equivalent) for XTO based on proven reserves (a little over $10 based on total reserves). Most of XTO's reserves are domestic (USA based) natural gas (not crude oil), with shale natural gas deposits expected to be the growth driver in the future.

Do the math: $13.42 BOE is about the same as $2.32 MMbtu of natural gas. Compare $2.32 against spot wholesale prices of around $5.40 in the US. While ~$2/MMcf gross sounds like a great profit margin, it is actually pretty blah (it is a small amount above average). In other words, XTO sold its reserves at slightly below what they might have expected if they developed everything themselves (apart from XOM).

Just as XOM was very candid about buying equity cheaper than developing reserves -- XTO was also very candid.

While XTO had the legal rights to these reserves, they did not have the capital or enough access to qualified labor. They know that developing the fields will be capital intensive, and they will have trouble attracting staff. This is already a huge problem in developing nat gas reserves in Asia (see the labor shortage issues in Australia for example)

General purpose labor is dirt cheap. Technical / high skill labor is in shortage.

With the banking industry unable to do much other than pay itself massive bonuses, Exxon's in-house investment banking abilities give it a distinct capital advantage over any competitor who has to rely on insolvent chartists from Wall Street.

XTO needed capital and labor to survive, much less flourish.

XOM needed to replenish US located reserves at economically feasible costs, and they know that new fields would have marginal costs well above anything the US market is likely to be ***able*** to pay.

XOM has the same problem as BRK/Warren Buffet. They have more cash than they are able to profitably deploy. Keeping the money "in the bank" makes little sense, even less so when the bank might go belly up any minute. XOM also faces a very hostile political environment filled with people who can't do simple math. XOM isn't making an energy bet with XTO -- they are making a politcal bet, while essentially treading water from a business standpoint.

Its not a great deal from XTO or XOM's standpoint -- and it certainly doesn't say anything about oil or NG prices

Anonymous said...

Anon 3:27 -- "if not all of OPEC can live with oil in $50-60 range."

False -- only Saudi Arabia could survive with WTI crude priced that low.

Most of OPEC needs $65-70 to be viable.

Mexico is likely to stop being a net exporter (at any price) in the next year or two... Even the ratings agencies have figured that out

Please do your homework before posting unfounded opinions here

leftback said...

Anon at 3:30 is obviously viewing the Bloomberg screen through an interesting filter today, copper or gold-colored spectacles perhaps? Wonder if the leveraged DGDF crowd are getting nervous yet?

k1 said...

Gary- a couple days ago you mentioned something about US residential real estate prices reverting to a long-term mean. Do you have a link to a chart showing this? I've been google-bashing without effect to find it myself. TIA.

Francis Cash said...

Do you think the dollar will continue to be strong? Also do you any good alerts sites I noticed one that looks good at www.getforexalerts.com another forex provider but don't know much about it.

Gary said...

K1 -- there are lots of sources, but to google them you need to decide which historical mean you are reverting to:

There is median home price to median income. This is a rough affordability index -- if I can't afford to buy a house (because my income is too low), then the bank has to lower loan standards just to maintain demand ... and at some point even that doesn't work.

There is median home price to construction cost (aka replacement cost). Call this builder profit margin or similar. When builder profit margin gets "too high", every idiot in the world becomes a builder and inventory (supply) explodes

In both measures, there are different housing indexes used to determine "median home price". Median income is usually from the census bureau. Replacement cost estimates usually come from P&C insurance actuary estimates. You will get slightly different ratios depending on the data sources used, but as long as you are consistent over time...

Some people like to look at price-to-rent ratios ... IMHO not as helpful because rents are subject to a lot of distortions (govt subsidies, pet rock effects, renewal / lock up periods, etc)

Anyway, google "home price to income ratio" and you will see a variety of sources. Just be sure to compare like against like data (eg don't compare OFHEO prices with Case Shiller)

PJ said...

MM - How do you avoid Greater Fool trades when every trade is a Greater Fool trade? When all risk goes up together and then comes down together? Or dollar-based assets are entirely out of fashion or entirely in fashion?

It seems you either have to position yourself either with or against the Fools and wait to find out if you're Greater or Lesser.

leftback said...

k1 - Take a look at the excellent Calculated Risk blog, there are a million of those charts over there, notional and inflation-adjusted. Mean reversion is some way off, especially for the North east markets. The sand states are much further along in their correction.

Anonymous said...

"Most of OPEC enjoys solid surplusses and no liquidity crunch. "

Please somebody take this man to the woodshed and shoot him. Look around and get the facts straight.

No oil glut? Are you serious?

Anonymous said...

