WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
George Santayana famously said, "Those who cannot remember the past are condemned to repeat it." I say that those who remember the past, but choose to ignore its message, deserve to repeat it! --Steven Jon Kaplan
GLOBAL EQUITIES WILL SOON RESUME THEIR RESPECTIVE DOWNTRENDS (May 4, 2008): There has been far too much optimism and even outright excitement over the rebound in global stock markets since March 17. Many investors are anticipating the end of the worldwide slowdown even before it has barely gotten underway. The recent move above their respective 200-day moving averages by many U.S. equity indices has encouraged many momentum players and others to jump aboard the bullish bandwagon.
A more rational analysis would show that the U.S. equity recovery over the past several weeks has been accompanied by much lower volume than was the case during the downtrend. In addition, many worldwide indices stand only modestly below the multi-year peaks that they had reached several years ago. It is absurdly unrealistic to think that the beginning of the worst global real-estate collapse in history could have ended with such a shallow pullback for global equities. The total magnitude of the declines for other benchmark indices are also significantly less than their normal periodic cyclical retracements.
The recent rebound in the U.S. dollar, which has been moving progressively upward since March 16, along with the final gasps of the commodity rally, which has left the energy complex as the only sector which has not yet experienced a significant retreat from its highs, are both highly uncharacteristic of a market which most analysts believe is supposedly set to continue higher. Even more importantly, long-dated U.S. Treasuries appear to be building a critical base of support at their respective 200-day moving averages. This generally occurs just before a major equity pullback. Meanwhile, top corporate insiders have sharply increased their selling. This demonstrates that the most knowledgeable investors are positioning themselves on the side of greater safety just as amateurs--many of whom sold in the first quarter near the lows--have been eager to jump back in.
The rotational pattern has also been bearish. The strongest performers in recent weeks have been precisely those sectors which had previously experienced the most substantial declines, including the so-called "four horsemen of the Nasdaq". In a bullish rotation, those sectors which most strongly resisted the overall retreat would generally take over as the best performers during the subsequent rebound.
The media have also turned almost giddily positive on stocks, just as they had been far more gloomy in the middle of March when global equities completed a short-term bottom.
Don't be fooled by the hype and by obsolete methods of technical analysis. The Presidential cycle correction is alive and well. The recent rebound is simply a head fake to fool amateurs into buying when they should be selling. Most global equity indices will slump toward much deeper bottoms over the next three to four months as recession fears spread from the U.S. toward most of the world, even including emerging markets. The U.S. dollar will continue its recovery--which will put additional pressure on multinationals, commodity producers, and other sectors which have benefited disproportionately from a weakening greenback and of investors falsely anticipating the resumption of a declining U.S. currency.
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THE FEW REMAINING PEAKS ARE CONFIRMING THE MAJOR REVERSAL IN COMMODITIES (April 27, 2008): Most investors have been highly skeptical of claims by myself and a few other analysts that the U.S. dollar bottomed on March 16, 2008 and began a powerful one-year rally. The media hype about a falling greenback has been so pervasive that dissenting voices have been almost completely suppressed until very recently.
However, in addition to making a bullish pattern of progressively higher lows over the past several weeks, gold mining funds and indices including GDX and HUI have recently touched four-month lows. Lower prices for gold producers are a reliable confirmation of a U.S. dollar rally. Prices for nearly all commodities have joined in the downtrend, with gold, silver, platinum, palladium, cocoa, wheat, corn, and soybeans among the vast majority of commodities that have been in multi-week downtrends after having rallied to multi-decade peaks in February and March.
I know you're thinking, wait just one minute--the media keeps saying that commodities are still going higher. What about crude oil and rice? This raises a critical point--the very few commodities which are still touching new multi-decade highs have gotten so much media attention that they have completely crowded out the true story, which is that more than 80% of all commodities have been moving substantially lower over the past several weeks.
The much-hyped minority of divergences, in other words, are distracting the average investor from the majority which constitute the main trend. This kind of behavior is quite common in the financial markets. By January 1973, for example, thousands of U.S. equities were already in major downtrends, but a tiny group of several dozen stocks, known popularly as the "Nifty Fifty", continued to set new highs amidst much media fanfare. These stocks, which supposedly "couldn't go down", thereafter plunged far more than the overall market.
