Trader Note

2-way will pay for everything else.

2018-01-08 Week

2018 Predictions - Bonds -Stocks - Food - Real Estate - Gold - Crypto

 

This Week

Look for a sell-off early in the week on S&P and Dow. This would just be a logical pullback after an NFP boost to prices.

Keep an eye on 10 year bond auctions this week. A failure in those markets will carry through to selling action across the board.

    

2018 Predictions

I am not deep into any markets at this point. I continue to take some chops, but I believe many things are overvalued. When that happens, it is best to move into cash and wait for a pullback to provide good entry prices. As such, I don't have any good trades this week, so instead I will give you an idea of what I see for the coming year. Such predictions do not mean very much, so take it as a long term OPINION, not a trading idea.

Central Banks

Interest rates must rise. Low rates stifle savings and reward credit. Longer term, low rates are unsustainable unless markets collapse and move to an entirely cash based system (exchange based for materials). In a collapse of credit, all those that overextended and cannot pay will win. All those that saved will be wiped out. The only solution is to slowly raise rates and drain the weak credit from the system.

This money pump into the system has gone too long. When interest rates rise only slightly, it will shock the system and markets. This puts potential collapse into focus. Over extended banks will fail on their massive derivatives positions, taking savers' money with it. When the banking failure occurred in Greece, savers accounts were looted to pay off banking debts. So get out early or pay the ultimate lazy-tax.

Protect your savings by moving away from banks and capital markets. In a credit locked market, cash is king… but only if you have access to YOUR cash.

Bonds

Only an idiot or central bank would buy bonds. No sound investor wants to lock up their money for 10 years or more at 2% interest or less. Price inflation is often expected to be around 2.5% per year, which is why salaries only increase by 2.2% per year (workers getting shafted in the long term). That means you make less every year compared to the cost of living.

People who save money (there are not many of those left) want to get paid for their sound financial planning. In the olden days, that was done with bonds that paid between 7% and 10%. Any bond paying higher than that was considered risky or junk. Now, junk bonds are often paying less than their risk value implies (5% or less), which will hit risk investors hard when those bonds default.

Money that would normally be invested in bonds (Mutual Funds, Growth Funds, and Diversified Funds) doesn't make much more than the investment fees. Because of that, safe-haven money has sought to invest in other assets. That has meant a mountain of cash boosting prices on other markets (stocks, crypto currency, and hard assets like real estate).

When bond interest rates start to rise, most investors will not care. Apathy for bonds will continue until prices cross 4% for sovereign low risk bonds, and much higher for defaulted junk. However, once bonds are seen as a safe haven investment (store of wins from other markets), then the liquidity will flow back into bonds, driving other market prices lower. This will not happen fast, or soon.

Stock Markets

I have lost a lot of money trading the short side of the S&P. The irrational exuberance in stocks has persisted longer than I expected. That has led me to avoid selling short share markets. I am also not good at cherry-picking stocks (long term), so I tend to avoid share markets unless I see a good chop opportunity (like selling an NFP spike higher).

I have been waiting for a meltdown in share markets for a few years, but saying such a thing does not make it true. Will 2018 be the year that share markets give up? Probably. Timing is always the challenge.

Share prices are overvalued. Many investors have pulled money out of these markets, yet prices move higher. Corporations have issued low interest bonds so they can purchase their own share price driving their prices higher so that board members can get massive bonuses. This pump-and-dump process has an end point that will likely occur this year.

Institutional investors have money in stocks but only to try to hit that magic 7% per year target. That target once was reached with 40% holding in 6% bonds, but now must be hit with an 80% stake in share markets. When the big money houses see an easier way to make money than the share market, expect an exodus from shares that will rival the 1930s crash.

Aside from a cataclysmic event, there are things that will make smart money exit share markets: Higher bond yields, higher stability and accessibility in crypto-currency markets, or a change to the USD as the oil reserve currency of choice.

USD

Russia, China and the Middle East are still working to create an Oil-Currency. This would remove the USD from oil trade, decimating the dollar. That is what happened to the United Kingdom when the pound was usurped by the USD. If that happens this year, then the USA economy is in for a hard fall.

Oil exchange currencies do not happen overnight. There will be a tests of oil crypto-currencies modeled on a basket of currencies and gold. There will be tests of exchange systems that do not need to be process through the SWIFT system (some countries are locked out of SWIFT because of embargos). So once an agreement is met, expect there to be a massive selloff in the USD. This will be a slow process, and will likely not happen in a single year.

Euro

Brexit is still hanging over the EU. It doesn't seem like any solid agreements or frameworks have been established. So maybe it won't happen ("ignore it and it will go away" policy). However, the specter of countries exiting this agreement will continue to weigh heavily.

PIIGS are still having money problems. Austerity has not boosted employment and local wealth. Civil unrest will continue to plague countries that have had corruption woven into local government for over 2000 years. Austerity only works if everyone believes that it is fair: All governments are corrupt, just to different levels of blatant corruption. So when Brussels calls for further tightening, expect many to want to exit. This has the potential to destabilize the EU and collapse the common market.

High influx of refugees into Europe will stress markets where many are unemployed. This may lead to civil tensions which will be costly to manage. It may even see nationalism rise in Europe, which will push counties away from cooperation.

Aussie Property

I think that the Australian real estate market is the most likely starting point for a world market collapse.

Chinese buyers have propped many real estate markets (Canada & Australia). When that money has fled China, and there is no more dodgy wealth to launder overseas, then what happens?

