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  • Archive for June, 2007

    XAU put/call ratio shows extreme fear

    Posted by ML on 29th June 2007

    If I had to use a single word to describe the actions in gold/silver in recent days, it would have been “painful”. Many gold “gurus” rushed to forecast lower prices Tuesday’s $11 drop (at its lowest point). It behooves us to once again look at the XAU put/call ratio as a contrarian indicator.

    I have previously called this a “mildly useful indicator”. Indeed, we have seen a number of spikes in this ratio to the range of 3-4. More often than not, such a spike is followed by 3-4 days of upside action. On Tuesday however, this ratio was above 5. The last spike of this magnitude occured at the low of this correction, where HUI bottomed at 275, some 15% lower than where it is now. As sentiment indicators go, the closer they are to the extremes, the more reliable they are; and the fear in gold investors was pretty palpable on Tuesday.

    Recall the time analysis I posted on May 30. The HUI made a low of 317.7 on that very day. This past Wednesday, HUI dropped to as low as 317.81 before turning higher. I can’t predict if 317 will hold, but buying when fear is rampant has been a good recipe for this bull market in gold.

    Posted in Gold/Silver, Investing | 1 Comment »

    Another non-event of Fed meeting this week

    Posted by Frugal on 27th June 2007

    Interest rate will stay at 5.25%. Fed governors will again emphasize the inflation risk verbally. But the longer Fed holds out for not cutting interest rate, the worse the housing markets will get. I don’t know what Fed has in mind. You can print money to buy stock futures. You can print money to keep loans and leverages up. But can you print money and buy individual houses? I don’t think that Helicopter Ben is that crazy yet. Besides, he is really under fire from all the Democrats.

    The monetary tide in housing credit boom has turned. The bond king Bill Gross said that Fed will cut interest rate in the next 6 months. With all the loan delinquency surging, I don’t know any other ways around for Fed. Personally I just think the Fed is trying to build up an image of credibility as an inflation fighter, keeping the US dollar up, while keeping the precious metals down. This is probably just all under plan. The only thing that I am not sure is whether Fed is over-confident about its maneuver and over-stay the 5.25% interest rate.

    We’ll see what happens later in the year. Maybe with the two trips to China, Ben and Paulson haven’t hammered out a deal with the Chinese. Yeah, bonds are dropping, and 10-year notes still refuse to drop their yield below 5.0%. That’s a showing of weak demand.

    Posted in Investing | 1 Comment »

    Subprime woes at Bear Stearns

    Posted by ML on 26th June 2007

    All was not well on Wall St. last week. The week started off on a wrong footing as Best Buy, Circuit City, and FedEx all reported disappointing earnings. Since middle of the week the woes of two two small hedge funds at Bear Stearns that invests in subprime mortgages has grabbed headlines. In its wake, the news that Home Depot was buying back a staggering $22.5bn worth of its stock was relegated to the side line.
    The saga at Bear Stearns is still ongoing. This commentary based on a WSJ article was worth a read. The central issue, as WSJ pointed out, was that hedge funds are marking the value of their MBS (mortgage backed security) portfolios to “model” rather than to “market”. Consequently, these hedge funds have not reported losses despite the large drop in the subprime ABX indexes. However, now that Meryl Lynch is threatening to sell off the assets in those Bear Stearns hedge funds, there may be a whole-sale re-pricing waiting to happen.

    The one other thing can trigger the hedge funds to “mark to market” a ratings change one of the agencies. That is precisely what’s coming. On Friday, both S&P and Fitch announced they may issue downgrades to certain CDOs (collateralized debt obligations).

    So early part of this week will probably see a fire storm, especially in the financials. After the 1.3% decline last Friday, the S&P 500 is sitting right below its (still rising) 50 DMA. However, a drop below the recent low of 1487 would establish a short term down trend that suggest a test of 1460, the February peak. We’re still a ways above the uptrend in the weekly chart so there is no reason to panic. From strictly an earnings point of view, there is obviously a slow-down as noted in the opening paragraph. But I believe the spinmeisters will succeed for at least one more quarter yet in convincing everyone a turn-around is right at the corner.

