A Crash Coming?

Copper is about to break through it’s highs. Meanwhile Oil has already broken to new highs. These could be construed as signs of recovery, though I believe it is more a result of a weakening dollar.

Reasons?

Fundamentals continue to be weak for copper.
Massive refining capacity as well as supply looms for oil

———————-

For the sake of ignoring the various red flags though, what if we were actually experiencing a real recovery? I believe that this scenario would bring up circumstances that will prove to be a dead end anyways.

First, with the amount of dollars in the system, and the continued weakening of the dollar, oil will go through the roof, thus strangling the US consumer. The consumer makes up 65-70% of the US economy. Shades of early fall ‘08 come to mind when oil rose almost exponentially and then crashed. The global economy cannot pick up the slack yet. Structural imbalances remain. Domestic economies for exporting countries are not developed. The process of converting exporting countries into self-sustaining economies with stronger domestic economies will take time, not 6 months but rather many years. If the US consumer retrenches, the global economy will eventually relapse again.

Second, if the dollar continues to weaken and is left unchecked, the chance of a currency collapse would begin to rise. The declining dollar and maybe even political pressure could force the Fed to begin scaling back on the liquidity. If the Fed proceeds to scale back liquidity in the system, the dollar would begin to rise. I suspect that the “short-dollar trade” is very crowded. Any sign of monetary tightening would set off a deluge of short coverings and a spike in the dollar. Everyone knows that the stock market has been following the dollar at almost perfect negative correlation for months. A spike in the dollar would have very adverse consequences for the stock and commodities markets.

Also lets not forget that monetary tightening could set off red flags to bond holders about possible rate hikes in the future. This would have very adverse consequences in the bond market as yields would spike thus derailing the recovery in housing.

It seems that any way you look at it, the Fed is trapped. Personally I am leaning not on a currency collapse occurring but rather the fundamental picture finally coming back into play. Everyone is starting to fear a dollar collapse, but no one is talking about how terrible the fundamental picture still looks. Regardless, given the circumstances, I believe that the chances of a major crash occurring are rising.

For everyone that has enjoyed the 60%+ rise in the stock market, I congratulate you. I have been bearish most of the way up. I did forecast a rally (See here), but nothing of this magnitude. I have learned many lessons on the way. The least that I would do though, after making a killing is to scale back some positions or begin to hedge your portfolio.

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