Monthly Archives: January 2009

Sailors be warned

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Red sky at night, sailor’s delight

Red sky at morn, sailors be warned.

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Technical musings

In recent trading days we have seen various indicators reach levels that, had they occurred together during another set of social and economic conditions, would have warranted an aggressive bullish stance. As they have arisen during the greatest depression and stock market collapse in any living person’s memory (geezers included), traders should perceive an elevated risk of a swift revival of market panic.

If we are going to start back towards the November lows sometime in the first half of the year, the next few days are as good a time as any. Optimism, or at least the abatement of fear, peaked around the first week of the year. At that time, most bulls and bears alike seemed to be counting on a BIG bounce, and that consensus view was manifested as as the top of a relatively anemic corrective rally.

Stocks then sold off solidly for two weeks, as the volatility index (VIX) ran from 38 to 58, a level that until last fall hadn’t been seen since a brief moment in 1987. Even 38 would have been indicated panic conditions until the world was turned upside down. In this environment, it indicates calm. Here is a six-month view:

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The bond market also indicated relief this month, as a rally for the history books finally broke when the 30-year Treasury bond yielded just 2.5%. Yesterday it yielded 3.41%, another level that until a few weeks ago had not been seen for decades (in this case, six of them). In this crash, 3.41% means complacency and even optimism. 30-year bond yield, 6-month view, courtesy of Yahoo! Finance:

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One more indication that the correction is exhausting itself has been the revival of animal spirits in commodities stocks, a popular ‘risk’ sector. XAU, the Philadelpia Gold and Silver Index, more than doubled from its crash lows. I am guessing that these stocks made their post-crash top yesterday, coinciding with bullion’s three-month high, because both are solidly overbought. This top in risk preference has occurred alongside the last few days’ rebound in the broader stocks indexes. Risk assets are the last to participate in rallies and the hardest hit in crashes.

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Now, with the exception of gold stocks and bullion, none of the above markets are particularly overextended at the moment. Bonds today made either a solid correction of their sell-off (corrective itself), or started a fresh leg up. The broad stock indexes are not overbought, which is the easiest time to identify shorting opportunities, so tread lightly if you are thinking about that route. I have been heavily long-term short for 18 months now, so if I am wrong on these little twists and turns it doesn’t bother me.

I would not be surprised by a loss of several percent in the Dow by next week, but neither am I counting on it. This market has been choppy and full of contradictions since December. Stocks went up with Treasury bonds last month, and this month the dollar has rallied with gold. Go figure. In cases like this, it is best to not have too strong an opinion on the market’s short-term moves. In recent days I have even covered several long-standing short positions as stocks such as Microsoft, Harley Davidson, Burlington Northern, and Union Pacific have pushed to new lows.

Keep in mind that we still could re-enact the November 1929 to April 1930 post-crash rally, in which the Dow rose 48% before the mood turned back down and stocks fell another 80% in two years. See A massive rally is straight out of the 1929 playbook.

Anyone sense a change in the air?

For the bigger picture, all you have to do is glance at a newspaper. From a non-technical perspective, the trend is clear: things are getting worse, much worse. Earnings will continue to surprise to the downside, to an extent that few can imagine. Firings and bankruptcies are just getting rolling. As the illusion of prosperity wilts away, we are going to discover that our productive capacity has been hollowed out by the distortions of the credit bubble and regulations, and that a drastically reduced standard of living awaits. Needless to say, stock prices will be proportionate.

Mish takes Peter Schiff to the cleaners

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Mish has composed a detailed post on the many ways in which the vociferous Peter Schiff has been dead wrong on just about everything in this crash (the two actually had a little debate in December 2007). Mish’s post is essential reading for anyone who is considering following Schiff’s investment advice. In his own way, the man is usually just as wrong as the Pollyannas that he challenges on bubblevision.

Here is an excerpt:

Schiff’s Investment Thesis

  • US Dollar Will Go To Zero (Hyperinflation).
  • Decoupling (The rest of the world would be immune to a US slowdown.
  • Buy foreign equities and commodities and hold them with no exit strategy.


12 Ways Schiff Was Wrong in 2008

  • Wrong about hyperinflation
  • Wrong about the dollar
  • Wrong about commodities except for gold
  • Wrong about foreign currencies except for the Yen
  • Wrong about foreign equities
  • Wrong in timing
  • Wrong in risk management
  • Wrong in buy and hold thesis
  • Wrong on decoupling
  • Wrong on China
  • Wrong on US treasuries
  • Wrong on interest rates, both foreign and domestic

That’s a lot of things to be wrong about, especially given all the “Peter Schiff Was Right” videos floating around everywhere. The one thing he was right about was the collapse of US equities and no part of his investment strategy sought to make a gain from that prediction.

I will admit that I was nearly taken in by Schiff’s thesis back in 2006 when I first became bearish on the economy and stock market. I even opened an account for someone with his firm, but the only thing I did with it was short the US market — I took none of his brokers’ advice on favored mining juniors.

