Practical Investment Commentary - No Hype

Okay, I may be exaggerating a bit with that title, but what else can you think when you read that the Treasury will Auction $104 billion in debt next week, an all time record? I guess with the national debt in the U.S. increasing by $3.8 billion per day, we shouldn’t be surprised that the feds want to raise another 27 days worth of spending money, but sheesh, that’s a lot of money, isn’t it?

I wonder if that’s why the U.S. dollar has been getting hammered recently?

It’s no surprise that countries like China and Russia are getting out of U.S. dollars, since there is no point in investing in a depreciating asset. If I held billions in U.S. dollars I’d be following the same strategy: say some nice things about the U.S., while in the background I’d be liquidating as much as the market can bear. I would use my U.S. dollars to buy hard assets, like companies, real estate, gold, or whatever else I could get my hands on.

Speaking of gold companies, if I had to pick one area to put my money in, that would be it. But not immediately.

Back on June 6 I explained My Conundrum, and I said that while I expect gold to perform very well in the long term, I also expect the traditional summer weakness to set in. I therefore positioned myself with 80% cash, and 20% in senior gold and silver stocks. I didn’t sell everything, because in these volatile times a sudden unexpected event could send gold soaring, and I want to be protected. For added insurance, I sold calls against the gold and silver stocks I owned.

Exactly as expected, in the last two weeks every one of those gold and silver stocks fell. Since I sold at or in the money call options, when the stocks fell the options lost their value, and today they all expired worthless. I therefore get to keep the premiums on all of the calls, which reduces my losses on the stocks.

Yes, I could have simply sold the stocks and then I would have no losses, but long term I will be buying these stocks, and I can’t pick the bottom, so this middle of the road strategy made perfect sense.

What next?

Strategy #2: Stair step stink bids

I’m not sure if that’s a real term or not, but here’s how it works, using AEM.TO - Agnico-Eagle Mines Ltd. as an example.

Agnico-Eagle closed on Friday at $59.98. In the last year it’s been as high as $78.79 (on July 14, 2008), and as low as $27.50 (on October 27, 2008). As an aside, that means that last year, from the summer peak to the fall crash, Agnico-Eagle lost 65% of it’s value. Of course that also means that from the bottom until today AEM has more than doubled in value. That’s volatility.

I therefore plan to put stink bids in at steps along the way. For example, I could put stink bids in at $28, $35, $45 and $55. Let’s say I want to own 1,000 shares (to keep the math simple), and I already own 200 shares (since I’m 20% invested). I look in my crystal ball and I see a down draft happening this summer, just like last summer, so I place my bids as follows:

• $55 - 100 shares
• $45 - 200 shares
• $35 - 300 shares
• $28 - 200 shares

If the price crashes to last October’s lows, I end up owning the 1,000 shares I want. Obviously I fully expect a drop below $55, so I’m only buying 100 shares at the $55 level, just in case I’m wrong. I’m happy to own them at $45, and at $35 it’s a great buy, so I’ll buy even more shares at that level. If another crash happens, I get even more shares at a bargain price.

What if I’m wrong and the share price starts going up on Monday, and never looks back? I guess I won’t buy any shares, but I don’t think that’s likely to happen.

There are of course two other strategies I could employ to build my portfolio.

Strategy #2: Covered Calls

I could repeat what I did in June: By the stocks, and then do covered writes against them. Again, assuming I own 200 shares of AEM that are currently trading at about $60, I could sell 2 contracts for the July 60 call option at $3.15 (you can get full quotes on Canadian options here). If AEM increases between now and July 17, I am forced to sell my shares at $60, but I pocket the $3.15 premium, so in effect I have sold my shares at $63.15, a 5% profit in less than a month. If they stay flat or fall, I have lowered my cost basis by $3.15, which gives me cash to buy more shares at an even lower price in July.

As an aside, as Peter518 pointed out on the Forum, a better strategy is to sell the options on the U.S. markets (for interlisted stocks), since the premiums are lower and the volume is higher, making for tighter spreads and faster executions. That’s true, and if I lived in the U.S. that’s what I’d be doing. However, as a Canadian, and given my negative outlook on the U.S. dollar, I prefer to limit my currency risk by staying with the Canadian options.

Strategy #3: Sell Puts

The final strategy, if I expect the price to drop, would be to sell puts. A call option gives me the right, but not the obligation, to buy a stock at a set price before a set date. A put is the opposite; I can sell a stock at a set price before a set date. If I sell the put or the call, it’s the opposite.

So, I could sell a put option, and if I’m wrong I’m forced to buy the stock. Let’s try an example:

I want to buy AEM.TO - Agnico-Eagle Mines Ltd. at $56. Today it’s at $60, so I sell a July 56 put for $1.65. If the price of AEM is below $56 on July 17 when the option expires, the holder of the option will “put” the stock to me, and I will have to buy it from them for $56. That’s fine, because I was going to place a stink bid at $56 anyway. (Actually I wanted to place a stink bid at $55, but these options trade in $2 increments). I pay the $56, but I already had $1.65 in my pocket, so it really only cost me $54.35.

If AEM goes up, the puts expire worthless and I keep the premium. If AEM crashes I shouldn’t have sold the puts in the first place, since I could now buy the stock for even less, but if I was going to place stink bids anyway, there’s no difference; that’s what I would have paid, with our without the puts.

The only problem with the put strategy is that there are margin requirements. You need some cash, or stock, in your account before you can start selling naked puts, so if I only own 200 shares, I can’t sell puts for 800 shares, unless I have the cash or other security to back up the potential loss.

Which strategy is better?

I’m not sure yet. I’ll do some number crunching and decide. On the surface, it would appear that taking in $3.15 on a covered call, at the money, is better than taking in $1.65 on a put that’s $4 out of the money. But, it depends on the price of the stock at options expiry.

If AEM is $56 on July 17 and I sold calls, my call options are worthless, so I make $3.15, and I own a stock worth $56.

If AEM is $56 on July 17 and I sold puts, the put options are in the money, and I’m required to pay $56 to buy the stock, so I own a stock worth $56, and I have $1.65 in my pocket from the premium on the put.

