Investing the Middle Way

Portfolio July 2008

2008-08-02T20:26:00.001-04:00

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.

PM price action alert

2008-07-23T21:05:00.000-04:00

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!

If you think gas prices are high, drive less!

2008-07-03T03:00:00.000-04:00

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.

Portfolio June 2008

2008-07-01T21:02:00.001-04:00

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.

Gold finds its mojo

2008-06-27T23:06:00.001-04:00

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!

China raises gas and diesel prices

2008-06-19T15:54:00.004-04:00

The bombshell today was that China is raising prices on refined products, gasoline and diesel. Detailed reports are confusing, not the least due to the currency and weight units used. The best I could find is: gasoline from 5980 to 6980 yuan/ton, diesel from 5520 to 6520 yuan/ton, and jet fuel from 5950 to 7420 yuan/ton. However, those appear to be the whole sale price. The new retail prices are reported to be 7540 and 7040 yuan/ton for gasoline and diesel, respectively. They represent an increase of 0.8 and 0.92 yuan/litter.

According to this website, 1 metric ton of gasoline is 1356 liters or 357.8 US gallons (1 gallon = 3.79 liters). So at the exchange rate of 1 US$ = 6.9 yuan, the new retail price in China (5.56 yuan/liter) is equivalent to $3.05 US/gallon. While it's over a dollar cheaper than the prices in the US, it's reportedly a 18% (As of last December, the price was equivalent to $2.65 USD/gallon, but the Yuan has strengthened since then). The price increase was about 40% for diesel since the same price increase of 1000 yuan/ton is spread over a smaller number of liters (diesel is denser at about 1190 liters/ton).

Prior to this price increase, the Chinese refiners (e.g. SNP, PTR) take a loss for each liter of gasoline and diesel they sell. Although they get a subsidy from the government, it has not kept up with the rising price of crude. As any rational, profit maximizing business would do in this situation, they reduced output, resulting in lines at the pump. The Times had an excellent report on the situation. One thing to keep in mind, while high prices in general attenuate demand, since Chinese refiners weren't at full capacity (and presumably now will be), it's not clear that crude demand will immediately be lowered.

I'm very heartened by this development on many levels. It was inevitable, but many thought China would delay it until after the Olympics. I'm glad that they took the pill early and didn't get bogged down by an artificial deadline. In doing so, they did everyone a favor by removing a distortion in the energy markets. It was a triumph of free markets and a defeat of price controls everywhere. Capitalists everywhere should rejoice. On a more personal level, I have been buying GuShan (GU) a Chinese biodiesel company that I mentioned in passing in the post on Darling International. GU is on pace to increase their production capacity to 400,000 tons in 2009 (corporate presentation). I have been averaging down (yeah, I know) lately as it dropped in anticipation of the lock-up period expiring. GU is now up over 16% on nearly four times average daily volume. It has been volatile, but I see it going much higher. For one, Chinese diesel prices are still below international levels. As stated in the Times article, the quality of Chinese diesel is appallingly low. On the other hand, GU's products are much cleaner and should be in demand when China raises its fuel standards as well. (See the corporate presentation. Biodiesel is inherently low sulphur.)

Fed tightening

2008-06-13T04:00:00.000-04:00

In the last post, I posed the question "Safe to dip in the gold pool again?" as the HUI was on the verge of breaking out of a down trend. The answer since has been an emphatic "No". Despite the awful employment number last Friday the expectation for Fed tightening has never been higher. Although I have been quite dismissive of the jawboning, a convincing case for tightening can be made on the following.

The primary argument against tightening has been the weak economy which has entered the political center stage in this election year. However, one may well argue that energy and food inflation brings an economic pain as pressing as any to the middle class. Therefore, there is plenty of political cover for tightening.
As far as the credit crisis is concerned, the alphabet soup of new credit facilities are more powerful and precise than the blunt instrument of the Fed funds rate.
Perhaps more importantly, the bond market has spoken and the expectation is definitely higher rates by October.

The dollar has been gaining strength on the back of all this talk of Fed hiking the rates. The energy complex has stayed firm because of the fundamental supply/demand. On the other hand, gold, which has been regarded as a pure dollar play, has been crushed. The mining stocks have been falling alongside the metal. The HUI, at 397 on Thursday, is now below the 200 dma and poised to test the April low of 385.

From an EW perspective, the most logical count has us in wave c of an abc correction where wave a bottomed at 385 (I thought it was the end of the correction then but that count was invalidated as the low in early May was taken out). I'm now expecting more weakness in the near term until the relative HUI (HUI/its 200 dma) becomes as attractive as say last August which would be another excellent entry point.

How do I recouncil Fed tightening/dollar strength with a long term bull market in gold? The simple answer is that I remain skeptical of new found hawkishness at the Fed. October is months away, I'll believe in those rate hikes when I see them. In the mean time, I'll be more wary of administrative measures at containing commodity prices such as releasing oil form the SPR or limits on the so-called commodity index funds.

Safe to dip in the gold pool again?

2008-06-07T01:30:00.001-04:00

What transpired in the past two days was simply stunning, up 200 Dow points then down 400, while crude gaining $17 in the same time span. The S&P has now broken decisively to the downside. I can easily see the 1325 level gets tested. 1310 would be the next resistance level. After that, it's straight to the March low. For me to continue holding my sanguine view on the market for the balance of 2008, the March low absolutely must hold.

Of course I don't structure my portfolio based on a "second half recovery". My commodity heavy portfolio only experienced a minor set back this week and I expect it to outdistance the general market further. I have not touched my core precious metal holdings which I think are on the verge of breaking out to the upside. One thing that the exploding unemployment number did was to call the bluff on the newfound hawkish stance of the "Bearded One". Although gold was among the few red spots in a sea of green on Thursday, it jumped over $24 on Friday to end the week above $900 once again. The chart on HUI shows an impending break out. The MACD is very slightly negative and the stochastics have already crossed over to the upside.

Ironically, judging by Friday's closing price relative to trend line, and MACD, the best looking stock is one that many gold bugs loved to hate for its erstwhile hedging program: ABX. Further encouraging signs include positive volume action for the past two sessions that is likely footprints of institutional money. It remains to be seen whether large cap miners will continue to be favored or whether the values in juniors will be realized if not by investors then at least by their acquirers.

Buying Frenzy

2008-06-05T22:32:00.000-04:00

I haven't been paying much attention to the market during the day recently as other commitments are making more demands on my time. When I turned on CNBC just after 4 pm today, I was quite surprised to see how well the market did. The breadth was very positive, especially in the up/down volume with the split being about 85/15 to the upside on the major exchanges. Gains were made in almost every sector, with oil notably up over $5. There is such a thing as having too positive a tape however, as the activity smacks of a short covering rally. For some reason, this particular passage in a recent Ken Heebner interview (worth reading in its own right) came to mind.

Immediately Heebner is peppering Fox with questions about where all this sovereign dough is going, wondering, for instance, whether Goldman is now recommending "short-busting" strategies to its worldwide clientele. (Short-busting involves trying to drive up the prices of stocks that a lot of investors have sold short.)

Speculation aside, I think we're not quite out of the recession woods yet even though I believe the market will end flat to positive from here till year end and that the bear market won't resume in force until 2009. For one thing, I think the retail figures released this morning was telegraphed by the expansion in consumer credit and reflects spending/pre-spending of the stimulus checks. The effect will temporarily mask the real and deep-seeded troubles in housing and credit markets. Plainly, in this election year, monetary and fiscal policies are geared towards "rescuing the consumer", "alleviating the pay at gas pump", or whatever catch phrase of the day may be. Ruefully, I believe some rule change restricting the "speculators" in commodities will also take place. It will likely produce an excellent buying opportunity :-)

My most recent action as disclosed in the last post was selling covered calls (all out of the money) on a number of energy and base metal names in my portfolio and parlaying a part of the premium into XLB puts. The worst that can happen were the market to rally much from here is that some of my core positions will be sold at prices above or close to their highs -- an outcome that I can easily live with.

Portfolio May 2008

2008-06-03T20:53:00.000-04:00

I booked another solid month as commodities, led by oil, had a tremendous run. The AM accounts gained 4.28%, or 7.93% YTD. The AA accounts gained 1.67%, or 0.32% YTD. Overall, the gain was 3.1% for the month and 4.43% YTD. With these results I have widened the lead over the benchmark indexes. I'm now beating the SPY by almost 8 percentage points. Among the equity index ETFs that I track, only EEM has a gain for the year -- a fact that lends some credence to the "decoupling" theory.

Looking ahead however, there are plenty of dark clouds on the horizon. The most ominous being the blazing, unsustainable run in oil. A fall from such lofty heights could be as spectacular as the move up. Not to mention the potential for oil to take the entire commodity complex down with it. On the other hand, I'm quite happy to stay with the energy, agricultural and base metal stocks that I have. As such, I wrote a number of covered calls on them in the past two days. I also used some of the proceeds to buy put options in XLB.

The portfolio mix hasn't changed much. One notable sell was GS which was before the big downgrade from Dick Bove. I'm still looking at GS and C for an entry point. Elsewhere, rebalancing of the AA accounts is almost completed. I did all the necessary selling which was the hard part. There are some changes in how I implement some allocation objectives which I'll write about once all is done.

Preferred way to play the financials

2008-05-30T22:02:00.000-04:00

I've been meaning to add some financials to my portfolio ever since the subprime crisis began. I traded GS for some short term profit recently but in general found the headlines a little too hard to handle. Ok, that was a bit tongue in cheek. I actually have a couple names in this sector on my short shopping list again. But the point I'm trying to make is that there is a less risky way to play the financials -- through their preferred shares, or you can do even better through closed-end funds of those preferreds that are trading at a discount to NAV.

Above is a list of closed-end funds of preferred stocks, provided by the WSJ market data center. I looked up these ticker symbols, with emphasis on the ones trading at significant discount to NAV at ETFconnect.com, my favorite site for doing research on closed-end funds. What I found most interesting was JQC (and its close cousin JPC), both managed by Nuveen. As of May 29, JQC had a distribution rate of 10.39% and was trading at a 11.82% discount. Its top holdings are Wachovia, Citi, Banco Santander, ING, AgFirst Farm Credit Bank, JP Morgan, Lincoln National, HSBC, Developers Diversified Realty, and Ace Limited. I doubt many of these companies will go bankrupt, and even if they do the preferred holders have precedence over common stock holders in claiming any assets.

The chart on JQC shows that it has pared back some losses sustained since last summer. I would love to get my hands on shares below $10, but I may have to wait an aweful long time.

Going back to my statement that the preferreds are less risky way than the common stocks (for financials), below is the long term JQC:XLF ratio chart. There wasn't any sustained down draft (longer than say, six months), and currently we're in a period of upswing. Combined with its yield and the discount to NAV as a cushion, JQC is quite attractive right now. As a matter of fact, in my on-going portfolio rebalance, I have switched out of my short government bond fund in lieu of JQC in the fixed income allocation.

Still in suspension

2008-05-28T03:17:00.000-04:00

Stocks were under the most severe pressure since the March bottom last week. That attention should be focused on the burdened consumer was never a surprise -- many that have called the March bottom correctly also predicted a later consumer-riven recession bottom. Still, the all-important question remains whether the March bottom will be broken. The answer remains elusive the first trading day after the Memorial holiday as the S&P successfully defended its 50 dma.

The positive return on Tuesday came mostly from a retreat in oil prices. However, we know that gas prices are stickier on the way down than on the way up, thus the relief felt by consumers will not be nearly as much as the drop in oil would indicate, not to mention that gas prices increased slower than crude in the first place. One way or another, I'm not letting headlines of the day sway own opinions. I still believe that the March bottom will hold and the S&P will be flat to slightly up at year end. I base this opinion partly on the Armstrong cycle which displayed outstanding accuracy in the two past turning points (and which predicts a rising market into 1Q 09), and partly on the four-year presidential cycle. Though I don't have a reference, I recall that the first year of a new president's term is especially ominous for the stock market if there's a change of party at the White House.

In-Depth Performance Analysis

2008-05-22T03:54:00.000-04:00

My main task this month is the annual rebalance of the asset allocation portfolio. It’s quite a hassle, involving the re-jigging of literally half a dozen accounts. Prior to that however, I've decided to take a deeper look at my performance to-date and see if the allocation plan itself needs changing (see current allocation here). The last time I took such an in-depth look was the end of 2006 when I had much less data.

Each month I calculate percent gains or losses for my AM, AA and total portfolios, as well as that of the benchmark index ETFs that are dividend-adjusted. So far I have data from 1/11/2006 to 5/5/2008. I have been fairly consistent in my approach, but there are a few aberrations. Jan 2006 was a partial month since this blog wasn’t launched till the 11th, as a result, my performance was shortchanged by about 4% relative to the S&P (Commodities and emerging markets were going gangbusters then). I missed the end of last month by a couple of days due to my vacation. In between, I also missed November and December of last year due to my computer woes, so the October entry last year actually encompassed the entire 4th quarter. While the data series wasn’t perfect, I made sure that the benchmark ETFs and my portfolios were calculated the same way so that a meaningful comparison can still be made.

The two charts above give a graphic representation of my returns versus the dividend-adjusted SPY. I choose SPY becaus the S&P 500 appears to be the most popular benchmark for money managers. At any rate, VTI (Wilshire 5000 index ETF), which is probably a better benchmark for my investing style, was very similar during this period. The first chart shows the monthly gains in a bar graph. It's evident that my portfolios, especially the AM portfolio, are quite volatile. The max monthly gain was almost 12% and the max loss about -8%. The second chart shows the cumulative performance which is really where the meat, or rather the dough, is. Here my portfolios handily beat SPY with most of the gain came from the AM portion. After 28 months, the AM portfolio gained 40% or 15.5% annualized. The AA portfolio gained 16.5% or 6.8% annualized. The total portfolio returned 29%, 11.5% annualized, while SPY returned 13.4% or 5.6% annualized.

Next I plot the monthly gains vs. SPY as well as the linear regressions. This is the classical treatment from Markowitz’s Capital Asset Pricing Model (CAMP). The slope of the line is the "beta", a measure of portfolio risk; and the intercept "alpha", a measure of manager's skill. The AA portfolio has (relatively) the best fit as shown by the (still small) R² value of 0.55. The intercept of 0.004 indicates that the AA portfolio is beating SPY by an average of 0.4% per month; however, the R² says there's a 45% chance that such outperformance was due to luck. The "beta" of the AA portfolio was 0.6. In other words, it was deemed to be taking only 60% of the market risk. due to the poor fit, one shouldn't put much store in that number. The other lines had such low R² numbers that they don't warrant much comment other than that the larger alphas were consistent with the larger gains. My AA portfolio had sizable deviations from SPY due to the presence of PM and commodities (16%), alternative assets (15%) and fixed income (20%). The correlation between the AM portfolio and SPY was non-existent due to heavier presence of PM and commodities, and the use of shorting and market timing.

The Sharpe ratio (SR) is a more meaningful measure of portfolio performance. It's also called risk-adjusted-return, defined as

SR = (R – R_f)/StdDev(R)

Where R is the average return; R_f is the risk-free rate; and StdDev(R) is the standard deviation of R. The numerator is the actual return above the risk-free rate, also called the excess return. The denominator is the standard deviation of the return, the technical measure of volatility. The SR, therefore, gives the return per unit of risk. There is a nice collection of web-based calculators including detailed instructions for this calculation at Bill Sharpe's website.

I calculated SR twice, once with a risk-free rate of 0 and once with a constant rate of 3%. Sharpe's calculator uses the rate of Vanguard's short-term treasury fund as the risk-free rate. It's more exact but I couldn't be bothered. In general, increasing the risk-free rate in the above equation favors the high-risk, high-reward approach.

The standard deviation of returns describe how volatile the investment is. My AA portfolio is about 80% as volatile as SPY and VTI in this sense. My AM portfolio is quite volatile, second only to EEM. The combined total is about equivalent to IWM, i.e. a portfolio full of small cap stocks. My SRs are quite respectable, beaten only by EEM, which although very volatile, also had the most gain. Note that the SR of the total portfolio is greater the AM and AA portfolios separately -- a vindication of my overall strategy.

I started this exercise to see if my allocation plan needs changing and I must say that I'm pleased with the way it is. After 28 months, the AA portfolio is ahead of SPY by 3.18%. The current allocation plan was implemented in June 2007, prior to that the AA portfolio was under performing SPY by about -3% as my market timing in early 2007 proved disastrous. In other words, the AA portfolio outperformed by over 6% last year while keeping the volatility low.

In keeping the same asset allocation, perhaps the most difficult thing to do is to sell the leaders (PM, commodities and emerging markets) and buy the laggards (small cap, REIT and private equity). The last (PSP) was especially difficult to justify since one can argue that the shares of private equity companies bear little resemblance to the returns enjoyed by the principles, not to mention a much tougher credit environment. I'm stomaching the 5% allocation for now while hoping the market has discounted most of the risks. We'll surely revisit this topic in a year.

