Thursday, March 01, 2012

The Morning Call + Subscriber Alert + The move in GLD was devastating

The Market


The indices (DJIA 12952, S&P 1365) fell yesterday. The Dow retreated below the psychologically important 13000 level; but remains above the lower boundary of its intermediate term up trend (12816-14590). The S&P finished the day below the upper boundary of its intermediate trading range (1101-1372).

This leaves Averages diverging with the S&P in a trading range and the DJIA in an up trend. Hence, under our discipline, they are directionless; and that argues for cautious investment strategy with a tilt towards the Sell side.

Volume rose; breadth declined. The VIX was up but not nearly as much as I expected. It closed within its short term down trend and above the lower boundary of its intermediate term trading range.

GLD got demolished, breaking below the lower boundary of its short term up trend as well as its initial support. This is technically devastating. Barring a rebound at the open, our Portfolios will Sell Half of their holding.

Bottom line: technically speaking, yesterday’s pin action changes nothing with respect to the Averages. They are out of sync and I continue to believe that divergence will be settled on the downside; that is, the intermediate term trading range will remain in tact at least for the moment.

GLD is another story. The technical damage is likely irreparable. As such protecting our principal is the most important consideration. Accordingly, I will be quick on the trigger today. If this turns out to be a false signal, I can always Buy GLD back.



US economic news dominated the headlines yesterday:

(1) the economic numbers were on the positive side of mixed: weekly mortgage applications were down, but purchase applications were strong; fourth quarter GDP was a tad stronger than expected while the accompanying deflator was almost double estimates; finally, the February Chicago PMI came in much better than anticipated. There is nothing earth shaking here, but it does keep our sluggish growth forecast on track.

(2) the latest Fed Beige Book reported was released. It characterized the economy as improving at a moderate pace with the consumer, manufacturing and hiring making progress but housing less consistent. Once again, this is not something that we didn’t already know, although it is reassuring.

(3) however, the real buzz yesterday was Bernanke’s appearance before the house financial services committee in which he [a] basically reiterated the tone of the Beige Book with respect to the economy, [b] said that the Fed would keep rates low for the foreseeable future, BUT..... drum roll [c] said nothing about QEIII. Investors interpreted that as meaning that there would be no QEIII and were not pleased. Stocks sold off and GLD was torched.

First let me say that if Bernanke intended to leave the impression that there would be no QEIII, then I say halleluiah. As you know, inflation is a huge worry of mine. And if the Fed has finally realized that they can’t print this country into prosperity, then that is a positive. I realize that the quants, traders and some short sighted investors will get their panties in wad because there may not be another injection of liquidity; but, if not implementing QEIII is the first step back to monetary sanity, then we should be applauding.

However, to be sure, if the Fed is starting to tighten, it will not be good for stocks short term and won’t be good for gold long term.

That said, there are two huge questions: [a] was downplaying QEIII really Bernanke’s intent? I think that will get the answer to that today when he testifies before the senate. If history is any guide, when the Markets react to the first day of Bernanke’s congressional testimony in a way not intended, then he will quickly correct that impression on the second day. So we should have clarity by mid morning.

[b] if it was his intent, then how long until the potentially inflationary inducing liquidity that now resides on bank balance sheets starts getting withdrawn? Regrettably this is a much more difficult issue. First, a QEIII would have simply been throwing gasoline on already exploding global liquidity--just look at the links below on the bank reserves of major central banks and the ECB. Inflation is a problem with or without QEIII.

So while I may cheer Bernanke if we get no further easing, {i} he/the Fed are facing the daunting task of pulling enormous excess reserves out of the banking system before they get lent out and {ii} even assuming that the Fed wants to remove these reserves, if the federal government continues its profligate ways, the Bernanke will almost assuredly yield to political pressure to monetize our government’s ever growing debt.

In other words, I hope the Fed is pulling the punch bowl but QEIII is a wart on a goat’s ass when it comes to what is needed to remove the liquidity that has been driving stocks, commodity [gold] prices and fears of inflation.

And don’t forget that the EU and Japan are facing economic problems far worse than our own; and they have been pumping in money like there is no tomorrow. Witness the latest round of funding announced today by the ECB. So even if the Fed begins reclaiming all those bank reserves, its attempt to withdraw liquidity could be countered by the actions of other governments.

Just look at the links below:

A visual of the ECB balance sheet:

And this--look at the last graph on central bank reserves:

The latest round of funding may delay the inevitable; but it is still inevitable (medium):

Finally, last night the International Swaps and Derivatives Association determined that there was no Greek default in the terms of the latest bail out. That is certainly a positive in the short term in that we avoid my nightmare scenario. However with this decision, if you are an investor in the bond market (especially the lower rated credits) that uses CDS to hedge, what are your likely responses? Avoid lower credits. Self insure on the higher credits. And what does that do to interest rates? In short, this action could wreck the CDS market and have a negative long term impact of credit availability and pricing. That said, the ISDA will have one more chance to do the right thing after the decision by the private holders of Greek bonds decide whether or not to accept the terms of the bail out deal.

Meanwhile, the Greek citizenry getting their cash out of the country as fast as possible:

Bottom line: we can only hope that the Fed has decided to pull the punch bowl; if it has, then that may the trigger for a correction in stocks and commodities. On the other hand, not executing QEIII is a minor issue when compared to the trillions of dollars of excess liquidity sloshing around the global financial system, So I am not sure if yesterday’s stock reaction was anything other than an excuse to take profits. As an equity investor, I am going to start to worry when the Fed raises interest (which it explicitedly didn’t do) and begins pulling out bank reserves.

While I may be a bit confused by the equity market’s reaction, I am completely confounded by the gold market. With stocks off 0.5% and gold off 5.0%, the reaction was hardly proportional. Furthermore, gold tends to be more correlated to interest rates than money supply (though clearly they are related) and, as I noted above, Bernanke said that the Fed intended to keep rates low. Of course, the gold market is a lot less liquid and has more speculative money as percent of total investments than the stock market. In addition, traders tell me that there were a lot of Stop Loss’ that got triggered and helped drive prices lower.

I recognize that I am trying to rationalize my book here which clearly doesn’t mean that the Market isn’t correct. Price is truth and we have to deal with it. So assuming a downside follow through in both the equity and gold markets, on the one hand, our recent sales of stock will look good but on the other, our purchases of gold will look bad. We will know more following Bernanke’s senate testimony.

The culture problems in the EU (medium):

The S&P yield versus the 10 year Treasury (short):

Subscriber Alert

The Dividend Growth and High Yield Portfolios will Sell their remaining shares o Federated Investors (FII-$20) at the Market open.

The stock price of South Jersey Industries (SJI -$52) has traded below the lower boundary of its Buy Value Range. Therefore, it is being Removed from the Dividend Growth Buy List. It remains above its Stop Loss Price; hence the Dividend Growth Portfolio will continue to Hold SJI.

The stock price of Balchem (BCPC-$27) has traded into its Buy Value Range. Accordingly, it is being Added to the Aggressive Growth Buy List. The Aggressive Growth Portfolio owns a one half position in BCPC having Sold Half (@ $44) of its position when the stock entered its Sell Half Range in 2011. The shares will not be Bought back at this time.

As noted above, barring a strong rebound on the open, our Portfolios will Sell one half of their GLD holdings.

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.