Europe Insult Diplomacy

Gold and Silver Updates

I am increasing my bullish bias on gold.

Fundamentally, the big picture points to a continuous devaluation of currencies.

Europe needs the EFSF to bailout weak nations in the Euro Zone. Japan intervened the yen to fight against the dollar. The Swiss decided to peg the Franc to the Euro, which is to me a big mistake.

IMF said that there are no resource barriers to solve the Euro crisis. In another word, more money supply and bailouts.

There are increased currency wars and bailouts and thus more money dropping from helicopter.

The fundamental of gold is not being recognized yet by the main stream media and the hedge funds.

Instead it is currently being sold because of liquidity squeeze as hedge fund redemption increased and tighter short term credits because of debacle of MF Global and the European banks.

All of these happenings virtually guarantee that gold will have a bigger role as we move forward. Gold will be the last store of value standing when everything gets wrung out with the euro and then the dollar. Focus is now on the euro but at some time focus will shift to the dollar. We had a spirited gold rally after ECB cut the rate as this was recognition that there would be more money printing. Ultimate reason for holding gold is because of the large amounts of paper printing….eventually there will be so many adjustments and so much pain that someone will want something like gold.

What is not recognized now is gold has no counter party risk. It cannot be created arbitrarily. It has historic intrinsic monetary value. It is a matter of time that it will be recognized.

The negative outlook presents opportunities for precious metal investors.

I am particularly interested in adding to my mining shares. There is a substantial disconnect has developed between the price of gold and the mining companies. Over the last 3 weeks, I have added some juniors and they are doing very well.  The disparity on real valuation and market value is so high that it is a rare opportunity that only comes once every few years.

I may have to wait 6-12 months maximum. In between, I may see another violent corrections although gold price movement is positive now but there are no definite signs clear up trend yet.

What are my strategies now?

I am holding on to a core position of gold and gold mining shares which I will not sell. These positions are hedged. Cost is being reduced through short options and dynamic collar strategies.  I have plenty of cash to patiently wait for the right timing.

Besides I am doing the following:

1. Compile a list of seniors to add on any weakness – a capitulative  bottom followed by a clear reversal. These companies need to fulfill the following criterion:

                                                    i.     Good cash flow and margins

                                                   ii.     Good organic growth without acquisition

                                                 iii.     Efficient production cost

2. A list of junior and exploration companies with the following criterion:
1. Confirm reserve with huge growth potentials
2. Cash to ride through any credit squeeze
3. Potential to be acquired
4. Some companies at advanced exploratory stage and positive preliminary economic assessment with potential for strong valuation growth.

Some of the companies in my portfolio are discussed in my blog posted today. I am still doing my research to gather a group of companies. The companies that I have accumulated over the last 3 weeks are:

1. NAK
2. SQI
3. TMM ( Listed in Canada)
4. NSU
5. TGB
6. SVM
7. SWC
8. SQI ( Listed in Canada )

For the time being, it is my beliefs that companies that I have added the last 2 weeks have the potential to high 80% profit if there is a Santa Claus rally. If there is a major breakdown in the Euro zone, they may another major run down for gold and silver. This negative break down will be fast and may last 2-3 months.  This will be a good time adding shares by selling puts and using the profit to accumulate shares.

I will also sell half my shares if the target of 100% is reached by the end of the year giving my other half a risk free ride.

In summary, the fundamentals look better every day but the technical signals are not convincing and may even break down. Gold at 1800-1840 will be a very important test for resistance.   Price can lag the fundamental for a period of time. So I have to wait for technical signals before going really bullish. Meanwhile, I am trying to maximize the trading range to reduce cost by selling options.

Going for the big profit.

In my trading history, I had missed some profits big time because I was unable to hold on my fundamental convictions.

I was very bullish on BIDU and APPLE at least 6 years ago. I bought the stock and traded in and out  2-3 times for a 30-40% profits with a holding period of 4-6 weeks and thought I was a hero making big gains.  At least it was >100% ROI.

AAPL had gone from $40 when I first bought to $400 now and BIDU has gone from $90 when I bought the stock to >$1300 ( before split ). I missed some really big runs. At least I was able to hold SLW from around $3 sold half of positions only when it was above $40.

Currently, I am giving a lot of thoughts on how to manage for maximum profit on selected trades.  50% of my trades are still short to mid-term swing strategies when I take profit once it hit my target of  >30% ROI annual. These are certainly opportunities where taking profit is a sound practice. It should be done regularly for majority of positions meant for a short to medium trade. These are very profitable, consistent trades

But the big money is also made from a minority of trades  ( about 30% ) I need to hold longer term. Trades can be divided into short term swing trades, long term income trades ( stocks which are stable and has high dividends, and long term  trades with huge potentials.

