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Stocks and Metals Get Crushed: Now What?


Taking our journey one step at a time.

Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

Yesterday morning, we asked a difficult but necessary question: Metals Melt: What Does it Mean for Stocks?

In that column, we touched on the relationship between stocks and commodities, the specter of deflation-the phantom who was all but left for dead-and the likelihood that one (or more) funds were liquidating their holdings. Also discussed was the necessity of approaching this market with discipline over conviction and employing risk-management rather than reward-chasing behavior.

Before I embark on this scribe, I will share that I entered the week with a full SPY (NYSEARCA:SPY) short position, as disclosed Friday. This doesn't mean I was all-in but rather that my directional bet was "fully loaded" as a percentage of my overall book. Indeed, last Thursday, as the tape tickled S&P (INDEXSP:.INX) 1600, I ratcheted my risk to "140% short" (in real-time on the Buzz & Banter) but unwound that overage on Friday, as I was too big (I know this as I was staring at every tick).

Given I spent yesterday at the Hospital for Special Surgery-where it was confirmed that I need at least one hip replaced-I was flying blind. I covered 25% of my risk in the morning (with the S&P down 8-10 handles) and most of my remaining risk at the end of the session (with the S&P down 30-plus). I did this for two reasons; first, I'm in hit-it-to-quit-it mode, and second, the more we slide below S&P 1580-1600, the less defined my risk becomes (if I were at a turret, I may have rolled down my stops).

Either way, I enter today with a placeholder 5% short position and a fresh head.

But enough about me; let's talk market. Below is an updated chart of commodities vs. the S&P. I opted to begin this juxtaposition at the beginning of 2009 as that's when the system formerly known as capitalism began stretching its legs.

You will note that the commodity complex led stocks higher before peaking in 2011 and trading lower. Stocks followed-but suddenly reversed course and continued higher-at least until yesterday. I won't offer that this was a function of government intervention as it doesn't really matter; in markets, as in life, we must trade the hand we've been dealt, not the one we want.

Color War!

There are two camps out there; I'm sure you've heard whispers from both.

Camp 1: The carnage in gold-a 15% loss from Friday to last night's lows-is bullish as investors migrate away from the "fear trade" and cash readies to deploy into stocks. Gold rallied on geopolitical uncertainty and/or as a fiat currency hedge; as our world becomes a better, safer place, as evidenced by the strength in credit markets and the oft-mention rally to all-time highs, gold is a source of funds for riskier assets.

Camp 2: There are no "safe-havens" in financial markets (we were taken to task for asserting this in September 2011 when gold was at $1900). And while circumstances have changed-credit markets and balance sheets are buff due to previous and current policies-our current situation is not entirely dissimilar from what we shared in September 2008; this time, however, instead of "credit" we can insert "psychology" or "trust" in the passages below:

Minyanville has monitored these cumulative imbalances since 2006 and discussed The Writing on the Wall.

The credit crisis has already infected the economy, starting with the homebuilders, spreading to the financials, engulfing financials in drag such as General Electric (NYSE:GE), General Motors (NYSE:GM) and Ford (NYSE:F) and will eventually phase through retail, technology, credit card companies, and commodities.

That's the orderly scenario, a stair-step through industries until debt is destroyed and a more sustainable economic foundation takes root. It's akin to credit cancer, and once it spreads through our entire financial body, we'll be in a position to enjoy the long-discussed globalization-themed "outside-in" recovery.

The other option is an outright car crash, a collision where credit seizes, capital markets freeze, price discovery permeates, and social mood shifts as we come to terms with the new world order. Neither of these options is something one would wish for, but hope has never been a viable investment thesis.

Yes indeed, the "other side" of all-time highs is the swift and sullen shift in social mood, a theme we've fingered for years but wish we missed.

There was no joy in positing these sobering thoughts in Vail or writing numerous columns-Will QE2 Trigger War Games, The Short Sale of American Icons, The Devolution of Social Mood-but we said and wrote them because they were-and are-an unavoidable consequence after years of societal largesse and a bifurcated society rife with vitriolic acrimony.

I'm no left- (or right-) wing nut-job; as a (socially liberal and financially conservative) father, someone who was once proud of greasing the wheels of capitalism, I pride myself on identifying solutions and leaving the world a better place for my kids. I've traded my way through a lot of tapes-23 years of flickering ticks-and I can't shake the sense that we're very close, if not at a space and place similar to where we were when I gave this interview in 2006.

The markets are at (near) all-time highs yet nobody really feels like we're at (near) all-time highs.

I'm not saying its game-over. I'm simply sharing the scary truth that the world is a fragile and dangerous place despite the price action in the marketplace; and when-not if, when-that shifts, we'll have to absorb, digest, and navigate the repercussions, for we didn't take our medicine after the first phase of the financial crisis; if anything, we simply took more drugs that further masked the symptoms.

Random Thoughts:

Twitter: @todd_harrison

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