Important lessons on trading

This is an interesting interview and it is worth some comments for our education

I had heard Peter personally in Vancouver about 2 years ago. Peter is a very articulate, charming, eloquent, convincingly, humorous, and assertive speaker.

However, what he is doing is actually dangerous for investor.  He holds the same views as a number of commentators and economists like Michael Pento,  Marc Faber, Peter Grandich, Doug Casey. They are all bullish on gold and silver;  bearish on the market, bearish on Treasury and very  bearish on US dollars.. These are the gold bugs, conspirator theorists, dollar bears and Fed hater. Their predictions were terribly wrong for the last 4 years.  Everything is moving in opposite directions to what they predicted.

I do not see how you can make money when you missed one of the biggest bull markets in the last 4 years. The dollar and treasury have  gone all time high and gold collapse 70% from the peak. 

There are important lessons that can be learned from what happened.

First the market has a way to inflict maximum pain. It will move violently and causing the the maximum number of people to lose money.

Sir John Templeton” The market can stay irrational longer than you can stay solvent.” Fundamentally, they could be right. I believe gold and silver will go up eventually. I believe the easy monetary policies globally will cause a catastrophe longer term and I am actually frightened to think of how it will end. But by the time the fundamentals catch up with the market probably in a few years, you will probably have lost all your capital. This is how many hedge funds blew up from time to time.

Peter Schiff came with an emotional baggage. His father had a unpleasant history with the Fed and the government. You can read it on  http://en.wikipedia.org/wiki/Irwin_Schiff.  His strong views probably have to do with what happened to his dad. Carrying this baggage into your trading is not going to work out well.

Trading or investing or speculating or gambling – whatever you call it has to deal with uncertainty. Even though one may have certain sets of conviction, one needs to be ready to acknowledge being wrong at least for the short term. But stubbornly clinging to your set of beliefs will eventually end up in disaster. As with gold bugs, when the price goes down, they blame in on manipulation by Fed and big banks. They will still find reasons to justify why gold will go up to the moon. When challenged about his prediction 2 years ago, he started to bring up how he was right in predicting the credit crisis. I think the easiest to lose success is to become convinced that you are successful.

.A trade or even an investment has built in volatility and risk. A good investor never believes in absolute certainty. A successful investor manages volatility and change.  Never fall in love with your views and ideas. There will be mistakes, losses and you will be wrong from time to time. The market has a way to keep you humble

The market is inherently uncertain. Any trade needs to start with a clear plan. The plan manages possible scenarios and losses, not to predict the future and profits.

Control you losses is one of the most important keys to a successful trader. Learning how NOT to lose money is more important that how to make money.

Finally, one of the cardinal rules of trading is “The trend is your friend”. Do no fight the trend. Technical signal trumps fundamental for the short term. Be patient and wait for confirmation of price action to fundamental directions before jumping in.

Reflection the a Future End Point

It does not seem to be happening but it is coming.

A friend sends me the following interview. http://www.thedailybell.com/29047/Anthony-Wile-Antal-Fekete-Gold-Backwardation-and-the-Collapse-of-the-Tacoma-Bridge.   It is difficult to listen but it points to the end point to which all these craziness happening in the world today. There are plenty of books and websites describing similar scenarios. The more balanced views are those by Jim Rickard “Currency Wars”,  Mauldin “End Game" Niall Fergusion "The Ascent of Money". There are the more extreme views  by like Prechter and Peter Schiff.  While I dismiss many of the Armageddon forecasts, I cannot deny that we will somehow end this modern experiment of Keynesian economics quite badly.

Technically, UK, France, Spain, Portugal Japan are bankrupt. Japan has reached 250% of debt to GDP

US is the biggest debtor in the world. It debt has gone from $800 billion when Obama took over to $3.2 T now. The balance sheet is growing exponentially.  

Fed is buying ¾ of the Treasuries issuances now. It is a matter of time, they will be buy 100%.

