Diary Archives - Mad Hedge Fund Trader

Emergency Strategy Reversal.

I think that Ben Bernanke?s QE3 is such a game changer, that we have to throw all existing strategies into the trash and start all over again from scratch. ?Suddenly, investors and traders have to face the prospect of adding $500 billion to $1 trillion to the Fed?s balance sheet, taking it to a record $3.7 trillion. ?All of this new money will go into risk assets.

This demands that I radically change my approach to the market. ?You can kiss the big September correction I was expecting goodbye and the ones for October, November, and December goodbye as well. ?The markets might even continue up for the rest of 2012.

In December, 1944, General George S. Patton accomplished one of the greatest feats in military history by wrenching the focus of his Third Army?s attack on Germany by 90 degrees to the North on three days? notice in the midst of a blinding snow storm with minimal supplies. ?The result was the relief of the besieged 101 Airborne Division at Bastogne and victory in the Battle of the Bulge. ?It is time for such a move in the markets.

Don?t try to apply any kind of fundamental analysis to this. ?You might overthink your way out of a job. ?This is a pure liquidity play. ?It means buying stocks solely on an anticipated multiple expansion from 14.5X today to a 15X or 15.5X multiple. ?Actual corporate earnings in the upcoming quarterly earnings cycle will be flat to down small.

I am not calling for the market to go ballistic here. ?I think a rise of 50 to 100 S&P 500 points to 1,500 or 1,550 is in the cards here. ?Why didn?t the market continue to rocket after the first day of QE3? ?I believe that there is a ?deer in the headlights? effect going on here. ?Everyone is so stunned from the magnitude of the Fed action that they have gone catatonic. ?Trading desks are awaiting a big dip to buy that isn?t happening.

I am not a person who is accustomed to buying market tops. ?I am the ultimate bargain seeker. ?I?m the guy who goes to garage sales in poor neighborhoods so I can find a full case of prime Japanese sake for $5, as I have done. ?But you don?t get a quantitative easing with these implications dumped on you very often either.

This augurs for an index that doesn?t crash, or doesn?t even have a substantial correction. ?It just continues to grind up slowly. ?There is too much cash sitting on the sidelines to allow otherwise. ?The most hated rally in stock market history is about to become even more despised. ?Best case, we add 7% by year end. ?Worst case, we continue to chop sideways and finish 2012 around these levels.

There is one stock that is certainly not going to announce an earnings disappointment, and that is Apple (AAPL). ?The roll out of the iPhone 5 is occurring faster than previous models. ?It will be offered for sale in 100 countries by yearend compared to only 53 for the iPhone 4s during the same period. ?So unit sales could reach 8 million by the end of Q3 and 49 million by Q4. ?This will create an unprecedented surge in Apple?s reported quarterly earnings. ?Those waiting to buy on the next big dip could end up missing one of the most impressive multi decade growth stories in history. ?This will impact the entire market sentiment, as it did in Q1.

On top of this, there is a serious reallocation trade going on whereby institutions are shifting money out of Treasury bonds and into the entire risk spectrum. ?This is why the Treasury bond ETF (TLT) has been hammered yet again, taking it down to a four month low. ?So the amount of money about to pour into risk assets will be a multiple of the $1 trillion mentioned above.

I?m not expecting any contribution to the economy from housing. ?So many millions of homes still suffer from negative equity that the Fed could take the 30-year conventional fixed rate mortgage rate to zero and it still will not generate much new construction where it can most-positively affect the economy. ?But from a market point of view, we don?t need their help for the time being.

What could go wrong with this scenario? ?Israel could attack Iran. ?There is no doubt that there is a partial mobilization of armed forces going on in Israel as I write this. ?I am getting frantic emails every day now from friends there about movement of troops, cancelled vacations, reserve call ups, and senior staff put on notice. ?When generals don?t return my phone calls, something is up.

