Saturday, August 02, 2008

Portfolio July 2008

My string of relative outperformance finally caught up with me in July. In what seemed to validate the "rolling bear market" thesis (where each sector gets taken out one by one rather than having a concerted bottom), it was a blood bath in many material and energy names. My actively managed accounts which had been doing very well in the first half of this year gave back all the gains and then some. Misery loves companies though. I note (ruefully) that Ken Heebners CGMFX and Tim Iacono's model portfolio are both now negative for the year.

In terms of actual numbers, the AM accounts gave back 9.15% to end at -0.73% YTD. The AA accounts gave back 3.06% to end at -7.70% YTD. Overall, I'm at -3.96% YTD which is still better than the double digit whacking took by the index ETFs I track.

Despite this set back, I remain committed to the general strategy of overweighing energy and material shares. I still have some DUG and UYG, purely for hedging purposes that I will probably jettison soon to make room for PCU which has taken a big hit lately.

In my last post I was pretty down on the PM sector, but it hung in there and was able to bounce back from $900. The most recent COT showed a big improvement. Coupled with a very low XAU:gold ratio, it should mark a low risk entry point for gold stocks.

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Wednesday, July 23, 2008

PM price action alert

This is a quick update following a second day of drubbing for the precious metals. The uptrend I drew in my previous post has been broken although GLD has remained above its 50 dma of $89.84. An optimist might argue that GLD is sitting at another more important trend line. Nonetheless, it's prudent to listen to the price action. If GLD closes below the 50 dma, it will be a good short given how gold trades. One may argue that the negative COT positions presaged this decline. Another indicator to pay attention to in the future!

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Thursday, July 03, 2008

If you think gas prices are high, drive less!

Please bear with me, I don't mean to be facetious here. Now that oil is over $140/barrel and everyone has a theory about why the price is so high, I thought I'd join the party and throw in my two cents as well.

First of all, there should be little contention that the commodity index funds raise futures prices, since buying, holding, and rolling over futures is what they are mandated to do. The table below shows crude contract prices out to December of 2016 (as last Friday). The price increase appears uniform, i.e., the market is not expecting a decline anytime soon. Commodity index funds tend to buy only the near month contracts (An exception is USL which buys one whole year into the future), so we are probably seeing the combined effects from the index funds and other speculators who may either have a view of their own or are riding on the coattails of the index funds. For the sake of brevity I'll use the term "speculator" in the rest of this post to describe all those participating in the futures market (with no intention to take delivery) with no regard to their intended holding period or long/short bias.

From the above starting point, a divergence of opinion quickly appears. Some argue that the total new futures demand is comparable to the actual new physical demand from emerging economies, while other argue that since speculators never take delivery, the spot price is solely a function of supply/demand. I'm not going to be a referee in this argument, instead, I'm here to explore a dynamic that I have seen mentioned elsewhere: the possibility of suppliers withholding production due to stable anticipated future prices.

First, let's recap the facts:

  • Speculators bid up futures, including long dated futures.
  • Speculators don't take delivery. There may indeed be hedge funds out there think about doing exactly this just as there are rumors that hedge funds are looking into buying grain elevators. For now, I take the inventory reports at face value. This is a crucial point as we know that the futures market in gold and silver do influence spot prices since a significant portion of physical demand is for investment which depends very much on investor psychology.

The common refrain is that producers have an incentive to produce as much as they can given a flat futures curve in order to maximize the present value of total return. This is the case for, say a copper mine. Since while the spot price, production cost and cutoff grade of the mine might change, the actual copper in the ground is fixed in place. However, an oil field is a far more temperamental beast. If there's anything I learned from Matt Simmons' Twilight in the Desert, it's that the ultimate recoverable resource (URR) of any field is rate dependent, i.e., running too fast a flow rate decreases the URR. A crude analogy which is also the extent of my understanding is this: imaging an oil well as a giant straw, the production rate can be increased by increasing the well pressure, commonly achieved by injecting water from underneath the oil layer. However, if the pressure is too high, oil can be driven above the opening of the "straw" and form pockets that are hard to get at, not to mention the water that also gets pumped out. In an environment of stable future prices, it is entirely possible that the present value of a mature field is higher if current production is tapered in exchange for a greater URR. Thus there is potential for a self-reinforcing, running-away train of oil prices. Once again it's hard to lay the blame on either the speculators who bid up futures or the pre-existing tight supply/demand condition, since both are necessary for this vicious circle to occur.

What to do
We might be tempted to put a stop to "speculation" as several bills in the congress are promising to do. I doubt if any of them will have the intended consequences. For starters, speculative capital is mobile. If people can't speculate in Chicago or New York, they will do so in London or Dubai. The real losers will be pension funds who don't have the luxury of leaving this country. They will struggle to meet future obligations as the best asset class in an inflationary world becomes unavailable to them. They will have to be bailed out by tax payers. So while the politicians are still at it, they might also want to read this timely article on the one commodity on which speculation has been banned.

