10/9/06 - Interest Rate Assumptions
The stock market is obviously trying its best to spin Goldilocks into something tangible and enduring. The hot sectors of the recent past, namely energy, precious metals, general commodities and housing, have been taken down hard (and right on cue I might add) in the face of Fed tightening, which has supported the US Dollar, which in turn was absolutely vital. But among the debris, there stands "Dow all-time highs!!!" which I have been giving weight to as a possibility all along, although it was not a part of the "script" for this to happen concurrent with major commodity corrections. The script called for nearly all markets to decline pretty much in unison, except for the bond market, which would make a strong pretense toward bullishness, thus alleviating "fears" of inflation and laying the groundwork for continued inflationary policy.
But a funny thing happened along the way to a well choreographed "deflation scare"; the stock market, carrying the hopes, dreams and assumptions of millions, has carried on higher. Some gold bugs may feel the Fed has them in its gun sights and its evil henchmen, "da boyz" are carrying out the decimation of "honest money" so it will not shine the light of truth on the monetary games where credit creation runs amok and indeed becomes the economy. But I think there is something much less dramatic at play here; a mini-bubble is being inflated in the stock market that we may call a safe haven or refuge bubble. In a global casino, the participants are not aware of exit signs, they only see the next "play". Risk management is all but bred out of them. The slots have run cold? A small cluster of highly visible patrons migrate over to the black jack table. The herd eventually takes note and you know the result. The stock market is the black jack table.
Now, enough with the metaphor. This is more serious than finding the next hot game. Philly Fed chief Charles Plosser's views on inflation were noted on the blog last week as were my remarks about same. To this point, I have discounted Fed officials as merely playing their respective roles in the "deflation scare" script; jaw boning inflation while having every intention to ease policy, which would have the ultimate effect of you guessed it, inflation. But with the stock market, jobs/wages and even commercial real estate still in expansionary mode, it is apparent that market casino patrons are trying to hide out in still-hot games. Fed heads like Mr. Plosser see them and want them figuratively executed so that the Fed may finally stand down. Last week the bond market made a strong, impulsive move toward higher rates, challenging the assumptions of the bond herd with a hard slap in the face. Ten year yields are near resistance and have not broken the recent downtrend, but this bears watching, as does the ratio of long rates to 3 mo. T-Bills (yield spread) which is also trying to turn up amid bullish divergence.
Conclusion: While I have speculated on the possibility of a new stock bubble, considering the trepidation of certain Fed members along with herds of convention-minded bond investors fully buying in to the slowing economy (and by extension, inflation) story, along with "Dow all-time high!" headlines that may be at least moderating the public's bearishness on the stock market, and considering the technical setup of the precious metals and commodity universe, I would not be surprised to see a reversal over the coming weeks of assumption-based market trends that have held sway since mid-summer. Also note the charts of the VIX and VXN we have presented over recent weeks; they are not bullish. I do not discount a new stock bubble, but have remained firm that a correction of some substantial degree is needed first, during which Goldilocks is caught red handed with the baby bear's porridge, the yield spread bottoms and turns up, gold ends a multi-month (and healthy) correction and the stock market gives back recent gains as we find out that embedded and systemic inflation is not so easily eradicated. Relevent ETF symbols to this commentary are GLD, USO, DIA, SPY and QQQQ, along with bond funds TLT, IEF and SHY. Good luck whether your bias is long, short or sidelines.
10/6/06 - VIX Daily & Weekly
I began working at 5:30 this morning on today's entry; a look at George Linday's 3 Peaks and a Domed House. The result of 2 hours of work was the whole thing getting thrown in the virtual trash can when ultimately I could not correlate the Domed House to today's Dow. In its place, and given the amping up of stock bubble chatter, I present a couple pictures of the VIX in real time. I will let you draw your own conclusions as to what this may mean in the near term.
10/5/06 - Risk Vs. Reward
To make money as a trader or investor on a consistent basis, through ever-changing cycles and market environments, it is critical that we develop the ability to step outside the noise of the moment and gain big picture perspective. Boy is there a lot of noise at this moment! My main areas of interest, the gold/precious metals, commodities and the broad stock market are all at varying points in their risk/reward profiles. Since this Letter is designed as an ongoing, real time chronicle of markets, I will not post an extensive in-depth analysis of the current state of these three investment areas. Rather, I will summarize where I think each one is amidst the noise of the moment.
Gold/Precious Metals: We are searching for a bottom and as difficult as it feels for an investor to buy while being negatively reinforced through painful correction activity, those who wisely avoided chasing rallies and kept cash for buying on hard down days, will eventually be rewarded for their foresight with out-performance gains. I cannot say for sure whether yesterday, which felt like it included some capitulation activity in the sector (would-be Gold bugs or "inflation trade bulls" getting out at all costs) is the ultimate bottom for this correction. But buying in the depths of such days (I added Goldcorp and a couple smaller miners near the lows) should ultimately prove worth the risk involved. The correction is now nearly 5 months old and yesterday got within spitting distance of my target near 260 on the HUI. Note that I do not "go all in" but rather I am slowly accumulating and plan to have cash on hand in the event of Huey 260 and XAU 115. With the gold indices this close to our targets and the "Goldiocks scenario" becoming somewhat mature in the investing public's consciousness, I believe it is time to be looking for real value. Risk/Reward Profile: Excellent in near, intermediate and long term.
