US Authorities Intervening In The Markets: They Are Not Suddenly Going To Make Them Better

We all know that governments around the world have pumped money into their domestic economies to a degree never seen before in order to avert a global depression. We certainly got a taste of what the US authorities are capable of doing, just by looking at the last 30-minutes trading result on Friday. The results were spectacular.

The issue in markets today is whether governments have pumped in enough money to stabilize the financial system, which failed in mid-2007 after the credit ring among major financial institutions broke. If stabilized, these financial services companies, through their lending practices, will pave the way for the owners of capital to take more risk in capital markets.

The problem of course is that printing money means expanding debt, which in turn means higher debt service costs, which leaves less to buy equities and also less to buy goods and services, homes, etc. But higher rates also mean that those with mortgage debt are more likely to foreclose, which means that the assets held by these financial institutions become less valuable.

So, for this model to work, a little magic is required. The potion concocted for the world is that America is now being led by a savior, who although he personally is somewhat unsophisticated about matters of finance and economics has surrounded himself with an all-knowing elite he calls the A-Team. But for those of us who have for 40 or more years watched similar parades of these so-called experts marching onto the world stage from close by the West Wing, we are not so impressed.

The magician we know that is needed today is, regrettably, the bearded one who was around during the pre-messiah days, the one who participated in the undoing of the US banking system and ergo the world economy. Yes, Ben Bernanke holds the keys to the US economy and the capital market both.

In a nutshell, can Bernanke keep Treasury debt prices high and yields low at the same time as supporting the US Dollar at a level that would keep the prices of oil, metals, food stuffs, and other commodities from soaring to a point that would smash hopes of economic revival?

The answer to whether or not Bernanke is a true magician will be obvious, I believe, from the price of gold and silver. For when the owners of capital decide to invest that capital in assets that pay no financial return, they will be doing essentially what they did in 2004-2006 with real estate, ignoring the cash flow and leaving all hope to rising prices of the principal. Another word for it is speculation. With gold, though, traders are speculating that Bernanke is no magician and Obama no messiah, ie, savior.

A week ago in this space I wrote:

The inflation versus deflation debate is about to become animated. Unfortunately most of it is lip-sync, creating the illusion of real debate, scripted to play the emotions of the public. Be wary of the conflicts of interest of the players. There are a lot of puppeteers in the background. In other words, it’s all just more of the ‘market on a string’ phenomenon, something along the lines of the present Bull versus Bear Market discussion, much ado about nothing… I think the results of this phase of the battle will be known in the next sixty days. Meanwhile we are almost finished with our put writes strategy, and have moved into one of selling call spreads, while awaiting a put purchases strategy for employment when the market confirms a pull-back.

Now we have to get down to brass tacks, as they say, because we traders are closing in on an important decision point where we should have in place a pre-determined plan of strategies and tactics.

As always, we don’t know what’s to happen next in capital markets but we do know that (i) equity prices have rallied significantly off their early March lows, from a low of 666 to a high of 930 for the S&P 500 (^GSPC), closing this week at 919 (ii) the $USD index has collapsed during that time from 90 to 79.43, (iii) gold has soared from 865 to 980 and silver from 11.75 to 15.75 in the past six weeks.

Regarding the S&P 500 (ie, the broad US equity market index), I have opined a few weeks ago at the 880 low end of the trading range that I do not foresee a break-out above 950 based on corporate fundamentals or macro-economic data. Moreover, the technical indicators, while obviously showing bullishness because of the bounce from 666 into the 880-920 trading range, are increasingly looking much less bullish.

In terms of the recent short-term high-risk buy signal, i.e., where RSI-7 bounced above 50, that indicator still shows potential for higher prices, but with greater risk. Moreover, we have seen the normal sector rotation, starting with strength in the Financials, which we saw in March, moving into the Consumers and Tech, which we saw in early April and then into Commodity producers in mid-April, the last move has been into Precious Metals, with typically silver leading gold. Now with gold and silver breaking to the upside, we know the risks are elevated to an extreme.

All along we told you that given the instability of equity markets, we would, during bullish phases, put on put write positions rather than buy the underlying stocks in most cases. Then as we saw the risks move to extremes, we started to close out these short puts and to put on call spread writes, particularly as we know that volatility tends to fall into the summer when pro traders tend to take vacations. We have not at all advocated buying puts at this point in the cycle because we see that prices of the underlyings are still rising, and we need to see an aggressive move to lower stock prices before we will take on added risk in the form of option premium.

