Wednesday, August 31, 2011

Stocks: More Selling To Come

It looks as if the bulls are back in the short term. However, I have a feeling that the rally will be short lived, before we retest that 1,100 area. I suspect that the strong supply zone around 1240 to 1260 on the S&P should contain the advance, but I am not the best short term trader. History shows that whenever we had a crash of this magnitude with a high VIX spike, we almost always retested the panic lows. This was true in 1990, 1998 and 2010 Note: In late 2001, we did not retest the lows, so therefore next year the market went much much lower down into the 2002 bottom.
I did not include 1987 and 2008 in the crash analogue above, because the price has stopped crashing and we have stabilised somewhat. We could now drift lower, but I do not think we are repeating 2008. Money Market Rates seem to be stable as well, even though CDS have been rising. This is not a huge corporate crisis (private sector) like in 2008. The bad fundamentals are now on the public sector balance sheets, as governments struggle to pay of their debts. But unlike private sector, the public sector has the ability to create money out of thin air and print it. This should benefit commodities, just like always throughout history.
Finally, there have been a lot of worries about a potential recession and the impact on corporate profit margins as well as earnings. I have addressed those worries quite well in my previous posts (What Are The Chances Of A Recession? - Part I and also What Are The Chances Of A Recession? - Part II). Finally it has come to my attention that there is now a huge divergence between the Treasury 10 Yr Break Evens (TIPs vs Treasuries Spread) and the S&P Implied Earnings Growth. It seems as if investors are more bearish on prospects of earnings growth rate today, than they were at the depths of the financial crisis in 2008 and into March 2009.

However, investors aren't as worried about deflation according to the 10 Year Break Even spread. Something doesn't add up. Either the earnings prospects will improve from very pessimistic levels or the CPI will start to deflate further, dragging down economic growth. I guess the super bears will argue that deflation is on its way, but they are always saying that. I would think that the current pessimism on earnings growth is deviating too far from its long term trend. I would also argue that the only asset class that has confirmed deflation and moved lower than the March 2009, is the 10 Year Treasury Note Yield. Crude Oil, Copper, Corn, Wheat, S&P 500, Emerging Markets, DAX 30, Nikkei 225, Euro, Aussie Dollar, Canadian Dollar, British Pound, Junk Bonds, Corporate Bonds, Emerging Market Bonds, etc, etc. Not one other asset class is lower than March 09. Not even the 30 Year Bond Yield has confirmed this move. Therefore, I would argue that deflationist are in the wrong as it is highly unlikely that one asset class is right, and the whole financial market is wrong.

Summary: While we could rally somewhat more from here, I expect a retest of those lows set on August 09th at 1101 on the S&P 500. September is typically the worst month of the year seasonally, so I would be surprised if we had two good Septembers in the row (remember September 2010?). Having said that, I think we are now closer to the end of this deflation trade (correction), which started earlier this year as the Fed gets ready to print even more money during their September FOMC meeting. I still recommend investors stick to commodities, instead of buying beaten down Financial Sector. As previously stated, I will be buying Agriculture and Energy, and staying away from Safe Havens like Treasury Bonds... and maybe even shorting them soon!

Tuesday, August 30, 2011

Economy: What Are The Chances Of A Recession? - Part II

It seems that everyone is discussing the recent Bloomberg article about the valuation of the stock market and the potential of another recession. When the article is a classic boxing match between bulls and bears, it completely misses the point of investing in the right asset class. None the less,the article was quoted saying:
Bears say valuations show the U.S. remains in the slowdown that began in 2007. Unlike under Reagan, when U.S. Federal Reserve Chairman Paul Volcker raised borrowing costs as high as 20 percent to combat inflation, interest rates are already near zero, leaving policy makers fewer tools to boost the economy, they say.
Bulls say the ratios are so low because they reflect indiscriminate selling by investors convinced that any slowdown will turn into a repeat of the 2008 credit crisis.
I agree that interest rates cannot go any lower, but that is no reason to be bearish. The zero interest rate policy, together with money printing will eventually work - at least for commodities, but more on that later. There are plenty of other points bears should have noted, including deteriorating economy, which could put a monkey wrench into companies stealer earnings trend over the last 2 years. Let me explain:
For example, consider the chart above, which is a measure of future U.S. economic growth thanks to the Economic Cycle Research Institute. The Weekly Leading Index fell to 122.8 last week ending August 19th, from 123.8 the previous week. At the same time, index's annualized growth rate sank to -2.1 percent from -0.1 percent a week earlier. This was the lowest growth rate since the week of November 26th, 2010.