But my Mossad friends tell me they aren?t going to pull the trigger. ?Prime Minister Benjamin Netanyahu is just reacting to the collapse of the Romney campaign in the U.S. presidential election. ?He has realized in the past two weeks that he is going to have to rattle his own sword from now on instead of counting on Romney to do it for him after November. ?Even if Israel does act, the impact on financial markets is likely to be brief and largely confined to the price of oil.

The other risk is that Romney could win the election. ?When Bernanke?s current term expires in January, 2014 he would be replaced by an austerity oriented, anti-quantitative easing hardliner. ?In that case, goodbye QE3, hello Dow 6,000. ?But at this point, this is an extreme outlier. ?You don?t see the Intrade betting on an Obama win surge from 57% to 66.3% very often, as it has done in the past week (click here for their site). ?If nothing else, Bernanke?s move on QE3 has certainly deep sixed any chance Romney had of winning.

What about the ?fiscal cliff?? ?It all boils down to the election. ?The Senate is now a Democratic lock, thanks to Mr. Todd Aiken of Missouri. ?There is a 50% chance that the Democrats retake the House on the coattails of the Romney crash. ?If they do, the fiscal cliff will disappear weeks after the election to be followed by another $1 trillion reflationary package entirely focused on infrastructure.

If the Republicans hold on, you can bet on Congress to weasel out of the mid-December deadline by kicking it forward two months. ?By then, recalcitrant losing Tea Party members will be flushed out of their seats, making the party much more manageable for the leadership and paving the way towards a real final agreement. ?Either way, we don?t go over the cliff, extending the present bull run for equities until Q2, 2013.

Taking all the above into consideration, I think the way to play here is through deep in the money call spreads in risk assets with December expirations. ?The strikes should be pegged 10% to 20% out-of-the-money so you could handle a 5% market correction without sweating it. ?The December expiration will allow you to wimp out just before the November 7 election and still keep a substantial portion of your profit.

The names I will be focusing on will be gold (GLD), silver (SLV) Apple, (AAPL), Google (GOOG), Qualcomm (QCOM), and Disney (DIS). ?I will attempt to scale into this portfolio and will send you urgent trade alerts when I see entry points. ?If the market goes down small, sideways, or up, as I expect, this should enable you to add 25% to the value of your portfolio by yearend.

Call me cautious, but you don?t get to be old by being incautious. ?In flight school there is a favorite saying: ?There are old pilots and bold pilots, but there are no old, bold pilots.?

Think of this as our ?bulge? moment. ?Isn?t life interesting? ?Oh, and thanks Uncle Al for the Bastogne angle, and sorry about the two toes you lost to frostbite there. At least you got a decent Veterans Administration disability check out of it.

Our "Battle of the Bulge" Moment.

Why Ben Bernanke Hates Me.

Diary

I don?t just think he hates me, he truly despises me. ?In fact, he does everything he can to put me out of business.

Take yesterday, for example, when the Federal Reserve Open Market Committee gave me and my views a complete thrashing. ?QE3 was the last thing in the world I was expecting because it was not justified by the current fundamentals. ?Most other independent analysts agreed with me, including several Fed govenors.

He could have let me off easy by announcing some minor back-door easings, like expanding his ?operation twist? to include mortgage-backed securities for the first time, or ceasing interest rate payments on deposits from private banks. ?But, no, Ben decided to make me look like a complete idiot, not by just announcing QE3, but one infinite in size that goes on forever. ?Talk about pouring salt on my wounds.

It?s not that I am not an all right guy. ?I am kind to children and small animals. ?I donate generously to many charities. ?I send my mother cards on her birthday (happy birthday mom!), even though she is 84 and not expected to last much longer. ?I even occasionally escort little old ladies across the street, although this is a holdover from my days as an Eagle Scout.

