Sand Castles: Part Two

By: John Mackenzie | Mon, Apr 18, 2005
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A few years back in an USA Today interview, Warren Buffet was asked his opinion of the "Buy & Hold" strategy for the average stock market investor. He stated that in plain English it was an absurd concept and went on to name a lengthy list of companies, household brands, whose stock prices had collapsed two decades ago and had not recovered. Some had simply gone out of business.

His warning to those proponents of "Buy & Hold" investors: "If you want to buy and hold stocks, you had better have a buy & hold portfolio." Simply put, he suggested that unless you had real "Value" to begin with, the probability of time making your portfolio whole was low at best.

A "narrow market" means that an entire stock market was being held aloft by a small and disproportionate basket of companies that eventually reached absurd levels of "price" valuation. Many, in fact, lost in excess of 95% of their peak price levels. Warren Buffet buys and holds Companies, not shares. His message is clear, own quality and be prepared to hold it for the long haul.

We have recommended owning the Precious Metals first for years. We believe you "Buy and Hold" Gold and Silver. They represent Honest Money, True Wealth and absolute preservation of Capital.

If we examine the forensic evidence to support Buffet's thesis we see the HUI certainly has fit the "Trade for Position" thesis we have maintained for years.

Figure 001: HUI Trailing Six Months Daily Chart

A 20.49% drop in four weeks and a 27.2% drop since the November 2004 high has left many a Gold Bull feeling somewhat queasy. Fear appears to be entering the sector and with just cause as "Buy the Dip" has been an abject failure. We marry ourselves to the Metal and trade the shares in order to purchase more Metals. It is a strategy we have recommended for years. The most recent divergence between Share and Metals Price illustrates all too clearly the axiom's weight.

Further, if one compares the "Trade for Position" strategy vs. the "Buy and Hold" mantra, it is again quite clear that those who are willing to entertain taking ownership of their capital can and will outperform the "Buy and Hold" herd. Short, Intermediate and Longer Term Lines provide ample cause and effect for those willing to study the Markets and accept the simple fact, manipulation is a constant.

We refer to this interventionist Din as the "Game" and we attempt to "Play the Game." It truly is an "All or Nothing" wager the Federal Reserve has placed us squarely in the center.

Depending upon your tax bracket the Differentials between Short and Long Term Capital Gains Illustrate the importance of Market timing with respect to the Precious Metals Sector; this Sector has been volatile and will likely to continue to remain as such for years to come.

Tax Bracket @ 15%
Short Term Capital Gains Rate 15%
Long Term Capital Gains Rate 10%
Differential ~ 5%

Tax Bracket @ 28%
Short Term Capital Gains Rate 28%
Long Term Capital Gains Rate 20%
Differential ~ 8%

Tax Bracket @ 31%
Short Term Capital Gains Rate 31%
Long Term Capital Gains Rate 20%
Differential ~ 11%

Tax Bracket @ 36%
Short Term Capital Gains Rate 36%
Long Term Capital Gains Rate 20%
Differential ~ 16%

Tax Bracket @ 39.6%
Short Term Capital Gains Rate 39.6%
Long Term Capital Gains Rate 20%
Differential ~ 19.6%

The above Differentials support the "Trade for Position" thesis. If we assume both the average and median to be 11% (from the 31% bracket) we observe the potential for a Capital Preservation at 9.49% (four week drop in HUI) and 16.2% (drop since the November 2004 high in the HUI). This of course assumes one is holding for the Short Term Gains. The Argument for "Buy and Hold" all but evaporates were one to have sold the interim highs and repositioned now with a Position Period beyond one year.

We may well have not seen the lows, so the potential gains would simply continue to compound.

It should be noted that the vast majority of "Day Traders" lose. Only a decidedly small portion ever come out on top, but again, this is not what our "Positioning" thesis suggests. Instead it requires understanding of both the Fundamental and Technical Landscapes to purchase for the greatest potential gains. Day trading is essentially a Zero Sum Game.

So how are we positioning for the present opportunities?

Let's review the landscape and see where the opportunities lie.