Conceptually the call strategy is easier to understand, so that’s probably what I will do. I prefer to do the covered writing with two or three weeks left until expiry, not a full month, since the premiums are still relatively high (there has been less erosion) and yet I’m only risking two or three weeks of movement. The perfect time to do the covered write is after a nice two or three day run up. I get great premiums, and it’s more likely a drop will be coming soon, since nothing rises forever.

As I did in June, sometime around the first or second week of July I will again cover the following stocks that I own, in addition to putting in stink bids at much lower prices to purchase more:

ABX.TO - Barrick Gold Corp. (I don’t currently own any Barrick, but if I did, I’d cover it; I’m not a big fan of this stock, so if I put in stink bids they will be at very low prices)

AEM.TO - Agnico-Eagle Mines Ltd.

K.TO - Kinross Gold Corp.

G.TO - Goldcorp Inc.

PAA.TO - Pan American Silver Corp.

SLW.TO - Silver Wheaton Corp.

SSO.TO - Silver Standard Resources, Inc.

The other stocks on my watch lists, the juniors that are not optionable, include:

WDO.TO - Wesdome Gold Mines (buy half a $1.00, half at 60 cents)

LSG.TO - Lake Shore Gold Corp. (buy half at $1.40, half at 80 cents)

CSI.TO - Colossus Minerals Inc (buy half at $1.50, half at 75 cents)

AND.TO - Andean Resources (or ASX:AND) (buy half at $1.00, half at 60 cents)

RMX.TO - Rubicon Minerals Corp. (NYSE.A:RBY) (buy half at $2.00, half at 1.25 cents) and

PG.TO - Premier Gold Mines Ltd. (buy half at $2.00, half at 1.50 cents)

I will eventually have 30% of the portfolio in junior stocks like the ones on the above list, and some others, 60% in the senior stocks, and a further 10% in whatever else appeals to me. Some of that 10% may eventually go into uraniums, or Rare Earth stocks that Dines is hyping at the moment, but for now they are so thinly traded that there is no point in putting any money into them at this point. I’ll wait for the inevitable correction this summer, and then consider my strategy.

So, to summarize: I expect weakness this summer, so I will scalp a few points using a conservative options strategy, I will start buying on dips (which I don’t expect to really start until July or August), and I will position myself for a great fall season.

Happy Father’s Day, and as always feel free to post your thoughts on the Buy High Sell Higher Forum. See you next week.

I knew enough to realize that the alligators were in the swamp and that it was time to circle the wagons.

-Rush Limbaugh

Is there anything more fun than a mixed metaphor? Who doesn’t want to circle the wagons around alligators in a swamp? On Wednesday morning I did my usual Wednesday morning elliptical machine workout, and I watched the Squawk Box crew on CNBC make fun of someone, I can’t remember who, mix the “walk in the park” and “piece of cake” metaphors to create “a walk in the cake.” Yup, that’s messy, and that’s mixing your metaphors.

If you want to amuse yourself this week, keep track of how many mixed metaphors you hear or read. Good sources for mixed metaphors are:

• Your boss at work trying to motivate you (’it’s our turn at bat, so let’s score a touchdown for the company”) (thanks to Grammar Girl for this mixed metaphor);
• Politicians: “This is the moment when we must defeat terror and dry up the well of extremism that supports it.” (Wells don’t support anything).
• The media: “So now what we are dealing with is the rubber meeting the road, and instead of biting the bullet on these issues, we just want to punt.” (Chicago Tribune).

Good luck finding them; it will keep you amused during these dismal economic times. (Post your favourites over on the Buy High Sell Higher Forum; maybe I can write a book about it someday).

The reason for a mixed metaphor, I assume, is because the speaker is mixed up. We try to make sense of two incongruous concepts, and it backfires.

Last week I discussed My Conundrum; how can I reconcile the fact that the S&P 500 is actually up for the year, and yet we have record unemployment, massive levels of personal, corporate and government debt, and a financial system that remains in crisis? For me, there are only two possible explanations:

One explanation is that the recession has ended, and we are now on our way to recovery. The stock market is a leading indicator, so the “smart money” is buying in advance of the upturn that will eventually be obvious to everyone.

The other explanation is that in every depression, in every bear market, there are short term rallies, and that’s what’s happening now. The smart money is driving up prices so that they can liquidate their dogs in advance of the inevitable correction that often happens in the summer.

I have been wrestling with these two competing views for quite some time. Back on April 9 I wrote a long dissertation on cognitive dissonance, which is that uncomfortable feeling caused by attempting to believe and follow two contradictory ideas or cognitions at the same time: the market has rallied huge in the last two months, but over the last two years we are still in a bear market. So which is it: up or down? (You know my thoughts).

Here’s another area where we appear to be out of sync: Here in Canada public companies are moving towards International Financial Reporting Standards (IFRS), as is the rest of the world. The impact: financial statements and disclosure documents will be much longer and more complex. Is this a positive development? In the wake of the Enron scandal and the collapse of our banking system it can be argued that more disclosure and regulation is a necessary development.

But ask yourself this: you own many stocks, so you get many annual and quarterly reports in the mail each year. Do you read them? Cover to cover? Do you read all of the notes to the financial statements? Personally, I have a university degree, an accounting designation, and a bunch of other letters after my name to signify my expertise in all things financial, and I don’t read them. By the time an annual report is issued the information is so outdated that it is virtually worthless.

The conundrum, the cognitive dissonance, the mixed metaphor, comes from the fact that we are piling on the IFRS regulations and increased reporting in a 140 character Twitter world. Do we want more, or do we want our information in quick, immediate, 140 character bursts of information?

I don’t know, but I can only assume that we are entering a period of intense dislocation and change. The forces of more regulation are smashing up against the forces of the 140 character sound bite. The forces of unrestrained free market capitalism are crashing into the power of governments to run a deficit of $2 trillion in a single year to “fix” the economy. We are in the middle of a hurricane, financially and socially speaking.

And being in the middle of a hurricane is not a fun place to be. You may get carried up, or you may get crashed down.

