Gold and Silver - its direction

There is still a big debate on the direction of gold.

On the mainstream media, gold is deemed something of no value, does not pay a dividend and probably just a barbarous relics as mentioned by economist Nouriel Roubini.  All these Keynesian academics including Bernanke, are of the view of economists who believe that the current pumping of money into the system is necessary to sustain the velocity of money or the world will not go into a deep depression. We have deflation now and not inflation. Deflation must be stopped.

In the academic world, gold is not accepted as a currency

In the mainstream, gold is usually portrayed negatively except for Jim Cramer who recently recommended buying gold in his TV show. Gold dropped from 1424 to 1330 2 days later after his talk. It was the biggest drop since the beginning of 2010.  To many, that is a sign of the top in gold if the mad trader recommended it! Most the high profile commentators include people like Dennis Gartman always say " it could go up a little more but....."

I was kind of surprise that when I heard Greg Jensen mentioned in an update on this Wednesday that gold price is on its way down. He anticipated it to crash. I have learned a lot from Greg on spread trading. He is  a great trader but I definitely disagree with his view on gold.

If  you hear a gold bug, you may got the feeling that these people are like strong headed and extreme fundamentalist who are thoroughly  dogmatic in their views. They look like fear mongers, last day evangelist trying to get the world back to morality. They are believers of conspiracy theories of the Fed and US Government. They are usually the gloom and doom preachers of the economy, high on emotions and conviction but low on logic. Interestingly, these people has been more right than wrong in their proclamation on the price of gold.

Fortunately, we also have fortunately a group of very smart money managers who had a consistent records of making money for many years are also in the same bullish camp for gold.

You may want to listen to recent interview by David Einhorn. In a surprise proclamation, he said clearly that gold is money! His thoughts are clear and arguments are very intelligent.

In the latest report, George Soros has an unusual large holding of gold ETFs and stocks.

We have Eric Sprout, Ambrose of Financial Times, Rick Rule and Bill Fleckenstein . I have followed these people for years.You cannot argue with the wildly successful track records. It is the direct opposite of perma-bear analyst like Nadler who have been wrong for almost a decade. Still today, people are listening to him!

There are  fundamentals that support the case for bullishness on gold. I will just list a few which I feel are most compelling.

1. The simplest argument in my non academic mind is that the whole world is in a crazy spiral of printing paper currency. USA with its bailouts aka  quantitative easing ( including a funny depiction of what is QE), Europe with the bailouts for Greece, now Ireland and eventually, Portugal, Spain and possibly Italy. China came out with a huge spending during the peak of the 2008 recession to revitalized the economy. Japan is determined to fight the appreciation of the Yen by buying back the Yen with their printing press with an amount almost unprecedented. Korea and Brazil are all fighting to keep their export economy. They will not lose out in their currency war by keep their the value of the real and won down.

The European situation is getting really serious. In the news, we know about Ireland but here all all the list of countries pending bailout:

Greece - required Euro 110  b bailout in May
Ireland - Requiring Euro 85 b bailout
Portugal - Pending imminent Euro 40-80  b  bailout
Belgium - Pending approx. Euro 50 b bailout
Spain - Pending Euro 400-500 b bailout
Italy - Pending approx Euro 1 trillion bailout.

Total funds available by all Euro members is estimiated at around Euro 750 b. They have no money. The results is most probably a dangerous spiral of money printing or quantitative easing. Government issue debt -->No demand for new money supply -->Print money to monetarize debt -->Pressure to raise interest rate -->Increase interest payments --->higher inflation - larger budget deficit and ever expanding spiral. Debt default is eventually inevitable in all these countries including USA. Currently, USA and Japan is saying hell to it and will continue to monetize debt forever!

This dangerous spiral is very bullish for all commodities especially gold. The probability of the system breaking down is high. If it does, there will be a parabolic mania in gold and silver. Certainly I do not want to miss this insane phase of the bullish cycle.

The result - where is the value of money anymore! The world is flooded with paper currency. People are "incentivized " to borrow just like the housing bubble. It is happening again. The value must go somewhere. The most logical flow is to hard assets and thus gold and silver are key commodities besides palladium, rare earth, copper, cotton, oil, and grains. Gold is a hedge for stored value.