The big profits are usually made in the longer term trade. I refrain from day trading. I identified the disadvantages of day trading are:

-        short term trades are more random and thus more vulnerable to whipsaw. I deal with the short term volatility with collar trades. It works best in volatile environment. It allows time for the trade to work. I consider this the best tool to fight the HFT and computer algorithm trading. It takes the emotions out of the trade.

-        I loss my edge on fundamentals and hedging

I am trying to maintain a list of stocks that give me the big runs. However, it is a very difficult task. It is not easy on the emotions.  It needs fortitude and convictions on the fundamentals. Very few people are able to capture the full extend of the trade.

Look at 2 examples of AAPL and SLW.

 

A correction can be as high as 61.8% from the top. This is a common retracement level. During 2003, AAPL dropped 82% from the top. This was not a normal correction and was influenced by fundamental events. Apple was on the verge of bankruptcy. It was the return of Steve Job that made the historic turnaround.

What are the steps for trading these high profit potential companies?

1. Identify the companies with overwhelming long term fundamentals. Focus on the big issues rather than the annoyance.  The best thing is to be able to identify the stock at the beginning stage. Many times, you only catch it when it is 1/3 of the way. It can be identified only when the stocks have already started the race. In the beginning, there will be high volatility which the task more challenging. This is something that has to be dealt with.

Note that the same fundamental can be applied similarly for stocks that are at the beginning of a decline. The clearest signs are when the stock is totally over valued with little fundamentals, potential of accounting frauds and obsolete business models. You know that the business model will never justify the PE or Price / sales ratios. Factors driving the stock price are purely momentum, euphoria and greed. When the bubble burst, it can give huge returns. I remembered during the dot.com bubble, I scanned the market and identify 5 stocks that trades with >1000 PE and >500X market cap/sales. I shorted all of them. Initially, I lost some money but when the bubble burst, it was extremely profitable.

It is usually a very tough ride with the high volatility. Option strategies have helped me cushion the volatility and thus control the emotions of fear and greed.

2. Read the technical signals.  Here are some simple but not perfect steps:
1. Look at longer term chart to identify the trend lines
2. Take note of the retracement. 50 and 61.% are common retracement level and seldom it goes above 78.6%
3. Observe the volume transactions
4. Decide the directions of the trends. For these I use Moving Average channels, MACD and overall trend and patterns to make a decision.
5. Look for major breakout with volume. 
3. Use a longer time frame to determine the trend and a shorter time frame to enter the trade. In this case with options, I use weekly charts to determine the longer term trend directions and daily charts to enter the trade. It gives excellent information on the trend for trading use options with monthly expiry. In between, I use daily and hourly to do some trading keeping the core position ( 50%) on the longer term trend. Think longer term all the time for the options to work. Short term volatility will kill the options.  Some short term trades may be initiated but it should be managed as swing trading opportunities only.

4. Never fight against the longer term trend.

I will explain more when it comes to actual examples used.

Once the stock is identified, I intend to keep it long term. Following are list of things I do:

1. For breakout, roll the SC. Let the winner run. The signal must be clear. Do not do it prematurely. It is never too late. Wait for the set up and clear trigger signal.
1. MACD positive
2. MA channel positive
3. Volume increases
4. Trendline positive
5. Break out from a period consolidation
6. Positive patterns – head and should, double bottom, bull flag, cup and handle

2. If there is short to mid term bearish breakdown, preserve the trades and go short term negative. Collar the trade by ensuring that there is a put and a SC. Bring the SC nearer ITM and out in time if it is really negative. It is a risky move as it turns the trade negatively biased. There is a high probability of being whip-sawed – having to take out or roll the SC for a loss if you want to keep the trade.

3.  Alternatively, I prefer to sell a longer term OTM SC and keep the put. When the stock stabilizes, I will cash out the puts and add shares to the stock and protecting it with another put if necessary. Buy a ATM or slightly OTM to protect if still not sure. May have to dollar average 2-3 times before you realize profit for the overall trade.

3. When the stock is trading in a range, sell an OTM call  when the stock hits resistance and an OTM put when the stock hits support. This will reduce the cost while you wait for the longer term trend.

If you decide to go negative short to mid term,  you are betting against your longer term bullish fundamental convictions.  The objective here is to keep investing until the trend is on your side. Use SC, SP and dollar averaging to reduce you cost.

Do not allow the loss to exceed 15% for the overall trade. If so, get out and then decide later. If discipline is exercise on adding puts and SC, you should not hit the stop loss limit easily.

4. When the trend is positive, take out the SC and even the puts and let the winner run. When volatility is high, you can add a SP to reduce the cost of the puts. The put can be removed once the bullish trend is clear.

