Research Archives - Mad Hedge Fund Trader

Amgen Big Win

Amgen Inc. (AMGN) won big in its patent case against Sanofi SA (SAN) and Regeneron Pharmaceuticals Inc. (REGN). The battle was over Repatha, a cholesterol-lowering drug said to be more potent than Pfizer’s Lipitor.

Billions of dollars in projected sales are anticipated to be at stake, with the court still in the process of determining how much the opposing companies owe Amgen in royalties.

A U.S. jury in Wilmington Delaware confirmed the validity of Amgen's patents on Repatha, rejecting the joint arguments of Sanofi and Regeneron that the documents failed to adequately describe the drug invention or explain the process of creating the antibodies the patents claim to cover.

This ruling confirms that the creation of Praluent, the competing cholesterol drug jointly created by Sanofi and Regeneron, infringed upon Amgen's patents.

The affirmation of these two patents validates three of Amgen's five claims against the opposing drug companies. However, the decision currently does not affect the U.S. availability of Regeneron and Sanofi's drug Praluent.

Praluent and Repatha are drugs categorized as “PCSK9 inhibitors.” These are designed for patients with ultra-high LDL or “bad” cholesterol whose condition cannot be regulated by commonly prescribed medications like Pfizer's Lipitor. These drugs claim to be able to lower a patient's cholesterol level to a "safe" point as opposed to allowing it to plummet to fatal levels.

Both Praluent and Repatha are anticipated to become blockbuster drugs for the biotech companies, with Sanofi and Amgen competing neck and neck in relative positioning.

Amgen's Repatha is projected to rake in an estimated $2.21 billion in sales by 2022, while Sanofi's Praluent is expected to reach roughly $800 million.

The legal battle between these biotech firms started in 2014, with Amgen winning a similar verdict in 2016 which resulted in a court order blocking the sales of Praluent. In October 2017 though, a U.S. Court of Appeals for the Federal Circuit vacated the district court's ruling to ban the sales of the embattled Sanofi cholesterol drug.

Although Amgen triumphed in this latest round, the fight is far from over as Sanofi and Regeneron announced their intention to challenge the ruling. The latter companies plan to file for post-trial motions in the succeeding months with the goal of overturning the verdict. They intend to demand a new trial as well.

Ironically, (REGN) has been the better performing stock since the Christmas Eve Massacre, rising by an eye-popping 27%, compared to (AMGN)’s almost 5.5% gain and (SNY)’s pocket change pick up of 2.1%.

BUY AMGEN ON THE DIP.

Why China’s US Treasury Dump Will Crush the Bond Market

Diary, Newsletter, Research

Years ago, if you asked traders what one event would destroy financial markets, the answer was always the same: China dumping its $1 trillion US treasury bond hoard.

It looks like Armageddon is finally here.

Once again, the Chinese boycotted this week’s US Treasury bond auction.

With a no-show like this, you could be printing a 2.90% yield in a couple of weeks. It also helps a lot that the charts are outing in a major long term double top.

You may read the president’s punitive duties on Chinese solar panels as yet another attempt to crush California’s burgeoning solar installation industry. I took it for what it really was: a signal to double up my short in the US Treasury bond market.

For it looks like the Chinese finally got the memo. Exploding American deficits have become the number one driver of all asset classes, perhaps for the next decade.

Not only are American bonds about to fall dramatically in value, so is the US dollar (UUP) in which they are denominated. This creates a double negative hockey stick effect on their value for any foreign investor.

In fact, you can draw up an all assets class portfolio based on the assumption that the US government is now the new debt hog:

Stocks – buy inflation plays like Freeport McMoRan (FCX) and US Steel (X)
Emerging Markets – Buy asset producers like Chile (ECH)
Bonds – run a double short position in the (TLT)
Foreign Exchange – buy the Euro (FXE), Yen (FXY), and Aussie (FXA)
Commodities – Buy copper (CU) as an inflation hedge
Energy – another inflation beneficiary (USO), (OXY)
Precious Metals – entering a new bull market for gold (GLD) and silver (SLV)

Yes, all of sudden everything has become so simple, as if the fog has suddenly been lifted.

Focus on the US budget deficit which has soared from $450 billion a year ago to over $1 trillion today on its way to $2 trillion later this year, and every investment decision becomes a piece of cake.

This exponential growth of US government borrowing should take the US National Debt from $22 to $30 trillion over the next decade.

I have been dealing with the Chinese government for 45 years and have come to know them well. They never forget anything. They are still trying to get the West to atone for three Opium Wars that started 180 years ago.

Imagine how long it will take them to forget about washing machine duties?

By the way, if I look uncommonly thin in the photo below it’s because there was a famine raging in China during the Cultural Revolution in which 50 million died. You couldn’t find food to buy in the countryside for all the money in the world. This is when you find out that food has no substitutes. The Chinese government never owned up to it.

About the Trade Alert Drought

Diary, Newsletter, Research

Long term subscribers are well aware that I sent out a flurry of Trade Alerts at the beginning of the year, almost all of which turned out to be profitable.

Unfortunately, if you came in any time after January 17 you watched us merrily take profits on position after position, whetting your appetite for more.

However, there was nary a new Trade Alert to be had, nothing, nada, and even bupkiss. This has been particularly true with particular in technology stocks.

There is a method to my madness.

I was willing to bet big that the Christmas Eve massacre on December 24 was the final capitulation bottom of the whole Q4 move down, and might even comprise the grand finale for an entire bear market.

So when the calendar turned the page, I went super aggressive, piling into a 60% leverage long positions in technology stocks. My theory was that the stocks that had the biggest falls would lead the recovery with the largest rises. That is exactly how things turned out.

As the market rose, I steadily fed my long positions into it. As of today we are 80% cash and are up a ballistic 13.51% in 2019. My only remaining positions are a long in gold (GLD) and a short in US Treasury bonds (TLT), both of which are making money.

So, you’re asking yourself, “Where’s my freakin' Trade Alert?

To quote my late friend, Chinese premier Deng Xiaoping, “There is a time to fish, and there is time to mend the nets.” This is now time to mend the nets.

Stocks have just enjoyed one of their most prolific straight line moves in history, up some 20% in nine weeks. Indexes are now more overbought than at any time in history. We have gone from the best time on record to buy shares to the worst time in little more than two months.

My own Mad Hedge Market Timing Index is now reading a nosebleed 74. Not to put too fine a point on it, but you would be out of your mind to buy stocks here. It would be trading malpractice and professional negligent to rush you into stocks at these high priced level.

Yes, I know the competition is pounding you with trade alerts every day. If they work, it is by accident as these are entirely generated by young marketing people. Notice that none of them publish their performance, let alone on a daily basis like I do.

You can’t sell short either because the “I’s” have not yet been dotted nor the “T’s” crossed on the China trade deal. It is impossible to quantify greed in rising markets, nor to measure the limit of the insanity of buyers.

When I sold you this service I promised to show you the “sweet spots” for market entry points. Sweet spots don’t occur every day, and there are certainly none now. If you get a couple dozen a year, you are lucky.

What do you buy at market highs? Cheap stuff. That would include all the weak dollar plays, including commodities, oil, gold, silver, copper, platinum, emerging markets, and yes, China, all of which are just coming out of seven-year BEAR markets.

After all, you have to trade the market you have in front of you, not the one you wish you had.

