This Week’s Commentary – October 20, 2007 – Finally the Buying Opportunity We’ve Been Waiting For?

by JDH on October 20, 2007

The purpose of this website is, quite simply, to help me learn from my mistakes. I’ve been investing for over 20 years now, and in that time I’ve learned that the best way to improve is to learn from your mistakes.  I assume that if I write down, in blog form, why I made the decision that I did, I can look back on it later and learn from both my wins and my loses.

This year has been a down year. At the moment I am down 27% on the year. When you compare that to 2006, when I ended the year up 94%, this has not been a good year. Clearly, down is not as good as up. I have made some mistakes this year. I did not take profits when the markets were up. It’s not a profit until you sell.

Does this mean I am ready to jump off a bridge?

Not at all. Here’s why:

First, the market is cyclical. At the end of September, 2006, I was up 6.1% for the year. That means that in October, November and December of last year my portfolio increased by 88%. The last quarter of 2006 was the year, thanks largely to uranium stocks. I’m not jumping off a bridge, because we are now moving in to the best part of the investing year, and I don’t plan to miss it.

As students of history will see, the resource stocks tend to peak in the spring, fall in the summer, bottom around September or October, then go on a tear until the end of the year. They pause a bit in early January, then run up to another peak in the spring. The exact dates are not the same each year, but the trends are similar.

Why is this? The market drops in the summer perhaps because everyone goes on vacation. If you are on vacation, you aren’t buying. It’s also possible that junior resource companies drill during the summer, and release the results in the fall. It could also be that it has always been that way, so the market repeats itself.

The second reason I am not ready to jump off a bridge is that, as the chart on the right hand side of this page shows, it appears that the price of uranium has finally bottomed out. After falling all year, it appears that the trend is turning back upward, and that’s good for uranium stocks.

The third reason I am not ready to jump off a bridge is that, over the last month, the market has unfolded pretty much as expected.

On September 22 I said: “The low point was on August 16. Since then the market has recovered somewhat. Is the damage over? I don’t think so. I still stubbornly believe that we have to retest the lows before we can rise again.”

On September 29 I said: “October will be the month to do a lot of buying, but that does not mean that October 1 will be the exact day to do a lot of buying. The markets have performed well the last few weeks. Uptrends don’t continue every day, day after day, for 100 days in a row with no down ticks. We will have a day or two, probably more, in the next two or three weeks where stocks pause. That’s the time to add to positions.”

On October 6 I said: “Given this uncertainty, the only logical strategy, as discussed last week, is to begin buying, very slowly, and with stink bids, to gradually accumulate a position during the balance of October, in anticipation of a much higher November and December.”

Well, it’s hard to argue that yesterday, October 19, 2007, the twentieth anniversary of the last “Big One”, was a down day. Of all of the stocks in my JDH Target Portfolio, most were down on Friday, by on average 1% to 4%. That sounds like a buying opportunity to me.

I have started buying, with a plan to get my portfolio allocated as described on my Top Picks page.

However, most of the stocks have not reached my “stink bid” level, so I’m not fully invested yet. In fact, as of today, I am still holding 47% of my portfolio in cash. Having said that, here is a list of the stocks that I believe have fallen enough that I can now accumulate the full position I want to hold:

So, what’s my plan? On Monday, which may very well be another down day, I plan to accumulate the rest of my position in the stocks listed above. I will also continue to monitor all of the other stocks on my JDH Target Portfolio, and if more of them come into the buying range I will be a buyer.

I assume that by the end of this month I will be close to fully invested, in anticipation of a very strong November and December.

Covered Writing

As a side note, for those who are interested (which I realize is not many of you), this past month I covered a number of stocks (meaning I owned the stock, but I sold call options, which gives the holder of the option the right to purchase my shares at a set price).

On October 4 I sold 10 contracts of the PAA October 30 calls for 30 cents; my net proceeds after commissions were $277.51 (since each contract represents the right to buy 100 shares). I also sold 10 Silver Standard October 38 calls for $427.51, and 10 Uranium One October 12 contracts also for $427.51.

Since the price of PAA.TO – Pan American Silver Corp. and SSO.TO – Silver Standard Resources Inc. and UUU.TO – Uranium One Inc. were below the strike price at options expiration on Friday, all of these calls expire worthless, and I get to keep the premiums collected of $1,132.53. This is exactly how I wanted to play it. I like the underlying stocks and I want to own them, but I was also worried that we were still in a correction phase. Since I can’t time the market perfectly, I wanted to have my cake and eat it too. If the stocks don’t go up much, I increase my returns by pocketing the options premium. If the stocks do go up, I limit my profit, but I still own the stock, so I still win. In this case these three stocks did not increase past the strike price, so I keep the premium.

Of course some of my covered stocks increased in value, which meant I had to buy back the options or risk losing the stock. For example on October 9 I sold 20 contracts of the Kinross October 15 call for 40 cents, netting $765.01, and I sold 10 contracts of the October 30 Goldcorp contract for 90 cents, netting $877.51.

Kinross was $15 when I covered, and it closed at $16.35 on Friday, so well I made a nice profit on the stock, I bought back the options at a cost of $2,634.99, for a loss on the covered write of $1,869.98. This loss is of course mitigated by the fact that the stock increased from $15 to $16.35, so I am up $1.35, or $2,700 on the 2,000 shares I am currently holding. Obviously I would have been smarter not to cover this one, although when we have a few more up days I will probably cover again and milk the time premium.

Goldcorp was $30.29 when I covered for $877.51; I repurchased for $1,622.49, for a loss on the cover of $744.98. Of course the stock has increased to $30.73, so on my 1,000 shares I am up $440, so it’s a net loser. However, I like the stock long term, so I’m holding.

Overall, I made $1,132.53 on the options that expired, and lost $2,614.96 on the calls I repurchased, for a net loss of $1,482.43 on my options strategy. This is mitigated by the stock price increase on the two losers of $3,140, so while I made money, I would have made more by not covering the two winners. (The three option winners also increased slightly during the period; the options expired because they didn’t increase all the way to the strike price, so I profited on the stock price as well).

Obviously the flaw in my options strategy has been that I am not taking in much in premium. Pocketing 40 cents is pointless, so I’m not going to cover again unless I can sell out of the money options for a decent premium, which is not easy to do in thinly traded Canadian stocks. This strategy will only make sense once we return to more volatile and hyped-up resource markets, which will increase the time premium.

So, the game plan for this week is to keep buying; I like the drop on Friday, and plan to profit from it over the weeks ahead.

As always, thanks for reading, and please continue to share your thoughts on the Buy High Sell Higher Forum.

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