    There has been a very significant pick-up in volume in the Powershares inverse ETFs (such as SDS, the double short S&P ETF) since March and the trend has only accelerated. Some of it must be traders wanting more juice from the intraday moves, but I’ll also hazard a guess that there is a positive correlation to retail holdings (institutions are more likely to short directly or use futures to hedge). Whether that is enough support for this market I cannot tell. For now I’m still expecting some upside but with greater volatility. I’m not going to short this market until there is an established intermediate down trend over the intermediate term.

    Posted in Market Pulses | Comments Off

    Portfolio Strategy Going Forward

    Posted by Frugal on 25th June 2007

    Stock market again took a fall on Friday. The stock market looks to be gradually unstable. Frank Barbera’s fall date for Shanghai’s market is around Jun29. My own date for US stock market currently is first or second week of July. Even though this bull market is getting really old, and also crazy, it has surprised me so many times. I am quite doubtful however that it can last until August 1st.

    Here is what I’ve collected from various pundits:
    1. Puplava believes the market can go as far as late in the year or even into 2008. Regardless, Puplava is raising LOTS of cash in the managed accounts. In fact, this is the first time I see so much cash in my managed account. But the percentage level of cash I believe is entirely prudent given my own bearish stand.
    2. Bill Cara is still pretty bullish on gold & goldminers. Although I can follow Bill’s reasoning, and am hopeful that he is right, I doubt that this stock market can last that long. I think Bill believes the high should be before October. That almost requires a rallying of PM right now or within 3 to 4 weeks. Again, I am not sure. But I won’t be selling out my substantial positions in PM either.
    3. Boy Hoye is still conservatively bullish on PM miners. He has been bullish for a while without not much happening. His previous bullish call in Jan was knocked out of place within a week. Regardless, I believe his intermediate and long term bullish forecast for PM is correct.
    4. Frank Barbera is bearish. Many ways of falling, but a big fall for sure in his opinion.

    I will be raising my cash further, and possibly buying puts in the coming weeks.

    Here is my own thoughts on various sectors taking a longer term view:
    1. Precious metals: my own belief is that PM/gold sectors may have skipped a heartbeat this time around due to all the central bank selling. It looks to me that it’s more likely that PM will NOT go up too much BEFORE stock market takes a BIG tumble. I believe that PM may have another retest of low along with the stock market falling down hard. But PM would break new high after stock market correction is over and starts to rise again.

    2. General stock market: I believe that once the stock market correction is over, one should be long aggressively on foreign stock markets (India, Brazil, China, etc), and aggressively long on energy sectors. The general stock market will rise too but probably will be a less stellar performer. I have stated previously that the secular bear market started in 2000 is over. By that, I mean US stock market will NOT break 2002 low in all likelihood. The Elliot Wave styled depression will not come before year 2032/33 (the peaking height of 51.6 or 309.6 economic cycle, which is a date within the calculated date of singular point from super-exponetial human and economic growth) if at all. It will continue to break new highs going forward with big/small corrections along the way.

    3. Energy sector: this should be the best and safest sector to bet on going forward. Whether you believe in a new era of global economic growth or whether you are a peak oil believer, this is the sector to put your bets in. I will be AGGRESSIVELY long in energy sector once the stock market correction has taken place. I positioned myself with about 50+% in precious metals, and 35% in energy coming into 2007. I thought that US housing market will cause a big fall in the general stock market and therefore I want to under-invest in energy since it is more sensitive to the global economic growth. Whether global economic growth will slow due to US housing market implosion is very debatable. But I believed that whether it slows or not, the stock market will be scared into a big fall. That has not happened yet. Instead, markets have broken new highs all over the place. I will probably raise my combined energy/foreign sector holdings to 50% or more.

    Basically, I will have 50% in energy and 50% in precious metals, and adjust the two holdings based on my relative bullishness in the two sectors.

    I will probably be selling out of energy sector in year 2009/2010 to prepare myself for the next half-PI date in 2011. Those dates correspond to a big wave in negative ARM resettings started in 2004/2005 (by adding 5). The current wave of subprime mortgage is due to 2005/2006 (plus 1 or 2). But that timeframe of 2011 is too far out right now.

