A Few Sample ETF Portfolios to Watch

Well 2014 has arrived with a tepid start and already the correction bells are ringing around the financial web. I’m as guilty as the next blogger of trying to front-run corrective moves in the greater markets, but in my experience, it’s rare to see a pack of pundits predicting market direction with collective accuracy. Sure, equities look a touch expensive here depending on which valuation-gauges you’re utilizing, but financial writers around the web(myself included) have been calling for corrections since the last one of note in June. Additionally, I’ve read plenty of analysts who state there’s still value at these stock prices.

Let’s consult the tea leaves and see what they communicate:

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As the squiggle shows, if this weak start to the year is the genuine beginning to a sizeable(but perfectly healthy) correction of at least 8%, then there will be plenty of time to get properly positioned to take advantage going in and coming out. Notice at the blue circles above, how long the market takes to actually set-up the real dip that shakes things up.

Last year was the Year of the Passive ETF. The year 2013 caught the hedge fund industry with its pants down and the rich, whose funds were locked into 2&20, drastically under-performed the plain old, vanilla ETF of SPY. The S&P 500 tracker returned 29% last year, beating it’s very long term CAGR by a very healthy premium. In a mad trading world of short-term thinking and instant gratification, the long-term view of the Bogleheads destroyed churning traders on an absolute basis. Will 2014 be more of the same? I wouldn’t bet on it, but the consensus view out there seems to be that 2014 will be another good year…just not as good as 2013. Some more consensus thinking has been, “We’ll probably finish the year with the stock markets up about 14% to 16% compared to the prior year’s 30%’s for some indices.”

So in the spirit of following what worked last year while trying to include a touch of the contrarian and a dash of new trends, I’ve put together an ETF portfolio that I’d like to track in 2014. Because chasing always works! As always, this is not an investment recommendation. Since buy & hold was an elite strategy for 2013, and really since 2009 apparently, let’s see if 2014 continues to favor buy & hold with good fortune.

We’ll title the portfolio, Look Back and Ahead. Here’s a snapshot of its construction using ETFreplay.com:

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Let it be acknowledged that this portfolio is only partially constructed using a rear-view mirror, and that investing with one’s view on the rear-view mirror is generally not going to lead to short-term success. The Look Back & Ahead (“LB&A”) portfolio was constructed for short-term results in 2014 only and is looking to utilize prevailing trends and combine them with some of the strategies that had a rough 2013. Eight of the chosen ETF’s follow trends established in 2013. These are Japan(DXJ), Junk Bonds(HYG), Biotech(IBB), Russell 2000(IWM), Tech(QQQ), Share buy-backs and dividends in earnings growth(SYLD), Consumer Discretionary(VCR), and Health Care(VHT).

The remaining 4 ETF’s of LB&A are the contrarian plays that could bounce back in 2014. Some of the possible reasons behind any potential bounce-backs are: extended negative sentiment ready for a turn, value at these prices, or hot money moves in together creating a new trend. The 4 trends waiting for a potential 2014 rally off some lows are: Emerging Markets(DEM), Europe(FEZ), Gold(GLD), and Muni-bonds(TFI).

You might be thinking muni’s and saying to yourself, “Really?” They’ve had a tough year for sure. Certainly one of the worst performing years in the sector over the last 20. Barclays produced a chart of performance for the past couple of decades. It shows that after a down year, the sector tends to rally quite nicely. Will this time be different?

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Since the S&P 500 index performed so well, we’ll track LB&A against the SPY for the year. But wait, there’s more. If I think that LB&A may be able to outperform the market by riding some established sector trends and a handful of potential counter trends, then why not leverage up. Well I have a portfolio for that too, that allows for a 2 or 3 times leveraged move in each of the sectors of LB&A without taking on margin risk into your investment account. Observe:

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Unfortunately, ETFreplay subscriptions do not provide access to the entire universe of ETF’s. As they state on their website, “As of 2010, less than 500 ETFs have provided >98% of the trading ETF/ETN volume in the U.S. market.” Which means that due to a lack of liquidity and volume, six of the levered plays are not in the ETFreplay database. As such, I am unable to easily save and track the portfolio with their site’s tools. I’ll just save it on another site’s portfolio tools and drum up some charts in Excel for performance tracking purposes. And in the continued spirit of simple benchmarking against the S&P 500, we’ll use SSO(2x levered S&P ETF) as our comparison benchmark.

Just for ha-ha’s, we’ll track another portfolio in 2014 of purely contrarian plays. Construction of this portfolio should be obvious to most, but have a look at its make-up. It’s titled Contrarian New Year.

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Obviously, the BRI of BRIC had a tough year so we’re allocating there for total country exposure. I also included Singapore but left out Turkey. With the ongoing corruption scandal in Erdogan’s government, there’s obviously a whole lot more than sentiment going on there. We’ll just see how that situation plays out and how it affects investor sentiment towards the Turkey ETF later in the year. Commodities were utterly atrocious, so I included DBC and GUNR but also wanted to concentrate performance for some mean reversion specifically in coffee, corn, aluminum, coal, and silver. Gold miners were…well you know the story by now. Utilities was one of the worst performing sectors in the US along with TIPS, as nobody expects inflation and everybody wants to buy growth. We’ll see if inflation starts to tick upward and relative value attracts some players back into the utility space in 2014.

Just like muni bonds up above, you may be thinking that the gold miners prove I’m a glutton for punishment. That may very well be, but risk can always be managed, and if the underlying product has a bounce-back year then the producers may see a little pop in performance. Especially if the metal can catch a bid sufficiently past most of the producers’ all-in-sustaining costs. Observe the following chart of the XAU’s performance over the last 30 years, courtesy of US Global investors via Bloomberg. It says to me that miners have a potential low risk/high reward set-up. Believe me, any time the word gold comes out of my mouth, I want to shoot myself in the face.

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Remember, that these sample ETF portfolios are not investment recommendations and I reserve the right to allocate my own funds as I see fit into or out of any of the fore mentioned investment products. If you’re interested in some of the more professional portfolio metrics and want backtest results, Sharpe ratios, alpha and beta, correlations, etc., then too bad. Go look it up yourself. The name of the game in 2013 was absolute performance and so that is what we are measuring in 2014 with these ETF experiments.

And that ladies and gentlemen, is about all there is to basic asset management. Here’s the basic formula: Follow some prevailing trends to cover career risk + buy some contrarian plays based on quantitative models to cover career risk = hopefully benchmark beating results…and winning the grand prize of more AUM, which inevitably leads to diminishing performance. Obviously, I’m highly generalizing here. Asset management in any shape or form is usually performed by very well educated individuals or groups utilizing highly sophisticated quantitative or fundamental models drawn from a wealth of experience and knowledge. I don’t mean to belittle that nor do I begrudge anybody able to obtain a position managing assets. At the higher levels it is a very, very lucrative career that can build high-quality, long-lasting relationships.

For now, I’ll continue to trade my accounts, spend time with my family, post to my blog, and pursue interests. Am I going to be nominated for fund manager of the year for my efforts? Certainly not; but I just may have a shot at Dad’o the Year.

Now this wouldn’t be a real MarginRich.com article, if I didn’t over-chart the reader. So with that, I’ll bid you adieu with a few charts to provide entertainment and food for thought. Charts are courtesy of some of the financial blogosphere’s most respected, TRB, Jesse, and Kimble.

