Thursday, March 10, 2011

If The Gold/Copper Ratio Is Truly A Harbinger Of Market Weakness, Here Are Some Pair Trade Ideas (but what about treasuries?)

Two smart [and actionable! -ed] posts at ZeroHedge yesterday:
Two days ago we pointed out the dramatic change in the ratio of copper to gold, which moved at the highest rate of change since June of 2010. Today, the rate of change is even higher at 4.3%. And with copper starting to seriously take on water, a curious observation emerges: is the gold-copper ratio, which on an inverted basis was virtually a tick for tick correlation conjugate for the S&P, now simply a harbinger of where the stock market is headed. All else equal, once the Chinese exuberance dynamics which appear to have stalled out in copper, move to equities (which as Finisair demonstrated yesterday is only a matter of time) we believe, as the attached chart shows, that the fair value of the stock market is about 120 points lower. Since this is a relative comparison, those who do not wish to trade a single series, can put on a pair trade of short the Gold/Copper ratio (predicting it will decline from the current 3.4 - it is shown inverted on the chart below) and short the S&P in expectation of a compression.

And for those who wish to have nothing to do with the Fed's third mandate in the form of the stock market (which is all), another even more convoluted way to play the current multi-asset mispricing, is to go long the Gold-Copper ratio (expect gold to stay flat while copper declines), while shorting the Gold Miner/Copper Miner ETFs (GDX, COPX)....MORE 
Advice On How To Trade Gross' Treasury Dump From A Former PIMCO Employee

From Brian Rogers at Fator Securities
The PIMCO call
The commentary today is about the bond fund manager PIMCO and the US Treasury holdings in their flagship $236bn Total Return Fund, the largest bond fund on the planet.  An article today on Zero Hedge discussed how as of 2/28/11, the Total Return Fund had reduced its holdings of US Treasuries down to 0%!  (link here)  This is a very big deal and the only time to my knowledge the fund has ever moved total US Treasury holdings to 0%. 

To give this call some perspective, the PIMCO Total Return Fund is managed vs. the BarCap Aggregrate Total Return Index (this is the former LBAGG or Lehman Brothers Aggregrate).  The BarCap Agg index has a total allocation to US Government securities of around 40% (link here).  This means that PIMCO is underweight its bogey in US Treasuries by about 40 % which in the bond market is a MASSIVE underweight.  PIMCO has also reduced duration in the fund to 3.89 years which is the lowest since December 2008 at the height of the liquidity crisis.

Why is this significant?
Having worked at PIMCO for 4.5 years, I can tell you that this kind of a major allocation decision was not reached overnight nor was it reached without considerable debate by every senior member of the firm....MORE