Last week was interesting. One that I would like to repeat with a little better patience. I have been saying since the beginning of the year that gold looked like a crowded traded, and I was going to wait for it to correct before increasing my position. Instead I bought another unit almost at the (interim) top. HGU tumbled terribly last week. Even worse, the US homebuilders performed very well, so both sides of my new trade moved against me (rather rapidly), causing a serious dent in my performance.
In fairness, it looked like a lot of trades were blowing up last week as margin calls were made and funds deleveraged. Commodities took the brunt of it, with oil, metals and the ags getting smashed. The yield curve flattened, even as yields on very short T-bills went to almost zero and TIPs yields moved positive again. In the equity markets, the indices were all over the place. In the end, SPX was up about 5% from its lows, while S&P/TSX was down, finally closing much of its perfomance gap with SPX.
I am remaining bearish on equities and positive on gold. The market is certainly far from its full bottom, and there is also little evidence that a short-term trading bottom has been formed. We still have not had a downside blow-out. The VIX jumped to 35 on Monday but it was very brief and rallied strongly from that level. Sentiment is poor but has yet to be seriously tested. There seem to be many people that assume that the bear stearns debacle marked a bottom and the markets are headed higher. This may be somewhat true but the upside seems rather limited. We are not going to have a 20% bear market rally when the market is only down 20% from its peak. In addition, the market has already rallied over 5% from the bottom. Not enough upside for my purposes i.e. the risk/reward looks terrible.
Gold miners, on the other hand, start to look attractive after a 12% fall in value over a few days though I am reluctant to increase my exposure there after last week. The agricultural equipment makers also look interesting after sharp declines on Thursday -- seems they have been caught up in the commodity price crash. But as I have said before, it is not necessary for whet prices to remain at $10 for these companies to perform very well. I will likely take a wait-and-see attitude this week, keeping an eye open for opportunities that may open up in the turbulence.
TRADES: SHORT EQUITIES (8 units); LONG GOLD vs. SHORT HOMEBUILDERS (2 units)
Sunday, March 23, 2008
Sunday, March 16, 2008
Waiting for the next shoe to drop
When I wrote the post on Feb. 29 ("getting close to meltdown?") I was not expecting this. A major investment bank, one of the Fed's primary dealers, on life support. I was also rather surprised how the pessimism never lifted this week after the Fed's big announcement on Tuesday. Shows the financial system is in really poor shape. The central banks in the US and UK are completely out of their depth. They are used to having the financial markets at their beck-and-call. If there were any serious problems, they made a few soothing statements, lowered interest rates, and everything was fine. But such is not the case this time -- they are lost -- and I get the impression that things are going to deteriorate until governments get involved.
I will re-iterate what I said last Saunday, that in the past, such periods (where the situation has looked really bad) have been good times to invest. But even if we are close time-wise, we may not be so close price-wise. This week will be a major test.
On Friday (March 14) I closed out my position in HEU at a small loss. If markets are going in the tank, I don't think it's a good idea to be long energy shares. On the same day I took a short position in the US hombuilders (ticker SRS) to counter-balance the long gold position. I think this is a good trade and may increase it if it performs well. House prices in the US need to fall substantially more in real terms. Either nominal values will fall and inflation will stay low, or inflation will pick up and the adjustment will happen that way. If nominal house prices fall, the homebuilders will get seriously screwed. Probably a few of the really big names (e.g. Toll, Lennar, Horton) will go under. Alternatively, if inflation picks up even more, gold should continue to do well.
I still am waiting to enter the agricultural equipment makers at a good price. If there is a sharp drop in their share prices in the near future, I will probably take advantage and start to build a position.
TRADES: SHORT EQUITIES (8 units); LONG GOLD vs. SHORT HOMEBUILDERS (2 units)
I will re-iterate what I said last Saunday, that in the past, such periods (where the situation has looked really bad) have been good times to invest. But even if we are close time-wise, we may not be so close price-wise. This week will be a major test.
On Friday (March 14) I closed out my position in HEU at a small loss. If markets are going in the tank, I don't think it's a good idea to be long energy shares. On the same day I took a short position in the US hombuilders (ticker SRS) to counter-balance the long gold position. I think this is a good trade and may increase it if it performs well. House prices in the US need to fall substantially more in real terms. Either nominal values will fall and inflation will stay low, or inflation will pick up and the adjustment will happen that way. If nominal house prices fall, the homebuilders will get seriously screwed. Probably a few of the really big names (e.g. Toll, Lennar, Horton) will go under. Alternatively, if inflation picks up even more, gold should continue to do well.
