Well my friends, Gold is setting new highs and that should be sending you a message loud and clear. The world’s financial system is only as good as the paper it’s printed on. We have been crowing about gold for what seems like an eternity, and the bets are paying off in spades.
The Contagion in Europe is not going to get out of control…It’s already there. The Euro-Zone found itself in very unpleasant corner. And, as politicians are wont to do at times of crisis, they cowered behind the massive printing presses and decided that a hasty retreat from past lessons of fiscal discipline was the best course of action. The consequences, while dire, are muted by the fact that every major economic power has already debased its currency. It a world where everyone is printing money, money is still worth something. That my friends is the paradox.
If the US prints an extra $2 trillion out of thin air, it should crash. But, if the Euro-zone prints an extra 2 trillion Euros, and the Japanese a trillion yen and the British a few hundred billion pounds…who’s the worse for it. They might as well just lop a few zeros of each country’s debt loads and call it even. The world is reflating and that is why gold is rising and why it will continue to rise. The currencies that are not affected, the Canadian Dollar, the Norwegian Krone, the Aussie Dollar, the Singapore Dollar, the Chinese Yuan…mean absolutely nothing. They are too small or as in the case of the Yuan too tied to the dollar, to ever be considered more than a sideshow where you can park a few dollars. The real winner in all of this: The US Dollar – who’d have thought?
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Continued Volatility – the Only Constant
In the last 13 trading sessions the Dow has either gained or lost more that 100 points 9 times. Volatility has doubled during the same time period. Past charts indicate that volatility does not level off quickly, although when it does level off it stays level for a while. Some pundits are calling for a significant correction. They might be right. Stocks have stopped rallying on news and fundamentals and re now trading on fear.
I will repeat the numbers you should be looking at on the Volatility Index (VIX) – points where you should be buying and points where you should be selling. If the VIX trades below 20, start selling stocks. If it falls below 15, start shorting the market. If it falls to 12 or below, back up the truck with short positions. On the other side, you are looking for numbers above 40 as signals to start buying stocks and call options.
We are seeing volatility increase across all sectors except for those that deal with consumer non-durables like Proctor and Gamble and Wal-Mart. The sectors that look primed for a breakout higher are the precious metals. The sector that looks primed for a breakdown is the financial sector. If the financials break, we could see significant pain for the rest of the market, as it is this sector that led the market higher.
The Goldman Sachs scandal, the continued push for derivatives and trading regulation are now driving this sector, not foreclosures or loan loss reserves. It is another indication that the market has swung to the emotions and not company performance.
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The Quiet Problem
Most people are ignoring a major event unfolding in Asia. It rarely makes news yet it has huge implications if the situation gets out of control. The other day there were shootings and killings on the streets of Bangkok and government troops tried to hold back demonstrators and supporters of the past president who resigned under a cloud of corruption.
If the situation in Thailand gets worse, it could lead to a round of emerging markets selling off, again based on fear and not fundamentals. The world is becoming crazy again and our markets seem to be shrugging everything off like its business as usual. Be careful, the market is jittery. There is a saying on Wall Street that you shouldn’t short a dull market. If that’s true, then what must you do in a volatile market?
While volatility has picked up, it is still cheap to short if you are using put options. Put options give you the right to sell stocks at certain levels, and the cost of buying puts are starting to increase. But, it’s still quite cheap compared to this time last year when the market was just beginning to come back. If you own a lot of stocks, consider buying some insurance against a downturn in your portfolio. This can be accomplished through put options on individual stocks that you own or on Indexes like the S&P 500. Think of it as insurance and remember the time to buy insurance is before a catastrophic event because no one is going to sell it to you during or after the fact.
That is where the recent bull market began its turn. That was more than a year ago and sometimes you need to remember the feeling in the pit of your stomach when that number was breached on the way down. Now, in just one year we have gained almost 4,500 Dow points. It might be time to give some back. Retracing 50% of an upside move is not unusual. In fact, may technical analysts feel that it is a normal, healthy event. If that were to occur, the Dow should drop back to the mid-8,000 level at some point in this cycle. While that would be a scary event, don’t discount it happening.
As the oft-misquoted American born Spanish philosopher George Santayana said, “Those who do not learn from history are doomed to repeat it”. This time be ready for a correction by having a few hedges in your portfolio, some extra cash on hand and put down the rose colored glasses that the market boosters and governments local and foreign want you to wear. There are real problems out there and precious few solutions on the horizon. The recent break-through of historical highs in the price of gold should be a clear signal that all is not well. Take heed and act accordingly.
All the best,