So, now is the time to engage in deep research on countries, sectors, and individual names so when a sweet spot doesn’t arrive, you can jump in with confidence and size. In other words, mend your net.

Sweet spots come and sweet spots go. Suffice it to say that there are plenty ahead of us. But if you lose all your money first chasing margin trades, you won’t be able to participate.

By the way, if you did buy my service recently, you received an immediate Trade Alert to by Microsoft (MSFT). Let’s see how those did.

In December, you received a Trade Alert to buy the Microsoft (MSFT) January 2019 $90-$95 in-the-money vertical BULL CALL spread at $4.40 or best.

That expired at a maximum profit point of $1,380. If you bought the stock it rose by 10%.

In January, you received a Trade Alert to buy the Microsoft (MSFT) February 2019 $85-$90 in-the-money vertical BULL CALL spread at $4.00 or best.

That expired last week at a maximum profit point of $1,380. If you bought the stock it rose by 12%.

So, as promised, you made enough on your first Trade Alert to cover the entire cost of your one-year subscription ON THE FIRST TRADE!

The most important thing you can do now is to maintain discipline. Preventing people from doing the wrong thing is often more valuable than encouraging them to do the right thing.

That is what I am attempting to accomplish today with this letter.

The Liquidity Crisis Coming to a Market Near You

Diary, Newsletter, Research

I had the great pleasure of having breakfast the other morning with my longtime friend, Mohamed El-Erian, former the co-CEO of the bond giant, PIMCO.

Mohamed argues that there has been a major loss of liquidity in the financial markets in recent decades that will eventually come home to haunt us all, and sooner than we think.

The result will be a structural increase in market volatility and wild gyrations in the prices of financial assets that will become commonplace.

We have already seen a few of these. Look no further than superstar NVIDIA (NVDA), which announced earnings in line with expectations in November but nevertheless responded with a 50% decline. It was a classic “Buy the rumor, sell the news” type move.

The worst is yet to come.

It is a problem that has been evolving for years.

When I started on Wall Street during the early 1980s, the model was very simple. You had a few big brokers servicing millions of small individual customers at fixed, non-negotiable commissions.

The big houses made so much money they could spend some dough facilitating counter cycle customers trades. This means they would step up to bid in falling markets and make offers in rising ones.

In any case, volatility was so low then that this never cost all that much, except on those rare occasions, such as the 1987 crash (we at Morgan Stanley lost $75 million in a day! Ouch!).

Competitive, meaning falling, commissions rates wiped out this business model. There were no longer profits to subsidize losses on the trading side, so the large firms quit risking their capital to help out customers altogether.

Now you have a larger number of brokers selling to a greatly shrunken number of end buyers, as financial assets in the US have become concentrated at the top.

Assets have also become institutionalized as they are piled into big hedge funds and a handful of very large index mutual funds and ETFs. These assets are managed by people who are also much smarter too.

The small individual investor on which the industry was originally built has almost become an extinct species.

There is no more “dumb money” left in the market, at least until this month.

Now those placing large orders were at the complete mercy of the market, often with egregious results.

Enter volatility. Lot’s of it.

What is particularly disturbing is that the disappearance of liquidity is coming now, just as the 35-year bull market in bonds is ending.

An entire generation of bond fund managers, almost two generations worth, have only seen prices rise, save for the occasional hickey that never lasted for more than a few months. They have no idea how to manage risk on the downside whatsoever.

I am willing to bet money that you or your clients have at least some, if not a lot of your money tied up in precisely these kinds of funds. All I can say is, “Watch out below.”

When the flash fire hits the movie theater, you are unlikely to be the one guy who gets out alive.

You hear a lot about when the Federal Reserve finally gets around to raising interest rates in earnest this year. They say it will make no difference as rates are coming off such a low base.

You know what? It may make a difference, maybe a big one.

This is because it will signify a major trend change, the first one for fixed income in more than three decades. Almost all of these guys really understand are trends and the next one will have a big fat “SELL” pasted on it for the fixed income world.

El-Erian has one of the best 90,000-foot views out there. A US citizen with an Egyptian father, he started out life at the old Salomon Smith Barney in London and went on to spend 15 years at the International Monetary Fund.

He joined PIMCO in 1999 and then moved on to manage the Harvard endowment fund.

He regularly makes the list of the world’s top thinkers. A lightweight Mohamed is not.

His final piece of advice? Engage in “constructive paranoia” and structure your portfolio to take advantage of these changes, rather than fall victim to them.

See the Long Term “Head and Shoulders” Top in the (TLT)?

Apple Seizes Victory from the Jaws of Defeat

Diary, Newsletter, Research, Tech Letter

After an almost 40% swan dive, Apple has found solid footing at these levels for the time being. 40% seems to be the magic number. Declines ALWAYS end at 40% with Apple.

About time!

It’s been an erratic last few months for the company that Steve Jobs built and this last earnings report will go a long way to somewhat stabilize the short-term share price.

The miniscule earnings beat telegraphs to investors that the bad news has been sucked out.

That is what Tim Cook wants the investor community to think.

But is he right?

I would argue that the bad news is over for the short-term but could rear its ugly head again later – it all rides on China’s shoulders.

Let’s take a look at the numbers.

Chinese revenue was down 27% YOY locking in $13.17 billion in quarterly revenue compared to $17.96 billion the prior year.

There is no two ways about this – it’s an awful number and a hurtful manifestation of the Chinese economy decelerating.

The unrelenting pressure of the geopolitical trade war has handcuffed Beijing’s drive to deleverage its balance sheet and steer its economy to a more consumption-supportive model.

China is lamentably back to its traditional ways - the old economy - infusing $2.2 trillion into its balance sheet along with cutting the reserve ratio for state banks hoping to incite economic growth.

Positive short-term catalyst but negative long-term consequences.

This is why I urged Apple lovers to stay away from this stock earlier because of the uncertainty of its current strategic position.

It makes no sense to place an indirect on the current Washington administration navigating a China soft landing.

As it stands, most of Apple’s supply chain is in China and moving it out will be done in piecemeal which is happening behind the scenes and will cause massive job loss in China further hurting the Chinese economy.

The ratcheting up of tensions signals the untenable end of American tech supply chains in China and no new foreign investment will pour into China.

Maybe even never.

I wholeheartedly blame CEO of Apple Tim Cook for not foreseeing this development.

That is what he is paid to do.

Then there is the issue of iPhone sales in China.

Chinese citizens aren’t buying iPhones because of three reasons.

The cohort of wealthy Chinese who can afford a $1,000 iPhone might think twice if they want to be seen outside with a product from a country that is becoming adversarial. Apple has incurred hard-to-quantify brand damage to its once pristine brand in a land that once worshipped the company.

The refresh cycle has elongated because Apple manufactures great smartphones and iPhone holders are waiting it out on the sidelines two or even three iterations down the road to upgrade because that is when they can unearth the relative value of the product.

Lastly, local Chinese smartphone markers have greatly enhanced their products because of a function of time and borrowed Western technology. It is now possible to buy a smartphone that offers around 80% of performance and functionality of an iPhone but for less than half the price.

The customers on the fence who once viewed iPhones as a must-buy are now migrating to the local Chinese competitor because they are a relatively good deal.

I can surmise that these three headwinds are just beginning and will become more entrenched over time.