"Its not a great deal from XTO or XOM's standpoint -- and it certainly doesn't say anything about oil or NG prices"

Sometimes I'm completely shocked by the lack of foresight by most investors. So let me get this straight...Exxon makes a $$30+ billion purchase of a major nat gas player for no apparent reason? Given the no end in sight for money printing and the potential for higher long term inflation it is very likely that Exxon is buying those reserves well below future marginal cost of production. Also given the apparent short term view of nat gas participants that are happy to chase downside momentum on short term glut while apparently paying no attention to long term macro forces...who am I suppose to take sides? The $30+ billion mammoth or the 2-lot trader?
Some lateral thinking and a little dose of Occam's razor would go a long way.

Gary said...

Anon 6:42

If you don't like my analysis, then go with Rex Tillerson's (the CEO of Exxon Mobil). He was asked where he thought oil and gas prices were going -- he replied "not a clue"

And if you bothered to read my comment carefully, I never said they did a $30 billion deal for no reason.

I said they did it reluctantly to reduce their cash horde, and from a ROI standpoint, the deal was mediocre at best. They are not making any forecast (bull or bear) on natural gas prices

To suggest that any halfway responsible CEO would make a $30 billion bet on the direction of NG prices is pretty absurd -- that's what hedge funds like Amaranth do (and why they are bankrupt).

Exxon bought XTO for similar reasons to why Warren Buffet (BRK) bought BNI ... in an inflation environment, the cost of having billions of cash sitting around at 0% becomes onerous. They were forced to put the money to work in a very average deal, instead of waiting for a really good deal (as both XOM and BRK have done in the past)

Anonymous said...

Exxon deal was a stock deal and not cash.

Also see the following below extracted from Bloomberg. Now you're telling me that Mr.Cohen's words cannot be interpreted as a bet on natural gas prices?

"Exxon, which also will assume $10 billion in debt, will get the largest producer of U.S. natural gas. Demand for the fuel will grow as U.S. carbon legislation prompts power producers to switch from coal, Kenneth Cohen, Exxon’s vice president for government affairs, said in a Dec. 7 interview. "

wcw said...

Gary, nice exposition. The OFHEO is now the FHFA HPI, though googling OFHEO will get you there eventually. Case-Shiller is good, too, and not limited to conforming-loan data. Medians nicely measure central tendency, but I avoid them for trend analysis as mostly reflecting sales mix.

With the caveat that these have even more problems than a median series, I used the Flow of Funds household real estate assets to construct a long-term chart of real estate as percent of GDP, and threw in another messy series in real dollars per unit. Both make things look overpriced still, but much less so than they had been. I'm all ears if you have a beter way to go back to the '50s.

Our Man in NYC said...

'ello 'ello 'ello...what's going on 'ere then?

leftback said...

feoloUm, anon @ 7:23, there might be actually be a bet based on VOLUME of gas used, independent of price, presumably a nat gas producer benefits if more people buy the stuff - as apart from gasoline, heating oil etc.. and then dare I make the obvious connection between "demand" and price?

Producers can't control the dollar or levels of economic activity, but they do understand things like President Obama saying "it would be a good idea to increase use of domestic clean fuels like CNG". Buying XTO happens to be a smarter way to play this than playing the futures market. So XOM is essentially hedging against declining use of oil and its refined products.

Timothy Cratchit said...

Pity party over and all that - your non predictions look to have been pretty good this yr MM...

Gary said...

wcw -

I agree that short term blips in Case Shiller / OFHEO / FHA often reflect sample errors. Median income from the census bureau (or even the IRS) has noise as well.

However, if you look at the house price / income ratio over a very long period of time (say 1930 to present) -- you generally see a lot of noise centered around 3.4x or 3.5x Over that time period, you have recessions, booms, inflation, wars, famines, plagues, etc.... but the ratio oscillates between around 3x to around 4x (depending on the decade). If you are buying a house, maybe you want to time your purchase -- but as a macro economic guide, its mostly noise.

Then in late 1990s, the ratio goes bezerk, surpassing 7.5 by some measures. That is massively overpriced, and clearly sticks out from the rest of the series.

Last week, I simply suggested that that ratio is likely to continue to revert towards the ~3.5 mean ... either higher incomes or lower housing prices.

BTW -- the ratios are showing that homes remain a bit overpriced, but much less so than 2007 (same as your data series).

If I remember correctly, I was referencing home prices and reversion to the mean to show that declining home prices are not evidence of deflation (any more than the 15% yoy appreciation 2000-2007 was evidence that Fed Funds should have been 15%)

Gary said...

Anon 7:23 Also see the following below extracted from Bloomberg. Now you're telling me that Mr.Cohen's words cannot be interpreted as a bet on natural gas prices?

"Exxon, which also will assume $10 billion in debt, will get the largest producer of U.S. natural gas. Demand for the fuel will grow as U.S. carbon legislation prompts power producers to switch from coal, Kenneth Cohen, Exxon’s vice president for government affairs, said in a Dec. 7 interview. "

First, I think somebody misquoted something -- Mr Cohen did not discuss the XTO acquisition in a December ***7*** interview. That is almost a week too early.

