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What Does Deleveraging Look Like

I have made a lot of reference to "deleveraging" within the current market and why it can often send false signals of strength as well as plain outright confusion between various asset classes. The following example I hope helps to clarify the point.

What does deleveraging look like? The two charts below show a "trade being put on" and a "trade being unwound." In this example the trade is long gold short equity. This is not necessarily endorsement of gold nor disdain for equity but speculation that gold will outperform equity. Similar trades may have been done for commodities especially during QE, silver, etc.

What this shows is that in a deleveraging or "selling of assets to get liquid" that false signals can appear. In this case many of the "short legs" of the trade, short equity is being unwound or in this case bought to cover putting a temporary bid into the stock market. Problem is once this process ends those "buyers of equity" are gone.

This unwind also helps explain the disorderly price action such as equity outperforming commodities or small and mid caps underperforming SPX.

Trade Being Put On - look at the five year weekly chart and how gold outperforms equity. Gold is being bought while equity being shorted.

Trade Being Taken Off - look at the six month daily chart and how gold underperforms equity. Gold is being sold while equity is being "bought to cover."

 

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