If the trade war becomes worse, the brand damage will accelerate. iPhones are becoming incrementally better which will delay new iPhone upgrades unless something revolutionary comes out that requires customers to upgrade to be a part of the new technology.

And sadly, Chinese competition is catching up quicker than Apple can innovate and that will not stop.

However, the silver lining is that the worst-case scenario won’t happen in the next quarter and the market won’t get wind of this until the second half of the year.

Instead of a meaningful sell-off because of this earnings report, Cook chose to front-run the weakness by reporting the hideous performance at the beginning of January.

Cook knew he needed to come clean with the negative news and the reformulated projections that were re-laid a few weeks ago were the same ones that Apple barely beat by one cent on the bottom line by posting EPS of $4.18 and marginally on the top line by $420 million.

I am in no way saying that this was a great earnings report – it wasn’t.

Apple mainly delivered on the mediocrity that they discussed a few weeks ago lowering the bar to the point where it would be a failure of epic proportions if Apple couldn’t beat significantly revised down earnings.

Then the outlook for the next quarter wasn’t as bad as people thought, but that doesn’t mean it was good.

When you start playing the game of not as bad as the market thought – it is a slippery slope to head down and halfway to the CEO getting sacked down the road.

I mentioned before that the macro headwinds came 2 years too early for Cook and pegging 60% of company revenue to a smartphone which has trended towards mass commoditization is a bad bet.

Cook has been painstakingly slow rewriting Apple as a service company which is his current get-out-of-jail-free card dangling in front of him like a juicy carrot.

iPhone gross margin is now 34.3% which is lower than the other Apple products whose margins are 38%.

Their flagship product isn’t as profitable on a per-unit basis as it once was highlighting the necessity for refreshing the product lines with not just new iterations but game-changing products.

The type of products that Steve Jobs used to mushroom popularity would suffice.

Gross margins will continue to come down as the smartphone market is saturated and customers won’t buy iPhones now unless they receive a drastic price reduction.

The result is that Apple no longer publishes iPhone unit sales to conceal the worst number for their most important and volume-heavy product.

A little too late if you tell me and irresponsible to investor transparency if you ask me.

Apple Pay, Apple Music, and iCloud storage eclipsed $10.9 billion demonstrating a 19% YOY increase.

This shows that this company still has strengths, but don’t forget that services are still less than 15% of total revenue even though they are the fastest growth part of their portfolio.

Cook isn’t doing enough to supercharge the content and services at Apple.

The top line number was $84.3 billion, a 5% YOY decline in revenue – a YOY decline hasn’t happened in 18 years and this is deeply troublesome.

Let me explain why Cook is the center of the problem.

The underlying issue is Cook doesn’t know what product should be next for Apple.

Apple dabbled with the Apple TV which didn’t pan out.

Then the autonomous vehicle unit just closed down sacking 200 employees.

And the content side of it hasn’t been developed fast enough relative to the slowing down of iPhone sales which is why you can blame Cook for being reactive instead of proactive.

It’s not like he can claim that his head was in the sand and couldn’t take note of what Netflix was doing and had gotten into that original content game sooner.

The hesitation is exactly what worries me with Cook. Cook is a great operations guy and can take an existing product, beef up margins, shave down expenses, streamline execution and boost top and bottom line profits.

Cook is being painfully exposed now that he is out of his comfort zone and must aggressively move in a direction that doesn’t have a red carpet laid out for him.

Even though the pre-earnings red flag raised many questions, Cook only satisfied these red flags on a short-term basis and Apple still needs to reconfigure its product roadmap for the long term.

If Cook plans to milk more out of the iPhone story, Apple becomes a sell the rallies stock, but the market will give the benefit of the doubt to Apple for a quarter or so.

The 800-pound gorilla in the room is the Chinese economy which could go into a hard landing if the stimulus fails to deliver economic respite or if the trade war tensions are exacerbated.

At the bare minimum, the waterfall of downgrades should be over for the time being, but this will come to the fore in a quarter or so when Apple will need to shine light on its plans moving forward.

I wouldn’t bet the ranch on Cook being innovative.

It looks like Apple will start to trade in a range.

It’s hard to believe any bad news superseding what came out at the beginning of this month in the short-term, but at the same time, there are no idiosyncratic catalysts to cause this stock to bullishly break out.

We are at an inflection point in Cook’s career and he is finding out that it's not as easy to be Apple as it used to, and mammoth decisions are on the horizon that must be addressed or possibly become the next IBM.

If you ask me, I’ve been calling on Apple to replace Cook for a while with Jack Dorsey as the signal caller, I still believe this is the only way to stay in the heavyweight division of tech titans five years from now.

Such is the competitive nature of the tech landscape these days.

THE NEXT IBM?

Risk Control for Dummies

Diary, Newsletter, Research

There is a method to my madness, although I understand that some new subscribers may need some convincing.

Whenever I change my positions, the market makes a major move or reaches a key crossroads, I look to stress test my portfolio by inflicting various extreme scenarios upon it and analyzing the outcome.

This is second nature for most hedge fund managers. In fact, the larger ones will use top of the line mainframes powered by $100 million worth of in-house custom programming to produce a real-time snapshot of their thousands of positions in all imaginable scenarios at all times.

If you want to invest with these guys feel free to do so. They require a $10-$25 million initial slug of capital, a one year lock up, charge a fixed management fee of 2% and a performance bonus of 20% or more.

You have to show minimum liquid assets of $2 million and sign 50 pages of disclosure documents. If you have ever sued a previous manager, forget it. The door slams shut. And, oh yes, the best performing funds are closed and have a ten-year waiting list to get in. Unless you are a major pension fund, they don’t want to hear from you.

Individual investors are not so sophisticated, and it clearly shows in their performance, which usually mirrors the indexes less a large haircut. So, I am going to let you in on my own, vastly simplified, dumbed down, seat of the pants, down and dirty style of risk management, scenario analysis, and stress testing that replicates 95% of the results of my vastly more expensive competitors.

There is no management fee, performance bonus, disclosure document, lock up, or upfront cash requirement. There’s just my token $3,000 a year subscription fee and that’s it. And I’m not choosy. I’ll take anyone whose credit card doesn’t get declined.

To make this even easier, you can perform your own analysis in the excel spreadsheet I post every day in the paid-up members section of Global Trading Dispatch. You can just download it and play around with it whenever you want, constructing your own best case and worst-case scenarios. To make this easy, I have posted this spreadsheet on my website for you to download by clicking here.

Since this is a “for dummies” explanation, I’ll keep this as simple as possible. No offense, we all started out as dummies, even me.

I’ll take Mad Hedge Model Trading Portfolio at the close of October 29, the date that the stock market bottomed and when I ramped up to a very aggressive 75% long with no hedges. This was the day when the Dow Average saw a 1,000 point intraday range, margin clerks were running rampant, and brokers were jumping out of windows.

I projected my portfolio returns in three possible scenarios: (1) The market collapses an additional 5% by the November 16 option expiration, some 15 trading days away, falling from $260 to $247, (2) the S&P 500 (SPY) rises 5% from $260 to $273 by November 16, and (3) the S&P 500 trades in a narrow range and remains around the then current level of $260.