Which is why I have made the decision to remain on the sidelines. On June 4 I covered all of my optionable gold and silver stocks. In the medium term I am a strong believer in gold and silver, so I don’t want to sell everything. But I also know that the summer is a historically poor time for gold and silver stocks, and I fully expect the general stock market to melt down over the next two months as well. So, I covered my bets by selling June calls against the stocks I own.

For example, on June 4 I sold June 21 calls against K.TO - Kinross Gold Corp. I took in a premium of $1.30. If Kinross closes above $21 on June 19 (the third Friday of the month), I will be required to sell my shares for $21, which is roughly what they were trading for on June 4 when I covered. If the shares are worth less than $21 the options expire worthless, and I keep the $1.30, which helps mitigate my loss.

Since June 4 Kinross has fallen over 7%, and closed on Friday at $19.68; if there is no upswing this week, I pocket the premium, and I still own the stock. If it recovers to $22 I sell the stock for $21, but I keep the $1.30, so in effect I sold the stock for $22.30, so I’m still happy. I only “lose” if the stock is over $22.30 on Friday, in which case it was a mistake to cover, since I gave up some profits.

Some may argue that if I was expecting weakness I should have sold the stock outright, and/or purchased some puts. That’s true, but I don’t know for sure that the stock will go down, and it would be silly to be betting against gold in a potentially hyper inflationary environment. Expecting a slight correction over a two week period is a relatively safe bet; going short is an entirely different matter.

I’ll report next week on how it all worked out, but as long as we remain stuck “between a rock and a hard place” I will stay on the sidelines, cover my bets, and hold cash. You can make your own decisions, and of course post your own thoughts and mixed metaphors over on the Buy High Sell Higher Forum. See you next week.

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So here’s my conundrum: Will my pessimism be proven correct, or should I jump on board the rally bandwagon?

Two weeks ago, and again last week, I showed this chart:

And I said:

From the chart, it’s easy to see a series of lower highs:

1. October 12, 2007: 1,562
2. December 7, 2007: 1,504
3. May 16, 2008: 1,425
4. October 31, 2008: 968
5. January 6, 2009: 935
6. May 8, 2009: 929

Clearly, all is not well with the markets. We have had lots of rallies over the past two years, but each and every rally failed to take out the previous high. The failure after May 8 to surpass the previous 935 level is very bad news. Each successive “lower high” may only be 4 or 5% lower than the previous high (with the exception of the 968 post “crash” high on October 31, which was 32% lower than the previous high), but lower is lower.

On average each successive low after a high is 21% lower, and it takes 77 days to get there. Some are shorter. The drop from the peak on October 31, 2008 at 968 to the valley on November 21, 2008 at 800 was only a 17% drop, and it only took 21 days. The 39% drop ending on October 24, 2008 took 161 days.

If you want to extrapolate the average, from the May 8, 2009 high of 929 we are looking at a 21% drop over 77 days, so we will land at 734 on the S&P 500 on July 24, 2009.

Well, guess what. The S&P 500 is now at 940, it’s highest level all year. Year to date the S&P is actually up 4%. That would appear to be something more than a a Sucker’s Rally. It would appear that Sell in May and Go Away was not the correct strategy. Maybe happy days are here again.

Part of the optimism may be due to President Obama’s impressive performance in Egypt on Thursday. I found myself on my Elliptical machine in my workout room at 6:00 am on Thursday morning, so when the President’s speech aired at 6:10 am I had 35 minutes to watch most of the speech. It was impressive. He said all the right things. Everybody with a brain agrees that it’s a good idea to talk with people who share different points of view, because through talking we may find common ground. And, of course, talking is generally less deadly than starting a war. Markets like peace and prosperity. So perhaps I should just go with the flow and start buying.

But as I did my early morning workout I started to think: will Obama’s speech change anything?

President Obama wants to change things, but will the American’s relationship with the Muslim world really change?

Will the Muslim world embrace democracy? They do in Turkey and Indonesia, but it most other countries, not so much. Egypt’s President Hosni Mubarak is an iron-fisted ruler, not a warm and cuddly advocate of democracy.

Women’s rights? In Saudi Arabia women are not allowed to drive, or get a fair divorce, or avoid a family imposed marriage. Change does not appear evident in this area.

Religious tolerance? Nope. Obama mentioned that there are 1,200 mosques in every state in the union. In the Arab world the Shiites and Sunnis kill each other, so forget about seeing Synagogues or other places of religious worship.

The right of Israel to exist? Nope, that’s against policy in many countries as well.

As regular readers know, I am a Canadian, so I have no voting interest in what happens in the USA. I hope Obama is successful. I hope he brings peace to the world. I admire his guts for taking on Middle East issues this early in his presidency; most of his predecessors wait until their final year in office to get involved, in the hopes of winning the Nobel Peace Prize. Spending some political capital on this now takes guts, and I admire him for it.

Unfortunately, the task is massive, and perhaps impossible. He is a great messenger, and he has a great message. I just don’t think a great speech will repair hatred that goes back a 1,000 years.

And therefore while I’m happy the market’s like it, I still don’t believe it’s real.

Yes, the market is up. Yes, the market is trading above it’s 200 day moving average, for the first time in a long time, and that’s good news. A close above 1,000 will be another decisive break of a down trend line. A close above 1,200 would be a break of the final significant down trend. If that happens, we may be out of the woods.

But look around you. Unemployment is still very high, and increasing, regardless of the positive spin the news media puts on it. Yes, house sales are up this month, but May and June are the busiest months of the year, so comparing them to the winter is a silly comparison.

And let’s not forget that GM went bankrupt this week, and Chrysler already was, so the world is not perfect yet.

So I solve the conundrum by sticking to my guns, and staying in cash, on the sidelines. I believe the Big Boys have created this rally to unload stock. Insider selling remains very high. The banks are issuing stock like crazy to pay off their TARP loans, and obviously if they thought that the market would be higher in six months they would wait six months to issue stock at higher prices. They are selling now because they know we are approaching a near term top.