Darling International (DAR)

2008-05-18T14:40:00.000-04:00

I've been meaning to write about this company for a while. Since I picked it up in March, it's been one of my better performers. Here's the business summary from Yahoo Finance:

Darling International, Inc. provides rendering, recycling, and recovery solutions to the food industry worldwide. It operates in two segments, Rendering and Restaurant Services. The Rendering segment engages in the collection and processing of animal by-products, including hides, from butcher shops, grocery stores, food service industry, and meat and poultry processors. It converts these products principally into useable oils and proteins utilized by the agricultural, leather, and oleo-chemical industries. The Restaurant Services segment involves in the collection of used cooking oils from food service establishments and recycling them into similar products, such as high-energy animal feed ingredients and industrial oils. It also provides grease trap collection services and sells equipment to restaurants. Darling International sells its products through commodities brokers and company agents, as well as directly to customers. The company was founded in 1882. It was formerly known as Darling-Delaware Company, Inc. and changed its name to Darling International, Inc. in 1993. The company is headquartered in Irving, Texas.

Besides being in the recycling business which is clearly environmentally positive and something that Americans don't do enough of, Darling's two end products: protein meal for feedstock and industrial oils (including biodiesel) puts it at the rare intersection between today's two hottest sectors: energy and agricultural products. What's more, I can't find any serious competitors in this sector. There is a Chinese company (GU) operating in the same space but obviously they are geographically distinct. Darling has 24 plants and 19 transfer station -- a considerable amount of infrastructure and simultaneously a significant barrier to entry for any likely competitor.

The stock is trading at a trailing P/E of 26 and a forward P/E of 16, not unreasonable given its profit growth in recent years. However, I can see two negatives. First, the bulk of revenue growth was probably from the increase in the price of end products rather than increased volume (just by eyeballing the numbers). Although I expect the trend of higher prices for its end products to continue, it does subject the company's revenue to the volatility of commodity prices. I would like to see the company having a clear strategy to expand its collection base either organically or through acquisitions, or an expansion into foreign markets. The second negative lies in the fact that the CEO has just sold a chunk of his holdings. All things considered however, I still see the positives outweigh the negatives, such that DAR is likely to be one of my core holdings for a while.

DAR looks strong technically, going the proverbial lower left to upper right. Excursions below the 50 dma have been good places for accumulation. We just had a small bounce from there, if the CEO's sale of stock precipitates more selling I might add to my position.

2008 Latin American Mining Congress

2008-05-14T01:29:00.000-04:00

Just a heads up to those that are interested in resources stocks and miners in particular. The webcast of the 2008 Latin American Mining Congress is a treasure trove of information. There is an excellent presentation from my old favorite: Excellon Resources. The keynote speech from US Global Investors had some excellent charts that illustrate the "global megatrend" for increased demand for natural resources.

Views on the current PM market

2008-05-11T23:25:00.000-04:00

It's been a while since I showed a chart on the HUI. The correction from the peak of 519.68 achieved in March has been nothing short of devastating. In the chart below, the HUI is examined in the weekly time frame that smooth out the higher frequency wiggles. The journey from 285 to 520 is labeled wave i of 3 of III, a clear upward 5-wave impulse wave. The 3-wave down correction to the 50 week MA is equally recognizable. This wave assignment implies that the most powerful iii of 3 of III will arrive shortly, if not already.

I have to admit that I have sounded this alarm before -- using earlier counts on the daily graph that in retrospect was totally off the mark (385 couldn't have occurred using under the previous counts). It does highlight the difficulty with labeling EW in real time. It's also a reminder that EW needs to be employed in conjunction with other indicators along with a rigid stop-loss discipline for successful trading. I do have a high degree of confidence of the current wave count, however, since it's on a longer time-scale and the waves are more "classic" looking. I'm also heartened by the fact that gold spot made a bottom just below $850, it's nominal high in the 80's. One positive for the patient gold investor is that the current bull phase now looks to extend in time at lest till the end of 08.

Portfolio April 2008

2008-05-08T22:00:00.001-04:00

It's good to be back! My "vacation" was more hurried than anticipated. Traveling with a toddler was much harder than anticipated. After only checking the market sporadically, I take some solace in ending with a positive month. My portfolio lagged behind the general market as gold and gold miners took a drubbing. The actively managed accounts gained 4.96%, bringing the YTD total to 3.5%. The asset allocation accounts gained 3.68%, bringing the YTD total to -1.32%. Both are doing well over the benchmarks, although the lead shrunk in the past month.

I'm still trying to get a handle on the markets after being away for two weeks. I've mentioned the "momentum" inherent in my views before; for now, I still see the S&P in a bull phase, the 200 pt drop on Tuesday notwithstanding. On the daily chart, some momentum indicators are pointing down, but I see that as a prelude to the necessary skirmishes around the critical 1400-1410 level. All that said, there's little sense to speculate on the S&P when both energy and materials are acting so well. It reinforces my point that we had an oversold interim bottom in Jan-Mar -- and an interim bottom does not change the major underlying trends, so what has worked will continue to work.

I anticipated some fireworks while away. There may be two events that fit that designation. Firstly, the Shanghai index successfully defended the 3000 level as I predicted and has been up over 20% since. The government reduced its stamp duty which was seen as an important change in attitude. (No, it's not a free market, but then again, there is no free market anywhere.) I normally like to see a second bottom but don't expect a severe re-test in this case. The second major event may be the bottoming of the PM complex with gold dropping below the $850, its nominal high in the 80's. I'll write about the PMs again later this week.

There wasn't much trading activity last month. I withdrew some funds from my trading account to pay for living expenses and taxes. The next major task is the annual rebalance of my asset allocation portfolio. I'll probably leave the allocation unchanged, but juggling half a dozen accounts and sort through the tax consequences will be challenging.

On vacation

2008-04-18T23:27:00.000-04:00

I'll be on vacation till May 3, 2008 during which I have limited internet access. I'll resume blogging with a portfolio summary for April.

The market has had strong directional moves during my previous vacations, at least that's how it felt like. So expect some fireworks :-)

Off to the races again

2008-04-17T01:47:00.001-04:00

Long time readers know that I'm pretty stubborn in that I hold on to my opinion unless incontrovertibly proven otherwise. Two views that I've expressed for a while are: 1) we made an interim bottom (basis the S&P) on Mar 17, and 2) we're still in phase 3 of III of the PM bull market that should see much loftier heights.

In the S&P chart below I drew a potential inverse head and shoulder pattern. The most recent low came last Friday when technically speaking the market had a good reason to drop another 20 S&P points. Naturally short covering was a part of Tuesday's rally, but the materials/energy names were too strong to be dismissed. My read here is that for now the bulls are in control as money on the sidelines rushing in. I have 1475-1500 as my first upside target.

I wish I have as specific an idea about the near term agenda of PM stocks as I gave above for the S&P. PM stocks have moved in tandem with the general market since the precipitous drop in March. As shown in the chart, the uptrend channel was broken and the HUI have just made it back into this channel. Painful as it was, this kind of volatility was fairly typical for PMs as we're once again reminded that the bull market tries to throw off as many people as possible along the way. As observed before, the HUI tends to take several tries before overcoming a significant demarcation line. Presently I expect the 500-515 region to be such a battleground.

The next bubble by Eric Janszen

2008-04-14T16:40:00.000-04:00

The February edition of the Harper magazine featured an article by Eric Janszen titled "The next bubble: Priming the markets for tomorrow's big crash". Eric Janszen, a venture capitalist, is also the proprietor of iTulip.com, a site originally devoted to chronicling the tech bubble, but has since been focusing on the one in housing. For those interested in longer term investment trends this article is a must-read.

The gist of the article is best summed up by the chart below where Janszen plotted the (actual and predicted) trajectories of the bubbles of past, present and future, namely the tech bubble, the housing bubble and the coming bubble in alternative energy and infrastructure.

A picture is worth a thousand words. This chart contains a lot of information:

First of all, Janszen defines various stages within a bubble: normal, formation, hyperinflation, dissipation and overshoot. It doesn't offer any particular insight but lays a common framework for analyzing all bubbles.
One major prediction of this article is the course of the current housing bubble, which is forecast to reach the overshoot stage in 2011-12.
Janszen's next bubble -- alternative energy and infrastructure is currently in the formation stage and bound to reach its hyperinflation stage in 2011-2013.

From a big picture perspective, how the current and any future bubbles pan out is obviously of the highest importance. In my personal situation, my wife and I don't own a home currently and I'm looking at 2009 as a time that we might start looking for a house. This is earlier than the trough in Janszen's chart because I expect a lot of real depreciation in housing to come from inflation rather than nominal price decline in the later years.

I'm also a believer in the alternative energy space, which is the main reason behind my recent purchase of PBW. I am however wondering why there isn't a commodity bubble prior, say peaking in 2011-2012. After all, what better justification for alternative energy than high conventional energy prices? In the inflation/deflation debate, Janszen is squarely in the former, so he's unlikely to argue for lower e.g. oil/gas prices based on waning global demand. The most plausible explanation is that the commodity bubble will be concurrent to the one in alternative energy. We know that silicon valley VCs have gone "green" in a big way. Janszen being a venture capitalist himself, is probably more conscientious of it.

I would like to hear your reviews of this article. I believe bubbles are of theuttermost importance. In fact, I'll go so far as to say that successful investing consists essentially of catching a bubble at its formation stage and not jumping ship too early or too late. So for now, I'm planning to do some reading on business relating to all manners of alternative energy as well as recycling.

Chindia

2008-04-08T21:25:00.000-04:00

Continue on with the notion that we've made an interim bottom in the S&P, I want to take a quick look at both the Chinese (the Shanghai index) and Indian (the Bombay Sensex) today. Unsurprisingly, they both appear to have bottomed based on extremely over sold RSI and stochastics.

SSEC declined from a high of 6124 in October to a low of 3271 or 46.6% in a little over 5 months. Measured from the 2005 low just under 1000, it has given back over 50% of the gains. The low of 3271 was between the 50% retracement and a very strong support at around 3000 that went back to Feb-Mar 2007. Back then, a 9% one day drop in the SSEC was the shot heard around the world, but it's hardly noticeable in this chart. The 61.8% retracement sits just under 3000. While there is some danger that the 3000 level is in play since the 50% retracement was taken out, the extreme RSI reading argues for at least a temporary rebound. At any rate, the 3000 level has every reason to hold if things come to that. So I would argue that the risk/reward here is acceptable for a long term investor. Among the myriad of China funds, my old favorites are FXI and CAF.

Unlike the SSEC, the BSE has suffered much less technical damage in comparison. Recent lows in RSI and stochastics were consistent with previous bottoms. It's also important to note that stochastic buy signals in the weekly chart were often followed by many months of steady increases. I would consider both IPN and IFN, or even the new Wisdomtree India ETF, EPI, here.

Portfolio March 2008

2008-04-07T01:23:00.000-04:00

In start contrast to the first two months of this year, March turned out to be one of the worst on record. The actively managed (AM) and asset allocation (AA) accounts lost 7.71% and 2.51% respectively. The total portfolio saw a set back of 5.44%. Both AM and AA portfolios are now negative YTD (-3% overall), although still doing much better than all the main stream indexes I track.

The culprit was clearly a severe sell-off in the commodities which were the key driver of the outperformance in months earlier. Live by the sword and die by the sword, as they say. Anyway, my current view is that the Mar 17 low in the S&P (1257) was a meaningful interim bottom that should last at least a couple of months. I view the rally in financials as an oversold rally precipitated by unprecedented actions by the Fed which is providing a backstop to the toxic mortgage backed papers. That is not to say that they can't or shouldn't go higher as the MBS market becomes more rational. Over the long term, I would avoid all but the strongest firms in this space, such as GS, WFC or BAC.

Despite the set back in commodities in March, I continue to be a strong believer in them and the global growth story. The notion of decoupling has gotten a black eye this year as financial markets world wide declined in concert. However, decoupling is probably best viewed in the realm of the real economy rather than financial markets. At the extreme, when it comes to central bank policies and latitudes in government fiscal policy, diametrically opposite is a better description of the gulf between US and the emerging markets. Hence, it's no surprise that oil prices remain stubbornly above $100 and aginflation is still unabated.

In the mean time, precious metals have come under pressure. Gold has dropped below the channel I drew here. It has held $900 which is the first step towards repairing the technical damage that has been done. However, I don't expect a new high any time soon. The more likely scenario is that it will retest $1000/oz soon but would fail again. I have previously describe how gold tends to take three to four tries before overcoming a significant milestone -- $1000/oz certainly qualifies here. My PM trading account dropped to 37k from 45k last month. I only took partial profits even though I was looking for a correction. I can't make any excuses for myself. I took my eyes off the ball, simple as that. On the brighter side, I now believe the current wave (iii of 3 of III) has quite a bit further to go. I'll go into more details in an upcoming post.

Barron's pans commodity investing

2008-03-31T01:22:00.002-04:00

The cover story of this week's Barron's was Guess who's behind commodities boom ($), with this quote on the cover: "More than half of all bullish bets on commodities have been made by speculators, both big and small. When these markets fall, they'll fall hard, perhaps by 30%."

That quote summarizes the article pretty well. The cornerstone of the author's argument was the current record net long position of speculators and the corresponding record net short position of the commercials who are considered the "smart money". Commitment of traders (COT) data is indeed a valuable tool in analyzing markets, but to ascribe the price run-up to speculative demand alone glosses over the very real bullish supply/demand fundamentals. For example, the chart below (source: FABRI world agricultural briefing book 2008) shows that the record run-up in wheat prices was accompanied by an equally significant decline in its stock-to-use ratio. Similarly bullish supply/demand picture for other agricultural commodities can be found in the same source. [These charts also predict future price declines for several major crops. Obviously, the level of confidence to be placed on future predictions vs. past data is quite different. At any rate, the point is that speculative demand cannot alone explain the price increase in many agricultural commodities.]

If the main thesis of the Barron's article was that the commodities will correct further, I would have titled this post "Barron's pans commodities". Hell, I probably would not have written this post since I see some short term technical difficulties myself. However, rather than voicing an opinion on the future price trajectory, the article was really an indictment on investing in commodities, or to be exact, investing in commodities in long-only index funds. One particular quote belies the author's disdain

In other words, they [the commodity index funds] trade the naive and potentially fatal assumption that commodities have the same tendency as stocks to rise over the long run.

Much of the article was an accusation that the commodity index funds distort the futures markets and it even implied that the CTFC might rescind an exemption that allows these commodity index funds to take on large long positions.

Given the size of the futures contracts, the commodity index funds represent the only realistic chance that individual investors can participate in this booming market. I don't know about you, but the prospect of government limiting access to tangible things of real value all the while debasing the currency so that the prices of real things have nowhere to go but up does not sit well with me.

The article spoke of an upcoming CFTC meeting on Arpil 22 "to hear firsthand from participants to ensure that the exchanges are functioning properly". I believe concerned individual investors should let relevant government officials know where they stand regarding their freedom to put their dollars. The contact information below may come handy.

US Commodity Futures Trading Commission
Contacts
Three Lafayette Centre, 1155 21st Street, NW Washington, DC 20581, 202-418-5000
Acting Chairman: Walter Lukken, (tel) 202-418-5014, (fax) 202-418-5550

US Senate Committee on Finance
219 Dirksen Senate Office Building, Washington, DC 20510-6200, (202) 224-4515
Committee Members

House Committee on Financial Services
House Financial Services Committee, Democratic Staff, 2129 Rayburn House Office Building, (202) 225–4247
Members
Committee Chairman: Barney Frank

Adding some PBW (Powershares Wilderhill Clean Energy ETF)

2008-03-25T18:12:00.001-04:00

My post over the weekend outlined my concern with the durability of the recent bottom due to a broad sell-off in commodities and materials related stocks. Their recovery so far this week is cementing the notion that we have made an interim bottom (perhaps of several months in duration?). I'm still skeptic regarding the financials as a whole although the best of breed probably deserves some more attention.

I added to my agricultural and base metal positions Monday and to my existing position in PBW (Powershares clean energy ETF) today. I've been wanting to add some beaten-down solar energy stocks but haven't yet done the homework in this sector. PBW has most of the major solar companies among its holdings and will serve as a core position in my portfolio. Its chart features a nice double bottom at $18.50. The downtrend line was just broken, shortly after demonstrating positive divergence.

What a week!

2008-03-23T21:30:00.000-04:00

This past week was undoubtedly one of the most schizophrenic in recent memory -- given how 2008 has unfolded that's saying a lot! I have been calling for a break of the January lows before moving higher. Now that the first part of that prediction has come true, the pressing question is "How durable is this low going to be?" I had thought before that we would have an intermediate term low. My thinking has been wavering in view of the broad sell-off in commodities this week.

