World Out Of Whack: One Of These Is Likely To Break

Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.

Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all its glorious insanity.

While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.

Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.

Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, we are capitalists.

In this week’s edition of the WOW we’re covering oil and the USD

Ok, so I’ve laid out the dollar thesis many times here. Basically, it’s not finished with its bull run. In fact, I think it’s going to surprise even the bulls as to how high it goes in the next few years. In the near term, however, weakness is to be completely expected.

Now that “the Don” has been anointed to the throne, investors will likely take profits on the reflationary trade and dollar bets come off. Do they come off rapidly or slowly where the market can easily digest the selling? I don’t pretend to know.

What I do know is that investors are very long dollars right now so it doesn’t make a lot of sense to try dive into the dollar. But all that said, I also don’t want to be out of what I believe to be a major trend, so I’m still long USD and using it as my base currency for the time being.

Do I care if it gets beaten up in the next 6 months? Not particularly, as my time horizon isn’t a 6-month time horizon.

Part of the rigorous questioning process I go through (because we’re all wrong sometime and someplace, and finding out fast and cutting losses is the hallmark of every great investor) is to look for evidence of being wrong.

And this is where I want to bring to your attention today – the disconnect between the dollar and oil.

We know that oil trades inversely to the dollar.

Now, take a look at speculative long positioning in oil.

Whoah! Something is out of whack!

So now we have a conundrum: The market is long the USD and it’s long oil.

Markets are like wives. They exhibit just three outcomes: Happy (up), grumpy (down), or neutral (sideways).

One of these outlooks is wrong.

Either the dollar longs are wrong and oil goes higher, in which case those speculative oil longs are right.

Or oil goes lower and the dollar goes higher.

The third option is that over time the speculators slowly reduce positions and we get back to levels which don’t exhibit such extremes. That can easily happen. One other interesting factoid is that the physical producers are currently the shortest in history. Hmmm, out of whack!

Clearly someone is wrong here.

It’s times like this that you can either sit out of the market, or you could take a market neutral stance and sell position on both sides of the fence awaiting convergence.

I’m not a short-term trader as I find it too stressful, and I’ve always found the big money never comes from trying to be cheeky on short term bets. Rather, it comes from taking positions on long-term trends, doing your homework, and having conviction to hold through any shakeouts and volatility.

I’ve also found that the amount of work you put in is directly correlated with the amount of steel you will find in your balls because it is often balls of steel that you’ll need to hold through gut wrenching volatility and volatility is seriously underpriced.

For this week’s World Out of Whack I ask the following question:

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– Chris

“Two roads diverged in a yellow wood, and sorry I could not travel both.” — Robert Frost


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