Commodities: I believe commodity markets may be setting up for at least a major bounce. For reference, see a chart of the CRB, which yesterday dipped to a new low below 293 (near our long-standing target of 290) before reversing upward to close above the previous day's close. Being one of those who discriminates between gold and general commodities, and given the current monetary backdrop and technical evidence in the bond market and economy, I cannot go long term bullish on commodities at this time. At the least, if the once and future "Helicopter Ben" fulfills his destiny and finds a way to inflate to beat the band, gold should be out ahead of silver as well as the general commodity pack. In other words, there would be time to accumulate commodities for the longer term based on signals that the "monetary metal" gives. Risk/Reward Profile: Good near term, neutral intermediate term and good in the long term.
Stock Market: What can I say? I own a grand total of ZERO bull stocks at this time. Herds of momo's, savvy traders, naive traders and heartfelt investors can ride this train. As I spotted this rally (beginning with the SOX downtrend break in August) and proceeded to absolutely NOT take advantage of it, the theme was that the market seemed to be running out of short-term bearish fuel to the downside. To be specific, the one indicator that "creeped me out" was the public bearishness and distrust of the market. Now, I do not count that as a major fundamental underpinning by any means, but FrankenMarket has spun a slowing economy and incorporated the public's bearishness, the shorts' gall (and attendant short-covering), the now prominent Goldilocks story, the old "wall of worry" chestnut, the election / manipulation hysteria and any other noisy idea it could get its hands on and rampaged higher. You don't argue with this type of activity. Many tried in 1999 and did not have the staying power to reach the ultimate peak and ride the whole mess to shorts' heaven. As a side note, the idea of "Dow 12K, 13K, heck why not 30K?" that I have noted over the last two years is bullish for stock prices, but that is about all it is bullish for. Either the broad market is the last holdout for bullish hope/denial/desperation and is about to follow the deflationist script into collapse or it is a harbinger of liquidity to come from the massive bond market and Bernanke's Fed telling us to look over here while warming up the choppers over there. Risk/Reward Profile: Near term highly unfavorable, intermediate neutral and long term undetermined/uncommitted.
10/4/06 - Dow/Gold Ratio, etc.
I do not want to beat a dead horse and in fact, when gold was pressing the 700's and the Dow was well contained in its ongoing bear market (in inflation-adjusted terms), I was noticeably quiet with regard to a pro-gold or anti-stock stance. So, all the writing about the gold sector lately is simply a manifestation of my perception of opportunity on the horizon.
As stated at the top of this page, the plan is for this letter to go subscription. But the markets have provided an opportunity in this regard as well. This is the reader's opportunity to watch a letter writer, in real time, working through one of the most challenging and exciting market and macroeconomic phases in his career. My portfolio still well-outperforms all major markets to this day (2006 YTD), but what good is that if my macro "assumptions" are not correct? "What have ya done for me lately?" might ask the reader. Good point! So I have decided to delay the launch of paid access until my main assumptions, my main beliefs and fundamental ideas are proven right. I love a challenge and for weeks now the markets, not necessarily unexpectedly, are moving against my core principles. If proven wrong and debt paper reigns supreme, I will likely take down this Letter, make adjustments as needed and keep the Biiwii website moving forward - free of charge. If I am proven right in my assumptions and fundamentals, you shall hear about it!
Anybody can make money and look smart when things are going their way. We are currently in a multi-month process of hunkering down in a deep cave of corrective activity to our investment stance. When we come out of the cave and again see the sunlight, I expect my patience to be rewarded. And I expect you will have had a good chance to evaluate this letter as it moves through the toughest of market environments. Let's see what the future holds. In the meantime, here is a monthly view of what I consider a crucial chart, the Dow-Gold Ratio. Stocks bullish in real terms? Nope, not yet.
10/3/06 - Quick Snapshot of a Few Markets
We used the SOX index as a leading indicator for the current rally in stocks and see no reason not to use it when looking for signs of reversal. CRB approaches our initial target near 290. The dollar remains firm and continues to "hang around" but has very strong resistance in the low 90's. Gold, meanwhile, is apparently intact and deciding whether to break up or down. Do not discount a shake-out move below 550 as real bull markets tend to shake off the fleas before moving higher.
10/2/06 - New Stock Market Bubble?
The new stock bubble theory is picking up steam. Here is an article by the Contrary Investor that is open to the possibility. In fact, the last paragraph sounds like it could have been written by this writer:
"Again, this discussion is not about fortune telling as it applies to the financial markets. It's about being aware of and accepting of historical seasonal tendencies and longer term equity market cycles that may indeed have meaning for what lies directly in front of us. It's about maintaining balance and flexibility."