The Outgoing Tide

Monetary Mystic and Maestro of Malfeasance, Alan Greenspan has played the most recent series of dislocations rather well. Astoundingly so, he, in my opinion, remains deserving of a Gran Tier seat in Hades; but that is for another essay and I'm quite certain there will be many to arise in the years ahead after it becomes widely acknowledged the "Maestro" was nothing corrupted by the his Political ambitions. Bob Woodward may well need to consider a follow on that outlines the clear and present dangers in which Alan Greenspan has lead this Nation. The Moral Hazards created under the auspices of the Greenspan Federal Reserve are unparalleled in History.

Precious Metals Bulls, take heart, paper shares are merely a trade, a hedge in the Short to intermediate Term, before uncertainty unfolds.

This is precisely why; we have remained congruent with respect to GOLD and SILVER: "Own the Metals first." Nothing suits Precious Metals more than uncertainty. CONfidence lost is certainty gained; five thousand years of History remain entirely congruent in this simple exercise. GOLD and SILVER are money, they are sound, honest and remain Debt free.

The paper shares, at some point in the not too distant future will go up in flames as well; they are merely a leveraged play in the Metals. The opportunity to position in the shares after we complete this most recent, forced trend reversal will provide an enormous potential for Capital Gains.

This most recent attack was perfectly orchestrated. Those who recognized the assault in advance moved aside and now have the ability to repurchase shares at much lower price levels, thereby gaining in terms of both positions for entry as well as being able to purchase more shares.

We trade for position, and seek to make the greatest returns when we Buy and collect when we Sell.

Financial leverage (Interest Rates) cannot be used to simmer the speculative excess, an excess Chairman Greenspan has allowed with poor Monetary Policies and further, horrific strategy. The Federal Reserve is approaching the end of their rope. They will likely raise nominal rates one additional time to their stated target of 3%. I doubt they will go any further unless forced by the Markets. They are cowards and know the damage done has been extraordinary. The most recent series of rate Hikes off Historic Lows has served to force contraction in the speculative arenas.

Housing is taking it on the chin; there are clear builds in Inventory. Housing Starts are contracting and the Price of Homes is on the decline in major markets. This after the most egregious series of disinformation in the History of the Federal Reserve with respect to the Health of the United States Economy... And when cowards are cornered, they'll attempt the insane... Alan Greenspan, once the greatest voice for Gold, projecting THE Anti Statist stance, has fallen victim to the Machine he so despised.

Sad and pathetic, the cognitive beauty of "Gold and Economic Freedom" has given up the ghost for a decidedly Evil Force, his monetary masters. Debt is the most insidious form of slavery ever propagated upon the masses.

Onto the coward's game afoot...

A mini bubble in Crude Oil has been allowed to form when Monetary Policy is teetering on abject failure; the Fed has chosen to employ farcical games in Commodities.

There is little doubt "Peak Oil" is approaching, but with economic contraction on a Global Scale comes a reduced demand for Energy inputs, including Crude Oil. This may prove to be a very short run adjustment in Crude Oil, but it will have a decided impact upon speculators who have chosen to enter the arena.

JP Morgan's Energy Reports confirmed, inventory builds and waning demand. This most recent rise in Crude was pure orchestration, a speculative bubble fostered as phantom Monetary Policy for cowards too lost in space to meet their malfeasance head on.

For the Fed, the best part was they accomplished a twofer:

Bonds received the inflows they needed in order for rates come back down while Broad Equities Markets began a massive sell down of inventory no one seemed to want given the present Economic Landscape. In addition, remarkably, the Dollar gained strength. There is little doubt the Federal Reserve is using the $1.25 Trillion short position as fodder for the Dollars orchestrated rise.

How many blowups are the Broad Markets willing to tolerate... AIG, GM and F represent more warning shots. They appear to have been heeded by the investing public at large. Inflows are down markedly and all the wrong people appear to be holding the bag; namely Federal Reserve Chairman Alan Greenspan's shareholders: direct and indirect. The most recent TIC report was astoundingly barren. The degree of "NO SHOWS" was apparent. Few, if any want our Treasury Debt. By example, China's participation was miniscule. Compare their recent trade surplus with UST purchases and them investing only 2% back into UST's of any duration. This is down from 2004's rate of reinvestment, twenty fold.

