Too soon to call time on our commodities theme
Of all our current themes, the most successful by far has been the pro-resource exporter bias we explicitly adopted in early April. This was an evolution of our “cheap carry” idea at the beginning of the year which recognised that the risk aversion of the last quarter of 2008 had taken the typical G10 “carry” basket from very expensive to unusually cheap in the space of just a few months. With Chinese business sentiment rallying strongly and G10 yield spreads narrowing quickly, we preferred to transform this bias from interest rate differentials per se, to a pro-commodity theme, aiming to benefit from a bounce in growth as the savage de-stocking of early 2009 came to an end.
With our chosen commodity basket of AUD, NZD and NOK gaining over 6% on average versus the euro and USD over the last six weeks, we have to consider whether to take profits on this theme. While it is true that valuations are no longer cheap, they are by no means outrageously expensive either. Nor are positions looking particularly over-extended. On balance, our stylised roadmap for this business cycle suggests to us that the initial bounce from the deepest G10 recession since the war could be marked by a temporary surge to above-trend growth which might inflame inflationary fears already ignited by the shift to quantitative easing in the US and the UK. This initial bounce will very likely give way to a temporary dip by mid 2010 as fiscal stimulus wanes and higher market interest rates pinch some areas of demand before an eventual grind higher becomes established in 2011/12. Against this background, we prefer to stick to the basic theme, but reduce the “beta” of the position a little. We achieve this by trimming positions in AUD, NZD and NOK in order to include CAD which has lagged so far on fears of quantitative easing that now looks less imminent than previously thought.
Elsewhere, we stick with our range-trading view on EUR/USD for now, while adding a new long GBP/USD position in recognition of the continued cheapness of sterling. We also halve our Swedish krona short as concerns over Eastern European banks ease following the new IMF lending facility introduced at the G20 meeting. The residual short position represents a relative play against neighbouring Norway which appears to be in much better shape to weather the current downturn.
Finally, the rally in emerging market currencies has extended beyond our initial expectations. While we have recently moved to a neutral overall stance, we are still benefiting by playing the right currencies long and short. Given the sharpness of the rally, we believe that it is prudent to remain neutral rather than to add back to positions here. However, we would advise against being short emerging market currencies - market dynamics seem positive, with many investors who have missed out on the rally so far still looking to get in. The key test will be to see how the economic recovery holds up beyond the fiscal stimulus which is the key driver at the moment. While significant challenges remain, we believe emerging markets are relatively well positioned to surprise on the upside. We would therefore expect to add to positions on any weakness.
