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Thursday, December 2, 2010

"The Top" In Gold And Silver

All markets gyrate back and forth and investors in every market go through phases of bullishness, fear and despondency. The key to being successful in the markets is to know when to take your chips off the table, as Kenny Rogers said “you’ve got to know when to hold them and know when to fold them”. Said in a different way is you have to know when to cut your losses and let your winners run. The problem for most people is that they allow their emotions to overcome their ability to do either. Many investors will not sell a particular asset for any number of reasons such as: they love the company, they think if they hold on the issue will recover and go up, or if they hold on that an issue will keep going to the moon. Conversely, many investors will not buy an asset because they think it is to expensive even if the true value is not reflected in the price, they don’t understand the drivers for the asset or it is in an under covered or “hated” sector, which is generally where the values are. To make good money in the markets you need to do as the Great One Gretzky used to say…”I don’t skate to where the puck is but instead I go where the puck will be”. Following the Gretzky logic is a lonely way to invest because you are consciously deciding not to be one of the lemmings; this does not mean that just because everyone is piling into Cisco (NASDAQ:CSCO) that you should go short, but instead that you should look for the investments that others are over looking because they are not in or sexy. You can make as much or more money by buying boring or unsexy assets with less volatility the downside is that it does not make for good cocktail party chatter, of course if you make enough you can throw the cocktail party and talk about what you want and then everyone will listen.

As an investor or a trader you have to learn to keep your rational mind in control of your emotional side, which believe me is a very difficult thing to do especially when we are all inundated with opinion and news from multiple portals much of which contradicts each other. This is why I have spent years working on controlling my emotional side and rely on thinking through each investment decision based upon my own research and knowledge. Just relying on market adages or sell side recommendations is a recipe for mediocre returns at best since none of them have a crystal ball or truly knows what will happen; instead you have to think for yourself and remember that no one will take better care of your savings or investments than you!

I believe that the absolute number one most important thing that any investor or trader needs to master is the ability to admit when you are wrong. More money has been lost hanging on to a mistake than can possibly be imagined. If an investment goes against you have rules to guide you to take the emotion out of the equation you will save yourself much heartache and live to invest or trade another day. As an investor you also have to reorient yourself to recognize certain truths about the markets; Wall Street, Mutual Funds, CNBC, Hedge Funds and the entire investment industry is geared to make money not so much for you but instead for themselves. I know we all believe that there are rules to protect the investor, however, judging by the successes of the SEC to prevent things like Madoff, Sanford, naked short selling  or any of the dozens of corporate malfeasance that has taken place over the past few years they are asleep at the switch. Sure the industry is not going to raid your account and take out money directly but who can forget all the brokerage houses hawking internet stocks to the public all the while trashing them in private; as they make their money by placing deals and off the commissions from the purchase and sale of investments.

For much longer than I would like to admit since it shows my age I have read Investor’s Business Daily (IBD) and while I use the resource the most important thing that I learned from the writings of Mr. O’Neil the founder was to have method or discipline to which you adhere. In fact it is one of O’Neil’s rules that I find to be critical to success and that is if an investment goes against you need to have a loss limit decided ahead of time. The caveat to the loss limit is that I believe that you need to keep the stop loss private as one of the favorite tactics of the market makers and specialists is to run the price of a security up or down to trigger stops and acquire shares as a result of a volatile swing one way or another. I am sure if you are an investor and have ever used a stop you have suffered from this phenomenon of having your stop triggered on a volatile day having your investment sold out form under you only to see it return to a higher price or close even higher. So while I do advocate the use of stops I am sure that most of you are not near a computer all day to monitor your positions but there is a way which puts the control in your hands and does not let the market maker\specialist have the upper hand. You can subscribe to a service called Tradestops, which will track your portfolio and provide you with an alert via email, text (SMS) or even pager for those of you stuck in the twentieth century, for a variety of triggering events ranging from stop loss to number of trading days that you have owned the investment. The cost for the service depending on the features you require is about $80 for the more basic plan to $110 For their most comprehensive plan, a worthwhile investment for you to regain control over the market makers\specialists. In the interest of full disclosure I do not receive anything (monetarily or otherwise) nor am I affiliated in any way with TradeStops, I just believe it is a great idea and gives the power back to the investor or trader where it belongs.

