There's How Much Sand In The Concrete?

  • Market Overview

Equity markets limped to another modest close higher on Friday in the US with energy and precious metals consolidating their impressive gains over the holiday period. Volumes were light however and will continue to be today, with New Years Day falling in the middle of the week. Strong directional moves at this time of the year should always be taken with a grain of salt with so many participants, either away, or having closed books for the year-end. Those foundations may have rather too much sand in the concrete for comfort.

The main driver continues to be an apparent impending signing of the US-China "phase-one" trade agreement in January and the ensuing boost to world growth that should follow. Whether that growth materialises or not, will be a story for another day, but one area it did make its presence felt was the currency markets on Friday. On a moribund day, the dollar endured its worst day in four months; the Dollar Index fell 0.63% on Friday, as the Euro and Sterling made substantial gains along with the trade-sensitive Australian and New Zealand Dollars.

The fact that the FX market has awoken from its slumber over the holiday period is a red flag for me about its longevity. Low volumes and below-average liquidity do not structural turns in markets make. That said, if a dollar sell-off continues into January on trade euphoria, I shall not be disappointed. The first significant moves of a new year, are more often than not, the wrong ones. With the Federal Reserve on hold for 2020 as the rest of the world cuts rates, and with US 10-year treasuries yielding 1.90%, dollar bears will find 2020 hard going.

South Korean data was mixed this morning with Industrial Production for November falling a more than expected 0.50%. An impressive bounce in November Retail Sales of 3.70% has offset that with the Kospi edging higher in early trade. The data calendar for Asia is now bare with official China Manufacturing PMI tomorrow, and the Caixin PMI on Thursday, along with Singapore Q4 GDP is the week's regional highlights.

North Korean sabre-rattling into the year-end seems to be weighing on Asian markets initially, with its leader still obsessed with external security. The fact the markets are paying any attention to the rhetoric again emphasises how quiet underlying activity is.

Equities

Asian markets are stubbornly refusing to join in the last gasp trade euphoria prevalent on Wall Street. The picture is mixed this morning, with the Kospi, Straits Times and Hang Seng edging higher. The ASX 200 is lower by 0,50%, likely driven by a strong rally in the AUD on Friday. The Nikkei 225 is down by 0.50%, weighed down by profit-taking and nervousness over a potential North Korean missile test.

The overall picture is one of book squaring and profit-taking in Asia with investors preferring to wait until next week before loading up on the first trades of a new decade.

Currencies

The US dollar fell quite sharply on Friday against most majors except Japanese Yen, and also lost ground against the Mexican Peso. EUR/USD climbed 80 points to 1.1175, its best one-day performance in two months. It has climbed further this morning to 1.1195, with options strikes and stop-losses no doubt lurking around 1.1200. As the ugliest horse in the economic glue factory in 2019, traders appear to be betting that an interim trade-deal will spur growth in Germany as China recovers.

Earlier in the year, I noted that President Trump's tariff turrets would swivel towards Europe once he had finished with China. That danger has not gone away remotely, and might even play well with voters in an election year. Investors should tread carefully in EUR/USD above 1.1200 and should keep the ejection handle close-by if we break above 1.1300.

GBP/USD broke back above 1.3000 and climbed to 1.3085 on Friday, marching higher to 1.3105 this morning. The post-election cleanout of long positioning has run its course with GBP/USD set to settle into a more balanced 1.3000/1.3200 range in the new year.

The AUD/USD and USD/NZD have both continued their Friday rallies this morning on improving trade sentiment. USD/JPY has fallen 0.20% to 109.25 with formidable resistance at 109.75. Should the Yen weaken on a safe-haven unwind, a break of 109.75 implies that USD/JPY will settle into a new range above 110.00.

Regional currencies should feel some benefit from the dollar sell-off against the majors on Friday. But with equity markets refusing to join the Wall Street FOMO trade, gains will be limited, and we can expect a quiet week ahead.

Oil

Oil had a quiet session on Friday with Brent climbing 0.40% to $68.20 a barrel and WTI unchanged at $61.65 in a low volume session. Both contracts have edged higher this morning in Asia with activity very light. North Korean concerns should lend some support to both contracts in Asia, absent any other headlines.

Brent is clearly targeting a test of $70.00 in the new year as global recovery hopes and OPEC+ enhanced production cuts. While both the Brent and WTI futures curves are in backwardation, and supportive of prices; it does imply that much spec-long positioning is parked into the front end of the curve. US shale will be positively drooling over these levels, and we can expect futures-based hedging of future production to pick up markedly in the New Year. For this reason, oil may have seen the best of its rally as 2020 begins.

Gold

Gold finished unchanged at $1511.50 on Friday but has edged 0.30% higher to $1515.00 an ounce in early Asian trading, assisted by low volumes and liquidity and North Korea nerves.

I will admit that I have got gold utterly wrong in 2019, expecting it to finish closer to $1400.00 an ounce instead of $1500.00 an ounce. I do remain suspicious though of the recent rally over Christmas which seems driven more by a lack of liquidity than a change in fundamentals.

That said the market is always right, and here we are, near 3-month highs. Resistance just above at $1520.00 an ounce is formidable. A break will no doubt see more algorithmic buyers and stop-loss buyers emerge. Therefore, it is quite conceivable we could see gold spike higher again this week and next.

I remain convinced though that the rally is built on concrete with too much sand in it. I sit happily on the sidelines, awaiting the arrival of the structural engineer to inspect the build quality.

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