2. Supply is tight. Total gold demand in the third quarter of 2010 was 922 tonnes, an increase of 12% from the same period a year ago. In U.S. dollar value terms, demand grew 43% to $36.4 billion over the same period.
As to silver, the situation is also aggravated by a tight supply situation. The supply is so tight that a severe shortage can occur anytime. Demand from industrial applications, world bank treasury, and ETFs and supply are totally out of whack. In a chart not shown normally on mainstream press, it can be shown that cumulative open interest of silver is about more than 2 times of net long positions of silver.








3. I wrote about a development on silver in April this year. Recently, things are getting very interesting.

It is well known that one of the major holders of short position of silver is JP Morgan. Also, it is supposed to be confidential with CFTC but this is well known in the precious resource investment community.The CFTC is taking a more serious interest now within its new proactive chairman Gary Gensler.. He seems to be an intelligent, straight shooter and no nonsense guy who wants to get to the bottom of the theory of silver manipulation over the years. To have short position concentrated at 4 largest traders at volume of more than 25% ( or 200 million ounces ) of silver mine annual production capacity, this is definitely unacceptable. Something is fishy. To get more details, read the recent intriguing interview by world leader silver analysts, Ted Butler.

In a surprise statement on October 26th 2010, CFTC commissioner, Bart Chilton admitted the silver market is suspected to be under manipulation and is fraudulent. He will get to the bottom of the matter.  Since then there are about 20 lawsuits filed against JPM by law firms. Many of these are from top tier law firms. It will be interesting to see the outcome

Signs are there that JPM is trying to wind down the shorts. During the last 2 option expirations, silver and gold successfully held their prices. The last expiration was just on Tuesday and it was gratifying to see the price did not drop. For many years, at option expiration prices would be pushed down so that short traders could roll their options to the next month. As a result, huge short positions are accumulated. Gene Arensberg in his report said that he had not seen this kind of actions for years.It is suspected JP Morgan has probably lost lot of money now winding down their shorts.

I have many other reasons to be bullish but I will just list one more important factors. For the first time in many years, central banks are net buyer and not seller of gold Just last month, Russia increased their holding of gold by 600,000 ounces. China is accumulating gold steadily and quietly.

The US has 72.8% of its reserves in gold and. China has only 1.6% of its reserves in gold. China will continue to be a big buyer although they tried very hard not rock the boat and drive the price higher too fast.

So what is my position? Of course I am still bullish. I have been bullish for the last 5 years.

But I am not a buy and hold investor although I suspect that if you have the guts over the last 5 years to do that, you would have made a lot of money. The volatility can be brutal.  I cannot tolerate the uncertainty. So I trade, hedge, buy and sell!

The dynamic collar is the best strategy to manage the trade. I have to depend on my signals from my technical analysis for adjustment. If bullish, I remove the short calls or puts. There are times I go completely naked.  Fortunately, the system allows some mistakes to be made but overall I am maintaining my bullish bias but I will not fall in love with the trade. I will not get out unless fundamentally, the situation has changed.

I remember I bought AAPL at 55 and sold at 90. I bought AMZN at 60 and sold at 85. I bought Bidu when it was 90 and sold at around 130 and today it is more than 1000 if you take out the split.

I learned that there is a tendency for a trade to get out too early that you missed the upside completely.The volatility WILL scare you out. I am getting better at handling it over the years especially after after I started to use option strategies as a key tool for my trade structure.

It is like riding a rodeo in a bull market. The weaker players will be shaken out! The key is that if you finally fall, you know how to break the fall and not get seriously hurt. At least now, I  managed to ride SLW from $3 at at the end of 2008 to about 36 now without wavering and actually added to my positions. It is the single biggest position in my portfolio now.

Similarly, I had done it with a number of stocks which are multi baggers. If I get out too early, I will miss the enjoyable ride. In between, I trade. I make mistakes. But I maintain my conviction on the fundamentals. I use the shorter term trends and adjust accordingly.

Take the example of the recent drop of gold and silver, many people called me and ask what I was doing. I wrote on Nov 16th and update with a comments on my adjustment. I will not have the time to update everything. One day, I can probably show a complete example of my adjustments with all the mistakes and how I am still profitable finally.

