Posted by: Bevan | July 1, 2012

June 2012 Trading Commentary

The great stalemate has continued this month in Europe, however the balance of power fascinatingly continues to adjust.  Increasingly Germany stands alone as the voice of fiscal responsibility, with France now joining the pro-growth agenda that seeks fiscal easing, direct bailouts of Mediterranean banks and central intervention (from the ECB or one of the rescue funds) to lower Sovereign bond interest rates for the likes of Spain and Italy.  Merkel plays a fascinating game of poker, with everyone wondering whether she will in the end blink to keep the Euro project alive a bit longer.  It seems that this would spell doom with the German electorate, but perhaps they would accept even these major sacrifices to keep the illusion of the Euro alive.  It seems that the cost Europe is prepared to tolerate to avoid having to accept that the Euro is a completely unrealistic and untenable project which completely ignores the political economy of Europe just keeps rising.  There will come a time of reality – probably a collapse, but a slim chance of individual Sovereign nations bending over to the will of Brussels.  It seems that this is still some distance away, and becoming more painful with each passing month.

Much the same is happening in the US and Britain as well.  Continued massive experimental interventions by Central Banks have less and less effect.  Eventually someone will realise that at some point significant contractions in the Western economies will occur (in either real or hopefully just nominal terms) to compensate for decades of totally fictitious expansion spawned by financial ‘innovation’ and debt creation by banks.  This statement of common sense reality (to be counteracted only by incredible innovations in productivity or resource discoveries) has not yet sunk in, or at least no-one wants to accept it on their watch.  It is symptomatic of a world where the leadership refuse to analyse the causes of the crisis and aggressively address them, accepting the tough steps required to normalise.

One of the areas where lessons have still not really been learnt is in dismantling much of what we call the ‘financial sector’.  These institutions which played a massive role in the crisis have been soaked in money instead of kerosene over the past few years.  They have also successfully shrugged off most attempts to regulate them, bleating that the big contributions they make to Western economies will  be lost as they head offshore to some unknown location.  In reality they have no-where to go, and much of their so-called financial innovation has in fact brought about the massive debt bubble, along with huge risk taking in the derivative markets.  This month’s debacle with Barclay’s manipulation of the Libor interest rate, along with the ongoing haemmoraging at JP Morgan from the “Whale Trade” are just the latest iterations of what will be a continuing parade of dangerous incompetence.  Until banks are slashed back to their basic economic functions again then we will wobble on towards the next crisis, and at best confidence will not return to the real economy.  It is time for moral hazard to strike at these institutions, and for them to be cleaned out by downsizing or nationalisation/liquidation.

The month has been a successful one for our trading program.  I have tightened up slightly on our risk taking with some outlier trades being excluded that were slightly over the % equity limit which I would have taken before.  In Trendfollowing the best returns usually come from periods of reduced volatility where a larger position can be taken.  The reward to risk ratio in those times where volatility is high, resulting in trades right at the edge or slightly beyond the risk envelope is small.  Although it has resulted in missing the short move in Crude, it has also prevented losses in other markets approaching or exceeding 1R.

Excessive volatility has resulted in us missing this down move in Crude.

June saw two trades closed.  A 10 Year Notes position from April closed with a 1.5R profit.  It would have been nice to see more profit here but with overhead resistance and the constant risk of a significant adverse move with these schizophrenic markets it was a good result.  Even better was the short Euro trade from early May which closed with a 2.6R profit.  A lot of large traders and hedge funds sound like they have really struggled with the Euro as the ‘obvious’ short trade just hasn’t worked a lot of the time, especially with the massive recovery from January onwards.  Trying to second guess what will happen is impossible – there are so many contrary comments and theories.  I have heard targets of 1.15 regularly mentioned, although one bank has a target of 1.40 by the end of the year!   The usual stories of ‘one sided’ trades and ‘oversold’ conditions also always rear their heads in times of crisis, quietly forgotten as the rate continues to fall, until the market reverses and the pundits point to their timely analysis!   It seems the big picture of the Interest rate differential, various forms of Quantitative Easing and perhaps capital repatriation keep resulting in surprising changes in the trend.  Our programme has traded four times over the past six months (1.93R, -1R, -.98R, 2.6R) producing reasonable results given the substantial whipsaws at times.  Although the middle two trades were disappointing, our Trendfollowing methodology did allow us to pull out reasonable profits on the other trades, sticking with them when they looked improbable, and getting out when conditions looked most dire and most commentators believed we were just experiencing a brief relief rally.

It is difficult to foresee what the next month may bring.  I hope for some consolidation in Crude so that if the downtrend continues we can participate.  We have open positions in the Eurodollar (long) and Yen (long USD/JPY) which at the moment don’t look like going anywhere fast – you never know where the trends will come from though!


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