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Wednesday, April 27, 2011

A Matter Of Perspective

We have all grown up hearing old adages like “a picture is worth 1000 words” or “beauty is in the eye of the beholder”. If you are an investor than adages like “sell in May and go away” or “bulls make money, bears make money, but pigs get slaughtered” will ring true. All these adages contain rudimentary but highly effective nuggets of wisdom. Adages can also color your thinking and allow you to be lulled in to sort of a go with the herd mentality, which can be a financially detrimental thing.

While the adages above and thousands more do help for the most part by imparting wisdom of prior generations of market participants who paid for these nuggets with market performance or lack thereof, it also can be good to change your perspective for validation. I am sure that many of you have seen the 2008 movie “Vantage Point”, starring Dennis Quaid, Forrest Whittaker and Mathew Fox, while not a cinematic masterpiece it does provide the idea of uncovering the truth from different “vantage points”. In the film the true plot is revealed by several different characters providing their perspective regarding an incident that has occurred. The movie is a good but not great watch; however, it does make you think of point of view and perception of reality.

To me the market is short term driven by perceptions and frame of reference while ultimately reality and fundamentals dictate the longer term. It is human nature to form an opinion based upon what you see, your bias, and perspective. If ten people witness a car accident and are later questioned by police several versions of what happened are likely to be told depending on the person’s point of view. When you look at stocks in the market you add an emotional factor as well as the “frame of reference” factor. Humans are emotional creatures and when you add something like money in to the equation many times the decisions made are not the best and can be counter intuitive.

I have worked very hard over the years to keep the emotional aspect out of my investing, but being human it is very difficult but not impossible to do so. As a result I have developed strict rules for my trading including position size limits and stop loss limits. I have the downside aspect of my investing covered as to respect Rule number 1 of investing which is to not loose principal and live to invest another day by using my rule set to prevent small mistakes from becoming huge ones. I do acknowledge that I struggle with the upside as being human I always worry that I have left money on the table, of course I have learned no one ever went broke by taking a profit.

In addition to my buy and sell rules I try to make sure that I am looking at things in a realistic manner and try and devise ways in which to look at various things through a different lens. One of the tools that I use to validate my perspective is a little game that I like to play which I call “buy it, hold it or fry it”. My investment style is to look at trends, evaluate the fundamentals and then use technical analysis to see good entry and or exit points

To play “Buy it, Hold it or Fry it” one has to take a stock chart and look at it blind meaning no stock name visible and no pricing, instead just the a plot of the price with 50 day and 200 day moving averages for a daily chart and price with 10 week and 50 week moving averages for on a monthly chart. Once you have the two charts look at them and ask yourself looking at the trend and or chart patterns would you buy this stock or sell it, remembering that you have already done the fundamental analysis.

Below is a daily chart for your review, would you buy or fry it?

And this chart is of the same stock but on a weekly basis.

The chart looks pretty good in both time frames doesn’t it? Well it does look like a pretty convincing double bottom and I am sure one would be tempted to buy it on a pullback. Looking at the chart in this manner gives you some perspective. Of course you may be wondering what stock does this chart represent, well first I want you to look at the next set of charts and play the same game.

The daily chart for the next stock

The weekly chart for the same issue.

I don’t know about you dear reader but this does not look like an issue I would like to buy although you could get a short covering bounce here. So you may be asking yourself what are the issues shown in the above charts? Well they are actually the same issue only the first two charts are inverted to make a point. The charts are the stock of the United States aka the Dollar. The point was that without knowing what the underlying issue is you are more open to interpreting the patterns.

I know there are many people calling for the Dollar to rally and based upon what I see in the above charts it had better move up to work its way out of the downtrend soon, but it appears that there is plenty resistance for the almighty Dollar to overcome. Additionally, those infamous “death crosses” abound on both time frames which is not a good omen to say the least. If the Dollar continues this decline key support on this chart going back 3 years is only a couple points below. A break in the key support could usher in a waterfall decline in the Dollar.

It is very worrisome that over the past couple months with all the turmoil in the world and financial markets that the dollar has relentlessly declined. It was not that long ago when something occurred and people wanted safety they ran to the Dollar even with all its flaws. This time around they are no longer seeking safe harbor in the Dollar but instead other assets like the Swiss Franc have benefited. Moreover, the precious metals have received inflows as a result and stocks have moved higher as well since it appears that investors want something of value to store their money in and due to FED policies most consider that cash is trash.

There is much talk in the media about the Dollar and even just yesterday Timmy “Turbo Tax” Geithner came out with a sound bite discussing a strong dollar policy is what he believes in as long as he holds the office of Treasurer. From the charts above you can clearly see that this is not the case and sound bites tell one story but the dollar is squealing like a pig to cop a turn of phrase from the movie Deliverance.

Much has been made about the Dollar and there are calls for a reversal because there is a lot of negativity surrounding the dollar, in fact the last figure I saw was on the order of 90% bears. While it is true that the dollar is “best house in a bad neighborhood” (choose your own metaphor: tallest midget, best of the worst, the best looking horse at the glue factory) but that will only carry you so far when the owner of the house and all the neighbors keep insisting on setting the neighborhood ablaze. The fact that negativity on the Dollar is through the roof yet it can’t even seem to get out of bed indicates to me that the problems that we as a country face are being recognized around the world and are probably even deeper than we suspect.

Today for the first time in the FED’s 98 year history the FED chairman held a press conference about 1.5 hours after the FOMC statement was released. Bernanke’s dog and pony with the press was cordial and he essentially said many words about nothing. The press asked questions and Ben did his usual dance around the actual answer routine. One thing that Bernanke did state that he would end the infamous QE2 on schedule, however, the language used about monitoring the situation leads one to believe that the back door has been left open for QE3. I hardly believe that they would call QE3 by that name, although a rose by any other name is still a rose. As Bernanke spoke the markets moved up and the precious metals roared to life.

