CAD-USD Commodity Correlations


The chart above is the DJ Commodity Index vs CAD-USD from 2007. The correlation of CAD with the DJ index is significant over the period at +0.76. What is interesting are periods of clear divergence between the two series. Have a look at the spike in CAD in 2007 to nearly 1.10. That spike correlated nicely with a sharp rally in the DJ commod index but as you can see the CAD rally turned out the be a short term spike while the commod index returns continued to motor higher. And when the DJ Index made a clear new high the CAD was in a long sideways period of consolidation. The period following is the two are pretty much in synch until you get to late 2010 when CAD forms a lovely double top and the DJ index fails to follow suit. After that they once again follow each other quite closely into a wider consolidation patter but once the DJ index shows some clear signs of breakdown CAD follows like an obedient servant. Fast forward to recent history and in the summer of 2015 the commod index forms a V shaped bottom and CAD does exactly the same. When commodities rally the CAD follows again until late 2016 and early 2017. CAD is now showing a bit of divergence, and what,  if anything, does this mean? 


Above is Dr. Copper over the same time period as the DJ index chart above. Notice that over this period the CAD- Copper correlation is higher still at +0.86. The is a similar divergence at the start of the period when copper forms a nice triple top but CAD keeps motoring higher to just shy of 1.10. As CAD comes off its spike Copper follows but there is once again a bit of divergence  in 2010 when Copper make a new high and CAD fails to retest is old high. On the follow CAD and Dr. Copper are pretty much back in synch as Copper tries  to take out the 4.00 level and fails, develops into a triangle consolidation pattern, which once it breaks down foreshadows weaker price trends for both. This patter holds until late in 2016 at the time of the US election copper breaks out of its 2.00-2.35 consolidation pattern, however this time CAD fails to follow. The same patter as we observed in the first chart above. 


Above is CAD vs. WTI over the same period as the two charts above. Notice, that in this case the positive correlation is lower than Dr. Copper, but higher than the DJ index. And as you can see again, there is a distinct divergence between WTI  and CAD when the CAD spike in 2007  is followed by a much later WTI spike that is not reciprocated in CAD-USD. The follow on action is similar to Dr. Copper & the DJ index but in this case WTI is consolidating in a rising wedge formation, while CAD is similar but showing clearer signs of weakness. The picture is a bit clearer if you look at it over a shorter time frame in the chart below.
WTI is having less of an effect as it tries to take out the $105-$110 area,  while CAD is steadily loosing ground. The CAD-USD price action is more in line with Dr. Copper than with crude. WTI crashes on the break of the wedge formation and in this case CAD follows suit. The two mirror one another into the low in WTI @$27-$28 forms a double bottom and they rally together until once again in early 2017 the two start to diverge. So what, if anything does this portend?  Here, for what it is worth,  is my biased opinion. While the positioning in the commodity markets, WTI and Copper, may well be long, and possibly stretched, this enthusiasm is not yet being shared by the commodity currencies, to the same degree. The current prevailing market bias is to run short CAD based on a number of macro factors. The macro indicators have been weak, at least until recently, and the economy is leveraged long to housing which may well be rolling over. Exports have not picked up to the same degree or in line with the 30% depreciation of the exchange rate. Finally the BoC current Governor has developed a bit of a penchant for a talking  the currency down. The argument back is that CAD is generally correlated to the so-called Global reflation trade. Admittedly, global PMIs were rising ahead of Trump's victory. It was interesting that the break higher in Dr. Copper occurred on the day of the US election, before the polls closed, and well before the results were in. The global reflation story was already starting to gain traction, but Trump election as we all know, ratcheted things up further with his infrastructure spending talk. If forced  to choose between China stimulus in comparison to Trump's reflation talk &  in terms of which will be the more salient factor, it is China and not the new US administration that will provide greater direction over the medium term. China, not the US, to put it bluntly   is the 800lb gorilla in the room. Having said that, it is doubtful we are in a secular bull market for commodities. At this point it is more accurate to say we are in a correction phase from a much longer term secular bear market. China stimulus measures may well be doubted, and fears of a hard landed are still justified, but one has to admit, the authorities seem to be doing a better job than their given credit by many (myself included) in their quest to re-balance the economy. Apart from China the rise in Global PMIs is real, even in Asia. Singapore's macro data which had been pretty weak in 2016 is turning around smartly. 4Q GDP announced on 3 Jan came in well ahead of expectations. Even euroscleroic Europe is showing signs of life, while  the UK enjoys a short term sugar rush from the 18% collapse in sterling. At the same time, US and even the more recent CAD macro data has been ahead of expectations. In equity land the reflation narrative has been central to the recovery in the high beta cyclical sectors, particularly those tied to the commodity complex, industrials, & financials. CAD and the commodity based currencies may well prove more resilient than expected in this environment. The price action will see more corrective periods of CAD strength with falling volatility as the CAD-USD continues its broad consolidation pattern. Option prices will get cheaper and skew will decline. Having said that however, the risk reward is asymmetrical. In other words, a clear break down the commodity index, copper, or WTI will lead to a much sharper sell-off in CAD.


