With the exception of uranium, I am not so hopeful on energy industry for this year. If you don’t sell them this round, there may be one more chance after some 1 or 2 weeks of the current short-term corrections. After that, energy stocks will probably drop along the general market, with bigger percentage of course.

The inventory picture for crude oil is simply terrible. Too many speculators have been playing the contango in the commodity futures market. What has been happening is that short-term price dropped too fast, while the longer term prices held up much better. A contango (higher future prices than current prices) in the futures market encourages traders to take current delivery, store it, and sell the futures at the same time. What resulted is basically additional (false) current demands that cushion the oil producers, at the expense of increase in future supplies from the release of inventory.

When inventory increases, it simply means that oil producers are not cutting production fast enough to match the fall in demand. That doesn’t bode well at all for the future prices.

I maintain my position that we will probably see something like a double-top formation in the general stock markets, with a second top forming at about June 15, plus or minus 1 week. After the second top falls off from the support trend line, the “sell in May, and go away” will reassert its power.

If you believe in Bible, what kind of investment choices should you make? One of the most mysterious chapters in Bible is the Revelation which predicts the end time. The most interesting part I would have to say are the seven seals. When I first read them, some were kind of clear, indicating wars and plagues. Some were not so clear at all, like the third seal (Revelation 6:6):
“A measure of wheat for a penny; and three measures of barley for a penny; and see thou hurt not the oil and the wine.” (King James Version)

My first reaction was what does that mean?? A penny? I learned much later what the penny means in Bible. Some versions use a shilling or (the Roman) denarius which is essentially a silver coin about the size of a dime, or about the wage of one day work (Matthew:20:2) at the time when Bible was written. In the New International Version, this is what it states for the same Revelation passage:
“A quart of wheat for a day’s wages, and three quarts of barley for a day’s wages, and do not damage the oil and the wine!”

Once you understand the units, it is more clear. First of all, silver which was the monetary unit was worth much more in ancient time, compared to our modern time. If we use an hourly (federal) minimum wage of US$6.55, and 8 hours a day, that will be $52.4, or about 3.75 one-ounce (28.35 gram) silver coins (at US$14) or about 23.5 denarius (4.5 gram of silver content). We are earning 24X in silver than ancient workers. So either it means that silver is vastly undervalued, or our wages are so much better valued than ancient workers. I’m guessing it’s probably somewhere in between, especially silver is no longer used as monetary units.

Secondly, the other part is that the wage of one entire day can only buy you very little amount of wheat or barley, barely enough to satisfy one man’s hunger. It is obvious that it means at the minimum that there is a great food inflation, if not inflation in general. However, it’s basically impossible to only have food inflation. Food is the most essential commodity. Food inflation will drive all other inflations.

As I contemplate what Bible means for the current global economic pictures, it is also important to note that United States is a predominantly Christian country. I think those scenarios if it comes unfolding could apply to US more than other countries through a US dollar depreciation.

We are obviously not through the current phase of economic deflation possibly until 2012. However, the next phase of great inflation is probably just around the corner. Keep the goal in sight.

Volatility is taking over the markets in all ways. Huge down and huge up. In less than a month, commodity complex has corrected significantly, while financial stocks have rebounded “strongly”.

(Click to see enlarged charts)

Since I’ve unloaded most of the energy stocks back in January (missing the entire run-up), I have been quite low on energy holdings. I picked up some natural gas stocks this week given that the price has dropped to the 40-weeks moving average.

There are many names that one can buy, APA, XTO, and CHK, not in any particular order. For a more conservative investor, one can also buy many of the Canadian energy trusts such as ERF, HTE, PWE, and PGH, which didn’t go up as much. And energy ETFs such as XLE, OIH, UNG, and USO, should be a very good way to participate too.

On the other hand, I don’t think the decline in commodities is over. The Elliot wave 3 should be over, and it will take some time for wave 4 to finish its consolidation. I do expect that commodities will probably trade in a range, either flat or slightly down.

If you are an investor, it should be a good time to restock at the low points. If you are a trader, you can probably trade this range for sometime, probably several months, or maybe even into next year.

