12-8-08

This Too Shall Pass

            Back in the day, I was a professional pilot. Before GPS, we would navigate from one radio beacon to the next. A little needle would point us in the right direction to get to a beacon. Once we flew over that beacon, the needle would point back at it and we could navigate this way too- by knowing the direction we were flying from.

            BUT, as we flew very close to and especially on top of the beacon, we entered something called the 'cone of confusion'. The needle didn't know which way to point because the beacon was right below it. That thing would swing around wildly and for a few seconds, we were effectively blind. The moment was brief, but nonetheless disconcerting.

            It's my belief that right now, markets are in a 'cone of confusion' where normal readings aren't making any sense. All markets have become extremely distorted by government intervention and wild panic. Traders who analyze fundamentals and charts alike are continuously getting it wrong. Even insiders are getting it wrong; one of the best know indicators of a good stock purchase was the announcement of a company director buying a heap of his own stock.

            Traders know this and are getting spooked. This only adds to the uncertainty.

            But think back to the 'cone of confusion' in the navigational sense. As we transition one route to another, we are temporarily blind.

            Whilst scary, it's necessary to continue the journey. Soon that needle will point backwards and we will be out the other side. The main thing is not to panic in this 'blind spot'...

            Even better, let's see how we can massively profit by this...

Oil is Worthless (!?)

            Did somebody invent a replacement for oil and not tell me?

            The price of a barrel of oil has tanked down in the $40 range and some predict it could go as low as $25. The excess barrels of 'black gold' are having to be put into tankers and left anchored at sea as onshore storage is running out. I'm sure the Somalian pirates will be pleased to hear that...

             Oil of course, isn't just used for gasoline. It's used for an amazingly wide variety of things in industry including rubber. One minute the world's superpowers are scrambling for the last of the planet's oil reserves, the next, they're practically dumping it into the sea.

            Or so the commodity traders think.

            Cast your mind back just a tiny bit. In summer, oil was trading at THREE TIMES this level.

            This is a highly instructive lesson for you and can serve you well. What you've seen here in a short space of time is how extreme market sentiment can be. You can take advantage of these extreme ways the market bounces around (you can of course make money from commodities like oil both falling and rising).

            Now, a company's share price can of course go to zero (if it goes bust). Two questions for you that demonstrate the stupidity of markets:

1)      Can the price of a barrel of oil go to zero? In other words, can oil (the actual commodity, not an oil company) go bust?

2)     Is the amount of oil in the world finite? Will oil ever run out?

Of course, the sane person's answer to those questions are 'no' and 'yes' respectively. So why then, is the commodity market pricing oil as if the answer to those questions are 'yes' and 'no' respectively?

         Their answer would be: "Look around dummy! We're entering a global recession (possibly a depression) with no end in sight. Consumption has dropped and will continue to do so."

         That's what the 'experts' say. That's what the majority opinion is (by definition which is why the price is so low).

         Ah, but here lies the key issue...

         Because majority opinion says this, these traders (who have jobs to protect) won't put their ass on the line by going against the majority consensus. They just want to be justified. If they were bullish on oil and they got their heads handed to them, their boss would fire them for being so stupid to do so in the face of a recession.

          And for a while, this is a self-fulfilling prophecy that drives a certain market in the direction they expected. Much like a recession gets worse because Main St hears about a recession and spends less. It's a spiral.

          In summary, the market only thinks short-term using the facts at hand. It deals with what we know right now- today. Certainty.

          You won't make any big money by trading on certainties. In fact, you'll probably lose. Uncertainty, and therefore risk, is how money can be made. Anything you read in the papers or Internet as a fact today is essentially worthless because it's a certainty.

          Information is sunshine. Money is made (and lost) in the fog.

          But it depends on your definition of risk. Will oil go to zero? I think not. Will oil run out? I think so. So LONG TERM, by definition, the commodity market is wrong to price oil where it is (as an aside, you could say the same for gold).

          The question is: how much loss can you handle on the ride and how long can you afford to tie that money up? Would you have made more money somewhere else?

           After all, there are some companies that are trading for less than the cash they have in the bank! That's to say, if they were to liquidate the company, shareholders would get back more than they paid if they had bought now. One such company is Trident Micro Systems (I do not hold stock in that company).

           One thing's for sure. At some point the market always does a U-turn as if the past sentiment never existed. If you'd have told oil traders back in summer that oil would be $45 a barrel now they'd have laughed at you (and the price on a futures contract would have reflected that fact). Not so long ago if you'd have asked a realtor for a 'fixer-upper' they'd have laughed in your face, now they'd take you for lunch and ask you to take your pick.

           Hmmm... maybe we need to pay attention when the majority laugh at you...
           

           Think back to the 'cone of confusion' I explained earlier. This area of uncertainty is actually one of opportunity in my view. Right now, everyone is in the dark waiting to see which way that needle points. By using sound logic and spreading my net widely, when the lights go back on I'll be set for the ride of a lifetime.

            Remember: the market is nothing more than the representation of human emotion- much more so than human logic. Emotions go to extremes and are by definition, illogical. And that's a good thing because it's how money is made. The day they let Dr. Spock and the Vulcans trade is the day I'm no longer a trader...

2009

              I'm putting together my predictions for 2009 as I do every year. Never before has it been such a tough task, but I shall do it nonetheless. One thing I'm certain of though is that in these times, doing nothing could well be the very worst thing one can do.

            As Christmas approaches, be sure to enjoy and remember that all things turn around in the end. If you cast your mind back, you've been there and done it. Fear of the unknown is often way worse than the event itself.

Until next time,

Mark Patricks

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