Broad Themes and Extremes (FCX,UUP,AAPL)
We’re going to revisit some of the themes we’ve been pressing over the past six months, particularly as they relate to the commodities, as it’s there we see the week’s best opportunity to write a trade.
But before we do, a little background.
The current move higher in the dollar is not over. We’ll get more upward pressure over the intermediate term as a function of a number of inputs, and we’ll discuss a few of those below. But take it as near a certainty as you’ll find in the financial world these days, that barring a cataclysmic event in Washington or Wall Street, the buck’s bounce is a buy.
And what does that mean for commodities?
Well, in a world where financial rules and inter-market relationships still applied, we’d tell you that a move higher in the dollar would be negative for commodities.
But today we don’t think so.
And here’s why.
Commodities got a pant-whacking over the past eight years – one that puts AG Schneiderman to shame. Across the board (almost), the entire asset class was trounced. And now, selectively, we’re seeing a return of funds to the ‘thingy’ sector. Energy in particular has sprung to life, but in a number of the base metals, too, the moves have been powerful of late. And this, too, we expect to continue.
First, because the broad flow of funds always moves from popular, overbought items to those that are underpriced and hated. This is a phenomenon that accelerates at the extremes, when the overbought asset is clearly expensive but still adored, while the outlook for the unpopular security is belittled and mocked.
We are currently facing such a scenario. With the bond market signaling higher rates for the foreseeable future, not only are fixed income holders about to take a hit – particularly those who purchased them via mutual funds and ETFs – but the money that would have been invested therein is going to start looking for a happier home.
That money will begin flowing out of the bond world in greater and greater volumes in the months ahead, and with increasing rapidity.
Indeed, a rising rate regime is good news only for those who are happy to sit out the move and hold their fixed income securities until maturity, and, of course, eat whatever opportunity cost might have accrued by selling now and redeploying to a more robust class of investments.
That said, rising rates are dollar supportive, hence the ongoing surge higher for the buck, as foreign funds arrive to take advantage of better investment opps than their own domestic bonds are offering.
A Third Post
The world of equities is the third pillar on which the investment world stands, and it’s there we see some fascinating action.
Oddly enough, the answer to that question is not so straightforward.
The truth of the matter, as pointed out adroitly by fellow Modern Bull scribbler Hugh L. O’Haynew in his screed of just a few days back, is that equities are being both bought and sold in great abundance.
As Hugh goes on to explain, however, the few big names into which the vast majority of funds are flowing is, indeed, lifting the indexes higher, but the rise is coming at the expense of the small- and mid-cap stocks who are experiencing a tremendous outflow at the same time.
In other words, breadth is thinning, and the degree to which investors are concentrating their bets has few historical precedents.
It’s fascinating to watch.
Hugh points out that a full quarter of the investing public is now beholden in one way or another to the biggest tech names that dominate both the financial news and a growing proportion of the market’s daily trade.
For how long folks will be willing to funnel their cash into these names is unknown. What is clear is that when the big FAANG names eventually turn over, when confidence in them falters, the whole edifice will experience a shudder the likes of which old Mort Isaacson felt when he woke up to find a massive wad of Double Bubble stuck to his exit pipe.
Make a Diagram, Matty!
Friends, if we had to put all of the above into a single, oversimplified diagram that charted out the broad flow of funds as we see it unfolding over the intermediate to long term, it would look something like this –
In short, the big winners going forward will be the commodities and big name tech, while the losers will be bonds and small- and mid-cap equities.
Over the longer term, however, the move in the ‘FAANG and friends’ group is not as sustainable as what we foresee for the commodities, so we expect better long term returns from the latter.
And that’s the way we’re playing this week’s trade.
But first, we have one initiative to shut down.
We wrote it on April 19th in a letter called We Are Investment Artists!, recommending you sell two (2) AAPL August 17th 165 PUTs for $4.65 each and buy the AAPL August 17th 180 CALL for $8.60. Total credit on the trade was $0.70.
Today, the CALL trades for $12.75 and the PUTs for $1.92 each. Sell off the former and buy back the latter and you net an unbelievable $9.61 in just three weeks. That’s 6306%!
THIS WEEK’S TRADE
A look at the following two charts, pairing the dollar basket (DXY) against Freeport McMoRan (NYSE:FCX), shows the former’s overbought status, and Freeport’s exaggerated decline over the last three weeks.
As one of the world’s premiere copper miners, with numerous energy and base metal interests, Freeport, we believe, is the best way to play the coming move higher in the commodities.
And while the dollar may be just at the beginning of a longer term uptrend, we expect some temporary weakness, a development that will also spur FCX buyers to move.
We’ll use the PowerShares US Dollar Bullish Fund (NYSE:UUP) to represent the dollar side.- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]
Many happy returns,