Chinese buyers of properties that are sitting abandoned will sell those properties. They will want to cash out, and look for more lucrative markets.

In places like Sydney, where some areas have been making 20% per year for over 10 years, this will put huge supply onto markets. In real estate, that sort of growth is unheard of except when being used as a lecture example about a market collapse.

A collapse in Australian property is expected, but may hold through the year (unlikely). The AU government has "negative gearing" which means that they let people write off investment property on their taxes. This has meant that the wealthy have snatched up any property they can get a loan for. It has also meant that the Aussie government has to find tax revenue elsewhere (petrol is twice the price of the USA, cigarettes are over $30 per pack and a 6-pack of beer is $15). The Australian government makes much of their real estate taxes from the sales of properties, so in an up or down market they will not move on property based on tax revenue. As the wealthy are the big winners from a property boom, most of the friends of the government have also made money on property. Expectations are low that they will pull negative gearing payouts.

That said, the Aussie property market is setting up for a collapse to rival the 1997 Asian financial collapse when Thailand real estate collapsed (followed by 1998 Russian default). Currently, prices are stagnating. As supply comes onto market (there are 250 cranes in Sydney but only 25 in Los Angeles) and buyers cannot afford prices, then prices will slide. Smart investors will exit their property early, further depressing price. Interest rates will rise, causing leveraged buyers to default. Banks will be stuck with properties that they cannot sell without destroying their own market. Credit will lock up as leveraged banks collapse (the AU government cannot afford to bail out the Australian banks like the USA did in 2007) and only cash buyers will be in that market. Cash buyers will only be looking for bargains, and at 20% per year rise, bargains prices are going to be less than half of current prices.

During such a collapse, the Australian dollar will be sold off into low levels. This will make the Aussie mining sector more attractive, if it can survive a seized credit market. Mining, resources and farming all do well in a low AUD situation, however they are also highly dependent on credit to function. Without that credit, many big players will be forced to shut their doors (layoffs, scarcity of products, collapsing infrastructure), leaving cash rich players to profit from higher prices and higher exchange rates (cherry picking is the challenge).

Misguided politicians touting Australian Nationalism will discourage overseas investors, leaving markets stalled for longer than necessary. So a smart overseas investor should establish themselves now, before the lock-out occurs. There will be many resource and food-producer bargains in the near future.

Food

Food prices will rise.

Grain prices have been quite low due to decent yields. However, the rule of thumb on a farm is 7 years of fat and 3 years of lean. Weather events will hit production, causing problems with supply. Supply chains disruptions will effect farm prices as transportation costs rise. Diminishing stockpiles from big harvests will give rise to higher prices. This may be a good year to take a broader long term buy side position on food.

Meat and softs are higher in price that expected at this time of year. This implies that dollar weakness has entered these markets. Inelastic demand side of food (everyone wants to eat) means that the supply side is where the price action will center the focus. Producers taking early profits on futures and physical markets will likely push prices moderately lower, but those prices have a high probability to move higher after that profit taking.

I love the spring Hog trade. That is where winter pushes down the futures price before summer demand comes in to boost markets. Current prices for Hogs should be lower, which implies a higher baseline for summer trade. By that I mean that summer prices may hit levels that shock markets, but look for a price dip for a long entry. Don't go in overweight or too early as markets can and do change their early opinions based on the real supply data about markets.

Gold & Silver

Gold and silver prices are starting to move higher. Gold should be seen as a store of value against currency and market failures (banking collapse and government collapse). As markets fail and fear becomes more prevalent, then expect gold and silver prices to climb.

Trading the paper gold market must be done expecting it to be slammed by short sellers. So if you are protecting wealth, then buy physical gold and silver.

If you are trading the long side, look to buy long dated option (wait for a dip to get a good long entry price). Exit well before the date of expiration (shift to later expiry dates if you like this trade).

Historic gold and silver demand (money hedging against government stupidity) is now flowing into crypto-currencies. So lower your expectations on the height that will be achieved by the gold price.

Crypto Currencies

These markets are awash with speculative money. I am still expecting a near-term pullback in price as big players take some profits. However, speculative demand seems to be higher than I expected, so price dips will be limited in scope. If speculative money (high risk money) is entering the crypto markets, then who is buying stocks at these prices?

Volatility will continue to be high in Crypto markets. As the market matures, early speculative trades will wash out (collapse) leaving many new traders out of pocket. Cherry-picking the winners will be a challenge to this market place, just as it was when the internet boom happened. If you are holding crypto as a hedge against broader markets, look to primaries (Bitcoin and Ethereum) for value.

Mediocre software and frequent outages to crypto markets make opportunities hard to trade. This market also suffers from platform arbitrage. That means that trading sites have variations on price that can often be extreme. The price action between currencies (like USD to EU) has upwards of 5% swings, making spreads more appealing. Once these markets become more accessible and stable, these differences in price will disappear (mostly). This will also bring more stability into these markets.

Governments always want a piece of the action. They haven’t figured out how to do that, but expect that they will try to levy fees, taxes and regulation to intervene in these markets. So pull wealth out of these markets BEFORE the government tries to take it from you.

Conclusion

After 10 years of these markets, it is likely that a change will occur. When changing markets occur, traders find opportunities if they are in cash. Thus, take some profits and look for opportunities.

Young traders don't know any other markets, except this grind-higher market. They will be unlikely to capitalize on changing markets, and their amassed fortunes will pass into new hands. When the exodus begins, it will be extended and deep. Avoid getting in too early, because there will be more than one dead-cat-bounce.

 

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