Newsletter Archives - Mad Hedge Fund Trader

The 30-Year View on What's Happening Today.

Take a look at the 30 year chart of the S&P 500 below, and it?s clear that the market is approaching a critical juncture. With the closely watched index closing at 1,460 today, we are a mere 140 points from the iron ceiling that has been unassailable for the past 13 years.

The chart is a roll call of past disasters for American investors. The 2000 peak was the apex of the Dotcom Bubble. The 2006 high water market defined the end of the Housing Bubble. Since March 9, 2009, a scant 15 days after president Obama took office, the index has soared by a record breaking 119%.

Something tells me this won?t go down in history as the ?Great Obama Bull Market?. Maybe it will become known as the ?Quantitative Easing Bubble? or the ?Bernanke Bubble?. Only future armchair economic historians will know for sure.

The chart clearly defines the last lost decade for stocks, as well as the second missing decade we are currently in. If the US economy were growing at a nice 3% annual clip, I would say that we are taking a run at the 13 year high, will breakout to the upside, and quickly tack on 10%-20% from there.

Unfortunately, that is not the world we live in. In fact, we are growing at half that rate on a good day, and are facing major challenges ahead. Bernanke?s announcement of QE3 last week (although he never used that precise term), will give markets the juice to take a serious run at 1,600 in the coming six months. But then, I think the fundamentals will cause it to fail once again.

Even the best case scenario for the resolution of the fiscal cliff at year-end takes a minimum of 3.5% out of GDP growth next year. The economies of Europe, China, and Japan remain in free-fall. U.S. corporations may be about to deliver their first YOY zero earnings growth in three years.

All of this sets up a recession in 2013 that will be tough to avoid. This is why U.S. companies are loathe to hire, have crimped capital spending at half of their historic levels at $2 trillion, and are sitting on cash mountains. They are obviously running scared.

The shock of the magnitude of this QE3 will get digested and fully priced in by the markets by Q1, 2013, right around the time the (SPX) is peaking short of 1,600. Then, one of the greatest shorting opportunities of the century will set up. I hate to sound like a broken record, but ?Sell in May and go away? is likely to work for the fourth year in a row. Except this time, you might not want to come back until August of 2014.

Is This a SELL Signal?

If You Had Any Doubts About Gold ...

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Since Ben Bernanke?s announcement of QE3 last week, new forecasts for gold have been popping up like acne at a high school prom. They range from the conservative to the absurd, from $1,900 to $55,000. But they all have one thing in common: higher. Before you head down to the local coin store to load up on bags of one ounce American gold eagles, let me go through the simplest of the many bull arguments.

The most positive interpretation of QE3 is that it will expand the Federal Reserve?s balance sheet from $2.7 trillion to $5 trillion over the next two years. This is up from only $800 billion in 2008. QE1&2 took the Fed balance sheet up by $2 trillion, but the money supply (M0) increased by only $300 billion. Where did the rest of the money go?

The answer is that it went into the reserves of private banks, where it still sits today. When these funds are released, everyone will rush out and buy stuff, and the inflationary implications will be awesome. This is bad news for the dollar. As gold is priced in dollars, it will be the first to feel the impact. Witness the 18% rise we have seen off of the July bottom.

How far does it have to run? The correlation between the price of gold and the broader money supply M1, a measure of the currency in circulation plus demand deposits or checking account balances at banks, is almost 1:1. In 2008, M1 doubled from $800 billion to $1.6 trillion, and so did the yellow metal, from $500 to $1,000. The Fed?s balance sheet is roughly equivalent to M1. So a near doubling of the balance sheet to $5 trillion should take gold up a similar amount. Using $1,720 as the base level before the Fed?s announcement, that takes the barbarous relic up to $3,440 over the next two years.

Spoiler alert! Gold tends to front run the growth of M1. So while we may see a disciplined straight-line rise in the Fed balance sheet as it diligently buys $40 billion a month in mortgage-backed securities, gold won?t be so patient. It could go parabolic at any time. My first target: the old inflation adjusted high of $2,300, which we could see some time in 2013.