The same is about to happen now with crude oil and related energy commodities. The current fantasy about how crude oil prices "can't meaningfully decline" or "can only experience temporary brief pullbacks" is identical to the nonsense about the Nifty Fifty 35 years ago, or real estate two years ago. If something is fundamentally overvalued, overbought, overhyped, and overloved, then it will surely plummet in price. The total decline for crude oil is likely to be about 50% over the next half year or so, which will make it one of the worst-performing global asset classes over that period of time.
The same will be true with rice. Just as wheat and soybeans and corn have initiated important downtrends, rice will not be a magical exception to the rule. There has been a lot of media foolishness about supply shortages, whereas actually there is more supply and less demand than there was a year ago.
The reason that we have had these divergences is that there is a lot of money worldwide which is currently invested in commodity funds. The fund managers see that gold, silver, cocoa, and wheat are falling in price, so they shift into the few commodities which are still rising, such as crude oil and rice. This has nothing to do with fundamentals and everything to do with fund managers trying to outperform each other to grab investors' money.
Remember that just six weeks ago, data showed that Indian gold demand had plunged by more than 80%. Many analysts insisted that "it doesn't matter--fund demand for gold will make up the difference". Now gold mining shares are at four-month lows. Physical demand for commodities always matters; artificial demand by fund managers can only create a temporary move higher.
Agricultural commodity funds were not actually consuming wheat or soybeans, so their prices eventually were forced to start declining--and have been doing so for two months. Oil hedge-fund managers are not consuming oil; they are just artificially pushing up its futures prices. Once they start selling, the truth of the situation will become clear and prices will rapidly plummet.
HOW DID THE PRICE OF CRUDE OIL GET SO HIGH IN THE FIRST PLACE? (April 27, 2008): The following is an explanation in a nutshell. In the middle of July 2007, the broad U.S. equity market began a multi-month downtrend. One month later, money which had previously gone into the stock market began to progressively move into commodities. As equities accelerated their downtrend around the world later in the year and in early 2008, commodities enjoyed a massive fund transfer. Many amateur investors bought commodity funds for the first time in their lives. By the middle of March 2008, as global stock markets had plummeted, many commodities enjoyed multi-decade peaks.
The U.S. dollar index bottomed on March 16, 2008. As it subsequently began to recover, one commodity after the other began a downtrend--gold, silver, corn, and so on. Some commodities such as wheat and soybeans had already peaked in February. Since crude oil was still rising in price, commodity fund managers and hedge-fund managers began to sell most commodities to buy those few which were still rising in price--especially crude oil.
In other words, it has nothing to do with logic--it's just that crude oil was in the right place at the right time. Falling stock markets around the world stimulated a massive investor shift into commodities, while the subsequent commodity collapse induced massive commodity fund buying of the few remaining commodities which were still rising in price.
Now, crude oil and rice will soon catch up to equities and other commodities by staging a dramatic collapse. That's how the financial markets have always behaved--and how they will always behave.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, which appeared on newsstands worldwide, and then again on page M14 of their February 25, 2008 issue.
CURRENT ASSET ALLOCATION (May 4, 2008): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 2.5%; municipal bonds, including MYJ, 2.5%; KRE, 1%; XRT, 0.5%; TOC, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 4.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX, GOOG, in that order), 38.5%; short EWM, 1%; short ILF, 1%; short GLD, 20%; short GDX, 3%; short USO, 5.5%; short SLV, 2%; short DBA, 8%; short BIK, 1%; short EWZ, 1%.
REMINISCENCE OF THE WEEK (May 4, 2008): When I was in high school, I had a friend named Kelly who enjoyed playing Led Zeppelin songs on electric guitar. Being a pianist myself, we worked out duets and performed in the neighborhood. When not playing music, Kelly was the biggest sweet talker (a.k.a. b.s.-er) that you could imagine. One day, I bet him lunch that if I dialed a number at random, he couldn't keep the person on the telephone for a full minute. He immediately accepted my challenge. I literally just picked out numbers without even looking at them, and a woman answered the phone. Kelly not only was able to keep the conversation going for more than three minutes, but in another three minutes had arranged a date with this woman. After high school, I didn't see him again for about a decade, when I ran into him in a well-known local music store where he was looking for some special guitar picks. Not surprisingly, he had become the lead salesman for some kind of shady outfit. I'm sure he's still out there selling timeshares or arranging subprime mortgages, and working on the arrangements for a few Zeppelin tunes.