In the very short-term, two weeks ago last Friday I said that I believed Precious Metals would have a run, led by silver, which at the time was a tad below $14. I said I had my eye on 14.50 followed by a strong bull run possibly to 17, which didn’t start to happen, at least not until the following Monday, and then on Wednesday the 14.50 mark was hit, followed by a very slight pull-back. On the trading desk, when discussing this pull-back, I actually said to the team that I believed 14.415 would be the low - laughingly saying I was cutting it pretty fine, but that at least I was 95% confident the silver price would soon soar. I also said that I believed that gold would pop, possibly to 980-1000. Within an hour, all of that started happening. Silver closed this week at 15.74 and gold is now at 979.45 in the spot (cash) market.

But, and this is key, I also opined that, at least in the short-term, with the $USD and $USB (the 30-year US Treasury Bond) extended on the downside, and the Euro, Pound and Canadian Dollar extended on the upside, this move in precious metals would likely be a short-lived spike. So, having reached our price targets for the style of trading we do, but also believing that the biggest gains are made at the most uncomfortable days and hours (i.e., highest market risk) when prices are spiking, we sold the majority of our long positions in the gold and silver miners on Friday, but, for insurance purposes, we covered off our risk that silver might run to above 17, and gold to above 1020, by buying July calls in the gold and silver stocks we think would have the best leverage in the market should that occur.

We have had an incredible string of good fortune, which was not based on luck, but on our trading discipline. If, as and when we see that equity markets are stabilizing, we will use much more buying power rather than keeping 75-80% in cash. Yes, we have been holding $USD rather than Euros, and we could have also been trading forex instruments that trade on the NYSE. But, while I might write this blog with an aggressive style, I will not manage client assets that way until we are ready. In truth, I think we all talk bigger than we act.

In any case, we had six month objectives in starting a business, and in looking back we believe we have proven ourselves in terms of: (i) the business model (ii) the quality of the team (iii) a basic level of efficiency of the team, (iv) the relationship with the broker, and (v) most importantly, a very high level of confidence of our clients. We have, I believe, exceeded expectations.

As we move into the second six month phase of the business, we intend to step up in terms of: (i) client communications because these people are our best salespeople, (ii) marketing, which to us means showing others our performance, not some slick TV commercial or print ad, or Talking Head, (iii) aggressive trading, both in terms of position sizes and percentage of assets invested, (iv) expanding our services to clients by trading in more markets, including currencies plus equity markets in Asia-Pacific and Europe and Canada, and (v) offering exchange-traded funds that will be available to most traders and investors in the world, including Canadians, regardless of choice of broker or financial advisor.

We are still at this point a tiny company - I don’t think JP Morgan Chase et al are shaking in their boots - but we are improving and with that will come size - at least until we personally believe at some point that even bigger is not better. That’s a long way off because I know how much we can improve.

Speaking of size; I’d like to put an end to Tout TV introducing a guest as “Manager of $20 billion or $200 billion or whatever.” That’s just not right. Most of these people are little more than Talking Heads for an organization, and some of them couldn’t even quickly tell you how many zeros there are in a billion. So, just ignore that stuff.

At the end of the day, as far as we independent traders are concerned, the markets are not marketing, but just price and volume. When you hear some talking head say he or she’s a Growth At a Reasonable Price or a Value or a Bottom-up or Top-down oriented investor, plug your ears because we are required to be all of the above. In the most basic terms, we want to buy low and sell high. Whether it’s fundamental, quantitative, technical or economic data that was the final influence in your trading decision, it doesn’t matter because all of us have to look at all that stuff.

The only difference that truly exists in one’s basic perspective on capital markets depends on whether we are on the buy side or the sell side. Each has an axe to grind. Ours on the buy side is to get the Interventionist politicians and bankers out of our lives so that we can independently and objectively trade prices in markets that will always, if left to natural devices, self-correct to the norm. Interventionists who screw things up constantly are not suddenly going to make them better. It’s our capital, hence our capital market. Those who wish to use those markets as an instrument for control by governments and other vested interests have no desire for complete transparency, or belief in the market’s role of pricing intrinsic value. These people ought to go away and stay away. There you have it, our axe to grind. As for the sell side’s axe, it’s been used so much; the edge is pretty dull by now. They certainly don’t get much sympathy in this Community.

I’ll finish off here by repeating my words of a week ago: “Remember; our average trade is now just one day to three weeks, and we are anticipating going into hand to hand trench battles that will last some hours and possibly minutes… Be ready. Be strong.”

For 30 minutes at the close of the week, our opponent showed its power. Respect it. On the other hand, have confidence in the tools we have to get the job done.

Subscribe by RSS Subscribe by Email