At These Levels

I will give you 2:1 odds that over the next 6 weeks the VIX will likely rise 40-50 percent, i.e. retest the March highs. Experienced options traders should capitalize on this. Those without experience should book some gains, raise cash, and don't chase anything to the upside.  This an opinion, not a guarantee.

This is a large move in the VIX after a massive volatility band squeeze. I know that setup very well, but,  I am surprised it came after the S&P made a high over the February high. Still, here it is. I'll let you know when I think it's over. Book some gains, now.

www.bloomberg.com

I'll be the first to tell you that the message of the stock market and the message of economic indicators are as different as night and day. The market is incredibly strong, while many reliable economic indicators are incredibly weak. Which is right?

The last time we saw an incredibly strong market with notably weakening economic indicators was in the spring and summer of 2000. When I say a strong market I refer to the large cap indexes. Save for the big crack in March, off the May bottom the Nasdaq rallied strongly all the way into Labor Day.

I'll also be the first to say that this time, according to everything I've looked at, the stock market is much stronger than in 2000 due to the breadth of the advance. The bid under the market is relentless.

The bizarre part is that many of the indicators that called the recession that began in late 2000 are now weaker. The only thing I can think of here is to play the upside with secular bull market stories in emerging markets and natural resources, and have a devised defensive plan with down-market strategies for when/if a selloff begins.

It doesn't pay to be bearish in this tape. People hate the bears when the market goes up because they blame them if they take their advice and don't buy aggressively on the way up (i.e., they miss the upside). Then they hate the bears when the market goes down as if the bears caused the selloff. In other words, they hate the bears, period. I would know.

Source: Northern Trust

Paul Kasriel has come up with a recession warning indicator that has called every recession since 1969 before it has opccured:

To refresh your memory, the combination of a year-over-year contraction in the quarterly average of the CPI-adjusted monetary base (unadjusted bank reserves and currency held by the public) and a negative four-quarter moving average of the spread between the 10-year Treasury bond yield and the federal funds rate has signaled every recession since that of 1969. I have modestly named this combination the Kasriel Recession Warning Indicator. As shown in Chart 3 [above], the KRWI is now sending out a recession warning as of the first quarter of this year in that the yield spread is negative and the real monetary base is contracting.

Are the LEI and the KRWI emitting false recession signals? Is it different this time? Let’s look at the behavior of the three private-sector elements of aggregate domestic demand – housing, business capital spending and consumer spending to help us answer this question. Firstly, housing… [Skip to page 3 and read about those aggregate demand components]

Now look at the S&P 500 Equal Weight Index (the components are weighted by a factor of 0.2 instead of market cap) that better shows the breadth of advance. It just hit an all-time high.

www.stockcharts.com

What recession? Hallelujah. We should find out this year which indicator is telling the truth.

Paul does have agood point in conclusion:

I am not aware that any recession has been predicted by a consensus of economic prognosticators. Two reliable recession indicators are now flashing a warning signal and private domestic demand is showing weakness. Maybe it’s different this time? Perhaps it isn’t. Only the National Bureau of Economic Research will know for sure.

While catching up with work after being away from the office, I had missed the last missive of Jeff Saut where he starts with:

“A man wakes up from a 20-year coma. He immediately calls his CPA/financial planner. "Excellent! My IBM is worth $6 million. And my Microsoft is worth $8 million." As he is asking about his AOL stock, the operator cuts in and says, "Please deposit another $3 million for the next three minutes."
-Anonymous

Jeff quotes another favorite, Dr. Marc Faber, whose acidic statements turn off too many people that would benefit greatly form his insights. If you have not read Marc’s book, Tomorrow’s Gold, do so. Otherwise, see what Jeff has to say about the real bull market in natural resources.

He doesn't believe the weak GDP numbers in the US, likes the Chinese and Indian currencies, doesn't like Chinese mainland shares...and a lot more (21 minutes, I enjoyed it.),

The GDP price index (4 percent) came in very strong and so did the core PCE (2.2 percent). I'm sure they'll spend a lot of time on TV today explaining how those are irrelevant signs of rising inflation in a slowing economy. And what about those rallying commodities in that same slowing economy? It's a brave new world out there. As brave as the 1970s.

www.bloomberg.com

Jeff Matthews not making this up about oil and real estate.