While the financials have made a tradable low based on extreme negative sentiment, I'm not sanguine about the long term prospects of this sector at least in terms of its relative weight in the S&P. This week's Economist has this to say about the leverage employed by investment banks:

This process has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out.

Looking at it this way, Carlyle Capital's 32x leverage was none the least extraordinary. In the current environment, one can safely say that the securitization business won't be the same for a long time. In contrast, the commercial banks have brightened their earnings prospects in theory due to the steeper yield curve, but unlike the investment banks, they have not been as aggressive in marking down assets. Another concern is whether they can find any worthy borrowers to take advantage of the yield spread. Lastly, the asset management business may provide some long term growth prospects, where the two E's, emerging economies and the elderly, should provide a growing ~~flock of sheep to be sheared~~ client base. But that growth will take time. In conclusion, besides trading profits and some asset mark-ups (by no means certain despite we hear on CNBC), I don't see a lot of positives for the balance sheets of financials as a whole. I certainly don't see them leading the charge into a new secular bull market.

As mentioned at the start of this post, I have grave concerns about the decline in commodities, should it progress further from here which would suggest something more sinister than profit-taking, hedge fund margin call, or a concern with broker liquidity. Some would character it as sector rotation, but to me sector rotation occurs within the framework of the existing market trend, which is bearish. Commodities/materials have been the last pillar of this market, if they were to fall, should there be a renewed concern with the financials, absolutely nothing could prop this market up.

Precious Metals
In the last post, I mentioned the possibility of a post-FOMC decline in the PM complex, but its ferocity still amazed me. Gold lost about $115/oz in a span of four days! Gut-wrenching this drop may be, gold and silver have merely fell to the bottom of their respective up trend channel as shown in the two charts below. Assuming those trends remain intact, this is another buying opportunity.

The HUI declined from a high of 520 to a low of 425 in less than four days. Looking at the bull leg from May'05 to May'06, there was a drop of similar magnitude in March'06 (albeit over a longer time period), the HUI subsequently recovered and went on to peak in May. Although the current decline took place much more quickly both declines were wave 4 corrections in their respective 5 wave advances by my count (see the last chart for my EW count for the current wave). The best case scenario is sketched in red in the next chart where the HUI traces out a triangular abc wave 4 correction pattern making a new high. Another argument here is that while the gold stocks have come a long way since their August bottom, there has yet been a parabolic type move that punctuated earlier uplegs. In summary, I believe there is still some ways to go in this PM bull leg yet, and I've been taking positions accordingly.

Records are made to be broken

2008-03-16T02:00:00.000-04:00

By now, a Friday swoon is all but de rigueur, nonetheless, the speed with with Bear Stearns found itself in trouble was astounding. The WSJ had an excellent report on this. Looking at archives for this blog, I found this post I wrote on Bear right after the New Century debacle. Soon after writing I thought I was being too harsh, little did I know how much it would have fallen! I was shorting BSC then, at around 150 if my memory serves. All I can say is that I wish I kept those shorts!

A couple of days ago, I pointed out the record CBOE equity put/call ratio. Well, records are meant to be broken and this one stood for only a week. A new high of 1.16 (meaning 1.16 equity puts for call was traded) was reached on Friday.

Concurrently, the VIX spiked up and closed at 31.16 on Friday.

Contrarian thinking would say that we are at or near an intermediate bottom. Many market historians point to major bank failures as signs of a market bottom. The situation at Bear probably qualifis as a modern version of a bank failure, not to mention the rumor that UBS may also be in a similarly unenviable position. By my EW count, we're in the final stage of this down leg, although there are alternative (read: more bearish) scenarios. Personally, I'm considering buying some calls on GS this week to play for a bounce with defined downside. I'll mention one more thing: if we're indeed at or near an intermediate bottom, the already considerable reputation of Martin Armstrong (see graph of Armstrong cycle here) will most certainly grow to legendary proportions.

Since gold touched $1000/oz on Friday, PMs merit a mention here. The FOMC meeting is the major event next week, with the futures currently pointing to an even probability between a cut of 50 and 75 bps. I'm leaning towards 75 bps especially if we witness another "run on the bank". Recall that for the last FOMC meeting on Jan 30, the question was whether the cut would be 25 or 50 bps. After Ben and company delivered 50 bps, PMs saw a temporary spike that quickly fizzled. I'll be watching out for a similar scenario this time around.

Double bottom?

2008-03-13T02:30:00.000-04:00

Looking at the chart of the S&P, a case can be made that it has made a double bottom around 1270, especially given the positive price/MACD divergence. However, the benefit of doubt still belongs to the bearish side until the S&P can make a higher high above around 1390, more preferably above 1406. Until the market is definitively in an uptrend I'll maintain the view that the January low will be broken to the downside. To that end, Tuesday's Fed induced rally is the start of wave iv of 5 by my count. In other words I'm trying to stake out a middle ground between the bulls who have call a bottom for weeks and the bears who are calling a continuation of the bear market for years.

As far as PMs are concerned, my opinion has been whipsawing around. My original short term correction target was 470-475 on the HUI, which I thought was reached when the intraday low for the HUI reached 477 on Mar 4th. FWIW, at the time I had a short term target around 540 for the HUI. While the momentum indicators for HUI and the metals themselves are still pointing down, I still believe we're in the most explosive stage of this advance, hence it's better to err on the long side.

Oops!

2008-03-10T22:33:00.002-04:00

I only have time for a very short post today: I don't like the action in precious metals at all today. Many charts are rolling over. I was relying on some timing analysis that has been serving me well. Right now I'm in capital preservation mode as far as the trading account is concerned. Other than that, I'm actually savoring the drop in stocks as I get ready to go shopping in the following areas: ag chemical, base metal, infrastructure, alternative energy and emerging markets.

Market update

2008-03-09T22:38:00.001-04:00

I'm not going to comment on the jobs number other than mentioning for the umpteenth time that employment is a lagging indicator as very convincingly shown in Ahead of the Curve (see my book review).

The S&P closed the week at 1293. The volume was 4.3 and 4.6 billion shares on Thursday and Friday, versus 6.0 and 6.5 billion shares on Jan 18/22. Clearly there was still no capitulation, thus the refrain that there was a lack of buyers rather than a surplus of sellers. We're two weeks away from the Mar 22 low of the Armstrong cycle, and all indications are that we would break the Jan low of 1270. I still believe that the coming low will be fairly durable, given a host of negative sentiment readings. An example of such a sentiment indicator is the CBOE equity put/call ratio, which hit a multi year high of 1.12 on Thursday.

My current EW count of the S&P has it in wave iii of a final 5th wave down. So I'm not calling for a final, precipitous drop right away that may be desirable to those who just want to get it over with. If anything, the unusual action in Ambak and Thornburg in the last minutes of Friday's trading session may be foretelling a nice bounce on Monday.

If we do have an early bounce next week for whatever reason, I expect precious metals to tag along for the ride. Overall, gold and silver held up well last week. Silver especially was able to doggedly stay above $20/ounce. According to the latest commitment of traders report, the commercials have been covering their shorts in a rising market. Whispers of a short squeeze have been making the rounds. This is definitely not something I mind: as of Friday my PM trading account is completely reloaded.

Scary Charts

2008-03-06T00:50:00.000-05:00

That the market could rally again on another rumored Ambac deal was well into the realm of absurdity. That said, it always frustrates the most people whenever possible. If the downward course were too well-lit and well-paved, there would be plenty of passengers with put protection, limiting the downside in the first place. On Monday we reached an intraday low of 1307 that was lower than the closing low of 1310.5 on Jan 22; however, there was no climatic volume or other tell-tale signs of capitulation. Thus I'm expecting more downside to come.

I found the following charts at the Financial Ninja, and they're scaring the bejesus out of me. I'm posting the first two and the rest can be found at the link above. The charts were from the St. Louis Fed and the commentary from Ben Bitrolff (aka the Financial Ninja). The first chart shows that total borrowing (by banks) is up from 16 billion in December to 46 billion in February. And if you think that is bad, look at the second where non-borrowed reserves dropped from 25 billion in December to LESS THAN ZERO! No wonder Bernanke is expecting bank failures.

At times like these, precious metals shines as a safe haven. I said before that the magnitude of the move currently underway will stun all but the most devout gold bugs. We got a flavor Wednesday when both gold and silver came back one day after a devastating loss to make new highs. That was enough to have me wading back in my trading account.

Portfolio February 2008

2008-03-01T15:24:00.000-05:00

I said in my previous post that barring a calamity on Friday, I was assured a good February. A 315 pt down day in the Dow wasn't exactly a calamity, but it did knock a couple point off an otherwise fantastic month. In the end, my actively managed (AM) accounts gained 8.66%, bring the YTD figure to +6.85%. The asset allocation accounts (AA) had a smaller gain of 1.76% for the month. YTD it's at -2.37%. Due to the strong performance of the AM accounts, the total portfolio swung to a +2.63% for the year. In terms of net dollar gained, it was the second best month after September of last year. I again significantly outperformed VTI and SPY, both gave back 2.5% for the month. EEM, at +1.99%, was the only index ETF in the table that had a good February.

The outperformance was due predominantly to precious metals, discussed in detail through out this blog, as well as other commodities. I raised some cash during this month for two reasons: to realize some capital losses to off-set the gains in my trading account, and to position for what I anticipate as another leg down in equities in the coming month. To that end, I pared back on some agrichemical names. I also ditched an oil refiner (TSO).

Despite some misstep with risk management early in the month, the PM trading account (distinct from the AM and AA accounts reported above) scored another good month. By closing out all my positions on Thursday, I avoided some heart ache on Friday. My current plan is to re-initiate positions next Tuesday-Wednesday, of course market conditions would dictate that. Total equity in that account stands at $45.3k from a month starting value of $35k and a year starting value of $25.2k.

Lastly, I went back into NXZ at an average basis of just under $14.70. Again, I was early, but at least it was significantly below where I sold it, so I'm not complaining.

Raising some cash for March

2008-02-29T00:49:00.001-05:00

The action in stocks continues to confound me. We had upside breakouts from widely observed triangle formations in both the Dow and S&P (graph below); however, both have been repelled by their 50 dma's. Wait a minute, was it just retesting the breakout? Either way, the tepid volume shows a lack of conviction in both bulls and bears.

If the S&P manages to get above the previous high of 1396, there is another overhead resistance around 1406-1410 that it needs to contend with. FWIW, I'm on record as saying we'll retest the January lows before moving higher. The most recent price action puts us in wave 4 of a 5 wave down. Accordingly, I've been raising some cash in order to better take advantage of another bottom.

About a week ago, I sold some agrichemical names that have been performing well, perhaps a little too early. Names like POT and MOS have been on a teer, but as I recall, they were taken to the woodshed several days before the January low. If the market were to break, the strongest sectors would break last, but break they will.

I also closed out all positions in my PM trading account today while leaving the core positions intact. I stand by my prediction that we'll see phenomenal returns over the next two months, but the PM action, particular that of silver, looks toppy. While we can certainly go higher without pausing, I wouldn't bet on it. More than anything though, I want to preserve this month as one of my best, which barring a calamity on Friday, is assured.

Pounding the table about PMs

2008-02-27T22:36:00.000-05:00

HUI made a new closing high of 485.9 today, besting the 480.99 mark set in January. The intraday high of 491.58 was also a record. With this new high, it is almost certain that we are in the middle of wave (3) of iii of 3 of III, first suggested here. In Elliott wave jargon, wave 3 is the most sustained portion of a 5 wave advance; more so for iii of 3, and so on. If this is the case, the advance of PM mining stocks in the next two months is likely to stun all but the most devout gold bugs.

Very tellingly, both ratios of HUI:Gold and Silver:Gold have been trending up which is an indication that the move in precious metals is gaining recognition and speculative fervor is brewing.

The picture at the start purports to depict a notorious incident when the then Soviet First Secretary Khrushchev pounded the table with his shoe at a UN assembly in 1960 (Wikipedia: Nikita Khrushchev).

The Golden Rule

2008-02-26T00:10:00.000-05:00

Gold was weak Monday on the heels of news that the Treasure department is lobbying congress to allow the IMF to sell 400 tonnes of its gold. Here's the original Reuters report of the planned gold sale. If we look at where the potential systemic financial failures are today, we'll come up with a handful of countries that were, let's say, never intended to be the recipient of IMF funds when it was founded. Surely, that irony is not missed by many. Be as it may, I don't expect the bureaucracy to call for its own demise, hence I don't yet consider its attempt to shore up revenue by selling gold as gold price manipulation.

On the other hand, similar proposals have come before, and each time rejected by the US Congress, proving that its collective IQ is at least in the double digits. Perhaps it is even aware of the golden rule:

He who has the gold, makes the rules.

While 400 tonnes may sound like a lot (about $12 billion at current market value), its a drop in the bucket compared with central bank reserves of countries that have stated their intention to diversify away from US dollar denominated assets. Here's a list of central bank gold holdings as a percentage of total reserves. A clear dichotomy exist between the CBs of "East" and "West". Since the annual production of gold is a small fraction of the above-the-ground stock (a defining characteristic of monetary metal, one might add), the best way to in crease CB gold holdings is to buy from other CBs. Hence I predict that no matter how much of its gold the IMF will sell, it will find eager buyers. At the mean time, any price weakness is a gift to buyers of physical bullion.

Indecision

2008-02-20T22:10:00.001-05:00

I confess to being a little befuddled by the market action of late. The nasty reversal on Tuesday was neatly canceled by the 200 Dow point reversal today. This morning's CPI number provided an ample reason for a big sell-off and the Dow was quickly off 100 pts. Then the market rallied around midday and never looked back, finishing up 90 pts in the Dow. Still, I consider the overall market direction to be in a downtrend until there is a higher high on the S&P (>1396). I'm still looking forward to a retest of the January lows. Below is my EW count on the S&P which would have us just into wave 5 of a 5-wave decline. [An alternative count is that we're finishing wave 4 and soon to enter wave 5; however, it doesn't change my near term views substantially.]

I've been going back to the Armstrong cycle which garnered a lot attention as it predicted a cliff-dive last February with pin-point accuracy. It shows an intermediate low on Mar 22 followed by a corrective rally into next April and then another nasty leg down into Jun 2011. As far as applying it to the stock market, we should note that stocks made higher highs well after Feb '07. Armstrong called his cycle the "global business cycle", so it may not coincide with market cycles. My feeling is that should one use it a a timing tool, it's should viewed as a kind of oscillator. At any rate, a decline into late March that takes out the January lows would be consistent with the EW count presented above.

While the overall stock market may be pausing before another decline, commodities are forging ahead. With oil above $100/barrel, the strength in the CRB index pointed out in the previous post has continued. However, with the exception of precious metals they're getting overbought territory and a pull-back is to be expected. Speaking of precious metals, the HUI finally broke out of the down channel I drew here, so to repeat a phrase being aired hundreds of time in the last two days: Houston, we have lift-off!

Long bond falling

2008-02-14T22:03:00.000-05:00

While credit concerns at monoline insurers played a hand in today's across-the board selling of muni closed-end funds, let's not overlook the fact that long treasuries were also falling hard. It happened at the same time that Bernanke was babbling about "inflation expectation being well anchored". Coincidence? I think not. The next major support on the TLT is 90. I doubt it will hold for long.

So where is this money going? Where is the new safe haven? On the same day that DOW dropped 175 pts, the CRB index is conspicuously strong.

Auction-Bond Failures Roil Munis, Pushing Rates Up

2008-02-13T22:35:00.001-05:00

Bloomberg reports:

Feb. 13 (Bloomberg) -- Bonds sold by U.S. municipal borrowers with rates set through periodic auctions failed to attract enough buyers as banks including Goldman Sachs Group Inc. and Citigroup Inc. that run the bidding won't commit their own capital to the debt.

Rates on $100 million of bonds sold by the Port Authority of New York and New Jersey, with bidding run by Goldman, soared to 20 percent yesterday from 4.3 percent a week ago, according to data compiled by Bloomberg. Presbyterian Healthcare in Albuquerque and New York state's Metropolitan Transportation Authority also experienced failures, officials said.

What began three weeks ago with too few bidders for auction-rate debt backed by relatively small entities, such as Georgetown University and Nevada Power, has widened in recent days to include large issues of state governments, such as New York state's Dormitory Authority. The auction failures provide new indication of Wall Street's unwillingness to commit capital amid $133 billion in credit losses and asset writedowns.

Recall that I exited my closed-end muni fund positions (NXZ in particular) the day after MLK day. Well, NXZ been trending up ever since and I had a great deal of self-doubt. Today it gave back 3.86% which was an enormous move for a bond fund. It's still above where I sold it but I'm beginning to think that my conservatism may be vindicated.

