This article is a guest contribution from Kristian Kerr, F/X Concepts, the world's largest currency hedge fund.
With the exception of wheat and a few other non-raw materials, commodities have maintained an almost unprecedented correlation with equities over the past few weeks with moves in the GSCI and CRB matching the S&P 500 seemingly tick for tick. This relationship has actually been quite tight since the start of the financial crisis with the statistical correlation between the S&P 500 and the CRB at an historical high. Such a tight correlation for such a long period of time is rare and we can’t find another instance with the data we have available. It suggests commodities are solely being evaluated on the greater macro
economic prospects as opposed to the individual commodity’s supply/demand picture. A similar occurrence can be seen in the stock market where individual equities are showing their highest correlation to the broader indices in over 20-years i.e. an individual company’s prospects are no longer really being evaluated but rather the market is making its wagers almost solely on what the broader economy is expected to do. In essence everyone has become a macro trader these days. “So what?” you might say. It is just a new regime. This might very well be true, but its implications are very negative. In an improving environment where fiscal and monetary initiatives were actually working and liquidity expanding, one would expect correlations to gradually begin to subside.
With so much money flooding the system, investors should be combing different markets in search of value. This clearly isn’t happening and suggests policy isn’t really working and we remain in crisis. This should be quite negative for all things pro risk including the commodity currencies which, not surprisingly, have high correlations with stocks.
One of the primary beneficiaries of the optimism-inspired rally that started last year was the Canadian dollar. Our cycles say this general period of strength is probably over and an important bottom in USD/CAD is already in place. The cycles argue some choppy trading should be seen over the next couple of weeks with the USD struggling lower, but the support at 1.0165 should easily hold and possibly the closer level at 1.0290. By the week of August 23rd, the USD should then turn higher again and commence a renewed advance into October towards at least 1.0860. Only unexpected aggressive weakness below 1.0165 would mean our call for an important bottom was premature.
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