There is one condition when I will get out of a trade structure although I am bullish fundamentally. It is when my overall trade starts to lose more than 10%. At this juncture, I know I have lost control of the trade. I will get out.. If I try to stay in the trade, I will make more mistakes. Also, I will lose my risk control.It is my way of breaking the fall. If the ride is still available, I will get on again. I will watch carefully for the right time to get back again. I will try not to forget to get back as long as the fundamentals are intact. It will be on the top priority on my watch list.

Ultimately,  you will  have to develop your own experience and trading style.

Precious Metal - I am on the defensive

A number of people called me to ask what I am doing with my precious metals stocks.

I am on the defensive! I have to protect my profit for this year.

It is not the perfect adjustment but I am cautious. Risk control procedures are kicking in.

Long term I am still very bullish on gold and silver.

Take the example of SLW. I rode happily naked at 25 since beginning of October and it went  > 36 last week. I was exuberant. On Friday, last week it issued a clear engulfing bearish candle which is a short term bearish signal.

So, what did I do?

I collared the stock. I added a Jan put at 35 and a Jan 37 SC on Friday. There are various scenario in this "chess game".

The stock can easily resume its bullish run and SLW could be 40-50 by the end of the year! As for now, it has no indication technically that this is the direction. But the fundamentals are still very strong. There could a run by those who shorted the stock.

As long as the stock does not trade much above 37, I will keep my short call. But if silver reverses quickly and move up aggressively with some fundamental events, I will remove the SC first at around 37 or 38. If it continues, the long put will be removed. I will lose some money on my puts and SC but will make money on the stock.

The most likelihood scenario is there will be a correction after such a parabolic move.This is very healthy. There is support at  31. There is strong support 26 if it breaks the 31 support.When it shows support at 31 and move back up technically, I will take profit on the put. By that time, there is high probability that I will keep the credit for my SC. I may take profit on the SC if there are strong bullish signal here.

It is also possible that the stock can break the first support at 31. If so, I will continue to roll the put protection to at least 45 days or more once it reaches about 3-4 weeks to expiration. I will continue to add SCs month by month until bullish signals are issued. Also, if it very bearish, the SC will be deployed nearer to the money or with some remote probability, ITM. The protection will continue until there are clear bullish signals.

If the stock drops more than 25% and there are clear bullish signal, I will add 50% more to my position size. In between. One good level to add is at 26. But I will not do anything until it shows clear support and gives bullish technical signals.  Alternatively, I may just add SPs when it is near 26 and be ready to take possession of the stock if it is assigned.

I had held SLW from around $3 since end 2008. I had added to my positions a few times along the way.

It is my belief that the bullish trend for precious metal is not over. So I look to add to my positions. I will not liquidate the stock position nor allowing it to be called out by the SC. As long as all the fundamentals are intact, there are no reasons for me to do otherwise.

Trading - a game of probability

A big part of trading is a probability game. The market can move any directions and many times against all logic and fundamentals for a period of time.

An edge in trading is the ability to have winning probabilities on your side.

Most people cannot distinguish between luck and skill when it comes to forecasting the market. At the best, I am right 70% of the time on fundamentals, 50% on the timing of the trade but I am making money on >80% of the trades.

I acknowledge I do not know how to predict the market timing with certainty. The process of trading is replete with errors and thus one has to cater for it.

Apparent randomness in the market is so complex that it cannot be managed with my finite mind.

So here are some ways that help me to handle the random behaviour of the market:

1. The first edge I have is to have the underlying fundamentals of the company. Although the stock may move short term against me but longer term it will be in my favour if the analysis of the fundamental is right. Thus, the probability is on my side assuming that my fundamental analysis is correct at least 70% of the time.

2. I use a set of technical indicators to determine the short-term trend and sentiments of the market. It is a relative simple system that I had used for probably more than 10 years.

Technical system does not need to be too complicated. Many technical systems will be correct >60% correct of the time if you apply it consistently. Normally, I use leading indicators ( price actions, patterns, and candlesticks ) and it is confirmed by the lagging indicators which are stochastic and MACD. There are some subjective judgments made when comes to trend lines, support and resistance. If the system is too complicated, you will not be able to apply it consistently.