So what the bears should be saying is that we got on our hands a very reliable leading indicator for the US economy (not a holy grail), that is showing strong signs of weakness. It is currently trading below its two year moving average, which I tend to consider a recession warning. This type of development increases risks of potential S&P earnings contraction, as we can see in the chart below:
Therefore, bears should also note that while earnings have been magnificent during this business cycle, surprising even the bulls, eventually they will mean revert together with corporate profit margins. This quote probably summarises the whole ordeal very well:
“Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.” ~ Jeremy Grantham
The article went onto state that either the stock market is cheap or that earnings will fall:
...S&P 500 traded at 10.8 times analysts’ forecast for profits in the next 12 months of $109.12 a share. For the P/E ratio to reach its five-decade average of 16.4 without shares appreciating, earnings would have to fall to about $71.76 a share... Should companies meet analysts’ profit estimates, the S&P 500 must advance to about 1,790 to trade at the average multiple of 16.4 since 1954, according to data compiled by Bloomberg. That’s more than 50 percent above its last close.
If we think this through we would ask ourselves a few questions. First, one has to ask themselves if revenue (top line) could disappoint due to a recession threat? My answer is most likely so. Second, will profit margins shrink too? My view is almost definitely. Third, what is the chance of earnings falling to $70 or even lower? My answer, once again, decently high. Therefore, 10.8 times Forward P/E ratio doesn't really mean anything, does it? If earnings fall, the stock market will look overvalued, potentially selling off once more. Furthermore, I have to say that Bloomberg's view of S&P 500 at 1790 is totally ludicrous.
"Near stock market tops the price-to-earnings ratio is frequently low because the problem lies less with the “price” than with the “earnings”. In 1929, the US stock market sold for less than 14-times earnings. But then earnings collapsed and stocks plunged by 90%." ~ Marc Faber
So far this whole article portrays quite a negative tone about future prospects of the economy which could impact S&P earnings and therefore the stock prices as well. Up to this point majority of the bears will agree with what I wrote, but I think that agreement stops here. You see, my view is that it's not all is that bad for the bulls, especially if you are commodity bull. When economic activity stagnates, history has proven time and time again that commodities are the right place to be. Let me explain:

Most bears and deflationists do not understand that during prolonged awful economic periods, commodities do very well. Bears will argue that during economic weakness, demand destruction occurs and commodity prices fall. They point to 2008 and say: "you see, you see... I am right!" However, what they failing to understand is that commodity markets are not just moved on the basis of rising and falling demand. The other side of the equation is supply. If you have falling demand, but even faster falling supply, you have a commodity bull market on your hands. And, 2008 has made sure that no new supply streams are coming on line. No one can even get loan, let alone fund a whole new mine. The most interesting thing is that commodities do great when the economy is struggling, when unemployment is extremely high and when consumer confidence is terrible. Consider the chart below:
In the 1930s and 1940s we had the Great Depression, deflation and a huge economic collapse, however the world experienced a roaring 20 year bull market in commodities. While demand was falling and the whole world was de leveraging (just like today), the constant crisis' made sure no investment into commodity supply was being made. Eventually huge shortages developed and the prices of everything went to the sky. On the other hand, in the 1960s and 1970s, majority of the global economy was in total disarray, but once again commodities boomed. Consumer spending collapsed, inflation constantly ravaged economies and created recessions every few years. Once again, huge shortages developed and on top of that, governments everywhere printed money. Eventually the prices of everything went to the sky... again.
Summary: I think the Bloomberg article completely misses the most important point. When global economy suffers, commodities do much better than stocks, bonds or cash. And yet no one even talks about this asset class. So... fast forward to 2000s & 2010s, and the story once again looks similar. Shortages everywhere are developing and global governments everywhere continue to print money, throwing fuel on the fire.

Consider that farming has been a terrible business for over 30 years, the amount of arable land has not increased since 1980s and days of supply for almost every agricultural product are the lowest in 20 years. Cimate change and weather effects have only made things worse and now shortages have developed everywhere. Invest in Agriculture.
Furthermore, the world has not found a major "elephant" Oil field for over 25 years, so over 40% of Corn (and a lot of Sugar supply) is now used in ethanol production. At the same time, known supplies of Oil are decreasing at the rate of 6% per annum. That means in about 15 to 20 years, we will have no global Oil reserves left. Once again, shortages are developing and when prices go sky high, they will even be drilling in front of the White House grass lawn to find some Oil. Invest in Energy.
Despite a potential global slowdown, smart investors should stick with commodities over the next several years, because that is where fundamentals keep getting better and better. Recession or no recession, a roaring bull market in commodities is set to continue due to shortages on the supply side and money printing almost guaranteed by General Bernanke. History does not lie, so is this time going to be different to 1930s and 1970s?

Monday, August 29, 2011

Economy: What Are The Chances Of A Recession?

Quick update away from the markets, QE3 noise, pessmistic sentiment, technical analysis and other mambo jumbo.

