Monday, July 9, 2012

"In my investing, I have often done the right thing for the wrong reason." --George Soros

WHILE EVERYONE IS FRETTING ABOUT EUROPE AND BAD JOB DATA, WATCH THE S&P 500 SOAR TO 1450 OR 1500 (July 8, 2012): There continues to be great concern about European sovereign debt issues, an economic slowdown in China, lackluster job growth in the United States, a potential end to housing bubbles in numerous countries including Canada, Australia, and Brazil, and any number of other reasons for forecasting a possible double-dip recession and other economic ills. As a result, investors have crowded into the U.S. dollar which has reached its highest point against many global currencies since August 2010. U.S. Treasuries and triple-A corporate bonds continue to experience dramatic investor inflows. Many shares of commodity producers and related assets have dropped by roughly half from their peaks of the first several months of 2011.

At the same time, most people are overlooking the fact that TLT and other Treasury assets have been forming bearish patterns of several lower highs since June 1, 2012. Nearly all risk assets, especially the shares of companies related to commodity production, have begun bullish uptrends of several higher lows since they completed their respective bottoms in May or June. Investors have fled the highest-beta risk assets, while crowding mercilessly into safe-haven assets. Probably this seems to make sense if we are going to experience a global economic slowdown--but the financial markets will never reward any consensus even if it is completely logical. In fact, the most plausible-sounding theory is inevitably the one which is most wrong. The financial markets will always act in whichever manner will harm the greatest number of its participants.

Very few analysts are expecting stock markets to surge around the world, and therefore the fewest investors since the summer of 2009 have positioned their portfolios to profit from such an uptrend. This will likely lead to a powerful rally for equities and commodities during the next several weeks. If we complete lower highs for the S&P 500 and similar well-known indices, then many current bears will happily stay bearish. They must be sorely tested and most of them must be convinced to switch to the bullish camp. This will almost surely require the S&P 500 to reach approximately 1450, which it has not touched since the beginning of 2008. It is possible that a flurry of buying could follow the achievement of this "upside breakout" milestone, which could push the S&P 500 even higher to around 1500--give or take a few percent in either direction.

It is ironic that just one year ago, most analysts were calling for the S&P 500 to reach 1500 by the end of 2011; a year later, almost none of them are expecting the same for the end of 2012. They were wrong last year by being far too bullish, and they'll be wrong this year by being far too bearish. With people in the remotest Asian fishing villages concerned about Italian or Spanish bond yields, further developments in Europe cannot possibly exert any meaningful negative impact on risk asset valuations, since anyone who would have considered selling on such information has already had more than ample time to take action.

While there is little incentive to purchase something like the S&P 500 which might gain 10%, a compelling argument can be made for buying funds of commodity producers which stand just above their lowest levels since the summer of 2009. If these merely return to their highs from February or March 2012, then they will generate gains of 30%-50% from their current levels. Perhaps they will fall short of accomplishing this milestone, but even a rebound of 20%-40% would be substantial and could occur within a few months. As I had stated in my last update on May 31, I made plans to continue to purchase the shares of my favorite commodity-related funds into weakness and repeatedly did so during June, so that today I have two thirds of my entire net worth invested in risk assets.

Disclosure: I am currently long GDXJ, VFWPX, KOL, XME, EWZ, RERGX, SLX, RSX, TNRPX, VGPMX, REMX, TRIEX, FCG, GDX, and NLR, in that order, with by far my greatest concentration in GDXJ. I have placed a ladder of good-until-cancelled orders to buy GDXJ near and below 19 dollars per share.