Scenario 1 – The S&P 500 Falls 5%

A 5% loss and an average of a 5% decline in all stocks would take the (SPY) down to $247, well below the February $250 low, and off an astonishing 15.70% in one month. Such a cataclysmic move would have taken our year to date down to +11.03%. The (SPY) $150-$160 and (AMZN) $1,550-$1,600 call spreads would be total losses but are partly offset by maximum gains on all remaining positions, including the S&P 500 (SPY), Salesforce (CRM), and the United States US Treasury Bond Fund (TLT). My Puts on the iPath S&P 500 VIX Short Term Futures ETN (VXX) would become worthless.

However, with real interest rates at zero (3.1% ten-year US Treasury yield minis 3.1% inflation rate), the geopolitical front quiet, and my Mad Hedge Market Timing Index at a 30 year low of only 4, I thought there was less than a 1% chance of this happening.

Scenario 2 – S&P 500 rises 5%

The impact of a 5% rise in the market is easy to calculate. All positions expire at their maximum profit point, taking our model trading portfolio up 37.03% for 2018. It would be a monster home run. I would make back a little bit on the (VXX) but not much because of time decay.

Scenario 3 – S&P 500 Remains Unchanged

Again, we do OK, given the circumstances. The year-to-date stands at a still respectable 22.03%. Only the (AMZN) $1,550-$1,600 call spread is a total loss. The (VXX) puts would become nearly a total loss.

As it turned out, Scenario 2 played out and was the way to go. I stopped out of the losing (AMZN) $1,550-$1,600 call spread two days later for only a 1.73% loss, instead of -12.23% in the worst-case scenario. It was a case of $12.23 worth of risk control that only cost me $1.73. I’ll do that all day long, even though it cost me money. When running hedge funds, you are judged on how you manage your losses, not your gains, which are easy.

I took profit on the rest of my positions when they reached 88%-95% of their maximum potential profits and thus cut my risk to zero during these uncertain times. October finished with a gain of +1.24. By the time I liquidated my last position and went 95% cash, I was up 32.95% so far in 2018, against a Dow average that is up 2% on the year. It was a performance for the ages.

Keep in mind that these are only estimates, not guarantees, nor are they set in stone. Future levels of securities, like index ETFs, are easy to estimate. For other positions, it is more of an educated guess. This analysis is only as good as its assumptions. As we used to say in the computer world, garbage in equals garbage out.

Professionals who may want to take this out a few iterations can make further assumptions about market volatility, options implied volatility or the future course of interest rates. And let’s face it, politics was a major influence this year.

Keep the number of positions small to keep your workload under control. Imagine being Goldman Sachs and doing this for several thousand positions a day across all asset classes.

Once you get the hang of this, you can start projecting the effect on your portfolio of all kinds of outlying events. What if a major world leader is assassinated? Piece of cake. How about another 9/11? No problem. Oil at $150 a barrel? That’s a gimme.

What if there is an Israeli attack on Iranian nuclear facilities? That might take you all of two minutes to figure out. The Federal Reserve launches a surprise QE5 out of the blue? I think you already know the answer.

Now that you know how to make money in the options market, thanks to my Trade Alert service, I am going to teach you how to hang on to it.

There is no point in being clever and executing profitable trades only to lose your profits through some simple, careless mistakes.

So I have posted a training video on Risk Management. Note: you have to be logged in to the www.madhedgefundtrader.com website to view it.

The first goal of risk control is to preserve whatever capital you have. I tell people that I am too old to lose all my money and start over again as a junior trader at Morgan Stanley. Therefore, I am pretty careful when it comes to risk control.

The other goal of risk control is the art of managing your portfolio to make sure it is profitable no matter what happens in the marketplace. Ideally, you want to be a winner whether the market moves up, down, or sideways. I do this on a regular basis.

Remember, we are not trying to beat an index here. Our goal is to make absolute returns, or real dollars, at all times, no matter what the market does. You can’t eat relative performance, nor can you use it to pay your bills.

So the second goal of every portfolio manager is to make it bomb proof. You never know when a flock of black swans is going to come out of nowhere, or another geopolitical shock occurs, causing the market crash.

I’ll also show you how to use my Trade Alert service to squeeze every dollar out of your trading.

So, let’s get on with it!

To watch the Introduction to Risk Management, please click here.

Mad Hedge Market Timing Index

Have Bonds Peaked?

Diary, Newsletter, Research

Selling short the US Treasury bond market (TLT) has been one of my core trades for the last 2 ½ years when rates hit a century low at 1.34%.

I call it my “Rich Uncle” trade. Every time bonds rallied five points, I unloaded government debt. If they rallied more, I doubled up. And my new “uncle” reliably wrote me a check every few weeks. As a result, I made money on 22 out of 23 consecutive Trade Alerts on this one asset class.

However, the gravy train may be coming to an end. Over the last week, two eminent authorities on bonds, my once Berkeley economics professor and former Federal Reserve governor Janet Yellen, and Golden Sachs (GS), one of the largest bond traders, have both opined that the yield on the ten-year US Treasury bond peaked last October at 3.25%.

My arguments against them are looking increasingly hollow, peaked, and facile. If bonds don’t resume their downtrend soon, I may have to surrender, run up the white flag, and toss my own 4.0% peak forecast in interest rates into the dustbin of history.

The data is undeniably starting to pile up in favor of Yellen and (GS). After a decade of economic expansion, inflation has absolutely failed to show. Sitting here in Silicon Valley which plans to use new technology to destroy 50 million jobs over the next 20 years, it was always obvious to me that wage gains in this recovery would be nil. Wages don’t rise in that circumstance.

So far, so good.

The China trade war continues to extract its pound of flesh from American business, trashing growth prospects everywhere. The government shutdown is also paring US growth by 0.10% a week. Hardly a day goes by now when another research house doesn’t predict a 2020 recession.

Current Fed governor Jay Powell has acknowledged as much, postponing any further interest rate hikes for the first half of this year.

If we peaked at 3.25% then where is the downside? How about zero, or better yet, negative -0.40%, the yield lows seen in Japan and Germany three years ago? That’s when my pal, hedge fund legend Paul Tudor Jones, started betting the ranch on the short side with European bonds making yet another fortune.

That’s when you’ll be able to refi your home with a 30-year conventional fixed rate loan of 2.0%. This is where home loans were available in Europe at the last lows.

After the traumatic move in yields from 3.25% down to 2.64% and (TLT) prices up from $111 to $124, you’d expect the market to give back half of its gains. That’s where we reassess. If the government shutdown is still on at that point, all bets are off.

The Bear Market in Bonds May Be Over

Here’s the Worst-Case Scenario

Diary, Newsletter, Research

Yesterday, I listed my Five Surprises of 2019 which will play out during the first half of the year prompting stocks to take another run at the highs, and then fail.

What if I’m wrong? I’ve always been a glass half full kind of guy. What if instead, we get the opposite of my five surprises? This is what they would look like. And better yet, this is how financial markets would perform.

*The government shutdown goes on indefinitely throwing the US economy into recession.

*The Chinese trade war escalates, deepening the recession both here and in the Middle Kingdom.

*The House moves to impeach the president, ignoring domestic issues, driven by the younger winners of the last election.

*A hard Brexit goes through completely cutting Britain off from Europe.

*The Mueller investigation concludes that Trump is a Russian agent and is guilty of 20 felonies including capital treason.

*All of the above are HUGELY risk negative and will trigger a MONSTER STOCK SELLOFF.

