Deliberate Destruction? Crooks, Thieves, Liars?

Like many traders, I've been having a rough go of it for the past month. It has been one of the toughest months I've ever had. At this writing, I have no trading positions, and am down to my bottom line core positions (2 stocks, 3 mutual funds) and mostly in cash. Because I have been so overweighted in commodity type stocks, this selloff has been particularly vicious.
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And yet, my opinion has not changed. The people who hate commodities and tell you that they are/were in a bubble cannot have it both ways. If the economy and the markets do well, then commodities must also. If commodities go into the tank, so does everything else. The reason is simple. This time things are different. China, and to a lesser extent India and the other Asian economies, have permanently altered the demand in the supply and demand equation.
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China is bent on becoming the world's superpower. When I think China, I think Germany 1936. Just as Germany tried to use the 1936 Olympics to impress the world, I expect China to do the same in 2008 when they host the Olympics.
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There is already a worldwide shortage of some commodities, copper for example. That makes it frustrating to hear that a stock such as PCU is bubble like when it has a trailing PE ratio of 6.85 and a projected PE ratio of 5.32 for the next 12 months, grew its revenue at 18% YOY (year over year), paid out 11.6% in dividends over the past year, and had 61% return on equity and a PEG ratio of 0.32 (all figures from Yahoo Finance).
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Or XTO, which is my all-time favorite, not because it is the best stock ever, but because it has been the one that has been the best to me over the years. XTO has a trailing PE of 9.42, a projected forward PE of 8.83, 0.47 PEG ratio, 39% return on equity and 91% YOY revenue growth. They also spun off shares of royalty trust HGT to shareholders this past year as a special dividend. Doesn't seem like a bubble to me in any way, especially compared to some of the 'glamour' stocks that we hear about all the time. Some of those stocks are not profitable, and won't be for a long time, if ever, but are still media darlings.
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Take Sirius Satellite and XM Radio, for example. I had a conversation with a man several months ago who thought that XTO and oil and gas stocks in general were 'too risky', but he was heavily into Sirius (SIRI). The stock has wide coverage and gets a lot of publicity by the talking heads. It has no PE or PEG ratios because it has never turned a profit and even at its current price sells for over 17 times revenues, not earnings because there are no earnings. It returned a minus 233% to its investors. But it's all good, no bubble there.
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Two interesting articles this morning caught my attention:
Mark Cuban, known mostly for being the owner of the Dallas Mavericks, though he made his fortune by selling Broadcast.com several years ago in the dot com era, is going to start a web site that will investigate the crooks in the business world. It will concentrate on stock fraud and other corporate wrongdoing. Should be no shortage of material there, and it promises to be very interesting if it gets going.
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The second was an article entitled Crashing The Dow by Alex Wallenwein. He is the editor and publisher of The Euro vs Dollar Currency War Monitor and he makes me feel like a flaming liberal. His contention is that the central bankers of the world are coordinating their efforts to collapse the commodities. That does make sense to me and would explain a lot of the relentless selling we have seen in the past month. When you are on the opposite side of the central bankers you are up against the deepest pockets and almost unimaginable powers in the world. Lots of charts and documentation in this article, and well worth the read. Some startling political commentary as well. Please read.
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Markets are due for a bounce, and the futures are up this morning at this point. It is also options expiration week, a week where trading is often unpredictable in the best of markets as option positions unwind and the markets try to hurt as many participants as possible. Paranoid? Perhaps, but there is even what is called a Max Pain barometer, a calculator that computes the figure that would hurt the most option traders at expiration. The result is the Max Pain number. Some traders use that number as a target for trading in options expiration week.
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The trend is solidly down. It will be down until it changes and starts up. Too simple? Just follow the money and try to stay out of trouble until the PTB (powers that be) decide to take it up. The IBD philosophy of waiting for the follow through day after a rally attempt is one good way to stay out of some trouble. Lots of differing opinions out there.
...I subscribe to Louis Navellier's Marketmail, a free weekly newsletter. Louis is usually bullish. In the latest Marketmail he thought the market had found a bottom last Thursday, was oversold, and this was the best buying opportunity of the year. On the other hand, 'dcb', a ClearStation pundit, says that the trend is solidly down, the bear market has resumed, and all rallies should be looked at as selling opportunities. I respect both these guys and their opinions, but they couldn't be more opposite in their outlooks. For the record, I agree with dcb.
...I also believe that we are undeniably in the last days before the return of Jesus Christ, and yes, that does affect my outlook on the markets, the economy and most everything else. See my other blogs for more on that, as this blog is for investing.