News From The Frontlines

"The greatest of faults, I should say, is to be conscious of none." -- Thomas Carlyle

By Ivan D. Martchev

I spent the end of last week at the Atlanta Investment Conference, a charity event organized by the Friends for Autism Foundation. The news from the frontlines is that the investor community is as bullish as ever on anything that comes out of the ground. And if you drop it on your foot and it hurts, they’re even more bullish.

It looks like the recent corrections in oil, copper and other resource markets have instilled some dose of reality, but so far interest is still healthy. I believe those corrections are now over. The next leg up for those resource markets has already started, so I don’t find any disconnect between the message from the market and the message from the crowd.

The wittiest line came from one of my colleagues, who said: “The gold bugs are the most-amazing crowd. They believe in economic Armageddon and that they can overcome it by buying penny mining stocks.”

Here's one definition of a gold bug . One thing missing in that definition is that a gold bug should have all his or her assets (or at least a very substantial part thereof) in gold.

There are also oil bugs who believe we’re running out of the sticky stuff and should put all our money in energy stocks. There’s substantial overlap between the two groups of investors. I’m not sure which is the bigger economic doom-and-gloom story: running out of oil or losing money in a hyperinflationary spiral.

My take is simple. Gold is in the midst of a bull market, just like any other natural resource out there. The gold bugs’ arguments had been dismissed for a while, but they’ve gathered a lot of support in the broader investor community in the last seven years--as evidenced by gold rallying to just below $700 an ounce.

Not recognizing that there’s a massive bull market will prevent many investors hostile to the gold bugs’ cause from realizing massive gains. The existence of numerous vehement skeptics, even after a seven-year bull run, suggests that the rally has further to go--all the better for you and me. The gold price is currently almost 70 percent below its inflation-adjusted high in 1980, which in today’s dollars is something close to $2,200 an ounce.

Being a gold bug in today’s crowd is the same as being a bull on technology back in 1991. No matter how scary the corrections looked along the way, the tech bulls looked brilliant up until 2000. How many of you wish you’d bought Intel and Cisco back in 1991? I bet more than a few.

 
Source: Bloomberg

I don’t think we'll run out of oil in the next 50 years, but we’re very far from the high price that black gold can fetch because of supply disruptions, strong demand and generally robust global economy.

How high will oil ultimately go? No one has a good idea. If you run the same comparison I highlighted above with gold and look at the inflation-adjusted high from 1980, oil’s high is about $100 a barrel in today’s dollars. In a supply disruption situation, where the world economy is strong, I bet it can go even higher.

I expect the oil market, and most other resource markets, to stay strong into the hurricane season. Oil is being propelled by positive seasonal factors, as well as the US economy’s improved performance regardless of what’s happening in housing. I thought housing was going to be a bigger factor by now, given how important it's been to overall economic growth during the past five years.

Source: Bloomberg

Gasoline is outperforming oil at this point--just like it does every year--so I expect oil to say strong at least until it’s clear how disruptive the hurricane season will or will not be. Last year, Mother Nature played a number on oil traders: After the most-disruptive hurricane season in US history in 2005, no hurricanes made landfall in 2006. I hope the same can happen this year, but as usual, you should hope for the best and be prepared for the worst.

Uranium, which has gone parabolic of late, was a big hit at the Atlanta Investment Conference. I highlighted a stock that hasn’t moved, even though it controls the biggest uranium trader in the world as well as the toll booth for processing uranium in the fourth-largest uranium reserve in the world.

I was also going to talk about a pure uranium fund (a closed-end fund that holds uranium), but I didn’t have a chance to comment--my presentation was cut short because of technical problems.

Many similar trading vehicles--not just the one I had in mind--trade at big premiums to the price of uranium. If the current price is $113 a pound, they can be trading at $150 a pound.

Some of those funds lend their uranium, sometimes completely. (Like a bank, they charge interest but don’t have it in their possession.) Their stocks, in effect, are only financial claims on uranium that’s already been lent but not actually possessed.

If you consider one of those for your portfolio, make sure you know what you're buying. I’ll stick with my uranium trader for the time being.

The euro short-term interest rates are still rising while the Fed funds rate is stable. Even though the differential is 1.5 percent in favor of the dollar, the movement is definitely in the euro's favor.