It?s just that Ben Bernanke and I don?t see eye-to-eye on a lot of important issues. He wants stocks to go up. ?As a hedge fund manager who plays from the short side more often than not when the economy is growing at a paltry 1.5% rate, I want them to go down. ?He wants bonds to go up too, as he clearly elicited with his ?twist policy? last year when he bought long term Treasury bonds and shorted overnight paper against it. ?I, on the other hand, want bonds to sell off because I know that when the bill comes due for all of this monetary easing, the crash will be momentous.

These are not the only matters we differ on. ?He wants to create jobs. ?He can wish this until the cows come home, but he?s not going to get them because of the gale-force demographic headwinds the country is now facing and the massive deleveraging by the public and private sector. ?The 6 million jobs we exported to China are never coming back.

However, all he has to do is make a mere mention of his desires, or even just mention the letter ?Q?, and asset prices go through the roof, forcing me to stop out of my shorts at losses. ?This is why I was in such a foul, acrimonious, and detestable mood during the first quarter, when stocks went up almost every day.

My problem is that Ben Bernanke isn?t the only person who dislikes me. ?President Obama doesn?t think much of me either. ?And it?s not because I refuse to buy a cold chicken dinner at his St. Francis Hotel fund raisers for $35,000, and $70,000 if I bring a date. ?He talks about jobs too. ?He frequently speaks about the need to improve our education system, even though I know he is poised to slash the budget for the Department of Education as part of some deal with the Republicans. ?Ditto for Social Security and defense.

Fortunately for me, I wrote off any prospect of getting a retirement check a long time ago and have made other arrangements, like becoming a hedge fund manager. Either the payments will be too small for me to live on, or they will be made in worthless Zimbabwean dollars.

I get along with Treasury Secretary, Timothy Geithner, OK, which keeps me on his ?must see? list whenever he stops in San Francisco on his way to Beijing to ask to borrow more money. ?But we go way back. ?There are only four people in U.S. history who can discuss Japanese monetary policy of the 1920?s in depth, and do it in Japanese just for laughs (it was clearly too easy, but they had to reflate after the 1923 Great Kanto Earthquake. ?Some things never change).

Two of them, Senator Mike Mansfield of Montana and Harvard professor, John K. Fairbank, died ages ago. ?So he is kind of limited in his choices. ?Besides, there are not a lot of people out there who can give him a 40 year view on the global economy, and I am one of them.

There are plenty of others who don?t think I am so hot. ?Try making a fortune in a market crash when everyone else is losing their shirt. ?While others in the locker room at my country club are slamming doors, tearing their hair out, and breaking golf clubs in half when they see the price feed on CNBC, I am chirping happily away about selling short at the top. ?I might as well be letting out a loud fart in Sunday church service. ?This explains why I stopped getting invitations to dinners ages ago.

It?s not that my relationship with Ben Bernanke is totally hopeless. ?When the demographic picture turns from a headwind to a tailwind and individuals and corporations cease deleveraging and return to re-leveraging, we?ll probably be reading from the same page of music. ?But according to the U.S. Census Bureau, the earliest this can happen is 2022. ?By then, he probably won?t be the Fed governor anymore and I won?t care if he likes me or not.

Besides, I may be able to make a new friend or two in the meantime. ?If Mitt Romney wins the presidential election he says he?ll fire Ben Bernanke on his first day in office. ?He can?t really do that, but Ben?s term does expire a year later. ?His two most widely rumored picks to fill the post are president of the Federal Reserve Bank of Dallas, Richard Fisher, and Stanford University professor, John Taylor.

These two are not in the least bit interested in all this quantitative easing malarkey. They are much more similar in philosophy to Herbert Hoover?s Treasury Secretary, Andrew Mellon, who popularized the ?let the chips fall where they may? approach to economic policy. ?Kick the props out from under this market and all of a sudden Dow 3,000 is on the table, as argued by Global strategist and demographics maven, Harry Dent.

They might even go as far as unwinding the Fed?s hefty $2.7 trillion balance sheet. ?That would give the Chinese, who hold $1 trillion of these bonds, a heart attack. ?But who cares? It would create the mother of all trading windfalls for me. ?Hell, they might not even care if I torture small animals, beat children with a switch, and leave little old ladies in the middle of onrushing traffic. ?I think we would get along just great.