Citigroup Economic Surprise Index is a mean reverting indicator, which tracks the difference between actual high frequency economic data and economist's expectations. When economists become too pessimistic, they lower their expectations and the economic data starts beating expectations. The opposite occurs when economists become overly optimistic.
Why is this important for market investors? Because, majority of the time, markets respond more to how numbers post up against economist’s expectations, rather than the actual numbers themselves. And since economists have a terrible forecast record, it pays to be contrarian against this group of market participants - just like in late 08 / early 09.

What we can notice in the chart above, is that data for the US economy reached extremes in May & June, and since than the data has been slowly but surely beating economist's expectations. The same is currently also true for Global Emerging Market economies. These trends are welcomed developments. However, majority of the Developed Market economies, which include the Eurozone are still showing a worrying trend, where the economic numbers continue to disappoint economists.

The question is whether the economists have not lowered their expectations enough, or has data become so awful, that a recession is just around the corner? What is the chance of a recession occurring?

One of my favourite ways to track the risk of a recession, at least in the US, is by following the Chicago Fed National Activity Index, which compromises over 70 nationwide economic indicators. Usually when the reading start approaching or goes below -1%, the risk of a recession increases dramatically. Even though the current data is only up to July, the US economic looks "OK" for now. The growth is below 0%, but quite flat. However we already know this by the recent average GDP numbers. Once again, please note that the data does not represent August readings (they are not out yet).

The economy is not booming, that is for sure. Furthermore, the market tends to look at the economic activity in the future, while economists look at the data from the past. The market is a discount mechanism, while economists are there just to make sure weather forecasters look good. Looking at old data to make investments, is like trying to drive a car by looking at the rear view mirror.

So the question is what has the market been "discounting" in August, with a crash of 15%?

The way I see it, when you have below average growth, any shock to the system which creates panic in confidence could very easily result in a recession. When I look at the CDS on various markets, be it Dow Jones companies, global financial sector, Emerging Market government bonds, LIBOR rates in Europe, European government bonds or banks... it becomes obvious that something is not right in the system.

Is Greece going to default? Is Bank of America strapped for cash? Is Soc Gen about to blow up? Is the world going to end?

Summary: Haha, sorry about the last one. It just seems that everyone is such a super bear, I thought I would jump in and have a go. You know, being ultra bearish can be a lot of fun at times. Anyways, back to the topic. I believe we are not repeating 2008 and I still remain in the camp of "no double dip". I am not sure if I am going to be right or wrong, but nonetheless I remain very cautious and hesitant to deploy my cash holdings just yet. Are we going to have a recession? You are going to have to ask Nostradamus that one.

If you are friends with Nostradamus, don't tell anyone, just email me privately and tell me what happens next. If there won't be a recession, shorting the Treasury Long Bond might be a big go, because its so overvalued due to panic buying. If we are going to have a recession, buying the US Dollar might be a big go, because its so cheap relative to other currencies.

Sunday, August 28, 2011

Chart Of The Day: DAX 30 Technically Oversold

I am not a big fan of technical analysis being used on its own. Having said that, today's chart of the day does precisely that, so try and not bet a farm on it. Because the US equity markets have been outperforming the world and the current crisis seems to be occurring within the EU zone, I had a look at German Xetra DAX – a highly cyclical and growth sensitive index of top 30 German companies, similar to the Korean KOSPI.
In the chart above, we can see that the DAX 30 is extremely oversold. The RSI has been in the oversold territory for pretty much the whole month now, while the MACD is very very far away from the 0 line. On top of that, Xetra DAX is showing bullish divergence between RSI and price, as well as plenty of bullish candle tails on a major support line at 5,400, including strong Friday's close. Finally, the current price is so far away from both the 50 day as well as 200 day moving average. Remember that markets are always mean reverting, so you should drop that perma-bearish emotion and turn contrarian.

Judging by this chart and simple technical tools, it seems that Johnny Come Lately's keep selling, while we are setting ourselves up for a very powerful short term rally from oversold conditions. It is also worth noting that, since the crash was one of the biggest in DAX's history, the rebound might go much further than most think as short covering takes hold. There are plenty of headless chooks running around telling people how we are repeating 2008 again, and these "perma-bears" are begging to be short squeezed.

Technical anaylsis is meant to show probability of outcome, so if I was a short term trader I would bet long the index spot or the equivalent ETF, plus write some naked puts on ATM options right now because Volatility-DAX Index (VDAX) is actually even higher than the VIX.

Friday, August 26, 2011

Stocks: No Bottom Yet, But Closer Than Before!

According to Bloomberg or CNBC, QE3 or not to QE3, that is the big question? I actually do not even have a clue what they are on about. Surely it cannot be that complicated. Due to high political backlash, Bernanke is coming in under the radar, so I wouldn't expect any formal signals that QE3 is on the way. Having said that, he seems to be doing a "bloody great job" (Australian slang) fooling the majority that QE3 has not started yet. What do I mean by that?