06/08/06 Pre-Market

...Pre-market futures down sharply. Overnight, world markets took another whacking. India's Sensex markets dropped 4.7% overnight, and are down 11% in the past week, and 26% since May 10. There was some talk about mutual funds redemptions forcing some of the selling. Stocks in most Asian markets are at their lowest levels in months, so the damage has not been just here in the U.S. markets.
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Commodities...
...Commodities have been getting slaughtered. I know most other things have been too, over the past month, but commodities in particular have just been getting hammered unmercifully. I have been down to my core positions, no trades for a couple of weeks, and even those small positions are being slaughtered relentlessly. It has been one of the most vicious selloffs I have experienced. It is not unusual to have sharp volatility in commodity related stocks, but this still has an extraordinary feel to it. I still maintain (see previous blogs if interested) that if the markets and the economy are to hold up, then commodities will as well. That makes the way they are acting now even more worrisome.
...Yesterday, I linked the interview with Jim Rogers, a legendary investor who is heavily into commodities and thinks that we are in the midst of a bull market in commodities that will last for several more years. Today, a couple of more things.
...Alan Greenspan, the former Maestro of the Fed, was on Capitol Hill yesterday. Unfortunately, Mr. Greenspan's testimony doesn't seem to be nearly has difficult to decipher now that he is no longer in the main chair. But his comments on oil were enlightening to say the least. Apparently the ex-Maestro believes the peak oil folks. He is skeptical as to whether there will be enough crude pumped to meet future demand. And in a striking contradiction to the folks who tell us about demand destruction and how the oil markets are only high as a result of fear and speculation, get this comment from Mr. Greenspan:
..."The balance of world oil supply and demand has become so precarious that even small acts of sabotage or local insurrection have a significant impact on oil prices." It's a good thing everything is so peaceful geo-politically on the world scene today, eh?
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A Behind the scenes explanation for the commodities selloff? Fascinating article on TheStreet.com website yesterday. The article says that the public warnings on high commodity prices by the Fedspeak folks have aided in the commodities selloff, but that behind the scenes there has been something else going on that had big implications and was only staved off by the cooperation of the IRS, of all things. Apparently there was a deadline approaching for commodity mutual funds to adjust their portfolios to come into line with new regulations. Many of the funds had been using types of derivative deals in the management of their funds. Unwinding all those deals could have been disastrous to those funds and the broader markets as well. I don't understand much about deriviatives at all, but this article is well worth the read and may explain some of the relentless onslaught of selling that has been going on in the commodities markets. And unless this is the 'big one', is it setting up another good buying op? Only time will tell.
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...About all I know regarding derivatives is that they are very complicated and allow for tremendous leverage on deals. Warren Buffett has referred to them as weapons of financial mass destruction. An insurance company his group purchased had a lot of derivative transactions going, and Mr. Buffett has spent millions of dollars over recent years trying to unwind those deals.
...I also remember a couple of years ago some of the gold bugs were stating that some of the major investment banks had derivative deals going that exceeded the GDP of the U.S. economy. I don't know about that, but this selling has been relentless. Bounces are tepid and don't last long. Doesn't seem like anybody wants to step up to the plate right now, whether the markets are oversold or not.
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06/06/06 Updates and Links

...Best Is Yet To Come, Says Superbull...Adding this to my rant a few days ago on commodities. Jim Rogers, one of the most famous investors in the world, weighed in again in an interview with the Guardian UK newspaper regarding commodities. Rogers says there is no bubble and the bull market in commodities likely has years to run. The whole article is here.
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...The Greater Depression - an Update...That's the title of another article that caught my eye today. This one is by Doug Casey, a longtime guru who pretty much believes we are in for a depression. The only question in his mind is whether it will be a deflationary depression, as in the U.S. in the 1930's; an inflationary depression as in Germany in the 1920's; or a combination of the two, in which the bond and real estate markets collapse, but the cost of things we need to live our daily lives, such as fuel and food go up. A thought provoking quote from the article: "The problem with debt is that it artificially increases our standard of living. But when we pay it off, especially with interest, it reduces our standard of living in a very real way."
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6/6/06 Notes