When the market falls, gold and everything else falls, in the short term, so on Thursday morning I covered all of my remaining gold and silver stock holdings. (I sold June at the money call options against all of the optionable gold and silver stocks I own. I took in a premium for doing so. If my shares are at the same level or lower by the close on June 19, I keep the premium. If shares advance between now and then I lose my stock, but that’s a risk I’m willing to take for the insurance).

I apologize for the lack of happy talk, but I call it as I see it, so I will remain in cash for a while longer yet, until the conundrum resolves itself. I’m not going to let a 4% rally on the year convince me that all is well.

Thanks for reading, as always feel free to post your thoughts on the Buy High Sell Higher Forum, and see you next week.

For the entire month of May I have continued to advance the theory that the current “rally” is about done, and we are due for a significant correct, probably even a crash. On May 2 I said Sell in May and Go Away. Since then the S&P 500 is up 5.3%. On May 9 I said we were in a Sucker’s Rally. The market peaked for the month on May 8 at 929, and the market is down marginally since then, closing the month at 919. So the jury is still out on whether or not my pessimism is warranted.

Last week I showed this chart:

And I said:

From the chart, it’s easy to see a series of lower highs:

1. October 12, 2007: 1,562
2. December 7, 2007: 1,504
3. May 16, 2008: 1,425
4. October 31, 2008: 968
5. January 6, 2009: 935
6. May 8, 2009: 929

Clearly, all is not well with the markets. We have had lots of rallies over the past two years, but each and every rally failed to take out the previous high. The failure after May 8 to surpass the previous 935 level is very bad news. Each successive “lower high” may only be 4 or 5% lower than the previous high (with the exception of the 968 post “crash” high on October 31, which was 32% lower than the previous high), but lower is lower.

On average each successive low after a high is 21% lower, and it takes 77 days to get there. Some are shorter. The drop from the peak on October 31, 2008 at 968 to the valley on November 21, 2008 at 800 was only a 17% drop, and it only took 21 days. The 39% drop ending on October 24, 2008 took 161 days.

If you want to extrapolate the average, from the May 8, 2009 high of 929 we are looking at a 21% drop over 77 days, so we will land at 734 on the S&P 500 on July 24, 2009.

A close at 919 is still below the last “high” on May 8 at 929, so despite this week’s rally, we are still falling. Yes, we may have a bounce on Monday or Tuesday up over 929, but will that mean all is well? I doubt it. Here are some charts, from Perotcharts.com (yes, apparently Ross Perot has a website, in case you were wondering what he’s been up to these last few years):

The news is not good on unemployment (click the chart for a larger version).

The news on the American federal deficit is even worse. (And for my Canadian readers, the socialist Conservative government, if that isn’t the craziest oxymoron you have ever heard, is projecting a record $50 billion deficit, so so much for fiscal conservatism). Can all of this spending actually be good for the long term health of the economy? I doubt it. The currency will get hammered, and at some point taxes must increase, and inflation will go ballistic.

And, of course, on Monday we get to witness the GM bankruptcy. I believe it was Lee Iacocca who once said “as GM goes, so goes the nation”. Yup, that’s pretty much it.

I said last week that I am 80% in cash, and I am. I’m holding a core position in gold and silver stocks, and they have been on a run recently, so even though I’m in cash I’m still up 5% on the year, which is better than the alternative.

Speaking of gold, is it a buy or sell now? Obviously long term it’s a buy, so if you plan to buy and hold then continuing to accumulate is not a bad idea. Of course I’m the guy who predicted $1,200 gold on March 31, and $1,800 gold on June 30, so it does not appear that I have any clue what I’m talking about. Of course I also predicted 8,000 on the Dow at March 31, and 6,000 on the Dow on June 30. I was close on March 31 (the Dow closed at 7,608), and I may still prove correct at the end of June; we shall see.

My read of the gold chart is that we are approaching significant resistance levels. Obviously $1,000 is significant resistance, a level that has never been decisively broken for an extended period of time. An RSI level of 70 has also proven to be significant resistance, as that’s where the last three tops have occurred. I therefore believe a short term top for gold is near.

So, here’s my prediction for June:

We may continue to rally into the first week or two, but the euphoria since early March is wearing thin, and as volume dries up in the summer, we are headed for a bad summer. If we have an overall market correction, even the gold, silver and uranium stocks will fall, so I am very comfortable at 80% cash. In fact, I may even take more gold profits off the table as we approach the $1,000 level.

As as example, G.TO - Goldcorp Inc. has risen from around $18 in October to $43 today. That’s quite a run, and it can’t continue forever. The RSI is now up to almost 70, and the $5 to $50 level appears to provide significant resistance.

I don’t have huge holdings, but putting in sell orders for some of my holdings at $45 is probably a prudent way to lock in some profits.

Again, if I am correct and a significant correction is coming, I want to have lots of cash to deploy. In hindsight, having cash in October, 2008, and having the guts to invest would have allowed me to buy Goldcorp at $18 and sell it today for $43. That’s the kind of profits we are looking for.

If I’m wrong, and the market continues to rally, I guess I’m sitting on cash and I won’t make any money. So be it. At this point, not losing and protecting capital is far more important than risking everything to buy at an intermediate market top.

That’s my story and I’m sticking to it. Thanks for reading, feel free to post your thoughts on the Buy High Sell Higher Forum, and see you next week.

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The S&P 500 Index was at 935 on January 6, 2009, and then fell to 676 on March 9 before running all the way up to 929 on May 8. In percentage terms, the market dropped 28%, and then had a 37% rally. 37% rallies lead commentators to include that a new bull market has begun, and all is well. But here’s the thing: if you bought the S&P on January 6, and held all the way through the 37% rally, you would still be down 6 points. Even a 37% rally is not enough to recover from a 28% drop.

From the chart, it’s easy to see a series of lower highs:

1. October 12, 2007: 1,562
2. December 7, 2007: 1,504
3. May 16, 2008: 1,425
4. October 31, 2008: 968
5. January 6, 2009: 935
6. May 8, 2009: 929

Clearly, all is not well with the markets. We have had lots of rallies over the past two years, but each and every rally failed to take out the previous high. The failure after May 8 to surpass the previous 935 level is very bad news. Each successive “lower high” may only be 4 or 5% lower than the previous high (with the exception of the 968 post “crash” high on October 31, which was 32% lower than the previous high), but lower is lower.