    By the way, the failure of PI date for predicting the lastest stock market height was not unexpected. Taking the example from last height, it didn’t happen until one year and eight months later. But the bottom date was correct. I believe that will be the pattern given increasingly available fiat money which can boost the long side.

    And don’t buy bonds and stay in cash for the long term. It is far better to take a calculated chance in (selected) stocks than a guaranteed loss in bonds (unless you are old enough, and can afford the short-term loss in buying power).

    Posted in Market Pulses, My Portfolio | 1 Comment »

    Subprime problem not going away

    Posted by Frugal on 22nd June 2007

    The two Bear Stearn hedge funds are facing liquidation by Merrill Lynch, JP Morgan, etc. While Bear Stearn and all the brokers try to avoid a fire sale of these CDO and subprime loans, someone will need to eat up the loss. What’s more important is that these illiquid CDO if being valued at the market price will most likely be a lot lower than being marked on the books of various hedge funds and brokerage houses. That is not a pretty sight. In the meantime, credit rating agency is taking their down grades slowly but inevitably. If you have funds in such hedge fund, you should redeem your shares ASAP by enjoying a higher falsely marked NAV. By the way, investors can no longer redeem their funds in the Bear Stearn hedge funds. The capital has been locked up since May.

    While everyone on Wallstreet is hoping that the subprime loans will recover by delaying the inevitable and postponing the revaluation, you just cannot squeeze a person without sufficient income and without asset and hope to get your money back. You can lock these liars on loans up or threaten them, but no money means no money. Now that housing market is stagnant or falling, the Ponzi scheme of refinancing can no longer continue. With more mortgage resets coming later this year after September, more “subprime” loan supply will come if they can materialize at all.

    Eventually someone will be stuck with losses. Make sure it’s not you.

    Posted in Mortgage | 2 Comments »

    Ron Paul for 2008

    Posted by Frugal on 20th June 2007

    I will be voting for Republican Congressman Ron Paul if he can become a presidential candidate. His views on reduced government, personal privacy, fiscal responsibility, and an anti-war foreign policy are everything that I believe in. Never in the past I’ve watched any primaries. But with Ron Paul in the race, I’m again hopeful for a better America that can happen sooner.

    I put up a small banner of his campaign on the right column linking to his website to show my support without too much distraction from this blog. I hope at least I’ve brought you some attention to this potential presidential candidate, a medical doctor (gynecologist) by profession, a conservative republican, who is daring and knowledgeable enough to challenge Greenspan and Bernanke for so many times. He is a true believer in the free markets, and wants to reverse the trend of a bigger and bigger government that gets into the private affair of free markets, taking away a bigger share of tax revenue each time for providing some inefficient services. If he is elected as the US president, I think for the first time, USA can cut tax and still close the budget deficit. This will be very very bullish for the stock market and USA in the long term. Less tax burden is always better.

    I’ve watched many of his YouTube videos. If you have some time, you could watch a couple. I don’t know about you, but I’m so excited and feel so refreshing to hear some unconventional political views. And you bet that he will bring our troop home for certain.

    Here is a recent video of Ron Paul in CNN debate on June 5th:

    Posted in World Politics | 8 Comments »

    Home prices really falling in California

    Posted by Frugal on 19th June 2007

    I just checked my local housing market this past weekend. It appears that prices are down at least by 5% from just a couple of months ago. This is true for both new homes and resales. End game is slowly coming. The 2008/2009 negative ARM reset is not even here with us yet. It could be ugly.

    Finally, I can walk into a sale office for new homes, with the ability to purchase the home outright without putting my name down on a long waiting list. And the price got cheaper even compared to a few months ago.

    Just a note to all the home buyers out there, the housing market will play through series of tango in the upcoming decline. First new home prices will undercut resale prices. This is happening now. Then resale prices need to come down to match or be lower. Then the drama replays again and again until it reaches bottom. Two months ago, some of the resale home prices are simply outrageously stupid. Why would I buy a 20 year old home which is more expensive than a new home? Be warned. Don’t be those stupid buyers. Real estate agents will be working overtime and cheat you into buying one of those resales. You think they would have told you that the new homes just around the corner are cheaper, but since they don’t get any commission from those sale, these “buyer”‘s agents will rather let you lose out tens of thousands of dollars on a stupid deal, and tell you straight in the face that “home prices always go up in the long term” or “all the people who got rich made their money in real estate”. Don’t listen to their lies. Sometimes, I can’t believe how these agents can face their conscience day-in and day-out. That even includes my Christian friend (as my buyer’s agent) who hasn’t told me a thing about any new homes. I guess lack of disclosure does not officially make him guilty.

