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For most of
Wall Street's history, trading in equities was fairly straightforward: buyers
and sellers gathered on exchange floors and haggled until they struck a deal.
Computerized trading of stocks didn't arrive onto the Wall Street scene until
the 1980's. Computer guided "Program trading," - defined by the
NYSE as an order to buy or sell 15-stocks or more, valued at over $1-million
total, was blamed for the "Black Monday" Crash of October 1987.
Then, in 1998, the internet opened-up markets to anyone with a desktop
computer, and a trading idea. Since then, computer trading programs have
grown vastly more powerful and the algorithms that guide their trading vastly
more sophisticated.
As such, the
average PC trader is no longer able to compete with Wall Street's computers.
Powerful algorithms, called "Algos," in
industry parlance, are executing millions of orders a second and scan dozens
of public and private marketplaces simultaneously. Algorithms can spot trends
in the global markets, evaluate and integrate the latest news releases,
changing orders and strategies within milliseconds, before PC investors can
blink.
As the use of
algorithms moves from hedge funds and Wall Street's trading desks to mutual-
and pension-fund managers, these computer guided trades now account for
roughly 60% to 70% of total US-equities trading volumes on the NYSE, Nasdaq, and electronic markets, known as Dark Pools. As a
result, many banks and brokerage firms have been able to slash their trading
desks' staff in half, while more than doubling their equity trading volume.
There's a
special class of algorithmic trading, called, "high-frequency
trading" (HFT), in which computers buy and sell equities based on
information that is received electronically, before human traders are capable
of processing the information. High-frequency traders (HFT) operate in the
shadows, often in quiet places located far from Wall Street, and trading
stocks at warp speed. HF traders move millions of shares around in minutes,
yet only seeking to profit by "scalping" a few pennies off each
share.
Over the past
few years, high speed traders have deployed algorithms more widely, and have
become bigger players in commodity futures, foreign currencies, international
stocks, and exchange traded funds. According to the Chicago Mercantile
Exchange, - roughly 35% of all commodity futures trades is now handled by
high speed computerized traders. That figure is expected to reach 60% of
commodities trading volumes in the years ahead.
Computer
Cowboys Invade Crude Oil Pits, With so many moving parts in the global
financial markets, moving at faster and faster speeds, it's no wonder that
commodity fund managers are increasingly turning to Algos.
Today, HFT and computer-generated trades account for 35% of the volume in Nymex energy futures. Even longer-term Macro traders that
hold positions for weeks or months are turning to Algos
to collect and analyze a wide range of data, such as interest rates,
employment numbers, purchasing managers' statistics, Chinese oil imports,
corporate earnings, global GDP figures, etc, at
millisecond speeds. Algos can read and evaluate 175
economic indicators at any moment in time, before firing off a trade.
How can the
average investor hope to outsmart an Algo trader?
Fortunately, computerized trading is mostly used in scalping operations,
providing massive liquidity to the markets, but isn't altering the market's
longer term mega-trends. In fact, Algos appear to
be utilizing traditional tools that have been used for decades, and are in
sync with today's "Financialization" of
the commodity markets. That is to say, Algos are
reinforcing the "inter-market" relationships between currencies,
interest rates, global equity markets, and the commodities sector, - most
notably, metals and crude oil. Such was the case over the past year, when the
gyrations of the Euro-zone's equity indexes, and the Euro's exchange rate
against the US$, were key drivers influencing the price of North Sea Brent
crude oil.
For example,
since peaking in mid-March, the exchange traded fund for the Euro-Zone's
broad stock market index, (NYSE ticker: EZU), has fallen sharply, from as
high as $32.50 /share to around $25 today. EZU has suffered a "double
whammy," including the Euro's 10% slide against the US-dollar. Thus, EZU
is a key Algo indicator for crude oil traders,
since it tracks the Euro-zone equity markets, - a real time barometer of the
market's outlook for the Euro-zone's economy, and is incorporates the Euro's
exchange rate. In turn, EZU's slide to $25 per share, has weighed heavily on
Brent's tumble to below $100 per barrel.