In his writings O’Neil suggests an 8% loss cut since if an investment falls 8% then in order to recoup the loss your next investment would only have to rise 8% to break even there by allowing you to make mistakes and still have money to invest, since to make 8% on an investment is not a rare occurrence. O’Neil goes on to point out that if your investment falls 50% then you need a 100% gain just to break even, which is not so easily achieved particularly in today’s markets. I generally use the 8% limit except when I am playing in a speculative area and the investment is small I may allow as much as a 15 to 25% loss limit to allow for the volatility. The loss limit methodology allows me to be confident that I can make mistakes and still be able to recover from the mistakes to grow my portfolio; let’s face it not everything you buy will go up for if it did you would not be reading this post instead you would be sunning yourself on a private island taking interviews from Robin Leach!

One of the other areas where investors come up short is the use of trailing stops which help to lock in profits and protect you from a catastrophic decline. It is just as important to know when to exit a security once it begins rising as to know how to cut ones losses upon entering the transaction. The concept of the trailing stop is that a stop loss order is set at a percentage or fixed number of points below the market price for a long position or above the market price for short position. The trailing stop can be either a limit or market order depending on your preference although with a short position I personally would set a specific limit and once violated sell immediately. The trailing stop price is adjusted as the price fluctuates but should the stock plunge then your shares would be sold locking in your profits and taking the emotion out of the equation; although if you had a stop limit then the shares may not be sold as the limit could have been exceeded. While I like the concept of the trailing stop given todays volatile markets with flash crashes and other events the trailing stop is kind of a double edged sword because you can be unnecessarily dumped out of a position and then have to figure out what move to make next with the capital; the flipside is that no one ever went broke while taking profits.

It is a complex battle for an investor or trader between managing risk and emotions. Yes there are mechanical tools to take the emotion out but they are not perfect either, the bottom line is that you need to control your emotions and continually evaluate your investments to see if they still make sense or are adjustments in order. A modicum of commonsense, investigation and observation prevents heap of losses.

In addition to using tools like stop losses and trailing stops, research and acquisition of market knowledge for investments is critical for success as well.  For me I like to look at anecdotal evidence as well as hard cold data to determine if an investment has run its course or not. We all know that no market goes straight up the exception to this rule is either a mania or just plain hot money rushing in to an area like internet stocks for example.

There is no shortage of talk regarding the fate of the gold and silver markets and so long as I hear plenty of negative arguments I am confident that the upward march will continue. If I begin to hear people at all levels of the socioeconomic ladder begin to talk about owning gold, silver or the shares I will get nervous. Gold and silver are currently consolidating and are getting ready to test the highs sooner or later. It has been my observation that once the metals breakout to a new high they tend to pull back sometimes violently along with the siren calls of “this is the top”. I have heard the same pronouncements since I began investing in gold in 2000 (first in the shares) at every level $325, $400, $450, $500, $1,000 etc… It then usually took three knocks at the door to leave a price level in the dust, meaning that the price would butt up to the high a minimum of two times and bust through to a new run on the third attempt although there was at least one occasion when it took four attempts if memory serves correctly. This type of action is found throughout the commodity \tangibles space so it is not that unusual and it does have a tendency to shake out the weak holders allowing stronger holders to carry the price higher.

