Wednesday, April 3, 2013

Currency Positioning By Hedge Funds

Before I start the post, I would like to apologise for the lack of replies on the blog and via email. I've spent some quality time with my family over the long weekend holiday (overdue). In the coming days, I will be replying to all the emails. In the meantime I hope you enjoy the new post. Furthermore, for those who have subscribed to the newsletter - you can expect the new issue to be released sometime today (US midday time). If you haven't signed up yet, do so by clicking here.

Chart 1: Hedge funds are currently net long the Dollar
Source: Short Side of Long

With the new CFTC report release, I thought it was overdue to see how hedge funds, speculators and other investors are positioned in the currency markets. Resurfacing issues in the Eurozone have pushed hedge funds into decently high Dollar long positions. As of last week, investors held bullish bets  nearing 23.5 billion dollars. Largest Dollar longs were at the expensive of currencies like Canadian Dollar and British Pound (more on that later).

Chart 2: Dollar sentiment is once again at nosebleed highs
Source: Short Side of Long

Confirming this optimistic view are various sentiment surveys on the greenback. Jason Goepfert from SentimenTrader (highly recommended publication) does a great job compiling all of the surveys into one indicator called the Public Opinion. Statistically, over the last decade or more, readings above 75% have only occurred 2% of the time and do a great job indicating an approaching intermediate price peak. As of last week, Public Opinion readings stood close to 77%.

Chart 3: Fund managers are extremely optimistic on the Dollar
Source: Merrill Lynch Fund Managers Survey

Additionally, last weeks Fund Managers Survey by Merrill Lynch revealed that almost 80% of managers hold a view that further appreciation of the US Dollar is very likely. The reading was the highest in the surveys history (inception in early 2001). Talk about group-think!

Chart 4: Euro continues to be disliked by global funds
Source: Short Side of Long

While funds favour the Dollar, the other side of the trade is obviously disliked. Foreign currencies as a whole have under-performed since 2011 (just like commodities and emerging market stocks) and the Euro is no exception. However, pessimism is not as wide spread as last summer - currently funds hold $7 billion shorts vs $33 billion shorts in June 2012. Focus has turned to other parts of the world.

Chart 5: Hedge Funds hold significant short bets on the Yen
Source: Short Side of Long

Be that as it may, investors always find an asset to dislike and the Japanese Yen today wins the award for the most hated currency in the world (taking the crown away from the Euro). Bets against the Yen have swelled up in recent months (between $12 to $14 billion). We haven't seen such negativity in years.

If we refer to Chart 3 again, we should also consider the fact that over 60% of global fund managers view further depreciation of the Yen highly likely. Last time we saw almost identical readings was in early 2002, just as the Yen bottomed out and began a bull market. I'm not necessarily forecasting another huge run up for the currency like in 2002 (you never know), but further downside from the near term oversold perspective seems very unlikely.

Chart 6: Bets against the Pound are at highest level since 2011
Source: Short Side of Long

It is also worth mentioning that the Yen is not the only hated currency right now. Since at least March 2012, I've been forecasting lower Pound levels and we have finally seen them. The fundamentals for the currency remain terrible, however from a contrarian point of view, this is not the best time to sell the Pound. 

The chart above shows us that just about every man and his dog has jumped the "Pound-shorting" bandwagon, with bets against the currency reaching levels last seen in October 2011. Therefore, from a near term oversold perspective, a counter trend rally or a consolidation is a more likely scenario. Either way, I would eventually expect a short squeeze.

Chart 7: Pessimism on the Loonie reaches 6 year highs
Source: Short Side of Long

All I can say is wow! Hedge funds have engaged into some serious shorting activity against the Canadian Dollar (the highest since late 2006). Regular readings of the blog might remember that I also opened short bets against the Loonie in September 2012 (when just about everyone was a bull) and closed them a few weeks ago.

In my opinion, such wide spread pessimism signals that further decline in price is quite unlikely. However, it is important for the price to prove itself and hold support levels from July 2010, October 2011 and June 2012 (around 95 to 97 cents on the chart). Otherwise, watch out below.

Chart 9: Indecisive speculators in the Aussie with large swings
Source: Short Side of Long

Aussie Dollar, everyones favourite risk asset and the poster boy of risk on / risk off trade, has been stuck in a sideways range for close to a year. As a matter of fact, the real peak in the Aussie came in June 2011 and the currency has not made any progress for almost two years now (similar to commodities). 

I have been short the currency since November 2012 (as a hedge), when bullish bets reached a record value of 11 billion dollars. However, the correction has been rather mild and with such a widespread negativity on various other currencies, I contemplate my short position daily. Unless we start breaking down, I might close my position very soon (I much rather be short US equities). 

The Bottom Line
While further appreciation in the US Dollar is not entirely impossible, I think it is unlikely. Sentiment has once again reached levels where intermediate tops occur frequently. US Dollar strength has led to widespread selling of foreign currencies like the Yen, the Loonie, the Pound, the Euro and so forth. 

Majority of these currencies are now oversold and in some cases hedge funds have amassed enormous short positions. Therefore from a contrary point of view, I expect to see a short squeeze propelling foreign currencies higher and the US Dollar lower. For investors looking to play the up-and-coming US Dollar weakness (if my view is right), I'd advise purchasing Precious Metals instead.

What I Am Watching