Second -- Mr Cohen (if quoted correctly) does not make any forecast about the price of natural gas. At best, he suggests there might be greater volume demand (as leftback suggests).

There is no guarantee any of this quasi-environmentalism from Obama will actually take hold. Obama's said his number one priority is health care reform, and even that is far from certain. Many CEO's (aka political donors needed to keep incumbents in power) have labeled the two proposals in Congress as "disasters"

But assuming the US starts to shift toward more natural gas -- the process will take many many years (a decade or more), even assuming politics or another president doesn't interrupt the process. It took Brazil 25 years to implement ethanol conversion (they had less infrastructure to convert than the US). And there is always a danger that new technology might be introduced over a multi-decade horizon

Hence, no company is going to make an acquisition based on a **price** bet on natural gas. It might be a volume bet, but even there it would need to be hedged.

In Exxon's case, they are merely trying to replace depleting reserves (which they have failed to do now for several years). They are buying what they can, not necessarily what they would like -- and doing so at a very average price (not getting a bargain as they have usually done in the past).

As for the deal being struck in stock (which Exxon bot in repurchases the last few years) or cash -- its a moot distinction.

Exxon doesn't just have $30 billion or so in cash, they also have historical assets throwing off more cash over time -- all of which needs to be put to work.

XTO needs capital to fully exploit its NG reserves. It would have a tough time raising that money from insolvent banks.

Exxon now has ready places to deploy its cash for the next few years, and projects to keep its skilled labor force from jumping ship. Its not an ideal use of capital -- the expected return is way less than what Exxon has looked for in the past.

But the Federal Reserve has a policy of running negative real interest rates for the foreseeable future (even if FF rise above zero, they will still be below true inflation). It is literally a tax on cash. In such an environment, sitting on lots of cash becomes very costly -- even for BRK or XOM.

So an average investment now is better than paying a cash tax for 4-5 years, hoping (against odds) that a better returning opportunity might appear.

k1 said...

Gary, leftback, wcw - thanks all for the housing data pointers. Much appreciated.

Gary- it was in fact your mention the other day of residential prices reverting to mean as opposed to evidence of deflation that caught my attention. Not to start up the inflation/deflation conflagration again, but I appreciated having the distinction pointed out.

LB- earlier you mention moving out in duration. Would you be kind enough to share with this bond newbie how far out in duration you mean?

leftback said...

k1 - a couple of things here, which many others do not agree with.

First, the yield curve is very very steep here on a historical basis. Second, if the FED were to do anything with rates early next year (which I don't think they will), then the short end rates will take off. Third, if the economy later proves weaker or more impaired than the happy-clappy crowd believes, then the yield curve can become much shallower, and hence the largest decreases in yield would be seen at the long end.

So it seems as though the risk-reward equation is tilting away from the short end (2y, 5y) toward the long end (10y, 30y), making this a better bet if you think that the TARP/stimulus money doesn't fill the present output gap, consumer credit is still declining, and if you see Japan-style stagnation as a possible scenario for the US. I won't bore you with the history of JGB yields, you can look it up.

Right now this is a minority view because This is America, It's Different Here, it's Morning in America, the stock market always goes up and Housing Always Comes Back.....

Anonymous said...

my life experience has taught me that those who speak or write extensively in such a manner expressing "higher knowledge" have little to offer or contribute. To wrap it up here and avoid more wasted words, let's come back in a year and see where the spread between nat gas and crude oil will be trading. That should seal the deal.

Gary said...

Anon 9:45 ... I don't claim superior knowledge, I claimed and continue to claim that Exxon made no forecast about natural gas prices when it bought XTO.

The "evidence" you presented (from Bloomberg) was clearly a misquote (date can't be right) and it doesn't support your higher natgas viewpoint anyways.

But now you want to check the **spread** between oil and natgas one year hence? Changing the argument as you go?

OK, I call your bluff. You were unable to show where Exxon forecast higher natgas prices. Now show us what misquote you think suggests Exxon is going short oil?

Where is this one year horizon coming from? Exxon, or any company that plans to be around in 2011, can't make a one year bet.

The deal (assuming it happens) won't be done for months. It still needs board and shareholder approval, regulatory approval, etc. Where do you get a 1yr horizon from?

leftback said...

German Landesbanken exposure to Eastern Europe the next canary in the coal mine, MM?

Sorry about the 'ammers.... LB is not entirely confident ahead of Wigan's visit tomorrow.

Anonymous said...

Gary are you intentionally a horse's ass?

Nic said...

I agree with Gary about XOM (+ I have a brother-in-law who works there). They are a very conservative company not prone to short term bets.
XOM already own a lot of global shale assets and the XTO acquisition brings skills/expertise.

Anonymous said...



That's some kind of wonderful. And when I google its meaning, it gets better yet:

Finanzmarktbeteiligung Aktiengesellschaft des Bundes

Now say that 3 times in rapid succession.