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Below is the final “Portfolio Update” posted on 1/4/2015:

Here’s where I’ll maintain the updates to the ETF portfolios that I outlined in the January 2014 post titled, A Few Sample ETF Portfolios to Watch. If you haven’t read it and are curious as to the rhyme and reason behind these experimental portfolios, then please read the post for a full explanation. The portfolios all started with a “play-money” value of $100K. We’ll see how “buy & hold” closes out 2014. CLICK ON EACH TO ENLARGE.

Update 1/4/2015:  Say goodbye to 2014, the year of nothing specifically working except holding everything. Obviously, the adroit speculator was able to generate income in various and specific asset classes. However, the casual investor trying to pick stocks or even the majority of hedge fund managers were both trounced again by a levered ETF of the S&P 500. So much for trying to follow the trend while also also trying to be contrarian. That little thought experiment crashed and burned. I have a strong suspicion that indexing ain’t gonna be as easy as it’s been the last 2 years but who knows. I’ll leave these results up for the rest of the month and then bid adieu to this specific page regarding the 2014 experimental portfolios. Maybe I’ll come up with something else to add to the site, but at the rate I’ve been posting, don’t get your hopes up. Good luck in 2015, muppets!

1. Look Back & Ahead as of 12/31/2014:Look Back & Ahead (2014 Year End)

2. S&P 500 as of 11/18/2014:
S&P 500 (2014 Year End)

3. Levered Look Back & Ahead as of 12/31/2014:Levered Look Back & Ahead (2014 Year End)

4. S&P 500 2x Levered as of 12/31/2014:Ultra S&P 500 (2014 Year End)

5. Contrarian New Year as of 12/31/2014:

Contrarian New Year (2014 Year End)

Being Early is the Same as Being Wrong?

How many times have you heard that saying from the post title in the world of speculation? A bazillion to be sure and it’s true, but the beautiful thing about that saying is that it only applies to timing. It does not necessarily always apply to analysis. Traders lose all the time. It’s just a way of trading life. That’s why the discipline to cut and run is all important. Just because your analysis may have led you to be early on a move, doesn’t mean you cut and run from the analysis. There could be profit left to squeeze out of it and if you let your emotions get the best of you, then you might leave money on the table…and we all know that’s a trading sin.

Observe the following 2 charts from a June post for a perfect example of this notion in action with the Aussie Dollar Currency Shares.

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Now I lost money on that first trade as the short energy simply had not dissipated yet. I thought the up-turn had occurred, but we had yet to even see a bottom in FXA. Serves me right for playing Mr. Pseudo-currency trader. My wheel-house is equities, but you read enough charts and conduct enough analysis and you just feel like you can trade anything. I kept my eye on the action in the Aussie dollar while also following the RBA decisions, amongst other indicators. As some real heavy hitters were reported to be short the Aussie dollar, it seemed as if the move had reached total extremis and a short covering rally was a distinct possibility. Additionally, the political hijinks of America were going to produce a counter-trend rally for some well-regarded international currencies, and the Aussie was as ripe as any. Observe the current action.

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If I had given up on this trade and just moved on to another asset class, then the profit would have totally been squandered along with the opportunity to reclaim the loss from being originally stopped out. You have to have conviction in your beliefs if you know your analysis is sound. Obviously, it doesn’t pay to fight the market but that doesn’t mean that the market will keep fighting you. Markets capitulate at extremes, providing fantastic opportunities for the diligent. And just for laughs, an ancient chart pattern, The Double Bottom, actually proved its efficacy in this particular instance in portending the trend change. Score one for classic technical analysis against the hyper-algo houses, however, don’t get used to it though. You’ll just lose money with that kind of thinking, that classical patterns will definitely play out in your favor. Have a look at Peter Brandt’s note on the H&S in GOOG back on October 9th. Granted, he did do the full disclosure thing stating that all patterns are subject to failure. Brandt is a true OG in the trading game, but everyone gets it wrong sometimes. Now I may miss out on some more upside in FXA, but I’m cool with recouping previous trade losses and harvesting new profits under my original analysis.

It can’t be reiterated enough how important it is to mind your stops with absolute discipline. You never want to enter your stops into the market because our algo-driven world has the ability to sniff these out and run them. Of course it takes position size for that to occur and an aggregation of sloppy retail holders may provide that size. Although if you simply cannot be disciplined enough to close out the trade when warranted, then do what you have to do by entering the stop. Again, I’m not abdicating for the usage of actually entering your stops into the broker. That’s amateur hour even for amateurs, but it takes time to learn how to cut and run. The primary thought process of the average amateur speculator goes something like this, “Well it’s moved so far below my purchase price that I might as well wait for it to come back and then at least I can break even.” Or if it’s an option, they foolishly allow it to expire with a total loss. Discipline is key and the trailing stop is one of the trader’s best friends.

It’s difficult to touch on this subject and not comment on the gold market. For the gold bugs, faithfully holding onto the precious metal and the precious shares it’s been a nightmare of a dislocation. For the “finanical-assets-are-the-only-place-to-be-and-a-gold-allocation-is-stupid” crowd, then this dislocation is providing the music for them to tap-dance on the hearts of the “sit-tight-and-be-right” hopeful holders of precious metals related assets. But are those tap-dancers early themselves? Are the people who have gathered precious metals related assets going to have the last laugh? Nobody can say or predict with any true credibility. There are credible sources on both sides of the argument for the gold price direction. The short-term extrapolation by the pro-financial-asset side is so glaringly and willfully ignorant of the many historical facts and the current trends that are racking up in favor of precious metals. But on the opposite side of the coin, the assumed guarantee of certain actions in the economy and thus the precious metals by the Hayek/Mises followers can also be labeled as glaringly and willfully ignorant of modern market & monetary dynamics.

Full disclosure: I do lean toward the Austrian line of thinking, but I’m not a blind fool. Let’s be real. You have to be allocated across multiple asset classes. If you have the means, it makes sense to take advantage of real estate values and advantageous financing…even after 1 year run-up’s in values and mortgage rates. The long-term statistics behind holding dividend growing, cash gushing mega brand companies speaks for itself. And nowhere has that been more recently evident than after the 2008 downturn. Fixed income is not dead. There are some sectors within that asset class that are struggling for breath, but fixed income will always be a sound allocation within a well balanced portfolio. Commodities are volatile and to over-allocate based on some historical precedents is unsound money management. As I stated though, maybe the goldbugs end up having the last laugh in that sort of The Big Short kind of way. To ignore the following chart, courtesy of Tom Fitzpatrick at CitiFX, is to think this time is different and mean reversion doesn’t work.

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Can you find a better, more consistent, and tighter correlation to gold than the US Debt Limit? If yes, then please feel free to comment below or e-mail. I’d like to hear other opinions, biased or unbiased. I’ve observed plenty of indicators over the years and this continues to be one of the strongest. Actually, there may just be one that is stronger. For some more ha-ha’s, I’ll include the following gold charts by the consistently insightful Tom McClellan. The gold price runs quite nicely with a certain 13 & 1/2 month cycle.

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You may be thinking that the timeline is so short that this correlation is statistically worthless. Well he provided a longer chart for that, too.

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So if you didn’t read the original note back in August, then you’re wondering what the heck is this fairly tight sine wave correlation to the gold price. The answer as presented by Mr. McClellan:

I mentioned that I don’t know why gold exhibits this very regular 13-1/2 month cycle.  But I do know that there is a very real and important anchor which seems to control its regularity.  You may have noticed that these charts show a rather funny looking representation of a sine wave cycle, with bars instead of a wiggly line.  Those bars have an important meaning: They represent the distance between the earth and moon on the day of the full moon.  So the 13-1/2 month cycle which is evident in gold prices just happens to match up really well with the lunar apogee-perigee cycle.  Or at least it has for a couple of decades, which ought to be long enough to establish it as a real phenomenon.

