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Shadow Capitalism

Market Commentary by Naufal Sanaullah

Naufal Sanaullah Risk back on as positive US & China data and short
covering in Eurozone sov credit drive markets
Busy day in the markets today as Eurozone concerns took a breather and a backseat to a
barrage of positive dataflow, starting with a big beat in Chinese November manufacturing
PMI (55.2 vs 54.8 expected vs 54.7 prior) that helped boost markets. Significant support levels
in the euro, which I pointed out in last night’s piece, and moving average ceiling in the US
Dollar Index, set up a market ripe for a rally and the data catalysts followed through. A great
beat in US November ADP employment (+93k vs +70k expected vs +82k prior) and a 56.6 print
for US ISM PMI, higher than the 55.5 consensus estimates, helped send markets rallying
further. Upward revisions by GS to its macro forecasts for both US & global growth added fuel
to the fire.

The S&P took off for an over 2% gain today, sending it over the 1200 level I’ve been
mentioning and setting the stage for a rally into year-end, as I’ve been positioning for. The
uptrend technicals are very much intact and 1170 proved to offer a strong floor for the two-
week consolidation in US equity. The Russell also rallied over 2% today and broke out to new
closing highs in what may be considered a cup & handle. A follow-through on today’s move in
equity would be quite bullish and with inflationary issues hitting EM and sovereign debt crises
headlining European markets, US markets look bullish on a relative basis, especially after
recovering from the second-half slowdown with positive data in the last few weeks.
EURUSD found a bid today at the 1.29 support level I’ve been highlighting, and the 200d
overhead resistance in the DXY helped provide some technical selling as well. I noted in my
piece last night that traders may offload some bearish positions ahead of tomorrow’s ECB
meeting and it seems that was the case today. Comments from a US official affirming support
for an expansion of the IMF’s contribution to, and thus size of, the EFSF sent the euro surging
and dollar plunging on suspicions the US would be joining in on the bailout directly, although
this interpretation was soon dispelled, although EURUSD was not negatively impacted.

There is much talk tomorrow of Trichet expanding ECB bond purchases, which I think is likely
and maybe even a consensus opinion by now. However, as I’ve stated in the past, I think that
the ECB has crossed the line into where liquidity fixes can only go so far and addressing
balance sheets is crucial and necessary to stop contagion spillover. As such, I stand by my
view that unsterilized bond purchases are the only feasible option left for the ECB, and will
probably be adding to my shorts on rallies. Although sovereign spreads tightened today, flow
suggested short-covering for the most part and there was little volume in periphery bonds
today, particularly Spanish paper, suggesting little conviction characterizing today’s
tightening. Eurozone GDP also came in-line today, and PPI saw a slight uptick.
Poor data dominated Australian newsflow, as the +0.2% QoQ Q3 GDP print missed the +0.4%
consensus estimates and October retail sales missed big with a 1.1% MoM decline missing
expectations of 0.4% growth. However, positive Chinese data, an overbought USD, and a
bullish technical setup helped propel AUDUSD higher anyway by almost two big figs.
However, AUD underperformed both NZD & CAD today, suggesting weak idiosyncratic
internals, and I remain bearish and holding shorts in AUDUSD and AUDCAD. 9700 will be the
first resistance level to test in AUDUSD, but unless the 55d is recaptured, I think 9500 is
eventually taken out and we head lower. Australian dataflow is definitely weakening and the
inflation and tightening risk from China is going to add fuel to that fire even further going
forward, and the high leverage and asset concentration in the Aussie banking system,
combined with the overvaluations in its housing sector and pervasive & quickly heightening
inability for mortgage financing by homeowners, could see AUD end up embroiled in a
perfect storm. For now, however, AUDUSD could be setting up for a retest of its 55d,
especially if today’s renewed USD weakness persists.

USDJPY reversed yesterday’s selloff with a strong big figure rally today as the risk-on
environment saw a selloff on US govys, with the 10yr note approaching its 200d and the 30yr
bond breaking its 200d and significant support at 125. These are quite significant
developments in US bond technicals and affirm my bearishness in Tsys going forward.

Treasuries and equities are back to their inverse risk-safety relationship, after months of
rallying together due to QE 2 expectations leading to equity buying from risk appetite and
bond buying from front-running Fed demand. Now that the Fed’s second easing program is
underway, the rally in Tsys is being uncovered as a “greater-fool” play (the Fed being the very
willing and knowing greater-fool) rather than a fundamental security-idiosyncratic play, a
theme I’ve written about multiple times in the past.

The BoJ is likely in the black in its September intervention into FX markets, which began over
100 pips below current levels, and the last leg of the USDJPY selloff, in which the
intervention-induced 300 pip rally saw a selloff twice as big in magnitude, may have set up
USDJPY for quite the short squeeze if Treasuries continue trading well on the offer side.
Unsurprisingly, the Nikkei rallied on the JPY weakness and is approaching a breakout of its
own. US & Japan remain the equity markets I’m bullish on and they are looking quite
constructive from a technical standpoint, especially if they can get a follow-through day this
week or next.
Swiss Q3 GDP beat today, posting a +0.7% MoM growth vs +0.5% expected, although a
downward revision to Q2’s print to +0.8% led to YoY figures missing +3.1% estimates by just
10bps. I’ve beginning to get bullish on CHF again, as I think that this iteration of the European
crisis is going to extend past southern Europe into CEE, and with Hungary as the big wild card
I am watching (and its homeowner base leveraged into one big CHF-funded carry trade with
its HUF-denominated income), I like CHF in 2011 and think it could outperform USD even as
the European crisis continues.

Technically, USDCHF is retesting important S/R at parity and after breaking down from a
massive multi-year triangle in September, I think the retest is a great buy opportunity in
Francs and potentially preceding a sharp selloff in Swissie next year, and more importantly,
presenting a very attractive risk/reward profile for such a trade.

UK data was very bullish today, with November manufacturing PMI rising to a very
respectable 58.0 vs expectations of 54.6, bringing the composite index to 1994 highs and the
employment component to series (post-ERM withdrawal) highs. The strong dataflow in
recent weeks could make GBP a risk currency of choice going forward, and unless and until
Cameron’s austerity plans negatively affect growth figures, the BoE won’t have to worry for
further monetary easing for the time being. Technicals remain bearish, however.
Despite less-than-expected drawdowns in distillates today, crude surged over 3% today and
will soon be challenging the $87-88/bbl resistance level that it hasn’t been above since
October 2008. Technicals look compelling from the bullish side in my opinion, and with
inflation as bad as it is in EM, and the debt-deflationary risks amply addressed and quelled
with pervasively expansionary monetary policy, I think the supply/demand dynamics of global
energy are back in play and triple-digit oil prices will characterize 2011’s energy complex
performance. 2010 saw very sideways oil market, after a rebound in 2009 with everything
else, but given the outperformance of EM in 2010, energy’s relative weakness probably
represented a purge/unwind of a lot of technical dynamics like the contango basis trade that
caused a lot of one-time hoarding demand on tankers. This sets up for a strong 2011 if
fundamentals continue to be bullish. The current technical pattern does indeed target over

Speaking of inflation, ags performed very well today, with wheat rallying over 7% on worries
that Australia’s rainfall may affect its harvest. Soybeans and corn rallied strongly as well, and
the UN’s announcement today that food prices are at two-year highs underscores the EM
inflation theme that I’ve been looking for and recently finally getting the technical
opportunities to trade on as well. Precious metals, due to the tightening in European credit,
underperformed, but did not post sharp declines like the USD.
One quick note about inflation: I am in the camp of food/energy inflation, while bearish on
industrial metals, particularly copper (although I was looking for a short-term breakout last
night and added a bit to my NZDUSD to hedge my /HG short, which worked out well).
Demand inelasticities are what I’m targeting with this bout of inflation, and although the
food/energy supply/demand story is well-known, the inflation from global monetary policies
is not fully discounted. In April, the market was discounting a hike in the Fed Funds rate by
year-end, but little did it know that the Fed would be two months into a second round of QE
by year-end. Two months ago, the ECB was talking about “exit strategies” as the topic to be
discussed in its December meeting, although as we now know it will be talking about
extending the bond purchases program rather than unwinding it.

The markets are coming around to the fact that the expansionary monetary policies from
central banks aren’t one-time responses to crises; central banks are engaged in an all-out
competition for a growth pie that’s diminishing, and the abundance of liquidity will chase
food & energy, the demand-inelastic items whose demand curves won’t be altered drastically
due to the rising prices (thus maintaining the high prices), while the supply sides of these
commodities, although well-known issues like I said, exacerbate the concern. 10% food
inflation in India & China are testaments to that fact. However, other commodities,
particularly China demand-linked industrial metals, could face sharp selloffs as the Chinese
slowdown begins in earnest and tightening becomes increasingly necessary to combat
inflation that the PBoC is a step behind of.

Below is a chart from Albert Edwards’ latest missive, mapping the Chinese OECD leading
indicator on top of the Thomson Reuters Equal-Weighted commodity index. Unlike most
commodity indices, which are very energy-heavy, this index is equally weighted between
energy, metals, softs, & ags, and in fact has a higher weighting for metals than energy. The
chart below suggests that the leading indicators are pointing toward a sharp decline in the
commodities index, which I agree with to a certain extent, in that I expect the China-driven
commodities (metals) to selloff hard but the energy & ags to remain supported by Western
CB flooded liquidity and their demand inelasticities. As a side note, although the Thomson
Reuters CCI below is at 2008 highs (mainly due to very bubbly price action in copper and
such), other well-known commodity indices (like the S&P GSCI) are nowhere near 2008 highs,
due to being overweight energy, which has a lot of room to cover still before challenging
2007-2008 levels. Putting all of this together helps to understand why I am long crude and
short copper.
The ECB meets at 7:45 AM ET on Thursday, the results of which will be very significant to all
global markets, while US pending home sales figures for October and initial jobless claims for
the week ending November 27 round up tomorrow’s dataflow. The potential for expansions
in the ECB’s bond purchase program and/or the introduction of the “Eurobond” (which may
or may constitute a credit event as defined by the ISDA, as CheekyBastard notes, and also is a
“stealth” form of QE in my opinion) will be key facets to watch tomorrow, as well as new
growth forecasts from the ECB.

To round up tonight’s piece, I’d like to bring up an interesting FT article that quotes Assured
Guaranty’s CEO claiming rough times ahead for banks due to MBS putback risk:

“The numbers that have been recognised to date are very low compared with what
the ultimate liability will potentially be [for banks]. This saga of mortgage dislocation
has a lot more chapters to play. There are a lot more layers to the onion that still
need to be peeled back and looked at. I think we’re at the tip of the iceberg.”

I mentioned my bearishness on BAC yesterday (and multiple times in the past) due to the
large MBS putback risk it holds, especially with the Kemp case with a BofA exec testifying that
Countrywide did not transfer the note properly. If Wikileak’s reported bombshell leak due for
early next year does indeed target BofA, things will get very interesting, and with Paulson
dumping shares, I feel comfortable holding BAC short.