Despite Warren Buffet's offer to provide a back-stop to the monoline insurers, the credit crisis is far from over. First of all, it's clear that if the monolines give up their muni business they may as well sign their own death warrant. The way I see it, the muni business is the only bargaining chip they have, as in "If we go down, we take the system down with us. So how about a few billions to help us out?"

That said, I'm sure eventually most of the muni bonds will find a high quality insurer. Their yields are very attractive now. Even more so should the dividend rate cut expire in 2010. The way things are going, soon I may even have a chance to go back in for less.

A few PM charts

2008-02-12T01:39:00.000-05:00

Since my call to buy the dips last Tuesday, the PM sector has performed admirably. Gold spot has gained for four consecutive days while the HUI has bounced strongly off its 50 DMA. Looking back at the gold site traffic as sentiment indicator I presented last time, a strong case can be made for having already entered wave (3) of iii of 3 of III which should bring some breathtaking advances. Below is my labeling of the Elliott wave pattern.

The just-ended wave (2) is a corrective wave that is composed of legs abc. Normally, one expects wave c to end lower than wave a, however the chart is complicated by the unwinding of SocGen trades. If we take a look at the line chart which plots closing prices only, it becomes clear that wave c did end lower than wave a. In addition, wave (2) is contained in a downward trend channel. If my labeling is accurate, an upward breakout of the channel should be imminent.

It's always important to pay attention to the ratios to see the relative valuations. For example, $xau:$gold recently dipped below 0.2 (gold/xau above 5), which according to John Hussman represents a good buying opportunity in gold stocks. The chart below compares the silver/gold ratio to the HUI/gold ratio. In recent years, notable lows in silver/gold either coincided or slightly lead notable lows in HUI/gold. Perhaps it's because both are more speculative and leveraged plays on gold and it takes time for the underlying trend in gold to be recognized. By and large, both ratios move in the same direction, which begs the question: how should the current discrepancy (circled in red) be resolved?

Another dip, another buying opportunity

2008-02-05T20:43:00.000-05:00

Since we last touched on gold, it had quite a ride. The GATA rally never materialized, and the pop we got from the Fed's 50 bps cut quickly fizzled away. Instead, we have an unpleasant "working-off" of the divergences I noted earlier.

With today's drop, sentiment surrounding precious metals is again reaching a low as judging by the internet traffic to three well known sites: Kitco, GoldSeek and Gold-Eagle.

Recent history suggests that dip buyers in the PM space will be rewarded, so I would reason that another opportunity is presenting itself if not already. For those of you with more doubt, I would urge a read of the most recent call transcript of Don Coxe for a refreshment of the macro trends in play.

PS I sold my SWC last Friday after another 20+% day. I was early which was fine with me.

Obama's plan for the tax man

2008-02-04T22:28:00.000-05:00

Tomorrow is "Super Tuesday". Chances are that a clear Republican winner will emerge at the end of the day but the Democratic contest will still be too close to call. FWIW, my personal choice for the presidency would be Ron Paul (Yes, unlikely), McCain, then Obama, in that order. McCain is the only Republican that stands a chance in the general election according to polling results summarized at RealClearPolitics.

The DC Current column in this week's Barron's (subscription) featured an interview with Austan Goolsbee, Obama's economic policy advisor, and we have a preview of tax policy under President Obama. Some highlights:

He would hike most rates on dividends and capital gains from their current top of 15% to between 24% and 25% in order to generate new revenue and pay for middle-class tax simplification... That's less than the 28% rate under Ronald REagan, and nore than the 20% rate under Bill Clinton.

To insure against a negative impact on innovation and new business formation, Obama would have a zero rate on capital gains for entrepreneurs, venture capitalists and small-business owners forming new enterprises.

And for ordinary income, Obama would allow the top marginal rates to return to the Clinton era's 39.6% versus 35% today. Obama would also eliminate all tax shelters and loopholes.

Fore moderate wage earners who take the standard deductions, tax filing would be simplified. The Internal Revenue Service would figure out their taxes for them and send them a one-page form to sign, reducing preparation costs.

Even with a Republican in the White House, it's probable that the Bush tax cuts will not become permanent given the Democratic control of Congress. However, a further increase of the capital gains rate to 25% (from the Clinton era's 20%) would have pretty dire consequences for the stock market.

Portfolio January 2008

2008-01-31T22:14:00.000-05:00

January was a month not too soon to be over. At one point, my portfolio was down double digits which would have made it the worst percentage decline ever. It recovered nicely though. The actively managed accounts retreated 1.67%, the asset allocation accounts 4.06%, giving an overall decline of 2.77%. It was nowhere as bad as the worst month (Sept 2006, -4.29%) or August and November of last year. Looking at the benchmark ETFs, SPY and VTI each gave up more than 6%. As horrible as they were, they fared better than EFA, EEM or the Q's. Relatively speaking, I did very well.

Most of the out performance came from the precious metals where the HUI index gained 12% for the month. However, my PM portfolio actually declined slightly since it was skewed towards silver and juniors which lagged big name gold miners. However, it was more than made up by the 16% increase in CEF.

I also did very well in my trading account which is not part of the portfolios reported here. I made a gain of $10k (from a starting value just over $25k) due to a combination of being on the right side, leverage and getting the major turning points right. It goes without saying that it's almost impossible to keep up this kind of performance although I'd like to try :-)

The month-ending portfolio allocations are in the tables below. This is the first time I break down the non-PM resource/commodity sector into subsectors of energy, base metal and agricultural. I'm underweighing base metals because of their sensitivity to economic conditions. On the other hand, I've been adding to agriculturals on weakness this past month.

As mentioned here, I got out of the closed-end muni bond funds. The choices are either going back in or to buy TIPS (TIP) on anticipation of an increase in inflation. Long bonds (i.e. TLT) are out of the question as we're near the top of its price channel. For now, I'm perfectly content to leave the money in cash to ponder my options.

GATA rally?

2008-01-29T22:47:00.000-05:00

News Alert
GATA (Gold Antitrust Action Committee) is set to take out a full page ad in Wall Street Journal this Thursday according to this article by FN Arena News.

The Gold Antitrust Action Committee (GATA) is an organisation which has been nipping at the heels of the US Treasury Federal Reserve for several years now. The basis of GATA's accusations is that these institutions, in coordination with other complicit central banks and the large gold-trading investment banks in the US, have been manipulating the price of gold for decades. Were it not for this manipulation, the gold price would now likely be in the thousands of US dollars, GATA suggests.

The means of manipulation have largely revolved around the gold leasing and gold derivatives markets. GATA believes the US Treasury has been able to effectively sell gold under the radar of the limited disclosure rules of the International Monetary Fund - global bookkeeper of central bank gold transactions - for the purpose of artificially supporting the value of the US dollar. The upshot is that while the IMF, and the world, is led to believe global central bank gold reserves total some 30,000 tons, the reality is more like 15,000 tons. Today's gold price is a reflection of the former figure.

A PDF version of the ad can be seen here.

Divergences

2008-01-29T21:45:00.001-05:00

Although I've kept my PM trading positions intact, there are several divergences that worry me. First is the divergence between HUI and gold where the stocks failed to make a new high while gold did. Some of that may be attributed to weaknesses in South African golds that were affected by the power outage; however, price/MACD divergence is also apparent in AEM, one of the strongest stocks.

Tomorrow's Fed action is all the more crucial in this light.

25 or 50 bps?

2008-01-28T22:24:00.000-05:00

All eyes will be on the Fed tomorrow. Although the market is expecting (demanding?) 50 bps, 25 is a real possibility since we've learned the real reason behind last Tuesday's collapse in futures was the unwinding of trades made by SocGen's rogue trader.

I've been just about all-in in my PM trading account since last Wednesday. The reason had more to do with the notable weaknesses on the mornings of last Tuesday and Wednesday than reaching my downside targets. I'll admit that I was a little scared Tuesday morning. And if someone who has a deep conviction in PMs like me felt that way, many weak hands must have folded -- which means we're cleared to take off. By my count, we should now be in the most vertiginous portion of this advance.

The biggest news last week was the mining interruptions in South Africa due to power outages. Platinum and the rest of the platinum group metals (PGMs) were the real beneficiaries of this supply disruption. A clear beneficiary is Stillwater (SWC) whose mining operations are in Montana; North American Palladium (PAL) is another. SWC jumped over 20% on the news on massive volume and broke out from a down trend. [Disclosure: I own SWC.]

Links, blogroll and book recommendations

2008-01-27T23:15:00.000-05:00

I'm moving the links, blogroll, and book recommendations here in order to reduce clutter on the home page. Pages should load faster due to less content in the sidebars.

Links

PM related 321 Gold Gold Eagle Gold Seek	Energy and Base Metals 321 Energy Kitco Casey Kitco Metals Resource Investor
General Commentary Contrary Investor Daily Reckoning Financial Sense Hussman Funds John Mauldin Jeff Saut, Raymond James Northern Trust Prudent Bear Safe Haven	Market Resources BullandBearWise ETF Connect Stockcharts Stock House Thomson I-Watch Weekly Alerts Yahoo World Markets

Blogroll

Economics & Markets Big Picture Bill Cara Calculated Risk Mish's Economic Analysis Random Roger Seeking Alpha	Personal Finance 2million Fearless Money Free Money Finance Hustler Money Blog Hustlerama
Trading and Investing Ron Sen Moomin Valley Sum of Some Banche e Risparmio	Blog Aggregator PFBlogs.org Phat Investor Market Blog Ring < ? Market Blogs £ >

Recommended Reading

The Economist	Index Funds: The 12-Step Program for Active Investors	The Intelligent Asset Allocator
Hot Commodities	Twilight in the Desert, Saudi oil crisis	The Dollar Crisis
Bull's Eye Investing	The New Reality of Wall Street	Unexpected Returns
Fooled by Randomness	How To Make Money In Stocks	How to Make Money Selling Stocks Short

Out of closed-end muni funds for now

2008-01-26T00:55:00.000-05:00

I have discussed before that for my asset allocation plan, I had chosen to have muni bonds in taxable accounts instead of taxable bonds in tax-deferred accounts. In fact, I purchased some NXZ at the beginning of the year. I got out of them last Tuesday, after the big panic. Although I managed a small profit, the selling price was below Friday's close. I wasn't too happy about the move at first, but my prudence may still be rewarded.

The motivation was of course the imminent downgrade of the bond insures Ambac and MBIA, which has been all over the news. To be fair, the muni insurance business is profitable, serves a useful purpose and will never be allowed to fold. However, some has suggested a figure of 200 billion! is needed to bail out the bond insurers. That may be too steep a price even for the billionaires who are circling around the (soon to be) carcasses. In all likelihood the 200 billion figure stems from the write-downs from CDS's (Bill Gross doesn't appear to be that far off), and you can bet that the bond insurers are clutching to their muni business like a lifeline. Barclays is now saying that if the bond insurers' rating are cut too deeply, banks faces additional 143 billion in write-downs. A hundred billion here, a hundred billion there, and pretty soon, we're talking real money!

Judging by the price action of those closed end funds, muni investors are nonplussed about all this ruckus. However, a little prudence may not be a bad thing. It's not unreasonable to assume that while Ambac and MBIA are drinking from the CDS cool-aid, some of that good fun got spilled over to the muni insurance side, and the default risks got under priced in some issues. At the least one would expect the balance sheets of municipalities hard hit by the housing crisis not look as sound. So while as the muni insurance business as a whole will never go away, it's not clear that all the muni bonds will keep their existing ratings in a re-shuffle.

I could pour over the latest quarterly reports of those muni funds to see what may be affected, but given the size of my investment that hardly worth the effort. I'll keep the cash and jump back in after this brouhaha is over.

CNH Global

2008-01-24T20:31:00.000-05:00

When I bought CNH two days ago, I though I had a low risk entry upon a bounce off its 200 DMA. Well, if I were to use a catching falling knives analogy, I didn't just cut my hands, I got them nailed to the floor. Nonetheless, I just can't see how the selling is justified by the fundamentals.

Ostensibly, the bloodbath was precipitated by a disappointing '08 EPS guidance of $3.30-3.60, below consensus of $3.67. However, at it lower bound the guidance is still 40% above the '07 EPS of $2.36. We can see from the chart below that the P/E of CNH was around 20 in '05 when earnings were flat. Through its bull run, its P/E rarely dip below 20. Today's closing price of $6.00 gives it a trailing P/E of 19.5 and a forward P/E of 13.9 assuming '08 EPS of $3.30. On a historical basis and in view of the 40+% anticipated earnings growth, the stock is cheap.

Perhaps people were unnerved with its guidance of North American construction equipment sales being down 10% in '08; however, for '07 the company saw a reduction of 23% in the same category but still managed a gain of 23% in worldwide construction equipment sales. The farm equipment side is more than twice as large and growing much faster. In summary, I see this sell-off as an over-reaction at a difficult time in the overall market. I'm holding onto CNH since I'm confident of its growth prospects.

BlackGolden Tuesday

2008-01-22T21:37:00.001-05:00

What could have been a cliff-dive was averted by the Fed's emergency 0.75% rate cut. The Dow managed down only 128 after opening down 460 points, but the real beneficiary was gold as its spot price gained $7.9 after down more than $23 overnight. The PM positions I picked up last Friday was comfortably in the green by 10 AM. I couldn't help but wondering what I would have done had the US markets been open on Monday. Would I have cut my losses early? Probably, but again, perhaps we would have seen the 75 basis point cut on Monday morning?

After a day like this, a near-term bottom must be considered a real possibility. I took some profits but net/net added more positions today such that the trading account is now back to 2/3 committed, all in PMs. There was a lot of strength in the old green back as world markets were crashing. Indeed, the dollar index may bounce further, but I do not expect gold to take the inverse course as many are conditioned to believe. Whatever renewed vigor in the dollar comes from competitive devaluation of other fiat currencies. The upshot will be that gold rises in all currencies.

Elsewhere, farm equipment makers Deere (DE) and CNH Global (CNH) had a good day, gaining 8.8% and 7.4% respectively. I picked up some CNH in the morning as its early gains stood out in a horrendous tape. As long as the US ethanol program remains and the Chinese eat more meat, I'm sticking with positive views on the agribusiness sector.

The 17 and 43 week EMA crossover

2008-01-21T21:12:00.000-05:00

I wrote this post a couple of days ago and it was actually posted to 1stmillionat33 this morning. However, in view of the world wide stock market carnage seen today, I'm not sure in what light I should present it. In the end, I decided not to change a word, even though the last paragraph may sound more than a little silly right now.

I learn about this long term indicator from an article on ContrarianInvestor (I’m a subscriber). I doubt they are the originator as moving average crossovers in general has been in use for a long time. The system looks at the relationship between the 17 and 43 week exponential moving averages (EMA) of the S&P 500 index. When the 17 week EMA is above the 43 week EMA, one should long the S&P, otherwise, one should short the S&P. The weekly EMAs are equivalent to the 85 and 215 day EMAs which is plotted below using the new Yahoo charts. I encourage you to play around with the time intervals for the averages. The signals are fairly “robust”, in the sense that buy/sell signals don’t change much given small variations in the intervals. For example, 85/200, 60/200, or even 60/170 give roughly the same thing.

The track record of this system is impressive: it correctly gave a buy signal in 1995, a sell signal in 2001 and a buy signal in 2003. One has to go back to 1991 to see a meaningful whiplash. If you go to a shorter interval, you’ll see that the two moving averages have been converging. Indeed, they crossed on Friday to give a fresh sell signal (using 85/215, shorter intervals would have generated the signal sooner)! Again, I encourage you to play around with the time periods to see how well this system worked (or not worked) before. Although I haven’t done the exact calculation, it seems that this system would handily beat a buy-and-hold approach while having shallower drawdowns since 1950 which is how far the Yahoo data goes back to.

So what’s so magical about 17 and 43 weeks? I can hear you ask. Of course there’s some leeway in those two numbers, but I guess what you’re really asking is the philosophical basis for this system. There is none, or anything a priori that I can tell. This system is based on a long history of observed facts, which by the way, is identical to the reasoning behind statements like “in the long run, stocks go up by x% a year”.

Personally, I’m taking this sell signal very seriously even though I recognize that the market is very oversold and ripe for a bounce. On the other hand, my portfolio is set up to benefit from the on-going global growth story thus is susceptible to a global recession. While I still regard that as unlikely, I will most likely treat any significant bounces in the general market as opportunities to build up a hedge.

Quick Friday roundup

2008-01-18T16:23:00.000-05:00

The S&P did manage to get a 1350 print today, but only for a fleeting moment. I wasn't nimble enough and gave back a big chunk of the profits made in the last couple of days. Oh, well. That should teach me a lesson not to trade against the trend!

On the other hand, I started rebuilding a trading position in PM equities. I had predicted earlier that we would see a spike to below 430 on the HUI and this is exactly what happened today. I can't preclude the possibility that this correction has more to run in terms of time but in terms of depth it may have run its course.