It’s really difficult to quantify how badly markets will behave given that this scenario amounts to five black swans landing simultaneously. However, we do have a recent benchmark with which to make comparisons, the 2008-2009 stock market crash and great recession. I’ll list off the damage report by asset class. I also include the exchange-traded fund you need to hedge yourself against Armageddon in each asset class.

*Stocks – Depending on how fast the above rolls out, you will see a stock market (SPY) collapse of Biblical proportions. You’ll easily unwind the Trump rally that started at a Dow Average of 18,000, down 25% from the current level, and off a gut-churning 9,000 points or 33% from the September top. The next support below is the 2015 low at 15,500, down 11,500 points, or 43% from the top. By comparison, during the 2008-2009 crash, we fell 52%. Everything falls and there is no safe place to hide. Buy the ProShares UltraShort S&P 500 bear ETF (SDS).

*Bonds – With the ten-year US Treasury yield peaking at 3.25% last summer, a buying panic would spill into the bond market. Inflation is nonexistent, we are running at only a 2.2% YOY rate now, so widespread deflation would rapidly swallow up the entire economy. In that case, all interest rates go to zero very quickly. The Fed cuts rates as fast as it can. Eventually, the ten-year yield drops to -0.40%, the bottom seen in Japanese and German debt three years ago. Buy the 2X short bond ETF (TBT) which will rocket to from $35 to $200.

*Foreign Exchange – With US interest rates going to zero, the US Dollar (UUP) gets the stuffing knocked out of it. The Euro soars from $1.10 to $1.60 last seen in 2010, and the Japanese yen (FXY) revisits Y80. Strong currencies then crush the economies of our largest trading partners. Their governments take their interest rates back to negative numbers to cool their own currencies. Cash becomes trash….globally.

*Commodities

Here’s the really ugly part about commodities. They are only just starting to crawl OUT of a seven-year bear market. To hit them with another price collapse now would devastate the industry. Producer bankruptcies would be widespread. The ags would get especially hard hit as they have already been pummeled by the trade war with China. Midwestern regional banks would get wiped out. Buy the DB Commodity Short ETN (DDP).

*Energy

The price of oil (USO) is also just crawling back from a correction for the ages, down from $77 to $42 a barrel in only three months. Hit the sector with a recession now in the face of global overproduction and the 2009 low of $25 becomes a chip shot, and possibly much lower. Those who chased for yield with energy master limited partnerships will get flushed. Several smaller exploration and production companies will get destroyed. And gasoline drops to $1 a gallon. The Middle East collapses into a geopolitical nightmare and much of Texas files chapter 11. Buy the ProShares UltraShort Bloomberg Crude Oil ETF (SCO).

*Precious metals

Gold (GLD) initially rallies on the flight to safety bid that we have seen since September. However, if things get really bad, EVERYTHING gets sold, even the barbarous relic, as margin clerks are in the driver’s seat. You sell what you can, not what you want to, as liquidity becomes paramount. This is what took the yellow metal down to $900 an ounce in 2009. Buy the DB Gold Short ETN (DGZ).

*Real Estate

Believe it or not, real estate doesn’t do all that bad in a worst-case scenario. It is perhaps the safest asset class around if a new crisis financial unfolds. For a start, interest rates at zero would provide a huge cushion. The Dodd-Frank financial regulation bill successfully prevented lenders returning to even a fraction of the leverage they used in the run-up to the last recession. We are about to enter a major demographic tailwind in housing as the Millennial generation become the predominant home buyers. I’ve never seen a housing slump in the face of a structural shortage. And homebuilder stocks (ITB) have already been discounting the next recession for the past year. A lot is already baked in the price.

Conclusion

Of course, it is highly unlikely that any of the above happens. Think of it all as what Albert Einstein called a “thought experiment.” But it is better to do the thinking now so you can do the trading later. There may not be time to do otherwise.

Be Careful, They Bite!

2019 Annual Asset Class Review: A Global Vision

Diary, Newsletter, Research

I am once again writing this report from a first-class sleeping cabin on Amtrak’s legendary California Zephyr.

By day, I have two comfortable seats facing each other next to a panoramic window. At night, they fold into two bunk beds, a single and a double. There is a shower, but only Houdini could get to navigate it.

I am not Houdini, so I go downstairs to use the larger public hot showers. They are divine.

We are now pulling away from Chicago’s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American exceptionalism.

I am headed for Emeryville, California, just across the bay from San Francisco, some 2,121.6 miles away. That gives me only 56 hours to complete this report.

I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure and to keep me up to date with the onboard gossip.

The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Microsoft’s Spellchecker can catch most of the mistakes, but not all of them.

As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied Internet searches during stops at major stations along the way to Google search obscure data points and download the latest charts.

You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS.

Who knew that 95% of America is off the grid? That explains so much about our country today.

I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone 10x.

After making the rounds with strategists, portfolio managers, and hedge fund traders in the run-up to this trip, I can confirm that 2018 was one of the most brutal to trade for careers lasting 30, 40, or 50 years. This was the year that EVERYTHING went down, the first time that has happened since 1972. Comparisons with 1929, 1987, and 2008 were frequently made.

While my own 23.56% return for last year is the most modest in a decade, it beats the pants off of the Dow Average plunge of 8% and 99.9% of the other managers out there. That is a mere shadow of the spectacular 57.91% profit I took in during 2017. This keeps my ten-year average annualized return at 34.20%.

Our entire fourth-quarter loss came from a single trade, a far too early bet that the Volatility Index would fall from the high of the year at $30.

For a decade, all you had to do was throw a dart at the stock page of the Wall Street Journal and you made money, as long as it didn’t end on retail. No more.

For the first time in years, the passive index funds lost out to the better active managers. The Golden Age of the active manager is over. Most hedge funds did horribly, leveraged long technology stocks and oil and short bonds. None of it worked.

If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:

The Nine Key Variables for 2019

1) Will the Fed raise rates one, two, or three times, or not at all?
2) Will there be a recession this year or will we have to wait for 2020?
3) Is the tax bill fully priced into the economy or is there more stimulus to come?
4) Will the Middle East drag us into a new war?
5) Will technology stocks regain market leadership or will it be replaced by other sectors?
6) Will gold and other commodities finally make a long-awaited comeback?
7) Will rising interest rates (positive) or deficits (negative) drive the US dollar this year?
8) Will oil prices recover in 2019?
9) Will bitcoin ever recover?

Here are your answers to the above: 1) Two, 2) 2020, 3) Yes, 4) No, 5) Both, 6) Yes, 7) Yes, 8) Yes, 9) No.

There you go! That’s all the research you have to do for the coming year. Everything else is a piece of cake. You can go back to your vacation.

The Twelve Highlights of 2018

1) Stocks will finish lower in 2019. However, we aren’t going to collapse from here. We will take one more rush at the all-time highs that will take us up 10% to 15% from current levels, and then fail. That will set up the perfect “head and shoulders” top on the long-term charts that will finally bring to an end this ten-year bull market. This is when you want to sell everything. The May 10, 2019 end to the bull market forecast I made a year ago is looking pretty good.

I think there is a lot to learn from the 1987 example when stocks crashed 20% in a single day, and 42% from their 1987 high, and then rallied for 28 more months until the next S&L crisis-induced recession in 1991.

Investors have just been put through a meat grinder. From here on, its all about trying to get out at a better price, except for the longest-term investors.

