I don’t necessarily think this weekend will be mark the all-out
Shadow Capitalism escalation of this Eurozone crisis, although obviously given
MARKET COMMENTARY BY NAUFAL SANAULLAH
Friday, November 26, 2010
Risk sees a very black Friday as trifecta of periphery
concerns, Korean tension, and cautious RBA sentiments
quell preliminary US holiday retailer optimism
This weekend is shaping up to be quite the significant one as
the illiquid holiday markets sold off pervasively, with a flurry
of high-volume dumping after-hours in US equity and other
risk products. The €85b Irish bailout package is expected to
be completed by this Sunday, but the conditions surrounding
the aid and the efficacy of it in preventing contagion risks
from flaring are hotly contested contingencies that are the
primary concerns weighing down markets today. The Irish
Times reported today that the nine-year EU-IMF joint bailout
loan would carry an interest rate below the 6.7% (150bps
spread to Greek bailout paper) reported earlier, but above
the Greek borrowing costs. However, the more important
news in the article, at least to me, was the following quote
“Officials in the EU-IMF mission to Dublin are examining how
senior bondholders could be compelled to pay some of the
cost of rescuing Ireland’s banks.” Subordinate paper is
already showing implied haircuts of over 60-70% for Allied
Irish & the Bank of Ireland, so there’s no surprise on that end.
Yet the senior debtholders are an altogether different issue,
especially the holders of senior debt guaranteed by the
government. Forced haircuts on that paper would be an
effective haircut on sovereign paper, which would shift the
euro crisis into an entirely new level, and confirm Merkel’s
refusal to back down on her proposed debt crisis resolution
mechanism. There was also news today reporting Merkel
rejected proposals to increase the EFSF’s funding capacity,
which heightens contagion risk to Portugal (and
consequently, and more importantly, to Spain) considerably. I
think Germany will (be forced to) stand down on at least one
of these stances, most likely the proposed haircuts for senior
Irish bank debt, this weekend, but things could escalate very
quickly if the market is not satisfied with developments on
Sunday. At this point, I have no room to judge what will be
the final outcome regarding the Irish bailout’s conditions,
although I am biased toward haircuts on senior debt being
limited to non-government-backed paper, but these
developments confirm to me the permanence of the German-
periphery rift and that the issue of sovereign paper haircuts
isn’t a question of if, but when. I did not add to my euro short
positions today, but will be adding on rallies/bounces and
expect Portugal to eventually need a bailout, as well as Spain.
everything I have laid out above, it is a risk to be considered.
Spain will need a bailout with or without contagion risk, due
to the weakness in its banking system, and is playing out in a
very similar way as Ireland did: initial large government
support in response to the financial crisis, subsequent sever
contagion in policy shift post-misstep, “stress tests” to
promote confidence in its banks, large sovereign paper roll in
2011 but even more acute bank liquidity concerns. Also,
Belgium is a country worth watching that isn’t mentioned
often due there being no “B” in “PIIGS” but with exposure to
Irish debt matching 5% of GDP, extreme policy risk due to the
lack of an effective government since March, CDS spreads
blowing out to all-time highs, and German posturing toward
periphery creditor losses, its prospects clearly show large
uncertainty. As all of this is occurring, Germany’s fifth and
final state to report November CPI, Bavaria, followed the
trend of each of the previous four, showing a 30bps increase
to 1.7%. I’ve been stating recently that I expect sovereign
bond purchases from the ECB to be inevitable by next year
and already BusinessWeek is reporting rumors that the ECB is
buying Irish & Portuguese paper. I am inclined toward
skepticism, given the other more politically practical and
palatable policy tools yet to be attempted or implemented, as
well as the fact that the Bundesbank hawks can easily point
to Germany’s surging headline inflation rates to quell QE talks
for now. I consider it more likely that Germany relents if the
market continues to punish the euro due to concerns about
Portugal, by giving the go-ahead for an expansion of the EFSF.
After all, the Chancellor’s and FinMin’s assurance that the
EFSF won’t expand was in response to proposals of doubling
it, and Weber did note just yesterday that €140b would be a
sufficient increase to cover Portugal, if the need should arise.
But the end-game is quickly approaching. Unless level-1
(cash-funded, rather than EU member-backed) EU or IMF
funding of the EFSF increase materially, and soon, Portugal
will be a problem requiring proactive steps in order to
prevent a run on Spanish bonds from bringing the Eurozone
to its knees. I think the end game is QE in response to slowing
growth figures (a slowing CPI print would help stave criticism
from Berlin inflation hawks), leading to a plunging euro but
also plunging periphery sovereign credit spreads. €265b of
Italian debt, €130b of Spanish debt, and €25b of Portuguese
debt come due next year, and the austerity policies show
now sign of relenting and every sign of expanding in the near-
term.
As per the Korean concerns, tensions are escalating ahead of
the joint US-Korean naval exercises on Sunday, which
Pyongyang has stated will push the situation “closer to the
brink of war.” Although I think this specific statement is potentially filled with fireworks, to HFT arbs unwinding long-
typical sensationalist North Korean rhetoric, as I’ve noted ES/short-GC positions (as per ZH), to the more conspiratorial