UPDATE
After taking another look at the charts and noting also that I didn't quite hedge myself above -- like any good prognosticator worth his salt always does. So here's the other interpretation: we're starting the b part of an abc move that will take us down to 400. If that scenario pans out, it would be a "back up the truck" time for me.

Eying a bounce tomorrow

2008-01-17T21:59:00.001-05:00

Unless you're an uber bear like Tim Knight you screen probably looked like a "baboon's ass" today. I share your pain. Although I'm making gains in my trading account, they in no way compensate for the losses in the portfolio I report here, which are much larger. That being said, I'm looking for a bounce tomorrow based on the VIX and put/call ratios both of which have spiked up.

Tomorrow is also option expiration day, so expect some fireworks. Below is part of a screen shot of SPX options traded on CBOE. Calls are on the left and puts on the right. The two right most columns are volume and open interest. You can see the volume and OI in puts far dwarf those of calls. If you subscribe to the idea that the market imparts the most amount of pain to participants then many put holders will be in a world of hurt tomorrow. 1350 is not out of the question IMO.

Ultrashort materials - SMN

2008-01-17T12:55:00.001-05:00

Since my timely call on the PM correction I had some success trading the EEV (Ultrashort emerging markets), since EEM has broken down from a consolidation triangle as I had been expecting. What's notable in yesterday's plunge was that the agricultural sector which has been a stellar performer of late was taken out the back and shot, so to speak. It doesn't bode well for the rest of the market now that the last bastion has been taken out.

I've been looking at the Ultrashort materials ETF, SMN. It moves as twice inverse of the DJ basic materials index (ETF: IYM, has a high correlation to XLB). It just broke decisively from a downtrend channel so may still have some room to run.

PM correction underway

2008-01-15T12:26:00.000-05:00

What started as a promising gain in gold fizzled by noon. PM stocks never got off the ground. One can even argue that this correction was foreshadowed by the continual but controlled decline throughout yesterday. I closed out all positions in my trading account and am waiting for a better entry. FWIW, my Elliott wave count shows that we just finished wave (1) of iii of 3 of III.

Normally, one would expect a correction back to the range of wave (iv) which is around the 50% retracement of 430. The 50 dma will also be in that neighborhood in one week. However,I won't be surprised if we spike a little lower given its recent behavior.

An old Chinese myth

2008-01-15T02:23:00.000-05:00

I love it when prevailing myths are exposed, especially when I have my own doubts but don't have the wherewithal to prove otherwise. So it was no surprise that I throughly enjoyed this article from last week's Economist.

The myth in question deals with China's dependence on exports. The most often quoted statistics is the ratio of total exports to GDP which is something like 40%. Herein lies the fallacy: "exports are measured as gross revenue while GDP is measured in value-added terms". The article quotes a study by UBS that conclude the "true" export share is just under 10% GDP.

This is highly pertinent to resource investors as China is by far the dominant user of commodities. If this conclusion were true, it would be a strong argument to continue holding base metal and energy companies or even add to them as others worry about the prospects of global growth in the face of a US slow down.

It has to be noted that this argument says nothing about how Chinese financial markets may react in the short run. Stocks in resource companies should be a safer bet than Chinese stocks which may have troubles of their own. And I'm not saying this because Asian stocks are awash in red tonight with the exception of Taiwan after a landslide victory by the China-friendly KMT in the parliamentary elections.

I should have been clearer in my characterization of the EEM chart the other day. It's in a triangle rather than a clear downtrend as there isn't lower lows. But if we break below 141, then look out below! (See Martin Goldberg)

Link exchanges

2008-01-15T01:32:00.000-05:00

Recently, I've been getting link exchange requests. There are also a couple from last year that I didn't reply with promptly because of the problem with my computer. I want to say that I'm honored by all these requests and I'll address all of them later this week.

CDS: the next shoe to drop

2008-01-14T00:40:00.001-05:00

The potential dangers of a crumbling CDS (credit default swaps) market are finally coming into the limelight. Frankly, I don't know why it took so long. It has been a perennial topic among analysts of the more bearish bent, even I wrote about it last September, albeit I was mostly copying somebody else. Now it's got prime billing in this week's Economist in an article titled Stepping beyond subprime (subscription), where JPMorgan is mentioned as having serious exposure.

In addition to the article in the Economist, Bill Gross of Pimco specifically mentioned the contraction in the "shadow banking system" in the Barron's Roundtable (subscription) this week. Gross further fleshed out this idea in his most recent Investment Outlook. It was the first time I saw anyone putting a number on the potential loss from CDS:

While the exact amount of reserves supporting the Bank of Shadows is undeterminable, let’s go back to the $45 trillion BIS estimate of outstanding CDS for more insight. If total investment grade and junk bond defaults approach historical norms of 1¼% in 2008 (Moody’s and S&P forecast something close) then $500 billion of these default contracts will be triggered resulting in losses of $250 billion or more to the "protection selling" party once recoveries are inserted into the equation. To put that number in perspective, many street estimates ascribe similar losses to subprime mortgages, a derivative category substantially distinct from CDS insurance.

So the loss from CDS will be comparable to that from subprime? Talk about a second shoe to drop. And what d'ya know, it's a matching pair!

Update
This FT article comments on the same estimates from Bill Gross. As they correctly point out, CDS is a insurance, so in theory the gain/loss should cancel out, unlike the real losses in a mortgage crisis. However, the "counter party risk" in an already liquidity-constrained system is a cause for concern.

Gold's rise continues

2008-01-11T00:20:00.000-05:00

Gold had another good day on Bernanke's promise of substantive action. Spot gold gained over $11 in regular trading one day after the Gartman dip (Dennis Gartman was on CNBC a day before saying that he sold half of his position).

Let's take a look a gold stocks (using GDX as a proxy) which as far as I'm concerned, is where the actions are. The stoschastics are in the overbought territory, but in a bull market, overbought can become more overbought. Indeed, we see the %k and %d lines criscross above 80 indicating very shallow pullbacks. Although I trimmed back my position on strength today as GDX got close to the top of its Bollinger band, I expect to re-load within the next couple of trading days.

When GLD, SLV and GDX are plotted together, it's obvious that gold has been leading the other two. GDX hasn't even regained its November high since money has been mostly flowing into the majors. This tells us that this advance is still in the early innings. We expect the opposite to be true when this advance matures.

Which way goes EEM?
I have had several EEM puts since the end of '07. After missing some great opportunities to take profits, they are now underwater. It's one big blemish on an otherwise great year so far. Anyway, if the downtrend is still intact then it's closer to the top of the channel than the bottom. Either way I won't have to wait for long to find out.

The bounce cometh

2008-01-09T21:39:00.000-05:00

I was half expecting a bounce today, based on two factors. First, the CBOE put/call ratio spiked up to 1.38 yesterday after reaching as low as 0.57 in December; second, the RSI on $SPX touched 30, where the previous lows in August and November occurred.

It so happened that I closed out my SPY puts around 2pm just as a battle around 138 was waging. The reason: I was taking my daughter to Border's. It pays to be a good father!

It's hard not to view today's action as an oversold bounce. I'm expecting this bounce to go as high as 1480-90 where I'll try to re-establish a short position.

2008 Predictions and Investment Plan, Part II

2008-01-08T13:46:00.000-05:00

Here's part II of my outlook for 2008. Before getting to it, I want to mention a post of mine made at the end of October Where to hide now? where I opined that utilities was a good place to be. Indeed, XLU has continued its bullish uptrend, bouncing off its rising 50 dma. It was one of the few green sectors last Friday. Just for reference, Barron's had a piece about a month ago which featured prognostications from strategists of all the big Wall St. firms. Utilities was the sector receiving the most negative votes. Amusing, isn't it?

Emerging markets
Emerging markets had a terrific 2007, gaining some 36% per the MSCI index. They have performed so consistently that for a while they were even touted as a “safe haven” play, decoupled from the slow-down in US. That thesis may be true someday. One can even argue it’s becoming truer every day, but it’s simply not the case today. To appreciate this point, one needs to look no further than the surprise contraction of Singapore’s GDP last quarter.

The ratio chart of EEM:SPY displays a prominent double top that argues for a more severe drop in EEM given its historically high beta. [Disclosure: I own some EEM puts since the end of last year.] So “decouple” may not a valid concept, but since this weakness originated from the US rather than the other way around, I expect a quick recovery in emerging markets as the global growth story is mostly intact. In short, I’m far more likely to treat the coming storm as a buying opportunity for emerging markets than domestic markets.

The one emerging market I commented most heavily on was the Shanghai market which was one of the top gainers last year at +96%. It has been in a correction since October. Early on the concerns were, in descending order, Chinese inflation and monetary tightening, the premium of A shares over H shares and the need for them to converge as China opens its currency controls, and finally a US led global slow-down. While the third reason is sure to gain prominence, historically the Shanghai market has had a low correction with the US. Technically, the $SSEC has managed to climb back above its 50 dma which is always a sign of strength. Fundamentally, I think the second half outlook is bright as inflationary pressures will abate due to the strength in the RMB and lower food price inflation (from increased pork output and easier YoY comparisons). My prediction: If the $SSEC can get above its high of 6124, it’ll reach 8000-10000 before its bubblicious nature finally catches up to it.

Russia seems to be on every pundit’s favorite list for 2008, and I won’t go against the grain here. As far as I’m concerned, the political situation is a plus as it depresses valuations. Now that Putin remains firmly in charge, there will be stability for the foreseeable future, however unpalatable that stability may seem to Western observers. I already have some exposure through TREMX, but if I were to use a fund, my preference would be the Market Vectors Russia ETF, RSX, unless there are compelling discounts in the closed-end funds TRF, RNE or CEE.

Finally, in 2008 I plan to look into the so called frontier markets – countries with young capital markets that heretofore not easily accessible. TRAMX and the Vietnam fund (VTOPF.PK) are the candidates.

Gold
Contrary to my dour look on US stocks, I see nothing but blue skies for precious metals (For a detailed projection on PM stocks, please see my earlier post). In short, 2008 may see the repeat of 2001-2002 where equities and gold went separate ways. Three years ago, a price target of $1000/oz for gold would have brought gasps, but today it’s so commonplace that repeating it here smacks of timidity. However, it’s still an important milestone and I’ll concentrate more on the timing.

From the chart above, I’m expecting the millennium mark to be reached by June which somewhat jives with my prediction for an HUI peak in May. This is all assuming the current up leg will be similar to the one from May ’05 to May ’06, even though the current wave is unfolding at a slower pace. I do expect gold to finish ’08 higher and I’ll leave that prediction till the millennium mark is actually reached. [This section was written during the last weekend, before today's ~$19 jump in gold.]

Action plan: Go after it aggressively early in the year, beware of a top in May, selling gold to buy financials then may well be the trade of the year.

Agbusiness
2007 was a bumper year for any agricultural commodities and related equities. This theme has been featured throughout this blog, and if I have any regret, it’s that I hadn’t taken a bigger position. I continue this trend to continue. Magazine covers such as the end of cheap food from the Economist are just starting to bring this sector to the attention of the masses. Although it could temporarily be a contrarian topping sign, I predict the trend will continue much like the energy story. Their tremendous rise since November was in part due to investors’ desire to delay profit-taking until the New Year – a tendency that I took advantage of a year ago with FXI options. In addition to the agricultural commodities ETF, DBA, some names were floated in an earlier blog entry and its comments section. The Market Vectors Agbusiness ETF with the apt ticker symbol, MOO, is another conveniently way to play this sector. I’m managing some money for my mother-in-law and MOO is on the to-buy list.

So those are my plans. Wish everyone a prosperous 2008!

2008 Predictions and Investment Plan, Part I

2008-01-06T22:30:00.000-05:00

Everywhere I look, there’s a 2008 prediction of some sorts, so I thought I’d chime in as well. However, I'm more concerned with concrete actions based on these predictions. Part I will cover my outlook and plans for the US stock market. Emerging markets, gold and other commodities will be covered in Part II.

US market
Before I begin, let me suggest a reading of this week's newsletter from John Mauldin, titled Forecast 2008: Recession and Recovery. I share most of his views, the difference is he explains it a lot better than I can.

After a tough 1st week, culminating with a very weak jobs report on Friday, recession talk in the media has reached somewhat of a crescendo. Although I have talked about a housing-lead slow down/recession for about a year, I’m still not sure if we’ll get a technical recession, defined as two consecutive quarters of negative GDP growth. What’s holding me back is not a belief in the “resilience of the economy” but rather the sleight of hand in government inflation statistics that could provide a politically expedient boost to the GDP. Clearly, this difference in semantics cannot deter me from predicting a bear market, conventionally defined as a 20% drawdown. For S&P, which peaked at 1576, it implies a downside target of below 1260.

Indeed, the charts of S&P are far from healthy-looking. On the long term chart, we’re sitting right at a multiyear support. At same time a closer look at the daily chart indicates that a bounce is not imminent. The usual sentiment indicators such as the VIX and the put/call ratio both indicate more pain before stabilizing.

I bought some SPY puts before closing on Friday. I usually don’t do this after a big downward move, but I had thought that a “Black Monday” was a real possibility. If there is a silver lining in this dour outlook, it’s that I still think the bear market won’t be anywhere nearly as bad as the one in 2000-02. For one, I plan to get together a shopping list for financials in the middle of the year. It will most likely be comprised of names like GS, BAC and WFC.

Action plan: Sit tight with base metal and energy positions through anticipated weaknesses. Pay more attention to breakouts of key financial stocks and consider taking positions in Q2/Q3. Hedge US market exposure by maintaining put/inverse fund positions (but take profits often!). The real danger to my portfolio is a more severe bear market than anticipated. To wit the well-known 17 and 43 week EMA crossover (more on this later) will be monitored closely.

Portfolio December 2007

2008-01-02T21:02:00.000-05:00

Since I wasn’t able to do a portfolio summary for October and November, I will first discuss the results of Q4 ’07 before giving a full year summary. November was an awful month that saw the retest of August lows in the general market. I added three names: BHP (under water now), SLB (showing a profit) and MOS (Yipee!), consistent with the resource/commodity theme I have been focusing on. All three were intended to be long term holds. Overall, I’m quite pleased with the +1.91% performance turned in by my actively managed accounts. The asset allocation accounts benefited from both the hedged mutual funds and the resource stocks. Although showing a decline of 1.08%, it gave up less than the benchmarks.

For the year, the AM accounts gained 16.35% and the AA accounts 4.90%, combining for a 10.67% gain overall. This was nearly double the 5+% dividend adjusted gains made by VTI and SPY, for which I’m quite pleased. The poorer performance of the AA accounts was primarily due to ill considered timing moves in the first half of this year. The current allocation plann was finalized in June, and since that time has outperformed SPY by about 3.5%. The weakest sectors in the allocation plan were real estate (implemented with RWX) and alternative investments (implemented with PSP). To some extent, their weaknesses was foreseen; however, the principles of asset allocation did not allow one the leeway to time the entry points. I'll stick with the allocation plan and rebalance some time before this June.

Current allocation and comments

PM and non-PM commodities and related companies each take up around 40% of my actively managed accounts (I haven’t incorporated my trading account at Zecco into this spreadsheet yet. It holds some PM positions as well.). Overall, around 25-30% of our entire net worth is in PM bullions and mining shares. When I say I’m a foaming-at-the-mouth bull, I have the numbers to back me up.

You may have noticed a heavy concentration of cash and no municipal bonds in the AA accounts. That was because I sold them to take the capital loss. Remember that I keep the majority of bond allocation in the form of closed-end muni funds in taxable accounts rather than taxable bond funds in retirement accounts because I want more tax-sheltered equity growth. I plan to re-purchase some closed-end muni funds shortly, but not exactly the same ones which would be a wash-sale. The muni funds have been beaten down this year in the wake of the subprime scandal but given their yields and discounts to NAV, represent a good value.

Precious Metals Update

2008-01-01T23:36:00.000-05:00

The holiday season has so far been a kind one to PM investors. Gold finally emerged from a consolidation triangle and seems well on its way to $1000/oz. As disclosed earlier, I had turned rabidly bullish in September. During the 6-wk correction that started in November, I bought call options on every significant dip. While some partial profits were taken on bounces, there are still a number of GDX and PAAS calls in my trading account at Zecco.

Readers know that I frequently use charts to determine entry and exit points. It’s something I’ve been doing without proper justification. Although there are plenty of academic research saying that technical analysis does not work, I’ve always thought that since there are plenty people out there believing in it, it has at least become a self-fulfilling prophecy. That’s a pretty good argument in break-out situations; however, in corrective pullbacks, a large number of technical traders can invalidate seemingly clear support levels. Case in point, the consolidation from May 2006 (wave 2) ran longer than expected and didn’t end until a long sideway channel was violated in mid August. The sharp drop and snap back was in fact the start of wave 3. [I’m labeling the waves here the same way as Martin Goldberg, which I think is the most “obvious” designation.] On this most recent pull back, first a triple bottom around 396 was violated, then a quick penetration below the range of wave iv as well as the 50% retracement level. Plenty of “weak hands” were taken out at these levels which paved the way for a new advance. The above shouldn’t be taken as an indictment against technical analysis. Rather the point is that its message should be interpreted with care. Indeed this recent behavior has been great for dip-buyers since it was clear where the major stop loss orders were.