For those who haven't "got it" yet, for a central bank to keep interest rates extremely low for "an extended period", it will have to interfere and intervene into the bond market again and again to suppress the rates. You cannot just say rates will stay at 0% and vuala... they stay at 0%. That means, in a certain sense, Bernanke has already pledged to start QE3 and majority of people don't even know it yet. In my opinion, this whole thing has nothing to do with fighting deflation - which doesn't even exist anyway, but has more to do with bailing out Wall Street bankers - not that I want to sound like a conspiracy theorist... but fuck, I hope everyone has figured it out by now!

Bernanke's buddies will now be able to borrow from the Fed at 0.2% interest over 2 years (2 Year Note), which is actually less than the 3 or 6 month LIBOR rate, and lend that money out to us consumers at over 2% for the 10 year period. The savers will be wiped out, while bankers will rebuild their balance sheets. This is a classic scam! In other words, Bernanke has told the Wall Street casino players, who work at the banks, that they have prescily two years left to repair their own balance sheet and you have to be dumb dumb dumb not to make any money under the these casino rules, with the Fed backstopping the financial collapse.

Deflationist will argue that this won't work, but they haven't yet figured out who they are dealing with. They should go back to the speech The Bernank wrote in 2001, pledging that if its necessary he will drop Dollar bills out of the Helicopter. I guess super bears and perma-deflationist just love being bearish all the time!

Back to market matters...

I had quite a few posts on the blog telling me that classic sentiment indicators like AAII, Investor Intelligence and a few others are not as bearish as they should be. That is true, as we can see from the chart above. The only "buy signal" I got this week was from NAAIM and also from the Corporate Insiders (last two weeks).

I have to admit, it is quite strange after a 20% crash. I remain in cash for the majority of my portfolio, but I am turning more and more bullish as I think majority of the volatility and price declines are behind us. That is not to say that we cannot make a new low or something similar, but I think if you haven't shorted the market back in July, you have now missed out. Consider the following chart:
I ran a stock market crash analogue with all the major panics in the last 25 years, which including 1987, 1990, 1998 and 2011. These aren't just any bear markets, but full blown straight line down waterfall crashes. Unless you believe that we are going to have a 1987 or even a 1929 repeat, you might be on the wrong side of the trade being bearish.
Obviously this is just an analogue correlation and not the ultimate holy grail indicator, but whatever does happen, I think majority of the bad news has already being discounted as the market got extremely oversold (chart above). At one point we had over 95% of all stocks within the S&P 500 at oversold level. While we aren't at the bottom yet as I expect a re-test or two or even a bear trap (lower low reversed quickly), I have to admit that we are damn close. Opinions?

Chart Of The Day: Where Is The Dollar Rally?

I update Quote Of the Day few times a week, so from now on, I will also be doing Chart of The Day as well.

I thought I start of with a great chart from Bank Credit Analyst newsletter, which is asking the same question a lot of currency traders are also asking themselves: where is the US Dollar rally?

When a price of an asset fails to rally on favourable conditions or news (EU problems is favourable for the Dollar as a safe haven), than it could be starting to price in more unfavourable conditions just around the corner.

Thursday, August 25, 2011

Merrill Lynch Fund Managers Survey - August 2011

Note: An overall total 244 panelists with US$718 billion of assets under management participated in the survey from 5 to 11 August. A total of 176 fund managers, managing a total of US$551 billion, participated in the global survey. A total of 136 managers, managing US$359 billion, participated in the regional surveys. The survey was conducted by BofA Merrill Lynch Research with the help of market research company TNS. The survey took place from August 5 to August 11, when world equities fell by 12.3 percent.

Tail Risks
Worsening growth expectations are a major theme in the August survey, with 29 percent of respondents feeling a recession is likely, a rise from 13 percent in the previous month. Investors' forecast for corporate profits shows the biggest downwards swing in the survey's history. A net 30 percent of the panel expects the profit outlook to deteriorate in the coming 12 months. In July, a net 11 percent forecast an improvement in profits.
The biggest “tail risk” seen by the portfolio managers remains European Union sovereign-debt funding. Three-quarters of investors this month identified business cycle risk as the number one risk to market stability -- up from 42 percent in July. The drastic change in investors’ economic outlook signals both an erosion of confidence and a significant degree of uncertainty. This latest survey shows that managers’ investing time horizons have fallen to the most short-sighted level on record.
Inflation expectations fell dramatically, with a net 6% of managers now believing inflation will be lower in the next 12 months. Last month, a net 28% felt it would be higher. Twenty-five percent of the group expects interest rates to rise; 72% thought that last month.

Monthly Questions
Interestingly, only 22% now rule out any prospect of another round of QE against 40% last month. About 60% of respondents think that the Fed would step in at an S&P level of 1,100, which was touched briefly on 09th of August 2011. Last month only 28% of hedge fund managers considered that a level of 1,100 or below would signal a third round of easing.