THE RALLY IS DEAD, LONG LIVE THE RALLY

Using the criteria set forth by Mr. William O’Neil, the founder and publisher of the daily IBD newspaper, and author of How To Make Money In Stocks, the latest rally attempt has officially failed. Mr. O’Neil’s criteria changes somewhat from time to time, so I am not sure what the exact parameters are nowadays, but I don’t imagine they are much different than formerly, i.e., when the market rallies off a new low on at least one percent higher volume, that marks the beginning of a new rally attempt. As long as any subsequent session does not undercut the low of the rally attempt, the rally lives. Sometime in the first ten market sessions in the new rally, a follow through day must occur to demonstrate that the rally has legs and has a chance to succeed. A follow through day, the last I recall, was another up day on higher than normal volume. The best ones occur between the 4^th and 7^th market sessions from the start of the new rally.

Mr. O’Neil is fond of pointing out that rallies may fail even after a valid follow through day, but all true rallies have always had a follow through day. In the last version of his book How To Make Money In Stocks that I own, he mentioned that occasionally deep pocketed institutions can paint a picture of a rally by forcing a follow through day, only to have the rally subsequently fail. I do not recall if he mentions the intent of the institution that does this. Are they doing it to try and get a new rally started, in the hope of inviting others to join them? Or are they luring in the small fry money that is attracted to momentum in the markets much as a bass is to a shiny lure?

I also have to debate whether ‘occasionally’ is the correct word in bear markets. I did a study back in the 2000-2002 bear market. I checked each occurrence of rally days and follow through days. During that prolonged bear market, you would expect to see that almost all of the rallies failed at some point. But it was still surprising to see how many ‘follow through’ days occurred like clockwork four to five trading sessions into the latest rally attempt, only to fail miserably shortly thereafter.

Yesterday’s big selloff undercut the latest rally attempts on all the major exchanges. So we start counting again, waiting for a brighter day – unless you are short the markets. But shorting is a game that most of us small fry do not like to play.

If you do not go short the markets or individual stocks, then there are periods of time when the best thing to do is sit on your hands and do nothing. This is one of those times. The most important single rule of trading is to cut your losses. If you limit your losses you can survive rough periods and live to trade again when the storm has passed. In my own trading I once had twelve losing trades in a row, and twenty out of twenty two. As devastating as that was psychologically, because I put strict loss limits on my trades, I was able to survive that slump relatively intact.

One of the books in my trading library is How I Trade For A Living by Gary Smith. In that book, Mr. Smith recounts how he was unsuccessful as a trader for about 19 years, basically treading water. But then he found his system and has been consistently profitable since, at least as of the date of the book’s publication. Amazingly, AFTER he has his epiphany, Mr. Smith went through a string of 23 consecutive losses. I cannot imagine how he felt he was finally on the right track while going through that many losses in a row.

My system of trading incurs a lot of losses. My best trades are trend trades. I never know going into a trade whether that trade will work or not. The best that I can do is wait for the criteria I use to line up, put the trade on, and then use money management strategies while in the trade. Sometimes trades work and sometimes they do not. Looking for trends, I know that statistically I am going to lose at least 50% of the time. That is why money management is crucial.

Mr. O’Neil points out why avoiding major losses is so important. If you do not cut your losses, the mathematics of trading start working against you in a big way. For instance, if you allow a trade to move against you by 50%, then you have to double your money from there just to get back to even. That’s a difficult chore and not something you want to be forced to do very often. If you lose 25% of your capital, you will need a 33% return from then on just to get back to even. Mr. O’Neil recommends setting your initial loss limit on a trade at no more than 8%.

The longer I trade the less attention I pay to technical indicators. I have concluded that big players often paint the charts to lure other traders to jump, then pull the rug out from under them. I have seen that over and over through the years, perfect chart patterns, where all the indicators were lined up in almost certain can’t miss alignment, only to immediately reverse and trap everyone who fell for the bait.

There is an old trading axiom that there are no rich chartists. I doubt that is true, but I certainly understand the sentiment. Most of the traders on the stock bulletin board I frequent are dedicated chartists and they continually get blown whatever direction the market wants to move them.

Having said all that, I do think it is worth mentioning that Dow averages failed at their 50 day exponential moving averages (ema) last week and again yesterday, and that the Nasdaq composite has not been able to penetrate its 200 day ema to the upside. The 50 day and 200 day averages are significant because they are yardsticks used by many major institutions. The 200 day average is often referred to as the bull/bear line.

