Saturday, August 20, 2011

Gold and Stocks

I sold most of my position in UGL late Thursday. (UGL is a 2x leveraged long gold ETF.) The price of gold had climbed too high not to take profit (1823 when I sold, see chart on right from Kitco). But since that time, gold has gone up even more (to 1881) – but then back down some (to just above 1840).

I also sold a position in FAZ (an ETF that tracks 3x the inverse of financial industry stocks) that I had entered on Tuesday, with a profit of 14 percent in two days. I had made 36 percent on a previous stake in FAZ entered during the first week of August and sold the next week. I may go in and out of FAZ with small portions of my accounts over the next few weeks depending on conditions. It has provided me with some rather extreme profits recently.

 The performance of FAZ over the last two weeks (click for larger).
I bought at 57.20 the previous week (not shown), sold at 78.00 on the 9th,  then bought again 57.93 on 16th, and sold at 66.31 on 18th.  I got a little lucky with the S&P downgrade on the first one, but hey, it was pretty obvious things were getting bad, true?

There is definitely a concern that gold could go down significantly, along with other commodities if Europe and China continue to decline, leaving the dollar stronger than other currencies. Probably a good play would be to short the Euro, and go long gold, but I am leery of Forex since it is all too politically controlled – and therefore unpredictable.

I do believe that the entire world economic situation is trending toward the inevitable outcome of extreme Keynesian intervention: stagflation. Based on that, a long term hard metal position could help maintain some value over the next few years. A 2x gold instrument position could actually build value in that situation. Probably not a bad idea to keep 20% of your investment in gold, but you may want to wait for a pull-back to buy.

Dow Jones Industrial Average (Five Years)

There are hints today that European banks are facing some liquidity “abnormalities”. The Swiss National Bank received $200M from the Federal Reserve special “swap line” for foreign central banks late this week, which they had not done since the swap lines were reopened in May2010. Earlier this week an unidentified bank in Europe borrowed $500M short term (one week) from the European Central Bank. See: Some European Banks Face Short-Term Funding Stress.

Remember that cascading liquidity issues were what caused the large number of bank and investment firm failures in the 2008 crisis. This was stopped (or slowed down at least) back then by the unprecedented action of the Federal Reserve to reduce rates and inject hundreds of billions of created dollars into the banking system. But now, rates are already zero, and any further quantitative easing would drive even more inflation – or stagflation actually.  Bernanke is stuck between a rock and a hard place, with few tools left in his bag.

I am mostly in cash and am willing to sit there for awhile. I may miss a big rally, but the risk is too high to be in stocks AT ALL right now. I like the following quotes from an article today on CNBC What Traders Are Saying: Uncertainty Stalks London:

A trader who identified himself only as Graham said between sips of beer in a Canary Wharf pub that the prevailing attitude in his workplace is this:

“The best bet right now is to do nothing. Every time you put risk on, you lose money. Every time you take risk off you lose money. You’re better off going away on a nice long holiday and hoping the fuss has died down by the time you come back. You’re also serving your clients better by doing nothing—although they won’t see it like that, and neither will the bank, and it’s not exactly what you get out of bed and go to work for.”

Those sentiments were echoed by other traders who shared their feelings with, including one who suggested he might not re-enter the market this year at all.

“I am biding my time," he said. "I won’t re-enter the market before January or February—maybe March. I don’t have the heart for it, with markets rising and falling 500 basis points at a time. I am superstitious, and after a loss, I need a gain to be double the size of that loss, to maintain mental equilibrium.

“I don’t think there’s any more bad news coming—like the S&P downgrade for example—but I think the bad news we have already had needs time to crystalize. I think things will start to settle down in September or October ... At the moment, I’m sitting with my hands under my thighs [to prevent himself from making trades].

“July and August are always quiet months, with European countries like Italy on holiday for a whole month," he said. "I think markets would be going down anyway, but the lack of liquidity available is exaggerating the downward impact of bad news.”

Other traders told of their fears over what the future would bring, including the threat of a US recession, slowing demand from China or another sovereign debt crisis in Europe.

“The second half of the year is going to be awful. I’m actually very positive in general, and never really thought about confidence, but I don’t want to go out and buy anything, because I’m worried about my job,” Siamek, a trader at a large investment bank, explained.

“The way you act is based on how clear the future is to you," he continued. "At the moment, there are too many uncertainties that you don’t really have the confidence to do anything about it.

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