Asset Exposure
Asset allocators have scaled back equity positions faster than in any previous month in the survey's history, which shows remarkably fast liquidation. A net 2 percent remain overweight equities, down from a net 35 percent in July. A net 48 percent of respondents said equities were undervalued, the record in the survey's history, which indicates willings to eventually buy back in. Global asset allocators have also departed cyclical stocks en masse over the past month.
Allocations towards industrials suffered a negative 27 percentage point change from July to August. A net 16 percent of global allocators are underweight Industrials, compared with a net 11 percent overweight in July. The proportion of respondents overweight energy stocks declined to a net 14 percent from a net 27 percent a month ago, which is a 13 percent drop. While a large majority of allocators remain underweight banks, the month-on-month swing in the sector was a modest 4 percentage points. Fund managers have rotated towards defensives, notably the utilities and food and drink sectors.
Cash holdings have soared to their highest levels since the depths of the credit crisis as investors have moved out of equities, notably cyclical stocks. Cash balances have climbed close to their high of 5.5 percent in December 2008. Global investors hold an average of 5.2 percent of portfolios in cash, up from 4.1 percent in July. A net 30 percent are overweight cash compared with their benchmark. Both numbers are at their highest level since March 2009.
Risk and liquidity premiums fell to 33, which is the lowest level since March 2009. Hedge funds reduced their gearing levels as well. The ratio of their gross assets relative to capital fell to 1.43 from 1.50 last month. Their net exposure to equity markets -- measured as long minus short as a percentage of capital -- rose to 33 percent from 31 percent.
Asset allocators have reduced their positions in the U.S. more aggressively than in any other region and at the sharpest rate the survey has ever recorded. Asset allocators responding to the global survey moved slightly underweight U.S. equities. A net 1 percent of the panel is underweight this month, compared with a net 23 percent overweight in July. Europe, despite the continuing pessimism on economic prospects for the region, did better. The percentage of global managers underweighted to European stocks dropped from 21% in July to 15% in August.

Asset allocators have reduced their overweight position in global emerging market (GEM) equities. A net 27 percent of the global panel is overweight the region, a fall of 8 percentage points month on month. Among emerging markets, Indonesia (+40%) and Russia (+27%), are the most favoured markets though the Russian bet is cut sharply in-line with the reduction in emerging market energy positions. China (+20%) and South Africa (+13) are the other notable overweights, while India (-40%) and Taiwan (-27%) are the least favoured.
Safe haven assets like Government Bonds, showed allocations moved to a net 33 percent underweight from 45 percent, coming closer to the long-run average of net 34 percent underweight. Investors have taken the view once more that Gold is overvalued. In July, the net percentage taking this view dipped to a net 17 percent. But with gold hitting new highs, a net 43 percent of August's panel believes it is overvalued. This reading is highest since the Gold survey started in 2008.
Finally, above average amount of hedge fund managers still remain optimistic on the European currency, but we have not reached any extreme positions just yet.

Personal Summary
My personal take on the current survey is that hedge fund managers are becoming extremely bearish, cutting exposure to risk assets and adding exposure to cash and bonds. Furthermore, inflation expectations have dropped considerably. That is a sign that one should turn contrarian and start expecting inflation to eventually come back again. Let me explain by using this example:

Managers are worried about EU debt crisis, and usually whatever they worry the most about, tends to work out in the opposite direction. Consider that in the April 2011 survey, hedge fund managers were the most worried about commodity inflation, just as the CRB Index as well as Crude Oil were peaking on 02nd of May.
A few months later and the commodity inflation worries have been cut at the fastest pace since the survey started. Therefore, if April 2011 was a great contrarian indicator to reduce exposure to commodities, than today's survey is just the opposite. Keeping all that in mind, while I don't think risk assets have bottomed just yet, I believe we are in the process of doing so over the coming months.

Finally, the potential catalyst to trigger such a rally could be the EU short/medium term fix. The fear is the greatest towards EU problems, and majority of the time these managers (which herd) tend to be wrong. So therefore, from the contrarian point of view, I would look towards Euro-Bonds as possible medium term fix to the problem.

Portfolio Update: Profit Taking On Sugar

Our fund just closed positions on the Sugar early this morning, which we bought in early May 2011. Our profits on this investment were quite large to be honest, at 43% gain in price with 2:1 leverage, meaning over 86% return on risk with large sum of money invested.

Please consider the section of the recent article concerning Sugar below:
"Announcement of frost related supply cuts from Brazil – the world’s top producer – was compounded by news that China – the world’s second biggest consumer – may restock by 600,000 tonnes more than its usual quota of 1.9 Mt this year. A Bloomberg survey of the industry finds a median expectation that sugar futures could continue to gain."
Sugar news is extremely favourable for continued rise in price. We have news from China and Indonesia of strong demand; and we have news out of Brazil of weak supply. Unica, main governing body for Sugar supply, has capitulated and now revised the output of production towards lower levels. With all these favourable outcomes, why did I close Sugar positions?

