A true contrarian look at investing and at life in general.
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.
THE STEEPEST PHASE OF THE U.S. STOCK-MARKET PLUNGE IS ABOUT TO OCCUR (September 7, 2008): Even after declining for nearly eleven months, most investors remain thoroughly complacent toward the possibility that U.S. equities will suffer an additional substantial pullback. Both VXO and VIX, the two most historically reliable gauges of fear, show no more concern today about a significant decline than had existed when the U.S. stock market was close to its seven-year peak in the second half of 2007.
A continued lack of fear in a falling market is the most dangerous scenario of all. The stock market has never completed any major bottom until the majority of investors were frightened enough to sell their stocks and to move their money into the safety of money-market funds and similar safe time deposits.
In confirmation of this outlook, the only insider buying by top executives has occurred in the most undervalued sectors, with continued selling in most industries.
While U.S. Treasuries have rallied to their highest levels since March, the spread between low-grade corporate bonds and U.S. Treasuries is at its highest point since early 2003. Fixed-income traders include very few emotional amateurs or novices, and are therefore generally more knowledgeable than the average equity investor. When the smartest participants have intentionally fled to the safety of U.S. Treasuries and have shown a marked aversion to low-grade corporate debt, this can only mean that the U.S. economy will soon go into a true recession.
You can forget about all those decoupling myths. Whenever the U.S. economy is weak, the rest of the world has proven to be even weaker. Emerging-market equities and commodities have slumped more in percentage terms than U.S. equity indices.
Whenever the U.S. government announces one plan of action or another, the stock market enjoys a sharp one-day rally. Friday's announcement about nationalizing Fannie Mae and Freddie Mac could lead to a sharp move higher for U.S. equities on Monday morning.
But one-day rallies have never been a feature of a healthy market. During the entire bull market from October 10, 2002 through October 11, 2007, there was not a single day when the Dow Jones Industrial Average rose 300 points or more. However, during the bear market from early 2000 through October 10, 2002, there were twelve such days--and six just since November 2007. Sharp one-day rebounds define a market which still has much farther to decline.
The steepest part of any correction almost always occurs in the final weeks, and even in the final days. It's not going to be a pretty picture. The U.S. stock market is going to reach an incredibly deep low in October 2008 that will be accompanied by three-year and even four-year bottoms for most U.S. equity indices.
BUY GOLD MINING SHARES AND FUNDS (September 7, 2008): One sector which has become severely oversold is gold mining shares. On Friday, September 5, 2008, GDX--the most popular fund of gold mining shares--touched a new all-time low of 31.65. [GDX had its debut on May 23, 2006.] This was slightly below its previous bottom of 31.82 from June 13, 2006. If you look at the ratio of gold mining shares to the price of gold, they were only this undervalued on one other occasion--when they completed a historic nadir in November 2000.
As central banks around the world are forced to cut interest rates to respond to a global economic contraction, this will prove to be strongly supportive of precious metals shares even as the U.S. dollar generally continues its rally for another half year or so.
Therefore, I have increased my holding in GDX to 10.5% of my total net worth (see my total asset allocation below), and will continue to gradually accumulate GDX and ASA on all dips over the next several weeks.
In the link below, I have updated my outlook on gold mining shares, as my target price of 295 for HUI was finally achieved.
IT'S TIME TO BUY GOLD MINING SHARES, AND TO SELL SHORT U.S. EQUITY FUNDS (August 17, 2008): This year has continued to provide fabulous opportunities throughout the financial markets. GDX, an exchange-traded fund of gold mining shares, had peaked at 56.87 on March 17, 2008. On August 11, 2008, it touched a low of 33.86, which represents a total pullback of 40.46% in five months.
This demonstrates fairly typical volatility for this sector, and is not surprising in itself. What is startling is that the same investors who were falling over themselves to buy GDX when it was near its peak, currently want nothing to do with it. As Mr. Spock would say, humans are indeed curious! Since gold mining shares have been in a powerful bull market since November 2000, this represents a very good buying opportunity for those who were patient enough to wait for a compelling value situation to present itself.
It is probable that the recent low for GDX represents a left shoulder in a typical head-and-shoulders bottom, rather than the ultimate nadir. However, any price near 34 or below is a compelling buying point for GDX, and therefore I covered my entire short position and invested 5% of my net worth in GDX as a long position. I plan to increase this allocation, especially if gold mining shares experience a final plunge at some point over the next few months. GDX is likely to enjoy periodic sharp upward bounces several times before it commences its next strong rally.
It should be pointed out that the 2006 bottom for GDX was 31.82 on June 13, 2006, while the 2007 low was 32.76 on August 16, 2007. So GDX is roughly repeating its support levels from each of the past two years.
Meanwhile, U.S. equities have been forming a pattern of marginally higher readings--rising just enough to shake out misinformed or uncommitted amateurs who do not realize that we are about to enjoy the sharpest phase of the entire U.S. equity correction which began in October 2007. QQQQ is a fund of the top 100 Nasdaq companies by market capitalization; the next several weeks will likely see this and similar funds plummet by 25% as U.S. equities retest important support levels from 2005-2006. I have therefore added to my already substantial short position in QQQQ in recent days, as its price moved above 48 dollars per share. Recent astonishingly low intraday volatility readings, including VXO at 20.94 and VIX at 19.57, confirm that U.S. equity investors are overly complacent when they should be maximally defensive.
Near the bottom of this update, you can find my current asset allocation. In the next paragraph is a link which provides much more detailed information about the behavior of gold mining shares during the past eight years, and where this sector is likely headed over the next few months.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, and then again on February 25, 2008 (page M14) and June 2, 2008 (page 41), as well as August 25, 2008 (page 32).
CURRENT ASSET ALLOCATION (September 7, 2008): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 4.50%), 4.6%; MYJ, 2.5%; TLT, 2.4%; other U.S. Treasury funds (VUSTX, VBTIX), 7%; GDX, 10.5%; KRE, 1%; XRT, 0.5%; TOC, 1.7% (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, 4.0%; SHORT POSITIONS: short QQQQ, 37.8%; short GOOG, 4%; short EWM, 1%; short ILF, 1%; short USO, 5.5%; short DBA, 8%; short BIK, 1%; short EWZ, 1%.
REMINISCENCE OF THE WEEK (September 7, 2008): When I lived in Baltimore, I wanted to visit my best friend from high school who was going to school at the University of Chicago. There were no direct flights from Baltimore, so I booked a trip from Washington National [now called Ronald Reagan]. Although I thought I had left plenty of time to drive there, I became hopelessly confused as many of the main streets were blocked off for some political function or another, and I hadn't studied the route well enough in advance. While mired in a particularly bewildering stretch with a lot of traffic circles, I noticed that a D.C. taxicab was driving immediately to my left. I motioned to the driver--who may have thought I was crazy, but who had the presence of mind to pull over to the side of the road where I joined him. "I'd like you to take me to the airport," I pleaded, "but first you have to take me to a parking lot where I can drop off my car." Fortunately, he knew of a reasonably-priced place nearby, and I made it to the airport just in time. The toughest part was remembering how to get back to that parking lot in the dark when I returned home from Chicago on a night flight.