5. When facing resistance, add an OTM SC. Do not allow the SC to be assigned. Take it out when the trend is clearly bullish. If not sure, just roll it up.

6. When the stock breaks a weekly trend line and indicators go bearish, add a put.

The steps are not easy to implement. It takes a lot of practice and experience.  Focus on keeping to the plan.

If fundamentals change, get out for a loss. If it is properly done, the loss should not be more than 10%. But if done right, the profit will be a few hundred percent.

Lets analyze a few stocks based on the above ideas:

AAPL

• AAPL had many minor corrections. As long as the weekly price does not fall below the MA channel, no puts are needed.
• Use an OTM SC. Points (D) shows that you may need to roll the SC twice before getting a profit.
• If the plan if followed, a put would be added in 2^nd half 2008 correction and dollar average on beginning 2009
• During early 2009, there was a nice consolidation and breakout with volume. It was a clear classical signal. Price clearly broke above MA channels with MACD turning positive and high volume.

Common Fib retracement level for AAPL is around 61.8%



SLW
 

• From the breakout of support at 15, the fib retracement is 61.8%. There is a probability of breaking down to 78.6% level as currently the pattern looks very similar to the pattern in A when it happened in 2008. So although I like SLW, I stay very cautious until I see a clearer breakout.  For this to happen, I like to see the MACD cuts positive ( better with volume ).
• I will trade slightly positive based on a collar with SCs at 40-45.  If it breaks down below 30, a put will be warranted until it breaks above 30 again proving that it is a head fake. If not, the trend can easily accelerated down to 20.
• In 2008, I bought SLW at the highs of $16 and cut loss when it fell below $15. I bought a lot when it went down to below $3 and finally showed signs of turning around. II bought a whole bunch of shares at <$3. It is one of the best trades I made for the last 2 years.
• The important break came in Q 3 of 2009 when it broke 19 ending a 3 years price consolidation. I added to my shares.
• Currently, I have taken profit on SLW and holding on to 50% of my normal position size. I am cautiously technically but very bullish fundamentally. Short to medium term, gold and silver may still experience 1-2 breakdowns. If macro economic fundamentals turn really negative, liquidity squeeze will force hedge funds and bank to sell silver and gold. Junior companies will find it difficult to get funding. If it does, I will be following my plan of adding puts, selling it later, adding shares and adding to my position size. I will control my loss to less than 10% for the overall trade at any time. Upon breaking up, I will certainly let the profit run by removing the SC, adding SP and eventually removing the long puts. For the time being the technical signals are not there yet but fundamentals are overwhelming positive.

There are signs on the daily that SLW is positive.  But it is not confirmed on the weekly. To get a clear bullish signal, it must first break 35 and then 40, which is a formidable resistance. If it does, we are off to the races. Meanwhile, I will trade based on a trading range between 30 and 40 with a slightly bullish bias.

 FCX

• It shows very clear and similar signals on a bullish reversal on 3 occasions on A, B, and C. Each signal comes with a positive break above MA channel, high volume and positive MACD crossover.

• Fundamentally, I like this stock. Compared to 2008, it has enough cash now to ride through any credit squeeze. It is producing copper at 1/3 the price of market thus able to cushion any drastic drop in copper price.

• Currently, my CC for FCX is ITM. I have added an 2X OTM naked put to collect more shares. If assigned, I will convert it to CC or collar depending on the market condition.

 GDX

·       It had a nice run from 2008 and is now trading at the long term support of 55.

·       It is now trading in a range between 55 and 65 more than a year. If it breaks above 65, I will be very bullish.

·       Strategies now is to maintain hedges either with married put or CC. Personally I prefer covered call but if it drops below 55, I will add a put to make it a collar

If my CC is called out because the stock is ramping up quickly above 65, it will be very bullish.  I may have to initiate a new trade with a married put, or call calendar, or just stocks or call.  If it breaks 65 and fails like last time when the stock rose to 66.98, I may have to collar the stock again.




SWC

·       This is a play on platinum and palladium. I have traded this counter for 4 years.

·       Recently, the stock dropped from a high of 25.2 to 7.5. The collar strategies were used. I suffered minor losses. SC were rolled down a couple of times. Finally, sold my puts and added to my position at around 8.0.

·       Company is a little tight on cash after making a new acquisition on Peregrine recently.

·       The resistance is now around $14-15. If breaks, it will double to above $25 again.

·       Daily chart is already very positive but weekly has yet to confirm. So I maintain a DEC 15 SC. May need to roll down SC short calls if breaks down, add a put if weekly confirms a break down below the MA channel.