What is more likely to account for the divergence between the commodity complex and spot CAD is the sharp narrowing in 2Y CAD-US interest rate differentials. As you can see above CAD has lost its positive spread vs the US two year.

In the same vein the chart above shows the spread between the average of 2s-5s-10s CAD-US interest rate differential (in blue) vs. spot USD-CAD (in red). Here too there are some interesting divergences. First at the left hand side of the chart in early 08 when the Dollar made a new low (CAD-high) in line with the differential narrowing, and then corrected back while the differential made a new low. A similar event occurred in 2008 with USD-CAD forming a double top around 1,3000 with the spread making a new high. And finally most recently in 2016 we are seeing the spread attempting to break to a fresh high with the spot below its previous peak. In order for CAD-USD to break down clearly, trends in the commodity complex have to be in alignment with the direction of interest rate spreads.

James
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Leftback
admin
January 19, 2017 at 9:04 PM ×

Great post, James. Thanks for reminding us that "Canada sells rocks and trees", as one Toronto-based manager once reminded us, and that whatever other distractions we dream up from time to time (housing bubble, Chinese hot money etc.), CAD is first and foremost a commodity currency, albeit one that always has one eye across the border to its bigger neighbor and principal trading partner to the South.

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Anonymous
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January 20, 2017 at 1:42 AM ×

Excellent post, James - very nice work... thx

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Gus
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January 20, 2017 at 2:33 AM ×

BTW Leftback: a little article on the latest musings of Lacy Hunt:

https://www.bloomberg.com/news/articles/2017-01-18/bond-guru-who-called-last-bear-market-40-years-ago-says-go-long

From the article:

The problem is money velocity in the U.S. (as measured by M2) has fallen to a record-low of 1.44, meaning every dollar spent circulates only 1.44 times in the economy, down from over 2 times at the peak in 1997. To Hunt and other adherents, that shows even after years of unprecedented money printing by the Federal Reserve, inflation will remain subdued and elusive, largely because the private sector has chosen to hoard, and not spend, the money in the years after the financial crisis.

"When debt is at high levels and increasingly counterproductive, the most important lesson of economic history is that the velocity of money falls," Hunt said. "I’m still long bonds, especially the long-end," the part of the yield curve that’s the most sensitive to rising inflation.

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Nico G
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January 20, 2017 at 8:37 AM ×

John the revelator

http://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx&mod=MW_story_quote

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Polemic
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January 20, 2017 at 10:32 AM ×

Thanks James. You are claiming the role of FX man after your piece on EUR/USD too. Btw any updates on your eurusd view?

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Anonymous
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January 20, 2017 at 2:49 PM ×

Never seen such stupid markets as these leading into the inauguration. America has turned into a country of cunts, with no one able to make a trading decision.

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johno
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January 20, 2017 at 3:36 PM ×

Well, I decided yesterday's selloff in equities was about as much as we'd get, and took off my options positions (at a loss). I figured the selloff would have to come by yesterday. My takeaway from Trump's presser was that the market was unlikely to plunge during his big public appearances. Of course, trying to mastermind market moves like this is probably all folly.
Markets are at an interesting juncture here. I think the Trump trades could have another burst of life coming out of the inauguration, just to suck in those desperate not to miss that trade that everyone is seen to have on. Watching the bond market and yen closely here.

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yassa
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January 20, 2017 at 4:49 PM ×

just dipped a toe in with R2K short. May well be taking a bath in a couple of hours...

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Anonymous
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January 20, 2017 at 5:08 PM ×

Trump becomes President, minutes later stocks start crashing. Fuck-wit Americans.