Because the market has most likely priced in all of these events. As of last night, the price of Sugar failed to make a new high, which was very critical, under favourble news and demand/supply conditions. I regard this as a highly negative signal. Another negative sign linking to this is the outside day reversal candle (chart below). Technical candlestick patterns like outside reversal days near tops or bottoms hold much more relevance than at any other random time.
It was Marc Faber who first taught me that when a price of an asset fails to make a new low on unfavourable news, it could be starting to price in more favourable conditions. The same is true for an asset that fails to make a new high under very favourable conditions.

Therefore, on any major weakness or extreme sell off, I will consider re-entering the market again, as long term fundamentals for the Sugar market remain extremely bullish. However, in the medium term, I think the bulls have completely priced in recent supply shortages out of Brazil and we could experience quite a large correction.

Tuesday, August 23, 2011

Portfolio Update: Short Gold

From now on I will be updating investments I'm adding to my portfolio. Therefore, everyone will have a chance to see where I'm putting my money and can comment on it.

Our fund just bought some PUTS on Gold. We usually do not trade, but we have a huge standard deviation parabolic event, which could correct at least a few hundred dollars.

On Friday we had 98% bulls according to Daily Sentiment Index. Last night was followed by another 98% bulls day. ETF inflows into the SPDR GLD are now at monthly record highs. Recent Merrill Lynch Fund Managers Survey placed Gold into an extremely overvalued position, which was a good guide in previous corrections. I also noticed that SPY ETF now has less net worth than GLD ETF. That is really remarkable. All in all, the current mood makes this quite a contrarian bet for a few months, until the price shakes out weak hands.

As a side note, all day today on CNBC and Bloomberg we had a gold bull after gold bull. CNBC has a poll which is asking if Gold could hit $130,000 levels. Totally insane. All in all, I think we are ovrdue for a serious correction around the next couple of months, despite the strong seasonality that usually happens in September.

Quote Of The Day

"When banks and deposits are not safe and governments are bankrupt, it is time to buy canned food spam, guns, ammo, gold bars and rush to your mountain log cabin." ~ Nouriel Roubini

Economy: Where Is Deflation? Not Here!

There is a lot of headless chooks running around, telling investors that we are suffering from the risks of deflation. These headless chooks can be found on CNBC or Bloomberg, at the Federal Reserve Open Market Committee or at, or for that matter any other random blog that is predicting the end of the world. Others are pointing to the Treasury Bond market, saying that deflation is now priced in and that the collapse of assets is about to follow. This is a total load of garbage. Please consider the two charts below:
Thanks to Doug Short (, we can see that inflation in general has increased between 25 to 34% in the last decade. On the other hand, the whole decade super bears have been talking about deflation. So where is it?

Education, energy and medical care has actually increase over 50% in that period. The source here is the government body (BLS), so if you are like me and don't believe these bogus figures, you would probably agree that inflation has actually increased substantially more. Much much more.
John Williams over at Shadow Stats still keeps tabs on the way the old CPI was calculated before Reagan era. Here, it is quite obvious that inflation could be running north of 10% as of last month. And you should also noticed that inflation has not been below 5% since the 1987 stock market crash!

Here in Australia, and for that matter in majority of Asia, premium unleaded fuel prices are higher than a year ago - and I have daily experience with that. Education fees are higher than a year ago - as I saw my brother's university fees. Medical products are higher than a year ago - as I buyt certain medication for my father.

Since I eat like every other human, maybe apart from Ben Bernanke, I have noticed that food prices are much much higher than a year ago. When I travel, I notice that plane tickets are higher than a year ago. Even the firm that pays for me to fly to the mines, is paying higher plane tickets than a year ago.

Monthly rents in Australia or Hong Kong are much higher than a year ago and so are the house prices. I even noticed that prices for washing your car are higher than a year ago. I don't know anything that is actually lower than a year ago... apart from US Government Bond Yields... which brings me to the next point.

There is no deflation, unless you are living on Mars, and clearly Treasuries are in a speculative bubble, pricing in more quantitate easing. These bond traders are addicted to bidding up pricing of bonds and than off loading them back to the Fed for a profit! If we truly were facing a deflation collapse right in the face, the Treasury yields wouldn't be the only asset making new lows below the 2008 low. Crude Oil, Copper, Global Stock Markets, Euro, Aussie Dollar, Gold, Silver, Wheat, Corn, Sugar, Heating Oil and many other assets would be joining in.

Eventually, Helicopter Ben will print more money and these bonds will reverse course once more as the Fed starts buying: creating a game of cat and mouse as Wall Street bankers front run the Fed for a nice profit on a long Treasury trade!