2) Stocks will rally from here because they are STILL receiving the greatest amount of stimulus in history. Energy prices have dropped by half, taxes are low, inflation is non-existent, and interest rates are still well below long term averages.

Corporate earnings will grow at a 6% rate, not the 26% we saw in 2018. But growing they are. At current prices, the stock market is assuming that companies will generate big losses in 2019, which they won’t. Just try to find a parking space at a shopping mall anywhere and you’ll see what I mean.

3) Technology stocks will lead any recovery. Love them or hate them, big tech accounts for 25% of stock market capitalization but 50% of US profits. That is where the money is. However, in 2019 they will be joined by biotech and health care companies as market leaders.

4) The next big rally in the market will be triggered by the end of the trade war with China. Don’t expect the US to get much out of the deal. It turns out that the Chinese can handle a 20% plunge in the stock market much better than we can.

5) The Treasury bond market will finally get the next leg down in its new 10-year bear market, but don’t expect Armageddon. The ten-year Treasury yield should hit at least 3.50%, and possibly 4.0%.

6) With slowing, US interest rate rises, the US dollar will have the wind knocked out of it. It’s already begun. The Euro and the Japanese yen will both gain about 10% against the greenback.

7) Political instability is a new unknown factor in making market predictions which most of us have not had to deal with since the Watergate crisis in 1974. It’s hard to imagine the upcoming Mueller Report not generating a large market impact, and presidential tweets are already giving us Dow 1,000-point range days. These are all out of the blue and totally unpredictable.

8) Oil at $42.50 a barrel has also fully discounted a full-on recession. So, if the economic slowdown doesn’t show, we can make it back up to $64 quickly, a 50% gain.

9) Gold continues its slow-motion bull market, gaining another 10% since the August low. It barely delivered in 2018 as a bear market hedge. But once inflation starts to pick up a head of steam, so should the price of the barbarous relic.

10) Commodities had a horrific year, pulled under by the trade war, rising rates, and strong dollar. Reverse all that and they should do better.

11) Residential real estate has been in a bear market since March. You’ll find out for sure if you try to sell your home. Rising interest rates and a slowing economy are not what housing bull markets are made of. However, prices will drop only slightly, like 10%, as there is still a structural shortage of housing in the US.

12) The new tax bill came and went with barely an impact on the economy. At best we got two-quarters of above-average growth and slightly higher capital spending before it returned to a 2%-2.5% mean. Unfortunately, it will cost us $4 trillion in new government debt to achieve this. It was probably the worst value for money spent in American history.

Dow Average 1987-90

The Thumbnail Portfolio

Equities - Go Long. The tenth year of the bull market takes the S&P 500 up 13% from $2,500 to $2,800 during the first half, and then down by more than that in the second half. This sets up the perfect “head and shoulders” top to the entire decade-long move that I have been talking about since the summer.

Technology, Pharmaceuticals, Healthcare, and Biotech will lead on the up moves and now is a great entry point for all of these. Buy low, sell high. Everyone talks about it but few ever actually execute like this.

Bonds - Sell Short. Down for the entire year big time. Sell short every five-point rally in the ten-year Treasury bond. Did I mention that bonds have just had a ten-point rally? That’s why I am doubled up on the short side.

Foreign Currencies - Buy. The US dollar has just ended its five-year bull trend. Any pause in the Fed’s rate rising schedule will send the buck on a swan dive, and it’s looking like we may be about to get a six-month break.

Commodities - Go Long. Global synchronized recovery continues the new bull market.

Precious Metals - Buy. Emerging market central bank demand, accelerating inflation, and a pause in interest rate rises will keep the yellow slowly rising.

Real Estate – Stand Aside. Prices are falling but not enough to make it worth selling your home and buying one back later. A multi-decade demographic tailwind is just starting, and it is just a matter of time before prices come roaring back.

1) The Economy-Slowing

A major $1.5 trillion fiscal stimulus was a terrible idea in the ninth year of an economic recovery with employment at a decade high. Nevertheless, that’s what we got.

The certainty going forward is that the gains provided by lower taxes will be entirely offset by higher interest rates, higher labor costs, and rising commodity and oil prices.

Since most of the benefits accrued to the top 1% of income earners, the proceeds of these breaks entirely ended up share buybacks and the bond market. This is why interest rates are still so incredibly low, even though the Fed has been tightening for 4 ½ years (remember the 2014 taper tantrum?) and raising rates for three years.

And every corporate management views these cuts as temporary so don’t expect any major capital investment or hiring binges based on them.

The trade wars have shifted the global economy from a synchronized recovery to a US only recovery, to a globally-showing one. It turns out that damaging the economies of your biggest economies is bad for your own business. They are also a major weight on US growth. CEOs would rather wait to see how things play out before making ANY long-term decisions.

As a result, I expect real US economic growth will retreat from the 3.0% level of 2018 to a much more modest 1.5%-2.0% range in 2019.

The government shutdown, now in its third week (and second year), will also start to impact 2019 growth estimates. For every two weeks of closure, you can subtract 0.1% in annual growth.

Twenty weeks would cut a full 1%. And if you only have 2% growth to start with that means you don’t have much to throw away until you end up in a full-on recession.

Hyper-accelerating and cross-fertilizing technology will remain a long term and underestimated positive. But you have to live here next to Silicon Valley to realize that.

S&P 500 earnings will grow from the current $170 to $180 at a price earnings multiple at the current 14X, a gain of 6%. Unfortunately, these will start to fade in the second half from the weight of rising interest rates, inflation, and political certainty. Loss of confidence will be a big influence in valuing shares in 2019.

Whatever happened to the $2.5 trillion in offshore funds held by American companies expected to be repatriated back to the US? That was supposed to be a huge market stimulus last year. It’s still sitting out there. It turns out companies still won’t bring the money home even with a lowly 10% tax rate. They’d rather keep it abroad to finance growth there or borrow against it in the US.

Here is the one big impact of the tax bill that everyone is still missing. The 57% of the home-owning population are about to find out how much their loss of local tax deductions and mortgage deductions is going to cost them when they file their 2018 returns in April. They happen to be the country’s biggest spenders. That’s another immeasurable negative for the economy.

Take money out of the pockets of the spenders and give it to the savers and you can’t have anything but a weakening on the economy.

All in all, it will be one of the worst years of the decade for the economy. Maybe that’s what the nightmarish fourth quarter crash was trying to tell us.

A Rocky Mountain Moose Family

2) Equities (SPX), (QQQ), (IWM) (AAPL), (XLF), (BAC)

The final move of a decade long bull market is upon us.

Corporate earnings are at record levels and are climbing at 6% a year. Cash on the balance sheet is at an all-time high as are profit margins. Interest rates are still near historic lows.

Yet, there is not a whiff of inflation anywhere except in now fading home costs and paper asset prices. Almost all other asset classes offer pitiful alternatives.

The golden age of passive index investing is over. This year, portfolio managers are going to have to earn their crust of bread through perfect market timing, sector selection, and individual name-picking. Good luck with that. But then, that’s why you read this newsletter.

I expect an inverse “V”, or Greek lambda type of year. Stocks will rally first, driven by delayed rate rises, a China war settlement, and the end of the government shut down. That will give the Fed the confidence to start raising rates again by mid-year because inflation is finally starting to show. This will deliver another gut-punching market selloff in the second half giving us a negative stock market return for the second year in a row. That hasn’t happened since the Dotcom Bust of 2001-2002.