The problem is that once you have the indicators, many people tends to second guess the indicators again. Emotions of greed and fear are at play. Once you deviated, the technical system with all its winning probabilities is no longer valid.

If you have a sound system, it does not matter whether any particular trade makes a profit or a loss. What matters is that the probabilities over time are in your favor. You must remember that no system is perfect, and prepare for losses along the way. You should measure yourself on whether you followed your rules and executed your system, for both winning and losing trades.

3. Use options to hedge. tame the volatility, buy time and reduce the emotions to allow you to follow the technical system. I found this to be very helpful and effective. Many people use options to leverage to enhance the performance. I use options mostly to hedge my trade to tame volatility and buy time to allow the fundamentals to work.

4. Keep your position size equal in your trade. For stock with higher volatility, the position size can be adjusted lower and vice versa. Statistically, it will allow winning probability, as fundamentals and technical analysis will be weighted to your favour. However, if the position size is not balance, a losing trade with a high position size will upset the portfolio performance although you may be >70% right on the fundamentals and technical analysis.


5. Strictly apply risk control rules. It is part of the whole trading plan. In a losing trade, many traders are like a deer in a highway facing a crash. They freeze when they see the crash charging towards them. Instead of stopping loss or readjust positions according to the system, they hope that this time it will be different. Many pray to God to give them a last chance. But “HOPE” is dirty four-letter word in trading. You need to follow your rules for getting out. Even if you are wrong and got whipsawed by the market, at least you will be preserving your capital.

6. Finally keep a journal. It is tedious work but it will be a great help. It will help you to know whether you are following the trading plan. One day, I will write in details on how I record my trades. It is a customized system using Excel. The journal should be customized to your style of trading. Keep it simple. Allow critical information like reasons for entering the trade, profit /loss %, number of days held, reasons for adjustments and getting out.

My Performance - Indexed

When I first looked at my performance I was not too happy especially for this year. I made some mistakes on Oct 2008, Jan 2010 and May 2010. I did not follow my discipline completely. 2008 Aug - Oct was the worst performance in my 15 years investing in the stock market. I had gone through the Asian Crisis, dotcom bust and year 2000 bug, but none even close to what happened then. I was actually profitable during those years!

After a painstaking effort indexing my portfolio, I feel better. Here is the result:



The idea of indexing your performance takes care of injection or withdrawal.
Indexing is like pricing your fund on a per share basis i.e. imagine when you first start off, you sell shares to your fund at par or $1.00 each share. Any injection subsequently is added at the prevailing price of the fund.
So you start off with say, $1million with shares at $1.00 per share. Then 6 mths later when your fund has appreciated 20%, each share is worth $1.20 each. Any injection will be for shares at $1.20 share so the index would be 120 at this point in time.

So by indexing the performance of the fund, there's no need to worry about how any injection or withdrawal would affect the total nominal value (size) of the fund.

After beginning Oct 2009, I was more confident with my money when I upgraded my strategy using options and added funds to my portfolio.The injection of capital has made my performance looks good!

CAT - Bear Call

I have not done vertical trades for a while. These are more speculative trades. Normally, trade will be placed at 1/4 of position size of a covered call or just stock. It comprises less than 10% of my portfolio.

Many people are afraid of a bear call. They view it as risky as if the call are assigned.

To me, this is the same risk as a bull put except that if the put is assigned, the theoretical maximum loss is when the stock is zero.

But the key is the risk control. If you have a plan, a bull put is the same as a bear call.

In this case, I am ready to adjust the bear call if it goes against me. The risk is if I am not vigilant and failed to follow my plan.

CAT has been stagnant for almost a month. After a good earning results, the shares actually went down. It is taking a rest.

I am betting that it will stay stagnant or slightly bearish for the next 4 weeks. I like the stock very much longer term but believe it is taking a rest.




Trade:



STO Nov 80 Call = 1.52
BTO Nov 75 Call = .32
Credit = 1.2
Maximum Loss for Trade = 3.8

It is a very good return on risk for the trade.

PE: Maximum return of full credit for 1.2 minus commissions

SE: This is somewhat contrarian trade. I am bullish on CAT but short term bearish. If there is any news or drivers that suddenly send the stock up, I will adjust it to a bullish trade by:


- Adding a Long call making it a ratio spread or call calendar
- Take ownership of the stock to create a covered call.