    With the mortgage rates jumped up by some 0.5% in the last week, that will spell disaster for the home inventory. There seems to be a rush too for all these home builders to rush out and build up their lands. I haven’t seen so many new communities opening up for such a long while. The bad news for the builders is that each new phase gets postponed further out due to lack of demand.

    Still I can’t figure out how these people around me can afford such expensive homes. If I include the opportunity cost of down payment by treating it as an interest-bearing at the same mortgage rate of 6%, a home that I just looked at for the price of $710K has a total annual cost of $60K, roughly 5,000 dollars per month. My own home has an opportunity cost of about $22K a year, or about 1,800 dollars per month. I really don’t understand how people can afford a $5,000 dollars per month, without putting up several hundreds of thousands of dollars for down payment.

    Well, of course, the real estate agents still keep repeating the same words. “There is never a better time to buy a home.” “Markets have stabilized.” “Prices will not come down too much.”

    I’m not really sure about that. I do hope that all of my blog readers won’t lose out when they buy their next home. It could very well determine whether you can be richer 5 to 10 years later by $100K to $200K depending on your personal situation. That gain is obviously not coming from buying a home, but rather coming from not losing that much of money in buying a home I believe. The only financial discipline that you would need to stick to is to save up your money if you’re a renter. If you tend to squander through your disposable income, you might as well buy a small home.

    Posted in Real Estate | 3 Comments »

    New portfolio composition

    Posted by ML on 19th June 2007

    Ever since quitting my job and becoming a full time dad I’ve be re-thinking about my portfolio and how to maximize its performance for several reasons. First, I needed to move my company 401k to a solo 401k at Fidelity. Second, I needed to deploy the funds resulting from exercising company stock options. Last but not least, I have felt a lack of discipline in carrying out specific plans, whether its stock selection, stop-loss taking or adherence to a certain time frame. To address all three items, I decided to redefine objectives of various parts of my portfolio and put them in writing.

    Before proceeding further let me say that I have learnt a lot from these two blogs: World Beta by Mebane Faber, a hedge fund manager, and Moomin Valley by mOOm, an economist and trader. Rather than highlighting any specific posts, I make the recommendations site-wide because of their consistent quality.

    Beyond Passive Allocation: all about Alpha and Beta
    In the capital asset pricing model (CAPM: primer), portfolio return is driven by two factors: alpha and beta. They are respectively, the intercept and slope of the linear regression of the portfolio return versus some benchmark. Beta is seen as a measure of the risk undertaken and alpha the extra return derived from the money manager’s skill. [I described alpha and beta for my own portfolio at the end of 2006.]
    Without going into too much details, I’ll simply state that I believe that “positive alpha” (the ability of managers to beat the market) exists. One good example is the so-called “activist” hedge fund that takes a substantial position in an undervalued company and then lifts the stock price by forcing through certain management/strategy changes. In this way, said hedge fund capitalizes on a certain market inefficiency.

    Current cutting edge thinking on portfolio construction is to combine both beta and alpha approaches. The beta portion of the portfolio would just be the passive asset allocation/index investing method that, e.g. Vanguard is all about. The alpha segment is considerably more complicated since there are so many different active management styles (long/short, global macro, distressed debt, event driven, etc.). Ideally, different strategies are uncorrelated with each other and the best managers in each can be found. This is essentially how those billion dollar endowment funds outperform the market year after year. While we individual investors rarely have access to the best money managers, the point is that there are other levels of diversification above just covering all the asset classes in a passive fashion.

    Finally, mOOm at moominvalley also uses two other terms “passive alpha” and “active alpha”, the former describes where he takes a position in publicly traded asset managers and the latter his own efforts in trading and stock picking.