Now I’m going to look at where this HUI rally may take us. It’s an about face because I’ll resort to trend lines/Fibonacci levels which I said may be giving misguiding signals just a second ago! Hey, did I mention this is guess work anyway?! Fact is, there is no other way to forecast time and price on this scale. So here it is: HUI = 580 by May and 760 by year end. The timing of the May peak is interesting in that significant peaks or troughs of the HUI tend to be made in that month (Peaks in May ‘01, May ‘02, May ‘06, troughs in March ‘03, May ‘04, May ‘05, nothing special in ‘07), although I believe we’ll be ultimately much higher by year end.

There is usually a great dispersion in upward price forecasts so I’m not worried about traders front-running these targets. Nonetheless, I’ll be very surprised (and proud) if the actual trajectory is anywhere close to what’s outlined here. I’ll settle for just getting the direction right.

Best luck in the New Year.

Update

2007-12-29T23:30:00.000-05:00

I'm back! After a harrowing three months my computer woes are finally over. Long story short, I sent my notebook to HP TWICE for repairs and as far as I could tell, they did nothing more than twiddling their thumbs. Finally I was able to reach someone higher up on the command chain and was able to get a replacement. My new notebook arrived the day after Xmas. It has updated specs which partially compensates for my lost time.

I owe a big apology to my readers who have put up with all these. The good thing is that this episode is finally behind me and I plan to resume blogging on a more regular schedule.

Portfolio update

I wasn't able to update my portfolio in the past couple of months. There will be a summary with more numbers as soon as the year's over. With one more trading day left, my actively managed portfolio stands at +17% for the year. The asset allocation portfolio is at only +4.6% which drags down the overall performance to +11%. I'm still quite satisfied considering that the S&P will probably end up in the mid single digit.

Economic Outlook

The traders at InTrade.com are pegging the possibility of a recession at just below 50% which is not that much different from main stream economists. After calling for one for much of the year, I'm now rethinking my position. The problem I have is with the technical definition of a recession which is two consecutive quarters of negative real GDP growth. However, since inflation is to be back out of the GDP figure, an understatement of inflation amounts to an artificial increase of GDP growth. With the Fed opening up the money spigot, it's likely that we'll have a "growth recession" -- something feels rather painful along with a GDP growth of 1-1.5%. To non-economists (presidential hopefuls excluded), the difference is a matter of semantics. Despite this minor waffle, I still believe a mini-bear market is likely, i.e., a decline of 20% from its peak in the stock market.

I've been a faithful follower of Don Coxe, Chief Global Strategist at BMO Nesbitt Burns. I never missed his weekly conference calls up to when its access became restricted to BMO clients. I think the web cast has again become available but haven't found the link yet. At any rate, there is an even better way to hear his thoughts as the transcripts are now available at BeEarly.com. I'll leave you with an excerpt from his Nov 23 call.

... My view is that as I've been telling you all year I believe that the agricultural commodities are much more attractive than the base metals. The base metals are the most cyclical of the commodities. But in order of attractiveness it's precious metals, agricultural, oil and base metals are the stocks that are least attractive. Having said that I wouldn't want you to sell any of them, because if we do have a recession these stocks are not going to collapse because they're just going to be bought out by other well-heeled commodity companies.

As you can see, I share much of his views (more precisely, you can say that I learned much from him.) In coming days, I'll try to flesh out the details of my thoughts, especially regarding gold. I'll also try to do something like predictions for 2008. Stay tuned and Happy New Year to all!

HP sucks!

2007-11-14T12:02:00.000-05:00

I haven't been able to blog because my HP notebook was sent in for repairs. I had two issues: the system doesn't recognize my wireless card, and the 2nd monitor doesn't disply colors properly. I was promised a turn-around time of 7-9 business days but didn't get my notebook back until this morning -- a two week delay.

I fired up the system again right away. Guess what? It had exactly the same problems! According to the note that came with it, they changed the wireless card. But apparently they didn't even bother to turn it back on afterwards, since any idiot would have seen the indicator light for the wireless card stayed orange (as opposed to turning blue).

After spending another hour with HP and talking to a supervisor, I'm again waiting for a pre-paid box to ship my notebook back...

Time to check out HP as a short.

Where to hide now?

2007-10-27T11:38:00.000-04:00

CNBC was full of talks about recessionary possibilities earlier this week. However, I did not at all feel vindicated given that I've been saying that for quite some time. Clearly it was a case of overdue bearish sentiment finding a convenient thesis. In other words, the market was very much in the grasp of cycles of sentiment. When optism ascends, people gravitate towards stories about robust consumer spending, stability in the credit markets and the next topic, the Fed ease. It is invariably followed by waxing pessimism when recession talks come to the fore. We just witnessed such a turn from the 360 pt lost the previous Friday to the rally last Friday in anticipation of a Fed ease. Make no mistake, the market is still in a bull phase: the down segments are much more swift than the up segments.

The corollary is that unfortunately, a recession is nowhere baked into stock prices. While a recession is not inevitable, the point of this post is to think prophylaxically and figure out what sectors to be for the next 3-6 months. I do not advocate shorting this market not only because I may be wrong about the economy, but also because of the 3pm ramp-up jobs we've witnessed this past week.

I remain bullish on precious metals for the next 6-12 months. I confessed to being "foaming in the mouth bullish" in the previous post. Translation: if I were underexposed to PMs, I would buy some now. If it goes down, I would buy more, and if it goes up I would still buy more. In fact, I'll throw caution to the wind as long as spot gold is still three digits and HUI doesn't yet have a 7 handle. The pull back this past Monday was snappy. We saw commercials covering from this week's COT report which had a cut-off time of Tuesday. Friday's $16 jump in gold undoubtedly made things interesting to the commercials who are still sitting on record level of shorts. I have a feeling that we'll have a show-down after the Fed meeting.

I just couldn't believe that oil is at $90+ a barrel. Make no mistake, it does wonders to my portfolio, but I much rather the increase be due to demand pressure than geopolitics which can turn on a dime. At least, refining margins seem have made a bottom which is good news to the Tesoros and Valeros. (I own TSO) I'm also hoping that concerns about global growth will (temporarily) bring down base metal miners -- enough for me to add to my positions. The same goes for agricultural commodities/chemicals, although arguable they are even less susceptible to an economic slow down.

Ok, so far it's a reiteration of my long-held positions. For a short time, I had some spare cash in long bonds (TLT). It's far from the worst place to be if a recession is indeed looming, but Fed is almost certain to cut at least 25 basis points next week and with oil at $90+, inflation expection may tick up again. So on Friday, I got out of TLT and got into XLU (utilities ETF). Utilities is one of those classic defensive sectors, the others being pharma (PPH) and consumer staples (XLP). Chart-wise I like XLU the most although all three have perked up last week. Besides the pricing power and yield of this sector, the non-oil based utilities should do especially well in this environment.

I'm under exposed to the tech sector. Right now, I'm not sure what to make of the divergence between the semis (SMH) and the software/internet/gadget companies. The big names like GOOG, AAPL, RIMM and MSFT are fast becoming over-owned and I'm not sure if they're immune to a consumer slow-down. So far, I've missed the big run-ups, so take my words with a grain of salt. In the end, I'm comfortable enough in the sectors I have followed for a long time that I don't feel the need to chase these big tech names.

Where I stand now

2007-10-19T10:55:00.000-04:00

Last two weeks have been nothing short of harrowing for me. First, I caught a nasty stomach virus which pretty much incapacitated me for over a week, although I did manage to fire off a b-school application during that time. While I was still recovering from electrolyte imbalances my daughter got the flu which gave everyone, my wife especially, a couple of sleepless nights. The good news is that everyone is currently on the mend and should all be 100% soon. The bad news is that it’s now my computer’s turn to be sick: my six-month old HP laptop has a couple of hardware glitches (wireless card and monitor out) that I can no longer ignore. I finally gave in and arranged it to be shipped back for repairs.

So it’s not smooth-sailing in terms of blogging yet. I’m getting this post off before saying bye-bye to my laptop. Oh, how am I going to deal with internet withdrawal?

The last time I wrote about the PMs was after the HUI tiptoeing across the all important 400 level. I warned of an impending “correction” which turned out shallower than I anticipated. The corresponding move in gold was barely noticeable and did nothing to the commercial net short positions that has gone nowhere but up since then. Even though the COTs still foreshadow a sharp correction in gold (It’s fun to dream that this time the “evil manipulators” get their heads handed to them but in reality trading successes against your bankers come rarely since they know exactly how many marbles you’re playing with!), with the HUI having punched through the 400 level decisively, I’m now a foaming-at-the-mouth PM bull over the intermediate term.

My favorite PM companies are now silver juniors that start with the letter “E” – and I’m not joking! I’ve menthe Excellon before, and they just reported some nice drill results again. Endeavour is another producing junior highly leveraged to the silver price. Among gold miners, I tend to favor strong mid-tier companies with good charts such as AEM, MDG and KGC.

Again, let me be clear that my bullishness is over the intermediate term which goes towards middle to late 2008. Near term, some negative divergences are visible in PMs, as well as oil. However, they are a lot healthier than the financials, such as the brokers ($XBD) and banks ($BKX), or the retailers (RTH). They didn't rise to new highs with the SPX and now all look about to break down.

This market rally has been sustained by tech, industrials and energy/materials. Last Tuesday was the so called “super Tuesday” with Intel, Yahoo and IBM reporting. They put in a solid quarter but the market was nonplussed, which is an indication that this latest rally is petering out.

Recession watch
I wrote before that US was on a recession path and I haven’t changed my mind. The housing bogeyman just refuses to go away. CalculatedRisk has been documenting the renewed decline in the ABX indexes which reflect the value of mortgage backed securities. FWIW, I personally won’t consider buying a house until 2009, and that’s me being very optimistic in assuming high inflation will arrest the decline in nominal prices by then.

Last week’s commentary from John Mauldin went into the details for computing the GDP. I have just been using the MEW and residential construction numbers to eyeball the impact of housing on GDP and thought there was a good chance for a recession if one considers the negative multiplier effect. Mauldin went into a lot more detail, including showing the strong personal income growth this year. The result is a far more complete and nuanced picture although he came to the same conclusion that although a recession is likely, it won’t be a depression that the doom-and-gloomers are calling for.

Recession without a bear market?
Apparently this view is gaining some traction. Rick Santelli (one of the most intelligent commentators on CNBC) even mentioned it the other day. The idea is that the stock market reflects the global growth story, so much so that a little hiccup at home won’t be enough to drag down the market. I wouldn’t put it past this market, but I personally find it wishful thinking, if only because so much of the global growth is aimed at satisfying whims of the American consumer.

In summary, short term there are danger signs in this market. The leaders: tech, industrials, and energy/materials all seem ready to take a breather while the financials and consumer discretionary are stuck in the down elevator where they belong. I expect recession worries to resurface as 4Q expectations are ratcheted down (don’t you love this game?) The $64k question is whether those worries will be realized. Even though I have an opinion, I still find it prudent to treat any dip as the pause that refreshes unless things get really ugly (e.g. if this summer’s lows fail to hold). For now, the only “sure thing” I can find is PMs which are going higher be it due to global liquidity or reflation.

About recent inactivity

2007-10-11T18:37:00.000-04:00

I caught a nasty intestinal virus last week. This is the first time I logged on in days and I'm still trying to recover. As usual, the market reserved exciting things for when I'm away. Hopefully, the fireworks will continue when I return next week.

Personal Savings Rate

2007-10-01T22:27:00.000-04:00

The personal savings rate (PSAVERT) is an overall measure of how much individual Americans are saving. It is defined roughly as Disposable Income – Personal Expenditure and expressed as a percentage of the disposable income. Savings is important because without savings there won’t be any investment, and investment in productive capacities, under the direction of a free market, is the best way to make economic progress known to man.

For a long time I was confused about whether 401(k) contributions are included in the PSAVERT or not. I have read opinions on both sides. Finally, I believe I found the answer in A Guide to the National Income and Product Accounts of the United States (NIPA) which defines the Personal Income and Outlay Account. It shows clearly that personal income comprises the usual sources less payroll tax, whereas personal outlay includes income taxes, personal expenditures, interest payments and other minor items. Therefore, 401(k) contributions, including employer matching, go towards the personal savings rate, as I believe they should be.

It should be noted that capital gains are not counted towards personal savings, as they do not appear in the Personal Income column. Nor do I believe capital gains should be counted. The reason is not their capricious nature, as many home owners are finding out, but rather that the only way these gains are to be realized is to be paid from someone else’s savings (in the case of someone taking out a mortgage to buy your appreciated house, he is paying from future savings). We should also note that mortgage payments towards the principle is counted as savings.

Many personal finance writers commented on the PSAVERT when it dipped into negative territory in 2005, so many people are aware of its long term decline from the 1980’s. The chart below is from the St. Louis Fed with recessions shaded in grey.

On a shorter time scale, we can see that the PSAVERT has perked up from its nadir in 2005 (It was very slightly negative in Q3 ‘06), although it’s still at no more than 1%.

Given the collapse of the housing bubble, I expect the personal savings rate to increase. One culprit of the low personal saving in recent years is the consumptions fueled by mortgage equity withdrawal (MEW). MEW is not counted towards personal income but the consumption it enables counts toward personal outlays, hence the housing bubble was directly responsible for the low savings rate. Now that refinancing has dried up, MEW should decrease drastically.

Increased personal savings, whether it’s due to a genuine change in attitude or forced upon by tighter credit, is a good thing. That’s because savings enable investments which develops the economy and lays the foundation for future savings and consumption. Instead, these days all we hear is “Consumption is 70% of the economy, therefore, we should keep consume to get the economy going”. It is repeated ad nauseum and never challenged. As ideas go, it’s got to be one of the most dangerous and damaging ideas ever devised.

Portfolio August and September

2007-09-30T21:19:00.000-04:00

I was too busy to post a portfolio summary last month so I will discuss both August and September’s performance here. As usual, the return was dominated by that of the resource/commodity sector. Both energy and precious metals were under pressure in August which resulted in a dour down month while the major indexes managed to recover from the subprime induced swoon and posted positive results. However, all has been forgotten by the end of September when energy/metals notched up huge gains and my portfolio posted the highest percentage and net dollar gains for as long as I have been tracking them.

For the month of September, the actively managed accounts gained 11.69% to bring the YTD figure to 14.17%, while the asset allocated accounts gained 5.27% to bring the YTD figure to 6.05%. Total YTD gain now stands at 8.61%. It is still below the 9+% increase in VTI and SPY but with precious metals having finally emerged from their 15 months correction (IMO), I have reason to believe that I’ll be able to beat these benchmarks this year.

As written elsewhere, I believe a recession is likely. I’ll put the time at around now and first quarter of 2008. However, there may be reasons to believe that the stock market will not see a severe contraction as global growth is unlikely to be derailed. That is not to say that there may not be any initial jitters in foreign markets (and I’ll stand ready to take advantage), it’s just that I don’t expect a depression like so many bears on the internet. One arbitrage play I’m considering is between money center and regional banks, specifically, long BAC (Bank of America) and short RKH (regional banks HOLDRs) or KRE (regional banking ETF). The idea is that the Fed is the regional banks are likely to see profits suffer as this housing mess unfolds and lending standards tighten; on the other hand, the Fed has come out saying they will draw “a ring of defense” around the money center banks.

Changes in reporting portfolio performance
Starting next month I’ll no longer report the actual size of my portfolio although I will continue to report the percentage change which will be computed exactly the same way. I’m not sure how helpful the dollar figures are in the first place. The portfolio reported here represents a significant portion, but not all, of our net worth. Since this blog is anonymous, I felt quite comfortable in showing the exact numbers initially. However, it has become an impediment to sharing this site with family, friends and certain other people. Hence the decision.

One step ahead

2007-09-24T22:41:00.000-04:00

I read about this interesting psychology experiment:

Take a large group of people, say >10. Let each pick a number between 0 and 100. Take the average of these numbers. Whoever’s pick comes closest to 2/3 of the average wins. All participants are informed of the rules of the game beforehand.

Time and time again, the winning pick lies around 22.

Here's how it works: if everyone picks randomly, the average should be around 50 and 2/3 of that is about 33. However, seeing that, most people (i.e., the crowd) picks a number around 33, so the eventual winning number is 2/3 of 33 which is 22.

One can take this logic one step further and pick 22 * 2/3, or another step, another step, and so on. Pretty soon one would arrive at zero. Unfortunately, such “farsightedness” doesn’t win the game, since the best can be hoped for is a tie when most other participants also pick zero.