The key point to watch is the BE point at 81.2. If it is getting close to this level fast or exceed this level, I will do the adjustment.

Also, this trade will make money when the stock is stagnant, bearish, slightly bearish, slightly bullish. I will need to adjust only if it is very bullish. It is a good probability trade.

Advice from the Masters

1. On diversification:

"Diversify your investments" - John Templeton
"Diversification is a hedge for ignorance" - William O Neil

2. On averaging down:

"You have to understand the biz of a company you have invested in, or you will not know whether to buy more if it goes down" - Peter Lynch
"Averaging down is an amateur strategy that can produce serious
Losses" - William O Neil


3. On bottom/top fishing

"Don't Bottom Fish" - Peter Lynch
"Don't try to buy at the bottom or sell at the top" - Bernard Baruch
"Maybe the trend is your friend for a few minutes in Chicago, but
for the most part it is rarely a way to get rich" - Jim Rogers
"I believe the very best money is made at the market turns. Everyone
says you get killed trying to pick tops & bottoms and you make all
the money by catching the trends in the middle. Well for 12 yrs
I have often been missing the meat in the middle but I have caught
a lot of bottoms and tops" - Paul Tudor Jones

The masters do not agree on how to make money but they do agree on one thing;
Losses!

"my basic advise is don’t lose money" - Jim Rogers
"I’m always thinking about losing money as opposed to making money
Don’t focus on making money, focus on protecting what you have"
- Paul Tudor Jones
"Investors 2 rules of investing: 1. Never lose money 2. Never forget
Rule NO. 1" - Warren Buffet
"The majority of investors stubbornly hold onto their losses when
it small & reasonable. They cud get out cheaply but being emotionally
involved and human, they keep waiting & hoping until their losses
get much bigger and cost them dearly"- William O Neil
"Learn to take losses quickly and cleanly. Don’t expect to be right
all the time. If you have a mistake, cut yr loss as quickly as
possible"- Bernard Baruch

Psychology of Trading

“There is one peculiarity about mass psychology in that when you are in a bubble, you can’t see it. Bubbles are invisible when you are inside the bubble,” said the charming Jim Dines, of The Dines Letter

"Sell them and you’llbe sorry
Buy them and you’ll regret
Hold them and you’ll worry
Do nothing and you’ll fret"



While I believe risk control is the single most important factor in trading, it is related to the trade psychology.

It is the proper psychological state that gives you the discipline and mental state to control your trades. Risk control is simple but difficult to implement. To do it properly, one needs to be prepared psychologically.

No wonder top trading trainers like Van Tharp and Alexander Elder rate psychology as the number factor for success.

Van Tharp uses NLP (Neuro linguistic Programming ) to help you to trade. He believes that people are generally programmed to do everything the wrong way. They have internal bias that seems to lead them to do the exact opposite required for success. Many of the right trades are contrary to human instinct. His recommendation is to observe and emulate those who are successful. It is similar to what Anthony Robbins used for his self improvement techniques.

Elder uses Alcohol Anonymous 12 step approach to help his students especially those that has fallen into "addiction". A losing trader can get caught in a bad spiral, repeat the same mistakes mindlessly, loses control of all forms of money management and tries to recover his loses. He needs to be "sober" again and cured of his "addiction".

The most difficult part is to control the emotions of fear and greed. When you winning, you take profit prematurely. Even more difficult is when on a losing streak, you find difficulties to adjust, protect or even cut loss. Most big losses are the result of failure to stop the bleeding. This happened to me for 2 trades last year. I refused to get out of TBT and BSX. As a result, these were my biggest losses. It is not the result of my trading system but my poor discipline and emotional control. Fortunately, it was just 2 positions.

Therefore, I include "setting clear rules" as a cardinal law of my trading. I want to be alienated from any emotions of fear and greed.

If there is anyone in trouble, I highly recommend you read Alexander Elder book on Trading for a Living.

For serious traders, it is good that you read both the books to understand the psychology of trading.

If there is anything that can put you in the right mental or psychological state, it will be greatly helpful.