Stocks: Could Dow Jones Hit 1,000?

I was reading the recent newsletter of Robert Prechter from Elliot Wave International. The gentleman, like many other deflationists, thinks that the stock market is on a downward trajectory in nominal terms. Fair enough. However, here is the icing on the cake about Prechter's thoughts. He thinks that the Dow Jones is heading towards 500 points. Thats right, it's not a spelling mistake! Let me remind you that Dow Jones is currently trading at 10,856 points as I write this, therefore this type of a crash would be a 96% drop from the current price. Prechter thinks this will occur over the next several years.

Before one completely rules out this case scenario, calling it totally insane, I would like to say that Robert is a very gifted and skilled market technician, who has been right with his grand calls many times, on many different occasions. I have also been following him for a decent amount of time now and always enjoy reading his views. He is also a pure contrarian, so majority of the time his calls are far far away from the consensus and therefore right. You see, the more people think you are crazy and the more they disagree with you - the better your chance of being right. Nonetheless, his success is also mired by his failures at times as well, where his perma-bearish outlook constantly led him to try and short the stock market advance from March 2009 lows. He did eventually get his call right this July 2011, when he recommended to go short and obviously caught a market crash. A great call!

Even though I hold a huge amount of respect for Robert, I would have to say that if the Dow Jones was to crash by 96%, the world would most likely go completely bust and there would be a huge war. I am sure some clown will leave a comment that this is not "technically" right and give me the necessary facts to back his university thesis up. Whatever. Either way, at that point, you wouldn't even make any money shorting the stock market as there would be no stock exchange around to profit from.
Therefore, if you are ultra bearish, like Prechter, instead of predicting the stock markets decline into dark ages, you should stock up on Gold (probably not right now because we have 98% bulls according to DSI) and build yourself a bunker, which would be protected by trip mines, which work on a laser system similar to that of a bank vault. On top of that make sure you stock up on a AK 47 (those don't lock up in water or mud) and plenty of hand grenades, a massive machete and a German Shepard. If all hell breaks lose with the stock market, at least you will be protected!

Please Note: Keeping all these ultra bearish thoughts in your mind, please participate in this month survey on the right side of the blog menu and tell me where you think the Dow will be by 2016. Thank you!

Update: After a couple of days of voting, only one person thinks Prechter could be right. I did say he was a contrarian! Majority thought Dow will be making an all time new nominal high.

Sunday, August 21, 2011

Currencies: Bonds vs Gold... They Are Both In Euphoria!

I have to admit, I love the "Safety Crowd." In case you don't know what that means, it's a term I coined for those who interpret every single set of news as bearish, regardless of it being inflationary or deflationary. This group of investors is also known as perma-bearish. And since we are in this perma-bearish environment, thanks to the total economic collapse in 2008, the old argument between Bonds vs Stocks is not even alive anymore. It has morphed itself into Bonds vs Gold.

You see it goes something like this: if a news report comes out showing that US ISM has declined below 50 (contracting) and that the economy is slowing, half of the Safety Crowd will tell you that this is an inflationary event because the slower the economy, the more money printing the Federal Reserve will do and the more Gold you shall buy - because Gold is a safe haven, they claim.

On the other hand, the other half of the Safety Crowd will argue that this is a deflationary event because the slower economy will tend to collapse on its own two feet and the worst thing you can have in a recession is a high amount of debt (asset deflation occurs while debts remain at the same level). Under this scenario, they claim, Treasury Bonds is the ultimate place to park your money, as they are a safe haven.

There is so much fear around since the end of 2007, that the Safety Crowd has on a consistent basis just recommended to buy Gold or Treasuries over and over and over again. They claim that these asset classes will preserve your capital and that when 2008 repeats, you are going to benefit from the risk off scenario.

Lets consider both...

In my own opinion, buying Gold right now would be extremely foolish and totally defeating the purpose of wisdom which states to "buy low, sell high". The sentiment for this asset as measured by ETF fund flows for SPDR GLD is now at the highest ever monthly inflows. Listen to that again.... highest ever monthly inflows. That means dumb money is doing exactly that... following the Safety Crowds advice. This trade has become so obvious to the public, which are scared out of their own minds, that it is obviously wrong.Furthermore, the Gold bull market has now been in progress for over 1000 days without even touching the 200 day moving average once. I admit my warnings have been a tad early, as I have already posted about this as early as late July, but in all honesty that was only three weeks ago. I guess majority of investors today are actually traders, who only use intra day charts, so gone are the days of actually buying something and riding out the trend. Either way, previous warnings can be read here, here and here.

And while Gold remains in a secular bull market and profoundly has good fundamentals behind it for several years to come, Treasury Bonds actually do not. They are even worse out of the two, because the Safety Crowd forgot to tell you that during recessions, tax revenues decline and therefore deficits will go through the roof. I do not know how they missed that, but it is similar to the Goldilocks Crowd in 2007, which forgot to tell you that Financial Sector was actually not cheap.