Two other key
variables that should be analyzed, are (1) the amount of crude oil that's
supplied by Saudi Arabia and the OPEC cartel, and (2) the direction of the
Euro versus the US$. Although its influence has waned over the past few
decades, the Saudi royal family is still the chief central banker of the
crude oil market, and is the swing producer of the OPEC cartel. Riyadh says
it has 2.5-million barrels per day (bpd) of spare capacity that can be pumped
into the market at a moment's notice, to either cap prices or knock prices
lower. It's interesting to note, that the peak in the North Sea Brent crude
oil market, at $127 per barrel, did coincide with a stern warning from Saudi
Arabia's oil chief, Ali al Naimi.
Writing a
rare opinion piece in the Financial Times on March 28th, Naimi
blasted "irrationally high oil prices," saying there was no
shortage of supply, and that Riyadh was ready to use its spare production
capacity "to supply the oil market with any additional required
volumes," he warned. "Supply is not the problem, and it has not
been a problem in the recent past. There is no rational reason why oil prices
are continuing to remain at these high levels ($127 /barrel). I hope by
speaking out on the issue that our intentions - and capabilities - are clear.
We want to see reasonable crude oil prices. Saudi Arabia will do what it can
to mitigate prices. The bottom line is that Saudi Arabia would like to see a
lower price," he warned. Earlier, Naimi identified
$100 a barrel as an ideal price for producers and consumers.
To make this happen,Saudi Arabia boosted its
oil output over the next few months to a record 10.1-million bpd, and lifted
OPEC's combined oil output to 31.8-million bpd in April - or 1.8-million
above OPEC's stated quota, thus greasing the skids under North Sea Brent. On
May 8th, Naimi first indicated that the Saudi
kingdom was pumping 10-million bpd and was also storing 80-million barrels to
meet any sudden disruption in supplies. "In addition to our spare
capacity of 2.5-million barrels per day, we have on the ground, in tanks and
in pipelines, about 80 million barrels of inventory. These are working
inventory," Naimi said.
Following Naimi's initial warning, on March 28th, the price of North
Sea Brent tumbled $40 per barrel lower to $88 per barrel in June, before
rebounding to around $100 today. Coinciding with crude oil's slide to below
$100, was a slide in the Euro's value from as high as $1.34 in early March to
as low as $1.2350 in late May. Traders reckon that Riyadh would try to put a
floor under North Sea Brent at around $84 per barrel, which is the estimated
"break-even" point, that's necessary for Riyadh to finance is
domestic spending programs.
The Euro's
Sharp Slide against the US$ has been a thorn in the side of the commodity
markets for the past 14-months. The Continuous Commodity Index, (CCI)
measuring a basket of 17-equally weighted commodities, stumbled into bear
market territory on June 20th, soon after the Federal Reserve balked at
launching a third round of quantitative easing (QE-3). The CCI fell as much
as -27% from last year's high, when it skidded to the 500-level, its lowest
since November 2010. In turn, the Euro's slide from as high as $1.4850 in
April '11 to $1.2150 today, a drop of -18%, and was a major catalyst behind
the CCI's demise.
The Euro also
fell to record lows against the Australian and New Zealand dollars, after the
ECB lowered it repo lending rate to a record low of
0.75% on July 5th. Traders expect more ECB rate cuts and another injection of
cheap, long-term loans (LTRO) for banks. The Euro also fell to a 3-½
year low against the British pound and a 10-year low against the Chinese yuan on July 9th. The People's Bank of China (PBoC) lowered its 1-year loan rate within minutes of the
ECB's rate cut, but failed to stop the Euro's slide versus the yuan.
Europe is the
world's biggest buyer of goods and services, buying 31% of all global
exports. However, with the Euro losing its purchasing power against most
major currencies, European consumers could be forced to cutback
on purchases of foreign imports. Unemployment in the Euro zone has reached a
record high of 11.1% in May, - a full 1% higher than in April 2010, and is
also denting consumer spending. The jobless rate is likely to climb higher in
the coming months, as depression like conditions in the peripheral
Euro-nations spreads to the core. Manufacturing in kingpin Germany, is
already showing signs of stagnation.
The
Euro-zone's record jobless rate is the result of the austerity measures
imposed by Germany, the IMF and the troika upon the so-called Club-Med
nations. These brutal measures are making the working class pay for balancing
budget deficits, while crony politicians transfer taxpayer monies from state
treasuries into the coffers of the European banking Oligarchs that are
receiving a bailout. In Greece, value added taxes have been sharply raised,
pensions have been slashed, and hundreds of thousands of workers have been
laid off in both the public and private sectors. Similar austerity policies
have been imposed in Spain, Portugal, and Ireland.