The instruments to entertain here are the gold ETF?s (GLD) and (IAU), gold miners like Barrick Gold (ABX), and the gold miners ETF (GDX). If you are hyper aggressive, you might look into 100 ounce gold futures contracts traded on the COMEX. They offer leverage of 19:1, with an initial margin requirement of $9,113. ?If my $3,440 target is achieved, the value of one contract would rocket to $166,800, an increase of 17,300%. But this is only for those who wish to play at the deep end of the pool and are authorized for futures trading.

And then there are those one-ounce American gold eagles, now retailing for $2,300.

Growth of M1 to 2014

One Ounce American Gold Eagle

Buy What Ben?s Buying.

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In view of Federal Reserve Chairman, Ben Bernanke, yesterday: ?it is time to reassess one?s investment strategy. ?The former Princeton professor didn?t give us QE3, he gave us QE3 with a turbocharger, on steroids, with an extra dose of adrenaline. ?He could spend another $1 trillion before all is said and done. ?If ever an economic theory was pursued to extremes, this is it. ?No doubt future PhD candidates will be writing theses on this move for the next 100 years.

If the QE3 guessing game was driving you nuts this year, you better sign up for frequent flier points with your psychiatrist. ?After the initial commitment, the Fed reserves the right to renew quantitative easing, with the decision to be rendered on the last business day of each month in any size to buy any securities. ?Yikes! ?Will the market now flat line every month and then gap up or down 500 points on the final day when the August decision is announced? ?Double Yikes!

I am not going to sit in my throne at the beach like King Cnut and order the tide not to rise and wet my feet and robes. ?It is not for us to trade the market we want, but the market we have. ?It is interesting listening to the commentary on all of this. The fundamentalists are pissed off because their hard work led to a near universal conclusion that the economy was tanking, only to be met by a stock market surging to a new five year high. ?The technicians are cautiously optimistic trumpeting new upside breakouts. ?The index players (what few are still in the market, anyway) are ecstatic, now that going to sleep is paying off once again.

The basic strategy here is to throw risk out the window and gun for yield, which the Fed has put squarely back on the table. ?That means buying junk bonds (JNK), (HYG), at a 7.00% yield, emerging market sovereign debt (PCY) at a 4.72% yield, and high-yield equities like the telecoms, such as Verizon (VZ) and AT&T (T), which both yield around 4.70%. ?At least this way, you get paid for waiting out any heat on the downside.

You could even buy exactly what Ben Bernanke is buying: mortgage-backed securities. The central bank will be purchasing half of the $140 billion a month in mortgage backed bonds that Fannie Mae (FNM), Freddie Mac, and Ginnie Mae sell to meet its new commitments. You can easily do that through picking up the Nuveen Mortgage Opportunity Term Fund (JLS), a closed end fund selling at a $2% premium to net asset value. It carries a hefty 7.7% yield, but not for long.

It is 73% invested in residential mortgage-backed securities, 12% in commercial mbs, and 7% in agency collateralized mortgage obligations. ?It does use leverage and hedging strategies to achieve this acrophobic yield, and already had a big gap up in price yesterday. ?But what are the chances that it discounted the next year of Fed bond buying in just one day? ?About zero.

QE3 Blows Out Bears.

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The big surprise today was not that the Federal Reserve launched QE3, but the extent of it. ?For a start, they moved the ?low interest rate? target out to mid-2015. ?They left the commitment to bond-buying open-ended. ?The first-year commitment came in at $480 billion, in-line with previous efforts.

Reading the statement from the Open Market Committee, you can?t imagine a more aggressive posture to stimulate the economy. ?You have to wonder how bad the data that we haven?t seen yet is, not just here, but in Europe and Asia as well. The big question now is: ?Will it make any difference??

Asset markets certainly bought the ?RISK ON? story hook, line, and sinker in the wake of the Fed action. ?Gold leapt $30, the Dow soared 200 points, the dollar (UUP) was crushed, the Australian dollar (FXA) rocketed a full penny (ouch!), and junk bonds (HYG) caught a new bid at all-time highs. ?The real puzzler was the Treasury bond market, which saw the (TLT) fall 2 ? points. ?I guess this is because the new Fed buying will be focused on mortgage-backed securities at the expense of Treasuries.

