Hi and welcome to your newsletter for w/c 23rd February 2009.

Last week market’s reaction to the continuing (and seemingly never ending) banking and economic crisis was swift and predictable: gold vaulted over $1000 as stock indices plunged key support levels – we are all technical traders now! The Swiss index led on worries over bank secrecy and tax evasion – indeed politicians now seem bent on closing down tax havens and hedge funds as they desperately try to find yet more scapegoats for this catastrophe.   We need, they say, a global regulator to keep a closer eye on those sneaky, pesky traders, speculators and tax dodgers.  It’s a pity we, the ordinary trader, investor and taxpayer, do not have our own regulator to oversee all the money the politicians have been tossing around without very much to show for it.   And, as we all know, when the politicians run out of money they will simply print some more!  Citigroup’s November 2008 forecast that gold could reach $2000 this year does not now seem so far fetched.

Joining the Swiss index was the Dow Jones which plunged to a new 6 year low, although the S&P and NASDAQ managed to remain above their lows of November 21 2008.   The Dow closed at 7365 last Friday, some way below the 7449 it reached at November’s low point.   Back in the first week of 2009, it seemed as if everything was going to be fine in the stock market. But now, the whole of that impressive 22% rally from 21 November to 6 January’s 9088 high has been wiped out.  But it’s actually far worse than that.  In fact, American shares haven’t traded this low since 1997.  If you exclude dividends, investors in the Dow haven’t made a bean in the last 12 years. One of the reasons given for the dramatic fall in the Dow was the rumour that Citigroup was in talks with federal officials as a prelude to the government substantially expanding, by as much as 40%, its ownership of the struggling bank.  In fact bank executives hope that it would not be more than 25% .   So long as uncertainty remains then gold will just keep on rising and  stock markets will keep on falling.

In the UK the FTSE too reacted badly as the key 4000 level was taken out – round numbers are always so important and they seem to act like magnets for both bull and bear traders and investors.   When markets reach key levels such as the FTSE 4000 it will keep trading around it for a while and likely spend a few sessions moving either side until it becomes exhausted before deciding to break either higher or lower.     With so many key levels now apparent – in indices, metals and commodities I can never remember a time when there was so much expectancy in the market.  Sadly my feeling is that the market will not be a good place for bulls or long only traders and investors. Last year two analysts, Albert Edwards and James Montier of SocGen wrote: “We see global equity markets falling some 70% from their October 2007 peak…..expect the S&P to bottom around 500 (versus the 1,575 peak) and the FTSE around 3,000” When these predictions were first published they were very controversial whereas now they seem all too real.   The fall in the value of all our assets, be it homes, pensions, money or bonds has deep and severe implications for the future and does not bode well for the political stability of many countries.    The reality for many is, of course, unemployment.  In the US almost 5m are claiming unemployment benefit while in Russia unemployment has reached 6.1m.   China’s unemployed are estimated at  around 20m.   Daily announcements of huge job cuts will continue and no longer shocks as firms try to stay in business.

As equity indices continue to push each other lower, gathering speed on the way down top quality Treasury paper will continue to command a massive premium, yield curves should flatten as central banks desperately try to stop the rot. The dollar too reacted badly to the Citigroup rumour and it dropped like a stone on Friday against the euro as hedge funds had (allegedly) sold the dollar on the pretext that US banks were in a worse position than their European counterparts.   However, as explained in last week ‘s newsletter the  European banks are facing a much more difficult situation as this crisis is threatening to destroy the EU itself.   It is Germany who is drafting the rescue plan to prevent default on the edges of the Eurozone in order to prevent a full-blown collapse of Europe’s monetary system.     The euro’s sudden rise last Friday can also be explained in technical terms as buy orders were triggered once it reached 1.2650.  For currency traders Friday afternoon can be a nightmare as the only market session open is the US so price action can sometimes break down as volatility rises.  However, this can also provide some excellent trading opportunities.  Today the dollar has clawed back most of the euro’s gains as we head back down towards 1.2650.   We can also expect a positive dollar reaction to Hilary Clinton’s recent visit to China.  The Chinese have expressed great delight in her visit especially as there was no mention of human rights or currency manipulation.  Instead economic relations and cooperation were the order of the day – ergo expect the sale of T Bills to rise.

As fast as the equity markets plunged so gold and silver soared and both these commodities are rapidly turning into the next asset bubble  or as Steve Ellis of RAB Capital says the next “mania asset”.   He writes in the FT:  “Gold is currently one of the few remaining major asset classes where a case could be made for it to rise in a parabolic fashion. Once the psychologically significant $1,000 an ounce is breached convincingly, the speed of the move beyond that level could accelerate sharply. One precondition for a mania is there must be uncertainty about how the asset is properly valued which allows “new era” thinking to take hold. This is very true for gold.”   Well we have pushed past $1000 and once above the $1000 mark the only technical indicator is fear.  A look at the cot data, which I updated earlier today, shows htere is still plenty of bullish momentum for both gold and silver – silver more so than gold.  In case you have not seen these charts before it is the left hand side of the graph which represents the latest trend. The data is my own interpretation and based on the numbers reported by the “Commercials” – ie the major producers.
The bubble in gold and silver is not replicated in other commodities.  After slumping by more than 50% last year, corn, wheat and soybeans have rebounded by almost 25% from their December lows.  Yet, for now, the scope for any further gains looks limited.  Investors had been looking forward to smaller harvests and therefore higher prices as Argentina (a key exporter,) is drought stricken and on course for its lowest soy production in at least 5 years.  Farmers in America are planting 9% less wheat this season and tight credit markets have hampered their  spending on fertilisers, which also points to smaller supplies.  The weather, as always, is the great unknown and it too could contribute to smaller harvests.  However, wheat inventories are at a six year high and the “key question” as the UN has pointed out “is demand, not supply”.  Agricultural commodities are not nearly as recession proof as investors assume.  Corn will fall in the US as ethanol consumption is down, while feedstock consumption too is falling as the demand for meat in the emerging markets drops.  As the International Council for Grains has said “immediate supply and demand outlook for grains remains generally bearish”.

Trading Tip:   Markets and prices always fall faster and harder than we think or would like and if not handled properly will simply induce in us a complete state of paralysis.   Sometimes the panic and fear is deliberately induced by the market makers and prices will only stop falling when the last “bull” has thrown in the towel.  Having been on the wrong side of the market on more than one occasion I know what it feels like to see my positions simply vaporize before my eyes.   So how can we protect ourselves from suffering such catastrophic losses? First it is imperative that you have a plan which will take account of the events which are currently unfolding.  Unfortunately the majority of traders and investors can only seem to cope with a long only strategy.  This is either because they do not know how to trade short or do not fully understand correlation and hedging.  One of the best ways to remedy this is to consider the use of options and in particular buying puts which will increase in value as the underlying asset falls in price.  Although this can seem a complicated subject to master it is worth the time and effort as it does provide the opportunity to trade both sides of the market in a relatively simple way.
Fortunately options are now readily available to retail traders and a good place to start is the education sections of either CBOT or the CME.  I have also published a number of free sites and details of these can be found on the front of the COT.
In the meantime stay safe and good luck with your trading and investing.
Regards.

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