Screw Social Security, and Ben Bernanke too.

The Great Kanto Earthquake of 1923

The Chinese Are Setting the Gold Market On Fire.

Diary

My friends in the gold futures puts have been telling me that the Chinese have emerged as major buyers in recent months. ?Year-to-date imports have reached 458 tonnes, more than four times the amount during the same period last year ? that amounts to $25 billion in real money. ?This is on top of the country?s massive local gold production, which is kept entirely in country, the exact details of which are unknown.

Explanations run the entire gamut of possibilities. ?There is a concerted attempt by the People?s Bank of China to diversify away from Treasury bills, notes and bonds at a 60-year market high. ?Since the end of 2011, the Middle Kingdom?s holdings of Treasuries have increased by a mere $12.4 billion to $1.164 trillion.

The Chinese have been investing in the entire range of higher-yielding securities, including European sovereign bonds with near junk bonds and emerging market debt, like the bonds issued by Singapore. ?They have also aggressively stepped up their foreign direct investment, picking up important energy assets in Canada just last month.

The Chinese could be buying gold for the simplest reason of all: it?s going up. Private gold ownership carried a death penalty there four years ago. Today there are precious metals coin shops in every city center.? The government is now encouraging individuals to keep some savings in gold. ?With a middle-class now at 400 million, that adds up to a lot of buyers.

Gold remains my favorite asset class, and I?ll be looking to jump back in on the next dip.

Quote of the Day

Diary

?We don?t think the economy is going to be overheating anytime soon,? said Federal Reserve Chairman, Ben Bernanke.

Testimonial.

Diary

?First, thanks so much for your Global Trading Dispatch Trade Alert service, which is not only a wealth building tool, but offers a comprehensive trading education. ?I sometimes trade your recommendations, and sometimes use your guidance to make more aggressive options and futures plays. ?I especially liked your call on gold (GLD).? It?s working very nicely for me.?

--Darell
USA

And My Prediction Is?

Diary

Take those predictions, forecasts, and prognostications with so many grains of salt. ?They have a notorious track record for being completely wrong, even when made by the leading experts in their fields. In preparing for my autumn lecture series, I came across these following nuggets and thought I?d share them with you ? There are some real howlers:

1876 ?This 'telephone' has too many shortcomings to
be seriously considered as a means of communication.?
-- Western Union internal memo.

1895? ?Heavier than air flying machines are impossible.?
-- Lord Kelvin, president of the Royal Society.

1927 "Who the hell wants to hear actors talk?"
-- H.M. Warner, founder of Warner Brothers.

1943 ?I think there is a world market for maybe five computers.?
-- Thomas Watson, Chairman of IBM.

1962 ?We don't like their sound, and guitar music
is on the way out.?
-- Decca Recording Co. rejecting the Beatles, 1962.

1981 ?640 kilobytes of memory ought to be enough for anybody.?
-- Bill Gates, founder of Microsoft.

September 12, 2012 -- Quote of the Day

Diary

?This has been the worst year for active managers in history. We have never seen numbers of people missing benchmarks so large. As the markets have moved up, the tracking error has grown. People are missing about a third of the upside in the markets,? said Thomas Lee, a chief equity strategist at JP Morgan.

Who is Ben Bernanke?

Diary

Since nothing less than the fate of the free world depends on the judgment of Ben Bernanke these days, I thought I?d touch base with David Wessel, the Wall Street Journal economics editor, who has just published In Fed We Trust: Ben Bernanke?s War on the Great Panic.

I doubted David could tell me anything more about the former Princeton professor I didn?t already know. I couldn?t have been more wrong, as David gave me some fascinating insights into the inner soul of our much-vaunted Chairman of the Federal Reserve.

