Tuesday, December 20, 2011

"Believe none of what you hear and half of what you see." --Benjamin Franklin

A STRONG SHORT-TERM STOCK-MARKET RALLY IS LIKELIEST WHENEVER THE FEWEST NUMBER WILL BENEFIT FROM IT (December 20, 2011): Since October 4, 2011, global equity indices and even well-known U.S. equity indices including the S&P 500 index have been in an important bull market. You would hardly know it without reviewing your charts, however, as the mainstream financial media have continued to promote gloom and doom. Such brainwashing, combined with an intuitive dislike for high-percentage fluctuations in both directions, encouraged amateurs to withdraw money from risk assets at roughly the same pace as they had done during the final months of 2008 and the early months of 2009 when we were in a far more severe bear market. Hedge funds have also sharply reduced their net equity holdings, leaving only top corporate insiders as notable net accumulators of stocks near all important lows since early August 2011. The financial markets classically behave in whichever manner will benefit the fewest number of people. Therefore, with the vast majority of investors having reduced risk, a strong rally will effectively punish such pusillanimous folks for their cowardly behavior.
Perhaps the most irrational decoupling in the financial markets today has been the surge by TLT to a level less than 1% below its all-time peak from October 4, 2011, while VIX has been slumping. TLT is a fund of U.S. Treasuries averaging 28 years to maturity, which is currently valued above its highest levels from late 2008 and early 2009 when the world was in a severe recession. Treasuries are therefore anticipating a true doomsday scenario which has nothing to do with financial reality. Meanwhile, VIX, which measures the implied volatility of a basket of options on the S&P 500 index, has demonstrated progressively less fear. Investors are eagerly selling calls to "generate income"--probably the most dangerous phrase heard in recent months--while cutting way back on their call buying. With the fewest possible number of speculators prepared to benefit from a sudden upward equity bounce, such a dramatic rebound becomes far more likely to occur.

Can there be a taxicab driver in Mongolia who is not intimately familiar with the latest Italian bond yields or what an allegedly important official in the ECB is saying about future bureaucratic decisions? Each fluctuation in the price of gold is attributed to the latest comment by Draghi or some other irrelevant speech which just happened to occur earlier the same day. When everyone knows exactly how doomsday is supposed to arrive, by definition it can no longer be a threat. If everyone is anticipating the demise of the euro, to the extent that it is routinely mocked in political cartoons, then the euro must be on the verge of a meaningful move higher versus the U.S. dollar. Speaking of the greenback, it has become suddenly trendy to forecast how much higher it will supposedly surge. It is similar to U.S. Treasuries, in which analysts are talking about the inevitability of lower Treasury yields no matter what the economy does. It is exactly the same as a year ago, except that analysts then were debating each other about how much higher Treasury rates would climb. They were wrong then, and they're not going to suddenly be geniuses this time.

The price of gold recently slumped below its 200-day simple moving average. The pullback for the yellow metal has caused amateurs to panic out of their holdings, and for chartists to sell short in anticipation of even lower prices. Each time a break below gold's 200-day moving average has occurred for more than a decade, it has represented an ideal buying opportunity for precious metals and the shares of their producers. GDXJ, a fund of small- and mid-cap gold mining shares [full disclosure: I have been purchasing GDXJ repeatedly during the past week] has presented an unusually compelling buying opportunity. GDXJ is trading at the same levels as it had done during the summer of 2010 and the final months of 2009, when the price of gold was several hundred dollars per ounce lower than it is today. Thus, you are paying the same for greater earnings. A gain of 20% for GDXJ during the next few months is probably too conservative an estimate based upon its historic behavior in past situations when it had similarly been so roundly disliked.