before I do think that 2010 is shaping up to be a pivotal point allegations of insider dumping ahead of either senior
in the politics of the Korean peninsula, with several reasons bondholder haircuts in the Irish bailout or significant threat of
but the most important of which is the Chinese factor. As I violence in response to Sunday’s US-S Korea naval exercises
speculated, China is not backing down from maintaining its (in the same vein as China’s threats and warnings against it).
neutral stance toward North Korea and in fact is opposing the Either way, today’s lack of volume prevents the selloff from
naval exercises this weekend, in response to which North affecting my directional bias on US equity too much, but as
Korea has initiated additional artillery exercises in the area. I’ve said before, I think 1200 and 1175 are the two levels that
This, combined with the South Korean defense minister being will determine direction from here upon their breakout or
replaced after the artillery attacks, is lending significant breakdown, and with leading stocks still doing well and
legitimacy to the North Korean strong-arming rhetoric. The showing bullish patterns (CMG rallied another 2.20% today), I
combination of the food crisis, transition of power, revealing have a slight bias to a breakout through 1200 but am sticking
of thousands of uranium-enriching centrifuges, and the strictly to bullish charts and will be shorting US equity indices
recent Cheonan bombing suggest that this is a pivotal time to and weaker single names upon a downside breach of 1170-
a situation that has been more of an annoyance thus far than 1175.
anything else. Sino-American relations are the most
important factor to consider regarding the Korean concern,
and how they develop will be vital to determine the course of
world economics and politics for the next several years. This
is the true significance of the Korean situation and extends
well beyond the bounds of Pyongyang and Seoul. Hillary
Clinton has her first very delicate issue to address with this
situation and how she deliberates with Beijing will be vitally
important going forward. The Korean concerns today sent the
yen selling off and my bottom-call in USDJPY is appearing
correct, for now at least. As I’ve noted before, a continued
rally in USDJPY will inevitably lead to a return to JPY-funding
in carry trades, after the USD dominated carry funding in
recent months due to QE-driven sentiment. In my opinion,
this is bullish for US markets as euro concerns provide less EURUSD today breached the 3300 level I’ve been mentioning,
potential for contagion into US risk assets via the FX channel setting up the potential for a sharp cascading selloff from
(due to EUR selloffs leading to USD rallies leading to unwinds here if this weekend brings about less-than-desirable news,
of USD-funded long-US risk carry trades). but from a technical perspective I still consider it safer to sell
on rips than sell at current levels. Perhaps the 200d will
US stocks sold off a percent in today’s holiday-shortened, provide a near-term bid, but the channel support trendline
illiquid trading session, but a high-volume plunge in S&P defining its rally from summer lows is definitely broken and if
futures after-hours is putting an increased damper on today’s we can get a bounce to the 1.36 area, I will likely take
market session. Further increasing the concern is the fact that advantage of the opportunity by doubling up on my short
there was little correlation in other products on the after- position.
hours /ES plunge, except for a concurrent surge in gold on
high-volume futures buying, matched by an absolute plunge
in the gold volatility index (as very astutely observed by Zero
Hedge), although the intraday chart suggests it may be a bad
print (any readers who can confirm/deny the print in the
^GVZ index are encouraged to email me). So risk down big,
but JPY down as well, with USD getting the safe-haven bid
and gold seeing safe-haven demand on the late futures
dump. Many explanations have been offered regarding the
after-hours action, ranging from traditional reasons of
illiquidity and exposure reduction ahead of a weekend
 AUDUSD also sold off heavily today, down over 140 pips on
One very interesting and seemingly underacknowledged
less-than-hawkish RBA minutes and overall risk aversion from
aspect of the Eurozone crisis redux is its quick spread to other
the multiple bearish themes of today’s markets. The cross
currencies, as USD strength is now leading to selloffs in cable,
broke below its 55d with conviction today, and given that I
Swissie, and other USD pairs that aren’t directly impacted by
consider EM inflation and consequent hawkish policy to be a
the current market themes. GBPUSD sold off almost two big-
very significant and continued theme of 2011, I think
figs today, and I shorted it at 1.57 on breakdown of its 100d
AUDUSD may have topped for quite a while going forward.
and again on its breakdown through October cycle lows. The
Chinese property prices, already slowing down considerably
rising wedge is now confirmed broken down and it will be
due to PBoC policy and a lack of remaining bullish drivers,
interesting to see if more downside materializes from here.
could see a considerable plunge next year as the massive
Again, I expect a similar situation in the UK as the US, where
decline in real rates characterizing 2010 in China gives way to
the lack of fiscal stimulus (in the UK, due to harsh austerity
a sharp reversal next year. Risk is looking bearish.
from Cameron) is compensated by monetary stimulus via a
second iteration of QE. If the BoE confirms my suspicions,
cable is headed much lower as well. Pervasive USD strength
seems to be the name of the game right now.