So what happens to the United States budget during a recession, which the perma-deflation Safety Crowd claims will be good for Treasuries?

You see during negative economic growth, company earnings as well as profits fall and jobs are cut. That means tax revenues decline. The Treasury will therefore have to issue new bonds at a very rapid speed to finance the deficit budget, which was already at over 4 trillion dollars last year (including hidden liabilities).
The fresh issues of new Treasuries will devalue the credit quality of the actual existing bonds (not that it has any credibility with the country being bust already). Therefore, the Treasury Bond will actually be close to reassembling a Junk Bond to a certain degree. Having said all that, an investor should also consider that optimism is so high on the Treasuries right now, that the asset class is actually setting itself up for a short of the decade!

Summary: My advice to investors with a six month to a few year time horizon looking at buying something during this turmoil is to stay away from the recommendations of the Safety Crowd perma-bears... stay away as far as possible. You must understand that these investments will not only lose you money, but also lose you sleep over the coming months. If I was to buy anything right now, it would actually be agricultural commodities or commodity related stocks that are linked to fertiliser.
Furthermore, as a side note, I would also look at buying energy commodities or commodity related stocks that are linked to Oil drilling. You see my view is that if Crude Oil declines below $75 per barrel, drilling will automatically stop and you can forget about the ability to actually find Oil at any price in the future! With the continuos increase in demand from Emerging Market economies, supply will just fail to keep pace, making Crude Oil price go much much higher. Higher than both you and I can imagine.

Chart Of The Day: Australian Mining Boom

Commodity prices continue to boom as the secular commodity bull market remains the main trend for several years to come...
... and with it mining investment in Australia. Unlike other Western developed economies which main relay on paper shuffling (financial sector), Australia also benefits from raw materials and commodity driven investments.
This is evident from the Terms of Trade, which is at a multi-century record highs and should continue at least for several years to come...
... while its good to see the Australian consumer benefiting from this investment, by de-leveraging and increasing their savings rates to over 13% per annum.

Unlike US or Eurozone economies, which are experiencing stagnation due to retrenching consumer spending, Australian GDP continues to outperform due to the benefit of raw material price increases. The secular commodity bull market trend still has legs for years to come, with prices of agriculture, energy and metals going higher from here due to one basic rule: demand and supply!

Saturday, August 20, 2011

Quote Of The Day

"It’s a suicidal investment to own 10 Year or 30 Year U.S. Treasuries. U.S. government bonds are junk bonds. As long as they can print, they can pay the interest. Another way to default is to pay the interest and principal in depreciating currency." ~ Marc Faber

Friday, August 19, 2011

Quote Of The Day

"In bull markets... who needs analysts? And bear markets... who needs stocks?" ~ Leon Cooperman, Omega Advisors

Stocks: Euro Banks Beaten Down

On Wednesday, The Investment Company Institute (ICI) estimated the outflows totaled $40.29 billion, the sharpest outflow since a $59.63 billion decline in October 2008. The latest outflows were led by funds invested in U.S. and foreign equities totalling over $30 billion. This figure is completely insane, considering that the S&P 500 was trading at around 850 during October 2008 and currently its at 1140. If we actually add up last four weeks of outflows, we get a figure that is close to $60 billion! It seems that majority are fleeing into cash or bonds. Bond funds have actually been huge winners, adding $75 billion in deposits this year, according to ICI. Confidence in the stock market is despairing, and with it the retail investor crowd. Apparently a good reason for selling out right now is that the Euro banks are finished and this is Lehman II!

Or at least CNBC and Bloomberg were very busy telling you this all day yesterday, even though we haven't even made a new low just yet. The media seems to be spreading fear faster than a winter flu. I cannot recall how many times news anchors mentioned that this could be a repeat of 2008. I guess we are a product of our recent experiences throughout life and the nightmare memorises of 2008 are still alive and well in all of us. It seems that the investment community, and especially retail investors, are scared to death of even hearing that there is a possibility that 2008 is going to repeat all over again.

And what do we make of those European banks that have been taken to the slaughter house in recent months? You got these media "intellectuals" telling you it would be totally insane and absurd to buy these assets. As a matter of fact some of them are even suggesting ideas on how to short them.

Now... I'm not bullish on Financial Sector at all. But after such an incredible fall and a massive spike in the VIX, you'd think we were very close to some type of a wash out. Why the hell would you bother shorting banks right now as so many pundits recommended last night on CNBC? We got an outright panic here, which usually signals the end of the collapse and even possibly some type of a rally for a few months. You'd think this would be completely obvious... but hey what would I know.

You are better off listening to CNBC, buying some bonds and selling your stocks right now, if you want to make a lot of money! *rolls eyes*