I knew that if they were to do anything, it would be aimed at the residential real estate market, which has been a thorn in their side for the last five years. ?The reason we have 1.5% growth instead of 3% is real estate. Real estate is the missing 1.5%.

But what will be the impact? ?Some $480 billion of buying of mortgage-backed securities over the next 12 months will lower the 30 year conventional mortgage from the current 3.70%. ?But all that will do is enable those who refinanced for the last two years in a row to do so a third time. Those who are underwater on their mortgages and have only negative equity to offer banks as collateral will remain shut out. ?This will generate a big payday for mortgage brokers, but won?t trigger any net new home-buying which the economy desperately needs.

The harsh reality for the housing market is that the demographic headwind of downsizing baby boomers is so ferocious that the Fed is unable to piss against it. Here is the problem:

*80 million baby boomers are trying to sell houses to 65 million Gen Xer?s who earn half as much

*6 million homes are late or in default on payments

*An additional shadow inventory of 15 million units overhangs the market owned by frustrated sellers

*Fannie Mae and Freddie Mac are in receivership, which account for? 95% of US home mortgages.? Each needs $100 billion in new capital. Good luck getting that out of a deadlocked congress

*The home mortgage deduction a big target in any tax revamp. The government would gain $250 billion in revenues in such a move

*The best case scenario for real estate is that we bump along a bottom for 5 years. The worst case is that we go down another 20% when a recession hits in 2013.

It could be that 95% of the new QE3 is already in the market, and that the markets will roll over once the initial headlines and ?feel good? factor wears off. ?With the markets discounting this action for nearly four months, this could be one of the greatest ?buy the rumor, sell the news? opportunities of all time.

Whatever the case, I am not inclined to chase risk assets up here. Anyway, I am now so far ahead of my performance benchmarks for the year that I can?t even see them on a clear day.

Is That My Benchmark Out There?

Raising My Apple Target to $1,600.

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Long-term readers of this letter are well aware of my pleadings with them a couple of years ago to buy Apple (AAPL) stock at $250 with a target of $1,000. Certainly, the 200 readers who work for Apple noticed. ?That was back when the main concern about the company was that Steve Jobs would die young.

In view of the upgrades present in the iPhone 5 announced today, I am going to have to raise my long term target for the shares to $1,600. ?And it could achieve that lofty price in as little as two years.

First, the specs: The new iPhone will be thinner, faster, and lighter, with a longer battery life. ?The new phone is a paper thin 7.6 mm thick and weighs 112 grams, 18% thinner and 20% lighter than the model 4s. ?The screen gains ? inch to 4 inches in able to accommodate a full HD format.? The new A6 processor is twice as fast as the old one. ?It offers full 4G LTE connectivity to handle wireless video. Talk time is extended to 8 hours, and 10 hours for web surfing. ?The camera jumps to a near professional 8 megapixels. ?In short, it is head-and-shoulders above any potential competitor.

You can preorder the phone from Friday. ?Some analysts see 50 million phones shipping in the next quarter and 170 million in all of 2013, generating 85% of the company?s total revenues. ?The order flow is expected to be so massive that economists think it could add as much as 0.3% to US Q4 GDP.

Apple is the ultimate value play. ?Looking at the forward financials, the stock is still astoundingly cheap, despite a 70% gain so far this year. ?It is selling at a bargain basement 11X 2013 earnings ex-cash. It has a dividend yield of 2%, no debt, and is growing at 15% a year.

By comparison, the S&P 500 is growing at 5% a year at best, offers a dividend yield of less than 2%, has debt of 35% of capital and sells at a 14X multiple. ?In other words, it is more expensive, slower growing, yielding less, with fewer assets backing the shares. ?Why anyone looks at other stocks than Apple is beyond me.

On top of this, Apple has a cash mountain of $120 billion which is growing at a prolific rate, and it has a fantastic lineup of new products in the pipeline. ?The recent Samsung patent win will do a lot to scare away potential competitors. ?The franchise value of the company is huge.