It seems pretty obvious that the FED knows there is inflation but they also recognize that the recovery if you can call it that is still fragile. He went on to say that he was prepared to continue keeping rates down for an extended period of time. The markets took this to mean that the FED was not going to add more to the punchbowl but they were not necessarily taking it away either. It appears that the markets responded the way they did because there is a sense that inflation is here and is bound to get worse so the move from cash swung in to high gear.

There is a camp of people who believe that the FED is omniscient and they will be able to fix everything, but I do not fall in to that camp. I would contend that in this case due to the amount of stimulus, bailouts and low rates for unprecedentedly long periods of time there are still severe dislocations in the economy and a vast amount of unrealized pent up inflation. Bernanke, believes in his heart of hearts, that inflation is the “core rate” because food and energy prices are transitory. He may well be right but the question is what period of time is the transitory period and what is the driver? It appears that we are in the midst of the FED own vicious feedback loop. Between the spending in Washington and the FEDs policies it is little wonder that the Dollar is taking a hit.

The monetary and fiscal policies that were initiated under President Bush and vastly expanded under President Obama planted the seeds for what we are beginning to sow today. Under normal circumstances it takes 6 to 9 months for FED policy adjustments to filter through to the economy, but these are not normal times. All the policies that have been put into place are now starting create inflationary pressures and drive the dollar down which in turn adds to those pressures. In other words the monetary policy has achieved critical mass no different than a nuclear chain reaction and it cannot be turned back at least not without devastating after effects. Besides, neither the FED nor politicians have the stomach to implement measures to actually heal the economy nor do either want to take a chance of doing anything given that we are entering the Presidential election cycle. The FED and Washington have essentially painted themselves in to a corner concerning inflation and there is no one with the spine of a Paul Volcker to actually implement a fix.

Bernanke stood in front of the TV cameras and trotted out the tired idea that the FED could implement an exit strategy. The market was not buying it obviously since it rallied instead of selling off. I think the market sees things clearly just like the movie Sophie’s Choice where the mother has to make a choice of which of her children to allow to be taken to the concentration camp during WWII so does Bernanke. “Bernanke’s Choice” is to sacrifice the bond market or sacrifice the Dollar. It would appear the market participants understand Bernanke has already made up his mind. If Bernanke were to raise interest rates then regardless of what he claims about selling bonds to reduce liquidity the FED would have to take a hit on their balance sheet, since bond prices are inversely proportional to interest rates. Since the FED tends to protect the banks and itself, it is apparent that Bernanke will sacrifice the Dollar.

As far as our leadership in Washington coming to an agreement that would actually remedy the current situation I believe we will be lucky to get enough of a compromise just to keep things rolling along. Remember we are currently at the beginning of the election season and congress's main objective is to get re-elected and cutting granny's medicare, dad's social security or the military would not go over well at the polls regardless of what people say in opinion polls. The congress does not know how to cut spending and it will have to be forced upon them, but that could still take a while. Look at the last big budget compromise that received the same treatemnt in the media as the Roayl Wedding is currently. The congress argued back and forth and finally agreed to cut $38 Billion and it only took 8 days. Of course in that 8 day the government spent $70 or so Billion more. To pour salt on to that would the CBO (Congressional Budget Office) scored the bill and showed that any savings were greatly exagerrated. Of course now the focus is on raising the debt ceiling which they will do and send yet another signal to the world at large that our fiscal house is no where near any semblance of order or discipline.

I could continue but the bottom line is that not much has really changed from an investment perspective in my opinion. The Dollar will continue its southward trek, and inflation will continue to heat up. One should invest in “things” as the prices for commodities, precious metals and other inflation hedges will do well going forward. There will also be many stocks that will rise at least in nominal value. One could park money in the market but it has to be in companies that either benefit or are not impacted by inflation, like biotech or some tech companies as well as producers of commodities. Other areas to look at are companies with pricing power and those that pay and continually raise dividends.

In this environment I believe a great alternative is still the anti-Dollar (or anti-currency) aka Gold and Silver as they should perform very well in this environment. Moreover, I believe the metals can continue to make gains and we will look back at these price levels and realize that they were fairly priced not expensive as most feel. The reality is if the Dollar and other FIAT currencies are being depreciated then it is not so much that precious metals are rising but instead currencies are falling. There are many that have trotted out charts and theories regarding precious metals prices but as I said before this is not your father’s market and we are in uncharted waters so the old rules may not work any longer.

The precious metals will experience more corrections along the way as the rise particularly in silver is steep, but I believe that it is playing catch up after years of abuse. Silver is known as the poor man’s gold and also a smaller market than gold. The mass affordability of silver has created an influx of new money and is driving the price as it cannot absorb the funds as easily as its fairer brother gold. In full disclosure I did take advantage of the price drops and added more precious metals. I also believe we are rapidly approaching the point in time where the mining shares are getting ready to outperform the metal, as the two flip flop leadership in the sector.

Last week I penned a missive about Silver Wheaton (NYSE: SLW) and I believe that issue has now made the turn and should begin the process of moving higher. The volume on the downside shook out the weak hands and SLW spent time below its 50 Day moving average, but it has rebounded on strong volume today to close above the 50 day. Additionally, SLW was heavily oversold and the stochastics began to turn up, so it looks like the correction in SLW has run its course. There is a chance of some backing and filling here, but the worst is over for SLW in my opinion thanks to Bernanke.

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Roger Vertes said...
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