A Quick Update

Just a few words since it has been a while since my last update.

The strength of the recent rally caught me by surprise.  Generally speaking, the market knows a lot more than I do – so if the market is moving in the opposite of what I expect it usually means that I am wrong and that I need to reevaluate my thinking.

However, every time I considered buying into this most recent run-up I found myself thinking about the following:

• Greece will likely default before the end of the year
• Once Greece defaults, Portugal is next
• Despite the recent upbeat news, we’re probably headed for a recession

Although it pains me to miss out on gains, I don’t believe that this is “priced in” and I can’t be a buyer here.

Gold and the Bear Market

Regular readers know that I am a fan of gold as an investment but not a true-believer in the hyper-inflation trade.

To me, the gold trade here is very simple:

1. We are in a bear market driven by concerns about sovereign default. 
2. If (when) Greece defaults, counter-parties (banks, investors, etc) will need to raise dollars for a variety of reasons.
3. Assets such as stocks and gold, regardless of their “intrinsic value,” will be liquidated in exchange for dollars.
4. At this time, governments and central banks appear to be too preoccupied with their own debt and inflation to provide enough supply to meet the coming dollar demand.
5. Eventually, our debt problem will only be solved by default or inflation.
6. In the event of default or inflation, hard assets (like gold) will rise in value.

After the recent run-up, gold is now approaching its 200 day moving average.  Over the past few years – this has been a solid entry point into gold.

However, over the past few years we have been in a bull market and not a bear market.  This is no longer the case.

As inflation policy shifts from its current stance (highly undesirable) to its future stance (the least horrible option) – gold will shift from an asset that must be liquidated to an asset that must be bought.

So, in other words, I am skeptical that gold will remain above its 200 day moving average right now – but it remains a long-term asset that must be owned.

Q3 2011 Results

While I am pleased to pull ahead of the S&P in relative terms, it’s never fun to lose money in real terms.

The biggest issue that I had this quarter was simply that I was not able to trade when the market made its big swoosh lower – and therefore I missed out on a huge chance to outperform. 

2011 Q3

S&P 500: –14.3%
My Portfolio: –10.9%
Relative Performance to S&P 500: +3.4%

2011 YTD

S&P 500: -10%
My Portfolio: –6.9%
Relative Performance to S&P 500: +3.1%

Trouble Ahead, Trouble Behind

The dollar broke through the 200 day moving average last week as  the Euro fell through the floor.

Unless there is some unexpected news out of Europe, I believe that the next leg down in the bear market is in progress. 

I will be largely in cash for the foreseeable future.  In terms of investments the only “safe” harbors are dollars, treasury bonds, or bear market index funds.  Gold may continue to ride high for a while, but when the liquidation phase of the bear market happens it will get whacked as well.

The Path of the Hurricane

Bearing in mind my earlier post about what a bear market “looks like” - I remain of the opinion that we are in a bear market rally.

My expectation is that we will rally for a bit more on declining volume and roll-over into further declines.

The Economics of the iPad

And now for something a little different…

In the not-too-distant past, the preferred handheld gaming platform was the Nintendo 3DS.  My two nephews have their own devices and they are pretty much glued to them at all times.  Except, of course, when I let them use my iPad – which offers a far superior gaming experience with its large screen and touch interface.  There is no doubt that, given the choice, they would much rather play on the iPad.

However, conventional wisdom is that purchasing an iPad as a gaming device for a youngster is an extravagance.  Starting at $499 its price towers over the $169 price of the latest Nintendo 3DS.

But the lifetime cost of an iPad versus a Nintendo 3DS tells a different story.  Those that have been to the App Store for iPad know that games can be had for between $2 to $10 at any time – and during special sale periods those same games sell for just $1.  I’ve purchased over 20 games for my iPad and I paid $1 for almost all of them.  Nintendo 3DS games, on the other hand, run from $19 to $39 with no such special discounts.

If a gamer were to purchase an iPad and 20 games (at an average price of $2) versus a Nintendo 3DS and 20 games (at an average price of $29) – the total cost of the iPad plus games is $539 versus a total cost of $749 for the Nintendo 3DS plus games.

Bear Market Update

I have been early to the game in the bear market watch for this cycle.

Back in May I noted that the market was putting in a rolling top, which is a bear market hallmark.

In June I noted that the rolling top had continued to form and was looking very ominous.

It appears as though those concerns have come to fruition and we are now in the grips of a bear market.  Before I talk about the current market activity, let’s do a quick refresher on the general patters in a bull and bear market.

Bull markets look like this:

Bear markets look like this:

Rolling tops (aka “head and shoulders”) look like this:

 

Now, here is the current chart of the S&P 500 for the past year:

Many market commentators have tried to draw a parallel between the 1987 crash and the current steep decline.  However, the 1987 crash was more like an extremely steep correction – the market had been rallying and then sharply dropped.  This current decline has come on the heels of a rolling top – which is indicative of a classic bear market.

Going forward, here is what I expect to see:

Long Term:

• I don’t expect to see the market drop more than 10%
• I expect the market to regain its highs within the next 12-18 months
• We are approaching a reasonably good long-term entry point
• All of this is null and void if Europe really falls off a cliff (which I don’t expect to happen)

Short Term:

• The rules of a correction apply, where are in phase 3 approaching a bottom
• I expect to see a lower-low, but not much lower
• I expect to see a sharp rally by the end of next week

Remember the anatomy of a correction