Going back to the title of this post, conservation, voluntary or not, is still the best option. A 10% rise in average auto mileage saves as much oil as the production of giant oil field. Futures price will come down when there is clear demand destruction. I even believe it's prudent to raise gas taxes. Politically, it's definitely a non-starter. I might even have surprised some readers since my thinking have been consistently libertarian. However, I'll argue that in this case there's no escaping paying the government, be it the US government now or the government of Iran, Saudi Arabia and Venezuela some time later. Who knows, it may even drive down gas prices.

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Tuesday, July 01, 2008

Portfolio June 2008

June was truly an awful month across many major market segments. The benchmark index ETFs all gave back between 8 to 10%. However, my actively managed portfolio benefited first from high energy prices and then from a reinvigorated PM bull to finished the month at +1.24%. YTD it's up 9.27%. The asset allocation accounts suffered with the rest of the market but fared better because of the overweight in energy and PMs along with hedged mutual funds. The AA accounts lost 5.09% for the month and 4.78% for the year. The overall portfolio lost 1.58% for the month but is still above water for the year with a gain of 2.78%.

As discussed in the previous post, I expect strength in the PM sector to continue. The overall market is frankly in dire straits as investor become disillusioned with the fairy tale of a 2nd half recovery. Cash is king again, or maybe it's only 2nd best? With real rates negative everywhere, gold is again shining through as a safehaven asset.

I'm making few allocation changes these days, although there are some short term trades around the margin. An example would be the covered calls I wrote last month. I'm not shorting this market aggressively as I've found that I do much better on the long side. With a heavy allocation to PM shares my portfolio is doing well despite the recent market turmoil.

There was a $20k addition to the AM accounts this month as I convinced my wife to move some cash from her ING accounts to Scottrade. I have already spread them over JTD, NXZ, BZF and CYB. The first two are closed end funds of dividend paying stocks and muni bonds respectively. The latter two are currency ETFs of the Brazillian Real and Chinese Yuan. The goal here is to better return than a savings account without taking too much risk.

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Friday, June 27, 2008

Gold finds its mojo

All day CNBC pundits have been screaming how this is the worst June since the Great Depression and how the DOW was already in bear market territory (intraday). If you recall, I have been leaning towards seeing the March lows hold for the rest of this year. Although I based that statement on the S&P which is still above the March low of 1257, all indications are that it will join the DOW and financials in dropping to a new low. Fortunately for me, it wasn't a conjecture that I base my investment decisions on. The emphasis in my portfolio has always been on precious metals, commodities, and the global growth story. That have worked well this year and is continuing to work in this difficult environment.

That said, I did some bottom picking this week, mostly the last hour on Thursday. I picked up some Citi during the last hour on Thursday. It slid further on Friday and was below $17 at one point but recovered to close at $17.25. I intended this to be a short term trade -- I'm betting on that some of the selling was due to quarter end window dressing and it will recover some ground next week.

I also picked up some COW (live stock ETN) on Thursday which was intended as a longer term position. Besides trying to complement my holdings in DBA, the move was also prompted by this piece from John Mauldin. Here's the relevant quote:

Because we have devoted so much of our arable land to corn (in a very misguided policy to turn food into ethanol), we have less for soybeans, which is putting upward price pressure on beans and other grains that are used to feed cattle, hogs, chickens, etc. In fact, it costs so much to feed livestock that ranchers are shrinking their herds.. This means more meat is coming into the system now, which is dampening prices. Increased supply will reduce prices in the short term, but next fall we will find that supplies of all types of meat will be short. That will potentially send meat prices soaring. Cereal and bakery products are up 10% over the last year. They could continue to rise in the fall if the corn crop does not yield more than currently projected. It will cost even more to feed your household and feed the animals we need for meat.

Undoubtedly the star performer in my portfolio this week has been PM stocks which awoke from a consolidation triangle. Gold gained over $30 on Thursday, the most ever so I heard. I was prepared to see gold take another drubbing going into the Fed meeting on Tuesday. The market seemed to think so as well since gold sold off that morning but finished strong after a rather bland Fed statement. It was a situation where if I were given an advance copy of the statement I still wouldn't be able to predict the market reaction. Apparently, the Fed was too dovish and the dollar sold off. To be honest, I don't see any near term catalyst for gold's move, at least not one that a CNBC anchor would give. Of course, the market could be realizing that real rates are negative everywhere and that gold is real money -- wouldn't that be nice!

On the other hand, a break out from a long consolidation, with no apparent reason, is usually the most powerful kind. One could also argue there is something magical about a 3.5-months consolidation (mid March to end of June) following a 7-months advance (mid August to mid March), which is, you know, astrology at its finest. The fact is, after a punishing month of June, the $vix is still only in the mid 20's. The workhorses that have been pulling this market along: fertilizer, coal, oil and nat gas all look toppy. Might gold be regaining some of its shine as a safe haven asset against a potential market crash? Who knows, but I'm holding onto my 35% allocation in PMs and PM miners in my actively managed accounts!

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