8-16-09

China Syndrome

            Hello again. Ready for the big picture view so you can plan accordingly? What's really going on out there...?

            I often like to review things I've said in this newsletter previously; it helps me stay on track. This from April of this year:

            "In past letters, I've explained the importance of ignoring all the opinion and just letting the market itself tell us what it's going to do next- it's called 'Dow Theory' (long time readers will recall me using this technique to predict a significant fall when the Dow went below 7470 on this advance- quickly after it sunk a thousand points). From this point of view, something very interesting happened recently.

            From the high in this rally of 8131 on the Dow, it sunk back again to 7500ish before rising again. NOW, IF it closes this week back above 8,131, it's extremely likely (it's never guaranteed) that the rally will resume.

          We now know this prophecy worked out and you could have made significant profit from the fact. But what next?

            The Dow Theory still points to further upside in this rally but this has not yet proven itself to be anything other than an upward correction in a bear market.

            Those that cite last March as the 'bottom' and the starting point of a brand new bear market, are saying this is a first in history and that 'this time it's different' (always a worrying term).

            If history is a guide, March was NOT the bottom. Why? Because new bull markets don't rocket up like this; they are born from black pessimism and most of all, LOW VALUES. I'm talking about stocks with P/Es of 5 and under that pay dividends of over 6%! We saw nothing like this in March.

            There's 3 possible scenarios which we'll look at in turn:

1.      This turns into a brand new bull market (a la 1982)

Nothing is impossible, but at this time, this scenario seems implausible, contrary to what the herd are saying.

Several factors are working in unison against this outcome: high unemployment, more deleveraging in the financial system, housing inventory not leveling until mid-2010 at the earliest and continued deflation.

2.      The market levels off and wanders around, slowly grinding down values (a la 1975)

This would be based on continued government intervention to fight the bear market by spending taxpayers money, borrowing and printing their way out resulting in the ultimate destruction of the dollar.

This is emerging as an increasingly likely situation; bobbing in and out of recession for a decade as in Japan in the nineties.

3.      The market crashes beneath the March lows within a year and the bear market resumes with vengeance (a la 1930)

While we can easily see a fall in markets very soon that may even violate the March lows, government response will be swift. They will throw more money at failing companies, banks and real estate. The main difference between now and 1930 from an economy stand-point, is government intervention.

"It's already conventional wisdom this year that China is rescuing the world economy as her voracious appetite for commodities rebounds after falling off a cliff in Q4. The country has spent about $586 billion since November on infrastructure spending, pushing up the prices of raw materials through the roof since March.

Yet according to Horseman Capital in London, China's demand for crude oil actually declined 2.9% over the first six months of the year. Isn't that statistic surprising?" - Eric Roseman.

            It is indeed surprising... and somewhat suspicious.

Remember, China's dictatorship puts it in a position to say what it likes regarding statistics, but certain numbers can't lie, like power consumption.

            All is certainly not what it seems. As I've said before, governments everywhere (in league with the media) are buying time with a pile of propaganda, hoping that people start spending and real estate levels off in the meantime to get the whole gravy-train back on its tracks. All we keep hearing is how "less bad" things are and how that's cause for celebration.

            So what do you think is really going on? Do you notice confidence returning to employment markets? What about real estate? Are YOU spending up your cards again?

            No, and I don't know anyone else who thinks so either. The America people are eagerly lapping up all the "good news", but they are thinking to themselves: "Great. I can't wait until the recovery comes to my town!"

            I somehow watched a piece on CNBC the other day entitled: "The Road to Recovery". I will never get those 30 minutes back again.

            Anyway, so what profit opportunities exist out there?

            Euro/Dollar. I think the dollar may be about to stage a rally and that the Euro is overvalued in relation to the banking crisis which is yet to fully emerge in the Eurozone. Intermediate/longer term, I see the Euro coming off 14200 back down to 13000 or lower.

            Natural Gas. This keeps trying to break out past $4. At these levels, it's worth a punt.

            Real Estate. The SRS is a fund that makes money by falling real estate and it's currently at major lows- now at $11 and last November it was over $250. Maybe not yet, but soon, this is worth a fun bet as it's running out of downside (it can't go to zero).

            Dow Jones. You know I ultimately see more downside here, but first, we could be about to see a final blow-off that takes it through 10,000. If you want to take this bet though, have a strict stop-loss.

            If you've seen some life put back into your portfolio, then that's great, but don't fall for gamblers ruin and hope to get it all back. By drawing a line in the sand to protect against further falls (maybe 10-15% under current levels), you'll be able to walk away in a better state.

            According to a Wall St Journal survey, 57% of economists think the recession is over and another 23% think it will be in the next couple of months. And I wouldn't be surprised to see some growth in the last half of the year from the GDP numbers that would add fuel to this final blow-off. France, Germany and Hong Kong have already reported growth. But from how low a level??

            To finish, here's another extract from a past newsletter I wrote in April:

            "As yet, the public aren't (back) in this market. I suspect they're waiting for more confirmation before they turn to 'gambler's ruin' and try to get their money back.

            And that raises a good point. This is perhaps THE most important lesson in money and investing...

            All asset classes- real estate, stocks, gold, bonds, everything- go through cycles of boom and bust. BUT, who loses and who wins at this game?

Most people are plain scared of losing money. So, before they take the plunge into anything, they await confirmation that everyone is doing it. They need to get reassurance from a collective mind- the herd- before doing anything. Thus, they are part of the herd. The time when the whole world jumps in is the precise time to GET OUT." 

             Until next time...

               Mark Patricks

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