6-15-09

False Premise

            "Find the premise which is false and bet against it." - George Soros.

            I often remind myself of that above quote from arguably one of the greatest hedge fund managers of all time. As regular readers will perhaps realize, a lot of the trades I like are based on it.

            In economics school, professors teach something called: 'The Efficient Market Theory'. This says that all prices reflected for any market at any given time are accurate, or efficiently priced, if you will.

            This theory gets a lot of flack because if it were true, everyone would make money from the markets. But there is truth in it because the price of anything from stocks to bonds to commodities is priced by buyers and sellers at any given time. The professors however need to add an important caveat:

            "Markets are efficiently priced at any given time based on all the information publically available at that time."

            So, following from that, if we are to make money trading anything (and that does NOT mean simply buying stocks and praying they go up!), we can't make decisions on information that is publically available. You see, the market has priced all that in already.

            But here's where it gets interesting...

            The market price of anything is effectively a representation of opinion TODAY.

           Let's take a recent example. The price of oil has surged this year from $32 a barrel to well over $70 a barrel as I write. Regular readers will know that I begged them all winter to buy oil. Anyway, here's what's so interesting: nothing has changed in the physical world to alter the oil price. No wars, pipeline interruptions, political unrest... NOTHING.

            All that changed on that meteoric rise was opinion.

            So let's think about this for a second...

            Could making money in markets be really 'only' about anticipating the next opinion of the herd?

            Well, I just made this case, didn't I?

            That's where Soros is coming from with that quote we started with:

"Find the premise which is false and bet against it."

            Ah, but the trick is knowing when a premise is false then isn't it?

            So let's take a little tour of what's going on lately and see if we can't figure out what our friend George Soros has been betting against (it is always a secret until after the trade has come good)...

             I've always liked to follow a particular analyst called Abby Cohen. Why? Because she's ultimately always wrong. Here's what she just said:

"U.S. financial markets have been moving 'back towards normal' since March, said Abby Joseph Cohen, Goldman Sachs Group Inc.'s senior investment strategist, in an interview.

"'Much of what we can recognize as happening now is really a restoration of where we should be,' Cohen said 'This situation is much closer to normal than any place we have been over the last 18 months.'"

            Normal? The only thing that's normal is the 'bond vigilantes' have finally woken up. This group are the buyers of government bonds and supposedly demand higher rates of interest on those bonds to 'punish' governments when they being fiscally irresponsible (like now).

            Efficient markets?? If markets were efficient, bond buyers would have demanded higher interest rates last winter when government plans to print money were made obvious. This is what the TBT trade I recommended readers make was all about; it was an anticipation of a change in opinion... a bet against a false premise. That false premise was that people would continue to accept low yields on government debt when that very government was printing money at will.

            Interest rates have now risen as a result (they are set by the bond market buyers just described). I told you weeks ago to refinance while you still had the chance.

            A little more on the government legal counterfeiting scheme by Arthur Laffer:

The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10. It is so far outside the realm of our prior experiential base that historical comparisons are rendered difficult if not meaningless... It's difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed's actions because, frankly, we haven't ever seen anything like this in the U.S. To date what's happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5%...

            To calm things down, Obama has announced the PAYGO system for government spending. They can only spend a dollar if they save a dollar somewhere else.

            HaHaHa!

            Like that's going to happen. Listen, he's a well intentioned guy, but on finance, he's a neophyte.

            Anyway, what do I see out there as the 'false premises' of the moment...?

1.      The market hates Natural Gas.

It costs about $4 to get a unit of natural gas and it's currently trading at less than that. If we get a recovery let down it may even drift lower. But like the oil story, ultimately the market will come to its senses. If it's not viable to get natural gas, companies will stop doing so, supply will slow. Inflation is in our future sooner or later so are alternative energies and winter is approaching. There have been scares about big new finds from 'shales' but there is evidence to suggest this is poorer quality and it still costs $4 to get it. Most of all though, the market has completely abandoned hope for it and a commodity can't go to zero, unlike a stock. Limited downside, upside could easily be $6-8. You could also get some gas producing company stock.

2.      The market loves bank stocks.

FAZ. I mentioned this one last week- it's basically a fund that bets against the stock price of major banks. Just as nothing changed in the world of oil, nothing has really changed in the banks' balance sheets. Worse, there are some nasty debts still to be exposed. I believe the public and companies and paying off loans, not getting new ones. Bank stocks also just rose too fast, too soon. Any stock market correction (which could be due soon) will be lead by banks.

3.      The market loves(ish) the Dow Jones.

Similar story to above. Last week I explained how the Dow Transports needed to rise above 3404 to make a further rise up likely. This didn't happen last week. I had imagined the Dow rising more from this bear market rally before turning down but it's starting to look decidedly unhealthy. Why I think the fall is getting increasingly likely now though is more people starting to call this a 'new bull market'. Long time readers will know that the point where you begin to think you're wrong is the point you're about to be proven right. I'm getting to that point. At the very least, a sharp correction down should be due even if, and that's a big if, this is a new bull market.

4.      The market(?) isn't sure about Gold.

With all that's going on, the price of gold should easily be double what it is now. I believe the price of gold is being held back through manipulation and that this cannot be sustained. This is a false premise that will be proven maybe tomorrow, maybe in a few years, but it will be proven. Don't try to time gold, just close your eyes, get some in some form, and forget about it. "

Best regards,

Mark Patricks

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