I owe Mish and Robert Prechter a huge debt of gratitude for beating some sense into me with solid logic. Readers can easily check my archives to see my pre-crash stances on commodities, gold stocks, Treasuries, the dollar, the Swiss Franc and the Euro and the inflation/deflation debate. I can report that things have turned out very well for those who went against the crowd of contrarians, swallowed their fear of the dollar, and shorted not just US stocks but almost everything else in sight. All the world was a bubble.

On the need to stay nimble

Yes, the deflationists were right and hopefully all made some money or at least avoided terrible losses, but nobody can afford to get cocky. The markets do not trade on fundamentals on anything but the longest time-frames, so the ability to read the prevailing mood and adjust accordingly is a critical part of asset management. So is the willingness to contradict yourself and change your mind.

I see now that this deflation can last even longer than I had suspected, and that there may be even ways to avoid hyperinflation, such as negotiated Treasury debt forgiveness, but there is no need to try to guess about outcomes that are years away when you know how to read the signs as they come and remain humble and liquid enough to change your stance as needed.

By the way, Mish manages client accounts

Mish is an investment advisor representative with Sitka Pacific (not Euro Pacific!), a firm that manages private accounts on a percent of assets fee basis. I am not a client, but I would not hesitate to suggest giving them a call. I am working on setting up my own firm of this type, which offers many advantages over hedge or mutual funds, especially when set up with the protections that Sitka Pacific has included. My own style of trading is somewhat different from any of the strategies Mish uses (for example, I am willing to go net short or to a majority cash position), and of course I am not always in agreement with Mish on every aspect of the markets.

Still bearish on the yellow metal

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As many readers know, I have been bearish on gold lately. I have been buying puts on GLD and GDX and bought more yesterday, though I do have a big chunk of assets in bullion (20x more than in puts). My bullion is not for sale, but I suspect that the reality of deflation and its likely duration has yet to fully sink in, and that we are due for a demoralizing event in the gold market.

Gold is not fully treated as money at the moment, though fiat currencies don’t satisfy all of the criteria for money either. Only precious metals can fully satisfy them, when governments allow.

So gold is not really money now, since its liquidity is limited, but it is a long-term store of value that outlasts currencies and governments. This is the key point: from the perspective of a large player who can afford warehouse costs, other metals or commodities can also serve as a store of value and hedge against fiscal calamity. Copper and cotton and rice will never go to zero either.

Almost all other commodities are down by huge percentages, though gold hangs on. It makes sense for gold to outperform the others, since it is more liquid and portable and people naturally prefer it during a crisis, but the premium seems way too high.

Once this panic phase of the depression is over, and a general funk and low-velocity environment settles in, with the dollar and other currencies having survived to the surprise of so many gold owners, the metal could be again seen as dead weight and fall as people still need plain old folding money to pay their bills, debts and taxes.

That is how I see things. Only time will tell if I am right.

Ahh, panic is back.

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Everything that was hot, all of a sudden is not.

For the past nine trading days, we’ve seen a rapid return of the kind of fear we experienced last fall. The carry-trade currencies (dollars and yen) and Treasuries have appreciated against everything else: stocks, the former bubble currencies (GBP, EUR, JPY, CAD, AUD, etc) gold, oil, grains and metals.

Today’s action was particularly convincing because of the breadth and extension of the equity sell-off, coincident with the VIX cracking 50, gold nearing 800 (a one-month low), and the 30-year Treasury yield pushing strongly back down to 2.9%. This across the board unwinding and preference for senior currencies and Treasuries is exactly what wave 3 of the crash looked like from September to November.

That’s all, folks.

I think we have seen all the bounce (Elliott wave 4) we are going to get off of the November 21 lows (Dow 7392). Too many bulls and bears alike were expecting a repeat of the November 1929 to April 1930 post-crash rally. Perhaps that rally was more powerful because it corrected a more oversold short-term condition, a 48% drop in 10 weeks that came right off the very peak of the preceding bull market. Animal spirits were still strong that winter, while the memories of rebounds and new highs were still fresh in traders’ minds. This time around, our rally only needed to correct a 35% drop over three months (Dow ~11,500 in August to Dow 7400 by Thanksgiving), while the underlying economic situation and social mood were in a more advanced stage of depression (at least a year into the economic contraction and two years into the housing bust).

The weakness of this post-crash rally is also another indication that we are in a larger degree decline than the depression of the ’30s, indeed a Greater Depression, as befits the aftermath of the largest credit bubble in all of history.

Targets and strategy.

At any rate, this plunge looks ready to take us much lower, probably well below 7000 on the Dow. I also hope that oil gets dragged to $25 and gold to near $600, where I will be a buyer of each for the multi-month corrective rally that should follow, prior to yet lower lows in equities (Dow 3000?) and mood.

I’m still holding many of my REIT, S&P 500, and miscellaneous stock puts from before the crash, and I intend to sell into the plunge just like the last time. If we bounce from here in the next few days, I’ll perhaps pick up some near-term puts for some extra oomph.

A bleak, bleak year ahead.