Seriously! The damn distance between the earth and moon during a lunar cycle. Hard to ignore it whether you think it is laughable or not. Gold has been showing some constructive action since going sub-$1,200 in June. It’s doing the classic higher lows walk right now and everybody can see the hardcore resistance at the $1,430’s and $1,530’s. Those most obvious resistance areas that literally everybody in the world can see makes me suspect that the paper price of gold will be sold off hard at those levels, by whatever entity or entities you want to believe conducts those sorts of operations. What we’ll really want to look for is the buying action off those potential sell-offs that will provide insight into how constructive the ongoing move really is coming out of June.

I don’t usually provide precious metals shares trading recommendations as the action in the shares is predicated solely on the underlying asset. With the volatility swinging so wildly with what appears to be no fundamental reasoning, it can be highly dangerous to speculate in gold or silver miners. Consider yourself duly warned and take another gander at the disclaimer as I’m not an investment professional and readers bear all the risk of trading or investing in these markets off of anything read here. Now that that’s off my chest, observe the following weekly charts of two quality miners. The first is Yamana (AUY) and the second is New Gold (NGD).

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The reason you’ll want to follow these two miners is that you get a top flight major producer (AUY), albeit very small compared to the big dogs, and a high level mid-tier producer (NGD). Both trade at penny stock prices. AUY and NGD share some operational qualities that distinguish them as quality picks in the mining space. They both possess top shelf management. They both possess some of the best all-in sustaining cost numbers for producers their size compared to their peers. They both possess readily available access to funds for project development. A majority of their mining and exploring operations are in respected, safe jurisdictions; especially New Gold. Most importantly they have huge growth already built into their production schedules over the next several years, which if precious metals resume their bull advance, then earnings growth has the potential to be very significant.

As far as a short-term trade to potentially leverage a move in gold over the next several months, I prefer AUY. And look…you can see that classic chart pattern again, The Double Bottom, rearing its head to possibly portend a trend change. There are a multitude of ways to execute a trade on these two. Simply buy the shares and go long. Buy some calls a handful of months out and subsidize part of the purchase with a put sell. Buy some LEAPs by themselves; hedge with some puts on the GLD. The last two times I played LEAPs in AUY, before the beginning of the Precious Dislocation, I was able to liquidate each trade with a 200% gain. The first in just a few weeks; the second in just a few months. Remember to conduct your own due diligence and structure a trade in which you are comfortable and allows you to sleep. Also, a concerted move below October lows will negate any analysis for a positive move upward

As far as a major move in gold pushing the price multiples higher in the years to come, well I’m in the camp that believes it’s probably going to happen. Am I a blind follower who prays to the Precious Metal gods daily and reads passages from the King Lebron James version of the Great Book of Precious Metals? All while rotating my alternating gold and silver rosary beads in my hand to add heft to my precious metals prayers? Decidedly not. In attempting to evaluate all the historical information at hand and objectively assess the current data, my noggin tells me to be positioned for a potential continued advance through this decade. At this point there is still plenty of time to open positions and begin accumulating the actual metals or quality shares, but to absolutely refuse an allocation based on pure ignorance or ego is a shameful act of poor money management. There are a plethora of wealth managers and bloggers whom have bought into their published stances with such conviction and unparalleled vanity, that they can’t truly admit to utilizing an objective or agnostic approach and perhaps are surrounded by one too many sycophants. It all sort of reminds me of the South Park episode where some of the parents start purchasing Toyota Priuses(Priusci, Priusae, Prius’s, or Priussessez) and then loving the smell of their own farts. Thankfully I reside in a country where everyone is entitled to their opinion, but the anti-PM crowd just may be early in their celebrations and wrong in their analysis.

Fear of Patience or Haste? Some Light Reading May Be Just What You Need

One of the notions I come across in conversations regarding the game of investing is the fear of making mistakes due to missing out(lack of action) or not waiting long enough(lack of patience). Bear in mind, we’re not talking about seasoned investment professionals(including myself). Oftentimes, this person is like many other hard-working individuals just trying to build something for the future. For the most part, that fear is completely unfounded as it generally stems from a person’s desire to invest or speculate outside of their competence levels. Why do people do that? Greed? Idiocy? Hubris? Ignorance? Naiveté? Who knows, but it definitely occurs on a daily basis with the retail set.

Two qualities that help to destroy the fear are knowledge and experience. With a healthy foundation of knowledge laid comes confidence. When combined with practical experience, one gets that level of seasoning that can lead to consistent investment success whether one is a pro or amateur. You may be thinking to yourself, “But I don’t have an MBA in finance from Wharton.” So what. Neither do a lot of successful professional investors. You going to work on Wall St.? No? Then who cares. There’s an endless supply of readily available books on everything one needs to at least complete the knowledge-half of the equation to start gaining investment confidence. The experience-half of the equation simply comes with practice, which obviously comes with time and repetition. Do you care enough about your financial future to put in the requisite time?

It all starts with one book, and if you really catch the bug, then it’ll turn into dozens or hundreds as you endeavor to consume as much information as possible to round out your self-education. Feel free to visit the MarginRich Books & Educational Content link at the top of the page(or click here if you suffer from acute wrist fatigue) to see some of the books that had the most positive influence on my own investing or speculating abilities. One can argue that there are better books or I should have read more economics or history or whatever. That’s true, but based on the population of books I have read so far, these had the most impact. When combined with regular perusal of relevant sites on the WWW, one can begin to reach that comfort level with taking appropriate action at the appropriate time based on a quality base of knowledge. Obviously, it’s my opinion that the list of links in Some Favorites off to the side or at the bottom on a mobile device, is a great place to start for web sources of relevant market information.

It is my experience that most people are simply too lazy to take the time to read or research. That’s why they listen to their Fidelity 401k advisor or their 2-bit Schwab financial advisor and wonder why they get average returns. It’s certainly true that just passively indexing in the recent past would have blown away many “complex” strategies, but any real downside protection is effectively eliminated in a down-move bust of the regular market cycle. Strategies really come down to timelines, so whether your horizon is way out or just ahead, it pays to be financially educated enough to truly take matters into your own hands. Building the foundation of knowledge and continuing to add to it will allow one to see value when it truly exists or determine extreme levels when potential outcomes are stretched; hence the tagline at the bottom of all the missives of “Read, Read, and Read some more.”

And let’s not forget the blue-blooded, Ivy League knuckleheads, allegedly the most educated financial professionals on the planet, that virtually blew up the whole system. I’ll never be convinced that it takes their magical, special sort of smarts to run a billion-dollar portfolio for an elite bank or large-scale insurance company and idiotically allow an excessive amount of funds to be gambled in the complex universe of the most esoteric derivatives all over the counter without any central clearing or oversight what so ever to potential worldwide ramifications. GTFOH with that! These fools almost blew it all up once, and you can be sure, the next time they’ll succeed…but life will go on and markets will continue to exist. Pick up a book you’ve been meaning to read and start perusing it. Whether it’s about investing or economics or history or anything, as long as it’s going to positively impact your overall investment skill set. Just…

Read, Read, and Read some more. Good luck out there.