Bernanke was the smartest kid in rural Dillon, South Carolina, who, through a series of improbable accidents, and intervention by a local black civil rights leader, ended up at Harvard. He built his career on studying the Great Depression, then the closest thing to paleontology economics had to offer, a field focused so distantly on the past, that it was irrelevant. Bernanke took over the Fed when Greenspan was considered a rock star, inhaling his libertarian, free-market, Ayn Rand inspired philosophy in great giant gulps.

Within a year, the economy suddenly transported itself back to the Jurassic Age, and the landscape was overrun with T-Rex?s and Brontesauri. He tried to stop the panic 150 different ways, 125 of which were terrible ideas, the remaining 25 saving us from the Great Depression II. This is why unemployment is now only 9.1%, instead of 25%.

The Fed governor is naturally a very shy and withdrawn person, and would have been quite happy limiting his political career to the Princeton, NJ school board. To rebuild confidence, he took his campaign to the masses, attending town hall meetings and pressing the flesh like a campaigning first term congressman.

The price tag for Ben?s success has been large, with the Fed balance sheet exploding from $800 million to $2.7 trillion, solely on his signature. The true cost of the financial crisis won?t be known for a decade or more. The biggest risk is that we grow complacent, having pulled back from the brink, and letting desperately needed reforms of the financial system and the rebuilding of Fannie Mae and Freddie Mac slide. This is already starting to happen.

How Bernanke unwinds this bubble will define his legacy. Too soon, and we go back into a real depression. Too late, and hyperinflation hits. That?s when we find out who Ben Bernanke really is.

Trading 101.

Diary

A number of readers have asked me why I?m not trading now. Since I put out my calls to sell Treasury bonds in August (click here for ?The Great Treasury Bond Crash of 2010? ), and buy US stocks in September (click here for ?My Equity Scenario for the Rest of 2010? ), I have mostly been sitting on my hands. I usually try to catch three or four trend changes a year, which might generate 50-100 trades, and often come in frenzied bursts.

Since I am one of the greatest tightwads that ever walked the planet, I only like to buy positions when we are at the height of despair and despondency, and traders are raining off the Golden Gate Bridge. Similarly, I only like to sell when the markets are tripping on steroids and ecstasy, and are convinced that they can live forever.

Some 99% of the time, the markets are in the middle, and there is nothing to do but deep research, looking for the next trade. That is the purpose of this letter. Over the four decades that I have been trading, I have learned a number of tried and true rules which have saved my bacon countless times. I will share them with you.

1) Don?t over trade. This is the number one reason why individual investors lose money. Look at your trades of the past year and apply the 90/10 rule. Dump the least profitable 90% and watch your performance skyrocket. Then aim for that 10%. Over trading is a great early retirement plan for your broker, not you.

2) Always use stops. Risk control is the measure of the good hedge fund trader. If you lose all your capital on the lemons, you can?t play when the great trades set up. Consider cash as having an option value.

3) Don?t forget to sell. Date, don?t marry you positions. Remember, pigs get slaughtered. Always leave the last 10% of a move for the next guy.

4) You don?t have to be a genius to play this game. If that was required, Wall Street would have run out of players a long time ago. If you employ risk control and stops, then you can be wrong 40% of the time, and still make a living. That?s little better than a coin toss. It you are wrong only 30% of the time, you can make millions. If you are wrong a scant 20% of the time, you are heading a trading desk at Goldman Sachs. If you are wrong a scant 10% of the time, you are running a $20 billion hedge fund that the public only hears about when you pay $100 million for a pickled shark at a modern art auction. If someone says they are never wrong, as is often claimed on the Internet, run a mile, because it is impossible.

5) This is hard work. Trading attracts a lot of wide eyed, na?ve, but lazy people because it appears so easy from the outside. You buy a stock, watch it go up, and make money. How hard is that? The reality is that successful investing requires twice as much work as a normal job. The more research you put into a trade, the more comfortable you will become, and the more profitable it will be. That?s what this letter is for.