On average each successive low after a high is 21% lower, and it takes 77 days to get there. Some are shorter. The drop from the peak on October 31, 2008 at 968 to the valley on November 21, 2008 at 800 was only a 17% drop, and it only took 21 days. The 39% drop ending on October 24, 2008 took 161 days.

If you want to extrapolate the average, from the May 8, 2009 high of 929 we are looking at a 21% drop over 77 days, so we will land at 734 on the S&P 500 on July 24, 2009.

And no, that’s not a prediction. Only a fool would compute some rough averages and assume that there is a repeatable pattern. That’s not the way life works. However, using those averages it’s not at all inconceivable that the markets will be lower at some point over the next two or three months than they are now.

What could cause lower markets? How about the bankruptcy of General Motors. Some commentators believe that the bankruptcy of GM would be an economic disaster, given the ancillary suppliers and support industries that would be hammered. Obviously bankruptcy hurts all stakeholders, but GM has been in bad shape for about 30 years, and the market has already discounted the share price, so it can’t fall below zero. (Here’s an interesting read on the history of GM’s mistakes).

The negative sentiment surrounding GM will hurt. The sell in May and go away philosophy will hurt. (Since April 30 the S&P is actually up 1.5%, but since the month’s peak on May 11 the market is down 4.5%, so selling the market in May appears to have been the correct strategy). The fact that the U.S. government’s deficit will no doubt be higher than $2 trillion this year is very bad for long term market health. After the recent rally insider selling has increased, and insider’s typically sell before a down leg. Unemployment remains high. Foreclosures are increasing. Etc. Etc.

I hate to spoil my American friend’s long weekend, but I am more bearish now than I was last week, or the week before.

My strategy is as follows:

First, hold cash. I am currently 80% in cash. My remaining holdings are gold and silver stocks, which I have continued to sell on up days. I will maintain a core position, but if the market tanks, everything will go down with it. Obviously having cash has hurt during the recent rally, but having cash will be wise if the market falls. My portfolio is up about 4% on the year, which isn’t great, but compared to the decimation of the past two years, and the fact that the market is down year to date, I’ll take it, and I’ll stay conservative.

Second, since I have yet to figure out how to play the short side of the market, so I am holding some RSW - Rydex Inverse 2X S&P ETF. These are short term holdings only. I sold some of them this week, and have sell orders already placed for next week. On weakness, I sell. If we have three strong up days, I’ll buy. I’m only using “play money” for these trades, since they are too risky to place any real money on leveraged ETFs.

Third, I am watching gold for a correction. It’s been strong recently, but as we all know the $1,000 level is a very strong resistance level, and I assume the market makers will do everything they can to hold the price under $1,000. That tells me I will have further buying opportunities, so I will be patient. Once gold breaks $1,000 it may quickly run to $1,500, and that’s why I want to have lots of cash on hand to take advantage of that buying opportunity.

Fourth, I am buying real things. Having money invested in a tanking market makes no sense, and what’s the point of working 80 hours a week and saving money if you can’t enjoy it. So, we are building a big shed on our property, and we are installing a pool. With the weak economy, swine flu, and the stupid security measures at airports I don’t plan to do a lot of traveling this summer, so I’ll do the next best thing and vacation at home. I’ll be spending the rest of today helping my brother in law install the racking in my new basement wine cellar. (I have no carpentry skills whatsoever, and he does, so I supply the food and drink, and he does the real man’s work). I will spend the rest of weekend planting the rest of my vegetable garden.

If the world tanks, at least I’ll have food, drink, and a cool place to relax.

Finally, I’m staying healthy. Sitting around worrying about the economy is not productive. With the return of nice weather I’m spending more time biking and running outside. I much prefer a morning run outside than half an hour on the treadmill watching the talking heads on CNBC, which only upsets me. My son and I did a 5 km run last month, and I’ve got another one next weekend, so that should keep me healthy and out of trouble.

And that’s my advice to you this Memorial Day Weekend. Shut off your computer, spend some time with your family, and use at least some of your hard earned money to invest in something you and your family will actually enjoy. Thanks, and see you next week.

Two weeks ago I expounded on the theory that you should sell in May and go away. A week ago that strategy was looking, at best, premature, as the Dow was up 4.41%, and the S&P 500 was up 5.89%. This week was a down week, so sell in May and go away is looking better. The Dow was down 3.57%, and the S&P 500 was down 4.99%, so the gains of two weeks ago were all but completely given back this week.

Obviously I am of the belief that down is more likely than up over the next few weeks (and months). Others agree; see for example this commentary from Danielle Park.

Some random thoughts this week:

First, the US Dollar appears to be breaking down again, as shown in this US Dollar Index Chart. Gold tends to rise as the U.S. dollar weakens, which longer term is good for gold. In the short term, who knows.

Second, the markets appear to be making a series of lower highs, which isn’t good.

We had a double top around the 1,000 level in the S&P 500 back in October-November 2008, and then another lower peak of around 950 in January. Neither of those peaks have been exceeded. What’s next, a peak of 800 in the summer? 700? Who knows, but I’m not optimistic.

Why I’m not optimistic

I suspect that many of you are tired of reading my doom and gloom. You would like me to tell you that everything is fixed, and all will be better. Unfortunately, I just can’t do that.

I am writing to you today from Windsor, Ontario, where I have spent the last day. Windsor is across the river from Detroit, Michigan. You can drive from downtown Windsor to the Joe Louis arena in Detroit in a matter of minutes (depending on how long you get stopped at the border). By power boat it’s about a four minute trip. The skyline of Windsor is dominated by the skyline of Detroit, which is dominated by the world headquarters of General Motors. It is a tall and beautiful building.

Unfortunately the news today is about the 1,000 dealers GM is closing, and the 789 dealers Chrysler is closing. That means tens of thousands of jobs will be gone in a matter of a month or two.