Cost average again when it reaches a new low and issue a reversal signal. Do not cost average if there are no reversal signals. It can go down even to 2008 low at 2.5. But that will present an opportunity to buy more shares on condition that the company do not face a liquidity squeeze.
 Misc junior metal companies: NAK, NSU, TGB and SVM


These are companies in my portfolio waiting for the big move. Options premium are huge because of the volatility.

NAK – a wealthy businessman tried to block the development with the residence of Lake and Peninsula Borough.. It is suspected he wants to protect his fishing and hunting activities. I do not think he will win the fight on Pebble mines with the Alaskan government. Pebble has the biggest deposits of copper in the world. There are also rare earth and gold deposits. It has long been a target of acquisition. Read http://www.washingtonpost.com/national/state-of-alaska-seeks-to-invalidate-borough-voters-initiative-aimed-at-gold-copper-mine/2011/10/28/gIQACHqNQM_story.html and http://www.alaskadispatch.com/article/pebble-mine-debate-unleashes-lies-hype-and-hyperbole


NSU – the UN is putting up a vote to sanction Eritrea because of a small nation Gabon putting tendering the motion. I do not believe it will be done because to have it passed, you need unanimous votes. China will not agree. I am adding to my shares of NSU. I do not think the sanction will be passed.  I added to the shares at 4.65.So far, the rumours have subsided


TGB – Environmentalists block the development of this huge mind in BC. It was blocked last year in a review by the Central Government in Ottawa, Canada. Expect an appeal and project will be reviewed again. It has world class copper, gold, molybdenum and niobium deposits. It is a very attractive candidate for acquisition.

SVM : received anonymous letter on accounting fraud. When it had been cleared, I bought the shares at around $7.3 in October.

I expect the bearish trend will resume beginning next year. At the height of maximum bearishness, I believe there will be plenty of opportunities to pick up shares. Potential candidates include uranium mining companies and basically companies which will be beaten down but has great fundamentals.

Using Ratio Back Spread

I have entered many ratio back spreads over the last 3-4 weeks and all of the trades are positive.

This is done to increase the theta gains especially for near term short options. Basically, the delta is neutralized against the Long options or stock and the theta gain is doubled.

Some guidelines:

• Increase 2 x Short term short options help to pay the long option or stock. Sometimes, to be safe, use 1.5X instead of 2X
• The shorts should be OTM preferably about 2 strikes down to prevent it from going ITM.
• Do not use time frame longer than 1 month as it is difficult to predict actions of the stocks. Weekly options are best for this purpose
• Do not use it when there is earning announcement and anticipation of a major volatility event.

Taking the example of a calendar option spread ( Long term Long option + 2X short term short options ), my observations over many trades are:

·       When the trend is against long option, the short option gain is able to offset the loss on long option

·       When the trend is in the direction of the long option, the gain in the long option is higher than the short option because of higher delta.

·       Note that in many cases that the trade makes money when the trend is up or down as long as it does not move too violently.

·       Even if the trend moves violently, it is not difficult to adjust the shorts by rolling it down or putting additional protection. There is enough time to do the adjustment. Volatility in the last few weeks are high enough to verify the trades

·       When the shorts go slightly ITM, the trade will still make money. But it goes ITM, it is a signal to be ready to close the trade, make the secondary exit or adjustment to protect the trade. I do not act on the day when it goes ITM but will initiate my SE once the overall trade turns negative.

I have used these strategies for the following trades

SPY Nov 120 / Oct 119 put calendar : broke even despite entering the put on a totally wrong timing. The trade was entered when SPY was at support at 120!

RIMM – Nov 23 /  Oct 21 ( 2x ) put – rolled to Oct 20 SP and rolled to Nov 19 SP. Trade is making money

IMAX – selling double the puts to pay for the put protection on the stock

FXE – a put calendar  Jan 140 / 135 (1.5X ) bought on 10/28. With all the swings in volatility , the trade is behaving very well. When FXE is up, the gain in the short is higher than the put. When FXE is down, the gain in the long is higher than the shorts.

I have done similar trades for GE, POT, FCX, EUO,APOL ( bear call calendar) – all of them with positive results.

There is an alternative use for the 2 X options. On 2 occasions I used 2 X short term long OTM options to protect any potential big moves in stock before an earning events. It is reasonably cheap that if the trade is in my direction, the trade can still make a profit with this cheap insurance.

The key learning is that using double short option, short term OTM can protect a long trade and help to reduce the cost. The short options theta gains will offset any loss on the long put and the long put gain will normally cover the loss of delta in the short options. It is best used when stock are traded in a range. Nevertheless, the trade can tolerate slightly wider range but not a complete break down or breaking up of price.

There are some risks involved but it is very manageable if the trades are placed OTM. It can take some volatility but still the trade should not be placed before earnings or any anticipated big movement or events.