You can also throw in the longer term arguments for the company that I have made before. ?After being shunned for decades, Apple products are now in the process of going mainstream corporate. ?A future China deal will give it access to 600 million new subscribers there. ?Any other new products on top of the iPhone 5, like Apple TV, an iPad mini, or enhanced iPods, will just be cream on the cake.

The trick is how to buy the stock, as it has been all year. ?We seem to get one 20% dip a year, as we saw in April this year and October, 2011 ? usually around an earnings disappointment or a generalized market selloff. ?Use the next one of these to load the boat. ?This is the stock you sock away for your kids? college educations or your own retirement, as I have done.

Steve Jobs would be smiling.

Nice Job, Steve!

My Fed Call.

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My Fed Call. Survey traders and investors today, and you will find that 99% believe further quantitative easing via QE3 will be announced on Thursday. Poll vote Fed governors and you get a more realistic 50% probability. I think it is much less than that ? and therein lies the trade.

I think that markets are getting rather over-expended up here. They have been discounting the launch of QE3 since June 1, or more than three months. The (SPY) has rocketed some 12.7% from $128 to $144.33 during this time. It has also done this in the face of a dramatically weakening economy around the world.

This means that an asymmetric situation has developed in the (SPY). If the Fed delivers, as most hope, we may rally a little further up to maybe $145 and then churn sideways until the presidential election. If it disappoints, as I expect, you could get a sudden, gut-churning sell-off worth 5-10 points in the (SPY).

So caution argues for covering all of my short put positions, and running my long put positions through the Fed decision. It?s a heads I lose $1, tails I win $10 situation. I?ll take those odds all day long.

The good news is that the economy is just not bad enough for a full blown QE3. It is growing at a 1.5% annual rate. It is not shrinking. Corporate profits are at an all-time high. S&P 500 companies will come in around $100 a share this year, compared to $50 four years ago, and are hardly in need of a rescue. They are sitting on a $2 trillion mountain of cash, much of it offshore. I don?t see a QE3 anywhere in this.

The August nonfarm payroll figures further bolster this view. We came in at 96,000, some 29,000 less than consensus expectations. This is a far cry from the 700,000 in losses we were clocking 3? years ago. Gains of this magnitude are about half of what we should be at this stage of the economic cycle. But they certainly don?t justify a last-ditch emergency bailout.

The Fed is in the safety-net business, not the stepladder lending business, so you can boost asset prices ever higher. If you only have one bullet left you don?t waste it taking pot shots at empty beer bottles ? you wait until you are surrounded by Indians who are about to set the wagons on fire.

You could argue that the Fed?s dual mandate to focus on both employment and inflation would urge it to accelerate the printing presses to boost employment. However, there is little evidence that flooding the money supply will create additional jobs. It is simply pushing on a string. The hurricane-force demographic headwind the U.S. will face until 2022 assures there will be little demand for new workers no matter what the Fed does.

While offering little upside, QE3 does offer plenty of potential downside costs. For a start, it would expand the Fed?s balance sheet by another $500 billion to $3.5 trillion, the minimum size that a QE3 would require. This increases inflation risks down the road, a subject that Fed governors are ever cognizant of.

Nor is the Fed in the ?feel good? business. Even if we do see QE3, it is already priced in the market. It would be the most over-anticipated, non-surprise of the year. There would be no impact on the economy. Any boost would be psychological and brief. Leave that chore to your therapist, or your local bartender.

Finally, if China and Europe and launching their own stimulus programs, as they have done in the last week, why should the U.S. bother? Our economy is the healthiest of the bunch. We are the engine in this train, not the caboose.

I happen to know that at least three Fed governors agree with me. For a policy as momentous as QE3, with such long term implications for the health of the U.S. economy, Ben Bernanke would prefer to have a consensus. My Fed contacts assure me that the consensus is just not there.

What do we do in the face of any substantial sell off on a QE3 disappointment? You buy. I think that any plunge will be temporary, and it could be a matter of days or weeks before we resume an uptrend. The impending end of the presidential election is market positive, no matter who wins, and so is the resolution of the fiscal cliff after that.

?What's on Your Mind, Ben??

Another Trade Alert Service All-Time High.

