Couldn't resist

I could not resist shorting energy shares. After buying and then quickly selling HEU at about $18.00 only about 2 months ago, I was forced to watch it march to almost $30 today. I have been patiently watching oil prices and waiting for the right time to enter on the short side. I think that time is now. Sentiment has changed dramatically over the past couple of months. When oil was at $90, no one thought it would sustainably break $100. Now the media is full of reports about oil going to $150 or even $200, and there is less talk about speculation -- it's all about the long-term fundamentals. I believe in the long-term fundamentals. Oil may go to $150 or $200.....but not right now. Not with the global economy slowing. Not with the US consumer suffering with higher food and gas prices.

Of course, I am taking a gamble here. I am going against an established trend, which is generally not a good idea from a trading perspective. And prices can sometimes go vertical at the top. The problem is that when commodities turn, they can sometimes do so very quickly, especially when one side of a trade has become very popular. I am not a very fast trader, so sometimes I must be a bit early. I have taken a small position, and entered tight stops.

I funded the trade by selling one unit of HGU (gold). Gold has had a nice run over the last month, but I fear it too is getting near its top. A return to $1,000 is looking unlikely (in the short-run). I will probably look to exit my other gold position over the next 1-2 months, depending on price action.

MARKET POSITION: SHORT EQUITIES (10 units); SHORT REAL ESTATE (3 units); LONG GOLD (1 unit); SHORT ENERGY (1 unit)

Everyone's confused (me too)

There is a sense of confusion in the markets. You see it in the indices, and you read about it in blogs and in the media. There seems to be 3 distinct groups emerging. The first see the indices as very over-bought, the fundamentals are terrible, and therefore the markets must be heading down in the near future. The second group is the complete opposite, arguing that the trend is up, it is strong, the data has all been better than expected, and the markets are heading higher. The third group falls somewhere in the middle and may be the largest. It sees the markets as overbought and the data as poor. It sees that the markets are probably due for a short-term correction. But it also recognises that the uptrend has been pretty strong, and if anything, the technicals are starting to look better. It also recognises that there are still a lot of people on the sidelines, and these people may need to get sucked into buying before we see a real reversal. That would send equity indices another 3-5% higher (approx.).

I fall into the last group somewhere. I already went out on a limb and called a top and was wrong. I am not going to try that again. But the data this week continued to be on the weak side, despite the fact that the market thought it “better than expectations”. That may be true, but to me it just showed that the underlying economic momentum was strong so it is taking the economy a little longer to slide. In fact, this is not new. In past recessions, there was often a period of mild weakness before the recession really got underway. And I really do not see how the economy is going to have a mild downturn with a sharp recovery when house prices are crashing and oil is at $125.

So I continue to believe that the downside risk to equities is much, much greater than the upside potential, and therefore I am keeping my short position. There is some evidence that market sentiment is getting very bullish, which is probably necessary before we can have a sustained downturn in equity prices. But there are still a lot of bears out there, hanging in (like me). So I am not going to rule out a pop as some more cover their shorts.

Rangebound (again)

It seems that the equity markets are probably rangebound again as everyone awaits a bit more clarity on the economic picture. Data over the past few weeks has generally been better than expected, showing that expectations had been set pretty low. But now people are starting to talk as if there is no recession at all, or it will be very mild. The data do not support this conclusion, either. Employment (including initial claims), consumer confidence, housing starts and the ISM manufacturing index are all signalling a weak economy, one that is probably mildly contracting.

Looking forward, there are few good reasons for optimism. The consumer is suffering from the powerful one-two combination of falling house prices and very high gas prices. The financial crisis, which may or may not be over (I am somewhat ambivalent here), has had a severe impact on consumer and business confidence. Interest rates have been lowered significantly but the full impact has not been passed through to the end-users due to the problems in the financial sector (mortage rates remain above 5%) and loan officers are reporting a tightening of lending standards.

What is obvious is that there has been a major shift in investor perceptions since the March lows, and most are now much more bullish and trading the recovery. This is good from a contrarian perspective. I assume that the recent peak around 1420 on SPX will hold and we will ultimately see the index around 1150 (though I dislike hard predictions like that). Any strong gains above 1420 would be a serious concern and force me to re-evaluate my positioning.

HXD continues to be a major loser in the portfolio and is a strong argument for the introduction of a stop-loss rule (which I abandoned soon after trading). However, I am becoming much more bearish on commodities after recent spikes and therefore am more comfortable with the HXD position. In some ways, this is shaping up to be a classic cycle where the Cdn market lags the US into a bear market by about 6-12 months due to the tendancy of commodity prices to increase sharply towards the end of the business cycle. I remain a long-term commodity bull but think that we have seen most of the gains this cycle as prices have moved too far too fast and the fundamentals cannot catch up. I was an oil bull at $90 but at $125 the effects on consumption will be gradual but strong. I will probably sell gold into any near-term strength.

MARKET POSITION: SHORT EQUITIES (10 units); LONG GOLD VS. SHORT REAL ESTATE (2 units)