More Dither than DATHER

Defensive positioning dominated most asset classes to start the week exacerbated by softer China macro data and some escalation of the political tensions in Hong Kong.

And the weaker CNH sent the resources complex lower out of the gate.

The considerable rotation into cyclical and out of defensives lately has pushed value stocks to relative highs for the year. Yesterday was an excellent test for sentiment and provided traders with a fantastic read on near term position tendencies.

The markets went bid on the SPX pull-back given the backdrop of improving US data, and the fact trade talks are in a much better place then they have ever been. The cyclical vs defensive rotation could provide the litmus test for equity market sentiment this week.

However, investors could remain skittish ahead of President Trump’s appearance at the New York Economic Club on Tuesday. This speech could be the main event this week, especially if the President dangles any tangible details about his upcoming meeting with President Xi of China. Likewise, any commentary on the expiring Section 232 auto tariff reprieve will garner significant attention.

Oil markets

The Oil market was, for the most part, following the general run of risk sentiment-driven mostly yesterday by weaker macro data out of China.

Oil markets are still weaker this morning despite the rebound in risk sentiment. However, the main story in oil markets was the news over the weekend of the discovery of new oil reserves by Iran. They were reported to have discovered an oil field containing the equivalent of 53bn barrels of oil; however, it is not clear how much of that is new or commercially viable. In a news conference oil minister, Bijan Zanganeg said that Iran sees a production recovery rate of 10%. The last thing OPEC needs is more oil discoveries given oil’s current level of abundance.

In spite of a large inventory build the net long oil positions on US crude increased last week for the third consecutive week mainly due to the tariff rollback headlines. So without a reaffirmation of progress between the US and China, these new contracts remain susceptible to headline risk and even a long position squeeze.

However, oil might find support, barring any untoward trade headlines, from the falling US rig count, down for the fourth consecutive week and now ~20% below this point last year, but again US-China trade will be the most crucial trigger for oil markets sentiment.

Although fixed income has rallied overnight, it was another rally to sell after the Hong Kong geopolitical effect lessened.

Gold Markets

Gold showed some signs of recovering on Monday after last week’s technical break of $1480, which had held more than five times last month. There was decent buying interest on the move lower due to uncertainty of trade talks and the uptick in geopolitical risk. But the yellow metal fell under pressure again as investors are finding it tough to shake last weeks sell-off when gold was the worst performer across the asset classes, falling 3.5 %. The traditional safe-haven was wracked by a trifecta of negativity: positive trade headlines a resilient USD and rising US real yields.

Still, there is a lot of length in the markets, especially from ETF positions that were built over the summer month, which are spooking market makers as these positions are prone to a long squeeze. Worrisome is that the first indications of a market cut and run are beginning to emerge as Gold ETF holdings registered declines for the fourth straight day as the US and Swiss-based funds saw outflows of 413.45koz and 212.04koz, respectively. Swiss-based gold ETFs saw the highest outflows since June 2013 while US-based gold funds recorded the most declines since early December 2016.

If ETF investors decide to leave en mass that significant weight alone could wrack markets decidedly lower.
I wrote up a more extensive gold outlook here detailing this week’s bearish and bullish triggers, including ETF positioning .

Gold View

Macro data might not justify the recent outperformance of risk assets. Besides, implied volatilities are low across the board. The same goes for position skews and sentiment gauges which are possibly stretched.

As such conditions could be ripe for a risk reversal as the bears may start to add or reengage tactically underweight global equities and overweight global sovereigns, particularly UST’s.

This rotation could send US yields lower, weighing on the US dollar and significantly boost gold sentiment.

The problem, however, is standing in front of a runaway sell-off that is dominated by emotion rather than economic facts.

Currency Markets

Traders are again turning neutral on currency markets possibly dud to the uncertainly around US-China trade talks.

The shift to geopolitical focus is changing the FX trading landscape.

With so much seemingly riding on the resolution of different geopolitical deals – whether it’s the s US-China trade talks or the Brexit Bedlam – currencies markets are now moving less to the beat of interest rate differentials and more about pricing geopolitical binary risks efficiently, so it’s all about RORO ( risk-on risk-off ) these days as geopolitical expectations drive the bus.

Currency View

With tons of trade optimism baked into the US rates, the risk for the US dollar is that the explosion in US bond yields has gotten too far ahead of the economic realities.

USDJPY closely correlates with Fed funds pricing suggesting moves to 110 may require the market to further price out Fed cuts through 2020. Perhaps even completely. This view is possibly a bridge too far given the macro data does not justify the recent outperformance of risk assets. Besides, implied volatilities are low across the board The same goes for position skews and sentiment gauges which are possibly stretched.

As such, conditions could be ripe for a reversal as the bears may start to add or reengage tactically underweight global equities and overweight global sovereigns, particularly UST’s. This rotation could weigh on the US dollar and boost gold sentiment.

This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader