Shadow Capitalism

Market Commentary by Naufal Sanaullah
Naufal Sanaullah

Earnings  beats  pair  with  strong  Eurozone  PMI  &  Canadian   CPI  data  to  lift  risk  back  higher  
  Yesterday   I   noted   that   given   the   S&P   announcement   and   lack   of   upside   momentum   the   entire   month,   the   doji   bar   to   close   the   day   in   equity   was   very   constructive,   especially   considering   we   reversed   right   off   of   the   100d   in   the   S&P.   Today,   risk   marched   higher,   extending   yesterday’s   intraday  reversal  off  of  the  lows  and  closing  today  at  the  highs.  Strong  Eurozone  PMIs  (composite   and   manufacturing   beat,   while   services   was   in-­‐line)   helped   to   get   some   risk   appetite   going   overnight,   while   solid   US   housing   starts   data   for   March   (549k   vs   520k   expected   vs   an   upwardly-­‐ revised  512k  prior)  and  a  strong  beat  in  March  building  permits  (11.2%  MoM  vs  1.1%  expected  vs  -­‐ 5.2%  prior)  added  fuel  to  the  rally.  Other  macro  data  was  also  supportive,  including  a  big  beat  in   March  Canadian  CPI  (1.1%  MoM  vs  0.6%  expected  vs  0.3%  prior),  which  helped  to  spark  a  rally  in   CAD  and  commodities.   The  S&P  rallied  0.57%  on  the  day,  closing  at  its  HOD  and  looking  very  constructive.  As  I  mentioned,   the   bounce   off   of   the   100d   looks   quite   bullish   and   today’s   follow-­‐through   from   yesterday’s   intraday  reversal  is  a  good  sign  for  risk.  The  1295-­‐1300  level  that  marked  yesterday’s  low  looks  like   it   could   be   representing   the   shoulder   line   for   an   inverse   head   &   shoulders   development,   as   the   February   low   was   less   than   a   point   away   from   yesterday’s   pivot.   A   break   through   resistance   at   1340   would   confirm   the   pattern,   which   targets   S&P   1430,   almost   9%   higher   from   today’s   close.   With  earnings  season  starting,  there  are  plenty  of  catalysts  for  this  pattern  to  play  out  and  I  think   we  could  see  a  breakout  into  new  highs  by  mid  next  month.  


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Manufacturing  data  out  of  the  Eurozone  today  showed  continued  improvement  this  month,  with   the  sub-­‐index  up  to  57.5  vs  57.0  expected  and  the  composite  index  at  57.8  vs  57.0  expected.  The   data  release  early  this  morning  sent  EURUSD  rallying  off  the  lows  and  the  cross  didn’t  look  back  all   day,   up   about   130   pips   since   PMIs   came   out.   German   data   was   especially   strong,   with   April   manufacturing  PMI  coming  in  at  61.7  vs  60.0  expected,  up  0.8  from  last  month.  Despite  weakness   in  the  services  data,  the  strength  of  the  manufacturing  figures  relieved  concerns  of  an  imminent   slowdown  as  the  boost  to  exports  from  crisis-­‐level  EURUSD  starts  to  give  way  for  more  normalized   exchange  rate-­‐based  conditions.   I  continue  to  be  bearish  on  the  Eurozone  on  a  longer  term  horizon,  but  given  the  tailwinds  to  risk   and   inflation   pressures   popping   up   in   commodities,   I   think   USD   will   continue   being   sold   for   the   time  being  and  EUR  has  a  lot  to  benefit  from  that.  The  Fed  is  not  going  to  be  hiking  anytime  soon   (a  third  of  investors  and  economists  recently  polled  by  Bloomberg  think  QE3  is  happening,  in  fact— though  I  disagree),  while  the  ECB  is  one  of  the  more  vocally  hawkish  CBs  right  now,  and  its  effect   on  rate  differentials  is  very  supportive  for  the  euro.  Coming  out  of  a  crisis,  “policy  arbitrage”  is  a   great  strategy  to  employ  in  macro,  as  the  crisis  sets  a  new  baseline  interest  rate  regime  all  over  the   world,  but  the  different  times  it  takes  for  different  central  banks  to  begin  hiking  again  sets  up  big   opportunities   in   carry   trading   due   to   widening   rate   spreads   between   opposite   policy   CBs.   I   think   rates  should  continue  to  drive  EURUSD  higher  for  the  near  future,  and  the  recent  breakout  through   (and   yesterday’s   successful   retest   of)   the   1.42-­‐1.43   level   is   bullish   from   a   technical   standpoint.   I   remain  long  EUR  vs  USD  &  JPY  and  holding.  