2009 will be the first time that it feels like a Depression to most people. Only about three million jobs were lost in 2008, and the crash came at the end, so most people have still been in denial about the severity of this event, or have yet to lose their faith in the Fed or the change in the White House. As stocks sink through their 2002 lows, house prices drop even faster, entire malls start to close, and huge waves of layoffs begin, the social mood will get dark and increasingly volatile.

Dollar rally hits gold and Treasuries.

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I first touched on this topic last week:

“So that’s what I’m working with. All three asset classes look overbought to me: bonds, gold and the Euro/CHF, and I suspect that their rallies are related and associated in traders’ minds with recent Fed and Treasury actions.”

Today the dollar is rallying strongly against other currencies and gold, which behaves like a volatile currency, and Treasuries are falling sharply. This is a reversal of December’s big moves. The dollar fell as the bond climbed. The two are maintaining a kind of balance — from a foreigner’s perspective, you don’t want to buy Treasuries with high bond prices and a high dollar, since that exposes you to elevated currency risk as well as price risk. As bonds correct their overbought condition, the dollar can rise.

This is just my 2 cents on the last few weeks — bonds and the dollar were strong together in the crash, and they can be again. It was only when bonds ran away in December that the dollar corrected sharply.

Is this the start of the next leg up in the dollar, which could push the Swiss Franc down under 80 cents, the Euro to under $1.15, and gold to near $600? Maybe, but it would be odd to see the dollar exhibit that kind of strength without further deleveraging in ‘risk’ assets like equities, corporate bonds, energy and base metals. So, the question is, should we expect such weakness in equities et al. or should we expect a short-lived dollar rally?

The strongest indicator we’ve had in the markets of late is that Treasuries were overbought by late December. This is not to say that we won’t see 2.5% yields on the 30-year again, but simply that this run was overdone. If Treasuries continue to fall, that would typically coincide with more animal spirits in the sectors that got clobbered this fall, in which case the dollar may find its rally short-lived at best, since dollar weakness was such a part of the bullish atmosphere from ’04 to early ’08.

The “short Treasuries” crowd is very much of the inflationist bent, so I would not be surprised to see oil and base metals surge with a continued sell-off in bonds, but then gold and gold stocks have already been overbought (I bought GDX and GLD puts last week), so we have a major divergence among the so-called hard assets.

This is not an easy market to read, as is characteristic of Elliott wave 4. It is best to just stand aside until things are more clear.

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PS — Just sold my TBT for a quick 8%, as well as those January DIA puts that I bought at Friday’s close. The Treasury short is a crowded trade, which I don’t like, and the strenuously overbought condition is now releaved. Bonds could fall a lot more here, but with a short ETF, any chop in the trading can eat up your returns.

Fear recedes, so how will it return?

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The markets are experiencing a bit of a thaw today, with the memory of panic several weeks behind us now. The VIX has just broken decisively below 40 for the first time since September. Treasury yields have broken out just a tad from their extreme lows. Oil has jumped back to the mid-40s, copper has relieved its oversold condition, the GDX gold stock ETF has more than doubled, and the Dow has crept back to near 9000 again.

The question now remains, how will fear return? In several more weeks or months after the mood turns from relief to greed (and fear of missing out), or in the very near future?

My mind is not made up, but any breakaway rally is way overdue. With every week since the November 21 lows, we have been relieving the oversold condition as a function of time rather than price. That is not to say that the Dow couldn’t creep all the way to 10,000 by March, but the longer we hover here, the less necessary such a rally becomes.

What would be interesting in a January plunge is for the bond market to sell off with the stock market for the first time in recent events. But if the inverse correlation still holds, the overbought condition in Treasuries could find relief in a “happy days are not quite here again but will be soon” rally in stocks. Today’s action is what such an environment would look like, but with a great deal more animal spirits — $65 oil might even materialize (before new lows of course).

At any event, with the VIX below 38 I picked up a few more cheap puts on GDX today. Gold stocks have had a great run, and the same people are buying them today as were holding them in the crash, and for the same reasons. That is a bad sign.

My favorite short though is still the death-defying Home Depot. Also keep an eye on WalMart. People need cheap stuff, but they don’t need as much of it as they have been buying in recent years. At 16.5, the PE on that behemoth is still out of line, as is Costco’s at 18.5.

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PS — Note that in this kind of analysis, I don’t pay much attention to news pieces or economic releases. That is not the way to trade. For instance, we have horrible manufacturing data out today, and all data is worse than 6 weeks ago, but the mood is hopeful and stocks are up, so how can you make money trading on the news?

I look at the mood of the market itself and try to figure out what it is feeling and what themes it is trading on: greed, panic, relief, inflation, deflation, dollar bad, dollar good, etc. I try to figure out the mood by what different asset prices are doing, and wait for entry and exit points when trends look exhaused. To know the larger trend is key, in this case deflation and depression, but the market’s take on the situation is always changing. You wait for Mr. Market to be very wrong about a situation or just too enthusiastic, as in the case of the overextended bond rally this month — in deflation, bonds are good, but overbought is overbought.