October 11, 2008 – Circling the Bowl

by JDH on October 11, 2008

The word of the week is: volatility.

The advantage of all of this volatility, for me, is that I wake up around 5:30 am every day wondering what the Asian and European markets are doing. I go downstairs to my basement work out room, flip on CNBC, and then, while I’m on the treadmill, the elliptical, or lifting weights, I’m watching the market action. My physical condition has never been better. Want to lose weight? Watch CNBC while you work out; you may find yourself spending hours in front of the TV; just making sure you are moving while you do.

(As an aside, most guests on CNBC recommend that you “don’t sell” because long term everything will come back. Alas, that’s been the wrong advice over the past few months).

Here’s how my Wednesday went: I got up at 5:30, started running on the treadmill, and watched CNBC explain the futures markets. Asia and Europe were down, and it looked like we were set for a big down day in North America. Then, at 7:00 am, the Fed and a bunch of other central bankers did a “co-ordinated rate cut”, bringing rates down by half a percent. The futures turned around, and the markets were looking up. I got into my car around 8:00 am to drive to Toronto, listening to CNBC on the way in (Note to self: satellite radio can be addictive). By the time the markets opened, the euphoria had worn off, and markets were down. Then up. They finally closed the day down.

Friday was no different. The Futures were lower during my 6:00 am workout, with Asia off 9%. By 9:38 am the DOW was down to 7,958; at 3:36 pm it was at 8,885, a swing of almost 900 points, or 11% in one day. It finally closed at 8,452, down a mere 1.5% on the day.

While I was in Toronto on Wednesday, I stopped by the precious metals desk of Scotiabank at Scotia Plaza. As I reported in my thoughts on gold last week, it’s hard to find any metal to buy, anywhere. Scotiabank is the largest precious metals dealing bank in Canada, so if anyone would have anything, they would. I asked to buy some silver bars. They had none. Nothing. Zip. One ounce, 1,000 ounce, all the same: nothing.

In my quest to actually buy some physical gold or silver, I asked for 100 silver Canadian Maple Leafs. With silver in the $12 per ounce range, I didn’t think a purchase of $1,200 worth of silver would be a problem. It was. I could only buy 25 coins. That was it. The biggest bullion and coin dealing bank in Canada, at their main branch, on top of their main vault, could only offer me a few hundred dollars worth of coins. I took them, although it’s such a small quantity that I’m not sure it was worth the bother.

They did have some gold Maple Leafs, but I’m still shocked at the shortage of silver.

On Wednesday on the Forum Davidslane posted this link to a great gold video on CNBC with the CEO of Swiss Asia Capital, making the point that there is a huge dis-joint between the paper market and the real market.

Ya think?

When I can’t even buy $500 worth of real silver from the biggest silver dealing bank in Canada, it’s obvious there is something out of whack somewhere. It makes you wonder what’s going to happen when the people trading the paper actually want physical delivery of the underlying precious metal. If it isn’t there, the prices will spike, big time.

So, it’s obvious that owning gold and silver stocks, and whatever physical metal you can find, is not only prudent, but also great insurance for the rough times ahead.

If that’s true, why was gold down $36 on Friday, closing around $850, after having traded over $900 earlier in the week? What exactly is going on?

I have no idea. But, since I’m writing this blog, allow me to speculate:

Measured from the March peak, gold is obviously in a down trend. Equally obvious is that gold has been range bound between $825 and $925 since mid September. Until gold breaks above $950, gold will remain in a down trend. This down trend is bizarre, given that the world is ending. The DOW lost 18% this week, the government is bailing out everyone, and yet we don’t have a rush to gold? You can’t buy the physical metal anywhere, and yet we don’t have higher prices?

I can only assume that the government, or the big boys, or both, have their fingers in the pie, and are holding the price of gold down to allow the big boys the chance to cover their shorts and get out whole. They can manipulate the market for a while, perhaps for a long while, but eventually the lid will be blown off.

You can buy gold futures on the Comex, and most buyers never take delivery. You are buying a piece of paper. So it’s fairly easy to manipulate the market.

In fact, I just had an idea. I call them the “Buy-High-Sell-Higher.com Gold Certificates” and here’s how they work. Each certificate entitles the bearer to 100 ounces of gold.. You send me your money, and I’ll send you your certificate. Simple. As the price of gold increases, the certificate’s value increases. Send your money now. You don’t have to worry about physically storing the gold; I’ll worry about that.

