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Weekend Edition 19-20 March 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as stocks continue to trend higher, with tech stocks storming a sharp rebound on signs of confidence in the U.S. economy by the Federal Reserve.

In brief (TL:DR)

  • U.S. stocks closed higher on Friday with the Dow Jones Industrial Average (+0.80%), the S&P 500 (+1.17%) and the Nasdaq Composite (+2.05%) all up as options expiring on Friday saw a short squeeze that saw traders buy up the bullish sentiment on the U.S. economy.

  • Asian stocks closed marginally higher on Friday as an early rally in Chinese shares started to lose steam by the end of the session.

  • Benchmark U.S. 10-year Treasury slipped to 2.153% (yields fall when bond prices rise) as investors snapped up stocks and Treasuries.

  • The dollar was unchanged.

  • Oil continued to rise with April 2022 contracts for WTI Crude Oil (Nymex) (+1.67%) at US$104.70 after the Kremlin cast doubt on how much progress ongoing cease-fire talks are making.

  • Gold was lower with April 2022 contracts for Gold (Comex) (-0.73%) at US$1,933.90.

  • Bitcoin (+0.24%)rallied over the weekend to US$42,000 in line with the rise in U.S. tech stocks

In today's issue...

  1. Rebound for Chinese Stocks was Signal to Sell

  2. Commodity Markets Are Seizing Up

  3. Bitcoin Stuck in a Trading Channel

Market Overview

Major U.S. stock indices notched their best week since November 2020 as oil prices stayed below their most recent highs and investors took comfort that the U.S. economy would be strong enough to absorb rate hikes by the U.S. Federal Reserve.

Big tech stocks were buoyed by the rally and helped take major indices higher.

A rebound in Chinese stocks on Friday started to fizzle out towards the end of the session, but allowed most major Asian indices to close higher into the weekend.

Asian markets were mostly higher at the close on Fridaywith Tokyo's Nikkei 225 (+0.65%), Sydney’s ASX 200 (+0.60%) and Seoul's Kospi Index (+0.46%) up, while Hong Kong's Hang Seng Index (-0.41%) was down by the end of the trading session.

1. Rebound for Chinese Stocks was Signal to Sell

  • Global investors heading for the exits on Chinese stocks, with some US$6 billion sold this year alone

  • Longer term, global investors will be slow to buy back in on Chinese shares as confidence has been shaken and Chinese markets will need to look to local investors to pick up the slack

Forget about the rebound in Chinese stocks which had some traders betting that the worst was behind shares of some of the Middle Kingdom’s most promising companies, for the bulk of global investors, that was the perfect opportunity to head for the exits.

In the first three months of 2022, a record US$6 billion worth of Chinese shares have been dumped by traders shaken by Beijing’s zero-Covid policy and the risk that Beijing may come on the side of Russia’s invasion of Ukraine.

And even as local Chinese investors have picked up the slack where global investors now fear to tread, thanks to Beijing’s pledge to take a suite of market-friendly measures, it’s not been enough to stem the tide of selling by foreigners.

Berkshire Hathaway, led by legendary value investor Warren Buffett has seen its purchase of shares in Alibaba Group Holdings fall by 25% from the time they were snapped up.

But Buffett and friends are famed for “being greedy when others are fearful,” could this be just such an occasion?

To be sure, there are plenty of reasons to be concerned about Chinese equities, from potential delistings in New York, to the recent surge of coronavirus cases in the major industrial and commercial hubs of Shanghai and Shenzhen which has renewed lockdowns.

Making matters worse, Beijing’s refusal to condemn Russia’s invasion of Ukraine and the prospect of it supplying Moscow with weapons or financial aid, could see it subject to the sharp end of sanctions by Western allies.

But on Tuesday, China’s Vice Premier Liu He and Chinese President Xi Jinping’s top economic adviser, announced on state media that the government would take measures to “boost the economy in the first quarter” and “introduce policies that are favorable to the market.”

Significantly, Liu had pledged to “quickly complete rectification of China’s big tech platforms” which could signal an end to the ill-conceived crackdown on Chinese tech companies and that Beijing would also scrap regional test runs of property taxes, meaning that the all-important real estate sector is in for a round of respite.

Nevertheless, it’s unlikely that this would be sufficient incentive for global investors to come pouring back into Chinese equities because trust, which is so important in the markets, may already have been lost.

Global investors who have been burned repeatedly by Beijing’s various machinations that have targeted everything from the property sector to afterschool education, both of which were hugely lucrative, will need time to heal and see concrete steps before they are likely to wade back in again.

China may need to rely on its own domestic investors to pick up the slack as it’s more likely than not that every rally, will be an opportunity for global investors to get out of a market that’s increasingly proving arbitrary and full of downside risks.