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washedup
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January 20, 2017 at 5:53 PM ×

whats with the america bashing bro? want a drone buzzing over ur head? don't you know we can track who u are and the badass we just swore in?
just kidding - its tough to get the market to do anything but chop on op-ex recently, especially as big as this one. I am leaning towards Johno's 'burst of life' view as well, while noting it does happen to be consensus.
UK retail sales were interesting - I think we may be at a cyclical high in global IP - china's RR cut was also out of the blue - what do they know?

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Anonymous
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January 20, 2017 at 6:15 PM ×

"Trump becomes President, minutes later stocks start crashing."

Twenty-five basis points is a "crash"? No wonder volatility is so low. :)

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Nico G
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January 20, 2017 at 6:24 PM ×

'protection'.... the P word is doing the round

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Nico G
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January 20, 2017 at 6:27 PM ×

johno sorry to hear that. this is why options don't work, you have to be right AND you have to be right fast. You may get out at same market level but time decay has played against your wallet

i don't remember your timeframe but you surely should allow more time for a correction to develop, inauguration week sure ain't enough. Protectionism is going to kill trade. Populism is not good for business. I stick to simple facts

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Nico G
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January 20, 2017 at 7:40 PM ×

FYI

http://blog.afraidtotrade.com/pondering-a-perfect-pattern-repeat-for-market-at-the-highs/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+afraidtotrade%2FNRSd+%28Afraid+to+Trade.com+Blog%29

good week end everyone

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IPA
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January 20, 2017 at 8:27 PM ×

Kudos Nico G,

Corey is a no nonsense chartist with calm approach to trading. I see a lot of fly-by-night bloggers out there thinking zerohedge-styled writing combined with a few amateur charting techniques gets them the audience for life. 2-3 months later they are gone as their brain is depleted. He has been doing it long enough to be followed by semi-professionals and actually has the knowledge and CMT designation to show for it.

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Anonymous
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January 20, 2017 at 8:27 PM ×

The market needs actions from Trump to meet all those expectations. Obamacare repealing needs a replacement, tax cut needs a new law, trade war should come after negotiation, Dodd–Frank repealing needs legislation. So what is the fastest action Trump can take? De-regulation on labor/environment.

Since Trump promised actions today, I would assume that he wants to make an announcement over weekend to show that he really means it. I would like to bet on his actor's instinct to attract attentions: so some quick and bold actions on deregulation over this weekend and early next week they can brag about: The beneficiary is energy sector IMO.

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Anonymous
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January 20, 2017 at 8:53 PM ×

kind of same thing happening to AUD. What makes me think market have not embarked on the last commodity train story. Very basic model puts AUDUSD around 80 at the current commodity prices. Looking through global trade data, we can see only a normalization of prices but still week volumes. Its very consistent with Global GDP growth.

@platosbunker

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Polemic
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January 20, 2017 at 9:06 PM ×

I have read nothing as I have been busy. The only thing I have seen in pasr 8 hrs are prices. No news. And in my favorite game of back engineering the news from the prices.. I can only assume what ever he said didn t matter.

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thud
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January 21, 2017 at 12:22 AM ×

Re: options and vol... I believe Nico called it a skeleton VIX the other day... My apologies if I've attributed it incorrectly; nevertheless, that's a pretty good visual depiction of the wings catching a bid and the body being left bare. Skew is high, term is steep, and vol-of-vol is divergent.

The perception/expectation of tail risk continues to grow... an interesting juncture, indeed.

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abee crombie
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January 21, 2017 at 3:15 AM ×

While US equities might be in a funk for the last month, EU is marching higher. If EURO is the funding currency then EU punters must either be assuming stocks are really cheap here or the market is making a big mistake. I'd watch this space, along with Financials and HY to see if we get a major change in sentiment. So far can't see anything. While Yen is off, meh, I think it more punters vs real money allocating like in those other markets.

Who knows what Trump will do. But feels like we can go higher still, not everyone is on board to silly town just yet. Plus equities can rotate the crap out of thematic trades yet still end up higher a few months later. What happens with rates and Dollar factor in a great deal as well but I still think equities driving the bus here.