Regardless, it is very evident that we have a synchronized global slowdown, signalled by emerging stock markets and commodity markets, as I have always believed back in January. In such a slowdown, most stocks will be down. I think the theme going forward will be first recession, and then stagflation.

Baltic Exchange Dry Index indicates the shipping rates around the globe. The actual data is not free and hard to look up. Here is the only place from investmenttools that I can to have any historical charts:

In conjunction with CRB index making new high, the “decoupling” theory of the global economy from US economy seems to be temporarily in play.

This has certainly not gone unnoticed by the shipping stocks NAT which were previously recommended here. NAT has gone from mid-20 to almost 40 now since March of 2008. I have recommended selling NAT back in Dec 2007 or early Jan 2008. My reasoning was that I did not subscribe to decoupling theory. However, whether decoupling theory is true or not, there seems to be an abundance of capital around the globe to bet on continual strength in emerging markets and its related bets.

Certainly, I have been more than amazed. But all the related charts seemed to indicate such. For now, I concede my defeat. However, it will be very interesting to see how things will look in the emerging markets when oil prices go above $200. As Mish have said in his blog, high energy price is actually deflationary (for non-energy related prices), only because you have less to spend on non-energy items.

It certainly looks like the commodity boom will continue for another while. If crude oil has a short term correction, I will definitely be a buyer. If not, I may have to slowly edge back into this market.

I missed out quite big on the recent waves of the hot energy sectors, due to my belief in the global synchronized slowdown. Energy sectors however are still in play (so far).

There are many sub-sectors in the energy. First it was coal, with FDG, PBT. Then it was natural gas, with CHK, APA. Then it was the rebirth of solar energy, with FSLR, SPWR. Most of these names have risen by at least 20% to 100%. And partly, thanks to the high crude oil price, the energy wave seems to be continuing.

Yes, to my surprise, crude oil price has not corrected much if at all. However, the calls from pundits for a significant commodity top, continue to worry me.

If I would have to invest now in the energy sector, I would probably invest in nuclear sector, with CCJ and DNN in mind, both of which I have already owned.

However, if crude oil does correct by more than 10%, expect these volatile stocks to go down even more.

The spot/future commodity markets in general may be making a major top. However, if the thesis of peak oil is correct, pretty much all of the above sub-sectors should give you very good return.

I look forward to a short-term bottom in the energy market to come. But I have been waiting for too long, just like waiting for the general stock markets to tank from last May to last October. Well, it did tank, but the grueling four months wore out my patience completely, and at the end, I gave up my short/hedge positions. Such is the tricky nature of the market.

I would recommend buying nuclear energy stocks for the long term. And if they correct 10% or more from here, I would load them up.

UNG and USO are the commodity ETFs created for people to invest in natural gas and crude oil. I thought after the debacle of under-performance of USO versus the spot market in 2006, UNG will at least wise up. Unfortunately, that is just not the case. It’s almost like a money-plundering business against retail investors, for participating in commodity markets via ETF. They just DON’T work.

I invested in UNG last July in 2007. At that time, the ratio chart of UNG versus $NATGAS was at about 6.25. Now, natural gas has been up significantly, but my ROI is barely some 2% gain. The UNG/$NATGAS ratio is now down at about 4.8, which is about 23% dropped, or money “stolen” from retail investors.

After under-perform by some 20% in USO in 2006, USO continues to under-perform by 7% in 2007. Since inception on April 12 2006, USO has under-performed by about 24%. Now the same story is repeating again in UNG, which started out on April 18, 2007. The tracking errors via futures market by the two fund managers are just too big in a timespan of 1 or 2 years.

I’m going to try out actual commodity futures market myself, instead of investing thru these stock ETFs. I plan to sell out UNG around this price, because I don’t believe in these ETFs anymore. Yeah, I’m going to roll-over the contracts myself if I have to, so that I don’t get hit by contango. In fact, I don’t plan to do any roll-over since I can simply buy the very far dated contracts instead.

Best luck.