How much money will I make this year? A lot more than last year’s middling 23.56% because now we have some reliable short selling opportunities for the first time in a decade. Short positions performed dreadfully when global liquidity is expanding. They do much better when it is shrinking, as it is now.

Frozen Headwaters of the Colorado River

3) Bonds (TLT), (TBT), (JNK), (PHB), (HYG), (MUB), (LQD)

Amtrak needs to fill every seat in the dining car to get everyone fed, so you never know who you will share a table with for breakfast, lunch, and dinner.

There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate fleeing Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.

A retired British couple was circumnavigating the entire US in a month on a “See America Pass.” Mennonites returning home by train because their religion forbade automobiles or airplanes.

This year is simply a numbers game for the bond market. The budget deficit should come in at a record $1.2 trillion. The Fed will take out another $600 billion through quantitative tightening. Some $1.8 trillion will be far too much for the bond market to soak up, meaning prices can only fall.

Except that this year is different for the following reasons.

1) The US government is now at war with the world’s largest bond buyer, the Chinese government.

2) A declining US dollar will frighten off foreign buyers to a large degree.

3) The tax cuts have come and gone with no real net benefit to the average American. Probably half of the country saw an actual tax increase from this tax cut, especially me.

All are HUGELY bond negative.

It all adds up to a massive crowding out of individual and corporate borrowers by the federal government, which will be forced to bid up for funds. You are already seeing this in exploding credit spreads. This will be a global problem. There are going to be a heck of a lot of government bonds out there for sale.

That 2.54% yield for the ten-year Treasury bond you saw on your screen in early January? You will laugh at that figure in a year as it hits 3.50% to 4.0%.

Bond investors today get an unbelievably bad deal. If they hang on to the longer maturities, they will get back only 90 cents worth of purchasing power at maturity for every dollar they invest a decade down the road at best.

The only short-term positive for bonds was Fed governor Jay Powell’s statement last week that our central bank will be sensitive to the level of the stock market when considering rate rises. That translates into the reality that rates won’t go up AT ALL as long as markets are in crash mode.

It all means that we are now only two and a half years into a bear market that could last for ten or twenty years.

The IShares 20+ Year Treasury Bond ETF (TLT) trading today at $123 could drop below $100. The 2X ProShares 20+ Short Treasury Bond Fund (TBT) now at $31 is headed for $50 or more.

Junk Bonds (HYG) are already reading the writing on the wall taking a shellacking during the Q4 stock market meltdown. This lackluster return ALWAYS presages an inverted yield curve by a year where short term interest rates are higher than long term ones. This in turn reliably predicts a full-scale recession by 2020 at the latest.

A Visit to the 19th Century

4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)

I have pounded away at you for years that interest rate differentials are far and away the biggest decider of the direction in currencies.

This year will prove that concept once again.

With overnight rates now at 2.50% and ten-year Treasury bonds at 2.54%, the US now has the highest interest rates of any major industrialized economy.

However, pause interest rate rises for six months or a year and the dollar loses its mojo very quickly.

Compounding the problem is that a weak dollar begets selling from foreign investors. They are in a mood to do so anyway, as they see rising political instability in the US a burgeoning threat to the value of the greenback.

So the dollar will turn weak against all major currencies, especially the Japanese yen (FXY), and the Australian (FXA) and Canadian (FXC) dollars.

You can take that to the bank.

5) Commodities (FCX), (VALE), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (PHO), (FIW), (CORN), (WEAT), (SOYB), (JJG)

A global synchronized economic slowdown can mean only one thing and that is sustainably lower commodity prices.

Industrial commodities, like copper, iron ore, performed abysmally in 2018, dope slapped by the twin evils of a strong dollar and the China trade war.

We aren’t returning to the heady days of the last commodity bubble top anytime soon. Investors are already front running that move now.

However, once this sector gets the whiff of a weak dollar or higher inflation, it will take off like a scalded chimp.

Now that their infrastructure is largely built out, the Middle Kingdom will change drivers of its economy. This is world-changing.

The shift will be from foreign exports to domestic consumption. This will be a multi-decade process, and they have $3.1 trillion in foreign exchange reserves to finance it.

It will still demand prodigious amounts of imported commodities but not as much as in the past.

This trend ran head-on into a decade-long expansion of capacity by the commodities industry, delivering the five-year bear market that we are only just crawling out of.

The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE) have all been some of the best-performing assets of 2017.

Snow Angel on the Continental Divide

6) Energy (DIG), (RIG), (USO), (DUG), (DIG), (UNG), (USO), (OXY), (XLE), (X)

If you expect a trade war-induced global economic slowdown, the last thing in the world you want to own is an energy investment.

And so it was in Q4 when the price of oil got hammered doing a swan dive from $68 to $42 a barrel, an incredible 38% hickey.

All eyes will be focused on OPEC production looking for new evidence of quota cheating which is slated to expire at the end of 2018. Their latest production cut looked great on paper but proved awful in practice. Welcome to the Middle East.

The only saving grace is that with crude at these subterranean levels, new investment in fracking production has virtually ceased. No matter, US pipelines are operating at full capacity anyway.

OPEC production versus American frackers will create the constant tension in the marketplace for all of 2019.

My argument in favor of commodities and emerging markets applies to Texas tea as well. A weaker US dollar, trade war end, interest rate halt are all big positives for any oil investment. The cure for low oil prices is low prices.

That makes energy Master Limited Partnerships, now yielding 6-10%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.

The Alerian MLP ETF (AMLP) does this for you in an ETF format.

Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system.

Three Burlington Northern engines are heaving to pull over 100 black, spanking brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.

There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day as he owns the railroad.

We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building.

Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.

As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again. In fact, the coming peak in oil prices may be the last one we ever see. The word is that leasing companies will stop offering five-year leases in five years because cars with internal combustion engines will become worthless in ten.

Add to your long-term portfolio (DIG), ExxonMobile (XOM), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). But date these stocks, don’t marry them.

Skip natural gas (UNG) price plays and only go after volume plays because the discovery of a new 100-year supply from “fracking” and horizontal drilling in shale formations is going to overhang this subsector for a very long time, like the rest of our lives.

It is a basic law of economics that cheaper prices bring greater demand and growing volumes which have to be transported. Any increase in fracking creates more supply of natural gas.

7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)

The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.

On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders.

The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.

In the snow-filled canyons, we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It’s a good omen for the coming year.

We also see countless abandoned 19^th century gold mines and the broken-down wooden trestles leading to them, relics of previous precious metals booms. So, it is timely here to speak about the future of precious metals.

Gold (GLD) lost money in 2018, off 2.4%. More volatile silver (SLV) shed 12%.

This was expected, as non-yielding assets like precious metals do terribly during times of rising interest rates.

In 2019, gold will finally be coming out of a long dark age. As long as the world was clamoring for paper assets like stocks, gold was just another shiny rock. After all, who needs an insurance policy if you are going to live forever?

But the long-term bull case is still there. Gold is not dead; it is just resting.

If you forgot to buy gold at $35, $300, or $800, another entry point here up for those who, so far, have missed the gravy train.

To a certain extent, the belief that high-interest rates are bad for gold is a myth. Wealth creation is a far bigger driver. To see what I mean, take a look at a gold chart for the 1970s when interest rates were rising sharply.

Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.