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IPA
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January 21, 2017 at 6:08 AM ×

abee,

DJT told us today what he's going to do. I have no doubt about him carrying out on his promises and try to fight for his constituents right from the get-go. The question here (at least for me) is what will McConnell and Ryan do? And more so Ryan, because McConnell's wife (if confirmed) would be a present conflict of interests as a part of DJT's cabinet. So Ryan it is... Will he give in and let DJT have the spotlight early or teach him who is the boss in DC? Put today aside, as it's all smiles and a celebration of O's departure more than DJT's arrival (for house and senate reps that is), but when they get into the same room with him (behind the closed doors) and start the conversation about all the things he wants to do, they might as well tell him how it will be impossible to reconcile the differences should he push for the term limits and continue to bash them in the open like he did during the speech today. These guys and gals intend to stay in DC for a long time after DJT's term is over. I am watching Ryan/DJT relationship for telling signs on the way this whole thing is to unfold. I just want to be next to sell button when we hear the first real friction between the two on whatever issue, especially the infrastructure and the tax cuts plans. My 2 cents...

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checkmate
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January 21, 2017 at 7:55 AM ×

I'll take the otherside of a couple of bullish ideas above. I'll go risk off because whatever Trump does or doesn't do what he does do starting now is add to the levels of market uncertainty. The pre Trump trade was fine in terms of optimism ,but the reality is uncertainty. Probably China have fired the first gun on what comes next.
Add in EU elections and we have plenty of reasons for people to put the Nico "P" into place. How you time this is up to you. I stared last week and got the option of adding to better my aggregate. Hoping to get another opportunity sooner than later to complete my short position.

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abee crombie
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January 21, 2017 at 2:26 PM ×

Ipa, interesting re ryan. Will put it on the radar. I think if he decides to go twitter on china that could be a big sell too. One china policy is non negotiatable.

Checkmate, agree there is election risk byt feels like everyone knows it. Im not advocating going long eu, just saying what markets are doing. Wouldnt surprise me to see eu much higher if eu election risk turns out to be nothing. Unlike in 2015 when everyone was long eurostoxx and greek negotiations stalled, now everone is underweight eu and waiting for elections.

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abee crombie
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January 21, 2017 at 2:41 PM ×

Ipa, interesting re ryan. Will put it on the radar. I think if he decides to go twitter on china that could be a big sell too. One china policy is non negotiatable.

Checkmate, agree there is election risk byt feels like everyone knows it. Im not advocating going long eu, just saying what markets are doing. Wouldnt surprise me to see eu much higher if eu election risk turns out to be nothing. Unlike in 2015 when everyone was long eurostoxx and greek negotiations stalled, now everone is underweight eu and waiting for elections.

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washedup
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January 21, 2017 at 3:14 PM ×

@abee just an FYI all your posts appear twice (have been for a while) - unless of course its intentional and you want punters to double their eurostoxx length!

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checkmate
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January 21, 2017 at 3:25 PM ×

Abee
I would agree that everyone should know "it". I just don't think they have begun to position for it. Looking back at UK ref and Trump markets were hopelessly complacent.

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Polemic
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January 21, 2017 at 3:38 PM ×

Abee re double comment posts. Happens to me all the time posting from android phone if you use 'go back' button after posting comment. Took a while for me to work out what was going on. I now close tab on posting.

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IPA
admin
January 21, 2017 at 7:01 PM ×

abee,

Let me give you another thing to put on your radar. Looking at ETF fund flows for the first three weeks of 2017 vs 2016, one can't ignore this year's rotation versus across-the-board exodus last year. So far in 2017 it's out of SPY into DIA, out of IWM into QQQ, out of TLT and HYG into LQD. But I see one startling difference which is standing out like a sore thumb this year - there may be distribution going on in SPY. It is seeing yuuuge outflows, three times larger than this time last year when price fell off the cliff. Take a note of this.

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Anonymous
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January 22, 2017 at 12:25 AM ×

Sold Trump speech. CIA and WH Secretary added further to uncertainty. I wasn't surprised about Brexit or Trump got in. The opening weekend is bad for marketa tho imho.

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January 23, 2017 at 11:37 AM ×

Hello,
Good to read out your post. I liked the things you have shared regarding Trade Commodity Finance. Do some more post. Thank you too much.......

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Anonymous
admin
January 23, 2017 at 12:11 PM ×

Lovely post, nice work there James.

On a separate note, at the risk of being a prude, do you think the administrator could do something about the potty mouth comments that are less than relevant to markets please?

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