Frugal at My 1st Million At 33 .com

First of all, let me say that I’m glad to be back to 1stmillionat33 after a long absence. I had some hardware issues which took a long time to resolve with HP. I’m glad that they are now behind me and I’m back to blogging full force.

Let me also wish everyone a belated Happy New Year even though the market started on a sour note. After all, money isn’t everything. Health and family count far more towards happiness – a truism reinforced for me during this past holiday season. That said, I remain optimistic, first and foremost, in my ability to navigate the economic waters to provide the best for me and my family. My overall perspective stays the same: I’m long gold and commodities and concerned with the economic prospects in the US due to an over emphasis on consumption. With that I’d like to talk about a long term technical indicator that has had uncanny accuracy in the past 15 years.

I learn about this long term indicator from an article on ContrarianInvestor (I’m a subscriber). I doubt they are the originator as moving average crossovers in general has been in use for a long time. The system looks at the relationship between the 17 and 43 week exponential moving averages (EMA) of the S&P 500 index. When the 17 week EMA is above the 43 week EMA, one should long the S&P, otherwise, one should short the S&P. The weekly EMAs are equivalent to the 85 and 215 day EMAs which I plotted using the new Yahoo charts below. I encourage you to play around with the time intervals for the averages. The signals are fairly “robust”, in the sense that buy/sell signals don’t change much given small variations in the intervals. For example, 85/200, 60/200, or even 60/170 give roughly the same thing.

Click to enlarge

The track record of this system is impressive: it correctly gave a buy signal in 1995, a sell signal in 2001 and a buy signal in 2003. One has to go back to 1991 to see a meaningful whiplash. If you go to a shorter interval, you’ll see that the two moving averages have been converging. Indeed, they crossed on Friday to give a fresh sell signal (using 85/215, shorter intervals would have generated the signal sooner)!

Again, I encourage you to play around with the time periods to see how well this system worked (or not worked) before. Although I haven’t done the exact calculation, it seems that this system would handily beat a buy-and-hold approach while having shallower drawdowns since 1950 which is how far the Yahoo data goes back to.

So what’s so magical about 17 and 43 weeks? I can hear you ask. Of course there’s some leeway in those two numbers, but I guess what you’re really asking is the philosophical basis for this system. There is none, or anything a priori that I can tell. This system is based on a long history of observed facts, which by the way, is identical to the reasoning behind statements like “in the long run, stocks go up by x% a year”.

Personally, I’m taking this sell signal very seriously even though I recognize that the market is very oversold and ripe for a bounce. On the other hand, my portfolio is set up to benefit from the on-going global growth story thus is susceptible to a global recession. While I still regard that as unlikely, I will most likely treat any significant bounces in the general market as opportunities to build up a hedge.

Yes, I know the markets are at new highs, and maybe I’m the last person who still hold the view that markets can still correct significantly (maybe by 10% to 15%).

Here are some recent articles that I gathered in no specific order. I suggest that you should read all of them. The markets are like a puzzle (and a moving/changing one). You must put all the pieces together, and attempt to decipher the whole view. I will not go into the details of these articles, but only make a brief comment on them.

1. Upcoming 4th quarter earnings & guidance from Todd Harrison. I consider Todd as one of the astute traders in the current credit crunch (based on his past articles). The 4th quarter guidance may become a point of realization where reality meets hype. Needless to say, I advise extreme caution.
2. Frank Barbera is indicating a potential top in crude oil, while Bob Hoye has gone out stating that the intermediate top in crude oil is/should be in already. Frank Barbera was a little more positive on crude. He believes a more sideways actions from crude due to falling of $US. In any case, what this entails for the the overall market is NOT good. Energy sector has been a leading sector in this bull market. But you can already see it faltering, especially the in the OIH chart (click on the chart, if you can’t see it clearly) which was definitely the leader in gain, but is NOT confirming the new highs in the markets. Furthermore, MACD is giving a sell signal.