News reports of foreclosures (apparently the U.S. government has 50,000 properties under foreclosure that they can’t sell) keep increasing.

Even worse, I spoke to over dozen people in Windsor, and the feeling today is one of despondence and despair. Fifty year old men who held a well paying job at a company for 20 years are now unemployed, surviving on unemployment insurance. This financial stress is causing an increasing number of marriages to break up. I predict the divorce statistics will show a massive increase over the next year or two.

(As an aside, I question the sanity of Windsor residents. Apparently city workers are on strike, so city properties are now overgrown with grass and weeds. Taxi drivers are also on strike. Everyone in the automotive sector is getting laid off, and people with jobs are on strike for more money! No wonder this world is in a mess).

The number of personal bankruptcies in Canada are at record levels, and they continue to increase at an ever faster rate.

The U.S. government’s tax revenues are way down, and deficit projections continue to be revised upward.

The point, dear readers, is that despite the talk of “green shoots” you may read about in the media can be more accurately described as “dead shots”. The economy is not improving; it’s getting worse, and getting worse at an ever increasing rate. Ever bad news report of dealerships closing and foreclosures increasing is yet another shot that renders another segment of the economy dead. It’s not pretty.

I apologize for being the bearer of bad news, but that’s how I see it.

(And yes, apparently Mr. Dines issued an Interim Warning Bulletin on Friday predicting slight turbulence but good times ahead. I’m not sure what he’s looking at, but I disagree).

Given this sorry state of affairs, I am holding cash, and I will probably liquidate further some of my gold holdings this week to lock in my gains, because further market weakness will depress all stocks, as we learned last fall. Once the IMF confirms they are selling some of their gold, an announcement that may happen in June, the price of gold will probably take a hit, and I want to have lots of cash on hand to do some serious buying.

So, for now, I hold cash, and I wait.

I don’t have a great internet connection where I sit at the moment, so I won’t post any charts. I’ll leave it to each of you to examine the fundamentals, and the technicals, to decide if my outlook is overly bearish.

Monday is a holiday in Ontario (Victoria Day) so the Toronto exchange will be closed, so we will see on Tuesday how the world in Canada progresses.

I will enjoy the long weekend, despite the negative outlook. Thanks for reading, and we’ll see if I’m in a more positive frame of mind next week.

One of these days I’m gonna lay this hammer down
And I won’t have to drag this weight around
When there ain’t no hunger
And there ain’t no pain
Then I won’t have to swing this thing
One of these day I’m gonna lay this hammer down

- Steve Earle, Steve’s Hammer (for Pete), from Washington Square Serenade (sounds better if you listen to it)

Last week I expounded on the theory that you should sell in May and go away. How did we do this week with that selling strategy? Not so good. The Dow was up 4.41%, and the S&P 500 was up 5.89%. At this rate the markets will be making new highs by the end of the summer.

On March 9 the S&P was at 676; it closed Friday at 929, for an impressive 29% gain in two months. Sure sounds like a bull market, right?

Maybe.

But let’s not forget that from November 20, 2008 to January 6, 2009 the S&P rose almost 16%, to 935, and everyone thought that was a new bull market, until all of those gains were erased, and a new low was made on March 9. That was a sucker’s rally.

Unfortunately, Sucker’s Rallys are common in bear markets. The 2000 to 2002 bear market had three sucker’s rallies, with average gains of 21 per cent in the Dow Jones Industrials over 45 days periods. During the Great Depression, the most severe bear market ever between 1929 and 1932, there were six sucker’s rallies, with an average gain of 47 per cent each.

So, am I impressed by the fact that the S&P is up 29% in two months. No I am not.

Technically, the RSI is now at the highest level it’s been since the start of the bear market; at these levels markets normally pull back. Also, the 200 day moving average is a significant resistance level, so a pull back as we approach 954 is to be expected. Finally, the top in January of 935 is also a resistance level, so with the S&P at 929 we could be close to a top.

Fundamentally, there are lots of other problems. Unemployment is up. Government spending and deficits are at record highs. The auto industry is in shambles. Even Toyota is losing money.

So why are the market’s rising? Because that’s what a bear market rally is. A bounce in a bear market.

I am unconvinced, and I will remain so. I may leave lots of profit on the table if the rally continues, but if I remain largely in cash I won’t lose anything if this goes the other way.

Sell in May and stay away. The weather is nice at this time of year. Sunday is Mother’s Day. Take a break from the markets. Spend time with your mother, or a mother close to you. Let the market’s do their thing, and start buying again when we get the next crash, which I assume will happen at some point before the end of the summer.

And now, I will take my own advice and shut off the computer and go outside to work. I am putting down the hammer that is the time we spend analyzing charts and graphs. To borrow a thought from Steve Earle, put the hammer down, stop dragging the weight around, ignore the markets for the rest of the weekend, and let’s see what happens next week. Thanks for reading; see you next week.

Welcome to the month of May. Before I talk about getting lucky (and no, sorry, it’s not what you think), I would like to comment on the discussion over on the Forum about “Sell in May and away”. You can pick up the thread on selling in May here. Is it true? Should you sell in May and go away? The theory goes that stock traders start selling in May and paying less attention to the markets as they start playing more golf, spend time at the cottage, and go on summer vacation. It makes sense, but is it true?

Here is a chart of DML.TO - Denison Mines Corp. from 2004 through 2008; short term peaks happened on March 26, 2004, April 1, 2005, March 3, 2006, May 11, 2007, and June 6, 2008 (click on the chart to see a bigger version).

I interpret from this that the spring peak can happen anywhere from the beginning of March through to the first week of June, with drops thereafter. So, sell in May is a good, but imprecise, rule. “Sell in spring” would be more accurate, but it’s such a general rule that it may be of no use. A further caveat is that I only pulled up Denison’s chart; other stocks may yield different results, so I encourage you to do your own research. (I did pull up a few other charts in other industries, and a quick look indicates that they all do follow a pattern similar to Denison’s, although not identical).