    Allocation Pyramid

    The pyramid chart illustrates my current target portfolio composition. At the foundation is the passively invested/asset allocated portion. Most of the money is in retirement accounts. It is currently 50% of the total portfolio and I vow not to tweak the allocation except at the annual rebalance. I have included some alternative asset managers and hedged mutual funds here. I consider this the beta and passive alpha portion of my portfolio.

    The middle trench consists of some income producing assets that includes CANROYs, oil tankers and other high dividend funds/stocks. I joking call this my “income on steroids” group. This trench also includes my PM and other commodity/resource stocks (obviously there are overlaps with the CANROYs). Finally, there is a less well defined “others” section that houses things like the aerospace and defense ETF (ITA). Most of the money in this section sits at Scottrade and TDAmeritrde where I do most of the intraday research.

    The top of the pyramid is a new section devoted to short term trading based on models I have been developing. The models have given excellent results in back-testing, but the whole thing is still a learning process as I confront my own psychology weaknesses. Currently it takes up less than 5% of my total portfolio but I hope to increase it if results warrant. The money now sits with Zecco despite the problems I’ve had (review part 1, 2, 3). Both top segments are in the “active alpha” category. Since I employ very different stock selection and trading strategies they should move quite independent from each other.

    Time frames and reliance on TA

    In the pyramid diagram I labeled the progression in the reliance on technical analysis as the time frame (intended holding period) shortens. My short term trading is momentum based and generally has holding periods of days. On the other hand, the passive accounts are for buy-and-hold with annual rebalancing. The trench in the middle lies in between the extremes. The “income on steroids” group, PM and resource stocks I’m quite happy about holding long term (i.e. years), while others I may look at weekly charts for good entry and exit points so that the holding period may be months. Naturally, as reliance on TA wanes, reliance on fundamental and big-picture analysis waxes.

    New asset allocation in the passive accounts
    My old asset allocation plan was approximately 30% domestic equities/30% foreign equities/10% PM and resource/30% bonds. The new plan is shown in the table below.

    Major changes include:

    • Bonds are reduced to 20% from 30% for a number of reasons. The primary one being that I feel we can take on a little more risk in our portfolios. I try to keep the duration short, but have added some floating rate, loan participation funds. I also have some closed-end municipal bond funds in a taxable account. Their leverage amplifies volatility which also justifies a lower bond weighting.
    • I reduced my domestic equity exposure to 20% from 30%; however, some of the alternate asset classes invest primarily in the US. My wife’s company’s stock has been performing well and I maintained a position in her 401k account. It’s not a large position so I didn’t bother classifying it into one of the other four classes. The top six lines in the table represent positions in my wife’s 401k account. Other than the company stock, they are like sub-accounts at an insurance company but the fees are decent.
    • The international equity exposure is now 24%, down from 30%, although I increased exposure to commodities with should benefit from a robust world economy and especially the emerging markets.
    • Previously, I didn’t have a position in REITs which turned out to be an excellent investment class last year. Now I have a 5% exposure despite the weak technical outlook of this sector. I chose to implement it with the international REIT index ETF (RWX) which I feel have better long term prospects.
    • The biggest change is the addition of what I call “alternative” that falls into the “passive alpha” category. PSP is an ETF of listed private equity companies; HSGFX is a fully hedged mutual fund managed by John Hussman; lastly, TFSMX is a market neutral fund with an excellent history of risk-adjusted-returns. HSGFX did well in the latest bear market but only provided bond like returns since 2003. I believe it will continue to provide low, positive returns if the bull market continues, which is another justification to lower the exposure to bonds.

    In future posts, I’ll discuss the other two segments in greater detail.

    Posted in Investing | 1 Comment »

    The last mad dash?

    Posted by ML on 18th June 2007

    What a difference one week makes! As the 10-year stabilized below the 5.25% level, bulls took over the reins again. By the end of the triple-witching Friday, the Dow had managed a stunning, 3-day, 240+ pts advance.