For many global investors, the China story may not be over, but once bitten twice shy, they may not have the appetite for trying to call a bottom.

2. Commodity Markets Are Seizing Up

  • A lack of liquidity in commodity markets is leading to large price swings in either direction

  • Specialty traders and market makers noticeably absent in commodity markets, making matters worse and exacerbating volatility

As any seasoned cryptocurrency trader will know, the published price is only one side of the problem when it comes to volatile markets, execution is what matters.

And in recent days, commodity traders are finding that they can’t execute without roiling markets further.

Everything from geopolitical turmoil to excessive one-directional bets have made it harder to deal in some of the world’s most important commodities, prompting traders to take to the sidelines, rapidly draining liquidity and exacerbating price swings off lower volumes.

Prices of everything from oil to natural gas, wheat to metals have become alarmingly erratic as the spread between buyers and sellers starts to widen, with sharp rallies quickly followed by dramatic drops.

The London Metal Exchange’s one-week closure, after a Chinese nickel giant took massive one way bets on a fall in the price of nickel saw nickel’s price surge by 250%, faster than a meme stock, to cover those short positions, is just one example of markets gumming up.

Making matters even more challenging for traders, because some moves appear to defy fundamentals.

Despite supply looking the tightest in years and geopolitics and inflation acting as tailwinds for commodities, hedge funds are exiting long-term bullish bets, just as things look brightest for these positions.

Much of it has to do with market mechanics than anything else.

The reopening snags at the London Metal Exchange has seen otherwise “in the money” positions by traders who took bullish bets on nickel prior to last week’s closure now stand in a long queue of sellers who are seeing their profits evaporate with the price falls.

By last Thursday, almost US$3.3 billion of nickel was on offer at the limit-down price, but there wasn’t a single bid on the London Metal Exchange’s order book.

That lack of liquidity is worrisome for companies that need these contracts to hedge their feedstock price risks and which use nickel heavily, from stainless steel manufacturers to electric-vehicle batteries.

But it’s not just nickel that’s been affected.

Markets in everything from aluminum to wheat, natural gas to crude oil, have seen a sharp drop off in open interest (a measure of the total number of outstanding derivative contracts that have not been settled).

Typically, liquidity is provided by specialist traders, hedge funds and algorithmic quant shops, but the huge swings are seeing many of them beat a hasty retreat, sucking the oxygen out of these markets and leading to massive spreads.

Many of these market makers are configured to trading tight spreads and hedging their exposure risk accordingly to remain market neutral in markets that had been assumed to be deep and liquid.

The loss of liquidity hits doubly hard – market makers don’t dare to make money off the huge spreads now, because there’s no guarantee that they can hedge their positions, because there’s no liquidity.

Although market makers provide liquidity, they also somewhat ironically need liquidity to operate, which there just isn’t enough of right now and why commodity markets are seizing up and prices swinging wildly.

3. Bitcoin Stuck in a Trading Channel

  • Few obvious catalysts for Bitcoin to move out of its rangebound trading in either direction

  • Macro environment not favorable for short term uptick in Bitcoin for now

Bitcoin may have had a great weekend so far and cleared US$42,000, but it’s far from out of the woods just yet, trading in a channel between US$38,000 to US$46,000 and barring any significant shifts one way or the other to bust out.

Even at current prices, there are a fair number of investors who remain out of the money, who are not ideologically invested in the promise of Bitcoin and who are probably looking for any major rally to cut their losses.

The benchmark cryptocurrency’s trading range narrowed towards the end of last week, as the war in Ukraine raged on and the U.S. Federal Reserve lifted borrowing costs, albeit well within expectations.

Some analysts believe that a sharp rally in tech stocks, which Bitcoin has demonstrated a strong correlation to, will be needed to hurl prices over technical levels of resistance for now.

Otherwise, a strong macro risk-on catalyst would be needed, for instance the Fed adopting a more dovish policy stance, which is highly unlikely for now.

Another possibility of course is that hedge funds and other specialist traders who are taking a breather from the carnage of the commodities market, divert their attention to the cryptocurrency markets, provided they have the mandate to do so.

Otherwise, Bitcoin prices are likely to stay rangebound for now, with long-term holders buying dips and short-term investors bugging out at the first hint of a rally.

Even Bitcoin bulls like Michael Novogratz don’t think that there are major drivers to sustain a rally for Bitcoin as the Fed tightens monetary policy.

Speaking on Bloomberg TV last Tuesday, Novogratz noted that Bitcoin was likely to stay in a range of US$30,000 to US$50,000 as interest rates in the U.S. were set to rise, one explanation of Bitcoin being stuck around US$40,000 to US$42,000 at the moment, smack in the middle of that trading band.

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