3. Despite the above negatives, I am carefully bullsih on precious metals because $US doesn’t seem to be turning around yet. I subscribe to Clive Maund’s observations that PM markets may continue to stride forward due to fall in $US.
4. From the venerable trader Bill Cara’s recent posts, it appears that he is in agreement with my view on the global markets (1998 or 1970). Once in a while, it feels good that someone really well-respected has independently reached similar projections as you do.

So what is the KEY to all these markets, and what would be the TRIGGER of the coming actions? I believe that the TRIGGER can be the 4th quarter earning, a currency unpegging event by China or Petro-country, or another credit crunch event. But the real KEY to global markets lies in the exchange rate of US dollar. If you go back to the recent market panic on August 16th, you will see that market falls are associated with a dramatic rise in $US (to 82.13) and usually a rise in US bonds too. It is counter-intuitive, but it is very true. If the $US falls, US (and global) stock markets tend to rise, and vice versa. Such relationship is not always true, but during those periods that when it is true, the correlation is quite strong. My explanation is that during those times, US markets are definitely not making new high in foreign currency, which is a clear indication that the bull market is associated with US dollar devaluation/asset inflation. And when it goes to reverse gear, for some right or wrong reason, both $US and $US bonds serve as a false safe haven for global financial markets, and all markets (especially emerging markets) get hammered and/or repatriated back to US.

Have you noticed that something weird is happening in the currency markets this week (or last)? $US dollar index stopped falling and turned back up from about 77.6 level. BUT both commodity currencies: Canadian and Australian currencies are either at new highs or close to new highs. If you dig into the details of the turnaround, you will see that while Euro did retreat a little which helped, Japanese Yen did more of the heavy lifting. Apparently, there is some global cooperation going around to help lifting US dollar. However, this turn-around of $US dollar index is FALSE, and therefore, global markets are still making new highs.

If and when US dollar make another strong dead cat bounce, then WATCH OUT. Based on the timing of treasury bond markets however, it seems that this event will probably happen later rather than earlier. The 10 year bond yield is at 4.65%, and it’s truly in the optimal range for Goldilock economy. I think we are at the final stretch of a top, where bond yields are low so that it’s not breaking the backbone of the stock markets, and yet the expectation and sentiments of the stock markets are not turning yet from bullish to bearish. Maybe stock markets can stretch this run all the way into next year before a bigger correction.

In any case, when the lows come, I repeat again here, that the lows in ALL markets should be BOUGHT. I seriously believe that the coming US dollar devaluation is going to generate US domestic inflation and export so much asset inflation around the world that it will be a “Weimar Republic-style hyperinflationary equity blow-off”. Because this blow-off is global in nature, I think the monetary force will be spreaded thinner, and therefore it won’t feel like hyperinflationary (yeah, I tell you that people in China & Petro-countries ARE taking in all of our inflation). However, the best fireworks should be in foreign and precious metal markets, even though US stock markets will probably do pretty okay also in comparison to cash and bonds. The poor bears and deflationists will be crushed by Bernanke, even though they have been always right about the state of economy.

Make sure you get the sequence right. It’s going to be mild inflation, higher inflation, and almost like hyper-inflation, and then deflation/depression. Don’t miss out on the inflationary rocket going to the moon. And of course, since your capital gain is really simply going to compensate/compromise all the inflation, saving on your capital gain tax such as using retirement accounts or Roth IRA probably won’t be a bad idea. And for the last time for your benefits, let me repeat that please forget about using bonds for your retirement for the next 20 to 30 years.

At last, if Peak Oil is really correct and here, then make sure you switch onto the energy bandwagon when the deflation/depression make its early start.

It’s late so I’m not going to dwell too much on the sell-off today. I’ll try to be brief and to the point.

I expected earnings to take a hit in Q3 so the string of Q2 downside surprises was somewhat of a surprise for me. For now, I’m still treating this as a controlled descent even though I have always expected housing weakness to “spill over”. There is a tendency to think the market will keep falling after a big drop like today but things rarely move in a straight line. While I’m not a buy-and-holder, I’ll wait for a downtrend to be convincingly established before changing my long stance.