  Meanwhile,   USDJPY   has   retraced   almost   four   big   figs   this   month   after   an   almost   1000   pip   rally   sparked   by   the   Bank   of   Japan’s   new   liquidity   injections.     I   noted   yesterday   that   the   155d   could   provide  a  zone  for  USDJPY  to  bounce  off  of,  after  being  the  S/R  level  that  the  February  &  March   highs   sold   off   from.   It   is   currently   bouncing   off   of   the   38.2%   Fibo   retracement   from   recent   cycle   highs,  and  with  risk  assets  looking  bullish,  JPY  could  see  a  lot  more  selling  pressure.  Not  to  mention   the  Bank  of  Japan  has  given  the  all-­‐clear  for  injecting  as  much  as  liquidity  as  is  needed  to  prevent   the   yen   from   surging,   especially   as   March   exports   saw   a   2.2%   decline,   which   was   double   the   contraction   the   consensus   expected.   USDJPY   78-­‐80   is   definitely   the   line   in   the   sand,   as   it   marked   a   significant   low   back   in   1995,   and   a   very   similar   sharp   hammer   off   of   that   level   marks   the   low   USDJPY  has  rallied  from  since  last  month.  If  history  repeats  itself,  USDJPY  will  be  breaking  back  out   of  its  consolidation  by  next  month.  

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  Since   S&P   cut   the   US’s   AAA   rating   outlook   to   negative   watch   yesterday,   the   UST   market   has   actually   rallied,   but   this   may   not   be   as   counterintuitive   as   it   seems.   After   all,   S&P   did   the   same   thing  during  Clinton’s  administration  during  a  budget  impasse,  and  although  nowadays  structural   concerns   weigh   on   US   creditworthiness   just   as   much   as   more   acute   political   factors,   I   think   the   reaction  to  the  news  may  have  been  a  bit  overblown.   After   all,   ratings   agencies   tend   to   be   lagging   indicators   more   than   anything   else.   The   S&P   news   adds  little  new  to  digest  and  the  long-­‐term  unsustainability  of  the  current  US  debt  trajectory  is  not   only   widely   acknowledged,   but   is   now   becoming   a   central   political   issue   that   will   likely   be   a   big   factor   in   2012   elections.   Curve   steepeners   have   outperformed   since   the   headline   hit   the   wires,   likely   due   to   the   spiked   political   environment,   which   could   lead   to   further   near-­‐term   fiscal   consolidation  and  dampers  to  growth.   However,  I  think  the  biggest  driving  force  behind  US  rates  is  the  Fed.  And  with  the  Fed  having  yet   to  suggest  any  continuation   of   QE  past  this  iteration’s  completion  in  June,  I  doubt  we  will  see  QE3,   at  least  anytime  soon.  I  do  think  rates  stay  low  through  this  year  and  most  (if  not  all)  of  next,  but  if   we   see   any   more   all-­‐out   quantitative   easing,   I   don’t   think   it   will   be   unless   we   see   dramatic   risks   to   growth  and  not  until  mid-­‐  to  late  2012.   Since   2008,   the   Fed   has   telegraphed   its   policy   actions   very   blatantly   and   has   allowed   the   entire   investment  community  to  load  the  boat  with  USTs  ahead  of  the  implicit  at-­‐any-­‐price  QE  bid,  as  well   as   offload   the   same   govys   back   to   the   Fed   during   the   actual   easing.   This   time   around,   assuming   no   surprise  QE3  this  year,  there  is  no  bid  to  front-­‐run  and  I  think  US  yields  could  head  much  higher,   especially  in  the  back  end  of  the  curve.  This  could  be  supportive  of  risk,  especially  because  one  of   the  few  USD  crosses  that  would  rally  on  higher  US  rates  would  be  USDJPY  (due  to  BoJ  being  the   only   competition   to   the   Fed   on   low   rates)   and   a   declining   yen   always   helps   to   support   risk   with   some  carry  funding.  Expect  more  steepening  unless  and  until  we  see  some  risk  aversion.  

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  One   risk   asset   I   am   getting   bearish   on,   at   least   on   a   relative   basis,   is   copper.   Chinese   property   prices   are   finally   showing   some   MoM   declines,   with   Beijing   residential   real   estate   price   growth   cut   by   a   quarter   in   March.   Regular   readers   will   know   I   am   bearish   on   Chinese   property   and   consequently   the   commodities   that   are   involved   in   China’s   property   boom,   like   copper.   Just   last   week,  Chinese  CPI  came  in  at  5.1%  YoY,  and  the  PBoC  has  signalled  more  tightening  ahead,  which   will  likely  be  the  catalyst  for  property  prices  to  begin  their  long  descent,  in  my  opinion.   As   the   new     Five   Year   Plan   begins,   with   domesticizing   consumption   at   the   top   of   the   checklist,   further   fixed   asset   investment   growth   and   money   supply   growth   will   be   muted,   if   not   reversed,   and  there’s  just  no  way  to  continue  this  credit  boom  without  sacrificing  the  consumption  power  of   the  Chinese  households.  There  is  a  very  significant  precedent  to  China’s  $3t  in  FX  reserves  and  30%   consumption   share   of   GDP:   1980s   Japan,   which   had   a   similar   reserves   size   to   global   GDP   and   household   consumption   contribution   to   GDP.   Not   to   mention,   the   1920s   US   also   had   a   similar   cache   of   reserves.   Both   Japan   and   America   were   bubbles   in   those   respective   time   periods,   and   both  crashed.   Turning  back  to  copper,  however,  it  is  interesting  to  note  that  after  a  meteoric  rally  in  2009,  led   mainly  by  China’s  massive  late  2008  stimulus  package  (as  well  as  overarching  risk  appetite  thanks   to   QE1),   copper   spent   most   of   the   first   half   of   2010   chopping   sideways,   until   QE2   led   to   a   sharp   rally   to   new   highs.   However,   now   we   have   a   much   different   scenario,   as   China   is   on   a   rather   dramatic  tightening  campaign  and  QE3  seems  very  unlikely.  I  think  copper  could  be  one  of  the  big   underperformers  this  year  in  commodities  space,  and  although  it  is  too  early  to  try  to  call  a  top,  I’m   watching  for  a  break  of  the  channel  support  trendline  below  to  trigger  a  short  entry  for  me.  The   key   level   in   the   grand   scheme   of   things   is   likely   the   $3.60-­‐$3.65/lb   zone,   a   breakdown   through   which  would  be  a  very  bearish  signal  to  me.  Such  a  breakdown  would  have  reversed  the  entire  QE2   breakout  in  copper  prices,  and  will  likely  see  some  high  volume  shorting  from  my  PA.  

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  Moving  over  to  precious  metals,  silver  continues  its  meteoric  surge  that  was  sparked  all  the  way   back   during   last   summer’s   Jackson   Hole   speech   by   Bernanke,   which   was   the   big   telegraphing   of   QE2.   I   have   written   extensively   about   the   merits   of   gold   and   silver   during   one   of   the   most   uncertain   sovereign   credit   environments   in   recent   memory,   and   although   I   continue   to   like   gold   at   current   levels,   I   think   silver   is   at   risk   for   a   sharp   correction   eventually.   Silver   stocks   are   already   lagging,   in   fact,   which   is   a   bearish   divergence.   EM   tightening   will   be   a   big   factor   regarding   this,   especially   as   silver   has   much   higher   industrial   sensitivity   than   gold.   Furthermore,   as   the   chart   below  of  the  silver  ETF  SLV  shows,  we  are  now  on  the  third  consecutive  support  trendline  of  higher   slope,   which   is   an   acceleration   that   usually   ends   in   a   sharp   reversal.   I   was   bearish   energy   &   commodities   in   the   summer   of   2008   for   this   exact   reason.   Contributor   Aaron   Murphy   also   sees   worrying   technicals   in   silver’s   chart,   comparing   it   to   the   mechanics   of   a   rally   during   the   dotcom   bubble.  He  also  employs  trendline  slope  analysis  in  drawing  his  conclusions.  


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Turning   over   to   equity,   I   mentioned   yesterday   that   I   liked   cloudtech   a   lot   at   current   levels   and   today   VMware’s   after-­‐hours   earnings   beat   provided   some   vindication.   VMW’s   Q1   profit   jumped   60%  YoY  and  its  Q2  guidance  also  exceeded  consensus  estimates.  The  stock  was  trading  up  12.48%   after-­‐hours  and  will  likely  break  out  to  new  highs  in  the  next  few  weeks  in  my  opinion.   I  also  mentioned  AAPL  in  yesterday’s  note,  as  the  strong  reversal  hammer  right  off  of  the  115d  on   high   volume   seemed   especially   bullish   to   me.   Sure   enough,   AAPL   followed   through   with   another   1.81%   in   gains   today   and   looks   poised   to   make   a   run   for   $400.   The   155d   is   a   great   moving   average   to  use  for  context  on  Apple’s  chart,  and  it  provided  significant  support  and  a  terrific  buy  point  last   August,  marking  the  cycle  low  before  a  50%+  rally  over  the  next  six  months.  

    NFLX   is   another   monster   stock   I’m   long   and   continue   to   be   bullish   on.   It   has   been   making   a   terrific   base  since  mid  February  and  is  now  poised  for  a  breakout  attempt  through  $250.  A  successful  rally   through  that  level  should  send  the  stock  to  $300  in  no  time,  in  my  opinion.  NFLX  is  a  great  chart   and  the  mini  cup  &  handle  base  it  has  been  making  is  very  constructive.  


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Back  to  cloud  names,  Rackspace  is  one  of  my  favorite  cloud  stocks,  given  its  dominance  in  cloud   storage,   and   its   chart   is   backing   up   the   thesis   with   very   bullish   technical.   Since   breaking   out   late   last   month,   RAX   has   been   basing   in   a   tight   consolidation   and   now   looks   poised   to   continue   its   march   higher.   A   breakout   through   $45   could   send   it   to   $55+   quickly,   and   I   expect   much   higher   prices   than   that   over   the   course   of   the   next   two   years.   Amazon’s   push   toward   music   cloud   lockers   will   lead   to   inevitable   competing   products   from   Apple   &   Google,   and   my   expectation   for   a   revamp   in  software  this  summer  from  Apple  (including  for  iTunes)  leads  me  to  believe  cloud  storage  will  go   mainstream  by  the  end  of  the  year  and  (in  my  personal  opinion)  setting  off  a  bubble.  

  As  great  as  tech  (both  large-­‐  and  small-­‐cap)  looks  to  me  right  now,  commodity  plays  are  where  the   trading   volume   has   been   in   equity   over   the   past   couple   months.   Natgas   is   making   a   serious   bottoming  push,  as  it  approaches  the  apex  of  a  massive  triangle  it  has  been  building  since  the  2008   crash.  As  I’ve  noted  in  previous  pieces,  multi-­‐year  post-­‐crash  consolidations  rarely  resolve  to  the   downside,   especially   after   a   crash   like   2008’s,   which   led   to   several   paradigm   shifts   in   the   investment   community.   With   oil   prices   creeping   up   and   natgas   benefitting   from   some   good   substitution   power,   I   like   the   commodity   and   am   bullish   stocks   connected   to   it,   particularly   Sandridge   Energy.   SD   has   already   risen   dramatically,   more   than   tripling   since   last   summer,   but   if   natgas  is  bottoming  out,  SD  has  a  lot  more  room  to  run.  After  correcting  in  a  sideways  base  since   the  Japanese  earthquake,  the  stock  looks  ready  for  primetime  again  as  it  bounces  off  of  its  55d.  A   break  through  $14-­‐15  should  send  it  much  higher.  


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Ferts  are  also  looking  bullish  here,  and  the  ags  ETF  MOO  appears  to  be  making  a  nice  inverted  head   &  shoulders  pattern.  It  is  important  to  remember  that  although  China  and  much  of  EM  are  hiking   (some  dramatically),  food  and  energy  tend  to  be  some  of  the  most  demand-­‐inelastic  items  in  the   world,   particularly   in   countries   that   import   most   of   their   food   &   energy   (like   China).   As   such,   commodities   like   silver   and   copper   are   likely   more   at   risk   of   tightening-­‐induced   selloffs   than   ags   and  energy.  

  POT,   one   of   the   biggest   names   in   ferts   space,   looks   especially   bullish   here.   After   breaking   out   through   the   very   significant   $50   level   at   the   beginning   of   this   year,   POT   has   bounced   around,   consolidating  its  late  2010  gains,  and  successfully  retested  that  breakout  level.  The  retest  showed  a   strong  hammer  reversal,  right  off  of  the  155d  once  again  (like  AAPL),  and  after  today’s  big  4%  rally,   the   cycle   low   appears   to   be   in   and   the   triangle   consolidation   seems   ready   for   resolution   to   the   upside.  

  Rounding   things   out   in   equity   space,   I   refer   back   to   the   cloud   stocks,   specifically   VirnetX,   which   provides   real-­‐time   communications   services   across   multiple   platforms.   This   is   a   classic   “bubble”   stock,   rich   in   valuation   and   expectations,   but   as   I’ve   said   before,   I   think   the   cloud   bubble   is   just   beginning  and  won’t  really  take  off  until  later  this  year.  In  the  meantime,  VHC  has  a  terrific  chart   and  since  breaking  through  significant  long-­‐term  resistance  at  $20  early  this  month,  it  has  retested    

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the  level  and  found  a  nice  bid  there.  Today  brought  a  12.41%  rally  in  the  stock  on  strong  volume,   and   it   looks   poised   to   attempt   another   breakout   to   new   highs   soon.   I   think   this   could   be   a   real   high-­‐flier   if   my   bubble   predictions   turn   out   correct,   and   I’d   be   a   buyer   even   if   I   didn’t   think   cloudtech   was   ready   for   a   massive   (albeit   unsustainable)   run-­‐up.   From   a   technical   perspective,   I   see  $30  in  the  cards  soon  for  this  stock,  and  eventually  $40-­‐45  this  year.  

  On   the   following   page   is   an   updated   trades   &   positions   sheet.   Because   the   majority   of   the   top   half   is  comprised  of  trades  left  over  from  earlier  (before  I  took  a  hiatus  from  my  commentaries)  that   were   not   stopped   out,   there   is   an   artificial   appearance   of   a   very   high   hit   rate   in   my   trades.   It   is   important   to   remember   that   trades   that   are   stopped   out   are   removed   from   the   sheet,   so   it   is   only   as  good  as  the  positions  Mr.  Market  doesn’t  stop  me  out  of.  With  that  said,  I  think  readers  will  be   pleasantly  surprised  to  see  how  the  positions  (if  any)  they  took  from  my  commentaries  are  doing,   particularly   in   stocks   like   AMRN,   TITN,   &   SINA.   Readers   will   also   likely   be   surprised   at   the   very   net-­‐ long  nature  of  current  holdings,  as  well  as  the  high  number  of  equity  positions  (as  opposed  to  my   bread  and  butter,  FX).  The  charts  are  only  letting  me  get  long  at  this  point,  and  the  few  names  that   I  do  short  keep  getting  stopped  out.   Tomorrow  brings:   • • • • • March  German  PPI  (2:00am:  6.6%  consensus  vs  6.4%  prior  –  YoY)   Bank  of  England  Minutes  (4:30am)   March  US  existing  home  sales  (10:00am:  2.5%  consensus  vs  -­‐9.6%  prior  –  MoM)   US  crude  oil  inventories  (10:30am)   Q1  Australian  PPI  (9:30pm:  1.0%  consensus  vs  0.1%  prior  –  QoQ)  