There are many things lining up all around the planet that have at least the potential to create the financial equivalent of a perfect storm. I believe that we have entered the last days before the return of Jesus Christ. I write more about that on my other blogs if you are interested in checking them out. I am not pessimistic, because I have read the ending in the Book, and the good guys win. But there will be a lot of stuff happening in the meantime.

Why I Still Like Commodities

This past month was one of the toughest I’ve had in the markets in quite some time. I know that is not unusual in any sense, as it was a tough month for most folks who were long common stocks. For me, it was particularly rough since I have been so much (too much?) overweight in energy and commodity stocks.

I just read where quite a few hedge funds gave up half their year to date gains over the past month due to the commodity correction. I have also seen quite a few articles recently on why oil and commodities are speculatively priced, are a bubble, and why they must come down. I think most of those articles are self-serving and wrong. There are always corrections in a bull market. In the world of commodities, those corrections can be particularly stunning in their viciousness. But, unless the economy goes in the tank, the odds favor this being just a correction in a longer term bull market, not the end of the commodities run.

In my opinion, the folks who are stock market bulls and commodity bears cannot have it both ways. If the economy and the markets are going to do well, then so will the commodity stocks. We are taught that when anyone says, “This time is different,” that we should immediately run the other way. Of course, many of the same folks who give that advice now did not recognize a bubble when it consisted of technology stocks in 2000.

But I believe this time is different. Every so often in history something comes along that changes everything forever. Electricity, machines, gunpowder, nuclear fission all come to mind as examples. The rise of the Asian countries, particularly China, may qualify as such an event. China has decided to become the world’s power. That requires all kinds of build ups in their nation’s infra-structure. That requires commodities. The rise of China, and to a lesser extent, India, the world’s two most populous countries will ensure that commodity prices stay overall higher, as there will be ever increasing demand chasing a more inelastic supply of natural resources.

Periodically we read where China’s growth is going to slow, but then we see a couple of months later that it did not. As I have said before, when I think of where China is right now, I think Germany 1936, when Hitler wanted to use the 1936 Olympic games to showcase his nation’s supremacy. China is hosting the 2008 Olympic Games. They want to become the world’s superpower. What are the chances they are not going to try and impress the world with their majesty and grandeur during the Olympics? That is going to require a continuing buildup of their infrastructure. And that is not even including all the resources they will need in other areas of their society to pursue their vision of world power.

This is the only scenario that makes sense to me UNLESS there is some event that truly does create demand destruction for the world’s natural resources. It is difficult to see how an event of that magnitude would also not take down the economy and the markets with it at the same time. So we’re back to square one. If the economy does well, then so will commodities.

Over the years I have learned that successful trading means blocking out as much of the noise as possible from Wall Street cheerleaders. There are some folks I have watched for years who have never seen a bad time to buy stocks. No matter what happens, it is a good time to buy something. Some of those folks are very well known and get a lot of tv time to espouse their gospel. Most permabulls do not like commodity stocks. The reason is simple. There is only so much money available for buying stocks. Every dollar that does into commodities does not go into the stocks they pump. Further, money that goes into commodities is, in a way, a vote against the permabull happyface mentality that Wall Street projects to the public.

Consider the source of the information you get (yes, including what you are reading right now. All decisions are ultimately yours.). If you went to a Chevy dealer for advice on buying a car, do you think he will direct you to the nearest Toyota dealership? Have you ever noticed that mutual fund oriented advice basically tells you that you cannot time the markets and that you cannot make your own investment decisions, that you should leave them to the professionals? Yet most commercials for the discount brokerages give you the exact opposite advice. You can do this, they say. And then there’s the full service brokers. You need to pay for their expertise, they tell you. It seems to me that most of the advice is predicated on the financial welfare of the party giving out that advice.

If the commodity stocks do not make a comeback fairly soon, I will be taking that as a canary in the mines warning. Be careful out there.

NoTouch Portfolio Results thru 5/31/06

...Tough month. NoTouch Portfolio down 2.7% for the month. But it is still ahead 6.1% year to date, which handily beats the major market averages:
Year to date returns:
NoTouch 6.1%
Dow 4.2%
S&P 500 1.7%
Nasdaq -1.2%
Nasdaq 100 -4.0%
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May 2006 results:
NoTouch -2.7%
Dow -1.9%
S&P 500 -3.2%
Nasdaq -6.5%
Nasdaq 100 -7.4%
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We are in a particularly interesting time in the markets. More to come...Just wanted to post the NoTouch results for now.
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