Market Timing – Trades You Can Apply Yourself

Below I will outline what I feel are some high-probability set-ups for a handful of swing trades. At the very least, maybe you’ll find it fun or interesting if you’re not up for the risk. In the beginning of the year and for the next several months subsequent, my timing skills became out of whack. This is normal as nobody is right all the time. I rely on my ability to “read the tape.” That’s one of my edges…allegedly. Unfortunately, my “tape reading” ability cycles up and down. But every now and again I can get in a zone where I feel like I’m seeing market moves ahead of time, and consequently, make a series of successful trades in a row. Since the return of volatility to the markets back at the end of May, I have been able to capitalize in one of those zones. That volatility has put my technical analysis skills back in play. Keep in mind that I’m not really using traditional chart reading methods where I look for a “flag” in a “rising bear wedge” to determine an intermediate trend change but the overall bull trend remains intact as long as the “Hindenburg Omen” doesn’t offset the “Golden Cross” which is contingent upon the patterns occurring on 5-minute and 60-minute charts but not a daily or a weekly chart. As I’ve relayed before, that kind of stuff can provide value but pretty much gets nullified by skilled systematic traders and the sheer volume of high-frequency-traders in the markets. However, this volatility does allow for my simple use of technical analysis combined with pure “tape reading” to allow for some wins.

Recall the e-mail sent in May, “Step Right Up and Grab Your Short Opportunity,” and the Toyota recommendation. Observe the results in the original chart(5/13) and the follow-up chart(6/26):

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And by the way that trade is still open for profit potential on a farther-out timescale. The set-up looked like a mini-Eiffel Tower and I think $105 is still in play. I may re-open the trade as Toyota’s action has been weak in light of the little bounce back in the markets. Now you may be thinking so what. Nice luck, clown. Or even the sun shines on a dog’s rear end, but keep in mind I closed similar trades for profit nailing the turn in the XHB(housing), XLU(utilities), and INTC after it’s jump to $25. Plus, I have other Put option trades open. I also stated in the KSU presentation that a takedown would offer a better entry point for that particular equity when it was priced at $118 at the time I posted the presentation. It’s low since was $102, but I think there’s even more room to correct. But the fun doesn’t end there as there is a tremendous amount of fear still residing in the market. It’s almost palpable and it calls to traders. There has been commentary that the big one is here. This is the beginning of the huge takedown, like in 2000 or 2007, with enormous sell-offs in bonds and stock markets. I disagree. I see the current situation as a natural correction off the irrational 6-month exuberance that existed from the beginning of the year to June. I can’t really speak for the debt markets, but for the stock markets we could see a bounce back to new highs from here and then a stronger, scarier takedown somewhere in the late-July through mid-September range. It’s more probable that we chop along moving sideways through the Summer with some up and down bouncing and then finish out the year strong as animal spirits recover and taper talk dies down with renewed vigor behind the rhetoric of quantitative easing. Now just because I’m an equities guy doesn’t mean I don’t understand the debt markets. It’s just not my primary field of play for profit. What I do think though is that the BIG, GIANT crash in bonds is not on us yet. That period for bonds will shock the markets as the derivatives and debts of the world come together for the big one. No, what I think the correction in bond prices and spike in yields are doing is conveying the first message that judgment day is coming, so it’s time to start worrying but keep partying for now. As always, who friggin knows?

So getting back to the potential money makers I referred to earlier…the first one is on the Aussie dollar. The whole world is short the Aussie dollar. The basic macroeconomic rationale is that the Australian economy is centered solely on commodities and the sale of those commodities to China. With the whole commodity complex coming down, then the Australian currency is due for a dive. And dived it has due to speculators, bond vigilante’s, or the boogeyman. The fact of the matter is that the Australian economy, although possibly overheating, has not blown up yet nor has their housing market yet, either. The central bank of Australia has been raising rates as opposed to lowering, although I suspect that should change in the near future. And the bottom line is that when the whole world agrees on a trade, you simply have to go contrarian. Even if the macroeconomic rationale is correct, there’s still that little matter of timing. Recall gold and gold shares for proof of that. Anyways, observe the following weekly and daily charts of FXA, which as you should know from previous market notes, is an ETF proxy for the Aussie currency.

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The hedge funds, family offices, and wealth managers can borrow in a stronger or weaker currencies and short or go long another. That’s a carry trade done on margin. It can blow up spectacularly when done in things like borrowing Yen on margin to buy US safe, dividend paying stocks. It works till it doesn’t and then it can blow up fantastically, which is what we have seen this month. Obviously, I’m not operating on that level. Our trade is the September Calls at a $98 strike on the FXA. These options tend to trade with a little bit wider spreads of around $0.10 despite adequate liquidity, so as of 6/26 each Call was trading between $0.40 and $0.50. Do not put more than 2% of your trading capital at stake in the trade. I use a very wider stop-loss generally on option trades. Sometimes you gotta give a thesis time to marinate and that’s what going far enough out with a wide stop-loss allows. Not to get too remedial or insult your intelligence, but let’s do a quick example of what that looks like. Hypothetically you have $10K to trade and a 50% stop loss. That means you’re willing to risk $200, which means that you’d place $400 into the trade if you’re using the 50% stop loss. The resistance point of $98 is a pre-planned sell price, however feel free to liquidate earlier if you’re satisfied with the profits earned…after accounting for transaction fees of course. Full disclosure, I’ve already put the trade in play.

The second trade is in emerging markets. I spend hours every day scouring the web researching various markets and gathering usable intelligence that will allow for a potentially profitable trade set-up. One of the things of I’ve noticed over the last week or so is all the overwhelming negative sentiment on emerging markets. Once again, the whole world is short emerging markets. Literally, all I read are negatives on Brazil, China, India, and the rest of the developing countries and how the US is so strong, while the emerging market investment will destroy your portfolio. As I stated up above, when the whole world is in on a trade then you really do have to go contrarian. Look at the emerging market ETF, EEM. It has been destroyed in the last 4 weeks and with a serious gap-down just last week. In the daily chart we have two 2 beautiful set-ups that I love to see:  1. confirmation of the beginning of a snap-back, and  2. a gap-down that appears as if it will be covered as part of the snap-back. The weekly shows the snap-back consistency subsequent to a parabolic sell-off. Observe the following charts.

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I often comment on snap-backs when it comes to trading and that’s because I’m always looking for extremes. It’s one of the easiest things to look for in trading set-ups. Others call it mean reversion, although that’s not always the case as the reversion move may not necessarily move back all the way to the mathematical mean, but you get the point. Regardless, I generalize these set-ups as snap-backs and they’re far and away my favorite set-ups to consistently trade. They can be executed up or down. It doesn’t matter. The only real difference is that downside moves are much more explosive than upside moves, so Put option purchases are a touch more delicate than Call purchases. The trade here is the August Calls at a $39 strike for EEM. Each Call is trading at a fair $0.75 despite the resistance point only being a dollar away. Waiting for the mini-gap will present an even better price point. Liquidate at $39 to be safe or earlier if you’re already satisfied with the profit level. The sentiment against EEM is definitely extreme as the top holdings in the ETF are companies like:  1. OAO Gazprom – Russia’s largest natural gas producer and thus Europe’s largest supplier  2. China Mobil – China’s largest mobile carrier  3. Samsung – Largest company in S. Korea and one of the largest consumer electronics companies in the world  4. America Movil – Mexico’s largest telecommunications company, etc. These aren’t exactly the kinds of companies that are about to become insolvent. Full disclosure, I have not put the play in motion yet as I am waiting to allocate once that mini gap is filled.