Since 2008, there is an injection of $20T into the market globally. Wonder why the market having a great time in an environment of anemic economic growth?

Total world debt is $250 Trillion excluding unfunded liabilities. Out of this amount, there is easily a 10% bad debt which is around $25 T.  The actual bad debt is most probably 33% which is around $70T. This is the same amount as the total world’s GDP. Add to this are one quadrillion of global derivatives accumulated during the 2008 crisis. Most of it is worthless now.

From March 2009 when the first round of quantitative easing began, central banks have cut interest rates a total of 515 times and injected $12 trillion into markets.

Keynesian economists point to the “escape velocity” needed to get us out of the poor economic environment. We will really need rocket fuel to get us out of these debts. All these scholarly discourse does not tell us how the debt will be repaid!

It is still partying time in the market. When this party will end, it is hard to conjecture. With all the manipulation and coordinated pumping of liquidity, the party can continue for a while. But it will end badly.

One cannot be too pessimistic short term or you will lose the intermediate gains which can be huge. If you follow the doom day scenario after the dot.com bubble around 2001 and housing crash on 2008, you would have lost huge opportunity to make money on the rebound.

But it will end. When it ends, a number of things should happen.

First, there will be a return to value which means assets which retains the value will go up in prices. A reset of the financial system will occur ending the experiment.

Second, there will be inflation or maybe hyperinflation.

Third, there will be a collapse of major currencies.

Finally, there will be massive bond and treasuries collapse ending the 30 years bond bubble. The price actions on the last few days points to bond prices breaking down. We should know by next week whether this is happening.

This is the black swan that will one day appear. It is not a question of whether it will be appearing but when.

These are all facts not some dreams, illusion or scholarly theories or formulae. These are empirical data and not theoretical assumptions of economics.

I shudder to think of what could happen.

Big disconnect in the market

I believe in fundamentals. But fundamentals can lag price action for an extended period of time.

This is exactly the current situation. I said this regarding gold in my previous post.

Most of the fundamental economic indicators are weak and market is on a historic move without a 5% correction for the longest period of time.

• April PPI is: -0.7%.
• May Empire State: -1.43%
• March Factory orders: -4%
• April NFIB index of small business Optimism a weak +2.5 to 92.1

Where are the effects of sequestration? What about the fiscal cliff? It is completely forgotten now. Is'nt there supposed to be tax increase with Obama's administration? Obviously, the tremendous amount of liquidity pumped into the market is having its effect.

Market ignore the economic data and trade like a teenager – buy and buy. People are being Abenomics is the real answer to all our problems. Kyle Bass is completely wrong for the time being.

Short players are being squeezed as seen in Tesla, Groupon, Pandora, Netflix and many speculative stocks. Telsla’s rise is historic.

People hate it but are buying it. Feel like the dot.com bubble all over again!

To quote Bill Gross recently: 

Never have investors reached so high in price for so low a return. Never have investors stooped so low for so much risk.

–Bill Gross, PIMCO, 14 May 2013

Old rules of buying the dips are suspended. There are no dips! There is also no sell in May and go away. Another rule says “don’t chase the market”. But if you do not chase, you are left out.

I have been chasing stock cautiously through naked puts and the stock keep running away from me.

In a normal market, I should have made a lot more money. In a way, I am still underinvested. Making money from naked puts does not help me to run with the market. Also, my core positions in precious metal is dragging my portfolio down.

Although this market makes me nervous but I am participating.

However, in this business, it is important to keep your eyes on the exit door.

Once it happens it can be really ugly. But for the time being, I expect the market to melt up

What are my strategies now?

I expect the market to melt up. I will remain bullish as long as the trend tells me so. Buy those that is showing strength and sell those showing weaknesses.

I will continue to use naked puts to get into positions with a clear exit if I am wrong.