Predicting
the future value of the Euro has taken on added complexities for both
computer cowboys and traditional commodity traders. Key variables that effect the Euro's value include the interest rate
differential between the yields on Germany's and Spain's 10-year bonds. Over
the past 14-months, the yield on Germany's 10-year Bund has declined by
-200-basis points (bps) to 1.30%, while at the same time, Spain's 10-year
yield has moved in the opposite direction, climbing +160-bps higher to 5.60%
today. A wider spread is a worrisome sign that Spain might default on its
debts, and could signal capital flight from the Euro currency.
For the past
17-weeks, the ECB has refrained from purchasing risky sovereign bonds under
its Securities Markets Program. Instead, the ECB's holding of sovereign bonds
has actually declined to €210.5-billion last week, down from
€219.5-billion in late-February. Since the ECB puts the brakes on its
bond buying program in February, the yield on Spain's 10-year note has
spiraled 2% higher to as high as the 7% level. In turn, selling pressure
intensified upon the Euro. That's convinced many analysts that the only way
to rescue the Euro from disintegration would be a new charter, allowing the
ECB to monetize trillions of Euros worth of sovereign debt. That option is
strongly opposed by Germany's Bundesbank, the ECB's
biggest stakeholder.Furthermore, under that scenario, the unbridled monetization of debts would sink
the Euro's exchange rate against other currencies, which is what traders are
betting on.
The latest EU
political accord arranged on June 30th, has designated the ECB as the buying
agent for bonds purchased by the ESM bailout fund that could act as a
"debt shield" for troubled Italy and Spain. The ESM has
€500-billion of ammunition, but €100-billion of that is already
earmarked for Spanish banks. Ominously, its remaining cash could dry-up very
quickly in the event of a panic in Italy's €2-trillion bond market.
Given these realities, the ESM funds could initially be used to put a ceiling
over Spanish government bond yields, at say 7%, and capping Italy's 10-year
bond yield at the 6% area. That's quite a different strategy than trying to
force Spain's borrowing costs lower. During this process, the risk of holding
toxic Italian and Spanish bonds would be transferred to the taxpayers in
Germany, Netherlands, Finland, and Luxembourg who are already on the hook for
€700-billion in bailouts for the their delinquent debtor neighbors, as
crony politicians clandestinely bailout the Oligarchic banks.
Capital
Flight From Euro, By cutting its repo lending rate 25-bps to a record low
0.75% on July 5th, the ECB has almost exhausted its normal ammunition. The
ECB could whittle the repo rate further to 0.25%. The ECB could also boost
its long-term liquidity offer. In December and February it injected over
€1-trillion into the coffers of the banking Oligarchs with 3-year
loans, or LTRO's. ECB chief Mario Draghi has poured
cold water on a third option - allowing the ESM rescue fund to borrow from
the ECB, which would dramatically boost its firepower and allow it to drive
bond yields lower. However, Euro-zone bankers are hoarding the ECB's cash
injections, and aren't lending Euros into the real economy and private
sector. As a result, the Euro-zone's economy is suffering from a severe
credit crunch, that's creating further hardships for small businesses, and
lifted youth unemployment to an average 22%.
At the end of
the day, global investors are worried that the Euro currency experiment would
break apart someday, as the wealthier nations grow tired of bailing out their
delinquent neighbors. Global investors are switching out of Euros and
shifting monies into British pounds, (among other currencies). Sterling rose
to a 3-½ year high against the Euro on July 10th, and is tracking the
upward spiral in credit default swap rates for Spain's debt, due to doubts
about the insufficient size of the ESM's bailout funds to fully backstop the
combined €3-trillion of debt outstanding in the Italian and Spanish
bond markets.
Shanghai
Red-chips Slide to 3-year Low, Points to "Hard Landing," There are
many moving parts in the world markets, for traders in commodities to analyze
and evaluate, before pulling the trigger on a trade. Dismal economic data
from China and India are signaling a further weakening of the global economy,
and undermining hopes the dynamic Emerging economies of Asia can prop-up
demand for industrial commodities, at a time when European economies are
stuck in a recession, and US-economic growth is stalling out.
China's
economy appears to be weakening more rapidly than official statistics would
suggest, raising fears of a hard landing that could be felt around the globe.