    There was some speculation that the sudden drop in the bond market was China sending a message in response to the new bill about it being a currency manipulator. I regard this as likely as I have previously noticed at least two other market moving gestures from China following political developments among China/Taiwan/US (one for a currency revaluation and one for removing export tax rebates on certain base metals). Whatever the reason behind the bond market plunge, even if the yield on the 10 year stabilizes between 5.1 and 5.25% it will still be a real drag on the economy, not to mention holders of the ARMs to be resetting later this year. The ARM reset schedule from the famous Ivy Zellman report shows a peak due in Nov 2007.

    The housing story has been the cornerstone of the bearish view. I myself have repeatedly predicted a housing induced economic slow-down. However, where I differ from most bearish analysts is that I think we will make new highs before reality finally catches up with this market, probably through a significant deterioration in earnings.

    The importance of the second bottom
    In the last weekly review, I said I was waiting for the “next leg down” to see what kind of divergences there may be. The second bottom came on Tuesday, sooner than I anticipated; at the same time, it was quite unambiguous. In the S&P chart, a clear “higher low” along the 50 DMA was made. The real give away was the bigger, higher volume move on Wednesday which signaled that bulls were back in control. There was likely substantial short-covering on Thursday and Friday.

    Commodities boom

    Brazil (EWZ) made new highs this week, but I thought the action in DBA (PowerShares DB agriculture ETF) was more notable in that it broke out before and help up well during the bond induced swoon.


    Not too long ago, just as people are uniformly calling the Chinese stock market a bubble, I voiced my doubts. The weekly chart with the uptrend line is updated here. 3404 was part of a one day 370 pt (10%!) reversal. The closing low was 3670 made on the day before, so I consider the uptrend still intact. Noteworthy is the divergence in FXI which lingered below the yearly high as $SSEC made new highs. FXI finally broke to new highs with decent volume last week.

    I have commented previously on the lack of retail participation for much of this bull market. The point was that retail investors must be sucked into being bag holders for this market to go down. Right now, the action in FXI as well as other evidence is signaling that they may be coming back finally. We may well be starting the blow-off phase just as the underpinning economy is under more and more strain. A year from now, one may marvel at the timing of the Blackstone IPO, but that will be missing the point. IMO, someone like Steve Schwartzman (co-founder of Blackstone) dictates the timing.

    As far as what I’m doing, I’m sure you can guess by now. I’m staying long unless there is a clear signal to do otherwise.

    Posted in Investing, Market Pulses | Comments Off

    Stock market keeps going up, and I’m left in dust

    Posted by Frugal on 15th June 2007

    The strength of the equity market is simply amazing. My short positions are hurting. This week I panicked a little bit, and the market turned right around to prove me wrong.

    I am beginning to think the year for comparison to the current timeframe probably is not year 2000, but rather 1998/1999. In 1998/1999, shorts in internet simply got killed, and people bailing out earlier missed a big chunk of gain, while the market went up like crazy. I was one of those people, and I may be simply repeating my actions again. Yes, eventually after 2 more years, I was proven right, but that is a lot of money missed in the up wave.

    But there is one very important difference between now and 1998/1999. The economy was still in favor of the stock market, while now we have a housing/mortgage implosion. But the factor working in favor of bulls is that the M3 and global money supply is expanding at a breathless pace. While housing stocks are tepid, profits at financial brokerage houses are going gang-buster. They obviously work with Fed and they are the direct beneficiaries from all the money expansion. In fact, the fund manager of CGMRX that I mentioned in a previous post may well be right again. He is buying up financial brokerages. Will the financial brokerage stocks be the next major investment themes going towards 2009 if not already? The leader of the market is definitely not high-tech so far. But if financial stocks go up, market will more than likely go up since it is one of the biggest component in S&P 500 at 20+%.

    Regardless of whether shorts are right about the state of economy or not, the stock market can stay irrational longer than the shorts can stay solvent. In fact, it looks like Fed will be blowing this bubble probably well into 2009. If a coming decline does happen, I am guessing that it will be 1987-styled rather than 2000-styled. Effectively speaking, I think that the secular bear in stock market (priced in $US) is over. That is contingent upon no war or big disaster happening in the next two years.

    Yeah, cash can be king for a short while, but it will be made into trash in the long term.

    Posted in Market Pulses | 5 Comments »