Trader thoughts - the long and short of it

The story in Australia right now is around the moves in commodities and the materials sector.

Source: Bloomberg

If you are a momentum, trend or even a quantitative trader, the commodities space is currently flashing red hot. If you are not exposed to the space, then you be missing out on what is arguably the best place to drive outperformance in an equity portfolio right now.

I have highlighted in recent reports that since the 10 January, sellers have pulled the ASX 200 lower from the unwinding of the morning auction, but at 10.28am (AEDT) yesterday, investors and traders pushed into material names. Volume was good, with $6.076 billion turnover through the market and 15.8% above the 30-day average. The bulls will take a market closing at its highs every day, but the big flows were in the mining space. 196 million shares traded (through the sector) was strong, but not breathtaking.

The good-will should flow through again today, with the ASX 200 materials sub-sector likely breaking out to the highest levels since August 2014, and BHP at the heart of this move, looking at an open some 1.7% higher to $27.46. The pure plays will likely rally more aggressively.

One way to look at the outperformance relative to the broader index is through ratio analysis. Here we can the ASX materials sector / ASX 200 ratio going from 1.24x in January 2016 to currently sit at 1.82x - the best levels since mid-2014. Aluminium looks super strong, trading at the highest levels since May 2015, with talk of producers cutting capacity. Copper has pushed 2.5% higher and is eyeing a break of the November highs of $2.75p/lb level, while the bulks have seen modest upside in the overnight session after strong gains yesterday. By way of a guide, just look at Freeport-McMoran (FCX) which has well and truly broken out and is now trading at the highest levels since July 2015, gaining 7.3% on the session. Shorting in this space is ill advised, it is long positions all the way - that is, until price action tells us otherwise.

By way of a lead, the S&P 500 has shown real signs of life and the bulls have pushed the S&P 500 to new all-time highs. A market at all-time highs is bullish and despite the climate of political uncertainty, I still can’t see how we can think of this move in US equities any other way. Earnings are coming in thick and fast, and names like DR Horton and Dupont have reported well. Still, if we look at the sectors, it’s a story of financials, energy and industrials putting in the points, helped by a rise in US treasury yield. Clearly fixed income traders have it tough right now, with yields all over the place!

These leads and the moves in commodities should push the ASX 200 into 5683 on open and through the January downtrend of 5664. Traders will be focused on moves today in copper, iron ore and steel futures (on the Dalian exchange) through the session to give mining stocks another leg up, while FX traders have the bigger event risk in the form of Aussie Q4 CPI at 11.30am AEDT.

If we focus on AUD/USD, we can see clear indecision in the market (marked by the ‘doji’ candle), with price trading in a range of $0.7609 to $0.7554. This makes sense when traders saw US treasury yields moving higher again and we have strong Aussie event risk, with calls from one investment house that a core inflation print of 0.3% (quarter-on-quarter) or below could force the Reserve Bank of Australia’s (RBA) hand in its February meeting. Given the market is pricing in eight basis points of tightening over the coming 12 months, one suspects a number below 0.3% will send the AUD into a tailspin, but I am still highly sceptical it will push the RBA to move in Q1. Low and behold we could even get an upside surprise, a core print of 0.7% quarter-on-quarter would really get the hawks excited. Remember the analysts have a poor record of forecasting quarterly inflation. As Citigroup point out, since 2010 we have seen 27 quarterly prints and over a third of them (on core inflation) have missed forecast by 0.3% or higher.

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