The third and final trade is a golden oldie. The sell-offs in the GLD on 6/20 and 6/26 also present my two favorite set-ups again. We have gap-downs and we have an extreme shift in the trend. By observing similar action in April, we can see the potential of the snap-back here in June. Understand I’m not calling for a secular trend change here in gold. I’m not saying go all-in gold because the correction is over. I’m just seeing a great set-up that deserves a short-term capital allocation. Observe the first chart, which is a daily chart of GLD. The second chart is of the COMEX paper gold. Using any technical analysis on gold is dangerous due to the gross manipulation, however trading is trading and greed is greed and extremes are extremes. These set-ups look compelling.

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I had shared with a colleague that I had purchased Calls for September, but was mistaken. The trade is for the August Calls at a $130 strike on GLD. These Calls got killed on 6/26 and could have been purchased for $0.85 as of the close, which is when I purchased my allotment. I suspect the trade will be ready for liquidation at $125, but if paper gold is running kind of hot off of the snap-back then there is the potential for $130, in which case the option should be liquidated. It is probable by that point that the takedown will resume in paper gold as $1,200 has not been hit yet and potentially slightly below $1,200, just to run all the stops set at $1,200 for easy profit.

There are some things to keep in mind when considering dipping your toes in. One is that it’s not as hard as it looks. Just be disciplined. Don’t over allocate and get out if the play moves against you. The second thing is that these moves aren’t for waiting on. The FXA and GLD options are for immediate purchase, so if you dilly dally and then decide you want to try, you’ll lose. The EEM is only a wait until the mini gap is covered which should happen the next day or two and then I’m going in. The third thing to consider is hedging. It’s not important to try to think outside of your realm of expertise and hedge each of these bets directly. For instance, you don’t need to short the dollar while buying Calls on GLD or buying E-mini Calls on the S&P 500 while you short the Aussie dollar. Hedge funds have expert analysts, with PhD’s, in combination with sophisticated software to determine correlations and anti-correlations between every asset class in the world and then calculate optimal statistical probabilities of a trade. We don’t have those resources. Like I stated in the previous note, think of your 401K’s and safely allocated retirement funds as your hedges to the risk you take on with options trades. It’s that simple.

I’m assuming that none of you will try these and I knew that before penned this note. I don’t care what the universities & the mutual fund marketers communicate about asset allocation and thinking of the long term. Markets ain’t efficient and short-term profit opportunities consistently present themselves. I enjoy deep-dive analysis on companies for long-term potential as much as the next value investor. That is also fun for me…and profitable. It’s just that swing trading is more fun and presents profits a lot more quickly, but of course the danger factor is amplified exponentially. At the very least, bookmark the charts from Stockcharts.com and the ticker profiles from Yahoo Finance for the next couple weeks to couple of months to see how these play out…just for laughs.

Lastly, remember these are simple option trade set-up’s of the purchase of a Put or Call. You can facilitate more complex option trades around the analysis, but that’s not what I share here. If you have the requisite skill set then you’re covered.

Read, Read, and Read some more. Good luck out there.

Currencies, Derivatives, and Metals…WTF!

Since it’s been awhile, this piece is sort of a long one.  Read it in chunks over a few days if you have attention issues or if you get bored; but grab your mom’s reading glasses from Rite Aid and follow along because I’ve compiled more derivatives data that I think you’ll find useful even if you already feel knowledgeable enough about the subject matter. Now let me just state for the record that I’m not some cutting edge journalist or a former banker and I rely heavily on info garnered from public sources, but of course I make every attempt to validate facts. There is quite a bit of content form ZeroHedge in this post as they provide content with great depth when it comes to derivatives. I don’t claim to have perfect knowledge of the mechanics of the entire exotic derivatives universe, but I do feel I have a perfunctory level understanding which allows me to comment with relative intelligence on the subject. Now back to the message…

Volatility, volatility, volatility in all markets. Taper or no Taper? That’s the question that Mr. Market continues to ask itself across bonds, equities, currencies, and commodities; basically all the markets. Consequently, traders are being provided sweet treats in these markets because the volatility is virtually a trader’s best friend. If you’re trying to time the markets, I hope you’re effectively managing risk. If not, continue to stick with a long-term strategy that helps you feel comfortable because it really is one giant rigged casino and long holding periods are the big body guards of the unskilled timers.

I came across an intriguing article the other day from a trading site I like to visit, MercenaryTrader.com. Please bear in mind that I greatly respect and enjoy the work generated by the team at MercenaryTrader, but I simply have a difference of opinion in regards to the following article. They have an interesting take on the US Dollar as they feel it is the premier currency now and going forward. I want to share quite a bit of their content here as they take such a stark, contrasting view to what the doom & gloom crowd believe is the fate of the USD. They present why the USD is in a secular i.e. long-term bull market and determine that the USD’s rise will highly correlate with the stock market’s own rise. Here’s a few choice thoughts from the piece by Jack Sparrow(they use nom de plume’s for their article writing because obviously the author’s not a fictional pirate):

Our thesis has long been that weakness in the USD was temporary — in large part driven by temporary unwinding of the yen carry trade. Basic fundamentals, plus confirming price action, put the USD in a long-term secular bull market after ten years of decline. This is the flipside of emerging markets imploding, which you also saw yesterday…Why did the dollar respond so powerfully to the Federal Reserve testimony? In part, we believe, because a clearer picture is finally emerging. The US economy is a juggernaut relative to dire Europe and weakening emerging markets. Asia is in a lot of trouble. Japan has already expressed the necessity of forcing a much weaker yen in order for Abenomics to work. In addition to this, you have serious credit crunch problems developing in China — and for the first time in a long time, the real prospect of a China crash. Investors are seeing inflation problems sweep through emerging markets — note the huge protests in Brazil. All these factors are combining to fuel a massive repatriation of funds out of EM assets and back into home-based dollars, again strengthening the greenback… As the great speculator George Soros once said, “I am good at riding the tide, but not the ripples of a swimming pool.” Translation: Traders need big trends to make the truly big money. The return of the US dollar — and the secular outperformance of the USD vs the rest of the world — is a HUGE, huge trend. HUGE.

Why has this possibility been so universally missed (or flat-out dismissed)? Perhaps, in part, because a large contingent of the trading community is bottom-up focused — not overly concerned with sea-change macro factors. And another large contingent of the trading community — call it the “Zero Hedge contingent” — has been myopically, religiously obsessed with the debt side of America’s balance sheet, without properly considering 1) the ASSET side of America’s balance sheet or 2) the positioning of the US vis a vis the rest of the world…

I mean, just stop and ponder for a second. The United States is:

· 1. an agrarian superpower (number one food exporter not counting multiple-country EU)

· 2. a military superpower (who else controls two oceans?)

· 3. a demographic superpower (look at our aging trends vs Europe, Japan, China)

· 4. a technology superpower (Google, Apple, Amazon, Intel, IBM, need I go on?)

· 5. a soon to be energy superpower (we are about to start exporting oil again)

· 6. the domicile of +$70 trillion in household wealth

· 7. the home of the most desired real estate in the world

And the United States government has access to all of the above, in terms of assets to draw down on, by dint of our representative democracy.”

MarginRich here; he goes on to explain the correlation values between the USD and the S&P 500:

Some other good news: A lasting resurgence in the US dollar need not be bearish for US equities. For many years, as I’m sure you’ll remember, the dollar was a key “risk off” indicator. When the dollar was up, equities tended to be down and vice versa. This was a function of heavy asset flows into emerging markets and multinational blue chips benefiting from emerging market revenues. But now the situation has reversed. With US domestic equities the new sweet spot for bullish positioning (see Bernstein argument), US equities can rise even as dollar flows repatriate back home to the United States. Think of this not just as a “great rotation” but a “great unwinding.” For a long time EM debt and EM equities seemed the place to be. With the dollar strengthening and the rest of the world faltering relative to the United States, that is no longer the case. With every uptick in the greenback, EM assets look a little bit less attractive in relative currency terms (not to mention the problems they are facing — riots in the streets anyone?). The massive over-allocation to emerging markets in recent years is being unwound, as the whole “emerging markets century” idea is getting its license revoked.