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Global Trading Dispatch?s Trade Alert Service posted a new all-time high yesterday, clocking a 63.2% return since inception. The 2012 YTD return is now at 23.05%. That takes the average annualized return up to 33.3%, ranking it among the top performing hedge funds in the world.

Those happy subscribers who bought my service on May 23 have seen an amazing 25 consecutive closing trade recommendations turn profitable, a new career high for myself.

My satisfaction in all of this comes from the knowledge that thousands of followers are making money in the markets that never would otherwise. I am protecting them from getting ripped off by the sharks on Wall Street with their conflicted and indifferent research.

I am expanding their understanding of not just financial markets, but the world at large. And I am doing this during some of the most difficult trading conditions in history. Only 11% of hedge funds have managed to beat the S&P 500 since January 1.

The roster of winning closed trades is below:

Global Trading Dispatch, my highly innovative and successful trade-mentoring program, earned a net return for readers of 40.17% in 2011. The service includes my Trade Alert Service, daily newsletter, real-time trading portfolio, an enormous trading idea database, and live biweekly strategy webinars. To subscribe, please go to my website at www.madhedgefundtrader.com, find the ?Global Trading Dispatch? box on the right, and click on the lime green ?SUBSCRIBE NOW? button.

?Trade Alert Service Since Inception

Buy the Big Dip in Gold.

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Look at the charts for the barbarous relic below and you can only come to one possible conclusion. If the Federal Reserve disappoints on Thursday, just a little bit, even by a smidgeon, and does not deliver QE3 and gold sells off big, you should jump in and by the stuff like crazy.

All of the charts for gold and the derivative plays are showing major breakouts to the upside. This is true for spot gold and the ETF (GLD), which broke a major downtrend line last week. It is the case for the gold miners ETF (GDX). It is also the reality for silver, the silver ETF (SLV), and the silver miners (SIL).

The entire precious metals space has been floated since the prospect of further quantitative easing from the world?s central banks started in earnest on May 15. Since then, it has been prudent and profitable to buy every dip.

European Central Bank president Mario Draghi did the heavy lifting in mid-July by promising to ?Do whatever it takes to rescue the Euro? (read: huge quantitative easing). He then put his money where his mouth was last week by announcing an unlimited bond-buying program.

Assorted dovish Federal Reserve governors have done their bit by talking up the prospect of further monetary easing. China threw in its ten cents by announcing a $150 billion reflationary budget on Friday. Even the Bank of Japan has been heard murmuring about additional money printing. It all has the smell of an international coordinated effort to reflate the global economy.

Where exactly do you get back in? The sweet spot in the (GLD) will be the 200 day moving average at $159.66, which fell at the end of August. That is down $7.94 in (GLD), or $79.40 in the spot market from here.

Would you Consider a Long-Term Relationship?

The China News is Big.

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NOTE TO READERS: There is a short letter today because I spent the entire weekend writing Trade Alerts, which you will receive right at the Monday morning opening.

Last Friday, China announced a $150 billion reflationary public works budget designed to arrest the current free fall in the country?s GDP growth rate. The move came totally out of the blue and caught many China bears by surprise.

The National Development and Reform Commission has approved 60 new projects, led by railways, roads, harbors, and airports. While the plethora of plans is stretched over several years, it is clear the Politburo is trying to help the Communist party through its handover of power later this autumn. This has major implications for the global economy.

Cheng Li, research director at the Brookings Institution, said Beijing slammed on the brakes too hard last year to break the back of the property boom. Home prices are now off as much as 25%. So the Middle Kingdom appears to be back-peddling on these measures as fast as it can.

The immediate impact on financial markets was almost as great in the U.S. as it was in the Middle Kingdom, which saw Shanghai rocket 5% in a single day. It was off to the races for anything commodity related, including Caterpillar (CAT), copper (CU), Freeport McMoRan (FCX), US Steel (X), coal (KOL), and other materials sectors, all of which have been in a vicious bear market since 2011. It also calls into question the prudence of my short position in the Australian dollar, which has added two cents since the announcement.

We will have to wait a few more days to see if this move is real and sustainable, or just another short covering dead cat bounce. But this is what bottoms look like, and if it is, the ?BUY? opportunities in the entire space are huge. These are almost the last cheap stocks left.