The money markets predict that the ECB will hike at least 2 more times to 4.25 percent. The fed fund futures predict one rate cut by December. That will shrink the interest rate differential to .75 percent in favor of the dollar.

Now you should ask how come an interest rate differential in favor of the dollar is a dollar negative since the exchange rate has moved to 1.3665 this morning, 1/100 of a cent off the all-time cash high of 1.3666 seen in January 2005.

It's key to remember that a move above that high (which by now is a forgone conclusion) opens the room for a test of the electronic high at 1.4557 back from 1992 when the euro was just an electronic basket of currencies.

How to play this? There's a euro ETF that trades on the NYSE; there are precious metals ETFs and generally all resource markets tend to see firmness in times of dollar weakness, to a varying degree. Keep in mind that the dollar tends to rally in a weak economy or financial market panic. We have neither of those at the moment.

www.bloomberg.com

Even after all this drama about Chavez being a communist, Merrill ups Venezuelan bonds (from my inbox this am):

Venezuela: Move to Overweight

On 23 March 2007, we recommended investors switch exposure out of Venezuela and into Ecuador. The move was based on the upcoming pressure that the issuance of US$7.5bn of PDVSA bonds was to have on the sovereign, and our view that fears of default in Ecuador would continue to decrease. Since then, the IGOV component of Venezuela has lost 44bp, while the Ecuadorian component has gained 715bp. We now believe the sell-off in Venezuela justifies adding exposure to the credit again. This view is based on two factors:

(1) Despite the size of the offering, the supply of PDVSA bonds to the Street has been modest. This is shown by the spread performance since they became tradable.

(2) The PDVSA bonds will be part of the major indices used by clients; therefore, some of the excess supply will be met by higher demand. Moreover, the fact that some Venezuelan clients may remain invested in these bonds will generate a scarcity of this paper that could benefit the sovereign. J.P. Morgan estimates Venezuela’s weight to increase to 8.26% from 6.50% in the EMBI Global and to 7.18% from 6.92% in the EMBI Global Diversified.

Beginning on 10 April, Venezuelan bonds underwent a second leg of underperformance due to the supply of a significant European fund that was rebalancing its holdings. While it is too early to know just when this supply will come to an end, we also believe that current market conditions make Venezuela one of the few cheap opportunities in the single-B area. As oil prices remain solid, Venezuela’s ability to pay continues to be strong. We would, however, avoid the ‘25s and increase exposure to the ‘18Ns and ‘20s.

www.bloomberg.com

Now, all this talk about Chavez is fine, but if anyone was so worried, why do they keep buying the bonds?

Some DB commentary that says why the market is as high as it is: earnings. It comes to me as an image.They are the only ones doing image emails.

Source: DB

Source: DB

The Brown Brothers Harriman strategist on the dollar (11 min). The action is bullish for the resource markets.

Plus, the Dow hits an all-time high on this news. It must be irrelevant.

Note: A not-fully-edited version of my weekly email went out yesterday for which I apologize. I will post those weekly commentaries here without the pesky little ads on the next day after they come out.

Head In The Oven, Feet In The Fridge

“Inflation is taxation without legislation.” -- Milton Friedman

By Ivan D. Martchev

This is how I heard someone describe the core rate of inflation: "If you don't send your kids to school, don't go the doctor, don't put gas in your car or heat your home, and skip on the groceries, there’s no inflation."

Here’s another (more gruesome) version: "If your head is in the oven and your feet are in the freezer, it’s neither too hot, nor too cold on average. (There’s no inflation)." In our case, those plummeting flat-screen TV prices are the freezer and the oven is food and energy prices.

The core inflation numbers were perceived as good this morning. And for another month, we’ll be kidding ourselves that inflation will go away.

The resource markets have been a lot stronger than any of the skeptics have prognosticated. Demand for natural resources from emerging markets isn't going away. This will raise the inflation rate and add even more fuel behind the rise of commodity prices and hard assets.

This is a virtuous circle for producers and a vicious cycle for consumers of natural resources. It is the 1970s all over again.