Since we have had a good run over the last month or two, my bias today is to take profits. If the market continues upward, at least I took profits. If it falls, I am even happier I took profits. So, on Friday I sold all of my remaining shares of Denison, at a very nice profit (more than a double).

I have also reduced my exposure on gold shares, and will start selling my silver shares as well (also at a profit). My plan is to raise cash, probably up to 85% of my portfolio.

Yes, I know, you are all thinking that I’m nuts. We hit the bottom last November, everything is on the upswing, it’s all good from here, and I’m selling. What an idiot I am.

Maybe.

Or, maybe, we need to retest the lows again before we can truly say we are in a new bull market. Perhaps the bankruptcy of Chrysler this week is not a sign of good things to come. Unemployment remains high. Foreclosures are still very high. Government spending is monstrous. Those are not generally leading indicators of a bull market.

Since the late spring and summer months tend to be weak, being in cash is prudent, so that’s what I’m doing. Now, let’s talk books.

JDH’s Book Report - Outliers

Remember when you were in school you had to read books and do book reports?

Today, I present to you the first ever JDH book report. I’m not much of a book reader, so don’t worry, this won’t be a weekly feature.

I would, however, like to comment on Outliers, “The Story of Success” by Malcolm Gladwell. Mr. Gladwell is a staff writer for The New Yorker. More impressive, his father is a professor at the University of Waterloo, so Malcolm spent some of his formative years in the sleepy town of Elmira, Ontario, a short drive from where I spend many days at my real job.

The premise of his book, if I may summarize, is that to be successful you need to be smart, hard working, and lucky.

We all agree with the first two attributes: smart and hard working. But luck?

Yes, luck is a key component to success. He starts the book with a typically Canadian example: the vast majority of professional hockey players were born in January, February or March. Why? Because when five year old kids are learning to skate, the older kids (born early in the year) do better. Being a few months older at age five makes a big difference. Those “better” kids get put on the “rep” team, that practices more and plays more games, so those kids get even better. And so it goes, throughout their formative years. More practice, so they get even better, so they get picked for the better teams, so they get better.

Of course those kids must still work hard and have some basic talent, but it is a fact that being born early in the year helps.

Mr. Gladwell gives numerous other similar examples. Bill Gates went to one of the few high schools in the world in the late 1960’s that actually had a computer terminal. He was able to get time on that terminal learning programming. He worked extremely hard, well into the night, and he was obviously very smart. But if he had not had access to that computer terminal, he would not have founded Microsoft.

Hard work and brains are important, but luck is equally important.

(For more, go to Amazon and buy Outliers: The Story of Success, or borrow it from the library; it’s a quick read).

So, why am I doing book reviews? Do I honestly think you will go to Amazon and buy a $15 book so I can earn 20 cents in commissions?

No, I don’t.

But I do think luck is important. My portfolio was up 52% in 2005, and 94% in 2006. I assumed I was a genius. I had figured out the stock market. I would retire by 2010 and live a life of leisure. Then came 2007, when I lost 33%, and 2008 when I dropped a further 45%. I ended 2008 back where I started 2005.

It turns out I was not a genius. I was lucky. If you bought stocks in the uranium sector in 2005 and 2006, you made money. If you put a list of all uranium stocks on a dart board and picked stocks to buy by throwing darts, you made money. Yes, I did research and analyzed stocks and was in the right sector at the right time, but then I was lucky, just like Malcolm Gladwell’s hockey players and Bill Gates.

If I truly was brilliant I would have continued to earn huge returns in 2007 and 2008, instead of giving it all back. Had the fundamentals for uranium changed? Was the energy crisis solved in 2007, such that nuclear power will no longer be necessary? Is global warming done? No, but markets get inflated and deflated, and if you are buying during the inflation phase you make money, and if you are holding during the inevitable sell off, you lose.

Let me say that again: during a bull market, stocks go up. Pick any stock, and it will, on average, go up. If you pick the leading industry group (like uraniums in 2006), virtually any stock in that industry will go up. You have to be smart to get the industry right, but you have to be lucky to be buying during a bull market.

The opposite is also true. You can be the best technical analyst in the world, and you can pick the stock with the best RSI or MACD or stochastics, and you can buy it, and if a bear market starts, you will get killed.

So what can we do? Should we just give up, and hope for luck? Is it pointless to do research and technical analysis?

No, I think hard work is very important. Understanding the markets are very important. But don’t believe your own press clippings. Don’t fool yourself into believing that just because you bought a stock and it went up that you are automatically a brilliant stock picker. You may be, or you may be lucky.

I met with a number of people this week who told me exactly the same story: They bought a bigger house two or three years ago, with very little money down. All was good until they lost their job, or their hours got cut back at work. Now if they sell their house and pay the real estate commissions, legal fees and penalties to break the mortgage, and pay off the mortgage, they will lose $20,000. Or $50,000. They thought buying “up” was a wise financial move because every knows that house prices always go up, and now they are on the verge of bankruptcy because house prices have crashed.

You are a brilliant real estate speculator if you buy at the start of a bull market, and you risk personal bankruptcy if you buy at the peak. Luck is funny that way.

The Toronto Star ran a story this morning titled Generation Why Me? that talks about young people who thought they were doing the right thing by buying a home and getting an education, but with rising youth unemployment they are now losing their homes. They are depressed thinking about the future. They are not out there buying goods and services, they are not driving the economy forward, because they can’t. People cutting back is not a recipe for future growth.

As I watch people walk away from their homes, and as I watch continued increases in unemployment, and as I watch marriages deteriorate due to financial pressures, I am not optimistic about the short term health of the North American economy. Government spending will not help; it will crush us in the medium term. And swine flu, or whatever they are telling us to call it now, probably won’t help either.

As I stare at the chart of the Dow, I do not see a pretty picture. Let’s not forget the “bottom” of 7,552 on November 20, 2008 was followed by another “bottom” of 6,547 on March 9, 2009. Is that the last bottom?

We all thought happy days were here again when the Dow jumped from the “bottom” of 7,552 on November 20, 2008 to 8,934 on December 8, 2008, a gain of over 18%, and the start of a new bull market. By January 2 we were over 9,000. We all know what happened from there. We crashed, again.

