5 Trade Ideas for Q2

21 March 2017

David Cheetham - report Q2 trade ideas

David Cheetham

  • EURAUD - will the euro be able to capitalise on an improving economic situation amid political turbulences?
  • EURJPY - what happens if Marine Le Pen wins presidential elections in France?
  • SPA35 & US500 - are there any opportunities in equity markets that seem to be overvalued?
  • Cotton - prices rallied briskly but isn’t extreme positioning a warning sign for the cotton market?
  • Platinum - precious metals started the year on a strong footing and platinum could benefit from favourable fundamentals
President Trump taking office and the Fed increasing interest rates for the third time dominated the markets in the first quarter of the year. Politics and central banks will remain under the spotlight in the spring but the emphasis will move towards Europe.


EURAUD
Following a period of lacklustre growth over the past few years, 2017 has started promisingly for the euro. Business indicators have been on the rise and not only have the PMI indicators been the highest since early 2011, but the improvement has been very broadly based. If this continues and we see a confirmation from the hard data like industrial output and GDP growth, the European Central Bank (ECB) may be willing to start unwinding its policy even before the year end. In fact, the Bank has already hinted at a possibility of deposit rate increases. In contrast, the Reserve Bank of Australia (RBA) seems to be very reluctant to even consider rate increases and has been content dismissing more rate cuts. The Australian economy has been sending mixed signals with relatively high growth rates and improving trade balance on one hand, but subdued labour market and core inflation on the other. The Australian economy and thus the AUD keep relying on elevated prices of industrial commodities and any pullback on markets like iron ore could weigh on the currency. Interest rates are higher in Australia compared to the European Economic and Monetary Union (EMU) in static terms, but this difference could narrow if the EMU economy retains the momentum of the recovery. In fact, just a revival of short-term market rates for the euro from a deeply negative territory with a stable rates in Australia could push EURAUD higher. Finally, the euro still seems to be offering some politics-related discount and a favourable election result in France (which would be anything but Le Pen win) could buoy the currency in the spring.
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EURAUD has been rebounding from the key support and fundamental factors could be encouraging buyers

 

TRY A FREE DEMO

The ‘Le Pen’ Trade – EURJPY
Presidential elections in France are the most important political event in the second quarter, not only in Europe but for global financial markets in general. There are two rounds and three candidates but one name is especially important – Marine Le Pen. Le Pen, a leader of anti-EU and anti-immigration National Front, promised a referendum on the EU membership within the first six months of her presidency. Such a move would be another blow for an already troubled Union and a Frexit could undermine the project altogether, making Le Pen win an existential risk for the euro.
Markets were increasingly afraid of Le Pen victory in February when her support seemed to be on the rise at the expense of a scandal-hit Francois Fillon. However, a surge in popularity of socialist-backed Emmanuel Macron seems to have decreased Le Pen’s chances. Having said that, polls were unable to properly identify the support trend in the two major votes last year – Brexit and US presidential elections still fresh in traders’ minds, so a reaction to an unexpected result could be very strong. Current polls have been giving an edge to Emmanuel Macron but Marine Le Pen’s position ahead of the first round is still strong and a victory cannot be completely dismissed at this stage. The first round of French presidential elections will be held on 23 April and the decisive second round on 7 May.

Bearing in mind the above, in the case of a Le Pen win, traders could consider taking a short position on EURJPY. The euro could be naturally under pressure and the yen could gain as risk aversion would most likely increase. Note that the intraday move downwards on the pair after the Brexit vote was around 1250 pips.

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EURJPY tumbled massively right after the Brexit vote, and the pair could react in a similar way should Le Pen win presidential elections in France


SPA35/US500
Equities seem to be at a very tricky spot. Valuations seem to be very rich on the majority of developed markets and especially in the US, where the cyclically adjusted price to earnings ratio has been higher only twice in the whole history. The second quarter has also been the weakest in this bull market so far offering a negative return of 1% since 2010.. First of all, the trend has been bullish and it would not seem there are legitimate reversing patterns. Secondly, measures of investors’ optimism are subdued despite indices being at all-time highs. We cannot rule out a continued surge into the overvalued territory. However, there could be some potential in cross market trades, like long SPA35 /short US500. SPA35, representing the Spanish equity market with IBEX35 futures as the underlying, could take advantage of the recovery in a eurozone that seems to be headed towards an eventual acceleration. What’s more, such a recovery chould lift market interest rates from negative territory which could boost banks’ profitability and help indices like the IBEX35. Furthermore, we expect political concerns to diminish after elections in France which could help European equities. Meanwhile, the US500 (S&P500 futures based instrument) is close to a major resistance level and while a lot of positive news has been priced in, investors may face a disappointment at some stage. Markets have been optimistic regarding future corporate tax cuts and infrastructure spending and a smaller than expected or a delayed delivery could spark a correction on Wall Street. Finally, the IBEX35/US500 ratio is 60% lower compared to where it was at the beginning of the decade, which could also be a positive sign for SPA35 in relative terms to US500.

IBEX35/S&P500 relationship

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A relationship between the Spanish IBEX35 and the US S&P500 is about 60% lower than at the beginning of the decade but now the tide could reverse.

APPLY FOR AN ACCOUNT
Cotton
Cotton is one of the most intriguing commodity markets at the moment. Prices have increased by more than 40% since the lows of early 2016 as China decreased output in a bid to reduce outsized inventories – the country has roughly half of global inventories. That translated into the first deficit in this decade last year and helped price recovery. However, fundamentals might no longer look excessively bullish at these higher prices. First of all, inventories remain large – stock to use ratio remains way above the average for the last 15 years. Demand outlook looks subdued. China might increase demand slightly but will use inventories first and therefore imports will be limited. Meanwhile global supply may recover; in the US farmers seem to be moving into cotton in a context of low prices of other soft commodities. Finally, positioning of speculative investors is the factor that suggests that a correction could be possible. The number of long positions is at a record high (by a good margin) and a number of shorts is close to multi-year lows. There have been major repositioning in similar situations on markets like oil, silver or the US dollar recently and cotton could be next commodity in line, unless fundamentals provide more fuel for a rally.

Non-Commercial positioning on the Cotton market

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An extreme level of non-commercial positioning on the Cotton market could be a warning sign for the buyers


Platinum
Platinum is not the first commodity that comes to mind when one mentions precious metals. However, the commodity may have brighter prospects than gold. The platinum/gold ratio was nearly at 1.4 over the past 25 years and there’s good reason behind it. Platinum is more expensive to mine. So called “cash costs” that measure costs of extracting each ounce of the metal are above $1000 for platinum and around $700 for gold on average. Yet the current price ratio is below 0.8 which means that the majority of platinum miners keeps losing money, even before counting research and exploration expenses. The last couple of years were unfavourable for precious metals as the US dollar strengthened and expectations for the Fed hikes increased. Platinum was additionally plagued by rumours of high inventories which were however reduced by declining production. Unlike gold, platinum production is concentrated in South Africa where labour protests could pose a risk of supply disruptions. Looking forward platinum could benefit not only from supply but also diversified demand. Jewellery demand could increase as consumers are lured by lower prices. Gold prices have already benefited substantially from the expansion of the ETF industry whereas these funds for platinum have been less popular to date. Therefore, popularisation of investments in physical metals could be another upside for the commodity prices. Technological changes in the automotive sector, where platinum is widely used in catalyst converters, is both a risk and a chance. A popularisation of cars using lithium battery would be adverse for platinum while a success of fuel cell cars would create a massive demand for the metal.

Outlook for the platinum market

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A balance of risk could seem favourable for platinum prices


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