There are some interesting issues being discussed by The Cunning Realist that have to do with the topic of inflation:

Direct and indirect spending on Iraq is an important part of what's driving the dollar down and the cost of living up. Current thinking in Washington is that a recession or weak stock market must be avoided in order to pay for Iraq. But the monetary stimulus this necessitates is driving up the price of everything, including stocks. It's also created a link between a rising stock market and inflation; the former exacerbates the latter.

The Cunning Realist also noted:

Just as the inflationary problems that confronted Carter and Reagan were rooted in Johnson's Vietnam spending fifteen years earlier, the worst effects of our fiscal and monetary distortions won't be felt for years. But remember, by the time this magazine cover hit the newsstands, LBJ was long gone. Will the public understand the connection between Iraq and the rising cost of living before the current actors hand things off to their successors? Probably not. But it's important.

(The whole post is available here.)

Commodity bull markets coincide with war cycles that many observers fail to mention when they talk about natural resources. They also coincide with inflation, as mentioned in the quotations above. Given that no change is visible on the war front, no one knows another war isn’t around the corner--there always is--and there’s high demand from emerging economies, my guess is that we’re in for years of rising natural resources prices.

There’s still a chance to get that fixed-rate mortgage.

I also offered some commentary on inflation in my subscription service. It’s relevant to many investors whose interest are in hard assets (gold, silver, etc.), broadly natural resources or just plain old seekers of better returns:

It’s been 11 months since gold hit its recent multiyear high of $730.40, and the selloffs (although sharp) are getting shallower and shallower. Buyers are coming in more aggressively at progressively higher levels, and before you know it, we could be well past that multiyear high from last May. I wouldn’t be surprised if we trade above $800 on gold ($20 for silver) by the end of the year on very stubborn inflation numbers coupled with ripples from the drama in housing.

Source: Bloomberg

Theory suggests that inflation should have subsided by now after such a long, protracted Federal Reserve interest rate hiking cycle, but it hasn’t. I showed the bull market in inflationary expectations as implied in Treasury Inflation-Protected Securities (TIPS) last issue. I recently updated a chart that I’ve explained in detail on my blog which supports the TIPS verdict. The CRB Raw Industrials Index is blasting away to unseen heights (see the chart below). Those are industrial commodities, many of which don’t have futures contracts. This is better for our purposes, as we can eliminate the option that this is just futures-driven speculation.

Source: Bloomberg

And palladium is moving--just a heads up.

I wrote the above in my subscription service a while back:

Elections typically provide an excuse to book profits. There wasn’t even a “sell the news” reaction, if you want to make the case that market participants expected and desired the Democrats to win and, therefore, correctly ran up the indexes right into the election. Still, no profit-taking rally materialized and prices kept going higher. And they’re still ticking up for some market sectors.

After such a big run, you’d generally expect the market to at least move sideways for some time and give back some gains in even a shallow profit-taking correction. This is normal. If prices are to run up even higher, the market has to breathe in and breathe out, just like any long-distance runner.

This sideways consolidation has already begun to be reflected in the Nasdaq 100 (NDX), traditionally the favorite institutional vehicle for the end-of-the-year rally. The NDX hasn’t made a new high since November 24, when it stood at 1,824.21. We’ve come close to that glass ceiling and every time, reliably, profits have been taken.

www.stockcharts.com

Let’s take a look at the most-important US benchmark index, the S&P 500. Since the beginning of the rally, you’ll note that the conclusion of the NDX’s outperformance has always preceded corrections. Sometimes it took a month or so for the overall market to decline more meaningfully. In the most-recent such case, at the beginning of 2006, the NDX began to lag in January but the real selloff didn’t commence until early May.

However, we never saw huge moves to the upside in the S&P 500 after the NDX went into lagging mode. January 2007 should be an interesting month because no one will dare jump the gun at the tail end of December unless there’s compelling evidence to do so.

This was written on December 21st. The Nasdaq 100 did exceed that level; now it is at 1834.91 and it has been as high as 1851.47 in February. But we also sold off to 1710.97 in March. The Nasdaq underperformance (or least a lack of leadership) still continues. Actually, form a longer term perspective the relative performance of NDX/SPX has rolled over as evidenced by the lower highs. But I would have never guessed that in that setup the S&P 500 will make a new high for the year like it did today.

Consider the above when trying to figure out if there is more upside than downside form current levels in the next three to six months.