Luck in stock market investing starts with guessing whether or not we are in a bull or bear market. In a bear market virtually everything goes down, notwithstanding some temporary bear market bounces. I believe we remain in a bear market. Until we stop making new lows, we are in a bear market.

And that’s why I’m moving even more of my portfolio into cash. The long term charts show conclusively that we are in a bear market. The seasonality of “sell in May and go away” leads me to believe that selling now is prudent. The horrible fundamentals of the economy tell me that there is more bad news to come.

Of course I could be wrong. It is accepted wisdom that the stock market is a leading indicator. The stock market today tells us what the economy will be doing six months from now, so the theory goes. The market has done great for the last six weeks, so the economy will be doing great by the end of the year. Or, we are in a dead cat bounce, and it won’t. I’m betting on the latter.

I’m not ready to start shorting anything yet. If I’m wrong and the market picks up, I leave profits on the table. If I short and the market picks up, I lose money, so for now I will watch and observe.

As always, thanks for reading, and feel free to comment on whether or not you think I’m crazy over on the Buy High Sell Higher Forum. See you next week.

{ 4 comments }

Good news! I am NOT going to talk about going green, or about Earth Day. I’m not going to give you a bunch on inane suggestions like take cold showers to save energy, or live in an unheated shack in the woods with no electricity to save the planet. I have no objection to saving the planet, and I personally don’t waste energy, and if you want to live in a shack in the woods, good for you. (Although if you have no electricity I don’t know how you will read my ramblings each week).

In other good news, the world did not end this week! Those of you who have followed the writings of Martin Armstrong will know that this was the week he predicted an intermediate top in the markets. Of course he may be correct; this week may indeed, in hindsight, mark an intermediate top, and the markets may fall to new lows from here. But, the markets didn’t crash this week, so let’s take comfort in that.

(As I posted on the Forum this week, for those who don’t know, Martin Armstrong eventually pleaded guilty and is currently serving time in jail for fraud (so we know he’s credible  . Here is a summary of Martin Armstrong’s predictions, and here’s the link to his long essay. You can judge for yourself whether or not he’s credible). The Dow and the S&P were relatively flat this week, with the Dow and the S&P down less than 1%, so on the broad averages it was an uneventful week.

Last week in my comments on gold I said:

Where is gold heading? My gut tells me we are nearing a near term bottom.

If you draw an uptrend line from the lows of November 2008, it hits where we are today. Coincidence? Perhaps. But the 200 Day Moving Average is $860.37, and gold closed on Friday at $869.10, so it’s possible that both the uptrend line and the 200 DMA are support levels.

Looking at the three month chart the $860 level also looks like support, and the RSI is as low as it’s been in months, so again, a bottom could be here.

If gold breaks below $850 this week, I will assume that we are going for a big fall. If not, we could be at a decent support level, so now may be a good buy point (although I will wait and see before committing any further cash).

Gold closed the week at $913, so all that stuff I said last week: yup, that was pretty much it. We did not break the $850 level, so the likely direction is up from here.

Not surprisingly, gold stocks did very well this week. Here is the performance this week in some of my gold stock holdings:

K.TO - Kinross Gold Corp. up 16.62%

ABX.TO - Barrick Gold Corp. up 12.29%

G.TO - Goldcorp Inc. up 10.02%

AEM.TO - Agnico-Eagle Mines Ltd. up 9.88%

Kinross was the best performer on the week, which isn’t surprising given my pessimistic comments from last week:

For example, K.TO - Kinross Gold Corp. closed the week at $16.73, a big drop from the $24 level we hit back in January, February and March. The RSI at 31.39 is also very low. Is this a breakdown with a big fall ahead, or is this a “breakdown” that was artificial, like we saw back in November, that was in hindsight a fantastic buying opportunity?

I won’t bore you with the charts, but the charts of AEM.TO - Agnico-Eagle Mines Ltd. and G.TO - Goldcorp Inc. and other gold stocks look remarkably similar. Gold itself has not broken through it’s base, but the gold stocks have, which either means they have over-corrected and are due for a bounce, or bad things are coming. In fact, even the silver stocks look the same (SLW.TO - Silver Wheaton Corp. and PAA.TO - Pan American Silver Corp., for example).

Again, it appears to me we are at a significant decision point. If these levels in gold and silver hold, we may be at a near term bottom. If they don’t, we could easily see $800 per ounce gold; we will have a good idea this week, and a very good idea before the end of the month.

So, do we have a better idea now?

I don’t know. Obviously all the gold stocks had a bounce this week, and obviously Kinross did not fall anywhere near to it’s November lows, so a bottom may be in. Historically an RSI passing over the 50 level is a good buy point. But, the stock has come a long way in a week, and the downtrend that started in February remains in place, so I’m undecided on this one. I therefore think the best option is to “hold”, although I may put in some sell orders at $22 to lock in some of the profits.

Silver stocks were also strong on the week:

PAA.TO - Pan American Silver Corp. up 10.87%

SLW.TO - Silver Wheaton Corp. up 9.21%

SSO.TO - Silver Standard Resources, Inc. up 7.55%

But what was the best performer on the week in my portfolio? DML.TO - Denison Mines Corp. up 28.37% on the week, including over a 9% gain on Friday. Denison was under a $1 earlier this month; I bought it for $1.11, and it looks like it’s headed for $2 before it gets even close to the down trend line.

A double in a month is a huge run, which I can’t believe is sustainable, so my sell order for half my holdings will be in at $2. If it keeps running, I leave some money on the table but that’s fine, I like cash in my pocket.

Beyond that, I still continue to maintain a bearish perspective. I still believe the economy is not even close to being out of the woods yet. The commercial real estate crisis and the credit card crisis is just beginning, and the problems in the auto sector are obviously not yet solved. Cash is king, and I want lots of it on hand if we see another big drop, which is what I expect. My portfolio is up slightly on the year, and I’d like to keep it that way.

The weather will great this weekend, so outside I go, thanks for reading, and please continue to post your thoughts on the Buy High Sell Higher Forum; see you next week.