As an aside, Assange’s Interpol arrest warrant is more of a publicity stunt than anything else,
in my opinion, as he is wanted as a witness, not as a convicted felon-at-large by any means,
and has yet to face formal charges due to the limited evidence and the unique nature of the
crime in question (it is not considered a crime, as presented by the allegations, in the US and
his native Australia in fact). As such, I don’t view litigation risk to Assange as a risk to
Wikileaks’ plan to release documents relating to “a large US bank.”
OPEN Long STT | 43.50 | stop 41.80 | +2.99%
Long PCAR | 54.95 | stop 52.00 | +1.69%
Short APOL | 51.90 | stop 54.00 | +33.62% Short FRO | 26.10 | stop 27.00 | -0.23%
Long VECO | 39.00 | stop 36.30 | +15.26% Short CCE | 24.00 | stop 25.75 | -3.25%
Long USD/JPY | 80.75 | stop 79.85 | +340 pips Long /CL | 85.00 | stop 82.80 | +2.00%
Long ACAS | 6.67 | stop 6.25 | +11.54% Short /NG | 4.33 | stop 4.55 | +0.46%
Long CAD/JPY | 79.60 | stop 78.55 | +340 pips Long SINA | 63.75 | stop 62.05 | +5.03%
Short EUR/CHF | 1.3725 | stop 1.3490 | +600 pips Short JKS | 25.65 | stop 27.90 | +14.19%
Short BP | 42.40 | stop 44.80 | +4.20% Long CLW | 80.80 | stop 78.50 | +0.67%
Long USD/HUF | 195.45 | stop 192.70 | +155 pips Long IO | 7.03 | stop 6.64 | +8.96%
Short ACOR | 28.00 | stop 28.70 | +5.46% Long /ZW | 690.00 | stop 675.30 | +8.26%
Short /HG | 4.06 | stop 4.15 | +2.22% Long /ZC | 550.00 | stop 541.90 | +2.23%
Short AUD/USD | 0.9980 | stop 1.0075 | +300 pips Long BHP | 82.55 | stop 80.90 | +3.59%
Long SGD/JPY | 63.60 | stop 62.95 | +60 pips Long NZD/USD | 0.7440 | stop 0.7390 | +100 pips
Long SNE | 33.70 | stop 32.30 | +8.22% Short GBP/SEK | 10.905 | stop 11.115 | +50 pips
Long HIT | 47.35 | stop 44.80 | +2.03% Short EOG | 89.00 | stop 93.10 | -3.25%
Long /NKD | 9768.00 | stop 9686.00 | +5.41% Short CHK | 22.00 | stop 22.70 | +2.68%
Short REV | 10.50 | stop 11.20 | +4.10% Long X | 48.10 | stop 46.40 | +4.55%
Long EK | 4.79 | stop 4.30 | -1.88% Long PUDA | 13.60 | stop 12.35 | +13.09%
Long AMR | 8.22 | stop 7.90 | +4.99% Long MEE | 49.10 | stop 47.25 | +1.02%
Long N | 24.00 | stop 23.20 | +5.29% Long BTU | 58.00 | stop 55.00 | +4.97%
Long LVS | 49.30 | stop 43.50 | +4.14% Long SVM | 12.35 | stop 11.20 | +2.83%
Long TGA | 14.65 | stop 13.45 | +16.45% Long AGQ | 130.65 | stop 117.00 | +4.74%
Long NOG | 22.20 | stop 21.80 | +5.41% Long RIMM | 60.50 | stop 57.70 | +2.18%
Long USD/SGD | 1.3085 | stop 1.3015 | +15 pips Short BAC | 11.20 | stop 11.40 | -0.80%
Long AAPL | 307.50 | stop 395.35 | +2.89%
Long CSTR | 63.45 | stop 58.15 | -0.14% CLOSED
Long MAT | 25.25 | stop 24.80 | +1.47%
Short ARG | 63.50 | stop 64.90 | +2.46% Short LMT | 68.30 | cover 68.70 | -0.59%
Long DG | 32.35 | stop 31.30 | -0.12% Short XRX | 11.50 | cover 11.65 | -1.30%
Long SNDK | 42.95 | stop 40.35 | +9.20% Short PIN | 23.75 | cover 24.45 | -2.74%
Long SSYS | 33.50 | stop 33.10 | +2.87% Long URRE | 2.90 | sell 3.80 | +31.03%
Long CMCSA | 20.15 | stop 19.70 | +3.37% Long MOTR | 30.90 | sell 29.40 | -4.85%
Long REGN | 29.25 | stop 28.35 | +0.82%
Long VSAT | 40.75 | stop 39.90 | +2.45% NEW
Long THRX | 21.65 | stop 20.55 | +16.77%
Long XEC | 81.00 | stop 78.15 | +3.38% Long XTXI | 9.35 | stop 8.95
Long FWLT | 28.30 | stop 27.00 | +3.32% Long SWC | 19.80 | stop 17.85
Long GRA | 33.40 | stop 31.00 | +2.31% Long PRX | 37.30 | stop 35.50
Long UAL | 28.10 | stop 27.00 | +0.96% Long AIN | 21.80 | stop 20.80
Long VSH | 14.15 | stop 13.30 | +5.80%
Short GBP/USD | 1.5700 | stop 1.5850 | +70 pips
Long CHF/HUF | 208.00 | stop 205.00 | +35 pips If you would like to subscribe to Shadow Capitalism Daily Market Commentary,
Long NG | 14.05 | stop 13.50 | +3.77% please email me at to be added to the mailing list.
Long SLW | 34.80 | stop 32.80 | +8.91%
DISCLAIMER: Nothing contained anywhere in this commentary, including
Long DNN | 2.85 | stop 2.60 | +18.95% analysis and trade ideas, constitutes or should be construed as investing or
Long CIE | 10.85 | stop 10.10 | +6.45% financial advice, suggestion, or recommendation. Please consult a financial
professional and do due diligence before engaging in any purchase or sale of