How does this experiment relate to investing and forecasting? It teaches that the essence of timing is to be one step, and only one step, ahead of the crowd. While it still doesn’t make forecasting any easier, at least it provides some explanation of why the market behaves the way it does.

The housing/MBS mess serves as a good example. The downturn in homebuilder stocks started in 2005-2006, then the subprime lenders such as New Century imploded this March, finally the subprime MBS caused a seizure in the credit markets this summer. With perfect hindsight, we now see clearly how the event in March should have warned us about the deeper problems in the mortgage market, and yet the market staged a quick recovery and robust rally following the correction in March.

Another recent example is the recent behavior of gold. In the immediate aftermath of the credit market turmoil, investors flocked to treasuries of all maturities and away from all things, including gold, that hedge funds are even suspected of holding. This was despite unprecedented liquidity injection by the central bankers and gold’s reputation as an inflation hedge. The selling culminated on Aug. 16. Since then, the attention has been shifted to a weakening dollar as the Fed started lowering interest rates aggressively in the face of a weakening economy. Gold prices soared to a quarter century high after this quick about face. In both examples, the market ignored what I considered “logical extensions” at the time; instead, it chose to react to the immediate facts/concerns at hand. To get ahead of the crowd by more than one step would incur significant losses even though the bet may eventually be proven correct.

That brings us to today. Are we really to believe that the housing ills can be cured with Fed rate cuts? (See the table mortgage of rates: rates are still higher than 6 months ago, especially jumbo rates that do not appeared to be affect by the 50 bps cut) What about the “private equity put” that not only has gone away but also is giving investment banks indigestion? No wonder Peter Grandich issued a call to short US stocks on Wednesday. (not investment advice)

Until we have convincing new highs (and preferably confirmed by the transports) I’m still operating under the assumption that we are in a relief rally as attention shifts between the credit market seizure and the weakness in the real economy. But I also thought the weak August jobs number would be a sufficient wake-up call. Instead, the market turned its focus onto the Fed without skipping a heart beat. The next make-or-break event is Q3 earnings.

As usual, we are more interested in the reaction than the actual numbers. A number of brokerages have already reported and despite Goldman’s stellar performance the broker/dealer index has once again broken its 50 dma. It should be a great cause for concern.

9/26/07 There was an error in this post: the last chart was of $bkx, the bank index, not $xbd which looks similar.

Go, Ron Paul, Go!

2007-09-21T01:38:00.000-04:00

RON PAUL FIGHTS POWERFUL PLUTOCRACY

HUI over 400!

2007-09-20T12:01:00.000-04:00

Wow, if the market always behave like this when I’m away, maybe I should take more vacations! The rather unexpected 50 bps cut lit a fire under the market and no other sector reacted as positively as the commodities, precious metals included.

The HUI index is challenging its old high of 401.69 as spot gold surpassed the old high of $730 reached in May 2006. However, I would urge a little caution amid this exuberance. From the Aug. 16 bottom of 284.85 I can clear count 5 waves up which indicates that a short term top may be near. Moreover, as I have pointed out before, the PM complex has a habit of taking 3-4 tries to overcome a significant resistance level which the 400 on the HUI certainly qualifies. So how long, if a correction should come, will it last? In terms of time, it could be anywhere from 50% to 100% of the preceding advance. It’s been almost 5 weeks since Aug. 16, so a correction could last anywhere between 3 to 5 weeks.

I plan to take on some more speculative positions on the coming dips. Within the PM complex, I continue to favor silver over gold given their present valuations. As can be seen from the $silver:$gold ratio, the price of silver is nowhere near its 2006 high. Additionally, current silver COTs are far more favorable to gold’s which reveals large recent increases in commercial short positions.

August NFP, Recession, Gold

2007-09-08T14:22:00.000-04:00

So there you have it. The August non-farm payroll was -4k vs. expectation of +100k (BLS report). June and July were also revised down sharply. I expected the number to be bad, but not that bad. The markets were obviously taken aback as well. On Friday, the Dow shed 250 pts or 1.87%. The Naz and S&P gave up 1.86% and 1.69% respectively. A 25 basis point cut seems baked in at this moment at the next Fed meeting on Sept. 18, with a 50 basis point cut likely.

If we do have a recession, and the odds are definitely that we will, it will be the second based on a collapse of investment after the one in 2000-2001 following the tech bubble. Some would say both are serial versions of a credit bubble where massive resources were misdirected to a segment of the economy. This is quite different from recessions of the bygone era which were mostly caused by inventory build-up and capacity glut (of manufactured goods). Recessions from credit bubbles are much more pernicious in that what’s left behind (think dot com companies and unfinished Miami condos) has little economic value. Moreover, in this particular instance, millions of home owners will have to face evaporated house values that may not recover for years. Keep that in mind next time you hear a so called economist citing from past recessions.

The main question I have regarding the equities is whether the relief rally I was anticipating has already played out. There is at least a 50/50 chance that it has. There’ll be a lot of speculation on the Fed next week, but I won’t be distracted. As far as I’m concerned, any bump due to Fed action is a good opportunity to sell.

I pay more attention to the Russell than any other index save the HUI these days because it’s more sensitive to economic conditions and it’s more detached from the emotions surrounding the financials. This year the Russell has been one of the weakest major indexes and it is looking sicker by the day. It has lingered sideways for weeks after coming down from the July top and unable to get above the 200 DMA. Now the 50 DMA has crossed below the 200 DMA. RSI, MACD and stochastics are all pointing down at this moment. [Disclosure: long TWM, the UltraShort Russell 2000 ETF]

Gold
I couldn’t be happier with the precious metals. They have diverged from general equities in the past week while base metals fell due to growth concerns. I haven’t written about them since the last bottom on Aug 16, fearing I that might jinx their advance. But I did manage to add to what’s already my largest sector holding on recent weakness.

I want to briefly mention the latest silver COT report which shows a commercial net short of only 25,000 contracts. This unprecedentedly low short position is extremely bullish for silver.

The contraction in the ABCP market is clearly deflationary. For those investors worried about gold in such an environment I heartily recommend this post from Mish: Is Gold Safe Place to Hide? The comments are worth a read as well.

There is broad consensus that credit contraction is deflationary and the central banks around the world will fight tooth-and-nail to re-inflate. I’m agnostic about the outcome of that battle; however, a case for precious metals can be made despite, or because of, this uncertainty. Despite what Mish wrote, the accepted wisdom is that gold performs well in hyperinflation and treasuries in deflation. However, gold is far from the worst investment one can make in a deflationary environment, and I would say much better than treasuries in hyperinflation. Therefore, given the uncertainty of the outcome, a prudent investor would have allocations to both gold and treasuries. Here’s the crux: even after the introduction of gold ETFs very few investors have any gold, so any re-recognition of it as a valid asset class would send the price soaring.

Despite too many false starts to count, the precious metals appear to be finally ready to start another run. As Prof. Lewis at Minanville says: “...the gold complex reacts positively to the monetary "medicine", not the sickness.” With ample cover provided by the weak NFP number, the Fed is ready to dispense plenty of “medicine”. I’ll be traveling next week. It seems important market moves always take place when I’m away. Let’s see if that continues.

Staffing companies and jobs number

2007-09-07T08:00:00.000-04:00

Friday is the much awaited August non-farm payroll report. I say “much awaited” because the market seems to be placing a huge emphasis on this number, although we know that this is a lagging indicator. [For example, see Joseph Ellis’s Ahead of the curve]

Both the Challenger survey and the ADP private sector numbers are pointing to a weak headline Friday morning. However, one never knows what the birth/death adjustments will do to the actually number. There may be another way of looking that the health of the job market that bypasses the statisticians.

Larry Kudlow and company will have you believe that the economy is strong and jobs are plentiful. If that were the case, the job placement firms should be doing a brisk business. Instead, we have a sector-wide warning on staffing companies from UBS.

UBS analyst Andrew Fones downgraded shares of Robert Half International Inc. and Monster Worldwide Inc. to "Neutral" from "Buy." He also lowered his stock ratings on Heidrick & Struggles International Inc. and Korn/Ferry International Inc. to "Sell" from "Neutral."

Fones said he expects U.S. hiring growth to deteriorate in coming months, especially because of turmoil in the credit market.

"We are concerned that a continuation of credit market difficulties could further weigh on recent weak hiring growth," Fones wrote in a client note.

Also, Fones said growth in temporary staffing has fallen steadily since December 2005. Temporary staffing is a leading indicator of overall employment trends because companies are quick to fire temporary employees when demand falls.

If you look at the group of charts below, you’ll see that the weakness is indeed a sector-wide phenomenon. 4 out of 9 stocks peaked well before July. Several of the charts feature 20 DMA below the 50 DMA (blue and red lines respectively), with the 20 DMA acting as upside resistance.

This doesn’t bode well for the employment picture, unless you believe that there is full employment and everyone is happy such that nobody is looking for a job. Of course if you do believe that, Larry Kudlow may be interested to have you on his show.

Housing and CDS

2007-09-03T14:49:00.000-04:00

We are undeniably in a period of high volatility with whipsaws every day, or at least as often as my blog entries. Having mentioned several positive factors and indicators in my last post and enjoyed last Friday’s uptick as much as any long, it’s only appropriate to look at the other side of the coin.

Housing
Housing remains the bogeyman. Tim Iacono of TheMessThatGreenSpanMade wrote a great piece to rebut one of the common arguments bulls use to dismiss subprime worries:

He starts by quoting an article Ben Stein wrote in New York Times:

The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13 percent, or about $1.35 trillion, is subprime — certainly a large sum. Of this, nearly 14 percent is delinquent, meaning late in payment or in foreclosure. Of this amount, about 5 percent is actually in foreclosure, or about $67 billion. Of this amount, according to my friends in real estate, at least about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to $34 billion.

The rate of loss in subprime mortgages keeps climbing. In time, perhaps it will double, maybe back to $67 billion. This is a large sum by absolute standards, and I would sure like to have it in my bank account.

But by the metrics of a large economy, it is nothing. The total wealth of the United States is about $70 trillion.

Then he proceeds to rip apart that argument.

According to the latest Federal Reserve Z1 report, the total value of owner-occupied housing is about $23 trillion. As shown in the chart below, the total is up considerably from just a few years ago as indicated in blue, however, the curve looks like it's beginning to flatten - keep an eye on that.

Who's been setting a lot of these prices at the margin?

Subprime borrowers.

They've been pushing home prices up from the bottom, paying more for starter homes, enabling more typical homeowners to cash out and trade up and so on, until home prices in your neighborhood are affected too.

Over at Pimco, they call them Plankton. If it turns out that people have been paying way too much for real estate in recent years because money has been so cheap and lenders so lax (it's looking more likely every day), markets will revert to the mean and there could be hell to pay.

A 10 percent drop from that $23 trillion total would be a loss of $2.3 trillion in national real estate wealth - a 20 percent decline would result in almost a $5 trillion hit.

That's a lot less home equity withdrawal and a lot fewer reverse mortgages - consumer spending and ultimately the broader economy will suffer. Maybe a lot.

These are big numbers - this is the giant thing hiding in the closet.

Goldman Sachs (via CalculatedRisk) just issued a report that estimated a 7% drop in home prices in both ’07 and ’08 basis the Case-Shiller index. GS definitely is not a permabear, so this report carries a lot of weight.

Credit default swaps
The other skeleton in the closet is CDS (credit default swap) which is basically a insurance against default on the underlying debt instrument [Here’s a short primer on CDS from which I will quote below]. For example, the holder of a high yielding junk bond can buy CDS to hedge the default risk of the bond. As long as the cost of the CDS is less than the spread between the bond yield and treasury yield, he has “safely” enhanced his return above that of the treasury. However, this safety is dependent upon solvency of the CDS issuer (aka the counterparty) just as an insurance policy is only good if the insurance company can pay up.

CDS has been a boon to the credit market. It allows risk to be transferred from one party to another and less risk concentration is certainly a good thing. However, one can’t expect Wall St. to leave a good thing alone. CDS "has grown from a $1 trillion industry a few years ago to a $26 trillion industry today." That’s because punters (mostly hedge funds) can buy or sell CDS on an asset that they don’t own – simply as a bet on the perceived default risk.

Heavy concentration of CDS in a few hands makes a disastrous "chain reaction" possible:

CDS doesn't exist on an exchange, much of the volume transfers through few hands -- namely the big banks like Goldman Sachs, JP Morgan, Morgan Stanley, and the like. Nobody on the outside knows how much CDS these banks hold and what kind of directional exposure they have. If hedge funds hold $100 billion of CDS protection and Morgan Stanley took the other side of the trade, if that $100 billion of debt defaulted with no recovery, Morgan Stanley has to pay $100 billion to those hedge funds. I highly doubt Morgan Stanley has $100 billion in loss reserves set aside. Should Morgan Stanley be unable to pay its debts, holders of Morgan Stanley CDS would then come into play -- and suppose Lehman Brothers is on the short end of $50 billion of Morgan Stanley CDS. You can see where this is going. It sounds absurd to say, but it's not inconceivable that a CDS domino effect could destroy the debt and credit markets as we know them.

This is why Warren Buffet called it (and other derivatives) financial weapons of mass destruction.

The burning questions are, “How much of CDS on subprime MBS was issued?”, “Are they considerably more than the amount of subprime mortgages outstanding?”, and “Who are the bag holders?”. Before they can be answered, “containment” is but a pipe dream.

A relief rally to sell into?
I’ve harped on separating the liquidity problem with weakness in the underlying economy. It’s a simplification because tight lending standards will put a crimp on access to credit and consumption. Nonetheless, if you believe that the Fed will be successful in restoring confidence in the credit market before the proverbial “second (or third, fourth…) shoe” drops, then there would be a relief rally to sell into. We’ll know this week when all the bigwigs are back from the Hamptons whether last Wednesday (8/29) marked the start of this rally.

All eyes on Uncle Ben

2007-08-30T23:15:00.000-04:00

I have to admit that I didn’t expect volatility to return with such a vengeance this week. Nor did I expect CNBC to continue putting up such an array or luminaries, including John Bogle of Vanguard, who were unabashedly calling for a recession. By the way, Bogle thought the likelihood of a recession was 75/25 in favor of having one.

Right now all eyes are on Ben Bernanke and his scheduled speech Friday in Jackson Hole, Wyoming. Personally, I don’t expect much from the speech which is to be given at a pseudo academic conference anyway. I’m also in the minority camp in thinking that the Fed may not cut at their next meeting on September 18, even though I’ve been calling for a “spill over” from housing since the start of this year. It’s just that so far I have actually been impressed by how well Bernanke has stuck to his guns in running a “data dependent” Fed.

So far I’m still looking at a recession in terms of probabilities which basically means that I have taken a hard look at my portfolio and made sure that I have convictions in every position that I intend to keep. In order to raise some cash (in case the $HUI crashes again), I have closed two positions–a small percentage of my overall portfolio.

You’re probably wondering why I have made such minor changes despite sounding dire at times. There are a number of reasons:

I still believe that even if a recession occurs, it would be shallow on account of the global growth story.
Insider buying shows conviction
Sovereign wealth funds and the global symbiosis
Overwhelming negative headline points to limited short-term downside
High VIX and put/call ratio which usually coincide with short-term bottoms

Finally, there are two most important reasons that I’m holding off drastic changes at the moment: I know how to protect myself from a prolonged bear market should one come, and I have sufficient cash reserves to see me through a long period of time. They are the safety nets that keeps me asleep at night.

Best of luck to you.

Chinese market keeps making new highs

2007-08-26T15:00:00.000-04:00

I watched quite a bit of CNBC last week. Among other things, I caught the interview with Countrywide’s Angelo Mozilo who called for a recession in no uncertain terms. This of course, is the man who had steadfastly defended CFC’s business while cashing out some $250 million of options in the past year. Nonetheless, the CNBC anchors all went ga ga over this comment and actually put up several economists/strategists of the more pessimistic bend. Long time readers know that I have long held the same view; however, the very fact that the “R” word is mentioned on CNBC about once every 10 minutes may well mean that a short term bottom is in. Sure enough, Friday saw some nice upside action following a strong durable goods report.

While I remain suspicious American consumer’s continuing willingness/ability to pile on debt, I give more credence to the other leg the bulls stand on: strong global growth. Nowhere is this more evident than in China. The Shanghai stock market made consecutive new highs last week to end at 5108. Again recall that not too long ago the ubiquitous worry was for an implosion in the China to bring down global markets. The fact is, since the July 19th peak in US and the rest of world markets, SSEC has gained over 25%. On Friday, FXI, the FTSE/Xinhua 25 ETF, also made a new high, finally confirming the move in Shanghai.