NZD, which I’d been bullish on (on a relative basis to AUD),

also sold off heavily today, and broke below the 9600 support
level I’ve been pointing out. All bets on NZD bullishness are
now off for me, and USD and CAD are now the only two
currencies I’m long in size.
Speaking of CAD, it sold off over a big fig today on the risk
aversion, although it held up vs EUR & GBP and extended its
rally vs AUD, due to oil prices again outperforming other risk
assets. Crude futures ended the day down about a quarter of
a percent, maintain bullish technical developments in a very
risk-off day.
Today’s Black Friday shopping volume in the US showed
anecdotal signs of considerable improvement from last
year’s, with consumers ignoring rainy weather in several big
cities and lining up at retailers for post-Thanksgiving deals.
One of my long positions, Mattel, posted a 1.10% rally today
(on strong volume considering today’s illiquid half-day in the
market) as news of strong demand for its Sing-a-ma-jig dolls
at Toys R Us provided a lift to shares. In other news,
Wikileaks, whose editor-in-chief & spokesperson Julian
Assange has an Interpol warrant out for his arrest regarding
rape allegations, is poised to release its “Embassy Files,” a
massive document release comprising “unvarnished
assessments of foreign governments circulated to mid to low
level US officials,” as per the FT. The article goes on to quote
Arab media reports claiming “the release could reveal US
support for the PKK, the Kurdish extremist group both
Washington and Turkey classify as terrorist, and that Turkey
failed to control its border with Iraq sufficiently, so providing
indirect assistance for al-Qaeda” and that “US officials had
briefed the UK, Russia, Italy, Israel, Iraq, Turkey, Norway,
Denmark, Iceland, Canada and Australia about the impending
leak” of almost three million documents, whose release date
is still unknown. Exposing undesirable truths about foreign
relations has the potential to be much more impactful than
the Afghan/Iraq war leaks and the “security threat”
counterargument to Wikileaks’ operations holds much less
weight in this situation. Could turn out to be nothing, as I
expected the war leaks to be (although I saw more impact
than I’d expected), but just conceptually this seems like it
could turn out be interesting. By the way, bought a few more
equities today, as I went further net-short in FX positions, and
one new holding I wanted to point out was a long position in
Uranium Resources (URRE), which is a chart play but also a
possible play on a developing N Korea situation given the
nuclear concerns.
Have a good weekend and keep your eyes peeled on the
newswires on Sunday.
OPEN TRADES
Short APOL | 51.90 | stop 54.00 | +33.48%
Long VECO | 39.00 | stop 36.30 | +13.05%
Long USD/JPY | 80.75 | stop 79.85 | +330 pips
Long ACAS | 6.67 | stop 6.25 | +10.19%
Long CAD/JPY | 79.60 | stop 78.55 | +270 pips