(And by the way, a side note to Jim Rogers: I love you Jimmy, your book “Investment Biker” was my literal inspiration for getting into markets. But your uber-bullish China call was about as long-term wrong as it is humanly possible to be. You are even wronger on that call than the Dow 36,000 guys circa Y2K bubble. And as for permanent gold bugs? Oh man. If you thought your world of hurt was bad already…)clip_image001The correlation chart above, from Bespoke Investment Group, shows how the US dollar / US equities relationship has changed. The dollar and US equities now have a positive correlation, rather than the negative one that persisted for years.”

MarginRich here again; what dollar bulls continue to completely fail to note in any of their commentaries or share in any of their trading strategies are any thoughts on the derivatives exposure of the biggest banks and thus the sovereign nations where the banks are domiciled. It’s as if the derivatives market and thus the shadow banking industry don’t exist to these people. I fully understand their views and theses but these could be perceived as somewhat short sighted as they fail to completely assess and include the notional derivatives exposure by the biggest power players on the planet. Let’s revisit what the derivatives situation looks like for the biggest banks on the planet(ex-China, ex-the rest of Westernized Nations, and ex-BlackRock). Keep in mind that after the 2008 crash, the Bank of International Settlements (“BIS” which is the central bank to the world’s central banks) changed the valuation method of derivatives for banks and thus halved derivative exposures across the world from approximately $1.4 quadrillion to between $600 & $700 trillion; of which all are just unfathomable numbers.  So here is what dollar bulls continually ignore, as reported by the US Office of the Comptroller of the Currency:clip_image003

I can’t begin to understand how the heck Deutsche was excluded off of this list. Through the alchemy of balance sheet netting and German domiciling, they’re not even in the top 25 of US holding companies, but observe a snapshot of DB’s derivative position and how that compares to the entire German economy(both courtesy of ZeroHedge):clip_image004clip_image005Once again, no big deal. DB only has Euro-denominated derivative exposure that is 20 times the size of the entire German 2012 GDP; and hell, Germany is only just the 4th biggest economy in the world. There is definitely no risk in that, because Germans can just print as many Marks as they need to deal with any potential liquidity or credit issues…oh wait…yeah the ECB. Well that’s how the Federal Reserve helps support Europe through the magic of currency swaps and the “unbiased” IMF.

In fact at the end of 2012, here is what the IMF had to say about derivatives via their staff discussion paper, “Shadow Banking: Economics and Policy“(again, courtesy of ZeroHedge):

Over-the-counter (OTC) derivatives markets straddle regulated systemically important financial institutions and the shadow banking world. Recent regulatory efforts focus on moving OTC derivatives contracts to central counterparties (CCPs). A CCP will be collecting collateral and netting bilateral positions. While CCPs do not have explicit taxpayer backing, they may be supported in times of stress. For example, the U.S. Dodd-Frank Act allows the Federal Reserve to lend to key financial market infrastructures during times of crises. Incentives to move OTC contracts could come from increasing bank capital charges on OTC positions that are not moved to CCP (BCBS, 2012).

The notional value of OTC contracts is about $600 trillion, but while much cited, that number overstates the still very sizable risks. A better estimate may be based on adding “in-the-money” (or gross positive value) and “out-of-the money” (or gross negative value) derivative positions (to obtain total exposures), further reduced by the “netting” of related positions. Once these are taken into account, the resulting exposures are currently about $3 trillion, down from $5 trillion (see table below; see also BIS, 2012, and Singh, 2010).

Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 – $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide.”

MarginRich again, so here’s the best part of that; the BIS states that once again due to the wizardry of netting that the world is only exposed to $3 trillion in derivatives. The precise number is $3.7 trillion as of the first half of 2012 which is basically the same number since 2009 after the crash in 2008, so there has effectively been absolutely no effort to wind down these derivative books which are of course only traded OTC which is why the shadow banking industry presents so much damn risk to the system. The kicker is that the BIS openly states above that there is only $600 to $700 billion backing these derivative transaction. My basic arithmetic skills show that as a very safe 5 times leverage. Thank god for conservatism by the banks, but if you take the collateral against the very real and un-netted number of $600 trillion then we calculate collateral coverage of approximately a tenth of 1% or for the layman, 1000 times leverage (as reported by ZH as well). But you may ask, well why does it say there is $1.8 trillion of collateral and what the hell is the reuse rate? That is how hypothecation comes into the picture. Financial institutions will re-post collateral that belongs to their clients in their own for-profit transactions, under the assumption that the game is such that they are guaranteed to get their money back or they’ll easily come up with the money if something goes south. This will occur with one piece of collateral between multiple entities and that is when re-hypothecation comes into play. How it’s legal is just absolutely beyond me. Feel free to revisit MF Global and the theft of innocent traders’ money who deposited their cash there for futures trading. JP Morgan re-hypothecated hundreds of millions, and by re-hypothecate I mean pilfer or let’s just call it outright stealing, from MF Global’s clients for bad bets that MF Global illegally made with depositors’ money. Many innocent people who trusted MF Global to just hold their cash as a trustee and simply help them facilitate futures trades as a brokerage are still waiting to be made whole. JPM doesn’t feel they have to give that money to the people it belongs to as they are first-in-line creditors, and the courts agree with them for now, so how this is all legal is seriously beyond me. Why would JPM be made whole before MF Global depositors when MF Global had to legally segregate depositor funds and thus could not post those segregated funds as collateral for MF Global’s own transactions, at least as I understand the laws and regulations? Anyways, that’s a discussion for another time and place but if you’re curiosity needs to be immediately satiated then you can visit here and here for a deeper dive along with the actual court case; both about Sentinel Management Group which is apparently establishing the case law however this definitely has the potential to get appealed and taken up to the Supreme Court.

Now all this talk of derivative exposure and bank collateral definitely sounds like the foundation for a long-term dollar bull market especially when you combine in the effects of quantitative easing and the inflationary effects on asset pricing. And if you don’t think asset price inflation exists, then please explain to me the rise of the stock market, the real estate market, the high yield bond markets, the fine art market, and of course the diamond markets, just to name a few several. The icing on the cake is how the US federal government intends to deal with any issues that could potentially arise in a liquidity or credit event in the banking industry. Observe the following chart displaying total FDIC assets, total US cash deposits, and the US derivative exposure all in one pretty little package(once again, courtesy of the OCC via ZH):  That’s right. Your eyes don’clip_image006t deceive.

The government has allocated $25 billion from the premiums paid by FDIC member banks to protect depositors in the event that a Lehman-style event occurs again. Do you feel good about the long-term condition of the USD? No doubt, the USD is the top of the currency game right now; but judgment day cometh at some point. I can’t tell you when. I’ve guessed somewhere in 2015 – 2016, but nobody can know. I will continue to say that you can only subvert basic economic and monetary laws for so long. At some point the unintended consequences of this entire 4 decade monetary experiment of exiting the gold standard in combination with the shadow banking system, will draw forth some sort of epic but indeterminate action. It’s guaranteed. Seeing the lack of liquidity in the system to deal with actual risks adds insight into the risks to your cash & assets and the plausibility of a bail-in using your money. The next event will be a triple-whammy as tax payers are hit thrice; once with the bail-outs and then again with the bail-ins and then again as I’m sure the capital gains tax will rise to some egregious percentage or windfall taxes are introduced. It brings clarity to the presentation I sent so many months back when I asked who the hell was JPM referring to in the slides about who will provide needed liquidity, what they leave unsaid is that “shareholders and creditors” really means you i.e. the depositor. Coming back to the buck and why we visited the whole derivatives situation, trend trading the USD right now is one thing but I think it is a stretch to label it as being in a “secular bull market” without fully considering the risks associated with the just-discussed derivative exposure.