Let me clarify my view on the Chinese market. Many have compared it to the Nasdaq bubble based on price trajectory alone. I will not debate that point. I will even grant that the Chinese market is in a bubble. But in my opinion, that misses the point entirely. Bubbles are grand money making opportunities, during both the expansion and implosion phases if you know which side of the market you’re on! So let’s put emotions aside and look at some relevant recent developments.

First of all, let’s look at some negative factors.

Chinese exporters enjoy a rebate of value added tax. On June 20, China announced that it will reduce tax rebates on exports of high energy-consuming, resource-intensive and environmentally-harmful products. The measure will take effect around September/October. Given that Chinese exports amounts to 30-40% of its GDP, lowering the rebate is a far more effective way to slow down its red-hot economy than raising interest rates.
Of course, they can do both at the same time! Chinese CPI was a blistering 5.6% for the month of July. The index was paced by food, especially pork , prices. In response, the PBoC (People’s Bank of China) raised deposit rates by 0.27% to 3.6%, and lending rates by 0.18% to 7.02%. It was the fourth raise this year.
I’ve always held the non-convertibility of the Yuan as a positive since the individual investor has few choices besides the domestic stocks. For example, some key state owned enterprises have listing in both Hong Kong (H shares, aka red chips) and Shanghai (A shares). But the A shares are far more expensive than H shares because there is too much money chasing the same shares. Two weeks ago I would have said that the day that the Yuan becomes fully convertible would be the top in the Chinese stock market as individual investors diversify out of the country en masse. In a surprise move last week, China declared it would allow individual investors investing abroad, starting with Hong Kong. The news sent the Hong Kong’s Hang Seng index up 10% last week with broader Asian markets following suite. Of course, some capital will be diverted away from the A shares market; on the other hand, this is gradual approach eliminates future shocks. It cools down the domestic market and relieves some exchange rate pressure at the same time – a stroke of genius really.
The Bank of China (BOC, not to be confused with PBoC, the central bank) and its Hong Kong arm disclosed that they hold $11.25 bn of CDO’s based on US subprime mortgages. The Industrial and Commercial Bank is on the hook for $1.23 bn.
Recalls of Chinese products, from tooth paste to sea food to toys with lead paints, are grabbing headlines everywhere.

The intriguing thing is that all these happened prior to last week where the Shanghai market had five consecutive up days. You can chalk it up to irrationality but the price action is to be respected nonetheless. In a way, it shows the power of liquidity since Chinese citizens are still pouring money stocks. Let’s now look a few positive factors.

One of the signs of excess that bears love to point to was the number of new stock trading accounts opened daily. It was somewhere around 100k before the last correction in May. Well, with the market at new highs, that number has increased to 150k or so – TDAmeritrade/eTrade, take that! Anyway, I never understood that logic behind that particular argument in the first place. Common sense says that the flow of money should peak well after the peak of number of accounts open. Besides, while 100k or 150k per day is a huge number, the number of potential investors in China is, well, huger!
If you’re wondering where all the juice in the Chinese market is from, just look at how fast Chinese wages are growing:
Combined annual wages reached 2.34 trillion yuan ($308 billion) at the end of last year, up from 1.32 trillion ($173 billion) in 2002, representing an average annual rate of increase of 13.5% after inflation, according to a report from state-owned Chinanews.com.cn on official figures released at a meeting put on recently by the China Association for Labor Studies.
Note this double digit increase is after inflation has been taken factored in. In coastal cities, annual wage increase in the high teens for the college-educated, 25-35 crowd is common. This increased wealth fuels the equity market both by fattening companies’ bottom line from increased consumption, and by channeling disposable income into the stock market.
Finally, while the health of the export sector may give investors doubts, recent advances in SSEC have been lead by RE developers/construction companies.

Despite new highs in SSEC as well as a clear non-correlation between Shanghai and the rest of global markets investor continue to shun Chinese stocks as indicated by the growing discount in the MS A shares closed-end fund (CAF) that now stands at 20%. For whatever it's worth, my own view is that aside from the threat of a weak Christmas shopping season in the US, the prospects remain rosy until the Olympics next August.

Disclosure: I own FXI and CAF.

Excellon Resources Followup

2007-08-21T23:33:00.000-04:00

A while ago I wrote about a promising silver exploration company in production with positive cash flow: Excellon Resources. My conclusion then was

...current valuation is largely supported by the test mining activities alone; therefore, investors are getting a near “free ride” on Excellon’s exploration potential.

The company just issued two noteworthy press releases. The second described recent drilling results from hole ST-50. The grades were nothing to write home about especially in view of the high grade ore Excellon is test-mining now. However, in their chase for the "world class CRD (carbonate replacement deposit)", this is the first time they did not draw blanks. Looking at the property map, ST-50 is located at the southern end of the Saultillera area, and more promising regions probably to lie further south.

I have always been intrigued by the extraordinarily high grade region Excellon is mining now. I'm not a geologist, but if it were a singular occurrence, it would very much go against my understanding of physical nature. With the latest development Excellon should be able to follow the breadcrumbs instead of going on wild goose chases to pursue the CRD so to speak.

Saultillera is sitting on the western edge of Excellon's property. According to the first of the two press releases, Excellon purchased two pieces of land recently, with the location of the second and more expensive purchase not given. Let's hope that management has some foresight and had spent wisely.

Disclosure: I'm long this stock.

Update: 8/22/07

Today's release was a pleasant surprise as I was not expecting so quick an answer to my question about the new land purchase. While the high grade holes between the Guadalupe mantos were entirely expected, I was very happy to see the map of the new land holding. It sits to the west and southwest of hole ST-50. Seems that Excellon management had spent wisely.

Has everyone sold?

2007-08-16T20:58:00.000-04:00

After this afternoon’s miracle rally, a short term bottom in equities appears be in. Financials which led the charge downward were the big winner today. The Russell 2000 appeared to have made a double bottom with positive divergence. Small caps led the way down, and now they appear to be leading the way back up. It remains to be seen whether we’ll see new highs or just a relief rally. While the liquidity crisis may be slowly under control, I expect to see real losses in the financial sector. Likewise, should we have a recession, small caps will be hit much harder than their larger cap brethrens.

Gold, far from being a safe haven, really took it on the chin today. It was down $25 at one point. HUI busted down an eight-month, slightly upward channel.

Gold was part of a major sell-off in commodity related stocks today. The apparent trigger was the deadline for hedge fund redemptions. Anything that they were even suspected holding were sold down hard. The credit squeeze and the subsequent liquidity injection were the catalyst that gold bugs were hoping for to send the yellow metal soaring. So I’m left to wonder if that are anyone besides the most masochistic ones who hasn’t sold.

For kicks, I looked up the Alexa traffic reach for Kitco, the preeminent gold website. I was amazed to see well resolved peaks corresponding to Dec 03 and May 06 – previous peaks in the PM complex. Traffic, and popular interest by inference, has steadily declined during the current correction and now stands at a level last seen in 2002. There may be a conclusion somewhere, but I’m too gun-shy to say it…

Let’s remember that markets always do the right thing, just not at the right time.

Looking to the stars

2007-08-12T21:50:00.000-04:00

Central banks around the world injected some US$339 billion worth of liquidity over Thursday and Friday of last week. Remarkable was that the Fed took in $19 billion worth of MBS as collateral for its first open market operation on Friday (I have seen no mention of how they were valued and whose bids were taken). It will go a long way towards calming the nerves in the credit market. As I have said many times, we need to separate the liquidity crisis from the underlying economy. There is a good chance that the equity market will bounce back as confidence is restored and the sea of liquidity finds a resting place.

However, I couldn’t help but wondering that a new appreciation for risk will linger no matter how successful the central banks’ market supporting endeavors. At a minimum, mortgage lending standards will tighten when trillion dollars of ARMs are still facing resetting in the next year. Near term, worries of the US economy and the remnants of the latest liquidity injection will have to battle it out. I’m keeping an eye on IWM (proxy for the Russell 2000) which is stuck between its long term trend line and the 200 DMA (about $75-80), a break either way should be telling.

Bradley Siderograph
We live in interesting times. For those of you wondering about the future and looking for a good laugh here’s something completely off the beaten path, from the field of astrology to be exact.

The Bradley siderograph was developed in the 40ies by Donald Bradley to forecast the stock markets. Bradley assigned numerical values to certain planetary constellations for every day, and the sum is the siderograph. It was originally intended to predict the stock markets. It is crucial to understand what the siderograph is about since almost all traders (and even and even financial astrologers!) misunderstand it. Over the decades it has been observed that the siderograph can NOT (!!!) reliably predict the direction but only turning points in the financial markets (stocks, bonds, bonds, commodities) within a time window of +/- 4 calendar days (in a few cases up to +/- 7 days). Inversions (i.e. a high instead of a low and vice versa) are quite common. Also, it is not a timing tool for short-term trends but rather for intermediate-term to longer-term trends because the turning window is rather wide.

Two important dates, 8/26 and 10/17, are fast approaching, with 10/17 being the most important date of the year.

Needless to say, I do not recommend trading base on this information.

China threatens 'nuclear option' of dollar sales

2007-08-07T22:42:00.000-04:00

This article from the UK Telegraph is as alarming as any in recent memory.

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

The symbiotic relationship between US and China has come to define our current globalized economy. It's a relationship based on mutual self-interests, notwithstanding the poisonous toy and seafood and funny paper that change hands. I believe that China had intended the Yuan to appreciate 5% per annum. For example, at the end of '06, the 12 month, non-deliverable yuan forward contracts were indicating an exchange rate of 7.41 by year's end. If this keeps up for 5 years, the yuan would have gained 25-30% on the dollar. This may very well be the most sensible way to bring the exchange rate into alignment; however, this being the year before presidential election, all bets are off.

All I've got to say is that, although gold will benefit immensely if China does dump its dollars, no gold bug should welcome this course of action as not even the most prepared survivalist would welcome the sight of mushroom clouds on the horizon.

Portfolio July 2007

2007-08-03T14:37:00.000-04:00

Last month was a wild ride in that my portfolio was up 6% overall at one point before giving it all back in the last week. The actively managed portion gained 1.66% which is almost entirely off-set by the 1.58% loss in the asset allocation account. The overall portfolio finished the month with a 0.12% gain. This result is superior to almost all benchmark indexes (emerging markets being the lone exception) that finished ~3% in the red for the most part.

The main on-going concern is whether to take defensive action against a possible vicious bear market that can send the market wheeling 30% or more. My approach is to use a couple long-term and slow-moving indicators. For example, one secondary indicator is the 200 day moving average (simple or exponential) of the S&P 500. I’ll start hedging 25-50% of my domestic equity exposure if the 200 DMA is breached. The primary indicator I follow is even slower-moving than the 200 DMA but also gives more reliable signals. Again, the idea is not to catch the exact top or bottom but to stay on the right side of the long term trend.

Decision time

2007-08-02T22:54:00.000-04:00

I haven’t been writing about this market downturn, since, well, I’m not sure I have much to say. On Wednesday the Dow rallied 200 pts in the last 40 minutes to finish up 140 pts, but the advance/decline was negative. Thursday’s 100-pt gained was accompanied by better breadth so we have likely seen a short term bottom. However, if it was truly a bottom, it felt a little flimsy. I won’t be surprised if another leg down starts within a week. At any rate, I believe in waiting for the second bottom to assess things. For now, I’m more concerned with the bigger picture.

The mess with housing/mortgages was entirely foreseen, it just took some hard evidence for the market to finally take notice. After all these drama this past week, we are still only 5% from the highs. Cutting through the myriad of data and spin, I see two broadly interacting cross-currents:

Liquidity waning due to MBS market implosion, mortgage lender restraint and corporate spreads widening
The global economy, especially Europe and the emerging markets, continues to power forward and placing high demands on energy and other commodities

Due to #1 above, the probability of a recession is likely 50/50. As mentioned before, I’m not at all focused on the employment data which is a lagging indicator, not to mention the birth/death adjustments. Consumer spending is something like 70% of our economy. I keep hearing that because the top 20% consumers are responsible for 40% (some say 60%) of the spending, and they are holding up well, overall consumer spending will remain resilient. But how can one just ignore the bottom 60% when it takes so little to tip the economy from regular expansion (3% per year) into recession (2 quarters of GDP contraction)?

The million $ question is whether #2 will be sufficient to counteract #1 in preventing a US recession. We use to say that when US coughs the rest of the world catches a cold. This time around, emerging market’s growth rate may be slowed by a US recession but I’m certain a positive rate it will remain. Whether a recession in the US can be averted remains to be seen but even if there is one, its severity is likely limited.

I don’t consider myself a buy-and-holder, instead I follow a long-term indicator which I will discuss in more detail later. For now, all I need to say is that this indicator is slow-moving enough that it will miss the true top or bottom by a couple of months and 10% or more. The idea is not to get me out of a 10% correction, but to get me out of the really nasty 30-50% down bear markets that come once a decade or so.

The indicator hasn’t flashed a sell signal yet, but it’s not too early to explore some options. The plan is to keep my asset allocation plan intact (see the bottom of the pyramid), and use options/shorts/inverse funds in my actively managed accounts for hedging, so I need to consider the hedging efficiency for the money spent. Ideally, I will target a high beta index/sector with good correlation to the S&P. When all markets move in tandem, the options that present themselves are traditionally the techs (QQQQ), emerging markets (EEM) and small caps (IWM). Of these, I would only seriously consider IWM now, again due to the macro perspective mentioned above. Today IWM is sitting at its long term trend line and I’ll consider breaking below $75 a very ominous sign.

Late night thoughts, 7/26/07

2007-07-26T23:56:00.000-04:00

It’s late so I’m not going to dwell too much on the sell-off today. I’ll try to be brief and to the point.

I expected earnings to take a hit in Q3 so the string of Q2 downside surprises was somewhat of a surprise for me. For now, I’m still treating this as a controlled descent even though I have always expected housing weakness to “spill over”. There is a tendency to think the market will keep falling after a big drop like today but things rarely move in a straight line. While I’m not a buy-and-holder, I’ll wait for a downtrend to be convincingly established before changing my long stance.

Precious metals

The XAU put/call ratio made a new high on Wednesday. I have discussed this ratio previously so I won’t belabor the background here. Let’s take a look at the three highest spikes, viz:

6/12/06 XAU put/call ratio = 6.7, 6/13/06 XAU intraday low = 119.11, 7/12/06 XAU intraday high = 150.70, a gain of 26.5%
6/26/07 XAU put/call ratio = 5.3, 6/27/07 XAU intraday low = 130.83, 7/20/07 XAU intraday high = 159.14, a gain of 21.6%
7/25/07 XAU put/call ratio = 7.3, 7/26/07 XAU intraday low = 144.50, …

To summarize, on the first two occasions, a significant bottom in XAU was made one day after and XAU gained 20+% within 1 month. What this most recent spike foretells remains to be seen.

Disclosure: I picked up some GDX calls today.

New high in Shanghai

Unbeknownest to many, Shanghai (SSEC) made a new high Wednesday night. Not too long ago just about everyone was worried about a Shanghai bust taking out the rest of the global markets. Well, I was never on that bandwagon. Recently, there has been an increase of IPO activity in China which is the chief mechanism by which mal-investments occur. However, my main argument was that time, or the persistence of price movements rather than its magnitude, contributes more to mass psychology in a bubble than anything else. Given that SSEC made a significant bottom in late 2005, this “bubble” is still in its early stage yet.

CAF (Morgan Stanley China A Share Fund) is the easiest way that I know to participate in the A shares market. It’s now sporting a 17% discount as US investors have been inundated with bubble talk. I currently have a small position in CAF in addition to some FXI.

“There’s a bull market somewhere”
So the saying goes. Today that somewhere is agricultural commodities (besides treasuries, that's too obvious). On a Dow-down-300-pts day, they massively outperformed. Just check out DBA, POT, TNH, and of cause, this impressive break out by BG:

Best.

Commercials upping their long positions

2007-07-23T11:34:00.000-04:00

“Curiouser and curiouser“ is how I would describe the latest commitment of traders report. Records from CME indicate that commercial traders increased their net long positions by nearly 6000 contracts in the S&P 500 index (each contract = index value X $250), and their net long positions in the S&P e-mini’s (each contract = index value X $50) by over 3000 contracts in the week to July 17. These are not large numbers by themselves, but remarkable since the commercial net long positions were already at extremes as this market climes a proverbial wall of worry.

One particularly cynical explanation I had was that Wall St. insiders were front-running the sovereign wealth funds, especially China’s. Of course, it may as well be that those running China’s 200 billion fund were smart enough to buy the futures first, knowing full well that their stock buying will drive up the S&P 500 index. No matter what the real story, it’s hard to believe this emphatic buying is not based on certain fore-knowledge. As long as this situation persists, it’s hard to imagine a big fall in the market even as we’re seeing more Q2 earnings disappointments, Google and Caterpillar being the latest examples.

Ron Paul @ Google

2007-07-22T23:22:00.000-04:00