If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation-adjusted all-time high, or more.

This is why emerging market central banks step in as large buyers every time we probe lower prices. China and India emerged as major buyers of gold in the final quarters of 2018.

They were joined by Russia which was looking for non-dollar investments to dodge US economic and banking sanctions.

That means it’s just a matter of time before gold breaks out to a new multiyear high above $1,300 an ounce. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).

I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV) which I think could rise from the present $14 and hit $50 once more, and eventually $100.

The turbocharger for gold will hit sometime in 2019 with the return of inflation. Hello stagflation, it’s been a long time.

Would You Believe This is a Purple State?

8) Real Estate (ITB), (LEN),

The majestic snow-covered Rocky Mountains are behind me. There is now a paucity of scenery with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write.

My apologies in advance to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.

It is a route long traversed by roving bands of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.

Passing by shantytowns and the forlorn communities of the high desert, I am prompted to comment on the state of the US real estate market.

There is no doubt a long-term bull market in real estate is taking a major break. If you didn’t sell your house by March last year you’re screwed and stuck for the duration.

And you’re doubly screwed if you’re trying to sell your home now during the government shutdown. With the IRS closed, tax return transcripts are unobtainable making any loan approval impossible. And no one at Fannie Mae or Freddie Mac, the ultimate buyers of 70% of US home loans, has answered their phone this year.

The good news is that we will not see a 2008 repeat when home values cratered by 50%-70%. There is just not enough leverage in the system to do any real damage. That has gone elsewhere, like in exchange-traded funds. You can thank Dodd/Frank for that which imposed capital rules so strict that it is almost impossible for banks to commit suicide.

And no matter how dire conditions may appear now, you are not going to see serious damage in a market where there is a generational structural shortage of supply.

We are probably seven years into a 17-year run at the next peak in 2028. What we are suffering now is a brief two-year pause to catch our breath. Those bidding wars were getting tiresome anyway.

There are only three numbers you need to know in the housing market for the next 20 years: there are 80 million baby boomers, 65 million Generation Xers who follow them, and 86 million in the generation after that, the Millennials.

The boomers have been unloading dwellings to the Gen Xers since prices peaked in 2007. But there is not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made. That’s what caused the financial crisis.

If they have prospered, banks won’t lend to them. Brokers used to say that their market was all about “location, location, location.” Now it is “financing, financing, financing.” Imminent deregulation is about to deep-six that problem.

There is a happy ending to this story.

Millennials now aged 23-38 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market.

The Great Millennial Migration to the suburbs has just begun.

As a result, the price of single-family homes should rocket tenfold during the 2020s as they did during the 1970s and the 1990s when similar demographic forces were at play.

This will happen in the context of a coming labor shortfall, soaring wages, and rising standards of living.

Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.

Remember too that, by then, the US will not have built any new houses in large numbers in 12 years.

We are still operating at only a half of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.

That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. And now that it is temporarily a buyer’s market, it is a good time to step in for investment purposes.

You will boast to your grandchildren how little you paid for your house as my grandparents once did to me ($3,000 for a four-bedroom brownstone in Brooklyn in 1922), or I do to my kids ($180,000 for an Upper East Side high rise in 1983).

That means the major homebuilders like Lennar (LEN), Pulte Homes (PHM), and KB Homes (KBH) may finally be a buy on the dip.

Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.

If you borrow at a 4% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house nearly for free.

How hard is that to figure out?

Crossing the Bridge to Home Sweet Home

9) Postscript

We have pulled into the station at Truckee in the midst of a howling blizzard.

My loyal staff has made the ten-mile treck from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.

After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.

Well, that’s all for now. We’ve just passed the Pacific mothball fleet moored near the Benicia Bridge. The pressure increase caused by a 7,200-foot descent from Donner Pass has crushed my water bottle.

The Golden Gate Bridge and the soaring spire of Salesforce Tower are just around the next bend across San Francisco Bay.

A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my MacBook Pro and iPhone X, pick up my various adapters, and pack up.

We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten-mile night hike up Grizzly Peak and still get home in time to watch the ball drop in New York’s Times Square.

I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.

I’ll shoot you a Trade Alert whenever I see a window open at a sweet spot on any of the dozens of trades described above.

Good trading in 2019!

John Thomas
The Mad Hedge Fund Trader

How to Play Apple in 2019

Diary, Newsletter, Research

Not a day goes by when someone doesn’t ask me about what to do about Apple (AAPL).

After all, it is the world largest company. It is the planet’s most widely owned stock. Almost everyone uses their products in some form or another.

So, the widespread interest is totally understandable.

Apple is a company with which I have a very long relationship. During the early 1980s, I was ordered by Morgan Stanley to take Steve Jobs around to the big New York Institutional Investors to pitch a secondary share offer for the sole reason that I was one of three people who worked for the firm who was then from California.

They thought one West Coast hippy would easily get along with another. Boy, were they wrong. It was the worst day of my life. Steve was not a guy who palled around with anyone.

Today, some 200 Apple employees subscribe to the Diary of a Mad Hedge Fund Trader looking to diversify their substantial holdings. Many own Apple stock with an adjusted cost basis of under $5. Suffice it to say, they all drive really nice Priuses.

So I get a lot of information about the firm far above and beyond the normal effluent of the media and stock analysts. That’s why Apple has become a favorite target of my Trade Alerts over the years.

And here is the take: You didn’t want to touch the stock during the last quarter of 2018.

And here’s why. Apple is all about the iPhone which accounts for 75% of its total earnings. The TV, the watch, the car, iPods, the iMac, and Apple pay are all a waste of time and consume far more coverage than they are collectively worth.

The good news is that iPhone sales are subject to a fairly reliable cycle. Apple launches a major new iPhone every other fall. The share price peaks shortly after that. The odd years see minor upgrades, not generational changes.

Just like you see a big pullback in the tide before a tsunami hits, iPhone sales are flattening out. This is because consumers start delaying purchases in expectation of the introduction of the iPhone 7 in September 2016 with far more power, gadgets, and gizmos.

Channel checks, however dubious these may be, are already confirming the slowdown of orders for iPhone-related semiconductors from suppliers you would expect from such a downturn.

So during those in-between years, the stock performance is disappointing. 2018 certainly followed this script with Apple down a horrific 30.13% at the lows. Maybe it’s a coincidence, but that last generation in Apple shares in 2015 brought a decline of, you guessed it, exactly 29.33%.

The coming quarter could bring the opposite.

After March, things will start to get interesting especially post the Q1 earnings report in April. That’s when investors will start to discount the rollout of the next iPhone seven months later.

The last time this happened, in 2018, Apple stock rocketed by $86, or 55.33%. This time, I expect a minimum rally to the old $233 high, a gain of $71, or 43.82%.

After all, I am such a conservative guy with my predictions.

Even at that price, it will still be one of the cheapest stocks in the market on a valuation basis which currently trades at a 14X earnings multiple. The value players will have no choice to join in, if they’re not already there.

But Apple is a much bigger company this time around, and well-established cycles tend to bring in diminishing returns. It’s like watching the declining peaks of a bouncing rubber ball.

The bull case for Apple isn’t dead, it is just resting.

The China business will continue to grow nicely once we get through the current trade war. Their new lease program promises to deliver a faster upgrade cycle that will allow higher premium prices for their products. That will bring larger profits.

Just thought you’d like to know.