Second-quarter statistics are due to be released on July 13th, and expected
to show the Chinese economy slowed to a +7.5% annualized rate, compared to
+8.1% in Q'1. That would be the slowest pace since the depths of the global
financial crisis. But government data are widely believed to understate the
extent of China's woes. On July 8th, Premier Wen Jiabao
warned of "huge downward pressures" on the world's #2 economy, - one of the strongest admissions yet that
China's top leaders are worried about the rippling effects of the Euro-zone's
recession.
The deceleration
in China's economy, and the brutal Bear market in the Shanghai red-chip
index, now 3-years old, follows a year long
tightening campaign, in which the People's Bank of China (PBoC)
drained 4.4-trillion yuan, ($700-billion) out of
the Shanghai money markets, and hiked its 1-year lending rate +125-bps to
6.56%, to combat a dangerously high rate of inflation. In turn, the
tightening of liquidity, slowed the growth of China's M2 money supply to
+12.4% annualized, from as fast as +29.7% in Nov '10. Draining liquidity and
hiking interest rates reinforced the bearish market trend in the Shanghai
red-chip index, - telegraphing an early warning signal to commodity traders
of a slowdown in China's economy.
The Shanghai
red-chip index closed at 2,164 on July 10th, a 3-year low, as June's export
data pointed to more signs of slowing demand abroad. China's Purchasing
Manager's sub-index for new export orders, fell to a reading of 45.2 in June,
falling further below the 50-mark, signaling a deepening contraction for
exports in the months ahead. Most worrisome of Beijing, the Euro continues to
lose ground to the Chinese yuan, losing as much as
-24% from its peak value three years ago, and Europe buys about one-third of
China's exports. Since the Euro buys fewer Chinese yuan,
European consumers could buy fewer Chinese made goods.
Beijing has
loosened its monetary policy in recent weeks, in a bid to stabilize the
world's second-biggest economy. The People's Bank of China (PBoC) on May 13th reduced the amount of depositors'
monies that banks must hold at the central bank to 20%, and in effect
injected about 400-billion yuan ($63-billion) into
the Shanghai money market. The 50-basis point cut to 20% in banks' reserve
requirement ratio (RRR) was the third such cut in six months.
The PBoC cut its key lending rate on July 5th for a second
time in one month in a new effort to reverse its deepest economic slump since
the 2008 global crisis. The PBoC lowered the rate
on its 1-year loan -31-basis points to 6-percent. It said banks will be
allowed to offer discounts to borrowers of up to 30% below that benchmark, an
increase from the 20% discount previously allowed. Although lowering the RRR
provides banks with more yuan available for lending
to borrowers, it's not likely the extra liquidity can offset the negative
effect of slackening exports to Europe and a weakening US-economy, - China's
biggest markets for factory goods.
Beijing must
proceed carefully with its easing campaign. China is still suffering the
fallout from the last round of state intervention following the 2008 global
crisis. To keep the economy humming, Beijing spent $400-billion on public
works projects and encouraged banks to lend -- easy credit that fueled a
housing bubble and a surge of borrowing by local governments. The real estate
sector is now deflating, in part because of government restrictions
introduced two years ago to clamp down on speculators. Home prices throughout
China have plummeted and developers have been saddled with tens of thousands
of unsold units.
Demand for
Steel and Iron Ore in China is taking a hit along with the overall economy.
The most-actively traded steel rebar contract for January delivery on the
Shanghai Futures Exchange fell as low as 3,906 yuan
($610) per ton this week. Australian miner Rio Tinto is offering its .5% grade
Australian Pilbara iron ore fines at $137 a ton via the platform run by the
China Mining Exchange, down sharply from around $175 /ton a year ago. China,
which buys around 60% of the world's iron ore, bought -9% less of the raw
material in June than May, the fourth month-on-month decline in imports this
year. Chinese steel mills are now purchasing more iron ore from stockpiles
sitting at ports which are cheaper than fresh cargoes amid fears that steel
demand won't pick up, due to slumping construction activity.
Latin
America's Biggest Economy, - Brazil has already seen its export sales of iron
ore, ethanol, cocoa, sugar, and other commodities begin to slump. The
recession in Europe and a sharp slowdown in top commodity-consumer China has already resulted in a big shrinkage in Brazil'strade surplus, cut in half to $7.1-billion in the
first six month of 2012, compared with a year ago, and marking the weakest
surplus for that period in a decade. Brazil posted a trade surplus of
$807-million in June, down from $2.95-billion in May and far below the $4.43
billion surplus in June of last year, - the smallest monthly trade surplus
for June since 2002.