There’s only one catch. I don’t actually have any gold. The certificates are backed by my promise, but not by any real gold. However, as long as you believe they are backed by gold, everything will be fine. (Incidentally, I have modeled my certificates on the U.S. Dollar, also backed by nothing).

The only flaw in my scheme will be that, if any of you actually want to take physical delivery of the underlying gold, I will have a problem. I don’t have the gold, and my entire scam (I mean investment opportunity) will collapse.

That’s the problem with all of the paper gold being traded. If people want the actual gold, and it isn’t there, you’ve got a problem. And, of course, that’s why real people are standing in line to buy physical gold.

The market’s crashed this week because of fear, as accurately stated by whatupdoc in his forum posting on fear, quoting Adam Hamilton:

Fear can only grow until everyone remotely interested in selling immediately has already sold.  After they are out, selling pressure abates dramatically so any bidding starts driving prices higher.  And of course higher prices cause fear to deflate fast.  Thus

extreme fear is self-limiting.  The more extreme a fear spike, the shorter it should last since extreme fear is so intense that it rapidly burns itself out.

And once fear reaches this point, where everyone is as scared as they can get, traders are presented with one of the greatest trading opportunities in the stock markets.  The fabled V-bounce!  Out of these fear extremes sparked by major bear-market downlegs, the biggest and fastest rallies ever witnessed erupt.  Traders who can fight their own fear while capitalizing on others’ can make fortunes in a matter of weeks by riding these exceedingly powerful and fast V-bounces.

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Now if extreme and unsustainable fear was the catalyst for massive relief rallies in the last cyclical bear, why should we expect anything different this time around?  Popular sentiment is like a giant pendulum swinging back and forth between greed and fear.  When either emotion gets too great to sustain, the pendulum starts swinging back in the opposite direction.  And after seeing all these crazy VXO records in the past couple weeks, it is hard to imagine fear getting greater.  It is finite, not infinite.

Strong contrarian traders can capitalize on this V-bounce tendency.  During periods of extreme fear, we need to be buying bargains while everyone else is selling in terror.  During times when the majority expects the stock markets to fall forever, we need to be throwing long with all we’ve got.  And with the VXO rocketing into the 70s this week, mind-bogglingly high, fear has to be at unsustainable extremes.

The fear may continue next week, or it may not. I’m betting that it will, because we are not out of the woods yet.

America has record trade deficits, and a record government deficit and debt. The average North American person is carrying more debt than ever before. (The average Canadian now has debt equal to over 131% of their annual personal disposable income, the highest level ever, and I assume it’s just as bad in the United States). The housing bubble has burst. The stock market bubble has burst. Things are not good, and they will not improve tomorrow.

This week was a puke, but I don’t think it was “The Big Puke”, because fear is still present, and the underlying problems have not been fixed.

My guess is this bear market lasts for another six months, and probably ends somewhere in the Dow 2,000 to 5,000 range. Last week, I gave you my plan, and here it is again:

The Plan Going Forward

Last week I said:

First, we are not out of the woods yet. The sell off after the bailout bill was passed proves that. So, for downside protection, I bought some RSW – Rydex Inverse 2X S&P ETF. This ETF is designed to go up by twice as much as the drop in the S&P. I bought it early Friday afternoon, and it sharply increased after that, so I’m actually in the money on that one. I assume that once earnings season starts, followed by tax loss selling season, the market will continue to fall, so I want to be protected. RSW is now 7% of my portfolio, and I will probably increase my holdings on up days.

Well, RSW closed the week up 43%, so that was nice insurance to have.

I will also continue to hold the solid gold stocks, like ABX.TO – Barrick Gold Corp., AEM.TO – Agnico-Eagle Mines Ltd., K.TO – Kinross Gold Corp. and G.TO – Goldcorp Inc. They got hammered on Friday, but that will probably be a good excuse to buy more next week (and I was buying on Friday).

(As another aside, just think how much more profitable the gold miners will be now that the cost of oil has dropped; they use a lot of heavy machinery, so that will help them).

I am now officially exhausted, and since it is Thanksgiving weekend here in Canada I won’t be watching CNBC. The weather is supposed to be great, so I’ll be spending the weekend outside. I’ll resume my worry about the end of the world next week. I do however think the market will continue to go down the toilet, hence my title this week: Circling the (toilet) bowl on the way down.

I’m exhausted, but you are welcome to respond on the Forum, and I encourage you to do so.

Thanks for reading, Happy Thanksgiving, and see you next week.

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