Funds Take a Shine to Gold

“Diversified stock funds have been purchasing actual gold bullion, and also piling into gold exchange-traded funds and stock of gold-mining companies.  They have been doing it partly as insurance against a worrisome monetary situation and possible inflation, and partly to goose their returns.”

“No one expects gold to plummet the way it did in the 1980s, from $2,300 per ounce in 2009 dollars to $298….” – WSJ

The market sentiment service sentimenTrader has four indicators for gold.  Three out of four are solidly bearish, and the fourth is neutral.  For instance, their Commitments of Traders (COT) indicator reads clearly: the smart money (commercial hedgers) are net short of gold.  Everyone else (mutual funds, hedge funds, and individuals) is long–really long.  I have been bearish on gold (and likewise bullish on the US dollar) for months and have been wrong, but I believe the tide has just turned.

Dollar-denominated deflation is about to come roaring back.  If you doubt this, look at the currency and bond markets.  Zero Hedge reports that T-bills again yield exactly nothing.  The dollar is rallying strongly.  Gold, playing its part, is falling.  These are ominous signs for both lenders and debtors alike, and the message is, “Own some cash, Dummy!”

For more information on how to protect yourself from a deflationary crash, I strongly recommend Robert Prechter, Jr.’s book Conquer the Crash.


“Funds Take a Shine to Gold,” Larry Light, The Wall Street Journal, 12/12-13/09, B2

House Flipping Makes a Comeback

“SCOTTSDALE, Ariz.–Four years after the collapse of the U.S. housing bubble, flipping homes is back in fashion.”

“The bidders often haven’t had a chance to inspect the property or determine whether it’s occupied by tenants, who may be hard to evict.”

“[T]rustees…offer as many as 600 to 700 houses every weekday.  A typical auction lasts only a few minutes.” – WSJ

Good grief!  Do I even need to write this post?

The author charitably refers to the flippers as ‘investors.’  I beg to differ.  House-flippers are not long-term investors who can afford to own the houses they acquire.  They merely borrow properties from whoever actually puts up the money.  They are leveraged speculators, plain and simple.  What’s more, the flippers highlighted in the article are mostly experienced players–not novices.  Some are still holding on to losers they bought before the crash.  That means they are now doubling-down at lower prices.  As Dennis Gartman teaches, this is trading suicide.

This is not the beginning of a long-term bull market in real estate–especially here in AZ.  Prices must first hit rock-bottom.  For that to happen, all the bad investments must be liquidated.  Right now investors are compounding–not unwinding–their mistakes.  The fact that these speculators have 1) the desire and 2) the means to take on more risk suggests there is an excess of optimism holding up prices in financial markets.  I would not even consider buying real estate as an investment in a climate like this.


“House Flipping Makes a Comeback,” James R. Hagerty, The Wall Street Journal, 12/8/09, A1

Top Watch: Race to the Top

December 2, 2009

“Share prices are racing higher everywhere as virtual panic is setting in on the part of those portfolio managers who’ve either been short or who’ve been less than fully invested and who’s [sic] mandates are the latter.  Nothing is more disconcerting than to have a mandate to replicate or at least come close to the returns earned by the broad market and to be less than invested and lagging those mandates as the year draws to a close.” – Dennis Gartman

Dennis Gartman (of whose excellent newsletter I am a ‘fully-paid-up’ subscriber) has noted the key to this rally: it is driven by professional money managers who are trying to outperform each other and nothing more.  Those that lag their peers are feeling the emotional pressure to get in and get in now.  What happens in the intermediate-to-long-term is not their concern.

This rally could last into the new year, but if there is any hint of a correction before then, look out below.  In that case, these same under-performing managers could herd to the short side, hoping to outperform the longs they have lagged for so many months.  Either way, the rally is on its last legs.

(Playing this rally is fine for traders, but for individuals: is this the type of environment in which to make long-term, sustainable investments?  I think not.  Don’t risk your retirement on the fickle behavior of Wall Street.)


Dennis Gartman, The Gartman Letter,  12/02/09

Top Watch: Hasty Retreat

November 24, 2009

“Germany’s new finance minister yesterday echoed Chinese warnings that low US interest rates and a weak dollar are raising the threat of fresh global asset price bubbles.” – FT

“The European Central Bank yesterday showed unexpected impatience to unwind emergency steps taken to combat the economic crisis, announcing plans to tighten the terms on which it lends liquidity to eurozone banks.” – FT

The Europeans are evidently anxious to get out of the way of what they view as a strong financial recovery.  In fact, they are so convinced of the rally’s upside potential that they are becoming concerned about asset bubbles stimulated by inflation–specifically in the US.