Short EUR/CHF | 1.3725 | stop 1.3490 | +445 pips
Short BP | 42.40 | stop 44.80 | +3.47%
Long CEO | 226.96 | stop 210.55 | -3.73%
Long USD/HUF | 195.45 | stop 192.70 | +165 pips
Short X | 47.30 | stop 49.25 | -0.04%
Short ACOR | 28.00 | stop 28.70 | +4.00%
Short /HG | 4.06 | stop 4.15 | +7.45%
Short AUD/USD | 0.9980 | stop 1.0075 | +335 pips
Long SGD/JPY | 63.60 | stop 62.95 | +10 pips
Long SNE | 33.70 | stop 32.30 | +2.76%
Long SBUX | 30.25 | stop 29.40 | +3.00%
Long HIT | 47.35 | stop 44.80 | -0.08%
Long /NKD | 9768.00 | stop 9686.00 | +2.15%
Short REV | 10.50 | stop 11.20 | +4.00%
Long EL | 72.00 | stop 69.30 | +5.30%
Long EK | 4.79 | stop 4.30 | -2.71%
Long AMR | 8.22 | stop 7.90 | +4.84%
Long N | 24.00 | stop 23.20 | +5.61%
Long EXXI | 25.50 | stop 23.35 | +0.61%
Long LVS | 49.30 | stop 43.50 | +1.54%
Long GOOG | 591.00 | stop 579.50 | -0.03%
Long TGA | 14.65 | stop 13.45 | +13.95%
Long NOG | 22.20 | stop 21.80 | +2.25%
Long USD/SGD | 1.3085 | stop 1.3015 | +115 pips
Long AAPL | 307.50 | stop 395.35 | +2.54%
Long CSTR | 63.45 | stop 58.15 | +4.37%
Long MAT | 25.25 | stop 24.80 | +1.89%
Short ARG | 63.50 | stop 64.90 | +2.33%
Long DG | 32.35 | stop 31.30 | +1.24%
Long VIA.B | 37.35 | stop 36.80 | +1.62%
Long SNDK | 42.95 | stop 40.35 | +4.70%
Long SSYS | 33.50 | stop 33.10 | +1.16%
Long CMCSA | 20.15 | stop 19.70 | +0.05%
Long REGN | 29.25 | stop 28.35 | -1.48%
Long VSAT | 40.75 | stop 39.90 | +2.12%
Short LMT | 68.30 | stop 69.50 | -0.66%
Short XRX | 11.50 | stop 11.90 | -2.31%
Long THRX | 21.65 | stop 20.55 | +5.55%
Short MT | 32.00 | stop 33.10 | +0.90%
Short FCX | 99.95 | stop 103.05 | +2.72%
Short SCCO | 42.75 | stop 46.00 | +1.25%
Short DB | 52.60 | stop 54.30 | +4.12%
Short PIN | 23.75 | stop 25.00 | +4.55%
Long XEC | 81.00 | stop 78.15 | +0.87%
Long FWLT | 28.30 | stop 27.00 | +1.71%
Long GRA | 33.40 | stop 31.00 | +1.26%
Long UAL | 28.10 | stop 27.00 | +2.70%
Long VSH | 14.15 | stop 13.30 | +2.26%

CLOSED TRADES

Short /ZB | 133’24 | cover 126’17 | +7’07

Long NZD/JPY | 64.20 | sell 63.50 | -70 pips
Long SOL | 9.50 | sell 9.55 | +0.53%
Short EUR/NZD | 1.7715 | cover 1.7500 | +215 pips

NEW TRADES

Short GBP/USD | 1.5700 | stop 1.5850

Long CHF/HUF | 208.00 | stop 205.00
Long NG | 14.05 | stop 13.50
Long SLW | 34.80 | stop 32.80
Long DNN | 2.85 | stop 2.60
Long CIE | 10.85 | stop 10.10
Long URRE | 2.90 | stop 2.50
Long STT | 43.50 | stop 41.80
Long PCAR | 54.95 | stop 52.00
Short FRO | 26.10 | stop 27.00

If you would like to subscribe to Shadow Capitalism Daily Market

Commentary, please email me at naufalsanaullah@gmail.com to be added to
the mailing list.

DISCLAIMER: Nothing contained anywhere in this commentary, including

analysis and trade ideas, constitutes or should be construed as investing or
financial advice, suggestion, or recommendation. Please consult a financial
professional and do due diligence before engaging in any purchase or sale of
securities.