One by one, respectable analysts I follow are coming on board to the idea of a bubble or at least an upside blow-off in stocks. For now I will take this as a necessary development in the market's effort to get as many people on the wrong side of the trade (long) as possible. But in a global-macroeconomic environment that has become a three ring circus of assets performing daring and breathtaking acts, we should not discount the idea of a great new stock bubble that climbs a "wall of worry" to dazzling hights, conveniently assuaging the investing public's fears about all that is wrong with a system where assets rise and economies grow because of global currency inflation and debt accumulation instead of real productivity. Yes, China is in some ways a model of ascending productivity, but insofar as it remains dependant on the the US' credit creation machine, it is vulnerable. The same goes for most of the rest of the industrialized world.
Here in the US, we are a "feel-good" nation not used to wallowing in the depths of the problems experienced routinely by much of the rest of the world. This has allowed the US to continue clinging to its debt for consumption raison d'être even as the consumer's supposed last liquidity umbilical cord is cut (housing ATM). Wouldn't a brand spanking new bubble in equities work wonders as scared, abundant and hot money panics into yet another asset class? This has become all about momentum and getting to the next hot play before the herd thunders in. It is why I call this a casino. It is advised to take care of real financial preparations and real life before you speculate in this circus. Then remain grounded and aware of all possibilities.
I expect Q4 to be supremely interesting and I also expect my portfolio to become more interesting, asset and hopefully performance-wise than it was in Q3, where surviving Goldilocks became my main priority. I will update the portfolio's composition as it materially changes. Good luck to all as we enter the witching season with contrarians getting contrary themselves, myths and stories being cemented and perceptions in flux.
At this point, the market looks ready to at least take a breather. At most, the VIX will break up from the wedge and reign havoc down on complacent bulls. But where would that impulse come from? At this time, I would have to conclude that absent any fundamentally earth shaking news, this is a market that wants to go higher as seemingly silly as that sounds.
Relevant ETF symbols include SPY, DIA and QQQQ for tracking and participating in the US stock market's fortunes, whether long or short.
10/1/06 - Manipulation?
Michael Nystrom of BullNotBull, a straight shooter whom I consider a virtual friend has just written a short piece called Manipulation. In it he shows the cover that Newsweek readers (Oct. 2nd issue) in Europe, Asia and Latin America saw titled "Losing Afghanistan" with a picture of a determined looking, Talibanesque man toting an RPG launcher while readers in the US are treated to a cover on the same date detailing Annie Leibovitz' "Life in Pictures". Huh? He then goes on to extrapolate these synergistic keeping up of "appearances" to the decline in the price of oil and the steady march upward of FrankenMarket (check out that video on the front page of this website - if you can't laugh at this stuff you very well may cry) in the run-up to the elections.
I am torn. On the one hand the charts are intact and things seem to be making sense as long as these hope and denial driven rising wedges resolve to the downside and provide a good lesson to greedy, lazy bulls that it just ain't that easy. On the other hand I see the herds driving the bond market higher on the conventional wisdom that the economy, driven by a real estate meltdown in the making, will decelerate markedly and contain inflation (we call this crack pipe thinking, don't we?). At the same time if the S&P drops 5 points it seems that some entity feels a desperate need to swoop in and buy with both hands. What a bargain! My scope here is to get the markets right. It is not to worry about manipulation (yes, I think it exists) because as I have written for years, I believe the whole mess is devoid of intrinsic value in an age where the debt for consumption ethic dwarfs the stodgy idea that productivity actually matters. So the question for me remains "how long can this entire game keep up appearances?", not whether it is valid or not. If indeed the markets are keeping up appearances, the average American may not even be falling for it. My aunt, a successful business person who is not known for harboring the alternative economic views of this writer is downright freaked out about two things; the Dow's approach of all-time highs at this time when it "should" be going down and something Bob Woodward wrote implying that things are coming apart at the seams, from what I gathered in talking to her.
I am bothered by the dropping of M3 statistics from the public record and often I think things like "how are these guys getting the juice into FrankenMarket without gold and commodities knowing about it?" but then I look at my Dow-Gold ratio chart and see that stocks have been absolutely bludgeoned for years when measured in gold during their supposed bull market (in nominal dollars) and were due for a relief rally. I see Goldilocks and a lot of business as usual on Wall St. I also see a bearish public, which truthfully gave me the creeps and kept me far away from any major short stance. Since the day (a much more innocent day of my youth) I and a couple friends allowed ourselves to be scammed by some two-bit boiler room operation (hello Ida, may you...) I have realized that what we call "Wall St." includes some pretty unsavory characters. What I only began to realize in the last few years is the depth to which the entire financial services industry is compromised by a combination of overly conventional thinking, ignorance and in some cases, misdirected priorities. I see a lot more stupidity and laziness than pure evil, but in the final analysis none of those is a good prescription for people who want to maximize their capital as safely and sensibly as possible.
So yes, Biiwii being Biiwii, we allow for the likelihood that manip is present and accounted for. We also see the massive, plodding financial services industry and the huge and frenetic hedge fund universe out there gaming. "Hey batter batter, he's no batter.............SWING BATTER!!". Everybody's in the game and truth be told, I am beyond worrying about whether the game is rigged; it is. I am here to use the game to my advantage while it exists. Manipulation or no.
Have a swell week.