Hmmm. Looks Like the Economy is Slowing Too Fast

Quit Singing ?Waltzing Matilda? in the Shower. Trade Alert:

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Sell Short the Currency Shares Australian Dollar Trust October, 2012 (FXA) $105-$108 call spread at $0.35 or best

Opening Trade

9-4-2012 ? 2:00 PM EST

expiration date: October 19, 2012

Portfolio weighting: 10% = 45 contracts on a net delta adjusted basis

This is a bet that the Currency Shares Australian Dollar Trust October, 2012 (FXA) trades at or below $105.35 on the October 21 expiration in six weeks. That means that the cash market has to move up 3.1 cents, or 3.0% from today?s level of $102.25 for you to lose money.

I saw this one coming a mile off, and have been urging listeners of my biweekly strategy webinars to use any good entry point to sell short the Australian dollar. But I missed my own chance to sell at the recent top at $105. I should try reading my own research someday.

Here is the base case to quit singing ?Waltzing Matilda? in the shower every morning. Australia?s largest export is iron ore, which accounts for 25% of the total. The problem is that the three-year slowdown in the Chinese economy has dragged the price for iron ore down 25% in the past month, and 50% from its 2011 top. It is the world?s second largest bilateral trade and a valuable window for traders and investors on the health of the global economy.

The country?s largest producers, Broken Hill (BHP) and Rio Tinto (RIO) have taken a major hit to profitability, and have begun delaying or cancelling new mines. To learn more about this foreboding developing in depth, please click here for ?BHP Cut Bodes Ill for the Global Economy? at http://madhedgefundradio.com/bhp-cut-bodes-ill-for-the-global-economy/). The hemorrhage is now predictably starting to feed into weaker Australian GDP growth figures.

Last night?s weaker-than-expected Chinese Purchasing Manager Index figure was the stick that finally broke the camel?s back. The Aussie responded by plunging a full penny, and slicing through the bottom of its recent trading range at $1.03.

The ideal way to do this trade was to buy something like an (FXA) November $101-$105 put spread. Since we are well off the top, there is no point in pursuing the Aussie with such an aggressive position at this level.

However, there is still plenty of nice, juicy premium left in out-of-the-money calls sitting on the table. I am more than happy to reap these in the form a short position in the (FXA) October $105-$108 call spread.

Tonight the Ministry of Finance in Canberra announces the most-recent GDP figures. If they come in weak, as I expect, the Aussie may accelerate its downward descent. If they come in better than expected, use the opportunity to add a short position in the Aussie at better prices. Neither the iron ore trade, nor the Chinese economy, are things that turn on a dime, as the capital investment lead times are so long.

If this spread expires anywhere under $105, as I hope, your total profit should amount to (45 X 100 X $0.35) = $1,575. That gives you a profit on this six-week play of 1.57% for the notional $100,000 model portfolio.

Keep in mind that this is a solid ?RISK OFF? trade, as it bets on the continued slowing of the global economy, especially for hard commodities like the base metals. It can therefore be used to offset the existing aggressive ?RISK ON? trades we already have in Apple (AAPL) and gold (GLD).

Don?t place a market order for this trade or the floor traders will rip your eyes out. Don?t place individual orders for the legs either. Instead, place a limit day order in the middle market to sell the entire call spread only around $0.35, and wait for the market to come to you. It will find you.

The market can be illiquid for the deep out-of-the money $108 calls. You need this leg to cap and define your risk, as well as minimize your margin requirement for the position.

If nothing happens then start raising your bid for the spread in 5 cent increments until something happens. You might also consider scaling into less leveraged short positions, such as through selling short the ETF (FXA) on any rally.

If you can?t get done at a price that you are happy with, then walk away and wait for the next trade alert. There will be plenty of trading opportunities in coming months. The same is true if I have failed to adequately explain this trade and you don?t understand it.

These are the trades you should execute:

Sell short 45 October, 2012 (FXA) $105 calls at??$0.40
Buy 45 October, 2012 (FXA) $108 calls at????.$0.05
Net Premium Proceeds:????.?..?????...$0.35

Time to short Crocodile Dundee