Market will return the mean over time but this excess could extend for a while. Exponential rising or falling market WILL go further than you think although it is not permanent. The greater the excess in one direction will lead to an opposite excess in the other direction. A good trader will make more money than a “buy and Hold” investor.

Whenever there is a conflict between price action and fundamental, follow the price action. Never trade against the trend. I must keep strict discipline to my weekly regression trend channels. Never let confirmation bias influence my trade.  In many cases we are breaking off on a stage 2 rally of market cycle. Enjoy the ride while you can but remember to say good bye when it is time.

It is my belief when it breaks, it can be very severe but it may be a while before this occurs. It will come like a black swan where nobody expects.
 

Historic price actions for gold

It is time that I put up a new post on precious metals. 

It has some historic moves. As I write, it is hovering around $1,350 an ounce. That's a 28% drop from its all-time high of $1,895 on September 5. It's the biggest two-day drop for gold in 30 years! This was also the biggest back to back drop sinc 1983.

Gold is still at its most oversold level since 1999.  Let me give you a perspective in a different angle. The amount of paper gold sold is equivalent to 100 years of production allegedly sold in one day. Comex traded an amount greater than the total above ground silver stores on the entire planet. 

Dr Craig Roberts made the following comments:

"Consider the 500 tons of paper gold sold on Friday. Begin with the question, how many ounces is 500 tons? There are 2,000 pounds to one ton. 500 tons equal 1,000,000 pounds. There are 16 ounces to one pound, which comes to 16 million ounces of short sales on Friday.

Who has 16 million ounces of gold? At the beginning gold price that day of about $1,550, that comes to $24,800,000,000. Who has that kind of money?"

What is happening?

Gold has had a dozen reasons to rally over the past six months. 

• the European monetary crisis, the Italian elections, the Spanish elections, 
• the Cyprus bank account seizures
• sequestration 
• the fiscal cliff, 
• Ben Bernanke’s QE3
• the Japanese ultra QE
• rising capital gains taxes
• the reelection of president Obama.
• negative real interest rates in the U.S. ...
• $7 trillion more in federal deficits ...
• multiplied our monetary base at the fastest rate in the history of this country and we're still printing approximately $85 billion a month ...
• Central Banks around the world are now engaged in currency wars to see who can devalue their money even faster ..

But it is not acting with the fundamentals. So short term, I stay bearish.

I am over hedging many of my positions and actually taking advantage of the downward momentum to make some money. But one has to be very vigilant. A rebound will be fast and furious. Thus, I will be ready to take profit very quickly.  It is a difficult play. For small positions, you might keep it and average up when the trend is back.  You can easily be whipped sawed if you short.

It is actually hard to conceive how one can be bearish in precious metals in this environment. 

Seth Klarman, the legendary value investor and head of the Baupost hedge fund described the situation like this in his annual letter:

"The short-term palliatives we are currently pursuing go against everything a long-term-oriented society should aspire to achieve. Today's policies encourage spending over savings, reward the profligate over the prudent, and support the failing at the expense of the successful. The antidote now being dispensed puts us squarely in uncharted territory in which the risks are outside the range of historical experience..."

We believe the world's economy is now entering a kind of blind alley. By willfully abdicating the responsibilities of the markets – by monetizing our debts, by deliberately inflating our currencies, by bailing out failed companies, and by promising to deliver more benefits than can be afforded – the major economies of the West (including America's) have chosen the path of socialism."

Besides, there are reports of  extraordinary physical deliveries, not just through London but also every other major global center including Shanghai. I cannot verify this but I believe it is true. There is record demand for metal from the US Mint. The official Chinese confirmed 90 metric tonnes of metal import in February  alone.  

Two weeks ago, ABN AMRO  failed to deliver the physical gold of customers that were in their vault. This is technically a default. 

These are all anecdotal evidence that there are bullish forces for gold despite the extreme bearishness of price actions right now.

There are possible reasons for smash of gold prices too. 

