Markets have drifted higher aboard The Great World Cruise of QE2 as market participants debate the classic question – what’s priced in? Readers know where we stand on this one so we’ll resist the urge to add our two cents. But perhaps the better question to ask, is how are speculators positioned? With most of the market leaning over one side of the boat, we feel safer Uncomfortably Alone on the opposite side. See Dave Rosenberg’s comments below:
The Fed’s jawboning has already triggered substantial speculative pressure across most asset classes. The net speculative long position in crude oil has surged to 209,535 contracts (contracts of 1,000 barrels). To put that in perspective, the largest net long position by non-commercial accounts on the Mercantile Exchange in 2008, when crude touched $145/bbl, was 152,282 contracts. Talk about danger levels of speculative activity — it is 40% higher today with oil at $80/bbl than it was back then at the price peaks.
The net speculative longs in copper are now 24,017 contacts. Platinum and palladium are off the charts (25,639 and 15,379 contracts, respectively). Corn is at 449,834 net longs. Gold is at a record 282,254 net longs. The net speculative long position in the Aussie dollar looks nuttier than it is in the case of the loonie — 67,788 net speculative long contracts. The net speculative long position in the yen (45,927 contracts) is in the upper end of the historical range even though the Bank of Japan is doing everything but wield a machete at the currency to weaken the thing.
Meanwhile, what are speculators short? The bond (8,261 contracts) and the VIX (17,176 contracts — the sixth largest ever; talk about complacency).
Anecdotal evidence appears to be largely consistent with the data above. At a recent Investment Roundtable we attended, full of nearly 70 institutional investment managers in the region, nearly every hand in the room went up when asked about those increasing their allocation to international and emerging markets. We were one of two or three Uncomfortably Alone in the room and willing to admit that we were cutting back. This is not to say that we are not believers in the long term secular growth dynamics of emerging economies. We all know that the world can’t depend on the G7 to pull us out of this funk. But this does not mean we can ignore price or sentiment. We were constructive on emerging equity markets early in 2009, as we discussed in the First Quarter 2009 Broyhill Letter. We still believe that Blowing Bubbles in emerging markets may well develop into the next Financial Mania. But after a QE-induced Melt Up in the Reflation Trade, investor fear has been quickly replaced with greed. And greed has an unfortunate habit of making investors blind to risks. We encourage folks to open their eyes and look at the one-way bets illustrated below. There is still a good chance that the Presidential Cycle sets us up for a powerful run over the next twelve months, but it’s difficult to imagine that run starting from today’s overbought extremes with wildly optimistic sentiment. An abrupt decline that cleared overbought levels and injected renewed fear into the psyche of speculators, might provide a better base for the typical Third Year Boom.
Disclosure: At the time of publication, the author was long Bonds, Gold and VIX and short Australian Dollar, Copper and Japanese Yen , although positions may change at any time.