6) Don?t chase the market. If you do, it will turn back and bite you. Wait for it to come to you. If your miss the train, there will be another one along in hours, days, weeks, or months. Patience is a virtue.

7) When I put on a position, I calculate how much I am willing to lose to keep it. I then put a stop just below there. If I get triggered, I just walk away. Only enter a trade when the risk/reward is in your favor. You can start at 3:1. That means only risk a dollar to potentially make three.

8) Don?t confuse a bull market with brilliance. I am not smart, just old as dirt.

9) Tape this quote from the great economist and early hedge fund trader of the thirties, John Maynard Keynes, to you computer monitor: "Markets can remain illogical longer than you can remain solvent." Hang around long enough, and you will see this proven time and again (ten year Treasuries at 2.4%?!).

10) Don?t believe the media. I know, I used to be one of them. Look for the hard data, the numbers, and you?ll see that often the talking heads, the paid industry apologists, and politicians don?t know what they are talking about (the Gulf oil spill will create a dead zone for decades?).

11) When you are running a long/short portfolio, 80% of your time is spent managing the shorts. If you don?t want to do the work, then cash beats a short any day of the week.

12) Sometimes the conventional wisdom is right.

13) Invest like a fundamentalist, execute like a technical analyst.

14) Use technical analysis only and you will buy every rally, sell every dip, and end up broke. That said, learn what an ?outside reversal? is, and who the hell is Leonardo Fibonacci.

15) The simpler a market approach, the better it works. Everyone talks about ?buy low and sell high?, but few actually do it. All black boxes eventually blow up, if they were ever there in the first place.

16) Markets are made up of people. Understand and anticipate how they think, and you will make a lot of money.

17) Understand what information is in the market and what isn?t and you will make more money.

18) Do the hard trade, the one that everyone tells you that you are ?Mad? to do. If you add a position and then throw up afterwards, then you know you?ve done the right thing. This is why people started calling me ?Mad? 40 years ago.

19) If you are trying to get out of a hole, the first thing to do is quit digging and throw away the shovel. A blank position sheet can be invigorating.

20) Making money in the market is an unnatural act. We humans are predators and hunters evolved to track game on the horizon of an African savanna. Modern humans are maybe 5 million years old, but civilization has been around for only 10,000 years. Our brains have not had time to make the adjustment. In the market, this means that if a stock has gone up, you believe it will continue. This is why market tops and bottoms see volume spikes. To make money, you have to go against these innate instincts. Some people are born with this ability, while others can only learn it through decades of training. I am in the latter group.

Great Hunter, Lousy Trader

The New California Gold Rush.

Diary

The gold rush is back on in California. On my way back from Lake Tahoe recently, I saw that every bend of the American river was dotted with hopeful amateur miners, looking to make a windfall fortune.

Weekend hobbyists were there panning away from the banks, while the hardcore pros stood in hip waders balancing portable pumps on truck inner tubes, pouring sand into sluice boxes. A sharp-eyed veteran can take in $2,000 worth of gold dust a day. The new 2012?ers were driven by a price of gold at $1,700 and the attendant headlines, but also by unemployment, and recent heavy rains last winter that flushed huge new quantities of the yellow metal out of the High Sierras.

They were no doubt inspired by the chance discovery of an 8.7 ounce nugget in May near Bakersfield, worth an impressive $10,000. Local folklore says that The Sierra?s have given up only 20% of their gold, and the remaining 80% is still up there awaiting discovery. Out of work construction workers are taking their heavy equipment up to the mountains and using it to reopen mines that have been abandoned since the 19th century.

The U.S. Bureau of Land Management says that mining permits in the Golden State this year have shot up from 15,606 to 23,974. Unfortunately, the big money here is being made by the sellers of supplies and services to the new miners, much as Levi Strauss and Wells Fargo did in the original 1849 gold rush. Of course, they could much more easily buy the Spider Gold Trust Shares ETF (GLD), but it wouldn?t be as much fun.

Nice to Meet You