The ECB–being a government entity–is playing its part perfectly by acting much too late to fix yesterday’s problems.  The asset bubbles are deflating in spite of trillions of new dollars being created.  Obviously something is different than in 2002.  This is not the time to be concerned about a repeat of the recent past.

Short-term swings in emotion-driven markets do not change the truth about most of the developed world: it carries way too much debt.  Today’s WSJ says it all:

1 in 4 Borrowers Under Water

Until this fundamental changes and people start building wealth–rather than just playing with other people’s money–there is little hope for a true financial and economic recovery.  Until then, deflation is the name of the game.


“Germany warns US on market bubbles,” Ralph Atkins and Aline van Duyn, Financial Times, 11/21-22/09, p.1

“ECB acts with haste to unwind liquidity support for bank sector,” Ralph Atkins and Jennifer Hughes, Financial Times, 11/21-22/09, p.4

“1 in 4 Borrowers Under Water,” Ruth Simon and James R. Hagerty, The Wall Street Journal, 11/24/09, A1

Why Stocks Will Rise

“With the yield spread at this level, stocks will probably climb, Smyth says.” – Bloomberg Markets

The analyst Smyth correctly noticed an inverse correlation between credit spreads (specifically between Moody’s Baa corporates and T-bonds) and the stock market.  He also got the order correct; credit seems to lead the stock market (at least since the crisis broke out in 2007).  He also pointed out that the spread is back to relatively low levels (under 3%), just like in late 2007 and early 2008.  The only thing he got wrong was his conclusion that this is a bullish sign.

Low credit spreads mean that investors are optimistic about the future.  They believe that they are being compensated for the risk of default by the small difference between the yields on the credit-risky asset and the credit-risk-less asset (the opportunity cost).  In contrast, when investors are pessimistic about the future, they demand a much larger cushion to protect them from what they expect to be elevated default levels.

Low credit spreads are a contrary indicator.  Crises break out from calm.  Complacency begets panic.

History shows what happens when complacency reigns.  As our bullish analyst Smyth pointed out, the last time spreads were this tight was in late 2007–right before the stock market crashed.  Smyth is in the unfortunate position of having to argue that “This time is different.”  I believe this time is the same.


“Why Stocks Will Rise,” David Wilson, Bloomberg Markets, December 2009, p.14

Dow Leaps in Skeptics’ Rally

“Enormous though it is, the investment boom since March has been a skeptics’ rally–fed by money managers who feel they must make risky bets in order to keep up with the market, but who don’t like what they see.”

“[M]any investors are uneasy.  For these people, the market is taking on a ‘greater fool’ feel, meaning that many don’t really believe in the investments they are making.  They are banking on being able to sell to a ‘greater fool’ later.”

“Investment stategist Ed Yardeni…says he has visited managers of pension funds, mutual funds and hedge funds in Boston, Chicago and London in the past two weeks and found most uncomfortable with their investments.  He calls them ‘fully invested bears.'” – WSJ

The warning signs are all over this article (lead position, front page) from today’s WSJ.

1. Notice all the emotional language.  Investors always follow their emotions.  This is no exception.  If owners of risky assets are nervous, there is only one way to remove the source of their discomfort: sell the assets.

2. Institutional investors are nervous, and yet they are fully invested in risky assets.  If they decide to sell, it could get ugly simply because of the large position sizes.

3. Investors don’t seem to care about long-term growth or dividends right now; they are focused on short-term capital gains.  Once the selling begins, it will feedback into itself as these people run for zee hills.

Whether or not the Dow touches a new recovery high and regardless of whether the other indexes confirm it, this is not a healthy bull market that presages a golden era of American prosperity.  This is a counter-trend rally that is on its last legs.


“Dow Leaps in Skeptics’ Rally,” E.S. Browning, The Wall Street Journal, 11/10/09, A1

Fears of a New Bubble as Cash Pours In

“Concerns are mounting that efforts by governments and central banks to stoke a recovery will create a nasty side-effect: asset bubbles in real-estate, stock and currency markets, especially in Asia.” – WSJ

This article would have been very prescient and timely if it had been written in the aftermath of the tech bubble.  During that time we all should have been worried about the Fed’s multi-year easing program.  Those actions encouraged the forming the credit bubble which inflated the prices of all risky assets (namely, global real estate and emerging markets’ stocks & currencies).

Those times are now over. Apparently, I’m one of the few that got the message!

