Commodities: long and wrong?

Although price action in some equity markets yesterday was meandering and indecisive, there was no such fence-sitting when it came to the dollar and the commodity complex.  With the voting emphatically in favour of the former and against the latter, it's shaping up as one of those "oh ****!" instances where markets have found themselves positioned too heavily the wrong way; it's all the more galling given that long USD was one of the default macro positions for much of the past couple of years.

Indeed, one wonders if the RBA's Glenn Stevens worked for the Looney Tunes organization in his youth.   Not since Mel Blanc was in his pomp has Macro Man seen as elegant a rendition of one of Wile E. Coyote's cliff jumps as the one the AUD has performed since the release of CPI last month.

Regular readers will know that Macro Man has been involved with GDX since January, holding a core long while trading around a speculative adjunct to the position.   Although he sold some of his length last week, he's beginning to think it may not have been enough.  The stock is regularly putting in 5% + days in either direction, with yesterday's 6.4% move coming the wrong way.  That type of vol is clearly indicative of instability in the market, which would be fine if punters were short the gold story and at risk of a squeeze.   The reality looks rather different, as the first chart above illustrates.  Moreover, the chart of GDX itself is starting to look a little ropy, at least tactically; yesterday's sell-off broke through a little support line.

The $64,000 question, of course, is whether this is just a correction or the start of a bigger dollar move.  On the face of it, you might be tempted to say the former...after all, US fixed income is rallying, and one might expect the dollar to require a more solid rate backing to develop a sustainable run.    Perhaps, but the fact is that the correlation between the dollar and US rate expectations has really dropped this year.   On a 60 day rolling basis, the current correlation between changes in the DXY and changes in the 1st vs 5th eurodollar contracts is just 0.1.

Many readers will be familiar with the notion of the "dollar smile", wherein the dollar rallies when things in the US are going great (yield premium, etc) and rallies when things generally are going to hell (USD/JPY and USD/CHF generally excepted) on risk aversion from more speculative bets.  It sells off when things are just generally blah and there are more interesting returns to be had in non dollar currencies.

Macro Man supposes the recent flirtation with a commodity reflation mini-theme in some ways represented an upgrade from "going to hell" to merely "blah".  (The framework is actually more sophisticated than this, but let's just keep it simple in this discussion.)  However, that may have run its course.   The Chinese look increasingly concerned over leverage, and it seems that much of that commodity rally may just have been debt-fueled speculation, after all.   As noted yesterday, iron ore futures (among the first to rally) have shown signs of peaking, and have now broken the uptrend of the entire rally.

Meanwhile, it seems as if the market has decided that the Saudi oil minister can be more bearish crude after all, after reports emerged that the previous incumbent was prepared to agree a production freeze with OPEC before getting yanked home.  A relapse back to the mid-30's would clearly send alarm bells ringing and provide a further bid to the dollar.

And lest we forget, earnings outlooks look pretty lousy in most places, especially China.

It's relatively easy to see how this has and might play out:

In this framework, we're currently in the red portion of the cycle.  If this theory's correct, then there's further to go in commodities and the dollar (and, alas GDX.)  Macro Man is likely to make further adjustments along these lines, pending further evidence and confirmation.