Good  luck  trading.      

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Trades  &  Positions  
Long/Short   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   S   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   L   Ticker   /ZC   OIH   TITN   NE   /CL   UA   MEE   CRR   SOHU   SINA   BIDU   AMRN   DECK   LULU   CMG   DNR   PCLN   WLL   MRCY   PRGO   CHK   CTXS   SCCO   USD/JPY   EUR/JPY   CAD/JPY   SGD/JPY   EUR/USD   RAX   TSLA   NFLX   SD   SHS   EQIX   VHC   MSFT   MO   NZD/JPY   WES   SGMO   N   AMZN   POT   DHX   Entry   550.00   150.00   21.30   37.65   86.30   57.55   55.55   114.33   80.04   87.55   118.30   8.85   79.92   75.15   240.67   21.60   440.72   63.02   18.70   72.76   30.65   69.61   41.25   78.85   116.60   81.30   62.55   1.4230   35.55   26.15   220.40   10.35   44.95   85.70   21.12   26.05   25.90   66.10   34.95   7.59   29.04   178.38   55.38   16.91   Stop   541.90   138.50   20.45   36.50   83.80   51.55   51.00   105.00   73.00   72.60   109.30   6.75   76.90   71.45   232.40   20.10   409.10   60.00   17.75   71.20   28.50   65.05   42.65   77.70   114.90   79.70   60.10   1.4085   33.45   21.70   202.15   9.15   40.45   82.10   18.65   24.60   25.30   64.00   32.90   6.90   26.75   169.90   50.20   14.95   Performance   +39.60%   +5.31%   +45.11%   +13.12%   +26.42%   +35.19%   +15.91%   +17.43%   +34.60%   +62.65%   +26.71%   +78.75%   +16.52%   +33.41%   +16.28%   +5.05%   +19.24%   +10.90%   +7.38%   +20.13%   +4.34%   +4.28%   +10.69%   +400  pips   +260  pips   +550  pips   +420  pips   +150  pips   +18.65%   –3.79%   +9.60%   +17.00%   +19.51%   +7.53%   +17.09%   –3.45%   +1.85%   –40  pips   +1.29%   +0.79%   –3.75%   +0.25%   +3.70%   +1.12%  

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  Open                   Closed    

Trades  &  Positions  (cont’d)  
Long/Short L   L   S   L   L   S   L   S   S   S   S   L   L   L   S  




Entry 7.22   26.44   154.05   7.05   131.91   12.00   27.93   9.27   66.63   45.40   58.36   30.10   19.95   521.10   1.0135  


Stop 6.45   25.25   158.50   5.65   115.60   13.60   25.25   10.30   74.00   47.05   61.05   28.55   17.20   499.90   1.0260  


Performance –1.94%   +1.06%   +1.42%   –1.28%   –1.05%   –2.33%   +4.55%   +1.51%   –0.60%   +1.23%   –2.14%   +2.96%   +0.65%   +0.01%   +30  pips  


Long/Short               Ticker         Entry         Stop         Performance  

Long/Short   L   S   L   Ticker   EUR/CHF   USD/CAD   TBT   Entry   1.2820   0.9655   36.35   Stop   1.2720   0.9715   34.95   Performance        



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