Portfolio Update - 08/31/07
By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .
Nothing, with the exception of US treasuries, has escaped the recent market turbulence unfazed. Here’s how various assets and indexes have performed since 7/19/07:
| Asset/Index | |
| GLD | |
| SLV | |
| S&P 500 (VFINX) | |
| NASDAQ 100 (QQQQ) | |
| Emerging Markets (EEM) | |
| Total Global Stock Index (EFA) |
When I suggested we would see gut-wrenching volatility, I didn’t even expect this. I expected 1-2% daily movements, not 2-3%. This market is selling off quicker than I had anticipated which has me worried for individuals who are holding on to traditional asset allocations.
Here is how my performance measured up to the averages on a YTD basis through July:
| PORTFOLIO | |
| Core Portfolio | |
| Focus Portfolio | |
| S&P 500 (VFINX) | |
| NASDAQ 100 (QQQQ) | |
| Benchmark |
On a YTD basis, my performance is still several points below the stock market averages and my benchmark. But I’d like to focus on what has taken place since the market turmoil began. Since the end of the last quarter (6/30/07), the S&P 500 has lost 2.2% while my portfolio has gained just under 1%. While two months is a short time frame, it does suggest that I’ll be able to protect your portfolio during the bear market. As I’ve stated many times before, I believe equity markets will be significantly lower within in the next 12 months than they are today while bond prices are likely to depreciate as well.
The root cause for my losses this month was the performance of our Silver ETF. It lost nearly 8%. The mining shares that I own took an even bigger hit but they are only a small percentage of your total portfolio. Another disappointing development was the hit our foreign bond ETFs took in share price even though their NAV only dipped slightly. (The discount on both foreign Bond ETF’s that we own are at multiple year lows so I’m hoping that investors will be attracted to these funds and they will outperform in the coming months but there is no guarantee this will happen.) Other than the PM exposure in my portfolios, the rest of the positions have made money in the last couple of months.
Despite the recent performance of Silver and the PM mining shares, I’m still bullish on this space and I’ll outline the reasons in the following section.
Just because something is inevitable doesn’t mean it’s imminent
Doug Casey – Casey Research LLC
This quote struck me as over the past 12 plus months, I’ve addressed various inevitabilities and while some have some have come to pass, I’m still waiting patiently for others to take place.
One inevitability is market corrections. Markets do not go up for forever. The jury is still out about whether the next bear market has begun or not. I would estimate that the bear market has begun as the last two rally’s have failed at their 50 day moving average, leadership is in the tank, the US$ is near it’s all-time low and consumer sentiment has taken a sizable hit the last couple of months.
Barry James of James Investment Research agrees:
The economy faces major hurdles. Foreclosures are reaching record levels, and home prices are falling. Home equity loans are drying up and individuals are being pinched. Not only are adjustable rate mortgages rising, the distress is coming home. Credit card delinquencies are up 33%, bankruptcies are up 66% and the second quarter spending results were only up 1%. We haven’t had a consumer led recession in a long time and we may be on the verge.
Even as the Fed Chairman and President seek to reassure the country and the investing public, we think this is more a sign of weakness than having reached the bottom. Our short term indicators have reversed and are negative. Our intermediate term indicators are neutral, but they don’t indicate a buying opportunity. They have done an excellent job of indicating market bottoms and we don’t yet see this indication. Caution continues to be the watchword.
But there are still some indicators that are remaining resiliently bullish or neutral that have given me some doubt about whether the bear market is eminent or just eventual. Market breadth is the primary technical indicator that still remains neutral as the vast majority of my other indicators are now bearish. A couple of trends could emerge that would change my outlook. If the market rallies past its 50 day moving average or if financial, utility and real estate stocks assume a leadership role to the upside, it could lead to a broad based market rally. Financials and REITs have been leading the market down and this trend would likely need to reverse for the market to rally in a significant manner.
I’ve mentioned before that I not optimistic about market breadth’s ability to accurately predict the next bear market. Breadth measures weakness at the margin. In most equity bear markets, the margin consists of assets that are traded on the exchanges (i.e. Tech in 2000). This time around, the margin is in debt/credit/housing and real estate. Debt and houses are not traded on the equity exchanges but stocks correlated with them are and these issues have significantly underperformed the market.
Furthermore, we have entered a globalized market where US securities are considered “safe” and the marginal securities may prove to be “emerging market” shares. In other words, risky, small-cap names in the US are considered safe, large-cap names globally. The research I subscribe to measures breadth in the US equity markets alone and doesn’t account for declining shares in domestic bond markets and non-US equity markets.