Do I believe we are at atop in the metals? The short answer is no. In prior posts I have gone in to why gold, silver and commodities are rising so I will not belabor that point here; instead I want to address the idea that we are at “the Top”. I believe that we are only in the second of three phases of this bull market and we still have the mania phase to go. The mania phase will be more like that of the internet bubble as everybody you meet will be talking about the metals, stocks that have the word gold or silver in the name will be bid up regardless of ability to produce just like internet companies that counted eyeballs not profits. People will be clamoring to buy metals and locations selling product will look like “black Friday” sales are going on. As an investor you need to be thinking ahead NOW as to what will you do when the mania comes. You don’t want to be left holding the bag you need to think about an exit plan, because when we do get to the mania it will be thrilling to see your holdings rise dramatically but no different than musical chairs at some point the music stops and there are not enough seats. By the time the mania is in full gear there should be other areas of the economy that are neglected or left for dead that will represent huge value and you will want to move most of your assets to them. You can also do what I do currently and that is to sell a portion of your position when you double so you are playing with the “house’s” money as this allows you to keep a toe hold in even as the mania peaks without risking your principal.

Today the main argument for bubble indicators seems to be the fact that there are ads in newspapers and on TV asking for you to sell your gold jewelry or gold scrap. There was even a pawn shop here in the Boston area that was running radio ads claiming that gold has peaked and that now was the time to dump your gold to them. They claimed to know that gold was peaking because they were buying at $300 an ounce and  they were sure that prices would not stay this high long and the bubble was going to burst. When I heard this ad it gave me comfort because it was geared to get John Q to part with metal not to sell it to him. Why is that distinction important? Well the fact is that this advertiser is in business to make money and he obviously sees that gold is going higher so he wants to obtain what he can on the cheap.  Another buyer was trying to motivate people to dump their scrap by resurrecting the 80’s icon associated with gold, Mr. T, having him pitch to John Q to turn over his scrap for a few bucks. These companies are not so much indications of a top in gold as a decline in the underlying economy. They are trying to obtain gold to profit on and are focusing John Q on cash payouts that are a fraction of what the metal is worth to them, a pretty good business if you don’t mind ripping off the public.

If the Pawn shop were on the airwaves touting buying gold as an investment for the public I would be more concerned that we were closer to a top. The day when John and Jane Q are out in full force trying to acquire the metals is the day were are much closer to a top than at present. When you see full page ads in the paper for department store gold sales and banks open gold windows we will be at or on the cusp of a top. When the top comes you will no longer see any ads for people to sell their gold jewelry or scrap because people will not be willing to sell it in anticipation of higher prices and that will be a top.

I know that there are ads running for Goldline and other bullion sellers mostly on Fox Business and CNBC because that is where they are getting the most bang for the buck with the early adopters. When Glen Beck is on Goldline commercials airing in prime time even 1/3 as frequently as Toyota commercials that will be a top!

I wish to relate my own anecdote from Thanksgiving with the in-laws. My In-laws have decided that it was time to sell their house of almost 40 years and as part of the clean out process my father in law had a giant bottle and a separate hard suitcase filled with change. His goal was to take all the change and convert it to cash to split amongst 6 grandkids. There was a lot of change in to the hundreds of dollars and the kids all sorted it in to the various denominations; I also had tem go through and pull out any $1 coins, ½ Dollars and change dated 1964 or earlier. The net result was that we ended up with a couple quarters pre 1964 and a few pre 1969 ½ dollars which my in laws had no idea were worth more than face value nor did they know how to get the value out of them. I ended up taking the hand full of coins to a coins shop which was not so easy to find as there are only a couple in the state where as there appear to be Dunkin Donuts on every corner.  All the grandkids benefited as I was able to convert this small amount of coins into a couple hundred extra dollars. While I was in the coin shop I noticed that there were others trying to sell coins as well but they appeared to me to be scrounging for money; one in particular had his whole family in tow and was desperate to get cash to be able to afford Christmas gifts. The owner of the coin shop confided in me after the family left that he sees more and more of this type situation every year and what a sad statement it is on the economy. Furthermore he went on to tell me that even with gold at current prices that his business is not reflecting the same mania type conditions as when he was selling gold and silver coins in the late 70’s.

My take away from this coin selling experience was twofold.  First, if educated and knowledgeable people, like my in laws had no idea what they had, nor what to do with it then John Q must also be in the dark regarding this topic. Second, the underlying economy is bad and people are still selling their metals and not buying where as businesses and people who understand are acquiring. Both factors tell me that the public is very far from being heavily involved in these markets and it is not the top!

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