Which brings us back to what I(along with countless others) continue to say will be the ultimate investment haven and of course absolute hedge to the the potential busted systems of the banks and governments…precious metals. By now I would understand if you’re finding it difficult to maintain positions in precious metals shares in your portfolio and have verbally cursed the day you may have taken a position in anything related to a precious metal. It’s easy to say right now I was wrong because I was so early and that the case for precious metals is totally bunk and busted. I won’t delve back into all the reasons why your portfolio is going to need precious metals to get through and possibly even prosper through the times I’ve already described.

You can call me a “gold bug” but I haven’t encountered too many gold bugs who’ve shorted gold(via the GLD) and the miners to wash the paper losses of the long-term precious metals holdings. I also am not going to present any new trading ideas for precious metals shares as I’ve already shared a majority of my favorite plays. I will fully admit to being early in some of the plays and I wish as much as any other speculator that I had waited until now to pick-up some of the best speculative names. I also wish I had a unicorn with a magical golden horn that granted wishes, but I’m content to live with reality.

I was sharing with a colleague in an earlier message regarding a junior silver producer to try and compare your situation to Dr. Michael Burry’s, the hedge fund manager formerly of Scion Capital from The Big Short. I know you’re all familiar but let me remind you that he was paying out millions in insurance premiums on the credit default swap derivatives on mbs, which he helped to invent, as a result of getting into the trade years early. His investors, who were humongous players such as Joel Greenblatt of Gotham Capital and White Mountain Insurance, were incensed at the very real losses the premiums paid represented in light of none of the derivative contracts paying off yet and housing just continuing to rise. They gave him hundreds of millions to manage and yet berated him incessantly and threatened him with litigation, but he was resolute and steadfast in his conviction that time would ultimately be the arbiter of value. When the bets paid off, his investors made hundreds of millions of dollars in one fell swoop and Dr. Burry was totally vindicated in his ability to foresee and sit tightly until the obvious end to the trade arrived.

And that is how you should consider your UNREALIZED, PAPER losses; as “insurance premiums” that are the cost of being years early in what has the potential to be the ultimate trade this decade. Think there’s a reason Dr. Burry bought a boat load of gold and farmland, closed up shop, and essentially dropped off the grid?  He just may be years early again.

Which brings us back to the shiny little metal which has caused so much pain and angst for speculators of all ilk. Gold has the potential to bring about a monetary revolution that will offset the full power of the USD over the coming years. Is the USD going to totally crash in value and be totally replaced by the Renminbi or SDR’s from the IMF? Obviously not. You can’t just displace an economic and military super-power who possesses the reserve currency in under a decade. The way the USD will drop in value will be the reduction in its use as the reserve currency around the world. Not totally of course, but as of right now, the USD has a 67% share of the currency market; a full 2/3rd. And virtually 100% for oil with the Petro Dollar, except where countries have worked out specific agreements with one another, which is already beginning to happen at a higher rate between China and other players. Take a gander at this article where China has worked out an agreement with the largest oil company on the planet in a $270B deal to double its Russian oil imports over the next 25 years. Even though the article did not specifically state which currency was used, I can state with fair assurance that it wasn’t the Petro dollar but instead probably a Renminbi/Ruble swap.

Now that USD reserve currency use percentage of 67% will inevitably drop to a much lower percentage of possibly between 40% and 50%, as the role of gold and other currencies increases and the other powers in the world decide they’ve had enough of the USD and wish to facilitate large-scale international transactions in different denominations. The drop to 50% USD use is a percentage that Ray Dalio, founder and CIO of Bridgewater, agreed would be probable. You may think to yourself, so what?  Who cares about a 17% reduction in the worldwide use of the USD as the reserve currency? Let me assure you that a drop like that can have earth shattering, negative impact to the markets.

And why do we even care what Bridgewater thinks? Well it’s because it’s the largest hedge fund in America with over $140B in assets under management. Dalio along with his Co-CIO, Robert Prince, consistently provide some great macro-economic commentary from an investment standpoint that simply has to be considered. Here’s another great quote from Ray Dalio regarding how the massive debt overhang of the Westernized nations will most probably be dealt with, “…one of 3 things will have to happen:  a global debt restructuring/repudiation; global hyperinflation to inflate away this debt, or a one-time financial tax on all individuals amounting to roughly 30% of all wealth. That’s pretty much it, at least according to mathematics.” Two of those outcomes spell nothing but upside for gold and Dalio said this back in September of 2011. Additionally, you’ve got Prince’s early 2012 commentary about bank debts and sovereign debts, “You’ve got insolvent banks supporting insolvent sovereigns and insolvent sovereigns supporting insolvent banks.” And lastly from Dalio regarding Buffet’s take on gold, “I think he is making a big mistake.”

Now that gold is suffering the most intense drops of the 2 year correction, especially with last Thursday’s action, let’s take a look at some potential catalysts for the metal. Incidentally, I think the bottom of this total corrective move from the September 2011 high, will be be down around $1,200; so we’re almost there. Try not to throw up in your mouth as you read that and the following. We’re seeing all-time low stock levels at the metals warehouses at the bullion banks for delivery via futures contracts through the COMEX and LBMA. Additionally, the Commercials(classified as the major producers who hedge and the bullion banks who facilitate large-scale transactions) at the COMEX are the least net short since the selloff’s of 2001, which marked an absolute low before the major run-up to September 2011. In fact, the Commitment of Traders (“CoT”) report is currently showing the absolute lowest net short position since 2001, which was essentially the all-time bottom in the gold price after it was untethered from the dollar in 1971.

This can be observed in the first chart below. According to the creator of this chart, Tom McClellan, “Commercial traders of gold futures are showing one of the most bullish conditions in years. They are usually presumed to be the “smart money”, and so when commercial traders move to a lopsided net position as a group, it usually means that prices are going to be moving in their chosen direction…In the first chart below, the current reading is the Commercials’ lowest net short position (as a percentage of total open interest) since 2001, which was when gold prices were just starting a multi-year uptrend from below $300/oz. The message here is that commercial traders as a group are convinced that gold prices are heading higher. They usually get proven right, eventually, although sometimes we have to wait around longer than we might wish for “eventually” to get here.”

For the second chart McClellan stated, “One other way I like to use the data in the CoT Report for an interesting insight is to watch total open interest numbers…when the 3-week rate of change of total open interest drops below around -12%, it is usually a pretty good indication of an important bottom for gold prices. Whether or not this recent sudden drop in open interest is going to lead to a real and lasting uptrend for gold prices, or instead just bring a temporary pop, is something that this indicator does not tell us. But history says that it should be associated with a meaningful price bottom, which tells me that we should get some meaningful amount of a price rally from here.” I strongly recommend a visit to mcoscillator.com, as they provide outstanding commentary.