I’ve addressed numerous inevitable economic and stock market issues that have come to pass. These include the popping of the Real Estate Bubble, the devaluation of the US$ and the beginnings of the Hedge Fund Scandal.
Another inevitability that has not yet come to pass is the reestablishment of Gold and Silver’s historical negative correlation with equities and positive correlation with other commodities. Since the summer of 2005, Gold has been joined at the hip with the equity markets. Silver has followed suite but has been many times more volatile. This has happened for two reasons:
- There has been an unprecendted amount of global liquidity pumped into financial markets by the world’s central banks which has resulted in the price of everything going up. When liquidity was restricted, the prices of everything came down. Money managers at hedge funds and private equity groups had to scramble to sell whatever liquid investment they could in order to meet margin calls and redemptions which meant selling everything, including precious metals, regardless of fundamentals.
- More recently, there has been a rush to US Treasuries every time equity markets panicked. This has resulted in short-term strength in the US$ (I don’t understand why when the sub prime debt that has been created by US citizens and banks and denominated in US$’s is severely devalued, the world bids our currency stronger.) Furthermore, every stock market pullback shifted sentiment towards economic recession which tempered inflation expectations. Rarely do recession and inflation co-exist, so the market discounts this outcome. Since Gold and Silver are inversely related to the US$ and serve as an inflation hedge, the PMs have sold off right along with equities.
Eventually, the strong positive correlation between equities and PM’s will cease to exist and the two will move independent of one another. But as Mr. Casey says “Just because it’s inevitable doesn’t mean it’s imminent.”
In a recent article written by Doug Casey, he provides four sound reasons for continuing to remain bullish on the PM’s and their mining companies. I’ve covered three of the four reasons on multiple occasions but the fourth reason is something I haven’t touched on and it may be the best of all. He says:
The public is still out of the gold market. I promise you that every market top I’ve witnessed in my life was accompanied by cocktail party chatter about the asset class in question. I have yet to have any indication the public has a clue that gold and other resources even exist. If this is a market top, it’s unique.
I know I’ve heard countless stories about vast fortunes made in real estate deals or hedge fund investments. I’ve had prospective clients of more humble means tell me how their IRA accounts just keep going up and up and they just don’t see how them doing anything different. But whenever people ask me what I’m invested in and I respond with Silver or Sugar or foreign government debt, I get these funny looks – like they have no idea what I’m even talking about. Typically, the conversation ends right there as they aren’t even interested in knowing why Silver could possibly go up several times over. This contrarian indicator has me convinced that we are right where we need to be.
While Mr. Casey’s commentary regarding the consensus opinion of gold and silver has merit, I still like to maintain a firm understanding of the fundamental case for my strategy. The following is an update of inflationary figures that I have been tracking which support the investment in PMs:
- Over the last two months, energy inventories have declined by 24.4M Barrels or close to 4%. Energy imports are down double digits YOY. This is biggest decline for the July-August period in the last several years. (I only have data going back to 2000, so honestly, I don’t know when or if there has ever been a bigger decline in July and Auguest.)
- Food prices, as measured by the CRB Index are up 17% YOY. Wheat saw its biggest one month gain in August since 1975. A billion people in China are eating tasty food for the first time I bet they won’t be able to “stop at just one” Lay’s potato chips either. As the middle class grows in China and other emerging markets, the amount and types of food they consume will change drastically putting significant pressures on the world’s food supplies.
- The CRB Index, whiling pulling back a few points in August, is up 5.8% YOY and 4.7% YTD.
- The US$ is only 1% above its all-time low since the Euro currency was established.
- Governments the world over are furiously pumping liquidity into markets. Central banks injected $300 Billion worth of liquidity into financial markets in just two days. That equates to $50 for every living person on this planet. The median individual in the world doesn’t even make $50/day. To give you a point of reference, the entire US Savings and Loan bailout only cost the US government $125B. Money supply is increasing at double digit rates in nearly every developed country in the world. Monetary inflation always precedes price inflation so we can expect to see continued upward pressure on commodities and finished goods.
Fundamentally, the PM’s are a very sound investment, but from a technical perspective, we are in “no-man’s land” which means that I can not confidently say when the inevitable parabolic rise for the PM’s will take place. In the interim, I’ve attempted to protect us from any precipitous decline in all asset classes due to a liquidity crunch. The next couple of months should provide some level of confirmation about the direction of equity and commodity markets.
As always, please call me if you have any questions or concerns regarding your account.
All the best,
Matt