Precious metals

The XAU put/call ratio made a new high on Wednesday. I have discussed this ratio previously so I won’t belabor the background here. Let’s take a look at the three highest spikes, viz:

• 6/12/06 XAU put/call ratio = 6.7, 6/13/06 XAU intraday low = 119.11, 7/12/06 XAU intraday high = 150.70, a gain of 26.5%
• 6/26/07 XAU put/call ratio = 5.3, 6/27/07 XAU intraday low = 130.83, 7/20/07 XAU intraday high = 159.14, a gain of 21.6%
• 7/25/07 XAU put/call ratio = 7.3, 7/26/07 XAU intraday low = 144.50, …

To summarize, on the first two occasions, a significant bottom in XAU was made one day after and XAU gained 20+% within 1 month. What this most recent spike foretells remains to be seen.

Disclosure: I picked up some GDX calls today.

New high in Shanghai

Unbeknownest to many, Shanghai (SSEC) made a new high Wednesday night. Not too long ago just about everyone was worried about a Shanghai bust taking out the rest of the global markets. Well, I was never on that bandwagon. Recently, there has been an increase of IPO activity in China which is the chief mechanism by which mal-investments occur. However, my main argument was that time, or the persistence of price movements rather than its magnitude, contributes more to mass psychology in a bubble than anything else. Given that SSEC made a significant bottom in late 2005, this “bubble” is still in its early stage yet.

CAF (Morgan Stanley China A Share Fund) is the easiest way that I know to participate in the A shares market. It’s now sporting a 17% discount as US investors have been inundated with bubble talk. I currently have a small position in CAF in addition to some FXI.

“There’s a bull market somewhere”
So the saying goes. Today that somewhere is agricultural commodities (besides treasuries, that’s too obvious). On a Dow-down-300-pts day, they massively outperformed. Just check out DBA, POT, TNH, and of cause, this impressive break out by BG:

Best.

After USO for crude oil, there is another energy commodity ETF for natural gas. It’s UNG. Like most of other commodity ETF, it starts falling right after debut. And it has fallen big too, down about 30% from the height. Given the recent price history of natural gas, it could fall to $4 from the current $6 (price is for the futures market, rather than UNG itself). That’s another 33% potential drop. But for sure it cannot go down to zero, unless you don’t need to pay any natural gas bill.

The advantage of diversifying into pure commodity plays is that while commodity producers are influenced by all kinds of stock market related factors, commodity itself is less swung by the up and down of the stock markets. Rather it is determined by the economics of the supply and demand. The supposed un-correlation should serve a good complement to a portfolio reducing the overall volatility.

To invest in natural gas, one can invest in UNG directly, and/or natural gas companies such as XTO, CHK, BTU, etc. I already own CHK and BTU, but XTO has been a much better performer. I have always wanted to buy XTO, but when I occasionally do remember to check its stock price, the price has never seemed right to me.

As the demand for energy goes up, I expect rotation of rising prices among all energy sources. It’s really the relative economics of different energy that matters. If crude oil prices go up too high, people will shift to other energy sources whenever and wherever it’s viable to do so. There are plenty of choices such as natural gas, nuclear energy, coal, or any other alternative energy. One should asset-allocating for different energies components, and possibly rotate through different forms of energy investment.

At the price of $6 natural gas, and $74 crude oil, it may make sense to re-balance the stakes between natural gas and crude oil bets.

By the way, UNG like USO is an ETF that employ futures contract, and is subjected to price manipulation around expiration dates. Excessive cost in rolling over the contracts will eat into the performance of the ETF. USO is probably the best example in how your pocket can be emptied even when you’re right. The crude oil price is roughly the same around $72 to $75 in May 2006 and now. But some manipulators have managed to empty USO by 20% in a little bit more than 1 year timeframe from $70 down to $56. Now if that is not manipulation, I don’t know what that is. Is that a “random walk”? Shouldn’t the average of contango and backwardation be zero? I’m sure you’ve read the story on Amaranth’s 6 billion hedge fund blowup. But probably less people paid attention to who pocketed their money.

Anyway, for the above reason, I would definitely not put my money into USO or UNG for the long haul. But as a trading vehicle, it should be fine.