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Additionally, demand for physical gold whether it’s bars, ingots, or coins has been through the roof and has stayed there since the down-move began in earnest back in mid-April. This kind of demand on quick moves down in a commodity always produces higher premiums over spot because the spike in demand paints the exact opposite picture of the tape that is trying to be painted with the paper market. McClellan produced some very interesting additional charts that also lend themselves to a potential rise in the gold price. Here is how he described them, “I have just learned recently that the behavior of gold coin dealers can offer us an interesting insight about where gold prices are headed, but perhaps not in a way one might have imagined. The Wall Street Journal publishes prices for gold coins on its web site every day. They even offer historical data going back as far as June 2007…What I discovered when looking at this data on American Eagle pricing is that the average premium over spot is around 4.88%.  But whenever it gets up above 6%, the days which follow nearly always see a rise in gold prices. That does not necessarily mean that a >6% reading is a bottom for gold prices. Absolute bottoms or tops are much less important than the direction forward from any given point, and when there is a bullish bias after a certain event, that’s really useful information…I just look at what the data say, and what I see in this week’s chart seems to show a periodically useful edge in terms of figuring out what gold prices will do, if one is willing to look patiently at gold coin prices every day and wait for those pearls to appear. Interestingly, this phenomenon is not confined to just American Eagle gold coins. Here is the premium over spot prices for Canadian Maple Leaf coins. The average premium over spot for Maple Leaf coins is 4.6%, and readings above around 5.5% tend to be followed by gold price rallies over the next several days in the same way that this principle works for American Eagle coin pricing. It also works for Krugerrands. When I say it “works”, I am referring to this phenomenon of the quoted coin price’s premium spiking up well above average, which for Krugerrands seems to be about 3.8%. Readings above 5.0% over spot tend to be followed by rising gold prices over the next several days. I don’t know if this is a case of the smart gold coin dealers sensing that a rally is coming, and thus bumping up their prices to take advantage, or if some other market dynamic is at work. I just know what I see in the data. One potential problem with this data is that it only comes from one source, and we don’t know how wide of a survey net they cast when gathering this price data. But on the positive side, the data are easily available. Interestingly, this momentary pricing anomaly for gold coins arrives at the same time that the Commitment of Traders (CoT) Report data are showing that gold and silver traders are at historic extremes of sentiment. In other words, things looks like a bottom for gold prices which should matter not just for a few days to follow, but for weeks or months.”

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The CoT data of the bullion banks(the bullion banks are the big banks) and commercial hedgers is important because they have essentially positioned long ahead of the hedge fund/managed money group. Now keep in mind we are not talking about giant hedge funds that you know. We are talking about the smaller ones with extremely less talented management who have a stronger tendency to believe in their trend trading systems and follow the herd. This is important because the bullion banks seem to control the gold game with what could be perceived as the help of the central banks and the BIS. They can crush the hedge fund/managed money shorts and they will choose the time of when they feel like beginning to harvest those profits and drive the gold price upward. The data shows that may start occurring in the later Summer or beginning in the Fall. Either way, do not forget that at this point the bullion banks are totally and completely controlling the paper gold game. Observe the following two charts, first by Nick Laird at Sharelynx.com and second by ZH, supporting the reduction in the big banks net short exposure and the significant increase in the hedge fund/managed money gold shorts, which supports the charts up above by McClellan.clip_image012clip_image013

That takedown last Thursday was enough to put the fear in any weak-handed gold speculator/investor. It appears to have been the work of the gold manipulators, which by now is well documented as being the work of the bullion banks in conjunction with the BIS and with the full approval of the central banks. And if you’re STILL in the camp that doesn’t think the precious metals are not manipulated or reserve judgment then please get a clue. LIBOR was reported manipulated and entire debt markets all over the world were affected. FOREX rates manipulated by banks through the front running of the rate-sets through Reuters system affecting THE biggest market in the entire world. Sovereign bond markets of the Western world are outright manipulated and accepted as the proper course of action via the quantitative easing which is the market operations by the Western central banks to simply monetize their own debt. Precious metals are manipulated because they send a most important warning message to the world about what is impending, so yes, I tend to agree with the contention that the metals are manipulated because the psychological effects are absolutely required to maintain control of the entire fiat façade. Control of the metals will also be required to slowly introduce a fix to the system and thus we see the bullion banks positioning their banks to the long side and will allow the release of the paper gold price at their own behest.

William Kaye, a hedge fund manager out of Hong Kong who worked with Goldman Sachs in M&A before forming his fund The Pacific Group in the 90’s, reported on King World News regarding the continued trading in gold that is exceptionally questionable:  “It’s the end game of a fantastic manipulation of the markets. I’m looking at my screen now as we talk, Eric. I’m in L.A. (Los Angeles), but we are still in Asian (trading) time with London just coming in at the moment, and we’ve traded over 94,000 contracts. So passing the baton to London we will have already traded 100,000 contracts. A normal night (during Asian trading) would be 20,000, to put that in perspective. So the question is, who is selling all of these contracts at levels that are multi-year lows? Who’s so keen to sell?… And if you need to sell, why are you selling at the worst time of day? Why are you selling in Asian time, which is always the thinnest section of trading?  Why don’t you wait for London and Chicago to take over? And the answer is very obvious, these markets are clearly and blatantly being manipulated. The people doing it have clear price objectives. My guess is they want to see a print below $1,300 (on gold) before they are done. That will allow people (trading for the bullion banks) to make profits on their shorts. The bullion banks, from the Commitment of Traders Reports that we’ve seen plus other information that we’ve gathered, strongly indicates that the banks, which are the  centerpiece of this conspiracy, have shifted rapidly from being on the edge of default, as ABN AMRO has already done, to being net long, and in some cases being very net long. So they (bullion banks) have taken the opportunity that’s been provided by the cover from what would appear to be official intervention, in what I suspect is the Fed and possibly the ECB, to take the other side of that trade. Now they are extremely net long and that sets the stage, in addition to a very promising technical picture, for a very powerful rally as we look at next week, into July and beyond. The second half (of the year) could be extremely explosive on the upside for gold and silver as well.”

Observe the following chart supporting Kaye’s thoughts and providing additional backing to McClellan’s charts up above. The very latest CoT as of 6/21/2013 was not available before I penned this, but several analysts contend that there is a small possibility that Commercials will actually print at net long next week for the first time since the beginning of the bull market, which would be very, very compelling for a potential trend change in gold if the $1,200 area is truly the bottom.

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You’re all grown-up’s so you can ascertain for yourself the credence you put behind the entirety of what you have just read. The derivatives in combination with sovereign debts are the biggest economic issues in the world. I strongly advise you do not take your eyes off of them. Regarding gold, it’s my hope that if you were beginning to doubt the decisions you have made to position yourself in any precious metals or precious metals shares, that this article has reaffirmed your original reasoning. I, nor anyone, knows the when, how or what of the final outcome of the endgame here but as always; you know where I stand. SAND continues to be my absolute favorite way to play the precious metals and I continue to have no doubts about the final outcome of where SAND will trade.

A key to successful trading is risk management and hedging your trades accordingly. For you all, your hedges are generally your 401K’s and IRA’s that allow you to safely compound your investments in relatively safe, reasonably priced names. You get paid to wait with the dividends which fortunately helps you lower your bases and reduce the risk of your positions in riskier other plays, such as the precious metals shares or option moves. Concentrate on risk management and stick to playing the game within your tolerance levels. One should only speculate with capital they can afford to lose but more importantly, position sizing is critical. Going all-in in a game like this is a suckers bet, but I think failing to have any exposure to the precious metals sector would be foolish.

Read, Read, and Read some more.  Good luck out there.