Wednesday, June 03, 2009

Drop May Have Started Today

Top Line: The stock market did a major head fake over the past week and today reality started to creep back in. Expect more downside directly ahead.

The most dramatic downside moves on Wednesday were in the commodities, which of course is what makes up most of our portfolio. We have some downside protection with our short positions but they can't make up for the huge down moves in commodities. Still, the commodities have been leading the broad market and this time they are leading it lower.

As you all know, our largest holding is GDX, a gold mining ETF, and it dropped from near 45 this week to 41.30 on its low today. For those of you who have missed out on GDX, we hope you did not buy it at 45 over the past few days. There may be an entry point coming up as the market drop continues. We would suggest that GDX will bottom first, maybe even ahead of gold itself. When GDX starts to make a positive move, in a week or two, that will give us a great early indication that the stock market is about to turn around.

Over the next few weeks, we (still) expect the SP500 to drop to the 850 range, which ia still a ways away from today's close of 931. This drop needs to happen because of all the recent bullishness that came out of just the latest week of the rally. General Public confidence of upside is a sure sign of price drops. When someone says, "I think stocks are going up", we would think that meant stocks Have Already gone up.

The bulls have taken over the sentiment and this attitude needs an adjustment. That will come as the market drops about 10% creating the same type of panic that people felt over the past year only in a mini version. We here at the Update will be watching our two favorite indicators at this time, the Treasury bonds and the volatility indexes, particularly the VXO which we have mentioned several times.

The T-bonds seem to have found a short term bottom. Our proxy for long dated Treasuries is TLT and that has been trading in the 90 to 92 range for several days. Should this pattern hold, we would expect that the TLT could move back up to near 100 or about 10%. From there the prices should drop to a much lower level as the stock market moves up.

Right now the VXO is around 30 and we would like to see this move up to 40 before we try to start buying our favorite stocks. As time goes by this month, these opportunities will only be available for a short period of time. Why? There are recent buyers that have come into the party very late in the price move and they need to feel some pain. Where were they in March when prices bottomed? At the same time, there are many entities that are looking to buy on a pullback. These people can't be given much of a chance either. The market won't give them much of an opportunity.

Our main goal will be to buy before prices go up which means that we will be paying higher prices and watch prices drop to the lows. We don't want to be too early but likewise we won't want to be too late. If you see these three leading indicators then you will probably see some good prices in your favorite stocks. We will be watching GDX to see if we can get in below 40 since we think the 30's will be a great support area.

We had a question off line today and would like to present the concept here. The question revolved around nat gas (natural gas) specifically whether it's a good buy right now. UNG is an ETF that corresponds to the price of natural gas. Today nat gas dropped by 10% during the day and represents a good value. If prices come down in the next few weeks from here, we would certainly buy some more. We actually bought some today. We had sold some on Monday near 16 in our trading account and decided to replace it here in the 14's again. If it goes down some more, we will buy more.

The question related to whether the fundamentals were strong enough to justify higher nat gas prices. Would economic contraction cause nat gas to decline further rather than go up? Our answer is that the economic contraction doesn't induce much real decline in usage of the product. Think of last year's price of oil near $145 a barrel. When the price dropped to $35, it wasn't because demand dropped by 60%, it was because of the herd mentality. Likewise, nat gas demand isn't driven by price too much. Yes, some will turn to nat gas to heat their homes or their water because it's now cheaper than other forms of energy for the same BTUs.

We recommend that if you are buying this or any stock over the next few weeks, please buy a small portion at a time and buy at Lower prices than your last. So, we paid 14.75 today and then bought some more at 14.32 and then bought more at 14.02. These prices now average much better than if we had purchased our entire position at 14.75. If you want more info on how to do this...leave a question in the comment section or contact me directly if you know how.

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