I still am waiting to enter the agricultural equipment makers at a good price. If there is a sharp drop in their share prices in the near future, I will probably take advantage and start to build a position.
TRADES: SHORT EQUITIES (8 units); LONG GOLD vs. SHORT HOMEBUILDERS (2 units)
Thursday, March 13, 2008
More of the same
Global markets were very weak Monday as liquidity tightened and risk aversion increased. Tuesday was looking pretty ugly until the Fed showed up and offered to take $200B of crappy mortgages onto its balance sheet. The markets bounced initially (equities in particular were up very strongly) but now seem uncertain. Today's action was both positive and negative. USD continues to plum new depths against EUR and JPY indicating more risk aversion and less love for the USA. On the latter theme, the US Treasury 10yr auction today was very weak, and apparently foreign participation was almost non-existent. Perhaps we are finally nearing the lows in treasury yields. It IS pretty crazy that people are willing to accept 2.5% nominal yield when inflation is currently over 4%. You need to have an absolute collapse in nominal GDP growth to justify such yields, which seems inprobable. Ben has shown clearly that he will do whatever it takes to keep the economy out of a deflationary trap.
On that note, the Fed's actions seem likely to have the same effect as in the recent past -- propping up financial markets for 1-2 months before the problems return. Commodities continue to be well-bid, with oil at $110 and gold touching $1,000 today. I continue to believe that we will have some sort of correction at some point but timing is uncertain and prices will probably not fall as much as I thought earlier. So I finally dipped my toe a little deeper in the water and increased my gold holdings by one unit, plus one unit of energy companies. These should both perform well in the medium-term given current gold and oil prices. However, I also note that I added the position today at a time when I was very tired and stressed, and my judgement on the timing may not have been optimal. Time will tell.
On a portfolio admin item, I am re-basing my calculations of units to account for the fact that my holdings of SDS / HGU have perform much better than HXD.
MARKET POSITION: EQUITIES - SHORT (8 units); GOLD - LONG (2 units); ENERGY - LONG (1 unit)
On that note, the Fed's actions seem likely to have the same effect as in the recent past -- propping up financial markets for 1-2 months before the problems return. Commodities continue to be well-bid, with oil at $110 and gold touching $1,000 today. I continue to believe that we will have some sort of correction at some point but timing is uncertain and prices will probably not fall as much as I thought earlier. So I finally dipped my toe a little deeper in the water and increased my gold holdings by one unit, plus one unit of energy companies. These should both perform well in the medium-term given current gold and oil prices. However, I also note that I added the position today at a time when I was very tired and stressed, and my judgement on the timing may not have been optimal. Time will tell.
On a portfolio admin item, I am re-basing my calculations of units to account for the fact that my holdings of SDS / HGU have perform much better than HXD.
MARKET POSITION: EQUITIES - SHORT (8 units); GOLD - LONG (2 units); ENERGY - LONG (1 unit)
Sunday, March 9, 2008
Where to from here?
The fixed income markets are in a very tight spot. Swap spreads are the highest in at least 20 years. There is a lot of pricing dislocation as investors flee to quality. The corp. bond market has virtually dried up, and apparently off-the-run treasuries were trading sluggishly on Friday. Traders are very nervous. Pricing dislocations abound. There has even been some "end of the world" type talk.
Is this the end of the world? Maybe, but probably not. There are certainly some aspects of the current situation that very serious, and probably make it worse than previous episodes. In 1998 there was essentially one hedge fund in trouble, albeit one that was very large and had significant linkages throughout the major banks. But currently, it is the banks themselves that are in trouble, and it is not just one. Bank capital is low and declining, forcing banks to protect their balance sheets. An incipient recession and housing bust provide a negative backdrop, while large CDS exposures and mark-to-market accounting threaten to amplify price declines. The Fed has increased liquidity multiple times over the past 7 months, but it has failed to correct the problem or reduce the sense of crisis. Even worse, there is no leadership and no reasonable proposals on how to get out of the mess.
In the past, such overly negative situations have signalled major buying opportunities. Is now such a time?
I would argue that we are near time-wise, but still have some way to go price-wise. Prices tend to go down exponentially in a "blow-out" situation, and we have yet to see such movements. Fixed income is arguably much of the way there already. Equities have started, but as I mentioned before, the movement has been remarkably gentle given the situation in the fixed income markets. Equities almost certainly have much farther to go. Commodities may act as the signal of the final turn. There appears to be a lot of speculation and risk capital in the commodities. When that money is finally pulled and prices get hit, it will be a strong signal that the end of the slide is nigh.
MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)
Is this the end of the world? Maybe, but probably not. There are certainly some aspects of the current situation that very serious, and probably make it worse than previous episodes. In 1998 there was essentially one hedge fund in trouble, albeit one that was very large and had significant linkages throughout the major banks. But currently, it is the banks themselves that are in trouble, and it is not just one. Bank capital is low and declining, forcing banks to protect their balance sheets. An incipient recession and housing bust provide a negative backdrop, while large CDS exposures and mark-to-market accounting threaten to amplify price declines. The Fed has increased liquidity multiple times over the past 7 months, but it has failed to correct the problem or reduce the sense of crisis. Even worse, there is no leadership and no reasonable proposals on how to get out of the mess.
In the past, such overly negative situations have signalled major buying opportunities. Is now such a time?
I would argue that we are near time-wise, but still have some way to go price-wise. Prices tend to go down exponentially in a "blow-out" situation, and we have yet to see such movements. Fixed income is arguably much of the way there already. Equities have started, but as I mentioned before, the movement has been remarkably gentle given the situation in the fixed income markets. Equities almost certainly have much farther to go. Commodities may act as the signal of the final turn. There appears to be a lot of speculation and risk capital in the commodities. When that money is finally pulled and prices get hit, it will be a strong signal that the end of the slide is nigh.
MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)
Portfolio performance
I will post this at the end of each month from now on. Performance at the start was dismal, but I feel I am improving. The trading portfolio just barely outperformed T-bills to March 7 close.Thursday, March 6, 2008
Wile E. Coyote moment
Global equity markets are markedly lower this week, but the slide so far has been rather orderly. The situation reminds me of last July or early January. The other, larger financial markets (FX, bonds, credit, commodities, etc) are signalling major problems, yet the equity markets are only just beginning to cotton on. USD/EUR is much lower, short-term government bond yields have collapsed, credit spreads (swaps, LIBOR, corporates, munis, agencies -- you name it) are blowing out, gold is pushing $1,000 and oil is well over $100. Banks are short capital, risk aversion is high, and liquidity is tight. 5 year TIPS real yields are now less than zero! The response? SPX is still above its January lows, and VIX is at 26.5. It's like the equity market has run off a cliff, but is only just realising it now....
Just to throw in one more issue: inflation expectations appear to be rising in the US treasury market. No wonder -- surprising it took so long. This is negative for earnings multiples. And I am not going to discuss the monolines.
As for the economy -- it's not looking good. Not terrible, mind you, but not good either. Both ISM surveys were below 50 this month. As the 4 week moving average of initial unemployment claims remained above 350k for the 3rd week in a row today, I feel comfortably declaring that the US is officially in recession. The ISM and unemployment numbers were not as bad as the market feared, but that does not mean the recession will be short or easy. This is only the beginning. It is natural that the indicators will be mild at the start. It's really the trend that matters. And the trend is not good.
As mentioned above, gold and oil continue to power higher. I am wary of jumping in here. No need to be greedy. Patience will be rewarded on the commodity trade. I think commodity prices will take a big hit sometime soon as people re-equate the US slowdown with lower demand for commodities. They will probably also be affected by the tightening of liquidity and falls in other asset prices. But that will set-up a good buying opportunity. This commodity bull market is far from over -- it's just gotten too far ahead of itself at this point.
MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)
Just to throw in one more issue: inflation expectations appear to be rising in the US treasury market. No wonder -- surprising it took so long. This is negative for earnings multiples. And I am not going to discuss the monolines.
As for the economy -- it's not looking good. Not terrible, mind you, but not good either. Both ISM surveys were below 50 this month. As the 4 week moving average of initial unemployment claims remained above 350k for the 3rd week in a row today, I feel comfortably declaring that the US is officially in recession. The ISM and unemployment numbers were not as bad as the market feared, but that does not mean the recession will be short or easy. This is only the beginning. It is natural that the indicators will be mild at the start. It's really the trend that matters. And the trend is not good.
As mentioned above, gold and oil continue to power higher. I am wary of jumping in here. No need to be greedy. Patience will be rewarded on the commodity trade. I think commodity prices will take a big hit sometime soon as people re-equate the US slowdown with lower demand for commodities. They will probably also be affected by the tightening of liquidity and falls in other asset prices. But that will set-up a good buying opportunity. This commodity bull market is far from over -- it's just gotten too far ahead of itself at this point.
MARKET POSITION: EQUITIES - SHORT (11 units); GOLD - LONG (1 unit)
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