Forget the central banks; they are helpless in the face of the ongoing implosion of debt.   A trillion or so newly ‘printed’ dollars is child’s play relative to $53 trillion in total debt outstanding.

The world is deleveraging in spite of governments’ efforts to keep debt levels high.  That is the trend to watch.


“Fears of a New Bubble as Cash Pours In,” Alex Frangos and Bob Davis, The Wall Street Journal, 11/4/09, A1

“Credit Market Debt Outstanding, All Sectors,” The Chart Store, 6/30/09

Top Watch: Cheap Rally

October 27, 2009

“Six months ago, the financial system was in deep distress, reeling from a meltdown.  Now despair and panic have been replaced not simply by relief–but, in some quarters, euphoria.  Never mind the high-profile rally that has occurred in the equity markets; what is perhaps the most stunning is the less visible rebound in debt and derivatives markets, as risk assets have displayed what Barclays describes as ‘stellar performance’….

“Yet, if you talk at length to traders…it seems that few truly believe that fundamentals alone explain this pattern.  Instead, the real trigger is the amount of money that central bankers have poured into the system that is frantically seeking a home, because most banks simply do not want to use that cash to make loans.  Hence, the fact that the prices of almost all risk assets are rallying….” – FT

There are many clues in these quotes that the top is either in or near:

1. “Despair” is out; “euphoria” is in.  This is the psychology of a top.

2. Derivatives, one of the key players in the AIG meltdown, are performing extremely well.  We haven’t learned a thing.

3. Traders aren’t even pretending to rely on fundamentals.  They are speculating, pure and simple.  If things turn sour, they will bail.

4. Central bank-created liquidity is “frantically” looking for a home, and it’s not in new loans.  Banks are earning profits by speculating in markets with ‘free’ money, not making conservative, long-term loans.


“Rally fuelled by cheap money brings a sense of foreboding,” Gillian Tett, Financial Times, 10/23/09, p.20

Top Watch: Bullish AIM

October 25, 2009

According to sentimenTrader‘s Advisor & Investor Model (AIM), both advisors and investors are bullish.  How bullish?  These levels haven’t been seen since early 2007–before the credit crisis broke out with the Bear Stearns hedge fund bail-outs.  These survey results are actually more bullish than near the 10/11/07 top in the S&P 500 (1576.09).

Wait–isn’t bullishness good for the market?  After all, bullish people buy stocks, right?  I will let sentimenTrader answer this one:

“This model takes advantage of the fact that when the typical investor and investment advisor should be most bullish, they are most bearish.  And, when the markets are getting overbought and are about to turn, these Johnny-come-lately are most bullish.”

The impulse to herd–built into each of us by evolution–is the key to explaining this behavior.  Markets don’t top for a lack of bullishness; they top because of an overabundance of bullishness.  It is safe to assume that the people surveyed are not bullish merely in opinion; they are invested in line with their views.  Once this bullishness reaches an extreme, there is nowhere else to go but down.

Top Watch: Memory Fades

October 19, 2009

Mounting optimism bolsters markets’ mood

“Wall Street passed an important psychological milestone this week as the Dow Jones Industrial Average broke back above the 10,000 level for the first time in a year.”

“As appetite for riskier assets such as equities, commodities and high-yielding currencies improved, government bonds and the dollar fell.”

“The key to the week’s price action came from corporate earnings.” – FT


1. Dow 10,000 is a nonevent. There is nothing special about any price level in itself, but how we get there certainly matters.  I don’t remember any celebration on October 7th, 2008 when the Dow decisively broke through 10,000 on the way down.

2. Corporate earnings reports are the exact wrong way to predict the future of companies. They are a backward-looking product of management. Enron published public financial reports. So did Bear Stearns, AIG, etc.

3. Investors haven’t learned a thing.  How soon they forget the rout of 2008 in stocks, commodities and high-yield currencies.

4. This is herding–plain and simple. Any talk of ‘value’ is post hoc rationalization. The true motivator is fear–not of leverage and volatility–fear of missing out on profits.

5. Contrary to the herd’s belief in a strong market, notes that 21 of the indicators it tracks (30% of the total) are flashing bearish warning signs.  For example, their Total Put/Call Ratio 10 Day indicator reached a new bearish extreme reading on Friday.  The number of bullish indicators is short: there are none.

In summary, the bearish case is building–not receding–with every tick higher in asset prices.  Who cares what the corporate reports say about last quarter?  The market is screaming “Sell!” right now to traders with the guts to go against the herd.


“Mounting optimism bolsters markets’ mood,” Dave Shellock, Financial Times, 10/17-18/09, p.14


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