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Jeff Saut: Financials and Real-Estate For Trading, Not Eating


Beaten down groups subject to bounce back.

"While gold was first discovered in Alaska during the 1870s, the 1890s have come to be known as the Yukon-Klondike Gold Rush days, as thousands of rugged individuals swarmed to the northern climes to find fortune and glory. Unsurprisingly, during the winter of 1896-97 the Alaskan ports were frozen solid and therefore closed to all shipping traffic. Food became very scarce and very expensive since new supplies had to be brought in over land at great hardship. Reportedly, a can of sardines that had cost $0.10 in New York could be priced at 10 times that amount by the time it reached the gold miners in Alaska. Still, there was great demand even at such inflated prices. For instance, in one remote mining town the price of a can of sardines was sold at rapidly escalating prices from $10.00, to $30.00, then $50.00. Finally, one desperately hungry miner paid $100.00 for a can of the highly sought after sardines. He took it back to his room to eat. He opened it. To his amazement he discovered the sardines were rotten. Angered, he found the person who sold him the tin and confronted him with the rotten evidence. The seller was amazed and shouted, 'You mean you actually opened that can of sardines? You fool; those were trading sardines, NOT eating sardines!'"

Similarly, "for trading, NOT for eating" has been the strategy my firm has employed with our recommendations on the financial and real estate groups since turning constructive on them at the end of June. Indeed, anticipating that the "selling stampede" was coming to an end, we advised accounts that at such downside inflection points you want to purchase those groups with the worst relative strength characteristics for trading purposes because those are the groups that have been "pushed down" the most. To be sure, just like when you push down too far on a spring you eventually get a "boing" bounce-back, we thought the financials and the real estate stocks had been compressed to the point where they would give us the biggest "bounce backs" off of the selling-climax "lows." My firm subsequently recommendeds numerous exchange-traded funds (ETFs) playing to those groups and began scale-buying them into the mid-July "lows."

Since those "lows" my firm has opined that the equity markets were likely involved in an upside "buying stampede," which should last the typical 17–25 sessions. In last Monday's letter we went on to state:

"Nevertheless, since July 15th the S&P 500 (SPX) has moved irregularly higher without so much as anything more than a one- to three-session pause/pullback with Friday's 300+ point DOW WOW coming on day 18. If the pattern continues to play, our day-count sequence would have the equity markets topping-out sometime this week as the 'short sellers' run for cover into Friday's option expiration expiation. The quid pro quo could be that the 25-session 'selling stampede' in indexes like the ProShares Ultra Oil & Gas (DIG) could be nearing an end, at least on a trading basis."

Well, last Friday's option expiration was indeed session 23 from the July 15th low and accordingly my firm followed our own advice and used strength during the week to scale-sell some more of our trading positions. Verily, we consider both the financial and real estate groups to be "trading sardines, not eating sardines" since we doubt the news surrounding them will get materially better anytime soon. And that, ladies and gentlemen, is why we just "rented" those positions for trading purposes rather than investing in them.

Speaking to the investing account, followers of these reports know that for months my firm has counseled accounts to reduce exposure to our beloved "stuff stocks" (energy, materials, base/precious-metals, cement, timber, etc.) even though we continue to think "stuff" remains in a secular bull market. We began recommending rebalancing (read: selling partial positions) said holdings on fears that the politicos were going to do everything in their power to drive the price of crude oil lower into the elections, for obvious reasons.

My firm's long-standing target for the price of crude has been its 200-day moving average (DMA), which now stands at $110. With rude crude changing hands in mid-July at $147/bbl that strategy looked pretty foolish. Last week, however, oil tagged $111/bbl and our strategy doesn't look nearly as wrong-footed. While crude oil's recent 25% price decline looks bad in the charts, the price declines of many energy-related equities now exceeds 40% over that same timeframe. We believe the "selling stampede" in the energy complex is overdone and is therefore nearing an end. Moreover, with the recent decline in crude prices, numerous members of OPEC have been calling for production cuts. While we are not expecting production cuts in the near-term, we continue to believe that if prices fall further, OPEC will step in and defend a price near $100/bbl. Obviously, we've found a price that slows oil demand, but in my firm's view, long-term oil fundamentals remain strong.

Consistent with these thoughts, my firm suggests looking at the gradual re-accumulation of the energy stocks, particularly ones with outsized dividend yields. For fund investors there are a plethora of closed-end funds and ETFs like the aforementioned ProShares Ultra Oil & Gas, which is leveraged two-to-one on the upside. Additionally, in past missives we have mentioned a number of higher yielding names recommended by our fundamental energy analysts, like 12%-yielding Linn Energy (LINE). This morning we offer for your consideration Delta Petroleum (DPTR) using its convertible bond, as well as Chesapeake Energy (CHK) using its convertible preferred "D" shares. As always, terms for these convertibles should be checked before purchase.

As with oil, my firm has been cautious on precious metals this year despite the belief that the yellow metal also remains in a secular bull market. We think the decline from $990/ounce on July 15, 2008 into last Friday's close of $792 is overdone. The gold stocks have fared even worse, as can be seen in the chart below.

Click to enlarge

While many pundits are blaming gold -- and oil's -- decline on the stronger dollar, my fir doesn't see it that way. Plainly, we have been bullish on the dollar since late last year when we recommended closing down all of our anti-dollar "bets" that had been in place since 4Q '01. And, at the margin the dollar's recent strength is responsible for a modicum of the slide in "stuff stocks." However, my firm thinks there is more afoot than just that. Indeed, the recent accelerating rotation out of "stuff" we think is largely being driven by a gathering sense that not only is the U.S. economy slowing noticeably, but so is the rest of the world. While true, we continue to believe the U.S. economy will avoid a recession and continue to muddle through (read: 0.0%–2% GDP growth), although the odds of a recession in 2009 have clearly risen. Nevertheless, we like gold stocks at these price-points, but are again turning cautious on the U.S. dollar (see the chart blow); and, as with energy stocks, are recommending gradual re-accumulation. Hereto there are numerous closed-end funds and ETFs, but one for your consideration is the Deutsche Bank Gold Double Long Note (DGP).

Click to enlarge

The call for this week: Regrettably, for most of this year it has been more of a trader's market than an investor's market. While my firm is a much better investor than trader, we have attempted to navigate the volatile environment using the trading side of the portfolio.

Recall that my firm advises using 80% of your equity portfolio for investment ideas and 20% for trading. And when we say "trading," we DON'T mean day trading! Rather, we try to wait for a trading "set up" whereby the odds are tipped so far in our favor that if we are wrong we are going to get stopped-out quickly with hopefully small losses and live to play another day. And, that's the way it is on session 24 since the July 15th "selling climax" lows. Indeed, "for trading, not investing!"
No positions in stocks mentioned.

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