Brazil's
economy, - the world's sixth-largest economy has decelerated significantly
over the past 1-½ years. It grew a stellar +7.5% in 2010, its fastest
pace in over two decades, but slowed sharply to +2.7% last year as the Bank
of Brazil lifted its overnight Selic rate to 12.5%,
in order combat an overheating inflation rate. Brazil's economy has been
stagnant during the first half of 2012, and is showing signs of slipping into
a outright recession.
Brazil's industrial output fell for a third straight month in May, falling
-0.9%, and output was -4.3% lower than a year earlier, the largest annual
decline since a -7.6% drop in Sept 2009.
Brazil's
factory sector continued to slump in June. The purchasing managers' index
(PMI) for Brazil's factory sector dropped to an eight-month low of 48.5 from
49.3 in May. Brazilian retail sales fell -0.8%in May, as Brazilians struggle
with rising defaults, which are rising to an all-time high, and in turn, has
prompted local banks to tighten lending. In an effort to stabilize the
economy, the Bank of Brazil slashed its Selic rate
50-bps to a record low of 8% on July 11th, amid a barrage of other stimulus
measures. So far, a deluge of interest rate cuts, tax breaks, and tens of
billions of Brazil reals in subsidized loans, and targeted state spending,
hasn't enabled Brazil's economy to regain its lost mojo.
It's an
ominous sign that Latin America's largest economy is no longer an engine of
growth for the world economy. As such, currency traders have dumped Brazil's
real, knocking it to around 49-US-cents this week, compared with
64.5-US-cents a year ago. The Real is a victim of the year long slide in
commodities, which account for half of Brazil's total exports. Brazil's
exports fell to $19.35-billion in June, or 18% lower than a year earlier.
US-Economy on
Brink of "Double-dip" Recession, The troubles afflicting the
economies of the Euro-zone, China, and Brazil have reached the shores of the
United States. The latest reading Purchasing Manager's Index (PMI) report is saying
the US-industrial sector's engines have gone into reverse. The factory PMI
fell below the 50-level in June for the first time since the Great Recession
officially ended in June 2009, and is the most visible sign yet that the US
is catching the flu that's already afflicting the rest of the world
economy.US-manufacturers have "tapped on the brakes" and are not
sure what lies ahead.
The drop of
12.3-points in the PMI's New Orders Index is the largest since October 2001
(when, in the wake of 9/11, the index dropped 12.4-points) and the second
largest decline since December 1980. Thus we are dealing with an event that
occurs once in 100 reports. The question is whether this plunge in new
orders, reflecting fears over Europe and China (the export order index fell
6-points), will bounce back (as the orders index did in November 2001) or
rather, is it a slide into the abyss of a double-dip
recession?
The
synchronized slowdown in the Asian, European, and US-factory sectors has
taken a toll on the Dow Jones Commodity Index, over the past 14-months. A
surge in Chicago grain markets, in corn, soybeans, and wheat, due to a crippling
drought in the Midwest farm region, has lifted the index in recent weeks.
However, industrial base metals, crude oil, gasoline, and silver prices
remain weak. Commodity and precious metal Bulls are desperately praying for
the arrival of the "Bernanke Put," - or a massive blast of fresh
US-dollar liquidity provided by the Fed, which can weaken the US-dollar's
exchange rate, and give a lift to commodity markets.
So far, the
Fed has frustrated the commodity and US-stock market Bulls, and Gold Bugs, by
refraining for launching QE-3. Perhaps, the Fed aims to stay politically
neutral ahead of the Nov 6th elections, and prefers to sit on the sidelines,
in order to avoid accusations from the Republican Party that its interfering with the outcome of all-important
elections. By launching QE-3, the Fed could artificially inflate the value of
the US-stock market, and deceive the gullible American public with the
illusion of an economic recovery on the horizon. Still, in the opinion of the
Global Money Trends newsletter, the Fed would continue to disappoint the QE-3
addicts, and stay politically neutral, until after the Nov 6th elections.
Gary Dorsch
Editor, Global Money Trends
www.sirchartsalot.com
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