Many gold bugs scream conspiracy theories and manipulation. I reserve my judgment on this. 

It is possible that the world is dumping hard assets of every description and pouring the money into paper ones. Commodities you can drop on your foot are getting dumped, and generous premiums are being paid for anything that can be created with a printing press. It is hard to believe but it is the way price are moving now. If this is true, it is short sighted and the trend will not last for long. 

This is also why both bonds and stocks going up at the same time, a rare event in capital markets. In effect, everything is now a bond, both the wide array of fixed income securities that are getting chased, along with dividend yielding stocks. This is why a wide swath of technology stocks, like Apple (AAPL), are not participating in the game. 

Some funds will be in trouble. The recent yen volatility has got some speculative funds into trouble. For that matter, when markets moves violently, there will be funds in trouble. The easiest thing to do to cover margin calls and redemption from customers is to sell including your long term gold holdings. John Paulson's fund is one of them. With the current gold price movements, I believe more funds will be in trouble. Margin clerks will be quite busy right now.

It is also that central bank printing is losing its impact on the markets. There are too much debt floating around the globe and there is not way central bank money printing can offset it. With the austerity in Europe and United States, there are overpowering the inflating impact of money supply.

Interestingly on the contrary,  Japan’s new aggressive policy to devalue its currency is also not bullish for gold. Japanese investors are plowing their money instead into their own stock market, and my sources tell me loads of Japanese capital is also fleeing to our stock market. People are looking for safety in cash and stocks.

All that matters is whether the sellers are in control or the buyers. All that matters is whether the market is in a bull market or a bear market and that is ALL YOU NEED TO KNOW. Trying to figure out why gold is dropping right is the wrong thing to do now. It is dropping because it has been in a bear market for almost two years now and at the end of bear markets you can get crashes and extremes in bearish sentiment as every person who is a potential seller finally sells in a giant capitulation.

When is the bottom?

Now, how do we know when it the bottom.

I will use silver for the analysis as it is highly correlated with gold. 

From a historical perspective, there were 5 major crashes in the last 10 years. I should say the bottom is quite close.

 

You can also examine the COT just before the crash, silver short is the highest in 2 decades. 

Lastly, lets look at Gold miners' bullish sentiments.  I wonder how low can it go. It is usually a good contrarian indicator.

As for gold stocks. the valuation really cheap. They are so cheap that no one wants them anymore.NEM is paying a 5% dividend. The gold stock ETF GDXJ is paying a 6.13% dividend.

When will I buy?

So, it is my belief we are in a capitulation phase. The volume transacted also pointing to this direction. We are near the bottom.

The mistake is usually made when one tries to catch the bottom. I will let the price actions show me the bottom itself. 

My guess, is that there will be a some strong rebound within the next few days. After that, there will be selling. The strength of the selling usually establish the bottom if it clearly stops at a higher low. Normally, it results in a cup and handle, head and shoulder or saucer formation. It is better to wait for the pattern to demonstrate itself. It needs a lot of patience. You can make good money trying to catch the bottom but you can lose big too.

Also, there could be be quick reversal with "a morning star" candlestick formation and reverses straight up. This is less slightly scenario unless it is followed by some clear fundamental events. A lot of technical damage has been done.

So when only when some bottoming action manifests itself,  you can start bottom fishing with naked or bull puts. Be very careful. If you are wrong, exercise your secondary exits which I had outlined in various posts in this blog. You may need to test the bottom a couple of times before getting it. If you are careful you will not be burnt and may even make some money as the price continues to move down. With options, the volatility allows you to safely test the bottom.

Once you are right and trend is clear, go with stocks or covered calls. If there is momentum, I will go with call calendar and calls.

The actions over the last few days show that some historical change is happening.  Eventually we will see the end of the Great Keynesian Experiment. Gold, commodities and hard assets will resume its appropriate positions in your investment assets. 

When it happens, these are the extremes in the market that helps in extraordinary gains.