All the while the demand for Physical Gold and Silver around the Globe continues to compound dramatically and Commodities have not seen dramatically lower prices, they have certainly adjusted, but the race for resources appears to be in full swing, upsetting the Fed's apple cart. They prefer to corner inflows and direct them into Bonds and away from real resources, they have fostered a Financial economy after all, one whereby modern day "Robber Barons" steal from us in many forms.

We are in deep, deep trouble.

Owning both GOLD and SILVER is the most intelligent hedge against disaster. CONfidence in the Powers that Be will continue to wane. Precious Metals will, once again, assume an important role. It is paramount that those seeking capital preservation own both GOLD and SILVER in physical form and take delivery do not wait, do not hesitate to do so. Do it NOW. Secure you capital, as much as you fell comfortable owning. It is life insurance at this juncture.

Mining equities are in no way the same as taking delivery of the physical metals. They remain priced in Fiat Currency, namely Dollars. They should provide a hedge against a Hyperinflationary environment in the Short to intermediate term, but it's difficult to project that lasting through a systemic failure of the Global Financial System.

We began issuing clear warnings as to this most recent attack in the Mining Sector several months ago suggesting the 170 - 188 range would come back into play as a potential first stop for the decline projected.:

On January 18th 2005:

"We have cleanly breached the 50 and appear to be heading towards the 100 @ 194.42 (green line). The 200 SMA resides at 144.44 (blue line). A retracement schedule between the 50 & 200 holds open the following targets: 185.67, 177.80 & 169.92 as potential pivot nodes for the massive reversal we have been stalking for a month now."

And again on February 2nd and the 9th:

"The Mining Equities have behaved as expected, hanging on to their respective trading ranges.

A break is certainly near, which direction will set the tone for a few days to weeks, and then we will need to observe the follow through.

The potential for a break below 200 on the HUI remains wide open..."

"Ideally, we need to see an additional thrust downward, to the 168/70, 182/185 & 190/194 levels to complete this consolidation. We will see how it plays out shortly. My Senticators are mixed at this point in time...so, playing the break will be our position for the coming week ahead."

It took time to develop, but the game afoot has unfolded as we expected.

Now is the time to focus upon the opportunity presented.

The Chart below is from M2 on February 9, 2005, it remains our preferred range for the HUI.

Figure 002: HUI Point & Figure Buy Zone target

A breach of the above range could land the HUI in the 150s - 170s range and possibly lower, but the risk/reward would be entry within this strata. We need to keep a close eye on 170.61 level now as the above chart is several months old at this point.

A failure of 170.61 would open a quick, sharp drop that could drive the HUI down to as low as 150/154 and a lower degree of probability remains in the 125/127 area. It is simply to early to tell, and any event could change the forensics above very quickly. We believe the 168/170 will provide solid entry and any drive lower will not be around very long.

We favor an event driven bottom, one that likely arrives in early to mid May and suspect the bottom formation will resemble a continuation for the present trend followed by a sharp reversal and then one additional sharp drop to an even lower low.

That would be what our projected bottom looks like, prior to an incredible run in Precious Metals and their paper derivatives, the Metals Shares.

It should be noted the above ramblings are an opinion, one of many. It is best to observe a diverse environment of analysis and make your own decision; it is after all, your money. Anything can and will happen and no one individual knows the future. We may merely speculate on the potential outcomes and assign probabilities to them. In the end some are better than others, but no one ever knows in absolute terms.

Were we to see a broad systemic collapse of the interconnected Global Financial System... the paper mining equities would not fare well in our opinion. The metals as well as productive resources would be the best places to be. Ending up a nation of "Sharecroppers" as Warren Buffet recently suggested would be tragic, but it appears to be precisely where we are headed.

We happen to believe the Federal Reserve is close to a "Panic" of their own doings and ultimately this will be very bullish for mining equities. As we begin to gain greater clarity in the days and weeks ahead, we will share our observations publicly.

We will begin to ladder in, 10, 20, 30 & 40% of our total position on this decline and will not worry about the lower low on the back test; it will likely be over before it's barely begun.

If it all goes south in a giant financial cyclone, it's not going to matter much anyway.

Own the metals first.


 

Author: John Mackenzie

John Mackenzie

John Mackenzie manages private capital.

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